UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2004
2005
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ____________________________________ to ____________
________________________
Commission File Number: 001-31458
Newcastle Investment Corp.
(Exact
NEWCASTLE INVESTMENT CORP.
(Exact name of registrant as specified in its charter)
| Maryland | | 81-0559116
(State |
(State or other jurisdiction of (I.R.S.incorporation | | (I.R.S. Employer
incorporation or organization) Identification No.) |
| or organization) | | |
12511345 Avenue of the Americas, New York, NY 10020
(Address | 10105 |
(Address of principal executive offices) (Zip | (Zip Code) |
Registrant's
Registrant’s telephone number, including area code: (212) 798-6100
Securities registered pursuant to Section 12 (b) of the Act:
| Title of each class: | | Name of exchange on which registered:
-------------------- -------------------------------------
|
| Common Stock, $0.01 par value per share | | New York Stock Exchange (NYSE) |
| 9.75% Series B Cumulative Redeemable Preferred Stock, $0.01 par value per share | | New York Stock Exchange (NYSE) |
| 8.05% Series C Cumulative Redeemable Preferred Stock, $0.01 par value per share | | New York Stock Exchange (NYSE) |
Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. xYes o No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes xNo
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X xYes oNo
- ----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant'sregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K -----
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):
Large Accelerated Filer xAccelerated Filer o Non-accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). X (Check One): o Yes xNo
- ----- -----
The aggregate market value of the voting common stock held by non-affiliates as of June 30, 20042005 (computed based on the closing price on such date as reported on the NYSE) was: $1,056.7$1,231.1 million.
Indicate the number of shares outstanding of each of the issuer'sissuer’s classes of common stock, as of the last practicable date.
Common stock, $0.01 par value per share: 43,744,91143,967,409 outstanding as of March 8,
2005.
6, 2006.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the Registrant's definitive proxy statement for the
Registrant's 2005 annual meeting, to be filed within 120 days after
the close of the Registrant's fiscal year, are incorporated by
reference into Part III of this Annual Report on Form 10-K.
| 1. | Portions of the Registrant’s definitive proxy statement for the Registrant’s 2006 annual meeting, to be filed within 120 days after the close of the Registrant’s fiscal year, are incorporated by reference into Part III of this Annual Report on Form 10-K. |
NEWCASTLE INVESTMENT CORP.
FORM 10-K
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Overview
Newcastle Investment Corp. ("Newcastle"(“Newcastle”) is a real estate investment and finance company. We invest in real estate securities, loans and other real estate-relatedestate related assets. We seek to deliver stable dividends and attractive risk-adjusted returns to our stockholders through prudent asset selection, active management and the use of match-fundedmatch funded financing structures, which reduce our interest rate and financing risks. We make money by optimizing our "net“net spread,"” the difference between the yield on our investments and the cost of financing these investments. We emphasize asset quality, diversification, match funded financing and credit risk management.
Our investment activities cover four distinct categories:
| 1) | Real Estate Securities: | We underwrite and acquire a diversified portfolio of moderately credit sensitive real estate securities, including commercial mortgage backed securities (CMBS), senior unsecured REIT debt issued by property REITs, real estate related asset backed securities (ABS) and agency residential mortgage backed securities (RMBS). We generally target investments rated A through BB, except for our agency RMBS which are generally considered AAA rated. As of December 31, 2004,2005, our investments in real estate securities represented 75%80% of our assets. |
| | |
| 2) | Real Estate Related Loans: | We acquire and originate loans to well capitalized real estate operatorsowners with strong track records and compelling business plans, including B-notes, mezzanine loans, bank loans, and real estate loans. As of December 31, 2004,2005, our investments in real estate related loans represented 9% of our assets. |
| | |
| 3) | Residential Mortgage Loans: | We acquire residential mortgage loans, including manufactured housing loans and subprime residential loans, that we believe will produce attractive risk-adjusted returns. As of December 31, 2005, our investments in residential mortgage loans represented 10% of our assets. In addition, we acquired a $1.5 billion portfolio of subprime residential loans subsequent to year end, as described in “Our Investing Activities- Residential Mortgage Loans” below. |
| | |
| 4) | Operating Real Estate: | We acquire direct and indirect interests in operating real estate. As of December 31, 2004,2005, our investments in operating real estate represented 2%1% of our assets.
4) Residential Mortgage Loans: We acquire residential mortgage loans,
including manufactured housing loans, that we
believe will produce attractive risk-adjusted
returns. As of December 31, 2004, our
investments in residential mortgage loans
represented 13% of our assets.
|
In addition, Newcastle had uninvested cash and other miscellaneous net assets which represented less than 1% of our assets at December 31, 2004.
2005.
Underpinning our investment activities is a disciplined approach to acquiring, financing and actively managing our assets. Our principal objective is to acquire a highly diversified portfolio of debt investments secured by real estate that havehas moderate credit risk and sufficient liquidity. Newcastle primarily utilizes a match-fundedmatch funded financing strategy in order to minimize refinancing and interest rate risks. This means that we seek both to match the maturities of our debt obligations with the maturities of our investments, in order to minimize the risk that we have to refinance our liabilities prior to the maturities of our assets, and to match the interest rates on our investments with like-kind debt (i.e. floating or fixed), in order to reduce the impact of changing interest rates on our earnings. Finally, we actively manage credit exposure through portfolio diversification and ongoing asset selection and surveillance. Newcastle, through its manager, has a dedicated team of senior investment professionals experienced in real estate capital markets, structured finance and asset management. We believe that these critical skills position us well not only to make prudent investment decisions but also to monitor and manage the credit profile of our investments.
Newcastle's
Newcastle’s stock is traded on the New York Stock Exchange under the symbol
"NCT"“NCT”. Newcastle is a real estate investment trust for federal income tax purposes and is externally managed and advised by its manager, Fortress Investment Group LLC. Fortress is a global alternative investment and asset management firm with approximately
$12$19 billion of capital under management as of March
8, 2005.6, 2006. Fortress was founded in 1998 and today employs over
280400 people. We believe that our
manager'smanager’s expertise and significant business relationships with participants in the fixed income, structured finance and real estate industries has enhanced our access to investment opportunities which may not be broadly marketed. For its services, our manager receives a management fee and incentive compensation pursuant to a management agreement. Our manager, through its affiliates, and its principals owned
2.82.9 million shares of our common stock and had options to purchase an additional
1.31.2 million shares of our common stock, which were issued in connection with our equity offerings, representing approximately
9.0%9.1% of our common stock on a fully diluted basis, as of March
8,
2005.
1
OUR STRATEGY
Newcastle's6, 2006.
Our Strategy
Newcastle’s investment strategy focuses predominantly on debt investments secured by real estate. We do not have specific policies as to the allocation among type of real estate related assets or investment categories since our investment decisions depend on changing market conditions. Instead, we focus on relative value and in-depth risk/reward analysis with an emphasis on asset quality, liquidity and diversification. Our focus on relative value means that assets which may be unattractive under particular market conditions may, if priced appropriately to compensate for risks such as projected defaults and prepayments, become attractive relative to other available investments. We utilize a match-fundedmatch funded financing strategy and active credit risk management to optimize our returns.
Our investment portfolio had the following characteristics (dollars in thousands):
| | | Total Portfolio (1) | | Core Investment Portfolio (2) | |
| | | December 31, | | December 31, | |
| | | 2005 | | 2004 | | 2005 | | 2004 | |
| Face amount | | $ | 6,111,464 | | $ | 4,493,274 | | $ | 5,413,142 | | $ | 4,294,092 | |
| Percentage of total assets | | | 99 | % | | 91 | % | | 87 | % | | 87 | % |
| Weighted average asset yield | | | 6.59 | % | | 5.91 | % | | 6.85 | % | | 5.98 | % |
| Weighted average liability cost | | | 5.12 | % | | 4.15 | % | | 5.22 | % | | 4.17 | % |
| Weighted average net spread | | | 1.47 | % | | 1.76 | % | | 1.63 | % | | 1.81 | % |
| | | | | | | | | | | | | | |
| (1) | Excluding the ICH loans, as described below. |
| (2) | Excluding the ICH loans and Agency RMBS, as described below. |
Asset Quality and Diversification
As of December 31, 2004,2005, our real estate securities and our real estate related
loans (excluding the ICH loans as described below)core investment portfolio (as defined above) had an overall weighted average credit rating of approximately BBB-BB+, and approximately 70%67% had an investment grade rating (BBB- or higher).
At December 31, 2004,2005, our residential mortgage loan portfolio was characterized by high credit quality borrowers with a weighted average Fair Isaac & Co. Credit ("FICO"(“FICO”) score of 722712 at origination, and had a weighted average loan to value
ratio of 72.5%.origination. As of December 31, 2004,2005, approximately $575.8$282.6 million face amount of our residential mortgage loans were held in securitized form, of which over 95%90% of the principal balance was AAA rated.
Our real estate securities and loan portfolios are diversified by asset type, industry, location and issuer. At December 31, 2004, we2005, our core investment portfolio (as defined above) had 455534 real estate securities and loans, excluding the ICH CMO loans as described below. Ourloans. The largest investment in a real estate security or real estate related loanour core investment portfolio was $86.7$138.8 million and ourits average investment size was $8.1$9.0 million at December 31, 2004.2005. The weighted average credit spread on this portfolio (i.e. the yield premium on our investments over the comparable U.S. Treasury rate or LIBOR) was 2.61% as of December 31, 2005. Furthermore, our real estate securities are supported by pools of underlying loans. For instance, our CMBS investments had 16,341over 21,000 underlying loans at December 31, 2004.2005.
Our residential and manufactured housing loans were well diversified with 919 loans and 7,067 loans, respectively, at December 31, 2005. We expect that this diversification will help to minimize the risk of capital loss, and will also enhance the terms of our financing structures.
Financing Strategy and Match-FundedMatch Funded Discipline
We employ leverage in order to achieve our return objectives. We do not have a predetermined target debt to equity ratio as we believe the appropriate leverage for the particular assets we are financing depends on the credit quality of those assets. As of December 31, 2004,2005, our debt to equity ratio was approximately 5.05.7 to 1. We maintain access to a broad array of capital resources in an effort to insulate our business from potential fluctuations in the availability of capital. We utilize multiple forms of financing including collateralized bond obligations (CBOs), which represent 66%68% of our debt obligations, other securitizations, and term loans, as well as short term financing in the form of repurchase agreements.agreements and our credit facility. Our manager may elect for us to bear a level of refinancing risk on a short term or longer term basis, such as is the case with investments financed with repurchase agreements, when based on all of the relevant factors, bearing such risk is advisable. As of December 31, 2005, approximately 20% of our debt obligations were in the form of repurchase agreements. We utilize leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.
We attempt to reduce interim refinancing risk and to minimize exposure to interest rate fluctuations through the use of match-fundedmatch funded financing structures whereby we seek (i) to match the maturities of our debt obligations with the maturities of our assets and (ii) to match the interest rates on our investments with like-kind debt (i.e.(i.e., floating rate assets are financed with floating rate debt and fixed rate assets are financed with fixed rate debt), directly or through the use of interest rate swaps, caps or other financial instruments, or through a combination of these strategies. This allows us to minimize the risk that we have to refinance our liabilities prior to the maturities of our assets and to reduce the impact of changing interest rates on our earnings. Our real
estate securitiesentire portfolio of assets and real estate related loan portfolio, excluding the ICH CMO
loans as described below, and their respective liabilities had a weighted average lifelives of 5.375.10 years and 5.724.59 years, respectively, as of December 31, 2004.2005. In addition, as of December 31, 2004,2005, a 100 basis point increase in short term interest rates would increasedecrease our earnings by approximately $0.7$0.2 million per annum.
Credit Risk Management
Credit risk refers to each individual
borrower'sborrower’s ability to make required interest and principal payments on the scheduled due dates. We believe, based on our due diligence process, that our investments offer attractive risk-adjusted returns with
long-termlong term principal protection under a variety of default and loss scenarios. We minimize credit risk by actively monitoring our investments and their underlying credit quality and, where appropriate, repositioning our investments to upgrade their credit quality and yield. A significant portion of our investments are financed with collateralized bond obligations, known as CBOs. Our CBO financings offer us structural flexibility to buy and sell certain investments to manage risk and, subject to certain limitations, to optimize returns.
2
Further, the expected yield on our real estate securities, which comprise a significant portion of our assets, is sensitive to the performance of the underlying loans, the first risk of default and loss is borne by the more subordinated securities or other features of the securitization transaction, in the case of commercial mortgage and asset backed securities, and the issuer'sissuer’s underlying equity and subordinated debt, in the case of senior unsecured REIT debt securities.
FORMATION
Formation
We were formed in June 2002 as a subsidiary of Newcastle Investment Holdings Corp. Prior to our initial public offering, Newcastle Investment Holdings contributed to us certain assets and related liabilities in exchange for approximately 16.5 million shares of our common stock. For accounting purposes, this transaction is presented as a reverse spin-off, whereby Newcastle Investment Corp. is treated as the continuing entity and the assets that were retained by Newcastle Investment Holdings and not contributed to us are accounted for as if they were distributed at their historical book basis through a spin-off to Newcastle Investment Holdings. Our operations commenced in July 2002. In May 2003, Newcastle Investment Holdings distributed to its stockholders all of the shares of our common stock that it owned, and it no longer owns any of our common equity.
The following table presents information on shares of our common stock issued since our formation:
| Year | | Shares Issued | | Range of Issue Prices (1) | | Net Proceeds (millions) | |
| Formation | | | 16,488,517 | | | N/A | | | N/A | |
| 2002 | | | 7,000,000 | | $ | 13.00 | | $ | 80.0 | |
| 2003 | | | 7,886,316 | | $ | 20.35-$22.85 | | $ | 163.4 | |
| 2004 | | | 8,484,648 | | $ | 26.30-$31.40 | | $ | 224.3 | |
| 2005 | | | 4,053,928 | | $ | 29.60 | | $ | 108.2 | |
| December 31, 2005 | | | 43,913,409 | | | | | | | |
| | | | | | | | | | | |
Range| (1) | Excludes prices of Issue Net Proceeds
Year Shares Issued Prices (1) (millions)
- ---- ------------- -------------- ------------
Formation 16,488,517 N/A N/A
2002 7,000,000 $13.00 $ 80.0
2003 7,886,316 $20.35-$22.85 $163.4
2004 8,484,648 $26.30-$31.40 $224.3
----------
December 31, 2004 39,859,481
==========
January 2005 3,300,000 $29.60 $ 96.6
shares issued pursuant to the exercise of options and shares issued to Newcastle's independent directors. |
(1) Excludes shares issued pursuant to the exercise of options and shares
issued to our independent directors.
OUR INVESTING ACTIVITIES
Our Investing Activities
Information regarding our business segments is provided in
"Management's“Management’s Discussion and Analysis of Financial Condition and Results of
Operations"Operations” and in Note 3 to our consolidated financial statements which appear in
"Financial“Financial Statements and Supplementary Data.
"
3
”The following is a description of our investments as of December 31, 2004.
REAL ESTATE SECURITIES
2005.
Real Estate Securities
We own a diversified portfolio of moderately credit sensitive real estate securities, which was comprised of the following at December 31,
20042005 (dollars in thousands):
Weighted Average
--------------------------------------
S&P
Current Face Carrying Number of Equivalent Maturity
Asset Type Amount Value Securities Rating Coupon Yield (Years)
- ---------- ------------ ---------- ---------- ---------- ------ ----- --------
CMBS-Conduit $1,024,762 $1,042,460 162 BBB- 6.17% 6.80% 7.53
CMBS-Large Loan 583,758 589,996 68 BBB 5.16% 5.41% 2.35
CMBS-B Note 173,587 173,119 28 BB+ 6.31% 6.58% 6.12
Unsecured REIT Debt 735,402 785,722 90 BBB- 6.51% 6.15% 7.34
ABS-Manufactured
Housing 221,803 199,015 11 B 7.10% 8.83% 5.67
ABS-Home Equity 298,934 300,072 44 A- 4.16% 4.29% 4.06
ABS-Franchise 77,825 77,584 17 BBB+ 7.13% 8.79% 5.25
Agency RMBS 199,182 201,528 3 AAA 4.69% 4.41% 3.35
---------- ---------- --- --- ---- ---- ----
Total/Average $3,315,253 $3,369,496 423 BBB 5.89% 6.19% 5.76
========== ========== === === ==== ==== ====
| | | | | | | | | Weighted Average | |
| Asset Type | | Current Face Amount | | Carrying Value | | Number of Securities | | S&P Equivalent Rating | | Coupon | | Yield | | Maturity (Years) | |
| CMBS-Conduit | | $ | 1,455,345 | | $ | 1,397,329 | | | 197 | | | BBB- | | | 5.84 | % | | 6.61 | % | | 7.87 | |
| CMBS-Large Loan | | | 578,331 | | | 584,163 | | | 61 | | | BBB- | | | 6.64 | % | | 6.75 | % | | 2.10 | |
| CMBS-B Note | | | 180,201 | | | 180,631 | | | 32 | | | BBB- | | | 6.62 | % | | 6.95 | % | | 5.97 | |
| Unsecured REIT Debt | | | 916,262 | | | 942,746 | | | 99 | | | BBB- | | | 6.34 | % | | 5.96 | % | | 6.95 | |
ABS-Manufactured Housing | | | 178,915 | | | 163,066 | | | 10 | | | A- | | | 7.12 | % | | 8.65 | % | | 6.64 | |
| ABS-Home Equity | | | 525,004 | | | 524,477 | | | 89 | | | B | | | 6.03 | % | | 6.10 | % | | 3.16 | |
| ABS-Franchise | | | 70,837 | | | 69,622 | | | 18 | | | BBB+ | | | 6.66 | % | | 8.12 | % | | 5.14 | |
| Agency RMBS | | | 698,322 | | | 692,485 | | | 19 | | | AAA | | | 4.76 | % | | 4.67 | % | | 4.90 | |
| Total/Average | | $ | 4,603,217 | | $ | 4,554,519 | | | 525 | | | BBB+ | | | 5.99 | % | | 6.25 | % | | 5.81 | |
The loans underlying our real estate securities were diversified by industry as follows at December 31, 2004:
2005:
| | | |
| Industry | | % of Face
Industry Amount
- -------- ---------
| |
Residential 26.1%
| | | 40.42 | % |
Retail 22.3%
| | | 21.03 | % |
Office 20.5%
Manufactured Housing 6.7%
| | | 18.73 | % |
Lodging 6.1%
| | | 5.70 | % |
Health Care 5.3%
| | | 4.73 | % |
Industrial 4.6%
| | | 3.63 | % |
Other 8.4%
| | | 5.76 | % |
We enter into
short-termshort term warehouse agreements
pursuant to which we make deposits with major investment banks for the right to purchase commercial mortgage backed securities, unsecured REIT debt, real estate loans and
real estate related asset backed securities for our real estate securities portfolios, prior to their being financed with CBOs. These agreements are treated as non-hedge derivatives for accounting purposes and are therefore marked to market through current income.
IfThe cost to us if the related CBO is not consummated
is limited, except
as a result ofwhere the non-consummation results from our gross negligence, willful misconduct or breach of contract,
we would be required to
paypayment of the Net Loss, if any, as defined, up to the related deposit, less any Excess Carry Amount, as defined, earned on such deposit.
Although we currently anticipate completing the most recent CBOThe income recorded on these agreements was approximately $2.4 million, $3.1 million, and $3.6 million in
the
near term, there is no assurance that such CBO will be consummated or on what
terms it will be consummated. The following table summarizes the agreements (in
thousands):
December 31,2005, 2004 Income Recorded
------------------------------------- ----------------------
Collateral Aggregate Fair
Deal Status Accumulated (1) Deposit Value 2004 2003 2002
- ----------- --------------- --------- ------- ------ ------ ----
Completed $2,604 $3,730 $652
Open $224,928 $24,901 $25,411 510 -- --
-------- ------- ------- ------ ------ ----
Total $3,114 $3,730 $652
====== ====== ====
(1) Excludes $32.5 million of collateral accumulated on balance sheet and
recorded in real estate securities.
4
REAL ESTATE RELATED LOANS
2003, respectively.
Real Estate Related Loans
We directly owned the following real estate related loans at December 31, 20042005 (dollars in thousands):
| Loan Type | | Current Face Amount | | Carrying Value | | Loan Count | | Weighted Avg. Yield | | Weighted Avg. Maturity (Years) | |
| B-Notes | | $ | 72,173 | | $ | 72,520 | | | 13 | | | 8.46 | % | | 2.40 | |
| Mezzanine Loans (1) | | | 302,740 | | | 302,816 | | | 8 | | | 8.44 | % | | 1.94 | |
| Bank Loans | | | 56,274 | | | 56,563 | | | 3 | | | 6.58 | % | | 2.51 | |
| Real Estate Loans | | | 23,082 | | | 22,364 | | | 1 | | | 20.02 | % | | 2.00 | |
| ICH Loans (2) | | | 165,514 | | | 161,288 | | | 96 | | | 8.64 | % | | 1.55 | |
| Total | | $ | 619,783 | | $ | 615,551 | | | 121 | | | 8.74 | % | | 1.94 | |
| | | | | | | | | | | | | | | | | |
Current
Face Carrying Loan Weighted Avg.
Loan Type Amount Value Count Yield
--------- -------- -------- ----- -------------
B-Notes $132,777 $133,344 23 6.44%
Mezzanine Loans 80,000 80,052 4 5.25%
Bank Loans 146,909 146,909 3 6.73%
Real Estate Loans 29,555 28,911 2 16.55%| (1) | One of these loans has a contractual exit fee which Newcastle will begin to accrue if and when management believes it is probable that such exit fee will be received. |
| (2) | In October 2003, pursuant to Financial Accounting Standards Board Interpretation No. 46 “Consolidation of Variable Interest Entities,” we consolidated an entity that holds a portfolio of commercial mortgage loans which has been securitized. This investment, which we refer to as ICH, CMO Loans (1) 205,147 202,674 123 8.16%
-------- -------- --- -----
Total $594,388 $591,890 155 7.44%
======== ======== === ====
was previously treated as a non-consolidated residual interest in such securitization. The primary effect of the consolidation is the requirement that we reflect the gross loan assets and gross bonds payable of this entity on our balance sheet, as well as the related gross interest income and expense in our statement of income. |
(1) In October 2003, pursuant to Financial Accounting Standards Board
Interpretation No. 46 "Consolidation of Variable Interest Entities," we
consolidated an entity that holds a portfolio of commercial mortgage loans
which has been securitized. This investment, which we refer to as the ICH
CMO, was previously treated as a non-consolidated residual interest in such
securitization. We exercise no control over the management or resolution of
these assets and our residual investment in this entity was recorded at
$2.9 million prior to its consolidation. The primary effect of the
consolidation is the requirement that we reflect the gross loan assets and
gross bonds payable of this entity on our balance sheet, as well as the
related gross interest income and expense in our statement of income. The
consolidation did not have any effect on our net basis in the investment or
on our equity and had no material effect on our net income.
We also indirectly owned the following interests in real estate related loans at December 31, 2004:
2005:
In November 2003, we co-invested, on equal terms, in a joint venture alongside an affiliate of our manager which acquired a pool of franchise loans collateralized by fee and leasehold interests and other assets. We, and our manager'smanager’s affiliate, each own an approximately 38% interest in the joint venture. The remaining approximately 24% interest is owned by a third party financial institution. Our investment totaled $23.5$17.8 million at December 31, 20042005 and is reflected as an investment in an unconsolidated subsidiary on our consolidated balance sheet.
Our relative interest in these franchise loans is summarized as
follows:
Current Weighted Weighted
Face Carrying Avg. Avg. Maturity
Amount Value Loan Count Yield (Years)
- ------- -------- ---------- -------- -------------
$36,398 $23,452 115 16.26% 0.64
In November 2004, wefollows (dollars in thousands):Current Face Amount | | Carrying Value | | Loan Count | | Weighted Avg. Yield | |
| $ 28,974 | | $ | 17,802 | | | 91 | | | 16.08 | % |
We have entered into
a total rate of return swaparrangements with a major investment bank
to finance certain loans whereby we receive the sum of all interest,
(at LIBOR + 2.25%), fees and any positive change in value amounts (the total return cash flows) from a
referenced term loan (toreference asset with a
retail mall REIT) with an initialspecified notional amount,
of $107.0 million, and pay interest
(at LIBOR + 0.50%) on such notional
amount plus any negative change in value amounts from such
loan. This agreement isasset. These agreements are recorded in Derivative Assets and treated as
a non-hedge
derivativederivatives for accounting purposes and
isare therefore
markedmark to market through income.
Net interest received is recorded to Interest Income and the mark to market is recorded to Other Income. If we owned the reference assets directly, they would not be marked to market. Under the
agreement,agreements, we
wereare required to post an initial margin deposit
equal to
17% of the notional amountan interest bearing account and additional margin may be payable in the event of a decline in value of the
referenced term
loan.reference asset. Any margin on deposit, less any negative change in value
payments,amounts, will be returned to us upon termination of the contract.
5
OPERATING REAL ESTATE
The following table presents information on these instruments as of December 31, 2005. Reference Asset | | Notional Amount | | Margin Amount | | Receive Interest Rate | | Pay Interest Rate | | Maturity Date | | Fair Value | |
Term loan to a retail mall REIT | | $ | 106,083 | | $ | 18,149 | | | LIBOR + 2.000% | | | LIBOR + 0.500% | | | Nov 2008 | | $ | 1,008 | |
| Term loan to a diversified real estate and finance company | | | 97,997 | | | 19,599 | | | LIBOR + 3.000% | | | LIBOR + 0.625% | | | Feb 2008 | | | 877 | |
| Mezzanine loan to a hotel company | | | 15,000 | | | 5,224 | | | LIBOR +4.985% | | | LIBOR + 1.350% | | | Jun 2007 | | | 101 | |
| Term loan to a diversified real estate company | | | 94,954 | | | 9,495 | | | LIBOR +1.750% | | | LIBOR + 0.500% | | | Aug 2007 | | | 904 | |
| Term loan to a retail company | | | 100,000 | | | 19,960 | | | LIBOR +3.000% | | | LIBOR + 0.500% | | | Dec 2008 | | | 206 | |
| | | $ | 414,034 | | $ | 72,427 | | | | | | | | | | | $ | 3,096 | |
Residential Mortgage Loans
We own portfolios of floating rate residential mortgage loans and manufactured housing loans on properties located in the U.S. The following table sets forth certain information with respect to our residential mortgage loan portfolios at December 31, 2005 (dollars in thousands):
| | Current Face Amount | | Carrying Value | | Loan Count | | Weighted Avg. Yield | | Weighted Avg. Maturity (Years) (1) | |
| Residential loans | | $ | 326,100 | | $ | 333,226 | | | 919 | | | 4.79 | % | | 2.73 | |
| Manufactured housing loans | | | 284,870 | | | 267,456 | | | 7,067 | | | 7.84 | % | | 5.78 | |
| Total | | $ | 610,970 | | $ | 600,682 | | | 7,986 | | | 6.15 | % | | 4.15 | |
| |
| (1) | Weighted average maturity was calculated based on a constant prepayment rate (CPR) of approximately 30% for residential loans and 10% for manufactured housing loans. |
In March 2006, a consolidated subsidiary of ours acquired a portfolio of approximately 11,300 subprime residential mortgage loans for $1.50 billion. The loans, substantially all of which were current at the time of acquisition, are 66% floating rate and 34% fixed rate. Their weighted average coupon is 7.6% and the loans have a weighted average remaining term of 345 months. This acquisition was initially funded with an approximately $1.47 billion repurchase agreement which bears interest at LIBOR + 0.50%. We have entered into an interest rate swap in order to hedge our exposure to the risk of changes in market interest rates with respect to this debt. We expect to finance this investment on a long term basis through the securitization markets in upcoming months.
Operating Real Estate
We own operating real estate located in Canada and in Belgium which is subject, in addition to all risks inherent in real estate investments generally, to fluctuations in foreign currency exchange rates, unexpected changes in regulatory requirements, political and economic instability in certain geographic locations, difficulties in managing international operations, potentially adverse tax consequences, enhanced accounting and control expenses and the burden of complying with a wide variety of foreign laws. A change in foreign currency exchange rates may adversely impact returns on our non-dollar denominated investments. Our only currency exposures are to the Euro and the
Canadian Dollar. Changes in the currency rates can adversely impact the fair values and earnings streams of our international holdings. We generally do not directly hedge our foreign currency risk through the use of derivatives, due to, among other things, REIT qualification issues.
Bell Canada Portfolio. At December 31, 2004, we owned two office properties and
an industrial/distribution property in Canada, of which one office property and
the industrial/distribution property were leased primarily to Bell Canada and
one office property was primarily vacant. We refer to these properties as the
Bell Canada portfolio. In January 2005, we agreed to the terms for a sale of the
vacant property and received a nonrefundable deposit thereon. In March 2005, we
agreed to the terms for a sale of the industrial/distribution property and
received a nonrefundable deposit thereon. The sales are expected to close in the
first half of 2005.
LIV Portfolio. At December 31, 2004, we owned one office property in Belgium,
which is the last remaining property of a portfolio referredwas leased primarily to as the LIV
portfolio. This property is classified as held for sale.
6
Bell Canada.
The following table sets forth certain information with respect to the operating real estate portfolios as of December 31, 2004 (dollars,2005
(dollars, others than per square foot amounts, in thousands):
BELL CANADA PORTFOLIO
| | | | | | | |
Property Address | | City / Submarket | | State/ Province | | Net Rentable Sq Ft | | Year Built/ Renovated | | Use | | | | | | | |
| 100 Dundas St. | | London (Central business district) | | ON | | 323,411 | | 1980 | | Office | | | | | | | |
| |
Tenant | | % of Total Sq Ft Leased | | Tenant Net Rentable Sq Ft | | Lease Start Date | | Lease End Date | | Annual Rent (1) (2) | | Current Rent per Sq Ft (1) | | Annual Real Estate Taxes (1) | | Tenant Credit Rating | |
| Bell Canada - Office | | | 89.89 | % | | 290,706 | | | 03/26/98 | | | 3/31/06 (4 | ) | $ | 1,751 | | $ | 6.02 | | $ | 1,146 | | | A | |
| Bell Canada - Storage | | | 3.99 | % | | 12,890 | | | 03/26/98 | | | 03/31/06 | | | 55 | | | 4.30 | | | | | | A | |
| Bell Canada - Communication | | | 0.52 | % | | 1,686 | | | 03/26/98 | | | 03/31/47 | | | 29 | | | 17.21 | | | | | | A | |
| Mactel | | | 0.16 | % | | 519 | | | 03/01/03 | | | (3) | | | 4 | | | 6.88 | | | | | | | |
| Tony & Fay Gardiner | | | 0.15 | % | | 475 | | | 09/01/02 | | | 08/31/07 | | | 4 | | | 9.04 | | | | | | | |
| O&Y Enterprise Office | | | 0.46 | % | | 1,478 | | | 03/26/98 | | | 03/31/06 | | | 13 | | | 9.04 | | | | | | | |
| COMTECH | | | 0.03 | % | | 96 | | | 01/01/00 | | | (3) | | | 1 | | | 6.88 | | | | | | | |
| Vacant | | | N/A | | | 15,561 | | | N/A | | | N/A | | | N/A | | | N/A | | | | | | | |
| Total | | | 95.20 | % | | 323,411 | | | | | | | | $ | 1,857 | | | | | $ | 1,146 | | | | |
Schedule of Lease Expirations (dollars in thousands):
Year | | Number of Tenant Leases Expiring | | Square Feet of Expiring Leases | | Annual Rent of Expiring Leases (1) | | % of Gross Annual Rent Represented by Expiring Leases | |
| | | | | | | | | | |
| Vacant | | | N/A | | | 15,561 | | | N/A | | | N/A | |
| 2006 (4) | | | 5 | | | 305,689 | | $ | 1,824 | | | 98.2 | % |
| 2007 | | | 1 | | | 475 | | | 4 | | | 0.2 | % |
| 2047 | | | 1 | | | 1,686 | | | 29 | | | 1.6 | % |
| Total | | | 7 | | | 323,411 | | $ | 1,857 | | | 100.0 | % |
| | | | | | | | | | | | | | |
% OF TENANT
NET YEAR TOTAL NET
PROPERTY CITY / STATE/ RENTABLE BUILT/ SQ FT RENTABLE
ADDRESS SUBMARKET | (1) | Monetary amounts are in U.S. dollars based on the December 31, 2005 Canadian dollar exchange rate of 1.1620. |
(2) PROVINCE SQ FT RENOVATED USE TENANT LEASED SQ FT
- -------------- ---------------- -------- --------- --------- ------------ ----------------------- ------ ---------
Etobicoke 1972/
(Toronto)/ Metro expanded
2 Fieldway Rd. West ON 177,214 1978 Office Vacant N/A 177,214
100 Dundas St. London/ CBD ON 325,764 1980 Office | Certain operating expenses are reimbursed by tenants at rates ranging up to 15% above actual cost. |
| (3) | These leases are running month to month. |
| (4) | 184,504 square feet have been released to Bell Canada - Office 89.24% 290,706
Bell Canada - Storage 3.96% 12,890
Bell Canada -
Communication 0.52% 1,686
Mactel 0.85% 2,759
Tony & Fay Gardiner 0.15% 475
O&Y Enterprise Office 0.45% 1,478
COMTECH 0.03% 96
Vacant N/A 15,674
20-40 Norelco
Dr., 83 Signet Toronto/ North 1963/ Industrial/
Dr. York ON 624,786 1971/1979 Distribution Bell Canada - Office 98.48% 615,274
Bell Canada - Cafeteria 0.73% 4,559
Bell Canada - Storage 0.47% 2,960
O & Y Enterprise 0.32% 1,993
--------- ----- ---------
Total 1,127,764 82.90% 1,127,764
========= ===== =========
ANNUAL
REAL
LEASE LEASE ANNUAL CURRENT ESTATE TENANT LEASE
PROPERTY START END RENT RENT PER TAXES CREDIT RENEWAL
ADDRESS DATE DATE (1) (3) SQ FT (1) (1) RATING OPTION
- -------------- -------- -------- ------- --------- ------ ------ -------
2 Fieldway Rd. N/A N/A N/A N/A $ 737
One 5
100 Dundas St. 03/26/98 03/31/06 $1,693 $ 5.82 1,199 A Year
One 5
03/26/98 03/31/06 54 4.16 A Year
03/26/98 03/31/47 28 16.64 A
03/01/03 05/31/05 18 6.66
09/01/02 08/31/07 4 7.90
03/26/98 03/31/06 13 8.74
01/01/00 12/31/05 1 6.66
N/A N/A N/A N/A
20-40 Norelco
Dr., 83 Signet One 5
Dr. 03/26/98 03/31/07 3,583 5.82 965 A Year
03/26/98 03/31/07 38 8.32 A
03/26/98 03/31/07 12 4.16 A
03/26/98 03/31/07 12 5.82
------ ------
Total $5,456 $2,901
====== ======
|
(1) Monetary amounts are in U.S. dollars based on the December 31, 2004
Canadian dollar exchange rate of 1.2019.
(2) CBD means central business district.
(3) Certain operating expenses are reimbursed by tenants at rates ranging up to
15% above actual cost.
LIV PORTFOLIO
% OF TENANT
YEAR TOTAL SQ NET
PROPERTY CITY/ STATE/ NET RENTABLE BUILT/ FT RENTABLE
ADDRESS SUBMARKET PROVINCE SQ FT RENOVATED USE TENANT LEASED SQ FT
- ------------- ---------------- -------- ------------ --------- ------- ------------------- -------- ---------
ALFA:
GOSSETLAAN 54 Groot-Bijgaarden Belgium 81,763 1994 Office
Lucent Technologies 25.51% 20,860
Wella 17.39% 14,219
United Biscuits 13.52% 11,055
Job @ 10.02% 8,191
RCI Benelux 17.58% 14,370
Vacant N/A 13,068
------ ----- ------
Total 81,763 84.02% 81,763
====== ===== ======
ANNUAL
REAL
LEASE LEASE ANNUAL CURRENT ESTATE
PROPERTY START END RENT RENT PER TAXES
ADDRESS DATE DATE (4) SQ FT (4)
- ------------- -------- -------- ------ -------- ------
ALFA:
GOSSETLAAN 54 $71
12/01/98 04/30/11 $ 384 18.39
01/01/99 12/31/07 269 18.90
03/01/99 02/28/08 225 20.33
07/01/00 06/30/09 139 16.94
03/01/04 02/28/13 207 14.42
N/A N/A N/A N/A
------ ---
Total $1,224 $71
====== ===
(4) Monetary amounts are in U.S. dollars based on the December 31, 2004 Euro to
U.S. dollar exchange rate of 0.7378.
7
SCHEDULE OF LEASE EXPIRATIONS (DOLLARS IN THOUSANDS):
BELL CANADA PORTFOLIO
% OF GROSS ANNUAL
NUMBER OF TENANT SQUARE FEET OF ANNUAL RENT OF RENT REPRESENTED
YEAR LEASES EXPIRING EXPIRING LEASES EXPIRING LEASES (1) BY EXPIRING LEASES
- ------ ---------------- --------------- ------------------- ------------------
Vacant N/A 192,888 N/A N/A
2005 2 2,855 $ 19 0.35%for six years commencing in April 2006 3 305,074 1,760 32.25%
2007 5 625,261 3,649 66.88%
2047 1 1,686 28 0.52%
--- --------- ------ ------
Total 11 1,127,764 $5,456 100.00%
=== ========= ====== ======
for $6.02 per square foot per annum, before adjustment for lease incentives, with one five year renewal option.
- ----------
(1) Monetary amounts are in U.S. dollars based on the December 31, 2004
Canadian dollar to U.S. dollar exchange rate of 1.2019.
LIV PORTFOLIO
% OF GROSS ANNUAL
NUMBER OF TENANT SQUARE FEET OF ANNUAL RENT OF RENT REPRESENTED
YEAR LEASES EXPIRING EXPIRING LEASES EXPIRING LEASES (1) BY EXPIRING LEASES
- ------ ---------------- --------------- ------------------- ------------------
Vacant N/A 13,068 N/A N/A
2005 0 -- $ -- --%
2006 0 -- -- --%
2007 1 14,219 269 21.98%
2008 1 11,055 225 18.37%
2009 1 8,191 139 11.34%
2011 1 20,860 384 31.37%
2013 1 14,370 207 16.94%
--- ------ ------ ------
TOTAL 5 81,763 $1,224 100.00%
=== ====== ====== ======
- ----------
(1) Monetary amounts are in U.S. dollars based on the December 31, 2004 Euro to
U.S. dollar exchange rate of 0.7378.
8
We also indirectly owned the following interest in operating real estate at December 31, 2004:
In March 2004, we purchased a 49% interest in a portfolio of convenience and retail gas stores located throughout the southeastern and southwestern regions of the U.S. The properties are subject to a sale-leaseback arrangement under
long-termlong term triple net leases with a 15 year minimum term. Circle K Stores Inc.
("Tenant"(“Tenant”), an indirect wholly owned subsidiary of Alimentation Couche-Tard Inc.
("ACT"(“ACT”), is the counterparty under the leases. ACT guarantees the obligations of Tenant under the leases. We structured this transaction through a joint venture in two limited liability companies with a private investment fund managed by an affiliate of our manager, pursuant to which it co-invested on equal terms.
One company held assets available for sale, the last of which was sold in September 2005, and one holds assets for investment. In October 2004, the
investment'sinvestment’s initial financing was refinanced with a
nonrecoursenon-recourse term loan ($53.0 million outstanding at December 31,
2004)2005), which bears interest at a fixed rate of 6.04%. The required payments under the loan consist of interest only during the first two years, followed by a 25-year amortization schedule with a balloon payment due in October 2014. At December 31,
2004,2005, we had a
$17.8$12.2 million investment in this entity.
RESIDENTIAL MORTGAGE LOANS
We own a portfolio of floating rate residential mortgage loans secured by first
priority liens on properties located in the U.S. The following table sets forth
certain information with respect to our residential mortgage loan portfolio at
December 31, 2004 (dollars in thousands):
Weighted Avg.
Current Weighted Avg. Weighted Avg. Loan to
Face Carrying Weighted Avg. Maturity FICO Score Value
Amount Value Loan Count Yield (Years) (1) at Origination Ratio
- -------- -------- ---------- ------------- ------------- -------------- --------
$645,381 $654,784 1,653 3.71% 3.84 722 72.5%
(1) Weighted average maturity was calculated based on a constant prepayment
rate (CPR) of 22.6%.
In January 2005, we acquired a portfolio of approximately 8,100 manufactured
housing loans for an aggregate purchase price of approximately $308.2 million.
The loans, which were all current at the time of acquisition, are primarily
fixed rate with a weighted average coupon of approximately 9.00%
Our Financing and a weighted
average remaining term of approximately 5.00 years.
OUR FINANCING ACTIVITIES
Hedging Activities
We employ leverage in order to achieve our return objectives. We do not have a predetermined target debt to equity ratio as we believe the appropriate leverage for the particular assets we are financing depends on the credit quality of those assets. As of December 31, 2004,2005, our debt to equity ratio was approximately 5.05.7 to 1. We maintain access to a broad array of capital resources in an effort to insulate our business from potential fluctuations in the availability of capital. We utilize multiple forms of financing including collateralized bond obligations (CBOs), other securitizations, and term loans, as well as short term financing in the form of repurchase agreements.agreements and our credit facility. Our manager may elect for us to bear a level of refinancing risk on a short term or longer term basis, such as is the case with investments financed with repurchase agreements, when, based on all of the relevant factors, bearing such risk is advisable. We utilize leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.
We attempt to reduce interim refinancing risk and to minimize exposure to interest rate fluctuations through the use of match-fundedmatch funded financing structures whereby we seek (i) to match the maturities of our debt obligations with the maturities of our assets and (ii) to match the interest rates on our investments with like-kind debt (i.e.(i.e., floating rate assets are financed with floating rate debt and fixed rate assets are financed with fixed rate debt), directly or through the use of interest rate swaps, caps or other financial instruments, or through a combination of these strategies. This allows us to minimize the risk that we have to refinance our liabilities prior to the maturities of our assets and to reduce the impact of changing interest rates on our earnings.
OUR HEDGING ACTIVITIES
We enter into hedging transactions to protect our positions from interest rate fluctuations and other changes in market conditions. These transactions may include interest rate swaps, the purchase or sale of interest rate collars, caps or floors, options, mortgage derivatives and other hedging instruments. These instruments may be used to hedge as much of the interest rate risk as our manager determines is in the best interest of our stockholders, given the cost of such hedges and the need to maintain our status as a REIT. Our manager elects to have us bear a level of interest rate risk that could otherwise be hedged when our manager believes, based on all relevant facts, that bearing such risks is advisable. We have extensive experience in hedging
real estate positions with these types of instruments. We engage
9
in hedging for the purpose of protecting against interest rate risk and not for the purpose of speculating on changes in interest rates.
Further details regarding our hedging derivativesactivities are presented in "Quantitative“Quantitative and Qualitative Disclosures About Market Risk-Fair Value."
”
Debt Obligations
The following table presents certain summary information regarding our debt obligations and related hedges as of December 31, 20042005 (unaudited) (dollars in thousands):
| Debt Obligation | | Current Face Amount | | Carrying Value | | Weighted Average Funding Cost (1) | | Weighted Average Maturity (Years) | | Face Amount of Floating Rate Debt | | Collateral Carrying Value | | Collateral Weighted Average Maturity (Years) | | Face Amount of Floating Rate Collateral | | Aggregate Notional Amount of Current Hedges | |
| CBO Bonds Payable | | $ | 3,560,953 | | $ | 3,530,384 | | | 5.27 | % | | 6.55 | | $ | 3,275,603 | | $ | 4,002,158 | | | 5.86 | | $ | 1,107,164 | | $ | 1,960,808 | |
| Other Bonds Payable | | | 353,330 | | | 353,330 | | | 5.94 | % | | 0.63 | | | 215,624 | | | 428,744 | | | 4.23 | | | 9,961 | | | 227,576 | |
| Notes Payable | | | 260,441 | | | 260,441 | | | 4.70 | % | | 1.21 | | | 260,441 | | | 288,683 | | | 2.69 | | | 282,589 | | | | |
| Repurchase Agreements | | | 1,048,203 | | | 1,048,203 | | | 4.68 | % | | 0.10 | | | 1,048,203 | | | 1,170,435 | | | 4.29 | | | 341,591 | | | 755,368 | |
| Credit Facility | | | 20,000 | | | 20,000 | | | 6.86 | % | | 2.55 | | | 20,000 | | | — | | | | | | | | | | |
| Total debt obligations | | $ | 5,242,927 | | $ | 5,212,358 | | | 5.17 | % | | 4.59 | | $ | 4,819,871 | | $ | 5,890,020 | | | 5.27 | | $ | 1,741,305 | | $ | 2,943,752 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Aggregate
Collateral Face Notional
Weighted Weighted Face Weighted Amount Amount| (1) | Including the effect of Current Average Average Amount Collateral Average of Floating Currently
Face Carrying Funding Maturity of Floating Carrying Maturity Rate Effective
Debt Obligation Amount Value Cost (1) (Years) Rate Debt Value (Years) Collateral Hedges
- --------------- ---------- ---------- -------- -------- ----------- ---------- ---------- ----------- ----------
CBO Bonds Payable $2,681,395 $2,656,510 4.59% 6.78 $2,409,445 $3,040,236 5.87 $ 933,943 $1,441,932
Other Bonds Payable 222,729 222,266 6.69% 2.53 3,684 259,867 N/A 3,684 --
Notes Payable 652,000 652,000 2.72% 1.93 652,000 717,831 3.40 709,668 --
Repurchase Agreements 490,620 490,620 3.67% 0.21 490,620 583,970 3.80 175,731 312,404
---------- ---------- ---- ---- ---------- ---------- ---------- ----------
Total debt obligations $4,046,744 $4,021,396 4.29% 4.97 $3,555,749 $4,601,904 $1,823,026 $1,754,336
========== ========== ==== ==== ========== ========== ========== ==========
applicable hedges. |
(1) Including the effect of applicable hedges.
Further details regarding our debt obligations are presented in "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
INVESTMENT GUIDELINES
”
Investment Guidelines
Our general investment guidelines, adopted by our board of directors, include:
- no investment is to be made which would cause us to fail to qualify as
a REIT;
- no investment is to be made which would cause us to be regulated as an
investment company;
- no more than 20% of our total equity, determined as of the date of
such investment, is to be invested in any single asset;
- our leverage is not to exceed 90% of the sum of our total debt and our
total equity; and
- we are not to co-invest with the manager or any of its affiliates
unless (i) our co-investment is otherwise in accordance with these
guidelines and (ii) the terms of such co-investment are at least as
favorable to us as to the manager or such affiliate (as applicable)
making such co-investment.
| · | no investment is to be made which would cause us to fail to qualify as a REIT; |
| · | no investment is to be made which would cause us to be regulated as an investment company; |
| · | no more than 20% of our total equity, determined as of the date of such investment, is to be invested in any single asset; |
| · | our leverage is not to exceed 90% of the sum of our total debt and our total equity; and |
| · | we are not to co-invest with the manager or any of its affiliates unless (i) our co-investment is otherwise in accordance with these guidelines and (ii) the terms of such co-investment are at least as favorable to us as to the manager or such affiliate (as applicable) making such co-investment. |
In addition, our manager is required to seek the approval of the independent members of our board of directors before we engage in a material transaction with another entity managed by our manager or any of its affiliates. These investment guidelines may be changed by our board of directors without the approval of our stockholders.
THE MANAGEMENT AGREEMENT
The Management Agreement
We are party to a management agreement with Fortress Investment Group, dated as of June 6, 2002, as amended on March 4, 2003, pursuant to which Fortress Investment Group, our manager, provides for the day-to-day management of our operations.
The management agreement requires our manager to manage our business affairs in conformity with the policies and the investment guidelines that are approved and monitored by our board of directors. Our manager'smanager’s management is under the direction of our board of directors. The manager is responsible for (i) the purchase and sale of real estate securities and other real estate-relatedestate related assets, (ii) the financing of our real estate securities and other real estate-relatedestate related assets, (iii) management of our real estate, including arranging for purchases, sales, leases, maintenance and insurance, (iv) the purchase, sale and servicing of loans for us, and (v) investment advisory services. Our manager is responsible for our day-to-day operations and performs (or causes to be performed) such services and activities relating to our assets and operations as may be appropriate.
We pay our manager an annual management fee equal to 1.5% of our gross equity, as defined in the agreement. The management agreement provides that we will reimburse our manager for various expenses incurred by our manager or its officers, employees and agents on our behalf, including costs of legal, accounting, tax, auditing, administrative and other similar services rendered for us by providers retained by our manager or, if provided by our
manager'smanager’s employees, in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an
arm's-lengtharm’s-length basis.
10
To provide an incentive for our manager to enhance the value of our common stock, our manager is entitled to receive an incentive return (the "Incentive
Compensation"“Incentive Compensation”) on a cumulative, but not compounding, basis in an amount equal to the product of (A) 25% of the dollar amount by which (1) (a) our funds from operations, as defined (before the Incentive Compensation) per share of common stock (based on the weighted average number of shares of common stock outstanding) plus (b) gains (or losses) from debt restructuring and from sales of property and other assets per share of common stock (based on the weighted average number of shares of common stock outstanding), exceed (2) an amount equal to (a) the weighted average of the price per share of common stock in our initial public offering and the value attributed to the net assets transferred to us by Newcastle Investment Holdings, and in any of our subsequent offerings (adjusted for prior capital dividends or capital distributions) multiplied by (b) a simple interest rate of 10% per annum (divided by four to adjust for quarterly calculations) multiplied by (B) the weighted average number of shares of common stock outstanding.
The management agreement provides for automatic one-year extensions from and
after June 6, 2003.one year extensions. Our independent directors review our manager'smanager’s performance annually and the management agreement may be terminated annually upon the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of a majority of the outstanding shares of our common stock, based upon unsatisfactory performance that is materially detrimental to us or a determination by our independent directors that the management fee earned by our manager is not fair, subject to our manager'smanager’s right to prevent such a management fee compensation termination by accepting a mutually acceptable reduction of fees. Our manager will be provided with 60 days'days’ prior notice of any such termination and will be paid a termination fee equal to the amount of the management fee earned by our manager during the twelve-monthtwelve month period preceding such termination which may make it more difficult for us to terminate the management agreement. Following any termination of the management agreement, we shall be entitled to purchase our manager'smanager’s right to receive the Incentive Compensation at a price determined as if our assets were sold for cash at their then current fair market value (as determined by an appraisal, taking into account, among other things, the expected future value of the underlying investments) or otherwise we may continue to pay the Incentive Compensation to our manager. In addition, if we do not purchase our manager'smanager’s Incentive Compensation, our manager may require us to purchase the same at the price discussed above. In addition, the management agreement may be terminated by us at any time for cause.
The principals of our manager includeare Messrs. Wesley R. Edens, Peter L. Briger, Jr., Robert I. Kauffman, Randal A. Nardone and Michael E. Novogratz.
POLICIES WITH RESPECT TO CERTAIN OTHER ACTIVITIES
Policies With Respect to Certain Other Activities
We have authority to offer our common stock or other equity or debt securities in exchange for property and to repurchase or otherwise reacquire our shares or any other securities and may engage in such activities in the future.
We also may make loans to, or provide guarantees of, our subsidiaries. Although we have no current intentions of doing so, we may repurchase or otherwise reacquire our shares or other securities.
Subject to the percentage ownership and gross income and asset tests necessary for REIT qualification, we may invest in securities of other REITs, other entities engaged in real estate activities or securities of other issuers, including for the purpose of exercising control over such entities.
We may engage in the purchase and sale of investments. We do not underwrite the securities of other issuers.
Our officers and directors may change any of these policies without a vote of our stockholders.
In the event that we determine to raise additional equity capital, our board of directors has the authority, without stockholder approval, to issue additional common stock or preferred stock in any manner and on such terms and for such consideration it deems appropriate, including in exchange for property.
Decisions regarding the form and other characteristics of the financing for our investments are made by our manager subject to the general investment guidelines adopted by our board of directors.
We have financed our assets with the net proceeds of our initial public offering, follow-on offerings, the issuance of preferred stock,
long-termlong term secured borrowings and
short-termshort term borrowings under repurchase
agreements.agreements and our credit facility. In the future, operations may be financed by future offerings of equity securities, as well as
short-termshort term and
long-termlong term unsecured and secured borrowings. We expect that, in general, we will employ leverage consistent with the type of assets acquired and the desired level of risk in various investment environments. Our governing documents do not explicitly limit the amount of leverage that we may employ. Instead, the general investment guidelines adopted by our board of directors limits total leverage to a maximum 9.0 to 1 debt to equity ratio. At December 31,
2005, 2004
2003 and
2002,2003, our debt to equity ratio was approximately
5.7 to 1, 5.0 to 1
5.4 to 1 and
4.35.4 to 1, respectively. Our policy relating to the maximum leverage we may utilize may be changed by our board of directors at any time in the future.
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COMPETITION
Competition
We are subject to significant competition in seeking investments. We compete with several other companies for investments, including other REITs, insurance companies and other investors. Some of our competitors have greater resources than we do and we may not be able to compete successfully for investments.
COMPLIANCE WITH APPLICABLE ENVIRONMENTAL LAWS
Compliance with Applicable Environmental Laws
Properties we own or may acquire are or would be subject to various foreign, federal, state and local environmental laws, ordinances and regulations. Under these laws, ordinances and regulations, a current or previous owner of real estate (including, in certain circumstances, a secured lender that succeeds to ownership or control of a property) may become liable for the costs of removal or remediation of certain hazardous or toxic substances or petroleum product releases at, on, under or in its property. These laws typically impose cleanup responsibility and liability without regard to whether the owner or control party knew of or was responsible for the release or presence of the hazardous or toxic substances. The costs of investigation, remediation or removal of these substances may be substantial and could exceed the value of the property. An owner or control party of a site may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site. Certain environmental laws also impose liability in connection with the handling of or exposure to asbestos-containing materials, pursuant to which third parties may seek recovery from owners of real properties for personal injuries associated with asbestos-containing materials. Our operating costs and values of these assets may be adversely affected by the obligation to pay for the cost of complying with existing environmental laws, ordinances and regulations, as well as the cost of complying with future legislation, and our income and ability to make distributions to our stockholders could be affected adversely by the existence of an environmental liability with respect to our properties. We endeavor to ensure that properties we own or acquire will be in compliance in all material respects with all foreign, federal, state and local laws, ordinances and regulations regarding hazardous or toxic substances or petroleum products.
EMPLOYEES
Employees
We are party to a management agreement with Fortress Investment Group LLC pursuant to which they advise us regarding investments, risk management, and other aspects of our business, and manage our day-to-day operations. As a result, we have no employees. From time to time, certain of our officers may enter into written agreements with us that memorialize the provision of certain services; these agreements do not provide for the payment of any cash compensation to such officers from us. The employees of Fortress Investment Group LLC are not a party to any collective bargaining agreement.
CORPORATE GOVERNANCE AND INTERNET ADDRESS
Corporate Governance and Internet Address
We emphasize the importance of professional business conduct and ethics through our corporate governance initiatives. Our board of directors consists of a majority of independent directors; the audit, nominating and corporate governance, and compensation committees of our board of directors are composed exclusively of independent directors. We have adopted corporate governance guidelines, and our manager has adopted a code of business conduct and ethics, which delineate our standards for our officers and directors, and employees of our manager.
Our internet address is http://www.newcastleinv.com. We make available, free of charge through a link on our site, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports, if any, as filed with the SEC as soon as reasonably practicable after such filing.
Our site also contains our code of business conduct and ethics, senior officer code of ethics, corporate governance guidelines, and the charters of the audit committee, nominating and corporate governance committee and compensation committee of our board of directors.
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CAUTIONARY STATEMENTS
This report contains certain "forward-looking statements"“forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments, the stability of our earnings, and our financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology such as "may," "will,"
"should," "potential," "intend," "expect," "endeavor," "seek," "anticipate,"
"estimate," "overestimate," "underestimate," "believe," "could," "project,"
"predict," "continue"“may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from forecasted results. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to, our ability to take advantage of opportunities in additional asset classes at attractive risk-adjusted prices, our ability to deploy capital accretively, the relationship between yields on assets which are paid off and yields on assets in which such monies can be reinvested, the relative spreads between the yield on the assets we invest in and the cost of financing, changes in economic conditions generally and the real estate and bond markets specifically; adverse changes in the financing markets we access affecting our ability to finance our real estate securities portfolios in general or particular real estate related assets, or in a manner that maintains our historic net spreads; changes in interest rates and/or credit spreads, as well as the success of our hedging strategy in relation to such changes; the quality and size of the investment pipeline and the rate at which we can invest our cash, including cash obtained in connection
with CBO financings;inside our CBOs; impairments in the value of the collateral underlying our real estate securities, real estate related loans and residential mortgage loans;loans and the relation of any such impairments in the value of our real estate
securities portfolio, loans or operating real estate to our judgments as to whether changes in the market value of our securities, loans or real estate are temporary or not and whether circumstances bearing on the value of our loans or operating real estatesuch assets warrant changes in carrying values; changes in the markets; legislative/regulatory changes; completion of pending investments; the availability and cost of capital for future investments; competition within the finance and real estate industries; and other risks detailed from time to time below and in our other SEC reports.
