NEWSTAR FINANCIAL, INC. Moderator: Colleen Banse February 17, :00 am CT

Transcription

1 Page 1 NEWSTAR FINANCIAL, INC. February 17, :00 am CT Operator: Good day everyone and welcome to the NewStar Financial Fourth Quarter 2009 Earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to your host for this morning, Ms. Colleen Banse. Please go ahead, ma'am. Colleen Banse: Thanks, Anthony and thanks to everyone for joining us for our earnings conference call, where we will be discussing our fourth quarter 2009 results. With me today are Tim Conway, Chairman and Chief Executive Officer of NewStar Financial and John Bray, our Chief Financial Officer. Before I turn the call over to Tim, I want to remind you that we have posted a presentation on the Investor Relations section of our Web site, Also available on our Web site is our financial results press release, which was filed on Form 8-K with the SEC this morning. This presentation and our financial results press release contain additional materials related to this conference call that we may refer to during our remarks today, including information with respect to certain non-gaap financial measures.

2 Page 2 This call is also being Web cast simultaneously on our Web site and a recording of the call will be available beginning at approximately 1:00 pm Eastern Time today. Our press release and Web site provide details on accessing the archived call. Also before we begin, I need to inform you that statements in this earnings call, which are not historical facts, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of All forward-looking statements including statements regarding future financial operating results involve risks, uncertainties and contingencies, many of which are beyond NewStar's control and which may cause actual results to differ materially from anticipated results. More detailed information about these risk factors can be found in our press release issued this morning and in the risk factor section as updated on our quarterly reports on Form 10-Q. NewStar is under no obligation to and we especially disclaim any such obligation to update or alter our forward-looking statements, whether as a result of information, future events or otherwise except where required by law. NewStar plans to file its Form 10-K with the SEC on or before March 16 and urges its shareholders to refer to that document for more complete information concerning the company's financial results. Now I'd like to turn the call over to NewStar's Chairman and Chief Executive Officer, Tim Conway. Tim Conway: Thanks, Colleen and thanks for joining the call today. A year ago, we were in the middle of the most severe market conditions most of us have ever seen. The credit crisis and the

3 Page 3 recession resulted in unprecedented levels of illiquidity and credit costs and virtually all lending activity ground to a halt. Like others, we expected 2009 to be an extremely challenging year. As a result, we focused on a strategy to defend our balance sheet and book value per share to emphasize three important objectives, extending our liabilities and maintaining an adequate liquidity buffer, managing credit for the best outcomes and right sizing the cost base. We were very pleased with the progress we made against each of these objectives in In doing so, I believe that we have positioned the company to take advantage of an exciting market opportunity. During the year, we took a number of steps to reposition the balance sheet and reduce short-term debt. We closed the year with the announcement of two milestone transactions that strengthened the company's balance sheet. In January, we completed a $75 million corporate debt financing which provides us with a conservative liquidity buffer and enhances our financial flexibility. This financing was attractively structured as a revolving credit facility, which enables us to use the facility only if we need it or if the returns we generate from usage are higher than the marginal cost of drawing on the facility. This flexibility will allows us to better manage credit outcomes and cash flows and to invest in other opportunities. Soon after closing the corporate debt facility, we further demonstrated our access to capital by completing a $275 million term debt securitization. We believe that this securitization was the first middle market CLO issued since the market collapsed. This transaction highlights the value of our direct lending franchise and the quality of our credit track record. The CLO will enable us to provide more capital to our customers in 2010.

4 Page 4 During the year, we renewed three debt facilities, extended the average life of our maturities and paid down debt. By doing this, we much better matched the duration of our assets with our liabilities. Short-term debt now totals $74 million, a reduction of $340 million or 82% since the beginning of the year. Our cash and liquidity position also improved during the year. Unrestricted cash increased to $40 million during the fourth quarter and at the end of the year, we had $115 million of cash and availability under the revolving credit facility. Our financial results in the fourth quarter and for the year were weak in that they reflected substantial additions to credit loss reserves. We reported an adjusted loss of $11.5 million in the fourth quarter as specific reserves totaled approximately $40 million. However, our credit outlook has improved, and we believe that provisions for loan losses and our allowance for loan loss reserves have peaked. We expect credit costs to moderate in 2010 but improvement in other credit metrics including NPAs and charge offs are likely to trail as we continue to resolve impaired loans within the portfolio. At this stage of the cycle, our confidence in the credit outlook is strengthened by better visibility based on the time spent working on each name in the portfolio as well as improvement in the broader economy. Importantly, we believe that our credit performance through the cycle will continue to compare favorably to peers and to recognized market benchmarks. We aggressively managed expenses in 2009, reducing headcount by 35% during the course of the year and now believe our expense structure is appropriately sized for the current market opportunity. We have been able to preserve the organization franchise through the credit crisis and I believe that we have a committed and energized team in place to execute on our plans.

5 Page 5 Although lending activity was slow throughout the course of the year, we were active in the market, closing 13 deals during Based on the steps we have taken to de-risk the balance sheet, an improving credit outlook and our current economic forecast, we now expect to return to profitability in With that, I'll turn it over to John to provide more detail on our fourth quarter results and then I'll wrap up with closing comments and our outlook for John. John Bray: Thank you, Tim. I'm going to begin with slide 8 or page 8, which is a summary of our Q financial results. The adjusted net loss was $11.5 million for the fourth quarter, which is GAAP net loss excluding after-tax noncash compensation expense of approximately $1.9 million related to equity grants made in connection with our initial public offering. The fourth quarter adjustment included a million dollar discrete tax item resulting from a vesting event in the quarter of restricted grants at the time of the IPO, issued at the time of the IPO. This resulted in adjusted basic and diluted loss per share of 23 cents for the quarter. On a GAAP basis, the net loss was $13.4 million and 27 cents per diluted share for the fourth quarter. Our share count on a weighted average basis was 49.3 million shares for the quarter. At the end of the quarter, we had almost 50 million shares outstanding, reflecting a restricted stock grant we made in December. If you turn to the next slide, I'd like to take you through the slide titled Funding Platform Strengthens by Recent Financing. As Tim mentioned, we have successfully addressed our funding risk. We completed a $275 million CLO and a $75 million revolving credit notes facility.

6 Page 6 Investors purchased 68% of the value of the CLO collateral pool and we retained the remainder. The vehicle also has a ramp up amount of $50 million, which we fill with new originations. The blended pricing of the notes offered was LIBOR plus 458 basis. Notes are expected to mature on July 30, The $75 million revolving credit notes begins to amortize in July 2011 and matures July 5, Advances under the notes are priced on a grid tied to usage, which was LIBOR plus 900 at closing. The credit facility provides us a buffer, which allows us to manage cash effectively, unlock cash trapped in funding vehicles and optimize recoveries on our impaired assets. In addition, we have the ability to reduce the commitment during the first year at our option. Without this line, we may have had to make decisions based solely on what was the best outcome for maximizing cash. The line provides us an insurance policy allowing us to deliver maximized value to our shareholders. As I mentioned last quarter, we renewed our Citi warehouse in November and extended liquidity maturity date to At December 31, we had $40 million of unrestricted cash, up from $31 million at the end of Q3. In addition, to the ramp up of the new CLO, we continued to have reinvestment capacity in the two existing CLOs at attractive lock and spreads. At year-end, we had capacity to originate approximately $120 million of loans and if you assume a 17-1/2 prepayment rate at the rate we are presently running, we have room to originate approximately $400 million for the balance sheet and the NewStar Credit Opportunities Fund in 2010.

7 Page 7 Our funding profile shows that substantially all of our outstanding debt is classified as either long term or medium term. If you now turn the next slide, this quarter we continued to provide additional disclosure through these next three slides, showing how the company funds its loan portfolio and lending operations through a combination of CLOs, medium term debt in large banks, warehouse lines of credit and equity. Sixty seven percent of our loans are funded through securitizations at attractive (locked) in spreads. CLOs represent a stable source of funding, which are designed with flexibility to absorbed nonperforming assets. If there's a deterioration in an asset held in a CLO, we have the option but not the obligation to repurchase the asset and substitute collateral. If we choose not to repurchase, the CLO will track cash in an account sufficient to pay down the debt. Having impaired assets in the CLOs can be effective liquidity strategy because the aggregate CLOs should generate well over $50 million of excess spread per year that can be used instead of balance sheet cash to cover nonperforming assets. The next slide shows that we have reduced our short term debt by 82% since December 31, Pro forma this new CLO pro forma for the new CLO proceeds to pay down bank debt. We have net asset positions of approximately $218 million. Including our CLOs and term debt, approximately 80% of our free loans were term funded. If you turn to the next slide, the key takeaway is that the $75 million revolving credit facility improves the company's financial flexibility. And we have actively supported our warehouses and CLOs by repurchasing more than $100 million during the cycle. By repurchasing credit impaired loans from the warehouse facilities, the company has avoided the need to sell loans at depressed prices and preserve the value of the residual interest in the loan portfolio.

8 Page 8 The next slide that I'd like to cover is the revenue increasing as balance sheet contracts. This shows our revenues increased during the quarter while the balance has contracted. Managed loan portfolio is roughly $2.6 billion, down slightly from levels over recent quarters, while adjusted revenue increased to $28.8 million. Net interest income decreased slightly to $24.4 million from $24.5 million in the third quarter. I'll explain the factors affecting the net interest income and the net interest margin in greater detail later. Non-interest income was $4.4 million in the fourth quarter, reflecting a $3.1 million gain from the repurchase of our CLO debt. The next slide, origination new loans funded by the CLOs and the NCOF. The origination slide describes the amount in composition of fourth quarter originations and related revenue that the origination line drives. Originations totaled $47 million, $13 million was retained on NewStar's balance sheet and $34 million was booked for the NewStar Credit Opportunities Fund. During 2009, we originated approximately $43 million for the balance sheet and approximately $77 million for the fund. We were also able to transfer approximately $193 million of assets out of our warehouse facilities and into our low cost CLOs. We optimized the cost and match our funding with assets in Credit spreads and amortizing fees on new loans originated in third quarter were roughly 660 basis points over LIBOR. We continue to get LIBOR floors in all of our new transactions and approximately 38% of our portfolio now includes them. These floors give us a natural hedge against our equity funded loans if interest rates move down. If rates move up, asset yields will not move as quickly as liabilities since the different levels of the floors are still in place.

9 Page 9 The next slide to look at is our net interest margin slide. The wider net interest margin was driven by benefits of LIBOR floors. The net interest margin was 431 for Q4, up from last quarter's numbers of 4.16%. And during the quarter we benefited by approximately 20 basis points from interest rate changes primarily within our liabilities and our LIBOR floors. Increased nonperforming assets were a negative drag on the margin of five basis points to the detriment. I would like to remind you that the amortization of deferred financing fees could have a negative impact on our margin. We incurred additional fees and have higher cost of funds associated with the new Fortress debt and the new CLO. We expect to see the impact of (UCs) and any other potential financing activities reflected in the future net interest margins. We made the trade to ensure that we had adequate liquidity. We gave up a little margin to ensure we had the proper liquidity levels for the environment we are in. In addition in the first quarter, we expect to amortize all unamortized fees with our Deutsche Bank facility totaling approximately $1.9 million. We were able to pay off this facility with the proceeds we received from our CLO. Our net interest margin will run under 4% moving forward. The next slide, diversified loan and investment portfolio continues to show that our loan portfolio's diversified, and we continue to reduce our real estate exposure. As we turn to the credit performance slide, we believe the outlook for credit is improving, which may signal a peak in the allowance for loan losses as of December 31. We increased our allowance for credit losses to 568 basis points on period end loans compared to 469 basis points at September 30. We recorded $40 million of specific reserves this quarter as the credit quality loans deteriorated and loans migrated from our general allowance to our specific allowance.

