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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
or
[ ] 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 name of registrant as specified in its charter)
Maryland 81-0559116
- --------------------------------------------- -------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
1251 Avenue of the Americas, New York, NY 10020
----------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(212) 798-6100
----------------------------------------------------
(Registrant's telephone number, including area code)
--------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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. Yes [X] No [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act). Yes [ ] No [X].
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
COMMON STOCK, $0.01 PAR VALUE PER SHARE: 28,090,057 OUTSTANDING AS OF NOVEMBER
10, 2003.
NEWCASTLE INVESTMENT CORP.
FORM 10-Q
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2003 (unaudited) and December 31, 2002 1
Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2003 and 2002 2
Consolidated Statements of Stockholders' Equity (unaudited) for the nine months ended September 30, 2003 and 2002 3
Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2003 and 2002 4
Notes to Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
Item 4. Controls and Procedures 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Changes in Securities and Use of Proceeds 29
Item 3. Defaults upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
SIGNATURES 30
CAUTIONARY STATEMENTS
The information contained in this quarterly report on Form 10-Q is not a
complete description of our business or the risks associated with an investment
in our Company. We urge you to carefully review and consider the various
disclosures made by us in this report and in our other filings with the SEC,
including our December 31, 2002 annual report on Form 10-K filed with the SEC,
that discuss our business in greater detail.
This report contains certain "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 and 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" 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, 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 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; impairments in the value of the
collateral underlying our real estate securities; the relation of any
impairments in the value of our real estate securities portfolio or operating
real estate to our judgments as to whether changes in the market value of our
securities are temporary or not and whether circumstances bearing on the value
of our operating real estate warrant changes in carrying values; carrying
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 in our SEC reports. Readers are cautioned not to
place undue reliance on any of these forward-looking statements, which reflect
our management'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 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.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
SEPTEMBER 30, 2003
(UNAUDITED) DECEMBER 31, 2002
------------------ -----------------
ASSETS
Real estate securities, available for sale $ 2,117,278 $ 1,069,892
Real estate securities portfolio deposit - 37,777
Operating real estate, net 126,606 113,652
Real estate held for sale - 3,471
Mortgage loans, net 427,197 258,198
Other securities, available for sale 33,649 11,209
Cash and cash equivalents 94,099 45,463
Restricted cash 13,445 10,380
Deferred costs, net 9,137 6,489
Receivables and other assets 23,512 16,036
------------------ -----------------
$ 2,844,923 $ 1,572,567
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
CBO bonds payable $ 1,792,503 $ 868,497
Other bonds payable 40,381 37,389
Notes payable 69,237 62,952
Repurchase agreements 407,740 248,169
Derivative liabilities 53,791 54,095
Dividends payable 15,061 9,161
Due to affiliates 2,046 1,335
Accrued expenses and other liabilities 8,145 6,728
------------------ -----------------
2,388,904 1,288,326
------------------ -----------------
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 at September 30, 2003 62,500 -
Common stock, $0.01 par value, 500,000,000 shares authorized, 28,090,057 and
23,488,517 shares issued and outstanding at September 30, 2003 and
December 31, 2002, respectively 281 235
Additional paid-in capital 377,100 290,935
Dividends in excess of earnings (14,350) (13,966)
Accumulated other comprehensive income 30,488 7,037
------------------ -----------------
456,019 284,241
------------------ -----------------
$ 2,844,923 $ 1,572,567
================== =================
See accompanying notes
1
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except share data)
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------------- --------------------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
------------------ ------------------ ------------------ ------------------
REVENUES
Interest income $ 33,909 $ 20,202 $ 89,771 $ 51,693
Rental and escalation income 5,621 5,035 17,639 14,751
Gain on settlement of investments 2,928 2,604 9,047 7,605
Management fee from affiliate - - - 4,470
Incentive income from affiliate - - - (1,218)
------------------ ------------------ ------------------ ------------------
42,458 27,841 116,457 77,301
------------------ ------------------ ------------------ ------------------
EXPENSES
Interest expense 20,220 13,483 54,998 34,992
Property operating expense 2,223 2,131 7,380 6,363
Loan servicing expense 665 126 1,588 327
General and administrative expense 673 659 2,434 2,214
Management fee to affiliate 1,783 917 4,537 8,085
Incentive compensation to affiliate 1,436 614 4,392 1,441
Depreciation and amortization 776 695 2,262 2,483
------------------ ------------------ ------------------ ------------------
27,776 18,625 77,591 55,905
------------------ ------------------ ------------------ ------------------
Income before equity in earnings (losses) of
unconsolidated subsidiaries 14,682 9,216 38,866 21,396
Equity in earnings (losses) of unconsolidated
subsidiaries - - - 362
------------------ ------------------ ------------------ ------------------
Income from continuing operations 14,682 9,216 38,866 21,758
Income (loss) from discontinued operations 24 (1,712) 360 5
------------------ ------------------ ------------------ ------------------
NET INCOME 14,706 7,504 39,226 21,763
Preferred dividends and related accretion (1,523) - (3,250) (1,162)
------------------ ------------------ ------------------ ------------------
INCOME AVAILABLE FOR COMMON STOCKHOLDERS $ 13,183 $ 7,504 $ 35,976 $ 20,601
================== ================== ================== ==================
NET INCOME PER SHARE OF COMMON STOCK, BASIC $ 0.48 $ 0.46 $ 1.45 $ 1.25
================== ================== ================== ==================
NET INCOME PER SHARE OF COMMON STOCK, DILUTED $ 0.48 $ 0.46 $ 1.44 $ 1.25
================== ================== ================== ==================
Income from continuing operations per share of
common stock, after preferred dividends
and related accretion, basic $ 0.48 $ 0.56 $ 1.44 $ 1.25
================== ================== ================== ==================
Income from continuing operations per share of
common stock, after preferred dividends and
related accretion, diluted $ 0.48 $ 0.56 $ 1.43 $ 1.25
================== ================== ================== ==================
Income (loss) from discontinued operations per
share of common stock, basic $ 0.00 $ (0.10) $ 0.01 $ 0.00
================== ================== ================== ==================
Income (loss) from discontinued operations per
share of common stock, diluted $ 0.00 $ (0.10) $ 0.01 $ 0.00
================== ================== ================== ==================
WEIGHTED AVERAGE NUMBER OF SHARES OF
COMMON STOCK OUTSTANDING, BASIC 27,340,057 16,488,517 24,786,517 16,488,517
================== ================== ================== ==================
WEIGHTED AVERAGE NUMBER OF SHARES OF
COMMON STOCK OUTSTANDING, DILUTED 27,620,076 16,488,517 24,987,583 16,488,517
================== ================== ================== ==================
DIVIDENDS DECLARED PER COMMON SHARE $ 0.50 $ 0.40 $ 1.45 $ 1.60
================== ================== ================== ==================
See accompanying notes
2
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(dollars in thousands)
PREFERRED STOCK COMMON STOCK
------------------- -------------------
SHARES AMOUNT SHARES AMOUNT
--------- -------- ---------- ------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2002 - $ - 23,488,517 $ 235
Dividends declared - - - -
Issuance of preferred stock 2,500,000 62,500 - -
Issuance of common stock to directors - - 1,540 -
Issuance of common stock - - 4,600,000 46
Comprehensive income:
Net income - - - -
Unrealized gain on securities - - - -
Realized (gain) on securities: reclassification adjustment - - - -
Foreign currency translation - - - -
Unrealized (loss) on derivatives designated as cash flow hedges - - - -
Total comprehensive income
--------- -------- ---------- ------
Stockholders' equity - September 30, 2003 2,500,000 $ 62,500 28,090,057 $ 281
========= ======== ========== ======
STOCKHOLDERS' EQUITY - DECEMBER 31, 2001 16,488,517 $ 165
Dividends declared by predecessor prior to commencement of our operations - -
Distribution to predecessor upon commencement of our operations - -
Dividends declared to predecessor after commencement of our operations,
but prior to our initial public offering - -
Comprehensive income:
Net income - -
Unrealized gain on securities - -
Realized (gain) on securities: reclassification adjustment - -
Foreign currency translation - -
Foreign currency translation: reclassification adjustment - -
Unrealized (loss) on derivatives designated as cash flow hedges - -
Realized (gain) on derivatives designated as cash flow hedges:
reclassification adjustment - -
Total comprehensive income
---------- ------
Stockholders' equity - September 30, 2002 16,488,517 $ 165
========== ======
ACCUM.