Risks relating to our management, business and company include, specifically:
Risks Relating to ourOur Management
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We are dependent on our manager and may not find a suitable replacement if our manager terminates the management agreement.
We have no paid employees. Our officers are employees of our manager. We have no separate facilities and are completely reliant on our manager, which has significant discretion as to the implementation of our operating policies and strategies. We are subject to the risk that our manager will terminate the management agreement and that no suitable replacement will be found to manage us. Furthermore, we are dependent on the services of certain key employees of our manager whose continued service is not guaranteed, and the loss of such services could temporarily adversely affect our operations.
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There are conflicts of interest in our relationship with our manager.
Our chairman and chief executive officer and each of our executive officers also serve as officers of our manager. As a result, our management agreement with our manager was not negotiated at arm's-length and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party.
There are conflicts of interest inherent in our relationship with our manager insofar as our manager and its affiliates manage and invest in other pooled investment vehicles (investment funds, private investment funds, or businesses) that invest in real estate securities, real estate related loans and operating real estate.
- estate and whose investment objectives overlap with our investment objectives. Certain investments appropriate for Newcastle may also be appropriate for one or more of these other investment vehicles. Members of our board of directors and employees of our manager who are our officers may serve as officers and/or directors of these other entities. In addition, our manager or its affiliates may have investments in and/or earn fees from such other investment vehicles which are larger than their economic interests in Newcastle and which may therefore create an incentive to allocate investments to such other investment vehicles. Our manager or its affiliates may determine, in their discretion, to make a particular investment through another investment vehicle rather than through Newcastle. It is possible that we may not be given the opportunity to participate at all in certain investments made by our affiliates that meet our investment objectives.
Our management agreement with our manager generally does not limit or restrict our manager or its affiliates from engaging in any business or managing other pooled investment vehicles that invest in investments that meet our investment objectives, except that under our management agreement neither our manager nor any entity controlled by or under common control with our manager is permitted to raise or sponsor any new pooled investment vehicle whose investment policies, guidelines or plan targets as its primary investment category investment in United States dollar-denominated credit sensitive real estate related securities reflecting primarily United States loans or assets. Our manager intends to engage in additional real estate related management and investment opportunities in the future which may compete with us for investments.
The ability of our manager and its officers and employees to engage in other business activities, subject to the terms of our management agreement with our manager, may reduce the time our manager spends managing Newcastle. In addition, we may engage in material transactions with our manager or another entity managed by our manager or one of its affiliates, including certain co-investments which present a conflict of interest, subject to our investment guidelines.
The management compensation structure that we have agreed to with our manager may cause our manager to invest in high risk investments. In addition to its management fee, our manager is entitled to receive incentive compensation based in part upon our achievement of targeted levels of funds from operations. In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on funds from operations may lead our manager to place undue emphasis on the maximization of funds from operations at the expense of other criteria, such as preservation of capital, in order to achieve higher incentive compensation. Investments with higher yield potential are generally riskier or more speculative. This could result in increased risk to the value of our investment portfolio.
Termination of the management agreement with our manager is difficult and costly. The management agreement may only be terminated annually upon the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of a majority of the outstanding shares of our common stock, based upon (1) unsatisfactory performance by our manager that is materially detrimental to us or (2) a determination that the management fee payable to our manager is not fair, subject to our manager's right to prevent such a compensation termination by accepting a mutually acceptable reduction of fees. Our manager will be provided 60 days' prior notice of any termination and will be paid a termination fee equal to the amount of the management fee earned by the manager during the twelve-month period preceding such termination. In addition, following any termination of the management agreement, the manager may require us to purchase its right to receive incentive compensation at a price determined as if our assets were sold for their fair market value (as determined by an appraisal, taking into account, among other things, the expected future value of the underlying investments) or otherwise we may continue to pay the incentive compensation to our manager. These provisions may increase the effective cost to us of terminating the management agreement, thereby adversely affecting our ability to terminate our manager without cause.
Our directors have approved very broad investment guidelines for our manager and do not approve individualeach investment or financing
decisionsdecision made by our manager.
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Our manager is authorized to follow very broad investment guidelines. Our directors periodically review our investment guidelines and our investment portfolio. However, our board does not review each proposed investment. In addition, in conducting periodic reviews, the directors rely primarily on information provided to them by our manager. Furthermore, transactions entered into by our manager may be difficult or impossible to unwind by the time they are reviewed by the directors. Our manager has great latitude within the broad investment guidelines in determining the types of assets it may decide are proper investments for us.
We may change our investment strategy without stockholder consent which may result in our holdingriskier investments that are riskier than our current investments.
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Decisions to make investments in entirely new asset categories present risks which may be difficult for us to adequately assess and could therefore reduce the stability of our dividends or have adverse effects on our financial condition. A change in our investment strategy may increase our exposure to interest rate and real estate market fluctuations.
Our investment strategy may evolve, in light of existing market conditions and investment opportunities, to continue to take advantage of opportunistic investments in real estate-relatedestate related assets, which may involve additional risks depending upon the nature of such assets and our ability to finance such assets on a short or long term basis. Investment opportunities that present unattractive risk-return profiles relative to other available investment opportunities under particular market conditions may become relatively attractive under changed market conditions and changes in market conditions may therefore result in changes in the investments we target. Our failure to accurately assess the risks inherent in new asset categories or the financing risks associated with such assets could adversely affect our results of operations and our financial condition.
Risks Relating to ourOur Business
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We are subject to significant competition and we may not compete successfully.
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We are subject to significant competition in seeking investments. We compete with other companies, including other REITs, insurance companies and other investors, including funds and companies affiliated with our manager. Some of our competitors have greater resources than us and we may not be able to compete successfully for investments.
Furthermore, competition for investments of the type to be made by us may lead to the returns available from such investments decreasing which may further limit our ability to generate our desired returns. We cannot assure you that other companies will not be formed that compete with us for investments or otherwise pursue investment strategies similar to ours.
Our determination of how much leverage to apply to our investments may adversely affect our return on our investments and may reduce cash available for distribution.
We leverage our portfolio through borrowings, generally through the use of credit facilities, warehouse facilities, repurchase agreements, mortgage loans on real estate, securitizations, including the issuance of CBOs, private or public offerings of debt by subsidiaries, loans to entities in which we hold, directly or indirectly, interests in pools of properties or loans, and other borrowings. Our investment policies do not limit the amount of leverage we may incur with respect to any specific asset or pool of assets, subject to an overall limit on our use of leverage to 90% of the value of our assets on an aggregate basis. Our return on our investments and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions cause the cost of our financing to increase relative to the income that can be derived from the assets acquired.
We finance certain of our investments with debt (e.g., repurchase agreements) that is subject to margin calls based on a decrease in the value of such investments, which could adversely impact our liquidity and, as a result of the need to post greater margin with respect to existing investments, our return on equity. If we do not have the funds available to or choose not to satisfy any such margin calls, we could be forced to sell the investments at a loss.
The loans we invest in and the loans underlying the securities and total rate of return swaps we invest in are subject to delinquency, foreclosure and loss, which could result in losses to us.
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Commercial mortgage loans are secured by multifamily or commercial property and are subject to risks of delinquency and foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower's ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other things: tenant mix, success of tenant businesses, property management decisions, property location and condition, competition from comparable types of properties, changes in laws that increase operating expense or limit rents that may be charged, any need to address environmental contamination at the property, the occurrence of any uninsured casualty at the property, changes in national, regional or local economic conditions and/or specific industry segments, declines in regional or local real estate values, declines in regional or local rental or occupancy rates, increases in interest rates, real estate tax rates and other operating expenses, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest and civil disturbances.
Residential mortgage loans and subprime mortgage loans are secured by single-family residential property and are subject to risks of delinquency and foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by a residential property is dependent upon the income or assets of the borrower. A number of factors may impair borrowers' abilities to repay their loans.
In the event of any default under a loan held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the loan, which could adversely affect our cash flow from operations. Foreclosure of a loan can be an expensive and lengthy process which could negatively affect our anticipated return on the foreclosed loan.
Mortgage and asset backed securities are bonds or notes backed by loans and/or other financial assets and include commercial mortgage back securities (CMBS), agency residential mortgage backed securities (RMBS), and real estate related asset backed securities (ABS). The ability of a borrower to repay these loans or other financial assets is dependant upon the income or assets of these borrowers. While we intend to focus on real estate related asset backed securities, there can be no assurance that we will not invest in other types of asset backed securities.
Our investments in mortgage and asset backed securities will also be adversely affected by defaults under the loans underlying such securities. To the extent losses are realized on the loans underlying the securities in which we invest, the company may not recover the amount invested in, or, in extreme cases, any of our investment in, such securities.
Subprime mortgage loans are generally loans to credit impaired borrowers and borrowers that are ineligible to qualify for loans from conventional mortgage sources due to loan size, credit characteristics or documentation standards. Loans to lower credit grade borrowers generally experience higher-than-average default and loss rates than do conforming mortgage loans. Material differences in the defaults, loss severities and/or prepayments on the subprime mortgage loans we acquire (or on the manufactured housing loans we acquire) from what we estimate in connection with our underwriting of the acquisition of such loans would cause reductions in our income and adversely affect our operating results, both with respect to unsecuritized loans and loans that we have securitized or otherwise financed on a long term match funded basis. We cannot assure you that our underwriting criteria will afford adequate protection against the higher risks associated with loans made to lower credit grade borrowers. If we underestimate the extent of losses that our loans will incur, then our business, financial condition, liquidity and results of operations will be adversely impacted.
Although we seek to match fund our investments to limit refinance risk and lock in net spreads, we do not employ this strategy with respect to certain of our investments, which increases the risks related to refinancing these investments.
A key to our investment strategy is to finance our investments using match funded financing structures, which match assets and liabilities with respect to maturities and interest rates. This limits our refinance risk, including the risk of being able to refinance an investment or refinance on favorable terms. We generally use match funded financing structures, such as CBOs, to finance our investments in real estate securities and loans. However, our manager may elect for us to bear a level of refinancing risk on a short term or longer term basis, such as is the case with investments financed with repurchase agreements, when, based on all of the relevant factors, bearing such risk is advisable. This is generally the case with respect to the residential mortgage loans and agency RMBS we invest in. The decision not to match fund certain investments exposes us to additional refinancing risks that may not apply to our other investments.
In addition, we anticipate that, in most cases, for any period during which our floating rate assets are not match funded with respect to maturity, the income from such assets may respond more slowly to interest rate fluctuations than the cost of our borrowings. Because of this dynamic, interest income from such investments may rise more slowly than the related interest expense, with a consequent decrease in our net income. Interest rate fluctuations resulting in our interest expense exceeding interest income would result in operating losses for us from these investments.
Accordingly, if we do not or are unable to match fund our investments with respect to maturities and interest rates, we will be exposed to the risk that we may not be able to finance or refinance our investments on economically favorable terms or may have to liquidate assets at a loss.
We may not be able to finance our investments on a long term basis on attractive terms, including by means of securitization, which may require us to seek more costly financing for our investments or to liquidate assets.
When financing our investments through CBOs, we accumulate securities through an arrangement in which a third party provides short term financing pending the issuance of the CBO bonds and we make a cash deposit with such third party. Under such arrangement, if the CBO financing were not consummated, we would be required to either purchase the securities and obtain other more expensive financing for such purchase, or pay the third party the lesser of the difference between the price it paid for the securities and the price at which it sold such securities, or our deposit.
Where we acquire a loan portfolio which we finance on a short term basis with a view to securitization or other long term financing, we bear the risk of being unable to securitize the loans or otherwise finance them on a long term basis at attractive prices or in a timely matter, or at all. If it is not possible or economical for us to securitize or otherwise finance such loans on a long term basis, we may be unable to pay down our short term credit facilities, or be required to liquidate the loans at a loss in order to do so.
Both during the ramp up phase of a potential CBO financing and following the closing of a CBO financing when we have locked in the liability costs for a CBO, the rate at which we are able to acquire eligible investments and changes in market conditions may adversely affect our anticipated returns.
We acquire real estate securities and loans and finance them on a long term basis, typically through the issuance of collateralized bond obligations. We use short term warehouse lines of credit to finance the acquisition of real estate securities and loans until a sufficient quantity of securities and loans is accumulated, at which time we may refinance these lines through a securitization, such as a CBO financing, or other long term financing. As a result, we are subject to the risk that we will not be able to acquire, during the period that our warehouse facility is available, a sufficient amount of eligible securities to maximize the efficiency of a collateralized bond obligation financing. In addition, conditions in the capital markets may make the issuance of a collateralized bond obligation less attractive to us when we do have a sufficient pool of collateral. If we are unable to issue a collateralized bond obligation to finance these assets, we may be required to seek other forms of potentially less attractive financing or otherwise to liquidate the assets.
In addition, following each CBO financing we must invest the net cash raised in the financing. Until we are able to acquire sufficient securities, our returns will reflect income earned on uninvested cash and, having locked in the cost of liabilities for the particular CBO, the particular CBO’s returns will be at risk of declining to the extent that yields on the securities to be acquired decline.
In general, our ability to acquire appropriate investments depends upon the supply in the market of investments we deem suitable, and changes in various economic factors may affect our determination of what constitutes a suitable investment.
Our returns will be adversely affected when proceeds of investments we have sold or which have been prepaid must be reinvested at lower yields than those of the investments sold or prepaid.
Real estate securities and loans are subject to prepayment risk. In addition, we may sell, and realize gains (or losses) on, investments. For those investments held in CBOs, the proceeds from such prepayments or sales must be reinvested inside the applicable CBO, prior to the end of the reinvestment period. Our net income will be adversely affected if proceeds from sales or prepayments of assets are reinvested at lower asset yields than the yields of such investments.
Our investments may be subject to impairment charges.
We will periodically evaluate our investments for impairment indicators. The judgment regarding the existence of impairment indicators is based on a variety of factors depending upon the nature of the investment and the manner in which the income related to such investment calculated for purposes of our financial statements. If we determine that a significant impairment has occurred, we would be required to make an adjustment to the net carrying value of the investment, which could adversely affect our results of operations and funds from operations in the applicable period.
Ourinvestments in senior unsecured REIT securities are subject to specific risks relating to the particular REIT issuer and to the general risks of investing in subordinated real estate securities, which may result in losses to us.
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Our investments in REIT securities involve special risks relating to the particular REIT issuer of the securities, including the financial condition and business outlook of the issuer. REITs generally are required to substantially invest in operating real estate or real estate related assets and are subject to the inherent risks associated with real estate related investments discussed in this report.
Our investments in REIT securities are also subject to the risks described above with respect to mortgage loans and mortgage backed securities and similar risks, including (i) risks of delinquency and foreclosure, and risks of loss in the event thereof, (ii) the dependence upon the successful operation of and net income from real property, (iii) risks generally incident to interests in real property, and (iv) risks that may be presented by the type and use of a particular commercial property.
REIT securities are generally unsecured and may also be subordinated to other obligations of the issuer. We may also invest in REIT securities that are rated below investment grade. As a result, investments in REIT securities are also subject to risks of: (i) limited liquidity in the secondary trading market, (ii) substantial market price volatility resulting from changes in prevailing interest rates, (iii) subordination to the prior claims of banks and other senior lenders to the issuer, (iv) the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause the issuer to reinvest premature redemption proceeds in lower yielding assets, (v) the possibility that earnings of the REIT issuer may be insufficient to meet its debt service and dividend obligations and (vi) the declining creditworthiness and potential for insolvency of the issuer of such REIT securities during periods of rising interest rates and economic downturn. These risks may adversely affect the value of outstanding REIT securities and the ability of the issuers thereof to repay principal and interest or make dividend payments.
The real estate related loans and other direct and indirect interests in pools of real estate properties or other loans that we invest in may be subject to additional risks relating to the privately negotiated structure and terms of the transaction, which may result in losses to us.
- Prepayment rates can increase, adversely affecting yields
We invest in real estate related loans and other direct and indirect interests in pools of real estate properties or loans.
We invest in mezzanine loans that take the form of subordinated loans secured by second mortgages on certainthe underlying real property or other business assets or revenue streams or loans secured by a pledge of our loans.
- Manythe ownership interests of ourthe entity owning real property or other business assets or revenue streams (or the ownership interest of the parent of such entity). These types of investments are illiquid, including our investments in
unconsolidated subsidiaries, andinvolve a higher degree of risk than long term senior lending secured by business assets or income producing real property because the investment may become unsecured as a result of foreclosure by a senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of such entity, or the assets of the entity may not be ablesufficient to varysatisfy our portfoliomezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in response to changes in economic and other conditions.
- Althoughthe event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt. As a result, we seek to match-fund our investments to limit refinance
risk, in particular with respect to a substantial portionmay not recover some or all of our investment. In addition, mezzanine loans may have higher loan to value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal.
We also invest in mortgage loans (“B” Notes) that while secured by a first mortgage on a single large commercial property or group of related properties are subordinated to an "A Note" secured by the same first mortgage on the same collateral. As a result, if an issuer defaults, there may not be sufficient funds remaining for B Note holders. B Notes reflect similar credit risks to comparably rated commercial mortgage backed securities. We also invest, directly or indirectly, in pools of real estate properties or loans. However, since each transaction is privately negotiated, these investments can vary in their structural characteristics and risks. For example, the rights of holders of B Notes to control the process following a borrower default may vary from transaction to transaction, while investments in pools of real estate properties or loans may be subject to varying contractual arrangements with third party co-investors in such pools. Further, B Notes typically are secured by a single property, and so reflect the risks associated with significant concentration. These investments also are less liquid than commercial mortgage backed securities.
Insurance on real estate in which we have interests (including the real estate serving as collateral for our real estate securities and loans, we do not employ this
strategy with respect to certain of our investments, which increases
refinance risks for and, therefore, the yield of these investments.
- We may not be able to match-fund our investments with respect to
maturities and interest rates, which exposes us to the risk that we
may not be able to finance or refinance our investments on
economically favorable terms.
- We finance certain of our investments with debt subject to margin
calls based on a decrease in the value of such investments, which
could adversely impact our liquidity.
- We may not be able to acquire eligible securities for a CBO financing,
or may not be able to issue CBO securities on attractive terms, which
may require us to seek more costly financing for our investments or to
liquidate assets. In addition, following the closing of a CBO
financing, the rate at which we are able to acquire eligible
securities may adversely impact our anticipated returns.
- Our determination of how much leverage to apply to our investments may
adversely affect our return on our investments and may reduce cash
available for distribution.
- Our hedging transactions may limit our gains or result in losses.
- Interest rate fluctuations may cause losses.
- Insurance on our owned real estate, mortgage loans and real estate
securities collateralloans) may not cover all losses.
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There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war, that may be uninsurable or not economically insurable. Inflation, changes in building codes and ordinances, environmental considerations, and other factors, including terrorism or acts of war, also might make the insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under such circumstances, the insurance proceeds received might not be adequate to restore our economic position with respect to the affected real property. As a result of the events of September 11, 2001, insurance companies are limiting and/or excluding coverage for acts of terrorism in insurance policies. As a result, we may suffer losses from acts of terrorism that are not covered by insurance.
In addition, the mortgage loans which are secured by certain of the properties in which we have interests contain customary covenants, including covenants that require property insurance to be maintained in an amount equal to the replacement cost of the properties. There can be no assurance that the lenders under these mortgage loans will not take the position that exclusions from coverage for losses due to terrorist acts is a breach of a covenant which, if uncured, could allow the lenders to declare an event of default and accelerate repayment of the mortgage loans.
Environmental compliance costs and liabilities with respect to our real estate in which we have interests may adversely affect our results of operations.
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Our non-U.S.operating costs may be affected by our obligation to pay for the cost of complying with existing environmental laws, ordinances and regulations, as well as the cost of complying with future legislation with respect to the assets, or loans secured by assets, with environmental problems that materially impair the value of the assets. Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under, or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of hazardous or toxic substances, or the failure to remediate properly, may adversely affect the owner's ability to borrow by using such real property as collateral. Certain environmental laws and common law principles could be used to impose liability for releases of hazardous materials, including asbestos-containing materials, into the environment, and third parties may seek recovery from owners or operators of real properties for personal injury associated with exposure to released asbestos-containing materials or other hazardous materials. Environmental laws may also impose restrictions on the manner in which a property may be used or transferred or in which businesses it may be operated, and these restrictions may require expenditures. In connection with the direct or indirect ownership and operation of properties, we may be potentially liable for any such costs. The cost of defending against claims of liability or remediating contaminated property and the cost of complying with environmental laws could adversely affect our results of operations and financial condition.
Many or our investments are illiquid and this lack of liquidity could significantly impede our ability to vary our portfolio in response to changes in economic and other conditions or to realize the value at which such investments are carried if we are required to dispose of them.
Operating real estate and other direct and indirect investments in real estate and real estate related assets are generally illiquid. Our investments in unconsolidated subsidiariesare also illiquid. In addition, the real estate securities that we purchase in connection with privately negotiated transactions are not registered under the relevant securities laws, resulting in a prohibition against their transfer, sale, pledge or other disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in accordance with, those laws. In addition, there are no established trading markets for a majority of our investments. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited.
Our assets are valued based primarily on third party quotations which are subject to currencysignificant variability based on market conditions. Certain of our investments, however, are highly illiquid and we will not have access to readily ascertainable market prices when establishing valuations of them. While we will endeavor to determine and establish valuations of our investments based on our manager’s estimate of the fair market value of such investments, if we are required to liquidate all or a portion of our illiquid investments quickly, we may realize significantly less than the amount at which we have previously valued these investments.
Interest rate fluctuations and shifts in the yield curve may cause losses.
Our primary interest rate exposures relate to our real estate securities, loans, floating rate debt obligations, interest rate swaps, and interest rate caps. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities and hedges. Changes in the level of interest rates also can affect, among other things, our ability to acquire real estate securities and loans at attractive prices, the value of our real estate securities, loans and derivatives and our ability to realize gains from the sale of such assets.
In the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults may increase and result in credit losses that would adversely affect our liquidity and operating results. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political conditions, and other factors beyond our control.
Our ability to execute our business strategy, particularly the growth of our investment portfolio, depends to a significant degree on our ability to obtain additional capital. Our financing strategy is dependent on our ability to place the match funded debt we use to finance our investments at rates that provide a positive net spread. If spreads for such liabilities widen or if demand for such liabilities ceases to exist, then our ability to execute future financings will be severely restricted.
Interest rate changes may also impact our net book value as our real estate securities and related hedge derivatives are marked to market each quarter. Our loan investments and debt obligations are not marked to market. Generally, as interest rates increase, the value of our fixed rate securities decreases, which will decrease the book value of our equity.
Furthermore, shifts in the U.S. Treasury yield curve, which represents the market's expectations of future interest rates, would also affect the yield required on our real estate securities and therefore their value. This would have similar effects on our real estate securities portfolio and our financial position and operations to a change in interest rates generally.
Our investments in real estate securities and loans are subject to changes in credit spreads which could adversely affect our ability to realize gains on the sale of such investments.
Real estate securities are subject to changes in credit spreads. Fixed rate securities are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. The value of these securities is dependent on the yield demanded on these securities by the market based on their credit relative to U.S. Treasuries. Excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher, or "wider," spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value such securities. Under such conditions, the value of our real estate securities portfolio would tend to decline. Conversely, if the spread used to value such securities were to decrease, or "tighten," the value of our real estate securities portfolio would tend to increase. Our floating rate securities are valued based on a market credit spread over LIBOR and are affected similarly by changes in LIBOR spreads. Such changes in the market value of our real estate securities portfolio may affect our net equity, net income or cash flow directly through their impact on unrealized gains or losses on available for sale securities, and therefore our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital.
Our loan portfolios are also subject to changes in credit spreads. Our floating rate loans are valued based on a market credit spread to LIBOR. The value of these loans is dependent on the yield demanded by the market based on their credit relative to LIBOR. The value of our floating rate loans would tend to decline should the market require a higher yield on such loans, resulting in the use of a higher spread over the benchmark rate (usually the applicable LIBOR yield). Our fixed rate loans are valued based on a market credit spread over U.S. Treasuries and are affected similarly by changes in U.S. Treasury spreads. If the value of our loans subject to repurchase agreements were to decline, it could affect our ability to refinance such loans upon the maturity of the related repurchase agreements. Any credit or spread related losses incurred with respect to our loans would affect us in the same way as similar losses on our real estate securities portfolio as described above, except that our loans are not marked to market.
In addition, widening credit spreads will generally result in a decrease in the mark to market value of certain investments which are treated as derivatives on our balance sheet, such as total rate of return swaps. Since changes in the value of such assets are reflected in our income statement, this would result in a decrease in our net income. To the extent that we choose to make increasing investments in real estate related assets by means of entering into total rate of return swaps, our net income will become more susceptible to decreases stemming from credit spread changes.
Our hedging transactions may limit our gains or result in losses.
We use derivatives to hedge our interest rate exposure and this has certain risks, including the uncertaintyrisk that losses on a hedge position will reduce the cash available for distribution to stockholders and that such losses may exceed the amount invested in such instruments. Our board of foreign lawsdirectors has adopted a general policy with respect to the use of derivatives, which generally allows us to use derivatives where appropriate, but does not set forth specific policies and markets.
procedures. We use derivative instruments, including forwards, futures, swaps and options, in our risk management strategy to limit the effects of changes in interest rates on our operations. A hedge may not be effective in eliminating all of the risks inherent in any particular position. Our profitability may be adversely affected during any period as a result of the use of derivatives.
There are limits to the ability of hedging strategy to protect us completely against interest rate risks. When rates change, we expect the gain or loss on derivatives to be offset by a related but inverse change in the value of the items, generally our liabilities, which we hedge. We cannot assure you, however, that our use of derivatives will offset the risks related to changes in interest rates. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses.
In managing our hedge instruments, we consider the effect of the expected hedging income on the REIT qualification tests that limit the amount of gross income that a REIT may receive from hedging. The REIT provisions of the Internal Revenue Code limit our ability to hedge. We need to carefully monitor, and may have to limit, our hedging strategy to assure that we do not realize hedging income, or hold hedges having a value, in excess of the amounts which would cause us to fail the REIT gross income and asset tests.
Accounting for derivatives under GAAP is extremely complicated Any failure by us to account for our derivatives properly in accordance with GAAP in our financial statements could adversely affect our earnings.
Prepayment rates can increase, adversely affecting yields on certain investments, including our residential mortgage loans.
The value of our assets may be affected by prepayment rates on our residential mortgage loans and other floating rate assets. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. In periods of declining mortgage interest rates, prepayments on loans generally increase. If general interest rates decline as well, the proceeds of such prepayments received during such periods are likely to be reinvested by us in assets yielding less than the yields on the assets that were prepaid. In addition, the market value of floating rate assets may, because of the risk of prepayment, benefit less than fixed rate assets from declining interest rates. Conversely, in periods of rising interest rates, prepayments on loans generally decrease, in which case we would not have the prepayment proceeds available to invest in assets with higher yields. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain investments.
In addition, when market conditions lead us to increase the portion of our CBO investments that are comprised of floating rate securities, the risk of assets inside our CBOs prepaying increases. Since our CBO financing costs are locked in, reinvestment of such prepayment proceeds at lower yields than the initial investments, as a result of changes in the interest rate or credit spread environment, will result in a decrease of the return on our equity and therefore our net income.
Risks Relating to ourOur Company
-
Our failure to qualify as a REIT would result in higher taxes and reduced cash available for stockholders.
-
We operate in a manner so as to qualify as a REIT for federal income tax purposes. Our ability to satisfy the asset tests depends upon our analysis of the fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis. Moreover, the proper classification of an instrument as debt or equity for federal income tax purposes may be uncertain in some circumstances, which could affect the application of the REIT qualification requirements as described below. Accordingly, there can be no assurance that the IRS will not contend that our interests in subsidiaries or other issuers will not cause a violation of the REIT requirements. If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of, and trading prices for, our stock. Unless entitled to relief under certain Internal Revenue Code provisions, we also would be disqualified from taxation as a REIT for the four taxable years following the year during which we ceased to qualify as a REIT. The rule against re-electing REIT status following a loss of such status could also apply to us if Newcastle Investment Holdings Corp., a former stockholder of the Company, failed to qualify as a REIT, and we are treated as a successor to Newcastle Investment Holdings for federal income tax purposes.
REIT distribution requirements could adversely affect our liquidity.
-
We generally must distribute annually at least 90% of our net taxable income, excluding any net capital gain, in order for corporate income tax not to apply to earnings that we distribute. We intend to make distributions to our stockholders to comply with the requirements of the Internal Revenue Code. However, differences in timing between the recognition of taxable income and the actual receipt of cash could require us to sell assets or borrow funds on a short term or long term basis to meet the 90% distribution requirement of the Internal Revenue Code. Certain of our assets generate substantial mismatches between taxable income and available cash. As a result, the requirement to distribute a substantial portion of our net taxable income could cause us to: (a) sell assets in adverse market conditions, (b) borrow on unfavorable terms, or (c) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt, in order to comply with REIT requirements.
Further, amounts distributed will not be available to fund investment activities. If we fail to obtain debt or equity capital in the future, it could limit our ability to grow, which could adversely affect the value of our common stock.
Dividends payable by REITs do not qualify for reduced tax rates.
Tax law changes in 2003 reduced the maximum tax rate for dividends payable to individuals from 35% to 15% (through 2008). Dividends payable by REITs, however, are generally not eligible for the reduced rates. Although this legislation does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who are individuals to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock. In addition, the relative attractiveness of real estate in general may be adversely affected by the newly favorable tax rates
under recently enacted tax legislation.
- treatment given to corporate dividends, which could affect the value of our real estate assets negatively.
Maintenance of our Investment Company Act exemption imposes limits on our operations.
-
We conduct our operations so as not to become regulated as an investment company under the Investment Company Act of 1940, as amended. We believe that there are a number of exemptions under the Investment Company Act that may be applicable to us. The assets that we may acquire, therefore, are limited by the provisions of the Investment Company Act and the rules and regulations promulgated under the Investment Company Act. In addition, we could, among other things, be required either (a) to change the manner in which we conduct our operations to avoid being required to register as an investment company or (b) to register as an investment company, either of which could adversely affect us and the market price for our stock.
ERISA may restrict investments by plans in our common stock.
-
A plan fiduciary considering an investment in our common stock should consider, among other things, whether such an investment is consistent with the fiduciary obligations under ERISA, including whether such investment might constitute or give rise to a prohibited transaction under ERISA, the Internal Revenue Code or any substantially similar federal, state or local law and, if so, whether an exemption from such prohibited transaction rules is available.
The stock ownership limits imposed by the Internal Revenue Code for REITs and our charter may inhibit market activity in our stock and may restrict our business combination opportunities.
- The following factors
In order for us to maintain our qualification as a REIT under the Internal Revenue Code, not more than 50% in value of our outstanding stock may inhibitbe owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) at any time during the last half of each taxable year after our first year. Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of directors, no person may own more than 8% of the aggregate value of all outstanding shares of our capital stock, treating classes and series of our stock in the aggregate, or more than 25% of the outstanding shares of our Series B Preferred Stock or Series C Preferred Stock. Our board may grant such an exemption, subject to such conditions, representations and undertakings as it may determine in its sole discretion. These ownership limits could delay or prevent a transaction or a change in our control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders. Our board of directors has granted limited exemptions to Fortress Principal Investment Holdings II LLC, our manager, a third party group of funds managed by Cohen & Steers, and certain affiliates of these entities.
Maryland takeover statutes may prevent a change of our control,
whichcontrol. This could depress our stock price:price.
Under Maryland takeover statutes;law, "business combinations" between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include certain mergers, consolidations, share exchanges, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities or a liquidation or dissolution. An interested stockholder is defined as:
| · | any person who beneficially owns 10% or more of the voting power of the corporation's outstanding shares; or |
| · | an affiliate or associate of a corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding stock of the corporation. |
A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by which he or she otherwise would have become an interested stockholder.
After the five--year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:
| · | 80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation voting together as a single group; and |
| · | two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder voting together as a single voting group. |
The business combination statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer, including potential acquisitions that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Our authorized, but unissued common and preferred stock;stock may prevent a change in our control.
Our charter authorizes us to issue additional authorized but unissued shares of our common stock or preferred stock. In addition, our board of directors may classify or reclassify any unissued shares of common stock or preferred stock and may set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board may establish a series of preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Our stockholder rights plan;plan could inhibit a change in our control.
We have adopted a stockholder rights agreement. Under the terms of the rights agreement, in general, if a person or group acquires more than 15% of the outstanding shares of our common stock, all of our other common stockholders will have the right to purchase securities from us at a discount to such securities' fair market value, thus causing substantial dilution to the acquiring person. The rights agreement may have the effect of inhibiting or impeding a change in control not approved by our board of directors and, therefore, could adversely affect our stockholders' ability to realize a premium over the then-prevailing market price for our common stock in connection with such a transaction. In addition, since our board of directors can prevent the rights agreement from operating, in the event our board approves of an acquiring person, the rights agreement gives our board of directors significant discretion over whether a potential acquirer's efforts to acquire a large interest in us will be successful. Because the rights agreement contains provisions that are designed to assure that the executive officers, our manager and its affiliates will never, alone, be considered a group that is an acquiring person, the rights agreement provides the executive officers, our manager and its affiliates with certain advantages under the rights agreement that are not available to other stockholders.
Our staggered board and other provisions of our charter and bylaws.
14
bylaws may prevent a change in our control.
Our board of directors is divided into three classes of directors. Directors of each class are chosen for three-year terms upon the expiration of their current terms, and each year one class of directors is elected by the stockholders. The staggered terms of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interest of our stockholders. In addition, our charter and bylaws also contain other provisions that may delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect our management'smanagement’s views as of the date of this report. The factors noted above could cause our actual results to differ significantly from those contained in any forward-looking statement. For a discussion of our critical accounting policies see "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations - Application of Critical Accounting Policies."
”
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.
15
ITEM
We have no unresolved staff comments.
Our direct investments in properties which comprise a substantial portion of
our operating real estate business segment, are described under "Business“Business - Our Investments."
Investing Activities.”
Our manager leases principal executive and administrative offices located at 12511345 Avenue of the Americas, New York, NY 10020, 16thNew York 10105, 46th floor. Its telephone number is (212) 798-6100. Our manager has leased additional office space in New
York City, which it expects to occupy in the fourth quarter of 2005.
ITEM
We are not a party to any material legal proceedings.
ITEM
No matters were submitted to a vote of our security holders during the fourth quarter of 2004.
2005.
Our common stock has been listed and is traded on the New York Stock Exchange (NYSE) under the symbol
"NCT"“NCT” since our initial public offering in October 2002. The following table sets forth, for the periods indicated, the high, low and last sale prices in dollars on the NYSE for our common stock and the distributions we declared with respect to the periods indicated.
Distributions
2004 High Low Last Sale Declared
---- ------ ------ --------- -------------
First Quarter $33.89 $25.51 $33.70 $0.600
Second Quarter $33.40 $24.51 $29.95 $0.600
Third Quarter $31.74 $27.97 $30.70 $0.600
Fourth Quarter $32.87 $29.84 $31.78 $0.625
Distributions
2003 High Low Last Sale Declared
---- ------ ------ --------- -------------
First Quarter $16.83 $15.46 $16.73 $0.450
Second Quarter $20.00 $16.50 $19.58 $0.500
Third Quarter $23.24 $19.00 $22.99 $0.500
Fourth Quarter $27.24 $22.64 $27.10 $0.500
| 2005 | | High | | Low | | Last Sale | | Distributions Declared | |
| First Quarter | | $ | 31.95 | | $ | 29.27 | | $ | 29.60 | | $ | 0.625 | |
| Second Quarter | | $ | 32.31 | | $ | 28.25 | | $ | 30.15 | | $ | 0.625 | |
| Third Quarter | | $ | 31.25 | | $ | 27.00 | | $ | 27.90 | | $ | 0.625 | |
| Fourth Quarter | | $ | 27.96 | | $ | 24.74 | | $ | 24.85 | | $ | 0.625 | |
| | | | | | | | | | | | | | |
| 2004 | | | High | | | Low | | | Last Sale | | | Distributions Declared | |
| First Quarter | | $ | 33.89 | | $ | 25.51 | | $ | 33.70 | | $ | 0.600 | |
| Second Quarter | | $ | 33.40 | | $ | 24.51 | | $ | 29.95 | | $ | 0.600 | |
| Third Quarter | | $ | 31.74 | | $ | 27.97 | | $ | 30.70 | | $ | 0.600 | |
| Fourth Quarter | | $ | 32.87 | | $ | 29.84 | | $ | 31.78 | | $ | 0.625 | |
We intend to continue to declare quarterly distributions on our common stock. No assurance, however, can be given as to the amounts or timing of future distributions as such distributions are subject to our earnings, financial condition, capital requirements and such other factors as our board of directors deems relevant.
On March
8, 2005,6, 2006, the closing sale price for our common stock, as reported on the NYSE, was
$30.73.$24.76. As of March
8, 2005,6, 2006, there were approximately
7799 record holders of our common stock. This figure does not reflect the beneficial ownership of shares held in nominee name.
16
EQUITY COMPENSATION PLAN INFORMATION
Equity Compensation Plan Information
The following table summarizes the total number of outstanding securities in the incentive plan and the number of securities remaining for future issuance, as well as the weighted average exercise price of all outstanding securities as of December 31, 2004.
2005.
| | Number of Securities to be Issued Upon Exercise of Outstanding Options | | Weighted Average Exercise Price of Outstanding Options | | Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans | |
Equity Compensation Plans Approved | | | | | | | |
by Security Holders: | | | | | | | |
| Newcastle Investment Corp. Nonqualified | | | | | | | |
| Stock Option and Incentive Award Plan | | | 1,811,807 (1 | ) | $ | 25.14 | | | 7,320,577 (2 | ) |
Equity Compensation Plans Not Approved | | | | | | | | | | |
by Security Holders: | | | | | | | | | | |
| None | | | N/A | | | N/A | | | N/A | |
| | | | | | | | | | | |
NUMBER OF SECURITIES
NUMBER OF SECURITIES TO WEIGHTED AVERAGE REMAINING AVAILABLE FOR
BE ISSUED UPON EXERCISE EXERCISE PRICE OF FUTURE ISSUANCE UNDER
PLAN CATEGORY OF OUTSTANDING OPTIONS OUTSTANDING OPTIONS EQUITY COMPENSATION PLANS
------------- ----------------------- ------------------- -------------------------
EQUITY COMPENSATION PLANS APPROVED
BY SECURITY HOLDERS:
Newcastle Investment Corp. Nonqualified
Stock Option| (1) | Includes options for (i) 1,170,317 shares held by an affiliate of our manager; (ii) 627,490 shares granted to our manager and Incentive Award Plan 2,231,727(1) $21.25 7,654,585(2)
EQUITY COMPENSATION PLANS NOT APPROVED
BY SECURITY HOLDERS:
None N/A N/A N/A
assigned to certain of the manager’s employees; and (iii) an aggregate of 14,000 shares held by our directors, other than Mr. Edens. |
- ----------
(1) Includes options for (i) 1,510,937 shares held by an affiliate of our
manager; (ii) 707,790 shares granted to our manager and assigned to certain
of the manager's employees; and (iii) an aggregate of 13,000 shares held by
our directors, other than Mr. Edens.
(2) The maximum available for issuance is equal to 10% of the number of
outstanding equity interests, subject to a maximum of 10,000,000 shares in
the aggregate over the term of the plan. The number of securities remaining
available for future issuance is net of an aggregate of 3,688 shares of our
common stock awards to our directors, other than Mr. Edens, representing
the aggregate annual automatic stock awards to each such director for 2003
and 2004, and of 110,000 shares issued to certain of our directors and
employees of our manager upon the exercise of previously granted options.
17
ITEM| (2) | The maximum available for issuance is equal to 10% of the number of outstanding equity interests, subject to a maximum of 10,000,000 shares in the aggregate over the term of the plan. The number of securities remaining available for future issuance is net of an aggregate of 5,696 shares of our common stock awards to our directors, other than Mr. Edens, representing the aggregate annual automatic stock awards to each such director for 2003 through 2005, and of 861,920 shares issued to certain of our directors and employees of our manager upon the exercise of previously granted options. |
The selected historical consolidated financial information set forth below as of December 31, 2005, 2004, 2003, 2002 2001 and 20002001 and for the years ended December 31, 2005, 2004, 2003, 2002 2001 and 20002001 has been derived from our audited historical consolidated financial statements.
The information below should be read in conjunction with "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations"Operations” and our consolidated financial statements and notes thereto included in "Financial“Financial Statements and Supplementary Data."
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(in”
Selected Consolidated Financial Information
(in thousands, except per share data)
| | | | |
| | | Year Ended December 31, | |
| | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
Operating Data | | | | | | | | (2) | | (1) | |
| Revenues | | | | | | | | | | | |
| Interest income | | $ | 348,516 | | $ | 225,761 | | $ | 133,183 | | $ | 73,620 | | $ | 48,729 | |
| Other income | | | 29,697 | | | 23,908 | | | 18,901 | | | 18,716 | | | 50,348 | |
| | | | 378,213 | | | 249,669 | | | 152,084 | | | 92,336 | | | 99,077 | |
| Expenses | | | | | | | | | | | | | | | | |
| Interest expense | | | 226,446 | | | 136,398 | | | 76,877 | | | 44,238 | | | 30,495 | |
| Other expense | | | 42,529 | | | 29,259 | | | 20,828 | | | 18,197 | | | 36,865 | |
| | | | 268,975 | | | 165,657 | | | 97,705 | | | 62,435 | | | 67,360 | |
| | | | | | | | | | | | | | | | | |
| Equity in earnings of unconsolidated subsidiaries | | | 5,930 | | | 12,465 | | | 862 | | | 362 | | | 2,807 | |
| Income taxes on related taxable subsidiaries | | | (321 | ) | | (2,508 | ) | | — | | | | | | | |
| | | | 5,609 | | | 9,957 | | | 862 | | | 362 | | | 2,807 | |
| | | | | | | | | | | | | | | | | |
| Income from continuing operations | | | 114,847 | | | 93,969 | | | 55,241 | | | 30,263 | | | 34,524 | |
| Income from discontinued operations | | | 2,108 | | | 4,446 | | | 877 | | | 1,232 | | | 9,147 | |
| Net income | | | 116,955 | | | 98,415 | | | 56,118 | | | 31,495 | | | 43,671 | |
| Preferred dividends and related accretion | | | (6,684 | ) | | (6,094 | ) | | (4,773 | ) | | (1,162 | ) | | (2,540 | ) |
| Income available for common stockholders | | $ | 110,271 | | $ | 92,321 | | $ | 51,345 | | $ | 30,333 | | $ | 41,131 | |
| Net income per share of common stock, diluted | | $ | 2.51 | | $ | 2.46 | | $ | 1.96 | | $ | 1.68 | | $ | 2.49 | |
| Income from continuing operations per share of common | | | | | | | | | | | | | |
| stock, after preferred dividends and related accretion, diluted | | $ | 2.46 | | $ | 2.34 | | $ | 1.93 | | $ | 1.61 | | $ | 1.94 | |
| Weighted average number of shares of common stock | | | | | | | | | | | | | | | | |
| outstanding, diluted | | | 43,986 | | | 37,558 | | | 26,141 | | | 18,090 | | | 16,493 | |
| Dividends declared per share of common stock | | $ | 2.500 | | $ | 2.425 | | $ | 1.950 | | $ | 2.050 | | $ | 2.000 | |
| | | | | | | | | | | | | | | | | |
| | | As Of December 31, | |
| | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 (1) | |
Balance Sheet Data | | | | | | | | | | | |
| Real estate securities, available for sale | | $ | 4,554,519 | | $ | 3,369,496 | | $ | 2,192,727 | | $ | 1,025,010 | | $ | 501,509 | |
| Real estate related loans, net | | | 615,551 | | | 591,890 | | | 402,784 | | | 26,417 | | | 20,662 | |
| Residential mortgage loans, net | | | 600,682 | | | 654,784 | | | 586,237 | | | 258,198 | | | | |
| Operating real estate, net | | | 16,673 | | | 57,193 | | | 102,995 | | | 113,652 | | | 524,834 | |
| Cash and cash equivalents | | | 21,275 | | | 37,911 | | | 60,403 | | | 45,463 | | | 31,360 | |
| Total assets | | | 6,209,699 | | | 4,932,720 | | | 3,550,299 | | | 1,574,828 | | | 1,262,509 | |
| Debt | | | 5,212,358 | | | 4,021,396 | | | 2,924,552 | | | 1,217,007 | | | 897,390 | |
| Total liabilities | | | 5,291,696 | | | 4,136,005 | | | 3,010,936 | | | 1,288,326 | | | 928,637 | |
| Common stockholders' equity | | | 815,503 | | | 734,215 | | | 476,863 | | | 284,241 | | | 310,545 | |
| Preferred stock | | | 102,500 | | | 62,500 | | | 62,500 | | | | | | | |
| | | | | | | | | | | | | | | | | |
Supplemental Balance Sheet Data | | | | | | | | | | | | | | | | |
| Common shares outstanding | | | 43,913 | | | 39,859 | | | 31,375 | | | 23,489 | | | 16,489 | |
| Book value per share of common stock, subsequent to | | | | | | | | | | | | | | | | |
| initial public offering | | $ | 18.57 | | $ | 18.42 | | $ | 15.20 | | $ | 12.10 | | | N/A | |
| | | | | | | | | | | | | | | | | |
YEAR ENDED DECEMBER 31,
---------------------------------------------------
2004 2003 2002 2001 2000
(2) (1) (1)
-------- -------- -------- -------- -------
OPERATING DATA
Revenues
Interest income $226,674 $134,672 $ 73,214 $ 48,806 $51,531
Other income 31,472 29,382 28,161 59,921 44,197
258,146 164,054 101,375 108,727 95,728
Expenses
Interest expense 138,847 79,084 46,375 32,550 33,986
Other expense 34,859 27,055 23,605 42,249 27,601
-------- -------- -------- -------- -------
173,706 106,139 69,980 74,799 61,587
Equity in earnings (losses) | Represents the operations and financial position of unconsolidated subsidiaries 12,465 862 362 2,807 (980)
Income taxes on related taxable subsidiaries (2,508) -- -- -- --
-------- -------- -------- -------- -------
Income from continuingour predecessor. |
| (2) | Includes the operations 94,397 58,777 31,757 36,735 33,161
Income (loss) from discontinuedof our predecessor through the date of commencement of our operations, 4,018 (2,659) (262) 6,936 9,699
-------- -------- -------- -------- -------
Net Income 98,415 56,118 31,495 43,671 42,860
Preferred dividendsJuly 12, 2002. |
| | | Year Ended December 31, | |
| | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
Other Data | | | | | | | | | | | |
| Cash Flow provided by (used in): | | | | | | | | | | | |
| Operating activities | | $ | 98,763 | | $ | 90,355 | | $ | 38,454 | | $ | 21,919 | | $ | 37,255 | |
| Investing activities | | | (1,334,746 | ) | | (1,332,164 | ) | | (1,659,026 | ) | | (683,053 | ) | | 103,246 | |
| Financing activities | | | 1,219,347 | | | 1,219,317 | | | 1,635,512 | | | 675,237 | | | (119,716 | ) |
| Funds from Operations (FFO) (1) | | | 104,031 | | | 86,201 | | | 54,380 | | | 37,633 | | | 48,264 | |
| | | | | | | | | | | | | | | | | |
| (1) | We believe FFO is one appropriate measure of the operating performance of real estate companies because it provides investors with information regarding our ability to service debt and related accretion (6,094) (4,773) (1,162) (2,540) (2,084)
-------- -------- -------- -------- -------
Incomemake capital expenditures. We also believe that FFO is an appropriate supplemental disclosure of operating performance for a REIT due to its widespread acceptance and use within the REIT and analyst communities. Furthermore, FFO is used to compute our incentive compensation to our manager. FFO, for our purposes, represents net income available for common stockholders $ 92,321 $ 51,345 $ 30,333 $ 41,131 $40,776
======== ======== ======== ======== =======
Net Income per share of common stock, diluted $ 2.46 $ 1.96 $ 1.68 $ 2.49 $ 2.16
======== ======== ======== ======== =======
Income from continuing operations per share of common stock,
after preferred dividends and related accretion, diluted $ 2.35 $ 2.06 $ 1.69 $ 2.07 $ 1.64
======== ======== ======== ======== =======
Weighted average number of shares of common stock
outstanding, diluted 37,558 26,141 18,090 16,493 18,892
======== ======== ======== ======== =======
Dividends declared per share of common stock $ 2.425 $ 1.950 $ 2.050 $ 2.000 $1.500
======== ======== ======== ======== =======
|
AS OF DECEMBER 31,
--------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
BALANCE SHEET DATA
Real estate securities, available for sale $3,369,496 $2,192,727 $1,025,010 $ 501,509 $ 550,220
Real estate related loans, net 591,890 402,784 26,417 20,662 106,957
Residential mortgage loans, net 654,784 586,237 258,198 -- --
Operating real estate, net 57,193 102,995 113,652 524,834 540,539
Cash and cash equivalents 37,911 60,403 45,463 31,360 10,575
Total assets 4,932,720 3,550,299 1,574,828 1,262,509 1,331,671
Debt 4,021,396 2,924,552 1,217,007 897,390 975,656
Stockholders' equity 796,715 539,363 284,241 310,545 300,655
SUPPLEMENTAL BALANCE SHEET DATA
Common shares outstanding 39,859 31,375 23,489 16,489 16,500
Book value per share of common stock, subsequent to
initial public offering $ 18.42 $ 15.20 $ 12.10 N/A N/A
(1) Represents the operations of our predecessor.
(2) Includes the operations of our predecessor through the date of commencement
of our operations, July 12, 2002.
18
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- --------- --------- ---------
OTHER DATA
Cash Flow provided by (used in):
Operating activities $ 77,890 $ 37,592 $ 21,557 $ 34,448 $ 24,823
Investing activities $(1,319,699) $(1,652,682) $(682,691) $ 106,053 $ 151,632
Financing activities $ 1,219,317 $ 1,630,030 $ 675,237 $(119,716) $(180,225)
Funds from Operations (FFO) (1) $ 86,201 $ 54,380 $ 37,633 $ 48,264 $ 53,523
(1) We believe FFO is one appropriate measure of the operating performance of
real estate companies because it provides investors with information
regarding our ability to service debt and make capital expenditures. We
also believe that FFO is an appropriate supplemental disclosure of
operating performance for a REIT due to its widespread acceptance and use
within the REIT and analyst communities. Furthermore, FFO is used to
compute our incentive compensation to our manager. FFO, for our purposes,
represents net income available for common stockholders (computed in accordance with GAAP), excluding extraordinary items, plus depreciation of our operating real estate, and after adjustments for unconsolidated
subsidiaries. We consider gains and losses on resolution of our investments
to be a normal part of our recurring operations and, therefore, do not
exclude such gains and losses when arriving at FFO. Adjustments for
unconsolidated subsidiaries are calculated to reflect FFO on the same
basis. FFO does not represent cash generated from operating activities in
accordance with GAAP and therefore should not be considered an alternative
to net income as an indicator of our operating performance or as an
alternative to cash flow as a measure of our liquidity and is not
necessarily indicative of cash available to fund cash needs. Our
calculation of FFO may be different from the calculation used by other
companies and, therefore, comparability may be limited.
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2004 2003 2002 2001 2000
------- ------- ------- ------- -------
CALCULATION OF FUNDS FROM OPERATIONS (FFO):
Income available for common stockholders $92,321 $51,345 $30,333 $41,131 $40,776
Operating real estate depreciation 2,199 3,035 7,994 12,909 12,621
Accumulated depreciation on operating real estate, sold (8,319) -- (2,847) -- --
Other-Fund I (1) -- -- 2,153 (5,776) 126
------- ------- ------- ------- -------
Fundsand after adjustments for unconsolidated subsidiaries, if any. We consider gains and losses on resolution of our investments to be a normal part of our recurring operations and, therefore, do not exclude such gains and losses when arriving at FFO. Adjustments for unconsolidated subsidiaries, if any, are calculated to reflect FFO on the same basis. FFO does not represent cash generated from operations (FFO) $86,201 $54,380 $37,633 $48,264 $53,523
======= ======= ======= ======= =======
operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indicator of our operating performance or as an alternative to cash flow as a measure of our liquidity and is not necessarily indicative of cash available to fund cash needs. Our calculation of FFO may be different from the calculation used by other companies and, therefore, comparability may be limited.
(1) Related to an investment retained by our predecessor.
19
ITEM| | | Year Ended December 31, | |
| | | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
Calculation of Funds From Operations (FFO): | | | | | | | | | | | |
| Income available for common stockholders | | $ | 110,271 | | $ | 92,321 | | $ | 51,345 | | $ | 30,333 | | $ | 41,131 | |
| Operating real estate depreciation | | | 702 | | | 2,199 | | | 3,035 | | | 7,994 | | | 12,909 | |
| Accumulated depreciation on operating real estate sold | | | (6,942 | ) | | (8,319 | ) | | — | | | (2,847 | ) | | | |
| Other-Fund I (1) | | | | | | | | | | | | 2,153 | | | (5,776 | ) |
| Funds from operations (FFO) | | $ | 104,031 | | $ | 86,201 | | $ | 54,380 | | $ | 37,633 | | $ | 48,264 | |
| | | | | | | | | | | | | | | | | |
| (1) | Related to an investment retained by our predecessor. |
The following should be read in conjunction with our consolidated financial statements and notes thereto included in "Financial“Financial Statements and Supplementary Data."
GENERAL”
General
Newcastle Investment Corp. is a real estate investment and finance company. We invest in real estate securities, loans and other real estate related assets. In addition, we consider other opportunistic investments which capitalize on our manager’s expertise and which we believe present attractive risk/return profiles and are consistent with our investment guidelines. We seek to deliver stable dividends and attractive risk-adjusted returns to our stockholders through prudent asset selection, active management and the use of match funded financing structures, which reduce our interest rate and financing risks. Our objective is to maximize the difference between the yield on our investments and the cost of financing these investments while hedging our interest rate risk. We emphasize asset quality, diversification, match funded financing and credit risk management.
We currently own a diversified portfolio of moderately credit sensitive real estate debt investments including securities and loans. Our portfolio of real estate securities includes commercial mortgage backed securities (CMBS), senior unsecured debt issued by property REITs, real estate related asset backed securities (ABS) and agency residential mortgage backed securities (RMBS). Mortgage backed securities are interests in or obligations secured by pools of mortgage loans. We generally target investments rated A through BB, except for our agency RMBS which are generally considered AAA rated. We also own, directly and indirectly, interests in loans and pools of loans, including real estate related loans, commercial mortgage loans, residential mortgage loans, and manufactured housing loans and subprime residential loans. We also own, directly and indirectly, interests in operating real estate.
We employ leverage in order to achieve our return objectives. We do not have a predetermined target debt to equity ratio as we believe the appropriate leverage for the particular assets we are financing depends on the credit quality of those assets. As of December 31, 2004,2005, our debt to equity ratio was approximately 5.05.7 to 1. We maintain access to a broad array of capital resources in an effort to insulate our business from potential fluctuations in the availability of capital. We utilize multiple forms of financing including collateralized bond obligations (CBOs), other securitizations, and term loans, as well as short term financing in the form of repurchase agreements.
agreements and our credit facility.
We seek to match-fundmatch fund our investments with respect to interest rates and maturities in order to minimize the impact of interest rate fluctuations on earnings and reduce the risk of refinancing our liabilities prior to the maturity of the investments. We seek to finance a substantial portion of our real estate securities and loans through the issuance of debt securities in the form of collateralized bond obligations, known as CBOs, which are obligations issued in multiple classes secured by an underlying portfolio of securities. Our CBO financings offer us the structural flexibility to buy and sell certain investments to manage risk and, subject to certain limitations, to optimize returns.
Market Considerations
Our objectiveability to maintain our dividends and grow our business is dependent on our ability to maximizeinvest our capital on a timely basis at yields which exceed our cost of capital. The primary market factor that bears on this is credit spread.
Generally speaking, tightening credit spreads increase the difference betweenunrealized gains on our current investments but reduce the yields available on potential new investments, while widening credit spreads reduce the unrealized gains on our current investments (or cause unrealized losses) but increase the yields available on potential new investments.
For the years 2003 and 2004, credit spreads tightened to historical lows, before widening in 2005. During this period, while new originations increased due to a growing commercial debt market, competition for available investments also increased.
With respect to new investments, this environment has caused the yield we can earn on certain investments to decrease. As a result of spread tightening, our related financing costs have also decreased, partially offsetting the decrease in yield. The net effect is that the return on equity available on certain investments has decreased. We continue to pursue opportunistic investments within our investment guidelines that offer a more attractive risk adjusted return, including investments in the residential debt market, and have experienced a trend of increasing returns on our recent investments.
