news-10q_20170930.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

OR

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)

Registrant’s telephone number, including area code: (617) 848-2500

 

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      No  

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      No  

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

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a small reporting company)

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

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

As of November 1, 2017, the registrant had 41,555,754 shares of common stock, $0.01 par value per share, outstanding.

 

 

 

 

 


TABLE OF CONTENTS

 

 

 

Page

 

PART I

 

 

FINANCIAL INFORMATION

 

Item 1.

Financial Statements (Unaudited)

5

 

Condensed Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016

5

 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2017 and 2016

6

 

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2017 and 2016

7

 

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2017 and 2016

8

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016

9

 

Notes to Condensed Consolidated Financial Statements

11

Item 2.

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

49

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

71

Item 4.

Controls and Procedures

72

 

PART II

 

 

OTHER INFORMATION

 

Item 1.

Legal Proceedings

73

Item 1A.

Risk Factors

73

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

74

Item 6.

Exhibits

75

SIGNATURES

77

 

 

2

 


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;

 

our stock price or dividend policy; and

 

the consummation of the transactions contemplated by our definitive merger agreement with First Eagle Holdings, Inc. (First Eagle) and our asset purchase agreement with GSO Diamond Portfolio Holdco LLC (GSO), each of which is described in more detail in this Quarterly Report.

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:

 

risk of 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;

 

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

 

risk and uncertainties related to our ability to obtain external financing;

 

risk and uncertainties relating to the regulation of the commercial lending industry by federal, state and local governments;

 

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

 

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

 

the failure to obtain the approval of the Company’s stockholders or required regulatory approvals or the failure to satisfy any other closing conditions to the Merger Agreement or the Asset Purchase Agreement as defined and described under Note 17 in this Quarterly Report;

 

the occurrence of any event, change or other circumstance that could give rise to the termination of the Merger Agreement or Asset Purchase Agreement; and

 

potential disruption of management’s attention from our ongoing business operations due to the transactions contemplated by the Merger Agreement and Asset Purchase Agreement, the effect of the announcement of these transactions and the effect of the operating restrictions in the transaction agreements on the ongoing operations of the Company and its relationship with its investors, funding sources, borrowers and others with whom it does business.

 

3

 


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, 2016, as supplemented by the risks outline under Part II, Item 1A of this Quarterly Report on Form 10-Q.

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. Statements relating to past dividends or our current dividend policy should not be construed as a guarantee that any future dividends will be paid.

 

4

 


PART I. FINANCIAL INFORMATION

 

 

Item 1.  Financial Statements.

NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

 

 

 

September 30, 2017

 

 

December 31, 2016

 

 

 

($ in thousands, except per share

and par value amounts)

 

Assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

62,538

 

 

$

154,480

 

Restricted cash

 

 

251,653

 

 

 

262,643

 

Cash collateral on deposit with custodians

 

 

7,564

 

 

 

7,564

 

Investments in debt securities, available-for-sale

 

 

175,837

 

 

 

119,307

 

Loans held-for-sale, net

 

 

371,941

 

 

 

144,060

 

Loans, net (including loans at fair value of $407,465 and $403,745, respectively)

 

 

2,995,997

 

 

 

3,239,191

 

Interest receivable

 

 

15,496

 

 

 

14,622

 

Property and equipment, net

 

 

212

 

 

 

274

 

Deferred income taxes, net

 

 

32,081

 

 

 

40,807

 

Income tax receivable

 

 

6,606

 

 

 

 

Goodwill

 

 

17,884

 

 

 

17,884

 

Identified intangible asset, net

 

 

5,318

 

 

 

572

 

Other assets

 

 

59,507

 

 

 

39,188

 

Total assets

 

$

4,002,634

 

 

$

4,040,592

 

Liabilities:

 

 

 

 

 

 

 

 

Credit facilities, net

 

$

456,961

 

 

$

445,493

 

Term debt, net

 

 

16,973

 

 

 

 

Term debt securitizations, net

 

 

2,085,733

 

 

 

2,195,064

 

Senior notes, net

 

 

375,287

 

 

 

373,919

 

Subordinated notes, net

 

 

246,929

 

 

 

241,390

 

Repurchase agreements, net

 

 

80,569

 

 

 

55,046

 

Accrued interest payable

 

 

34,435

 

 

 

21,319

 

Income tax payable

 

 

 

 

 

12,562

 

Other liabilities

 

 

59,995

 

 

 

48,377

 

Total liabilities

 

 

3,356,882

 

 

 

3,393,170

 

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 2017 and 2016;

 

 

 

 

 

 

 

 

Shares outstanding 41,480,754 in 2017 and 42,820,198 in 2016

 

 

415

 

 

 

428

 

Additional paid-in capital

 

 

747,438

 

 

 

743,783

 

Retained earnings

 

 

67,173

 

 

 

59,577

 

Common stock held in treasury, at cost; 16,182,143 in 2017 and 14,352,904 in 2016

 

 

(171,288

)

 

 

(152,720

)

Accumulated other comprehensive income (loss), net

 

 

2,014

 

 

 

(3,646

)

Total stockholders’ equity

 

 

645,752

 

 

 

647,422

 

Total liabilities and stockholders’ equity

 

$

4,002,634

 

 

$

4,040,592

 

 

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

5

 


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

 

 

($ in thousands, except per share amounts)

 

Net interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

58,752

 

 

$

65,155

 

 

$

170,747

 

 

$

186,499

 

Interest expense

 

 

43,145

 

 

 

39,897

 

 

 

126,144

 

 

 

117,816

 

Net interest income

 

 

15,607

 

 

 

25,258

 

 

 

44,603

 

 

 

68,683

 

Provision for credit losses

 

 

1,494

 

 

 

3,570

 

 

 

10,341

 

 

 

24,906

 

Net interest income after provision for credit losses

 

 

14,113

 

 

 

21,688

 

 

 

34,262

 

 

 

43,777

 

Non-interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset management income

 

 

3,544

 

 

 

3,353

 

 

 

11,017

 

 

 

10,337

 

Fee income

 

 

1,025

 

 

 

2,946

 

 

 

6,379

 

 

 

5,836

 

Realized loss on derivatives, net

 

 

 

 

 

(13

)

 

 

 

 

 

(31

)

Realized gain (loss) on sale of loans, net

 

 

294

 

 

 

(19

)

 

 

1,501

 

 

 

36

 

Other miscellaneous income, net

 

 

1,984

 

 

 

794

 

 

 

5,330

 

 

 

3,490

 

Mark to market adjustment on fair value loans

 

 

(867

)

 

 

3,437

 

 

 

(6,817

)

 

 

3,705

 

Loss on total return swap

 

 

 

 

 

 

 

 

 

 

 

(6,062

)

Unrealized (loss) gain on loans held-for-sale, net

 

 

(457

)

 

 

468

 

 

 

(557

)

 

 

(5,345

)

Gain on sale of Business Credit, net

 

 

 

 

 

 

 

 

 

 

 

22,511

 

Total non-interest income

 

 

5,523

 

 

 

10,966

 

 

 

16,853

 

 

 

34,477

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

7,480

 

 

 

13,175

 

 

 

21,664

 

 

 

32,640

 

General and administrative expenses

 

 

4,420

 

 

 

4,894

 

 

 

12,172

 

 

 

15,337

 

Total operating expenses

 

 

11,900

 

 

 

18,069

 

 

 

33,836

 

 

 

47,977

 

Income before income taxes

 

 

7,736

 

 

 

14,585

 

 

 

17,279

 

 

 

30,277

 

Income tax expense

 

 

3,151

 

 

 

5,941

 

 

 

7,160

 

 

 

12,383

 

Net income

 

$

4,585

 

 

$

8,644

 

 

$

10,119

 

 

$

17,894

 

Basic Earnings per share

 

$

0.11

 

 

$

0.19

 

 

$

0.24

 

 

$

0.38

 

Diluted Earnings per share

 

$

0.11

 

 

$

0.19

 

 

$

0.24

 

 

$

0.38

 

Dividends declared per common share

 

$

0.02

 

 

$

 

 

$

0.06

 

 

$

 

 

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

6

 


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Unaudited

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

 

 

($ in thousands, except per share amounts)

 

Net income

 

$

4,585

 

 

$

8,644

 

 

$

10,119

 

 

$

17,894

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

   (benefit) of $604, $2,044, $3,871 and $789, respectively

 

 

884

 

 

 

3,028

 

 

 

5,664

 

 

 

1,193

 

Net unrealized derivative gains, net of tax expense

   (benefit) of $[-], $5, $(3) and $2, respectively

 

 

 

 

 

8

 

 

 

(4

)

 

 

(3

)

Other comprehensive income (loss)

 

 

884

 

 

 

3,036

 

 

 

5,660

 

 

 

1,190

 

Comprehensive income

 

$

5,469

 

 

$

11,680

 

 

$

15,779

 

 

$

19,084

 

 

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

7

 


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Unaudited

 

 

 

NewStar Financial, Inc. Stockholders’ Equity

For the Nine Months Ended September 30, 2017

 

 

 

Common

Stock

 

 

Additional

Paid-in

Capital

 

 

Retained

Earnings

 

 

Treasury

Stock

 

 

Accumulated

Other

Comprehensive

Loss, net

 

 

Common

Stockholders’

Equity

 

 

 

($ in thousands)

 

Balance at January 1, 2017

 

$

428

 

 

$

743,783

 

 

$

59,577

 

 

$

(152,720

)

 

$

(3,646

)

 

$

647,422

 

Net income

 

 

 

 

 

 

 

 

10,119

 

 

 

 

 

 

 

 

 

10,119

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5,660

 

 

 

5,660

 

Common stock dividends of $0.06 per share

 

 

 

 

 

 

 

 

(2,523

)

 

 

 

 

 

 

 

 

(2,523

)

Issuance of restricted stock

 

 

4

 

 

 

(4

)

 

 

 

 

 

 

 

 

 

 

 

 

Net shares reacquired from employee transactions

 

 

(1

)

 

 

1

 

 

 

 

 

 

(829

)

 

 

 

 

 

(829

)

Repurchase of common stock

 

 

(18

)

 

 

18

 

 

 

 

 

 

(17,739

)

 

 

 

 

 

(17,739

)

Exercise of common stock options, net

 

 

2

 

 

 

1,039

 

 

 

 

 

 

 

 

 

 

 

 

1,041

 

Amortization of restricted common stock awards

 

 

 

 

 

2,601

 

 

 

 

 

 

 

 

 

 

 

 

2,601

 

Balance at September 30, 2017

 

$

415

 

 

$

747,438

 

 

$

67,173

 

 

$

(171,288

)

 

$

2,014

 

 

$

645,752

 

 

 

 

NewStar Financial, Inc. Stockholders’ Equity

For the Nine Months Ended September 30, 2016

 

 

 

Common

Stock

 

 

Additional

Paid-in

Capital

 

 

Retained

Earnings

 

 

Treasury

Stock

 

 

Accumulated

Other

Comprehensive

Income, net

 

 

Common

Stockholders’

Equity

 

 

 

($ in thousands)

 

Balance at January 1, 2016

 

$

465

 

 

$

742,970

 

 

$

31,353

 

 

$

(109,245

)

 

$

(6,065

)

 

$

659,478

 

Net income

 

 

 

 

 

 

 

 

17,894

 

 

 

 

 

 

 

 

 

17,894

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,190

 

 

 

1,190

 

Issuance of restricted stock

 

 

6

 

 

 

(6

)

 

 

 

 

 

 

 

 

 

 

 

 

Net Shares reacquired from employee transactions

 

 

(1

)

 

 

1

 

 

 

 

 

 

(445

)

 

 

 

 

 

(445

)

Tax benefit (expense) from vesting of restricted stock

 

 

 

 

 

(473

)

 

 

 

 

 

 

 

 

 

 

 

(473

)

Repurchase of common stock

 

 

(12

)

 

 

12

 

 

 

 

 

 

(8,862

)

 

 

 

 

 

(8,862

)

Exercise of common stock options, net

 

 

9

 

 

 

(1,108

)

 

 

 

 

 

 

 

 

 

 

 

(1,099

)

Tax benefit from exercise of stock options

 

 

 

 

 

1,225

 

 

 

 

 

 

 

 

 

 

 

 

1,225

 

Amortization of restricted common stock awards

 

 

 

 

 

2,822

 

 

 

 

 

 

 

 

 

 

 

 

2,822

 

Balance at September 30, 2016

 

$

467

 

 

$

745,443

 

 

$

49,247

 

 

$

(118,552

)

 

$

(4,875

)

 

$

671,730

 

 

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

8

 


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

 

 

 

Nine Months Ended September 30,

 

 

 

 

2017

 

 

 

2016

 

 

 

($ in thousands)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

10,119

 

 

$

17,894

 

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

 

 

 

 

 

 

 

 

Provision for credit losses

 

 

10,341

 

 

 

24,906

 

Depreciation, amortization and accretion, net

 

 

(9,609

)

 

 

(9,159

)

Amortization of debt issuance costs

 

 

12,818

 

 

 

13,720

 

Equity compensation expense

 

 

2,601

 

 

 

2,822

 

Gain on sale of Business Credit, net

 

 

 

 

 

(22,511

)

Gain on sale of loans, net

 

 

(1,501

)

 

 

(36

)

Loss on total return swap

 

 

 

 

 

6,062

 

Gain on sale of equipment, net

 

 

 

 

 

(724

)

Loss on sale of CLO bonds

 

 

2

 

 

 

 

Net change in deferred income taxes

 

 

4,859

 

 

 

2,466

 

Loans held-for-sale originated

 

 

(765,180

)

 

 

(217,132

)

Proceeds from sale of loans held-for-sale

 

 

568,288

 

 

 

313,287

 

Unrealized loss on loans held-for-sale, net

 

 

557

 

 

 

5,345

 

Net change in interest receivable

 

 

(874

)

 

 

(2,340

)

Net change in other assets

 

 

(17,406

)

 

 

(15,090

)

Net change in accrued interest payable

 

 

13,116

 

 

 

13,086

 

Net change in other liabilities

 

 

(32,505

)

 

 

(11,165

)

Net cash (used in) provided by operating activities

 

 

(204,374

)

 

 

121,431

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Net change in restricted cash

 

 

10,991

 

 

 

(240,397

)

Net change in loans and leases

 

 

233,681

 

 

 

(92,685

)

Purchase of equity investments

 

 

(5,222

)

 

 

(4,052

)

Return of capital - equity investments

 

 

793

 

 

 

 

Purchase of debt securities, available-for-sale

 

 

(39,709

)

 

 

 

Proceeds from debt securities, available-for-sale

 

 

6,226

 

 

 

6,000

 

Purchase of property and equipment

 

 

(20

)

 

 

(9

)

Net cash provided by (used in) investing activities

 

 

206,740

 

 

 

(331,143

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Inputs from exercise of stock options, net

 

 

1,041

 

 

 

(1,099

)

Tax benefit from exercise of stock options

 

 

 

 

 

1,225

 

Tax expense from vesting of restricted stock

 

 

 

 

 

(473

)

Payment of dividends on common stock

 

 

(2,523

)

 

 

 

Advances on credit facilities

 

 

431,100

 

 

 

1,282,522

 

Repayment of borrowings on credit facilities

 

 

(421,500

)

 

 

(1,602,978

)

Issuance of term debt securitization

 

 

303,000

 

 

 

623,197

 

Borrowings on term debt securitization

 

 

 

 

 

37,600

 

Repayment of borrowings on term debt securitization

 

 

(415,057

)

 

 

(142,155

)

Borrowing of term debt

 

 

4,000

 

 

 

 

Borrowing on subordinated notes

 

 

 

 

 

24,500

 

Borrowings on repurchase agreements

 

 

29,539

 

 

 

3,496

 

Repayment of borrowings on repurchase agreements

 

 

(4,016

)

 

 

(47,694

)

Release of cash collateral

 

 

 

 

 

53,517

 

Payment of deferred financing costs

 

 

(1,324

)

 

 

(10,240

)

Purchase of treasury stock

 

 

(18,568

)

 

 

(9,307

)

Net cash (used in) provided by financing activities

 

 

(94,308

)

 

 

212,111

 

Net decrease in cash during the period

 

 

(91,942

)

 

 

2,399

 

Cash and cash equivalents at beginning of period

 

 

154,480

 

 

 

35,933

 

Less cash of Equipment Finance held-for-sale

 

 

 

 

 

(2,066

)

Cash and cash equivalents at end of period

 

$

62,538

 

 

$

36,266

 

9

 


NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued

Unaudited

 

 

 

Nine Months Ended September 30,

 

 

 

 

2017

 

 

 

2016

 

 

 

($ in thousands)

 

Supplemental cash flows information:

 

 

 

 

 

 

 

 

Interest paid

 

$

113,078

 

 

$

104,731

 

Taxes paid, net of refund

 

 

21,478

 

 

 

5,201

 

Assumed debt related to acquisition of investment in available for sale securities

 

 

12,973

 

 

 

 

Transfer of loans, net to other real estate owned

 

 

 

 

 

15,781

 

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

 

 

31,546

 

 

 

67,704

 

Transfer of Equipment Finance assets to held-for-sale

 

 

 

 

 

160,735

 

Transfer of Equipment Finance liabilities to held-for-sale

 

 

 

 

 

44,158

 

Unsettled trades payable

 

 

21,488

 

 

 

138,639

 

 

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

 

10

 


NEWSTAR FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

 

Note 1. Organization

NewStar Financial, Inc. ("NewStar"), together with its consolidated subsidiaries (collectively, the "Company"), is an internally-managed, middle market direct lender and credit-oriented asset manager headquartered in Boston, MA. The Company’s direct lending activities are focused on meeting the complex financing needs of companies and private investors in the middle market by offering a range of flexible debt financing options. The Company also offers a range of investment management products employing credit-oriented strategies focused on middle market loans and liquid, tradeable credit. The Company manages approximately $7.2 billion of assets, $3.6 billion held in consolidated subsidiaries of the Company and $3.6 billion in off balance sheet credit funds.

NewStar operates its business through two reportable segments: Commercial Lending and Asset Management.

Commercial Lending

These lending activities require specialized skills and transaction experience, as well as a significant investment in personnel and operating infrastructure. To meet these demands, our loans are originated directly by teams of credit-trained bankers. These teams are supported by centralized credit management and operating platforms. This structure enables us to leverage common standards, systems, and industry and professional expertise across the two segments.

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 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 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 arranges larger transactions that it may retain on its balance sheet or syndicate to other lenders, which include off balance sheet managed credit funds managed by the Company for third party institutional investors. By syndicating loans to other lenders and the Company's off balance sheet managed credit funds, it is able to provide larger financing commitments to its customers and generate fee income, while limiting its risk exposure to single borrowers.

Asset Management

As a registered investment adviser, NewStar offers a range of investment products employing credit-oriented strategies focused on middle market loans and liquid tradeable credit. The Company manages a series of private credit funds that co-invest in middle market loans originated through its established leveraged finance lending platform. Through its registered investment adviser subsidiary, NewStar Capital, the Company also manages assets across a series of CLOs that invest primarily in broadly syndicated loans, as well as other sponsored funds and managed accounts that invest across various liquid, non-investment grade asset classes, including broadly syndicated loans and bonds.  

 

 

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 and those variable interest entities (“VIEs”) where the Company is the primary beneficiary. These interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X.  

11

 


Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. All significant intercompany transactions have been eliminated in consolidation. In the opinion of Management, all adjustments (consisting of normal recurring adjustments) considered necessary for the fair presentation of the interim condensed consolidated financial statements have been included. 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, 2016.

As discussed in Note 17, the Company entered into a definitive agreement with First Eagle Holdings, Inc. and certain of its direct and indirect subsidiaries, as a result of which the Company will become an indirect wholly-owned subsidiary of First Eagle. The closing of the transactions contemplated by the agreement is subject to the approval of our stockholders, regulatory approvals, and other conditions. As a result, none of the condensed consolidated financial statements and related disclosures in this Form 10-Q consider the potential impact of the pending merger and related transactions.

Principles of Consolidation

The Company consolidates entities in which it, directly or indirectly, is determined to have a controlling financial interest under ASC Topic 810, as amended by ASU No. 2015-02, Consolidation – Amendments to the Consolidation Analysis, which revised the existing consolidation guidance and required the Company to re-evaluate whether to consolidate certain types of entities. The Company evaluates (1) whether it holds a variable interest in an entity, (2) whether the entity is a VIE, and (3) whether the Company’s involvement would make it the primary beneficiary.

Investments in Consolidated Variable Interest Entities

The Company sponsors the formation of various entities that are considered to be VIEs. The majority of these VIEs were formed to issue term debt securitizations used to fund the Company’s lending activities. The assets of the VIEs are primarily comprised of senior secured loans and the liabilities are primarily comprised of asset backed securities. In instances where the Company retains 100% of the equity interests and services the loans, the Company is considered the primary beneficiary of the VIE and consolidates the entities.  

Investments in Unconsolidated Variable Interest Entities and Other Unconsolidated Entities

The Company also holds variable interests in certain VIEs that are not consolidated because the Company is not considered the primary beneficiary, including its investments in certain managed credit funds and CLOs.  The Company’s involvement with such entities is in the form of equity interests that the Company has deemed more than insignificant and/or asset management fees for services provided. In instances where the Company holds equity interests, those interests are held on our balance sheet and included in Investments in Debt Securities, Available-for-Sale.

The Company manages a series of other entities and separately managed accounts for third parties. The Company receives fees for services performed with respect to such entities, which the Company has determined are not variable interests.  These fees earned by the Company are included in asset management income.

Investments in unconsolidated variable interest entities and other unconsolidated entities are referred to in this Quarterly Report as off balance sheet managed credit funds.

Prior Period Reclassification

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

Recently Adopted Accounting Standards

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740). ASU 2015-17 eliminates the requirement to separate deferred income tax liabilities into current and non-current classification in a classified balance sheet. It further requires that all deferred income taxes be classified as non-current in a classified balance sheet. ASU 2015-17 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2016. The Company adopted ASU 2015-17 on January 1, 2017.  The adoption of ASU 2015-17 did not have an impact on its consolidated financial statements as the Company does not classify its deferred income tax liabilities into current and non-current on its Consolidated Balance Sheet.

In March 2016, the FASB issued ASU 2016-07, Simplifying the Transition to the Equity Method of Accounting (Topic 323).  ASU 2016-07 eliminates the requirement for an investor to retroactively apply the equity method when its increase in ownership interest (or degree of influence) in an investee triggers equity method accounting. ASU 2016-07 is effective for interim and

12

 


annual periods in fiscal years beginning after December 15, 2016. The Company adopted ASU 2016-07 on January 1, 2017. The adoption of ASU 2016-07 did not impact its consolidated financial statements.

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, 2016. The Company adopted ASU 2016-09 on January 1, 2017 and elected to continue to estimate forfeitures. The Company’s adoption was prospective, therefore, prior periods have not been adjusted. The adoption of ASU 2016-09 could result in increased volatility to reported income tax expense related to excess tax benefits and tax deficiencies for employee share-based transactions, however, the actual amounts recognized in income tax expense will be dependent on the amount of employee share-based transactions and the stock price at the time of vesting or exercise. For the first quarter of 2017, the adoption of ASU 2016-09 resulted in a decrease to the provision for income taxes, primarily due to the tax benefit from the exercise of stock options and the vesting of restricted stock. The presentation of excess tax benefits in the statement of cash flows shifted to an operating activity from the prior classification as a financing activity.

In December 2016, the FASB issued ASU 2016-19, Technical Corrections and Improvements. ASU 2016-19 includes amendments to provide guidance clarification and references corrections and provide minor structural changes to headings or minor editing to text to improve usefulness and understandability. ASU 2016-19 is effective for annual periods and interim periods within that reporting period beginning after December 31, 2016.  The Company adopted ASU 2016-19 as of January 1, 2017. The adoption of ASU 2016-19 did not have a material impact on its consolidated financial statements.  

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. ASU 2017-01 clarifies the definition of a business to assist with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2017, with early adoption permitted. The Company early adopted ASU 2017-01 as a result of the Fifth Street CLO Management LLC acquisition. The adoption of ASU 2017-01 did not have a material impact on its consolidated financial statements.  

Issued Accounting Standards Not Yet Adopted

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 to annual and interim periods beginning after December 15, 2017, while earlier application is permitted only for annual and interim periods beginning after December 31, 2016. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), that clarifies how to apply revenue recognition guidance related to whether an entity is a principal or an agent. The update clarifies that an entity is a principal when it controls the specified good or service before that good or service is transferred to the customer, and is an agent when it does not control the specified good or service before it is transferred to the customer. The effective date and transition of ASU 2016-08 is the same as the effective date and transition of ASU 2014-09. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, which provides additional clarification and improvements for the following areas: loan guarantee fees, contract costs-impairment testing, provision for losses on construction-type and production-type contracts, cost capitalization guidance, and disclosure requirements. The effective date and transition of ASU 2016-20 is the same as the effective date and transition of ASU 2014-09. The Company has established a team which continues to evaluate and document the possible impacts of the standard, including potential changes to the accounting for investment management services performed, and also consider any reporting, tax and operational implications. The Company has not yet finalized its transition method, but does not expect, under either method, the provisions of ASU 2014-09 to result in any material changes to the timing of when revenue is recognized. The Company plans to adopt this standard effective January 1, 2018.