DIVIDENDS OTHER TOTAL STOCK-
ADDITIONAL IN EXCESS OF COMP. HOLDERS'
PD. IN CAPITAL EARNINGS INCOME EQUITY
-------------- ------------ -------- ------------
STOCKHOLDERS' EQUITY - DECEMBER 31, 2002 $ 290,935 $ (13,966) $ 7,037 $ 284,241
Dividends declared - (39,610) - (39,610)
Issuance of preferred stock (2,436) - - 60,064
Issuance of common stock to directors 30 - - 30
Issuance of common stock 88,571 - - 88,617
Comprehensive income:
Net income - 39,226 - 39,226
Unrealized gain on securities - - 32,654 32,654
Realized (gain) on securities: reclassification adjustment - - (9,260) (9,260)
Foreign currency translation - - 3,991 3,991
Unrealized (loss) on derivatives designated as cash flow hedges - - (3,934) (3,934)
------------
Total comprehensive income 62,677
-------------- ------------ -------- ------------
Stockholders' equity - September 30, 2003 $ 377,100 $ (14,350) $ 30,488 $ 456,019
============== ============ ======== ============
STOCKHOLDERS' EQUITY - DECEMBER 31, 2001 $ 309,356 $ (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 (98,378) - (11,075) (109,453)
Dividends declared to predecessor after commencement of our operations,
but prior to our initial public offering - (6,595) - (6,595)
Comprehensive income:
Net income - 21,763 - 21,763
Unrealized gain on securities - - 80,799 80,799
Realized (gain) on securities: reclassification adjustment - - (2,550) (2,550)
Foreign currency translation - - 3,364 3,364
Foreign currency translation: reclassification adjustment - - (258) (258)
Unrealized (loss) on derivatives designated as cash flow hedges - - (50,629) (50,629)
Realized (gain) on derivatives designated as cash flow hedges:
reclassification adjustment - - (130) (130)
------------
Total comprehensive income 52,359
-------------- ------------ -------- ------------
Stockholders' equity - September 30, 2002 $ 210,978 $ (13,548) $ 28,312 $ 225,907
============== ============ ======== ============
See accompanying notes
3
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
(dollars in thousands)
NINE MONTHS ENDED
----------------------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
------------------ ------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 39,226 $ 21,763
Adjustments to reconcile net income to net cash provided by operating activities
(inclusive of amounts related to discontinued operations):
Depreciation and amortization 2,263 7,882
Accretion of discount and other amortization (3,097) (3,135)
Equity in (earnings) losses of unconsolidated subsidiaries - (362)
Accrued incentive (income) loss from affiliate - 1,218
Non-cash incentive compensation to affiliate - 14
Deferred rent (1,292) (1,149)
Gain on settlement of investments (9,182) (5,935)
Unrealized gain on non-hedge derivatives (3,065) -
Non-cash directors' compensation 30 -
Change in:
Restricted cash (2,972) (5,880)
Receivables and other assets (5,957) (3,956)
Due to affiliates 711 (1,002)
Accrued expenses and other liabilities 2,194 5,876
------------------ ------------------
Net cash provided by operating activities 18,859 15,334
------------------ ------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase and improvement of operating real estate (316) (2,254)
Proceeds from sale of operating real estate 5,228 42,826
Purchase of mortgage loans (358,594) -
Repayments of loan and security principal 61,618 12,055
Proceeds from settlement of mortgage loans 164,406 364
Contributions to unconsolidated subsidiaries - (19,991)
Distributions from unconsolidated subsidiaries - 8,265
Purchase of real estate securities (1,086,214) (646,420)
Proceeds from sale of real estate securities 145,993 225,923
Deposit on real estate securities (40,602) -
Payment of deferred transaction costs - (1,432)
Purchase of other securities (48,692) (6,941)
------------------ ------------------
Net cash used in investing activities (1,157,173) (387,605)
------------------ ------------------
Continued on Page 5
See accompanying notes
4
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
(dollars in thousands)
NINE MONTHS ENDED
----------------------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
------------------ ------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under repurchase agreements 340,591 -
Repayments of repurchase agreements (181,020) -
Repayments of notes payable (667) (65,840)
Issuance of CBO bonds payable 921,513 438,787
Repayments of CBO bonds payable - (17,742)
Issuance of other bonds payable - 37,169
Repayments of other bonds payable (3,084) (8,151)
Draws under credit facility - 20,000
Repayments of credit facility - (1,750)
Issuance of preferred stock 62,500 -
Costs related to issuance of preferred stock (2,436) -
Redemption of preferred stock - (20,410)
Issuance of common stock 93,610 -
Costs related to issuance of common stock (4,993) -
Dividends paid (33,710) (19,938)
Distribution of cash to predecessor - (12,423)
Payment of deferred financing costs (5,354) (1,672)
------------------ ------------------
Net cash provided by financing activities 1,186,950 348,030
------------------ ------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 48,636 (24,241)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 45,463 31,360
------------------ ------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 94,099 $ 7,119
================== ==================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest expense $ 53,714 $ 42,608
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Common stock dividends declared but not paid $ 14,045 $ 6,595
Preferred stock dividends declared but not paid $ 1,016 $ -
Deposits used in acquisition of real estate securities $ 81,492 $ 23,631
Contribution of assets to unconsolidated subsidiary $ - $ 1,454
Distribution of non-cash assets and liabilities to predecessor $ - $ 109,453
See accompanying notes
5
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2003
(dollars in tables in thousands, except per share data)
1. GENERAL
Newcastle Investment Corp. (and subsidiaries, "Newcastle") is a Maryland
corporation that was formed in June 2002. Newcastle conducts its business
through three primary segments: (i) real estate securities, (ii) operating real
estate, primarily credit leased operating real estate, and (iii) mortgage loans.
Newcastle was formed as a wholly owned subsidiary of Newcastle Investment
Holdings Corp. ("Holdings") for the purpose of separating the real estate
securities and certain of the credit leased operating real estate businesses
from Holdings' other investments. Prior to Newcastle's initial public offering,
Holdings contributed to Newcastle certain assets and liabilities in exchange for
16,488,517 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 on July 12, 2002. On May 19, 2003, Holdings distributed to its
stockholders all of the shares of Newcastle's common stock that it held.
Approximately 2.8 million of such shares were distributed by Holdings to an
affiliate of the Manager (see below).
In October 2002, Newcastle sold 7 million shares of its common stock in a public
offering at a price to the public of $13.00 per share, for net proceeds of
approximately $80 million. In July 2003, Newcastle sold 4.6 million shares of
its common stock in a pubic offering at a price to the public of $20.35 per
share, for net proceeds of approximately $88.6 million. Newcastle had 28,090,057
shares of common stock outstanding at September 30, 2003.
Newcastle is organized and conducts its operations to qualify as a real estate
investment trust ("REIT") for federal income tax purposes. As such, Newcastle
will generally not be subject to federal income tax on that portion of its
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") with
Fortress Investment Group LLC (the "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'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").
The consolidated financial statements include the accounts of Newcastle and its
controlled subsidiaries, subsequent to the date of commencement of its
operations, and also include the accounts of its predecessor, Holdings, prior to
such date.
Holdings is a Maryland corporation that invests in real estate-related assets on
a global basis. Its primary businesses as our predecessor were (1) investing in
real estate securities, (2) investing in operating real estate, primarily credit
leased operating real estate, (3) investing in Fund I and (4) investing in
distressed, sub-performing and performing residential and commercial mortgage
loans, or portfolios thereof, and related properties acquired in foreclosure or
by deed-in-lieu of foreclosure.
Holdings' investments in real estate securities and a portion of its investments
in operating real estate were transferred to Newcastle in connection with
Newcastle's organization. The operating real estate and mortgage 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."
The accompanying consolidated financial statements and related notes of
Newcastle have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial reporting and the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain
information and footnote disclosures normally included in financial statements
prepared under accounting principles generally accepted in the United States
have been condensed or omitted. In the opinion of management, all adjustments
considered necessary for a fair presentation of Newcastle's financial position,
results of operations and cash flows have been included and are of a normal and
recurring nature. The operating results presented for interim periods are not
necessarily indicative of the results that may be expected for any other interim
period or for the entire year. These financial statements should be read in
conjunction with Newcastle's December 31, 2002 consolidated financial statements
and notes thereto included in Newcastle's annual report on Form 10-K filed with
the Securities and Exchange
6
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2003
Commission. Capitalized terms used herein, and not otherwise defined, are
defined in Newcastle's December 31, 2002 consolidated financial statements.
2. INFORMATION REGARDING BUSINESS SEGMENTS
Newcastle conducts its business through three primary segments: real estate
securities, operating real estate and mortgage loans.
Holdings conducted its business as our predecessor in four primary segments:
real estate securities, operating real estate, mortgage loans, and its
investment in Fund I.
The real estate securities segment was 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 mortgage loans and Fund I segments were distributed to Holdings.