Since the tightening of spreads was more pronounced in fixed rate investments than in floating rate investments, we increased our investment in floating rate assets. Recently rising interest rates and increasing property values have contributed to a high prepayment rate on our floating rate investments. These asset prepayments, coupled with the proceeds from sales of investments, increase our uninvested cash. Tightened credit spreads and the resulting scarcity of attractive investments have caused us to be more selective in our investment process, which in turn has caused delays in the investment or reinvestment of our cash, leading to a reduction in our overall return on equity. Furthermore, the reinvestment of proceeds from investments that prepaid or were sold has generally been at lower yields than the yields earned on such prepaid or sold investments due to the environment of tighter spreads.
In addition, trends in market interest rates also affect our operations, although to a lesser degree due to our match funded financing strategy. Interest rates had been historically low throughout 2003 and 2004, before rising in 2005.
In addition to the effect on prepayments as described above, recently rising interest rates have caused the net unrealized gains on our securities and derivatives, recorded in accumulated other comprehensive income, to decrease on a net basis, despite the tightening of spreads. Although this has no direct impact on our results of operations, cash flows, or ability to pay a dividend, it has reduced the amount of built in gains on our existing investments and, the costtherefore, our book value per share and our ability to realize gains on such investments.
If credit spreads widen and interest rates continue to increase, we expect that our new investment activities will benefit and our earnings will increase, although our net book value per share may decrease.
Certain aspects of financing these investments while hedging our interest rate
risk. We emphasize asset quality, liquidity, diversification, match-funded
financingeffects are more fully described in “Management’s Discussion and credit risk management.
Analysis of Financial Condition and Results of Operations - Interest Rate, Credit and Spread Risk” as well as in “Quantitative and Qualitative Disclosures About Market Risk.”
Formation and Organization
We were formed in June 2002 as a subsidiary of Newcastle Investment Holdings Corp. (referred to herein as Holdings). Prior to our initial public offering, Holdings contributed to us certain assets and liabilities in exchange for approximately 16.5 million shares of our common stock. For accounting purposes,
this transaction is presented as a reverse spin-off, whereby Newcastle
Investment Corp. is treated as the continuing entity and the assets that were
retained by Holdings and not contributed to us are accounted for as if they were
distributed at their historical book basis through a spin-off to Holdings. Our operations commenced in July 2002. In May 2003, Holdings distributed to its stockholders all of the shares of our common stock that it held, and it no longer owns any of our common equity.
The following table presents information on shares of our common stock issued since our formation:
| Year | | Shares Issued | | Range of Issue Prices per Share (1) | | Net Proceeds (millions) | |
| | | | | | | | |
| Formation | | | 16,488,517 | | | N/A | | | N/A | |
| 2002 | | | 7,000,000 | | $ | 13.00 | | $ | 80.0 | |
| 2003 | | | 7,886,316 | | $ | 20.35-$22.85 | | $ | 163.4 | |
| 2004 | | | 8,484,648 | | $ | 26.30-$31.40 | | $ | 224.3 | |
| 2005 | | | 4,053,928 | | $ | 29.60 | | $ | 108.2 | |
| December 31, 2005 | | | 43,913,409 | | | | | | | |
| | | | | | | | | | | |
| (1) | Excludes prices of shares issued pursuant to the exercise of options and shares issued to Newcastle’s independent directors. |
As of December 31,
2004,2005, approximately
2.32.9 million of
suchour shares
of common stock were held by an affiliate of our manager and its principals. In addition, an affiliate of our manager held options to purchase approximately
1.51.2 million shares of our common stock at December 31,
2004.
The analysis in this section treats us as the successor to Holdings and
therefore includes historical information, through the date of the commencement
of our operations, regarding operations of Holdings which were distributed to
them and therefore are unrelated to our ongoing operations. Transactions
completed by Holdings related to investments retained by Holdings (not
contributed to us) are referred to as being completed by our predecessor.
The following table presents information on shares of our common stock issued
since our formation:
Year Shares Issued Range of Issue Prices (1) Net Proceeds (millions)
- ---- ------------- ------------------------- -----------------------
Formation 16,488,517 N/A N/A
2002 7,000,000 $13.00 $ 80.0
2003 7,886,316 $20.35-$22.85 $163.4
2004 8,484,648 $26.30-$31.40 $224.3
----------
December 31, 2004 39,859,481
==========
January 2005 3,879,000 $29.60 $105.4
(1) Excludes shares issued pursuant to the exercise of options and shares
issued to our independent directors.
20
2005.
We are organized and conduct our operations to qualify as a REIT for U.S. federal income tax purposes. As such, we will generally not be subject to U.S. federal income tax on that portion of our income that is distributed to stockholders if we distribute at least 90% of our REIT taxable income to our stockholders by prescribed dates and comply with various other requirements.
We conduct our business by investing in three primary business segments: (i) real estate securities and real estate related loans, (ii) residential mortgage loans and (iii) operating real estate
and (iii) residential mortgage loans. We have retroactively combined two
business segments which were previously reported separately: real estate
securities and real estate related loans. Management no longer reviews
disaggregated, discrete financial information on these two investment categories
since, among other reasons, they are cross-financed and share common credit risk
characteristics. Holdings, our predecessor, conducted its business through three
primary segments: (1) real estate securities and real estate related loans, (2)
operating real estate, primarily credit leased operating real estate and (3) its
investment in Fortress Investment Fund LLC ("Fund I"). Holdings' investments in
real estate securities and a portion of its investments in operating real estate
were contributed to us. The operating real estate and real estate related loans
distributed to Holdings have been treated as discontinued operations, because
they constituted a component of an entity, while the other operations
distributed to Holdings, including the investment in Fund I, have not been
treated as such, because they did not constitute a component of an entity as
defined in SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets."
In addition to certain of the investments distributed to Holdings as described
above, ourestate.
Our discontinued operations include the operations of properties which have been sold or classified as Real Estate Held for Sale pursuant to SFAS No. 144. For more information on these properties, see Note 6 of our consolidated financial statements which appear in "Financial“Financial Statements and Supplementary Data."
” Net proceeds from the sales of such properties have been redeployed to other investments which better meet our strategic objectives.
Revenues attributable to each segment are disclosed below (unaudited) (in thousands).
Real Estate
Securities and Residential
Real Estate Operating Mortgage
For the Year Ended Related Loans Real Estate Loans Fund I Unallocated Total
- ------------------ -------------- ----------- ----------- ------ ----------- --------
December 31, 2004 $225,236 $13,222 $19,135 $ -- $553 $258,146
December 31, 2003 $134,348 $16,234 $12,892 $ -- $580 $164,054
December 31, 2002 $ 83,259 $13,116 $ 1,281 $3,287 $432 $101,375
TAXATION
| For the Year Ended | | Real Estate Securities and Real Estate Related Loans | | Residential Mortgage Loans | | Operating Real Estate | | Unallocated | | Total | |
| December 31, 2005 | | $ | 321,889 | | $ | 48,844 | | $ | 6,772 | | $ | 708 | | $ | 378,213 | |
| December 31, 2004 | | $ | 225,236 | | $ | 19,135 | | $ | 4,745 | | $ | 553 | | $ | 249,669 | |
| December 31, 2003 | | $ | 134,348 | | $ | 12,892 | | $ | 4,264 | | $ | 580 | | $ | 152,084 | |
Taxation
We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended (the "Code"), and we intend to continue to operate in such a manner. Our current and continuing qualification as a REIT depends on our ability to meet various tax law requirements, including, among others, requirements relating to the sources of our income, the nature of our assets, the composition of our stockholders, and the timing and amount of distributions that we make.
As a REIT, we will generally not be subject to U.S. federal corporate income tax on our net income that is currently distributed to stockholders. We may, however, nevertheless be subject to certain state, local and foreign income and other taxes, and to U.S. federal income and excise taxes and penalties in certain situations, including taxes on our undistributed income. In addition, our stockholders may be subject to state, local or foreign taxation in various jurisdictions, including those in which they or we transact business or reside. The state, local and foreign tax treatment of us and our stockholders may not conform to the U.S. federal income tax treatment.
If, in any taxable year, we fail to satisfy one or more of the various tax law requirements, we could fail to qualify as a REIT. In addition, if Newcastle Investment Holdings failed to qualify as a REIT and we are treated as a successor to Newcastle Investment Holdings, this could cause us to likewise fail to qualify as a REIT. If we fail to qualify as a REIT for a particular tax year, our income in that year would be subject to U.S. federal corporate income tax (including any applicable alternative minimum tax), and we may need to borrow funds or liquidate certain investments in order to pay the applicable tax, and we would not be compelled by the Code to make distributions. Unless entitled to relief under certain statutory provisions, we would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost.
Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax or other developments may cause us to fail to qualify as a REIT, or may cause our board of directors to revoke the REIT election.
21
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Management's
Application of Critical Accounting Policies
Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles generally accepted in the
United States ("GAAP"(“GAAP”). The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Actual results could differ from these estimates. A summary of our significant accounting policies is presented in Note 2 to our consolidated financial statements, which appear in "Financial“Financial Statements and Supplementary Data."” The following is a summary of our accounting policies that are most effected by judgments, estimates and assumptions.
Variable Interest Entities
In December 2003, Financial Accounting Standards Board Interpretation ("FIN"(“FIN”) No. 46R "Consolidation“Consolidation of Variable Interest Entities"Entities” was issued as a modification of FIN 46. FIN 46R, which became effective in the first quarter of 2004, clarified the methodology for determining whether an entity is a variable interest entity ("VIE"(“VIE”) and the methodology for assessing who is the primary beneficiary of a VIE. VIEs are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, and only its primary beneficiary, which is defined as the party who will absorb a majority of the VIE'sVIE’s expected losses or receive a majority of the expected residual returns as a result of holding variable interests.
We
To date, we have historically consolidated our existing CBO transactions (the "CBO“CBO Entities) because we own the entire equity interest in each of them, representing a substantial portion of their capitalization, and we control the management and resolution of their assets. We have determined that certain of the CBO Entities are VIEs and that we are the primary beneficiary of each of these VIEs and will therefore continue to consolidate them. We have also determined that the application of FIN 46R did not result in a change in our accounting for any other entities which were previously consolidated. However, it did cause us to consolidate one entity which was previously not consolidated, ICH CMO, as described below under " - Liquidity“Liquidity and Capital Resources."” We will continue to analyze future CBO entities, as well as other investments, pursuant to the requirements of FIN 46R. These analyses require considerable judgment in determining the primary beneficiary of a VIE since they involve subjectiveestimated probability weighting of subjectively determined possible cash flow scenarios. The result could be the consolidation of an entity acquired or formed in the future that would otherwise not have been consolidated or the non-consolidation of such an entity that would otherwise have been consolidated.
Valuation and Impairment of Securities
We have classified our real estate securities as available for sale. As such, they are carried at fair value with net unrealized gains or losses reported as a component of accumulated other comprehensive income. Fair value is based primarily upon broker quotations, as well as counterparty quotations, which provide valuation estimates based upon reasonable market order indications or a good faith estimate thereof. These quotations are subject to significant variability based on market conditions, such as interest rates and credit spreads. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in our book equity. We must also assess whether unrealized losses on securities, if any, reflect a decline in value which is other than temporary and, accordingly, write the impaired security down to its value through earnings. For example, a decline in value is deemed to be other than temporary if it is probable that we will be unable to collect all amounts due according to the contractual terms of a security which was not impaired at acquisition.acquisition, or if we do not have the ability and intent to hold a security in an unrealized loss position until its anticipated recovery (if any). Temporary declines in value generally result from changes in market factors, such as market interest rates and credit spreads, or from certain macroeconomic events, including market disruptions and supply changes, which do not directly impact our ability to collect amounts contractually due. We continually evaluate the credit status of each of our securities and, if necessary, the collateral supporting our securities. This evaluation includes a review of the credit of the issuer of the security (if applicable), the credit rating of the security, the key terms of the security (including credit support), debt service coverage and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the collateral supporting such loans, including the effect of local, industry and broader economic trends and factors. These factors include loan default expectations and loss severities, which are analyzed in connection with a particular security’s credit support, as well as prepayment rates. The result of this evaluation is considered in relation to the amount of the unrealized loss and the period elapsed since it was incurred. Significant judgment is required in this analysis. To date, no such write-downs have been made.
Revenue Recognition on Securities
Income on these securities is recognized using a level yield methodology based upon a number of
cash flow assumptions that are subject to uncertainties and contingencies. Such assumptions include
the expected disposal date of such
security and the rate and timing of principal and interest receipts (which may be subject to prepayments
delinquencies and defaults).
These assumptions are updated on at least a quarterly basis to reflect changes related to a particular security, actual historical data, and market changes. These uncertainties and contingencies are difficult to predict and are subject to future events and economic and market conditions, which may alter the assumptions.
22
For securities acquired at a discount for credit quality, the net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income, offset by a provision for probable, incurred credit losses which would be accrued on a periodic basis to Provision for Credit Losses. The provision is determined based on an evaluation of the credit status of securities, as described in connection with the analysis of impairment above. A rollforward of the provision, if any, is included in Note 4 to our consolidated financial statements in “Financial Statements and Supplementary Data.”
Valuation of Derivatives
Similarly, our derivative instruments are carried at fair value pursuant to Statement of Financial Accounting Standards ("SFAS"SFAS'') No. 133 "Accounting for Derivative Instruments and Hedging Activities,"'' as amended. Fair value is based on counterparty quotations. To the extent they qualify as cash flow hedges under SFAS No. 133, net unrealized gains or losses are reported as a component of accumulated other comprehensive income; otherwise, they are reported currently in income. To the extent they qualify as a componentfair value hedges, net unrealized gains or losses on both the derivative and the related portion of currentthe hedged item are reported currently in income. Fair values of such derivatives are subject to significant variability based on many of the same factors as the securities discussed above. The results of such variability could be a significant increase or decrease in our book equity and/or earnings.
Impairment of Loans
We purchase, directly and indirectly, real estate related, commercial mortgage and residential mortgage loans, including manufactured housing loans, to be held for investment. We must periodically evaluate each of these loans or loan pools for possible impairment. Impairment is indicated when it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the loan, or, for loans acquired at a discount for credit losses, when it is deemed probable that we will be unable to collect as anticipated. Upon determination of impairment, we would establish a specific valuation allowance with a corresponding charge to earnings. We continually evaluate our loans receivable for impairment. Our residential mortgage loans, including manufactured housing loans, are aggregated into pools for evaluation based on like characteristics, such as loan type and acquisition date. Individual loans are evaluated based on an analysis of the borrower’s performance, the credit rating of the borrower, debt service coverage and loan to value ratios, the estimated value of the underlying collateral, the key terms of the loan, and the effect of local, industry and broader economic trends and factors. Pools of loans are also evaluated based on similar criteria, including trends in defaults, delinquencies and loss severities for the type and seasoning of loans being evaluated. This information is used to estimate specific impairment charges on individual loans as well as provisions for estimated unidentified incurred losses on pools of loans. Significant judgment is required both in determining impairment and in estimating the resulting loss allowance. In
2003, a loss allowanceWe have recorded approximately $2.9 million of $0.1 million was recordedimpairment with respect to the residential mortgageICH loans in our portfolio. No2005, primarily related to a single borrower who defaulted on a number of cross-collateralized loans. In 2006, we transferred those loans out of the securitization trust, and foreclosed on the related properties. To date, no other loan impairments have been recorded to date.
recorded.
Revenue Recognition on Loans
Income on these loans is recognized similarly to that on our securities and is subject to similar uncertainties and contingencies.
contingencies, which are also analyzed on at least a quarterly basis. For loans acquired at a discount for credit quality, the net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income, offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Provision for Credit Losses. The provision is determined based on an evaluation of the loans as described under “Impairment of Loans” above. We have recorded approximately $5.5 million of provision related to our residential mortgage loan segment in 2005. A rollforward of the provision is included in Note 5 to our consolidated financial statements in “Financial Statements and Supplementary Data.”
Impairment of Operating Real Estate
We own operating real estate held for investment. We review our operating real estate for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Upon determination of impairment, we would record a write-down of the asset, which would be charged to earnings. Significant judgment is required both in determining impairment and in estimating the resulting write-down. To date, we have determined that no write-downs have been necessary on the operating real estate in our portfolio. In addition, when operating real estate is classified as held for sale, it must be recorded at the lower of its carrying amount or fair value less costs of sale. Significant judgment is required in determining the fair value of such properties. In December 2003, we classified five properties as held for sale and recorded a loss of $1.5 million; these properties were sold in June 2004. In March 2004, we classified one property as held for sale, which did not result in a loss; this property was still heldsold in June 2005 at a net loss of $0.7 million, primarily due to costs associated with the sale. No other losses have been recorded with respect to operating real estate subsequent to our initial public offering.
Accounting Treatment for Certain Investments Financed with Repurchase Agreements
We owned $323.2 million of assets purchased from particular counterparties which are financed via $287.5 million of repurchase agreements with the same counterparties at December 31, 2004.2005. Currently, we record such assets and the related financings gross on our balance sheet, and the corresponding interest income and interest expense gross on our income statement. In December 2004, we sold two properties ataddition, if the asset is a gain of $5.3
million. In January 2005, we classified one property as heldsecurity, any change in fair value is reported through other comprehensive income (since it is considered “available for sale, which did
not resultsale”).
However, in a
loss.
23
RESULTS OF OPERATIONStransaction where assets are acquired from and financed under a repurchase agreement with the same counterparty, the acquisition may not qualify as a sale from the seller’s perspective; in such cases, the seller may be required to continue to consolidate the assets sold to us, based on their “continuing involvement” with such investments. The result is that we may be precluded from presenting the assets gross on our balance sheet as we currently do, and may instead be required to treat our net investment in such assets as a derivative.
If it is determined that these transactions should be treated as investments in derivatives, the interest rate swaps entered into by us to hedge our interest rate exposure with respect to these transactions would no longer qualify for hedge accounting, but would, as the underlying asset transactions, also be marked to market through the income statement.
This potential change in accounting treatment does not affect the economics of the transactions but does affect how the transactions are reported in our financial statements. Our independent operations commenced in July 2002cash flows, our liquidity and our initial public
offering was completed in October 2002.ability to pay a dividend would be unchanged, and we do not believe our taxable income would be affected. Our net income and net equity would not be materially affected. In addition, this would not affect Newcastle’s status as a REIT or cause it to fail to qualify for its Investment Company Act exemption. We understand that this issue has been submitted to accounting standard setters for resolution. If we had one offeringwere to change our current accounting treatment for these transactions, our total assets and total liabilities would each be reduced by $287.9 million and $240.4 million at December 31, 2005 and 2004, respectively.
Results of preferred stock and twoOperations
We raised a significant amount of capital in public offerings in each of common stock during 2003 as well as three
offerings of common stock in 2004. These events resultedthese years, resulting in additional capital being deployed to our investments which, in turn, resulted incaused changes to our results operations. Furthermore, the results of operations described below
include the operations of our predecessor through July 12, 2002, the date of the
commencement of our operations. Therefore, many items discussed below prior to
such date will not have a continuing impact on our operations.
The following table summarizes the changes in our results of operations from year-to-year (dollars in thousands):
| | | Year-to-Year Increase (Decrease) | | Year-to-Year Percent Change | | Explanation | |
| | | 2005/2004 | | 2004/2003 | | 2005/2004 | | 2004/2003 | | 2005/2004 | | 2004/2003 | |
| Interest income | | $ | 122,755 | | $ | 92,578 | | | 54.4 | % | | 69.5 | % | | (1 | ) | | (1 | ) |
| Rental and escalation income | | | 1,903 | | | 506 | | | 40.1 | % | | 11.9 | % | | (2 | ) | | (2 | ) |
| Gain on sale of investments | | | 1,991 | | | 5,135 | | | 10.9 | % | | 39.0 | % | | (3 | ) | | (3 | ) |
| Other income | | | 1,895 | | | (634 | ) | | 222.9 | % | | (42.7 | %) | | (4 | ) | | | |
| Interest expense | | | 90,048 | | | 59,521 | | | 66.0 | % | | 77.4 | % | | (1 | ) | | (1 | ) |
| Property operating expense | | | (212 | ) | | 148 | | | (8.2 | %) | | 6.1 | % | | (2 | ) | | (2 | ) |
| Loan and security servicing expense | | | 2,936 | | | 903 | | | 96.0 | % | | 41.9 | % | | (1 | ) | | (1 | ) |
| Provision for credit losses | | | 8,421 | | | - | | | N/A | | | N/A | | | (5 | ) | | | |
| General and administrative expense | | | (438 | ) | | 1,449 | | | (9.5 | %) | | 46.0 | % | | (6 | ) | | (6 | ) |
| Management fee to affiliate | | | 2,705 | | | 4,152 | | | 25.5 | % | | 64.2 | % | | (7 | ) | | (7 | ) |
| Incentive compensation to affiliate | | | (332 | ) | | 1,733 | | | (4.2 | %) | | 27.8 | % | | (7 | ) | | (7 | ) |
| Depreciation and amortization | | | 190 | | | 46 | | | 42.1 | % | | 11.4 | % | | (8 | ) | | (8 | ) |
| Equity in earnings of | | | | | | | | | | | | | | | | | | | |
| unconsolidated subsidiaries, net of taxes on related taxable subsidiaries | | | (4,348 | ) | | 9,095 | | | (43.7 | %) | | 1,055.1 | % | | (9 | ) | | (9 | ) |
| Income from continuing operations | | $ | 20,878 | | $ | 38,728 | | | 22.2 | % | | 70.1 | % | | | | | | |
Year-to-Year Year-to-Year
Increase (Decrease) Percent Change Explanation
--------------------- --------------------- ----------------------
2004/2003 2003/2002 2004/2003 2003/2002 2004/2003 2003/2002
--------- --------- --------- --------- --------- ----------
Interest| (1) | Changes in interest income $92,002 $61,458 68.3% 83.9% (1) (1)
Rental and escalation income (2,701) 2,683 (16.7%) 19.8% (2) (2)
Gain on settlementexpense are primarily due to our acquisition during these periods of investments 4,791 1,790 36.4% 15.7% (3) (3)
Management fee from affiliate -- (4,470) -- N/A (4) (4)
Incentive income from affiliate -- 1,218 -- N/A (4) (4)
Interest expense 59,763 32,709 75.6% 70.5% (1) (1)
Property operating expense (538) 891 (6.9%) 12.9% (2) (2)
Loaninterest bearing assets and security servicing expense 903 1,499 41.9% 228.9% (1) (1)
General and administrative expense 1,444 838 45.2% 35.6% (5) (5)
Management fee to affiliate 4,152 (2,782) 64.2% (30.1%) (6) (6)
Incentive compensation to affiliate 1,733 3,370 27.8% 118.0% (6) (6)
Depreciation and amortization 110 (366) 9.2% (23.5%) (7) (7)
Equity in earnings of
unconsolidated subsidiaries 9,095 500 1,055.1% 138.1% (8) (8)
------- ------- ------- -----
Income from continuing operations $35,620 $27,020 60.6% 85.1%
======= ======= ======= =====
|
(1) Changes in interest income and expense are primarily due to our acquisition
of interest bearing assets and related financings, as follows:
Year-to-Year Income (Decrease)
---------------------------------------------
Interest Income Interest Expense
--------------------- ---------------------
2004/2003 2003/2002 2004/2003 2003/2002
--------- --------- --------- ---------
Real estate security and loan portfolios(A) $43,682 $41,551 $31,856 $28,039
ABS-manufactured housing portfolio 14,211 733 4,824 205
Residential mortgage loan portfolio 7,113 11,004 4,701 5,504
ICH CMO loan portfolio 13,870 4,988 11,878 4,074
Other real estate related loans 9,332 593 3,528 230
Other 3,794 2,589 2,976 (5,343)
------- ------- ------- -------
$92,002 $61,458 $59,763 $32,709
======= ======= ======= =======
financings, as follows
(A) Represents our second through our sixth CBO financings and the acquisition
of the related collateral.
| | | Year-to-Year Increase | |
| | | Interest Income | | Interest Expense | |
| | | 2005/2004 | | 2005/2004 | |
| Real estate security and loan portfolios (A) | | $ | 61,251 | | $ | 48,213 | |
| Agency RMBS | | | 18,350 | | | 16,981 | |
| Residential mortgage loan portfolio | | | 1,147 | | | 5,727 | |
| Manufactured housing loan portfolio | | | 27,717 | | | 13,164 | |
| Other real estate related loans | | | 20,878 | | | 3,809 | |
| Other (B) | | | 3,181 | | | 7,023 | |
| ABS - manufactured housing portfolio (C) | | | (2,777 | ) | | (426 | ) |
| ICH loan portfolio (C) | | | (3,963 | ) | | (3,655 | ) |
| Other real estate related loans (C) | | | (3,029 | ) | | (788 | ) |
| | | $ | 122,755 | | $ | 90,048 | |
| (A) Represents our third through our eighth CBO financings and the acquisition of the |
| related collateral. | | | | | | | |
| (B) Primarily due to increasing interest rates on floating rate assets and liabilities owned |
| during the entire period. | | | | | | | |
| (C) These loans received paydowns during the period which served to offset the |
| amounts listed above. | | | | | | | |
| | | Year-to-Year Increase | |
| | | Interest Income | | Interest Expense | |
| | | 2004/2003 | | 2004/2003 | |
| Real estate security and loan portfolios (A) | | $ | 43,682 | | $ | 31,856 | |
| ABS - manufactured housing portfolio | | | 14,211 | | | 4,824 | |
| Residential mortgage loan portfolio | | | 7,113 | | | 4,701 | |
| ICH loan portfolio | | | 13,870 | | | 11,878 | |
| Other real estate related loans | | | 9,332 | | | 3,528 | |
| Other (B) | | | 4,370 | | | 2,734 | |
| | | $ | 92,578 | | $ | 59,521 | |
| (A) Represents our second through our seventh CBO financings and the acquisition of the |
| related collateral. | | | | | | | |
| (B) Primarily due to increasing interest rates on floating rate assets and liabilities owned |
| during the entire period. | | | | | | | |
Changes in loan and security servicing expense are also primarily due to these acquisitions.
(2)
| (2) | These changes are primarily the result of the effect of the termination of a lease (including the acceleration of lease termination income), offset by foreign currency fluctuations. |
| (3) | These changes are primarily a result of the volume of sales of real estate securities. Sales of real estate securities are based on a number of factors including credit, asset type and industry and can be expected to increase or decrease from time to time. Periodic fluctuations in the volume of sales of securities is dependent upon, among other things, management's assessment of credit risk, asset concentration, portfolio balance and other factors. |
| (4) | The increase from 2004 to 2005 is primarily the result of recent investments in total return swaps which are treated as non-hedge derivatives and marked to market through the income statement. |
| (5) | The increase from 2004 to 2005 is primarily the result of the acquisition of manufactured housing and residential mortgage loan pools at a discount for credit quality and $2.9 million of impairment recorded with respect to the ICH loans in 2005. |
| (6) | The changes in general and administrative expense are primarily increases as a result of our increased size, resulting from our equity issuances during the periods presented, offset by decreases in insurance and professional fees. Professional fees increased in 2004 due to the initial adoption of the Sarbanes-Oxley Act of 2002, then decreased in 2005 as a result of cost savings in the second year of adoption. |
| (7) | The increases in management fees are a result of our increased size resulting from our equity issuances during these periods. The changes in incentive compensation are primarily a result of our increased earnings, offset by FFO losses recorded with respect to the sale of certain properties during these periods. |
| (8) | The increase in depreciation is primarily due to the acquisition of new information systems. |
| (9) | The changes in earnings from unconsolidated subsidiaries are primarily a result of our late 2003 acquisition of an interest in an LLC which owns a portfolio of real estate related loans and our early 2004 acquisition of an interest in an LLC which owns a portfolio of convenience and retail gas stores, offset by the fact that a significant portion of the latter portfolio, which was held for sale from the date it was acquired, was sold during these periods. Note that the amounts shown are net of income taxes on related taxable subsidiaries. |
Liquidity and the termination of a lease, offset by foreign currency
fluctuations.
(3) These changes are primarily a result of the volume of sales of real estate
securities. Sales of real estate securities are based on a number of
factors including credit, asset type and industry and can be expected to
increase or decrease from time to time. Periodic fluctuations in the volume
of sales of securities is dependent upon, among other things, management's
assessment of credit risk, asset concentration, portfolio balance and other
factors.
(4) These items relate to our predecessor's investment in Fund I, prior to its
distribution to Holdings.
(5) The increases in general and administrative expense are primarily a result
of our increased size, resulting from our equity issuances during this
period, as well as due to increased professional fees related to our
compliance with the Sarbanes-Oxley Act of 2002.
24
(6) Excluding management fees and incentive compensation which were passed
through our predecessor to our manager and which related to our
predecessor's investment in Fund I, the changes in management fees and
incentive compensation were as follows:
Year-to-Year Increase
(Decrease)
---------------------
2004/2003 2003/2002
--------- ---------
Management Fee to Affiliate $4,152 $1,688
Incentive Compensation to Affiliate $1,733 $2,761
The increases in management fees are a result of our increased size
resulting from our equity issuances during these periods. The increases in
incentive compensation are primarily a result of our increased earnings.
(7) The 2003/2002 decrease in depreciation and amortization is primarily the
result of the distribution of depreciable assets to Holdings. The 2004/2003
increase is primarily due to foreign currency fluctuations.
(8) The increase in earnings from unconsolidated subsidiaries are primarily a
result of our late 2003 acquisition of an interest in an LLC which owns a
portfolio of real estate related loans and our early 2004 acquisition of an
interest in an LLC which owns a portfolio of convenience and retail gas
stores. Note that the amounts shown are net of income taxes on related
taxable subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
Capital Resources Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, and other general business needs. Additionally, to maintain our status as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our REIT taxable income. Our primary sources of funds for liquidity consist of net cash provided by operating activities, borrowings under loans, and the issuance of debt and equity securities. Additional sources of liquidity include investments that are readily saleable prior to their maturity. Our debt obligations are generally secured directly by our investment assets.
We expect that our cash on hand and our cash flow provided by operations, as well as our credit facility, will satisfy our liquidity needs with respect to our current investment portfolio over the next twelve months. However, we currently expect to seek additional capital in order to grow our investment portfolio. We have an effective shelf registration statement with the SEC which allows us to issue various types of securities, such as common stock, preferred stock, depository shares, debt securities and warrants, from time to time, up to an aggregate of $750 million, of which approximately $448$311 million remained available as of December 31, 2004.
2005.
We expect to meet our long-termlong term liquidity requirements, specifically the repayment of our debt obligations, through additional borrowings and the liquidation or refinancing of our assets at maturity. We believe that the value of these assets is, and will continue to be, sufficient to repay our debt at maturity under either scenario. Our ability to meet our long-termlong term liquidity requirements relating to capital required for the growth of our investment portfolio is subject to obtaining additional equity and debt financing. Decisions by investors and lenders to enter into such transactions with us will depend upon a number of factors, such as our historical and projected financial performance, compliance with the terms of our current credit arrangements, industry and market trends, the availability of capital and our investors'investors’ and lenders'lenders’ policies and rates applicable thereto, and the relative attractiveness of alternative investment or lending opportunities. We maintain access to a broad array of capital resources in an effort to insulate our business from potential fluctuations in the availability of capital.
Our ability to execute our business strategy, particularly the growth of our investment portfolio, depends to a significant degree on our ability to obtain additional capital. Our core business strategy is dependent upon our ability to finance our real estate securities and other real estate related assets with match-fundedmatch funded debt at rates that provide a positive net spread. If spreads for such liabilities widen or if demand for such liabilities ceases to exist, then our ability to execute future financings will be severely restricted. Furthermore, in an environment where spreads are tightening, if spreads tighten on the assets we purchase to a greater degree than they tighten on the liabilities we issue, our net spread will be reduced.
We expect to meet our
short-termshort term liquidity requirements generally through our cash flow provided by operations
and our credit facility, as well as investment specific borrowings. In addition, at December 31,
2004,2005, we had an unrestricted cash balance of
$37.9
million.$21.3 million and an undrawn balance of $55.0 million on our credit facility. Our cash flow provided by operations differs from our net income due to
fourfive primary factors: (i) accretion of discount or premium on our real estate securities and loans
(including the accrual of interest and fees payable at maturity), discount on our debt obligations, deferred financing costs and interest rate cap premiums, and deferred hedge gains and losses, (ii) gains and losses from sales of assets financed with CBOs, (iii) depreciation
and straight-lined rental income of our operating real estate,
(iv) the provision for credit losses recorded in connection with our loan assets, and
(iv) straight-lined rental income.(v) unrealized gains or losses on our non-hedge derivatives, particularly our total return swaps and our warehouse agreements, as described below. Proceeds from the sale of assets which serve as collateral for our CBO financings, including gains thereon, are required to be retained in the CBO structure until the related bonds are retired and are therefore not available to fund current cash needs.
25
Our match-fundedmatch funded investments are financed long-termlong term and their credit status is continuously monitored; therefore, these investments are expected to generate a generally stable current return, subject to limited interest rate fluctuations. See "Quantitative and Qualitative Disclosures About Market Risk --— Interest Rate Exposure"Exposure'' below. Our remaining investments, generally financed with short term repurchase agreements, are also subject to refinancing risk upon the maturity of the related debt. See "Debt Obligations"“Debt Obligations” below.
With respect to our operating real estate, we expect to incur expenditures of approximately $0.5$4.1 million relating to tenant improvements in connection with the inception of leases and capital expenditures during the year ending December 31, 2005.
2006.
With respect to one of our real estate related loans, we were committed to fund up to an additional
$22.7$11.9 million at December 31,
2004,2005, subject to certain conditions to be met by the borrower.
26
As described below, under “Interest Rate, Credit and Spread Risk,” we are subject to margin calls in connection with our assets financed with repurchase agreements. We do not expect these potential margin calls to materially affect our financial condition or results of operations.
Debt Obligations
The following table presents certain information regarding our debt obligations and related hedges as of December 31, 20042005 (unaudited) (dollars in thousands):
Debt Obligation/Collateral | | | Month Issued | | | Current Face Amount | | | Carrying Value | | | Unhedged Weighted Average Funding Cost | | | Final Stated Maturity | | | Weighted Average Funding Cost (1) | | | Weighted Average Maturity (Years) | | | Face Amount of Floating Rate Debt | | | Collateral Carrying Value | | | Collateral Weighted Average Maturity (Years) | | | Face Amount of Floating Rate Collateral | | | Aggregate Notional Amount of Current Hedges | |
CBO Bonds Payable | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate securities | | | Jul 1999 | | $ | 426,653 | | $ | 423,191 | | | 5.67% (2) | | | Jul 2038 | | | 4.89 | % | | 3.18 | | $ | 331,653 | | $ | 562,803 | | | 5.01 | | $ | - | | $ | 262,732 | |
| Real estate securities and loans | | | Apr 2002 | | | 444,000 | | | 441,054 | | | 5.43% (2) | | | Apr 2037 | | | 6.56 | % | | 4.46 | | | 372,000 | | | 498,998 | | | 5.61 | | | 56,526 | | | 290,000 | |
| Real estate securities and loans | | | Mar 2003 | | | 472,000 | | | 468,413 | | | 5.46% (2 | | | Mar 2038 | | | 5.08 | % | | 6.30 | | | 427,800 | | | 516,042 | | | 5.25 | | | 142,775 | | | 276,060 | |
| Real estate securities and loans | | | Sep 2003 | | | 460,000 | | | 455,657 | | | 5.16% (2) | | | Sep 2038 | | | 5.38 | % | | 6.85 | | | 442,500 | | | 506,290 | | | 4.71 | | | 180,598 | | | 192,500 | |
| Real estate securities and loans | | | Mar 2004 | | | 414,000 | | | 410,511 | | | 5.15% (2) | | | Mar 2039 | | | 4.94 | % | | 6.61 | | | 382,750 | | | 444,037 | | | 5.27 | | | 214,876 | | | 165,300 | |
| Real estate securities and loans | | | Sep 2004 | | | 454,500 | | | 450,639 | | | 5.09% (2) | | | Sep 2039 | | | 5.03 | % | | 7.19 | | | 442,500 | | | 494,099 | | | 5.80 | | | 221,569 | | | 189,373 | |
| Real estate securities and loans | | | Apr 2005 | | | 447,000 | | | 442,379 | | | 4.85% (2) | | | Apr 2040 | | | 5.10 | % | | 8.17 | | | 439,600 | | | 481,954 | | | 6.54 | | | 193,471 | | | 243,337 | |
| Real estate securities | | | Dec 2005 | | | 442,800 | | | 438,540 | | | 4.83% (2) | | | Dec 2050 | | | 5.14 | % | | 9.53 | | | 436,800 | | | 497,935 | | | 8.49 | | | 97,349 | | | 341,506 | |
| | | | | | | 3,560,953 | | | 3,530,384 | | | | | | | | | 5.27 | % | | 6.55 | | | 3,275,603 | | | 4,002,158 | | | 5.86 | | | 1,107,164 | | | 1,960,808 | |
| Other Bonds Payable | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| ICH loans (3) | | | (3) | | | 141,311 | | | 141,311 | | | 6.68% (2) | | | Aug 2030 | | | 6.68 | % | | 1.46 | | | 3,605 | | | 161,288 | | | 1.55 | | | 3,605 | | | - | |
| Manufactured housing loans (4) | | | Jan 2005 | | | 212,019 | | | 212,019 | | | LIBOR +1.25% | | | Jan 2006(7) | | | 5.45 | % | | 0.08 | | | 212,019 | | | 267,456 | | | 5.78 | | | 6,356 | | | 227,576 | |
| | | | | | | 353,330 | | | 353,330 | | | | | | | | | 5.94 | % | | 0.63 | | | 215,624 | | | 428,744 | | | 4.23 | | | 9,961 | | | 227,576 | |
| Notes Payable | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgage loans (4) | | | Nov 2004 | | | 260,441 | | | 260,441 | | | LIBOR+0.16% | | | Nov 2007 | | | 4.70 | % | | 1.21 | | | 260,441 | | | 288,683 | | | 2.69 | | | 282,589 | | | - | |
| | | | | | | 260,441 | | | 260,441 | | | | | | | | | 4.70 | % | | 1.21 | | | 260,441 | | | 288,683 | | | 2.69 | | | 282,589 | | | - | |
| Repurchase Agreements (4) (10) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgage loans | | | Rolling | | | 41,853 | | | 41,853 | | | LIBOR + 0.43% | | | Mar 2006 | | | 4.95 | % | | 0.25 | | | 41,853 | | | 44,543 | | | 2.98 | | | 43,511 | | | - | |
| Agency RMBS (5) | | | Rolling | | | 671,526 | | | 671,526 | | | LIBOR + 0.13% | | | Jan 2006 | | | 4.48 | % | | 0.08 | | | 671,526 | | | 692,486 | | | 4.90 | | | - | | | 665,965 | |
| Real estate securities | | | Rolling | | | 149,546 | | | 149,546 | | | LIBOR + 0.58% | | | Various (8) | | | 4.65 | % | | 0.16 | | | 149,546 | | | 166,737 | | | 5.86 | | | 31,450 | | | 89,403 | |
| Real estate related loans | | | Rolling | | | 185,278 | | | 185,278 | | | LIBOR + 1.01% | | | Various (8) | | | 5.38 | % | | 0.08 | | | 185,278 | | | 266,669 | | | 1.82 | | | 266,630 | | | - | |
| | | | | | | 1,048,203 | | | 1,048,203 | | | | | | | | | 4.68 | % | | 0.10 | | | 1,048,203 | | | 1,170,435 | | | 4.29 | | | 341,591 | | | 755,368 | |
| Credit facility (6) | | | | | | 20,000 | | | 20,000 | | | LIBOR +2.50% (9) | | | Jul 2008 | | | 6.86 | % | | 2.55 | | | 20,000 | | | - | | | - | | | - | | | - | |
| Total debt obligations | | | | | $ | 5,242,927 | | $ | 5,212,358 | | | | | | | | | 5.17 | % | | 4.59 | | $ | 4,819,871 | | $ | 5,890,020 | | | 5.27 | | $ | 1,741,305 | | $ | 2,943,752 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Unhedged| (1) Including the effect of applicable hedges. |
(2) Weighted Weighted
Current Weighted Final Average Average
Debt Obligation/Collateral Month Face Carrying Average Stated Funding Maturity
CBO Bonds Payable Issued Amount Value Funding Cost Maturity Cost (1) (Years)
- -------------------------- ---------- ---------- ---------- ------------ ---------- -------- --------
Real estate securitiesaverage, including floating and loans July 1999 $ 436,895 $ 432,893 4.08% (2) July 2038 4.85% 4.21
Real estate securitiesfixed rate classes. |
| (3) See "Business-Our Investing Activities-Real Estate Related Loans" above. |
| (4) Subject to potential mandatory prepayments based on collateral value. |
| (5) A maximum of $1 billion is available until November 2006. |
| (6) A maximum of $100 million can be drawn (increased from $75 million in February 2006). |
| (7) This financing was replaced with a new term financing in January 2006; the new maturity date is January 2009. |
| (8) The longest maturity is March 2006. |
(9) In addition, unused commitment fees of between 0.125% and loans April 2002 444,000 440,427 3.67% (2) April 2037 6.18% 5.38
Real estate securities0.250% are paid. |
(10) The counterparties on our repurchase agreements include: Bank of America Securities LLC ($693.4 million), Bear Stearns Mortgage Capital Corporation ($181.1 million), Greenwich Capital Markets Inc ($72.2 million), Deutsche Bank AG ($58.1 million), and loans March 2003 472,000 467,905 3.68% (2) March 2038 4.45% 7.31
Real estate securities and loans Sept. 2003 460,000 455,115 3.28% (2) Sept. 2038 4.32% 7.87
Real estate securities and loans March 2004 414,000 410,018 3.31% (2) March 2039 3.85% 7.63
Real estate securities and loans Sept. 2004 454,500 450,152 3.16% (2) Sept. 2039 3.90% 8.20
---------- ---------- ---- ----
2,681,395 2,656,510 4.59% 6.78
---------- ---------- ---- ----
Other Bonds Payable
Bell Canada portfolio (3) April 2002 42,885 42,422 7.02% April 2012 7.02% 1.43
ICH CMO loans (4) (4) 179,844 179,844 6.61% (2) Aug. 2030 6.61% 2.79
---------- ---------- ---- ----
222,729 222,266 6.69% 2.53
---------- ---------- ---- ----
Notes Payable
Real estate related loan Nov. 2003 67,523 67,523 LIBOR+1.50% Nov. 2006 3.92% 1.64
Real estate related loan (5) Feb. 2004 40,000 40,000 LIBOR+1.50% Feb. 2005 4.26% 0.17
Residential mortgage loans (6) Nov. 2004 544,477 544,477 LIBOR+0.15% Nov. 2007 2.46% 2.10
---------- ---------- ---- ----
652,000 652,000 2.72% 1.93
---------- ---------- ---- ----
Repurchase Agreements (6)
Residential mortgage loans (7) Rolling 67,382 67,382 LIBOR +0.43% Mar. 2005 2.99% 0.25
ABS-manufactured housing (8) Rolling 103,738 103,738 LIBOR +0.64% Mar. 2005 4.29% 0.17
Agency RMBS (9) Rolling 195,754 195,754 LIBOR +0.13% Jan. 2005 3.81% 0.08
Real estate securities Rolling 67,471 67,471 LIBOR +0.61% Oct. 2005 3.29% 0.22
Real estate related loans (10) Rolling 56,275 56,275 LIBOR +0.95% Oct. 2005 3.34% 0.69
---------- ---------- ---- ----
490,620 490,620 3.67% 0.21
---------- ---------- ---- ----
Total debt obligations $4,046,744 $4,021,396 4.29% 4.97
========== ========== ==== ====
Aggregate
Collateral Face Notional
Face Weighted Amount Amount of
Amount Collateral Average of Floating Currently
Debt Obligation/Collateral of Floating Carrying Maturity Rate Hedges Effective
CBO Bonds Payable Rate Debt Value (Years) Collateral Owned Hedges
- -------------------------- ----------- ---------- ---------- ----------- ----------- ----------
Two swaps,
Real estate securities and loans $ 341,895 $ 587,861 6.04 $ -- one cap $ 328,699
One swap,
Real estate securities and loans 372,000 505,927 6.16 84,733 one cap 290,000
One swap,
Real estate securities and loans 427,800 499,813 5.60 144,682 one cap 276,060
One swap,
Real estate securities and loans 442,500 497,524 4.93 233,990 one cap 192,500
Real estate securities and loans 382,750 449,244 6.01 217,652 One swap 165,300
Real estate securities and loans 442,500 499,867 6.46 252,886 One swap 189,373
---------- ---------- ---- ---------- ----------
2,409,445 3,040,236 5.87 933,943 1,441,932
---------- ---------- ---- ---------- ----------
Other Bonds Payable
Bell Canada portfolio (3) -- 57,193 N/A -- None --
ICH CMO loans (4) 3,684 202,674 2.86 3,684 None --
---------- ---------- ---------- ----------
3,684 259,867 3,684 --
---------- ---------- ---------- ----------
Notes Payable
Real estate related loan 67,523 83,909 1.64 83,909 None --
Real estate related loan (5) 40,000 50,000 2.13 50,000 None --
Residential mortgage loans (6) 544,477 583,922 3.76 575,759 None --
---------- ---------- ---- ---------- ----------
652,000 717,831 3.40 709,668 --
---------- ---------- ---- ---------- ----------
Repurchase Agreements (6)
Residential mortgage loans (7) 67,382 70,862 4.49 69,622 None --
ABS-manufactured housing (8) 103,738 146,309 5.11 -- Eight swaps 95,700
Agency RMBS (9) 195,754 201,528 3.35 -- Three swaps 195,409
Real estate securities 67,471 91,771 3.73 32,609 Two swaps 21,295
Real estate related loans (10) 56,275 73,500 1.87 73,500 None --
---------- ---------- ---- ---------- ----------
490,620 583,970 3.80 175,731 312,404
---------- ---------- ---- ---------- ----------
Total debt obligations $3,555,749 $4,601,904 $1,823,026 $1,754,336
========== ========== ========== ==========
other ($43.4 million). |
(1) Including the effect of applicable hedges.
(2) Weighted average, including floating and fixed rate classes.
(3) Denominated in Canadian dollars.
(4) See "Business-Our Investing Activities-Real Estate Related Loans" above.
(5) Maturity date extended in January 2005 from February 2005 to February 2006.
(6) Subject to potential mandatory prepayments based on collateral value.
(7) The counterparty on this repo is Bear Stearns Mortgage Capital Corporation.
(8) The counterparty on these repos is Greenwich Capital Markets Inc.
(9) The counterparty on this repo is Bank of America Securities LLC.
(10) The counterparty on these repos is Deutsche Bank AG.
27
Our
long-term debt obligations existing at December 31,
20042005 (gross of
$25.3$30.6 million of discounts) have contractual maturities as follows (unaudited) (in millions):
2005 $ 535,870
2006 62,273
2007 544,477
2008 --
2009 --
Thereafter 2,904,124
----------
Total $4,046,744
==========
| 2006 | | $ | 1,260,222 | |
| 2007 | | | 260,441 | |
| 2008 | | | 20,000 | |
| 2009 | | | - | |
| 2010 | | | - | |
| Thereafter | | | 3,702,264 | |
| Total | | $ | 5,242,927 | |
Certain of the debt obligations included above are obligations of our consolidated subsidiaries which own the related collateral. In some cases, including the CBO and Other Bonds Payable, such collateral is not available to other creditors of ours.
In connection with the sale of two classes of CBO bonds, we entered into two
interest rate swaps and three interest rate cap agreements that do not qualify
for hedge accounting.
In November 2001, we sold the retained subordinated $17.5 million Class E Note from our first CBO to a third party. The Class E Note bore interest at a fixed
rate of 8.0% and had a stated maturity of June 2038. The sale of the Class E Note represented an issuance of debt and was recorded as additional CBO bonds payable. In April 2002, a wholly owned subsidiary of ours repurchased the Class E Note. The repurchase of the Class E Note represented a repayment of debt and was recorded as a reduction of CBO bonds payable. The Class E Note is included in the collateral for our second CBO. The Class E Note is eliminated in consolidation.
One class
Two classes of
theseparately issued CBO bonds, with
a $395.0an aggregate $718.0 million face amount,
waswere issued subject to remarketing procedures and related agreements whereby such bonds are remarketed and sold on a periodic basis.
These$395.0 million of these bonds are fully insured by a third party with respect to the timely payment of interest and principal thereon.
We enter into short-term warehouse agreements with major investment banks for
the right to purchase commercial mortgage backed securities, unsecured REIT
debt, real estate related loans and asset backed securities for our real estate
securities portfolios, prior to their being financed with CBOs. These agreements
are treated as non-hedge derivatives for accounting purposes and are therefore
marked to market through current income. If the related CBO is not consummated,
except as a result of our gross negligence, willful misconduct or breach of
contract, we would be required to pay the Net Loss, if any, as defined, up to
the related deposit, less any Excess Carry Amount, as defined, earned on such
deposit. Although we currently anticipate completing the most recent CBO in the
near term, there is no assurance that such CBO will be consummated or on what
terms it will be consummated. The following table summarizes the agreements (in
thousands):
December 31, 2004 Income (Loss) Recorded
------------------------------------- ----------------------
Deal Collateral Aggregate Fair
Status Accumulated (1) Deposit Value 2004 2003 2002
- --------- --------------- --------- ------- ------ ------ ----
Completed $2,604 $3,730 $652
Open $224,928 $24,901 $25,411 510 -- --
------ ------ ----
Total $3,114 $3,730 $652
====== ====== ====
(1) Excludes $32.5 million of collateral accumulated on balance sheet and
recorded in real estate securities.
In October 2003, pursuant to FIN No. 46R, we consolidated an entity which holds a portfolio of commercial mortgage loans which has been securitized. This investment, which we refer to as the ICH, CMO, was previously treated as a non-consolidated residual interest in such securitization. We exercise no
control over the management or resolution of these assets and our residual
investment in this entity was recorded at $2.9 million prior to its
consolidation. The primary effect of the consolidation is the requirement that we reflect the gross loan assets and gross bonds payable of this entity in our financial statements.
In July 2004, we refinanced $342.5 million of the AAA and AA bonds in our first CBO. $322.5 million of AAA bonds were refinanced at LIBOR + 0.30% from LIBOR + 0.65% and $20.0 million of AA bonds were refinanced at LIBOR + 0.50% from LIBOR + 0.80%.
During 2004,
In November 2005, Moody’s Investors Service upgraded the note payablecredit ratings on the LIV portfolionon-AAA classes of operating real estate was
repaidbonds within our first CBO by one to two notches.
Our debt obligations contain various customary loan covenants. Such covenants do not, in
full.
28
management’s opinion, materially restrict our investment strategy or ability to raise capital. We are in compliance with all of our loan covenants as of December 31, 2005.
In January 2005, weMarch 2006, a consolidated subsidiary of ours acquired a portfolio of approximately 8,100 manufactured
housing11,300 subprime residential mortgage loans for an aggregate purchase price of approximately $308.2 million.$1.50 billion. The loans, substantially all of which were all current at the time of acquisition, are primarily66% floating rate and 34% fixed rate with arate. Their weighted average coupon of approximately 9.00%is 7.6% and the loans have a weighted average remaining term of approximately 5.00 years. Our345 months. This acquisition was initially funded with an approximately $246.5 million of one-year debt provided by
two investment banks$1.47 billion repurchase agreement which is subject to adjustment based on the market value
and performance of the related portfolio. The debt bears interest at LIBOR + 1.25%0.50%. We obtainedhave entered into an interest rate swap in order to hedge our exposure to the risk of changes in market interest rates with respect to this debt. Other
In March 2004, we purchasedWe expect to finance this investment on a 49% interestlong term basis through the securitization markets in a portfolio of convenience and
retail gas stores located throughout the southeastern and southwestern regions
of the U.S. The properties are subject to a sale-leaseback arrangement under
long-term triple net leases with a 15 year minimum term. upcoming months.
Other
We structured this
transaction through a joint venture with an affiliate of our manager on equal
terms. In October 2004, the investment's initial financing was refinanced with a
nonrecourse term loan ($53.0 million outstanding at December 31, 2004). The term
loan bears interest at a fixed rate of 6.04%, with payments of interest only
during the first two years and a 25-year amortization schedule with a balloon
payment due in October 2014. This investment is reflected as an investment in an
unconsolidated subsidiary and is included in the operating real estate segment.
At December 31, 2004, we had a $17.8 million investment in this entity.
In November 2004, wehave entered into a total rate of return swaparrangements with a major investment bank to finance certain loans whereby we receive the sum of all interest, (at LIBOR + 2.25%), fees and any positive change in value amounts (the total return cash flows) from a referenced term loan (toreference asset with a retail mall REIT) with an initialspecified notional amount, of $107.0 million, and pay interest (at LIBOR + 0.50%) on such notional plus any negative change in value amounts from such loan. This agreement isasset. These agreements are recorded in Derivative Assets and treated as a
non-hedge derivativederivatives for accounting purposes and isare therefore marked to market through income. Net interest received is recorded to Interest Income and the mark to market is recorded to Other Income. If we owned the reference assets directly, they would not be marked to market. Under the agreement, we wereagreements, Newcastle is required to post an initial margin deposit equal to 17% of the notional amountan interest bearing account and additional margin may be payable in the event of a decline in value of the referenced term loan.reference asset. Any margin on deposit, less any negative change in value payments,amounts, will be returned to us upon termination of the contract. Stockholders'The following table presents information on these instruments as of December 31, 2005.
| Reference Asset | | Notional Amount | | Margin Amount | | Receive Interest Rate | | Pay Interest Rate | | Maturity Date | | Fair Value | |
| Term loan to a retail mall REIT | | $ | 106,083 | | $ | 18,149 | | | LIBOR +
2.000% | | | LIBOR +
0.500% | | | Nov 2008 | | $ | 1,008 | |
| Term loan to a diversified real estate and finance company | | | 97,997 | | | 19,599 | | | LIBOR +
3.000% | | | LIBOR +
0.625% | | | Feb 2008 | | | 877 | |
Mezzanine loan to a hotel company | | | 15,000 | | | 5,224 | | | LIBOR +
4.985% | | | LIBOR +
1.350% | | | Jun 2007 | | | 101 | |
| Term loan to a diversified real estate company | | | 94,954 | | | 9,495 | | | LIBOR +
1.750% | | | LIBOR +
0.500% | | | Aug 2007 | | | 904 | |
| Term loan to a retail company | | | 100,000 | | | 19,960 | | | LIBOR +
3.000% | | | LIBOR +
0.500% | | | Dec 2008 | | | 206 | |
| | | $ | 414,034 | | $ | 72,427 | | | | | | | | | | | $ | 3,096 | |
We enter into short term warehouse agreements pursuant to which we make deposits with major investment banks for the right to purchase commercial mortgage backed securities, unsecured REIT debt, real estate related loans and real estate related asset backed securities for our real estate securities portfolios, prior to their being financed with CBOs. These agreements are treated as non-hedge derivatives for accounting purposes and are therefore marked to market through current income. The cost to us if the related CBO is not consummated is limited, except where the non-consummation results from our gross negligence, willful misconduct or breach of contract, to payment of the Net Loss, if any, as defined, up to the related deposit, less any Excess Carry Amount, as defined, earned on such deposit. The income recorded on these agreements was approximately $2.4 million, $3.1 million and $3.6 million in 2005, 2004 and 2003, respectively.
Stockholders’ Equity
Common Stock Offerings
The following table presents information on shares of our common stock issued since our formation.
| Year | | Shares Issued | | Range of Issue Prices per Share (1) | | Net Proceeds (millions) | | Options Granted to Manager | |
| | | | | | | | | | |
| Formation | | | 16,488,517 | | | N/A | | | N/A | | | N/A | |
| 2002 | | | 7,000,000 | | $ | 13.00 | | $ | 80.0 | | | 700,000 | |
| 2003 | | | 7,886,316 | | $ | 20.35-$22.85 | | $ | 163.4 | | | 788,227 | |
| 2004 | | | 8,484,648 | | $ | 26.30-$31.40 | | $ | 224.3 | | | 837,500 | |
| 2005 | | | 4,053,928 | | $ | 29.60 | | $ | 108.2 | | | 330,000 | |
| December 31, 2005 | | | 43,913,409 | | | | | | | | | | |
Range| (1) | Excludes prices of Issue
Shares Prices Net Proceeds Options Granted
Year Issued per Share(1) (millions)shares issued pursuant to Manager
- ---- ---------- -------------- ------------ ---------------
Formation 16,488,517 N/A N/A N/A
2002 7,000,000 $13.00 $ 80.0 700,000
2003 7,886,316 $20.35-$22.85 $163.4 788,227
2004 8,484,648 $26.30-$31.40 $224.3 837,500
----------
December 31, 2004 39,859,481
==========
January 2005 3,879,000 $29.60 $105.4 330,000
|
(1) Excludes shares issued pursuant to the exercise of options and shares issued to
our independent directors.
Through December 31, 2005, our independent directors.
During 2003 and 2004, our manager had assigned, for no value, options to purchase approximately 0.8 million shares of our common stock to certain of our manager'smanager’s employees, of which approximately 0.10.2 million werehad been exercised. In addition, our manager had exercised in 2004.
0.7 million of its options.
