Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

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

For the fiscal year ended December 31, 2013

OR

 

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

For the transition period from             to            

Commission file number 001-33211

 

 

NewStar Financial, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware    54-2157878

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

500 Boylston Street, Suite 1250, Boston, MA    02116
(Address of principal executive offices)    (Zip Code)

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

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $0.01 per share   The NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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 website, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K    ¨

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 “accelerated filer”, “large 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 June 28, 2013 the last business day of our most recently completed second fiscal quarter, the aggregate market value of the voting stock held by non-affiliates was $345,561,333, based on the number of shares held by non-affiliates of the registrant as of June 28, 2013, and based on the reported last sale price of common stock on June 28, 2013. This calculation does not reflect a determination that persons are affiliates for any other purposes.

As of March 13, 2014, 48,798,395 shares of common stock, par value of $0.01 per share, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission (“SEC”) pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), relating to the Registrant’s Annual Meeting of Stockholders scheduled to be held May 20, 2014 are incorporated by reference into Part III of this Form 10-K. With the exception of the portions of the Proxy Statement specifically incorporated herein by reference, the Proxy Statement is not deemed to be filed as part of this Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  
PART I   

Item 1.

   Business      2   

Item 1A.

  

Risk Factors

     14   

Item 1B.

  

Unresolved Staff Comments

     25   

Item 2.

  

Properties

     25   

Item 3.

  

Legal Proceedings

     26   

Item 4.

  

Mine Safety Disclosures

     26   
PART II   

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     27   

Item 6.

  

Selected Financial Data

     29   

Item 7.

  

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

     32   

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

     63   

Item 8.

  

Financial Statements and Supplementary Data

     65   

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     115   

Item 9A.

  

Controls and Procedures

     115   

Item 9B.

  

Other Information

     115   
PART III   

Item 10.

   Directors, Executive Officers and Corporate Governance      116   

Item 11.

  

Executive Compensation

     117   

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     117   

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

     117   

Item 14.

  

Principal Accounting Fees and Services

     117   
PART IV   

Item 15.

  

Exhibits, Financial Statement Schedules

     118   

Signatures

        119   

 

1


Table of Contents

Forward-Looking Statements

Statements in this Annual Report about our anticipated financial condition, results of operations, and growth, as well as about the future development of our products and markets and the future performance of the financial markets in general, are forward-looking statements. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. They may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “should,” “can have,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events and circumstances. These forward-looking statements are based on assumptions that we have made in light of our industry experience and on our perceptions of historical trends, current conditions, expected future developments and other factors. As you read this Annual Report, you should understand that these statements are not guarantees of performance or results. They involve risks and uncertainties that are beyond our control. Important information about the bases for our assumptions and factors that may cause our actual results and other circumstances to differ materially from those described in the forward-looking statements are discussed in Item 1A. “Risk Factors” and generally throughout this Annual Report.

 

Item 1. Business

Corporate History and Information

NewStar Financial, Inc. (which is referred to throughout this Annual Report as “NewStar”, “the Company”, “we” and “us”) was founded in June 2004 by a team of experienced commercial bankers and debt capital markets executives. On December 14, 2006, our common stock began trading on the NASDAQ Global Market, and on December 19, 2006 we completed the initial public offering of our common stock.

We are a Delaware corporation. Our principal executive office is located at 500 Boylston Street, Suite 1250, Boston, Massachusetts 02116, and our telephone number is (617) 848-2500. We maintain a website at www.newstarfin.com.

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 focus primarily on the direct origination of loans and equipment leases through teams of credit-trained bankers and marketing officers organized around key industry and market segments. Our marketing and direct origination efforts target private equity sponsors, mid-sized companies, corporate executives, regional banks, real estate investors and a variety of other referral sources and financial intermediaries to source new customer relationships and lending opportunities. Our emphasis on direct origination is an important aspect of our marketing and credit strategy because it provides us with direct access to our customers’ management teams and enhances our ability to conduct detailed due diligence and credit analysis of prospective borrowers. It also allows us to negotiate transaction terms directly with borrowers and, as a result, we have significant input into our customers’ financial strategies and capital structures. We also participate in loans as a member of a lending group. The mix of our originations may vary from period to period. We employ highly experienced bankers, marketing officers and credit professionals to identify and structure new lending opportunities and manage customer relationships. We believe that the quality of our professionals, the breadth of their relationships and referral networks, and their ability to develop creative solutions for customers position us to be a valued partner and preferred lender for mid-sized companies.

We operate on a national basis and specialize in providing a range of senior secured debt financing options to mid-sized companies to fund working capital, growth strategies, acquisitions and recapitalizations, as well as, equipment purchases. Our loans and other debt products typically range in size from $5 million to $20 million. We also selectively arrange larger transactions, which we may hold on our balance sheet or syndicate to other lenders. By syndicating loans to other lenders, we are able to provide larger financing commitments to our

 

2


Table of Contents

customers and generate fee income, while limiting our risk exposure to a single borrower. From time to time, however, our balance sheet exposure to certain loans and other debt products may exceed $20 million.

We operate as a single segment, and we derive revenues from four specialized lending groups that target market segments in which we believe that we have a competitive advantage:

 

   

Leveraged Finance, provides senior, secured cash flow loans and, to a lesser extent, second lien loans, which are primarily used to finance acquisitions of mid-sized companies with annual cash flow (EBITDA) typically between $5 million and $30 million by private equity investment funds managed by established professional alternative asset managers;

 

   

Business Credit, provides senior, secured asset-based loans primarily to fund working capital needs of mid-sized companies with sales typically totaling between $25 million and $500 million;

 

   

Real Estate, manages a portfolio of first mortgage debt which was sourced primarily to finance acquisitions of commercial real estate properties typically valued between $10 million and $50 million by professional commercial real estate investors; and

 

   

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

Information regarding revenues, profits and losses and total assets of this single segment can be found in the financial statements in Item 8.

As of December 31, 2013, our portfolio of loans, leases and other debt products, which we refer to as our loan portfolio, totaled approximately $2.7 billion of funding commitments, representing $2.4 billion of balances outstanding and $0.3 billion of funds committed but undrawn. We finance our loan portfolio through a combination of debt and equity.

As of December 31, 2013, 84.8% of our loan portfolio was comprised of loans originated by our Leveraged Finance group and 10.0% of our loan portfolio was originated by our Business Credit and Equipment Finance lending groups, with the remaining 5.2% originated by our Real Estate lending group. At December 31, 2013, 96.9% of our portfolio was first lien, senior debt.

On April 8, 2013, we announced that we had formed a new managed credit fund, NewStar Arlington Fund LLC (“Arlington Fund”) in partnership with an institutional investor to co-invest in middle market commercial loans originated by our Leveraged Finance group. As the managing member of Arlington Fund, we retain full discretion over Arlington Fund’s investment decisions, subject to usual and customary limitations, and earn management fees as compensation for our services. As of December 31, 2013 the Arlington Fund loan portfolios had total funding commitments and balances outstanding of approximately $177.4 million and $172.6 million, respectively. Consolidation of the financial results of Arlington Fund with our results of operations and statements of financial position began in April 2013.

On April 4, 2013, Arlington Fund entered into an agreement establishing $147.0 million of Class A variable funding notes (the “Class A Notes”) and $28.0 million of Class B variable funding notes (the “Class B Notes”) to partially fund eligible middle market loan origination for Arlington Fund. Wells Fargo Bank, National Association has committed to fund the Class A Notes as the initial Class A lender and we have committed to fund the Class B Notes as the initial Class B lender.

Although we consolidate all of the assets and liabilities of Arlington Fund, our maximum exposure to loss is limited to our investments in membership interests in Arlington Fund, our Class B Note receivable, as well as the management fee receivable from Arlington Fund. These items define our economic relationship with Arlington Fund but are eliminated upon consolidation. We manage the assets of Arlington Fund solely for the benefit of our lenders and investors. If we were to liquidate, the assets of Arlington Fund would not be available to our general

 

3


Table of Contents

creditors, and as a result, we do not consider Arlington Fund’s assets to be part of the Company. Conversely, the investors in the debt of Arlington Fund have no recourse to our general assets. Therefore, we do not consider this debt our obligation.

As of December 31, 2013, we had purchased membership interests totaling $5.0 million in Arlington Fund and a third-party investor had purchased membership interests totaling $30.0 million. As a result of consolidating Arlington Fund as a variable interest entity, or VIE, the membership interests representing equity ownership of Arlington Fund are characterized as debt in our consolidated statement of financial position. We apply an imputed interest rate to that debt and record the resulting interest expense in its consolidated statement of operations. The actual return on investments in Arlington Fund’s membership interests may or may not equal the imputed rate applied to the membership interests that are characterized as debt. In the consolidation, we eliminate the economic results of its related portion of the membership interests and the applied interest expense from its results of operations and statements of financial position.

