news-10q_20160331.htm

 

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 March 31, 2016

OR

o

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 001-33211

 

NewStar Financial, Inc.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

54-2157878

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

500 Boylston Street, Suite 1250,

Boston, MA

 

02116

(Address of principal executive offices)

 

(Zip Code)

(617) 848-2500

(Registrant’s telephone number, including area code)

N/A

(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  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

¨

 

Accelerated filer

 

x

 

 

 

 

Non-accelerated filer

 

¨

 

Smaller reporting company

 

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x

As of May 7, 2016, 47,651,095  shares of common stock, par value of $0.01 per share, were outstanding.

 

 

 

 

 


TABLE OF CONTENTS

 

 

 

Page

 

PART I

 

 

FINANCIAL INFORMATION

 

Item 1.

Financial Statements (Unaudited)

3

 

Condensed Consolidated Balance Sheets as of March 31, 2016 and December 31, 2015

3

 

Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2016 and 2015

4

 

Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2016 and 2015

5

 

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2016 and 2015

6

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2016 and 2015

7

 

Notes to Condensed Consolidated Financial Statements

9

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

43

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

65

Item 4.

Controls and Procedures

66

 

PART II

 

 

OTHER INFORMATION

 

Item 1.

Legal Proceedings

66

Item 1A.

Risk Factors

66

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

66

Item 6.

Exhibits

67

SIGNATURES

69

 

 

1


Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q of NewStar Financial, Inc., contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These are statements that relate to future periods and include statements about:

 

·

our anticipated financial condition, including estimated loan losses;

 

·

our expected results of operation;

 

·

our growth and market opportunities;

 

·

trends and conditions in the financial markets in which we operate;

 

·

our future funding needs and sources and availability of funding;

 

·

our involvement in capital-raising transactions;

 

·

our ability to meet draw requests under commitments to borrowers under certain conditions;

 

·

our competitors;

 

·

our provision for credit losses;

 

·

our future development of our products and markets;

 

·

our ability to compete; and

 

·

our stock price.

Generally, the words “anticipates,” “believes,” “expects,” “intends,” “estimates,” “projects,” “plans” and similar expressions identify forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance, achievements or industry results to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. These risks, uncertainties and other important factors include, among others:

 

·

deterioration in credit quality that could result in levels of delinquent or non-accrual loans that would force us to realize credit losses exceeding our allowance for credit losses and deplete our cash position;

 

·

risks and uncertainties relating to the financial markets generally, including disruptions in the global financial markets;

 

·

the market price of our common stock prevailing from time to time;

 

·

our ability to obtain external financing;

 

·

the regulation of the commercial lending industry by federal, state and local governments;

 

·

risks and uncertainties relating to our limited operating history;

 

·

our ability to minimize losses, achieve profitability, and realize our deferred tax asset; and

 

·

the competitive nature of the commercial lending industry and our ability to effectively compete.

For a further description of these and other risks and uncertainties, we encourage you to carefully read section Item 1A. “Risk Factors” of our Annual Report on Form 10-K, for the year ended December 31, 2015.

The forward-looking statements contained in this Quarterly Report on Form 10-Q speak only as of the date of this report. We expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained in this Quarterly Report to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any forward-looking statement is based, except as may be required by law.

 

2


PART I. FINANCIAL INFORMATION

 

 

Item 1.  Financial Statements.

NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

 

 

 

March 31, 2016

 

 

December 31, 2015

 

 

 

($ in thousands, except share

and par value amounts)

 

Assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

150,657

 

 

$

35,933

 

Restricted cash

 

 

155,346

 

 

 

153,992

 

Cash collateral on deposit with custodian

 

 

19,442

 

 

 

61,081

 

Investments in debt securities, available-for-sale

 

 

89,687

 

 

 

94,177

 

Loans held-for-sale, net

 

 

468,443

 

 

 

478,785

 

Loans and leases, net (including loans at fair value of $89,244 and $0, respectively)

 

 

3,029,315

 

 

 

3,134,072

 

Interest receivable

 

 

13,269

 

 

 

13,932

 

Property and equipment, net

 

 

405

 

 

 

638

 

Deferred income taxes, net

 

 

33,653

 

 

 

33,133

 

Income tax receivable

 

 

6,398

 

 

 

5,342

 

Goodwill

 

 

17,884

 

 

 

17,884

 

Identified intangible asset, net

 

 

822

 

 

 

910

 

Other assets

 

 

22,623

 

 

 

21,504

 

Total assets

 

$

4,007,944

 

 

$

4,051,383

 

Liabilities:

 

 

 

 

 

 

 

 

Credit facilities, net

 

$

538,512

 

 

$

832,686

 

Term debt securitizations, net

 

 

2,044,931

 

 

 

1,821,519

 

Senior notes, net

 

 

372,560

 

 

 

372,153

 

Subordinated notes, net

 

 

235,855

 

 

 

209,509

 

Repurchase agreements, net

 

 

94,785

 

 

 