As of December 31, 2004,2005, our outstanding options had a weighted average strike price of $21.25$25.14 and were summarized as follows:
Held by our manager 1,510,937
| | | 1,170,317 | |
Issued to our manager and subsequently assigned to certain of our manager's employees 707,790
| | | 627,490 | |
Held by directors 13,000
---------
and former directors | | | 14,000 | |
Total 2,231,727
=========
| | | 1,811,807 | |
29
Preferred Stock
In March 2003, we issued 2.5 million shares ($62.5 million face amount) of 9.75% Series B Cumulative Redeemable Preferred Stock (the "Series“Series B Preferred"Preferred”). In October 2005, we issued 1.6 million shares ($40.0 million face amount) of 8.05% Series C Cumulative Redeemable Preferred Stock (the “Series C Preferred”). The Series B Preferred hasand Series C Preferred have a $25 liquidation preference, no maturity date and no mandatory redemption. We have the option to redeem the Series B Preferred beginning in March 2008.
2008 and the Series C Preferred beginning in October 2010.
Other Comprehensive Income
During the year ended December 31,
2004,2005, our accumulated other comprehensive income increased due to the following factors (in thousands):
Accumulated other comprehensive income, December 31, 2003 $ 39,413
Unrealized gain on securities 34,088
Reclassification of realized (gain) on securities into earnings (14,574)
Foreign currency translation 1,984
Reclassification of realized foreign currency translation into earnings (1,478)
Unrealized gain on derivatives designated as cash flow hedges 11,973
Reclassification of realized loss on derivatives designated as cash
flow hedges into earnings 364
--------
Accumulated other comprehensive income, December 31, 2004 $ 71,770
========
| Accumulated other comprehensive income, December 31, 2004 | | $ | 71,770 | |
| Net unrealized (loss) on securities | | | (67,077 | ) |
| Reclassification of net realized (gain) on securities into earnings | | | (16,015 | ) |
| Foreign currency translation | | | (1,089 | ) |
| Reclassification of net realized foreign currency translation into earnings | | | (626 | ) |
| Net unrealized gain on derivatives designated as cash flow hedges | | | 56,426 | |
| Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings | | | 2,175 | |
| Accumulated other comprehensive income, December 31, 2005 | | $ | 45,564 | |
Our book equity changes as our real estate securities portfolio and derivatives are marked to market each quarter, among other factors. The primary causes of mark to market changes are changes in interest rates and credit spreads. During the year, the combination of tighteningwidening credit spreads and risingincreasing interest rates has resulted in a net increasedecrease in unrealized gains on our real estate securities portfolio. InWe believe that our ongoing investment activities benefit in general from an environment of widening credit spreads and increasing interest rates, we believe our new investment activities will benefit.rates. While such an environment will likely result in a decrease in the fair value of our existing securities portfolio and therefore reduce our book equity and ability to realize gains on such existing securities, it would not directly affect our earnings or our cash flow or our ability to pay a dividend.
In addition, the weakening of the U.S. dollar against both the Canadian dollar
and the Euro has resulted in an increase in unrealized gains on our Canadian and
Belgian operating real estate.
dividends.
Common Dividends Paid
| Declared for the Period Ended | | Paid | | Amount Per Share
- ----------------------------- ------------ ----------------
September 30, 2002 October 2002 $0.400
October 9, 2002 October 2002 $0.060
December 31, 2002 January 2003 $0.390
|
| March 31, 2003 | | April 2003 $0.450
| | $0.450 |
| June 30, 2003 | | July 2003 $0.500
| | $0.500 |
| September 30, 2003 | | October 2003 $0.500
| | $0.500 |
| December 31, 2003 | | January 2004 $0.500
| | $0.500 |
| March 31, 2004 | | April 2004 $0.600
| | $0.600 |
| June 30, 2004 | | July 2004 $0.600
| | $0.600 |
| September 30, 2004 | | October 2004 $0.600
| | $0.600 |
| December 31, 2004 | | January 2005 $0.625
| | $0.625 |
| March 31, 2005 | | April 2005 | | $0.625 |
| June 30, 2005 | | July 2005 | | $0.625 |
| September 30, 2005 | | October 2005 | | $0.625 |
| December 31, 2005 | | January 2006 | | $0.625 |
Our Predecessor
The following is a discussion of our predecessor's historical liquidity and
capital resources, primarily related to operations distributed to them.
In May 1999, Holdings closed on the $399.1 million GSA securitization, which
financed the GSA portfolio of operating real estate. The GSA securitization, and
related assets, were retained by Holdings.
In November 1999, Holdings obtained the $24.8 million GSA Kansas City mortgage,
which was repaid in May 2002 upon the sale of the related asset.
30
In July 2000, Holdings entered into a $40 million revolving credit agreement,
which bore interest at LIBOR +4.25%. Holdings hedged its exposure to the risk of
changes in market interest rates with respect to the credit agreement by
obtaining an interest rate swap. This credit agreement was retained by Holdings.
Cash Flow
Net cash flow provided by operating activities increased from $37.6$90.4 million for the year ended December 31, 2004 to $98.8 million for the year ended December 31, 2005. It increased from $38.5 million for the year ended December 31, 2003 to $78.0$90.4 million for the year ended December 31, 2004. It increased from $21.6 million for the year ended December 31, 2002
to $37.6 million for the year ended December 31, 2003. These changes resulted from the acquisition and settlement of our investments as described above,
including the distribution of investments to Holdings.
above.
Investing activities used ($1,319.71,334.7 million), ($1,652.71,332.2 million) and ($682.71,659.0 million) during the years ended December 31, 2005, 2004 2003 and 2002,2003, respectively. Investing activities consisted primarily of the acquisition of properties and the investments made in real estate securities and loans, net of proceeds from the sale or settlement of investments.
Financing activities provided $1,219.3 million, $1,630.0$1,219.3 million and $675.2$1,635.5 million during the years ended December 31, 2005, 2004 2003 and 2002,2003, respectively. The equity issuances, borrowings and debt issuances described above served as the primary sources of cash flow from financing activities. Offsetting uses included the payment of related deferred financing costs, the purchase of hedging instruments, the payment of dividends, the redemption of common and
preferred stock and the repayment of debt as described above.
See the consolidated statements of cash flows in our consolidated financial statements included in "Financial“Financial Statements and Supplementary Data"Data” for a reconciliation of our cash position (including our predecessor's cash position
prior to the commencement of our operations) for the periods described herein.
INTEREST RATE, CREDIT AND SPREAD RISK
Interest Rate, Credit and Spread Risk
We are subject to interest rate, credit and spread risk with respect to our investments.
Our primary interest rate exposures relate to our real estate securities, loans and floating rate debt obligations, as well as our interest rate swaps and caps. Changes in the general level of interest rates can effect our net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities and hedges. Changes in the level of interest rates also can effect, among other things, our ability to acquire real estate securities and loans at attractive prices, the value of our real estate securities, loans and derivatives, and our ability to realize gains from the settlementsale of such assets.
Our general financing strategy focuses on the use of match-fundedmatch funded structures. This means that we seek to match the maturities of our debt obligations with the maturities of our investments to minimize the risk that we have to refinance our liabilities prior to the maturities of our assets, and to reduce the impact of changing interest rates on our earnings. In addition, we generally match-fundmatch fund interest rates on our investments with like-kind debt (i.e., fixed rate assets are financed with fixed rate debt and floating rate assets are financed with floating rate debt), directly or through the use of interest rate swaps, caps or other financial instruments, or through a combination of these strategies, which allows us to reduce the impact of changing interest rates on our earnings. See "Quantitative“Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Exposure"Exposure” below.
Real Estate Securities
Interest rate changes may also impact our net book value as our real estate securities and related hedge derivatives are marked to market each quarter. Our loan investments and debt obligations are not marked to market. Generally, as interest rates increase, the value of our fixed rate securities decreases, and as interest rates decrease, the value of such securities will increase. In general, we would expect that over time, decreases in the value of our real estate securities portfolio attributable to interest rate changes will be offset to some degree by increases in the value of our swaps, and vice versa. However, the relationship between spreads on securities and spreads on swaps may vary from time to time, resulting in a net aggregate book value increase or decline. Our real estate securities portfolio is largely financed to maturity through long-termlong term CBO financings that are not redeemable as a result of book value changes. Accordingly, unless there is a material impairment in value that would result in a payment not being received on a security, changes in the book value of our securities portfolio will not directly affect our recurring earnings or our ability to pay a dividend.
dividends.
The commercial mortgageand asset backed securities we invest in are generally junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of one or more subordinate classes of securities or other form of credit support within a securitization transaction. The senior unsecured REIT debt securities we invest in reflect comparable credit risk. Credit risk refers to each individual borrower'sborrower’s ability to make
31
required interest and principal payments on the scheduled due dates. We believe, based on our due diligence process, that these securities offer attractive risk-adjusted returns with long-termlong term principal protection under a variety of default and loss scenarios. While the expected yield on these securities is sensitive to the performance of the underlying assets, the more subordinated securities or other features of the securitization transaction, in the case of commercial mortgage and asset backed securities, and the issuer'sissuer’s underlying equity and subordinated debt, in the case of senior unsecured REIT debt securities, are designed to bear the first risk of default and loss. We further minimize credit risk by actively monitoring our real estate securities and loan portfolio and the underlying credit quality of our holdings and, where appropriate, repositioning our investments to upgrade the credit quality and yield on our investments. While we have not experienced any significant credit losses, in the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults may increase and result in credit losses that would adversely affect our liquidity and operating results.
Our real estate securities portfolio is diversified by asset type, industry,
location and issuer. At December 31, 2004, we had 455 real estate securities and
loans, excluding the ICH CMO loans as described above. Our largest investment in
a real estate security or real estate related loan was $86.7 million and our
average investment size was $8.1 million at December 31, 2004. Furthermore, our
real estate securities are supported by pools of underlying loans. For instance,
our CMBS investments had 16,341 underlying loans at December 31, 2004. We expect
that this diversification also helps to minimize the risk of capital loss. At
December 31, 2004, our real estate securities and real estate related loans
(excluding the ICH loans as described above) had an overall weighted average
credit rating of approximately BBB-, and approximately 70% had an investment
grade rating (BBB- or higher).
Our real estate securities are also subject to spread risk. Our fixed rate securities are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. In other words, their value is dependent on the yield demanded on such securities by the market based on their credit relative to U.S. Treasuries. Excessive supply of such securities combined with reduced demand will generally cause the market to require a higher yield on such securities, resulting in the use of a higher (or "wider"“wider”) spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value such securities. Under such conditions, the value of our real estate securities portfolio would tend to decline. Conversely, if the spread used to value such securities were to decrease (or "tighten"“tighten”), the value of our real estate securities portfolio would tend to increase. Our floating rate securities are valued based on a market credit spread over LIBOR and are effected similarly by changes in LIBOR spreads. Such changes in the market value of our real estate securities portfolio may effect our net equity, net income or cash flow directly through their impact on the amount of unrealized gains or losses on available-for-sale securities, and therefore on our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital. If the value of our securities subject to repurchase agreements were to decline, it could affect our ability to refinance such loanssecurities upon the maturity of the related repurchase agreements.agreements, adversely impacting our rate of return on such securities. See "Quantitative“Quantitative and Qualitative Disclosures About Market Risk-Credit Spread Curve Exposure"Exposure” below.
Furthermore, shifts in the U.S. Treasury yield curve, which represents the market'smarket’s expectations of future interest rates, would also effect the yield required on our real estate securities and therefore their value. This would have similar effects on our real estate securities portfolio and our financial position and operations to a change in spreads.
Loans
Similar to our real estate securities portfolio, we are subject to credit and spread risk with respect to our real estate related commercial mortgage and residential mortgage loan portfolios. However, unlike our real estate securities portfolio, our loans generally do not benefit from the support of junior classes of securities, but rather bear the first risk of default and loss. We believe that this credit risk is mitigated through our due diligence process and periodiccontinual reviews of the borrower'sborrower’s payment history, delinquency status, and the relationship of the loan balance to the underlying property value. At December
31, 2004, our residential mortgage loan portfolio was characterized by high
credit quality borrowers with a weighted average FICO score of 722 at
origination, and had a weighted average loan to value ratio of 72.5%. As of
December 31, 2004, approximately $575.8 million of our residential mortgage
loans were held in securitized form, of which over 95% of the principal balance
was AAA rated.
Our loan portfolios are diversified by geographic location and by borrower. We
believe that this diversification also helps to minimize the risk of capital
loss.
Our loan portfolios are also subject to spread risk. Our floating rate loans are valued based on a market credit spread to LIBOR. The value of these loans is dependent upon the yield demanded by the market based on their credit relative to LIBOR. The value of our floating rate loans would tend to decline should the market require a higher yield on such loans, resulting in the use of a higher spread over the benchmark rate (usually the applicable LIBOR yield). Our fixed rate loans are valued based on a market credit spread over U.S. Treasuries and are effected similarly by changes in U.S. Treasury spreads. If the value of our loans subject to repurchase agreements were to decline, it could affect our ability to refinance such loans upon the maturity of the related repurchase agreements.
32
Any credit or spread losses incurred with respect to our loan portfolios would affect us in the same way as similar losses on our real estate securities portfolio as described above, except that our loan portfolios are not marked to market. OFF-BALANCE SHEET ARRANGEMENTS
Accordingly, unless there is a material impairment in value that would result in a payment not being received on a loan, changes in the value of our loan portfolio will not directly affect our recurring earnings or our ability to pay dividends.
Statistics
| | | Total Portfolio (1) | | Core Investment Portfolio (2) | |
| | | December 31, | | December 31, | |
| | | 2005 | | 2004 | | 2005 | | 2004 | |
| Face amount | | $ | 6,111,464 | | $ | 4,493,274 | | $ | 5,413,142 | | $ | 4,294,092 | |
| Percentage of total assets | | | 99 | % | | 91 | % | | 87 | % | | 87 | % |
| Weighted average asset yield | | | 6.59 | % | | 5.91 | % | | 6.85 | % | | 5.98 | % |
| Weighted average liability cost | | | 5.12 | % | | 4.15 | % | | 5.22 | % | | 4.17 | % |
| Weighted average net spread | | | 1.47 | % | | 1.76 | % | | 1.63 | % | | 1.81 | % |
| | | | | | | | | | | | | | |
| (1) Excluding the ICH loans, as described in "Business - Our Strategy." |
| (2) Excluding the ICH loans and Agency RMBS, as described in "Business - Our Strategy." |
As of December 31, 2004,2005, our core investment portfolio (as defined above) had an overall weighted average credit rating of approximately BB+, and approximately 67% had an investment grade rating (BBB- or higher).
Our real estate securities and loan portfolios are diversified by asset type, industry, location and issuer. At December 31, 2005, our core investment portfolio (as defined above) had 534 real estate securities and loans. The largest investment in our core investment portfolio was $138.8 million and its average investment size was $9.0 million at December 31, 2005. The weighted average credit spread on this portfolio (i.e. the yield premium on our investments over the comparable U.S. Treasury rate or LIBOR) was 2.61% as of December 31, 2005. Furthermore, our real estate securities are supported by pools of underlying loans. For instance, our CMBS investments had over 21,000 underlying loans at December 31, 2005. We expect that this diversification helps to minimize the risk of capital loss, and will also enhance the terms of our financing structures.
At December 31, 2005, our residential mortgage loan portfolio was characterized by high credit quality borrowers with a weighted average FICO score of 712 at origination. As of December 31, 2005, approximately $282.6 million face amount of our residential mortgage loans were held in securitized form, of which over 90% of the principal balance was AAA rated.
Our loan portfolios are diversified by geographic location and by borrower. Our residential and manufactured housing loans were well diversified with 919 loans and 7,067 loans, respectively, at December 31, 2005. We believe that this diversification also helps to minimize the risk of capital loss.
Margin
Certain of our investments are financed through repurchase agreements or total return swaps which are subject to margin calls based on the value of such investments. Margin calls resulting from decreases in value related to rising interest rates are substantially offset by our ability to make margin calls on our interest rate derivatives. We maintain adequate cash reserves or availability on our credit facility to meet any margin calls resulting from decreases in value related to a reasonably possible (in the opinion of management) widening of credit spreads. Funding a margin call on our credit facility would have a dilutive effect on our earnings, however we would not expect this to be material.
Off-Balance Sheet Arrangements
As of December 31, 2005, we had the followingno material off-balance sheet arrangements:
- - The $25.4 million carrying valuearrangements.
We did have the following arrangements which do not meet the definition of our deposit on our seventh real estate
securities portfolio, as described above under "-Liquidity and Capital
Resources." Except as a result of our gross negligence, willful misconduct
or breach of contract, our potential loss is limited to the amount shown,
which is included in our consolidatedoff balance sheet.
- - A guarantee of certain payments under an interest rate swap which may be
entered into in 2007 in connection with the securitizationsheet arrangements, but do have some of the Bell
Canada portfolio, if the related bonds are not fully repaid by such date.
We believe the fair valuecharacteristics of this guarantee is negligible at December 31,
2004.
At this time, we do not anticipate a substantial risk of incurring a loss with
respect to any of theoff balance sheet arrangements.
We are also party to a total return swapswaps which isare treated as a non-hedge derivative.derivatives. For further information on this investment,these investments, see "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
CONTRACTUAL OBLIGATIONS
”
We also have made investments in two unconsolidated subsidiaries. See Note 3 to our consolidated financial statements in “Financial Statements and Supplementary Data.”
In each case, our exposure to loss is limited to the carrying value of our investment.
Contractual Obligations
As of December 31, 2004,2005, we had the following material contractual obligations (payments in thousands):
| Contract | | Terms
- -------- -----
|
| CBO bonds payable | | Described under "Quantitative“Quantitative and Qualitative Disclosures About Market Risk"
Risk” |
| Other bonds payable | | Described under "Quantitative“Quantitative and Qualitative Disclosures About Market Risk"
Risk” |
| Notes payable | | Described under "Quantitative“Quantitative and Qualitative Disclosures About Market Risk"
Risk” |
| Repurchase agreements | | Described under "Quantitative“Quantitative and Qualitative Disclosures About Market Risk"
Risk” |
| Credit facility | | Described under “Quantitative and Qualitative Disclosures About Market Risk” |
| Interest rate swaps, treated as hedges | | Described under "Quantitative“Quantitative and Qualitative Disclosures About Market Risk"
Real estate securities portfolio
deposit Risk” |
| Non-hedge derivative obligations | | Described under "Quantitative“Quantitative and Qualitative Disclosures About Market Risk"
Non-hedge derivative obligations
Risk” |
CBO IV wrap agreement Described under "Quantitative and Qualitative
Disclosures About Market Risk" The largest
tranche | | Two classes of our CBO IV bonds, the $395.0with an aggregate $718.0 million face amount, of Class I-MM bonds, waswere issued subject to remarketing procedures and related agreements whereby such bonds are remarketed and sold on a periodic basis. The
Class I-MM$395.0 million of these bonds are fully insured by a third party with respect to the timely payment of interest and principal thereon, pursuant to a financial guaranty insurance policy ("wrap"(“wrap”). We pay annual fees of 0.12% of the outstanding face amount of the Class I-MM
bonds under this agreement. |
CBO IV backstop agreement agreements | | In connection with the remarketing procedures described above, a backstop agreement hasagreements have been created whereby a third party financial institution is required to purchase the Class
I-MM$718.0 million face amount of bonds at the end of any remarketing period if such bonds could not be resold in the market by the remarketing agent. We pay annual fees ofbetween 0.15% and 0.20% of the outstanding face amount of the Class I-MMsuch bonds under this
agreement.
these agreements. |
CBO IV remarketing agreement agreements | | In connection with the remarketing procedures described above, the remarketing agent is paid an annual fee of 0.05% of the outstanding face amount of the Class I-MM
bonds under the remarketing agreement.
agreements. |
| Loan servicing agreements | | We are a party to servicing agreements with respect to our residential mortgage loans, including manufactured housing loans, and our ICH loans. We pay annual fees generally equal to 0.38% of the outstanding face amount of the residential mortgage loans, 1.00% of the outstanding face amount of the manufactured housing loans, and approximately 0.11% of the outstanding face amount of the ICH loans under these agreements. |
| Contract | | Terms |
| Trustee agreements | | We have entered into trustee agreements in connection with our securitized investments, primarily our CBOs. We pay annual fees of between 0.015% and 0.020% of the outstanding face amount of the CBO bonds under these agreements. |
| Management agreement | | Our manager is paid an annual management fee of 1.5% of our gross equity, as defined, an expense reimbursement, and incentive compensation equal to 25% of our FFO above a certain threshold. For more information on this agreement, as well as historical amounts earned, see Note 10 to our audited consolidated financial statements under "Financial“Financial Statements and Supplementary Data."
” |
33
| | | Actual Payments | | Fixed and Determinable Payments Due by Period (2) | |
| Contract | | 2005 (1) | | 2006 | | 2007-2008 | | 2009-2010 | | Thereafter | | Total | |
| | | | | | | | | | | | | | |
| CBO bonds payable | | $ | 130,722 | | $ | - | | $ | - | | $ | - | | $ | 3,560,953 | | $ | 3,560,953 | |
| Other bonds payable | | | 138,380 | | | 212,019 | | | - | | | - | | | 141,311 | | | 353,330 | |
| Notes payable | | | 408,283 | | | - | | | 260,441 | | | - | | | - | | | 260,441 | |
| Repurchase agreements | | | 284,073 | | | 1,048,203 | | | - | | | - | | | - | | | 1,048,203 | |
| Credit facility | | | 42,204 | | | - | | | 20,000 | | | - | | | - | | | 20,000 | |
| Interest rate swaps, treated as hedges | | | 25,749 | | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) |
| Non-hedge derivative obligations | | | 907 | | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) |
| CBO wrap agreement | | | 481 | | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) |
| CBO backstop agreements | | | 1,147 | | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) |
| CBO remarketing agreements | | | 316 | | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) |
| Loan servicing agreements | | | 4,851 | | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) |
| Trustee agreements | | | 747 | | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) |
| Management agreement | | | 21,132 | | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) | | (3 | ) |
| Total | | $ | 1,058,992 | | $ | 1,260,222 | | $ | 280,441 | | $ | - | | $ | 3,702,264 | | $ | 5,242,927 | |
| | | | | | | | | | | | | | | | | | | | |
Actual Fixed| (1) | Includes all payments made under the respective agreements. The management agreement payments shown include $13.1 million of management fees and Determinable Payments Due by Period expense reimbursements and $8.0 million of incentive compensation. |
(2)
Payments ----------------------------------------------------------
Contract 2004 (1) 2005 2006-2007 2008-2009 Thereafter Total
- -------- ---------- -------- --------- --------- ---------- ----------
CBO bonds payable $ 58,896 $ -- $ -- $-- $2,681,395 $2,681,395
Other bonds payable 60,475 -- -- -- 222,729 222,729
Notes payable 114,678 45,250 606,750 -- -- 652,000
Repurchase agreements 887,429 490,620 -- -- -- 490,620
Interest rate swaps, treated as hedges 53,066 | Represents debt principal due based on contractual maturities. |
(3) (3) (3) (3) (3)
Non-hedge derivative obligations 4,117 (3) (3) (3) (3) (3)
CBO IV wrap agreement 482 (3) (3) (3) (3) (3)
CBO IV backstop agreement 803 (3) (3) (3) (3) (3)
CBO IV remarketing agreement 200 (3) (3) (3) (3) (3)
Management agreement 12,062 (3) (3) (3) (3) (3)
---------- -------- -------- --- ---------- ----------
Total $1,192,208 $535,870 $606,750 $-- $2,904,124 $4,046,744
========== ======== ======== === ========== ==========
| These contracts do not have fixed and determinable payments. |
(1) Includes all payments made under the respective agreements. The management
agreement payments shown include $10.4 million of management fees and
expense reimbursements and $1.7 million of incentive compensation.
(2) Represents debt principal due based on contractual maturities.
(3) These contracts do not have fixed and determinable payments.
INFLATION
Inflation
We believe that our risk of increases in market interest rates on our floating rate debt as a result of inflation is largely offset by our use of match-fundingmatch funding and hedging instruments as described above. See "Quantitative and Qualitative Disclosure About Market Risk --— Interest Rate Exposure"Exposure'' below.
Substantially all of our office leases provide for separate escalations of real
estate taxes and operating expenses over a base amount, and/or increases in the
base rent based on changes in a Belgian index with respect to the LIV portfolio.
We believe that inflationary increases in expenses will generally be offset by
the expense reimbursements and contractual rent increases described above.
FUNDS FROM OPERATIONS
Funds from Operations
We believe Funds from Operations (FFO) is one appropriate measure of the operating performance of real estate companies because it provides investors with information regarding our ability to service debt and make capital expenditures. We also believe that FFO is an appropriate supplemental disclosure of operating performance for a REIT due to its widespread acceptance and use within the REIT and analyst communities. Furthermore, FFO is used to compute our incentive compensation to our manager. FFO, for our purposes, represents net income available for common stockholders (computed in accordance with GAAP), excluding extraordinary items, plus depreciation of our operating real estate, and after adjustments for unconsolidated
subsidiaries.subsidiaries, if any. We consider gains and losses on resolution of our investments to be a normal part of our recurring operations and, therefore, do not exclude such gains and losses when arriving at FFO. Adjustments for unconsolidated subsidiaries,
if any, are calculated to reflect FFO on the same basis. FFO does not represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indicator of our operating performance or as an alternative to cash flow as a measure of liquidity and is not necessarily indicative of cash available to fund cash needs. Our calculation of FFO may be different from the calculation used by other companies and, therefore, comparability may be limited.
34
Funds from Operations (FFO) is calculated as follows (unaudited) (in thousands):
For the Year Ended December 31,
-------------------------------
2004 2003 2002
------- ------- -------
Income available for common stockholders $92,321 $51,345 $30,333
Operating real estate depreciation 2,199 3,035 7,994
Accumulated depreciation on operating real estate sold (8,319) -- (2,847)
Other- Fund I (1) -- -- 2,153
------- ------- -------
Funds from operations (FFO) $86,201 $54,380 $37,633
======= ======= =======
(1) Related to an investment retained by our predecessor.
| | | For the Year Ended December 31, | |
| | | 2005 | | 2004 | | 2003 | |
| Income available for common stockholders | | $ | 110,271 | | $ | 92,321 | | $ | 51,345 | |
| Operating real estate depreciation | | | 702 | | | 2,199 | | | 3,035 | |
| Accumulated depreciation on operating real estate sold | | | (6,942 | ) | | (8,319 | ) | | - | |
| Funds from operations (FFO) | | $ | 104,031 | | $ | 86,201 | | $ | 54,380 | |
Funds from operations was derived from our segments as follows (unaudited) (in thousands):
| | | Book Equity December 31, 2005 (1) | | Average Invested Common Equity for the Year Ended December 31, 2005 (2) | | FFO for the Year Ended December 31, 2005 | | Return on Invested Common Equity (ROE) for the Year Ended December 31, 2005 (3) | | ROE for the Year Ended December 31, 2004 (3) | | ROE for the Year Ended December 31, 2003 (3) | |
| | | | | | | | | | | | | |
Real estate securities and real estate related loans | | $ | 790,990 | | $ | 700,146 | | $ | 125,028 | | | 17.9 | % | | 20.5 | % | | 23.2 | % |
| Residential mortgage loans | | | 86,024 | | | 95,148 | | | 8,706 | | | 9.1 | % | | 16.7 | % | | 25.7 | % |
| Operating real estate | | | 35,976 | | | 47,579 | | | 1,686 | | | 3.5 | % | | 9.2 | % | | 12.2 | % |
| Unallocated (1) | | | (139,515 | ) | | (66,508 | ) | | (31,389 | ) | | N/A | | | N/A | | | N/A | |
| Total (2) | | | 773,475 | | $ | 776,365 | | $ | 104,031 | | | 13.4 | % | | 14.5 | % | | 16.4 | % |
| Preferred stock | | | 102,500 | | | | | | | | | | | | | | | | |
| Accumulated depreciation | | | (3,536 | ) | | | | | | | | | | | | | | | |
| Accumulated other comprehensive income | | | 45,564 | | | | | | | | | | | | | | | | |
| Net book equity | | $ | 918,003 | | | | | | | | | | | | | | | | |
Return on | (1) | Unallocated FFO represents ($0.4 million) of interest expense, ($6.7 million) of preferred dividends and ($24.3 million) of corporate general and administrative expense, management fees and incentive compensation. |
| (2) | Invested Average Invested Common Equity
Common Equity (ROE) for the Year ROE for the Year
Book Equity for the Year Ended FFO for the Year Ended Ended
December 31, 2004 December 31, 2004 Ended December 31, 2004 December 31, 2003
(1) (2) December 31, 2004 (3) (3)
----------------- ------------------ ----------------- ------------------ -----------------
Real estate securitiescommon equity is equal to book equity excluding preferred stock, accumulated depreciation and real estate related loans $625,703 $502,731 $103,245 20.5% 23.2%
Residential mortgage loans 46,291 35,682 5,953 16.7% 25.7%
Operating real estate 68,279 60,021 5,533 9.2% 12.2%
Unallocated (1) (69,330) (2,037) (28,530) N/A N/A
-------- -------- -------- ---- ----
Total (2) 670,943 $596,397 $ 86,201 14.5% 16.4%
======== ======== ======== ==== ====
Preferred stock 62,500
Accumulated depreciation (8,498)
Accumulatedaccumulated other comprehensive income 71,770
--------
Net book equity $796,715
========
income. |
(1) Unallocated FFO represents ($6,094) of preferred dividends and ($22,436) of
corporate general and administrative expense, management fees and incentive
compensation.
(2) Invested common equity is equal to book equity excluding preferred stock,
accumulated depreciation and accumulated other comprehensive income.
(3) FFO divided by average invested common equity.
RELATED PARTY TRANSACTIONS
| (3) | FFO divided by average invested common equity. |
Related Party Transactions
In November 2003, we and a private investment fund managed by an affiliate of our manager co-invested and each indirectly own an approximately 38% interest in a limited liability company that acquired a pool of franchise loans from a third party financial institution. Our investment in this entity, reflected as an investment in an unconsolidated subsidiary on our consolidated balance sheet, was approximately $23.5$17.8 million at December 31, 2004.2005. The remaining approximately 24% interest in the limited liability company is owned by the above-referencedabove referenced third party financial institution.
In January 2004,
As of December 31, 2005, we purchased, in a private placement fromowned an underwriter, $31.5aggregate of approximately $48.5 million face amount of B and BB rated securities of Global Signal Trust I aand II, special purpose vehiclevehicles established by Global Signal Inc. Two, which were purchased in private placements from underwriters in January 2004 and April 2005. One of our directors areis the CEO, chairman of the board, and President of Global Signal, Inc., respectively. A and private equity fundfunds managed by an affiliate of our manager ownsown a significant portion of Global Signal Inc.'s’s common stock. Approximately $418.0In February 2006, we purchased from an underwriter $91.0 million face amount of Global
Signal Trust I securities were issued in 7 classes, rated AAA though B, of which
the BBBB- and BB classes constituted $73.0 million. The balance of the B and BB
securities was sold on identical terms to a private investment fund managed by
an affiliate of our manager and to a large third party mutual fund complex. The
proceeds of the offering were utilized by Global Signal Inc. to repay an
existing credit facility, to pay an extraordinary dividend of approximately $140
million to its stockholders of which approximately $67 million was paid to the
above-referenced private equity fund, and for general working capital purposes.
In December 2004, through our warehouse, we placed a deposit of approximately
$2.6 million on $17.0 million of BBBB+ rated securities of Global Signal Trust II,III, a special purpose vehicle established by Global Signal, Inc. Pursuant to an underwritten 144A offering, approximately $293.8$1,550.0 million of Global Signal Trust IIIII securities were issued in 78 classes, rated AAA through BB-BB+, of which the BB
class constituted approximately $35.4BBB- and BB+ classes aggregated $188.3 million. 35
The balance of the BBB- and BB+ securities were sold on identical terms to third parties. A portion of the proceeds were used to repay $402.7 million of indebtedness of Global Signal, Inc., of which we owned $31.5 million, and to fund the prepayment penalty associated with this debt.
In March 2004, we and a private investment fund managed by an affiliate of our manager co-invested and each indirectly own an approximately 49% interest in two limited liability companies that have acquired, in a sale-leaseback transaction, a portfolio of convenience and retail gas stores from a public company. The properties are subject to a number of master leases, the initial term of which in each case is a minimum of 15 years. This investment was financed with nonrecourse debt at the limited liability company level and our investment in this entity, reflected as an investment in an unconsolidated subsidiary on our consolidated balance sheet, was approximately $17.8$12.2 million at December 31, 2004.
2005. In March 2005, the property management agreement related to these properties was transferred to an affiliate of our manager from a third party servicer; our allocable portion of the related fees, approximately $20,000 per year for three years, was not changed.
In December 2004, we and a private investment fund managed by an affiliate of our manager each made an initial investment in a new real estate related loan with a maximum loan amount of $128 million, subject to being drawn down under certain conditions. The loan is secured by a mezzanine loan on one of the phases and a first mortgage on the remaining phases of a large development project and related assets. We own a 27.3% interest in the loan and the private investment fund owns a 72.7% interest in the loan. Major decisions require the unanimous approval of holders of interests in the loan, while for
other decisions require the approval of a majority of holders of interests in the loan, vote based on their percentage interestinterests therein. We and our affiliated investment fund are each entitled to transfer all or any portion of our respective interests in the loan to third parties. Our investment in this loan was approximately $11.9$22.4 million at December 31, 2004.
2005.
In January 2005, we entered into a servicing agreement with a portfolio company of a private equity fund advised by an affiliate of our manager for them to service a portfolio of manufactured housing loans.loans, which was acquired at the same time. As compensation under the servicing agreement, the portfolio company will receive, on a monthly basis, a net servicing fee equal to 1.00% per annum on the unpaid principal balance of the loans being serviced. We acquiredThe outstanding unpaid principal balance of this portfolio was approximately $284.9 million at December 31, 2005. In January 2006, we closed on a portfolionew term financing of such loans in January 2005this portfolio. In connection with this term financing, we renewed our servicing agreement at a cost of $308.2 million.
the same terms.
In each instance described above, affiliates of our manager have an investment in the applicable affiliated fund and receive from the fund, in addition to management fees, incentive compensation if the fund'sfund’s aggregate investment returns exceed certain thresholds.
ITEM
Market risk is the exposure to loss resulting from changes in interest rates, credit spreads, foreign currency exchange rates, commodity prices and equity prices. The primary market risks that we are exposed to are interest rate risk and credit spread risk and foreign currency exchange rate risk. These risks are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. All of our market risk sensitive assets, liabilities and related derivative positions are for non-trading purposes only. For a further understanding of how market risk may effect our financial position or operating results, please refer to the "Application“Application of Critical Accounting Policies"Policies” section of "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations."
INTEREST RATE EXPOSURE
”
Interest Rate Exposure
Our primary interest rate exposures relate to our real estate securities, loans,
and floating rate debt obligations,
as well as our interest rate swaps, and
interest rate caps. Changes in the general level of interest rates can effect our net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities and hedges. Changes in the level of interest rates also can effect, among other things, our ability to acquire real estate securities and loans
at attractive prices, the value of our real estate securities, loans and derivatives, and our ability to realize gains from the
settlementsale of such assets. While our strategy is to utilize interest rate swaps, caps and
match-fundedmatch funded financings in order to limit the effects of changes in interest rates on our operations, there can be no assurance that our profitability will not be adversely affected during any period as a result of changing interest rates.
As of December 31, 2004, a 100 basis point increase in short term
interest rates would increase our earnings by approximately $0.7 million per
annum.
While we have not experienced any significant credit losses, inIn the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults may increase and result in credit losses that would adversely affect our liquidity and operating results.
36
As of December 31, 2005, a 100 basis point increase in short term interest rates would decrease our earnings by approximately $0.2 million per annum.
A period of rising interest rates as we are currently experiencing negatively impacts our return on certain investments, particularly our floating rate residential mortgage loans. Although these loans are financed with floating rate debt, the interest rate on the debt resets prior to, and in some cases more frequently than, the interest rate on the assets, causing a decrease in return on equity during a period of rising interest rates. When interest rates stabilize, we expect these investments will return to their historical returns on equity.
Interest rate changes may also impact our net book value as our real estate securities and related hedge derivatives are marked to market each quarter. Our loan investments and debt obligations are not marked to market. Generally, as interest rates increase, the value of our fixed rate securities decreases, and as interest rates decrease, the value of such securities will increase. In general, we would expect that over time, decreases in the value of our real estate securities portfolio attributable to interest rate changes will be offset to some degree by increases in the value of our swaps, and vice versa. However, the relationship between spreads on securities and spreads on swaps may vary from time to time, resulting in a net aggregate book value increase or decline. Our real estate securities portfolio is largely financed to maturity through long-termlong term CBO financings that are not redeemable as a result of book value changes. Accordingly, unless there is a material impairment in value that would result in a payment not being received on a security, changes in the book value of our portfolio will not directly affect our recurring earnings or our ability to pay a dividend.dividends. As of December 31, 2004,2005, a 100 basis point change in short term interest rates would impact our net book value by approximately $47.0$58.4 million.
Our general financing strategy focuses on the use of match-fundedmatch funded structures. This means that we seek to match the maturities of our debt obligations with the maturities of our investments to minimize the risk that we have to refinance our liabilities prior to the maturities of our assets, and to reduce the impact of changing interest rates on our earnings. In addition, we generally match-fundmatch fund interest rates on our investments with like-kind debt (i.e., fixed rate assets are financed with fixed rate debt and floating rate assets are financed with floating rate debt), directly or through the use of interest rate swaps, caps, or other financial instruments, or through a combination of these strategies, which allows us to reduce the impact of changing interest rates on our earnings. Our real estate securitiesentire portfolio of assets and real estatethe related loan portfolio, excluding the
ICH CMO loans as described below, and their respective liabilities had a weighted average lifelives of 5.375.10 years and 5.724.59 years, respectively, as of December 31, 2004.2005. Our financing strategy is dependent on our ability to place the match-fundedmatch funded debt we use to finance our investments at rates that provide a positive net spread. If spreads for such liabilities widen or if demand for such liabilities ceases to exist, then our ability to execute future financings will be severely restricted.
Interest rate swaps are agreements in which a series of interest rate flows are exchanged with a third party (counterparty) over a prescribed period. The notional amount on which swaps are based is not exchanged. In general, our swaps are "pay fixed" swaps involving the exchange of floating rate interest payments from the counterparty for fixed interest payments from us. This can effectively convert a floating rate debt obligation into a fixed rate debt obligation.
Similarly, an interest rate cap or floor agreement is a contract in which we purchase a cap or floor contract on a notional face amount. We will make an up-frontupfront payment to the counterparty for which the counterparty agrees to make future payments to us should the reference rate (typically one- or three-month LIBOR) rise above (cap agreements) or fall below (floor agreements) the "strike" rate specified in the contract. Should the reference rate rise above the contractual strike rate in a cap, we will earn cap income; should the reference rate fall below the contractual strike rate in a floor, we will earn floor income. Payments on an annualized basis will equal the contractual notional face amount multiplied by the difference between the actual reference rate and the contracted strike rate.
While a REIT may utilize these types of derivative instruments to hedge interest rate risk on its liabilities or for other purposes, such derivative instruments could generate income that is not qualified income for purposes of maintaining REIT status. As a consequence, we may only engage in such instruments to hedge such risks within the constraints of maintaining our standing as a REIT. We do not enter into derivative contracts for speculative purposes nor as a hedge against changes in credit risk.
Our hedging transactions using derivative instruments also involve certain additional risks such as counterparty credit risk, the enforceability of hedging contracts and the risk that unanticipated and significant changes in interest rates will cause a significant loss of basis in the contract. The counterparties to our derivative arrangements are major financial institutions with high credit ratings with which we and our affiliates may also have other financial relationships. As a result, we do not anticipate that any of these counterparties will fail to meet their obligations. There can be no assurance that we will be able to adequately protect against the foregoing risks and will ultimately realize an economic benefit that exceeds the related amounts incurred in connection with engaging in such hedging strategies.
CREDIT SPREAD CURVE EXPOSURE
Credit Spread Exposure
Our real estate securities are also subject to spread risk. Our fixed rate securities are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. In other words, their value is dependent on the yield demanded on such securities by the market based on their credit relative to U.S. Treasuries. Excessive supply of such securities combined with reduced demand will generally cause the market to require a higher yield on such securities, resulting in the use of a higher (or
"wider"“wider”) spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value such securities. Under such conditions, the value of our real estate securities
37
portfolio would tend to decline. Conversely, if the spread used to value such securities were to decrease (or "tighten"“tighten”), the value of our real estate securities portfolio would tend to increase. Our floating rate securities are valued based on a market credit spread over LIBOR and are effected similarly by changes in LIBOR spreads. Such changes in the market value of our real estate securities portfolio may effect our net equity, net income or cash flow directly through their impact on unrealized gains or losses on available-for-sale securities, and therefore our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital.Furthermore, shifts in the U.S. Treasury yield curve, which represents the market'smarket’s expectations of future interest rates, would also effect the yield required on our real estate securities and therefore their value. This would have similar effects on our real estate securities portfolio and our financial position and operations to a change in spreads.
Our loan portfolios are also subject to spread risk. Our floating rate loans are valued based on a market credit spread to LIBOR. The value of these loans is dependent upon the yield demanded by the market based on their credit relative to LIBOR. The value of our floating rate loans would tend to decline should the market require a higher yield on such loans, resulting in the use of a higher spread over the benchmark rate (usually the applicable LIBOR yield). Our fixed rate loans are valued based on a market credit spread over U.S. Treasuries and are effected similarly by changes in U.S. Treasury spreads. If the value of our loans subject to repurchase agreements were to decline, it could affect our ability to refinance such loans upon the maturity of the related repurchase agreements.
Any decreases in the value of our loan portfolios due to spread changes would effect us in the same way as similar changes to our real estate securities portfolio as described above, except that our loan portfolios are not marked to market.
As of December 31, 2004,2005, a 25 basis point movement in credit spreads would impact our net book value by approximately $39.7$49.5 million, but would not directly affect our earnings or cash flow.
CURRENCY RATE EXPOSURE
Our primary foreign currency exchange rate exposures relate to our operating
real estate and related leases. Our principal direct currency exposures are to
the Euro and the Canadian Dollar. Changes in the currency rates can adversely
impact the fair values and earnings streams
Margin
Certain of our non-U.S. holdings. We have
attemptedinvestments are financed through repurchase agreements or total return swaps which are subject to mitigate this impactmargin calls based on the value of such investments. Margin calls resulting from decreases in partvalue related to rising interest rates are substantially offset by utilizing local
currency-denominated financingour ability to make margin calls on our foreigninterest rate derivatives. We maintain adequate cash reserves or availability on our credit facility to meet any margin calls resulting from decreases in value related to a reasonably possible (in the opinion of management) widening of credit spreads. Funding a margin call on our credit facility would have a dilutive effect on our earnings, however we would not expect this to be material.
Fair Value
Fair values for a majority of our investments to partially hedge, in
effect, these assets.
We have investments in the LIV portfolio and the Bell Canada portfolio. These
properties are financed utilizing debt denominated in their respective local
currencies (the Euro and the Canadian Dollar). The net equity invested in these
portfolios at December 31, 2004, approximately $12.5 million and $22.3 million,
respectively, is exposed to foreign currency exchange risk.
FAIR VALUEreadily obtainable through broker quotations. For certain of our financial instruments, fair values are not readily available since there are no active trading markets as characterized by current exchanges between willing parties. Accordingly, fair values can only be derived or estimated for these instruments using various valuation techniques, such as computing the present value of estimated future cash flows using discount rates commensurate with the risks involved. However, the determination of estimated future cash flows is inherently subjective and imprecise. We note that minor changes in assumptions or estimation methodologies can have a material effect on these derived or estimated fair values, and that the fair values reflected below are indicative of the interest rate and credit spread and currency rate environments as of December 31, 20042005 and do not take into consideration the effects of subsequent interest rate or credit spread or currency rate
fluctuations.
We note that the values of our investments in real estate securities, loans and derivative instruments, primarily interest rate hedges on our debt obligations, are sensitive to changes in market interest rates,
interest rate spreads, credit spreads and other market factors. The value of these investments can vary, and has varied, materially from period to period.
38
Interest Rate and Credit Spread Risk
We held the following interest rate and credit spread risk sensitive instruments at December 31, 20042005 (in thousands):
| | | Carrying Value December 31, 2005 | | December 31, 2005 | | | | Fair Value December 31, 2005 |
| | | 2005 | | 2004 | | Principal Balance or Notional Amount | | Weighted Average Yield/ Funding Cost | | Maturity Date | | 2005 | | 2004 | |
Assets: | | | | | | | | | | | | | | | |
| Real estate securities, | | | | | | | | | | | | | | | |
| available for sale (1) | | $ | 4,554,519 | | $ | 3,369,496 | | $ | 4,603,217 | | | 6.25 | % | | (1) | | $ | 4,554,519 | | $ | 3,369,496 | |
| Real estate securities | | | | | | | | | | | | | | | | | | | | | | |
| portfolio deposit (2) | | | - | | | 25,411 | | | - | | | N/A | | | N/A | | | - | | | 25,411 | |
| Real estate related loans (3) | | | 615,551 | | | 591,890 | | | 619,783 | | | 8.74 | % | | (3) | | | 615,865 | | | 600,528 | |
| Residential mortgage loans (4) | | | 600,682 | | | 654,784 | | | 610,970 | | | 6.15 | % | | (4) | | | 609,486 | | | 654,784 | |
| Interest rate caps, treated as hedges (5) | | | 2,145 | | | 3,554 | | | 342,351 | | | N/A | | | (5) | | | 2,145 | | | 3,554 | |
| Total return swaps (6) | | | 3,096 | | | 399 | | | 414,034 | | | N/A | | | (6) | | | 3,096 | | | 399 | |
Liabilities: | | | | | | | | | | | | | | | | | | | | | | |
| CBO bonds payable (7) | | | 3,530,384 | | | 2,656,510 | | | 3,560,953 | | | 5.27 | % | | (7) | | | 3,594,638 | | | 2,720,704 | |
| Other bonds payable (8) | | | 353,330 | | | 222,266 | | | 353,330 | | | 5.94 | % | | (8) | | | 356,294 | | | 227,510 | |
| Notes payable (9) | | | 260,441 | | | 652,000 | | | 260,441 | | | 4.70 | % | | (9) | | | 260,441 | | | 652,000 | |
| Repurchase agreements (10) | | | 1,048,203 | | | 490,620 | | | 1,048,203 | | | 4.68 | % | | (10) | | | 1,048,203 | | | 490,620 | |
| Credit facility (11) | | | 20,000 | | | - | | | 20,000 | | | 6.86 | % | | (11) | | | 20,000 | | | - | |
| Interest rate swaps, treated as hedges (12) | | | (41,170 | ) | | 13,239 | | | 2,943,752 | | | N/A | | | (12) | | | (41,170 | ) | | 13,239 | |
| Non-hedge derivative obligations (13) | | | 90 | | | 796 | | | (13 | ) | | N/A | | | (13) | | | 90 | | | 796 | |
DECEMBER 31, 2004
-------------------------
CARRYING VALUE PRINCIPAL WEIGHTED FAIR VALUE
DECEMBER 31, BALANCE OR AVERAGE DECEMBER 31,
----------------------- NOTIONAL YIELD/ MATURITY -----------------------
2004 2003 AMOUNT FUNDING COST DATE 2004 2003
---------- ---------- ---------- ------------ -------- ---------- ----------
ASSETS:
Real estate| (1) | These securities available for sale (1) $3,369,496 $2,192,727 $3,315,253 6.19% (1) $3,369,496 $2,192,727
Real estate securities
portfolio deposit (2) 25,411 19,541 (2) (2) (2) 25,411 19,541
Real estate related loans (3) 591,890 402,784 594,388 7.44% (3) 600,528 429,860
Residential mortgage
loans (4) 654,784 586,237 645,381 3.71% (4) 654,784 586,237
Interest rate caps, treated
as hedges (5) 3,554 8,294 375,019 N/A (5) 3,554 8,294
Total return swap (6) 399 -- (6) N/A (6) 399 --
LIABILITIES:
CBO bonds payable (7) 2,656,510 1,793,533 2,681,395 4.59% (7) 2,720,704 1,836,628
Other bonds payable (8) 222,266 260,674 222,729 6.69% (8) 227,510 282,014
Notes payable (9) 652,000 154,562 652,000 2.72% (9) 652,000 155,058
Repurchase agreements (10) 490,620 715,783 490,620 3.67% (10) 490,620 715,783
Interest rate swaps, treated
as hedges, (11) 13,239 28,881 2,011,418 N/A (11) 13,239 28,881
Non-hedge derivative
obligations (12) 796 747 (12) N/A (12) 796 747
|
- ----------
(1) These securities contain various terms, including fixed and floating rates,
self-amortizing and interest only. Their weighted average maturity is 5.76contain various terms, including fixed and floating rates, self-amortizing and interest only. Their weighted average maturity is 5.81 years. The fair value of these securities is estimated
by obtaining third party broker quotations, if available and practicable, and counterparty quotations. | (2) | The fair value of the real estate securities portfolio deposit, which is treated as a non-hedge derivative, is estimated by obtaining third party broker quotations on the underlying securities, if available and practicable, and counterparty quotations, including a counterparty quotation on the portion of the fair value resulting from the Excess Carry Amount, as defined, earned on such deposit. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources” for a further discussion of this deposit. |
| (3) | Represents the following loans: |
| Loan Type | | Current Face Amount | | Carrying Value | | Weighted Avg. Yield | | Weighted Average Maturity (Years) | | Floating Rate Loans as a % of Carrying Value | | Fair Value | |
| B-Notes | | $ | 72,173 | | $ | 72,520 | | | 8.46 | % | | 2.40 | | | 73.69 | % | $ | 72,631 | |
| Mezzanine Loans | | | 302,740 | | | 302,816 | | | 8.44 | % | | 1.94 | | | 100.00 | % | | 302,190 | |
| Bank Loans | | | 56,274 | | | 56,563 | | | 6.58 | % | | 2.51 | | | 100.00 | % | | 56,677 | |
| Real Estate Loans | | | 23,082 | | | 22,364 | | | 20.02 | % | | 2.00 | | | 0.00 | % | | 23,079 | |
| ICH Loans | | | 165,514 | | | 161,288 | | | 8.64 | % | | 1.55 | | | 2.24 | % | | 161,288 | |
| | | $ | 619,783 | | $ | 615,551 | | | 8.74 | % | | 1.94 | | | 67.06 | % | $ | 615,865 | |
The ICH loans were valued by discounting expected future cash flows by the loans’ effective rate at acquisition. The rest of the loans were valued by obtaining third party broker quotations, if available and practicable, and counterparty quotations.
(2) The fair value of the real estate securities portfolio deposit, which is
treated as a non-hedge derivative, is estimated by obtaining third party
broker quotations on the underlying securities, if available and
practicable, and counterparty quotations, including a counterparty
quotation on the portion of the fair value resulting from the Excess Carry
Amount, as defined, earned on such deposit. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Liquidity and
Capital Resources" for a further discussion of this deposit.
39
(3) Represents the following loans:
Weighted Floating Rate Loans| (4) | This aggregate portfolio of residential loans consists of a portfolio of floating rate residential mortgage loans as Carrying Loan Weighted Avg. Averagewell as a %portfolio of Carrying
Name Value Count Yield Maturity (Years) Amount Fair Value
---- -------- ----- ------------- ---------------- ---------------------- ----------
B-Notes $133,344 23 6.44% 2.30 85.6% $133,617
Mezzanine Loans 80,052 4 5.25% 1.97 100.0% 80,052
Bank Loans 146,909 3 6.73% 1.99 100.0% 146,909
Real Estate Loans 28,911 2 16.55% 1.24 58.9% 28,911
ICH CMO Loans 202,674 123 8.16% 2.86 1.8% 211,039
-------- --- ----- ---- ----- --------
$591,890 155 7.44% 2.32 61.1% $600,528
======== === ===== ==== ===== ========
primarily fixed rate manufactured housing loans. The $333.2 million portfolio of residential mortgage loans has a weighted average maturity of 2.73 years. The $267.5 million portfolio of manufactured housing loans has a weighted average maturity of 5.78 years. These loans were valued by discounting expected future cash flows by a rate calculated based on current market conditions for comparable financial instruments, including market interest rates and credit spreads. |
The fixed rate B-Notes were valued by obtaining counterparty quotations.
The rest of the B-Notes as well as the mezzanine loans, bank loans, and
real estate loans, with one exception, bear floating rates of interest and
we believe that, for similar financial instruments with comparable credit
risks, their effective rates approximate market rates. Accordingly, the
carrying amounts outstanding are believed to approximate fair value. The
one fixed rate loan was purchased on December 29, 2004 and therefore its
carrying amount is believed to approximate fair value. The ICH CMO loans
were valued by discounting expected future receipts by a rate calculated
based on current market conditions for comparable financial instruments,
including market interest rates and credit spreads.
(4) This portfolio of mortgage loans bears a floating rate of interest and has
a weighted average maturity of 3.84 years. We believe that, for similar
financial instruments with comparable credit risks, the effective rate on
this portfolio approximates a market rate. Accordingly, the carrying amount
of this portfolio is believed to approximate fair value.
(5) Represents cap agreements as follows:
Notional Balance Effective Date Maturity Date Capped Rate Strike Rate Fair Value
- ---------------- -------------- -------------- ------------- ----------- ----------
$295,400 Current March 2009 1-Month LIBOR 6.50% $ 585
18,000 January 2010 October 2015 3-Month LIBOR 8.00% 592
8,619 December 2010 June 2015 3-Month LIBOR 7.00% 863
53,000 May 2011 September 2015 1-Month LIBOR 7.50% 1,514
-------- ------
$375,019 $3,554
======== ======
| (5) | Represents cap agreements as follows: |
| Notional Balance | | Effective Date | | Maturity Date | | Capped Rate | | Strike Rate | | Fair Value |
| $ 262,732 | | Current | | March 2009 | | 1-Month LIBOR | | 6.50% | | $ 184 |
| 18,000 | | January 2010 | | October 2015 | | 3-Month LIBOR | | 8.00% | | 342 |
| 8,619 | | December 2010 | | June 2015 | | 3-Month LIBOR | | 7.00% | | 567 |
| 53,000 | | May 2011 | | September 2015 | | 1-Month LIBOR | | 7.50% | | 1,052 |
| $ 342,351 | | | | | | | | | | $ 2,145 |
The fair value of these agreements is estimated by obtaining counterparty quotations.
(6) Represents a total return swap which is treated as a non-hedge derivative.
The fair value of this agreement, which is included in derivative assets,
is estimated by obtaining a counterparty quotation. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources" for a further discussion of
this swap.
(7) These bonds were valued by discounting expected future payments by a rate
calculated based on current market conditions for comparable financial
instruments, including market interest rates and credit spreads. The
weighted average maturity of the CBO bonds payable is 6.78 years. The CBO
bonds payable amortize principal prior to maturity based on collateral
receipts, subject to reinvestment requirements.
(8) The Bell Canada bonds were valued, in U.S. dollars at the period end
exchange rate, by discounting expected future payments by a rate calculated
by imputing a spread over a market index on the date of borrowing. It
amortizes principal periodically with a balloon payment at maturity in
April 2012. The ICH CMO bonds were valued by discounting expected future
payments by a rate calculated based on current market conditions for
comparable financial instruments, including market interest rates and
credit spreads. They amortize principal prior to maturity based on
collateral receipts and their final stated maturity is in August 2030.
(9) The LIV mortgage was valued, in U.S. dollars at the period end exchange
rate, by discounting expected future payments by a rate calculated by
imputing a spread over a market index on the date of borrowing. It was
repaid
| (6) | Represents total return swaps which are treated as non-hedge derivatives. The fair value of these agreements, which is included in Derivative Assets, is estimated by obtaining counterparty quotations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources” for a further discussion of these swaps. |
| (7) | These bonds were valued by discounting expected future cash flows by a rate calculated based on current market conditions for comparable financial instruments, including market interest rates and credit spreads. The weighted average maturity of the CBO bonds payable is 6.55 years. The CBO bonds payable amortize principal prior to maturity based on collateral receipts, subject to reinvestment requirements. |
| (8) | These bonds were valued by discounting expected future cash flows by a rate calculated based on current market conditions for comparable financial instruments, including market interest rates and credit spreads. The ICH bonds amortize principal prior to maturity based on collateral receipts and have a weighted average maturity of 1.46 years. The manufactured housing loan bonds have a weighted average maturity of 0.08 years, bear a floating rate of interest, and are subject to adjustment monthly based on the agreed upon market value of the loan portfolio. |
| (9) | The residential mortgage loan financing has a weighted average maturity of 1.21 years, bears a floating rate of interest, and is subject to adjustment monthly based on the agreed upon market value of the loan portfolio. This financing was valued by discounting expected future cash flows by a rate calculated based on current market conditions for comparable financial instruments, including market interest rates and credit spreads. |
| (10) | These agreements bear floating rates of interest, which reset monthly or quarterly to a market credit spread, and we believe that, for similar financial instruments with comparable credit risks, the effective rates approximate market rates. Accordingly, the carrying amounts outstanding are believed to approximate fair value. These agreements have a weighted average maturity of 0.10 years. |
| (11) | This facility, which has a weighted average maturity of 2.55 years, bears a floating rate of interest. We believe that, for similar financial instruments with comparable credit risk, the effective rate approximates a market rate. We note that two new banks joined the lending group in December 2004. The first real estate related loan financing
matures in November 2006, bears a floating rate of interest and amortizes
principal based on collateral receipts. The second real estate related loan
financing matures in February 2006, after an extension, bears a floating
rate of interest, and amortizes principal based on collateral receipts. The
residential mortgage loan financing matures in November 2007, bears a
floating rate of interest, and is subject to adjustment monthly based on
the agreed upon market value of the loan portfolio. We believe that, for
similar financial instruments with comparable credit risks, their effective
rates approximate market rates. Accordingly, the carrying amounts
outstanding are believed to approximate fair value.