We also manage a private debt fund, the NewStar Credit Opportunities Fund, Ltd. (the “NCOF”), for third-party institutional investors. Like the Arlington Fund, the NCOF invested in loans and other debt products originated or acquired by us. The NCOF was capitalized with $150.0 million of equity raised from third-party institutional investors and initially had a $400.0 million committed credit facility that was refinanced by a term debt securitization. The facility entered into its scheduled amortization period on December 17, 2012. On December 27, 2013, the NCOF paid off the outstanding notes of its term debt securitization at par. As of December 31, 2013, we had purchased $217.9 million of the $276.5 million of outstanding loans previously owned by the NCOF (the “NCOF portfolio purchase”). As of December 31, 2013, the NCOF’s and NCOF CLO II’s (defined below) loan portfolios had total funding commitments and balances outstanding of approximately $110.6 million and $93.3 million, respectively.

Our managed loan portfolio, which includes our loan portfolio, the Arlington Fund loan portfolio (which is consolidated as a variable interest entity (“VIE”), and the loan portfolio of the NCOF, totaled approximately $2.8 billion of commitments and $2.5 billion of balances outstanding as of December 31, 2013.

Recent Developments

Liquidity

On March 6, 2014, as permitted under our corporate credit facility with Fortress Credit Corp., we requested and received an increase of $28.5 million to the Initial Funding under this credit facility. We borrowed the entire $28.5 million on March 6, 2014.

On December 12, 2013, we entered into an amendment to our credit facility used to fund new equipment lease origination with Wells Fargo Bank, National Association. The amendment extended the provision for optional termination of the revolving period from January 16, 2014 to March 17, 2014, and extends the Turbo Event (as defined in the Note Purchase Agreement) from January 16, 2014 to March 17, 2014.

On December 27, 2013, the NCOF paid off the outstanding notes of its term debt securitization at par. As of December 31, 2013, we had purchased $217.9 million of the $276.5 million of outstanding loans previously owned by the NCOF.

On November 26, 2013, we entered into an amendment to our credit facility with Wells Fargo Bank, National Association to fund leveraged finance loans. The amendment increased the commitment amount under the credit facility from $175.0 million to $275.0 million, increased the amount by which the commitment amount may be increased to up to $325.0 million, and modified certain concentration amounts and specified threshold amounts, among other things.

Stock Repurchase Program

On November 19, 2012, our Board of Directors 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 was determined by the Company’s management based on its

 

4


Table of Contents

evaluation of market conditions and other factors. The repurchase program expired on December 31, 2013. As of December 31, 2013, we had repurchased 17,665 shares of our common stock at a weighted average price per share of $12.22.

Lending Groups

Our lending activities are organized into four specialized lending groups: Leveraged Finance, Business Credit, Real Estate, and Equipment Finance.

Leveraged Finance

Our Leveraged Finance group originates, structures and underwrites senior, secured cash flow loans and, to a lesser extent, second lien loans for companies with annual EBITDA typically between $5 million and $30 million, the proceeds of which are primarily used for acquisition financing, growth and working capital, recapitalizations and other purposes. Our Leveraged Finance group also provides senior secured loans to larger middle market companies with greater financing needs by participating in larger credit facilities with other lenders as a member of a syndicate. During 2013, approximately 30% of our loan origination total was attributable to purchasing a portion of syndicated deals.

We develop new customer relationships and source our loans primarily through the direct marketing and origination efforts of our bankers. Our bankers have established networks of relationships with a wide range of prospective customers and referral sources, including mid-sized companies, private equity firms, corporate executives, regional banks, other non-bank “club” lenders, other finance companies, and investment and commercial banks. To a lesser extent, we may also source loans and other debt products by participating in larger credit facilities syndicated by other lenders.

We target mid-sized companies operating in selected industries and market segments where we believe that we have a competitive advantage and significant lending and underwriting experience, including:

 

   

healthcare;

 

   

manufacturing and industrial;

 

   

financial services;

 

   

energy/chemical services;

 

   

printing/publishing;

 

   

consumer, retail and restaurants; and

 

   

business and technology services.

We currently offer a range of senior debt financing options, including revolving credit facilities, term loans and other debt products secured by a variety of business assets.

Our loans and other debt products, which may be part of larger credit facilities, typically range in size from $5 million to $20 million, although we generally limit the size of the loans that we retain to $17.5 million. In certain cases, however, our loans and debt products may exceed $20 million.

 

5


Table of Contents

We also have the capability to arrange significantly larger transactions which we syndicate to other lenders. As a result of that syndication activity, our balance sheet exposure to certain loans and other debt products may exceed $20 million from time to time as reflected in “Loans held-for-sale” which represent amounts in excess of our target hold for investment position. As of December 31, 2013, on a consolidated basis we had 23 loans which had an outstanding balance greater than $17.5 million. Excluding the consolidation of the Arlington Fund we had 12 loans which had an outstanding balance greater than $17.5 million. In each of these cases, we either added to our position to maximize our potential recovery of the outstanding principal of loans in workout or our hold size increased as a result of the NCOF portfolio purchase. As of December 31, 2013, we had three restructured impaired loans which had an outstanding balance greater than $20 million. As of December 31, 2013 our largest outstanding loan was 1.4% of our loan portfolio, and the top ten outstanding loans comprised 10.0% of our loan portfolio. Our loans and other debt products typically mature in two to six years and require monthly or quarterly interest payments at variable rates based on a spread to LIBOR or the prime rate, many with interest rate floors; however, some of our loans are fixed rate.

In determining our corporate borrowers’ ability and willingness to repay loans, our Leveraged Finance group conducts a substantial due diligence investigation and performs detailed credit analyses that consider many factors, including the borrowers’:

 

   

primary and secondary sources of repayment;

 

   

equity sponsorship and capital structure;

 

   

management strength and experience;

 

   

market position;

 

   

historical and projected profitability and free cash flow available to service debt;

 

   

balance sheet strength and liquidity;

 

   

ability to withstand competitive challenges; and

 

   

relationships with customers and suppliers.

Among other things, loan agreements typically include a number of financial and restrictive covenants that borrowers must comply with through the term of the loan. These covenants generally may include one or more of the following:

 

   

maximum ratio of senior debt and/or total debt to EBITDA;

 

   

minimum level of EBITDA;

 

   

minimum fixed charge coverage;

 

   

minimum interest coverage; and

 

   

limits on capital expenditures and distributions.

As of December 31, 2013, our Leveraged Finance loan portfolio totaled $2.2 billion in funding commitments and $2.0 billion in balances outstanding, representing 84.8% of our loan portfolio. This represented 181 transactions with an average balance outstanding of approximately $11.1 million. During 2013, we originated $1.1 billion of new Leveraged Finance loans (including the NCOF portfolio purchase), of which we retained $966.3 million and originated $25.1 million for the NCOF and $163.4 million for the Arlington Fund.

Business Credit

NewStar Business Credit originates, structures and underwrites senior, secured asset-based loans for companies with sales typically between $25 million and $500 million operating across a range of industry sectors. Our asset-based loans typically range in size from $1 million to $20 million. We also have the ability to

 

6


Table of Contents

arrange significantly larger transactions that we may syndicate to others. Our asset-based loans are typically used to fund working capital needs and are secured by eligible, margined collateral, including accounts receivable, inventories, and, to a lesser extent, other long–term assets.

Our asset-based loans typically provide capital for the following purposes:

 

   

working capital;

 

   

acquisitions;

 

   

dividend recapitalizations;

 

   

refinancings and restructurings;

 

   

corporate growth; and

 

   

management buyouts.

We target mid-sized companies in a variety of asset-intensive industries for our asset-based loans including:

 

   

business services;

 

   

auto/transportation;

 

   

marketing;

 

   

retail;

 

   

general manufacturing;

 

   

wholesale distribution; and

 

   

technology.

Our asset-based credit products include the following:

 

   

revolving lines of credit; and

 

   

senior secured term loans.

In determining our borrowers’ ability and willingness to repay loans, our Business Credit group conducts a detailed due diligence investigation to assess financial reporting accuracy and capabilities as well as to verify the values of business assets among other things. We employ third parties to conduct field exams to audit financial reporting and to appraise the value of certain types of collateral in order to estimate its liquidation value. Financing arrangements with our customers also typically include substantial controls over the application of borrowers’ cash and we typically retain discretion over collateral advance rates and eligibility among other key terms and conditions.

As of December 31, 2013 our Business Credit loan portfolio totaled $337.7 million in funding commitments and $182.6 million in balances outstanding, representing 7.7% of our loan portfolio. This represented 31 transactions with an average balance outstanding of approximately $5.9 million. During 2013, we originated $53.0 million of new asset-based loans.

Real Estate

Our Real Estate group manages an existing portfolio of first mortgage debt which was used primarily to finance the acquisition of commercial real estate properties typically valued between $10 million and $50 million.

Our portfolio of commercial real estate loans and other debt products was sourced primarily through property investors, specialized commercial real estate brokers, regional banks and other financial intermediaries.

 

7


Table of Contents

Our commercial real estate loans typically provide capital for the following purposes:

 

   

acquisitions;

 

   

lease-ups;

 

   

repositioning and build-outs; and

 

   

refinancings and recapitalizations.

