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Newcastle Investment (NCT) |
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WIKI ANALYSIS
Newcastle Investment Corporation (NCT) is a mortgage real estate investment trust (REIT) that specializes in real estate securities and other real estate-related assets. The company's business activity is segmented into Real Estate Securities, Operating Real Estate, Residential Mortgage Loans, and Real Estate Loans. The Real Estate Securities segment issues and manages investments in mortgage-backed assets (such as commercial mortgage-backed securities, or CMBS) and securitized real estate debt instruments. Operating Real Estate includes credit-leased real estate located in the U.S., Canada, and Belgium. Real estate leased to tenants with investment-grade credit ratings is known as credit-leased real estate. The purchase of residential mortgage loans advanced to high-risk borrowers comprises the Residential Mortgage Loans segment. Real Estate Loans consists of loan and mortgage pools. Newcastle funds its investments with secured borrowings, such as collateralized bond/debt obligations (CBOs/CDOs) and equity offerings. Formed in June 2002, the company is the result of a reverse spin-off from Newcastle Investment Holdings Corporation (NCT Holding), whereby it is treated as the continuing entity. Newcastle went public in October 2002, and is managed externally by Fortress Investment Group. As of September 30, 2007, the company had a core investment portfolio of $8.9 billion, which consisted of $4.1 billion of commercial real estate securities and loans, $2 billion of residential securities and loans, $927 million of REIT debt, $597 million of corporate bank loans. 84.6% of the total portfolio had an implied rating of AAA, with a weighted average rating of BBB.
NCT reported FFO of $(39.0) million, or $(0.74) per share. FFO included impairments of $74.9 million. Excluding the effect of charges, FFO was $0.68 per share. Net Income was $(39.3) million, or $(0.74) per share. Excluding the effect of non-recurring impairments, net income was $35.6 million, or $0.67 per diluted share. Recurring EPS was $0.09 below our estimates, which was due to a slowdown in new originations.
The company has sufficient cash and commitments to weather the current liquidity crisis in real estate debt markets. NCT has approximately $41 million of cash, $200 million available on its line, and $883 million available under various facilities. Cash flows have not declined significantly and we expect NCT to continue producing enough cash to cover the dividend in the coming quarters. The company's investment strategy is to generate recurring earnings through investments in non-cyclical real estate debt products. Due to current market conditions, credit spreads have widened considerably, and this will give the company attractive investment opportunities going forward. As loans are pre-paid, NCT will have capital to continue investing in high yielding securities. NCT expects $1 billion of assets to prepay next year, which will be reinvested in higher interest securities, which could add $0.20 per share to core earnings. The company's current yield, now over 20%, remains attractive. NCT recently raised its quarterly dividend to $0.72 per share, a 10.8% increase from 3Q 2006. While we do not expect any more increases in the dividend in the 2008, we expect the company will continue to fund its dividend with free cash flow as operations improve and the company's new investments incrementally add to the bottom line. The company is now achieving above average returns on its most current investments which will continue to drive earnings into 2008.
Newcastle is backed by a strong balance sheet, with nearly 60% of its real estate securities portfolio being investment grade. Investment activity slowed in the 3rd quarter, as the company has entered a defensive mode and is being more selective in deals. NCT purchased $273.7 million of commercial assets in the quarter, sold $55.9 million, and had paydowns of $254.9 million, resulting in net decrease of $37.1 million. By loan type the company funded CMBS ($240 million), Mezzanine Loans and B-Notes ($34 million). On the residential side, the company sold $16.1 million and experienced pay downs of $72.6 million. As a result there was a net decrease of $88.7 million in the residential portfolio. Purchased residential loans included subprime securities ($619 million), Agency RMBS ($671 million), subprime loans held for sale ($406 million). We remain concerned about the company's exposure to subprime loans NCT has $57.3 million of sub prime loans downgraded in the 3rd quarter and recorded impairments of nearly $68 million. The sub prime segment maintained an average rating of BBB and experienced two downgrades in the quarter.
Newcastle expects the commercial real estate sector to continue to drive investment activities in 2008. In the near term, focus will be primarily on mezzanine loans and B-notes, where there is a large amount of deal flow and the opportunity to realize good risk adjusted returns.
NCT's diversification significantly lessens the company's risk profile and enables the company to weather downturns in particular areas. 46% of the company's loans are commercial, 22% residential and 17% corporate bank loans and REIT debt. The credit profile of NCT's portfolio continues to improve, as 16 of the company's CMBS loans were upgraded ($117 million), while only 1 was downgraded ($16 million) in the quarter. The company's CMBS portfolio has a delinquency rate of only 0.33%, while the mezzanine and B-note portfolio has no delinquencies.
A $1.09 billion securitization of the sub prime mortgage loan portfolio (acquired in March and April 2007) was closed in July. Through the securitization trust, the company issued $1.02 billion face amount of investment grade notes ($979 million of these were sold to third parties) and invested approximately $50 million of equity. Also in July, NCT closed a $1.4 billion collateralized debt obligation. With this, NCT was able to reduce the financing cost by 39 basis points on $1.29 billion of debt and extended maturities outward.
Market uncertainty should cause credit spreads to widen in the coming quarters which will create opportunities for fresh capital investments at attractive returns. As of September 30, the company's weighted average net spread in its total portfolio was 1.54%, down from 1.50% last quarter. Core portfolio spreads were 1.73%, down slightly from 1.72% in the last quarter. The weighted average asset yield on the company's investment portfolio slightly decreased to 7.36% in the quarter, from 7.46% in Q2 2007.
We are maintaining our Buy rating on NCT. The company should continue to grow earnings with its diverse portfolio of commercial loans. While we expect housing loan volumes to continue to slow, the company will continue to be active in commercial real estate debt. The continued deterioration in subprime and Alt A residential loans could create more opportunities for NCT throughout the next six months. As spreads widen, spread investors like NCT could benefit. Although, the company will have to come up with financing in a tough environment to take advantage of opportunities. We feel that the sell off over the past three months was overblown, and the company, now trading at just over 5x 2007 EPS estimates represents a good value to investors.
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