40
(10) These agreements bear floating rates of interest and we believe that, for
similar financial instruments with comparable credit risks, the effective
rates approximate market rates. Accordingly, the carrying amounts
outstanding are believed to approximate fair value. These agreements mature
in one to ten months.
(11) Represents swap agreements as follows (in thousands):
Notional Balance Effective Date Maturity Date Swapped Rate Fixed Rate Fair Value
- ---------------- -------------- -------------- ------------- ----------- ----------
$ 33,299 Current July 2005 1-Month LIBOR 6.1755% $ 366
295,400 Current March 2009 1-Month LIBOR* 3.1250% (4,547)
290,000 Current April 2011 3-Month LIBOR 5.9325% 26,181
276,060 Current March 2013 3-Month LIBOR 3.8650% (7,888)
192,500 Current March 2015 1-Month LIBOR 4.8880% 6,868
165,300 Current March 2014 3-Month LIBOR 3.9945% (4,708)
189,373 Current September 2014 3-Month LIBOR 4.3731% (2,534)
11,000 Current November 2008 1-Month LIBOR 3.5400% (97)
7,500 Current July 2018 1-Month LIBOR 4.8300% 118
5,500 Current November 2018 1-Month LIBOR 4.4800% 28
65,200 Current January 2009 1-Month LIBOR 3.6500% (405)
6,500 Current March 2009 1-Month LIBOR 3.3360% (126)
236,582 January 2005 February 2014 1-Month LIBOR 4.2070% 640
85,757 Current October 2009 1-Month LIBOR 3.7150% (116)
81,571 Current September 2009 1-Month LIBOR 3.7090% (104)
28,081 Current December 2009 1-Month LIBOR 3.8290% 38
21,295 Current January 2009 1-Month LIBOR 3.2900% (476)
20,500 Current September 2011 1-Month LIBOR 4.2225% 1
---------- -------
$2,011,418 $13,239
========== =======
at the same rate. Accordingly, the carrying amount outstanding is believed to approximate fair value.
* up to 6.50%
| (12) | Represents current swap agreements as follows (in thousands): |
| Notional Balance | | Maturity Date | | Swapped Rate | | Fixed Rate | | Fair Value | | $ 262,732 | | March 2009 | | 1-Month LIBOR* | | 3.1250% | | $ (10,106) | | 290,000 | | April 2011 | | 3-Month LIBOR | | 5.9325% | | 12,628 | | 276,060 | | March 2013 | | 3-Month LIBOR | | 3.8650% | | (14,599) | | 192,500 | | March 2015 | | 1-Month LIBOR | | 4.8880% | | 478 | | 165,300 | | March 2014 | | 3-Month LIBOR | | 3.9945% | | (8,492) | | 189,373 | | September 2014 | | 3-Month LIBOR | | 4.3731% | | (6,566) | | 243,337 | | March 2015 | | 1-Month LIBOR | | 4.8495% | | (331) | | 307,355 | | December 2015 | | 1-Month LIBOR | | 4.9885% | | 2,179 | | 34,151 | | December 2015 | | 1-Month LIBOR | | 5.0098% | | 335 | | 227,576 | | February 2014 | | 1-Month LIBOR | | 4.2070% | | (5,010) | | 5,000 | | November 2008 | | 1-Month LIBOR | | 3.5400% | | (165) | | 4,500 | | November 2018 | | 1-Month LIBOR | | 4.4800% | | (88) | | 45,600 | | January 2009 | | 1-Month LIBOR | | 3.6500% | | (1,467) | | 12,000 | | January 2015 | | 1-Month LIBOR | | 4.5100% | | (334) | | 68,606 | | October 2009 | | 1-Month LIBOR | | 3.7150% | | (1,763) | | 65,257 | | September 2009 | | 1-Month LIBOR | | 3.7090% | | (1,665) | | 22,465 | | December 2009 | | 1-Month LIBOR | | 3.8290% | | (534) | | 7,614 | | August 2009 | | 1-Month LIBOR | | 4.0690% | | (128) | | 22,091 | | February 2010 | | 1-Month LIBOR | | 4.1030% | | (386) | | 34,692 | | April 2010 | | 1-Month LIBOR | | 4.5310% | | (245) | | 30,062 | | March 2010 | | 1-Month LIBOR | | 4.5260% | | (212) | | 25,328 | | April 2010 | | 1-Month LIBOR | | 4.1640% | | (413) | | 42,954 | | March 2010 | | 1-Month LIBOR | | 4.0910% | | (760) | | 44,113 | | May 2010 | | 1-Month LIBOR | | 3.9900% | | (925) | | 22,037 | | April 2010 | | 1-Month LIBOR | | 3.9880% | | (457) | | 38,293 | | September 2010 | | 1-Month LIBOR | | 4.3980% | | (421) | | 18,698 | | September 2010 | | 1-Month LIBOR | | 4.4300% | | (190) | | 45,174 | | August 2010 | | 1-Month LIBOR | | 4.4865% | | (378) | | 28,336 | | August 2010 | | 1-Month LIBOR | | 4.4210% | | (290) | | 21,666 | | June 2010 | | 1-Month LIBOR | | 4.4870% | | (180) | | 22,818 | | August 2010 | | 1-Month LIBOR | | 4.4900% | | (192) | | 44,776 | | July 2010 | | 1-Month LIBOR | | 4.4290% | | (455) | | 60,985 | | December 2010 | | 1-Month LIBOR | | 4.7710% | | (78) | | 5,433 | | December 2015 | | 3-Month LIBOR | | 4.9618% | | 8 | | 16,870 | | December 2015 | | 3-Month LIBOR | | 4.9670% | | 32 | | $ 2,943,752 | | | | | | | | $ (41,170) |
The fair value of these agreements is estimated by obtaining counterparty quotations. A positive fair value represents a liability.
(12) liability; therefore, we currently have a net swap asset.
| These are two essentially offsetting interest rate caps and two essentially offsetting interest rate swaps, each with notional amounts of $32.5 million, an interest rate cap with a notional balance of $17.5 million, and four interest rate swaps with an aggregate notional amount of $19.2 million. The maturity date of the purchased swap is July 2009; the maturity date of the sold swap is July 2014, the maturity date of the $32.5 million caps is July 2038, the maturity date of the $17.5 million cap is July 2009, and the maturity dates of the latter four interest rate swaps range between November 2008 and January 2009. The fair value of these agreements is estimated by obtaining counterparty quotations. |
Item 8.Financial Statements and two essentially
offsetting interest rate swaps, each with notional amounts of $32.5
million, an interest rate cap with a notional balance of $17.5 million, and
two interest rate swaps with notional amounts of $26.3 million and $2.0
million. The maturity date of the purchased swap is July 2009; the maturity
date of the sold swap is July 2014, the maturity date of the $32.5 million
caps is July 2038, the maturity date of the $17.5 million cap is July 2009,
and the maturity dates of the latter two interest rate swaps are February
2014 and January 2009, respectively. The fair value of these agreements is
estimated by obtaining counterparty quotations.
Currency Risk
We held the following currency rate risk sensitive balances at December 31, 2004
(unaudited) (U.S. dollars; in thousands, except exchange rates):
CURRENT EFFECT OF A 5% EFFECT OF A 5%
CARRYING EXCHANGE NEGATIVE NEGATIVE
AMOUNT LOCAL RATE TO CHANGE IN CHANGE IN
(USD) CURRENCY USD EURO RATE CAD RATE
-------- -------- -------- -------------- --------------
Assets:
LIV portfolio ............... $12,376 Euro 0.7378 $(619) N/A
Bell Canada portfolio ....... 57,193 CAD 1.2019 N/A $(2,860)
LIV other, net .............. 156 Euro 0.7378 (8) N/A
Bell Canada other, net ...... 7,542 CAD 1.2019 N/A (377)
Liabilities:
Bell Canada bonds ........... 42,422 CAD 1.2019 N/A 2,121
----- -------
Total at December 31, 2004 $(627) $(1,116)
===== =======
Total at December 31, 2003 $(277) $(1,045)
===== =======
- ----------
USD refers to U.S. dollars; CAD refers to Canadian dollars.
41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Supplementary Data.
Index to Financial Statements:
Audit Report of Independent Registered Public Accounting Firm Report on Internal Control Over Financial Reporting of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of December 31, 20042005 and December 31, 2003
2004 Consolidated Statements of Income for the years ended December 31, 2005, 2004 2003
and 2002
2003 Consolidated Statements of Stockholders'Stockholders’ Equity and Redeemable Preferred Stock for the years ended December 31, 2005, 2004 2003 and 2002
2003 Consolidated Statements of Cash Flow for the years ended December 31, 2005, 2004 2003
and 2002
2003 Notes to Consolidated Financial Statements All schedules have been omitted because either the required information is included in our consolidated financial statements and notes thereto or it is not applicable.
42
The Board of Directors and Stockholders of Newcastle Investment Corporation
We have audited the accompanying consolidated balance sheets of Newcastle Investment Corporation and subsidiaries (the "Company"“Company”) as of December 31, 20042005 and 2003,2004, and the related consolidated statements of income, stockholders'stockholders’ equity, and redeemable preferred stock, and cash flows for each of the three years in the period ended December 31, 2004.2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 20042005 and 2003,2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004,2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company'sCompany’s internal control over financial reporting as of December 31, 2004,2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 200515, 2006 expressed an unqualified opinion thereon.
/s/
/s/ Ernst & Young LLP New York, NY March 3, 2005
43
15, 2006
The Board of Directors and Stockholders of Newcastle Investment Corporation
We have audited management'smanagement’s assessment, included in the accompanying Management'sManagement’s Report on Internal Control Over Financial Reporting, that Newcastle Investment Corporation and subsidiaries (the "Company"“Company”) maintained effective internal control over financial reporting as of December 31, 2004,2005, based on criteria established in Internal Control-IntegratedControl—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company'sCompany’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management'smanagement’s assessment and an opinion on the effectiveness of the company'sCompany’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management'smanagement’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company'scompany’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company'scompany’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company'scompany’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management'smanagement’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004,2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004,2005, based onthe COSO criteria.
criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders'stockholders’ equity, and redeemable preferred stock, and cash flows for each of the three years in the period ended December 31, 20042005 of the Company and our report dated March 3, 200515, 2006 expressed an unqualified opinion thereon.
/s/
/s/ Ernst & Young LLP New York, NY March 3, 2005
44
15, 2006
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
(dollars in thousands, except share data)
DECEMBER 31,
-----------------------
2004 2003
---------- ----------
ASSETS
Real estate securities, available for sale - Note 4 $3,369,496 $2,192,727
Real estate securities portfolio deposit - Note 4 25,411 19,541
Real estate related loans, net - Note 5 591,890 402,784
Investments in unconsolidated subsidiaries - Note 3 41,230 30,640
Operating real estate, net - Note 6 57,193 102,995
Real estate held for sale - Note 6 12,376 29,404
Residential mortgage loans, net - Note 5 654,784 586,237
Cash and cash equivalents 37,911 60,403
Restricted cash 77,974 70,103
Derivative assets - Note 7 27,122 25,512
Deferred costs, net 2,043 2,010
Receivables and other assets 35,290 27,943
---------- ----------
$4,932,720 $3,550,299
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
CBO bonds payable - Note 8 $2,656,510 $1,793,533
Other bonds payable - Note 8 222,266 260,674
Notes payable - Note 8 652,000 154,562
Repurchase agreements - Note 8 490,620 715,783
Derivative liabilities - Note 7 39,661 49,675
Dividends payable 25,928 16,703
Due to affiliates - Note 10 8,963 2,445
Accrued expenses and other liabilities 40,057 17,561
---------- ----------
4,136,005 3,010,936
---------- ----------
Commitments and contingencies - Notes 9, 10 and 11 -- --
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value, 100,000,000 shares authorized, 2,500,000
shares of Series B Cumulative Redeemable Preferred Stock, liquidation
preference $25.00 per share, issued and outstanding 62,500 62,500
Common stock, $0.01 par value, 500,000,000 shares authorized, 39,859,481
and 31,374,833 shares issued and outstanding at
December 31, 2004 and 2003, respectively 399 314
Additional paid-in capital 676,015 451,806
Dividends in excess of earnings - Note 2 (13,969) (14,670)
Accumulated other comprehensive income - Note 2 71,770 39,413
---------- ----------
796,715 539,363
---------- ----------
$4,932,720 $3,550,299
========== ==========
| | | | | | | | December 31, | | | | | 2005 | | 2004 | | Assets | | | | | | | Real estate securities, available for sale - Note 4 | | $ | 4,554,519 | | $ | 3,369,496 | | | Real estate securities portfolio deposit - Note 4 | | | — | | | 25,411 | | | Real estate related loans, net - Note 5 | | | 615,551 | | | 591,890 | | | Residential mortgage loans, net - Note 5 | | | 600,682 | | | 654,784 | | | Investments in unconsolidated subsidiaries - Note 3 | | | 29,953 | | | 41,230 | | | Operating real estate, net - Note 6 | | | 16,673 | | | 57,193 | | | Real estate held for sale - Note 6 | | | | | | 12,376 | | | Cash and cash equivalents | | | 21,275 | | | 37,911 | | | Restricted cash | | | 268,910 | | | 77,974 | | | Derivative assets - Note 7 | | | 63,834 | | | 27,122 | | | Receivables and other assets | | | 38,302 | | | 37,333 | | | | | $ | 6,209,699 | | $ | 4,932,720 | | | | | | | | | | | Liabilities and Stockholders' Equity | | | | | | | | | | | | | | | | | Liabilities | | | | | | | | | CBO bonds payable - Note 8 | | $ | 3,530,384 | | $ | 2,656,510 | | | Other bonds payable - Note 8 | | | 353,330 | | | 222,266 | | | Notes payable - Note 8 | | | 260,441 | | | 652,000 | | | Repurchase agreements - Note 8 | | | 1,048,203 | | | 490,620 | | | Credit facility - Note 8 | | | 20,000 | | | | | | Derivative liabilities - Note 7 | | | 18,392 | | | 39,661 | | | Dividends payable | | | 29,052 | | | 25,928 | | | Due to affiliates - Note 10 | | | 8,783 | | | 8,963 | | | Accrued expenses and other liabilities | | | 23,111 | | | 40,057 | | | | | | 5,291,696 | | | 4,136,005 | | | | | | | | | | | | Commitments and contingencies - Notes 9, 10 and 11 | | | — | | | | | Stockholders' Equity | | | | | | | | | Preferred stock, $0.01 par value, 100,000,000 shares authorized, 2,500,000 | | | | | | | | | Redeemable preferred stock, $.01 par value, 100,000,000 shares authorized, | | | | | | | | | shares of 9.75% Series B Cumulative Redeemable Preferred Stock | | | | | | | | | and 1,600,000 shares of 8.05% Series C Cumulative Redeemable Preferred Stock, | | | | | | | | | liquidation preference $25.00 per share, issued and outstanding | | | 102,500 | | | 62,500 | | | (Series C issued in 2005) | | | | | | | | | Common stock, $0.01 par value, 500,000,000 shares authorized, 43,913,409 | | | | | | | | | and 39,859,481 shares issued and outstanding at | | | | | | | | | December 31, 2005 and 2004, respectively | | | 439 | | | 399 | | | Additional paid-in capital | | | 782,735 | | | 676,015 | | | Dividends in excess of earnings - Note 2 | | | (13,235 | ) | | (13,969 | ) | | Accumulated other comprehensive income - Note 2 | | | 45,564 | | | 71,770 | | | | | | 918,003 | | | 796,715 | | | | | | | | | | | | | | $ | 6,209,699 | | $ | 4,932,720 | | | | | | | | | | |
See notes to consolidated financial statements.
45
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
(dollars in thousands, except share data)
YEAR ENDED DECEMBER 31,
---------------------------------------
2004 2003 2002
----------- ----------- -----------
REVENUES
Interest income $ 226,674 $ 134,672 $ 73,214
Rental and escalation income 13,502 16,203 13,520
Gain on settlement of investments, net 17,970 13,179 11,389
Management fee from affiliate - Note 3 -- -- 4,470
Incentive income from affiliate - Note 3 -- -- (1,218)
----------- ----------- -----------
258,146 164,054 101,375
----------- ----------- -----------
EXPENSES
Interest expense 138,847 79,084 46,375
Property operating expense 7,281 7,819 6,928
Loan and security servicing expense 3,057 2,154 655
General and administrative expense 4,638 3,194 2,356
Management fee to affiliate - Notes 3 and 10 10,620 6,468 9,250
Incentive compensation to affiliate - Notes 3 and 10 7,959 6,226 2,856
Depreciation and amortization 1,304 1,194 1,560
----------- ----------- -----------
173,706 106,139 69,980
----------- ----------- -----------
Income before equity in earnings of unconsolidated subsidiaries 84,440 57,915 31,395
Equity in earnings of unconsolidated subsidiaries - Note 3 12,465 862 362
Income taxes on related taxable subsidiaries - Note 12 (2,508) -- --
----------- ----------- -----------
Income from continuing operations 94,397 58,777 31,757
Income (loss) from discontinued operations - Note 6 4,018 (2,659) (262)
----------- ----------- -----------
NET INCOME 98,415 56,118 31,495
Preferred dividends and related accretion (6,094) (4,773) (1,162)
----------- ----------- -----------
INCOME AVAILABLE FOR COMMON STOCKHOLDERS $ 92,321 $ 51,345 $ 30,333
=========== =========== ===========
NET INCOME PER SHARE OF COMMON STOCK
BASIC $ 2.50 $ 1.98 $ 1.68
=========== =========== ===========
DILUTED $ 2.46 $ 1.96 $ 1.68
=========== =========== ===========
Income from continuing operations per share of common
stock, after preferred dividends and related accretion
Basic $ 2.39 $ 2.08 $ 1.69
=========== =========== ===========
Diluted $ 2.35 $ 2.06 $ 1.69
=========== =========== ===========
Income (loss) from discontinued operations per share of common
stock
Basic $ 0.11 $ (0.10) $ (0.01)
=========== =========== ===========
Diluted $ 0.11 $ (0.10) $ (0.01)
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF SHARES OF COMMON STOCK
OUTSTANDING
BASIC 36,943,752 25,898,288 18,080,298
=========== =========== ===========
DILUTED 37,557,790 26,140,777 18,090,052
=========== =========== ===========
DIVIDENDS DECLARED PER SHARE OF COMMON STOCK $ 2.425 $ 1.950 $ 2.050
=========== =========== ===========
| | | Year Ended December 31, | | | | | 2005 | | 2004 | | 2003 | | Revenues | | | | | | | | | Interest income | | $ | 348,516 | | $ | 225,761 | | $ | 133,183 | | | Rental and escalation income | | | 6,647 | | | 4,744 | | | 4,238 | | | Gain on sale of investments, net | | | 20,305 | | | 18,314 | | | 13,179 | | | Other income | | | 2,745 | | | 850 | | | 1,484 | | | | | | 378,213 | | | 249,669 | | | 152,084 | | Expenses | | | | | | | | | | | | Interest expense | | | 226,446 | | | 136,398 | | | 76,877 | | | Property operating expense | | | 2,363 | | | 2,575 | | | 2,427 | | | Loan and security servicing expense | | | 5,993 | | | 3,057 | | | 2,154 | | | Provision for credit losses | | | 8,421 | | | - | | | - | | | General and administrative expense | | | 4,159 | | | 4,597 | | | 3,148 | | | Management fee to affiliate - Note 10 | | | 13,325 | | | 10,620 | | | 6,468 | | | Incentive compensation to affiliate - Note 10 | | | 7,627 | | | 7,959 | | | 6,226 | | | Depreciation and amortization | | | 641 | | | 451 | | | 405 | | | | | | 268,975 | | | 165,657 | | | 97,705 | | | | | | | | | | | | | | | Income before equity in earnings of unconsolidated subsidiaries | | | 109,238 | | | 84,012 | | | 54,379 | | | Equity in earnings of unconsolidated subsidiaries - Note 3 | | | 5,930 | | | 12,465 | | | 862 | | | Income taxes on related taxable subsidiaries - Note 12 | | | (321 | ) | | (2,508 | ) | | - | | | | | | | | | | | | | | | Income from continuing operations | | | 114,847 | | | 93,969 | | | 55,241 | | | Income from discontinued operations - Note 6 | | | 2,108 | | | 4,446 | | | 877 | | Net Income | | | 116,955 | | | 98,415 | | | 56,118 | | | Preferred dividends | | | (6,684 | ) | | (6,094 | ) | | (4,773 | ) | Income available for common stockholders | | $ | 110,271 | | $ | 92,321 | | $ | 51,345 | | | | | | | | | | | | | | Net Income Per Share of Common Stock | | | | | | | | | | | Basic | | $ | 2.53 | | $ | 2.50 | | $ | 1.98 | | Diluted | | $ | 2.51 | | $ | 2.46 | | $ | 1.96 | | | | | | | | | | | | | | Income from continuing operations per share of common stock, after preferred dividends | | | | | | | | | | | | Basic | | $ | 2.48 | | $ | 2.38 | | $ | 1.95 | | | Diluted | | $ | 2.46 | | $ | 2.34 | | $ | 1.93 | | | Income (loss) from discontinued operations per share of common stock | | | | | | | | | | | | Basic | | $ | 0.05 | | $ | 0.12 | | $ | 0.03 | | | Diluted | | $ | 0.05 | | $ | 0.12 | | $ | 0.03 | | Weighted Average Number of Shares of Common Stock | | | | | | | | | | | Outstanding | | | | | | | | | | | Basic | | | 43,671,517 | | | 36,943,752 | | | 25,898,288 | | Diluted | | | 43,985,642 | | | 37,557,790 | | | 26,140,777 | | | | | | | | | | | | | | Dividends Declared per Share of Common Stock | | $ | 2.500 | | $ | 2.425 | | $ | 1.950 | |
See notes to consolidated financial statements.
46
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars in thousands)
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------- ------------------- PD. IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
--------- ------- ---------- ------ ----------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2003 2,500,000 $62,500 31,374,833 $314 $451,806
Dividends declared -- -- -- -- --
Issuance of common stock -- -- 8,375,000 84 222,721
Issuance of common stock to directors -- -- 2,148 -- 60
Exercise of common stock options -- -- 107,500 1 1,428
Comprehensive income:
Net income -- -- -- -- --
Unrealized gain on securities -- -- -- -- --
Reclassification of realized (gain) on
securities into earnings -- -- -- -- --
Foreign currency translation -- -- -- -- --
Reclassification of realized foreign
currency translation into earnings -- -- -- -- --
Unrealized gain on derivatives designated
as cash flow hedges -- -- -- -- --
Reclassification of realized loss on derivatives
designated as cash flow hedges into earnings -- -- -- -- --
Total comprehensive income
--------- ------- ---------- ---- --------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2004 2,500,000 $62,500 39,859,481 $399 $676,015
========= ======= ========== ==== ========
STOCKHOLDERS' EQUITY - DECEMBER 31, 2002 -- $ -- 23,488,517 $235 $290,935
Dividends declared -- -- -- -- --
Issuance of preferred stock 2,500,000 62,500 -- -- (2,436)
Issuance of common stock -- -- 7,882,276 79 163,242
Issuance of common stock to directors -- -- 1,540 -- 30
Exercise of common stock options -- -- 2,500 -- 35
Comprehensive income:
Net income -- -- -- -- --
Unrealized gain on securities -- -- -- -- --
Reclassification of realized (gain) on
securities into earnings -- -- -- -- --
Foreign currency translation -- -- -- -- --
Reclassification of realized foreign currency
translation into earnings -- -- -- -- --
Unrealized (loss) on derivatives designated
as cash flow hedges -- -- -- -- --
Total comprehensive income
--------- ------- ---------- ---- --------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2003 2,500,000 $62,500 31,374,833 $314 $451,806
========= ======= ========== ==== ========
DIVIDENDS TOTAL STOCK-
IN EXCESS OF ACCUM. OTHER HOLDERS'
EARNINGS COMP. INCOME EQUITY
------------ ------------ ------------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2003 $(14,670) $ 39,413 $539,363
Dividends declared (97,714) -- (97,714)
Issuance of common stock -- -- 222,805
Issuance of common stock to directors -- -- 60
Exercise of common stock options -- -- 1,429
Comprehensive income:
Net income 98,415 -- 98,415
Unrealized gain on securities -- 34,088 34,088
Reclassification of realized (gain) on
securities into earnings -- (14,574) (14,574)
Foreign currency translation -- 1,984 1,984
Reclassification of realized foreign
currency translation into earnings -- (1,478) (1,478)
Unrealized gain on derivatives designated
as cash flow hedges -- 11,973 11,973
Reclassification of realized loss on derivatives
designated as cash flow hedges into earnings -- 364 364
Total comprehensive income 130,772
-------- -------- --------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2004 $(13,969) $ 71,770 $796,715
======== ======== ========
STOCKHOLDERS' EQUITY - DECEMBER 31, 2002 $(13,966) $ 7,037 $284,241
Dividends declared (56,822) -- (56,822)
Issuance of preferred stock -- -- 60,064
Issuance of common stock -- -- 163,321
Issuance of common stock to directors -- -- 30
Exercise of common stock options -- -- 35
Comprehensive income:
Net income 56,118 -- 56,118
Unrealized gain on securities -- 23,670 23,670
Reclassification of realized (gain) on
securities into earnings -- (13,185) (13,185)
Foreign currency translation -- 4,653 4,653
Reclassification of realized foreign currency
translation into earnings -- 396 396
Unrealized (loss) on derivatives designated
as cash flow hedges -- 16,842 16,842
Total comprehensive income 88,494
-------- -------- --------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2003 $(14,670) $ 39,413 $539,363
======== ======== ========
| | | Preferred Stock | | Common Stock | | | | | | | | | | | | | Shares | | Amount | | Shares | | Amount | | Additional Pd. in Capital | | Dividends in Excess of Earnings | | Accum. Other Comp. Income | | Total Stock-Holders' Equity | | Stockholders' equity - December 31, 2004 | | | 2,500,000 | | $ | 62,500 | | | 39,859,481 | | $ | 399 | | $ | 676,015 | | $ | (13,969 | ) | $ | 71,770 | | $ | 796,715 | | | Dividends declared | | | - | | | - | | | - | | | - | | | - | | | (116,221 | ) | | - | | | (116,221 | ) | | Issuance of common stock | | | - | | | - | | | 3,300,000 | | | 33 | | | 96,449 | | | - | | | - | | | 96,482 | | | Issuance of common stock to directors | | | - | | | - | | | 2,008 | | | - | | | 67 | | | - | | | - | | | 67 | | | Exercise of common stock options | | | - | | | - | | | 751,920 | | | 7 | | | 11,687 | | | - | | | - | | | 11,694 | | | Issuance of preferred stock | | | 1,600,000 | | | 40,000 | | | - | | | - | | | (1,483 | ) | | - | | | - | | | 38,517 | | | Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | | - | | | - | | | - | | | - | | | - | | | 116,955 | | | - | | | 116,955 | | | Net unrealized (loss) on securities | | | - | | | - | | | - | | | - | | | - | | | - | | | (67,077 | ) | | (67,077 | ) | | Reclassification of net realized (gain) on securities into earnings | | | - | | | - | | | - | | | - | | | - | | | - | | | (16,015 | ) | | (16,015 | ) | | Foreign currency translation | | | - | | | - | | | - | | | - | | | - | | | - | | | (1,089 | ) | | (1,089 | ) | | Reclassification of net realized foreign currency translation into earnings | | | - | | | - | | | - | | | - | | | - | | | - | | | (626 | ) | | (626 | ) | | Net unrealized gain on derivatives designated as cash flow hedges | | | - | | | - | | | - | | | - | | | - | | | - | | | 56,426 | | | 56,426 | | | Reclassification of net realized loss on derivatives designated cash flow hedges into earnings | | | - | | | - | | | - | | | - | | | - | | | - | | | 2,175 | | | 2,175 | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | 90,749 | | Stockholders' equity - December 31, 2005 | | | 4,100,000 | | $ | 102,500 | | | 43,913,409 | | $ | 439 | | $ | 782,735 | | $ | (13,235 | ) | $ | 45,564 | | $ | 918,003 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Stockholders' equity - December 31, 2003 | | | 2,500,000 | | $ | 62,500 | | | 31,374,833 | | $ | 314 | | $ | 451,806 | | $ | (14,670 | ) | $ | 39,413 | | $ | 539,363 | | | Dividends declared | | | - | | | - | | | - | | | - | | | - | | | (97,714 | ) | | - | | | (97,714 | ) | | Issuance of common stock | | | - | | | - | | | 8,375,000 | | | 84 | | | 222,721 | | | - | | | - | | | 222,805 | | | Issuance of common stock to directors | | | - | | | - | | | 2,148 | | | - | | | 60 | | | - | | | - | | | 60 | | | Exercise of common stock options | | | - | | | - | | | 107,500 | | | 1 | | | 1,428 | | | - | | | - | | | 1,429 | | | Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | | - | | | - | | | - | | | - | | | - | | | 98,415 | | | - | | | 98,415 | | | Net unrealized gain on securities | | | - | | | - | | | - | | | - | | | - | | | - | | | 34,088 | | | 34,088 | | | Reclassification of net realized (gain) on securities into earnings | | | - | | | - | | | - | | | - | | | - | | | - | | | (14,574 | ) | | (14,574 | ) | | Foreign currency translation | | | - | | | - | | | - | | | - | | | - | | | - | | | 1,984 | | | 1,984 | | | Reclassification of net realized foreign currency translation into earnings | | | - | | | - | | | - | | | - | | | - | | | - | | | (1,478 | ) | | (1,478 | ) | | Net unrealized gain on derivatives designated as cash flow hedges | | | - | | | - | | | - | | | - | | | - | | | - | | | 11,973 | | | 11,973 | | Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings | | | - | | | - | | | - | | | - | | | - | | | - | | | 364 | | | 364 | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | 130,772 | | Stockholders' equity - December 31, 2004 | | | 2,500,000 | | $ | 62,500 | | | 39,859,481 | | $ | 399 | | $ | 676,015 | | $ | (13,969 | ) | $ | 71,770 | | $ | 796,715 | |
Continued on next page.
47
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS'STOCKHOLDERS’ EQUITY AND REDEEMABLE PREFERRED STOCK
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars (dollars in thousands)
REDEEMABLE
PREFERRED
STOCK COMMON STOCK ADDITIONAL
--------------------- ------------------- PD. IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
---------- -------- ---------- ------ ----------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2001 1,020,517 $ 20,410 16,488,517 $165 $309,356
Dividends declared by predecessor prior to
commencement of our operations -- -- -- -- --
Distribution to predecessor upon commencement
of our operations -- -- -- -- (98,378)
Dividends declared to predecessor after commencement
of our operations, but prior to our initial
public offering -- -- -- -- --
Redemption of redeemable preferred stock (1,020,517) (20,410) -- -- --
Initial public offering of shares of common stock -- -- 7,000,000 70 79,957
Dividends declared subsequent to our initial public offering -- -- -- -- --
Comprehensive income:
Net income -- -- -- -- --
Unrealized gain on securities -- -- -- -- --
Reclassification of realized (gain) on
securities into earnings -- -- -- -- --
Foreign currency translation -- -- -- -- --
Reclassification of realized foreign currency
translation into earnings -- -- -- -- --
Unrealized (loss) on derivatives designated
as cash flow hedges -- -- -- -- --
Reclassification of realized (gain) on derivatives
designated as cash flow hedges into earnings -- -- -- -- --
Total comprehensive income
---------- -------- ---------- ---- --------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2002 -- $ -- 23,488,517 $235 $290,935
========== ======== ========== ==== ========
DIVIDENDS ACCUM. OTHER TOTAL STOCK-
IN EXCESS OF COMP. HOLDERS'
EARNINGS INCOME EQUITY
------------ ------------ ------------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2001 $ (7,767) $ 8,791 $ 310,545
Dividends declared by predecessor prior to
commencement of our operations (20,949) -- (20,949)
Distribution to predecessor upon commencement
of our operations -- (11,075) (109,453)
Dividends declared to predecessor after commencement
of our operations, but prior to our initial
public offering (7,584) -- (7,584)
Redemption of redeemable preferred stock -- -- --
Initial public offering of shares of common stock -- -- 80,027
Dividends declared subsequent to our initial public offering (9,161) -- (9,161)
Comprehensive income:
Net income 31,495 -- 31,495
Unrealized gain on securities -- 62,170 62,170
Reclassification of realized (gain) on
securities into earnings -- (4,364) (4,364)
Foreign currency translation -- 4,387 4,387
Reclassification of realized foreign currency
translation into earnings -- (496) (496)
Unrealized (loss) on derivatives designated
as cash flow hedges -- (52,102) (52,102)
Reclassification of realized (gain) on derivatives
designated as cash flow hedges into earnings -- (274) (274)
Total comprehensive income 40,816
-------- -------- ---------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2002 $(13,966) $ 7,037 $ 284,241
======== ======== =========
| | | Preferred Stock | | Common Stock | | Additional Pd. in | | Dividends in Excess of | | Accum. Other Comp. | | Total Stock-Holders' | | | | | Shares | | Amount | | Shares | | Amount | | Capital | | Earnings | | Income | | Equity | | Stockholders' equity - December 31, 2002 | | | - | | $ | - | | | 23,488,517 | | $ | 235 | | $ | 290,935 | | $ | (13,966 | ) | $ | 7,037 | | $ | 284,241 | | | Dividends declared | | | - | | | - | | | - | | | - | | | - | | | (56,822 | ) | | - | | | (56,822 | ) | | Issuance of preferred stock | | | 2,500,000 | | | 62,500 | | | - | | | - | | | (2,436 | ) | | - | | | - | | | 60,064 | | | Issuance of common stock | | | - | | | - | | | 7,882,276 | | | 79 | | | 163,242 | | | - | | | - | | | 163,321 | | | Issuance of common stock to directors | | | - | | | - | | | 1,540 | | | - | | | 30 | | | - | | | - | | | 30 | | | Exercise of common stock options | | | - | | | - | | | 2,500 | | | - | | | 35 | | | - | | | - | | | 35 | | | Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | | - | | | - | | | - | | | - | | | - | | | 56,118 | | | - | | | 56,118 | | | Net unrealized gain on securities | | | - | | | - | | | - | | | - | | | - | | | - | | | 23,670 | | | 23,670 | | | Reclassification of net realized (gain) on securities into earnings | | | - | | | - | | | - | | | - | | | - | | | - | | | (13,185 | ) | | (13,185 | ) | | Foreign currency translation | | | - | | | - | | | - | | | - | | | - | | | - | | | 4,653 | | | 4,653 | | | Reclassification of net realized foreign currency translation into earnings | | | - | | | - | | | - | | | - | | | - | | | - | | | 396 | | | 396 | | | Net unrealized (loss) on derivatives designated as cash flow hedges | | | - | | | - | | | - | | | - | | | - | | | - | | | 16,842 | | | 16,842 | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | 88,494 | | Stockholders' equity - December 31, 2003 | | | 2,500,000 | | $ | 62,500 | | | 31,374,833 | | $ | 314 | | $ | 451,806 | | $ | (14,670 | ) | $ | 39,413 | | $ | 539,363 | |
See notes to consolidated financial statements.
48
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
(dollars in thousands)
YEAR ENDED DECEMBER 31,
-------------------------------------
2004 2003 2002
----------- ----------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 98,415 $ 56,118 $ 31,495
Adjustments to reconcile net income to net cash provided by operating
activities (inclusive of amounts related to discontinued operations)
Depreciation and amortization 2,253 3,085 8,603
Accretion of discount and other amortization 1,898 (3,761) (4,767)
Equity in earnings of unconsolidated subsidiaries (12,465) (862) (362)
Accrued incentive (income) loss from affiliate -- -- 1,218
Non-cash incentive compensation to affiliate -- -- 14
Deferred rent (1,380) (1,853) (1,353)
Gain on settlement of investments (22,029) (11,789) (9,619)
Unrealized gain on non-hedge derivatives (3,332) (3,696) --
Non-cash directors' compensation 60 30 --
Change in
Restricted cash (8,137) (2,564) (3,186)
Receivables and other assets (5,431) (9,403) (4,449)
Due to affiliates 6,518 1,110 (1,506)
Accrued expenses and other liabilities 21,520 11,177 5,469
----------- ----------- ---------
Net cash provided by operating activities: 77,890 37,592 21,557
----------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of real estate securities (1,426,762) (1,407,948) (689,255)
Proceeds from sale of real estate securities 193,246 255,030 276,704
Deposit on real estate securities (treated as a derivative) (80,311) (59,676) (37,125)
Purchase of loans (631,728) (685,311) (276,612)
Proceeds from settlement of loans 124,440 164,404 372
Repayments of loan and security principal 428,091 105,848 15,217
Purchase and improvement of operating real estate (141) (576) (2,250)
Proceeds from sale of operating real estate 71,871 5,331 42,492
Contributions to unconsolidated subsidiaries (26,789) (30,871) (19,991)
Distributions from unconsolidated subsidiaries 28,664 1,087 8,265
Payment of deferred transaction costs (280) -- (508)
----------- ----------- ---------
Net cash provided by (used in) investing activities (1,319,699) (1,652,682) (682,691)
=========== =========== =========
| | | Year Ended December 31, | | | | | 2005 | | 2004 | | 2003 | | Cash Flows From Operating Activities | | | | | | | | | Net income | | $ | 116,955 | | $ | 98,415 | | $ | 56,118 | | Adjustments to reconcile net income to net cash provided by operating activities (inclusive of amounts related to discontinued operations): | | | | | | | | | | | | Depreciation and amortization | | | 818 | | | 2,253 | | | 3,085 | | | Accretion of discount and other amortization | | | (2,645 | ) | | 1,898 | | | (3,761 | ) | | Equity in earnings of unconsolidated subsidiaries | | | (5,930 | ) | | (12,465 | ) | | (862 | ) | | Distributions of earnings from unconsolidated subsidiaries | | | 5,930 | | | 12,465 | | | 862 | | | Deferred rent | | | (2,539 | ) | | (1,380 | ) | | (1,853 | ) | | Gain on sale of investments | | | (20,811 | ) | | (22,029 | ) | | (11,789 | ) | | Unrealized gain on non-hedge derivatives | | | (2,839 | ) | | (3,332 | ) | | (3,696 | ) | | Provision for credit losses | | | 8,421 | | | - | | | - | | | Non-cash directors' compensation | | | 67 | | | 60 | | | 30 | | | Change in | | | | | | | | | | | | Restricted cash | | | (7,980 | ) | | (8,137 | ) | | (2,564 | ) | | Receivables and other assets | | | 218 | | | (5,431 | ) | | (9,403 | ) | | Due to affiliates | | | (180 | ) | | 6,518 | | | 1,110 | | | Accrued expenses and other liabilities | | | 9,278 | | | 21,520 | | | 11,177 | | | Net cash provided by operating activities: | | | 98,763 | | | 90,355 | | | 38,454 | | Cash Flows From Investing Activities | | | | | | | | | | | | Purchase of real estate securities | | | (1,463,581 | ) | | (1,426,762 | ) | | (1,407,948 | ) | | Proceeds from sale of real estate securities | | | 60,254 | | | 193,246 | | | 255,030 | | | Deposit on real estate securities (treated as a derivative) | | | (57,149 | ) | | (80,311 | ) | | (59,676 | ) | | Purchase of and advances on loans | | | (584,270 | ) | | (631,728 | ) | | (685,311 | ) | | Proceeds from settlement of loans | | | 1,901 | | | 124,440 | | | 164,404 | | | Repayments of loan and security principal | | | 698,002 | | | 428,091 | | | 105,848 | | | Purchase of derivative instruments | | | - | | | - | | | (5,482 | ) | | Margin deposit on derivative instruments | | | (53,518 | ) | | - | | | - | | | Proceeds from sale of derivative instruments | | | 1,338 | | | - | | | - | | | Payments on settlement of derivative instruments | | | (1,112 | ) | | - | | | - | | | Purchase and improvement of operating real estate | | | (182 | ) | | (141 | ) | | (576 | ) | | Proceeds from sale of operating real estate | | | 52,333 | | | 71,871 | | | 5,331 | | | Contributions to unconsolidated subsidiaries | | | - | | | (26,789 | ) | | (30,871 | ) | | Distributions of capital from unconsolidated subsidiaries | | | 11,277 | | | 16,199 | | | 225 | | | Payment of deferred transaction costs | | | (39 | ) | | (280 | ) | | - | | | Net cash used in investing activities | | | (1,334,746 | ) | | (1,332,164 | ) | | (1,659,026 | ) |
Continued on next page.
49
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(dollars (dollars in thousands)
YEAR ENDED DECEMBER 31,
-----------------------------------
2004 2003 2002
---------- ---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of CBO bonds payable 859,719 921,503 438,787
Repayments of CBO bonds payable (604) -- (17,742)
Issuance of other bonds payable -- -- 37,001
Repayments of other bonds payable (41,759) (6,413) (8,151)
Borrowings under notes payable 614,106 80,000 62,952
Repayments of notes payable (119,407) (906) (119,670)
Borrowings under repurchase agreements 654,254 663,120 246,712
Repayments of repurchase agreements (879,417) (195,506) --
Draws under credit facility -- -- 20,000
Repayments of credit facility -- -- (1,750)
Issuance of common stock 222,805 168,610 91,000
Costs related to issuance of common stock -- (5,289) (10,185)
Exercise of common stock options 1,429 35 --
Issuance of preferred stock -- 62,500 --
Costs related to issuance of preferred stock -- (2,436) --
Redemption of preferred stock -- -- (20,410)
Dividends paid (88,489) (49,280) (27,522)
Distribution of cash to predecessor -- -- (12,423)
Purchase of derivative assets -- (5,482) (1,200)
Payment of deferred financing costs (3,320) (426) (2,162)
---------- ---------- ---------
Net cash provided by (used in) financing activities 1,219,317 1,630,030 675,237
---------- ---------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (22,492) 14,940 14,103
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 60,403 45,463 31,360
---------- ---------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 37,911 $ 60,403 $ 45,463
========== ========== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest expense $ 135,172 $ 80,522 $ 56,365
Cash paid during the period for income taxes $ 2,639 $ -- $ --
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Common stock dividends declared but not paid $ 24,912 $ 15,687 $ 9,161
Preferred stock dividends declared but not paid $ 1,016 $ 1,016 $ --
Deposits used in acquisiton of real estate securities (treated as
derivatives) $ 75,824 $ 81,492 $ 23,631
Contribution of assets to unconsolidated subsidiary $ -- $ -- $ 1,454
Distribution of non-cash assets and liabilities to predecessor $ -- $ -- $ 97,030
| | | Year Ended December 31, | | | | | 2005 | | 2004 | | 2003 | | Cash Flows From Financing Activities | | | | | | | | | Issuance of CBO bonds payable | | | 880,570 | | | 859,719 | | | 921,503 | | | Repayments of CBO bonds payable | | | (10,241 | ) | | (604 | ) | | - | | | Issuance of other bonds payable | | | 246,547 | | | - | | | - | | | Repayments of other bonds payable | | | (114,780 | ) | | (41,759 | ) | | (6,413 | ) | | Borrowings under notes payable | | | - | | | 614,106 | | | 80,000 | | | Repayments of notes payable | | | (391,559 | ) | | (119,407 | ) | | (906 | ) | | Borrowings under repurchase agreements | | | 815,840 | | | 654,254 | | | 663,120 | | | Repayments of repurchase agreements | | | (258,257 | ) | | (879,417 | ) | | (195,506 | ) | | Draws under credit facility | | | 62,000 | | | - | | | - | | | Repayments of credit facility | | | (42,000 | ) | | - | | | - | | | Issuance of common stock | | | 97,680 | | | 222,805 | | | 168,610 | | | Costs related to issuance of common stock | | | (1,198 | ) | | - | | | (5,289 | ) | | Exercise of common stock options | | | 11,694 | | | 1,429 | | | 35 | | | Issuance of preferred stock | | | 40,000 | | | - | | | 62,500 | | | Costs related to issuance of preferred stock | | | (1,483 | ) | | - | | | (2,436 | ) | | Dividends paid | | | (113,097 | ) | | (88,489 | ) | | (49,280 | ) | | Payment of deferred financing costs | | | (2,369 | ) | | (3,320 | ) | | (426 | ) | | Net cash provided by financing activities | | | 1,219,347 | | | 1,219,317 | | | 1,635,512 | | Net Increase (Decrease) in Cash and Cash Equivalents | | | (16,636 | ) | | (22,492 | ) | | 14,940 | | Cash and Cash Equivalents, Beginning of Period | | | 37,911 | | | 60,403 | | | 45,463 | | Cash and Cash Equivalents, End of Period | | $ | 21,275 | | $ | 37,911 | | $ | 60,403 | | Supplemental Disclosure of Cash Flow Information | | | | | | �� | | | | | | Cash paid during the period for interest expense | | $ | 213,070 | | $ | 135,172 | | $ | 80,522 | | | Cash paid during the period for income taxes | | $ | 448 | | $ | 2,639 | | $ | - | | Supplemental Schedule of Non-cash Investing and Financing Activities | | | | | | | | | | | | Common stock dividends declared but not paid | | $ | 27,446 | | $ | 24,912 | | $ | 15,687 | | | Preferred stock dividends declared but not paid | | $ | 1,606 | | $ | 1,016 | | $ | 1,016 | | | Deposits used in acquisiton of real estate securities (treated as derivatives) | | $ | 82,334 | | $ | 75,824 | | $ | 81,492 | | | Consolidation of ICH CMO | | $ | - | | $ | - | | $ | 221,773 | |
See notes to consolidated financial statements.
50
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars (dollars in tables in thousands, except per share data)
1. ORGANIZATION
Newcastle Investment Corp. (and its subsidiaries, "Newcastle"“Newcastle”) is a Maryland corporation that was formed in June 2002. Newcastle conducts its business through three primary segments: (i) real estate securities and real estate related loans, (ii) residential mortgage loans, and (iii) operating real estate, and (iii)
residential mortgage loans.
Newcastle was formed as a subsidiary of Newcastle Investment Holdings Corp.
("Holdings"). Prior to Newcastle's initial public offering, Holdings
contributed to Newcastle certain assets and liabilities in exchange for
approximately 16.5 million shares of Newcastle's common stock. For
accounting purposes, this transaction is presented as a reverse spin-off,
whereby Newcastle is treated as the continuing entity and the assets that
were retained by Holdings and not contributed to Newcastle are accounted
for as if they were distributed at their historical book basis through a
spin-off to Holdings. Newcastle's operations commenced in July 2002. In May
2003, Holdings distributed to its stockholders all of the shares of
Newcastle's common stock that it held, and it no longer owns any of
Newcastle's common equity.
estate.
The following table presents information on shares of Newcastle'sNewcastle’s common stock issued subsequent to its formation:
Year Shares Issued Range of Issue Prices (1) Net Proceeds (millions)
- ---- ------------- ------------------------- -----------------------
Formation 16,488,517 N/A N/A
2002 7,000,000 $13.00 $ 80.0
2003 7,886,316 $20.35-$22.85 $163.4
2004 8,484,648 $26.30-$31.40 $224.3
----------
December 31, 2004 39,859,481
==========
January 2005 3,879,000 $29.60 $105.4
| Year | | | Shares Issued | | | Range of Issue Prices (1) | | | Net Proceeds (millions) | | | Formation | | | 16,488,517 | | | N/A | | | N/A | | | 2002 | | | 7,000,000 | | $ | 13.00 | | $ | 80.0 | | | 2003 | | | 7,886,316 | | $ | 20.35-$22.85 | | $ | 163.4 | | | 2004 | | | 8,484,648 | | $ | 26.30-$31.40 | | $ | 224.3 | | | 2005 | | | 4,053,928 | | $ | 29.60 | | $ | 108.2 | | | December 31, 2005 | | | 43,913,409 | | | | | | | | | | | | | | | | | | | |
(1) Excludes prices of shares issued pursuant to the exercise of options and shares issued to ourNewcastle's independent directors.
In March 2003, Newcastle issued 2.5 million shares ($62.5 million face
amount) of its 9.75% Series B Cumulative Redeemable Preferred Stock (the
"Series B Preferred") in a public, registered offering for net proceeds of
approximately $60.1 million. The Series B Preferred is non-voting, has a
$25 per share liquidation preference, no maturity date and no mandatory
redemption. Newcastle has the option to redeem the Series B Preferred
beginning in March 2008.
Newcastle is organized and conducts its operations to qualify as a real estate investment trust ("REIT"(“REIT”) for federal income tax purposes.under the Internal Revenue Code of 1986, as amended (the “Code”). As such, Newcastle will generally not be subject to U.S. federal corporate income tax on that portion of its net income that is distributed to stockholders if it distributes at least 90% of its REIT taxable income to its stockholders by prescribed dates and complies with various other requirements. Newcastle is party to a management agreement (the "Management Agreement"“Management Agreement”) with Fortress Investment Group LLC (the "Manager"“Manager”), an affiliate, under which the Manager advises Newcastle on various aspects of its business and manages its day-to-day operations, subject to the supervision of Newcastle'sNewcastle’s board of directors. For its services, the Manager receives an annual management fee and incentive compensation, both as defined in the Management Agreement. The Manager also manages, among other entities,
Holdings and Fortress Investment Fund LLC ("Fund I"). For a further discussion of the Management Agreement, see Note 10.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Approximately 2.9 million shares of Newcastle’s common stock were held by an affiliate of the Manager and its principals at December 31, 2005. In addition, an affiliate of the Manager held options to purchase approximately 1.2 million shares of Newcastle’s common stock at December 31, 2005.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
GENERAL
BASIS OF ACCOUNTING
Basis of Accounting -The accompanying consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"GAAP''). The consolidated financial statements include the accounts of Newcastle and its consolidated subsidiaries, subsequent to the
date of commencement of its operations, and also include the accounts of
its predecessor, Holdings, prior to such date.subsidiaries. All significant intercompany transactions and balances have been eliminated. Newcastle consolidates those entities in which it has an investment of 50% or more and has control over significant operating, financial and investing decisions of the entity.
51
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars (dollars in tables in thousands, except per share data)
In January 2003, Financial Accounting Standards Board Interpretation ("FIN"(“FIN”) No. 46 "Consolidation“Consolidation of Variable Interest Entities,"” which explains how to identify variable interest entities and how to assess whether to consolidate such entities, was issued. As a result of this FIN, Newcastle consolidated the ICH CMO (Note 5).
In December 2003, FIN No. 46R "Consolidation“Consolidation of Variable Interest Entities"Entities” was issued as a modification of FIN 46. FIN 46R, which became effective in the first quarter of 2004, clarified the methodology for determining whether an entity is a variable interest entity ("VIE"(“VIE”) and the methodology for assessing who is the primary beneficiary of a VIE. VIEs are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, and only its primary beneficiary, which is defined as the party who will absorb a majority of the VIE'sVIE’s expected losses or receive a majority of the expected residual returns as a result of holding variable interests. The application of FIN 46R did not result in a change in our accounting for any entities. Our CBO subsidiaries are considered VIEs of which we are the primary beneficiary.
For entities over which Newcastle exercises significant influence, but which do not meet the requirements for consolidation, Newcastle uses the equity method of accounting whereby it records its share of the underlying income of such entities. Newcastle owns an equity method investment in two limited liability companies (Note 3) which are investment companies and therefore maintain their financial records on a fair value basis. Newcastle has retained such accounting relative to its investments in such companies pursuant to the Emerging Issues Task Force ("EITF"(“EITF”) Issue No. 85-12 "Retention“Retention of Specialized Accounting for Investments in Consolidation."
Holdings was a Maryland corporation that invested in real estate-related
assets. Its primary businesses were investing in (1) real estate securities
and real estate related loans, (2) operating real estate, primarily credit
leased operating real estate and (3) Fund I. Holdings' investments in real
estate securities and a portion of its investments operating real estate
were transferred to Newcastle in connection with it organization. The
operating real estate (GSA Portfolio - Note 6) and real estate related
loans distributed to Holdings have been treated as discontinued operations,
because they constituted a component of an entity, while the other
operations distributed to Holdings, including the investment in Fund I,
have not been treated as such, because they did not constitute a component
of an entity as defined in Statement of Financial Accounting Standards
("SFAS") No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets."
”
Certain prior year amounts have been reclassified to conform to the current yearyear’s presentation.
RISKS AND UNCERTAINTIES --
Risks and Uncertainties ¾ In the normal course of business, Newcastle encounters primarily two significant types of economic risk: credit and market. Credit risk is the risk of default on Newcastle'sNewcastle’s securities, loans, leases,derivatives, and derivativesleases that results from a borrower's, lessee'sderivative counterparty's or derivative counterparty'slessee's inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of investments in securities, loans and real estatederivatives or in derivativesreal estate due to changes in interest rates, spreads or other market factors, including the value of the collateral underlying loans and securities and the valuation of real estate held by Newcastle. Management believes that the carrying values of its investments are reasonable taking into consideration these risks along with estimated collateral values, payment histories, and other borrower information.
Newcastle invests in real estate located outside of the United States. Newcastle'sNewcastle’s non-U.S. investments are subject to the same risks associated with its United States investments as well as additional risks, such as fluctuations in foreign currency exchange rates, unexpected changes in regulatory requirements, heightened risk of political and economic instability, difficulties in managing non-U.S. investments, potentially adverse tax consequences and the burden of complying with a wide variety of foreign laws.
52
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
Additionally, Newcastle is subject to significant tax risks. If Newcastle were to fail to qualify as a REIT in any taxable year, Newcastle would be subject to U.S. federal corporate income tax (including any applicable alternative minimum tax), which could be material. In addition, if Newcastle’s predecessor, Newcastle Investment Holdings Corp. (“Holdings”), failed to qualify as a REIT and Newcastle is treated as a successor to Holdings, this could cause Newcastle to likewise fail to qualify as a REIT. Unless entitled to relief under certain statutory provisions, Newcastle would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost.
USE OF ESTIMATES --
Use of Estimates¾ The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
FEDERAL INCOME TAXES AND DIVIDENDS -- Newcastle is organized and conducts
its operations to qualify as a REIT under the Internal Revenue Code of
1986, as amended (the "Code"). A REIT will generally not be subject to U.S.
federal corporate income tax on that portion of its net income that is
distributed to stockholders if it distributes at least 90% of its REIT
taxable income to its stockholders by prescribed dates and complies with
various other requirements.
Since Newcastle distributed 100% of its 2004, 2003 and 2002 REIT taxable
income, no provision has been made for U.S. federal corporate income taxes
in the accompanying consolidated financial statements, except in connection
with Newcastle's taxable REIT subsidiary ("TRS").
Newcastle holds one of its investments in a TRS (Note 12). Newcastle
records income taxes related to this TRS using the asset and liability
method under which deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective bases.
Distributions relating to 2004, 2003 and 2002 were taxable as follows:
Book Basis Tax Basis
Dividends Per Share Dividends Per Share
(A) (B) Ordinary Income Captial Gains Return of Capital
------------------- ------------------- --------------- ------------- -----------------
2004 $2.425 $2.432 76.60% 23.40% None
2003 $1.950 $1.843 77.66% 22.34% None
2002 $0.850 $0.577 100.00% None None
(A) The excess of book basis dividends over tax basis dividends is carried
forward to the next year for tax purposes.
The distributions disclosed above do not include the distributions made by
our predecessor, Holdings. Holdings made per share distributions of $1.20
in 2002 prior to the commencement of our operations. Holdings also elected
to be taxed as a REIT.
Dividends in Excess of Earnings includes ($14.5 million) related to the
operations of our predecessor.
EARNINGS PER SHARE -- Newcastle is required to present both basic and
diluted earnings per share ("EPS"). Basic EPS is calculated by dividing net
income available for common stockholders by the weighted average number of
shares of common stock outstanding during each period. Diluted EPS is
calculated by dividing net income available for common stockholders by the
weighted average number of shares of common stock outstanding plus the
additional dilutive effect of common stock equivalents during each period.
Newcastle's common stock equivalents are its stock options (Note 9). During
2004, 2003 and 2002, based on the treasury stock method, Newcastle had
614,038, 242,489 and 9,754 dilutive common stock equivalents, respectively,
resulting from its outstanding options. Net income available for common
stockholders is equal to net income less preferred dividends, and less the
accretion of the discount on Holdings' Series A Preferred which was fully
redeemed in June 2002.
