§

Investment Activity – New funded credit investments totaled $300 million in the first quarter, down from $705 million last quarter and $609 million from the same quarter in the prior year due to an increase in credit selectivity and a slowdown in overall market activity.  

§

Divestiture – Sold NewStar Business Credit LLC (“NSBC”), the company’s asset-based lending subsidiary, for approximately 1.27x book value, or approximately $112 million in cash, net of debt repayment, fees and expenses.  The transaction generated a gain of approximately $22.5 million and net proceeds of more than $117 million, which included retention of excess cash and transaction proceeds.  

§

Asset Growth – Managed loans and credit investments decreased by $330 million to $6.6 billion, or 4.7%, from the prior quarter due primarily to the sale of the Company’s asset-based lending business, but increased $2.8 billion, or 75%, from the same period last year due to a combination of acquisition activity and organic growth.  Excluding the impact of the sale of the Company’s asset-based lending subsidiary, managed loans and credit investments increased by $14 million from the prior quarter as new investment activity was mostly offset by runoff.      

§

Revenue – Total revenue¹ increased by $14.0 million, or 51%, from the prior quarter to $41.7 million in the first quarter due primarily to the gain recognized on the sale of the Company’s asset-based lending business. The impact of the gain was partly offset by a $1.9 million increase in losses on a total return swap referencing a portfolio of loans and $1.1 million increase in losses recognized on loans-held-for-sale due to a decrease in market values.  

§

Net Interest Margin – The margin narrowed to 2.21% for the first quarter from 2.45% in the fourth quarter as an increase in the cost of funds outpaced increases in the portfolio yield due primarily to the issuance of additional higher cost subordinated notes and the impact of a full quarter of interest expense on senior notes issued in November 2015.  

§

Credit – Provision expense was elevated in the first quarter due primarily to a rapidly developing credit event that led to a $5.0 million charge-off and additional reserves established on two legacy loans in connection with restructuring strategies and related activity.  Net charge-offs in the first quarter were $7.3 million.  

§

Funding – Completed thirteenth loan securitization, issuing $256 million of CLO notes and repaid approximately $237 million of debt in connection with the sale of the asset-based lending business. Issued the final $25 million of subordinated notes under a previous commitment and added a $375 million warehouse credit facility to support the launch of a new managed fund.  

¹ 

Total revenue is defined as the sum of net interest income and non-interest income

§

On March 31, 2016, the Company sold its asset-based lending subsidiary, NewStar Business Credit LLC (“NSBC”), to Sterling National Bank, a wholly-owned subsidiary of Sterling Bancorp, for 1.27x book value, or approximately $112 million in cash, net of debt repayment, fees and certain transaction expenses.  

§

NSBC provided flexible, working capital financing solutions to middle market companies nationwide.  Its loans were structured primarily as revolving lines of credit that allowed companies to borrow against estimated liquidation values of their working capital assets such as accounts receivable and inventory.  

§

The NSBC platform was acquired in late 2010 from American Capital and expanded significantly over the last five years.

§

The transaction was structured as a sale of ownership interests in NSBC and generated net proceeds of more than $117 million, which included retention of excess cash and net proceeds from the sale.

§

The sale generated a gain of approximately $22.5 million in the first quarter.  Total transaction costs of $2.5 million were included in operating expenses.

§

NSBC had gross loans of totaling approximately $331 million as of March 31, 2016 when it was sold.  It had a staff of 26 and a run-rate expense base of approximately $7.2 million.  It contributed approximately $3.7 million to net income in 2015.

§

Total new funded credit investments were $300 million in the first quarter of 2016 compared to $705 million in the prior quarter and $609 million in the same quarter last year.  The decrease in investment activity reflected an overall slowdown in market activity and an increase in the Company’s selectivity due to heightened volatility across the credit markets and uncertainty about the future direction of the economy.  

§

Balance sheet runoff from scheduled amortization, prepayments and loan sales totaled approximately $170 million, or 4.5% of the loan balances at the beginning of the period, down sharply from $402 million, or 11.4% of balances in the prior quarter.  Runoff in the first quarter included $80 million of prepayments, $49 million of loan sales and $41 million of contractual amortization compared to prepayments of $311 million, loan sales of $45 million and amortization of $45 million in the prior quarter.  

§

Average yields on new loans and other credit investments in the first quarter were 7.4%, up from 6.8% in the prior quarter, reflecting both greater credit selectivity and an improved pricing environment during the period.  

§

Loans and other investments outstanding, excluding assets managed for third parties, decreased by $96 million, or 2.5% from the prior quarter due primarily to the sale of the Company’s asset-based lending business, which had loans totaling $342 million in the prior period.  Excluding the impact of the sale, loans and other investments outstanding increased by $246 million, or 7.1%, from the prior quarter despite slower new investment activity as runoff abated.  Net loan growth in the first quarter was driven by lending activity generated through our Leveraged Finance group and the purchase of a $139 million portfolio that was previously managed through a total return swap which matured at the end of the quarter.  Compared to the first quarter of 2015, loans and investments increased $924 million, or 32.9% due to a combination of acquisition activity and organic growth, which was partly offset by the sale of NSBC. 

§

The Leveraged Finance loan portfolio increased by $266 million during the first quarter to $3.5 billion, while loans and leases in our Equipment Finance portfolio increased slightly to $176 million.    

§

New equipment loan and lease volume was $13 million in the first quarter, up slightly from $12 million last quarter and down from $21 million in the first quarter of 2015.    

§

Assets held in managed funds decreased by $144 million to approximately $3 billion as of March 31, 2016 due to the termination of a total return swap program that referenced a $163 million loan portfolio and amortization of certain managed CLOs.  The decrease was partly offset by the formation of the Arch Street fund, which added assets totaling $89.2 million.  

§

The owned loan portfolio remained balanced across industry sectors and highly diversified by issuer. Exposure to energy sectors was 2.5%, up slightly from the prior quarter.  As of March 31, 2016, no outstanding borrowings by a single obligor represented more than 1.2% of total loans outstanding, and the ten largest obligors comprised approximately 9.9% of the loan portfolio.

§

Net interest income decreased by $1.9 million, or 7.6%, to $22.5 million in the first quarter compared to $24.4 million in the prior quarter as a $3.2 million increase in interest expense exceeded a $1.4 million increase in interest income.  The increase in interest income was due primarily to a 3.7% increase in average interest earning assets for the first quarter.  The increase in interest expense reflected higher average debt balances in the first quarter and an increase in the cost of funds due partly to the issuance of senior notes totaling $80 million in November 2015 and $25 million of subordinated notes in the first quarter.

§

The portfolio yield decreased to 6.28% in the first quarter of 2016 compared to 6.33% in the prior quarter and 6.00% in the first quarter of 2015.  The decrease reflected lower amortization of deferred loans fees due to a decrease in runoff, which was partly offset by a continued positive trend in yields on new investments.

§

Funding costs increased to 4.56% in the first quarter compared to 4.32% in the prior quarter, and 4.11% in the comparable period in the prior year.  The change from the prior period was due primarily to the issuance of higher cost senior notes totaling $80 million in November 2015 and $25 million of subordinated notes in the first quarter. The increase in funding costs from the comparable period in the prior year also reflected the issuance of senior notes totaling $300 million in April 2015.  

§

As a result, net interest margin narrowed to 2.21% for the first quarter of 2016 compared to 2.45% for the prior quarter and 2.51% in the first quarter of 2015.      

§

Non-interest income increased by $15.8 million to $19.2 million for the first quarter of 2016 compared to $3.3 million in the prior quarter and $4.1 million in the same period last year.  The increase reflected a $22.5 million gain on the sale of NSBC, which was partly offset by the recognition of unrealized losses totaling $3.7 million on loans-held-for sale and $6.1 million of realized losses on a portfolio of loans referenced by a total return swap that matured during the quarter.  

§

Other non-interest income in the first quarter of 2016 was centered in asset management income of $3.4 million, $0.5 million of placement and amendment fees, $0.2 million of unused fees on revolving credit commitments, $0.4 million

of business credit fees and $0.6 million of gain on equity instruments held by the Company as a result of a loan that had been previously restructured.   

§

Provision expense was $17.7 million in the first quarter, an increase of $14.0 million compared to the prior quarter. This was higher than expected due primarily to a credit event that developed rapidly and resulted in a $5 million charge-off.  The addition of specific reserves to several legacy loans in connection with restructuring strategies and related activity also contributed to the increase.  Despite the elevated level of credit costs in the first quarter, however, we do not believe it represents a signal of broader credit deterioration.  Each situation reflected a unique set of facts and circumstances that drove the timing and amount of losses recognized in the quarter.      

§

Total net specific provision expense increased by approximately $14.2 million in the first quarter of 2016 to $16.6 million compared to $2.4 million in the prior quarter.  

§

Charge-offs were $7.3 million in the first quarter of 2016, reflecting the credit event mentioned previously and the final charge-off of a legacy loan totaling $1.1 million against a previously established specific reserve.  It also included a $1.3 million charge-off on commercial real estate loans that were reclassified as loans held-for-sale.    

§

The allowance for credit losses was $67.3 million, or 2.19% of consolidated loans and approximately 59% of NPLs, at March 31, 2016, compared to $58.7 million, or 1.81% of loans and approximately 53% of NPLs, at December 31, 2015.

§

Non-performing assets increased slightly to $114.7 million, or 3.63% of loans held for investment and repossessed equipment at March 31, 2016 compared to $111.5 million or 3.44% of loans held for investment and repossessed equipment at the end of the prior period.  

§

Three loans totaling $10.2 million were placed on non-accrual status in the first quarter.  

§

Operating expenses were consistent with the prior quarter at $17.1 million, but included $2.5 million of transaction costs related to the sale of a subsidiary.

§

As a result, expenses as a percentage of average assets remained consistent at 1.68% of average assets in the first quarter consistent with the prior quarter.

§

Adjusted operating expenses, excluding non-cash equity compensation, were $16.1 million in the first quarter, consistent with the fourth quarter.  

§

The Company had 95 full-time employees at March 31, 2016 compared to 122 full-time employees at December 31, 2015.  The reduction in staffing levels reflects the sale of NSBC which had a staff of 26 full-time employees.  

§

Deferred income taxes remained consistent with the prior period at $33.7 million as of March 31, 2016 as an increase in deferred income taxes related to our allowance for credit losses was offset by decreases from the exercise of stock options, equipment leasing activity and realization of proceeds from equity positions.  

§

Approximately $33 million and $11 million of the net deferred tax asset as of March 31, 2016 were related to our allowance for credit losses and incentive compensation, respectively, which was partially offset by $13 million of deferred tax liabilities related to the lease portfolio.

·

Total cash and equivalents as of March 31, 2016 were $306 million, of which $150.7 million was unrestricted. Unrestricted cash increased from approximately $35.9 million at December 31, 2015 due primarily to receipt of cash

proceeds from the sale of the asset-based lending subsidiary.  Restricted cash increased by approximately $1.4 million at March 31, 2016 from approximately $154.0 million as of December 31, 2015.  

·

Advances under credit facilities decreased by approximately $294 million during the first quarter due to the repayment of credit facilities used by NSBC and the repayment of advances under warehouse facilities in connection with the issuance of a new loan securitization.  The decrease in warehouse debt was partly offset by $65 million of advances under a new $375 million warehouse credit facility which will be used to partially finance credit investments by a new fund managed by NewStar Capital.  

·

Term debt securitizations increased from the prior quarter by approximately $223 million to $2.0 billion at March 31, 2016.  The increase was due to issuance of the 2016-1 CLO, the Company’s thirteenth loan securitization.  

·

$25 million of additional long-term subordinated notes were issued in the quarter under an existing commitment from funds managed by GSO Capital and Franklin Square. The commitment is fully drawn.  

·

Total debt decreased by approximately $45 million to $3.3 billion at March 31, 2016, which led to a slight decrease in leverage to 5.0x from 5.1x at December 31, 2015. (Debt balances are now reported net of capitalized financing costs – prior periods have been adjusted.)

§

Book value per share decreased $0.33 to $13.84 at the end of the first quarter of 2016, down from $14.17 at the end of the prior quarter due primarily to an increase of 1.1 million basic shares resulting primarily from the exercise of stock options and other comprehensive income for the quarter, which reflected approximately $2.8 million of unrealized losses on securities.  Option exercises were elevated in both the fourth quarter of 2015 and first quarter of 2016 as holders exercised options that were expiring in March 2016.  

§

Average diluted shares outstanding were 46.4 million shares for the quarter, down from 47.0 million for the prior quarter, and total outstanding shares at March 31, 2016 were 47.6 million compared to 46.5 million at December 31, 2015.

§

Pre-tax returns on average equity decreased slightly to 4.2% in the first quarter, from 4.3% in the prior quarter.  On an after-tax basis, returns on average equity were consistent at 2.5% in the first quarter and the prior quarter.  

Robert K. Brown

500 Boylston St., Suite 1250

Boston, MA 02116

P. 617.848.2558

F. 617.848.4390

rbrown@newstarfin.com

March 31,

December 31,

March 31,

($ in thousands)

2016

2015

2015

Assets:

Cash and cash equivalents

$

150,657

$

35,933

$

28,666

Restricted cash

155,346

153,992

214,853

Cash collateral on deposit with custodian

19,442

61,081

49,082

Investments in debt securities, available-for-sale

89,687

94,177

79,891

Loans held-for-sale, net

468,443

478,785

149,609

Loans and leases, net

3,029,315

3,134,072

2,496,564

Interest receivable

13,269

13,932

8,394

Property and equipment, net

405

638

613

Deferred income taxes, net

33,653

33,133

30,376

Income tax receivable

6,398

5,342

103

Goodwill

17,884

17,884

-

Identified intangible asset, net

822

910

-

Other assets

22,623

21,504

32,712

Total assets (1)

$

4,007,944

$

4,051,383

$

3,090,863

Liabilities:

Credit facilities, net (1)

$

538,512

$

832,686

$

365,074

Term debt securitizations, net (1)

2,044,931

1,821,519

1,558,522

Senior notes, net  (1)

372,560

372,153

-

Subordinated notes, net (1)

235,855

209,509

130,643

Repurchase agreements, net (1)

94,785

96,224

78,942

Corporate debt, net (1)

-

-

234,438

Accrued interest payable

30,333

18,073

10,656

Other liabilities

31,552

41,741

56,300

Total liabilities

3,348,528

3,391,905

2,434,575

Total stockholders' equity

659,416

659,478

656,288

Total liabilities and stockholders’ equity

$

4,007,944

$

4,051,383

$

3,090,863

Three Months Ended

March 31,

December 31,

March 31,

($ in thousands, except per share amounts)

2016

2015

2015

Net interest income:

Interest income

$

61,952

$

60,591

$

39,749

Interest expense

39,433

36,222

22,334

Net interest income

22,519

24,369

17,415

Provision for credit losses

17,713

3,667

6,978

Net interest income after provision for credit losses

4,806

20,702

10,437

Non-interest income (loss):

Asset management income

3,441

3,707

920

Fee income

1,193

2,999

1,158

Loss on derivatives

(7

)

(5

)

(9

)

Gain (loss) on sale of loans, net

(107

)

154

(15

)

Other miscellaneous income

1,850

3,144

869

(Loss) gain on total return swap

(6,062

)

(4,121

)

1,203

Unrealized loss on loans held-for-sale

(3,667

)

(2,568

)

-

Gain on sale of Business Credit

22,511

-

-

Total non-interest income

19,152

3,310

4,126

Operating expenses:

Compensation and benefits

10,638

11,905

6,733

General and administrative expenses

6,430

4,967

3,499

Total operating expenses

17,068

16,872

10,232

Income from operations before income taxes

6,890

7,140

4,331

Income tax expense

2,881

2,931

1,792

Net income

$

4,009

$

4,209

$

2,539

Earnings per share:

Basic EPS

$

0.09

$

0.09

$

0.05

Diluted EPS

$

0.09

$

0.09

$

0.05

Weighted average shares outstanding:

Basic

46,447,008

45,601,534

46,769,864

Diluted

46,447,008

46,954,059

49,406,234

Three Months Ended

March 31,

December

March 31,

($ in thousands)

2016

2015

2015

Performance Ratios:

Return on average assets

0.40

%

0.42

%

0.36

%

Return on average equity

2.46

2.52

1.57

Pre-tax return on average equity (ROAE)

4.23

4.28

2.67

Net interest margin, before provision

2.21

2.45

2.51

Operating expenses as a percentage of average AUM

1.00

1.06

1.18

Operating expenses as a percentage of average total assets

1.68

1.68

1.44

Efficiency ratio

40.96

60.96

47.50

Portfolio yield

6.28

6.33

6.00

Credit Quality Ratios:

Delinquent loan rate for loans 60 days or more

past due (at period end)

0.60

%

0.84

%

1.68

%

Delinquent loan rate for accruing loans 60 days

or more past due (at period end)

—

0.26

—

Non-accrual loan rate (at period end)

3.62

3.43

3.90

Non-performing asset rate (at period end)

3.63

3.44

4.01

Annualized net charge off rate (end of period loans)

0.93

(0.07

)

—

Annualized net charge off rate (average period loans)

0.76

(0.06

)

—

Allowance for credit losses ratio (at period end)

2.19

1.81

1.97

Capital and Leverage Ratios:

Equity to assets

16.45

%

16.12

%

21.03

%

Debt to equity (1)

4.98

5.05

3.61

Book value per share

$

13.84

$

14.17

$

14.26

Average Balances:

Loans and other debt products, gross

$

3,963,680

$

3,792,173

$

2,683,211

Interest earning assets

4,099,105

3,951,302

2,817,452

Total assets

4,079,168

3,986,034

2,887,434

Interest bearing liabilities

3,475,454

3,327,106

2,205,096

Equity

655,422

661,339

657,090

Assets under management

6,883,009

6,340,199

3,520,963

Allowance for credit loss activity:

Balance as of beginning of period

$

58,726

$

54,481

$

43,693

General provision for credit losses

1,070

1,244

3,997

Specific provision for credit losses

16,642

2,422

2,981

Net (charge offs) recoveries

(7,327

)

579

68

Reversal due to sale of Business Credit

(1,819

)

-

-

Balance as of end of period

$

67,292

$

58,726

$

50,739

Three Months Ended

March 31,

December 31,

March 31,

($ in thousands)

2016

2015

2015

Supplemental Data (at period end):

Investments in debt securities

$

96,288

$

100,943

$

87,514

Loans held-for-sale

475,383

485,874

150,987

Loans held-for-investment

3,162,571

3,243,580

2,572,202

Loans and investments in debt securities

3,734,242

3,830,397

2,810,703

Deferred fees, net

(79,929

)

(65,104

)

(32,407

)

Allowance for loan losses - general

(29,533

)

(31,506

)

(26,230

)

Allowance for loan losses - specific

(37,335

)

(26,753

)

(23,706

)

Total loans and investments in debt securities, net

$

3,587,445

$

3,707,034

$

2,728,360

Unused lines of credit

280,283

601,805

330,041

Standby letters of credit

8,745

8,696

7,974

Total unfunded commitments

$

289,028

$

610,501

$

338,015

Three Months Ended

March 31,

December 31,

March 31,

($ in thousands)

2016

2015

2015

Performance Ratios:

Adjusted operating expenses as a percentage of average total assets

1.59

%

1.60

%

1.33

%

Consolidated Statement of Operations  Adjustments (1):

Operating expenses

$

17,068

$

16,872

$

10,232

Less: non-cash equity compensation expense (2)

951

823

730

Adjusted operating expenses

$

16,117

$

16,049

$

9,502

Average Balances:

Equity

$

655,422

$

661,339

$

657,090

Adjusted equity

$

655,422

$

661,339

$

657,090

Three Months Ended

March 31,

December 31,

March 31,

2016

2015

2015

Risk-adjusted revenue

Net interest income after provision for credit losses

$

4,806

$

20,702

$

10,437

Non-interest income

19,152

3,310

4,126

Risk-adjusted revenue

$

23,958

$

24,012

$

14,563

(1)

Adjustments are pre-tax, unless otherwise noted.

(2)

Non-cash compensation charge related to restricted stock grants and option grants.

March 31,

December 31,

March 31,

($ in thousands)

2016

2015

2015

Portfolio Data: (Balance Sheet AUM)

Senior secured cash flow

$

3,247,965

87.0

%

$

3,008,829

78.6

%

$

2,177,755

78.3

%

Senior secured asset-based

207,304

5.6

534,979

14.0

415,093

13.9

First mortgage

78,999

2.1

100,732

2.6

109,622

3.9

Other

199,974

5.4

185,857

4.8

108,037

3.9

Total

$

3,734,242

100.00

%

$

3,830,397

100.0

%

$

2,810,507

100.0

%

Leveraged Finance

$

3,479,737

93.2

%

$

3,214,131

83.9

%

$

2,322,310

82.6

%

Business Credit

-

-

342,281

9.0

264,910

9.4

Real Estate

78,999

2.1

100,732

2.6

109,622

3.9

Equipment Finance

175,506

4.7

173,253

4.5

113,665

4.1

Total

$

3,734,242

100.0

%

$

3,830,397

100.0

%

$

2,810,507

100.0

%

Managed Portfolio (AUM)

Commercial Lending

Loans held-for-investment

3,073,327

46.8

%

3,243,580

46.7

%

2,572,202

68.1

%

Loans held-for-sale

475,383

6.7

485,874

7.0

150,987

4.0

Total Commercial Lending

3,548,710

53.5

3,729,454

53.7

2,723,189

72.1

Asset Management

   Middle Market Direct Lending

    Investments in debt securities

$

96,288

1.5

%

$

100,943

1.4

%

$

87,514

2.3

%

    Arlington Program (2)

401,901

6.1

401,794

5.8

399,590

10.6

    Clarendon Fund (2)

401,366

6.1

397,852

5.7

387,420

10.3

    Credit Opportunities Fund (2)

15,360

0.2

24,926

0.4

35,444

0.9

       Sub-total Middle Market Direct Lending

914,915

13.9

%

925,515

13.3

%

909,968

24.1

%

   Liquid/Tradeable Credit

    Arch Street (2)

89,244

1.4

-

-

-

-

    Avery Street (2)

108,697

1.6

123,765

1.8

-

-

    Emerson Place (2)

156,147

2.4

163,575

2.3

-

-

    Hull Street (2)

500,717

7.6

499,428

7.2

-

-

    Lime Street (2)

250,904

3.8

251,628

3.6

-

-

    Longfellow Place (2)

502,182

7.6

502,038

7.2

-

-

    Staniford Street (2)

400,803

6.1

400,074

5.8

-

-

    TRS Fund (1,3)

-

-

163,399

2.4

141,586

3.8

    Other (1)

147,590

2.2

190,590

2.7

-

  Sub-total Liquid/Tradeable Credit

2,156,284

32.6

%

2,294,497

33.0

%

141,586

3.8

%

               Total Managed Assets

$

6,619,909

100.0

%

$

6,949,466

100.0

%

$

3,774,743

100.0

%

(1)

Managed assets owned by NewStar Financial Inc. include investments in debt securities, loans held-for-sale (LHFS) and loans held-for-investment, as well as loans referenced by a total return swap managed in the TRS Fund. Cash and other consolidated assets of NewStar Financial Inc. are excluded.  

(2)

Managed assets include loans, cash and other investments held by funds and managed by NewStar Financial and its affiliates.  

(3)

TRS Fund was structured as a total return swap that references a portfolio of broadly syndicated loans. NewStar earns net interest income and retains the risk of the reference assets.