10 Page 10 Nonaccrual loans increased to $163 million at the end of the fourth quarter. Other real estate owned consists of two properties totaling $9.4 million as of December 31, resulting in a nonperforming asset rate of 8.55%. Our annualized charge off rate increased to 5.1% as a period end loans. When we look at the annualized charge off rate on a lag basis it's 4.8%. Although specific and nonaccrual loans increased in the fourth quarter, we believe we are near the peak of specific reserves. However, we expect the levels of charge offs in NPAs to remain elevated for several quarters. The next slide, nonperforming assets, this slide breaks down our nonperforming assets by industry and then on average we were carrying our NPAs as 54% of face value. We continue to experience weakness in the commercial real estate building products in advertising base media. Next our Q4 income statement slide, this slide is our income statement for the quarter. As I mentioned earlier, adjusted net loss was $11.5 million for the quarter and GAAP net loss was $13.4 million. Net interest income was $24.4 million for the fourth quarter compared to $24.5 million in the third quarter. The margin came in at 431 versus 416 as I explained earlier. We increased provision from $32.6 million in the quarter to $39 million for the fourth quarter. Non-interest income increased to $4.4 million in this quarter due to the gain related or CLO debt. Expenses decreased to $9.6 million for the fourth quarter from $10.9 million in the third quarter primarily due to severance costs incurred in the third quarter. Headcount was reduced from 68 people as of September 30 to 61 at the end of the fourth quarter. The next our final slide my final slide is the balance sheet, Q4 balance sheet is shown on the next slide. NewStar's book equity at quarter end was $546 million and our book value per share

11 Page 11 was $ Last month we announced that our board approved a stock repurchase program. Over the next year we plan to buy back approximately $10 million of outstanding common stock, either through the open market, a 10b5-1 plan or through privately negotiated transactions. To date we have not purchased any of our outstanding shares. Our 10b5-1 program will go into effect after our blackout period ends on February 19. If you use an average stock price of $5, we expect to reduce our outstanding share count by about 2 million shares. I will now turn it back to Tim. Tim Conway: Thanks, John. With a stronger balance sheet and improved outlook, we have now shifted our focus to the future direction of the company and to generating attractive returns. I believe we're well positioned to take additional steps to enhance shareholder value. The credit markets are clearly getting better and while our near term imbalance of supply and demand has put pressure on spreads in recent months, longer term we expect spreads to be attractive due to an increased demand in a much thinner competitive landscape. We expect our own lending activity to increase significantly over the course of the year. As evidenced by the recent announcement of our stock buyback program that John just referenced, we will continue to take steps to enhance shareholder value. Our ability to pursue a repurchase program at this time reflects our improved cash position, our strong believe in the intrinsic value of the company and our commitment to improving the investment value of our stock. We believe the business model can still generate attractive returns even with lower leverage and higher cost of funds than we had originally targeted.

12 Page 12 Going forward, a business strategy focused on senior debt should support leverage in the 4-1/2 to 5-1/2 times range. With normalized margins for the business at about 450 basis points and fee revenue approximately equal to expenses at 1-1/4 to 150 basis points, we will generate attractive returns for shareholders. That concludes my prepared remarks and we're happy to take any questions you might have. Operator: Thank you. The question and answer session will be conducted electronically. If you would like to signal for a question, you may do so by pressing the star key followed by the digit 1 on your touchtone telephone. If you're using a speakerphone, please make sure your mute button is off or you pick up the handset before you press any numbers. Once again at this time, that's star 1 if you'd like to signal for a question. We'll take our first question from Sameer Gokhale at KBW. Please go ahead. Sameer Gokhale: Hi, thank you and good morning. Just a few questions, first one is, your loans held for sale seem to have increased during the quarter to (15.7) million from 3.1 million at the end of last quarter. Could you tell us what kinds of loans these are and where were they marked, if they're mark-to-market relative to face value? John Bray: Sameer, they're two loans that were originated to be moved to the NewStar Credit Opportunities Fund. What we do is we have to season them 30 days in loans held for sale and then they move to the Credit Opportunities Fund and so they basically move at PAR and they've actually already moved. Sameer Gokhale: OK, so that's helpful. They're going to be moved to the fund as opposed to selling to some other third party elsewhere.

13 Page 13 John Bray: That's correct. Sameer Gokhale: OK, that's helpful. And then you know your commentary on the credit quality improvement, I wanted to drill down on that a little bit further because you know it seems like NPAs have increased. And you said that you expect them to remain at elevated levels. But there was you know I would say a pretty meaningful increase in NPAs or loans of nonaccrual this quarter, charge offs are increasing, provisions were also higher. So you know what are you seeing if anything specifically that's driving you to think that the credit outlook has improved? Is just kind of general the tone regarding the economy and what you're seeing overall or is there something in your portfolio that's leading you to think that credit is going the outlook is improving? Tim Conway: Thanks, Sameer. What we really focus on is specific reserves and so we're looking at each name in the portfolio and determining whether there's any credit impairment in each name and taking a specific reserve when we believe that is the case. NPAs and frankly charge offs tend to lag specifics in terms of when they come through based on when we charge off ultimately charge off the piece of a loan. So our outlook with respect to specific reserves that'll drive earnings going forward is really based on one hand improving the economy and certainly more liquidity in the marketplace but more so on a specific name by name review that we do of the portfolio on a regular basis. And so we've been following each of these names obviously very carefully through the crisis and what we're seeing now is a pretty consistent theme. And that is in the beginning of the crisis as companies tried to work their way through it, they were reducing costs to try to increase earnings.