53
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars (dollars in tables in thousands, except per share data)
COMPREHENSIVE INCOME -
Comprehensive Income¾ Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances, excluding those resulting from investments by and distributions to owners. For Newcastle'sNewcastle’s purposes, comprehensive income represents net income, as presented in the statements of income, adjusted for net foreign currency translation adjustments and unrealized gains or losses on securities available for sale and derivatives designated as cash flow hedges.hedges and net foreign currency translation adjustments. The following table summarizes our accumulated other comprehensive income:
December 31,
-------------------
2004 2003
-------- --------
Net unrealized gains on securities $ 99,875 $ 80,361
Net unrealized (losses) on derivatives
designated as cash flow hedges (31,862) (44,199)
Net foreign currency translation adjustments 3,757 3,251
-------- --------
Accumulated other comprehensive income $ 71,770 $ 39,413
======== ========
| | | December 31, | | | | | 2005 | | 2004 | | | Net unrealized gains on securities | | $ | 16,782 | | $ | 99,875 | | Net unrealized gains (losses) on derivatives designated as cash flow hedges | | | 26,738 | | | (31,862 | ) | | Net foreign currency translation adjustments | | | 2,044 | | | 3,757 | | | Accumulated other comprehensive income | | $ | 45,564 | | $ | 71,770 | |
REVENUE RECOGNITION
REAL ESTATE SECURITIES AND LOANS RECEIVABLE--Newcastle Real Estate Securities and Loans Receivable ¾ Newcastle invests in securities, including commercial mortgage backed securities, senior unsecured debt issued by property REITS, real estate related asset backed securities and agency residential mortgage backed securities. Newcastle also invests in loans, including real estate related loans, commercial mortgage loans, residential mortgage loans and manufactured housing loans. Newcastle determines at acquisition whether loans will be assembledaggregated into pools based on common risk characteristics (credit quality, loan type, and date of origination)origination or acquisition); loans assembledaggregated into pools are accounted for as if each pool were a single loan. Loans receivable are presented in the consolidated balance sheet net of any unamortized discount (or gross of any unamortized premium) and an allowance for loan losses. Discounts or premiums are accreted into interest income on an effective yield or "interest"“interest” method, based upon a comparison of actual collections and expected collections,cash flows, through the expected maturity date of the security or loan. Depending on the nature of the investment, changes to expected cash flows may result in a prospective change to yield or a retrospective change which would include a catch up adjustment. For loans acquired at a discount for credit quality, the difference between contractual cash flows and expected cash flows at acquisition is not accreted (nonaccretable difference). Income is not accrued on non-performing securities or loans; cash received on such securities or loans is treated as income to the extent of interest previously accrued. Interest income with respect to non-discounted securities or loans is recognized on an accrual basis. Deferred fees and costs, if any, are recognized as interest income over the terms of the securities or loans using the interest method. Upon settlement of securities and loans, the excess (or deficiency) of net proceeds over the net carrying value of thesuch security or loan is recognized as a gain (or loss) in the period of settlement. IMPAIRMENT OF SECURITIES AND LOANS --Interest income includes prepayment penalties received of $3.2 million, $0.6 million and $0.4 million in 2005, 2004 and 2003, respectively. Impairment of Securities and Loans¾ Newcastle periodicallycontinually evaluates securities and loans for impairment. This evaluation includes the following, as applicable: (i) review of the credit of the issuer or the borrower, (ii) review of the credit rating of the security, (iii) review of thekey terms of the security or loan, (iv) review of the performance of the loan or underlying loans, including debt service coverage and loan to value ratios, (v) analysis of the value of the collateral for the loan or underlying loans, (vi) analysis of the effect of local, industry and broader economic factors, and (vii) analysis of trends in defaults and loss severities for similar loans. Securities and loans are considered to be impaired, for financial reporting purposes, when it is probable that Newcastle will be unable to collect all principal or interest when due according to the contractual terms of the original agreements, or, for securities or loans purchased at a discount for credit quality or that represent beneficial interests in securitizations, when Newcastle determines that it is probable that it will be unable to collect as anticipated. For loans purchased at a discount for credit quality, if Newcastle determines that it is probable that it will collect more than previously anticipated, the yield accrued on such loan or security is adjusted upward, on a prospective basis. Upon determination of impairment, Newcastle establishes specific valuation allowances for loans or records a direct write down for securities, through provisions for losses, based on the estimated fair value of the underlying collateral using a discounted cash flow analysis.analysis or based on observable market value. Newcastle also establishes allowances for estimated unidentified incurred losses on pools of loans. The allowance for each security or loan is maintained at a level believed adequate by management to absorb probable losses, based on periodic reviews of actual and expected losses. It is Newcastle'sNewcastle’s policy to establish an allowance for uncollectible interest on performing securities or loans that are past due more than 90 days or sooner when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. Upon such a determination, those loans are deemed to be non-performing. Actual losses may differ from Newcastle's estimates.
54
Newcastle’s estimate.
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars (dollars in tables in thousands, except per share data)
RENTAL AND ESCALATION INCOME --Contractual minimum rental income is
recognized on a straight-line basis over the terms of the related operating
leases. The excess of straight-line rents above contractual amounts was
$1.4 million, $1.9 million and $1.4 million during 2004, 2003 and 2002,
respectively. Expense recoveries are included in rental and escalation
income.
MANAGEMENT FEE AND INCENTIVE INCOME FROM AFFILIATE -- These income items
relate to Holdings' investment in Fund I which was not transferred to
Newcastle and is not part of our ongoing operations. For a further
discussion of this income, see Note 3.
EXPENSE RECOGNITION
INTEREST EXPENSE --
InterestExpense ¾Newcastle finances its investments using both fixed and floating rate debt, including securitizations, loans and repurchase agreements, and other financing vehicles. Certain of this debt has been issued at discounts. Discounts are accreted into interest expense on the interest method through the expected maturity date of the financing.
DEFERRED COSTS AND INTEREST RATE CAP PREMIUMS -- Deferred Costs and Interest Rate Cap Premiums ¾Deferred costs consist primarily of costs incurred in obtaining financing which are amortized into interest expense over the term of such financing using the interest method. Interest rate cap premiums, which are included in Derivative Assets, are amortized as described below. During 2004, 2003 Derivatives and 2002, approximately $4.0 million,
$1.5 million and $1.4 million of such costs were amortized into interest
expense, respectively.
DERIVATIVES AND HEDGING ACTIVITIES --Hedging Activities ¾ All derivatives are recognized as either assets or liabilities in the statement of financial position and measured at fair value. Fair value adjustments affect either stockholders' equity or net income depending on whether the derivative instrument qualifies as a hedge for accounting purposes and, if so, the nature of the hedging activity. For those derivative instruments that are designated and qualify as hedging instruments, Newcastle designates the hedging instrument, based upon the exposure being hedged, as either a cash flow hedge, a fair value hedge or a hedge of a net investment in a foreign operation.
Derivative transactions are entered into by Newcastle solely for risk-managementrisk management purposes, except for real estate securities portfolio deposits as described in Note 4 and the total return swapswaps described in Note 5. Such total return swaps are essentially financings of certain reference assets which are treated as derivatives for accounting purposes. The decision of whether or not a given transaction/position (or portion thereof) is hedged is made on a case-by-case basis, based on the risks involved and other factors as determined by senior management, including restrictions imposed by the Code among others. In determining whether to hedge a risk, Newcastle may consider whether other assets, liabilities, firm commitments and anticipated transactions already offset or reduce the risk. All transactions undertaken as hedges are entered into with a view towards minimizing the potential for economic losses that could be incurred by Newcastle. Generally, all derivatives entered into are intended to qualify as hedges under GAAP, unless specifically stated otherwise. To this end, terms of hedges are matched closely to the terms of hedged items.
Description of the risks being hedged
1) Interest rate risk, existing positions - Newcastle generally hedges
the aggregate risk of interest rate fluctuations with respect to its
borrowings, regardless of the form of such borrowings, which require
payments based on a variable interest rate index. Newcastle generally
intends to hedge only the risk related to changes in the benchmark
interest rate (LIBOR or a Treasury rate). In order to reduce such
risks, Newcastle may enter into swap agreements whereby Newcastle
would receive floating rate payments in exchange for fixed rate
payments, effectively converting the borrowing to fixed rate.
Newcastle may also enter into cap agreements whereby, in exchange for
a premium, Newcastle would be reimbursed for interest paid in excess
of a certain cap rate.
55
| 1) | Interest rate risk, existing debt obligations - Newcastle generally hedges the risk of interest rate fluctuations with respect to its borrowings, regardless of the form of such borrowings, which require payments based on a variable interest rate index. Newcastle generally intends to hedge only the risk related to changes in the benchmark interest rate (LIBOR or a Treasury rate). In order to reduce such risks, Newcastle may enter into swap agreements whereby Newcastle would receive floating rate payments in exchange for fixed rate payments, effectively converting the borrowing to fixed rate. Newcastle may also enter into cap agreements whereby, in exchange for a premium, Newcastle would be reimbursed for interest paid in excess of a certain cap rate. |
| 2) | Interest rate risk, anticipated transactions - Newcastle may hedge the aggregate risk of interest rate fluctuations with respect to anticipated transactions, primarily anticipated borrowings. The primary risk involved in an anticipated borrowing is that interest rates may increase between the date the transaction becomes probable and the date of consummation. Newcastle generally intends to hedge only the risk related to changes in the benchmark interest rate (LIBOR or a Treasury rate). This is generally accomplished through the use of interest rate swaps. |
| 3) | Interest rate risk, fair value of investments - Newcastle occasionally hedges the fair value of investments acquired outside of its warehouse agreements (Note 4) prior to such investments being included in a CBO financing (Note 8). The primary risk involved is the risk that the fair value of such an investment will change between the acquisition date and the date the terms of the related financing are “locked in.” Newcastle generally intends to hedge only the risk related to changes in the benchmark interest rate (LIBOR or a Treasury rate). This is generally accomplished through the use of interest rate swaps. |
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars (dollars in tables in thousands, except per share data)
2) Interest rate risk, anticipated transactions - Newcastle may hedge the
aggregate risk of interest rate fluctuations with respect to
anticipated transactions, primarily anticipated borrowings. The
primary risk involved in an anticipated borrowing is that interest
rates may increase between the date the transaction becomes probable
and the date of consummation. Newcastle generally intends to hedge
only the risk related to changes in the benchmark interest rate (LIBOR
or a Treasury rate). This is generally accomplished through the use of
interest rate swaps.
3) Foreign currency rate risk, net investments - Newcastle may hedge the
aggregate risk of fluctuations in the exchange rate between a foreign
currency, in which Newcastle has made a net investment, and the U.S.
dollar. In order to reduce this risk, Newcastle may maintain a short
position in the applicable foreign currency. The amount of the
position would be equal to the anticipated net equity in the foreign
investment at a forward date, as denominated in the foreign currency.
This effectively locks in the current exchange rate on Newcastle's net
equity position for the period of such position. At December 31, 2004,
no such derivative transactions were outstanding.
Cash flow hedges Newcastle has employed interest rate swaps primarily in two ways: (i) to hedge its exposure to changes in market interest rates with respect to its floating rate debt and (ii) to hedge anticipated financings. Interest on approximately $375.0$342.4 million and $1,990.9$2,941.7 million in principal amount of Newcastle'sNewcastle’s floating rate debt was designated as the hedged items to interest rate cap and swap agreements, respectively, at December 31, 2004.
2005.
To qualify for cash flow hedge accounting, interest rate swaps and caps must meet certain criteria, including (1) the items to be hedged expose Newcastle to interest rate risk, (2) the interest rate swaps or caps are highly effective in reducing Newcastle'sNewcastle’s exposure to interest rate risk, and (3) with respect to an anticipated transaction, such transaction is probable. Correlation and effectiveness are periodically assessed based upon a comparison of the relative changes in the fair values or cash flows of the interest rate swaps and caps and the items being hedged.
For derivative instruments that are designated and qualify as a cash flow hedge (i.e. hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss, and net payments received or made, on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings during the period of change. Ineffectiveness of approximately $0.1$0.2 million and ($0.1 million) of gain (loss) was recorded in 2005 and 2004, respectively, to Gain on Settlement of
Investments.Other Income. No material ineffectiveness was recorded during the yearsyear ended December 31, 2003 or 2002. Costs incurred in connection with the
purchase of2003. The premiums paid for interest rate caps, treated as cash flow hedges, are amortized into interest expense based on the estimated value of such cap for each period covered by such cap.
With respect to interest rate swaps which have been designated as hedges of anticipated financings, periodic net payments are recognized currently as adjustments to interest expense; any gain or loss from fluctuations in the fair value of the interest rate swaps is recorded as a deferred hedginghedge gain or loss in accumulated other comprehensive income and treated as a component of the anticipated transaction. In the event the anticipated refinancing failed to occur as expected, the deferred hedginghedge credit or charge would be recognized currently in income. Newcastle'sNewcastle’s hedges of such refinancing were terminated upon the consummation of such refinancing. As of December 31, 2005 and 2004, $(3.5 million) and 2003, $(5.5 million) and $3.4 million,, of such
gains (losses) were deferred, net of amortization, respectively.
During 2004 and 2005, Newcastle dedesignated fourcertain of its hedge derivatives, and in some cases redesignated all or a portion thereof as hedges. As a result of this
dedesignation, sincethese dedesignations, in the cases where the originally hedged items arewere still owned by Newcastle, the unrealized loss was recorded in OCI as a deferred hedginghedge loss and is being amortized over the life of the hedged item. In the cases where the dedesignation resulted in immediate recognition, Newcastle recognized $0.3 million of gain. As of December 31, 2005 and 2004, $0.2 million and $0.4 million of such loss was deferred, net of amortization.
56
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
amortization, respectively.
Fair Value Hedges
At December 31, 2004,2005, Newcastle owned onetwo interest rate swapswaps designated as a fair value hedgehedges of a fixed rate investmentinvestments with aan aggregate notional amount of $20.5$2.1 million. Any gainunrealized gains or loss,losses, as well as net payments received or made, on thisthese derivative instrument,instruments are recorded currently in income, as isare any
gain or loss (including unrealized gains or losses)losses on the associated hedged itemitems related to changes in interest rates.
With respect to interest rate swaps which were designated as hedges of the fair value of lease payments, periodic net payments and any gain or loss from fluctuations in the fair value of the interest rate swaps were capitalized to accumulated other comprehensive income and are being recognized over the term of the leases as adjustments to rental income. Newcastle'sNewcastle’s hedge of such payments was terminated in 1999. As of December 31, 2005 and 2004, and 2003, $1.0$0.1 million and $1.4$1.0 million of such losses were deferred, net of amortization, respectively.
Classification
During the years ended December
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005, 2004 2003 and 2002, Newcastle recorded
an aggregate of $12.3 million, $16.8 million and ($52.4 million) of net
gain (loss) to other comprehensive income and an aggregate of $2.1 million,
$4.8 million and $4.6 million of gain to earnings, as an adjustment to
interest expense, respectively, related to such hedges. 2003 (dollars in tables in thousands, except per share data)
Classification
Newcastle expects to reclassify approximately $1.7$1.0 million of net loss on derivative instruments from accumulated other comprehensive income to earnings during the twelve months ending December 31, 20052006 due to amortization of net deferred hedge losses.
Newcastle's
Newcastle’s derivatives are recorded on its balance sheet as follows (excluding the real estate securities portfolio deposit, which is reported separately):
| Derivative Assets | | 2005 | | 2004 | | | Interest rate caps (A) | | $ | 2,145 | | $ | 3,554 | | | Interest rate swaps (A) | | | 56,829 | | | 21,001 | | | Total return swaps | | | 3,096 | | | 399 | | | Non-hedge derivatives (B) | | | 1,764 | | | 2,168 | | | | | $ | 63,834 | | $ | 27,122 | | | | | | | | | | | | Derivative Liabilities | | | | | | | | | Interest rate swaps (A) | | $ | 15,659 | | $ | 34,240 | | | Interest payable | | | 1,059 | | | 2,457 | | | Non-hedge derivatives (B) | | | 1,674 | | | 2,964 | | | | | $ | 18,392 | | $ | 39,661 | |
2004 2003
------- -------
Interest rate caps (A) $ 3,554 $ 8,294Treated as hedges | | | | | | | | (B) Interest rate swaps (A) 21,001 14,194
Totaland caps | | | | | | | |
Unrealized gains (losses) related to real estate securities portfolio deposits of ($0.7 million) and $0.6 million, related to total return swaps 399 --
Non-hedge derivatives (B) 2,168 3,024
------- -------
Total Derivative Assets $27,122 $25,512
======= =======
Interest rate swaps (A) $34,240 $43,075
Interest payable 2,457 2,829
Non-hedge derivatives (B) 2,964 3,771
------- -------
Total Derivative Liabilities $39,661 $49,675
======= =======
|
(A) Treated as hedges
(B) Interest rates swaps
of $2.1 million and
caps
$0.2 million, and related to other non-hedge derivatives of $1.0 million and $0.0 million, were recorded in Other Income in 2005 and 2004, respectively.
With respect to interest rate swaps and caps that have not been designated as hedges, any net payments under, or fluctuations in the fair value of, such swaps and caps has been recognized currently in income.
Newcastle'sOther Income.
Newcastle’s derivative financial instruments contain credit risk to the extent that its bank counterparties may be unable to meet the terms of the agreements. Newcastle minimizes such risk by limiting its counterparties to highly rated major financial institutions with good credit ratings. In addition, the potential risk of loss with any one party resulting from this type of credit risk is monitored. Management does not expect any material losses as a result of default by other parties. Newcastle does not require collateral.
MANAGEMENT FEES AND INCENTIVE COMPENSATION TO AFFILIATE -- collateral; however, Newcastle does call margin from its counterparties when applicable.
Management Fees and Incentive Compensation to Affiliate ¾These represent amounts due to the Manager pursuant to the Management Agreement as well as
amounts due to the Manager related to Holdings' investment in Fund I, which
were passed through Holdings' income statement on a gross basis through the
date of the commencement of our operations.Agreement. For further information on the Management Agreement, see Note 10. For further information the Fund I
related expenses, see Note 3.
57
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
BALANCE SHEET MEASUREMENT
INVESTMENT IN REAL ESTATE SECURITIES --
Investment in Real Estate Securities ¾Newcastle has classified its investments in securities as available for sale. Securities available for sale are carried at market value with the net unrealized gains or losses reported as a separate component of accumulated other comprehensive income. At disposition, the net realized gain or loss is determined on the basis of the cost of the specific investments and is included in earnings. Unrealized losses on securities are charged to earnings if they reflect a decline in value that is other than temporary. A decline in value is considered other than temporary if either (a) it is deemed probable that Newcastle will be unable to collect all amounts anticipated to be collected at acquisition, or (b) Newcastle does not have the ability and intent to hold such investment until a forecasted market price recovery.
INVESTMENT IN LOANS --
Investment in Loans¾Loans receivable are presented net of any unamortized discount (or gross of any unamortized premium), including any fees received, and an allowance for loan losses. All of Newcastle’s loans receivable are classified as held for investment.
NEWCASTLE INVESTMENT IN OPERATING REAL ESTATE -- CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003
(dollars in tables in thousands, except per share data)
Investment in Operating Real Estate ¾Operating real estate is recorded at cost less accumulated depreciation. Depreciation is computed on a straight-line basis. Buildings are depreciated over 40 years. Major improvements are capitalized and depreciated over their estimated useful lives. Fees and costs incurred in the successful negotiation of leases are deferred and amortized on a straight-line basis over the terms of the respective leases. Expenditures for repairs and maintenance are expensed as incurred. Newcastle adopted SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets" in 2002. Pursuant to such pronouncement,
Newcastle reviews its real estate assets for impairment annually or whenever events or changes in circumstances indicate that the carrying amountvalue of an asset may not be recoverable. No material impairment was
recorded during 2004, 2003 or 2002. SFAS No. 144 also specifies that
long-livedLong-lived assets to be disposed of by sale, which meet certain criteria, should beare reclassified to Real Estate Held for Sale and measured at the lower of itstheir carrying amount or fair value less costs of sale. As of
December 31, 2004 and 2003, Newcastle had one and five properties
classified as Real Estate Held for Sale, respectively (Note 6). The results of operations for such an asset, assuming such asset qualifies as a "component“component of an entity"entity” as defined, in SFAS No. 144, are retroactively reclassified to Income (Loss) from Discontinued Operations for all periods presented.
FOREIGN CURRENCY INVESTMENTS --
Foreign Currency Investments¾Assets and liabilities relating to foreign investments are translated using exchange rates as of the end of each reporting period. The results of Newcastle'sNewcastle’s foreign operations are translated at the weighted average exchange rate for each reporting period. Translation adjustments are included as a component of accumulated other comprehensive income.
Foreign exchange contracts may, from time to time, be used to hedge
Newcastle's net foreign investments. Gainsincome until realized.
Cash and losses on foreign exchange
contracts which qualify as hedges of net foreign investments as well as
changes in the market value of these instruments are included in
accumulated other comprehensive income. Upon sale or liquidation of a
foreign investment, the related amount in accumulated other comprehensive
income is reclassified to transaction gain or loss in the period of such
liquidation.
Transaction gainsCash Equivalents and losses that arise from exchange rate fluctuations on
transactions denominated in a currency other than the functional currency,
except those transactions which qualify as a hedge, are included currently
in income.
58
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH -- Restricted Cash¾Newcastle considers all highly liquid short-termshort term investments with maturities of 90 days or less when purchased to be cash equivalents. Substantially all amounts on deposit with major financial institutions exceed insured limits. Restricted cash consisted of:
December 31,
-----------------
2004 2003
------- -------
Derivative margin accounts $20,763 $ 2,339
Restricted property operating accounts 549 604
Trustee accounts 9,652 8,105
Bond sinking funds 207 --
Held in CBO structures (Note 8)
pending reinvestment 44,719 56,971
Reserve accounts 2,084 2,084
------- -------
$77,974 $70,103
======= =======
STOCK OPTIONS -- | | | December 31, | |
| | | 2005 | | 2004 | |
| Held in CBO structures (Note 8) pending reinvestment | | $ | 173,438 | | $ | 44,719 | |
| Total return swap margin accounts | | | 72,427 | | | 18,190 | |
| Bond sinking funds | | | 9,532 | | | 207 | |
| Trustee accounts | | | 9,047 | | | 9,652 | |
| Reserve accounts | | | 2,558 | | | 2,084 | |
| Derivative margin accounts | | | 1,908 | | | 2,573 | |
| Restricted property operating accounts | | | - | | | 549 | |
| | | $ | 268,910 | | $ | 77,974 | |
Stock Options ¾Newcastle accounts for stock options granted in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation"Compensation'' as revised in December 2004 and amended by EITF Issue No. 96-18 "Accounting“Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Loans or Services."” The fair value of the options issued as compensation to the Manager for its successful efforts in raising capital for Newcastle in 2005, 2004 2003 and 20022003 was recorded as an increase in stockholders'stockholders’ equity with an offsetting reduction of capital proceeds received. Options granted to Newcastle'sNewcastle’s directors were accounted for using the intrinsicfair value methodmethod.
Preferred Stock ¾ In March 2003, Newcastle issued 2.5 million shares ($62.5 million face amount) of its 9.75% Series B Cumulative Redeemable Preferred Stock (the “Series B Preferred”) for net proceeds of approximately $60.1 million. In October 2005, Newcastle issued 1.6 million shares ($40.0 million face amount) of its 8.05% Series C Cumulative Redeemable Preferred Stock (the “Series C Preferred”) for net proceeds of approximately $38.5 million. The Series B Preferred and Series C Preferred are non-voting, have a $25 per share liquidation preference, no maturity date and no mandatory redemption. Newcastle has the option to redeem the Series B Preferred beginning in March 2008 and the Series C Preferred beginning in October 2010 at their face amount.
In connection with the issuance of the Series B Preferred Stock and Series C Preferred Stock, Newcastle incurred approximately $2.4 million and $1.5 million of costs, respectively, which were netted against the proceeds of such offerings. If either series of preferred stock were redeemed, the related costs would be recorded as an adjustment to income available for common stockholders at that time.
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003
(dollars in tables in thousands, except per share data)
Accretion of Discount and Other Amortization ¾ As reflected on the Consolidated Statements of Cash Flow, this item is comprised of the following:
| | | 2005 | | 2004 | | 2003 | |
| Accretion of net discount on securities and loans | | $ | (13,432 | ) | $ | (4,282 | ) | $ | (4,532 | ) |
| Amortization of net discount on debt obligations | | | 4,574 | | | 4,132 | | | 3,800 | |
| Amortization of deferred financing costs and interest rate cap premiums | | | 4,417 | | | 3,979 | | | 1,531 | |
| Amortization of net deferred hedge gains and losses - debt | | | 1,587 | | | (2,118 | ) | | (4,752 | ) |
| Amortization of deferred hedge loss - leases | | | 209 | | | 187 | | | 192 | |
| | | $ | (2,645 | ) | $ | 1,898 | | $ | (3,761 | ) |
Accounting Treatment for Certain Investments Financed with Repurchase Agreements ¾Newcastle owned $323.2 million of assets purchased from particular counterparties which are financed via $287.5 million of repurchase agreements with the same counterparties at December 31, 2005. Currently, Newcastle records such assets and the related financings gross on its balance sheet, and the corresponding interest income and interest expense gross on its income statement. In addition, if the asset is a security, any change in fair value is reported through other comprehensive income (since it is considered “available for sale”).
However, in a transaction where assets are acquired from and financed under APB Opinion No. 25,a repurchase agreement with the same counterparty, the acquisition may not qualify as permitteda sale from the seller’s perspective; in such cases, the seller may be required to continue to consolidate the assets sold to Newcastle, based on their “continuing involvement” with such investments. The result is that Newcastle may be precluded from presenting the assets gross on its balance sheet as it currently does, and may instead be required to treat its net investment in such assets as a derivative.
If it is determined that these transactions should be treated as investments in derivatives, the interest rate swaps entered into by SFAS
No.123 priorNewcastle to hedge its revision. Sinceinterest rate exposure with respect to these options were fully vested before
such revision became effective, such revision didtransactions would no longer qualify for hedge accounting, but would, as the underlying asset transactions, also be marked to market through the income statement.
This potential change in accounting treatment does not affect Newcastle.
3. the economics of the transactions but does affect how the transactions are reported in Newcastle’s financial statements. Newcastle’s cash flows, its liquidity and its ability to pay a dividend would be unchanged, and Newcastle does not believe its taxable income would be affected. Newcastle’s net income and net equity would not be materially affected. In addition, this would not affect Newcastle’s status as a REIT or cause it to fail to qualify for its Investment Company Act exemption. Management understands that this issue has been submitted to accounting standard setters for resolution. If Newcastle were to change its current accounting treatment for these transactions, its total assets and total liabilities would each be reduced by $287.9 million and $240.4 million at December 31, 2005 and 2004, respectively.
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003
(dollars in tables in thousands, except per share data)
| 3. | INFORMATION REGARDING BUSINESS SEGMENTS AND UNCONSOLIDATED SUBSIDIARIES |
Newcastle conducts its business through three primary segments: real estate securities and real estate related loans, residential mortgage loans and operating real estate and
residential mortgage loans.estate. Details of Newcastle'sNewcastle’s investments in such segments can be found in Notes 4, 5 and 6. Newcastle has retroactively
combined two business segments which were previously reported separately:
real estate securities and real estate related loans. Management no longer
reviews disaggregated, discrete financial information on these two
investment categories since, among other reasons, they are cross-financed
and share common credit risk characteristics.
Holdings conducted its business in three primary segments: real estate
securities and real estate related loans, operating real estate and its
investment in Fund I. The real estate securities investments were retained
by Newcastle. The operating real estate segment, which comprised three
portfolios of properties, was split as follows: the Bell Canada (Canadian)
and LIV (Belgian) portfolios were retained by Newcastle while the GSA
(U.S.) portfolio was distributed to Holdings. The existing real estate
related loans and Fund I investments were distributed to Holdings.
The unallocated portion consists primarily of interest on
short-termshort term investments, general and administrative expenses,
and management fees and incentive compensation pursuant to the Management
Agreement, and interest
on Holdings' credit facility.
59
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
Agreement.
Summary financial data on Newcastle'sNewcastle’s segments is given below, together with a reconciliation to the same data for Newcastle as a whole (including
its predecessor, through the date of the commencement of Newcastle's
operations, as describedwhole:
| | | Real Estate Securities and Real Estate Related Loans | | Residential Mortgage Loans | | Operating Real Estate | | Unallocated | | Total | |
| December 31, 2005 and the Year then Ended | | | | | | | | | | | |
| Gross revenues | | $ | 321,889 | | $ | 48,844 | | $ | 6,772 | | $ | 708 | | $ | 378,213 | |
| Operating expenses | | | (4,163 | ) | | (10,384 | ) | | (2,456 | ) | | (24,885 | ) | | (41,888 | ) |
| Operating income (loss) | | | 317,726 | | | 38,460 | | | 4,316 | | | (24,177 | ) | | 336,325 | |
| Interest expense | | | (196,026 | ) | | (29,754 | ) | | (251 | ) | | (415 | ) | | (226,446 | ) |
| Depreciation and amortization | | | - | | | - | | | (528 | ) | | (113 | ) | | (641 | ) |
| Equity in earnings of unconsolidated subsidiaries (A) | | | 3,328 | | | - | | | 2,281 | | | - | | | 5,609 | |
| Income (loss) from continuing operations | | | 125,028 | | | 8,706 | | | 5,818 | | | (24,705 | ) | | 114,847 | |
| Income (loss) from discontinued operations | | | - | | | - | | | 2,108 | | | - | | | 2,108 | |
| Net income (loss) | | $ | 125,028 | | $ | 8,706 | | $ | 7,926 | | $ | (24,705 | ) | $ | 116,955 | |
| Revenue derived from non-US sources: | | | | | | | | | | | | | | | | |
| Canada | | $ | - | | $ | - | | $ | 12,157 | | $ | - | | $ | 12,157 | |
| Belgium | | $ | - | | $ | - | | $ | 125 | | $ | - | | $ | 125 | |
| Total assets | | $ | 5,544,818 | | $ | 606,320 | | $ | 36,306 | | $ | 22,255 | | $ | 6,209,699 | |
| Long-lived assets outside the US: | | | | | | | | | | | | | | | | |
| Canada | | $ | - | | $ | - | | $ | 16,673 | | $ | - | | $ | 16,673 | |
| December 31, 2004 and the Year then Ended | | | | | | | | | | | | | | | | |
| Gross revenues | | $ | 225,236 | | $ | 19,135 | | $ | 4,745 | | $ | 553 | | $ | 249,669 | |
| Operating expenses | | | (828 | ) | | (2,319 | ) | | (2,678 | ) | | (22,983 | ) | | (28,808 | ) |
| Operating income (loss) | | | 224,408 | | | 16,816 | | | 2,067 | | | (22,430 | ) | | 220,861 | |
| Interest expense | | | (124,930 | ) | | (10,863 | ) | | (605 | ) | | - | | | (136,398 | ) |
| Depreciation and amortization | | | - | | | - | | | (445 | ) | | (6 | ) | | (451 | ) |
| Equity in earnings of unconsolidated subsidiaries (A) | | | 3,767 | | | - | | | 6,190 | | | - | | | 9,957 | |
| Income (loss) from continuing operations | | | 103,245 | | | 5,953 | | | 7,207 | | | (22,436 | ) | | 93,969 | |
| Income (loss) from discontinued operations | | | - | | | - | | | 4,446 | | | - | | | 4,446 | |
| Net income (loss) | | $ | 103,245 | | $ | 5,953 | | $ | 11,653 | | $ | (22,436 | ) | $ | 98,415 | |
| Revenue derived from non-US sources: | | | | | | | | | | | | | | | | |
| Canada | | $ | - | | $ | - | | $ | 13,203 | | $ | - | | $ | 13,203 | |
| Belgium | | $ | - | | $ | - | | $ | 10,602 | | $ | - | | $ | 10,602 | |
| Total assets | | $ | 4,136,203 | | $ | 658,643 | | $ | 108,322 | | $ | 29,552 | | $ | 4,932,720 | |
| Long-lived assets outside the US: | | | | | | | | | | | | | | | | |
| Canada | | $ | - | | $ | - | | $ | 57,193 | | $ | - | | $ | 57,193 | |
| Belgium | | $ | - | | $ | - | | $ | 12,376 | | $ | - | | $ | 12,376 | |
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003
(dollars in Notes 1 and 2):
Real Estate
Securities and Residential
Real Estate Operating Mortgage
Related Loans Real Estate Loans Unallocated Total
-------------- ----------- ----------- ----------- ----------
December 31, 2004 and the Year then Ended
Gross revenues $ 225,236 $ 13,222 $ 19,135 $ 553 $ 258,146
Operating expenses (828) (7,425) (2,319) (22,983) (33,555)
---------- -------- -------- -------- ----------
Operating income (loss) 224,408 5,797 16,816 (22,430) 224,591
Interest expense (124,930) (3,054) (10,863) -- (138,847)
Depreciation and amortization -- (1,298) -- (6) (1,304)
Equity in earnings of unconsolidated subsidiaries (A) 3,767 6,190 -- -- 9,957
---------- -------- -------- -------- ----------
Income (loss) from continuing operations 103,245 7,635 5,953 (22,436) 94,397
Income (loss) from discontinued operations -- 4,018 -- -- 4,018
---------- -------- -------- -------- ----------
Net Income (Loss) $ 103,245 $ 11,653 $ 5,953 $(22,436) $ 98,415
========== ======== ======== ======== ==========
Revenue derived from non-US sources:
Canada $ -- $ 13,203 $ -- $ -- $ 13,203
========== ======== ======== ======== ==========
Belgium $ -- $ 10,602 $ -- $ -- $ 10,602
========== ======== ======== ======== ==========
Total assets $4,136,203 $108,322 $658,643 $ 29,552 $4,932,720
========== ======== ======== ======== ==========
Long-lived assets outside the US:
Canada $ -- $ 57,193 $ -- $ -- $ 57,193
========== ======== ======== ======== ==========
Belgium $ -- $ 12,376 $ -- $ -- $ 12,376
========== ======== ======== ======== ==========
December 31, 2003 and the Year then Ended
Gross revenues $ 134,348 $ 16,234 $ 12,892 $ 580 $ 164,054
Operating expenses (821) (7,931) (1,506) (15,603) (25,861)
---------- -------- -------- -------- ----------
Operating income (loss) 133,527 8,303 11,386 (15,023) 138,193
Interest expense (70,192) (2,730) (6,162) -- (79,084)
Depreciation and amortization -- (1,194) -- -- (1,194)
Equity in earnings of unconsolidated subsidiaries 861 -- -- 1 862
---------- -------- -------- -------- ----------
Income (loss) from continuing operations 64,196 4,379 5,224 (15,022) 58,777
Income (loss) from discontinued operations -- (2,659) -- -- (2,659)
---------- -------- -------- -------- ----------
Net Income (Loss) $ 64,196 $ 1,720 $ 5,224 $(15,022) $ 56,118
========== ======== ======== ======== ==========
Revenue derived from non-US sources:
Canada $ -- $ 16,940 $ -- $ -- $ 16,940
========== ======== ======== ======== ==========
Belgium $ -- $ 5,999 $ -- $ -- $ 5,999
========== ======== ======== ======== ==========
Total assets $2,756,262 $146,635 $587,831 $ 59,571 $3,550,299
========== ======== ======== ======== ==========
Long-lived assets outside the US:
Canada $ -- $ 54,250 $ -- $ -- $ 54,250
========== ======== ======== ======== ==========
Belgium $ -- $ 78,149 $ -- $ -- $ 78,149
========== ======== ======== ======== ==========
tables in thousands, except per share data)
| | | Real Estate Securities and Real Estate Related Loans | | Residential Mortgage Loans | | Operating Real Estate | | Unallocated | | Total | |
| December 31, 2003 and the Year then Ended | | | | | | | | | | | |
| Gross revenues | | $ | 134,348 | | $ | 12,892 | | $ | 4,264 | | $ | 580 | | $ | 152,084 | |
| Operating expenses | | | (821 | ) | | (1,506 | ) | | (2,493 | ) | | (15,603 | ) | | (20,423 | ) |
| Operating income (loss) | | | 133,527 | | | 11,386 | | | 1,771 | | | (15,023 | ) | | 131,661 | |
| Interest expense | | | (70,192 | ) | | (6,162 | ) | | (523 | ) | | - | | | (76,877 | ) |
| Depreciation and amortization | | | - | | | - | | | (405 | ) | | - | | | (405 | ) |
| Equity in earnings of unconsolidated subsidiaries (A) | | | 861 | | | - | | | - | | | 1 | | | 862 | |
| Income (loss) from continuing operations | | | 64,196 | | | 5,224 | | | 843 | | | (15,022 | ) | | 55,241 | |
| Income (loss) from discontinued operations | | | - | | | - | | | 877 | | | - | | | 877 | |
| Net income (loss) | | $ | 64,196 | | $ | 5,224 | | $ | 1,720 | | $ | (15,022 | ) | $ | 56,118 | |
| Revenue derived from non-US sources: | | | | | | | | | | | | | | | | |
| Canada | | $ | - | | $ | - | | $ | 16,940 | | $ | - | | $ | 16,940 | |
| Belgium | | $ | - | | $ | - | | $ | 5,999 | | $ | - | | $ | 5,999 | |
| Total assets | | $ | 2,756,262 | | $ | 587,831 | | $ | 146,635 | | $ | 59,571 | | $ | 3,550,299 | |
| Long-lived assets outside the US: | | | | | | | | | | | | | | | | |
| Canada | | $ | - | | $ | - | | $ | 54,250 | | $ | - | | $ | 54,250 | |
| Belgium | | $ | - | | $ | - | | $ | 78,149 | | $ | - | | $ | 78,149 | |
(A) Net of income taxes on related taxable subsidiaries.
60
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
Real Estate
Securities and Residential
Real Estate Operating Mortgage
Related Loans Real Estate Loans Fund I Unallocated Total
-------------- ----------- ----------- ------- ----------- ----------
December 31, 2002 and the Year then Ended (A)
Gross revenues $ 83,259 $ 13,116 $ 1,281 $ 3,287 $ 432 $ 101,375
Operating expenses (586) (6,984) (141) (3,861) (10,473) (22,045)
---------- -------- -------- ------- -------- ----------
Operating income (loss) 82,673 6,132 1,140 (574) (10,041) 79,330
Interest expense (40,805) (2,576) (658) -- (2,336) (46,375)
Depreciation and amortization -- (1,130) -- (329) (101) (1,560)
Equity in earnings of unconsolidated subsidiaries -- -- -- 303 59 362
---------- -------- -------- ------- -------- ----------
Income (loss) from continuing operations 41,868 2,426 482 (600) (12,419) 31,757
Income (loss) from discontinued operations (499) 237 -- -- -- (262)
---------- -------- -------- ------- -------- ----------
Net Income (Loss) $ 41,369 $ 2,663 $ 482 $ (600) $(12,419) $ 31,495
========== ======== ======== ======= ======== ==========
Revenue derived from non-US sources:
Canada $ -- $ 14,015 $ -- $ -- $ -- $ 14,015
========== ======== ======== ======= ======== ==========
Belgium $ -- $ 5,402 $ -- $ -- $ -- $ 5,402
========== ======== ======== ======= ======== ==========
Italy $ 180 $ -- $ -- $ -- $ -- $ 180
========== ======== ======== ======= ======== ==========
Total assets $1,138,767 $128,831 $259,381 $ -- $ 45,588 $1,572,567
========== ======== ======== ======= ======== ==========
Long-lived assets outside the US:
Canada $ -- $ 49,271 $ -- $ -- $ -- $ 49,271
========== ======== ======== ======= ======== ==========
Belgium $ -- $ 67,852 $ -- $ -- $ -- $ 67,852
========== ======== ======== ======= ======== ==========
(A) The Fund I segment and a portion of the Unallocated segment (through the
date of the commencement of Newcastle's operations in July 2002) and the
discontinued operations of the Operating Real Estate and Real Estate
Securities and Real Estate Related Loans segments represent operations
related to activities treated as distributed to our predecessor.
UNCONSOLIDATED SUBSIDIARIES
Unconsolidated Subsidiaries
Newcastle has two unconsolidated subsidiaries which it accounts for under the equity method.
Holdings held two such investments, neither of which were
transferred to Newcastle; such investments are included in Newcastle's financial
statements through the date of the commencement of Newcastle's operations.
61
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
The following table summarizes the activity affecting the equity held by Newcastle in unconsolidated subsidiaries:
Operating Real Real Estate Loan
Estate Subsidiary Subsidiary
----------------- ----------------
BALANCE AT DECEMBER 31, 2002 $ -- $ --
Contributions to unconsolidated
subsidiaries -- 30,827
Distributions from unconsolidated
subsidiaries -- (1,041)
Equity in earnings of unconsolidated
subsidiaries -- 861
Other -- (7)
-------- --------
BALANCE AT DECEMBER 31, 2003 $ -- $ 30,640
Contributions to unconsolidated
subsidiaries 26,789 --
Distributions from unconsolidated
subsidiaries (17,709) (10,955)
Equity in earnings of unconsolidated
subsidiaries 8,698 3,767
Other -- --
-------- --------
BALANCE AT DECEMBER 31, 2004 $ 17,778 $ 23,452
======== ========
| | | Operating Real Estate Subsidiary | | Real Estate Loan Subsidiary | |
Balance at December 31, 2003 | | $ | - | | $ | 30,640 | |
| Contributions to unconsolidated subsidiaries | | | 26,789 | | | - | |
Distributions from unconsolidated subsidiaries | | | (17,709 | ) | | (10,955 | ) |
Equity in earnings of unconsolidated subsidiaries | | | 8,698 | | | 3,767 | |
Balance at December 31, 2004 | | $ | 17,778 | | $ | 23,452 | |
| Contributions to unconsolidated subsidiaries | | | - | | | - | |
Distributions from unconsolidated subsidiaries | | | (8,229 | ) | | (8,978 | ) |
Equity in earnings of unconsolidated subsidiaries | | | 2,602 | | | 3,328 | |
Balance at December 31, 2005 | | $ | 12,151 | | $ | 17,802 | |
Summarized financial information related to Newcastle'sNewcastle’s unconsolidated subsidiaries through the date of their distribution to Holdings, as applicable,
was as follows (in thousands):
follows:
| | | Operating Real Estate Subsidiary (A) (B) | | Real Estate Loan Subsidiary (A) (C) | |
| | | December 31, | | December 31, | |
| | | 2005 | | 2004 | | 2005 | | 2004 | | 2003 | |
| Assets | | $ | 77,758 | | $ | 89,222 | | $ | 35,806 | | $ | 47,170 | | $ | 61,628 | |
| Liabilities | | | (53,000 | ) | | (53,000 | ) | | - | | | - | | | - | |
| Minority interest | | | (455 | ) | | (666 | ) | | (202 | ) | | (266 | ) | | (348 | ) |
| Equity | | $ | 24,303 | | $ | 35,556 | | $ | 35,604 | | $ | 46,904 | | $ | 61,280 | |
| Equity held by Newcastle (D) | | $ | 12,151 | | $ | 17,778 | | $ | 17,802 | | $ | 23,452 | | $ | 30,640 | |
| | | | | | | | | | | | | | | | | |
| | | | 2005 | | | 2004 | | | 2005 | | | 2004 | | | 2003 | |
| Revenues | | $ | 10,196 | | $ | 25,011 | | $ | 6,738 | | $ | 7,852 | | $ | 1,885 | |
| Expenses | | | (4,896 | ) | | (7,159 | ) | | (42 | ) | | (111 | ) | | (152 | ) |
| Minority interest | | | (97 | ) | | (328 | ) | | (39 | ) | | (44 | ) | | (10 | ) |
| Net income | | $ | 5,203 | | $ | 17,524 | | $ | 6,657 | | $ | 7,697 | | $ | 1,723 | |
| Newcastle's equity in net income (D) | | $ | 2,602 | | $ | 8,698 | | $ | 3,328 | | $ | 3,767 | | $ | 862 | |
Operating Real Estate Loan
Real Estate Subsidiary | (A) | The unconsolidated subsidiaries’ summary financial information is presented on a fair value basis, consistent with their internal basis of accounting. |
| (B) | Included in the operating real estate segment. |
(C)
Subsidiary (A) (B) December 31,
December 31, ------------------
2004 2004 2003
------------------ ------- -------
Assets $ 89,222 $47,170 $61,628
Liabilities (53,000) -- --
Minority interest (666) (266) (348)
-------- ------- -------
Equity $ 35,556 $46,904 $61,280
======== ======= =======
Equity held by Newcastle $ 17,778 $23,452 $30,640 Austin | Included in the real estate securities and real estate related loans segment. |
(D) Fund I (A)
======== ======= ======= ---------- ----------
2004 2004 2003 2002 2002
-------- ------- ------- ----- -------
Revenues $ 25,011 $ 7,852 $ 1,885 $ 585 $ 9,740
Expenses (7,159) (111) (152) (477) (4,470)
Minority interest (328) (44) (10) (45) --
-------- ------- ------- ----- -------
Net income (loss) $ 17,524 $ 7,697 $ 1,723 $ 63 $ 5,270
======== ======= ======= ===== =======
Newcastle's | With respect to the operating real estate subsidiary, $0.8 million and $7.2 million of Newcastle’s equity in net income (loss) $ 8,698 $ 3,767 $ 862 $ 59 $ 303
======== ======= ======= ===== =======
was derived from the company holding assets available for sale in 2005 and 2004, respectively, while $1.8 million and $1.5 million of Newcastle’s equity in net income was derived from the company holding assets for investment in 2005 and 2004, respectively. As of December 31, 2004, $5.6 million of the equity held by Newcastle related to the company holding assets available for sale and $12.2 million related to the company holding assets for investment. As of December 31, 2005, all of the equity held by Newcastle related to the company holding assets for investment. This subsidiary is more fully described below. |
(A) Except for Austin, the unconsolidated subsidiaries' summary financial
information is presented on a fair value basis, consistent with their
internal basis of accounting. Newcastle's equity in net income excludes its
predecessor's incentive income with respect to Fund I.
(B) Included in the operating real estate segment.
(C) Included in the real estate securities and real estate related loans
segment.
(D) Included in the unallocated segment.
62
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
OPERATING REAL ESTATE SUBSIDIARY
Operating Real Estate Subsidiary
In March 2004 Newcastle purchased a 49% interest in a portfolio of convenience and retail gas stores located throughout the southeastern and southwestern regions of the U.S. The properties are subject to a sale-leaseback arrangement under long-termlong term triple net leases with a 15 year minimum term. Circle K Stores Inc. ("Tenant"(“Tenant”), an indirect wholly owned subsidiary of Alimentation Couche-Tard Inc. ("ACT"(“ACT”), is the counterparty under the leases. ACT guarantees the obligations of Tenant under the leases. Newcastle structured this transaction through a joint venture in two limited liability companies with a private investment fund managed by an affiliate of its manager, pursuant to which such affiliate co-invested on equal terms. One company held assets available for sale, the last of which was sold in September 2005, and one holds assets for investment. In October 2004, the investment'sinvestment’s initial financing was refinanced with a nonrecourse term loan ($53.0 million outstanding at December 31, 2004)2005), which bears interest at a fixed rate of 6.04%. The required payments under the loan consist of interest only during the first two years, followed by a 25-year amortization schedule with a balloon payment due in October 2014. ThisNewcastle has no additional capital commitment to the limited liability company is an investment company and therefore
maintains its financial records on a fair value basis. Newcastle has
retained such accounting relative to its investment in such limited
liability company, which is accounted for under the equity method at fair
value.
REAL ESTATE LOAN SUBSIDIARY
companies.
Real Estate Loan Subsidiary
In November 2003, Newcastle and a private investment fund managed by an affiliate of the Manager co-invested and each indirectly own an approximately 38% interest in DBNC Peach Manager LLC, a limited liability company that has acquired a pool of franchise loans collateralized by fee and leasehold interests and other assets from a third party financial institution. The Manager receives from this private investment fund, in
addition to management fees, incentive compensation if the fund's aggregate
investment returns exceed certain thresholds. The remaining approximately 24% interest in the limited liability company is owned by the above-referenced third party financial institution. Newcastle has no additional capital commitment to the limited liability company.
This
Each of these limited liability
companycompanies is an investment company and therefore maintains its financial records on a fair value basis. Newcastle has retained such accounting relative to its investment in such limited liability
company,companies, which
isare accounted for under the equity method at fair value.
FUND I
The managing member of Fund I was Fortress Fund MM LLC (the "Fund I
Managing Member"), which was owned jointly, through subsidiaries, by
Holdings, approximately 94%, and the Manager, approximately 6%. A separate
class of membership interests in the Fund I Managing Member reflected the
entitlement to the incentive return payable by Fund I, as described below,
which was owned 50% by the Manager and 50% by Holdings.
The Fund I Managing Member was entitled to receive an annual management fee
of up to 1.5% of Fund I's invested capital or total equity commitments.
Holdings was not charged management fees for its investment in Fund I.
Pursuant to an agreement between the Fund I Managing Member and the
Manager, the Manager was entitled to 100% of the management fee paid by
Fund I to the Fund I Managing Member. Since the management fees paid to the
Manager flowed through Holdings through its ownership of the Fund I
Managing Member, they were reflected as gross amounts in both Management
Fee from Affiliate and Management Fee to Affiliate, although they had no
effect on net income.
The Fund I Managing Member was entitled to an incentive return (the
"Incentive Return") generally equal to 20% of Fund I 's returns, as
defined. Holdings recorded as incentive income the amount that would be due
based on the fair value of the assets in Fund I exceeding the required
return at a specific point in time as if the management arrangement was
terminated on that date. Based on this methodology, Holdings' incentive
income in each reporting period reflected changes in the fair value of the
assets in Fund I. As such, Holdings accrued $27.5 million of Incentive
Return through the date of the commencement of Newcastle's operations. This
amount was recorded in Incentive Income from Affiliate. The Manager was
entitled to 50% of this income which Holdings recorded as Incentive
Compensation to Affiliate.
63
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
AUSTIN
In 1998, Holdings and Fortress Principal Investment Group LLC ("FPIG"), an
affiliate of the Manager, formed Austin Holdings Corporation ("Austin").
Holdings held non-voting preferred stock in Austin which represented a 95%
economic ownership, and had a liquidation preference over the common
stockholders. FPIG was the holder of all of the common stock which
represented 100% of the vote and 5% of the economic ownership interest of
Austin. Austin owned certain non-performing loans and foreclosed real
estate as well as 100% of the common stock of Ascend Residential Holdings,
Inc. ("Ascend"). Ascend's primary business was the acquisition,
rehabilitation and sale of single-family residential properties.
64
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
4. REAL ESTATE SECURITIES
The following is a summary of Newcastle'sNewcastle’s real estate securities at December 31, 20042005 and 2003,2004, all of which are classified as available for sale and are therefore marked to market through other comprehensive income
pursuant to SFAS No. 115 "Accounting for Certain Investments in Debt and
Equity Securities."
DECEMBERincome.
December 31, 2004
2005
| | | | | | | Gross Unrealized | | | | | | Weighted Average | |
| Asset Type | | Current Face Amount | | Amortized Cost Basis | | Gains | | Losses | | Carrying Value | | Number of Securities | | S&P Equivalent Rating | | Coupon | | Yield | | Maturity (Years) | |
| CMBS-Conduit | | $ | 1,455,345 | | $ | 1,397,868 | | $ | 26,367 | | $ | (26,906 | ) | $ | 1,397,329 | | | 197 | | | BBB- | | | 5.84 | % | | 6.61 | % | | 7.87 | |
| CMBS-Large Loan | | | 578,331 | | | 575,444 | | | 9,096 | | | (377 | ) | | 584,163 | | | 61 | | | BBB- | | | 6.64 | % | | 6.75 | % | | 2.10 | |
| CMBS- B-Note | | | 180,201 | | | 176,228 | | | 4,732 | | | (329 | ) | | 180,631 | | | 32 | | | BBB- | | | 6.62 | % | | 6.95 | % | | 5.97 | |
| Unsecured REIT Debt | | | 916,262 | | | 931,777 | | | 20,804 | | | (9,835 | ) | | 942,746 | | | 99 | | | BBB- | | | 6.34 | % | | 5.96 | % | | 6.95 | |
| ABS-Manufactured Housing | | | 178,915 | | | 162,410 | | | 2,422 | | | (1,766 | ) | | 163,066 | | | 10 | | | A- | | | 7.12 | % | | 8.65 | % | | 6.64 | |
| ABS-Home Equity | | | 525,004 | | | 523,363 | | | 3,429 | | | (2,315 | ) | | 524,477 | | | 89 | | | B | | | 6.03 | % | | 6.10 | % | | 3.16 | |
| ABS-Franchise | | | 70,837 | | | 69,732 | | | 1,113 | | | (1,223 | ) | | 69,622 | | | 18 | | | BBB+ | | | 6.66 | % | | 8.12 | % | | 5.14 | |
| Agency RMBS | | | 698,322 | | | 700,912 | | | 145 | | | (8,572 | ) | | 692,485 | | | 19 | | | AAA | | | 4.76 | % | | 4.67 | % | | 4.90 | |
| Total/Average (A) | | $ | 4,603,217 | | $ | 4,537,734 | | $ | 68,108 | | $ | (51,323 | ) | $ | 4,554,519 | | | 525 | | | BBB+ | | | 5.99 | % | | 6.25 | % | | 5.81 | |
Weighted Average
-----------------------------------
Gross Unrealized S&P
Current Face Amortized ------------------ Number| (A) | The total current face amount of Equivalent Maturity
Asset Type Amount Cost Basis Gains Losses Carrying Value Securities Rating Coupon Yield (Years)
- ---------- ------------ ---------- -------- -------- -------------- ---------- ---------- ------ ----- --------
CMBS-Conduit $1,024,762 $ 995,194 $ 54,506 $ (7,240) $1,042,460 162 BBB- 6.17% 6.80% 7.53
CMBS-Large Loan 583,758 580,383 9,781 (168) 589,996 68 BBB 5.16% 5.41% 2.35
CMBS- B-Note 173,587 170,884 2,614 (379) 173,119 28 BB+ 6.31% 6.58% 6.12
Unsecured REIT Debt 735,402 750,489 38,433 (3,200) 785,722 90 BBB- 6.51% 6.15% 7.34
ABS-Manufactured
Housin 221,803 198,181 5,328 (4,494) 199,015 11 B 7.10% 8.83% 5.67
ABS-Home Equity 298,934 297,083 3,072 (83) 300,072 44 A- 4.16% 4.29% 4.06
ABS-Franchise 77,825 75,631 2,493 (540) 77,584 17 BBB+ 7.13% 8.79% 5.25
Agency RMBS 199,182 201,803 -- (275) 201,528 3 AAA 4.69% 4.41% 3.35
---------- ---------- -------- -------- ---------- --- --- ---- ---- ----
Total/Average (A) $3,315,253 $3,269,648 $116,227 $(16,379) $3,369,496 423 BBB 5.89% 6.19% 5.76
========== ========== ======== ======== ========== === === ==== ==== ====
fixed rate securities was $3,584.4 million, and of floating rate securities was $1,018.8 million. |
(A) The total current face amount of fixed rate securities was $2,472.1million,
and of floating rate securities was $843.2 million.
2003 or 2002.2003. The unrealized losses on Newcastle'sNewcastle’s securities are primarily the result of market factors, rather than credit impairment, and Newcastle believes their carrying values are fully recoverable over their expected holding period. One of the securities had an immaterial interest
shortfall at December 31, 2004, which has subsequently been brought current; no
other securities are delinquent.
Securities in an Unrealized Loss Position
- -----------------------------------------
Less Than Twelve Months $866,660 $872,077 $-- $ (9,202) $862,875 95 BBB+ 5.45% 5.37% 6.47
Twelve or More Months 63,484 60,355 -- (7,178) 53,177 7 BB- 6.37% 7.66% 5.92
-------- -------- --- -------- -------- --- ---- ---- ---- ----
Total $930,144 $932,432 $-- $(16,380) $916,052 102 BBB+ 5.51% 5.52% 6.43
======== ======== === ======== ======== === ==== ==== ==== ====
The unrealized losses on most of the securities in the "Twelve or More Months"
category were primarily caused by changes in market credit spreads. With respect
to two of such securities, the unrealized losses were primarily caused by market
perceptions of the credit quality of such securities. None of the securities in
this category arewere in default or delinquent andas of December 31, 2005. Newcastle has performed credit analyses (described in Note 2) in relation to such securities which support its belief that the carrying values of such securities are fully recoverable over their expected holding period. Although management expects to hold these securities until their recovery, there is no assurance that such securities will not be sold or at what price they may be sold.