We have a selective focus on property types where we have significant lending and underwriting experience, including:

 

   

office;

 

   

multi-family;

 

   

retail; and

 

   

industrial.

Our focus on property types may vary by geographic region based on both economic fundamentals and underlying local market conditions that impact the demand for real estate. Our loans and other debt products typically range in size from $5 million to $20 million. Although we generally limit loan sizes to $17.5 million, our exposure to certain loans and other debt products may exceed $20 million from time to time. Our loans and other debt products typically mature in two to five years and require monthly or quarterly interest payments at variable rates based on a spread to LIBOR or the prime rate; however, some of our loans are fixed rate.

For our commercial real estate loans, we perform due diligence and credit analyses that focus on the following key considerations:

 

   

the sponsor’s history, capital and liquidity, and portfolio of other properties;

 

   

the property’s historical and projected cash flow as a primary source of repayment;

 

   

tenant creditworthiness;

 

   

the borrower’s plan for the subject property, including refinancing options upon stabilization as a secondary source of repayment;

 

   

the property’s condition;

 

   

local real estate market conditions;

 

   

loan-to-value based on independent third-party appraisals;

 

   

the borrower’s demonstrated operating capability and creditworthiness;

 

   

licensing and environmental issues related to the property and the borrower; and

 

   

the borrower’s management.

As of December 31, 2013 our Real Estate loan portfolio totaled $129.7 million in funding commitments and $123.0 million in balances outstanding, representing 5.2% of our total loan portfolio. This represented nine lending relationships with an average balance outstanding of approximately $13.7 million. During 2013, we originated $43.1 million of new commercial real estate loans.

Equipment Finance

Our Equipment Finance group provides a range of lease financing options to mid-sized companies to fund various types of capital expenditures. We originate new equipment finance business through a team of internal marketing officers. We have continued to expand our internal sales and marketing efforts to cross-sell leases to

 

8


Table of Contents

our existing customers and call directly on other end-users in the market, including portfolio companies owned by private equity investment firms with whom we have established relationships through our Leveraged Finance group. We finance essential-use equipment for mid-sized businesses nationwide. Our Equipment Finance group offers a variety of leases and loan products with various end-of-term options to fund a wide range of equipment types, including manufacturing, technology, healthcare, transportation, and telecom equipment. Targeted transaction sizes range from $1.0 million to $10 million. We also offer lease lines to meet customers’ needs for planned capital expenditures. We focus on companies with annual sales of at least $25 million across a broad array of industries, including business services, healthcare, telecommunications, financial services, education, retail and manufacturing.

As of December 31, 2013, our Equipment Finance portfolio totaled $54.4 million in funding commitments and balances outstanding, representing 2.3% of our loan portfolio. This represented 48 transactions with an average balance outstanding of approximately $1.1 million. During 2013, we originated $45.4 million of new equipment finance products.

Loans and Other Debt Products

First mortgage

Our first mortgage loans are provided by our Real Estate group and are secured by a mortgage bearing a first lien on the real property serving as collateral. Our first mortgage loans require borrowers to demonstrate satisfactory collateral value at closing through a third party property appraisal and typically contain provisions governing the use of property operating cash flow and disbursement of loan proceeds during the term of the loan.

As of December 31, 2013, first mortgage loans totaled $129.7 million in funding commitments and $123.0 million in balances outstanding, representing 5.2% of our loan portfolio.

Senior secured asset-based

Our senior secured asset-based loans are provided primarily by our Business Credit group, and to a lesser degree by our Leveraged Finance group, and are secured by a first-priority lien on tangible assets and have a first-priority in right of payment. Senior secured asset-based loans are typically advanced under revolving credit facilities against a borrowing base comprised of collateral, including eligible accounts receivable, inventories and other long-term assets.

As of December 31, 2013, senior secured asset-based loans totaled $394.4 million in funding commitments and $239.3 million in balances outstanding, representing 10.1% of our loan portfolio.

Senior secured cash flow

Our senior secured cash flow loans are provided by our Leveraged Finance group. We underwrite these loans based on the cash flow, profitability and enterprise value of the borrower, with the value of any tangible assets as secondary protection. These loans are generally secured by a first-priority security interest in all or substantially all of the borrowers’ assets and, in certain transactions, the pledge of their common stock.

As of December 31, 2013, senior secured cash flow loans totaled $2.1 billion in funding commitments and $1.9 billion in balances outstanding, representing 82.4% of our loan portfolio.

Other

Our Other loans and debt products are categorized as $23.0 million of senior subordinated asset-based (which are equal as to collateral and subordinate as to right of payment to other senior lenders), $1.8 million of senior subordinated cash flow (which are equal as to collateral and subordinate in right of payment of principal and interest to other senior lenders), $23.3 million of second lien (which are second liens on all or substantially all of a borrower’s assets, and in some cases, junior in right of payment to senior lenders), and $6.0 million of mezzanine/subordinated (which are subordinated as to rights to collateral and right of payment to senior lenders).

 

9


Table of Contents

Loan Portfolio Overview

The following tables present information regarding the outstanding balances of our loans and other debt products:

 

     December 31,  
     2013     2012     2011  
     ($ in thousands)  

Composition Type

               

First mortgage

   $ 123,029         5.2   $ 177,462         9.5   $ 252,927         13.4

Senior secured asset-based

     239,314         10.1        201,219         10.7        114,585         6.1   

Senior secured cash flow

     1,948,965         82.4        1,448,182         77.3        1,439,181         76.4   

Other

     54,031         2.3        47,400         2.5        77,635         4.1   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 2,365,339         100.0   $ 1,874,263         100.0   $ 1,884,328         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     December 31,  
     2013      2012      2011  
     ($ in thousands)  

Composition by Lending Group

        

Leveraged Finance

   $ 2,005,325       $ 1,499,833       $ 1,501,175   

Business Credit

     182,633         177,587         108,084   

Real Estate

     123,029         177,478         271,381   

Equipment Finance

     54,352         19,365         3,688   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,365,339       $ 1,874,263       $ 1,884,328   
  

 

 

    

 

 

    

 

 

 

 

     December 31, 2013  
     Percentage of
Leveraged
Finance
    Percentage of
Loan Portfolio
 

Leveraged Finance by Industry

    

Other business services

     18.1     15.3

Industrial/Other

     15.3        13.0   

Manufacturing—consumer non-durable

     11.0        9.3   

Healthcare

     10.4        8.8   

Financial services

     7.6        6.4   

Restaurants

     5.3        4.5   

Auto/Transportation

     4.5        3.9   

Consumer services

     4.2        3.5   

Tech services

     3.7        3.2   

Environmental services

     3.3        2.8   

Manufacturing—consumer durable

     3.3        2.8   

Cable/Telecom

     3.2        2.7   

Printing/Publishing

     3.2        2.7   

Energy/Chemical Services

     2.0        1.7   

Building materials

     1.4        1.2   

Retail

     1.2        1.0   

Broadcasting

     0.9        0.8   

Marketing services

     0.9        0.7   

Entertainment/Leisure

     0.5        0.5   

Consumer—non-mortgage

     0.0        0.0   
  

 

 

   

 

 

 

Total

     100.0     84.8
  

 

 

   

 

 

 

 

10


Table of Contents
     December 31, 2013  
     Percentage of
Business Credit
    Percentage of
Loan Portfolio
 

Business Credit and Leasing by Industry

    

Other Business Services

     37.3     3.7

Manufacturing—consumer non-durable

     18.9        1.9   

Industrial/Other

     12.8        1.3   

Building materials

     8.5        0.9   

Auto/Transportation

     7.9        0.8   

Retail

     2.9        0.3   

Energy/Chemical Services

     2.4        0.2   

Manufacturing—consumer durable

     2.4        0.2   

Healthcare

     2.3        0.2   

Entertainment/Leisure

     1.5        0.2   

Marketing services

     1.0        0.1   

Environmental Services

     1.0        0.1   

Cable/Telecom

     0.4        0.1   

Restaurants

     0.3        0.0   

Financial services

     0.2        0.0   

Tech Services

     0.1        0.0   

Consumer services

     0.1        0.0   
  

 

 

   

 

 

 

Total

     100.0     10.0
  

 

 

   

 

 

 

 

     December 31, 2013  
     Percentage of
Real Estate
    Percentage of
Loan Portfolio
 

Real Estate by Property Type

    

Office

     58.1     3.0

Retail

     25.0        1.3   

Multi-family

     16.9        0.9   
  

 

 

   

 

 

 

Total

     100.0     5.2
  

 

 

   

 

 

 

The table below shows the final maturities of our loan portfolio as of December 31, 2013:

 

     Due in One
Year or Less
     Due in One to
Five Years
     Due After
Five Years
     Total  
     ($ in thousands)  

First mortgage

   $ 56,069       $ 66,960       $ ––      $ 123,029   

Senior secured asset-based

     31,849         204,545         2,920         239,314   

Senior secured cash flow

     93,648         1,431,492         423,825         1,948,965   

Other

     ––         22,205         31,826         54,031   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 181,566       $ 1,725,202       $ 458,571       $ 2,365,339   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

11


Table of Contents

The table below shows the outstanding balances of fixed-rate and adjustable-rate loans and other debt products as of December 31, 2013:

 

     Fixed-
Rate(1)
     Adjustable-
Rate(2)(3)
     Total  
     ($ in thousands)  

First mortgage

   $       $ 123,029       $ 123,029   

Senior secured asset-based

     54,283         185,031         239,314   

Senior secured cash flow

     51,631         1,897,334         1,948,965   

Other

     8,826         45,205         54,031   
  

 

 

    

 

 

    

 

 

 

Total

   $ 114,740       $ 2,250,599       $ 2,365,339   
  

 

 

    

 

 

    

 

 

 

 

(1) As of December 31, 2013, we did not have any interest-rate protection products against the $114.7 million of fixed-rate loans and other debt products outstanding.
(2) As of December 31, 2013, we had interest rate floors on $1.9 billion of adjustable-rate loans outstanding.
(3) As of December 31, 2013, adjustable-rate loans include $70.7 million of non-accrual loans.

Competition

Our markets are highly competitive and are characterized by competitive factors that vary based upon product and geographic region. We currently compete with a large number of financial services companies, including:

 

   

specialty and commercial finance companies, including business development companies;

 

   

private investment funds and hedge funds;

 

   

national and regional banks;

 

   

investment banks; and

 

   

insurance companies.

The markets in which we operate are fragmented. We compete based on the following factors, which vary by industry, asset class and property types:

 

   

the interest rates and other pricing and/or loan or other debt product terms;

 

   

the quality of our people and their relationships;

 

   

our knowledge of our customers’ industries and business needs;

 

   

the flexibility of our product offering;

 

   

the responsiveness of our process; and

 

   

our focus on customer service.

Regulation

Some aspects of our operations are subject to supervision and regulation by state and federal governmental authorities and may be subject to various laws and regulations imposing various requirements and restrictions, which, among other things:

 

   

regulate credit granting activities, including establishing licensing requirements in some jurisdictions;

 

   

establish the maximum interest rates, finance charges and other fees we may charge our customers;

 

   

govern secured transactions;

 

   

require specified information disclosures to our customers;

 

12


Table of Contents
   

set collection, foreclosure, repossession and claims handling customer procedures and other trade practices;

 

   

regulate our customers’ insurance coverage;

 

   

prohibit discrimination in the extension of credit and administration of our loans; and

 

   

regulate the use and reporting of information related to a customer’s credit experience.

Many of our competitors are subject to more extensive supervision and regulation. If we were to become subject to similar supervision or regulation in the future, it could impact our ability to conduct our business.

During 2012, we registered as an investment adviser under the Investment Adviser Act of 1940 (the “Advisers Act”) as a result of SEC rules promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Advisers Act imposes numerous obligations on such registered investment advisers including fiduciary duties, disclosure obligations and record-keeping, operational and marketing requirements. Registered investment advisors are required by the SEC to adopt and implement written policies and procedures designed to prevent violations of the Advisers Act and to designate a chief compliance officer responsible for administering these policies and procedures. The SEC is authorized to institute proceedings and impose sanctions for violations for the Advisers Act, which may include fines, censure or the suspension or termination of an investment adviser’s registration.

Employees

As of December 31, 2013, we employed 101 people compared to 104 people at December 31, 2012. At December 31, 2013, our origination group had 32 employees, including 24 bankers who were either managing directors, directors or vice presidents, and eight associates and analysts. Our credit organization had 28 employees, including 11 managing directors. Additionally, we employed 35 people who were involved in operational or administrative roles. We believe our relations with our employees are good. We had 99 employees as of March 13, 2014.

Available Information

NewStar files Annual, Quarterly and Current Reports, proxy statements and other information with the Securities and Exchange Commission (SEC). These documents are available free of charge at www.newstarfin.com shortly after such material is electronically filed with or furnished to the SEC. In addition, NewStar’s codes of business conduct and ethics as well as the various charters governing the actions of certain of NewStar’s Committees of its Board of Directors, including its Audit Committee, Risk Policy Committee, Compensation Committee and its Nominating and Corporate Governance Committee, are available at www.newstarfin.com. References to our website are not intended to incorporate information on our website into this Annual Report by reference.

The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, including NewStar, that file electronically with the SEC, which is available at www.SEC.gov.

We will provide to any shareholder, upon request and without charge, copies of these documents (excluding any applicable exhibits unless specifically requested). Written requests should be directed to: Investor Relations, NewStar Financial, Inc., 500 Boylston St., Suite 1250, Boston, Massachusetts 02116.

 

13


Table of Contents
Item 1A. Risk Factors

The following are important risks and uncertainties we have identified that could materially affect our future results. You should consider them carefully when evaluating forward-looking statements contained in this Annual Report and otherwise made by us or on our behalf because these contingencies could cause actual results and circumstances to differ materially from those projected in forward-looking statements. The Company’s actual future results and trends may differ materially depending on a variety of factors including, but not limited to, the risks and uncertainties discussed below. If any of those contingencies actually occurs, our business, financial condition and results of operations could be negatively impacted and the trading price of our common stock could decline.

Risks Related to Our Loan Portfolio and Lending Activities

We may not recover all amounts contractually owed to us by our borrowers resulting in charge-offs, impairments and non-accruals, which may exceed our allowance for credit losses and could negatively impact our financial results and our ability to secure additional funding.

We charged off $17.9 million of loans during 2013, and expect to have additional credit losses in the future through the normal course of our lending operations. If we were to experience a material increase in credit losses exceeding our allowance for loan losses in the future, our assets, net income and operating results would be adversely impacted, which could also lead to challenges in securing additional financing.

As of December 31, 2013, we had delinquent loans of $5.1 million and had loans with an aggregate outstanding balance of $271.0 million classified as impaired. Of these impaired loans, loans with an aggregate outstanding balance of $70.7 million at December 31, 2013 were also on non-accrual status.

Like other commercial lenders, we experience delinquencies, impairments and non-accruals, which may indicate that our risk of credit loss for a particular loan has materially increased. When a loan is over 90 days past due or if management believes it is probable that we will be unable to collect principal and interest contractually owed to us, it is our policy to place the loan on non-accrual status and classify it as impaired. In certain circumstances, a loan can be classified as impaired, but continue to be performing as a result of a troubled debt restructuring.

As of December 31, 2013, we had an allowance for credit losses of $41.9 million, including specific reserves of $23.3 million. Management periodically reviews the appropriateness of our allowance for credit losses. However, the relatively limited history of our loans and leases makes it difficult to judge the expected credit performance of our loans and leases, as it may not be predictive of future losses. Our estimates and judgments with respect to the appropriateness of our allowance for credit losses may not be accurate, and the assumptions we use to make such estimates and judgments may not be accurate. Our allowance may not be adequate to cover credit or other losses related to our loans and leases as a result of unanticipated adverse changes in the economy or events adversely affecting specific customers, industries or markets. If we were to experience material credit losses related to our loans, such losses could adversely impact our ability to fund future loans and our business and, to the extent losses exceed our allowance for credit losses, our results of operations and financial condition would be adversely affected.

We may have hold positions that exceed our targets which may result in more volatility in the performance of our loan portfolio.

Our loans and other debt products, which may be part of larger credit facilities, typically range in size from $5 million to $20 million, although we generally limit the size of the loans that we retain to $17.5 million. In certain cases, however, our loans and debt products may exceed $20 million. As of December 31, 2013, on a consolidated basis, we had 23 loans that had an outstanding balance greater than $17.5 million. Excluding the consolidation of the Arlington Fund we had 12 loans that had an outstanding balance greater than $17.5 million.

 

14


Table of Contents

In each of these cases, we either added to our position to maximize our potential recovery of the outstanding principal of loans in workout or our hold size increased as a result of the NCOF portfolio purchase. As of December 31, 2013, we had three restructured impaired loans which had an outstanding balance greater than $20 million. If a borrower in one of these larger hold positions were to experience difficulty in adhering to the repayment terms of its loan with us, the negative impact to our results of operations and financial condition could be greater than a loan within our general size limits.

Disruptions in global financial markets have and may continue to increase the number of charge-offs, impairments and non-accruals in our loan portfolio, which may exceed our allowance for credit losses and could negatively impact our financial results.

Our business, financial condition and results of operations may be adversely affected by the economic and business conditions in the markets in which we operate. Delinquencies, non-accruals and credit losses generally increase during economic slowdowns or recessions. Our Leveraged Finance, Business Credit and Equipment Finance groups primarily consist of loans and leases to small and medium-sized businesses that may be particularly susceptible to economic slowdowns or recessions and may be unable to make scheduled payments of interest or principal on their borrowings during these periods. In our Real Estate group, the recent economic slowdown and recession has led to increases in payment defaults on the underlying commercial real estate. Therefore, to the extent that economic and business conditions are unfavorable as they were during recent periods, our non-performing assets are likely to remain elevated and the value of our loan portfolio is likely to decrease. Adverse economic conditions also may decrease the estimated value of the collateral, particularly real estate, securing some of our loans or other debt products. As a result, we may have certain commercial real estate loans that we have not classified as impaired with outstanding balances greater than the estimated value of the underlying collateral. Further or prolonged economic slowdowns or recessions could lead to financial losses in our loan portfolio and a decrease in our net interest income, net income and book value.

We make loans primarily to privately-owned, small and medium-sized companies that may carry more inherent risk and present an increased potential for loss than loans to larger companies.

Our loan portfolio consists primarily of loans to small and medium-sized, privately-owned companies, most of which do not publicly report their financial condition. Compared to larger, publicly-traded firms, loans to these types of companies may carry more inherent risk. The companies that we lend to generally have more limited access to capital and higher funding costs, may be in a weaker financial position, may need more capital to expand or compete, and may be unable to obtain financing from public capital markets or from traditional sources, such as commercial banks. Accordingly, loans and leases made to these types of customers involve higher risks than loans and leases made to companies that have larger businesses, greater financial resources or are otherwise able to access traditional credit sources. Numerous factors may make these types of companies more vulnerable to variations in results of operations, changes impacting their industry and changes in general market conditions. Companies in this market segment also face intense competition, including from companies with greater financial, technical, managerial and marketing resources. Any of these factors could impair a customer’s cash flow or result in other adverse events, such as bankruptcy, which could limit a customer’s ability to make scheduled payments on our loans and leases, and may lead to losses in our loan portfolio and a decrease in our net interest income, net income and book value.

Additionally, because most of our customers do not publicly report their financial condition, we are more susceptible to a customer’s fraud, which could cause us to suffer losses on our loan portfolio. The failure of a customer to accurately report its financial position, compliance with loan covenants or eligibility for additional borrowings could result in our providing loans, leases or other debt products that do not meet our underwriting criteria, defaults in loan and lease payments, the loss of some or all of the principal of a particular loan or loans, including, in the case of revolving loans, amounts we may not have advanced had we possessed complete and accurate information.

 

15


Table of Contents

Our concentration of loans and other debt products within a particular industry or region could impair our financial condition or results of operations if that industry or region were to experience adverse changes to economic or business conditions.

We specialize in certain broad industry segments, such as business services, industrial, manufacturing and healthcare in which our bankers have experience and strong networks of proprietary deal sources and our credit personnel have significant underwriting expertise. As a result, our portfolio currently has and may develop other concentrations of risk exposure related to those industry segments. If industry segments in which we have a concentration of investments experience adverse economic or business conditions, our delinquencies, default rate and loan charge-offs in those segments may increase, which may negatively impact our financial condition and results of operations.

Our balloon and bullet transactions may involve a greater degree of risk than other types of loans.

As of December 31, 2013, balloon and bullet transactions represented 95% of the outstanding balance of our loan portfolio. Balloon and bullet loans involve a greater degree of risk than other types of transactions because they are structured to allow for either small (balloon) or no (bullet) principal payments over the term of the loan, requiring the borrower to make a large final payment upon the maturity of the loan. The ability of our customers to make this final payment upon the maturity of the loan typically depends upon their ability either to refinance the loan prior to maturity or to generate sufficient cash flow to repay the loan at maturity. The ability of a customer to accomplish any of these goals will be affected by many factors, including the availability of financing at acceptable rates to the customer, the financial condition of the customer, the marketability of the related collateral, the operating history of the related business, tax laws and the prevailing general economic conditions. Consequently, the customer may not have the ability to repay the loan at maturity, and we could lose all or most of the principal of our loan. Given their relative size and limited resources and access to capital, our small and mid-sized customers may have difficulty in repaying or financing their balloon and bullet loans on a timely basis or at all.

Our cash flow transactions are not fully covered by the value of tangible assets or collateral of the customer and, consequently, if any of these transactions become non-performing, we could suffer a loss of some or all of our value in the assets.

Cash flow lending involves lending money to a customer based primarily on the expected cash flow, profitability and enterprise value of a customer, with the value of any tangible assets as secondary protection. In some cases, these loans may have more leverage than traditional bank debt. As of December 31, 2013, cash flow transactions comprised $1.9 billion, or 82%, of the outstanding balance of our loan portfolio. In the case of our senior cash flow loans, we generally take a lien on substantially all of a customer’s assets, but the value of those assets is typically substantially less than the amount of money we advance to the customer under a cash flow transaction. In addition, some of our cash flow loans may be viewed as stretch loans, meaning they may be at leverage multiples that exceed traditional accepted bank lending standards for senior cash flow loans. Thus, if a cash flow transaction becomes non-performing, our primary recourse to recover some or all of the principal of our loan or other debt product would be to force the sale of all or part of the company as a going concern. Additionally, we may obtain equity ownership in a borrower as a means to recover some or all of the principal of our loan. The risks inherent in cash flow lending include, among other things:

 

   

reduced use of or demand for the customer’s products or services and, thus, reduced cash flow of the customer to service the loan and other debt product as well as reduced value of the customer as a going concern;

 

   

inability of the customer to manage working capital, which could result in lower cash flow;

 

   

inaccurate or fraudulent reporting of our customer’s positions or financial statements;

 

   

economic downturns, political events, regulatory changes, litigation or acts of terrorism that affect the customer’s business, financial condition and prospects; and

 

   

our customer’s poor management of their business.

 

16


Table of Contents

Additionally, many of our customers use the proceeds of our cash flow transactions to make acquisitions. Poorly executed or poorly conceived acquisitions can tax management, systems and the operations of the existing business, causing a decline in both the customer’s cash flow and the value of its business as a going concern. In addition, many acquisitions involve new management teams taking over control of a business. These new management teams may fail to execute at the same level as the former management team, which could reduce the cash flow of the customer available to service the loan or other debt product, as well as reduce the value of the customer as a going concern.

If interest rates rise, demand for our loans or other debt products may decrease and some of our existing customers may be unable to service interest on their loans or other debt products.

Most of our loans and other debt products bear interest at floating interest rates subject to floors. To the extent interest rates increase, monthly interest obligations owed by our customers to us will also increase. Demand for our loans or other debt products may decrease as interest rates rise or if interest rates are expected to rise in the future. In addition, if prevailing interest rates increase, some of our customers may not be able to make the increased interest payments or refinance their balloon and bullet transaction, resulting in payment defaults and loan impairments. Conversely if interest rates decline, our customers may refinance the loans they have with us at lower interest rates, or with others, leading to lower revenues.

Errors by, or dishonesty of, our employees in making credit decisions or in our loan and other debt product servicing activities could result in credit losses and harm our reputation.

We rely heavily on the performance and integrity of our employees in making our initial credit decisions with respect to our loans and other debt products and in servicing our loans and other debt products after they have closed. Because there is generally little or no publicly available information about our customers, we cannot independently confirm or verify the information our employees provide us for use in making our credit and funding decisions. Errors by our employees in assembling, analyzing or recording information concerning our customers could cause us to originate loans or fund subsequent advances that we would not otherwise originate or fund, which could result in loan losses. Losses could also arise if any of our employees were dishonest, particularly if they colluded with a customer to misrepresent the creditworthiness of a prospective customer or to provide inaccurate reports regarding the customer’s compliance with the covenants in its loan or other debt products agreement. If, based on an employee’s dishonesty, we made a loan or other debt product to a customer that was not creditworthy or failed to exercise our rights under a loan or other debt product agreement against a customer that was not in compliance with covenants in the agreement, we could lose some or all of the principal of the loan or other debt product. Fraud or dishonesty on the part of our employees could also damage our reputation which could harm our competitive position and adversely affect our business.

We are not the sole lender or agent for most of our leveraged finance loans or other debt products. Consequently, we do not have absolute control over how these loans or other debt products are administered or have control over those loans. When we are not the sole lender or agent, we may be required to seek approvals from other lenders before we take actions to enforce our rights.

A majority of our leveraged finance loan portfolio consists of loans and other debt products in which we are neither the sole lender, the agent for the lending group that receives payments under the loan or other debt product nor the agent that controls the underlying collateral. For these loans and other debt products, we may not have direct access to the customer and, as a result, may not receive the same financial or operational information as we receive for loans or other debt products for which we are the agent. This may make it more difficult for us to track or rate these loans or other debt products. Additionally, we may be prohibited or otherwise restricted from taking actions to enforce the loan or other debt product or to foreclose upon the collateral securing the loan or other debt product without the agreement of other lenders holding a specified minimum aggregate percentage, generally a majority or two-thirds of the outstanding principal balance. It is possible that an agent for one of these loans or other debt products may choose not to take the same actions to enforce the loan or other debt product or to foreclose upon the collateral securing the loan that we would have taken had we been the agent for the loan or other debt product.

 

17


Table of Contents

Our commitments to lend additional sums to customers may exceed our resources available to fund these commitments, adversely affecting our financial condition and results of operations.

Our contractual commitments to lend additional sums to our customers may exceed our resources available to fund these commitments. Some of our funding sources are only available to fund a portion of a loan and other funding sources may not be immediately available. Our customers’ ability to borrow these funds may be restricted until they are able to demonstrate, among other things, that they have sufficient collateral to secure the requested additional borrowings or that the borrowing conforms to specific uses or meets certain conditions. We may have miscalculated the likelihood that our customers will request additional borrowings in excess of our readily available funds. If our calculations prove incorrect, we will not have the funds to make these loan advances without obtaining additional financing. Our failure to satisfy our full contractual funding commitment to one or more of our customers could create breach of contract or other liabilities for us and damage our reputation in the marketplace, which could then adversely affect our financial condition and results of operations.

Because there is no active trading market for most of the loans and other debt products in our loan portfolio, we might not be able to sell them at a favorable price or at all. The lack of active secondary markets for some of our investments may also create uncertainty as to the value of these investments.

We may seek to dispose of one or more of our loans and other debt products to obtain liquidity or to reduce or limit potential losses with respect to non-performing assets. There is no established trading market for most of our loans and other debt products. In addition, the fair value of other debt products that have lower levels of liquidity or are not publicly-traded may not be readily determinable and may fluctuate significantly on a monthly, quarterly and annual basis. Because these valuations are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of the fair value of our other debt products may differ materially from the values that we ultimately attain for these debt products or would be able to attain if we have to sell our other debt products. The value of our common stock could be adversely affected if our determinations regarding the fair value of these investments are materially higher than the values that we ultimately realize upon their disposal. In addition, given the limited trading market for our loans and other debt products and the uncertainty as to their fair value at any point in time, if we seek to sell a loan or other debt product to obtain liquidity or reduce or limit losses, we may not be able to do so at a favorable price or at all.

We selectively underwrite transactions that we may be unable to syndicate.

On a selective basis, we commit to underwrite transactions that are significantly larger than our internal hold targets and we then seek to syndicate amounts in excess of our target to other lenders. If we are unable to syndicate these commitments, we may have to sell the additional exposure on unfavorable terms, which could adversely affect our financial condition or results of operations. In addition, if we must hold a larger portion of a transaction than we would like, we may not be able to complete other transactions and our loan portfolio may become more concentrated, which could affect our business, financial condition and results of operations.

We provide second lien, subordinated / mezzanine loans, other debt products and equity-linked products that may rank junior to rights of other lenders, representing a higher risk of loss than our other loans and debt products in which we have a first priority position.

To a lesser extent, and generally in connection with existing workouts, we provide second lien, subordinated / mezzanine loans, other debt products and equity-linked products, which are typically junior in right of payment to obligations to customers’ senior secured lenders and contain either junior or no collateral rights. As a result of their junior nature, we may be limited in our ability to enforce our rights to collect principal and interest on these loans and other debt products or to recover any of their outstanding balance through a foreclosure of collateral. For example, typically we are not contractually entitled to receive payments of principal on a junior loan or other debt product until the senior loan or other debt product is paid in full, and we may only receive interest payments on a second lien or subordinated / mezzanine asset if the customer is not in default under its senior secured loan.

 

18


Table of Contents

In many instances, we are also prohibited from foreclosing on collateral securing a second lien, subordinated / mezzanine loan or other debt product until the senior loan is paid in full. Moreover, any amounts that we might realize as a result of our collection efforts or in connection with a bankruptcy or insolvency proceeding involving a customer under a second lien, subordinated / mezzanine loan or other debt product must generally be turned over to the senior secured lender until the senior secured lender has realized the full value of its own claims. These restrictions may materially and adversely affect our ability to recover the principal of any non-performing senior subordinate, second lien, subordinated / mezzanine loans and other debt product. In addition, on occasion we provide senior loans or other debt products that are contractually subordinated to one or more senior secured loans for the customer. In those cases we may have a first lien security interest, but one or more creditors have payment priority over us. As of December 31, 2013, our second lien and, subordinated/mezzanine loans totaled $54.0 million.

Risks Related to Our Funding and Leverage

Our ability to grow our business depends on our ability to obtain external financing. If our lenders terminate any of our credit facilities or if we default on our credit facilities, we may not be able to continue to fund our business.

We require a substantial amount of cash to provide new loans and other debt products and to fund our obligations to existing customers. In the past, we have obtained the cash required for our operations through the issuance of equity interests and by borrowing money through credit facilities, term debt securitizations and repurchase agreements. We may not be able to continue to access these or other sources of funds.

During 2013, we completed a $400 million term debt securitization, increased the size of a leveraged finance credit facility from $175 million to $275 million, increased the size of another leveraged finance credit facility from $150 million to $175 million, and increased the size of the term loan under our corporate credit facility from $100 million to $200 million. Additionally, we called a term debt securitization and redeemed the notes at par.

Substantially all of our non-securitized loans and other debt products are held in these facilities. Our credit facilities contain customary representations and warranties, covenants, conditions, events of default and termination events that if breached, not satisfied or triggered, could result in termination of the facility. These events of default and termination events 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. Further, all cash flow generated by our loans and other debt products subject to a particular facility would go to pay down our borrowings thereunder rather than to us if we are in default. Additionally, if the facility were terminated due to our breach, noncompliance or default, our lenders could liquidate or sell all or a portion of our loans and other debt products held in that facility. Also, if we trigger a default or there is a termination event under one facility and that default or termination results in a payment default or in the acceleration of that facility’s debt, it may trigger a default or termination event under our other facilities that have cross-acceleration or payment cross-default provisions. Consequently, if one or more of these facilities were to terminate prior to its expected maturity date, our liquidity position would be materially adversely affected, and we may not be able to satisfy our undrawn commitment balances, originate new loans or other debt products or continue to fund our operations. Even if we are able to refinance our debt, we may not be able to do so on favorable terms. If we are not able to obtain additional funding on favorable terms or at all, our ability to grow our business will be impaired.

Our deferred financing fees amortize over the contractual life of credit facilities and over the weighted average expected life of our term debt securitizations.

We have recorded deferred financing fees associated with most of our financing facilities. These deferred financing fees amortize over the contractual life of our credit facilities and over the weighted average expected life of our term debt securitizations. If a credit facility were to terminate before its contractual maturity date or if

 

19


Table of Contents

a term debt securitization were to terminate before its weighted average expected life, we would be required to accelerate amortization of the remaining balance of the deferred financing fees which could have a negative impact our results of operations and financial condition. For example, in 2011 we called our 2009-1 CLO Trust and redeemed the notes, which resulted in the accelerated amortization of deferred financing fees under this term debt securitization.

Our lenders and noteholders could terminate us as servicer of our loans, which would adversely affect our ability to manage our loan portfolio and reduce our net interest income.

Upon the occurrence of specified servicer termination events, our lenders under our credit facilities and the holders of the notes issued in our term debt securitizations may elect to terminate us as servicer of the loans and other debt products under the applicable facility and appoint a successor servicer. These servicer termination events include, but are not limited to, maintenance of certain financial covenants and the loss of certain key members of our senior management, including our Chief Executive Officer and Chief Investment Officer. We do not maintain key man life insurance on any of our senior management nor have we taken any other precautions to offset the financial loss we could incur as a result of any of their departures, however, we do have employment contracts with our senior management. Certain of our credit facilities include cure rights which would enable us to correct the event of default and maintain our status as servicer.

If we are terminated as servicer, we will no longer receive our servicing fee, but we will continue to receive the excess interest rate spread as long as the term debt securitization does not need to trap the excess spread as a result of defaulted loan collateral. In addition, because any successor servicer may not be able to service our loan portfolio according to our standards, any transfer of servicing to a successor servicer could result in reduced or delayed collections, delays in processing payments and information regarding the loans and other debt products and a failure to meet all of the servicing procedures required by the applicable servicing agreement. Consequently, the performance of our loans and other debt products could be adversely affected and our income generated from those loans and other debt products significantly reduced.

Our liquidity position could be adversely affected if we were unable to complete additional term debt securitizations in the future, or if the reinvestment periods in our term debt securitizations terminate early, which could create a material adverse affect on our financial condition and results of operations.

We have completed six term debt securitizations to fund our loans and other debt products, all of which we accounted for on our balance sheet, through which we issued $2.2 billion of rated notes. Our term debt securitizations consist of asset securitization transactions in which we transfer loans and other debt products to a trust that aggregates our loans and, in turn, sells notes, collateralized by the trust’s assets, to institutional investors. The notes issued by the trusts have been rated by nationally recognized statistical rating organizations. At December 31, 2013, the ratings range from AAA to CCC- by Standard & Poor’s, Inc. and Fitch Ratings, Inc. and Aaa to Ba2 by Moody’s Investors Service, Inc., depending on the class of notes.

We intend to complete additional term debt securitizations in the future. Several factors will affect demand for, and our ability to complete additional term debt securitizations, including:

 

   

disruptions in the capital markets generally, and the asset-backed securities market in particular;

 

   

disruptions in the credit quality and performance of our loan portfolio, particularly that portion which has been previously securitized and serves as collateral for existing term debt securitizations;

 

   

regulatory considerations;

 

   

changes in rating agency methodology;

 

   

our ability to service our loan portfolio and that ability continuing to be perceived as adequate to make the issued securities attractive to investors; and

 

20


Table of Contents
   

any material downgrading or withdrawal of ratings given to securities previously issued in our term debt securitizations.