14 Page 14 And now what we're seeing is revenue growth in a number of different sectors. And so we're seeing a consistent improvement in the portfolio and we have a much better handle today on what we think the specific reserves will be going forward. Sameer Gokhale: OK, so when you talk to your actual customers, your borrowers, you're seeing a kind of improvement in discussions with them in their own businesses as well. And that's kind of leading you to think that maybe the performance of the portfolio should improve if it doesn't improve outlook. Tim Conway: Yes, it's clearly based on a name by name analysis. We're in touch with most of these companies on a monthly basis and looking at their numbers. And so it's really based on that. We do think the economy's going to get better but we think we're operating in a very volatile economic environment still and so our indications on where we think credit is going is really based primarily on a name by name buildup. Sameer Gokhale: OK, thanks. And then just my last question on your deferred tax asset, I think it's $56-1/2 million, is there already a valuation allowance embedded in there? And you know how do you think about you know not having to take future impairment charges to that deferred tax asset? John Bray: There's a very minor couple hundred thousand dollar valuation allowance in there and that has to do with some capital gains losses that we've taken and whether we can use capital gains if we're able to generate capital gains. We spend an inordinate amount of time ensuring that that asset is viable. And it really comes driven to looking out into the future and seeing when the different components of that $56 million will turn. There are two major components to that deferred tax asset, one being about $46 million of it is the difference in when we've set up specific reserves versus when we'll actually take those charge offs on those specific reserves.

15 Page 15 The second piece of it is about $11 million, which has to do with the amortization of our equity comp. You don't recognize the for tax purposes, the equity comp until either you have a vesting event or an exercise of the options. And so what you have to be able to demonstrate to keep that deferred tax asset on your books is that you will have future earnings to be able to offset when those items turn. And we have been able to I think demonstrate to the parties who have to agree with us that we plan to recognize all of it. Sameer Gokhale: OK, that's great. Thanks, John. Tim Conway: Thanks, Sameer. Operator: And as a reminder, that's star 1 if you'd like to signal for a question; star 1. We'll take our next question from David Long at William Blair; please go ahead. David Long: Hey, guys. Tim Conway: Hey, David. David Long: You mentioned a restricted stock grant in December. Can you provide a little bit more color and what are you using for the period end share count? John Bray: The period end share count is about 49.9 million. I think it's million to be exact. And we granted restricted shares in December to the company to reflect I think it was to the tune of I'm trying to get the right amount, hold on 1 second. Yes, 915,000 shares were granted in December for restricted shares.

16 Page 16 Tim Conway: Those are shares we had as part of an ongoing you know compensation and retention plan. But we're also at this point very excited about the fact that we've got a committed management team. The management team has really signed up for the next 3 years to execute on the plan and that was part of a long term incentive. It's a 3-year vesting period, long term incentive to consistent with our objective of keeping key people in place to execute on the business plan. David Long: OK, thanks for that additional color. Tim Conway: Those shares vest in 3 years. David Long: Right, OK. And then just to clarify on your you talked about being a return to profitability in Is that for the full year 2010 or are you saying in any in one of the quarters you guys will start to produce a profit again? Tim Conway: All right, number 1 we're operating in a volatile environment and credit costs can be lumpy but our view is that we will return to profitability for the year at this point. David Long: OK, great. Thanks, guys. Tim Conway: Thanks, Dave. Operator: And with no further additional questions in the queue, I'd like to turn the conference back over to Ms. Banse for any additional or closing remarks.

17 Page 17 Colleen Banse: Thanks, Anthony. That will conclude our remarks for today and thanks again to everyone for joining our earnings conference call. Operator: This does conclude today's presentation. We thank everyone for their participation. END