65
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
DECEMBER
| | | | | | | Gross Unrealized | | | | | | Weighted Average | |
| | | Current Face Amount | | Amortized Cost Basis | | Gains | | Losses | | Carrying Value | | Number of Securities | | S&P Equivalent Rating | | Coupon | | Yield | | Maturity (Years) | |
Securities in an Unrealized Loss Position | | | | | | | | | | | | | | | | | | | | | |
| Less Than Twelve Months | | $ | 2,212,833 | | $ | 2,201,085 | | $ | - | | $ | (38,770 | ) | $ | 2,162,315 | | | 264 | | | A- | | | 5.65 | % | | 5.67 | % | | 6.20 | |
| Twelve or More Months | | | 274,127 | | | 279,868 | | | - | | | (12,756 | ) | | 267,112 | | | 42 | | | BBB+ | | | 5.71 | % | | 5.32 | % | | 7.15 | |
| Total | | $ | 2,486,960 | | $ | 2,480,953 | | $ | - | | $ | (51,526 | ) | $ | 2,429,427 | | | 306 | | | A- | | | 5.66 | % | | 5.63 | % | | 6.31 | |
December 31, 2003
Weighted Average
-----------------------------------
Gross Unrealized S&P
Current Face Amortized ----------------- Carrying Number of Equivalent Maturity
Asset Type Amount Cost Basis Gains Losses Value Securities Rating Coupon Yield (Years)
- ---------- ------------ ---------- ------- -------- ---------- ---------- ---------- ------ ----- --------
CMBS-Conduit $ 830,471 $ 794,973 $39,308 $ (7,313) $ 826,968 126 BBB- 6.39% 7.13% 7.64
CMBS-Large Loan 374,208 370,480 2,064 (1,003) 371,541 43 BBB 3.98% 4.40% 2.65
CMBS- B-Note 57,653 55,577 1,141 (41) 56,677 10 BB+ 6.37% 7.05% 7.06
Unsecured REIT De 532,008 541,648 44,301 (1,241) 584,708 71 BBB- 7.18% 6.85% 7.28
ABS-Manufactured
Housing 243,938 217,244 3,402 (2,947) 217,699 8 BBB+ 7.07% 8.98% 6.11
ABS-Home Equity 74,867 74,845 785 -- 75,630 15 A 3.26% 3.35% 4.88
ABS-Franchise 60,393 57,598 2,383 (477) 59,504 11 A 8.60% 10.00% 5.95
---------- ---------- ------- -------- ---------- --- --- ---- ----- ----
Total/Average (A) $2,173,538 $2,112,365 $93,384 $(13,022) $2,192,727 284 BBB 6.20% 6.71% 6.36
========== ========== ======= ======== ========== === === ==== ===== ====
2004
| | | | | | | Gross Unrealized | | | | | Weighted Average | |
| Asset Type | | Current Face Amount | | Amortized Cost Basis | | Gains | | Losses | | Carrying Value | | Number of Securities | | S&P Equivalent Rating | | | Coupon | | | | | | Maturity (Years) | |
| CMBS-Conduit | | $ | 1,024,762 | | $ | 995,194 | | $ | 54,506 | | $ | (7,240 | ) | $ | 1,042,460 | | | 162 | | | BBB- | | | 6.17 | % | | 6.80 | % | | 7.53 | |
| CMBS-Large Loan | | | 583,758 | | | 580,383 | | | 9,781 | | | (168 | ) | | 589,996 | | | 68 | | | BBB | | | 5.16 | % | | 5.41 | % | | 2.35 | |
| CMBS- B-Note | | | 173,587 | | | 170,884 | | | 2,614 | | | (379 | ) | | 173,119 | | | 28 | | | BB+ | | | 6.31 | % | | 6.58 | % | | 6.12 | |
| Unsecured REIT Debt | | | 735,402 | | | 750,489 | | | 38,433 | | | (3,200 | ) | | 785,722 | | | 90 | | | BBB- | | | 6.51 | % | | 6.15 | % | | 7.34 | |
| ABS-Manufactured Housing | | | 221,803 | | | 198,181 | | | 5,328 | | | (4,494 | ) | | 199,015 | | | 11 | | | B | | | 7.10 | % | | 8.83 | % | | 5.67 | |
| ABS-Home Equity | | | 298,934 | | | 297,083 | | | 3,072 | | | (83 | ) | | 300,072 | | | 44 | | | A- | | | 4.16 | % | | 4.29 | % | | 4.06 | |
| ABS-Franchise | | | 77,825 | | | 75,631 | | | 2,493 | | | (540 | ) | | 77,584 | | | 17 | | | BBB+ | | | 7.13 | % | | 8.79 | % | | 5.25 | |
| Agency RMBS | | | 199,182 | | | 201,803 | | | - | | | (275 | ) | | 201,528 | | | 3 | | | AAA | | | 4.69 | % | | 4.41 | % | | 3.35 | |
| Total/Average (A) | | $ | 3,315,253 | | $ | 3,269,648 | | $ | 116,227 | | $ | (16,379 | ) | $ | 3,369,496 | | | 423 | | | BBB | | | 5.89 | % | | 6.19 | % | | 5.76 | |
(A) The total current face amount of fixed rate securities was $1,531.6$2,472.1 million, and of floating rate securities was $457.5$843.2 million.
The following is a reconciliation of real estate securities:
REAL ESTATE SECURITIES
---------------------------------------------------
Market
Current Face (Discount)/ Loss Amortized
Amount Premium Allowance Cost Basis
------------ ----------- --------- ----------
BALANCE AT DECEMBER 31, 2002 $1,025,680 $(70,546) $-- $ 955,134
Purchases 1,476,600 (14,428) -- 1,462,172
Collections of principal (45,183) (608) -- (45,791)
Cost of securities sold (249,303) 6,846 -- (242,457)
Accretion -- 5,710 -- 5,710
Consolidation of ICH CMO
(Note 6) (34,256) 11,853 -- (22,403)
---------------------------------------------------
BALANCE AT DECEMBER 31, 2003 $2,173,538 $(61,173) $-- $2,112,365
Purchases 1,500,549 4,084 -- 1,504,633
Collections of principal (181,008) -- -- (181,008)
Cost of securities sold (177,826) 4,677 -- (173,149)
Accretion -- 6,807 -- 6,807
---------- -------- --- ----------
BALANCE AT DECEMBER 31, 2004 $3,315,253 $(45,605) $-- $3,269,648
========== ======== === ==========
During| | | | Current Face Amount | | | Market (Discount) / Premium | | | | | | Amortized Cost Basis | |
December 31, 2003 | | $ | 2,173,538 | | $ | (61,173 | ) | $ | - | | $ | 2,112,365 | |
| Purchases | | | 1,500,549 | | | 4,084 | | | - | | | 1,504,633 | |
| Collection of principal | | | (181,008 | ) | | - | | | - | | | (181,008 | ) |
| Cost of securities sold | | | (177,826 | ) | | 4,677 | | | - | | | (173,149 | ) |
| Accretion | | | - | | | 6,807 | | | - | | | 6,807 | |
December 31, 2004 | | $ | 3,315,253 | | $ | (45,605 | ) | $ | - | | $ | 3,269,648 | |
| Purchases | | | 1,895,580 | | | (45,385 | ) | | - | | | 1,850,195 | |
| Collection of principal | | | (382,872 | ) | | - | | | - | | | (382,872 | ) |
| Cost of securities sold | | | (224,744 | ) | | 18,912 | | | - | | | (205,832 | ) |
| Accretion | | | - | | | 6,595 | | | - | | | 6,595 | |
December 31, 2005 | | $ | 4,603,217 | | $ | (65,483 | ) | $ | - | | $ | 4,537,734 | |
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003
(dollars in tables in thousands, except per share data)
During 2005 and 2004, Newcastle recorded gross realized gains of approximately $20.0$24.0 million and $14.5$20.0 million, respectively, and gross realized losses of approximately $0.0$3.4 million and $1.9$0.0 million, respectively, related to the sale of real estate securities.
The securities are encumbered by the CBO
securitizationsbonds payable and by repurchase agreements (Note 8) at December 31,
2004.
66
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
2005.Newcastle enters into
short-termshort term warehouse agreements
pursuant to which it makes deposits with major investment banks for the right to purchase commercial mortgage backed securities, unsecured REIT debt, real estate
related loans and
real estate related asset backed securities for its real estate securities portfolios, prior to their being financed with CBOs. These agreements are treated as non-hedge derivatives for accounting purposes and are therefore marked to market through current income.
IfThe cost to Newcastle if the related CBO is not consummated
is limited, except
as a result of Newcastle'swhere the non-consummation results from Newcastle’s gross negligence, willful misconduct or breach of contract,
Newcastle would be
required to
paypayment of the Net Loss, if any, as defined, up to the related deposit, less any Excess Carry Amount, as defined, earned on such deposit.
Although Newcastle currently anticipates completing the most recent CBOThe income recorded on these agreements was approximately $2.4 million, $3.1 million, and $3.6 million in
the near term, there is no assurance that such CBO will be consummated or
on what terms it will be consummated. The following table summarizes the
agreements (in thousands):
December 31,2005, 2004 Income (Loss) Recorded
- ------------------------------------------------- ----------------------
Deal Collateral Aggregate Fair
Status Accumulated (1) Deposit Value 2004 2003 2002
- --------- --------------- --------- ------- ------ ------ ----
Completed $2,604 $3,730 $652
Open $224,928 $24,901 $25,411 510 -- --
------ ------ ----
Total $3,114 $3,730 $652
====== ====== ====
(1) Excludes $32.5 million of collateral accumulated on balance sheet and
recorded2003, respectively.
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003
(dollars in real estate securities.
5. tables in thousands, except per share data)
| 5. | REAL ESTATE RELATED LOANS AND RESIDENTIAL MORTGAGE LOANS AND RESIDENTIAL MORTGAGE LOANS |
The following is a summary of real estate related loans and residential mortgage loans. The loans contain various terms, including fixed and floating rates, self-amortizing and interest only. They are generally subject to prepayment.
| | | December 31, | | December 31, 2005 | |
| | | 2005 | | 2004 | | 2005 | | 2004 | | | | | | | | | |
Loan Type | | Current Face Amount | | Carrying Value (C) | | Loan Count | | Wtd. Avg. Yield | | Weighted Average Maturity (Years) (D) | | Delinquent Carrying Amount (E) | |
| B-Notes | | $ | 72,173 | | $ | 132,777 | | $ | 72,520 | | $ | 133,344 | | | 13 | | | 8.46 | % | | 2.40 | | $ | - | |
| Mezzanine Loans (A) | | | 302,740 | | | 80,000 | | | 302,816 | | | 80,052 | | | 8 | | | 8.44 | % | | 1.94 | | | - | |
| Bank Loans | | | 56,274 | | | 146,909 | | | 56,563 | | | 146,909 | | | 3 | | | 6.58 | % | | 2.51 | | | - | |
| Real Estate Loans | | | 23,082 | | | 29,555 | | | 22,364 | | | 28,911 | | | 1 | | | 20.02 | % | | 2.00 | | | - | |
| ICH Loans (B) | | | 165,514 | | | 205,147 | | | 161,288 | | | 202,674 | | | 96 | | | 8.64 | % | | 1.55 | | | 22,136 | |
| Total Real Estate | | | | | | | | | | | | | | | | | | | | | | | | | |
| Related Loans | | $ | 619,783 | | $ | 594,388 | | $ | 615,551 | | $ | 591,890 | | | 121 | | | 8.74 | % | | 1.94 | | $ | 22,136 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential Loans | | $ | 326,100 | | $ | 645,381 | | $ | 333,226 | | $ | 654,784 | | | 919 | | | 4.79 | % | | 2.73 | | $ | 3,699 | |
| Manufactured | | | | | | | | | | | | | | | | | | | | | | | | | |
| Housing Loans | | | 284,870 | | | - | | | 267,456 | | | - | | | 7,067 | | | 7.84 | % | | 5.78 | | | 2,927 | |
| Total Residential | | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage Loans | | $ | 610,970 | | $ | 645,381 | | $ | 600,682 | | $ | 654,784 | | | 7,986 | | | 6.15 | % | | 4.15 | | $ | 6,626 | |
| (A) | One of these loans has a contractual exit fee which Newcastle will begin to accrue if and when management believes it is probable that such exit fee will be received. These loans are comprised of the following: |
| | | | | | | | | | | | | | | | |
| $ 50,000 | | $ | 50,000 | | $ | 50,003 | | $ | 50,008 | | | 1 | | | 7.10 | % | | 0.71 | | $ | - | |
| 38,000 | | | - | | | 38,016 | | | - | | | 1 | | | 8.51 | % | | 1.81 | | | - | |
| 100,000 | | | - | | | 100,052 | | | - | | | 1 | | | 7.60 | % | | 2.53 | | | - | |
| 58,630 | | | - | | | 58,662 | | | - | | | 1 | | | 8.87 | % | | 1.70 | | | - | |
| 56,110 | | | 30,000 | | | 56,083 | | | 30,044 | | | 4 | | | 10.64 | % | | 2.32 | | | - | |
| $ 302,740 | | $ | 80,000 | | $ | 302,816 | | $ | 80,052 | | | 8 | | | 8.44 | % | | 1.94 | | $ | - | |
| (B) | In October 2003, pursuant to FIN No. 46, Newcastle consolidated an entity which holds a portfolio of commercial mortgage loans which has been securitized. This investment, which is referred to as ICH, was previously treated as a non-consolidated residual interest in such securitization. The primary effect of the consolidation is the requirement that Newcastle reflect the gross loan assets and gross bonds payable of this entity in its financial statements. |
| (C) | The aggregate United States federal income tax basis for such assets at December 31, December 31, 2004
----------------------------------------- -----------------------
2004 2003 2004 2003 Weighted
-------- -------- ------- ---------- Average
Current Loan Wtd. Avg. Maturity Delinquent Carrying
Loan Type Face Amount Carrying Value (B) Count Yield (Years) (C) Amount
- --------- ------------------- ------------------- ----- --------- ----------- -------------------
B-Notes $132,777 $ 61,640 $133,344 $ 61,591 23 6.44% 2.30 $ --
Mezzanine2005 was approximately equal to their book basis. |
| (D) | The weighted average maturity for the residential loan portfolio and the manufactured housing loan portfolio were calculated based on constant prepayment rates (CPR) of approximately 30% and 10%, respectively. |
| (E) | This face amount of loans is 60 or more days delinquent. $14.8 million of the delinquent ICH Loans 80,000 -- 80,052 -- 4 5.25% 1.97 --
Bank Loans 146,909 99,859 146,909 99,859 3 6.73% 1.99 --
Real Estate Loans 29,555 -- 28,911 -- 2 16.55% 1.24 --
ICH CMO Loans (A) 205,147 243,809 202,674 241,334 123 8.16% 2.86 11,274
-------- -------- -------- -------- ----- ----- ---- -------
Total Real Estate
Related Loans $594,388 $405,308 $591,890 $402,784 155 7.44% 2.32 $11,274
======== ======== ======== ======== ===== ===== ==== =======
Residential Mortgage
Loan Portfolio $645,381 $578,330 $654,784 $586,237 1,653 3.71% 3.84 $ 1,148
were transferred out of the securitization trust and the related properties were foreclosed on in 2006. |
(A) In October 2003, pursuant to FIN No.46, Newcastle consolidated an
entity which holds a portfolio of commercial mortgage loans which has
been securitized. This investment, which is referred to as the ICH
CMO, was previously treated as a non-consolidated residual interest in
such securitization. Newcastle exercises no control over the
management or resolution of these assets and its residual investment
in this entity was recorded at $2.9 million prior to its
consolidation. The primary effect of the consolidation is the
requirement that Newcastle reflect the gross loan assets and gross
bonds payable of this entity in its financial statements.
67
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
(B) The aggregate United States federal income tax basis for such assets
at December 31, 2004 was approximately equal to their book basis.
(C) The weighted average maturity for the residential mortgage loan
portfolio was calculated based on a constant prepayment rate (CPR) of
22.6%.
The following is a reconciliation of real estate related loans and residential mortgage loans.
Real Estate Related Loans Residential Mortgage Loans
------------------------------------------------- -------------------------------------------------
Market Market
Current Face (Discount)/ Loss Carrying Current (Discount)/ Loss Carrying
Amount Premium Allowance Value Face Amount Premium Allowance Value
------------ ----------- --------- -------- ----------- ----------- --------- ---------
BALANCE AT DECEMBER 31, 2002 $ 26,423 $ (6) $ -- $ 26,417 $ 254,201 $ 3,997 $ -- $ 258,198
Purchases/advances 152,322 (84) -- 152,238 524,502 8,116 -- 532,618
Collections of principal (20,513) -- -- (20,513) (39,545) -- -- (39,545)
Cost of loans sold -- -- -- -- (160,828) (2,869) -- (163,697)
Accretion -- 41 -- 41 -- (1,237) -- (1,237)
Loss allowance -- -- -- -- -- -- (100) (100)
Consolidation of ICH CMO 247,076 -- (2,475) 244,601 -- -- -- --
-------- ---- ------- -------- --------- ------- ----- ---------
BALANCE AT DECEMBER 31, 2003 $405,308 $(49) $(2,475) $402,784 $ 578,330 $ 8,007 $(100) $ 586,237
Purchases/advances 281,340 15 -- 281,355 347,318 3,055 -- 350,373
Collections of principal (92,425) -- 2 (92,423) (154,660) -- -- (154,660)
Cost of loans sold -- -- -- -- (125,607) 874 -- (124,733)
Accretion 165 9 -- 174 -- (2,533) -- (2,533)
Loss allowance -- -- -- -- -- -- 100 100
-------- ---- ------- -------- --------- ------- ----- ---------
BALANCE AT DECEMBER 31, 2004 $594,388 $(25) $(2,473) $591,890 $ 645,381 $ 9,403 $ -- $ 654,784
======== ==== ======= ======== ========= ======= ===== =========
68
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
In November 2004, | | | | | | | | | | | | | | | | | | |
| | | Real Estate Related Loans | | Residential Mortgage Loans | |
| | | Current Face Amount | | Market (Discount)/ Premium | | Loss Allowance | | Carrying Value | | Current Face Amount | | Market (Discount)/ Premium | | Loss Allowance | | Carrying Value | |
Balance at December 31, 2003 | | $ | 405,308 | | $ | (49 | ) | $ | (2,475 | ) | $ | 402,784 | | $ | 578,330 | | $ | 8,007 | | $ | (100 | ) | $ | 586,237 | |
| Purchases/advances | | | 281,340 | | | 15 | | | - | | | 281,355 | | | 347,318 | | | 3,055 | | | - | | | 350,373 | |
| Collections of principal | | | (92,425 | ) | | - | | | 2 | | | (92,423 | ) | | (154,660 | ) | | - | | | - | | | (154,660 | ) |
| Cost of loans sold | | | - | | | - | | | - | | | - | | | (125,607 | ) | | 874 | | | - | | | (124,733 | ) |
| Accretion | | | 165 | | | 9 | | | - | | | 174 | | | - | | | (2,533 | ) | | - | | | (2,533 | ) |
| Loss allowance | | | - | | | - | | | - | | | - | | | - | | | - | | | 100 | | | 100 | |
Balance at December 31, 2004 | | $ | 594,388 | | $ | (25 | ) | $ | (2,473 | ) | $ | 591,890 | | $ | 645,381 | | $ | 9,403 | | $ | - | | $ | 654,784 | |
| Purchases/advances | | | 341,676 | | | (505 | ) | | - | | | 341,171 | | | 327,855 | | | (18,150 | ) | | - | | | 309,705 | |
| Collections of principal | | | (319,830 | ) | | - | | | - | | | (319,830 | ) | | (359,905 | ) | | - | | | - | | | (359,905 | ) |
| Accretion | | | - | | | 524 | | | - | | | 524 | | | - | | | 1,666 | | | - | | | 1,666 | |
| Paid-in-kind interest | | | 4,648 | | | - | | | - | | | 4,648 | | | - | | | - | | | - | | | - | |
| Loss allowance | | | - | | | - | | | (2,852 | ) | | (2,852 | ) | | - | | | - | | | (5,568 | ) | | (5,568 | ) |
| Realized losses | | | (1,099 | ) | | - | | | 1,099 | | | - | | | (2,361 | ) | | - | | | 2,361 | | | - | |
Balance at December 31, 2005 | | $ | 619,783 | | $ | (6 | ) | $ | (4,226 | ) | $ | 615,551 | | $ | 610,970 | | $ | (7,081 | ) | $ | (3,207 | ) | $ | 600,682 | |
Newcastle has entered into a total rate of return swaparrangements with a major investment bank to finance certain loans whereby Newcastle receives the sum of all interest,
(at LIBOR + 2.25%), fees and any positive change in value amounts (the total return cash flows) from a referenced term loan (toreference asset with a retail mall
REIT) with an initialspecified notional amount, of $107.0 million, and pays interest
(at LIBOR + 0.50%) on such notional plus any negative change in value amounts from such loan. This agreement isasset. These agreements are recorded in Derivative Assets and is treated as a non-hedge derivativederivatives for accounting purposes and isare therefore marked to market through income. Net interest received is recorded to Interest Income and the mark to market is recorded to Other Income. If Newcastle owned the reference assets directly, they would not be marked to market. Under the agreement,agreements, Newcastle wasis required to post an initial margin deposit equal to 17% of the notional
amountan interest bearing account and additional margin may be payable in the event of a decline in value of the referenced term loan.reference asset. Any margin on deposit (recorded in Restricted Cash), less any negative change in value payments,amounts, will be returned to Newcastle upon termination of the contract. The following table presents information on these instruments as of December 31, 2005.
Reference Asset | | Notional Amount | | Margin Amount | | Receive Interest Rate | | Pay Interest Rate | | Maturity Date | | Fair Value | |
| Term loan to a retail mall REIT | | $ | 106,083 | | $ | 18,149 | | | LIBOR + 2.000% | % | | LIBOR + 0.500% | | | Nov 2008 | | $ | 1,008 | |
Term loan to a diversified real estate and finance company | | | 97,997 | | | 19,599 | | | LIBOR + 3.000% | % | | LIBOR + 0.625% | | | Feb 2008 | | | 877 | |
| Mezzanine loan to a hotel company | | | 15,000 | | | 5,224 | | | LIBOR + 4.985% | % | | LIBOR + 1.350% | | | Jun 2007 | | | 101 | |
Term loan to a diversified real estate company | | | 94,954 | | | 9,495 | | | LIBOR + 1.750% | % | | LIBOR + 0.500% | | | Aug 2007 | | | 904 | |
| Term loan to a retail company | | | 100,000 | | | 19,960 | | | LIBOR + 3.000% | % | | LIBOR + 0.500% | | | Dec 2008 | | | 206 | |
| | | $ | 414,034 | | $ | 72,427 | | | | | | | | | | | $ | 3,096 | |
The average carrying amount of Newcastle'sNewcastle’s real estate related loans was approximately $594.1 million and $486.2 million during 2005 and $113.6 million during 2004, and 2003, respectively, on which Newcastle earned approximately $36.7$54.7 million and $10.7$36.7 million of gross revenues, respectively.
The average carrying amount of Newcastle'sNewcastle’s residential mortgage loans was approximately $764.2 million and $637.4 million during 2005 and $400.0 million during 2004, and 2003, respectively, on which Newcastle earned approximately $19.1$48.8 million and $12.9$19.1 million of gross revenues, respectively.
The residential mortgage loan portfolio is encumbered by repurchase
agreements and a term loan (Note 8), the ICH CMO loans are encumbered by various debt obligations as described in Note 8.
Real estate owned (“REO”) as a result of foreclosure on loans is included in Receivables and Other Assets, and is recorded at the
ICH CMO Bonds (Note 8) and the real estate related loans are encumbered
by the CBO securitizations, term loans and repurchase agreements (Note 8).
69
lower of cost or fair value. No material REO was owned as of December 31, 2005 or 2004.
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
6. OPERATING REAL ESTATE
The following is a reconciliation of operating real estate assets and accumulated depreciation:
Accumulated
Operating Real Estate Gross Depreciation Net
--------------------- -------- ------------ --------
BALANCE AT DECEMBER 31, 2002 $123,112 $ (9,460) $113,652
Improvements 576 -- 576
Foreign currency translation 25,313 (2,247) 23,066
Depreciation -- (3,043) (3,043)
Transferred to Real Estate Held for Sale (34,671) 3,415 (31,256)
-------- -------- --------
BALANCE AT DECEMBER 31, 2003 $114,330 $(11,335) $102,995
Improvements 148 -- 148
Foreign currency translation 8,899 (1,094) 7,805
Depreciation -- (2,137) (2,137)
Transferred to Real Estate Held for Sale (57,686) 6,068 (51,618)
-------- -------- --------
BALANCE AT DECEMBER 31, 2004 $ 65,691 $ (8,498) $ 57,193
======== ======== ========
Canadian Properties $ 65,691 $ (8,498) $ 57,193
Belgian Properties -- -- --
-------- -------- --------
Total $ 65,691 $ (8,498) $ 57,193
======== ======== ========
Real Estate Held for Sale
BALANCE AT DECEMBER 31, 2002 $ 3,471
Sold (3,471)
Transferred from Operating Real Estate 31,256
Mark to market (1,852)
--------
BALANCE AT DECEMBER 31, 2003 $ 29,404
Improvements 73
Foreign currency translation (735)
Sold (67,984)
Transferred from Operating Real Estate 51,618
--------
BALANCE AT DECEMBER 31, 2004 $ 12,376
========
Canadian Properties $ --
Belgian Properties 12,376
--------
Total $ 12,376
========
70
| Operating Real Estate | | | | | | | | | | |
Balance at December 31, 2003 | | $ | 114,330 | | $ | (11,335 | ) | $ | 102,995 | |
| Improvements | | | 148 | | | - | | | 148 | |
| Foreign currency translation | | | 8,899 | | | (1,094 | ) | | 7,805 | |
| Depreciation | | | - | | | (2,137 | ) | | (2,137 | ) |
| Transferred to Real Estate Held for Sale | | | (57,686 | ) | | 6,068 | | | (51,618 | ) |
Balance at December 31, 2004 | | $ | 65,691 | | $ | (8,498 | ) | $ | 57,193 | |
| Improvements | | | - | | | - | | | - | |
| Foreign currency translation | | | (422 | ) | | (28 | ) | | (450 | ) |
| Depreciation | | | - | | | (704 | ) | | (704 | ) |
| Transferred to Real Estate Held for Sale | | | (45,060 | ) | | 5,694 | | | (39,366 | ) |
Balance at December 31, 2005 | | $ | 20,209 | | $ | (3,536 | ) | $ | 16,673 | |
| | | | | | | | | | | |
Real Estate Held for Sale | | | | | | | | | | |
Balance at December 31, 2003 | | | | | | | | $ | 29,404 | |
| Improvements | | | | | | | | | 73 | |
| Foreign currency translation | | | | | | | | | (735 | ) |
| Sold | | | | | | | | | (67,984 | ) |
| Transferred from Operating Real Estate | | | | | | | | | 51,618 | |
Balance at December 31, 2004 | | | | | | | | $ | 12,376 | |
| Improvements | | | | | | | | | 182 | |
| Foreign currency translation | | | | | | | | | (1,620 | ) |
| Sold | | | | | | | | | (50,304 | ) |
| Transferred from Operating Real Estate | | | | | | | | | 39,366 | |
Balance at December 31, 2005 | | | | | | | | $ | - | |
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
All
During the periods presented, Newcastle’s operating real estate was comprised of Newcastle's U.S.Canadian properties, (the "GSA Portfolio") were distributed
to Holdings prior to the commencement of Newcastle's operations. SuchBelgian properties were primarily leased to the General Services Administration of
the U.S. Government. The GSA Portfolio was financed by a securitizationand an investment in an unconsolidated subsidiary which was also distributed to Holdings.
owns domestic properties.
The Canadian properties arewere primarily leased to Bell Canada, a wholly-owned subsidiary of BCE, Inc. and are referred to as the "Bell“Bell Canada Portfolio."” For 2005, 2004 and 2003, and 2002, approximately 99%, 98% and 99%primarily all of Newcastle'sNewcastle’s consolidated rental and escalation income from continuing operations was attributable to Bell Canada. The Bell Canada leases expire in 2006 and
2007. The lease of the primary tenant of one of these properties, the
smallest property in the portfolio, expired in March 2004 and this building
is now vacant; in January 2005, we agreed to the terms for a sale of this
property and received a nonrefundable deposit thereon. In March 2005, we
agreed to the terms for a sale of another of the Bell Canada properties and
received a nonrefundable deposit thereon. Eachremaining Bell Canada lease contains
one five-year lease renewal optionexpires in 2006 and provides for a significant payment due upon expiration of the lease. These terminal payments havelease, which has been includedreceived in 2006. Bell Canada has agreed to release a portion of this space upon expiration of the calculation of straight-line rental income assuming that
each lease is renewed once.lease. The Bell Canada leaseslease also provideprovides for the reimbursement of substantially all operating expenses and property taxes plus an administrative fee. The Bell Canada Portfolio is encumbered by the
Bell Canada bonds (Note 8).
The Belgian properties, which have all been sold, are referred to as the "LIV Portfolio" and are
leased to a variety of tenants. The leases on the Belgian properties
provide for annual increases in base rent based on the change in a Belgian
index, as well as payment of increases in operating expenses and real
estate taxes over base year amounts.
“LIV Portfolio.”
The following is a schedule of the future minimum rental payments to be received under non-cancelable operating
leases:
2005 $ 6,221
2006 4,403
2007 1,279
2008 190
2009 190
Thereafter 190
-------
$12,473
=======
leases (including the lease renewal signed in 2006):| 2006 | | $ | 745 | |
| 2007 | | | 1,114 | |
| 2008 | | | 1,111 | |
| 2009 | | | 1,111 | |
| 2010 | | | 278 | |
| | | $ | 4,359 | |
In May 2002, Holdings sold oneApril 2003, Newcastle consummated the sale of its GSA Properties with a net basis of
$33.0 million for a net purchase price of approximately $34.1 million, at a
gain of $1.1 million.
In May 2002, Newcastle sold a propertytwo properties in the LIV portfolioBell Canada portfolio. These properties had been classified as held for gross
proceeds of approximately $8.9 million, atsale in 2002. Newcastle recognized a loss of approximately $1.1
million.
In 2002, Newcastle entered into contracts to sell two commercial properties
located in Canada for gross proceeds of approximately $2.6 million, at a
loss of approximately $1.6 million including the write offloss on this sale in 2002. In addition, Newcastle recognized a $0.6 million gain in 2003, net of accumulated
other comprehensive incomea $0.3 million loss related to foreign currency translation. The
sales were completed in April 2003.
the prepayment of the debt on such properties.
In June 2004, Newcastle consummated the sale of five properties in the LIV portfolio. These properties had been classified as held for sale since December 2003. Newcastle recognized a $1.5 million loss on this sale in December 2003. In addition, Newcastle recognized a $1.2$1.1 million loss in 2004, primarily related to the prepayment of the debt on such properties.
In December 2004, Newcastle sold two properties in the LIV portfolio at a gain of approximately $5.3 million, net of $2.6 million of prepayment penalties on the related debt.
In March 2005, Newcastle closed on the sale of a property in the Bell Canada portfolio and recorded a gain of approximately $0.4 million, net of $0.9 million of prepayment penalties on the related debt. Newcastle posted a CAD $1.1 million letter of credit to cover potential Canadian taxes arising from this sale, however no taxes are expected to be paid.
In March 2004,June 2005, Newcastle committedclosed on the sale of a property in the Bell Canada portfolio and recorded a gain (net of Canadian taxes) of approximately $0.9 million, net of $2.1 million of prepayment penalties on the related debt. Newcastle posted a CAD $4.9 million letter of credit to a plancover potential Canadian taxes arising from this sale, however no taxes are expected to sell onebe paid in excess of those accrued at closing.
In June 2005, Newcastle closed on the sale of the last property in the LIV
portfolio. Newcastle expectsportfolio and recorded a
saleloss of
this property to be completed by
the first quarter of 2005. Accordingly, this property has been reclassified
as Real Estate Held for Sale. Although Newcastle currently anticipates
completing this sale in the near term, there is no assurance that this sale
will be completed or on what terms it will be completed. This property is
the last remaining property in the LIV portfolio.
71
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
approximately $0.7 million.
Pursuant to SFAS No. 144, Newcastle has retroactively recorded the operations, including the gain or loss, of all sold or "held“held for sale"sale” properties in Income from Discontinued Operations for all periods presented.
Gross revenues from discontinued operations
which include those
investments distributed to Holdings as discussed in Note 2, were approximately
$10.6$5.5 million,
$6.7$19.1 million and
$35.4$18.7 million in
2005, 2004
2003
and
2002,2003, respectively. Interest expense included in discontinued operations was approximately
$3.4$0.8 million,
$4.0$5.9 million, and
$15.2$6.2 million in
2005, 2004
and 2003,
and 2002 respectively.
72
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
The following table sets forth certain information regarding the operating real estate portfolio:
DECEMBER 31, 2004
COSTS ------------------------------------------------
CAPITALIZED GROSS NET
INITIAL SUBSEQ. TO CARRYING ACCUM. CARRYING OCC.
TYPE OF PROPERTY LOCATION COST (A) ACQ'N (A) AMOUNT DEPR. VALUE | | | | | | | | | | |
Type of
Property | | Location | | Net Rentable Sq. Ft. (A) | | Acq'n Date (A) | | Year Built/ Renovated (A) | |
| | | | | | | | | | |
| Off. Bldg. | | London, ON | | 323,411 | | 10/98 | | 1980 | |
| | | | | December 31, 2005 | |
Initial Cost (B) | | Costs Capitalized Subseq. to Acq'n (B) | | Gross Carrying Amount | | Accum. Depr. | | Net Carrying Value (C) | | Encumb. | | Occ. (A) | |
| | | | | | | | | | | | | | |
| $ 19,790 | | $ | 419 | | $ | 20,209 | | $ | (3,536 | ) | $ | 16,673 | | $ | - | | | 95.2 | % |
(B) ENCUMB. (C)
---------------- -------- -------- ----------- -------- ------ ---------- ------- -----
Off. Bldg. Etobicoke, ON $11,687 $ 866 $12,553 $1,817 $10,736 $10,623 --%
Off. Bldg. London, ON 19,133 400 19,533 2,880 16,653 9,286 95.2%
Industrial/Distribution Toronto, ON 33,376 229 33,605 3,801 29,804 22,513 100.0%
------- ------ ------- ------ ------- ------- -----
SUBTOTAL - CANADA 64,196 1,495 65,691 8,498 57,193 42,422 82.9%
------- ------ ------- ------ ------- ------- -----
Off. Bldg. G. Bijgaarden, BEL N/A N/A 12,376 N/A 12,376 -- 84.0%
------- ------ ------- ------ ------- ------- -----
SUBTOTAL - BELGIUM
(HELD FOR SALE) -- -- 12,376 -- 12,376 -- 84.0%
------- ------ ------- ------ ------- ------- -----
TOTALS: $64,196 $1,495 $78,067 $8,498 $69,569 $42,422 83.0%
======= ====== ======= ====== ======= ======= =====
NET ACQ'N YEAR BUILT/
RENTABLE DATE RENOVATED
TYPE OF PROPERTY LOCATION SQ. FT. (C) (C) (C)
---------------- -------- ----------- ----- -----------
Off. Bldg. Etobicoke, ON 177,214 10/98 1972/1978
Off. Bldg. London, ON 325,764 10/98 1980
Industrial/Distribution Toronto, ON 624,786 10/98 1963/71/79
---------
SUBTOTAL - CANADA 1,127,764
---------
Off. Bldg. G. Bijgaarden, BEL 81,763 11/99 1994
---------
SUBTOTAL - BELGIUM
(HELD FOR SALE) 81,763
---------
TOTALS: 1,209,527
=========
(A) Adjusted for changes in foreign currency exchange rates, which aggregated
$4.7$0.7 million of gain and
$10.4$1.4 million of gain between land, building and improvements in
2005 and 2004,
and 2003 respectively.
(B)(C) The aggregate United States federal income tax basis for such assets at December 31,
20042005 was
approximately $71.8 million.
(C) Unaudited.
73
equal to its net carrying value.
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
7.
| 7. | FAIR VALUE OF FINANCIAL INSTRUMENTS |
Fair values for a majority of Newcastle’s investments are readily obtainable through broker quotations. For certain of Newcastle'sNewcastle’s financial instruments, fair values are not readily available since there are no active trading markets as characterized by current exchanges between willing parties. Accordingly, fair values can only be derived or estimated for these instruments using various valuation techniques, such as computing the present value of estimated future cash flows using discount rates commensurate with the risks involved. However, the determination of estimated future cash flows is inherently subjective and imprecise. It should be noted that minor changes in assumptions or estimation methodologies can have a material effect on these derived or estimated fair values, and that the fair values reflected below are indicative of the interest rate and credit spread and
currency rate environments as of December 31, 20042005 and do not take into consideration the effects of subsequent interest rate or credit spread or
currency rate fluctuations.
The carrying values and estimated fair values of Newcastle's financial instruments at December 31,
20042005 and
20032004 were as follows:
Principal Balance or
Carrying Value Notional Amount Estimated Fair Value
December 31, December 31, December 31,
----------------------- -------------------- -----------------------
2004 2003 2004 2004 2003
---------- ---------- ---------- ---------- ----------
ASSETS:
Real estate securities, available for sale $3,369,496 $2,192,727 $3,315,253 $3,369,496 $2,192,727
Real estate securities portfolio deposit 25,411 19,541 See below 25,411 19,541
Real estate related loans 591,890 402,784 594,388 600,528 429,860
Residential mortgage loans 654,784 586,237 645,381 654,784 586,237
Interest rate caps, treated as hedges (A) 3,554 8,294 375,019 3,554 8,294
Total return swap (A) 399 -- See below 399 --
LIABILITIES:
CBO bonds payable 2,656,510 1,793,533 2,681,395 2,720,704 1,836,628
Other bonds payable 222,266 260,674 222,729 227,510 282,014
Notes payable 652,000 154,562 652,000 652,000 155,058
Repurchase agreements 490,620 715,783 490,620 490,620 715,783
Interest rate swaps, treated as hedges (B) 13,239 28,881 2,011,418 13,239 28,881
Non-hedge derivative obligations (C) 796 747 See below 796 747
| | | Carrying Value | | Principal Balance or Notional Amount | | Estimated Fair Value | |
| | | December 31, | | December 31, | | December 31, | |
| | | 2005 | | 2004 | | 2005 | | 2005 | | 2004 | |
Assets: | | | | | | | | | | | |
| Real estate securities, available for sale | | $ | 4,554,519 | | $ | 3,369,496 | | $ | 4,603,217 | | $ | 4,554,519 | | $ | 3,369,496 | |
| Real estate securities portfolio deposit | | | - | | | 25,411 | | | - | | | - | | | 25,411 | |
| Real estate related loans | | | 615,551 | | | 591,890 | | | 619,783 | | | 615,865 | | | 600,528 | |
| Residential mortgage loans | | | 600,682 | | | 654,784 | | | 610,970 | | | 609,486 | | | 654,784 | |
| Interest rate caps, treated as hedges (A) | | | 2,145 | | | 3,554 | | | 342,351 | | | 2,145 | | | 3,554 | |
| Total return swaps (A) | | | 3,096 | | | 399 | | | 414,034 | | | 3,096 | | | 399 | |
Liabilities: | | | | | | | | | | | | | | | | |
| CBO bonds payable | | | 3,530,384 | | | 2,656,510 | | | 3,560,953 | | | 3,594,638 | | | 2,720,704 | |
| Other bonds payable | | | 353,330 | | | 222,266 | | | 353,330 | | | 356,294 | | | 227,510 | |
| Notes payable | | | 260,441 | | | 652,000 | | | 260,441 | | | 260,441 | | | 652,000 | |
| Repurchase agreements | | | 1,048,203 | | | 490,620 | | | 1,048,203 | | | 1,048,203 | | | 490,620 | |
| Credit facility | | | 20,000 | | | - | | | 20,000 | | | 20,000 | | | - | |
| Interest rate swaps, treated as hedges (B) | | | (41,170 | ) | | 13,239 | | | 2,943,752 | | | (41,170 | ) | | 13,239 | |
| Non-hedge derivative obligations (C) | | | 90 | | | 796 | | | See below | | | 90 | | | 796 | |
| | | | | | | | | | | | | | | | | |
(A) Included in Derivative Assets. The longest cap maturity is October 2015. The longest total return swap matures in Novembermaturity is December 2008.
(B) Included in Derivative Assets or Liabilities, as applicable. The longest swap maturity is November 2018.
(C) Included in Derivative Assets or Liabilities, as applicable. The longest maturity is July 2038.
74
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
The methodologies used and key assumptions made to estimate fair value are as follows:
REAL ESTATE SECURITIES, AVAILABLE FOR SALE --
Real Estate Securities, Available for Sale ¾The fair value of these securities is estimated by obtaining third party broker quotations, if available and practicable, and counterparty quotations.
REAL ESTATE SECURITIES PORTFOLIO DEPOSIT --
Real Estate Securities Portfolio Deposit ¾ The fair value of this deposit, which is treated as a non-hedge derivative, is estimated by obtaining third party broker quotations on the underlying securities, if available and practicable, and counterparty quotations, including a counterparty quotation on the portion of the fair value resulting from the Excess Carry Amount, as defined, earned on such deposit. This deposit is more fully described in Note 4.
REAL ESTATE RELATED LOANS --
Real Estate Related Loans ¾ The fixed rate B-Notes were valued by
obtaining counterparty quotations. The rest of the B-Notes as well as the
mezzanine loans, bank loans, and real estate loans, with one exception,
bear floating rates of interest and Newcastle believes that, for similar
financial instruments with comparable credit risks, their effective rates
approximate market rates. Accordingly, the carrying amounts outstanding are
believed to approximate fair value. The one fixed rate loan was purchased
on December 29, 2004 and therefore its carrying amount is believed to
approximate fair value. The ICH CMO loans were valued by discounting expected future receiptscash flows by the loans’ effective rate at acquisition. The rest of the loans were valued by obtaining third party broker quotations, if available and practicable, and counterparty quotations.
Residential Mortgage Loans ¾ This aggregate portfolio of residential loans consists of a portfolio of floating rate residential mortgage loans as well as a portfolio of primarily fixed rate manufactured housing loans. These loans were valued by discounting expected future cash flows by a rate calculated based on current market conditions for comparable financial instruments, including market interest rates and credit spreads.
RESIDENTIAL MORTGAGE LOANS -- This portfolio of mortgage loans bears a
floating rate of interest. Newcastle believes that, for similar financial
instruments with comparable credit risks, the effective rate on this
portfolio approximates a market rate. Accordingly, the carrying amount of
this portfolio is believed to approximate fair value.
INTEREST RATE CAP AND SWAP AGREEMENTS, TOTAL RETURN SWAP AND NON-HEDGE
DERIVATIVE OBLIGATIONS --
Interest Rate Cap and Swap Agreements, Total Return Swaps and Non-Hedge Derivative Obligations ¾ The fair value of these agreements is estimated by obtaining counterparty quotations. The total return swap isswaps are more fully described in Note 5.
CBO BONDS PAYABLE --Bonds Payable ¾ These bonds were valued by discounting expected future paymentscash flows by a rate calculated based on current market conditions for comparable financial instruments, including market interest rates and credit spreads.
OTHER BONDS PAYABLE --
Other Bonds Payable¾ The Bell Canada bonds (which were repaid in 2005) were valued, in U.S. dollars at the period end exchange rate, by discounting expected future paymentscash flows by a rate calculated by imputing a spread over a market index on the date of borrowing. The ICH CMObonds and manufactured housing loan bonds were valued by discounting expected future paymentscash flows by a rate calculated based on current market conditions for comparable financial instruments, including market interest rates and credit spreads.
NOTES PAYABLE -- The LIV mortgage was valued, in U.S. dollars at the period
end exchange rate, by discounting expected future payments by a rate
calculated by imputing a spread over a market index on the date of
borrowing. It was repaid in December 2004.
Notes Payable¾ The real estate related loan financingsfinancing (which was repaid in 2005) and residential mortgage loan financing bear floating rates of interest. Newcastle believes that,They were valued by discounting expected future cash flows by a rate calculated based on current market conditions for similarcomparable financial instruments, with
comparableincluding market interest rates and credit risks, their effective rates approximate market rates.
Accordingly, the carrying amounts outstanding are believed to approximate
fair value.
REPURCHASE AGREEMENTS --spreads.
Repurchase Agreements ¾ These agreements bear floating rates of interest, which reset monthly or quarterly to a market credit spread, and Newcastle believes that, for similar financial instruments with comparable credit risks, the effective rates approximate market rates. Accordingly, the carrying amounts outstanding are believed to approximate fair value.
75
Credit Facility ¾This facility bears a floating rate of interest. Newcastle believes that, for similar financial instruments with comparable credit risk, the effective rate approximates a market rate. Newcastle notes that two new banks joined the lending group in December 2005 at the same rate. Accordingly, the carrying amount outstanding is believed to approximate fair value.
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
8. DEBT OBLIGATIONS
The following table presents certain information regarding Newcastle'sNewcastle’s debt obligations and related hedges:
| Debt Obligation/Collateral | | Month Issued | | Current Face Amount | | Carrying Value | | Unhedged Weighted Average Funding Cost | | Final Stated Maturity | | Weighted Average Funding Cost (1) | | Weighted Average Maturity (Years) | | Face Amount of Floating Rate Debt | | Collateral Carrying Value | | Collateral Weighted Average Maturity (Years) | | Face Amount of Floating Rate Collateral | | Aggregate Notional Amount of Current Hedges | |
| | | | | December 31, | | December 31, | | December 31, 2005 | |
CBO Bonds Payable | | | | 2005 | | 2004 | | 2005 | | 2004 | | | | | | | | | | | | | | | | | | | |
| Real estate securities | | | Jul 1999 | | $ | 426,653 | | $ | 436,895 | | $ | 423,191 | | $ | 432,893 | | | 5.67% (2) | | | Jul 2038 | | | 4.89 | % | | 3.18 | | $ | 331,653 | | $ | 562,803 | | | 5.01 | | $ | - | | $ | 262,732 | |
| Real estate securities and loans | | | Apr 2002 | | | 444,000 | | | 444,000 | | | 441,054 | | | 440,427 | | | 5.43% (2) | | | Apr 2037 | | | 6.56 | % | | 4.46 | | | 372,000 | | | 498,998 | | | 5.61 | | | 56,526 | | | 290,000 | |
| Real estate securities and loans | | | Mar 2003 | | | 472,000 | | | 472,000 | | | 468,413 | | | 467,905 | | | 5.46% (2) | | | Mar 2038 | | | 5.08 | % | | 6.30 | | | 427,800 | | | 516,042 | | | 5.25 | | | 142,775 | | | 276,060 | |
| Real estate securities and loans | | | Sep 2003 | | | 460,000 | | | 460,000 | | | 455,657 | | | 455,115 | | | 5.16% (2) | | | Sep 2038 | | | 5.38 | % | | 6.85 | | | 442,500 | | | 506,290 | | | 4.71 | | | 180,598 | | | 192,500 | |
| Real estate securities and loans | | | Mar 2004 | | | 414,000 | | | 414,000 | | | 410,511 | | | 410,018 | | | 5.15% (2) | | | Mar 2039 | | | 4.94 | % | | 6.61 | | | 382,750 | | | 444,037 | | | 5.27 | | | 214,876 | | | 165,300 | |
| Real estate securities and loans | | | Sep 2004 | | | 454,500 | | | 454,500 | | | 450,639 | | | 450,152 | | | 5.09% (2) | | | Sep 2039 | | | 5.03 | % | | 7.19 | | | 442,500 | | | 494,099 | | | 5.80 | | | 221,569 | | | 189,373 | |
| Real estate securities and loans | | | Apr 2005 | | | 447,000 | | | - | | | 442,379 | | | - | | | 4.85% (2) | | | Apr 2040 | | | 5.10 | % | | 8.17 | | | 439,600 | | | 481,954 | | | 6.54 | | | 193,471 | | | 243,337 | |
| Real estate securities and loans | | | Dec 2005 | | | 442,800 | | | - | | | 438,540 | | | - | | | 4.82% (2) | | | Dec 2050 | | | 5.14 | % | | 9.53 | | | 436,800 | | | 497,935 | | | 8.49 | | | 97,349 | | | 341,506 | |
| | | | | | | 3,560,953 | | | 2,681,395 | | | 3,530,384 | | | 2,656,510 | | | | | | | | | 5.27 | % | | 6.55 | | | 3,275,603 | | | 4,002,158 | | | 5.86 | | | 1,107,164 | | | 1,960,808 | |
Other Bonds Payable | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Bell Canada portfolio | | | Apr 2002 | | | - | | | 42,885 | | | - | | | 42,422 | | | 7.02% | | | Repaid | | | - | | | - | | | - | | | - | | | - | | | - | | | - | |
| ICH loans (3) | | | (3) | | | 141,311 | | | 179,844 | | | 141,311 | | | 179,844 | | | 6.68% (2) | | | Aug 2030 | | | 6.68 | % | | 1.46 | | | 3,605 | | | 161,288 | | | 1.55 | | | 3,605 | | | - | |
| Manufactured housing loans (4) | | | Jan 2005 | | | 212,019 | | | - | | | 212,019 | | | - | | | LIBOR +1.25% | | | Jan 2006(7) | | | 5.45 | % | | 0.08 | | | 212,019 | | | 267,456 | | | 5.78 | | | 6,356 | | | 227,576 | |
| | | | | | | 353,330 | | | 222,729 | | | 353,330 | | | 222,266 | | | | | | | | | 5.94 | % | | 0.63 | | | 215,624 | | | 428,744 | | | 4.23 | | | 9,961 | | | 227,576 | |
Notes Payable | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate related loan | | | Nov 2003 | | | - | | | 67,523 | | | - | | | 67,523 | | | LIBOR +1.50% | | | Repaid | | | - | | | - | | | - | | | - | | | - | | | - | | | - | |
| Real estate related loan | | | Feb 2004 | | | - | | | 40,000 | | | - | | | 40,000 | | | LIBOR +1.50% | | | Repaid | | | - | | | - | | | - | | | - | | | - | | | - | | | - | |
| Residential mortgage loans (4) | | | Nov 2004 | | | 260,441 | | | 544,477 | | | 260,441 | | | 544,477 | | | LIBOR +0.15% | | | Nov 2007 | | | 4.70 | % | | 1.21 | | | 260,441 | | | 288,683 | | | 2.69 | | | 282,589 | | | - | |
| | | | | | | 260,441 | | | 652,000 | | | 260,441 | | | 652,000 | | | | | | | | | 4.70 | % | | 1.21 | | | 260,441 | | | 288,683 | | | 2.69 | | | 282,589 | | | - | |
Repurchase Agreements (4) (10) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgage loans | | | Rolling | | | 41,853 | | | 67,382 | | | 41,853 | | | 67,382 | | | LIBOR + 0.43% | | | Mar 2006 | | | 4.95 | % | | 0.25 | | | 41,853 | | | 44,543 | | | 2.81 | | | 43,511 | | | - | |
| Agency RMBS (5) | | | Rolling | | | 671,526 | | | 195,754 | | | 671,526 | | | 195,754 | | | LIBOR + 0.13% | | | Jan 2006 | | | 4.48 | % | | 0.08 | | | 671,526 | | | 692,486 | | | 4.90 | | | - | | | 665,965 | |
| Real estate securities | | | Rolling | | | 149,546 | | | 171,209 | | | 149,546 | | | 171,209 | | | LIBOR + 0.39% | | | Various (8) | | | 4.65 | % | | 0.16 | | | 149,546 | | | 166,737 | | | 5.84 | | | 31,450 | | | 89,403 | |
| Real estate related loans | | | Rolling | | | 185,278 | | | 56,275 | | | 185,278 | | | 56,275 | | | LIBOR + 1.01% | | | Various (8) | | | 5.38 | % | | 0.08 | | | 185,278 | | | 266,669 | | | 1.82 | | | 266,630 | | | - | |
| | | | | | | 1,048,203 | | | 490,620 | | | 1,048,203 | | | 490,620 | | | | | | | | | 4.68 | % | | 0.10 | | | 1,048,203 | | | 1,170,435 | | | 4.29 | | | 341,591 | | | 755,368 | |
| Credit facility (6) | | | | | | 20,000 | | | - | | | 20,000 | | | - | | | LIBOR + 2.50% (9) | | | Jul 2008 | | | 6.86 | % | | 2.55 | | | 20,000 | | | - | | | - | | | - | | | - | |
| Total debt obligations | | | | | $ | 5,242,927 | | $ | 4,046,744 | | $ | 5,212,358 | | $ | 4,021,396 | | | | | | | | | 5.17 | % | | 4.59 | | $ | 4,819,871 | | $ | 5,890,020 | | | 5.25 | | $ | 1,741,305 | | $ | 2,943,752 | |
Current
Face Carrying
Amount Value Unhedged
December 31, December 31, | (1) | Including the effect of applicable hedges. |
| (2) | Weighted Final
Month ----------------------- ----------------------- Average Stated
Debt Obligation/Collateral Issued 2004 2003 2004 2003 Funding Cost Maturity
- -------------------------- --------- ---------- ---------- ---------- ---------- ------------ ---------
CBO Bonds Payable
Real estate securitiesaverage, including floating and loans July 1999 $ 436,895 $ 437,500 $ 432,893 $ 431,802 4.08% (2) July 2038
Real estate securitiesfixed rate classes. |
| (4) | Subject to potential mandatory prepayments based on collateral value. |
| (5) | A maximum of $1 billion is available until November 2006. |
| (6) | A maximum of $100 million can be drawn (increased from $75 million in February 2006). |
| (7) | This financing was replaced with a new term financing in January 2006; the new maturity date is January 2009. |
| (8) | The longest maturity is March 2006. |
| (9) | In addition, unused commitment fees of between 0.125% and loans Apr 2002 444,000 444,000 440,427 439,832 3.67% (2) Apr 2037
Real estate securities0.250% are paid. |
| (10) | The counterparties on our repurchase agreements include: Bank of America Securities LLC ($693.4million), Bear Stearns Mortgage Capital Corporation ($181.1 million), Greenwich Capital Markets Inc ($72.2 million), Deutsche Bank AG ($58.1 million), and loans Mar 2003 472,000 472,000 467,905 467,325 3.68% (2) Mar 2038
Real estate securities and loans Sept 2003 460,000 460,000 455,115 454,574 3.28% (2) Sept 2038
Real estate securities and loans Mar 2004 414,000 -- 410,018 -- 3.31% (2) Mar 2039
Real estate securities and loans Sept 2004 454,500 -- 450,152 -- 3.16% (2) Sept 2039
---------- ---------- ---------- ----------
2,681,395 1,813,500 2,656,510 1,793,533
---------- ---------- ---------- ----------
Other Bonds Payable
Bell Canada portfolio (4) Apr 2002 42,885 42,866 42,422 42,168 7.02% Apr 2012
ICH CMO loans (5) (5) 179,844 218,506 179,844 218,506 6.61% (2) Aug 2030
---------- ---------- ---------- ----------
222,729 261,372 222,266 260,674
---------- ---------- ---------- ----------
Notes Payable
LIV portfolio Nov 2002 -- 74,562 -- 74,562 N/A (3)
Real estate related loan Nov 2003 67,523 80,000 67,523 80,000 LIBOR+1.50% Nov. 2006
Real estate related loan (6) Feb 2004 40,000 -- 40,000 -- LIBOR+1.50% Feb. 2005
Residential mortgage loans (7) Nov 2004 544,477 -- 544,477 -- LIBOR+0.15% Nov. 2007
---------- ---------- ---------- ----------
652,000 154,562 652,000 154,562
---------- ---------- ---------- ----------
Repurchase Agreements (7)
Residential mortgage loans (8) Rolling 67,382 557,191 67,382 557,191 LIBOR + 0.43% Mar. 2005
ABS-manufactured housing (9) Rolling 103,738 138,992 103,738 138,992 LIBOR + 0.64% Mar. 2005
Agency RMBS (10) Rolling 195,754 -- 195,754 -- LIBOR + 0.13% Jan. 2005
Real estate securities Rolling 67,471 19,600 67,471 19,600 LIBOR + 0.61% Oct. 2005
Real estate related loans (11) Rolling 56,275 -- 56,275 -- LIBOR + 0.95% Oct. 2005
---------- ---------- ---------- ----------
490,620 715,783 490,620 715,783
---------- ---------- ---------- ----------
Total debt obligations $4,046,744 $2,945,217 $4,021,396 $2,924,552
========== ========== ========== ==========
Face Aggregate
Face Collateral Amount Notional
Weighted Weighted Amount Weighted of Amount of
Average Average of Floating Collateral Average Floating Currently
Funding Maturity Rate Carrying Maturity Rate Effective
Debt Obligation/Collateral Cost (1) (Years) Debt Value (Years) Collateral Hedges
- -------------------------- -------- -------- ----------- ---------- ---------- ---------- ----------
CBO Bonds Payable
Real estate securities and loans 4.85% 4.21 $ 341,895 $ 587,861 6.04 $ -- $ 328,699
Real estate securities and loans 6.18% 5.38 372,000 505,927 6.16 84,733 290,000
Real estate securities and loans 4.45% 7.31 427,800 499,813 5.60 144,682 276,060
Real estate securities and loans 4.32% 7.87 442,500 497,524 4.93 233,990 192,500
Real estate securities and loans 3.85% 7.63 382,750 449,244 6.01 217,652 165,300
Real estate securities and loans 3.90% 8.20 442,500 499,867 6.46 252,886 189,373
----- ---- ----------- ---------- ---- ---------- ----------
4.59% 6.78 2,409,445 3,040,236 5.87 933,943 1,441,932
----- ---- ----------- ---------- ---- ---------- ----------
Other Bonds Payable
Bell Canada portfolio (4) 7.02% 1.43 -- 57,193 N/A -- --
ICH CMO loans (5) 6.61% 2.79 3,684 202,674 2.86 3,684 --
----- ---- ----------- ---------- ---------- ----------
6.69% 2.53 3,684 259,867 3,684 --
----- ---- ----------- ---------- ---------- ----------
Notes Payable
LIV portfolio N/A -- -- -- -- -- --
Real estate related loan 3.92% 1.64 67,523 83,909 1.64 83,909 --
Real estate related loan (6) 4.26% 0.17 40,000 50,000 2.13 50,000 --
Residential mortgage loans (7) 2.46% 2.10 544,477 583,922 3.76 575,759 --
----- ---- ----------- ---------- ---- ---------- ----------
2.72% 1.93 652,000 717,831 3.4 709,668 --
----- ---- ----------- ---------- ---- ---------- ----------
Repurchase Agreements (7)
Residential mortgage loans (8) 2.99% 0.25 67,382 70,862 4.49 69,622 --
ABS-manufactured housing (9) 4.29% 0.17 103,738 146,309 5.11 -- 95,700
Agency RMBS (10) 3.81% 0.08 195,754 201,528 3.35 -- 195,409
Real estate securities 3.29% 0.22 67,471 91,771 3.73 32,609 21,295
Real estate related loans (11) 3.34% 0.69 56,275 73,500 1.87 73,500 --
----- ---- ----------- ---------- ---- ---------- ----------
3.67% 0.21 490,620 583,970 3.80 175,731 312,404
----- ---- ----------- ---------- ---- ---------- ----------
Total debt obligations 4.29% 4.97 $3,555,749 $4,601,904 $1,823,026 $1,754,336
===== ==== =========== ========== ========== ==========
other ($43.4 million). |
(1) Including the effect of applicable hedges.
