Form 10-Q
Table of Contents

 

 

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 June 30, 2011

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)

(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  ¨

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  ¨

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  ¨    No  x

As of July 29, 2011, 50,188,816 shares of common stock, par value of $0.01 per share, were outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

             Page      
 

PART I

FINANCIAL INFORMATION

  

Item 1.

 

Financial Statements (Unaudited)

     3   
 

Condensed Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010

     3   
 

Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30,  2011 and 2010

     4   
 

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Six Months ended June 30, 2011 and 2010

     5   
 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010

     6   
 

Notes to Condensed Consolidated Financial Statements

     7   

Item 2.

 

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

     29   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     45   

Item 4.

 

Controls and Procedures

     46   
 

PART II

OTHER INFORMATION

  

Item 1.

 

Legal Proceedings

     46   

Item 1A.

 

Risk Factors

     46   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     46   

Item 6.

 

Exhibits

     47   

SIGNATURES

     48   

 

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Table of Contents

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;

 

   

expected results of operation;

 

   

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

 

   

growth and market opportunities;

 

   

future development of our products and markets;

 

   

ability to compete; and

 

   

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:

 

   

acceleration 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;

 

   

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, 2010.

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.

 

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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     June 30,
2011
     December 31,
2010
 
     (unaudited)         
    

($ in thousands, except share

and par value amounts)

 

Assets:

     

Cash and cash equivalents

   $ 49,380        $ 54,365    

Restricted cash

     109,942          178,364    

Investments in debt securities, available-for-sale

     17,117          4,014    

Loans held-for-sale, net

     11,565          41,386    

Loans and leases, net

     1,646,070          1,590,331    

Deferred financing costs, net

     13,287          15,504    

Interest receivable

     7,819          6,797    

Property and equipment, net

     927          879    

Deferred income taxes, net

     48,502          48,093    

Income tax receivable

     1,718          5,435    

Other assets

     22,525          29,798    
  

 

 

    

 

 

 

Total assets

   $ 1,928,852        $ 1,974,966    
  

 

 

    

 

 

 

Liabilities:

     

Credit facilities

   $ 78,701        $ 108,502    

Term debt

     1,180,142          1,278,868    

Repurchase agreements

     68,000            

Accrued interest payable

     2,169          4,014    

Accounts payable

     774          242    

Other liabilities

     37,773          29,161    
  

 

 

    

 

 

 

Total liabilities

     1,367,559          1,420,787    
  

 

 

    

 

 

 

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 2011 and 2010;

     

Shares outstanding 50,362,664 in 2011 and 50,562,826 in 2010

     504          506    

Additional paid-in capital

     631,770          626,177    

Accumulated deficit

     (54,479)         (58,851)   

Common stock held in treasury, at cost $0.01 par value; 2,147,933 in 2011 and 1,864,263 in 2010

     (15,868)         (13,115)   

Accumulated other comprehensive loss, net

     (634)         (538)   
  

 

 

    

 

 

 

Total stockholders’ equity

     561,293          554,179    
  

 

 

    

 

 

 

Total liabilities and stockholders’ equity

   $ 1,928,852        $ 1,974,966    
  

 

 

    

 

 

 

 

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

 

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NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

 

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2011      2010      2011      2010  
     ($ in thousands, except per share amounts)  

Net interest income:

           

Interest income

   $ 28,315        $ 28,218        $ 55,303        $ 57,321    

Interest expense

     8,357          9,160          16,899          22,209    
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     19,958          19,058          38,404          35,112    

Provision for credit losses

     2,337          5,542          8,590          32,589    
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for credit losses

     17,621          13,516          29,814          2,523    
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest income:

           

Fee income

     359          343          934          724    

Asset management income – related party

     626          681          1,254          1,332    

Gain on derivatives

     29          125          25          143    

Gain (loss) on sale of loans

     108          (113)         108          (113)   

Other income (loss)

     (1,872)         3,727          (3,552)         7,248    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income (loss)

     (750)         4,763          (1,231)         9,334    
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating expenses:

           

Compensation and benefits

     7,070          6,182          14,615          12,566    

Occupancy and equipment

     497          450          1,021          1,094    

General and administrative expenses

     3,251          2,911          5,331          5,676    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

     10,818          9,543          20,967          19,336    
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     6,053          8,736          7,616          (7,479)   

Income tax expense (benefit)

     2,607          3,310          3,244          (3,063)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss) before noncontrolling interest

     3,446          5,426          4,372          (4,416)   

Net income attributable to noncontrolling interest

             (98)                 (187)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss) attributable to NewStar Financial, Inc. common stockholders

   $ 3,446        $ 5,328        $ 4,372        $ (4,603)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic income (loss) per share

   $ 0.07        $ 0.11        $ 0.09        $ (0.09)   

Diluted income (loss) per share

     0.06          0.10          0.08          (0.09)   

 

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

 

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NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Unaudited

 

     NewStar Financial, Inc. Stockholders’ Equity      Noncontrolling
Interest
 
     Common
Stock
     Additional
Paid-in
Capital
     Accumulated
Deficit
    Treasury
Stock
    Accumulated
Other
Comprehensive
Loss, net
    Common
Stockholders’
Equity
    
     ($ in thousands)  

Balance at January 1, 2011

   $ 506        $ 626,177        $ (58,851)      $ (13,115)      $ (538)      $ 554,179        $   

Net income

                    4,372                      4,372            

Other comprehensive income:

                 

Net unrealized securities losses, net of tax benefit of $274

                                 (405)        (405)           

Net unrealized derivatives gains, net of tax benefit of $159

                                 309         309            
              

 

 

    

Total comprehensive income

                 4,276       

Net shares reacquired from employee transactions

     (1)         180                 (988)              (809)           

Tax benefit from vesting of restricted common stock awards

            796                              796            

Repurchase of common stock

     (1)                        (1,765)               (1,765)           

Amortization of restricted common stock awards

            3,242                              3,242            

Amortization of stock option awards

            1,374                              1,374            
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at June 30, 2011

   $ 504        $  631,770        $ (54,479)      $  (15,868)      $ (634)      $ 561,293        $   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 
     NewStar Financial, Inc. Stockholders’ Equity      Noncontrolling
Interest
 
     Common
Stock
     Additional
Paid-in
Capital
     Accumulated
Deficit
    Treasury
Stock
    Accumulated
Other
Comprehensive
Loss, net
    Common
Stockholders’
Equity
    
     ($ in thousands)  

Balance at January 1, 2010

   $ 500        $ 616,762        $ (69,083)      $ (1,331)      $ (786)      $ 546,062        $ 4,058    

Net income (loss)

                   (4,603)                    (4,603)         187    

Other comprehensive income:

                 

Net unrealized securities losses, net of tax expense of $31

                               (47)        (47)          

Net unrealized derivatives gains, net of tax expense of $119

                               223         223           
              

 

 

    

Total comprehensive income

                 (4,427)      

Distributions from noncontrolling interest

                                               (4,245)   

Issuance of restricted stock

     20          (20)                                       

Shares reacquired from employee transactions

     (1)                      (546)              (547)          

Tax benefit from vesting of restricted common stock awards

            351                            351           

Repurchase of common stock

     (3)                       (1,854)              (1,854)          

Amortization of restricted common stock awards

            2,359                            2,359           

Amortization of stock option awards

            1,546                            1,546           
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at June 30, 2010

   $ 516        $  621,001        $ (73,686   $ (3,731   $ (610   $ 543,490        $   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

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

 

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NEWSTAR FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

 

     Six Months Ended June 30,  
     2011      2010  
     ($ in thousands)  

Cash flows from operating activities:

     

Net income (loss)

   $ 4,372        $ (4,603)   

Adjustments to reconcile net income (loss) to net cash used for operations:

     

Provision for credit losses

     8,590          32,589    

Depreciation and amortization and accretion

     (4,805)         (4,445)   

Amortization of debt issuance costs

     4,132          8,041    

Equity compensation expense

     4,616          4,256    

Gain on repurchase of debt

     (1,550)         (6,733)   

Losses from equity method investments

               

(Gains) losses on sale of loans

     (108)         113    

Loss on other real estate owned

     600            

Net change in deferred income taxes

     (311)         1,694    

Originations of loans held-for-sale

     (11,565)         (29,081)   

Proceeds from sale of loans held-for-sale

     41,386          34,193    

Net change in interest receivable

     (1,022)         320    

Net change in other assets

     12,110          (8,469)   

Net change in accrued interest payable

     (1,845)         3,405    

Net change in accounts payable and other liabilities

     7,802          1,366    
  

 

 

    

 

 

 

Net cash provided by operating activities

     62,402          32,646    
  

 

 

    

 

 

 

Cash flows from investing activities:

     

Net change in restricted cash

     68,422          (9,764)   

Net change in loans

     (58,594)         150,900    

Proceeds from the sale of other real estate owned

             5,331    

Purchase of debt securities available-for-sale

     (14,065)           

Proceeds from repayments of debt securities available-for-sale

     286          140    

Acquisition of property and equipment

     (281)         (31)   
  

 

 

    

 

 

 

Net cash (used in) provided by investing activities

     (4,232)         146,576    
  

 

 

    

 

 

 

Cash flows from financing activities:

     

Proceeds from exercise of stock options

     180            

Tax benefit from vesting of restricted stock

     796            

Borrowings on credit facilities

     167,654          37,515    

Repayment of borrowings on credit facilities

     (197,455)         (70,080)   

Issuance of term debt

             187,304    

Borrowings on term debt

     96,476          1,500    

Repayment of borrowings on term debt

     (194,138)         (323,969)   

Borrowings on repurchase agreements

     68,000            

Payment of deferred financing costs

     (1,915)         (8,970)   

Purchase of treasury stock

     (2,753)         (2,400)   
  

 

 

    

 

 

 

Net cash used in financing activities

     (63,155)         (179,100)   
  

 

 

    

 

 

 

Net increase (decrease) in cash during the period

     (4,985)         122    

Cash and cash equivalents at beginning of period

     54,365          39,848    
  

 

 

    

 

 

 

Cash and cash equivalents at end of period

   $ 49,380        $ 39,970    
  

 

 

    

 

 

 

Supplemental cash flows information:

     

Interest paid

   $ 18,744        $ 18,804    

Taxes paid

     2,500            

Decrease (increase) in fair value of investments in debt securities

     679          78    

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

 

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NEWSTAR FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

Note 1. Organization

NewStar Financial, Inc. (the “Company”), a Delaware corporation, is a commercial finance company focused on meeting the complex financing needs of companies and private investors in the middle market. The Company principally focuses on the direct origination of loans and leases that meet its risk and return parameters. The Company’s direct origination efforts target mid-sized companies, private equity sponsors, corporate executives, regional banks, real estate investors and a variety of other financial intermediaries to source transaction opportunities. Direct origination provides direct access to customers’ management, enhances due diligence, and allows significant input into customers’ capital structure and direct negotiation of transaction pricing and terms. We also participate in larger loans as a member of a syndicate.

The Company operates as a single segment and derives its revenues from four national specialized lending groups:

 

   

Leveraged Finance, which originates, structures and underwrites senior cash flow loans and, to a lesser extent, second lien, subordinated debt, and equity or other equity-linked products for companies with annual EBITDA typically between $5 million and $50 million;

 

   

Real Estate, which originates, structures and underwrites first mortgage debt and, to a lesser extent, subordinated debt, primarily to finance acquisitions of commercial real estate properties typically valued between $10 million and $50 million;

 

   

Business Credit, which originates, structures and underwrites senior asset-based loans for companies with sales typically totaling between $25 million and $500 million; and

 

   

Equipment Finance, which originates, structures and underwrites leases and lease lines to finance equipment purchases and other capital expenditures typically for companies with annual sales of at least $25 million.

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 and (v) determination of other than temporary impairments and temporary impairments. 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, 2010.

Noncontrolling Interest

During 2009, the Company along with a wholly-owned subsidiary of the NewStar Credit Opportunities Fund, Ltd. (“NCOF”) created a limited liability company as part of the resolution of a troubled commercial real estate loan. The limited liability company was formed to take control of the underlying commercial real estate property which was its sole asset. The Company maintained a majority and controlling interest in the limited liability company which was classified as other real estate owned (“OREO”). On May 11, 2010, the limited liability company sold the commercial real estate property.

The 2010 consolidated financial statements include the results of operations of the Company as well as the NCOF’s noncontrolling interest of the limited liability company which previously owned the OREO. All significant intercompany balances and transactions have been eliminated in consolidation. The noncontrolling interest represented the minority partner’s equity and accumulated earnings in the limited liability company. The NCOF’s noncontrolling interest had no recourse to the Company.

 

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Recently Adopted Accounting Standards

In July 2010, the FASB issued ASU 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 amends Topic 310 to provide greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. The new disclosures as of the end of the reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The new disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of ASU 2010-20 did not have a material effect on the Company’s results from operations or financial position as it only impacts the required disclosures as incorporated into Note 3.

In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 provides amendments to Topic 820 that require new disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. The new disclosures regarding the activity in Level 3 fair value measurements is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. All other requirements of ASU 2010-06 are effective in interim and annual periods beginning after December 15, 2009. The adoption of ASU 2010-06 did not have a material effect on the Company’s results from operations or financial position as it only impacts the required disclosures as incorporated into Note 12.

Recently Issued Accounting Standards

On January 19, 2011, the FASB issued ASU No. 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, which temporarily delays the effective date for public entities of the disclosures about troubled debt restructurings (TDRs) in ASU No. 2010-20. The deferral will allow the FASB to complete its deliberations on what constitutes a TDR, to coordinate the effective dates of the new disclosures about TDRs for public entities in ASU No. 2010-20, and the guidance for determining what constitutes a TDR.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. ASU 2011-02 states when a creditor evaluates whether a restructuring constitutes a troubled debt restructuring, it must separately conclude that both of the following exist: 1) the restructuring must constitute a concession and 2) the debtor is experiencing financial difficulties. ASU 2011-02 amends Topic 310 by clarifying the guidance on a creditor’s evaluation of whether it has granted a concession to a borrower. ASU 2011-02 is effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The Company is currently evaluating the impact of the adoption of ASU 2011-02 will have on its results from operations or financial position.

In April 2011, the FASB issued ASU 2011-03, Transfers and Servicings (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. ASU 2011-03 changes the assessment of effective control by focusing on the transferor’s contractual rights and obligations and removing the criterion to assess the ability to exercise those rights or honor those obligations. ASU 2011-03 is effective for the interim or annual period beginning on or after December 15, 2011. The Company is currently evaluating the impact of the adoption of ASU 2011-03 will have on its results from operations or financial position.

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU 2011-04 establishes common fair value measurement and disclosure requirements in GAAP and IFRS. ASU 2011-04 amends topic 820 by clarifying the intent of the application of existing fair value measurement and disclosure requirements. The amendments in this update also change the fair value measurement of financial instruments that are managed within a portfolio subject to market risks and the credit risk of counterparties, the application of premiums and discounts in a fair value measurement, and require additional fair value measurement disclosures. ASU 2011-04 will be applied prospectively and is effective during interim and annual periods beginning after December 15, 2011. The Company is currently evaluating the impact of the adoption of ASU 2011-02 will have on its results from operations or financial position.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income. ASU 2011-05 gives two options for presenting other comprehensive income (“OCI”). An OCI statement can be included with the net income statement, which together will make a statement of total comprehensive income. Alternatively an OCI statement may be presented separately from a net income statement, but the two statements must appear consecutively within a financial report. ASU 2011-05 will be applied retrospectively and is effective for fiscal years and interim periods within those years, beginning after December 15, 2011. Adoption of ASU 2011-05 will not have an impact on the Company’s results of operations or financial position as it only impacts required disclosures.

 

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Note 3. Loans Held-for-Sale, Loans and Leases, and Allowance for Credit Losses

Loans classified as held-for-sale may consist of loans originated by the Company and intended to be sold or syndicated to third parties (including the NewStar Credit Opportunities Fund, Ltd., a related party) or impaired loans for which a sale of the loan is expected as a result of a workout strategy. At June 30, 2011 loans held-for-sale consisted of leveraged finance loans to four borrowers which are intended to be sold to the NewStar Credit Opportunities Fund, Ltd. at an agreed upon price. Subsequent to June 30, 2011, the Company sold loans with an aggregate outstanding balance of $3.0 million to the NewStar Credit Opportunities Fund, Ltd. as intended.

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

As of June 30, 2011 and December 31, 2010, loans held-for-sale consisted of the following:

 

       June 30,  
2011
         December 31,    
2010
 
     ($ in thousands)  

Leveraged Finance

   $ 11,779        $ 42,228    
  

 

 

    

 

 

 

Gross loans

     11,779          42,228    

Deferred loan fees, net

     (214)         (842)   
  

 

 

    

 

 

 

Total loans, net

   $   11,565        $   41,386    
  

 

 

    

 

 

 

The Company sold loans with an aggregate outstanding balance of $28.3 million for a gain of $0.1 million to entities other than the NCOF during the six months ended June 30, 2011. The Company sold two loans for a loss of $0.1 million to entities other than the NCOF during the six months ended June 30, 2010.

As of June 30, 2011 and December 31, 2010, the Company’s loans and leases consisted of the following:

 

     June 30,
2011
     December 31,
2010
 
     ($ in thousands)  

Leveraged Finance

   $ 1,378,235        $ 1,348,238    

Real Estate

     271,818          282,610    

Business Credit

     98,757          67,390    
  

 

 

    

 

 

 

Gross loans

     1,748,810          1,698,238    

Deferred loan fees, net

     (25,085)         (23,405)   

Allowance for loan losses

     (77,655)         (84,502)   
  

 

 

    

 

 

 

Total loans, net

   $   1,646,070        $   1,590,331    
  

 

 

    

 

 

 

The Company grants commercial loans, commercial real estate loans, and leases to customers throughout the United States. Although the Company has a diversified loan and lease portfolio, certain events have occurred, including, but not limited to, adverse economic conditions and adverse events affecting specific clients, industries or markets, that may adversely affect the ability of borrowers to make timely scheduled principal and interest payments on their loans and leases.

On November 1, 2010, the Company acquired Core Business Credit, LLC, an asset-based lender located in Dallas, Texas with the fair value of outstanding loans totaling $73.4 million as of October 31, 2010, and its wholly-owned subsidiaries (collectively “Business Credit”) and recognized a gain of $5.6 million in connection with the acquisition. On April 1, 2011, Core Business Credit, LLC changed its name to NewStar Business Credit, LLC. The following table sets forth the activity of the accretable purchase discount related to the acquisition of Business Credit:

 

     Six Months Ended
June 30,
 
   2011      2010  
     ($ in thousands)  

Balance, beginning of year

   $ 84       $ —     

Additions due to acquisitions

     —           —     

Accretion

     (16)         —     

Reduction due to payments or sale

     —           —     
  

 

 

    

 

 

 

Balance, end of period

   $ 68        $ —     
  

 

 

    

 

 

 

 

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The Company also recorded a $1.7 million non-accretable discount resulting from the fair value of certain loans acquired from Business Credit, of which $0.5 was recognized in interest income during the six months ended June 30, 2011 as a result of loan repayments.

As of June 30, 2011, the Company had impaired loans with an aggregate outstanding balance of $352.4 million. Impaired loans with an aggregate outstanding balance of $234.1 million have been restructured and classified as troubled debt restructurings (“TDR”). In connection with troubled debt restructurings during the three months ended June 30, 2011, the Company received $4.6 million of equity in certain of its borrowers in exchange for debt. As of June 30, 2011, the aggregate equity received in certain of the Company’s borrowers in connection with troubled debt restructurings totaled $8.7 million. Impaired loans with an aggregate outstanding balance of $109.0 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 has been brought current. During the six months ended June 30, 2011, previously identified non-accrual loans with an aggregate balance of $35.6 million at December 31, 2010 were taken off non-accrual status, and loans with an aggregate balance of $20.4 million were placed on non-accrual status. During the three and six months ended June 30, 2011, the Company recorded $6.0 million and $12.1 million of specific provisions for impaired loans. At June 30, 2011, the Company had a $56.6 million specific allowance for impaired loans with an aggregate outstanding balance of $221.5 million. At June 30, 2011, additional funding commitments for impaired loans totaled $40.1 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 and the borrowing base availability for asset-based loans, or if the borrower is not in compliance additional funding commitments may be made at the Company’s discretion. As of June 30, 2011, $86.3 million of loans on non-accrual status were greater than 60 days past due and classified as delinquent by the Company. Included in the $56.6 million specific allowance for impaired loans was $26.6 million related to delinquent loans.

As of December 31, 2010, the Company had impaired loans with an aggregate outstanding balance of $356.6 million. Impaired loans with an aggregate outstanding balance of $222.6 million have been restructured and classified as TDR. Impaired loans with an aggregate outstanding balance of $135.6 million were also on non-accrual status. During 2010, the Company recorded $47.7 million of specific provisions for impaired loans. At December 31, 2010, the Company had a $60.4 million specific allowance for impaired loans with an aggregate outstanding balance of $238.5 million. At December 31, 2010, additional funding commitments for impaired loans totaled $54.9 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 December 31, 2010, $106.0 million of impaired loans and $8.4 million of accruing loans were greater than 60 days past due and classified as delinquent by the Company. Included in the $60.4 million specific allowance for impaired loans was $26.7 million related to delinquent loans.

A summary of impaired loans is as follows:

 

     Investment      Unpaid
Principal
    Recorded Investment with  a
Related Allowance for
Credit Losses
   Recorded Investment
without a Related Allowance
for Credit Losses

June 30, 2011

                     ($ in thousands)                        

Leveraged Finance

   $   254,112       $ 308,410         $ 158,138             $ 95,974      

Real Estate

     93,339         110,319           63,360               29,979      

Business Credit

     4,979         6,147           —                 4,979      
  

 

 

    

 

 

      

 

 

          

 

 

    

Total

   $ 352,430       $   424,876         $ 221,498             $ 130,932      
  

 

 

    

 

 

      

 

 

          

 

 

    

December 31, 2010

                                              

Leveraged Finance

   $ 262,394       $ 336,054         $ 168,279             $ 94,115      

Real Estate

     87,448         93,829           70,231               17,217      

Business Credit

     6,732         8,250           —                 6,732      
  

 

 

    

 

 

      

 

 

          

 

 

    

Total

   $ 356,574       $ 438,133         $ 238,510             $ 118,064      
  

 

 

    

 

 

      

 

 

          

 

 

    

 

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Below is a summary of the Company’s evaluation of its portfolio and allowance for loan and lease losses by impairment methodology:

 

     Leveraged Finance      Real Estate      Business Credit  

June 30, 2011

   Investment      Allowance      Investment      Allowance      Investment     Allowance  
     ($ in thousands)  

Collectively evaluated (1)

   $ 1,124,123       $ 16,635       $ 178,479       $ 4,275       $ 93,778      $ 150   

Individually evaluated (2)

     254,112         45,305         93,339         11,297         4,979        —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 1,378,235       $ 61,940       $ 271,818       $ 15,572       $ 98,757      $ 150   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
     Leveraged Finance      Real Estate      Business Credit  

December 31, 2010

   Investment      Allowance      Investment      Allowance      Investment     Allowance  
     ($ in thousands)  

Collectively evaluated (1)

   $ 1,085,844       $ 17,562       $ 195,162       $ 6,869       $ 60,658 (3)    $ —     

Individually evaluated (2)

     262,394         41,350         87,448         19,000         6,732 (3)      —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 1,348,238       $ 58,912       $ 282,610       $ 25,869       $ 67,390      $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Represents loans and leases collectively evaluated for impairment in accordance with ASC 450-20, Loss Contingencies, and pursuant to amendments by ASU 2010-20 regarding allowance for unimpaired loans. These loans and leases had a weighted average risk rating of 5.4 and 5.5 based on the Company’s internally developed 12 point scale at June 30, 2011 and December 31, 2010, respectively.
(2) Represents loans individually evaluated for impairment in accordance with ASU 310-10, Receivables, and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.
(3) Represents the Business Credit acquisition portfolio of loans which the Company recorded at fair value on the date of acquisition.

The Company classifies a loan as Past Due when it is over 60 days delinquent.

An age analysis of the Company’s past due receivables is as follows:

 

     60-89 Days
Past Due
     Greater than
90 Days
     Total Past
Due
     Current      Total Loans
and Leases
     Investment in
> 60  Days &
Accruing
 

June 30, 2011

   ($ in thousands)  

Leveraged Finance

   $ 11,626       $ 61,423       $ 73,049       $ 1,316,965       $ 1,390,014       $ —     

Real Estate

     —           8,263         8,263         263,555         271,818         —     

Business Credit

     4,978         —           4,978         93,779         98,757         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 16,604       $ 69,686       $ 86,290       $ 1,674,299       $ 1,760,589       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2010

                                         

Leveraged Finance

   $ 17,224       $ 70,061       $ 87,285       $ 1,309,649       $ 1,396,934       $ —     

Real Estate

     —           27,196         27,196         255,414         282,610         8,438   

Business Credit

     —           —           —           67,390         67,390         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 17,224       $ 97,257       $ 114,481       $ 1,632,453       $ 1,746,934       $ 8,438   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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A summary of the activity in the allowance for credit losses is as follows:

 

     Three Months Ended June 30, 2011  
     Leveraged
Finance
     Real Estate      Business
Credit
     Total  
     ($ in thousands)  

Balance, beginning of period

   $ 60,963        $ 24,711        $ 38        $ 85,712    

Provision for credit losses—general

     (1,151)         (2,601)         112          (3,640)   

Provision for credit losses—specific

     2,520          3,457          —           5,977    

Loans charged off, net of recoveries

     —           (10,009)         —           (10,009)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 62,332        $ 15,558        $ 150        $ 78,040    
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period—specific

   $ 45,305        $ 11,297        $ —         $ 56,602    
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period—general

   $ 17,027        $ 4,261        $ 150        $ 21,438    
  

 

 

    

 

 

    

 

 

    

 

 

 

Average balance of impaired loans

   $ 257,202       $ 103,561       $ 6,680       $ 367,443   

Interest recognized from impaired loans

   $ 4,116       $ 893       $ 38       $ 5,047   

Loans and leases

           

Loans individually evaluated with specific allowance

   $ 158,138        $ 63,360        $ —         $ 221,498    

Loans individually evaluated with no specific allowance

     95,974          29,979          —           125,953    

Loans acquired with deteriorating credit quality

     —           —           4,979          4,979    

Loans and leases collectively evaluated without specific allowance

     1,124,123          178,479          93,778          1,396,380    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans and leases

   $ 1,378,235        $ 271,818        $   98,757        $ 1,748,810    
  

 

 

    

 

 

    

 

 

    

 

 

 
     Six Months Ended June 30, 2011  
     Leveraged
Finance
     Real Estate      Business
Credit
     Total  
     ($ in thousands)  

Balance, beginning of year

   $ 58,912        $ 25,869        $ —         $ 84,781    

Provision for credit losses—general

     (534)         (3,082)         150          (3,466)   

Provision for credit losses—specific

     9,276          2,780          —           12,056    

Loans charged off, net of recoveries

     (5,322)         (10,009)         —           (15,331)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 62,332        $ 15,558        $ 150        $ 78,040    
  

 

 

    

 

 

    

 

 

    

 

 

 

Average balance of impaired loans

   $ 304,247       $ 107,882       $ 7,408       $ 419,536   

Interest recognized from impaired loans

   $ 7,681       $ 1,764       $ 189       $ 9,634   

During the six months ended June 30, 2011, the Company recorded a total provision for credit losses of $8.6 million. The Company reduced its allowance for credit losses to $78.0 million as of June 30, 2011 from $84.8 million at December 31, 2010. This reduction in allowance for credit losses resulted primarily from a decrease in the specific allowance for impaired loans, and charge offs of impaired loans with a specific allowance during the six months ended June 30, 2011. The general allowance for credit losses covers probable losses in the Company’s loan and lease portfolio with respect to loans and leases for which no specific impairment has been identified. A specific provision for credit losses is recorded with respect to loans for which it is probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement for which there is impairment recognized. The outstanding balance of impaired loans, which include all of the outstanding balances of the Company’s delinquent loans and its troubled debt restructurings, as a percentage of “Loans and leases, net” increased to 21% as of June 30, 2011 as compared to 20% as of June 30, 2010. When a loan is classified as impaired, the loan is evaluated for a specific allowance and a specific provision may be recorded, thereby removing it from consideration under the general component of the allowance analysis. Loans that are deemed to be uncollectible are charged off and deducted from the allowance, and recoveries on loans previously charged off are netted against loans charged off.

The Company closely monitors the credit quality of its loans and leases which is partly reflected in its credit metrics such as loan delinquencies, non-accruals and charge offs. Changes in these credit metrics are largely due to changes in economic conditions and seasoning of the loan and lease portfolio.

 

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Included in the allowance for credit losses at June 30, 2011 and December 31, 2010 is an allowance for unfunded commitments of $0.4 million and $0.3 million, respectively, which is recorded as a component of other liabilities on the Company’s consolidated balance sheet with changes recorded in the provision for credit losses on the Company’s consolidated statement of operations. The methodology for determining the allowance for unfunded commitments is consistent with the methodology for determining the allowance for loan and lease losses.

Based on the Company’s evaluation process to determine the level of the allowance for loan and lease losses, management believes the allowance to be adequate as of June 30, 2011 in light of the estimated known and inherent risks identified through its analysis. The Company continually evaluates the appropriateness of its allowance for credit losses methodology.

During the three and six months ended June 30, 2010, the aggregate average balance of impaired loans was $375.5 million and $400.3 million, respectively. The total amount of interest income recognized during the three and six months ended June 30, 2010 from impaired loans was $3.2 million and $6.6 million, respectively. The amount of cash basis interest income that was recognized for the three and six months ended June 30, 2010 was $2.3 million and $5.4 million, respectively.

During 2009, in connection with the resolution of two impaired commercial real estate loans, the Company took control of the underlying commercial real estate properties. During 2010, the Company sold one of these commercial real estate properties. At June 30, 2011, the remaining asset had a carrying amount of $2.8 million and was classified as other real estate owned (“OREO”) and included in “Other assets” in the Company’s balance sheet.

Note 4. Restricted Cash

Restricted cash as of June 30, 2011 and December 31, 2010 was as follows:

 

     June 30,
2011
      December 31,  
2010
 
     ($ in thousands)  

Collections on loans pledged to credit facilities

   $ 36,488       $ 32,356    

Principal and interest collections on loans held in trust and prefunding amounts

     63,039         132,969    

Customer escrow accounts

     10,415         13,039    
  

 

 

   

 

 

 

Total

   $   109,942       $   178,364    
  

 

 

   

 

 

 

Note 5. Investments in Debt Securities, Available-for-Sale

During the three months ended June 30, 2011, the Company purchased four debt securities for $14.1 million.

Amortized cost of investments in debt securities as of June 30, 2011 and December 31, 2010 was as follows:

 

         June 30,    
2011
      December 31,  
2010
 
     ($ in thousands)  

Investments in debt securities - gross

   $ 21,184       $ 6,468    

Unamortized discount

     (3,232)        (2,298)   
  

 

 

   

 

 

 

Investments in debt securities - amortized cost

   $   17,952       $   4,170    
  

 

 

   

 

 

 

 

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The amortized cost, gross unrealized holding gains, gross unrealized holding losses, and fair value of available-for-sale securities at June 30, 2011 and December 31, 2010 were as follows:

 

     Amortized
cost
     Gross
unrealized
holding gains
     Gross
unrealized
holding losses
     Fair value  
     ($ in thousands)  

June 30, 2011:

           

Other debt obligation(1)

   $     17,952        $     —         $     (835)        $     17,117    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 17,952        $ —         $ (835)        $ 17,117    
  

 

 

    

 

 

    

 

 

    

 

 

 
     Amortized
cost
     Gross
unrealized
holding gains
     Gross
unrealized
holding losses
     Fair value  
     ($ in thousands)  

December 31, 2010:

           

Other debt obligation(1)

   $ 4,170        $ —         $ (156)        $ 4,014    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 4,170        $ —         $ (156)        $ 4,014    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Securitization collateralized by future cash flows from multiple property easements.

The Company did not sell any debt securities during the six months ended June 30, 2011 and 2010.

The Company did not record any net Other Than Temporary Impairment charges during the six months ended June 30, 2011 and 2010.

The following is an analysis of the continuous periods during which the Company has held investment positions which were carried at an unrealized loss as of June 30, 2011 and December 31, 2010:

 

     June 30, 2011  
     Less than
12  Months
     Greater than
or Equal to

12 Months
     Total  
     ($ in thousands)  

Number of positions

                      

Fair value

   $   13,312       $   3,805        $   17,117    

Amortized cost

     14,066         3,886          17,952    
  

 

 

    

 

 

    

 

 

 

Unrealized loss

   $ 754       $ 81        $ 835    
  

 

 

    

 

 

    

 

 

 
     December 31, 2010  
     Less than
12  Months
     Greater than
or Equal to
12 Months
     Total  
     ($ in thousands)  

Number of positions

     —                     

Fair value

   $ —         $ 4,014        $ 4,014    

Amortized cost

     —           4,170          4,170    
  

 

 

    

 

 

    

 

 

 

Unrealized loss

   $ —         $ 156        $ 156    
  

 

 

    

 

 

    

 

 

 

As a result of the Company’s evaluation of the security, management concluded that the unrealized losses at June 30, 2011 and December 31, 2010 were caused by changes in market prices driven by interest rates and credit spreads. The Company’s evaluation of impairment included adjustments to prepayment speeds, delinquency, an analysis of expected cash flows, interest rates, market discount rates, other contract terms, and the timing and level of losses on the loans and leases within the underlying trusts. At June 30, 2011, the Company has determined that it is not more likely than not that it will be required to sell the securities before the Company recovers its amortized cost basis in the security. The Company has also determined that there has not been an adverse change in the cash flows expected to be collected. Based upon the Company’s impairment review process, and the Company’s ability and intent to hold these securities until maturity or a recovery of fair value, the decline in the value of these investments is not considered to be “Other Than Temporary.”

 

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Table of Contents

Maturities of debt securities classified as available-for-sale were as follows at June 30, 2011 and December 31, 2010 (maturities of asset-backed and mortgage-backed securities have been allocated based upon estimated maturities, assuming no change in the current interest rate environment):

 

     June 30, 2011     December 31, 2010  
       Amortized  
cost
       Fair value         Amortized  
cost
       Fair value    
     ($ in thousands)  

Available-for-sale:

          

Due one year or less

   $ —         $ —        $ —         $ —     

Due after one year through five years

     —           —          —           —     

Due after five years

     17,952          17,117         4,170          4,014    
                                  

Total

   $     17,952        $   17,117       $     4,170        $     4,014    
                                  

Note 6. Derivative Financial Instrument Hedging Activities

During 2010, the Company entered into three short-term interest rate swap agreements which were designated and qualified as cash flow hedges of the risk of changes in the Company’s interest payments on LIBOR-indexed debt. The three interest rate swap agreements matured prior to December 31, 2010. During 2006, the Company entered into interest rate swap agreements which were designated and qualified as cash flow hedges of the risk of changes in the Company’s interest payments on LIBOR-indexed debt. At June 30, 2011, the lone remaining outstanding interest rate swap agreement had a notional value of $3.5 million and had a scheduled maturity of October 20, 2013. The Company records the contracted interest rate swap net amounts exchanged in interest expense in the accompanying consolidated statements of operations. During the six months ended June 30, 2011 and 2010, the Company recorded hedge ineffectiveness of $1,998 and $(38,629), respectively, which is included in gain (loss) on derivatives in the Company’s consolidated statements of operations. The Company estimates that the net amount of existing unrealized losses at June 30, 2011 expected to be classified from accumulated other comprehensive income into earnings within the next 12 months is approximately $0.4 million. The reclassification is expected to result in additional interest expense.

Interest rate risk mitigation products are offered to enable customers to meet their financing and risk management objectives. Derivative financial instruments consist predominantly of interest rate swaps, interest rate caps and floors. The interest rate risks to the Company of these customer derivatives is mitigated by entering into similar derivatives having offsetting terms with other counterparties consisting primarily of large financial institutions. The interest rate mitigation products do not qualify for hedge accounting treatment.

The fair values of the Company’s derivative instruments outstanding as of June 30, 2011 were as follows:

 

     Asset Derivatives      Liability Derivatives  

($ in thousands)

       Balance Sheet    
Location
         Fair Value          Balance  Sheet
Location
         Fair Value      

Derivative instruments designated as hedging instruments under ASC 815:

           

Interest rate contracts

     Other assets       $ —           Other liabilities       $ 326     

Derivative instruments not designated as hedging instruments under ASC 815:

           

Interest rate contracts

     Other assets       $   1,302           Other liabilities       $   1,249     

 

15


Table of Contents

The gains and losses on the Company’s derivative instruments during the three months ended June 30, 2011 were as follows:

 

($ in thousands)

                              

Derivatives in ASC 815

Cash Flow Hedging

Relationships:

   Amount of
Gain (Loss)
Recognized in
OCI (Effective
Portion)
     Location of Gain
(Loss)
Reclassified
from Accumulated

OCI into Income
(Effective Portion)
   Amount of Gain
(Loss)  Reclassified
from Accumulated
OCI into Income
(Effective Portion)
     Location of Gain
(Loss)  Recognized
in Income
(Ineffective
Portion)
   Amount of Gain
(Loss)  Recognized
in Income
(Ineffective
Portion)
 

Interest rate contracts

   $     47           Gain (loss) on

derivatives

   $     (99)           Gain (loss) on

derivatives

   $   —         

 

Derivatives Not Designated

as Hedging Instruments

under ASC 815

   Amount of
Gain (Loss)
Recognized  in
Income
     Location of Gain  (Loss)
Recognized in Income

Interest rate contracts

   $     9           Gain (loss) on
derivatives

The gains and losses on the Company’s derivative instruments during the six months ended June 30, 2011 were as follows:

 

($ in thousands)

                              

Derivatives in ASC 815

Cash Flow Hedging

Relationships:

   Amount of
Gain (Loss)

Recognized in
OCI  (Effective
Portion)
     Location of Gain
(Loss)
Reclassified
from Accumulated
OCI into Income
(Effective Portion)
   Amount of Gain
(Loss)  Reclassified
from Accumulated
OCI into Income
(Effective Portion)
     Location of Gain
(Loss)  Recognized
in Income
(Ineffective
Portion)
   Amount of Gain
(Loss) Recognized

in Income
(Ineffective

Portion)
 

Interest rate contracts

   $     48           Gain (loss) on
derivatives
   $     (198)           Gain (loss) on
derivatives
   $   —         

 

Derivatives Not Designated

as Hedging Instruments

under ASC 815

   Amount of
Gain (Loss)
Recognized in

Income
     Location of Gain (Loss)
Recognized in Income

Interest rate contracts

   $     8           Gain (loss) on
derivatives

As of June 30, 2011, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, was $1.6 million. The Company did not have any minimum collateral posting thresholds with any of its derivative counterparties at June 30, 2011.

If the Company defaults on any of its indebtedness under these derivatives, including defaults where repayment of the indebtedness has not been accelerated by the lender, or if the Company defaults on its credit facility with Wachovia Capital Markets, LLC or its note agreement with Fortress Credit Corp., then the Company could be declared in default on its derivative obligations with the respective counterparties. In addition, if the Company fails to maintain a minimum net worth of $300 million, then the Company could be declared in default on certain of its derivative obligations. As of June 30, 2011, the Company was in compliance with all of these provisions.

If the Company had been declared in default of any of these provisions at June 30, 2011, its derivative counterparties could have required the Company to settle its obligations under the respective derivatives at their termination value, which would have totaled $1.5 million in the aggregate.

Note 7. Borrowings

Credit Facilities

As of June 30, 2011 the Company had three credit facilities: (i) a $50 million facility with NATIXIS Financial Products, Inc. (“NATIXIS”), (ii) a $225 million credit facility with DZ Bank AG Deutsche Zentral-Genossenschaftsbank Frankfurt (“DZ Bank”) and (iii) a $75 million credit facility with Wells Fargo Bank, National Association (“Wells Fargo”).

In connection with the NATIXIS credit facility entered into in August 2005, the Company formed a wholly owned subsidiary, NewStar Short-Term Funding, LLC, a single-purpose bankruptcy-remote entity, to purchase or hold loans and investments for 90 days

 

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or less. The amount outstanding under the credit facility varies with the balances outstanding of pledged loans and investments depending on the mix of assets. On July 15, 2011, the Company entered into an amendment with NATIXIS which extended the revolving period under the credit facility to August 23, 2012. NewStar Short-Term Funding, LLC must comply with various covenants, the breach of which could result in a termination event. These covenants include, but are not limited to, failure to service debt obligations and failure to remain within prescribed facility portfolio charge-off levels. At June 30, 2011, NewStar Short-Term Funding, LLC was in compliance with all such covenants. Interest on this facility accrues at a variable rate per annum, which was 3.69% at June 30, 2011. As of June 30, 2011, unamortized deferred financing fees were $0.04 million and the outstanding balance was $15.7 million.

As part of the Company’s acquisition of Core Business Credit, LLC (now known as NewStar Business Credit, LLC) and its wholly-owned subsidiaries (“Business Credit”) on November 1, 2010, it became a party to an existing $225.0 million credit facility with DZ Bank. The credit facility with DZ Bank had an outstanding balance of $63.0 million as of June 30, 2011. Interest on this facility accrues at a variable rate per annum. As part of the agreement, there is a minimum payment of $2.8 million per annum required to be made to satisfy the minimum requirement. If the facility is not utilized to cover this minimum requirement, then a make-whole fee is required to be made. The Company is permitted to use the proceeds of borrowings under the credit facility to fund commitments under existing or new asset based loans. This facility is scheduled to mature on April 25, 2013.

On January 25, 2011, the Company entered into a note purchase agreement with Wells Fargo. Under the terms of the note purchase agreement, Wells Fargo agreed to provide a $75 million revolving credit facility to fund new equipment lease origination. The credit facility is scheduled to mature four years after the initial advance under the credit facility. As of June 30, 2011, the Company had not drawn any amounts from this credit facility.

On July 12, 2011, the Company entered into an amendment with Wells Fargo to its term debt facility with Wachovia Capital Markets, LLC. The amendment increased the amount of the facility to $125.0 million and provides for a revolving reinvestment period of 18 months with a two-year amortization period. The facility accrues interest at a variable rate per annum.

The Company had a $75.0 million credit facility agreement with Citicorp North America, Inc. (“Citicorp”) scheduled to mature on June 15, 2011. On June 7, 2011, the Company fully repaid the outstanding balance of this facility with the proceeds received from its financing arrangement with Macquarie Bank Limited (see Note 8) and the credit facility was terminated.

Corporate Credit Facility

On January 5, 2010, the Company entered into a note agreement with Fortress Credit Corp. The credit facility consists of a $50.0 million revolving note and a $50.0 million term note, which matures on August 31, 2014. The credit facility accrues interest equal to the London Interbank Offered Rate (LIBOR) plus 7.00%.

The Company is permitted to use the proceeds of borrowings under the credit facility for general corporate purposes including, but not limited to, funding loans, working capital, paying down outstanding debt, making certain types of acquisitions and repurchasing capital stock up to $10 million.

The applicable unused fee rate of the revolving note is 4.0% of the undrawn amount of the revolving note when the total outstanding amount of both notes is less than 50% of the $100.0 million commitment amount, 3.0% of the undrawn amount of the revolving note when the total outstanding amount is greater than or equal to 50% but less than 75% of the commitment amount, and 2.0% of the undrawn amount of the revolving note when the total outstanding amount is greater than or equal to 75% of the commitment amount. As of June 30, 2011, the Company had not drawn any amounts from the revolving note. As of June 30, 2011, unamortized deferred financing fees were $3.2 million.

The term note may be prepaid subject to a prepayment fee, payable whether the prepayment is voluntary or involuntary. If any such prepayment is made on or before August 30, 2012, the prepayment fee will be calculated for the period commencing on the date of such prepayment and continuing through August 30, 2012 and shall be equal to the product of 7.00% per annum multiplied by the amount of the prepayment. If any such prepayment is made after August 30, 2012, such prepayment fee will be equal to the product of (a) the amount of the prepayment and (b)(i) in the case of any such prepayment made during the period commencing on August 31, 2012 and ending on August 30, 2013, 2.00% and (ii) in the case of any such prepayment made at any time after August 30, 2013, 1%. As of June 30, 2011, the term note had an outstanding balance of $50.0 million.

Term Debt Facilities

As of June 30, 2011, the Company had one term debt facility, a $14.5 million facility with Wachovia Capital Markets, LLC (“Wachovia”).

In connection with the Wachovia credit facility, the Company formed a wholly owned subsidiary, NewStar CP Funding, LLC, a single-purpose bankruptcy-remote entity, to purchase or hold loans and investments. NewStar must comply with various covenants, the breach of which could result in a termination event. These covenants include, but are not limited to, failure to service debt

 

17


Table of Contents

obligations, and failure to meet tangible net worth covenants and overcollateralization tests. At June 30, 2011, NewStar was in compliance with all such covenants. This credit facility was amended on July 12, 2011. Interest on this facility accrued at a variable rate per annum, which was 3.94% at June 30, 2011. As of June 30, 2011, unamortized deferred financing fees were $0.9 million and the outstanding balance was $13.0 million.

Term Debt Securitizations

In August 2005 the Company completed a term debt transaction. In conjunction with this transaction the Company established a separate single-purpose bankruptcy-remote subsidiary, NewStar Trust 2005-1 (the “2005 CLO Trust”) and contributed $375 million in loans and investments (including unfunded commitments), or portions thereof, to the 2005 CLO Trust. The Company remains the servicer of the loans and investments. Simultaneously with the initial contributions, the 2005 CLO Trust issued $343.4 million of notes to institutional investors and issued $31.6 million of trust certificates of which the Company retained 100%. At June 30, 2011, the $176.2 million of outstanding notes were collateralized by the specific loans and investments, principal collections account cash and principal payment receivables totaling $207.8 million. At June 30, 2011, deferred financing fees were $0.2 million. The 2005 CLO Trust permitted reinvestment of collateral principal repayments for a three-year period which ended in October 2008. During the six months ended June 30, 2011, the Company repurchased $3.9 million of the 2005 CLO Trust’s Class E notes. During 2010, the Company repurchased $4.6 million of the 2005 CLO Trust’s Class D notes. During 2009, the Company repurchased $1.4 million of the 2005 CLO Trust’s Class D notes and $1.2 million of the Class E notes. During 2008, the Company repurchased $5.8 million of the 2005 CLO Trust’s Class E notes. During 2007, the Company repurchased $5.0 million of the 2005 CLO Trust’s Class E notes. During 2009, Moody’s downgraded all of the notes of the 2005 CLO Trust. As a result of the downgrades, amortization of the 2005 CLO Trust changed from pro rata to sequential, resulting in scheduled principal payments made in order of the notes seniority until all available funds are exhausted for each payment. During the second quarter of 2010, Standard and Poor’s downgraded all of the notes of the 2005 CLO Trust. During the third quarter of 2010, Fitch affirmed its ratings of the Class A-1 notes, the Class A-2 notes and the Class B notes, and downgraded the Class C notes, the Class D notes and the Class E notes. The downgrades during 2010 did not have any material consequence as the amortization of the 2005 CLO Trust changed from pro rata to sequential after the Moody’s downgrade in 2009.

The Company receives a loan collateral management fee and excess interest spread. The Company expects to receive a principal distribution when the term debt is retired. The most recent quarterly report of the 2005 CLO Trust dated April 13, 2011 identified $49.1 million of certain loan collateral in the 2005 CLO Trust as delinquent or charged-off under the terms of the trust indenture. As a result, the excess interest spread from the 2005 CLO Trust will be redirected and combined with recoveries and will be used to repay the outstanding notes until note redemptions equal the underlying non-accrual loan balances or until the Company purchases such loans. As of the April 13, 2011 report, the cumulative amount redirected was $13.8 million. The Company may have additional defaults in the 2005 CLO Trust in the future. If the Company does not elect to remove any future defaulted loans, it would not expect to receive excess interest spread payments until the undistributed cash plus any recoveries equal the outstanding balances of defaulted loan collateral.

 

     Notes
originally
issued
     Outstanding
balance
June 30,
2011
     Interest
rate
    Original
maturity
   Ratings
(S&P/Moody’s/
Fitch)(1)
     ($ in thousands)                  

2005 CLO Trust:

             

Class A-1

   $ 156,000       $ 60,686         Libor + 0.28   July 25, 2018    AA+/Aa2/AAA

Class A-2

     80,477         30,979         Libor + 0.30   July 25, 2018    AA+/Aa2/AAA

Class B

     18,750         18,683         Libor + 0.50   July 25, 2018    A+/A2/AA

Class C

     39,375         39,233         Libor + 0.85   July 25, 2018    B+/Ba1/BB

Class D

     24,375         18,224         Libor + 1.50   July 25, 2018    CCC-/B1/CCC

Class E

     24,375         8,418         Libor + 4.75   July 25, 2018    CCC-/Caa2/CC
  

 

 

    

 

 

         
   $ 343,352       $ 176,223           
  

 

 

    

 

 

         

 

(1) The ratings, initially given in August 2005, are unaudited and are subject to change from time to time. Fitch affirmed its ratings on February 24, 2009 and downgraded the Class D notes and the Class E notes. The Fitch downgrade did not have an impact on the 2005 CLO Trust. During the first quarter of 2009, Moody’s downgraded the Class C notes, the Class D notes and the Class E notes to the ratings shown above. During the third quarter of 2009, Moody’s downgraded the Class A-1 notes, the Class A-2 notes and the Class B notes to the ratings shown above. During the second quarter of 2010, Standard and Poor’s downgraded all of the notes to the ratings shown above. During the third quarter of 2010, Fitch downgraded the Class C notes, the Class D notes and the Class E notes to the ratings shown above. (source: Bloomberg Finance L.P.).

 

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In June 2006 the Company completed a term debt transaction. In conjunction with this transaction the Company established a separate single-purpose bankruptcy remote subsidiary, NewStar Commercial Loan Trust 2006-1 (the “2006 CLO Trust”) and contributed $500 million in loans and investments (including unfunded commitments), or portions thereof, to the 2006 CLO Trust. The Company remains the servicer of the loans. Simultaneously with the initial contributions, the 2006 CLO Trust issued $456.3 million of notes to institutional investors. The Company retained $43.8 million, comprising 100% of the 2006 Trust’s trust certificates. At June 30, 2011, the $409.1 million of outstanding drawn notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $454.9 million. At June 30, 2011, deferred financing fees were $2.2 million. The 2006 CLO Trust permits reinvestment of collateral principal repayments for a five-year period which ended in June 2011. During the six months ended June 30, 2011, the Company repurchased $4.0 million of the 2006 CLO Trust’s Class D notes. During 2010, the Company repurchased $3.0 million of the 2006 CLO Trust’s Class D notes and $3.0 million of the 2006 CLO Trust’s Class E notes. During 2009, the Company repurchased $6.5 million of the 2006 CLO Trust’s Class D notes and $1.8 million of the 2006 CLO Trust’s Class E notes. During 2008, the Company repurchased $3.3 million of the 2006 CLO Trust’s Class D and $2.5 million of the 2006 CLO Trust’s Class E notes, respectively. During 2009, Moody’s downgraded all of the notes of the 2006 CLO Trust. As a result of the downgrade, amortization of the 2006 CLO Trust changed from pro rata to sequential, resulting in future scheduled principal payments made in order of the notes seniority until all available funds are exhausted for each payment. During the second quarter of 2010, Standard and Poor’s downgraded the Class A-1 notes, the Class A-2 notes, the Class C notes, the Class D notes and the Class E notes of the 2006 CLO Trust. The downgrade did not have any material consequence as the amortization of the 2006 CLO Trust changed from pro rata to sequential after the Moody’s downgrade in 2009.

The Company receives a loan collateral management fee and excess interest spread. The Company expects to receive a principal distribution when the term debt is retired. The most recent quarterly report of the 2006 CLO Trust dated June 13, 2011 identified $21.6 million of certain loan collateral in the 2006 CLO Trust as delinquent or charged-off under the terms of the trust indenture. As a result, the excess interest spread from the 2006 CLO Trust will be redirected and combined with recoveries and will be used to repay the outstanding notes until note redemptions equal the underlying non-accrual loan balances or until the Company purchases such loans. During the six months ended June 30, 2011, the Company elected to purchase $11.1 million of defaulted collateral from the 2006 CLO Trust to reduce the amount of excess interest spread that otherwise would have been required to be redirected. Consequently, as of the June 13, 2011 quarterly report, the entire $21.6 million had been redirected or repurchased. The Company may have additional defaults in the 2006 CLO Trust in the future. If the Company does not elect to remove any future defaulted loans, it would not expect to receive excess interest spread payments until the undistributed cash plus any recoveries equal the outstanding balances of defaulted loan collateral.

 

     Notes
originally
issued
     Outstanding
balance
June 30,
2011
     Interest
rate
    Original
maturity
   Ratings
(S&P/Moody’s/

Fitch)(1)
   ($ in thousands)                  

2006 CLO Trust

             

Class A-1

   $ 320,000       $ 298,881         Libor +0.27   March 30, 2022    AA+/Aa2/AAA

Class A-2

     40,000         40,000         Libor +0.28   March 30, 2022    AA+/Aa2/AAA

Class B

     22,500         22,500         Libor +0.38   March 30, 2022    AA/A3/AA

Class C

     35,000         35,000         Libor +0.68   March 30, 2022    BBB+/Ba1/A

Class D

     25,000         8,250         Libor +1.35   March 30, 2022    CCC+/B1/BBB

Class E

     13,750         6,500         Libor +1.75   March 30, 2022    CCC-/B2/BB
  

 

 

    

 

 

         
   $ 456,250       $ 411,131           
  

 

 

    

 

 

         

 

(1) These ratings, initially given in June 2006, are unaudited and are subject to change from time to time. Fitch affirmed its ratings on February 24, 2009. During the first quarter of 2009, Moody’s downgraded the Class C notes, the Class D notes and the Class E notes to the ratings shown above. During the third quarter of 2009, Moody’s downgraded the Class A-1 notes, the Class A-2 notes and the Class B notes to the ratings shown above. During the second quarter of 2010, Standard and Poor’s downgraded the Class A-1 notes, the Class A-2 notes, the Class C notes, the Class D notes and the Class E notes to the ratings shown above. (source: Bloomberg Finance L.P.).

 

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In June 2007 the Company completed a term debt transaction. In conjunction with this transaction the Company established a separate single-purpose bankruptcy-remote subsidiary, NewStar Commercial Loan Trust 2007-1 (the “2007 CLO Trust”) and contributed $600 million in loans and investments (including unfunded commitments), or portions thereof, to the 2007 CLO Trust. The Company remains the servicer of the loans. Simultaneously with the initial contributions, the 2007 CLO Trust issued $546.0 million of notes to institutional investors. The Company retained $54.0 million, comprising 100% of the 2007 CLO Trust’s trust certificates. At June 30, 2011, the $477.5 million of outstanding drawn notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $531.5 million. At June 30, 2011, deferred financing fees were $3.4 million. The 2007 CLO Trust permits reinvestment of collateral principal repayments for a six-year period ending in May 2013. Should the Company determine that reinvestment of collateral principal repayments are impractical in light of market conditions or if collateral principal repayments are not reinvested within a prescribed timeframe, such funds may be used to repay the outstanding notes. During 2010, the Company repurchased $5.0 million of the 2007 CLO Trust’s Class D notes. During 2009, the Company repurchased $1.0 million of the 2007 CLO Trust’s Class D notes. During 2009, Moody’s downgraded all of the notes of the 2007 CLO Trust. As a result of the downgrade, amortization of the 2007 CLO Trust changed from pro rata to sequential, resulting in future scheduled principal payments made in order of the notes seniority until all available funds are exhausted for each payment. On April 7, 2011, Moody’s upgraded the Class C notes, the Class D notes, and the Class E notes. During the second quarter of 2010, Standard and Poor’s downgraded the Class A-1 notes, the Class A-2 notes, the Class C notes and the Class D notes of the 2007 CLO Trust. The downgrade did not have any material consequence as the amortization of the 2007 CLO Trust changed from pro rata to sequential after the Moody’s downgrade in 2009. On April 19, 2011, Standard and Poor’s upgraded the Class D notes.

The Company receives a loan collateral management fee and excess interest spread. The Company expects to receive a principal distribution when the term debt is retired. If loan collateral in the 2007 CLO Trust is in default under the terms of the indenture, the excess interest spread from the 2007 CLO Trust could not be distributed until the undistributed cash plus recoveries equals the outstanding balance of the defaulted loan or if the Company elected to remove the defaulted collateral. The Company may have future defaults in the 2007 CLO Trust in the future. If the Company does not elect to remove any future defaulted loans, it would not expect to receive excess interest spread payments until the undistributed cash plus any recoveries equal the outstanding balances of any potential defaulted loan collateral. During 2010, the Company elected to purchase $38.8 million of defaulted collateral from the 2007 CLO Trust to reduce the amount of excess interest spread that otherwise would have been required to be redirected.

 

     Notes
originally
issued
     Outstanding
balance
June 30,
2011
     Interest
rate
    Original
maturity
     Ratings
(S&P/Moody’s/
Fitch)(1)
   ($ in thousands)                    

2007 CLO Trust

             

Class A-1

   $ 336,500       $ 318,258         Libor +0.24     September 30, 2022       AA+/Aa2/AAA

Class A-2

     100,000         55,767         Libor +0.26     September 30, 2022       AA+/Aa2/AAA

Class B

     24,000         24,000         Libor +0.55     September 30, 2022       AA/A2/AA

Class C

     58,500         58,500         Libor +1.30     September 30, 2022       BBB+/Baa3/A

Class D

     27,000         21,000         Libor +2.30     September 30, 2022       BB-/Ba2/BBB+
  

 

 

    

 

 

         
   $ 546,000       $ 477,525           
  

 

 

    

 

 

         

 

(1) These ratings, initially given in June 2007, are unaudited and are subject to change from time to time. Fitch affirmed its ratings on February 24, 2009. During the first quarter of 2009, Moody’s downgraded the Class C notes and the Class D notes. During the third quarter of 2009, Moody’s downgraded the Class A-1 notes, the Class A-2 notes and the Class B notes to the ratings shown above. During the second quarter of 2010, Standard and Poor’s downgraded the Class A-1 notes, the Class A-2 notes, the Class C notes to the ratings shown above, and also downgraded the Class D notes. On April 7, 2011, Moody’s upgraded the Class C notes and the Class D notes to the ratings shown above. On April 19, 2011, Standard and Poor’s upgraded the Class D note to the ratings shown above (source: Bloomberg Finance L.P.).

 

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On January 7, 2010, the Company completed a term debt securitization. In conjunction with this transaction the Company established a separate single-purpose bankruptcy-remote subsidiary, NewStar Commercial Loan Trust 2009-1 (the “2009 CLO Trust”) and contributed $225 million in loans and investments (including unfunded commitments), or portions thereof, to the 2009 CLO Trust at close. The Company had the ability to contribute an additional $50 million of loan collateral by July 30, 2010 and contributed the full amount during the six months ended June 30, 2010. The Company remains the servicer of the loans. Simultaneously with the initial contributions, the 2009 CLO Trust issued $190.5 million of notes to institutional investors. The Company retained all of the Class C and subordinated notes, which totaled approximately $87.9 million, representing 32% of the value of the collateral pool. At June 30, 2011, the $52.3 million of outstanding notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $140.2 million. At June 30, 2011, deferred financing fees were $1.6 million and the unamortized discount was $2.0 million. The 2009 CLO Trust is a static pool of loans that does not permit for reinvestment of collateral principal repayments. On April 1, 2011, Moody’s upgraded the Class B notes.

The 2009 CLO Trust is callable without penalty on the distribution date in July 2011 and on each distribution date thereafter. On August 1, 2011, the Company called the 2009 CLO Trust in accordance with its terms without penalty.

     Notes
originally
issued
     Outstanding
balance
June 30,
2011
    

Interest
rate

  

Original
maturity

  

Ratings
(Moody’s)
(1)

   ($ in thousands)                 

2009 CLO Trust

              

Class A

   $ 148,500       $ 12,234       Libor +3.75%    July 30, 2018    Aaa

Class B

     42,000         40,028       Libor +5.00%(2)    July 30, 2018    Aaa
  

 

 

    

 

 

          
   $ 190,500       $ 52,262            
  

 

 

    

 

 

          

 

 

(1) These ratings, initially given in January 2010, are unaudited and are subject to change from time to time. On April 1, 2011, Moody’s upgraded the Class B notes to the rating shown above.
(2) The Class B notes carry a Libor +5.00% coupon rate but were priced at a 91.85% discount to yield Libor +7.50% on a par amount of $42.0 million.

Note 8. Repurchase Agreement

 

Loans sold under agreements to repurchase

   Six Months  Ended
June 30, 2011
    Year Ended
December 31, 2010
 
     ($ in thousands)  

Outstanding at end of period

   $ 68,000      $ —     

Maximum outstanding at any month end

     68,000        —     

Average balance for the period

     9,017        —     

Weighted average rate at end of period

     5.20         N/A   

On June 7, 2011, the Company entered into a five-year, $68.0 million financing arrangement with Macquarie backed primarily by a portfolio of commercial mortgage loans previously originated by the Company. The financing was structured as a master repurchase agreement under which the Company sold the portfolio of commercial mortgage loans to Macquarie for an aggregate purchase price of $68.0 million. The Company also agreed to repurchase the commercial mortgage loans from time to time (including a minimum quarterly amount), and agreed to repurchase all of the commercial mortgage loans by June 7, 2016. Upon the repurchase of a commercial mortgage loan, the Company is obligated to repay the principal amount related to such mortgage loan plus accrued interest (at a rate based on LIBOR plus a margin) to the date of repurchase. The Company will continue to service the commercial mortgage loans. The facility accrues interest at a variable rate per annum, which was 5.20% as of June 30, 2011. As of June 30, 2011, unamortized deferred financing fees were $1.5 million and the outstanding balance was $68.0 million. As part of the agreement, there is a minimum aggregate interest margin payment of $8.4 million required to be made over the life of the facility. If the facility is not utilized to cover this minimum requirement, then a make-whole fee is required to be made to satisfy the minimum aggregate interest margin payment.

The proceeds of the Macquarie transaction were used to fully repay the Company’s credit facility with Citicorp and refinance all of the commercial mortgage loans previously funded by its warehouse line with Wachovia. The transaction generated net proceeds for the Company after retirement of debt and transaction costs of $20.0 million. The Company did not record any gains or losses. The commercial mortgage loans and related repurchase obligations are consolidated and reflected in the Company’s financial statements.

 

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Note 9. Stockholders’ Equity

Stockholders’ Equity

As of June 30, 2011 and December 31, 2010, the Company’s authorized capital consists of preferred and common stock and the following was authorized and outstanding:

 

     June 30, 2011      December 31, 2010  
     Shares
    authorized    
     Shares
    outstanding    
     Shares
    authorized    
     Shares
    outstanding    
 
     (In thousands)  

Preferred stock

     5,000         —           5,000         —     

Common stock

         145,000             50,363             145,000             50,563   
  

 

 

    

 

 

    

 

 

    

 

 

 

Preferred Stock

Upon completion of the Company’s initial public offering on December 13, 2006, the Company’s authorized capital stock included 5,000,000 shares of preferred stock with a par value of $0.01 per share. As of June 30, 2011, all of the shares remained undesignated.

Common Stock

In connection with the Company’s initial public offering on December 13, 2006, the Company issued and sold 12,000,000 shares of its common stock. On December 19, 2006, the underwriters of the initial public offering purchased an additional 1,800,000 shares of the Company’s common stock.

On November 12, 2007, the Company entered into a definitive agreement with institutional investors to issue 12.5 million shares of the Company’s common stock in a private placement at a price per share of $10.00. The gross proceeds from the offering, which closed in two tranches, were $125 million. The first tranche of 7.25 million shares closed on November 29, 2007. The second tranche of 5.25 million shares was subject to the Company obtaining stockholder approval, and was approved at a special meeting of stockholders held on January 15, 2008. The second tranche closed on January 18, 2008.

In connection with the private placement, the Company entered into a Registration Rights Agreement with the institutional investors, whereby the Company agreed to register common stock as defined in the agreement. The Company registered the stock on Form S-3 on May 1, 2008, and the SEC deemed the registration effective on May 8, 2008.

On January 25, 2010, the Company announced that its Board of Directors had authorized the repurchase of up to $10 million of the Company’s common stock from time to time on the open market or in privately negotiated transactions. On December 3, 2010, the Company had repurchased the entire $10 million allotment of its stock. The timing and amount of any shares purchased were determined by management based on its evaluation of market condition and other factors and required use of cash. Upon completion of the stock repurchase program, the Company had repurchased 1,372,300 shares of its common stock under the program at a weighted average price per share of $7.26.

On May 4, 2011, the Company announced that its Board of Directors had authorized the repurchase of up to $10 million of the Company’s common stock from time to time on the open market or in privately negotiated transactions. The timing and amount of any shares purchased will be determined by management based on its evaluation of market conditions and other factors and required use of cash. The repurchase program, which will expire on April 28, 2012 unless extended by the Board of Directors, may be suspended or discontinued at any time without notice. As of June 30, 2011, the Company had repurchased 186,827 shares of its common stock under the program at a weighted average price per share of $9.42.

Restricted Stock

During the six months ended June 30, 2011, the Company issued 42,500 shares of restricted stock to certain employees of the Company pursuant to the Company’s 2006 Incentive Plan, as amended and 34,615 shares of restricted stock to certain members of its Board of Directors. The fair value of the shares of restricted stock is equal to the closing price of the Company’s stock on the date of issuance. The shares of restricted stock granted to employees vest in three equal installments on each of the first three anniversaries of the date of grant. The shares of restricted stock granted to directors will vest in full on the one-year anniversary of the grant date.

 

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Restricted stock activity for the six months ended June 30, 2011 was as follows:

 

     Shares      Weighted average
    grant-date fair value     
 
            ($ in thousands)  

Non-vested as of December 31, 2010

     3,647,141        $ 25,397    

Granted

     77,115          784    

Vested

     (318,965)         (585)   

Forfeited

     (18,439)         (121)   
  

 

 

    

 

 

 

Non-vested as of June 30, 2011

         3,386,852        $ 25,475    
  

 

 

    

 

 

 

The Company’s compensation expense related to restricted stock was $1.6 million and $3.2 million, respectively, for the three and six months ended June 30, 2011 and $1.4 million and $2.4 million, respectively, for the three and six months ended June 30, 2010. The unrecognized compensation cost of $10.6 million at June 30, 2011 is expected to be recognized over the next three years.

Stock Options

Under the Company’s 2006 Incentive Plan, the Company’s compensation committee may grant options to purchase shares of common stock. Stock options may either be incentive stock options (“ISOs”) or non-qualified stock options. ISOs may only be granted to officers and employees. The compensation committee will, with regard to each stock option, determine the number of shares subject to the stock option, the manner and time of exercise, vesting, and the exercise price, which will not be less than 100% of the fair market value of the common stock on the date of the grant. The shares of common stock issuable upon exercise of options or other awards or upon grant of any other award may be either previously authorized but unissued shares or treasury shares.

During the six months ended June 30, 2011, stock options exercisable for an aggregate 52,500 shares of common stock were issued to certain employees of the Company pursuant to the Company’s 2006 Equity Incentive Plan, as amended and stock options exercisable for an aggregate of 55,000 shares were issued to certain members of its Board of Directors. The stock options have an exercise price equal to the closing price of the Company’s common stock on the date of issuance. The options granted to employees vest in three equal installments on each of the first three anniversaries of the date of grant and have a seven-year life. The options granted to directors vest in full on the one-year anniversary of the date of grant and have a seven–year life.

Stock option activity for the six months ended June 30, 2011 was as follows:

 

     Options  

Outstanding as of January 1, 2011

     5,959,736    

Granted

     107,500    

Exercised

     (24,832)   

Forfeited

     (32,500)   
  

 

 

 

Outstanding as of June 30, 2011

     6,009,904    
  

 

 

 

Vested as of June 30, 2011

     4,126,718    
  

 

 

 

Exercisable as of June 30, 2011

         4,126,718    
  

 

 

 

For the six months ended June 30, 2011, the weighted average grant date fair value of options granted was $5.18 per share. As of June 30, 2011, the total unrecognized compensation cost related to nonvested options granted was $2.1 million. This cost is expected to be recognized over a weighted average period of one year. The Company’s compensation expense related to its stock options was $0.7 million and $1.4 million, respectively, for the three and six months ended June 30, 2011, and $0.7 million and $1.5 million, respectively, for the three and six months ended June 30, 2010.

 

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Note 10. Income (Loss) Per Share

The computations of basic and diluted income (loss) per share for the three and six months ended June 30, 2011 and 2010 are as follows:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2011      2010      2011      2010  
     (In thousands)  

Numerator:

           

Net income (loss) attributable to NewStar Financial, Inc. common stockholders

   $     3,446       $     5,328       $     4,372       $     (4,603)   

Denominator:

           

Denominator for basic income (loss) per common share

     48,507         49,822         48,526         49,880    
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator:

           

Denominator for diluted income (loss) per common share

     48,507         49,822         48,526         49,880    

Potentially dilutive securities - options

     2,751         967         2,767         ––    

Potentially dilutive securities – restricted stock

     2,000         935         2,000         ––    

Potentially dilutive securities - warrants

     —           —           ––           ––    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total weighted average diluted shares

     53,258         51,724         53,293         49,880    
  

 

 

    

 

 

    

 

 

    

 

 

 

Warrants to purchase common stock totaling 1,452,656, were not included in the computation of diluted earnings per share for the three and six months ended June 30, 2011 due to the fact that the results would be anti-dilutive.

Warrants to purchase common stock totaling 1,452,656, were not included in the computation of diluted earnings per share for the three months ended June 30, 2010 due to the fact that the results would be anti-dilutive. Weighted average stock options totaling 5,497,454, weighted average restricted shares of 472,527 and 1,452,656 warrants to purchase common stock were not included in the computation of diluted earnings per share for the six months ended June 30, 2010 due to the fact that the results would be anti-dilutive.

Note 11. Financial Instruments with Off-Balance Sheet Risk

The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include unused lines of credit, standby letters of credit and interest rate risk mitigation products. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Unused lines of credit are commitments to lend to a customer if certain conditions have been met. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since certain commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on factors that include management’s credit evaluation of the borrower, the borrower’s compliance with financial covenants and management’s discretion, among other evaluations. Due to their nature, the Company cannot know with certainty the aggregate amounts that will be required to fund the Company’s unused lines of credit. The aggregate amount of these unfunded commitments currently does not exceed our available funds but may exceed our available funds in the future.

At June 30, 2011, we had $259.0 million of unused lines of credit. Of these unused lines of credit, unfunded commitments related to revolving credit facilities were $208.3 million and unfunded commitments related to delayed draw term loans were $42.9 million. $7.8 million of the unused commitments are unavailable to the borrowers, which may be related to the borrowers’ inability to meet covenant obligations or other similar events.

Revolving credit facilities allow our borrowers to draw up to a specified amount, subject to customary borrowing conditions. The unfunded revolving commitments of $208.3 million are further categorized as either contingent or unrestricted. Contingent commitments limit a borrower’s ability to access the revolver unless it meets an enumerated borrowing base covenant or other restrictions. At June 30, 2011, we categorized $133.5 million of the unfunded commitments related to revolving credit facilities as

 

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contingent. Unrestricted commitments represent commitments that are currently accessible, assuming the borrower is in compliance with certain customary loan terms and conditions. At June 30, 2011, we had $74.8 million of unfunded unrestricted revolving commitments.

During the three months ended June 30, 2011, revolver usage averaged approximately 43%, which is slightly lower than the average of 38% over the previous four quarters. Management’s experience indicates that borrowers typically do not seek to exercise their entire available line of credit at any point in time. During the three and six months ended June 30, 2011, revolving commitments increased $29.5 million and $9.7 million, respectively.

Delayed draw credit facilities allow our borrowers to draw predefined amounts of the approved loan commitment at contractually set times, subject to specific conditions, such as capital expenditures in corporate loans or for tenant improvements in commercial real estate loans. During the three and six months ended June 30, 2011, delayed draw credit facility commitments increased $10.7 million and $18.2 million, respectively.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a borrower to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to borrowers.

Interest rate risk mitigation products are offered to enable customers to meet their financing and risk management objectives. Derivative financial instruments consist predominantly of interest rate swaps, interest rate caps and floors. The interest rate risks to the Company of these customer derivatives is mitigated by entering into similar derivatives having offsetting terms with other counterparties.

These interest rate risk mitigation products do not qualify for hedge accounting treatment. These interest rate swaps and caps contracts are recorded at fair value on the Company’s balance sheet in either “Other assets” or “Other liabilities”. Gains and losses on derivatives not designated as cash flow hedges, including any cash payments made or received are reported as gains or losses on derivatives in the consolidated statements of operations.

Financial instruments with off-balance sheet risk are summarized as follows:

 

         June 30, 2011              December 31, 2010      
     ($ in thousands)  

Unused lines of credit

   $         259,029       $         270,793   

Standby letters of credit

     8,710         8,737   

Interest rate mitigation products (notional)

     60,182         125,450   

Note 12. Fair Value

ASC 820, Fair Value Measurements (“ASC 820”) establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

 

   

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

   

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 

   

Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

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The following table presents recorded amounts of assets and liabilities measured at fair value on a recurring and nonrecurring basis as of June 30, 2011, by caption in the consolidated balance sheet and by ASC 820 valuation hierarchy (as described above).

 

     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Total
Carrying
Value in
Consolidated
Balance Sheet
 
     ($ in thousands)  

Recurring Basis:

           

Investments in debt securities, available-for-sale

   $ —         $ —         $ 17,117       $ 17,117   

Derivatives—interest rate contracts (assets)

     —           1,302         —           1,302   
                                   

Total assets recorded at fair value on a recurring basis

   $ —         $ 1,302       $ 17,117       $ 18,419   
                                   

Derivatives—interest rate contracts (liabilities)

   $ —         $ 1,575       $ —         $ 1,575   
                                   

Nonrecurring Basis:

           

Loans, net

   $ —         $ —         $ 82,993       $ 82,993   

Loans held-for-sale, net

     11,565         —           —           11,565   

Other real estate owned

     —           —           2,800         2,800   
                                   

Total assets recorded at fair value on a nonrecurring basis

   $ 11,565       $ —         $ 85,793       $ 97,358   
                                   

At June 30, 2011, “Loans, net” measured at fair value on a nonrecurring basis consisted of impaired collateral-dependent commercial real estate loans. The fair values of these loans are based on third party appraisals of the underlying collateral value as well as the Company’s internal analysis. During the six months ended June 30, 2011, the Company recorded a $2.8 million of specific provision for credit losses related to “Loans, net” measured at fair value.

At June 30, 2011, “Loans held-for-sale, net” consisted of leveraged finance loans intended to be sold to the NCOF. The fair values of the loans are based on contractual selling prices.

At June 30, 2011, “Other real estate owned” consisted of one commercial real estate property.

The following table presents recorded amounts of assets and liabilities measured at fair value on a recurring and nonrecurring basis as of December 31, 2010, by caption in the consolidated balance sheet and by ASC 820 valuation hierarchy (as described above).

 

     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Total
Carrying
Value in
Consolidated
Balance Sheet
 
     ($ in thousands)  

Recurring Basis:

           

Investments in debt securities, available-for-sale

   $ —         $ —         $ 4,014       $ 4,014   

Derivatives—interest rate contracts (assets)

     —           863         —           863   
                                   

Total assets recorded at fair value on a recurring basis

   $ —         $ 863       $ 4,014       $ 4,877   
                                   

Derivatives—interest rate contracts (liabilities)

   $ —         $ 1,174       $ —         $ 1,174   
                                   

Nonrecurring Basis:

           

Loans, net

   $ —         $ —         $ 69,067       $ 69,067   

Loans held-for-sale, net

     41,386         —           —           41,386   

Other real estate owned

     —           —           3,400         3,400   
                                   

Total assets recorded at fair value on a nonrecurring basis

   $ 41,386       $ —         $ 72,467       $ 113,853   
                                   

 

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At December 31, 2010, “Loans, net” measured at fair value on a nonrecurring basis consisted of impaired collateral-dependent commercial real estate loans. The fair values of these loans are based on third party appraisals of the underlying collateral value as well as the Company’s internal analysis. During 2010, the Company recorded $12.6 million of specific provision for credit losses related to “Loans, net” measured at fair value.

At December 31, 2010, “Loans held-for-sale, net” consisted of leveraged finance loans intended to be sold to the NCOF. The fair values of the loans are based on contractual selling prices.

At December 31, 2010, “Other real estate owned” consisted of one commercial real estate property.

Changes in level 3 recurring fair value measurements

The table below illustrates the change in balance sheet amounts during the three and six months ended June 30, 2011 and 2010 (including the change in fair value), for financial instruments measured on a recurring basis and classified by the Company as level 3 in the valuation hierarchy. When a determination is made to classify a financial instrument as level 3, the determination is based upon the significance of the unobservable parameters to the overall fair value measurement. However, level 3 financial instruments typically include, in addition to the unobservable or level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources); accordingly, the gains and losses in the table below include changes in fair value due in part to observable factors that are part of the valuation methodology. The Company did not transfer any financial instruments in or out of levels 1, 2 or 3 during the three or six months ended June 30, 2011 or 2010.

For the three months ended June 30, 2011:

 

     Investments in
Debt Securities,
Available-for-sale
 
     ($ in thousands)  

Balance as of March 31, 2011

   $ 4,049    

Total gains or losses (realized/unrealized)

  

Included in earnings

     —      

Included in other comprehensive income

     (789)   

Purchases, issuances or settlements

     13,857    
  

 

 

 

Balance as of June 30, 2011

   $         17,117    
  

 

 

 

For the three months ended June 30, 2010:

 

     Investments in
Debt Securities,
Available-for-sale
     Warrants  
     ($ in thousands)  

Balance as of March 31, 2010

   $ 4,051        $   

Total gains or losses (realized/unrealized)

     

Included in earnings

     —            (1)   

Included in other comprehensive income

     19          —      

Purchases, issuances or settlements

     (48)         —      
  

 

 

    

 

 

 

Balance as of June 30, 2010

   $         4,022        $         —    
  

 

 

    

 

 

 

For the six months ended June 30, 2011:

 

     Investments in
Debt Securities,
Available-for-sale
 
     ($ in thousands)  

Balance as of December 31, 2010

   $ 4,051    

Total gains or losses (realized/unrealized)

  

Included in earnings

     —      

Included in other comprehensive income

     (679

Purchases, issuances or settlements

     13,745    
  

 

 

 

Balance as of June 30, 2011

   $         17,117    
  

 

 

 

 

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For the six months ended June 30, 2010:

 

     Investments in
Debt Securities,
Available-for-sale
     Warrants  
     ($ in thousands)  

Balance as of December 31, 2009

   $ 4,183        $   

Total gains or losses (realized/unrealized)

     

Included in earnings

     —            (1)  

Included in other comprehensive income

     (78)         —    

Purchases, issuances or settlements

     (83)         —    
  

 

 

    

 

 

 

Balance as of June 30, 2010

   $         4,022        $       —    
  

 

 

    

 

 

 

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments at June 30, 2011 and December 31, 2010. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties.

 

     June 30, 2011      December 31, 2010  
     Carrying
amount
     Fair value      Carrying
amount
     Fair value  
     ($ in thousands)  

Financial assets:

           

Cash and cash equivalents

   $ 49,380       $ 49,380       $ 54,365       $ 54,365   

Restricted cash

     109,942         109,942         178,364         178,364   

Loans held-for-sale

     11,565         11,565         41,386         41,386   

Loans and leases, net

     1,646,070         1,606,448         1,590,331         1,554,509   

Investments in debt securities available-for-sale

     17,117         17,117         4,014         4,014   

Derivative instruments

     1,302         1,302         863         863   

Other assets

     8,015         8,015         7,546         7,546   

Financial liabilities:

           

Credit facilities

   $ 78,701       $ 78,701       $ 108,502       $ 108,502   

Term debt

     1,180,142         1,255,158         1,278,868         1,148,083   

Repurchase agreements

     68,000         68,000         —           —     

Derivatives instruments

     1,575         1,575         1,174         1,174   

 

The carrying amounts shown in the table are included in the consolidated balance sheets under the indicated captions.

Note 13. Employee Benefit Plans

The Company maintains a contributory 401(k) plan covering all full-time employees. The Company matches 100% of an employee’s voluntary contributions up to a limit of 6% of the employee’s base salary, subject to IRS guidelines. Expense for the three and six months ended June 30, 2011 was $0.2 million and $0.3 million, respectively and $0.1 million and $0.3 million for the three and six months ended June 30, 2010, respectively.

Note 14. Related-Party Transactions

Pursuant to an Investment Management Agreement dated August 3, 2005, the Company serves as investment manager of the NewStar Credit Opportunities Fund, Ltd. (the “Fund”), a Cayman Islands exempted company limited by shares incorporated under the provisions of The Companies Law of the Cayman Islands. The Fund pays the Company a management fee, payable monthly in arrears, based on the carrying value of the total gross assets attributable to the applicable series of each class of shares at the end of each month. For the three and six months ended June 30, 2011, the Fund’s asset management fees were $0.6 million and $1.3 million, respectively, and $0.7 million and $1.3 million for the three and six months ended June 30, 2010, respectively.

During 2006, the Company made a loan based on market terms to a company with a director who is a relative of one of the Company’s officers. At June 30, 2011, the loan balance outstanding and amount of committed funds were $7.2 million and $9.2 million, respectively.

During the six months ended June 30, 2011, the Company made a loan based on market terms to a company that is 40% owned by a major stockholder of the Company and with respect to which two members of the Company’s Board of Directors are affiliated. At June 30, 2011, the loan balance outstanding and amount of committed funds were $5.4 million and $5.6 million, respectively.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion contains forward-looking statements. Important factors that may cause actual results and circumstances to differ materially from those described in such statements are described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010, as well as throughout this Item 2. You are cautioned not to place undue reliance on the forward-looking statements contained in this document. These statements speak only as of the date of this document, and we undertake no obligation to update or revise these statements, except as may be required by law.

Overview

We are a specialized commercial finance company focused on meeting the complex financing needs of companies and private investors in the middle market. We principally focus on the direct origination of loans and leases that meet our risk and return parameters. Our direct origination efforts target mid-sized companies, private equity sponsors, corporate executives, regional banks, real estate investors and a variety of other financial intermediaries to source transaction opportunities. Direct origination provides direct access to customers’ management, enhances due diligence, and allows significant input into customers’ capital structure and direct negotiation of transaction pricing and terms. We also participate in larger loans as a member of a syndicate.

We operate as a single segment and derive revenues from four national specialized lending groups:

 

   

Leveraged Finance, which originates, structures and underwrites senior cash flow loans and, to a lesser extent, second lien, subordinated debt, and equity or equity-linked products for companies with annual EBITDA typically between $5 million and $50 million;

 

   

Real Estate, which originates, structures and underwrites first mortgage debt and, to a lesser extent, subordinated debt, primarily to finance acquisitions of real estate properties typically valued between $10 million and $50 million;

 

   

Business Credit, which originates, structures and underwrites senior asset-based debt for companies with sales typically totaling between $25 to $500 million; and

 

   

Equipment Finance, which originates, structures and underwrites operating leases, capital leases, and lease lines to finance equipment purchases and other capital expenditures typically for companies with annual sales of at least $25 million.

Market Conditions

Conditions in the capital markets remained generally supportive, but somewhat mixed, in the second quarter of 2011 as weakening economic conditions, headline risks and increasing uncertainty in the overall business environment weighed negatively on consumer sentiment and investor confidence. Weak retail sales and housing markets, high energy prices, disappointing job market conditions, renewed European sovereign debt issues, and the uncertainty of a political compromise on the US debt ceiling all contributed to concerns about the direction and sustainability of the economic recovery. As a result, market conditions were more volatile in the second quarter.

Conditions in the US corporate bond and syndicated loan markets weakened somewhat as volatility in the non-investment grade bond market led to a relatively weak return performance for investors. As a result, new bond issuance was down substantially from the first quarter, but remained within historical standards. New loan volumes were less impacted by the volatility as funds continued to flow into the market to support new issuance. The composition of new issuance in the credit markets continued to be dominated by refinancing transactions, but acquisition and other investment activities increased modestly as a percentage.

The larger more liquid segments of the securitization markets continued to be supportive of new issuance for securities backed by mortgages, credit cards and auto loans. As liquidity has returned to those asset classes and market conditions have normalized, the securitization markets for other asset types, including CLOs, have also recovered to a point that we believe they provide a reliable source of funding for companies like NewStar.

Conditions in the securitization market for bank loans, which the Company partially relies upon for funding, were not immune to the market volatility but continued to improve in the second quarter of 2011. CLO bonds traded in the secondary market maintained value and are currently trading at levels and implied yields that support increasing levels of new issuance. New CLO issuance in the US exceeded $6 billion in the first half of the year, and pricing for new AAA-rated CLO bonds tightened to Libor plus 1.20%, the lowest level since the credit crisis began in 2008. The forward calendar of new issuance also continues to build. The pace of recovery in this market has been accelerating, and we expect the favorable trends to continue as spreads tighten across other types of asset-backed securities and investors continue to emphasize a preference for higher yielding, floating rate asset classes.

In the second quarter, we completed a new financing to fund a portfolio of legacy commercial mortgage loans, and in July we amended one of our existing credit facilities to increase its size and extend its effective maturity to provide new warehouse financing

 

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capacity for new loan origination on more favorable terms. We believe that our ability to add and amend these credit facilities reflects an overall improvement in the market conditions for funding. In addition to these signs of improving market conditions, we believe the Company has substantially greater financial flexibility and multiple other financing options due to the improvement in our financial performance and market capitalization.

We continue to believe that a significant lasting impact of the credit crisis will be a reduction in the number and capacity of lenders in the markets in which we compete. As a result, we anticipate that conditions in our lending markets will remain favorable for an extended period. In the first quarter of 2011, credit spreads came under pressure as M&A activity slowed and liquidity in the market increased, providing supportive conditions for issuers to refinance higher cost debt and fund dividend recapitalization transactions. These conditions stabilized in March, as lenders adjusted to growing uncertainty driven by geopolitical events and signs of weakening economic conditions, and remained relatively stable through the second quarter at levels that exceeded historical standards.

After increasing our allowance for loan losses through 2009 and 2010 for probable loan losses, our overall credit performance improved through most of 2010 as negative migration slowed and our provision for credit losses decreased significantly. Our credit performance has continued to improve in 2011 as we resolve non-performing assets. Although we expect provisions for credit losses to stabilize in 2011, quarterly improvement may be uneven and non-accrual loans and charge offs are expected to remain elevated as we work to resolve existing impaired loans through 2011.

Although the credit performance of our commercial real estate portfolio was particularly weak amid high unemployment and poor demand for office space, we believe that many commercial real estate markets have begun to stabilize. We have been repaid as agreed on certain loans and successfully resolved foreclosed real estate at values within expected ranges. While we remain cautious about the sector, we believe that the availability of financing has improved and values have begun to stabilize. As a result, our borrowers’ ability and willingness to repay debt has also improved. As the commercial real estate markets began to weaken in early 2008, we discontinued originating new loans and began to reduce our credit exposure to this segment. We have begun to selectively evaluate new real estate lending opportunities as market conditions have improved.

Recent Developments

Liquidity

On August 1, 2011, we called the 2009 CLO Trust, in accordance with its terms without penalty.

On July 15, 2011, we entered into an amendment with NATIXIS Financial Products LLC which extended the revolving period under the credit facility to August 23, 2011.

On July 12, 2011, we entered into an amendment with Wells Fargo to our term debt facility with Wachovia Capital Markets, LLC. The amendment increased the amount of the facility to $125.0 million and provides for a revolving reinvestment period of 18 months with a two-year amortization period.

On June 7, 2011, we entered into a five-year $68.0 million financing arrangement with Macquarie Bank Limited backed primarily by a portfolio of legacy commercial mortgage loans we previously originated.

On June 7, 2011, we fully repaid our credit facility with Citibank, N.A., and the facility was terminated.

Stock Repurchase Program

On May 4, 2011, we announced that our Board of Directors had authorized the repurchase of up to $10 million of the Company’s common stock from time to time on the open market or in privately negotiated transactions. The timing and amount of any shares purchased will be determined by management based on its evaluation of market condition and other factors and required use of cash. The repurchase program, which will expire on April 28, 2012 unless extended by the Board of Directors, may be suspended or discontinued at any time without notice. As of June 30, 2011, we had repurchased 186,827 shares of our common stock under the program at a weighted average price per share of $9.42.

RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 AND 2010

NewStar’s basic and diluted income per share for the three months ended June 30, 2011 was $0.07 and $0.06, respectively, and $0.9 and $0.8 for the six months ended June 30, 2011, respectively on net income of $3.4 million and $4.4 million, respectively, compared to a basic and diluted income per share for the three months ended June 30, 2010 was $0.11 and $0.10, respectively, on net income of $5.3 million, and a loss per share of $0.09, on a loss of $4.7 million for the six months ended June 30, 2010. Our managed loan portfolio was $2.3 billion at June 30, 2011 compared to $2.2 billion at December 31, 2010. As of June 30, 2011, loans owned by the NewStar Credit Opportunities Fund (“NCOF”) were $471.3 million.

Loan portfolio yield

Loan portfolio yield, which is interest income on our loans and leases divided by the average balances outstanding of our loans and leases, was 6.42% and 6.37% for the three and six months ended June 30, 2011 and 5.94% and 5.92% for the three and six months ended June 30, 2010. The increase from 2010 to 2011 in loan portfolio yield was primarily driven by an increase in our average yield on interest earning assets from new loan and lease origination and re-pricings subsequent to June 30, 2010. The portfolio yield for accruing loans and leases was 6.89% and 6.87% for the three and six months ended June 30, 2011.

 

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Net interest margin

Net interest margin, which is net interest income divided by average interest earning assets, was 4.28% and 4.15% for the three and six months ended June 30, 2011 and 3.75% and 3.38% for the three and six months ended June 30, 2010. The primary factors impacting net interest margin were non-accrual loans, changes in three-month LIBOR, our product mix, debt to equity ratio, credit spreads and cost of borrowings. The primary factors impacting net interest margin for 2010 were accelerated amortization of deferred financing fees resulting from the repayment of our Deutsche Bank term debt facility and the reduction of the commitment amount under our credit facility with Citicorp.

Efficiency ratio

Our efficiency ratio, which is total operating expenses divided by net interest income before provision for credit losses plus total non-interest income, was 56.32% and 56.40% for the three and six months ended June 30, 2011 and 40.23% and 43.69% for the three and six months ended June 30, 2010. The increase in our efficiency ratio during 2011 as compared to 2010 was primarily due to a decrease in net interest income and non-interest income during 2010.

Allowance for credit losses ratio

Allowance for credit losses ratio, which is allowance for credit losses divided by outstanding gross loans and leases excluding loans held-for-sale, was 4.46% at June 30, 2011 and 4.99% as of December 31, 2010. The decrease in the allowance for credit losses ratio is primarily due to a decrease in the balance of the specific allowance for credit losses, and slowing negative credit migration and improving economic conditions. During the three and six months ended June 30, 2011, we recorded $6.0 million and $12.1 million of specific provision for credit losses on previously identified impaired loans. At June 30, 2011, the specific allowance for credit losses was $56.6 million, and the general allowance for credit losses was $21.4 million. The allowance for credit losses at December 31, 2010 included a specific allowance of $60.4 million and a general allowance of $24.4 million. We continually evaluate our allowance for credit losses methodology. If we determine that a change in our allowance for credit losses methodology is advisable, as a result of the rapidly changing economic environment or otherwise, the revised allowance methodology may result in higher or lower levels of allowance. Moreover, actual losses under our current or any revised methodology may differ materially from our estimate.

Delinquent loan rate

Delinquent loan rate, which is total delinquent loans that are 60 days or more past due, divided by outstanding gross loans and leases, was 4.93% as of June 30, 2011 as compared to 6.74% as of December 31, 2010. We expect the delinquent loan rate to remain elevated if economic conditions continue to negatively impact the financial performance of certain borrowers and their ability to meet their obligations on a timely basis.

Delinquent loan rate for accruing loans 60 days or more past due

Delinquent loan rate for accruing loans 60 days or more past due, which is total delinquent accruing loans net of charge offs that are 60 days or more past due and less than 90 days past due, divided by outstanding gross loans and leases, was 0.50% as of December 31, 2010. We did not have any delinquent accruing loans as of June 30, 2011. We expect the delinquent accruing loan rate to remain elevated if economic conditions continue to negatively impact the financial performance of certain borrowers and their ability to meet their obligations on a timely basis.

Non-accrual loan rate

Non-accrual loan rate is defined as total balances outstanding of loans on non-accrual status divided by the total outstanding balance of our loans and leases held for investment. Loans are put on non-accrual status if they are 90 days or more past due or if management believes it is probable that the Company will be unable to collect contractual principal and interest in the normal course of business. The non-accrual loan rate was 6.23% as of June 30, 2011 and 7.98% as of December 31, 2010. As of June 30, 2011 and December 31, 2010, the aggregate outstanding balance of non-accrual loans was $109.0 million and $135.6 million, respectively and total outstanding loans and leases held for investment was $1.7 billion at each period end. We expect the non-accrual loan rate to remain elevated if economic conditions continue to impair certain borrowers’ ability to fully repay principal and interest under the terms of their loan agreement.

Non-performing asset rate

Non-performing asset rate is defined as the sum of total balances outstanding of loans on non-accrual status and other real estate owned, divided by the sum of the total outstanding balance of our loans and leases held for investment and other real estate owned.

 

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The non-performing asset rate was 6.38% as of June 30, 2011 and 8.17% as of December 31, 2010. As of June 30, 2011 and December 31, 2010, the sum of the aggregate outstanding balance of non-performing assets was $111.8 million and $139.0 million, respectively. We expect the non-performing asset rate to remain elevated if economic conditions continue to impair certain borrowers’ ability to fully repay principal and interest under the terms of their loan agreements.

Net charge off rate (end of period loans and leases)

Net charge off rate as a percentage of end of period loan and lease portfolio is defined as annualized charge offs net of recoveries divided by the total outstanding balance of our loans and leases held for investment. A charge off occurs when management believes that all or part of the principal of a particular loan is no longer recoverable and will not be repaid. The net charge off rate was 2.30% and 1.86% for the three and six months ended June 30, 2011 and 4.57% and 5.13% for the three and six months ended June 30, 2010. We expect the net charge off rate (end of period loans and leases) to remain elevated if economic conditions continue to impair certain borrowers’ ability to fully repay principal and interest under the terms of their loan agreement.

Net charge off rate (average period loans and leases)

Net charge off rate as a percentage of average period loan and lease portfolio is defined as annualized charge offs net of recoveries divided by the average total outstanding balance of our loans and leases held for investment for the period. The net charge off rate was 2.29% and 1.87% for the three and six months ended June 30, 2011 and 4.39% and 4.81% for the three and six months ended June 30, 2010. We expect the net charge off rate (average period loans and leases) to remain elevated if economic conditions continue to impair certain borrowers’ ability to fully repay principal and interest under the terms of their loan agreement.

Return on average assets

Return on average assets, which is net income divided by average total assets, was 0.74% and 0.47% for the three and six months ended June 30, 2011. Return on average assets was 1.05% for the three months ended June 30, 2010. Return on average assets was not meaningful for the six months ended June 30, 2010 as we had a net loss.

Return on average equity

Return on average equity, which is net income divided by average equity, was 2.46% and 1.58% for the three and six months ended June 30, 2011. Return on average equity was 3.94% for the three months ended June 30, 2010. Return on average equity was not meaningful for the six months ended June 30, 2010 as we had a net loss.

 

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Review of Consolidated Results

A summary of NewStar Financial’s consolidated financial results for the three and six months ended June 30, 2011 and 2010 follows:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
   2011      2010      2011      2010  
     ($ in thousands)  

Net interest income:

     

Interest income

     $     28,315          $     28,218          $     55,303          $     57,321    

Interest expense

     8,357          9,160          16,899          22,209    
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     19,958          19,058          38,404          35,112    

Provision for credit losses

     2,337          5,542          8,590          32,589    
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for credit losses

     17,621          13,516          29,814          2,523    
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest income:

           

Fee income

     359          343          934          724    

Asset management income

     626          681          1,254          1,332    

Gain on derivatives

     29          125          25          143    

Gain (loss) on sale of loans

     108          (113)         108          (113)   

Other income (loss)

     (1,872)         3,727          (3,552)         7,248    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income (loss)

     (750)         4,763          (1,231)         9,334    
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating expenses:

           

Compensation and benefits

     7,070          6,182          14,615          12,566    

Occupancy and equipment

     497          450          1,021          1,094    

General and administrative expenses

     3,251          2,911          5,331          5,676    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

     10,818          9,543          20,967          19,336    
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     6,053          8,736          7,616          (7,479)   

Income tax expense (benefit)

     2,607          3,310          3,244          (3,063)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss) before noncontrolling interest

     3,446          5,426          4,372          (4,416)   

Net income attributable to noncontrolling interest

     —           (98)         —           (187)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

     $ 3,446          $ 5,328          $ 4,372          $ (4,603)   
  

 

 

    

 

 

    

 

 

    

 

 

 

Comparison of the Three Months Ended June 30, 2011 and 2010

Interest income. Interest income increased $0.1 million, to $28.3 million for the three months ended June 30, 2011 from $28.2 million for the three months ended June 30, 2010. The increase was primarily due to an increase in the yield on average interest earning assets to 6.08% from 5.55% primarily driven by an increase in contractual interest rates from new loan origination and re-pricings subsequent to June 30, 2010, partially offset by a decrease in average balance of our interest earning assets to $1.9 billion from $2.0 billion.

Interest expense. Interest expense decreased $0.8 million, to $8.4 million for the three months ended June 30, 2011 from $9.2 million for the three months ended June 30, 2010. The decrease was primarily due to a decrease in the average balance of our interest bearing liabilities. The decrease in the average balance of our interest bearing liabilities is primarily attributable to the reduction of total debt from $1.4 billion as of June 30, 2010 to $1.3 billion as of June 30, 2011.

Net interest margin. Net interest margin increased to 4.28% for the three months ended June 30, 2011 from 3.75% for the three months ended June 30, 2010. The increase in net interest margin was primarily due an increase in our average yield on interest earning assets from new loan origination and re-pricings subsequent to June 30, 2010, partially offset by non-payment of interest income from non-accrual loans and an increase in our average cost of interest bearing liabilities . The net interest spread, the difference between gross yield on our interest earning assets and the total cost of our interest bearing liabilities, increased to 3.44% from 3.03%. At June 30, 2011, 58% of our adjustable rate loans included interest rate floors.

The following table summarizes the yield and cost of interest earning assets and interest bearing liabilities for the three months ended June 30, 2011 and 2010:

 

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     Three Months Ended June 30, 2011    Three Months Ended June 30, 2010  
     ($ in thousands)  
         Average    
Balance
     Interest
Income/
Expense
       Average  
Yield/
Cost
   Average
Balance
     Interest
Income/
Expense
       Average  
Yield/
Cost
 

Total interest earning assets

   $   1,868,519        $   28,315        6.08%    $   2,041,022        $   28,218          5.55%   

Total interest bearing liabilities

     1,269,618          8,357        2.64         1,462,981          9,160          2.51      
     

 

 

    

 

     

 

 

    

 

 

 

Net interest spread

      $ 19,958        3.44%       $ 19,058          3.03%   
     

 

 

    

 

     

 

 

    

 

 

 

Net interest margin

         4.28%                3.75%       
        

 

        

 

 

 

Provision for credit losses. The provision for credit losses decreased to $2.3 million for the three months ended June 30, 2011 from $5.5 million for the three months ended June 30, 2010. The decrease in the provision was primarily due to a decrease of $8.3 million of specific provisions, partially offset by a decrease of $5.1 million of reversal of general provisions recorded during the three months ended June 30, 2011 as compared to the three months ended June 30, 2010. During the three months ended June 30, 2011, we recorded specific provisions of $6.0 million compared to $14.2 million recorded during the three months ended June 30, 2010. The decrease in the specific component of the provision for credit losses was primarily due to charge offs since June 30, 2010 of impaired loans with a specific allowance, slowing negative credit migration, and improving economic conditions. We charged off $10.0 million and $20.8 million of impaired loans during the three months ended June 30, 2011 and 2010, respectively. The decrease in the reversal of the general component of the provision for credit losses was primarily due to higher loan origination volume during the three months ended June 30, 2011 as compared to the three months ended June 30, 2010. Our general allowance for credit losses covers probable losses in our loan and lease portfolio with respect to loans and leases for which no specific impairment has been identified. A specific provision for credit losses is recorded with respect to loans for which it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement for which there is impairment recognized. Impaired loans, which include all of our delinquent loans and troubled debt restructurings, as a percentage of “Loans and leases, net” increased to 21% as of June 30, 2011 as compared to 20% as of June 30, 2010. When a loan is classified as impaired, the loan is evaluated for a specific allowance and a specific provision may be recorded, thereby removing it from consideration under the general component of the allowance analysis. Consequently, as the percentage of impaired loans in our loan portfolio increased as compared to June 30, 2010, the percentage of loans in our loan and lease portfolio being evaluated under our general allowance analysis has decreased.

A general allowance is provided for loans and leases that are not impaired. The Company employs a variety of internally developed and third-party modeling and estimation tools for measuring credit risk, which are used in developing an allowance for loan and lease losses on outstanding loans and leases. The Company’s allowance framework addresses economic conditions, capital market liquidity and industry circumstances from both a top-down and bottom-up perspective. The Company considers and evaluates changes in economic conditions, credit availability, industry and multiple obligor concentrations in assessing both probabilities of default and loss severities as part of the general component of the allowance for loan and lease losses.

On at least a quarterly basis, loans and leases are internally risk-rated based on individual credit criteria, including loan and lease type, loan and lease structures (including balloon and bullet structures common in the Company’s Leveraged Finance and Real Estate cash flow loans), borrower industry, payment capacity, location and quality of collateral if any (including the Company’s Real Estate loans). Borrowers provide the Company with financial information on either a monthly or quarterly basis. Ratings, corresponding assumed default rates and assumed loss severities are dynamically updated to reflect any changes in borrower condition or profile.

For Leveraged Finance loans, the data set used to construct probabilities of default in its allowance for loan and lease losses model, Moody’s CRD Private Firm Database, primarily contains middle market loans that share attributes similar to the Company’s loans. The Company also considers the quality of the loan or lease terms in determining a loan or lease loss in the event of default.

For Real Estate loans, the Company employs two mechanisms to capture the impact of industry and economic conditions. First, a loan’s risk rating, and thereby its assumed default likelihood, can be adjusted to account for overall commercial real estate market conditions. Second, to the extent that economic or industry trends adversely affect a substandard rated borrower’s loan-to-value ratio enough to impact its repayment ability, the Company applies a stress multiplier to the loan’s probability of default. The multiplier is designed to account for default characteristics that are difficult to quantify when market conditions cause commercial real estate prices to decline.

During 2010, the Company refined its allowance for credit losses methodology regarding commercial real estate. If the Company determines that additional changes in its allowance for credit losses methodology are advisable, as a result of changes in the economic environment or otherwise, the revised allowance methodology may result in higher or lower levels of allowance. Moreover, given uncertain market conditions, actual losses under the Company’s current or any revised allowance methodology may differ materially from the Company’s estimate.

 

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Additionally, when determining the amount of the general allowance, the Company supplements the base amount with a judgmental amount which is governed by a score card system comprised of ten individually weighted risk factors. The risk factors are designed based on those outlined in the Comptrollers of the Currency’s Allowance for Loan and Lease Losses Handbook. The Company also performs a ratio analysis of comparable money center banks, regional banks and finance companies. While the Company does not rely on this peer group comparison to set the level of allowance for credit losses, it does assist management in identifying market trends and serves as an overall reasonableness check on the allowance for credit losses computation. During the first quarter of 2011, we reduced our general allowance for credit losses to reflect improving performance in our non-impaired loan portfolio.

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. 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 for all loans for which we have serious doubts as to the ability of the borrowers to comply with the present loan repayment terms.

Impaired loans at June 30, 2011 and 2010 were in both Real Estate and in Leveraged Finance, over a range of industries impacted by the then current economic environment including the following: Buildings and Commercial Real Estate, Broadcast and Entertainment, Nondurable Consumer Products, Energy and Chemical Services, Financial Services, Healthcare, Printing and Publishing, Restaurants, and Industrial and Other Business Services. For impaired Leveraged Finance loans, the Company measured impairment based on expected cash flows utilizing relevant information provided by the borrower and consideration of other market conditions or specific factors impacting recoverability. Such amounts are discounted based on original loan terms. For impaired Real Estate loans, the Company determined that the loans were collateral dependent and measured impairment based on the fair value of the related collateral utilizing recent appraisals from third-party appraisers, as well as internal estimates of market value.

Non-interest income. Non-interest income decreased $5.5 million, to a loss of $0.8 million for the three months ended June 30, 2011 from $4.8 million for the three months ended June 30, 2010. The decrease is primarily due to a $3.5 million loss on the value of equity interests in certain impaired borrowers and a $3.3 million decrease in the gain recognized in connection with the repurchase of debt, partially offset by a net gain of $0.7 million on equity method of accounting interests. The equity interest in certain impaired borrowers is initially recorded at fair value when the debt is restructured and is subsequently analyzed at the end of each quarter.

As a result of certain of our troubled debt restructurings, we have received an equity interest in several of our impaired borrowers. In situations where we are deemed to be under the equity method of accounting, we record our ownership share of the borrowers’ results of operations in non-interest income. Additionally, our corresponding share of our borrowers’ results of operations directly impacts the remaining net book value of these respective loans. These equity interests may give rise to potential capital gains or losses, for tax purposes. This could impact future period tax rates depending on our ability to recognize capital losses to the extent of any capital gains.

Operating expenses. Operating expenses increased $1.3 million, to $10.8 million for the three months ended June 30, 2011 from $9.5 million for the three months ended June 30, 2010 primarily due to the acquisition of Business Credit in November 2010. Employee compensation and benefits increased 0.9 million primarily due to higher headcount and an increase in the non-cash compensation charge related to equity award grants. General and administrative expenses increased $0.3 million due primarily to an increase in loan workout costs.

Income taxes. For the three months ended June 30, 2011 and 2010, we provided for income taxes based on an effective tax rate of 43% and 39%, respectively. Our effective tax rate for the three months ended June 30, 2011 reflects the impact of state tax related discrete items recorded during the quarter. The effective tax rate for the three months ended June 30, 2010 included the impact of a valuation allowance recorded during the quarter.

As of June 30, 2011 and December 31, 2010, we had net deferred tax assets of $48.5 million and $48.1 million, respectively. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. We considered all available evidence, both positive and negative, in determining the realizability of deferred tax assets at June 30, 2011. We considered carryback availability, the scheduled reversals of deferred tax liabilities, projected future taxable income during the reversal periods, and tax planning strategies in making this assessment. We also considered our recent history of taxable income, trends in our earnings and tax rate, positive financial ratios, and the impact of the downturn in the current economic environment (including the impact of credit on allowance and provision for loan losses; and the impact on funding levels) on the Company. Based upon our assessment, we believe that a valuation allowance was not necessary as of June 30, 2011. As of June 30, 2011, our deferred tax asset was primarily comprised of $31.3 million related to our allowance for credit losses and $13.6 million related to equity compensation.

Further, we evaluated our business plans and results during our forecast period of future taxable income (including consideration of liquidity, available sources of funding and capital from existing sources). Our forecast utilized in our June 30, 2011 analysis included a sufficient level of earnings over a reasonable period of time.

 

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Based upon carryback availability, the timing of reversals of deferred tax assets and liabilities including the impact of available carryback and carryforward periods, and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.

Comparison of the Six Months Ended June 30, 2011 and 2010

Interest income. Interest income decreased $2.0 million, to $55.3 million for the six months ended June 30, 2011 from $57.3 million for the six months ended June 30, 2010. The decrease was primarily due to a decrease in average balance of our interest earning assets to $1.9 billion from $2.1 billion, partially offset by an increase in the yield on average interest earning assets to 5.98% from 5.52% primarily driven by an increase in contractual interest rates from new loan origination and re-pricings subsequent to June 30, 2010.

Interest expense. Interest expense decreased $5.3 million, to $16.9 million for the six months ended June 30, 2011 from $22.2 million for the six months ended June 30, 2010. The decrease was primarily due to a decrease in the average balance of our interest bearing liabilities, and the decrease in accelerated amortization of certain deferred financing fees. The decrease in the average balance of our interest bearing liabilities is primarily attributable to the reduction of total debt from $1.4 billion as of June 30, 2010 to $1.3 billion as of June 30, 2011. During the six months ended June 30, 2010, we accelerated the amortization of $3.6 million of deferred financing fees resulted from the repayment of our Deutsche Bank term debt facility and the reduction of the commitment amount under our credit facility with Citicorp.

Net interest margin. Net interest margin increased to 4.15% for the six months ended June 30, 2011 from 3.38% for the six months ended June 30, 2010. The increase in net interest margin was primarily due to a decrease in our average cost of interest bearing liabilities, an increase in our average yield on interest earning assets from new loan origination and re-pricings subsequent to June 30, 2010, partially offset by non-payment of interest income from non-accrual loans. The decrease in average cost of funds is primarily due to the accelerated amortization of $3.6 million of deferred financing fees during the six months ended June 30, 2010 resulting from the repayment of our Deutsche Bank term debt facility and the reduction of the commitment amount under our credit facility with Citicorp. The net interest spread, the difference between gross yield on our interest earning assets and the total cost of our interest bearing liabilities, increased to 3.28% from 2.56%. At June 30, 2011, 58% of our adjustable rate loans included interest rate floors.

The following table summarizes the yield and cost of interest earning assets and interest bearing liabilities for the six months ended June 30, 2011 and 2010:

 

     Six Months Ended June 30, 2011      Six Months Ended June 30, 2010  
     ($ in thousands)  
         Average    
Balance
     Interest
Income/
  Expense  
       Average  
Yield/
Cost
     Average
Balance
     Interest
Income/
  Expense  
       Average  
Yield/
Cost
 

Total interest earning assets

   $     1,865,547           $ 55,303          5.98  %       $   2,094,531        $ 57,321          5.52%   

Total interest bearing liabilities

     1,264,959             16,899          2.69              1,514,518          22,209          2.96      
     

 

 

    

 

 

       

 

 

    

 

 

 

Net interest spread

      $   38,404            3.28  %          $   35,112          2.56%   
     

 

 

    

 

 

       

 

 

    

 

 

 

Net interest margin

             4.15  %               3.38%      
        

 

 

          

 

 

 

Provision for credit losses. The provision for credit losses decreased to $8.6 million for the six months ended June 30, 2011 from $32.6 million for the six months ended June 30, 2010. The decrease in the provision was primarily due to a decrease of $24.5 million of specific provisions recorded during the six months ended June 30, 2011 as compared to the six months ended June 30, 2010. During the six months ended June 30, 2011, we recorded specific provisions of $12.1 million compared to $36.5 million recorded during the six months ended June 30, 2010. The decrease in the specific component of the provision for credit losses was principally due to charge offs since June 30, 2010 of impaired loans with a specific allowance, slowing negative credit migration, and improving economic conditions. Our general allowance for credit losses covers probable losses in our loan and lease portfolio with respect to loans and leases for which no specific impairment has been identified. A specific provision for credit losses is recorded with respect to loans for which it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement for which there is impairment recognized. Impaired loans, which include all of our delinquent loans and troubled debt restructurings, as a percentage of “Loans and leases, net” increased to 21% as of June 30, 2011 as compared to 20% as of June 30, 2010. When a loan is classified as impaired, the loan is evaluated for a specific allowance and a specific provision may be recorded, thereby removing it from consideration under the general component of the allowance analysis. Consequently, as the percentage of impaired loans in our loan portfolio increased as compared to June 30, 2010, the percentage of loans in our loan portfolio being evaluated under our general allowance analysis has decreased.

 

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Non-interest income. Non-interest income decreased $10.6 million, to a loss of $1.2 million for the six months ended June 30, 2011 from $9.3 million for the six months ended June 30, 2010. The decrease is primarily due to a $5.4 million loss on the value of equity interests in certain impaired borrowers, a $1.2 million net loss on equity method of accounting interests, and a $5.2 million decrease in the gain recognized in connection with the repurchase of debt. The equity interest in certain impaired borrowers is initially recorded at fair value when the debt is restructured and is subsequently analyzed at the end of each quarter.

Operating expenses. Operating expenses increased $1.6 million, to $21.0 million for the six months ended June 30, 2011 from $19.3 million for the six months ended June 30, 2010 primarily due to the acquisition of Business Credit in November 2010. Employee compensation and benefits increased $2.1 million primarily due to higher headcount and an increase in the non-cash compensation charge related to equity award grants. General and administrative expenses decreased $0.3 million due primarily to a decrease in professional service costs.

Income taxes. For the six months ended June 30, 2011 and 2010, we provided for income taxes based on an effective tax rate of 43% and 40%, respectively. Our effective tax rate for the six months ended June 30, 2011 reflects the impact of state tax related discrete items recorded during the six months ended June 30, 2011. The effective tax rate for the six months ended June 30, 2010 included the impact of a valuation allowance recorded during that time period.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity consist of cash flow from operations, credit facilities, term debt securitizations and proceeds from equity and debt offerings. We believe these sources will be sufficient to fund our current operations, lending activities and other short-term liquidity needs. Our future liquidity needs will be determined primarily based on the credit performance of our loan portfolio, origination volume, potential acquisitions and other growth initiatives. We may need to raise additional capital through the incurrence of indebtedness or issuance of equity based on various factors, including if the level of non-accrual loans increases faster than expected, recoveries are lower than anticipated, we are unable to fund certain loans with credit facilities, or if our cash flow from operations is lower than expected. We may not be able to raise debt or equity capital on acceptable terms or at all. The incurrence of additional debt will increase our leverage and interest expense, and the issuance of any equity or securities exercisable, convertible or exchangeable into Company common stock may be dilutive for existing shareholders.

Conditions in the capital markets continued to demonstrate signs of improvement in the second quarter of 2011 as economic growth in the US stabilized. The larger, more liquid segments of the securitization markets have also substantially recovered, supporting increasing levels of new issuance for securities backed by mortgages, credit cards, equipment and auto loans. As liquidity has returned to those asset classes and market conditions normalized, the securitization markets for other asset types, including CLOs, have also recovered to a point that we believe they provide a reliable source of capital for companies like NewStar. Conditions in the securitization market for bank loans, which the Company partially relies upon for funding, have continued to improve as loan values have recovered and default rates have declined. The pace of recovery in this market is slow, but has improved and we expect the favorable trends to continue as spreads tighten across other types of asset-backed securities and investors continue to emphasize a preference for higher yielding, floating rate asset classes. In addition to these signs of improving market conditions, we believe the Company has substantially greater financial flexibility and other financing options due to the improvement in our financial performance.

During the second quarter of 2011, we closed on a five-year master repurchase facility to finance a portion of our commercial real estate portfolio. In 2010, we renewed a warehouse credit facility on more favorable terms and amended a corporate debt facility to increase the size of the commitment and establish better pricing and advance rates among other improved terms. We believe that our ability to access new credit facilities and renew and amend our existing credit facilities reflects an overall improvement in the market conditions for funding and may represent a turning point in our ability to obtain financings on improved terms in the future. Despite these signs of improving market conditions, we cannot assure you that this will continue, and it is possible that market conditions could become more uncertain or worsen. If they do, we could face materially higher financing costs, which would affect our operating strategy and could materially and adversely affect our financial condition.

Cash and Cash Equivalents

As of June 30, 2011 and December 31, 2010, we had $49.4 million and $54.4 million, respectively, in cash and cash equivalents. We may invest a portion of cash on hand in short-term liquid investments. From time to time, we may use a portion of our non-restricted cash to pay down our credit facilities. During the second quarter, we fully repaid our credit facility with Citibank, N.A., and we paid down our term credit facility with Wachovia Capital Markets, LLC.

Restricted Cash

Separately, we had $109.9 million and $178.4 million of restricted cash as of June 30, 2011 and December 31, 2010, respectively. The restricted cash represents the balance of the principal and interest collections accounts and pre-funding amounts in our credit facilities, our term debt securitizations and customer holdbacks and escrows. The use of the principal collection accounts’ cash is limited to funding the growth of our loan and portfolio within the facilities or paying down related credit facilities or term debt securitizations. As of June 30, 2011, we could use $20.6 million of restricted cash to fund new or existing loans. The interest collection account cash is limited to the payment of interest, servicing fees and other expenses of our credit facilities and term debt securitizations and, if either a ratings downgrade or failure to receive ratings confirmation occurs on the rated notes in a term debt

 

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securitization at the end of the funding period or if coverage ratios are not met, paying down principal with respect thereto. Cash to fund the growth of our loan portfolio and to pay interest on our term debt securitizations represented a large portion of our restricted cash balance at June 30, 2011.

Asset Quality and Allowance for Loan and Lease Losses

If a loan is 90 days or more past due, or if management believes it is probable we will unable to collect contractual principal and interest in the normal course of business, it is our policy to place the loan on non-accrual status. If a loan financed by a term debt securitization is placed on non-accrual status, the loan may remain in the term debt securitization and excess interest spread cash distributions to us will cease until cash accumulated in the term debt securitization equals the outstanding balance of the non-accrual loan. When a loan is on non-accrual status, accrued interest previously recognized as interest income subsequent to the last cash receipt in the current year will be reversed, and the recognition of interest income on that loan will stop until factors indicating doubtful collection no longer exist and the loan has been brought current. We may make exceptions to this policy if the loan is well secured and is in the process of collection. As of June 30, 2011, we had impaired loans with an aggregate outstanding balance of $352.4 million. Impaired loans with an aggregate outstanding balance of $234.1 million have been restructured and classified as troubled debt restructurings. Impaired loans with an aggregate outstanding balance of $109.0 million were on non-accrual status. During the six months ended June 30, 2011, previously identified non-accrual loans with an aggregate balance of $35.6 million at December 31, 2010 were taken off non-accrual status, and loans with an aggregate balance of $20.4 million were placed on non-accrual status. Impaired loans of $86.3 million were greater than 60 days past due and classified as delinquent. During the three and six months ended June 30, 2011, we recorded $6.0 million and $12.1 million of specific provisions for impaired loans. Included in our specific allowance for impaired loans was $26.6 million related to delinquent loans.

We closely monitor the credit quality of our loans and leases which is partly reflected in our credit metrics such as loan delinquencies, non-accruals, and charge offs. Changes to these credit metrics are largely due to changes in economic conditions and seasoning of the loan and lease portfolio.

We have provided an allowance for loan and lease losses to provide for probable losses inherent in our loan and lease portfolio. Our allowance for loan and lease losses as of June 30, 2011 and December 31, 2010 was $77.7 million and $84.5 million, or 4.44% and 4.98% of loans and leases, gross, respectively. As of June 30, 2011, we also had a $0.4 million allowance for unfunded commitments, resulting in an allowance for credit losses of 4.46%.

The allowance for credit losses is based on a review of the appropriateness of the allowance for credit losses and its two components on a quarterly basis. The estimate of each component is based on observable information and on market and third-party data believed to be reflective of the underlying credit losses being estimated.

It is the Company’s policy that during the reporting period to record a specific provision for credit losses for all loans which we have identified impairments. Subsequently, we may charge off the portion of the loan for which a specific provision was recorded. All of these loans are classified as impaired (if they have not been so classified already as a result of a troubled debt restructuring) and are disclosed in the Allowance for Credit Losses footnote to the financial statements.

Activity in the allowance for loan and lease losses for the six months ended June 30, 2011 and for the year ended December 31, 2010 was as follows:

 

     Six Months
Ended
June 30,
2011
     Year
Ended
December 31,
2010
 
     ($ in thousands)  

Balance as of beginning of period

   $         84,503         $         113,865     

General provision for loan and lease losses

     (3,573)          (14,371)    

Specific provision for loan losses

     12,056           47,695     

Net charge offs

     (15,331)          (62,686)    
  

 

 

    

 

 

 

Balance as of end of period

     77,655           84,503     

Allowance for losses on unfunded loan commitments

     385           278     
  

 

 

    

 

 

 

Allowance for credit losses

   $ 78,040         $ 84,781     
  

 

 

    

 

 

 

During the six months ended June 30, 2011 we recorded a total provision for credit losses of $8.6 million. The Company reduced its allowance for credit losses three basis points to 4.46% of gross loans and leases at June 30, 2011 from 4.99% at December 31, 2010, resulting from the increase in its specific allowance for loan and lease losses.

 

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Borrowings and Liquidity

As of June 30, 2011 and December 31, 2010, we had outstanding borrowings totaling $1.3 billion and $1.4 billion, respectively. Borrowings under our various credit facilities and term debt securitizations have supported our loan growth.

As of June 30, 2011, our funding sources, maximum debt amounts, amounts outstanding and unused debt capacity, subject to certain covenants and conditions, are summarized below:

 

Funding Source

     Maximum Debt  
Amount
     Amounts
  Outstanding  
       Unused Debt  
Capacity
     Maturity  
     ($ in thousands)  

Credit facilities

   $     350,000         $ 78,701         $     271,299           2012 – 2015   

Term debt (1)

     1,277,764           1,180,142           97,622             2012 – 2022   

Repurchase agreements

     68,000           68,000           —               2016   
  

 

 

    

 

 

    

 

 

    

Total

   $ 1,695,764         $   1,326,843         $ 368,921        
  

 

 

    

 

 

    

 

 

    

 

(1) Maturities for term debt are based on contractual maturity dates. Actual maturities may occur earlier.

We must comply with various covenants, the breach of which could result in a termination event, and at June 30, 2011, we were in compliance with all such covenants. These covenants vary depending on the type of facility and are customary for facilities of this type. These covenants include, but are not limited to, failure to service debt obligations, failure to meet liquidity covenants and tangible net worth covenants, and failure to remain within prescribed facility portfolio delinquency and charge-off levels.

Credit facilities

As of June 30, 2011 we had three credit facilities: (i) a $50.0 million facility with NATIXIS Financial Products, Inc. (“NATIXIS”), (ii) a $225 million credit facility with DZ Bank AG Deutsche Zentral-Genossenschaftsbank Frankfurt (“DZ Bank”) and (iii) a $75 million credit facility with Wells Fargo Bank, National Association (“Wells Fargo”).

We have a $50.0 million credit facility agreement with NATIXIS that had an outstanding balance of $15.7 million and unamortized deferred financing fees of $0.04 million as of June 30, 2011. Interest on this facility accrues at a variable rate per annum, which was 3.69% at June 30, 2011. On July 15, 2011, we entered into an amendment with NATIXIS which extended the revolving period under the credit facility to August 23, 2012.

As part of our acquisition of Core Business Credit, LLC (now known as NewStar Business Credit, LLC) and its wholly-owned subsidiaries (“Business Credit”) on November 1, 2010, we became a party to an existing $225.0 million credit facility with DZ Bank. The credit facility with DZ Bank had an outstanding balance of $63.0 million as of June 30, 2011. Interest on this facility accrues at a variable rate per annum. As part of the agreement, there is a minimum payment of $2.8 million per annum required to be made to satisfy the minimum requirement. If the facility is not utilized to cover this minimum requirement, then a make-whole fee is required to be made. We are permitted to use the proceeds of borrowings under the credit facility to fund commitments under existing or new asset based loans. This facility is scheduled to mature on April 25, 2013.

On January 25, 2011, we entered into a note purchase agreement with Wells Fargo. Under the terms of the note purchase agreement, Wells Fargo agreed to provide a $75 million revolving credit facility to fund new equipment lease origination. The credit facility is scheduled to mature four years after the initial advance under the credit facility. As of June 30, 2011, we had not drawn any amounts from this credit facility.

On July 12, 2011, we entered into an amendment with Wells Fargo to our term debt facility with Wachovia Capital Markets, LLC (see below). The amendment increased the amount of the facility to $125.0 million and provides for a revolving reinvestment period of 18 months with a two-year amortization period. The facility accrues interest at a variable rate per annum.

We had a $75.0 million credit facility agreement with Citicorp North America, Inc. (“Citicorp”) scheduled to mature on June 15, 2011. On June 7, 2011, we fully repaid the outstanding balance of this facility with the proceeds received from our financing arrangement with Macquarie Bank Limited (see below) and the facility was terminated.

Corporate Credit Facility

On January 5, 2010, we entered into a note agreement with Fortress Credit Corp., which was subsequently amended on August 31, 2010. The credit facility, as amended, consists of a $50.0 million revolving note and a $50.0 million term note, which matures on August 31, 2014. The credit facility accrues interest equal to the London Interbank Offered Rate (LIBOR) plus 7.00%.

 

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We are permitted to use the proceeds of borrowings under the credit facility for general corporate purposes including, but not limited to, funding loans, working capital, paying down outstanding debt, making certain types of acquisitions and repurchasing capital stock up to $10 million.

The applicable unused fee rate of the revolving note is 4.0% of the undrawn amount of the revolving note when the total outstanding amount of both notes is less than 50% of the $100.0 million commitment amount, 3.0% of the undrawn amount of the revolving note when the total outstanding amount is greater than or equal to 50% but less than 75% of the commitment amount, and 2.0% of the undrawn amount of the revolving note when the total outstanding amount is greater than or equal to 75% of the commitment amount. As of June 30, 2011, we had not drawn any amounts from the revolving note. As of June 30, 2011, unamortized deferred financing fees were $3.2 million.

The term note may be prepaid subject to a prepayment fee, payable whether the prepayment is voluntary or involuntary. If any such prepayment is made on or before August 30, 2012, the prepayment fee will be calculated for the period commencing on the date of such prepayment and continuing through August 30, 2012 and shall be equal to the product of 7.00% per annum multiplied by the amount of the prepayment. If any such prepayment is made after August 30, 2012, such prepayment fee will be equal to the product of (a) the amount of the prepayment and (b)(i) in the case of any such prepayment made during the period commencing on August 31, 2012 and ending on August 30, 2013, 2.00% and (ii) in the case of any such prepayment made at any time after August 30, 2013, 1%. As of June 30, 2011, the term note had an outstanding principal balance of $50.0 million.

Term Debt Facilities

As of June 30, 2011, we had one term debt facility, a $14.5 million facility with Wachovia Capital Markets, LLC (“Wachovia”).

Interest on the Wachovia facility accrued at a variable rate per annum, which was 3.94% at June 30, 2011. As of June 30, 2011, the outstanding balance was $13.0 million and unamortized deferred financing fees were $0.9 million. The credit facility was amended on July 12, 2011.

Term Debt Securitizations

In August 2005 we completed a term debt transaction. In conjunction with this transaction we established a separate single-purpose bankruptcy-remote subsidiary, NewStar Trust 2005-1 (the “2005 CLO Trust”) and contributed $375 million in loans and investments (including unfunded commitments), or portions thereof, to the 2005 CLO Trust. We remain the servicer of the loans and investments. Simultaneously with the initial contributions, the 2005 CLO Trust issued $343.4 million of notes to institutional investors and issued $31.6 million of trust certificates of which we retained 100%. At June 30, 2011, the $176.2 million of outstanding notes were collateralized by the specific loans and investments, principal collections account cash and principal payment receivables totaling $207.8 million. At June 30, 2011, deferred financing fees were $0.2 million. The 2005 CLO Trust permitted reinvestment of collateral principal repayments for a three-year period which ended in October 2008. During the six months ended June 30, 2011, we repurchased $3.9 million the 2005 CLO Trust’s Class E notes. During 2010, we repurchased $4.6 million of the 2005 CLO Trust’s Class D notes. During 2009, we repurchased $1.4 million of the 2005 CLO Trust’s Class D notes and $1.2 million of the Class E notes. During 2008, we repurchased $5.8 million of the 2005 CLO Trust’s Class E notes. During 2007, we repurchased $5.0 million of the 2005 CLO Trust’s Class E notes. During 2009, Moody’s downgraded all of the notes of the 2005 CLO Trust. As a result of the downgrades, amortization of the 2005 CLO Trust changed from pro rata to sequential, resulting in scheduled principal payments made in order of the notes seniority until all available funds are exhausted for each payment. During the second quarter of 2010, Standard and Poor’s downgraded all of the notes of the 2005 CLO Trust. During the third quarter of 2010, Fitch affirmed its ratings of the Class A-1 notes, the Class A-2 notes and the Class B notes, and downgraded the Class C notes, the Class D notes and the Class E notes. The downgrades during 2010 did not have any material consequence as the amortization of the 2005 CLO Trust changed from pro rata to sequential after the Moody’s downgrade in 2009.

We receive a loan collateral management fee and excess interest spread. We expect to receive a principal distribution when the term debt is retired. The most recent quarterly report of the 2005 CLO Trust dated April 13, 2011 identified $49.1 million of certain loan collateral in the 2005 CLO Trust as delinquent or charged-off under the terms of the trust indenture. As a result, the excess interest spread from the 2005 CLO Trust will be redirected and combined with recoveries and will be used to repay the outstanding notes until note redemptions equal the underlying non-accrual loan balances or until we purchase such loans. As of the April 13, 2011 report, the cumulative amount redirected was $13.8 million. We may have additional defaults in the 2005 CLO Trust in the future. If we do not elect to remove any future defaulted loans, we would not expect to receive excess interest spread payments until the undistributed cash plus any recoveries equal the outstanding balances of defaulted loan collateral.

 

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The following table sets forth selected information with respect to the 2005 CLO Trust:

 

     Notes and
certificates
originally
issued
     Outstanding
balance
June  30,

2011
     Borrowing
spread to
LIBOR
     Ratings
(S&P/Moody’s/
Fitch)(1)
     ($ in thousands)      %       

2005 CLO Trust:

           

Class A-1

   $ 156,000       $ 60,686         0.28%       AA+/Aa2/AAA

Class A-2

     80,477         30,979         0.30          AA+/Aa2/AAA

Class B

     18,750         18,683         0.50          A+/A2/AA

Class C

     39,375         39,233         0.85          B+/Ba1/BB

Class D

     24,375         18,224         1.50          CCC-/B1/CCC

Class E

     24,375         8,418         4.75          CCC-/Caa2/CC
  

 

 

    

 

 

       

Total notes

     343,352         176,223         

Class F (trust certificates)

     31,648         31,538         N/A          N/A
  

 

 

    

 

 

       

Total for 2005 CLO Trust

   $     375,000       $     207,761         
  

 

 

    

 

 

       

 

(1) The ratings were initially given in August 2005, are unaudited and are subject to change from time to time. Fitch affirmed its ratings on February 24, 2009 and downgraded the Class D notes and Class E notes. The Fitch downgrade did not have an impact on the 2005 CLO Trust. During the first quarter of 2009, Moody’s downgraded the Class C notes, the Class D notes and the Class E notes to the ratings shown above. During the third quarter of 2009, Moody’s downgraded the Class A-1 notes, the Class A-2 notes and the Class B notes to the ratings shown above. During the second quarter of 2010, Standard and Poor’s downgraded all of the notes to the ratings shown above. During the third quarter of 2010, Fitch downgraded the Class C notes, the Class D notes and the Class E notes to the ratings shown above. (source: Bloomberg Finance L.P.).

In June 2006 we completed a term debt transaction. In conjunction with this transaction we established a separate single-purpose bankruptcy remote subsidiary, NewStar Commercial Loan Trust 2006-1 (the “2006 CLO Trust”) and contributed $500 million in loans and investments (including unfunded commitments), or portions thereof, to the 2006 CLO Trust. We remain the servicer of the loans. Simultaneously with the initial contributions, the 2006 CLO Trust issued $456.3 million of notes to institutional investors. We retained $43.8 million, comprising 100% of the 2006 Trust’s trust certificates. At June 30, 2011, the $409.1 million of outstanding drawn notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $454.9 million. At June 30, 2011, deferred financing fees were $2.2 million. The 2006 CLO Trust permitted reinvestment of collateral principal repayments for a five-year period which ended in June 2011. During the six months ended June 30, 2011, we repurchased $4.0 million of the 2006 CLO Trust’s Class D notes. During 2010, we repurchased $3.0 million of the 2006 CLO Trust’s Class D notes and $3.0 million of the 2006 CLO Trust’s Class E notes. During 2009, we repurchased $6.5 million of the 2006 CLO Trust’s Class D notes and $1.8 million of the 2006 CLO Trust’s Class E notes. During 2008, we repurchased $3.3 million of the 2006 CLO Trust’s Class D and $2.5 million of the 2006 CLO Trust’s Class E notes, respectively. During 2009, Moody’s downgraded all of the notes of the 2006 CLO Trust. As a result of the downgrade, amortization of the 2006 CLO Trust changed from pro rata to sequential, resulting in future scheduled principal payments made in order of the notes seniority until all available funds are exhausted for each payment. During the second quarter of 2010, Standard and Poor’s downgraded the Class A-1 notes, the Class A-2 notes, the Class C notes, the Class D notes and the Class E notes of the 2006 CLO Trust. The downgrade did not have any material consequence as the amortization of the 2006 CLO Trust changed from pro rata to sequential after the Moody’s downgrade in 2009.

We receive a loan collateral management fee and excess interest spread. We expect to receive a principal distribution when the term debt is retired. The most recent quarterly report of the 2006 CLO Trust dated June 13, 2011 identified $21.6 million of certain loan collateral in the 2006 CLO Trust as delinquent or charged-off under the terms of the trust indenture. As a result, the excess interest spread from the 2006 CLO Trust will be redirected and combined with recoveries and will be used to repay the outstanding notes until note redemptions equal the underlying non-accrual loan balances or until we purchase such loans. During the six months ended June 30, 2011, the Company elected to purchase $11.1 million of defaulted collateral from the 2006 CLO Trust to reduce the amount of excess interest spread that otherwise would have been required to be redirected. Consequently, as of the June 13, 2011 quarterly report, the entire $21.6 million had been redirected or repurchased. We may have additional defaults in the 2006 CLO Trust in the future. If we do not elect to remove any future defaulted loans, we would not expect to receive excess interest spread payments until the undistributed cash plus any recoveries equal the outstanding balances of defaulted loan collateral.

 

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The following table sets forth the selected information with respect to the 2006 CLO Trust:

 

     Notes and
certificates
originally
issued
     Outstanding
balance
June  30,

2011
     Borrowing
spread to
LIBOR
     Ratings
(S&P/Moody’s/
Fitch)(1)
     ($ in thousands)      %       

2006 CLO Trust:

           

Class A-1

   $ 320,000       $ 298,881         0.27%       AA+/Aa2/AAA

Class A-2

     40,000         40,000         0.28          AA+/Aa2/AAA

Class B

     22,500         22,500         0.38          AA/A3/AA

Class C

     35,000         35,000         0.68          BBB+/Ba1/A

Class D

     25,000         8,250         1.35          CCC+/B1/BBB

Class E

     13,750         6,500         1.75          CCC-/B2/BB
  

 

 

    

 

 

       

Total notes

     456,250         411,131         

Class F (trust certificates)

     43,750         43,750         N/A          N/A
  

 

 

    

 

 

       

Total for 2006 CLO Trust

   $     500,000       $     454,881         
  

 

 

    

 

 

       

 

(1) These ratings were initially given in June 2006, are unaudited and are subject to change from time to time. Fitch affirmed its ratings on February 24, 2009. During the first quarter of 2009, Moody’s downgraded the Class C notes, the Class D notes and the Class E notes to the ratings shown above. During the third quarter of 2009, Moody’s downgraded the Class A-1 notes, the Class A-2 notes and the Class B notes to the ratings shown above. During the second quarter of 2010, Standard and Poor’s downgraded the Class A-1 notes, the Class A-2 notes, the Class C notes, the Class D notes and the Class E notes to the ratings shown above. (source: Bloomberg Finance L.P.).

In June 2007 we completed a term debt transaction. In conjunction with this transaction we established a separate single-purpose bankruptcy-remote subsidiary, NewStar Commercial Loan Trust 2007-1 (the “2007 CLO Trust”) and contributed $600 million in loans and investments (including unfunded commitments), or portions thereof, to the 2007 CLO Trust. We remain the servicer of the loans. Simultaneously with the initial contributions, the 2007 CLO Trust issued $546.0 million of notes to institutional investors. We retained $54.0 million, comprising 100% of the 2007 CLO Trust’s trust certificates. At June 30, 2011, the $477.5 million of outstanding drawn notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $531.5 million. At June 30, 2011, deferred financing fees were $3.4 million. The 2007 CLO Trust permits reinvestment of collateral principal repayments for a six-year period ending in May 2013. Should we determine that reinvestment of collateral principal repayments are impractical in light of market conditions or if collateral principal repayments are not reinvested within a prescribed timeframe, such funds may be used to repay the outstanding notes. During 2010, we repurchased $5.0 million of the 2007 CLO Trust’s Class D notes. During 2009, we repurchased $1.0 million of the 2007 CLO Trust’s Class D notes. During 2009, Moody’s downgraded all of the notes of the 2007 CLO Trust. As a result of the downgrade, amortization of the 2007 CLO Trust changed from pro rata to sequential, resulting in future scheduled principal payments made in order of the notes seniority until all available funds are exhausted for each payment. On April 17, 2011, Moody’s upgraded the Class C notes, the Class D notes, and the Class E notes. During the second quarter of 2010, Standard and Poor’s downgraded the Class A-1 notes, the Class A-2 notes, the Class C notes and the Class D notes of the 2007 CLO Trust. The downgrade did not have any material consequence as the amortization of the 2007 CLO Trust changed from pro rata to sequential after the Moody’s downgrade in 2009. On April 19, 2011, Standard and Poor’s upgraded the Class D notes.

We receive a loan collateral management fee and excess interest spread. We expect to receive a principal distribution when the term debt is retired. If loan collateral in the 2007 CLO Trust is in default under the terms of the indenture, the excess interest spread from the 2007 CLO Trust could not be distributed until the undistributed cash plus recoveries equals the outstanding balance of the defaulted loan or if we elected to remove the defaulted collateral. We may have future defaults in the 2007 CLO Trust in the future. If we do not elect to remove any future defaulted loans, we would not expect to receive excess interest spread payments until the undistributed cash plus any recoveries equal the outstanding balances of any potential defaulted loan collateral. During 2010, we elected to purchase $38.8 million of defaulted collateral from the 2007 CLO Trust to reduce the amount of excess interest spread that otherwise would have been required to be redirected.

 

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The following table sets forth selected information with respect to the 2007 CLO Trust:

 

     Notes
originally
issued
     Outstanding
balance
June  30,

2011
     Borrowing
spread to
LIBOR
     Ratings
(S&P/Moody’s/
Fitch)(1)
     ($ in thousands)              

2007 CLO Trust

           

Class A-1

   $ 336,500       $ 318,258         0.24%       AA+/Aa2/AAA

Class A-2

     100,000         55,767         0.26          AA+/Aa2/AAA

Class B

     24,000         24,000         0.55          AA/A2/AA

Class C

     58,500         58,500         1.30          BBB+/Baa3/A

Class D

     27,000         21,000         2.30          BB-/Ba2/BBB+
  

 

 

    

 

 

       

Total notes

     546,000         477,525         

Class E (trust certificates)

     29,100         29,100         N/A          N/A

Class F (trust certificates)

     24,900         24,900         N/A          N/A
  

 

 

    

 

 

       

Total for 2007 CLO Trust

   $     600,000       $     531,525         
  

 

 

    

 

 

       

 

(1) These ratings were initially given in June 2007, are unaudited and are subject to change from time to time. Fitch affirmed its ratings on February 24, 2009. During the first quarter of 2009, Moody’s downgraded the Class C notes and the Class D notes. During the third quarter of 2009, Moody’s downgraded the Class A-1 notes, the Class A-2 notes and the Class B notes to the ratings shown above. During the second quarter of 2010, Standard and Poor’s downgraded the Class A-1 notes, the Class A-2 notes, the Class C notes to the ratings shown above, and also downgraded the Class D notes. On April 7, 2011, Moody’s upgraded the Class C notes and the Class D notes to the ratings shown above. On April 19, 2011, Standard and Poor’s upgraded the Class D notes to the rating shown above (source: Bloomberg Finance L.P.).

On January 7, 2010, we completed a term debt securitization. In conjunction with this transaction we established a separate single-purpose bankruptcy-remote subsidiary, NewStar Commercial Loan Trust 2009-1 (the “2009 CLO Trust”) and contributed $225 million in loans and investments (including unfunded commitments), or portions thereof, to the 2009 CLO Trust at close. We had the ability to contribute an additional $50 million of loan collateral by July 30, 2010 and contributed the full amount during the six months ended June 30, 2010. We remain the servicer of the loans. Simultaneously with the initial contributions, the 2009 CLO Trust issued $190.5 million of notes to institutional investors. We retained all of the Class C and subordinated notes, which totaled approximately $87.9 million, representing 32% of the value of the collateral pool. At June 30, 2011, the $52.3 million of outstanding notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $140.2 million. At June 30, 2011, deferred financing fees were $1.6 million and the unamortized discount was $2.0 million. The 2009 CLO Trust is a static pool of loans that does not permit for reinvestment of collateral principal repayments. On April 1, 2011, Moody’s upgraded the Class B notes and the Class C notes.

The 2009 CLO Trust is callable without penalty on the distribution date in July 2011 and on each distribution date thereafter. On August 1, 2011, we called the 2009 CLO Trust in accordance with its terms without penalty.

 

     Notes
originally
issued
     Outstanding
balance
June  30,

2011
     Interest
rate
     Original
maturity
     Ratings
(Moody’s)(1)
     ($ in thousands)                     

2009 CLO Trust

              

Class A

   $     148,500       $ 12,234         Libor +3.75%             July 30, 2018       Aaa

Class B

     42,000         40,028         Libor +5.00%(2)         July 30, 2018       Aaa
  

 

 

    

 

 

          

Total issued

     190,500         52,262            

Class C

     31,000         31,000         Libor +5.50%             July 30, 2018       Baa1

Subordinated

     56,900         56,921         N/A                July 30, 2018       NR
  

 

 

    

 

 

          
   $ 278,400       $     140,183            
  

 

 

    

 

 

          

 

(1) These ratings, initially given in January 2010, are unaudited and are subject to change from time to time. On April 1, 2011, Moody’s upgraded the Class B notes and the Class C notes to the ratings shown above.
(2) The Class B notes carry a Libor +5.00% coupon rate but were priced at a 91.85% discount to yield Libor +7.50% on a par amount of $42.0 million.

 

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Table of Contents

    Repurchase Agreement

On June 7, 2011, we entered into a five-year, $68.0 million financing arrangement with Macquarie backed primarily by a portfolio of legacy commercial mortgage loans previously originated by us. The financing was structured as a master repurchase agreement under which we sold the portfolio of commercial mortgage loans to Macquarie for an aggregate purchase price of $68.0 million. We also agreed to repurchase the commercial mortgage loans from time to time (including a minimum quarterly amount), and agreed to repurchase all of the commercial mortgage loans by June 7, 2016. Upon the repurchase of a commercial mortgage loan, we are obligated to repay the principal amount related to such mortgage loan plus accrued interest (at a rate based on LIBOR plus a margin) to the date of repurchase. We will continue to service the commercial mortgage loans. The facility accrues interest at a variable rate per annum, which was 5.20% as of June 30, 2011. As of June 30, 2011, unamortized deferred financing fees were $1.5 million and the outstanding balance was $68.0 million. As part of the agreement, there is a minimum aggregate interest margin payment of $8.4 million required to be made over the life of the facility. If the facility is not utilized to cover this minimum requirement, then a make-whole fee is required to be made to satisfy the minimum aggregate interest margin payment.

The proceeds of the Macquarie transaction were used to fully repay our credit facility with Citicorp and refinance all of the commercial mortgage loans previously funded by our warehouse line with Wachovia. The transaction generated net proceeds for us after retirement of debt and transaction costs of approximately $20.0 million. We did not record any gains or losses. The commercial mortgage loans and related repurchase obligations are consolidated and reflected in our financial statements.

OFF BALANCE SHEET ARRANGEMENTS

We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our borrowers. These financial instruments include unfunded commitments, standby letters of credit and interest rate mitigation products. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement we have in particular classes of financial ins