If we are unable to complete additional term debt securitizations, our ability to obtain the capital needed for us to continue to operate and grow our business would be adversely affected. In addition, our credit facilities are only intended to provide short-term financing for our transactions. If we are unable to finance our transactions over the longer term through our term debt securitizations, our credit facilities may not be renewed. Moreover, our credit facilities typically carry a higher interest rate than our term debt securitizations. Accordingly, our inability to complete additional term debt securitizations in the future could have a material adverse effect on our financial conditions and result of operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Conditions.”

If a specified default event occurred in a term debt securitization, the reinvestment period would be terminated. This could have an adverse effect on our ability to fund new assets.

The cash flows we receive from the interests we retain in our term debt securitizations could be delayed or reduced due to the requirements of the term debt securitization.

We have retained 100% of the junior-most interests, which we refer to as the trust certificates, issued in the term debt securitizations, totaling $221.8 million in principal amount, issued in each of our four outstanding term debt securitizations that were outstanding as of December 31, 2013. Also, as of December 31, 2013, we have repurchased $41.2 million of outstanding notes of our term debt securitizations that were outstanding as of December 31, 2013. The notes issued in the term debt securitizations that we did not retain are senior to the trust certificates we did retain. Our receipt of future cash flows on the trust certificates is governed by provisions that control the distribution of cash flows from the loans and other debt products included in our term debt securitizations. On a quarterly basis, interest cash flows from the loans and other debt products must first be used to pay the interest on the senior notes and expenses of the term debt securitization. Any funds remaining after the payment of these amounts are distributed to us.

Several factors may influence the timing and amount of the cash flows we receive from loans and other debt products included in our term debt securitizations, including:

 

   

if any loan or other debt product included in a term debt securitization becomes (a) delinquent for a specified period of time as outlined in the indenture, (b) is classified as a non-performing asset, or (c) is charged off, all funds, after paying expenses and interest to the senior notes, go to a reserve account which then pays down an amount of senior notes equal to the amount of the delinquent loan or other debt product or if an overcollateralization test is present, is diverted, and used to de-lever the securitization to bring the ratio back into compliance . Except for specified senior management fees, we will not receive any distributions from funds during this period; and

 

   

if other specified events occur to the trusts, for example an event of default, our cash flows would be used to reduce the outstanding balance of the senior notes and would not be available to us until the full principal balance of the senior notes had been repaid.

We have obtained a significant portion of our debt financing through a limited number of financial institutions. This concentration of funding sources exposes us to funding risks.

We have obtained our credit facility financing from a limited number of financial institutions. Our reliance on the underwriters of our debt financing and their affiliates for a significant amount of our funding exposes us to funding risks. If these participating lenders decided to terminate our credit facilities, we would need to establish new lending relationships to satisfy our funding needs.

 

21


Table of Contents

Risks Related to Our Operations and Financial Results

Our quarterly net interest income and results of operations are difficult to forecast and may fluctuate substantially.

Our quarterly net interest income and results of operations are difficult to forecast. We have and may continue to experience substantial fluctuations in net interest income and results of operations from quarter to quarter. You should not rely on our results of operations in any prior reporting period to be indicative of our performance in future reporting periods. Many different factors could cause our results of operations to vary from quarter to quarter, including:

 

   

the success of our origination activities;

 

   

pre-payments on our loan portfolio;

 

   

credit losses on recent transaction and legacy workouts

 

   

default rates;

 

   

our ability to enter into financing arrangements;

 

   

competition;

 

   

seasonal fluctuations in our business, including the timing of transactions;

 

   

costs of compliance with regulatory requirements;

 

   

private equity activity;

 

   

the timing and affect of any future acquisitions;

 

   

personnel changes;

 

   

changes in accounting rules;

 

   

changes in allowance for credit losses methodology;

 

   

changes in prevailing interest rates;

 

   

general changes to the U.S. and global economies; and

 

   

political conditions or events.

We base our current and future operating expense levels and our investment plans on estimates of future net interest income, transaction activity and rate of growth. We expect that our expenses will increase in the future, and we may not be able to adjust our spending quickly enough if our net interest income falls short of our expectations. Any shortfalls in our net interest income or in our expected growth rates could result in decreases in our stock price.

Our business is highly dependent on key personnel.

Our future success depends to a significant extent on the continued services of our Chief Executive Officer and our Chief Investment Officer as well as other key personnel. Our employment agreements with each of these officers will terminate in October 2015. Although we intend to enter into new employment agreements with these officers, if we were to lose the services of any of these executives for any reason, including voluntary resignation or retirement, we may not be able to replace them with someone of equal skill or ability and our business may be adversely affected. Moreover, we may not function well without the continued services of these executives.

We may not be able to attract and retain the highly skilled employees we need to support our business.

Our ability to originate and underwrite loans and other debt products is dependent on the experience and expertise of our employees. In order to grow our business, we must attract and retain qualified personnel,

 

22


Table of Contents

especially origination and credit personnel with relationships with referral sources and an understanding of small and middle-market businesses and the industries in which our borrowers operate. Many of the financial institutions with which we compete for experienced personnel may be able to offer more attractive terms of employment. If any of our key origination personnel leave, our new loan and other debt product volume from their business contacts may decline or cease, regardless of the terms of our loan and other debt product offerings or our level of service. In addition, we invest significant time and expense in training our employees, which increases their value to competitors who may seek to recruit them and increases the costs of replacing them. As competition for qualified employees grows, our cost of labor could increase, which could adversely impact our results of operations.

Maintenance of our Investment Company Act exemption imposes limits on our operations.

We intend to conduct our operations so that we are not required to register as an investment company under the Investment Company Act of 1940, as amended, which we refer to as the Investment Company Act. Section 3(a)(1)(C) of the Investment Company Act defines as an investment company any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40.0% of the value of the issuer’s total assets (exclusive of government securities and cash items) on an unconsolidated basis. Excluded from the term “investment securities” are, among other things, securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.

We expect that many of our majority-owned subsidiaries, including those which we have created (or may in the future create) in connection with our term debt securitizations, will rely on exceptions and exemptions from the Investment Company Act available to certain structured finance companies and that our interests in those subsidiaries will not constitute “investment securities” for purposes of the Investment Company Act. Because these exceptions and exemptions may, among other things, limit the types of assets these subsidiaries may purchase or counterparties with which we may deal, we must monitor each subsidiary’s compliance with its applicable exception or exemption.

We must also monitor our loan portfolio to ensure that the value of the investment securities we hold does not exceed 40.0% of our total assets (exclusive of government securities and cash items) on an unconsolidated basis. If the combined value of the investment securities issued by our subsidiaries that are investment companies or that must rely on the exceptions provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act rather than another exception or exemption, together with any other investment securities we may own, exceeds 40.0% of our total assets on an unconsolidated basis, we may be deemed to be an investment company. Because we believe that the interests we hold in our subsidiaries generally will not be investment securities, we do not expect to own nor do we propose to acquire investment securities in excess of 40.0% of the value of our total assets on an unconsolidated basis. However, the SEC is considering proposing amendments to Rule 3a-7 under the Investment Company Act and issued an advance notice of proposed rulemaking in August 2011 (Release No. IC-29779) to solicit public comment on the treatment of asset-backed issuers under the Investment Company Act. Under consideration are changes that could amend or eliminate the provision upon which we currently rely to ensure that our interests in certain of our subsidiaries do not constitute investment securities for purposes of the Investment Company Act. If adopted, such changes could, among other things, require us to register as an investment company or take other actions to permit us to continue to be excluded from the definition of investment company. These actions could involve substantial changes to our operations and organizational structure.

We monitor for compliance with the Investment Company Act on an ongoing basis and may be compelled to take or refrain from taking actions, to acquire additional income or loss generating assets or to forego opportunities that might otherwise be beneficial or advisable, including, but not limited to selling assets that are considered to be investment securities or foregoing sale of assets which are not investment securities, in order to

 

23


Table of Contents

ensure that we (or a subsidiary) may continue to rely on the applicable exceptions or exemptions. These limitations on our freedom of action could have a material adverse effect on our financial condition and results of operations.

If we fail to maintain an exemption, exception or other exclusion from registration as an investment company, we could, among other things, be required to substantially change the manner in which we conduct our operations either to avoid being required to register as an investment company or to register as an investment company. If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to, among other things, our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to diversification and industry concentration, and our financial condition and results of operations may be adversely affected. If we did not register despite being required to do so, criminal and civil actions could be brought against us, our contracts would be unenforceable unless a court was to require enforcement, and a court could appoint a receiver to take control of us and liquidate our business.

Risks Related to Our Operating and Trading History

We have incurred losses in the past and may not achieve profitability in future periods.

For the years ended December 31, 2013, 2012 and 2011, we recorded net income of $24.6 million, $24.0 million, and $14.1 million, respectively. We may not be profitable in future periods for a variety of reasons. If we are unable to achieve, maintain and increase our profitability in the future, the market value of our common stock could further decline.