(2) Weighted average, including floating and fixed rate classes.
(3) Repaid in December 2004.
(4) Denominated in Canadian dollars.
(5) See Note 5.
(6) Maturity date extended in January 2005 from February 2005 to February 2006.
(7) Subject to potential mandatory prepayments based on collateral value.
(8) The counterparty on this repo is Bear Stearns Mortgage Capital Corporation.
(9) The counterparty on these repos is Greenwich Capital Markets Inc.
(10) The counterparty on this repo is Bank of America Securities LLC.
(11) The counterparty on these repos is Deutsche Bank AG.
76
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
Certain of the debt obligations included above are obligations of consolidated subsidiaries of Newcastle which own the related collateral. In some cases, including the CBO and Other Bonds Payable, such collateral is not available to other creditors of Newcastle.
CBO Bonds Payable
In connection with the sale of two classes of CBO bonds in our first CBO, Newcastle entered into two interest rate swaps and three interest rate cap agreements that do not qualify for hedge accounting. Changes in the values of these
instruments have been recorded currently in income.
In November 2001, Newcastle sold the retained subordinated $17.5 million Class E Note from its first CBO to a third party. The Class E Note bore
interest at a fixed rate of 8.0% and had a stated maturity of June 2038. The sale of the Class E Note represented an issuance of debt and was recorded as additional CBO Bonds Payable. In April 2002, a wholly-owned subsidiary of Newcastle repurchased the Class E Note. The repurchase of the Class E Note represented a repayment of debt and was recorded as a reduction of CBO Bonds Payable. The Class E Note is included in the collateral for Newcastle'sNewcastle’s second CBO. The Class E Note is eliminated in consolidation.
One class
Two classes of theseparately issued CBO bonds, with a $395.0an aggregate $718.0 million face amount, waswere issued subject to remarketing procedures and related agreements whereby such bonds are remarketed and sold on a periodic basis. These$395.0 million of these bonds are fully insured by a third party with respect to the timely payment of interest and principal thereon.
In July 2004, Newcastle refinanced $342.5 million of the AAA and AA bonds in its first CBO. $322.5 million of AAA bonds were refinanced at LIBOR +0.30% from LIBOR +0.65% and $20.0 million of AA bonds were refinanced at LIBOR +0.50% from LIBOR +0.80%. In connection with this transaction, Newcastle incurred approximately $1.5 million of costs, which are included in Gain on SettlementSale of Investments, Net.
Other Bonds Payable
In connection with the Bell Canada securitization, Newcastle guaranteed
certain payments under an interest rate swap to be entered into in 2007, if
the Bell Canada securitization is not fully repaid by such date. Newcastle
believes the fair value of this guarantee is negligible at December 31,
2004. A portion of the Bell Canada securitization has been repaid with
proceeds from the sale of properties in the Bell Canada portfolio.
In October 2003, Newcastle consolidated an entity which holds a portfolio of commercial mortgage loans which has been securitized. The primary effect of the consolidation is the requirement that Newcastle reflect the gross loans assets (Note 5) and gross bonds payable of this entity in its financial statements.
77
Maturity Table
Newcastle’s debt obligations (gross of $30.6 million of discounts at December 31, 2005) have contractual maturities as follows (in millions):
| 2006 | | $ | 1,260,222 | |
| 2007 | | | 260,441 | |
| 2008 | | | 20,000 | |
| 2009 | | | - | |
| 2010 | | | - | |
| Thereafter | | | 3,702,264 | |
| | | $ | 5,242,927 | |
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
Notes Payable
The LIV mortgage was repaid in full during 2004 with proceeds from the sale
of properties in the LIV portfolio.
Predecessor
Newcastle's predecessor had two primary debt obligations which were
distributed to it upon Newcastle's formation, a securitization which was
secured by the GSA Portfolio (Note 6) and a credit facility. Interest on
the securitization is included in discontinued operations through the date
of Newcastle's formation; interest on the credit facility is included in
interest expense through such date.
Maturity Table
Newcastle's debt obligations (gross of $25.3 million of discounts at
December 31, 2004) have contractual maturities as follows (in millions):
2005 $ 535,870
2006 62,273
2007 544,477
2008 --
2009 --
Theafter 2,904,124
----------
$4,046,744
==========
78
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
9. | 9. | STOCK OPTION PLAN AND EARNINGS PER SHARE |
Newcastle is required to present both basic and diluted earnings per share (“EPS”). Basic EPS is calculated by dividing net income available for common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted EPS is calculated by dividing net income available for common stockholders by the weighted average number of shares of common stock outstanding plus the additional dilutive effect of common stock equivalents during each period. Newcastle’s common stock equivalents are its stock options. During 2005, 2004 and 2003, based on the treasury stock method, Newcastle had 314,125, 614,038 and 242,489 dilutive common stock equivalents, respectively, resulting from its outstanding options. Net income available for common stockholders is equal to net income less preferred dividends.
In June 2002, Newcastle (with the approval of the board of directors) adopted a nonqualified stock option and incentive award plan (the "Newcastle Option Plan"Plan'') for officers, directors, consultants and advisors, including the Manager and its employees. The maximum available for issuance is equal to 10% of the number of outstanding equity interests of Newcastle, subject to a maximum of 10,000,000 shares in the aggregate over the term of the plan.
The non-employee directors have been, in accordance with the Newcastle Option Plan, automatically granted options to acquire an aggregate of 16,00018,000 shares of common stock, which vest over three years.stock. The fair value of such options was not material at the date of grant.
Through December 31,
2004,2005, for the purpose of compensating the Manager for its successful efforts in raising capital for Newcastle, the Manager has been granted options representing the right to acquire
2,325,7272,655,727 shares of common stock, with strike prices subject to adjustment as necessary to preserve the value of such options in connection with the occurrence of certain events (including capital dividends and capital distributions made by Newcastle). The Manager options represented an amount equal to 10% of the shares of common stock of Newcastle sold in its public offerings and the value of such options was recorded as an increase in
stockholders'stockholders’ equity with an offsetting reduction of capital proceeds received. The options granted to the Manager, which may be assigned by the Manager to its employees, were fully vested on the date of grant and one thirtieth of the options become exercisable on the first day of each of the following thirty calendar months, or earlier upon the occurrence of certain events, such as a change in control of Newcastle or the termination of the Management Agreement. The options expire ten years from the date of issuance.
79
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
The following table summarizes our outstanding options at December 31, 2004:
2005. Note that the last sales price on the New York Stock Exchange for our common stock in the year ended December 31, 2005 was $24.85.
Recipient | | Date of Grant/ Exercise | | Number of Options | | Weighted Average Exercise Price | | Fair Value At Grant Date (millions) | |
| Directors | | | Various | | | 18,000 | | $ | 17.38 | | | Not Material | |
| Manager (B) | | | October 2002 | | | 700,000 | | $ | 13.00 | | $ | 0.4 (A | ) |
| Manager (B) | | | July 2003 | | | 460,000 | | $ | 20.35 | | $ | 0.8 (A | ) |
| Manager (B) | | | December 2003 | | | 328,227 | | $ | 22.85 | | $ | 0.4 (A | ) |
| Manager (B) | | | January 2004 | | | 330,000 | | $ | 26.30 | | $ | 0.6 (A | ) |
| Manager (B) | | | May 2004 | | | 345,000 | | $ | 25.75 | | $ | 0.5 (A | ) |
| Manager (B) | | | November 2004 | | | 162,500 | | $ | 31.40 | | $ | 0.5 (A | ) |
| Manager (B) | | | January 2005 | | | 330,000 | | $ | 29.60 | | $ | 1.1 (A | ) |
| Exercised (B) | | | Prior to 2005 | | | (110,000 | ) | $ | 13.31 | | | | |
| Exercised (B) | | | 2005 | | | (751,920 | ) | $ | 15.55 | | | | |
| Outstanding | | | | | | 1,811,807 | | $ | 25.14 | | | | |
Fair Value
Date of Grant/ Weighted Average At Grant Date
Recipient Exercise Number of Options Exercise Price (millions)
- ------------- -------------- ----------------- ---------------- -------------
Directors Various 16,000 $15.69 Not Material
Manager (B) October 2002 700,000 $13.00 $0.4 | (A)
Manager (B) July 2003 460,000 $20.35 $0.8 (A)
Manager (B) December 2003 328,227 $22.85 $0.4 (A)
Manager (B) January 2004 330,000 $26.30 $0.6 (A)
Manager (B) May 2004 345,000 $25.75 $0.5 (A)
Manager (B) November 2004 162,500 $31.40 $0.5 (A)
Exercised (B) Prior to 2004 (2,500) $13.90
Exercised (B) 2004 (107,500) $13.29
------
Outstanding 2,231,727 $21.25
======
|
(A) The fair value of the options was estimated using a binomial option pricing model. Since the Newcastle Option Plan has characteristics significantly different from those of traded options, and since the assumptions used in such model, particularly the volatility assumption, are subject to significant judgment and variability, the actual value of the options could vary materially from management’s estimate. The assumptions used in such model were as follows: |
Date of Grant | | Volatility | | Dividend Yield | | Expected Life (Years) | | Risk-Free Rate | |
| October 2002 | | | 15 | % | | 13.85 | % | | 10 | | | 4.05 | % |
| July 2003 | | | 15 | % | | 9.83 | % | | 10 | | | 3.63 | % |
| December 2003 | | | 15 | % | | 8.75 | % | | 10 | | | 4.23 | % |
| January 2004 | | | 15 | % | | 7.60 | % | | 10 | | | 4.23 | % |
| May 2004 | | | 15 | % | | 9.32 | % | | 10 | | | 4.77 | % |
| November 2004 | | | 18 | % | | 7.64 | % | | 10 | | | 4.21 | % |
| January 2005 | | | 21 | % | | 8.45 | % | | 10 | | | 4.27 | % |
The volatility assumption for options issued in 2005 was estimated based primarily on the historical volatility of Newcastle’s common stock and management’s expectations regarding future volatility. The expected life assumption for options issued subsequent to January 2005 was estimated based on the simplified term method.
| (B) | The Manager assigned certain of its options to its employees as follows: |
| | | | | Year Assigned | |
| | | | | | | | |
| Strike Price | | 2004 | | 2003 | | | |
| $13.00 | | | 267,750 | | | 1,750 | | | 269,500 | |
| $20.35 | | | 192,050 | | | 1,150 | | | 193,200 | |
| $22.85 | | | 139,355 | | | - | | | 139,355 | |
| $26.30 | | | 127,050 | | | - | | | 127,050 | |
| $31.40 | | | 62,563 | | | - | | | 62,563 | |
| Total | | | 788,768 | | | 2,900 | | | 791,668 | |
670,620 of the
total options
was estimatedexercised were by
reference to a binomial
option pricing model. Since the
Newcastle Option Plan has
characteristics significantly different from those of traded options,
and since the assumptions used in such model, particularly the
volatility assumption, are subject to significant judgment and
variability, the actual valueManager. 187,300 of the
total options
could vary materially
from management's estimate. The assumptions used in such modelexercised were
as
follows:
Expected Life
Date of Grant Volatility Dividend Yield (Years) Risk-Free Rate
- ------------- ---------- -------------- ------------- --------------
October 2002 15% 13.85% 10 4.05%
July 2003 15% 9.83% 10 3.63%
December 2003 15% 8.75% 10 4.23%
January 2004 15% 7.60% 10 4.23%
May 2004 15% 9.32% 10 4.77%
November 2004 18% 7.64% 10 4.21%
(B) The Manager assigned certain of its options to its employees as
follows:
Year Assigned
-----------------------------------
Total
Strike Price 2004 2003 Inception to Date
- ------------ ------- ----- -----------------
$13.00 267,750 1,750 269,500
$20.35 192,050 1,150 193,200
$22.85 147,702 -- 147,702
$26.30 136,950 -- 136,950
$31.40 67,438 -- 67,438
------- ----- -------
Total 811,890 2,900 814,790
======= ===== =======
107,000 of the exercised options were exercised by employees of the Manager subsequent to their assignment.
3,0004,000 of the
total options exercised
options were
exercised by directors.
80
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
10. MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS
MANAGER
| 10. | MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS |
Manager
Newcastle entered into the Management Agreement with the Manager in June 2002, which provided for an initial term of one year with automatic one-yearone year extensions, subject to certain termination rights. After the initial one year term, the Manager's performance is reviewed annually and the Management Agreement may be terminated by Newcastle by payment of a termination fee, as defined in the Management Agreement, equal to the amount of management fees earned by the Manager during the twelve consecutive calendar months immediately preceding the termination, upon the affirmative vote of at least two-thirds of the independent directors, or by a majority vote of the holders of common stock. Pursuant to the Management Agreement, the Manager, under the supervision of Newcastle'sNewcastle’s board of directors, formulates investment strategies, arranges for the acquisition of assets, arranges for financing, monitors the performance of Newcastle's assets and provides certain advisory, administrative and managerial services in connection with the operations of Newcastle. For performing these services, Newcastle pays the Manager an annual management fee equal to 1.5% of the gross equity of Newcastle, as defined. Holdings' management
agreement with the Manager contained substantially the same terms.
The Management Agreement provides that Newcastle will reimburse the Manager for various expenses incurred by the Manager or its officers, employees and agents on Newcastle's behalf, including costs of legal, accounting, tax, auditing, administrative and other similar services rendered for Newcastle by providers retained by the Manager or, if provided by the Manager's employees, in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm's-length basis.
To provide an incentive for the Manager to enhance the value of the common stock, the Manager is entitled to receive an incentive return (the "Incentive
Compensation"Compensation'') on a cumulative, but not compounding, basis in an amount equal to the product of (A) 25% of the dollar amount by which (1) (a) the Funds from Operations, as defined (before the Incentive Compensation) of Newcastle per share of common stock (based on the weighted average number of shares of common stock outstanding) plus (b) gains (or losses) from debt restructuring and from sales of property and other assets per share of common stock (based on the weighted average number of shares of common stock outstanding), exceed (2) an amount equal to (a) the weighted average of the price per share of common stock in the IPO and the value attributed to the net assets transferred to us by
Holdings,our predecessor, and in any subsequent offerings by Newcastle (adjusted for prior capital dividends or capital distributions) multiplied by (b) a simple interest rate of 10% per annum (divided by four to adjust for quarterly calculations) multiplied by (B) the weighted average number of shares of common stock outstanding.
An affiliate of the Manager was entitled to a similar incentive return from
Holdings.
AMOUNTS INCURRED (IN MILLIONS)
------------------------------
2004 2003 2002
----- ---- ----
Management Fee ........... $10.1 $6.0 $4.3
Expense Reimbursement .... $ 0.5 $0.5 $0.5
Incentive Compensation ... $ 8.0 $6.2 $3.5
| | | Amounts Incurred (in millions) | |
| | | 2005 | | 2004 | | 2003 | |
| Management Fee | | $ | 12.8 | | $ | 10.1 | | $ | 6.0 | |
| Expense Reimbursement | | | 0.5 | | | 0.5 | | | 0.5 | |
| Incentive Compensation | | | 7.6 | | | 8.0 | | | 6.2 | |
At December 31, 2004,2005, an affiliate of the Manager, and its principals, owned 2.32.9 million shares of Newcastle'sNewcastle’s common stock and had options to purchase an additional 1.51.2 million shares of Newcastle'sNewcastle’s common stock (Note 9).
At December 31, 2004,2005, Due To Affiliates is comprised of $8.0$7.6 million of incentive compensation payable and $1.0$1.2 million of management fees and expense reimbursements payable to the Manager.
OTHER AFFILIATES
Other Affiliates
In November 2003, Newcastle and a private investment fund managed by an affiliate of our manager co-invested and each indirectly own an approximately 38% interest in a limited liability company (Note 3) that has acquired a pool of franchise loans from a third party financial institution.
Newcastle'sNewcastle’s investment in this entity, reflected as an investment in an unconsolidated subsidiary on
Newcastle'sNewcastle’s consolidated balance sheet, was approximately
81
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(dollars in tables in thousands, except per share data)
$23.5$17.8 million at December 31, 2004.2005. The remaining approximately 24% interest in the limited liability company is owned by the above-referenced third party financial institution.
In JanuaryNEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003
(dollars in tables in thousands, except per share data)
As of December 31, 2005, Newcastle purchased fromowned an underwriter $31.5aggregate of approximately $48.5 million face
amount of B and BB rated real estate securities (Note 4) of Global Signal Trust I aand II , special purpose vehiclevehicles established by Global Signal Inc. Two, which were purchased in private placements from underwriters in January 2004 and April 2005. One of Newcastle'sNewcastle’s directors areis the CEO, chairman of the board, and President of Global Signal, Inc.,
respectively. A and private equity fundfunds managed by an affiliate of Newcastle'sNewcastle’s manager ownsown a significant portion of Global Signal Inc.'s’s common stock. Approximately $418.0In February 2006, Newcastle purchased from an underwriter $91.0 million face amount of Global Signal Trust I securities were
issued in 7 classes, rated AAA though B, of which the BBBB- and BB classes
constituted $73.0 million. The balance of the B and BB securities was sold
on identical terms to a private investment fund managed by an affiliate of
our manager and to a large third party mutual fund complex. The proceeds of
the offering were utilized by Global Signal Inc. to repay an existing
credit facility, to pay an extraordinary dividend of approximately $140
million to its stockholders of which approximately $67 million was paid to
the above-referenced private equity fund, and for general working capital
purposes. In December 2004, through its warehouse, Newcastle placed a
deposit of approximately $2.6 million on $17.0 million of BBBB+ rated securities of Global Signal Trust II,III, a special purpose vehicle established by Global Signal, Inc. Pursuant to an underwritten 144A offering, approximately $293.8$1,550.0 million of Global Signal Trust IIIII securities were issued in 78 classes, rated AAA through BB-BB+, of which the BB class
constituted approximately $35.4BBB- and BB+ classes aggregated $188.3 million. The balance of the BBB- and BB+ securities were sold on identical terms to third parties. A portion of the proceeds were used to repay $402.7 million of indebtedness of Global Signal, Inc., of which Newcastle owned $31.5 million, and to fund the prepayment penalty associated with this debt.
In March 2004, Newcastle and a private investment fund managed by an affiliate of Newcastle'sNewcastle’s manager co-invested and each indirectly own an approximately 49% interest in atwo limited liability companycompanies (Note 3) that hashave acquired, in a sale-leaseback transaction, a portfolio of convenience and retail gas stores from a public company. The properties are subject to a number of master leases, the initial term of which in each case is a minimum of 15 years. This investment was financed with nonrecourse debt at the limited liability company level and Newcastle'sNewcastle’s investment in this entity, reflected as an investment in an unconsolidated subsidiary on Newcastle'sNewcastle’s consolidated balance sheet, was approximately $17.8$12.2 million at December 31, 2004.
2005. In March 2005, the property management agreement related to these properties was transferred to an affiliate of Newcastle’s manager from a third party servicer; Newcastle’s allocable portion of the related fees, approximately $20,000 per year for three years, was not changed.
In December 2004, Newcastle and a private investment fund managed by an affiliate of Newcastle'sNewcastle’s manager each made an initial investment in a new real estate related loan (Note 5) with a maximum loan amount of $128 million, subject to being drawn down under certain conditions. The loan is secured by a mezzanine loan on one of the phases and a first mortgage on the remaining phases of a large development project and related assets. Newcastle owns a 27.3% interest in the loan and the private investment fund owns a 72.7% interest in the loan. Major decisions require the unanimous approval of holders of interests in the loan, while for other decisions require the approval of a majority of holders of interests in the loan, vote based on their percentage interestinterests therein. Newcastle and our affiliated investment fund are each entitled to transfer all or any portion of their respective interests in the loan to third parties. Newcastle'sNewcastle’s investment in this loan was approximately $11.9$22.4 million at December 31, 2004.
2005.
In January 2005, Newcastle entered into a servicing agreement with a portfolio company of a private equity fund advised by an affiliate of Newcastle'sNewcastle’s manager for them to service a portfolio of manufactured housing loans (Note 5)., which was acquired at the same time. As compensation under the servicing agreement, the portfolio company will receive, on a monthly basis, a net servicing fee equal to 1.00% per annum on the unpaid principal balance of the loans being serviced. The outstanding unpaid principal balance of this portfolio was approximately $284.9 million at December 31, 2005. In January 2006, Newcastle acquiredclosed on a portfolionew term financing of such loans in January 2005this portfolio. In connection with this term financing, Newcastle renewed its servicing agreement at a
cost of $308.2 million.
the same terms.
In each instance described above, affiliates of
Newcastle'sNewcastle’s manager have an investment in the applicable affiliated fund and receive from the fund, in addition to management fees, incentive compensation if the
fund'sfund’s aggregate investment returns exceed certain thresholds.
82
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
11. COMMITMENTS AND CONTINGENCIES
REMARKETING AGREEMENTS -- One tranche
| 11. | COMMITMENTS AND CONTINGENCIES |
Remarketing Agreements ¾ Two classes of Newcastle'sseparately issued CBO bonds (Note 8), with a $395.0an aggregate $718.0 million face amount, waswere issued subject to remarketing procedures and related agreements whereby such bonds are remarketed and sold on a periodic basis. These$395.0 million of these bonds are fully insured by a third party with respect to the timely payment of interest and principal thereon, pursuant to a financial guaranty insurance policy ("wrap"(“wrap”). Newcastle pays annual fees of 0.12% of the outstanding face amount of such bonds under this agreement.
In connection with the remarketing procedures described above, a backstop agreement hasagreements have been created whereby a third party financial institution is required to purchase suchthe $718.0 million face amount of bonds at the end of any remarketing period if such bonds could not be resold in the market by the remarketing agent. Newcastle pays an annual fee of between 0.15% and 0.20% of the outstanding face amount of such bonds under this agreement.
these agreements.
In addition, the remarketing agent is paid an annual fee of 0.05% of the outstanding face amount of such bonds under the remarketing agreement.
REAL ESTATE SECURITIES PORTFOLIO DEPOSIT --agreements.
Real Estate Securities Portfolio Deposit¾ During periods when such a deposit is outstanding, Newcastle has the option to purchase certain real estate securities and loans from an investment bank. To the extent that such securities decline in value, Newcastle must either purchase such securities or lose an amount equal to the lesser of such decline or its deposit. See Note 4.
GUARANTEE OF SWAP PAYMENTS -- In connection with the Bell Canada bonds
(Note 8), Newcastle has guaranteed certain payments under an interest rate
swap to be entered into in 2007, if the Bell Canada bonds are not fully
repaid by such date. Newcastle believes the fair value of this guarantee is
negligible at December 31, 2004.
LOAN COMMITMENT--
Loan Commitment— With respect to one of its real estate related loans, Newcastle was committed to fund up to an additional $22.7$11.9 million at December 31, 2004,2005, subject to certain conditions to be met by the borrower.
STOCKHOLDER RIGHTS AGREEMENT --
Stockholder Rights Agreement¾ Newcastle has adopted a stockholder rights agreement (the "Rights Agreement"Agreement''). Pursuant to the terms of the Rights Agreement, Newcastle will attach to each share of common stock one preferred stock purchase right (a "Right""Right''). Each Right entitles the registered holder to purchase from Newcastle a unit consisting of one one-hundredth of a share of Series A Junior Participation Preferred Stock, par value $0.01 per share, at a purchase price of $70 per unit. Initially, the Rights are not exercisable and are attached to and transfer and trade with the outstanding shares of common stock. The Rights will separate from the common stock and will become exercisable upon the acquisition or tender offer to acquire a 15% beneficial ownership interest by an acquiring person, as defined. The effect of the Rights Agreement will be to dilute the acquiring party's beneficial interest. Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of Newcastle.
LITIGATION --
Litigation ¾ Newcastle is, from time to time, a defendant in legal actions from transactions conducted in the ordinary course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such actions which existed at December 31, 2004,2005, if any, will not materially affect Newcastle'sNewcastle’s consolidated results of operations or financial position.
ENVIRONMENTAL COSTS --
Environmental Costs ¾ As a commercial real estate owner, Newcastle is subject to potential environmental costs. At December 31, 2004,2005, management of Newcastle is not aware of any environmental concerns that would have a material adverse effect on Newcastle's consolidated financial position or results of operations.
DEBT COVENANTS --
Debt Covenants ¾Newcastle's debt obligations contain various customary loan covenants. Such covenants do not, in management's opinion, materially restrict Newcastle's investment strategy or ability to raise capital.capital at this time. Newcastle is in compliance with all of its loan covenants at December 31, 2004.
83
2005. Exit Fee ¾One of Newcastle’s loan investments provides for a $50 million contractual exit fee which Newcastle will begin to accrue if and when management believes it is probable that such exit fee will be received.
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
12.
| 12. | INCOME TAXES AND DIVIDENDS |
Newcastle Investment Corp. is organized and conducts its operations to qualify as a REIT under the Code. A REIT will generally not be subject to U.S. federal corporate income tax on that portion of its net income that it distributesis distributed to its stockholders if it distributes at least 90% of its REIT taxable income to its stockholders by prescribed dates and complies with various other requirements.
Since Newcastle distributed 100% of its 2005, 2004 and 2003 REIT taxable income, no provision has been made for U.S. federal corporate income taxes in the accompanying consolidated financial statements, except in connection with Newcastle’s taxable REIT subsidiary (“TRS”).
Distributions relating to 2005, 2004, and 2003 were taxable as follows:
| | | | Book Basis Dividends Per Share (A) | | | Tax Basis Dividends Per Share (A) | | | Ordinary/ Qualified Income | | | Captial Gains | | | Return of Capital | |
| 2005 | | $ | 2.500 | | $ | 2.540 | | | 86.41 | % | | 13.59 | % | | None | |
| | | | | | | | | | | | | | | | | |
| 2004 | | $ | 2.425 | | $ | 2.432 | | | 76.60 | % | | 23.40 | % | | None | |
| | | | | | | | | | | | | | | | | |
| 2003 | | $ | 1.950 | | $ | 1.843 | | | 77.66 | % | | 22.34 | % | | None | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
(A) Any excess of book basis dividends over tax basis dividends would generally be carried forward to the next year for tax purposes.
Dividends in Excess of Earnings includes ($14.5 million) related to the operations of our predecessor.
Newcastle has elected to treat NC Circle Holdings II LLC as a taxable REIT subsidiary ("TRS"(“TRS”), effective February 27, 2004. NC Circle Holdings II LLC ownsowned a portion of Newcastle'sNewcastle’s investment in a portfolio of convenience and retail gas stores as described in Note 3. To the extent
thatFor taxable income generated by NC Circle Holdings II LLC, generates taxable income, Newcastle has provided for relevant income taxes based on a blended statutory rate of 40%. Newcastle accounts for income taxes in accordance with the provisions
of SFAS No. 109 "Accounting for Income Taxes." Under SFAS No. 109, Newcastle accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. No such material differences have been recognized through December 31, 2004.
13. SUBSEQUENT EVENTS
2005.
In January 2005, NCT sold 3.3 millionFebruary 2006, employees of the Manager exercised options to acquire 54,000 shares of itsNewcastle’s common stock in a
public offering at a price to the public of $29.60 per share, for net proceeds of approximately $96.6 million. For the purpose of compensating
the Manager for its successful efforts in raising capital for Newcastle, in
connection with this offering, Newcastle granted options to the Manager to
purchase 330,000 shares of Newcastle's common stock at the public offering
price, which were valued at approximately $1.1 million.
In January
2005, Newcastle's Manager and certain2006, Newcastle closed on a three year term financing of
the Manager's employees
exercised approximately 0.6 million optionsits manufactured housing loan portfolio which provided for
shares of Newcastle's
common stock. In connection with this exercise, Newcastle received proceedsan initial financing amount of approximately
$8.9 million.
In January 2005, Newcastle agreed to the terms for a sale of the vacant
property in the Bell Canada portfolio (Note 6). The terms include a sales
price of $14.3 million CAD ($11.9 million USD at December 31, 2004) and
Newcastle has received a nonrefundable deposit thereon. In March 2005,
Newcastle agreed to the terms for a sale of the industrial/distribution
property in the Bell Canada portfolio (Note 6). The terms include a gross
sale price of $47.6 million CAD ($39.6 million USD at December 31, 2004)
and Newcastle has received a nonrefundable deposit thereon.
In January 2005, Newcastle, through a consolidated subsidiary, acquired a
portfolio of approximately 8,100 manufactured housing loans for an
aggregate purchase price of approximately $308.2$237.1 million. The
loans, which
were all current at the time of acquisition, are primarily fixed rate with
a weighted average coupon of approximately 9.00% and a weighted average
remaining term of approximately 5.00 years. Newcastle's acquisition was
initially funded with approximately $246.5 million of one-year debt
provided by two investment banks which is subject to adjustment based on
the market value and performance of the related portfolio. The debtfinancing bears interest at LIBOR + 1.25%.
The lender received an upfront structuring fee equal to 0.75% of the initial financing amount. Newcastle
obtainedentered into an interest rate swap in order to hedge its exposure to the risk of changes in market interest rates with respect to this debt.
84
In connection with this term financing, Newcastle renewed its servicing agreement on these loans, with a portfolio company of a private equity fund advised by an affiliate of our manager, at the same terms.
In March 2006, Newcastle, through a consolidated subsidiary, acquired a portfolio of approximately 11,300 subprime residential mortgage loans for $1.50 billion. The loans, substantially all of which were current at the time of acquisition, are 66% floating rate and 34% fixed rate. Their weighted average coupon is 7.6% and the loans have a weighted average remaining term of 345 months. This acquisition was initially funded with an approximately $1.47 billion repurchase agreement which bears interest at LIBOR + 0.50%. Newcastle entered into an interest rate swap in order to hedge its exposure to the risk of changes in market interest rates with respect to this debt. Newcastle expects to finance this investment on a long term basis through the securitization markets in the upcoming months.
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
14. SUMMARY QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
| 14. | SUMMARY QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED) |
The following is unaudited summary information on
Newcastle'sNewcastle’s quarterly operations.
The distribution of investments, and related liabilities, to
Holdings and the commencement of Newcastle's independent operations occurred at
the beginning of the quarter ended September 30, 2002. Therefore, periods prior
to this quarter are not reflective of Newcastle's ongoing operations nor are
they comparable to subsequent quarters.
2004
----------------------------------------------------------------------
QUARTER ENDED
-------------------------------------------------------- Year Ended
March 31(A) June 30(A) September 30(A) December 31 December 31
----------- ---------- --------------- ----------- -----------
Gross Revenues $ 58,857 $ 63,326 $ 64,886 $ 71,077 $ 258,146
Operating expenses (8,860) (7,417) (8,952) (8,326) (33,555)
-------- -------- -------- -------- ---------
Operating income 49,997 55,909 55,934 62,751 224,591
Interest expense (28,926) (33,148) (34,152) (42,621) (138,847)
Depreciation and amortization (333) (306) (319) (346) (1,304)
Equity in earnings of unconsolidated subsidiaries (A) 1,223 2,218 3,179 3,337 9,957
-------- -------- -------- -------- ---------
Income from continuing operations 21,961 24,673 24,642 23,121 94,397
Income (loss) from discontinued operations (110) (1,498) 325 5,301 4,018
Preferred dividends (1,523) (1,524) (1,523) (1,524) (6,094)
-------- -------- -------- -------- ---------
Income available for common stockholders $ 20,328 $ 21,651 $ 23,444 $ 26,898 $ 92,321
======== ======== ======== ======== =========
Net Income per share of common stock
Basic $ 0.59 $ 0.60 $ 0.61 $ 0.70 $ 2.50
======== ======== ======== ======== =========
Diluted $ 0.58 $ 0.59 $ 0.60 $ 0.69 $ 2.46
======== ======== ======== ======== =========
Income from continuing operations per share of common
stock, after preferred dividends and related accretion
Basic $ 0.59 $ 0.64 $ 0.60 $ 0.56 $ 2.39
======== ======== ======== ======== =========
Diluted $ 0.58 $ 0.63 $ 0.59 $ 0.55 $ 2.35
======== ======== ======== ======== =========
Income (loss) from discontinued operations per share of
common stock
Basic $ -- $ (0.04) $ 0.01 $ 0.14 $ 0.11
======== ======== ======== ======== =========
Diluted $ -- $ (0.04) $ 0.01 $ 0.14 $ 0.11
======== ======== ======== ======== =========
Weighted average number of shares of common stock
outstanding
Basic 34,402 36,161 38,234 38,941 36,944
======== ======== ======== ======== =========
Diluted 34,976 36,671 38,883 39,663 37,558
======== ======== ======== ======== =========
(A) Net of income taxes on related taxable subsidiaries.
85
| | | 2005 | |
| | | Quarter Ended | | | |
| | | March 31 (A) | | June 30 (A) | | September 30 (A) | | December 31 | | Year Ended December 31 | |
| Gross Revenues | | $ | 83,663 | | $ | 92,065 | | $ | 99,850 | | $ | 102,635 | | $ | 378,213 | |
| Operating expenses | | | (9,114 | ) | | (8,832 | ) | | (12,934 | ) | | (11,008 | ) | | (41,888 | ) |
| Operating income | | | 74,549 | | | 83,233 | | | 86,916 | | | 91,627 | | | 336,325 | |
| Interest expense | | | (48,766 | ) | | (55,791 | ) | | (58,681 | ) | | (63,208 | ) | | (226,446 | ) |
| Depreciation and amortization | | | (136 | ) | | (135 | ) | | (182 | ) | | (188 | ) | | (641 | ) |
| Equity in earnings of unconsolidated subsidiaries (B) | | | 1,853 | | | 1,393 | | | 1,061 | | | 1,302 | | | 5,609 | |
| Income from continuing operations | | | 27,500 | | | 28,700 | | | 29,114 | | | 29,533 | | | 114,847 | |
| Income (loss) from discontinued operations | | | 1,184 | | | 781 | | | 86 | | | 57 | | | 2,108 | |
| Preferred dividends | | | (1,523 | ) | | (1,524 | ) | | (1,523 | ) | | (2,114 | ) | | (6,684 | ) |
| Income available for common stockholders | | $ | 27,161 | | $ | 27,957 | | $ | 27,677 | | $ | 27,476 | | $ | 110,271 | |
| Net Income per share of common stock | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.63 | | $ | 0.64 | | $ | 0.63 | | $ | 0.63 | | $ | 2.53 | |
| Diluted | | $ | 0.62 | | $ | 0.63 | | $ | 0.63 | | $ | 0.63 | | $ | 2.51 | |
| Income from continuing operations per share of common | | | | | | | | | | | | | | | | |
| stock, after preferred dividends and related accretion | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.60 | | $ | 0.62 | | $ | 0.63 | | $ | 0.63 | | $ | 2.48 | |
| Diluted | | $ | 0.59 | | $ | 0.61 | | $ | 0.63 | | $ | 0.63 | | $ | 2.46 | |
| Income (loss) from discontinued operations per share of common | | | | | | | | | | | | | | | | |
| stock | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.03 | | $ | 0.02 | | $ | 0.00 | | $ | 0.00 | | $ | 0.05 | |
| Diluted | | $ | 0.03 | | $ | 0.02 | | $ | 0.00 | | $ | 0.00 | | $ | 0.05 | |
| Weighted average number of shares of common stock | | | | | | | | | | | | | | | | |
| outstanding | | | | | | | | | | | | | | | | |
| Basic | | | 43,222 | | | 43,768 | | | 43,790 | | | 43,897 | | | 43,672 | |
| Diluted | | | 43,629 | | | 44,127 | | | 44,121 | | | 44,059 | | | 43,986 | |
| | | 2004 | |
| | | Quarter Ended | | | |
| | | March 31 (A) | | June 30 (A) | | September 30 (A) | | December 31 | | Year Ended December 31 | |
| Gross Revenues | | $ | 55,309 | | $ | 61,612 | | $ | 63,146 | | $ | 69,602 | | $ | 249,669 | |
| Operating expenses | | | (7,333 | ) | | (6,354 | ) | | (7,822 | ) | | (7,299 | ) | | (28,808 | ) |
| Operating income | | | 47,976 | | | 55,258 | | | 55,324 | | | 62,303 | | | 220,861 | |
| Interest expense | | | (28,091 | ) | | (32,615 | ) | | (33,612 | ) | | (42,080 | ) | | (136,398 | ) |
| Depreciation and amortization | | | (113 | ) | | (95 | ) | | (108 | ) | | (135 | ) | | (451 | ) |
| Equity in earnings of unconsolidated subsidiaries (B) | | | 1,223 | | | 2,218 | | | 3,179 | | | 3,337 | | | 9,957 | |
| Income from continuing operations | | | 20,995 | | | 24,766 | | | 24,783 | | | 23,425 | | | 93,969 | |
| Income (loss) from discontinued operations | | | 856 | | | (1,591 | ) | | 185 | | | 4,996 | | | 4,446 | |
| Preferred dividends | | | (1,523 | ) | | (1,524 | ) | | (1,523 | ) | | (1,524 | ) | | (6,094 | ) |
| Income available for common stockholders | | $ | 20,328 | | $ | 21,651 | | $ | 23,445 | | $ | 26,897 | | $ | 92,321 | |
| Net Income per share of common stock | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.59 | | $ | 0.60 | | $ | 0.61 | | $ | 0.70 | | $ | 2.50 | |
| Diluted | | $ | 0.58 | | $ | 0.59 | | $ | 0.60 | | $ | 0.69 | | $ | 2.46 | |
| Income from continuing operations per share of common | | | | | | | | | | | | | | | | |
| stock, after preferred dividends and related accretion | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.57 | | $ | 0.64 | | $ | 0.61 | | $ | 0.56 | | $ | 2.38 | |
| Diluted | | $ | 0.56 | | $ | 0.63 | | $ | 0.60 | | $ | 0.55 | | $ | 2.34 | |
| Income (loss) from discontinued operations per share of common | | | | | | | | | | | | | | | | |
| stock | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.02 | | $ | (0.04 | ) | $ | 0.00 | | $ | 0.14 | | $ | 0.12 | |
| Diluted | | $ | 0.02 | | $ | (0.04 | ) | $ | 0.00 | | $ | 0.14 | | $ | 0.12 | |
| Weighted average number of shares of common stock | | | | | | | | | | | | | | | | |
| outstanding | | | | | | | | | | | | | | | | |
| Basic | | | 34,402 | | | 36,161 | | | 38,234 | | | 38,941 | | | 36,944 | |
| Diluted | | | 34,976 | | | 36,671 | | | 38,883 | | | 39,663 | | | 37,558 | |
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005, 2004 and 2003 AND 2002
(dollars
(dollars in tables in thousands, except per share data)
| | | 2003 | |
| | | Quarter Ended | | | |
| | | March 31 (A) | | June 30 (A) | | September 30 (A) | | December 31 | | Year Ended December 31 | |
| Gross Revenues | | $ | 28,429 | | $ | 35,577 | | $ | 37,905 | | $ | 50,173 | | $ | 152,084 | |
| Operating expenses | | | (4,231 | ) | | (4,880 | ) | | (5,004 | ) | | (6,308 | ) | | (20,423 | ) |
| Operating income | | | 24,198 | | | 30,697 | | | 32,901 | | | 43,865 | | | 131,661 | |
| Interest expense | | | (13,336 | ) | | (18,348 | ) | | (18,693 | ) | | (26,500 | ) | | (76,877 | ) |
| Depreciation and amortization | | | (80 | ) | | (101 | ) | | (105 | ) | | (119 | ) | | (405 | ) |
| Equity in earnings of unconsolidated subsidiaries (B) | | | - | | | - | | | - | | | 862 | | | 862 | |
| Income from continuing operations | | | 10,782 | | | 12,248 | | | 14,103 | | | 18,108 | | | 55,241 | |
| Income (loss) from discontinued operations | | | 321 | | | 1,169 | | | 603 | | | (1,216 | ) | | 877 | |
| Preferred dividends | | | (203 | ) | | (1,524 | ) | | (1,523 | ) | | (1,523 | ) | | (4,773 | ) |
| Income available for common stockholders | | $ | 10,900 | | $ | 11,893 | | $ | 13,183 | | $ | 15,369 | | $ | 51,345 | |
| Net Income per share of common stock | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.46 | | $ | 0.51 | | $ | 0.48 | | $ | 0.53 | | $ | 1.98 | |
| Diluted | | $ | 0.46 | | $ | 0.50 | | $ | 0.48 | | $ | 0.52 | | $ | 1.96 | |
| Income from continuing operations per share of common | | | | | | | | | | | | | | | | |
| stock, after preferred dividends and related accretion | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.45 | | $ | 0.46 | | $ | 0.46 | | $ | 0.57 | | $ | 1.94 | |
| Diluted | | $ | 0.45 | | $ | 0.45 | | $ | 0.46 | | $ | 0.56 | | $ | 1.92 | |
| Income (loss) from discontinued operations per share of common | | | | | | | | | | | | | | | | |
| stock | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.01 | | $ | 0.05 | | $ | 0.02 | | $ | (0.04 | ) | $ | 0.04 | |
| Diluted | | $ | 0.01 | | $ | 0.05 | | $ | 0.02 | | $ | (0.04 | ) | $ | 0.04 | |
| Weighted average number of shares of common stock | | | | | | | | | | | | | | | | |
| outstanding | | | | | | | | | | | | | | | | |
| Basic | | | 23,489 | | | 23,489 | | | 27,340 | | | 29,197 | | | 25,898 | |
| Diluted | | | 23,620 | | | 23,679 | | | 27,620 | | | 29,563 | | | 26,141 | |
2003
----------------------------------------------------------------------
QUARTER ENDED
-------------------------------------------------------- Year Ended
March 31(A) June 30(A) September 30(A) December 31 December 31
----------- ---------- --------------- ----------- -----------
Gross Revenues $ 31,398 $ 38,678 $ 40,772 $ 53,206 $164,054
Operating expenses (5,811) (6,257) (6,171) (7,622) (25,861)
-------- -------- -------- -------- --------
Operating | (A) | The Income Available for Common Stockholders shown agrees with Newcastle’s quarterly report(s) on Form 10-Q as filed with the Securities and Exchange Commission. However, individual line items may vary from such report(s) due to the operations of properties sold, or classified as held for sale, during subsequent periods being retroactively reclassified to Income for Discontinued Operations for all periods presented (Note 5). |
| (B) | Net of income 25,587 32,421 34,601 45,584 138,193
Interest expense (13,896) (18,892) (19,244) (27,052) (79,084)
Depreciation and amortization (281) (297) (301) (315) (1,194)
Equity in earnings of unconsolidated subsidiaries -- -- -- 862 862
-------- -------- -------- -------- --------
Income from continuing operations 11,410 13,232 15,056 19,079 58,777
Income (loss) from discontinued operations (307) 185 (350) (2,187) (2,659)
Preferred dividends (203) (1,524) (1,523) (1,523) (4,773)
-------- -------- -------- -------- --------
Income available for common stockholders $ 10,900 $ 11,893 $ 13,183 $ 15,369 $ 51,345
======== ======== ======== ======== ========
Net Income per share of common stock
Basic $ 0.46 $ 0.51 $ 0.48 $ 0.53 $ 1.98
======== ======== ======== ======== ========
Diluted $ 0.46 $ 0.50 $ 0.48 $ 0.52 $ 1.96
======== ======== ======== ======== ========
Income from continuing operations per share of common
stock, after preferred dividends andtaxes on related accretion
Basic $ 0.48 $ 0.50 $ 0.49 $ 0.61 $ 2.08
======== ======== ======== ======== ========
Diluted $ 0.48 $ 0.49 $ 0.49 $ 0.60 $ 2.06
======== ======== ======== ======== ========
Income (loss) from discontinued operations per share of
common stock
Basic $ (0.02) $ 0.01 $ (0.01) $ (0.08) $ (0.10)
======== ======== ======== ======== ========
Diluted $ (0.02) $ 0.01 $ (0.01) $ (0.08) $ (0.10)
======== ======== ======== ======== ========
Weighted average number of shares of common stock
outstanding
Basic 23,489 23,489 27,340 29,197 25,898
======== ======== ======== ======== ========
Diluted 23,620 23,679 27,620 29,563 26,141
======== ======== ======== ======== ========
taxable subsidiaries. |
2002
----------------------------------------------------------------------
QUARTER ENDED
-------------------------------------------------------- Year Ended
March 31(A) June 30(A) September 30(A) December 31 December 31
----------- ---------- --------------- ----------- -----------
Gross Revenues $ 8,817 $ 37,596 $ 26,286 $ 28,676 $101,375
Operating expenses (366) (12,338) (3,982) (5,359) (22,045)
------- -------- -------- -------- --------
Operating income 8,451 25,258 22,304 23,317 79,330
Interest expense (7,747) (12,469) (12,835) (13,324) (46,375)
Depreciation and amortization (477) (544) (273) (266) (1,560)
Equity in earnings of unconsolidated subsidiaries (452) 814 -- -- 362
------- -------- -------- -------- --------
Income from continuing operations (225) 13,059 9,196 9,727 31,757
Income (loss) from discontinued operations 1,096 329 (1,692) 5 (262)
Preferred dividends and related accretion (638) (524) -- -- (1,162)
Income available for common stockholders $ 233 $ 12,864 $ 7,504 $ 9,732 $ 30,333
======= ======== ======== ======== ========
Net Income per share of common stock, basic and diluted $ 0.01 $ 0.78 $ 0.46 $ 0.43 $ 1.68
======= ======== ======== ======== ========
Income (loss) from continuing operations per share of
common stock, after preferred dividends and related
accretion, basic and diluted $ (0.06) $ 0.76 $ 0.56 $ 0.43 $ 1.69
======= ======== ======== ======== ========
Income (loss) from discontinued operations per share of
common stock, basic and diluted $ 0.07 $ 0.02 $ (0.10) $ 0.00 $ (0.01)
======= ======== ======== ======== ========
Weighted average number of shares of common stock
outstanding
Basic 16,489 16,489 16,489 22,804 18,080
======= ======== ======== ======== ========
Diluted 16,489 16,489 16,489 22,843 18,090
======= ======== ======== ======== ========
(A) The Income Available for Common Stockholders shown agrees
None.
ITEM
| (a) | Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d -15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. The Company’s disclosure controls and procedures are designed to provide reasonable assurance that information is recorded, processed, summarized and reported accurately and on a timely basis. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective. |
| (b) | Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Acts) during the most recent fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. |
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, the Company'sCompany’s principal executive and principal financial officers and effected by the Company'sCompany’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States and includes those policies and procedures that:
- pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions
of the assets of the Company;
- provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with accounting principles generally accepted in the
United States, and that receipts and expenditures of the Company
are being made only in accordance with authorizations of
management and directors of the Company; and
- provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the
Company's assets that could have a material effect on the
financial statements.
| · | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; |
| · | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and |
| · | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company'sCompany’s internal control over financial reporting as of December 31, 2004.2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Framework.
Based on our assessment, management concluded that, as of December 31, 2004,2005, the Company'sCompany’s internal control over financial reporting is designed and operating effectively.
The Company'sCompany’s independent auditors haveregistered public accounting firm has issued an audit report on our assessment of the Company'sCompany’s internal control over financial reporting. This report appears at the beginning of "Financial“Financial Statements and Supplementary Data."
By: /s/ Wesley R. Edens
------------------------------------
Wesley R. Edens
”
| | | |
| By: /s/ Wesley R. Edens | | | |
Wesley R. Edens | | | |
| Chairman of the Board | | | |
| | | |
| | | |
| By: /s/ Debra A. Hess | | | |
Debra A. Hess | | | |
| Chief Financial Officer | | | |
| | | |
None.
Incorporated by reference to our definitive proxy statement for the 20052006 annual meeting of stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, within 120 days after the fiscal year ended December 31, 2004.
ITEM2005.
Incorporated by reference to our definitive proxy statement for the 20052006 annual meeting of stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, within 120 days after the fiscal year ended December 31, 2004.
ITEM2005.
Incorporated by reference to our definitive proxy statement for the 20052006 annual meeting of stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, within 120 days after the fiscal year ended December 31, 2004.
ITEM2005.
Incorporated by reference to our definitive proxy statement for the 20052006 annual meeting of stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, within 120 days after the fiscal year ended December 31, 2004.
ITEM2005.
Incorporated by reference to our definitive proxy statement for the
20052006 annual meeting of stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, within 120 days after the fiscal year ended December 31,
2004.
89
2005.
| (a) | and (c) Financial statements and schedules: |
See
"Financial“Financial Statements and Supplementary Data.
"
(b) Exhibits filed with this Form 10-K:
3.1 Articles of Amendment and Restatement (incorporated by reference
to the Registrant's Registration Statement on Form S-11 (File No.
333-90578), Exhibit 3.1).
3.2 Articles Supplementary relating to the Series B Preferred Stock
(incorporated by reference to the Registrant's Quarterly Report
on Form 10-Q for the period ended March 31, 2003, Exhibit 3.3).
3.3 By-laws (incorporated by reference to the Registrant's
Registration Statement on Form S-11, (File No. 333-90578),
Exhibit 3.2).
4.1 Rights Agreement between the Registrant and American Stock
Transfer and Trust Company, as Rights Agent, dated October 16,
2002 (incorporated by reference to the Registrant's Quarterly
Report on Form 10-Q for the period ended September 30, 2003,
Exhibit 4.1).
10.1 Amended and Restated Management and Advisory Agreement by and
among the Registrant and Fortress Investment Group LLC, dated
June 23 2003 (incorporated by reference to the Registrant's
Statement on Form S-11 (File No. 333-106135), Exhibit 10.1).
12.1 Statements re: Computation of Ratios
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent accountants.
31.1 Certification of Chief Executive Officer as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
90
”
| (b) | Exhibits filed with this Form 10-K: |
| 3.1 | Articles of Amendment and Restatement (incorporated by reference to the Registrant’s Registration Statement on Form S-11 (File No. 333-90578), Exhibit 3.1). |
| 3.2 | Articles Supplementary relating to the Series B Preferred Stock (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2003, Exhibit 3.3). |
| 3.3 | Articles Supplementary relating to the Series C Preferred Stock (incorporated by reference to the Registrant’s Report on Form 8-K, Exhibit 3.3, filed on October 25, 2005). |
| 3.4 | By-laws (incorporated by reference to the Registrant’s Registration Statement on Form S-11, (File No. 333-90578), Exhibit 3.2). |
| 4.1 | Rights Agreement between the Registrant and American Stock Transfer and Trust Company, as Rights Agent, dated October 16, 2002 (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 2003, Exhibit 4.1). |
| 10.1 | Amended and Restated Management and Advisory Agreement by and among the Registrant and Fortress Investment Group LLC, dated June 23 2003 (incorporated by reference to the Registrant’s Statement on Form S-11 (File No. 333-106135), Exhibit 10.1). |
| 10.2 | Newcastle Investment Corp. Nonqualified Stock Option and Incentive Award Plan Amended and Restated Effective as of February 11, 2004. |
| 12.1 | Statements re: Computation of Ratios |
| 21.1 | Subsidiaries of the Registrant. |
| 23.1 | Consent of Ernst & Young LLP, independent accountants. |
| 31.1 | Certification of Chief Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | Certification of Chief Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:
NEWCASTLE INVESTMENT CORP.
March 16, 2005
By: /s/ Wesley R. Edens
------------------------------------
Wesley R. Edens
Chairman of the Board
| | |
| NEWCASTLE INVESTMENT CORP. |
| |
| March 15, 2006 |
|
|
|
| By: | /s/ Wesley R. Edens |
|
Wesley R. Edens |
| Chairman of the Board |
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following person on behalf of the Registrant and in the capacities and on the dates indicated.
March 16, 2005
By: /s/ Wesley R. Edens
---------------------------------
Wesley R. Edens
Chief Executive Officer
March 16, 2005
By: /s/ Debra A. Hess
---------------------------------
Debra A. Hess
Chief Financial Officer
March 16, 2005
By: /s/ David J. Grain
---------------------------------
David J. Grain
Director
March 16, 2005
By: /s/ Stuart A. McFarland
---------------------------------
Stuart A. McFarland
Director
March 16, 2005
By: /s/ David K. McKown
---------------------------------
David K. McKown
Director
March 16, 2005
By: /s/ Peter M. Miller
---------------------------------
Peter M. Miller
Director
91
EXHIBIT INDEX
3.1 Articles of Amendment and Restatement (incorporated by reference to the
Registrant's Registration Statement on Form S-11 (File No. 333-90578),
| March 15, 2006 | | | |
| | | |
| | | |
| By: /s/ Wesley R. Edens | | | |
Wesley R. Edens | | | |
| Chief Executive Officer | | | |
| March 15, 2006 | | | |
| | | |
| | | |
| By: /s/ Debra A. Hess | | | |
Debra A. Hess | | | |
| Chief Financial Officer | | | |
| March 15, 2006 | | | |
| | | |
| | | |
| By: /s/ Kevin J. Finnerty | | | |
Kevin J. Finnerty | | | |
| Director | | | |
| March 15, 2006 | | | |
| | | |
| | | |
| By: /s/ Stuart A. McFarland | | | |
Stuart A. McFarland | | | |
| Director | | | |
| March 15, 2006 | | | |
| | | |
| | | |
| By: /s/ David K. McKown | | | |
David K. McKown | | | |
| Director |
| March 15, 2006 | | | |
| | | |
| | | |
| By: /s/ Peter M. Miller | | | |
Peter M. Miller | | | |
| Director |
Exhibit 3.1).
3.2 Articles Supplementary relating to the Series B Preferred Stock
(incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the period ended March 31, 2003, Exhibit 3.3).
3.3 By-laws (incorporated by reference to the Registrant's Registration
Statement on Form S-11, (File No. 333-90578), Exhibit 3.2).
4.1 Rights Agreement between the Registrant and American Stock Transfer and
Trust Company, as Rights Agent, dated October 16, 2002 (incorporated by
reference to the Registrant's Quarterly Report on Form 10-Q for the
period ended September 30, 2002, Exhibit 4.1).
10.1 Amended and Restated Management and Advisory Agreement by and among the
Registrant and Fortress Investment Group LLC, dated June 23, 2003
(incorporated by reference to the Registrant's Statement on Form S-11
(File No. 333-106135), Exhibit 10.1).
12.1 Statements re: Computation of Ratios
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent accountants.
31.1 Certification of Chief Executive Officer as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
Index
| 3.1 | Articles of Amendment and Restatement (incorporated by reference to the Registrant’s Registration Statement on Form S-11 (File No. 333-90578), Exhibit 3.1). |
| 3.2 | Articles Supplementary relating to the Series B Preferred Stock (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2003, Exhibit 3.3). |
| 3.3 | Articles Supplementary relating to the Series C Preferred Stock (incorporated by reference to the Registrant’s Report on Form 8-K, Exhibit 3.3, filed on October 25, 2005). |
| 3.4 | By-laws (incorporated by reference to the Registrant’s Registration Statement on Form S-11, (File No. 333-90578), Exhibit 3.2). |
| 4.1 | Rights Agreement between the Registrant and American Stock Transfer and Trust Company, as Rights Agent, dated October 16, 2002 (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 2002, Exhibit 4.1). |
| 10.1 | Amended and Restated Management and Advisory Agreement by and among the Registrant and Fortress Investment Group LLC, dated June 23, 2003 (incorporated by reference to the Registrant’s Statement on Form S-11 (File No. 333-106135), Exhibit 10.1). |
| 10.2 | Newcastle Investment Corp. Nonqualified Stock Option and Incentive Award Plan Amended and Restated Effective as of February 11, 2004. |
| 12.1 | Statements re: Computation of Ratios |
| 21.1 | Subsidiaries of the Registrant. |
| 23.1 | Consent of Ernst & Young LLP, independent accountants. |
| 31.1 | Certification of Chief Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | Certification of Chief Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |