Drive Shack Inc.
Q4 2010 Earnings Call Transcript

Published: 1 Mar 2011

[Operator:]

Good morning, my name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Newcastle’s Fourth Quarter and Year-End Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. I would now like to turn the conference over to Nadean Novogratz. Please go ahead, ma’am.

[Nadean Novogratz:]

Thank you, Tiffany, and good morning, everyone. I'd like to welcome all of you today, March 1, 2011, to Newcastle's fourth quarter and full-year 2010 earnings conference call. Joining us today are Ken Riis, our CEO and President; and Brian Sigman, our Chief Financial Officer. I would also like to point out that statements today, which are not historical facts, may be forward-looking statements. Our actual results may differ materially from the estimates or expectations in any forward-looking statements. These statements represent the company's beliefs regarding events that by their nature are uncertain and outside of the company's control. So you should not place undue reliance on any of these statements. I would encourage you to review the forward-looking statement disclaimer in our earnings press release, including the recommendation to review the risk factors contained in our annual and quarterly reports filed with the SEC. Now I would like to turn the call over to Ken Riis. Ken?

[Ken Riis:]

Thanks, Nadean. Good morning, and thank you for joining our fourth quarter and full-year 2010 earnings conference call. 2010 was very active and a productive year for Newcastle. Last year we set in motion several key initiatives that significantly increased shareholder value, deleveraged our balance sheet, and stabilized cash flow generated from our CDOs and operations. As a result of our success in 2010, today our cash flows and our overall operating results are much more predictable and reliable. There are few significant activities from last year that I would like to highlight on the call today. First, we generated approximately $50 million of cash flow from operations for the full-year. Second, with the tender of 60% or $90 million of our outstanding preferred stock and the retirement of $51 million of our trust preferred debt at a discount, we created $80 million of shareholder value and eliminated $12 million of annual interest expense. Third, we repurchased approximately 480 million of CDO debt at an average price of $0.45 on the dollar generating $266 million of stockholder value. And finally, we reinvested a large amount of restricted cash at significant discount prices and high returns. For the year, we purchased 625 million face amount of assets at an average price of $0.78 on the dollar generating an unleveraged return of 12%. This investment activity not only stabilized the quarterly cash flows coming from CDO VIII, IX, X but it also increased our expected principle recovery on the junior CDO bonds held on our balance sheet in those deals. As it relates to the fourth quarter, we finished the year strong. We repurchased $316 million of CDO debt and produced good operating results. The major transaction for the quarter represented the purchase of 257 million of CDO VI Class I notes at a price of 67% of par. This purchase represented our first large acquisition of senior CDO bonds. We repurchased 100% of the outstanding notes using a combination of restricted and unrestricted cash and a $19 million loan. Obviously, these transactions require more capital as this debt trades at higher prices and in larger block sizes. The benefit is being senior in the capital structures and the first to receive principal as the underlining collateral pays down. In this case, we expect to realize all interest due and recover the 33-point discount over an average of three years, resulting in an unleveraged mid-teens return on the $174 million investment. We are in a good place, and with a stabilized balance sheet 2011 is about new investment in earnings growth. We had a good start to the year so far. First, we received a 190 million mezzanine loan payoff, increasing cash on our balance sheet and in our CDOs. Second, we repurchased the CDO management rights on 17 CDOs for $2 million. All of these deals are static and much of the work is administrative and easily absorbed into our existing platform. These deals are distressed in much of the collateral backing the CDOs has defaulted. Today, the non-defaulted collateral balance equals $1.3 billion and the face amount of debt equals $4 billion. As a collateral manager, we will earn a senior management fee of 20 basis points on the non-defaulted balance and project to earn about 2 million in fees in 2011. This is all good and we will continue to earn management fees over the coming years, but the bigger opportunity may come from the 4 billion face amount of outstanding CDO debt. All of this debt trades at a discount, and I think we can source some good investment opportunities here. Today we have 58 million of unrestricted cash and 190 million of restricted CDO cash to invest. We plan to use our existing balance sheet cash to repurchase CDO debt and other assets offering a mid-teens return in equity. For our restricted CDO cash, we will continue to target new security and loan investments with stable credits and unleveraged returns of 8 to 9%. We are currently seeing a strong investment pipeline and look forward to discussing our investment progress in the near future. Now with that, I’ll hand it over to Brian Sigman, our Chief Financial Officer, to review our results in more detail. Brain?

[Brian Sigman:]

Thanks, Ken, and good morning, everyone. Based on Ken’s broader view of Newcastle and the markets, I will drill down on our liquidity, financial results for the quarter, and finish with some key points. Our liquidity

[Operator:]

(Operator Instructions). Your first question is from the line of Joshua Barber of Stifel Nicolaus

[Joshua Barber:]

Hi. Good morning. Congratulations on another solid quarter. A couple of quick questions. Do you have – could you give us the remaining time left to invest the restricted cash just given the CDO reinvestment periods?

[Brian Sigman:]

CDO VIII is November, 2011. CDO IX is May, 2012. And CDO X is July, 2012.

[Joshua Barber:]

Okay. So suffice to say that you’re going to try to get most of that cash invested this year?

[Brian Sigman:]

Yes, definitely.

[Joshua Barber:]

Could you talk a little bit about the C-backed deal for a minute? You had mentioned about $4 billion in collateral, but the release said something about 1.3 billion. Is that just the difference in the defaulted collateral and the performing collateral?

[Ken Riis:]

Yeah, the amount of – there’s more collateral backing the CDOs. So what I was trying to highlight, this is Ken, there is $1.3 billion of non-defaulted collateral that we get paid a fee on. But there’s $4 billion of sort of face amount of debt outstanding. So you know, these deals are obviously in distress, they’re backed by, you know, asset-backed securities but we earned the fee on the non-defaulted balance, which is currently, or as of January, was $1.3 billion.

[Joshua Barber:]

And just to clarify, you didn’t actually buy the CDO equity, you just bought the management rights, correct?

[Ken Riis:]

That’s correct.

[Joshua Barber:]

So you won’t have to consolidate them or anything?

[Brian Sigman:]

We do own some bonds and as you see in the 10-K, that we’re still evaluating. On the whole, we don’t think we’ll end up having to consolidate most but we just have to go through the deal. So we don’t think we’re going to have to consolidate.

[Joshua Barber:]

Okay. But if you would end up being able to buy back some of those other bonds at a discount, it’s not like you would be getting the big cash flow from the CDO equity if that were to be able to get turned back on?

[Brian Sigman:]

Well, you would get the sub fees and to an extent, your bonds were cash falling because they were passing the test, you would. But like Ken said, they are in a lot of distress but there are certain bonds that we could buy back that would create cash flow to those bonds. And if you, you know, the more you do buy back, and you would buy back the equity of the deal, then you probably would have a consolidation under GAAP.

[Joshua Barber:]

Understood. Thanks very much, guys.

[Brian Sigman:]

Thanks.

[Operator:]

Your next question is from Matthew Howlett of Macquarie.

[Matthew Howlett:]

Okay, guys, thanks for taking my question. Great start to the year. My question is, Ken, what do you consider the firm’s get capacity at? How many more lies can you get set up again? What’s available to you? The rate looks terrific, the terms look good; what can we expect in 2011?

[Ken Riis:]

Just to clarify, the debt capacity in terms of CDO debt?

[Matthew Howlett:]

In terms of credit – I’m sorry – in terms of non-agency MBS credit line set up to buy credit, CDOs and CMES, or something outside securitization or even include securitization.

[Ken Riis:]

We’re not, at this point, pursuing credit lines or recourse facilities beyond what we need to do, or specific to one acquisition as we did in the fourth quarter with CDO VI. So you know, we’re not looking at establishing those lines of credit. And you know, we have a fair amount of cash, more cash than I would like in our CDOs to reinvest, and $58 million of cash in our balance sheet. And you know, so we’re focused on buying assets that are unlevered that earn a mid-teens return. We did that in the fourth quarter and I think we could continue to do that without really adding any additional debt on our balance sheet.

[Matthew Howlett:]

Got you. So the mid-teens returns are still available even on the senior pieces of the CDOs?

[Ken Riis:]

Yes. It’s subject to obviously sellers wanting to sell there, but you know, we’re seeing some opportunity there.

[Matthew Howlett:]

Great. And just before I get to the opportunities, the 59 million, the difference, the remainder of the CW bought-back indices Class 1 MM was that senior or was that mezz from other CDOs?

[Brian Sigman:]

It was mezz from other CDOs. Really, the CDO VI transaction was the first – like Ken said, the first significant senior bond that we bought.

[Matthew Howlett:]

Great. And then would you be looking for some of the CDOs, IV, V, VI and VII? I mean, could there be more senior acquisitions going forward? I mean, if they’re anything in size, could you do again similar to what you did in December?

[Brian Sigman:]

That’s a potential, you know, depending on the deal. The senior bonds are held in large concentration so there’s not a large amount of investors that hold those securities. So to the extent they have a seller, we have a seller of those bonds, you know, we’re talking to them and we’re trying to pull them out.

[Matthew Howlett:]

Great. And then just moving to the OC test on CDO X, that’s the one that you guys have said in the past you are most concerned about the assets and watch that went down with I guess, were there downgrades? What happened there when OC levels improved? It looks like the excess cash was flat on that one. I mean, where do you stand on that one? Are you feeling much better about it today? It’s certainly your largest one and the one that has the longest reinvestment period. What happened in the quarter where these assets and washouts in 400 million came off?

[Ken Riis:]

We did have significant downgrades in the assets in CDO X. They weren’t downgraded to a point where they really affected our OC significantly in the transactions or in the deals. So we feel good about that. And we feel better that, you know, there’s a smaller amount still on negative watch, and you know, we feel better than we did last quarter as it relates to the cash flows coming to us from that CDO.

[Matthew Howlett:]

Okay. On some of the mezz delinquencies that went out, did those just get resolved or did you sell those? There was a big drop in the mezz delinquency, or the B notes.

[Brian Sigman:]

Yeah. There was actually one mezz loan that we had moved to the other investments and I think that actually had a significant decrease, so it was delinquent, it got pulled out of that line item and went to the one below. I think that represents most of the change from 33% to 19%.

[Matthew Howlett:]

Great. Great, thanks guys. Congratulations.

[Brian Sigman:]

Thanks.

[Operator:]

Your next question is from the line of John Evans of Edmunds White Partners

[John Evans:]

Hey, it’s John Evans at Edmunds White Partners. Can you, first of all, about the negative credit watch, your negative credit watch came down significantly sequentially and it’s come down significantly over the last six quarters. Can you talk a little bit about that trend first of all, and does that have to do anything with the rating agencies changing or is it just that we should take that the credit quality of the CDOs is improving that substantially?

[Ken Riis:]

I think the change in the negative watch assets is a function of the rating agency is going through their evaluation process, which takes time. And then recording their downgrades along the way. You know, fortunately for us now, we’re sort of at the tail end of that process and you know, we’ve had a lot of downgrades and we feel good about where we are as it relates to the CDOs that are currently generating cash flow for the company.

[John Evans:]

Okay. Can you talk a little bit about – you did something a little different in the quarter, you reinstated the preferred. You’ve done that on and off. Is the thought process of you and the Board is to continue to pay the preferred on a quarterly basis now because you have enough stability in the cash flows and seeing the investment opportunities? Can you give us any insight into that?

[Ken Riis:]

Well, it’s a quarter-to-quarter evaluation as we sit down every quarter with the Board to make that decision. We – our operating results have stabilized so we feel better about paying the preferred dividend. I mean, the way we think about the preferred dividend, if we don’t pay in the quarter, as you’ve seen in the past, we’ve pretty much caught up any deferral that we didn’t pay in subsequent quarters. So for us, going forward, it’s a quarter-to-quarter decision and it really will come down to our operating results and that’s when we’ll make the decision as to whether we’ll pay it or not. And you know, the good news is with the conversion sized buyback we did last year, we did take away a lot of the amount that needs to be paid. So right now it’s at a nice level where our operating cash flow is justified making the payment.

[John Evans:]

Because what is, I guess, all in on an annual basis, what is the preferred dividend for you?

[Ken Riis:]

Like 5.5 million.

[John Evans:]

Okay. And so you’re on a run rate of – you’re doing somewhere between 13 and 17 million, kind of a quarter, just on your income off the CDOs. Correct?

[Ken Riis:]

Yeah. We did 13 million in the fourth quarter off the CDOs.

[John Evans:]

Then the other question I had for you – you’ve done a great job going through this transition and adding a lot of shareholder value from the standpoint of buying your CDOs back. It seems like there’s a lot of opportunities for investments. You’ll get some cash back from existing CDOs and you have reinvestment periods, but can you give us any kind of insight as shareholders, just your thought process of what NCP becomes longer term and how you raise capital longer term? Do you think you start to institute a dividend on the common and that’s how you – and then you start to raise capital with the common? Are you going to tap the debt markets? How do you take advantage of the opportunities that you see out there?

[Ken Riis:]

Well, there’s a lot in that question. One thing I’ll say is being managed by Fortress is a big advantage of ours because we do see a tremendous amount of deal flow across different asset classes. So as we see new investment opportunities come up, we’re definitely all over those and if they’re accretive and make sense for the company, we’ll go ahead and pursue those. As it relates to raising new capital or where we’re going to – what new investments we’re going to target and we don’t really comment on that, but you know, again, we do see good deal flow and we’ll take it as it comes.

[John Evans:]

Right. But I guess, I mean, you just did that one deal that you talked about where you think the unlevered return is going to be mid-teens over three years. I mean, that’s a pretty darn good return. So if there’s more deals like that, do you potentially lever up? I mean, this line that you’ve got is LIBOR plus 150, I mean, it seems like you have a lot of opportunity to reinvest a lot of capital. I guess, I think it would be very helpful if you could give your shareholders kind of a roadmap of kind of how you think you’re going to grow the business going forward and that’s probably the next level to take the stock. So when you start to articulate that strategy, I understand you want to keep your investments close to the vest, but I think you owe that to your shareholders, don’t you?

[Ken Riis:]

Well, I think what we owe to our shareholders is, you know, generating good operating results. We don’t want to – we don’t typically project investment activity or earnings and we haven’t done that since we’ve been a public company. So I think it’s a – you know, as we sit here today, you should feel confident that we’re looking at all new investment opportunities and as they come up we’ll take advantage of those.

[John Evans:]

Okay, then the last question I’ll ask you, when you look at the opportunities that you have right now that you see in the different markets, can you just talk a little bit about the potentially unlevered returns that you do see and do you feel like you have enough capital currently to put – to work in those different opportunities or could you use more capital?

[Brian Sigman:]

I think that we had this big payoff in the beginning of February, which was pretty great from a capital perspective. We have a lot of money in the CDOs. We’re actually very focused on putting that to work. CDOs have their own restrictions on what you can and can’t do and right now we’re sitting on about 60 million outside of CDOs which is kind of where we were at the end of the last call. And you know, a nice, big, large opportunity presented itself, we were able to get some great financing on it and if that comes up again we’re going to try and take advantage and in the event that we run out of that and we still see accretive opportunities out there, then yeah, we would try and raise capital either through debt or equity market to continue to try and take advantage of it. And I think, you know, Ken’s biggest point is that we do see a lot of opportunities here that maybe some of our competitors, just being affiliated with the company like Fortress.

[John Evans:]

Okay. But the long and short of it, we should take away that you have plenty of capital potentially to put to work and that you see nice opportunities where you could potentially get mid-teens kind of unlevered returns. Is that fair? I’m not trying to put words in your mouth.

[Brian Sigman:]

Yeah. That’s fair. But you know again, that capital can be 60 million today and if we have another large transaction like we did in December, then it could go away pretty fast. And then the next one would require more capital. Or you know, to the extend other investments pay off, or we generate some capital on the Triple-As that we bought back, you know, there’s other means where the capital can be generated internally. But I think you’re 100% right. Once we do use that up and if we still think it’s accretive to find new purchases at the returns that are accretive to shareholders, then yeah, we’ll definitely go back to the capital market.

[Operator:]

There are no further questions at this time. I would now like to turn the conference back over to Nadean Novogratz.

[Nadean Novogratz:]

Thanks again, everyone, for joining us today. We really appreciate it and we look forward to speaking to you next quarter. Thank you.

[Operator:]

This concludes today’s conference call. You may now disconnect.