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, require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset and eliminate 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.

13

 


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. ASU 2016-02 mandates a modified retrospective transition method for all entities. The Company has performed a preliminary analysis of ASU 2016-02. The adoption of ASU 2016-02 is expected to impact the balance sheet of the Company, as both the value of the leased office space as well as the current value of future lease liabilities will be recorded, however the evaluation has not yet been completed. The Company plans to adopt this standard effective January 1, 2019.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326). ASU 2016-13 sets forth a “current expected credit loss” (CECL) model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. ASU 2016-13 requires enhanced disclosures, including qualitative and quantitative requirements, to help understand significant estimates and judgments used in estimating credit losses, as well as provide additional information about the amounts recorded in the financial statements. ASU 2016-13 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2019, with early adoption permitted after annual and interim periods within that reporting period beginning after December 31, 2018. ASU 2016-13 mandates a modified retrospective transition method for all entities.  The Company is currently in the scoping and evaluating phase of the adoption of ASU 2016-13.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). ASU 2016-15 provides guidance on the classification of certain cash receipts and cash payments for presentation in the statement of cash flows. ASU 2016-15 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 2016-15 will have on results from operations or financial position.

In October 2016, the FASB issued ASU 2016-17, Consolidation (Topic 810), Interest Held Through Related Parties That Are Under Common Control. ASU 2016-17 changes the evaluation of whether a reporting entity is the primary beneficiary of a VIE by changing how a reporting entity that is a single decision maker of a VIE treats indirect interests in the entity held through related parties that are under common control with the reporting entity. ASU 2016-17 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 potential impact of ASU 2016-17 on our consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU 2016-18 requires that the statement of cash flows include restricted cash in the beginning and end-of-period total amounts shown on the statement of cash flows and that the statement of cash flows explain changes in restricted cash during the period. ASU 2016-18 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2017, with early adoption permitted. However, adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Company does not expect the adoption of ASU 2016-18 to have a material impact on its financial statements and expects the impact to be disclosure only.

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.  ASU 2017-04 simplifies the measurement of goodwill impairment by eliminating Step 2 from the goodwill impairment test. Under ASU 2017-04 an entity should perform its annual or interim goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount, and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value with the loss not exceeding the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2019, with early adoption permitted. The Company is currently evaluating the potential impact of ASU 2017-04 on our consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Topic 310): Premium Amortization on Purchased Callable Debt Securities.  ASU 2017-08 amends the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date. ASU 2017-08 is effective for annual periods and interim periods within that reporting period beginning after December 15, 2018, with early adoption permitted. ASU 2017-08 will be adopted using a modified retrospective approach, with the cumulative effect adjustment recognized to retained earnings as of the beginning of the period of adoption. Entities are also required to provide disclosures about a change in accounting principle in the period of adoption. The Company is currently evaluating the potential impact of ASU 2017-08 on our consolidated financial statements.

 

 

14

 


Note 3. Acquisition and Disposition Activities

Acquisition of Fifth Street CLO Management LLC

On July 20, 2017, the Company acquired 100% of the limited liability company interests of Fifth Street CLO Management LLC (“FSCM”), a wholly-owned subsidiary of Fifth Street Holdings L.P. The purchase included contracts to manage two off balance sheet middle market CLOs and certain interests in the CLOs which will be held on the balance sheet of NewStar after the acquisition to comply with risk retention requirements. FSCM was subsequently rebranded and now operates as NewStar Commercial Loan Originator II LLC, a wholly-owned subsidiary of the Company. The Company evaluated the transaction under ASU 2017-01 and concluded that it does not meet the definition of a business and therefore is treated as an asset acquisition.  

The purchase price was $16.6 million, net of $13.1 million of assumed indebtedness. The assets acquired and the liabilities assumed in the acquisition were recorded by the company at their estimated fair values as of the acquisition date.

 

 

 

Fair Value

 

 

 

($ in thousands)

 

Assets Acquired

 

 

 

 

Investment in available for sale securities

 

$

23,068

 

Identified intangible assets

 

 

5,394

 

Other assets

 

 

1,221

 

Total assets acquired

 

$

29,683

 

Liabilities Assumed

 

 

 

 

Accrued expenses

 

$

125

 

Term Debt

 

 

12,973

 

Total Liabilities Assumed

 

$

13,098

 

Identified, net assets acquired

 

$

16,585

 

Fair values of the major categories of assets acquired and liabilities assumed were determined as follows:

The fair value of investments in available for sale securities was determined based upon the value of notes of the CLO’s determined through a third party appraisal. The majority of these notes were retained for European Union (“EU”) risk retention rules.  

The fair value of the customer contracts and related customer relationships included in identified intangible assets above, was determined using the excess earnings method under the income approach per ASC 820.  Management projected net cash flows of each investment / collateral management agreement acquired to estimate the useful life of the respective contracts. These net after-tax cash flows were discounted to present value as of the acquisition date. The fair value of customer contracts and related customer relationships was estimated at $5.4 million. The intangible assets are being amortized over their expected economic useful life, which we estimate at 3.5 years.

The fair value of other assets included accrued management fees, prepaid expenses and miscellaneous receivables which the Company believes approximated carrying value.  

The fair value of the accrued expenses approximated the carrying value of these accounts.  

The fair value of the term debt was recorded at the outstanding amount due to the third party as of the acquisition date which the Company believes approximated carrying value.

Sale of NewStar Equipment Finance assets and related platform

On December 1, 2016, the Company sold the assets of NewStar Equipment Finance (“Equipment Finance”) and related platform to a third party and exited the business. The sale of Equipment Finance assets was the result of the Company’s decision to exit businesses with economic models increasingly challenged by competition from banks and other lenders with access to lower cost funding.  The sale resulted in a gain of $6.7 million, before transaction related costs of $4.3 million. The net gain was recorded in non-interest income on the consolidated statement of operations. In connection with the sale of the assets of Equipment Finance, the Company established a $1.4 million contingent liability to cover any potential credit indemnification costs resulting from actual credit losses incurred on the assets sold.  As of September 30, 2017, this amount was reduced to $1.0 million. This liability reflects management’s best estimate of losses, taking into consideration the individual credit quality and borrower activity since origination and the anticipated residual value of the assets sold. As of September 30, 2017, the Company had not been notified or required to pay for any credit losses on the assets sold. The initial indemnification is capped at $10.0 million of actual credit losses and is reduced to $8.0 million at December 31, 2017, then further reduced to $5.0 million at December 31, 2018, $3.0 million at December 31, 2019 and zero as of December 31, 2020.  

15

 


Sale of NewStar Business Credit LLC

On March 31, 2016, the Company sold its asset based lending business, NewStar Business Credit LLC (“Business Credit”) to a third party. The sale resulted in a gain of $22.5 million, before transaction related costs of $2.5 million. The net gain was recorded in non-interest income on the accompanying consolidated statement of operations.

 

 

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

As of September 30, 2017 and December 31, 2016, loans held-for-sale consisted of the following:

 

 

 

September 30, 2017

 

 

December 31, 2016

 

 

 

($ in thousands)

 

Leveraged Finance

 

$

376,276

 

 

$

146,126

 

Lower cost or market adjustment

 

 

(716

)

 

 

(160

)

Gross loans held-for-sale

 

 

375,560

 

 

 

145,966

 

Deferred loan fees, net

 

 

(3,619

)

 

 

(1,906

)

Loans held-for-sale, net

 

$

371,941

 

 

$

144,060

 

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

At September 30, 2017, loans held-for-sale consisted of loans with an aggregate outstanding balance of $376.3 million that were intended to be sold to off balance sheet managed credit funds. The Company sold loans with an outstanding balance totaling $48.3 million to entities other than off balance sheet managed credit funds for an aggregate gain of $0.1 million during the nine months ended September 30, 2017.  The Company sold loans with an outstanding balance of $105.0 million for a net loss of $0.04 million to entities other than off balance sheet managed credit funds during the nine months ended September 30, 2016.

As of September 30, 2017, and December 31, 2016, loans consisted of the following:

 

 

 

September 30, 2017

 

 

December 31, 2016

 

 

 

($ in thousands)

 

Leveraged Finance (1)

 

$

3,049,574

 

 

$

3,308,926

 

Real Estate

 

 

10,716

 

 

 

10,624

 

Gross loans

 

 

3,060,290

 

 

 

3,319,550

 

Deferred loan fees and discount, net

 

 

(24,534

)

 

 

(29,423

)

Allowance for loan losses

 

 

(39,759

)

 

 

(50,936

)

Total loans, net

 

$

2,995,997