Summary financial data on Newcastle'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
described in Note 1):
Real Estate Operating Real Mortgage
Securities Estate Loans Unallocated Total
------------ -------------- ------------ ------------ ------------
September 30, 2003 and the Nine Months then Ended
Gross revenues $ 88,882 $ 17,677 $ 9,732 $ 166 $ 116,457
Operating expenses (604) (8,037) (1,097) (10,593) (20,331)
------------ -------------- ------------ ------------ ------------
Operating income (loss) 88,278 9,640 8,635 (10,427) 96,126
Interest expense (45,522) (4,966) (4,510) - (54,998)
Depreciation and amortization - (2,262) - - (2,262)
------------ -------------- ------------ ------------ ------------
Income (loss) from continuing operations 42,756 2,412 4,125 (10,427) 38,866
Income from discontinued operations - 360 - - 360
------------ -------------- ------------ ------------ ------------
Net Income (Loss) $ 42,756 $ 2,772 $ 4,125 $ (10,427) $ 39,226
============ ============== ============ ============ ============
Revenue derived from non-US sources:
Canada $ - $ 12,774 $ - $ - $ 12,774
============ ============== ============ ============ ============
Belgium $ - $ 5,609 $ - $ - $ 5,609
============ ============== ============ ============ ============
Total assets $ 2,183,260 $ 140,653 $ 428,352 $ 92,658 $ 2,844,923
============ ============== ============ ============ ============
Long-lived assets outside the US:
Canada $ - $ 52,261 $ - $ - $ 52,261
============ ============== ============ ============ ============
Belgium $ - $ 74,345 $ - $ - $ 74,345
============ ============== ============ ============ ============
Three Months Ended September 30, 2003
Gross revenues $ 33,444 $ 5,632 $ 3,288 $ 94 $ 42,458
Operating expenses (275) (2,359) (432) (3,714) (6,780)
------------ -------------- ------------ ------------ ------------
Operating income (loss) 33,169 3,273 2,856 (3,620) 35,678
Interest expense (16,958) (1,674) (1,588) - (20,220)
Depreciation and amortization - (776) - - (776)
------------ -------------- ------------ ------------ ------------
Income (loss) from continuing operations 16,211 823 1,268 (3,620) 14,682
Income from discontinued operations - 24 - - 24
------------ -------------- ------------ ------------ ------------
Net Income (Loss) $ 16,211 $ 847 $ 1,268 $ (3,620) $ 14,706
============ ============== ============ ============ ============
Revenue derived from non-US sources:
Canada $ - $ 3,949 $ - $ - $ 3,949
============ ============== ============ ============ ============
Belgium $ - $ 1,686 $ - $ - $ 1,686
============ ============== ============ ============ ============
Continued in next page
7
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2003
Real Estate Operating Real
Securities Estate Mortgage Loans Fund I Unallocated Total
----------- -------------- -------------- --------- ----------- -----------
December 31, 2002
Total assets $ 1,138,767 $ 128,831 $ 259,381 $ - $ 45,588 $ 1,572,567
=========== ============== ============== ========= =========== ===========
Long-lived assets outside the US:
Canada $ - $ 45,800 $ - $ - $ - $ 45,800
=========== ============== ============== ========= =========== ===========
Belgium $ - $ 67,852 $ - $ - $ - $ 67,852
=========== ============== ============== ========= =========== ===========
Nine Months Ended September 30, 2002
Gross revenues $ 59,151 $ 14,693 $ - $ 3,287 $ 170 $ 77,301
Operating expenses (370) (6,908) - (3,861) (7,291) (18,430)
----------- -------------- -------------- --------- ----------- -----------
Operating income (loss) 58,781 7,785 - (574) (7,121) 58,871
Interest expense (28,864) (3,792) - - (2,336) (34,992)
Depreciation and amortization - (2,053) - (329) (101) (2,483)
Equity in earnings (loss) of unconsolidated
subsidiaries - - - 303 59 362
----------- -------------- -------------- --------- ----------- -----------
Income (loss) from continuing operations 29,917 1,940 - (600) (9,499) 21,758
Income (loss) from discontinued operations - 504 (499) - - 5
----------- -------------- -------------- --------- ----------- -----------
Net Income (Loss) $ 29,917 $ 2,444 $ (499) $ (600) $ (9,499) $ 21,763
=========== ============== ============== ========= =========== ===========
Revenue derived from non-US sources:
Canada $ - $ 10,198 $ - $ - $ - $ 10,198
=========== ============== ============== ========= =========== ===========
Belgium $ - $ 3,736 $ - $ - $ - $ 3,736
=========== ============== ============== ========= =========== ===========
Italy $ - $ - $ 180 $ - $ - $ 180
=========== ============== ============== ========= =========== ===========
Three Months Ended September 30, 2002
Gross revenues $ 22,870 $ 4,966 $ - $ - $ 5 $ 27,841
Operating expenses (137) (2,217) - - (2,093) (4,447)
----------- -------------- -------------- --------- ----------- -----------
Operating income (loss) 22,733 2,749 - - (2,088) 23,394
Interest expense (12,197) (1,286) - - - (13,483)
Depreciation and amortization - (695) - - - (695)
Equity in earnings (loss) of unconsolidated
subsidiaries - - - - - -
----------- -------------- -------------- --------- ----------- -----------
Income (loss) from continuing operations 10,536 768 - - (2,088) 9,216
Income (loss) from discontinued operations - (1,712) - - - (1,712)
----------- -------------- -------------- --------- ----------- -----------
Net Income (Loss) $ 10,536 $ (944) $ - $ - $ (2,088) $ 7,504
=========== ============== ============== ========= =========== ===========
Revenue derived from non-US sources:
Canada $ - $ 2,446 $ - $ - $ - $ 2,446
=========== ============== ============== ========= =========== ===========
Belgium $ - $ 1,101 $ - $ - $ - $ 1,101
=========== ============== ============== ========= =========== ===========
Italy $ - $ - $ - $ - $ - $ -
=========== ============== ============== ========= =========== ===========
8
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2003
3. REAL ESTATE SECURITIES
The following is a summary of Newcastle's real estate securities at September
30, 2003, 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." Unrealized
losses that are considered other than temporary are recognized currently in
income. There were no such losses incurred during the nine months ended
September 30, 2003.
Gross Unrealized Weighted Average
---------------- ----------------
Term to
Current Face Amortized Cost Maturity
Amount Basis Gains Losses Carrying Value S&P Rating Coupon Yield (Years)
------------ -------------- -------- --------- -------------- ---------- ------ ----- --------
Portfolio I
CMBS $ 326,722 $ 293,761 $ 25,723 $(3,719) $ 315,765 BB+ 6.72% 9.10% 6.58
Unsecured REIT debt 224,192 226,199 22,980 (903) 248,276 BBB 7.24% 7.08% 6.48
---------- ---------- -------- ------- ---------- --- ---- ---- ----
Subtotal - Portfolio I 550,914 519,960 48,703 (4,622) 564,041 BBB- 6.93% 8.22% 6.54
---------- ---------- -------- ------- ---------- --- ---- ---- ----
Portfolio II
CMBS 305,417 293,083 17,928 (634) 310,377 BBB- 6.28% 7.12% 6.48
Unsecured REIT debt 113,858 113,463 15,091 - 128,554 BBB- 7.80% 7.82% 7.48
Asset-backed securities 59,239 57,254 972 (1,164) 57,062 AA 7.30% 8.24% 7.01
---------- ---------- -------- ------- ---------- --- ---- ---- ----
Subtotal - Portfolio II 478,514 463,800 33,991 (1,798) 495,993 BBB 6.77% 7.43% 6.78
---------- ---------- -------- ------- ---------- --- ---- ---- ----
Portfolio III
CMBS 332,931 346,074 1,898 (1,860) 346,112 BBB 5.88% 5.26% 6.34
Unsecured REIT debt 105,110 109,820 5,207 - 115,027 BBB- 7.04% 6.32% 8.37
Asset-backed securities 60,836 59,175 1,100 (318) 59,957 A 4.09% 4.82% 5.18
---------- ---------- -------- ------- ---------- --- ---- ---- ----
Subtotal - Portfolio III 498,877 515,069 8,205 (2,178) 521,096 BBB 5.91% 5.44% 6.63
---------- ---------- -------- ------- ---------- --- ---- ---- ----
Portfolio IV
CMBS 283,196 274,580 5,862 (115) 280,327 BBB 4.26% 4.77% 5.25
Unsecured REIT debt 95,628 99,281 5,197 - 104,478 BBB 6.66% 6.02% 8.65
Asset-backed securities 19,932 19,943 25 - 19,968 A- 3.34% 3.34% 4.73
---------- ---------- -------- ------- ---------- --- ---- ---- ----
Subtotal - Portfolio IV 398,756 393,804 11,084 (115) 404,773 BBB 4.79% 5.01% 6.04
---------- ---------- -------- ------- ---------- --- ---- ---- ----
Total Real Estate
Securities* $1,927,061 $1,892,633 $101,983 $(8,713) $1,985,903 BBB- 6.18% 6.60% 6.52
========== ========== ======== ======= ========== === ==== ==== ====
* Carrying value excludes restricted cash included in Real Estate Securities
pending its reinvestment of $131.4 million ($26.2 million at November 6,
2003). At September 30, 2003, the total current face amount of fixed rate
securities was $1,515.5 million, and of floating rate securities was $411.6
million.
9
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2003
4. RECENT ACTIVITIES
In February 2003, Newcastle sold its entire position in conforming residential
mortgage loans (a portion of its mortgage loan portfolio) for gross proceeds of
approximately $162.6 million at a gain of approximately $0.7 million. As a
result of the sale, the existing repurchase agreement allocated to the
conforming loans was satisfied for approximately $153.9 million. Simultaneously,
Newcastle purchased additional non-conforming residential mortgage loans at a
cost of approximately $210.2 million. In connection with this purchase, the
outstanding balance of the existing repurchase agreement was increased by a net
of $45.9 million, after the repayment described above.
In March 2003, Newcastle completed its third CBO financing ("CBO III") whereby a
portfolio of real estate securities was contributed to a consolidated subsidiary
which issued $472.0 million face amount of investment grade senior bonds and
$28.0 million face amount of non-investment grade subordinated bonds in a
private placement. At September 30, 2003, the subordinated bonds were retained
by Newcastle and the $467.2 million carrying amount of senior bonds, which bore
interest at a weighted average effective rate, including discount and cost
amortization, of 2.40%, had an expected weighted average life of approximately
8.45 years. One class of the senior bonds bears a floating interest rate.