96,224

 

Accrued interest payable

 

 

30,333

 

 

 

18,073

 

Other liabilities

 

 

31,552

 

 

 

41,741

 

Total liabilities

 

 

3,348,528

 

 

 

3,391,905

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Preferred stock, par value $0.01 per share (5,000,000 shares authorized;

   no shares outstanding)

 

 

 

 

 

 

Common stock, par value $0.01 per share:

 

 

 

 

 

 

 

 

Shares authorized: 145,000,000 in 2016 and 2015;

 

 

 

 

 

 

 

 

Shares outstanding 47,638,653 in 2016 and 46,527,288 in 2015

 

 

476

 

 

 

465

 

Additional paid-in capital

 

 

742,962

 

 

 

742,970

 

Retained earnings

 

 

35,362

 

 

 

31,353

 

Common stock held in treasury, at cost $0.01 par value; 9,342,166 in 2016 and 9,154,548

   in 2015

 

 

(110,540

)

 

 

(109,245

)

Accumulated other comprehensive loss, net

 

 

(8,844

)

 

 

(6,065

)

Total stockholders’ equity

 

 

659,416

 

 

 

659,478

 

Total liabilities and stockholders’ equity

 

$

4,007,944

 

 

$

4,051,383

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

3


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

 

 

 

Three Months Ended March 31,

 

 

 

2016

 

 

2015

 

 

 

($ in thousands, except per share amounts)

 

Net interest income:

 

 

 

 

 

 

 

 

Interest income

 

$

61,952

 

 

$

39,749

 

Interest expense

 

 

39,433

 

 

 

22,334

 

Net interest income

 

 

22,519

 

 

 

17,415

 

Provision for credit losses

 

 

17,713

 

 

 

6,978

 

Net interest income after provision for credit losses

 

 

4,806

 

 

 

10,437

 

Non-interest income (loss):

 

 

 

 

 

 

 

 

Asset management income

 

 

3,441

 

 

 

920

 

Fee income

 

 

1,193

 

 

 

1,158

 

Realized loss on derivatives

 

 

(7

)

 

 

(9

)

Realized loss on sale of loans, net

 

 

(107

)

 

 

(15

)

Other miscellaneous income (expense), net

 

 

1,850

 

 

 

869

 

(Loss) gain on total return swap

 

 

(6,062

)

 

 

1,203

 

Loss on loans held- for- sale

 

 

(3,667

)

 

 

 

Gain on sale of Business Credit

 

 

22,511

 

 

 

 

Total non-interest income

 

 

19,152

 

 

 

4,126

 

Operating expenses:

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

10,638

 

 

 

6,733

 

General and administrative expenses

 

 

6,430

 

 

 

3,499

 

Total operating expenses

 

 

17,068

 

 

 

10,232

 

Income before income taxes

 

 

6,890

 

 

 

4,331

 

Income tax expense

 

 

2,881

 

 

 

1,792

 

Net income

 

$

4,009

 

 

$

2,539

 

Basic Earnings per share

 

$

0.09

 

 

$

0.05

 

Diluted Earnings per share

 

$

0.09

 

 

$

0.05

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

4


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Unaudited

 

 

 

Three Months Ended March 31,

 

 

 

2016

 

 

2015

 

 

 

($ in thousands, except per share amounts)

 

Net income

 

$

4,009

 

 

$

2,539

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

Net unrealized securities (losses) gains, net of tax (benefit) expense

    of $(1,899) and $76 respectively

 

 

(2,767

)

 

 

109

 

Net unrealized derivative losses, net of tax

benefit of $(7) and $(22), respectively

 

 

(12

)

 

 

(25

)

Other comprehensive (loss) income

 

 

(2,779

)

 

 

84

 

Comprehensive income

 

$

1,230

 

 

$

2,623

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

5


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Unaudited

 

 

 

NewStar Financial, Inc. Stockholders’ Equity

For the Three Months Ended March 31, 2016

 

 

 

Common

Stock

 

 

Additional

Paid-in

Capital

 

 

Retained

Earnings

 

 

Treasury

Stock

 

 

Accumulated

Other

Comprehensive

Loss, net

 

 

Common

Stockholders’

Equity

 

 

 

($ in thousands)

 

Balance at January 1, 2016

 

$

465

 

 

$

742,970

 

 

$

31,353

 

 

$

(109,245

)

 

$

(6,065

)

 

$

659,478

 

Net income

 

 

 

 

 

 

 

 

4,009

 

 

 

 

 

 

 

 

 

4,009

 

Other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,779

)

 

 

(2,779

)

Issuance of restricted stock

 

 

5

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

 

 

Shares reacquired from employee transactions

 

 

(1

)

 

 

1

 

 

 

 

 

 

(377

)

 

 

 

 

 

(377

)

Tax benefit from vesting of stock awards

 

 

 

 

 

(398

)

 

 

 

 

 

 

 

 

 

 

 

(398

)

Repurchase of common stock

 

 

(1

)

 

 

1

 

 

 

 

 

 

(918

)

 

 

 

 

 

(918

)

Exercise of common stock options

 

 

8

 

 

 

(1,815

)

 

 

 

 

 

 

 

 

 

 

 

(1,807

)

Tax benefit from exercise of common stock awards

 

 

 

 

 

1,257

 

 

 

 

 

 

 

 

 

 

 

 

1,257

 

Amortization of restricted common stock awards

 

 

 

 

 

951

 

 

 

 

 

 

 

 

 

 

 

 

951

 

Balance at March 31, 2016

 

$

476

 

 

$

742,962

 

 

$

35,362

 

 

$

(110,540

)

 

$

(8,844

)

 

$

659,416

 

 

 

 

NewStar Financial, Inc. Stockholders’ Equity

For the Three Months Ended March 31, 2015

 

 

 

Common

Stock

 

 

Additional

Paid-in

Capital

 

 

Retained

Earnings

 

 

Treasury

Stock

 

 

Accumulated

Other

Comprehensive

Income, net

 

 

Common

Stockholders’

Equity

 

 

 

($ in thousands)

 

Balance at January 1, 2015

 

$

466

 

 

$

718,825

 

 

$

14,463

 

 

$

(92,724

)

 

$

(33

)

 

$

640,997

 

Net income

 

 

 

 

 

 

 

 

2,539

 

 

 

 

 

 

 

 

 

2,539

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

84

 

 

 

84

 

Issuance of restricted stock

 

 

4

 

 

 

(4

)

 

 

 

 

 

 

 

 

 

 

 

 

Shares reacquired from employee

   transactions

 

 

 

 

 

 

 

 

 

 

 

(140

)

 

 

 

 

 

(140

)

Tax benefit from vesting of stock awards

 

 

 

 

 

(109

)

 

 

 

 

 

 

 

 

 

 

 

(109

)

Repurchase of common stock

 

 

(11

)

 

 

11

 

 

 

 

 

 

(11,060

)

 

 

 

 

 

(11,060

)

Issuance of warrants

 

 

 

 

 

21,766

 

 

 

 

 

 

 

 

 

 

 

 

21,766

 

Exercise of common stock options

 

 

1

 

 

 

1,403

 

 

 

 

 

 

 

 

 

 

 

 

1,404

 

Tax benefit from exercise of common stock

   awards

 

 

 

 

 

77

 

 

 

 

 

 

 

 

 

 

 

 

77

 

Amortization of restricted common stock

   awards

 

 

 

 

 

730

 

 

 

 

 

 

 

 

 

 

 

 

730

 

Balance at March 31, 2015

 

$

460

 

 

$

742,699

 

 

$

17,002

 

 

$

(103,924

)

 

$

51

 

 

$

656,288

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

6


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

 

 

 

Three Months Ended March 31,

 

 

 

 

2016

 

 

 

2015

 

 

 

($ in thousands)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

4,009

 

 

$

2,539

 

Adjustments to reconcile net income to net cash used for operations:

 

 

 

 

 

 

 

 

Provision for credit losses

 

 

17,713

 

 

 

6,978

 

Depreciation, amortization and accretion

 

 

(6,309

)

 

 

(1,471

)

Amortization of debt issuance costs

 

 

4,451

 

 

 

3,455

 

Equity compensation expense

 

 

951

 

 

 

730

 

Gain on sale of Business Credit

 

 

(22,511

)

 

 

-

 

Loss on sale of loans

 

 

107

 

 

 

15

 

Loss (gain) on total return swap

 

 

6,062

 

 

 

(1,203

)

Gain on sale of equipment, net

 

 

(222

)

 

 

(137

)

Net change in deferred income taxes

 

 

1,376

 

 

 

(2,241

)

Loans held-for-sale originated

 

 

(76,923

)

 

 

(68,511

)

Proceeds from sale of loans held-for-sale

 

 

83,599

 

 

 

119,456

 

Loss on loans held-for-sale

 

 

3,667

 

 

 

 

Net change in securities available for sale

 

 

4,655

 

 

 

(184

)

Net change in interest receivable

 

 

(780

)

 

 

(917

)

Net change in other assets

 

 

(4,450

)

 

 

(4,385

)

Net change in accrued interest payable

 

 

12,260

 

 

 

4,080

 

Net change in accounts payable and other liabilities

 

 

(14,086

)

 

 

26,230

 

Net cash provided by operating activities

 

 

13,569

 

 

 

84,434

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Net change in restricted cash

 

 

(1,354

)

 

 

(119,442

)

Net change in loans

 

 

114,794

 

 

 

(195,818

)

Purchase of debt securities, available-for-sale

 

 

 

 

 

(32,714

)

Proceeds from sale of other real estate owned

 

 

 

 

 

185

 

Acquisition of property and equipment

 

 

(7

)

 

 

(7

)

Net cash provided by (used in) investing activities

 

 

113,433

 

 

 

(347,796

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from exercise of stock options, net

 

 

(1,815

)

 

 

1,403

 

Tax benefit from exercise of stock options

 

 

1,257

 

 

 

77

 

Tax benefit (expense) from vesting of restricted stock

 

 

(398

)

 

 

(109

)

Advances on credit facilities

 

 

982,409

 

 

 

488,016

 

Repayment of borrowings on credit facilities

 

 

(1,278,352

)

 

 

(605,890

)

Issuance of term debt

 

 

255,750

 

 

 

410,250

 

Borrowings on term debt

 

 

22,100

 

 

 

16,000

 

Repayment of borrowings on term debt

 

 

(52,721

)

 

 

(46,953

)

Borrowing on subordinated notes

 

 

24,500

 

 

 

 

Borrowings on repurchase agreements

 

 

 

 

 

27,158

 

Repayment of borrowings on repurchase agreements

 

 

(1,542

)

 

 

(4,625

)

Repayment of corporate debt

 

 

 

 

 

(200

)

Release (posting) of cash collateral

 

 

41,639

 

 

 

(10,107

)

Payment of deferred financing costs

 

 

(3,810

)

 

 

(4,825

)

Purchase of treasury stock

 

 

(1,295

)

 

 

(11,200

)

Net cash (used in) provided by  financing activities

 

 

(12,278

)

 

 

258,995

 

Net increase (decrease) in cash during the period

 

 

114,724

 

 

 

(4,367

)

Cash and cash equivalents at beginning of period

 

 

35,933

 

 

 

33,033

 

Cash and cash equivalents at end of period

 

 

150,657

 

 

 

28,666

 

7


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued

Unaudited

 

 

 

Three Months Ended March 31,

 

 

 

 

 

 

2016

 

 

 

2015

 

 

 

($ in thousands)

 

Supplemental cash flows information:

 

 

 

 

 

 

 

 

Interest paid

 

$

23,871

 

 

$

18,254

 

Taxes paid, net of refund

 

 

1,703

 

 

 

891

 

Transfer of loans, net to loans held-for-sale, at fair value

 

 

33,121

 

 

 

-

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

8


NEWSTAR FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

 

Note 1. Organization

NewStar Financial, Inc. is an internally-managed, commercial finance company with specialized lending platforms focused on meeting the complex financing needs of companies and private investors in the middle market. The Company and its wholly owned investment management subsidiary, NewStar Capital LLC, are registered investment advisers and provide asset management services to institutional investors. The Company manages several private credit funds that co-invest in loan origination through its leveraged finance lending platform.  Through its wholly owned subsidiary, NewStar Capital, the Company also manages a series of funds structured as CLOs that invest primarily in broadly syndicated loans, as well as other sponsored funds and managed accounts that invest across various asset classes, including broadly syndicated loans, high yield bonds and distressed credits. Through its specialized lending platforms, the Company provides a range of senior secured debt financing options to mid-sized companies to fund working capital, growth strategies, acquisitions and recapitalizations, as well as purchases of equipment and other capital assets.

These lending activities require specialized skills and transaction experience, as well as a significant investment in personnel and operating infrastructure.  Our loans and leases are originated directly by teams of credit-trained bankers and experienced marketing officers organized around key industry and market segments. These teams represent specialized lending groups that are supported by centralized credit management and operating platforms. This structure enables us to leverage common standards, systems, and industry and professional expertise across multiple businesses.

The Company targets its marketing and origination efforts at private equity firms, mid-sized companies, corporate executives, banks, and a variety of other referral sources and financial intermediaries to develop new customer relationships and source lending opportunities. The Company's origination network is national in scope and it targets companies with business operations across a broad range of industry sectors. The Company employs highly experienced bankers, marketing officers and credit professionals to identify and structure new lending opportunities and manage customer relationships. The Company believes that the quality of its professionals, the breadth of their relationships and referral networks, and their ability to develop creative solutions for customers position it to be a valued partner and preferred lender for mid-sized companies and private equity funds with middle market investment strategies.

The Company's emphasis on direct origination is an important aspect of its marketing and credit strategy. The Company's national network is designed around specialized origination channels intended to generate a large set of potential lending opportunities. That allows the Company to be highly selective in its credit process and to allocate capital to market segments that we believe represent the most attractive opportunities. The Company's direct origination network also generates proprietary lending opportunities with yield characteristics that we believe would not otherwise be available through intermediaries. In addition, direct origination provides the Company with direct access to management teams and enhances its ability to conduct detailed due diligence and credit analysis of prospective borrowers. It also allows the Company to negotiate transaction terms directly with borrowers and, as a result, advise its customers on financial strategies and capital structures, which it believes benefits its credit performance.

The Company typically provides financing commitments to companies in amounts that range in size from $10 million to $50 million. The size of financing commitments depends on various factors, including the type of loan, the credit characteristics of the borrower, the economic characteristics of the loan, and the Company's role in the transaction. The Company also selectively arranges larger transactions that it may retain on its balance sheet or syndicate to other lenders, which may include funds that it manages for third party institutional investors. By syndicating loans to other lenders and the Company's managed funds, it is able to provide larger financing commitments to its customers and generate fee income, while limiting our risk exposure to single borrowers. From time to time, however, the Company's balance sheet exposure to a single borrower exceeds $35 million.

Beginning in January 2016, the Company’s operations were divided into two reportable segments that represent its core businesses, Commercial Lending and Asset Management.

The Commercial Lending segment provides a range of senior secured flexible debt options to mid-sized companies with annual cash flow (EBITDA) typically between $10 million and $50 million owned by private equity investment funds and managed by established professional alternative asset managers.

The Asset Management segment provides opportunities for qualified institutions to invest in a range of credit funds managed by the Company that employ credit-oriented strategies focused on middle market loans and liquid, tradeable credit.  

 

 

9


Note 2. Summary of Significant Accounting Policies

Basis of Presentation

These interim condensed consolidated financial statements include the accounts of the Company and its subsidiaries (collectively, “NewStar”) and have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). All significant intercompany transactions have been eliminated in consolidation. These interim condensed financial statements include adjustments of a normal and recurring nature considered necessary by management to fairly present NewStar’s financial position, results of operations and cash flows. These interim condensed financial statements may not be indicative of financial results for the full year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. The estimates most susceptible to change in the near-term are the Company’s estimates of its (i) allowance for credit losses, (ii) recorded amounts of deferred income taxes, (iii) fair value measurements used to record fair value adjustments to certain financial instruments, (iv) valuation of investments (v) determination of other than temporary impairments and temporary impairments and (vi) impairment of goodwill and identified intangible assets. The interim condensed consolidated financial statements and notes thereto should be read in conjunction with the Company’s Annual Report on Form 10-K, for the year ended December 31, 2015.

Prior Period Reclassification

Prior period amounts are reclassified wherever necessary to confirm with current period presentation.  

Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries (collectively, “NewStar”) and have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). All significant intercompany transactions have been eliminated in consolidation.

Segment Reporting

Due to the continued expansion of our asset management activities, through new fund formation and the acquisition of NewStar Capital, the Company reassessed its classification of reporting as a single segment under ASC 280, Segment Reporting.  Based on this evaluation, the Company determined that reporting the results of its Commercial Lending and Asset Management as two segments would better reflect how the Company is now managed and how information is internally reviewed.  For complete segment information, see Note 15.

Recently Adopted Accounting Standards

In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. ASU 2015-03 is effective for the interim or annual period beginning after December 15, 2015. The Company adopted ASU 2015-03 on January 1, 2016 and applied the standard retrospectively. The balance sheet presented has been adjusted to reflect the period specific effects of the adoption of the guidance.  The adoption of ASU 2015-03 had the following impact on the December 31, 2015 on the Condensed Consolidated Balance Sheets.

(in thousands)

 

December 31, 2015

 

As previously reported under GAAP applicable at the time

 

 

 

 

Deferred financing costs, net

 

 

40,733

 

Credit facilities

 

 

843,896

 

Term debt securitizations, net

 

 

1,837,889

 

Senior notes, net

 

 

379,232

 

Subordinated notes, net

 

 

215,018

 

Repurchase agreements

 

 

96,789

 

 

 

 

 

 

As currently reported under ASU 2015-03

 

 

 

 

Deferred financing costs, net

 

 

-

 

Credit facilities, net

 

 

832,686

 

Term debt securitizations, net

 

 

1,821,519

 

Senior notes, net

 

 

372,153

 

Subordinated notes, net

 

 

209,509

 

Repurchase agreements, net

 

 

96,224

 

 

10


In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments in Business Combinations (Topic 805).  ASU 2015-16 eliminated the requirement to retrospectively adjust the financial statements for measurement-period adjustments that occur in periods after a business combination is consummated.  ASU 2015-16 is effective for annual periods and interim periods within that period beginning after December 15, 2015.  The Company adopted ASU 2015-16 on January 1, 2016.  The adoption of ASU 2015-16 did not have a material impact on our results from operations or financial position.

 

Recently Issued Accounting Standards

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments  – Recognition and Measurement of Financial Assets and Financial Liabilities (Topic 825-10).  ASU 2016-01 amends existing guidance related to the accounting for certain financial assets and liabilities. These amendments, among other things, require equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset and eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. ASU 2016-01 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the impact that the adoption of ASU 2016-01 will have on results from operations and financial position.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842).  ASU 2016-02 amends existing guidance related to the accounting for leases. These amendments, among other things, require lessees to account for most leases on the balance sheet while recognizing expense on the income statement in a manner similar to existing guidance.  For lessors the guidance modifies the classification criteria and the accounting for sales-type and direct finance leases. ASU 2016-02 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact that the adoption of ASU 2016-02 will have on results from operations and financial position.

 

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 718).  ASU 2016-09 simplifies several aspects of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification of related amounts within the statement of cash flows. ASU 2016-09 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the impact that the adoption of ASU 2016-09 will have on results from operations and financial position.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 provides a framework that replaces existing revenue recognition guidance. ASU 2014-09 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2017. Early adoption is not permitted. The Company is currently evaluating the impact that the adoption of ASU 2014-09 will have on results from operations or financial position.

 

11


Note 3. Acquisition and Disposition Activities

Acquisition

As previously disclosed, the Company acquired 100% of the outstanding limited liability company interests of Boston-based Feingold O’Keeffe Capital, LLC (“FOC Partners”), a boutique credit manager, in October 2015. The Company now operates FOC Partners as NewStar Capital, a wholly owned subsidiary of the Company.  

During the three months ended March 31, 2016, the Company completed its purchase price allocations and deemed the difference to be immaterial between the provisional and final purchase price allocations.  As the result of facts and circumstances related to the customer contracts and related customer relationships that existed at the acquisition date but were unknown at that date, the Company reassessed the expected economic useful life of these contracts to be approximately 33 months instead of 12 months as originally estimated.    

Sale of NewStar Business Credit LLC

On March 31, 2016, the Company sold NewStar Business Credit LLC (“Business Credit”) to a third party. The Company made the decision to sell Business Credit in order to exit a business with an economic model which was challenged by competition from banks and other lenders with access to lower cost of funding than the Company had through its warehouse lines.  The sale resulted in a gain of $22.5 million, before transaction related costs of $2.5 million.   The gain is recorded in non-interest income on the accompanying consolidated statement of operations

Business Credit contributed a loss of $0.3 million inclusive of the $2.5 million of transaction related costs and $1.9 million in pretax earnings for the three months ended March 31, 2016 and 2015 respectively.

The Company performed an analysis of the sale in accordance with the amended guidance specified in ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.  The amended guidance requires a disposal of a component of an entity or a group of components of an entity to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results when any of the following occurs: 1) the component of an entity or group of components of an entity meets the criteria to be classified as held for sale; 2) the component of an entity or group of components of an entity is disposed of by sale; or 3) the component of an entity or group of components of an entity is disposed of other than by sale (for example, by abandonment or in a distribution to owners in a spinoff).   Based on the analysis performed by the Company, the sale of Business Credit does meet the criteria of discontinued operations.

 

Note 4. Loans Held-for-Sale, Loans, Leases and Allowance for Credit Losses

As of March 31, 2016 and December 31, 2015, loans held-for-sale consisted of the following:

 

 

 

March 31, 2016

 

 

December 31, 2015

 

 

 

($ in thousands)

 

Leveraged Finance

 

$

475,383

 

 

$

485,874

 

Gross loans held-for-sale

 

 

475,383

 

 

 

485,874

 

Deferred loan fees, net

 

 

(6,940

)

 

 

(7,089

)

Total loans held-for-sale, net

 

$

468,443

 

 

$

478,785

 

Loans classified as held-for-sale consist primarily of loans originated or purchased by the Company and intended to be sold to third parties (including credit funds managed by the Company).

These loans are carried at the lower of either market value or aggregate cost, net of any deferred origination costs or fees.

 

At March 31, 2016, loans held-for-sale include loans with an aggregate outstanding balance of $439.7 million that were intended to be sold to credit funds managed by the Company.  The Company sold loans with an aggregate outstanding balance of $48.7 million for a net loss of $0.1 million to entities other than credit funds managed by the Company during the three months ended March 31, 2016. The Company sold loans with an outstanding balance of $4.0 million for a loss of $0.01 million to entities other than credit funds during the three months ended March 31, 2015.

12


As of March 31, 2016, and December 31, 2015, loans and leases consisted of the following:

 

 

 

March 31, 2016

 

 

December 31, 2015

 

 

 

($ in thousands)

 

Leveraged Finance

 

$

2,942,478

 

 

$

2,627,314

 

Business Credit

 

 

 

 

 

342,281

 

Real Estate

 

 

44,587

 

 

 

100,732

 

Equipment Finance

 

 

175,506

 

 

 

173,253

 

Gross loans and leases

 

 

3,162,571

 

 

 

3,243,580

 

Deferred loan fees and discount, net

 

 

(66,388

)

 

 

(51,249

)

Allowance for loan and lease losses

 

 

(66,868

)

 

 

(58,259

)

Total loans and leases, net (1)

 

$

3,029,315

 

 

$

3,134,072

 

 

(1)

Includes loans at fair value of $89,244 and $0, respectively.  

 

During the three months ended March 31, 2016, the Company purchased $138.9 million of loans that were referenced by the total return swap portfolio.  The majority of these loans were purchased to fund future CLOs.  The purchased loans were recorded at fair value with no initial associated allowance for loan loss.  At acquisition, the purchased loans were segregated into three groups: (i) loans to be allocated to credit funds managed by NewStar Capital, (ii) other performing loans, and (iii) one credit impaired loan.  

 

Loans purchased by NewStar Capital totaled $89.5 million.  The Company elected the fair value option under ASC 825-10 to account for these loans in accordance with the Company’s policy. The election was made on the acquisition date. As a result, changes in fair value of these loans will be reported in non-interest income within the consolidated statement of operations.  

 

The Company purchased other performing loans totaling $47.6 million.  These loans are accounted for under ASC 310-20. As a result, any premium/discount determined at the date of purchase is amortized/accreted into interest income over the life of the loans.   Any acquired loans which exhibit credit deterioration from the date of acquisition will be evaluated for an allowance for loan losses under methods similar to those used for loans originated in the ordinary course of business

 

The Company purchased one credit impaired loan totaling $1.8 million.  This loan was accounted for under ASC 310-30.  Under ASC 310-30, the excess cash flows expected to be collected over the carrying amount is the accretable yield and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and cash flows expected to be collected, considering the impact of prepayments, is the nonaccretable difference. Any subsequent decrease in the expected principal cash flows will result in a charge to the provision for loan losses and a corresponding increase to the allowance for loan losses. Subsequent increases in expected principal cash flows will result in recovery of any previously recorded allowance for loan losses, to the extent applicable, and a reclassification from nonaccretable difference to accretable yield for any remaining increase, which will result in an increase in interest income over the remaining life of the loan.

 

The following table sets forth the activity relating to the accretable discount for loans purchased.

 

 

 

March 31, 2016

 

 

December 31, 2015

 

 

 

($ in thousands)

 

Balance, beginning of the year

 

$

 

 

$

 

Purchased loans

 

 

2,593

 

 

 

 

Accretion of income

 

 

(24

)

 

 

 

Reduction due to payments or sale

 

 

(4

)

 

 

 

Balance, end of year

 

$

2,565

 

 

$

 

 

During the three months ended March 31, 2016, the Company also recorded an $8.1 million non –accretable discount resulting from the fair value of the credit impaired loan discussed above.

 

The Company internally risk rates loans based on individual credit criteria on at least a quarterly basis. Borrowers provide the Company with financial information on either a quarterly or monthly basis. Loan ratings as well as identification of impaired loans are dynamically updated to reflect changes in borrower condition or profile. A loan is considered to be impaired when it is probable that the Company will be unable to collect all amounts due to it according to the contractual terms of the loan agreement. Impaired loans include all non-accrual loans, loans with partial charge-offs and loans which are troubled debt restructurings (“TDR”).

The Company utilizes a number of analytical tools for the purpose of estimating probability of default and loss given default for its three specialized lending groups. The quantitative models employed by the Company in its Leveraged Finance and Equipment Finance businesses utilize Moody’s KMV RiskCalc credit risk model in combination with a proprietary qualitative model, which

13


generates a rating that maps to a probability of default estimate. Real Estate utilizes a proprietary model that has been developed to capture risk characteristics unique to the lending activities in that line of business. The model produces an obligor risk rating which corresponds to a probability of default and also calculates a loss given default. In each case, the probability of default and the loss given default are used to calculate an expected loss for those lending groups. Prior to its sale, Business Credit utilized a proprietary model that produced a rating that corresponded to an expected loss, without calculating a probability of default and loss given default. In each case, the expected loss is the primary component in a formulaic calculation of general reserves attributable to a given loan. Loans and leases which are rated at or better than a specified threshold are typically classified as “Pass”, and loans and leases rated worse than that threshold are typically classified as “Criticized”, a characterization that may apply to impaired loans, including TDR. As of March 31, 2016, $164.6 million of the Company’s loans were classified as “Criticized,” all of which were impaired loans, and $3.0 billion were classified as “Pass”. As of December 31, 2015, $152.1 million of the Company’s loans were classified as “Criticized”, including $143.6 million of the Company’s impaired loans, and $3.1 billion were classified as “Pass”.

When the Company rates a loan above a certain risk rating threshold and the loan is deemed to be impaired, the Company will establish a specific allowance, if appropriate, and the loan will be analyzed and may be placed on non-accrual. If the asset deteriorates further, the specific allowance may increase, and ultimately may result in a loss and charge-off.

A TDR that performs in accordance with the terms of the restructuring may improve its risk profile over time. While the concessions in terms of pricing or amortization may not have been reversed and further amended to “market” levels, the financial condition of the borrower may improve over time to the point where the rating improves from the “Criticized” classification that was appropriate immediately prior to, or at, restructuring.

A loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The measurement of impairment of a loan is based upon (i) the present value of expected future cash flows discounted at the loan’s effective interest rate, (ii) the loan’s observable market price, or (iii) the fair value of the collateral if the loan is collateral dependent, depending on the circumstances and our collection strategy. Impaired loans are identified based on the loan-by-loan risk rating process described above. It is the Company’s policy during the reporting period to record a specific provision for credit losses and/or partial or full charge off for all loans for which we have serious doubts as to the ability of the borrowers to comply with the present loan repayment terms.

As of March 31, 2016, the Company had impaired loans with a balance of $214.6 million. Included in this balance was one impaired loan retained from the Business Credit portfolio with a balance of $12.5 million, and a specific reserve of $1.1 million. This loan is included in the Leveraged Finance balance at March 31, 2016.  Impaired loans with an aggregate outstanding balance of $181.2 million have been restructured and classified as TDR.  At March 31, 2016, additional funding commitments for TDRs totaled $6.9 million.   As of March 31, 2016, the aggregate carrying value of equity investments in certain of the Company’s borrowers in connection with troubled debt restructurings totaled $10.7 million. Impaired loans with an aggregate outstanding balance of $114.5 million were also on non-accrual status. For impaired loans on non-accrual status, the Company’s policy is to reverse the accrued interest previously recognized as interest income subsequent to the last cash receipt in the current year. The recognition of interest income on the loan only resumes when factors indicating doubtful collection no longer exist and the non-accrual loan payment status has been brought current. During the three months ended March 31, 2016, the Company charged off $6.1 million of non-accruing loan balances.  During the three months ended March 31, 2016, the Company placed loans with an aggregate outstanding balance of $5.1 million on non-accrual status.  During the three months ended March 31, 2016, the Company recorded $16.6 million of net specific provisions for impaired loans. At March 31, 2016, the Company had a $37.3 million specific allowance for impaired loans with an aggregate outstanding balance of $161.8 million. At March 31, 2016, additional funding commitments for impaired loans totaled $8.9 million. The Company’s obligation to fulfill the additional funding commitments on impaired loans is generally contingent on the borrower’s compliance with the terms of the credit agreement, or if the borrower is not in compliance additional funding commitments may be made at the Company’s discretion. As of March 31, 2016, loans to three borrowers totaling $18.9 million of loans on non-accrual status were greater than 60 days past due and classified as delinquent by the Company. Included in the $37.3 million specific allowance for impaired loans was $1.8 million related to delinquent loans.  

As of December 31, 2015, the Company had impaired loans with a balance of $193.2 million. At that date, impaired loans with an aggregate outstanding balance of $183.6 million had been restructured and classified as TDR. As of December 31, 2015, the aggregate carrying value of equity investments in certain of the Company’s borrowers in connection with troubled debt restructurings totaled $11.4 million. Impaired loans with an aggregate outstanding balance of $111.3 million were also on non-accrual status. During 2015, the Company charged off $4.0 million of outstanding non-accrual loans. During 2015, the Company placed loans with an aggregate outstanding balance of $38.2 million on non-accrual status and returned loans with an aggregate outstanding balance of $0.9 million to performing status. During 2015, the Company recorded $9.5 million of net specific provisions for impaired loans. At December 31, 2015, the Company had a $26.8 million specific allowance for impaired loans with an aggregate outstanding balance of $121.1 million. At December 31, 2015, additional funding commitments for impaired loans totaled $10.9 million. As of December 31, 2015, loans to three borrowers totaling approximately $18.6 million were on non-accrual status and were greater than 60 days past due and classified as delinquent by the Company. Included in the $26.8 million specific allowance for impaired loans was $2.8 million related to delinquent loans.

14


A summary of impaired loans is as follows:

 

 

 

Investment, Net of Charge-offs

 

 

Investment, Net

of Unamortized

Discount/Premium

 

 

Unpaid

Principal

 

 

 

($ in thousands)

 

March 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

Leveraged Finance

 

$

178,627

 

 

$

163,703

 

 

$

223,739

 

Real Estate

 

 

35,270

 

 

 

35,248

 

 

 

38,616

 

Equipment Finance

 

 

697

 

 

 

645

 

 

 

697

 

Total

 

$

214,594

 

 

$

199,596

 

 

$

263,052

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

Leveraged Finance

 

$

157,446

 

 

$

150,692

 

 

$

188,453

 

Business Credit

 

 

 

 

 

 

 

 

 

Real Estate

 

 

34,941

 

 

 

34,915

 

 

 

38,286

 

Equipment Finance

 

 

772

 

 

 

709

 

 

 

772

 

Total

 

$

193,159

 

 

$

186,316

 

 

$

227,511

 

 

 

 

Recorded

Investment with a

Related Allowance

for Credit Losses

 

 

Recorded

Investment, net,

with a Related

Allowance for

Credit Losses

 

 

Recorded

Investment

without a Related

Allowance for

Credit Losses

 

 

Recorded

Investment, net,

without a Related

Allowance for

Credit Losses

 

 

 

($ in thousands)

 

March 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Leveraged Finance

 

$

133,733

 

 

$

127,004

 

 

$

44,894

 

 

$

36,699

 

Real Estate

 

 

28,058

 

 

 

28,036

 

 

 

7,212

 

 

 

7,212

 

Equipment Finance

 

 

 

 

 

 

 

 

697

 

 

 

645

 

Total

 

$

161,791

 

 

$

155,040

 

 

$

52,803

 

 

$

44,556

 

December 31, 2015