Newcastle has obtained an interest rate swap and cap in order to hedge its
exposure to the risk of changes in market interest rates with respect to these
bonds, at an initial cost of approximately $1.3 million. CBO III's weighted
average effective interest rate, including the effect of such hedges, was 4.00%
at September 30, 2003.
In March 2003, Newcastle issued 2.5 million shares 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 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.
In March 2003, an affiliate of the Manager purchased an additional 50,000 shares
of Holdings' common stock from a third party. In April 2003, Holdings
repurchased 2,178 shares of Newcastle's common stock from an affiliate of the
Manager.
Subsequent to Newcastle's initial public offering, options to purchase an
aggregate of 12,000 shares of its common stock were automatically granted by
Newcastle to certain of its non-officer directors, in accordance with the terms
of the Newcastle Stock Option and Incentive Award Plan (the "Award Plan").
In April 2003, Newcastle purchased additional non-conforming residential
floating rate mortgage loans at a cost of approximately $148.3 million. The
purchase was 95% financed subject to a floating rate repurchase agreement, which
bears interest at LIBOR + 0.425% for a term commitment of six months.
In June 2003, Newcastle issued an aggregate of 1,540 shares of its common stock
to its non-officer directors pursuant to the Award Plan.
In June 2003, Newcastle entered into an agreement with an investment bank
whereby such bank would purchase up to $500 million of real estate securities
(the "Portfolio IV Collateral"), subject to Newcastle's right, but not the
obligation, to purchase such securities from them. This agreement was treated as
a non-hedge derivative for accounting purposes and was therefore
marked-to-market through current income; a mark of approximately $1.4 million
has been recorded prior to September 30, 2003, which is included in Interest
Income. In September 2003, Newcastle completed a financing transaction ("CBO
IV") whereby the Portfolio IV Collateral was purchased by a consolidated
subsidiary which issued $460.0 million face amount of investment grade bonds and
$40.0 million face amount of non-investment grade bonds in a private placement.
At September 30, 2003, the non-investment grade bonds were retained by Newcastle
and the $454. 4 million carrying amount of investment grade bonds, which bore
interest at a weighted average effective rate, including discount and cost
amortization, of 2.01%, had an expected weighted average life of approximately
8.62 years. The largest tranche, the $395.0 million face amount of Class I-MM
notes, was issued subject to remarketing procedures and related agreements
whereby the securities are remarketed and sold on a periodic basis. The Class
I-MM notes are fully insured by a third party with respect to the timely payment
of interest and principal thereon. Four tranches of the investment grade bonds
bear a floating interest rate. Newcastle has obtained an interest rate swap and
cap in order to hedge its exposure to the risk of changes in market interest
rates with respect to these bonds, at an initial cost of $3.1 million. CBO IV's
weighted average effective interest rate, including the effect of such hedges,
was 3.59% at September 30, 2003.
10
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2003
In July 2003, Newcastle sold 4.6 million shares of its common stock in a public
offering at a price to the public of $20.35 per share, for net proceeds of
approximately $88.6 million. In connection with this offering, Newcastle granted
an option to the Manager to purchase 460,000 shares of its common stock at the
offering price as compensation for its efforts in raising capital for Newcastle.
This option was valued at approximately $0.8 million using an option pricing
model. The estimated value of this option was recorded as a reduction of the
proceeds from the offering. The calculation of the value of such option is
subject to significant judgment and the actual value of such option could vary
materially from management's estimate.
In October 2003, Newcastle entered into an agreement with a major investment
bank for the right to purchase commercial mortgage backed securities, unsecured
REIT debt, real estate loans and asset backed securities (the "Portfolio V
Collateral") for Newcastle's next real estate securities portfolio which is
targeted to be $500 million. The agreement will be treated as a non-hedge
derivative for accounting purposes and will therefore be marked-to-market
through current income. The Portfolio V Collateral is expected to be included in
a financing transaction in which Newcastle would acquire the equity interest
("CBO V"). As the Portfolio V Collateral is acquired by such bank, Newcastle
will make deposits (the "Portfolio V Deposit") which will earn an Excess Carry
Amount, as defined, to be settled upon closing. If CBO V is not consummated as a
result of Newcastle's failure to acquire the equity interest, except as a result
of Newcastle's gross negligence or willful misconduct, Newcastle would be
required to either purchase the Portfolio V Collateral or pay the Realized Loss,
as defined, up to the Portfolio V Deposit, less any Excess Carry Amount.
Although Newcastle currently anticipates completing CBO V in the near term,
there is no assurance that CBO V will be consummated or on what terms it will be
consummated.
In October 2003, Newcastle entered into an arrangement whereby it will own a 37%
interest in a limited liability company that will acquire approximately 135
loans from a third party financial institution. An investment fund managed by an
affiliate of the Manager will acquire an equal ownership interest in such
company on identical terms. The remaining 26% interest is being retained by the
seller. The expected purchase price of the loans is approximately $80 million.
The transaction is expected to close in the fourth quarter of 2003.
At September 30, 2003, Due To Affiliates was comprised of $1.4 million of
preferred incentive compensation and $0.6 million of management fees and expense
reimbursements payable to the Manager.
One of Newcastle's Other Securities represents a $2.9 million residual interest
in a securitization of real estate securities. Newcastle has no funding or other
obligations with respect to this securitization, which contained approximately
$250 million of assets at September 30, 2003. Newcastle has not yet determined
whether this interest represents a "variable interest entity" pursuant to FASB
Interpretation No. 46 "Consolidation of Variable Interest Entities." Should such
a determination be made, Newcastle would consolidate the gross assets and
liabilities of the securitization beginning in the fourth quarter of 2003. This
would increase both the assets and liabilities of Newcastle, but would not
effect equity or net income.
5. DERIVATIVE INSTRUMENTS
The following table summarizes the notional amounts and fair (carrying) values
of Newcastle's derivative financial instruments as of September 30, 2003.
Notional Amount Fair Value Longest Maturity
--------------- ---------- ----------------
Interest rate caps treated as hedges (A) $ 555,313 $ 7,609 October 2015
Interest rate swaps, treated as hedges (B) $1,158,613 $(49,789) March 2015
Non-hedge derivative obligations (B) (C) $ (792) July 2038
(A) Included in Deferred Costs, Net.
(B) Included in Derivative Liabilities.
(C) Represents 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
amount of $17.5 million, and an interest rate cap with a notional
amount of approximately $65.5 million..
11
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2003
6. 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, of which 1,176,000 were outstanding at September 30, 2003. Net
income available for common stockholders is equal to net income less preferred
dividends, and also less accretion of the discount on Holdings' Series A
Preferred, which was fully redeemed in June 2002.
The following is a reconciliation of the weighted average number of shares of
common stock outstanding on a diluted basis.
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------------- --------------------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
------------------ ------------------ ------------------ ------------------
Weighted average number of shares of common
stock outstanding, basic 27,340,057 16,488,517 24,786,517 16,488,517
Dilutive effect of stock options, based
on the treasury stock method 280,019 - 201,066 -
---------- ---------- ---------- ----------
Weighted average number of shares of common
stock outstanding, diluted 27,620,076 16,488,517 24,987,583 16,488,517
========== ========== ========== ==========
Newcastle accounts for its stock options using the intrinsic value method
pursuant to Accounting Principles Board Opinion No. 25 "Accounting for Stock
Issued to Employees," whereby no compensation cost is recorded for options
issued to employees (including directors) when the strike price is at market at
the date of grant. If Newcastle had accounted for such options using the fair
value method pursuant to SFAS No. 123 "Accounting for Stock-Based Compensation,
as amended by SFAS No. 148 "Accounting for Stock-Based Compensation - Transition
and Disclosure," the options issued during the nine months ended September 30,
2003 to its directors would have been recorded as compensation expense at their
fair value, which was immaterial (less than $10,000) on the date of grant.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following should be read in conjunction with the unaudited consolidated
financial statements and notes included herein.
GENERAL
We own a diversified portfolio of moderately credit sensitive real estate
securities, including commercial mortgage backed securities, senior unsecured
debt issued by property REITs and asset backed securities. Mortgage backed
securities are interests in or obligations secured by pools of mortgage loans.
We generally target investments rated A through BB. We also own credit leased
operating real estate in Canada and Belgium. We consider credit leased operating
real estate to be real estate that is leased primarily to tenants with, or whose
major tenant has, investment grade credit ratings. We also own, directly and
indirectly, interest in pools of mortgage loans, including residential mortgage
loans.
We seek to match-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. Our objective is to maximize the difference between
the yield on our investments and the cost of financing these investments while
hedging our positions.
We focus on investing in moderately credit sensitive real estate securities,
including commercial mortgage backed securities, senior unsecured debt issued by
property REITs and asset backed securities. We seek to finance our real estate
securities 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 structural flexibility to buy and sell certain investments to manage
risk and, subject to certain limitations, to optimize returns.
We were formed in June 2002 as a wholly owned subsidiary of Newcastle Investment
Holdings Corp. (referred to as Holdings) for the purpose of separating the real
estate securities and certain of the credit leased operating real estate
businesses from Holdings' other investments. Prior to our initial public
offering, Holdings contributed to us certain assets and liabilities in exchange
for 16,488,517 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 on July 12, 2002.
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.
In October 2002, we sold 7 million shares of our common stock in a public
offering at a price to the public of $13.00 per share, for net proceeds of
approximately $80 million. In July 2003, we sold 4.6 million shares of our
common stock in a public offering at a price to the public of $20.35 per share,
for net proceeds of approximately $88.6 million. Subsequent to this offering, we
had 28,090,057 shares of common stock outstanding.
On May 19, 2003, Holdings distributed to its stockholders all of the shares of
Newcastle's common stock that it held. Approximately 2.8 million of such shares
were distributed by Holdings to an affiliate of our manager.
We are organized and conduct our operations to qualify as a REIT for federal
income tax purposes. As such, we will generally not be subject to 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 through three primary segments: (i) real estate
securities, (ii) operating real estate, primarily credit leased operating real
estate, including a portfolio of properties located in Canada, which we refer to
as our Bell Canada portfolio, and a portfolio of properties located in Belgium,
which we refer to as our LIV portfolio, and (iii) mortgage loans.
As our predecessor, Holdings conducted its business through four primary
segments: (1) real estate securities, (2) operating real estate, primarily
credit leased operating real estate, (3) its investment in Fortress Investment
Fund LLC ("Fund I") and (4) mortgage loans. 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 mortgage loans distributed to
Holdings have been treated as discontinued
13
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." Revenues attributable to each segment are disclosed below
(unaudited) (in thousands).
For the Nine Months Real Estate Operating Real Mortgage
Ended Securities Estate Loans Fund I Unallocated Total
- ------------------- ----------- -------------- -------- ------ ----------- --------
September 30, 2003 $88,882 $17,677 $9,732 $ - $166 $116,457
September 30, 2002 $59,151 $14,693 $ - $3,287 $170 $ 77,301
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 accounting principles generally accepted in the
United States ("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. The following is a summary of our accounting
policies that are most effected by judgments, estimates and assumptions.
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 multiple broker 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. 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. Significant judgment is required in this
analysis. To date, no such write-downs have been recorded.
Income on these securities is recognized using a level yield methodology based
upon a number of 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 uncertainties and
contingencies are difficult to predict and are subject to future events, and
economic and market conditions, which may alter the assumptions.
Similarly, our derivative instruments, held for hedging purposes, are carried at
fair value pursuant to Statement of Financial Accounting Standards ("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
hedges under SFAS No. 133, net unrealized gains or losses are reported as a
component of accumulated other comprehensive income; otherwise, they are
reported as a component of current 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.
We purchase mortgage loans to be held for investment. We must periodically
evaluate each of these loans 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. Upon determination of
impairment, we would establish a specific valuation allowance with a
corresponding charge to earnings. Significant judgment is required both in
determining impairment and in estimating the resulting loss allowance. To date,
we have determined that no loss allowances have been necessary on the loans in
our portfolio.
We own operating real estate held for investment. We review our operating real
estate for impairment 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.
14
RESULTS OF OPERATIONS
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2003 TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2002
Interest income, derived primarily from our investments in real estate
securities and mortgage loans, increased by $38.1 million, or 74%, from $51.7
million to $89.8 million. This increase is primarily the result of the
acquisition of real estate securities used as collateral for the CBO II, CBO III
and CBO IV financings ($28.5 million) as well as the acquisition of the mortgage
loans ($9.0 million).
Rental and escalation income, derived from our Bell Canada and LIV portfolios,
increased by $2.8 million, or 20%, from $14.8 million to $17.6 million. This
increase is primarily the result of foreign currency fluctuations related to our
Bell Canada and LIV portfolios, net of the disposition of certain smaller
properties. Escalation income represents contractual increases in rental income
to offset increases in expenses or general price increases over a base amount.
Gain on settlement of investments increased by $1.4 million, from $7.6 million
to $9.0 million, primarily as a result of an increase in the volume of sales of
certain 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. Furthermore, market conditions can reduce or eliminate the availability
of gains. The increased volume of sales of securities during this period
reflects management's determination that the portfolio required more adjustment
than in prior periods.
Management fee and incentive income from affiliate related solely to our
predecessor's investment in Fund I.
Interest expense increased by $20.0 million, or 57%, from $35.0 million to $55.0
million. This increase is primarily the result of interest on the CBO II, CBO
III and CBO IV financings ($19.3 million), as well as interest on the financing
of the mortgage loans ($4.5 million) and foreign currency fluctuations related
to our Bell Canada and LIV debt ($1.2 million), offset by lower interest rates
on the CBO I financing ($2.6 million) and the elimination of interest on our
predecessor's line of credit ($2.3 million).
Property operating expense increased by $1.0 million, or 16%, from $6.4 million
to $7.4 million, primarily as the result of foreign currency fluctuations
related to our Bell Canada and LIV portfolios, net of the disposition of certain
smaller properties.
Loan servicing expense increased by $1.3 million, or 386%, from $0.3 million to
$1.6 million, primarily as a result of the acquisition of the collateral for the
CBO II, CBO III and CBO IV financings and the acquisition of the mortgage loans.
General and administrative expense increased by $0.2 million, or 10%, from $2.2
million to $2.4 million, primarily as a result of increased costs related to
being a public company.
Management fee to affiliate, excluding $4.5 million of management fee expense in
2002 relating to our predecessor's investment in Fund I, increased by $0.9
million, or 26%, from $3.6 million to $4.5 million, primarily as a result of our
initial public offering, our preferred stock offering and our additional common
stock offering, which increased our equity, offset by the distribution of assets
to Holdings which reduced our equity.
Incentive compensation to affiliate, excluding an expense reversal of $0.6
million in 2002 related to our predecessor's investment in Fund I, increased by
$2.4 million, from $2.0 million to $4.4 million, primarily as a result of
increased earnings.
Depreciation and amortization decreased by $0.2 million, or 9%, from $2.5
million to $2.3 million, primarily as a result of the distribution to Holdings
of depreciable assets.
Equity in earnings of unconsolidated subsidiaries related solely to our
predecessor's activities.
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2003 TO THE THREE MONTHS
ENDED SEPTEMBER 30, 2002
Interest income, derived primarily from our investments in real estate
securities and mortgage loans, increased by $13.7 million, or 68%, from $20.2
million to $33.9 million. This increase is primarily the result of the
acquisition of real estate securities used as collateral for the CBO III and CBO
IV financings ($9.6 million) as well as the acquisition of the mortgage loans
($3.3 million).
15
Rental and escalation income, derived from our Bell Canada and LIV portfolios,
increased by $0.6 million, or 12%, from $5.0 million to $5.6 million. This
increase is primarily the result of foreign currency fluctuations related to our
Bell Canada and LIV portfolios, net of the disposition of certain smaller
properties. Escalation income represents contractual increases in rental income
to offset increases in expenses or general price increases over a base amount.
Gain on settlement of investments increased by $0.3 million, from $2.6 million
to $2.9 million, primarily as a result of an increase in the volume of sales of
certain 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. Furthermore, market conditions can reduce or eliminate the availability
of gains. The increased volume of sales of securities during this period
reflects management's determination that the portfolio required more adjustment
than in prior periods.
Interest expense increased by $6.7 million, or 50%, from $13.5 million to $20.2
million. This increase is primarily the result of interest on the CBO III and
CBO IV financings ($5.7 million), as well as interest on the financing of the
mortgage loans ($1.6 million) and foreign currency fluctuations related to our
Bell Canada and LIV debt ($0.4 million), offset by lower interest rates on the
CBO I financing ($0.9 million).
Property operating expense increased by $0.1 million, or 4%, from $2.1 million
to $2.2 million, primarily as the result of foreign currency fluctuations
related to our Bell Canada and LIV portfolios, net of the disposition of certain
smaller properties.
Loan servicing expense increased by $0.6 million, or 428%, from $0.1 million to
$0.7 million, primarily as a result of the acquisition of the collateral for the
CBO III and CBO IV financings and the acquisition of the mortgage loans.
General and administrative expense was approximately $0.7 million for both
periods.
Management fee to affiliate increased by $0.9 million, or 94%, from $0.9 million
to $1.8 million, primarily as a result of our initial public offering, our
preferred stock offering and our additional common stock offering, which
increased our equity.
Incentive compensation to affiliate increased by $0.8 million, from $0.6 million
to $1.4 million, primarily as a result of increased earnings.
Depreciation and amortization increased by $0.1 million, or 12%, from $0.7
million to $0.8 million, primarily as a result of foreign currency fluctuations
related to our Bell Canada and LIV portfolios.
LIQUIDITY AND 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. Our loans and debt securities are
generally secured directly by our investment assets. As of September 30, 2003,
our real estate securities purchased in connection with our CBO financings as
well as our Bell Canada portfolio were securitized, while our LIV portfolio,
mortgage loan portfolio, and one of our other real estate related securities
served as collateral for loans.
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
issue the match-funded debt we use to finance our real estate securities at
spreads that provide a positive arbitrage. If spreads for CBO liabilities widen
or if demand for such liabilities ceases to exist, then our ability to execute
future CBO financings will be severely restricted.
We expect to meet our short-term liquidity requirements generally through our
cash flow provided by operations, as well as investment specific borrowings. In
addition, at September 30, 2003 we had an unrestricted cash balance of $94.1
million. Our cash flow provided by operations differs from our net income due to
four primary factors: (i) depreciation of our operating real estate, (ii)
accretion of discount on our real estate securities, discount on our debt
obligations, and deferred hedge gains and losses, (iii) straight-lined rental
income, and (iv) gains and losses. Proceeds from the sale of real estate
securities 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.
Our operating real estate is financed long-term and primarily leased to credit
tenants with long-term leases and is therefore expected to generate generally
stable current cash flows. Our real estate securities are also financed
long-term and their credit status is continuously monitored; therefore, these
investments are also expected to generate a generally stable current return,
16
subject to interest rate fluctuations. See "Quantitative and Qualitative
Disclosures About Market Risk -- Interest Rate Exposure" below. We consider our
ability to generate cash to be adequate and expect it to continue to be adequate
to meet operating requirements both in the short- and long-term.
We expect to meet our long-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
obligations at maturity. Our ability to meet our long-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' and
lenders' policies and rates applicable thereto, and the relative attractiveness
of alternative investment or lending opportunities.
We expect that our cash on hand and our cash flow provided by operations 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.
With respect to our operating real estate, we expect to incur expenditures of
approximately $3.8 million relating to tenant improvements in connection with
the inception of leases and capital expenditures during the twelve months ending
September 30, 2004.
17
The following table presents certain information regarding Newcastle's debt
obligations as of September 30, 2003 (unaudited) (dollars in thousands):
Unhedged Weighted Weighted Average
Average Effective Stated Effective Interest Rate Weighted Average
Carrying Amount Face Amount Interest Rate Maturity (B) Expected Life
--------------- ----------- ----------------- ---------- ----------------------- ----------------
CBO I Bonds $ 431,174 $ 437,500 3.81% (C) July 2038 5.04% 4.93 Years
CBO II Bonds 439,686 444,000 2.87% (C) April 2037 6.02% 6.72 Years
CBO III Bonds 467,198 472,000 2.40% (C) March 2038 4.00% 8.75 Years
CBO IV Bonds 454,445 460,000 2.01% (C) Sept. 2038 3.59% 8.59 Years
---------- ---------- ---- ----------
Total CBO Bonds 1,792,503 1,813,500 4.64% 7.29 Years
---------- ---------- ---- ----------
Bell Canada Securitization 40,381 41,119 7.00% April 2012 7.00% 2.32 Years
LIV Mortgage 69,237 69,237 6.10% Nov. 2006 6.10% 3.00 Years
CMBS Repo 1,457 1,457 LIBOR+1.35% One Month 2.47% 1 Month
Mortgage Loan Repo (A) 406,283 406,283 LIBOR+0.40% March 2004 1.52% 6 Months
---------- ---------- ----
Total repurchase agreements 407,740 407,740 1.52%
---------- ---------- ----
Total debt obligations $2,309,861 $2,331,596 4.17%
========== ========== ====
(A) The counterparty on this repo is Bear Stearns Mortgage Capital Corporation.
(B) Including the effect of applicable hedges.
(C) Weighted average, including floating and fixed rate classes.
Our long-term debt obligations existing at September 30, 2003 (gross of $21.7
million of discounts) are expected to mature as follows (unaudited) (in
millions):
Period from October 1, 2003 through December 31, 2003 $ 1.7
2004 411.4
2005 1.9
2006 64.9
2007 -
2008 -
Thereafter 1,851.7
--------
Total $2,331.6
========
CBO Bonds Payable
In July 1999, we completed our first CBO financing, CBO I, whereby a portfolio
of real estate securities was contributed to a consolidated subsidiary which
issued $437.5 million face amount of investment grade senior bonds and $62.5
million face amount of non-investment grade subordinated bonds, which were
retained by us, in a private placement. Two classes of the senior bonds bear
floating interest rates. In 1999, we obtained an interest rate swap and cap in
order to hedge our exposure to the risk of changes in market interest rates with
respect to these bonds, at an initial cost of approximately $14.3 million. In
June 2003, we obtained an additional interest rate swap and cap in order to
further hedge our exposure to the risk of changes in market interest rates with
respect to these bonds, at an initial cost of approximately $1.1 million. In
addition, in connection with the sale of two classes of bonds, we entered into
two interest rate swaps and three interest rate cap agreements that do not
qualify for hedge accounting.
In April 2002, we completed our second CBO financing, CBO II, whereby a
portfolio of real estate securities was contributed to a consolidated subsidiary
which issued $444.0 million face amount of investment grade senior bonds and
$56.0 million face amount of non-investment grade subordinated bonds, which were
retained by us, in a private placement. One class of the senior bonds bears a
floating interest rate. We obtained an interest rate swap and cap in order to
hedge our exposure to the changes in market interest rates with respect to these
bonds, at an initial cost of $1.2 million.
In November 2001, we sold the retained subordinated $17.5 million Class E Note
from CBO I 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 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
18
bonds payable. The Class E Note is included in the collateral for CBO II. The
Class E Note is eliminated in consolidation.
In March 2003, we completed our third CBO financing, CBO III, whereby a
portfolio of real estate securities was contributed to a consolidated subsidiary
which issued $472.0 million face amount of investment grade senior bonds and
$28.0 million face amount on non-investment grade subordinated bonds, which were
retained by us, in a private placement. One class of the senior bonds bears a
floating interest rate. We obtained an interest rate swap and cap in order to
hedge our exposure to the risk of changes in market interest rates with respect
to these bonds, at an initial cost of approximately $1.3 million.
In June 2003, we entered into an agreement with an investment bank whereby such
bank would purchase up to $500 million of real estate securities (the "Portfolio
IV Collateral"), subject to our right, but not the obligation, to purchase such
securities from them. The agreement was treated as a non-hedge derivative for
accounting purposes and was therefore marked-to-market through current income; a
mark of approximately $1.4 million has been recorded prior to September 30,
2003. In September 2003, we completed a financing transaction ("CBO IV") whereby
the Portfolio IV Collateral was purchased by a consolidated subsidiary which
issued $460.0 million face amount of investment grade bonds and $40.0 million
face amount of non-investment grade bonds, which were retained by us, in a
private placement. The largest tranche, the $395.0 million face amount of Class
I-MM notes, was issued subject to remarketing procedures and related agreements
whereby the securities are remarketed and sold on a periodic basis. The Class
I-MM notes are fully insured by a third party with respect to the timely payment
of interest and principal thereon. Four tranches of the investment grade bonds
bear a floating interest rate. We have obtained an interest rate swap and cap in
order to hedge our exposure to the risk of changes in market interest rates with
respect to these bonds, at an initial cost of $3.1 million.
In October 2003, we entered into an agreement with a major investment bank for
the right to purchase commercial mortgage backed securities, unsecured REIT
debt, real estate loans and asset backed securities (the "Portfolio V
Collateral") for our next real estate securities portfolio which is targeted to
be $500 million. The agreement will be treated as a non-hedge derivative for
accounting purposes and will therefore be marked-to-market through current
income. The Portfolio V Collateral is expected to be included in a financing
transaction which we would acquire the equity interest ("CBO V"). As the
Portfolio V Collateral is acquired by such bank, we will make deposits (the
"Portfolio V Deposit") which will earn an Excess Carry Amount, as defined, to be
settled upon closing (the "Portfolio V Deposit"). If CBO V is not consummated as
a result of our failure to acquire the equity interest, except as a result of
our gross negligence or willful misconduct, we would be required to either
purchase the Portfolio V Collateral or pay the Realized Loss, as defined, up to
the Portfolio V Deposit, less and Excess Carry Amount. Although we currently
anticipate completing CBO V in the near term, there is no assurance that CBO V
will be consummated or on what terms it will be consummated.
Other Bonds Payable
In April 2002, we refinanced the Bell Canada portfolio through a securitization
transaction denominated in CAD. We have retained one class of the issued bonds.
In connection with this securitization, we guaranteed certain payments under an
interest rate swap to be entered into in 2007 if the bonds are not fully repaid
by such date. We believe the fair value of this guarantee is negligible at
September 30, 2003.
Notes Payable
In November 2002, we refinanced the LIV portfolio with a loan denominated in
EUR.
Repurchase Agreements
In November 2002, we purchased a portfolio of floating rate residential mortgage
loans subject to floating rate financing. In February 2003, we sold our entire
position in conforming residential mortgage loans (a portion of our mortgage
loan portfolio) for gross proceeds of approximately $162.6 million at a gain of
approximately $0.7 million. As a result of the sale, the existing repurchase
agreement allocated to the conforming loans was satisfied for approximately
$153.9 million. Simultaneously, we purchased additional non-conforming
residential mortgage loans at a cost of approximately $210.2 million. In
connection with this purchase, the outstanding balance of the existing
repurchase agreement was increased by a net of $45.9 million, after the
repayment described above. In April 2003, we purchased additional non-conforming
residential mortgage loans at a cost of approximately $148.3 million, subject to
approximately $140.9 million of additional financing.
Stockholders' Equity
In October 2002, we sold 7 million shares of our common stock in a public
offering at a price to the public of $13.00 per share, for net proceeds of
approximately $80 million.
In March 2003, we issued 2.5 million shares of our 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
has a $25 per share liquidation preference, no maturity date and no mandatory
redemption. We have the option to redeem the Series B Preferred beginning in
March 2008.
19
In July 2003, we sold 4.6 million shares of our common stock in a public
offering at a price to the public of $20.35 per share, for net proceeds of
approximately $88.6 million. In connection with this offering, we granted an
option to the Manager to purchase 460,000 shares of our common stock at the
offering price.
Other
In October 2003, we entered into an arrangement whereby we will own a 37%
interest in a limited liability company that will acquire approximately 135
loans from a third party financial institution. An investment fund managed by an
affiliate of the Manager will acquire an equal ownership interest in such
company on identical terms. The remaining 26% interest is being retained by the
seller. The expected purchase price of the loans is approximately $80 million.
The transaction is expected to close in the fourth quarter of 2003.
We declared a dividend of $0.45 per share of common stock to our stockholders of
record at the close of business on April 7, 2003 for the quarter ended March 31,
2003. This dividend was paid in April 2003. We declared a dividend of $0.50 per
share of common stock to our stockholders of record at the close of business on
July 7, 2003 for the quarter ended June 30, 2003. This dividend was paid in July
2003. We declared a dividend of $0.50 per share of common stock to our
stockholders of record at the close of business on October 27, 2003 for the
quarter ended September 30, 2003. This dividend was paid in October 2003.
Cash Flow
Net cash flow provided by operating activities increased from $15.3 million for
the nine months ended September 30, 2002 to $18.9 million for the nine months
ended September 30, 2003. This change resulted from the acquisition and
settlement of our investments as described above, including the distribution of
investments to Holdings.
Investing activities (used) ($1,157.2 million) and ($387.6 million) during the
nine months ended September 30, 2003 and 2002, respectively. Investing
activities consisted primarily of investments made in certain real estate
securities and mortgage loans, net of proceeds from the settlement of
investments as well as the sale of properties.
Financing activities provided $1,187.0 million and $348.0 million during the
nine months ended September 30, 2003 and 2002, respectively. The borrowings,
debt and equity issuances described above served as the primary sources of cash
flow from financing activities. Offsetting uses included the payment of related
deferred financing costs (including the purchase of hedging instruments), the
payment of dividends, and the repayment of debt obligations as described above.
See the consolidated statements of cash flows included in our consolidated
financial statements included herein 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.
CREDIT AND INTEREST RATE RISK
We are subject to credit, spread and interest rate risk with respect to our
investments in real estate securities.
The commercial mortgage-backed securities (CMBS) 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's ability to make 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-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 mortgage backed
securities, and the issuer's underlying equity and subordinated debt, in the
case of REIT securities, are designed to bear the first risk of default and
loss. We further minimize credit risk by actively monitoring our real estate
securities 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.
Our real estate securities portfolio is diversified by asset type, industry,
location and issuer. We believe that this diversification also helps to minimize
the risk of capital loss.
At September 30, 2003, our real estate securities which serve as collateral for
our CBO financings had an overall weighted average credit rating of
approximately BBB-, and approximately 78% of these securities had an investment
grade rating (BBB- or higher).
Our real estate securities are also subject to spread risk. The majority of such
securities are fixed rate securities, which are valued based on a market credit
spread over the rate payable on fixed rate U.S. Treasuries of like maturity. In
other words,
20
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") 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 would tend to increase. 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. See " Quantitative and Qualitative Disclosures About Market Risk
- - Credit Spread Curve Exposure" below.
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 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.
Returns on our real estate securities are sensitive to interest rate volatility.
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 general financing strategy focuses on the use of match-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 earnings. In addition, we generally match-fund
interest rates with like-kind debt (i.e., fixed rate assets are financed with
fixed rate debt and floating rates 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. Our financing
strategy is dependent on our ability to place the match-funded debt we use to
finance our real estate securities at spreads that provide a positive arbitrage.
If spreads for CBO liabilities (i.e., bonds issued by CBOs) widen or if demand
for such liabilities ceases to exist, then our ability to execute future CBO
financings will be severely restricted. See "Quantitative and Qualitative
Disclosures About Market Risk - Interest Rate Exposure" below.
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.
Generally, as interest rates increase, the value of our fixed rate securities,
such as CMBS, decreases and as interest rates decrease, the value of such
securities will increase. We seek to hedge changes in value attributable to
changes in interest rates by entering into interest rate swaps and other
derivative instruments. 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-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 real estate securities portfolio will
not directly affect our recurring earnings or our ability to pay a dividend.
Similar to our real estate securities portfolio, we are subject to credit and
spread risk with respect to our mortgage loan portfolio.
Unlike our real estate securities portfolio, our mortgage loan portfolio does
not benefit from the support of junior classes of securities, but rather bears
the first risk of default and loss. We believe that this credit risk is
mitigated through our extensive due diligence process, periodic reviews of the
borrower's payment history, delinquency status, and the relationship of the loan
balance to the underlying property value.
Our mortgage loan portfolio is diversified by geographic location and by
borrower. We believe that this diversification also helps to minimize the risk
of capital loss.
Our mortgage loan portfolio is also subject to spread risk. The majority of such
loans are floating rate loans, which are valued based on a market credit spread
to LIBOR. The value of the loans is dependent upon the yield demanded by the
market based on their credit relative to LIBOR. The value of our portfolio 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). If the value of our mortgage loan portfolio were to
decline, it could affect our ability to refinance such portfolio upon the
maturity of the related repurchase agreement.
Any credit or spread losses incurred with respect to our mortgage loan portfolio
would effect us in the same way as similar losses on our real estate securities
portfolio as described above.
21
OFF-BALANCE SHEET ARRANGEMENTS
As of September 30, 2003, we had the following material off-balance sheet
arrangements:
- A $2.9 million equity interest in a securitization, described in Note 7
to our consolidated financial statements included in our December 31,
2002 annual report on Form 10-K filed with the Securities and Exchange
Commission ("SEC").
- A guarantee of certain payments under an interest rate swap which may
be entered into in 2007 in connection with the securitization of the
Bell Canada portfolio, if the bonds are not fully repaid by such date.
We believe the fair value of this guarantee is negligible at September
30, 2003.
In the first case, our potential loss is limited to the amount shown above which
is included in our consolidated balance sheet. At this time, we do not
anticipate a substantial risk of incurring a loss with respect to any of the
arrangements.
INFLATION
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.
We believe that our risk of increases in the market interest rates on our
floating rate debt as a result of inflation is largely offset by our use of
match-funding and hedging instruments as described above. See "Quantitative and
Qualitative Disclosure About Market Risk -- Interest Rate Exposure" below.
FUNDS FROM OPERATIONS
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
the Manager. FFO, for our purposes, represents net income available for common
stockholders (computed in accordance with GAAP), excluding extraordinary items,
plus depreciation of operating real estate, and 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 prior to the commencement of our operations includes certain
adjustments related to our predecessor's investment in Fund I. 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.
22
Funds from Operations (FFO), is calculated as follows (unaudited) (in
thousands):
For the Nine Months For the Three
Ended September 30, Months Ended
2003 September 30, 2003
-------------------- ------------------
Income available for common stockholders $35,976 $13,183
Operating real estate depreciation 2,225 765
------- -------
Funds from Operations (FFO) $38,201 $13,948
======= =======
Funds from Operations was derived from the Company's segments as follows
(unaudited) (in thousands):
Average Invested Common
Equity for the Nine Months FFO for the Nine
Book Equity at Ended September 30, 2003 Months Ended Return on Common
September 30, 2003 (2) September 30, 2003 Equity (ROE) (3)
------------------ -------------------------- ------------------ ----------------
Real estate and other securities $ 302,255 $255,412 $ 42,756 22.3%
Operating real estate 39,793 39,287 4,997 17.0%
Mortgage loans 21,836 19,141 4,125 28.7%
Unallocated (1) 12,199 1,200 (13,677) N/A
--------- -------- -------- ----
Total (2) 376,083 $315,040 $ 38,201 16.2%
======== ======== ====
Preferred stock 62,500
Accumulated depreciation (13,052)
Accumulated other comprehensive income 30,488
---------
Net book equity $ 456,019
=========
Average Invested Common
Equity for the Three Months FFO for the Three
Book Equity at Ended September 30, 2003 Months Ended Return on Common
September 30, 2003 (2) September 30, 2003 Equity (ROE) (3)
------------------ --------------------------- ------------------ ----------------
Real estate and other securities $ 302,255 $299,724 $ 16,211 21.6%
Operating real estate 39,793 39,243 1,612 16.4%
Mortgage loans 21,836 21,762 1,268 23.3%
Unallocated (1) 12,199 (4,367) (5,143) N/A
--------- -------- -------- ----
Total (2) 376,083 $356,362 $ 13,948 15.7%
======== ======== ====
Preferred stock 62,500
Accumulated depreciation (13,052)
Accumulated other comprehensive income 30,488
---------
Net book equity $ 456,019
=========
(1) Unallocated FFO represents ($1,523) and ($3,250) of preferred dividends and
($3,620) and ($10,427) of corporate general and administrative expense,
management fees and incentive compensation for the three and nine months
ended September 30, 2003, respectively.
(2) Invested common equity is equal to book equity gross of preferred stock,
accumulated depreciation and accumulated other comprehensive income.
(3) FFO divided by average invested common equity, annualized.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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,
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 affect Newcastle's financial
position or operating results, please refer to the "Application of Critical
Accounting Policies" section of Management's Discussion and Analysis.
INTEREST RATE EXPOSURE
Our primary interest rate exposures relate to our mortgage loans, real estate
securities 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. Changes in the level of interest rates also
can affect, among other things, our ability to acquire mortgage loans and
securities, the value of our mortgage loans and real estate securities, and our
ability to realize gains from the settlement of such assets.
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 general financing strategy focuses on the use of match-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 earnings. In addition, we generally match-fund
interest rates 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. Our financing
strategy is dependent on our ability to place the match-funded debt we use to
finance our real estate securities at spreads that provide a positive arbitrage.
If spreads for CBO liabilities widen or if demand for such liabilities ceases to
exits, then our ability to execute future CBO 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 rate 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-front 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.
While our strategy is to utilize interest rate swaps, caps and match-funded
financing 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 October 29, 2003, a 100 basis point increase in short term interest rates
would effect our earnings by no more than $0.5 million per annum.
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
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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.
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.
Generally, as interest rates increase, the value of our fixed rate securities,
such as CMBS, decreases and as interest rates decrease, the value of such
securities will increase. We seek to hedge changes in value attributable to
changes in interest rates by entering into interest rate swaps and other
derivative instruments. 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-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 real estate securities portfolio will
not directly affect our recurring earnings or our ability to pay a dividend. As
of September 30, 2003, a 100 basis point increase in short term interest rates
would impact our net book value by approximately $17.6 million.
CREDIT SPREAD CURVE EXPOSURE
Our real estate securities are also subject to spread risk. The majority of such
securities are fixed rate securities, which 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
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 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's expectations of future interest rates, would also effect the yield
required on our 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.
As of September 30, 2003, a 25 basis point movement in credit spreads would
impact our net book value by approximately $25.4 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 of our international holdings. We
have attempted to mitigate this impact in part by utilizing local
currency-denominated financing on our foreign investments to partially hedge, in
effect, these assets.
We have material investments in a portfolio of Belgian properties, the LIV
portfolio, and a portfolio of Canadian properties, 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 September 30, 2003, approximately $7.2 million and $20.4
million, respectively, is exposed to foreign currency exchange risk.
FAIR VALUES
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 investments 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, credit spread and currency rate
environments as of September 30, 2003 and do not take into consideration the
effects of subsequent interest rate, credit spread or currency rate
fluctuations.
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We note that the values of our investments in real estate securities and in
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. Historically, the values of our
real estate securities have tended to vary inversely with those of our
derivative instruments.
We held the following interest rate risk sensitive instruments at September 30,
2003 (unaudited) (dollars in thousands):
Weighted Average
Carrying Principal Balance or Effective Interest Maturity
Amount Notional Amount Rate Date Fair Value
---------- -------------------- ------------------ -------- ----------
ASSETS:
Real estate securities, available for sale (A) $2,117,278 $2,058,434 6.60% (A) $2,117,278
Mortgage loans (B) 427,197 421,737 2.98% (B) 427,197
Other securities, available for sale (C) 33,649 45,776 13.02% (C) 33,649
Interest rate caps, treated as hedges (D) 7,609 555,313 N/A (D) 7,609
LIABILITIES:
CBO bonds payable (E) 1,792,503 1,813,500 4.64% (E) 1,841,074
Other bonds payable (F) 40,381 41,119 7.00% April 2012 40,503
Notes payable (F) 69,237 69,237 6.10% Nov 2006 69,731
Repurchase agreements (G) 407,740 407,740 1.52% Short-term 407,740
Interest rate swaps, treated as hedges (H) 49,789 1,158,613 N/A (H) 49,789
Non-hedge derivative obligations (I) 792 (I) N/A (I) 792
(A) These securities serve as collateral for our CBO financings and contain
various terms, including floating and fixed rates, self-amortizing and
interest only. Their weighted average term to maturity is 6.52 years. The
fair value of these securities is estimated by obtaining third party broker
quotations, if available and practicable, or counterparty quotations.
(B) This portfolio of mortgage loans bears a floating rate of interest and has
a weighted average term to maturity of 23.42 years. We believe that for
similar financial investments with comparable credit risks, the effective
rate on this portfolio approximates the market rate. Accordingly, the
carrying amount of this portfolio is believed to approximate fair value.
(C) These five securities have maturity dates ranging from July 2005 to
December 2027. Two of these securities represent subordinate and residual
interests in securitizations, two represent asset-backed securities and one
represents a CMBS. The fair values of the former two securities, for which
quoted market prices are not readily available, are estimated by means of a
price/yield analysis based on our expected disposition strategies for such
assets. The fair value of the other securities were obtained from third
party broker quotations.
(D) Represents five agreements as follows (dollars in thousands):
September 30, 2003
Notional Balance Effective Date Maturity Date Capped Rate Strike Rate
- ------------------ -------------- -------------- ------------- -----------
$237,847 Current March 2009 1-Month LIBOR 6.50%
237,847 Current December 2004 1-Month LIBOR 1.32%*
18,000 January 2010 October 2015 3-Month LIBOR 8.00%
8,619 December 2010 June 2015 3-Month LIBOR 7.00%
53,000 May 2011 September 2015 1-Month LIBOR 7.50%
*up to 6.50%
(E) 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 stated maturity of the CBO bonds payable is February 2037.
The CBO bonds payable amortize principal prior to maturity based on
collateral receipts, subject to reinvestment requirements.
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(F) The Bell Canada Securitization and LIV Mortgage were valued by discounting
expected future payments by a rate calculated by imputing a spread over a
market index on the date of borrowing. They both amortize principal
periodically with a balloon payment at maturity.
(G) 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 pay
interest only prior to maturity.
(H) Represents five agreements as follows (dollars in the thousands):
September 30, 2003
Notional Balance Effective Date Maturity Date Swapped Rate Fixed Rate
- ------------------ -------------- ------------- ------------- ----------
$104,653 Current July 2005 1-Month LIBOR 6.1755%
290,000 Current April 2011 3-Month LIBOR 5.9325%
276,060 Current March 2013 3-Month LIBOR 3.865%
192,500 Current March 2015 1-Month LIBOR 4.888%
295,400 December 2004 March 2009 1-Month LIBOR* 3.125%
*up to 6.50%
(I) 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
an interest rate cap with a notional balance of approximately $65.5
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 date of the $65.5 million cap is August 2004. They have
been valued by reference to counterparty quotations.
Currency Rate Risk
We held the following currency rate risk sensitive balances at September 30,
2003 (unaudited) (U.S. dollars; dollars in thousands, except exchange rates):
Current
Carrying Exchange Rate Effect of a 5% Negative Effect of a 5% Negative
Amount Local Currency to USD Change in Euro Rate Change in CAD Rate
-------- -------------- ------------- ----------------------- -----------------------
Assets:
LIV portfolio $ 74,345 Euro 0.85793 $(3,717) N/A
Bell Canada portfolio 52,261 CAD 1.35210 N/A $(2,613)
LIV other, net 2,072 Euro 0.85793 (104) N/A
Bell Canada other, net 8,474 CAD 1.35210 N/A (424)
Liabilities:
LIV mortgage 69,237 Euro 0.85793 3,462 N/A
Bell Canada bonds 40,381 CAD 1.35210 N/A 2,019
------- -------
Total $ (359) $(1,018)
======= =======
USD refers to U.S. dollars; CAD refers to Canadian dollars.
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ITEM 4. CONTROLS AND PROCEDURES
(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 Act) during the
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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not party to any material legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 9, 2003, Newcastle CDO III, Limited and Newcastle CDO III Corp.
issued $460 million face amount of collateralized bond obligations in a
transaction exempt from the registration requirements of the Securities Act
pursuant to Rule 144A and Regulation S thereunder to qualified institutional
buyers and persons outside the United States.
On June 23, 2003, Newcastle issued 385 shares of the Company's common stock to
each of its directors, other than Mr. Edens (for a total of 1,540 shares) to
provide such directors the benefit of the change in director compensation for
the remainder of the 2003 fiscal year. The shares were issued in a transaction
exempt from the registration requirements of the Securities Act pursuant to
Section 4 (2).
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits filed with this Form 10-Q:
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 By-laws (incorporated by reference to the Registrant's Registration
Statement on Form S-11 (File No. 333-90578), Exhibit 3.2).
3.3 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).
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 Registration Statement
on Form S-11 (File No. 333-106135), Exhibit 10.1).
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.
(b) Reports on Form 8-K filed by the registrant during its fiscal quarter ended
September 30, 2003:
Form 8-K filed with the Securities and Exchange Commission on July 30, 2003,
regarding the Registrant's results of operations for the quarter ended June 30,
2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized:
NEWCASTLE INVESTMENT CORP.
--------------------------
(REGISTRANT)
By: /s/ Wesley R. Edens
--------------------
Wesley R. Edens
Chairman of the Board
Chief Executive Officer
Date: November 10, 2003
By: /s/ Debra A. Hess
--------------------
Debra A. Hess
Chief Financial Officer
Date: November 10, 2003
30