We are in a highly competitive business and may not be able to compete effectively, which could impact our profitability.

The commercial lending industry is highly competitive and includes a number of competitors who provide similar types of loans to our target customers. Our principal competitors include a variety of:

 

   

specialty and commercial finance companies, including business development companies and real estate investment trusts;

 

   

private investment funds and hedge funds;

 

   

national and regional banks;

 

   

investment banks; and

 

   

insurance companies.

Some of our competitors offer a broader range of financial, lending and banking services than we do and can leverage their existing customer relationships to offer and sell services that compete directly with our products and services. In addition, some of our competitors have greater financial, technical, marketing, origination and other resources than we do. They may also have greater access to capital than we do and at a lower cost than is available to us. For example, if national and regional banks or other large competitors seek to expand within or enter our target markets, they may provide loans at lower interest rates to gain market share, which could force us to lower our rates and result in decreased returns. As a result of competition, we may not be able to attract new customers, retain existing customers or sustain the rate of growth that we have experienced to date, and our ability to expand our loan portfolio and grow future revenue may decline. If our existing customers choose to use competing sources of credit to refinance their debt, our loan portfolio could be adversely affected.

 

24


Table of Contents

We are subject to regulation, which limits our activities and exposes us to additional fines and penalties, and any changes in such regulations could affect our business and our profitability.

We are subject to federal, state and local laws and regulations that govern non-depository commercial lenders and businesses generally. In response to SEC rules promulgated under the Dodd-Frank Act, we have registered with the SEC as an investment adviser and conformed our activities to regulation under the Investment Advisers Act of 1940. Each of the regulatory bodies with jurisdiction over us has regulatory powers dealing with many aspects of financial services, including the authority to grant, and, in specific circumstances to cancel, permissions to carry on particular businesses. Our failure to comply with applicable laws or regulations could result in fines, censure, suspensions of personnel or other sanctions, including revocation of any registration that we may be required to hold. Even if a sanction imposed against us or our personnel is small in monetary amount, the adverse publicity arising from the imposition of sanctions against us by regulators could harm our reputation and impair our ability to retain clients and develop new client relationships, which may reduce our revenues.

Furthermore, the regulatory environment in which we operate is subject to further modifications and regulation. Any changes in such laws or regulations could affect our business and profitability. In addition, if we expand our business into areas or jurisdictions that are subject to, or have adopted, more stringent laws and regulations than those that are currently applicable to us and our business, we may have to incur significant additional expense or restrict our operations in order to comply, which could adversely impact our business, results of operations or prospects.

Our common stock may continue to have a volatile public trading price.

Historically, the market price of our common stock has been highly volatile, and the market for our common stock has experienced significant price and volume fluctuations, some of which are unrelated to our company’s operating performance. Since our common stock began trading publicly on December 14, 2006, the trading price of our stock has fluctuated from a high of $20.85 to a low of $0.61. It is likely that the market price of our common stock will continue to fluctuate in the future. Factors which may have a significant adverse effect on our common stock’s market price include:

 

   

the rate of charge-offs, impairments and non-accruals in our loan portfolio;

 

   

fluctuations in interest rates and the actual or perceived impact of these rates on our current customers and future prospects;

 

   

changes to the regulatory environment in which we operate;

 

   

our ability to raise additional capital and the terms on which we can secure such capital;

 

   

general market and economic conditions; and

 

   

quarterly fluctuations in our revenues and other financial results.

The reported average daily trading volume of our common stock for the twelve-month period ending December 31, 2013 was approximately 32,000 shares, however our trading volume has exceeded 1,000,000 shares on several occasions since our initial public offering. Such a low average trading volume may impact our shareholders’ ability to buy and sell shares of our common stock.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

Our headquarters is located at 500 Boylston Street, Suite 1250, Boston, Massachusetts 02116, where we lease 18,628 square feet of office space under a lease that is scheduled to terminate on February 28, 2020. We

 

25


Table of Contents

also maintain leased offices in Darien, Connecticut, Atlanta, Georgia, Chicago, Illinois, Dallas, Texas, Los Angeles, California, New York, New York, Portland, Oregon, and San Francisco, California. We believe our office facilities are suitable and adequate for us to conduct our business.

 

Item 3. Legal Proceedings

The Company from time to time is involved in litigation in the ordinary course of business. We are not currently subject to any material pending legal proceedings.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

26


Table of Contents

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

As of March 13, 2014, there were approximately 79 stockholders of record. The number of stockholders does not include individuals or entities who beneficially own shares but whose shares are held of record by a broker or clearing agency, but does include each such broker or clearing agency as one stockholder. American Stock Transfer & Trust Company serves as transfer agent for our shares of common stock.

Our common stock has traded on the NASDAQ Global Market under the symbol “NEWS” since December 14, 2006. The quarterly range of the high and low sales price for our common stock during 2013 and 2012 is presented below:

 

     2013      2012  
     High      Low      High      Low  

Quarter ended:

           

December 31

   $ 19.02       $ 14.18       $ 14.22       $ 10.94   

September 30

     19.83         12.82         13.63         10.83   

June 30

     13.60         11.37         12.99         10.05   

March 31

     14.81         12.95         11.22         9.05   

On March 13, 2014, the last reported closing price of our common stock on the NASDAQ Global Market was $14.98 per share.

The following graph shows a comparison from December 31, 2008 through December 31, 2013 of cumulative total return for our common stock, the S&P 500 Index and the S&P Financials Index. The graph assumes a $100 investment at the closing price on December 31, 2008. Such returns are based on historical results and are not intended to suggest future performance. The following information in this Item 5 of this Annual Report on Form 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing.

 

LOGO

 

27


Table of Contents

Dividend Policy

We have never declared or paid cash dividends on our common stock. We have no current plans to pay cash dividends on our common stock. We intend to retain available funds and any future earnings to reduce debt and fund the development and growth of our business.

Issuer Purchases of Equity Securities

The following table sets forth the repurchases of our Common Stock that we made for the three-month period ending on December 31, 2013:

 

 

Period

   Total
Number  of
Shares

Purchased (1)(2)
     Average
Price Paid
Per Share (1)(2)
     Total Number  of
Shares
Purchased

as Part of
Publicly
Announced
Plans or
Programs (3)
     Approximate
Dollar Value  of
Shares that May
Yet Be
Purchased
Under the Plans
or Programs (3)
 

October 1-31, 2013

     262       $ 18.65         ––         $ 9,784,055   

November 1-30, 2013

     20,073         16.22         ––           9,784,055   

December 1-31, 2013

     19,628         18.06         ––           9,784,055   
  

 

 

       

 

 

    

Total: Three months ended December 31, 2013

     39,963         17.14         ––           9,784,055   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) The Company did not repurchase any shares during the period in connection with our share repurchase program that we announced on November 19, 2012.
(2) These columns include the acquisition of an aggregate of 39,963 shares of Common Stock from individuals in order to satisfy tax withholding requirements in connection with the vesting of restricted stock awards under equity compensation plans during the fourth quarter.
(3) The repurchase program referenced in footnote (1) provided for 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 repurchase program expired on December 31, 2013.

 

28


Table of Contents
Item 6. Selected Financial Data

Selected consolidated financial and other data for the periods and at the dates indicated and should be read in conjunction with the consolidated audited financial statements, related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein.

 

    Year Ended December 31,  
    2013     2012     2011     2010     2009  
    ($ in thousands, except for share and per share data)  

Statement of Operations Data:

         

Interest income

  $ 127,684      $ 123,945      $ 115,680      $ 112,826      $ 136,569   

Interest expense

    42,971        35,591        34,953        40,558        41,927   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    84,713        88,354        80,727        72,268        94,642   

Provision for credit losses

    9,738        12,651        17,312        32,997        133,093   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (loss) after provision for credit losses

    74,975        75,703        63,415        39,271        (38,451

Fee income

    3,670        4,619        3,070        2,409        1,657   

Asset management income

    2,482        2,984        2,635        2,872        2,934   

Gain (loss) on derivatives

    (143     (315     242        28        533   

Gain (loss) on sale of loans and debt securities

    72        335        128        (116      

Gain on acquisition

           ––               5,649         

Other income (loss)

    7,431        3,948        (2,008     7,854        5,529   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

    13,512        11,571        4,067        18,696        10,653   

Compensation and benefits

    32,672        31,139        30,144        26,418        26,403   

General and administrative expenses

    16,726        15,158        13,787        14,195        16,032   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    49,398        46,297        43,931        40,613        42,435   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss) before income taxes

    39,089        40,977        23,551        17,354        (70,233

Results of Consolidated VIE

         

Interest income

    5,321        ––        ––        ––        ––   

Interest expense—credit facilities

    1,879        ––        ––        ––        ––   

Interest expense—Fund membership interest

    1,353        ––        ––        ––        ––   

Other income

    51        ––        ––        ––        ––   

Operating expenses

    78        ––        ––        ––        ––   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net results from consolidated VIE

    2,062        ––        ––        ––        ––   

Income (loss) before income taxes

    41,151        40,977        23,551        17,354        (70,233

Income tax expense (benefit)

    16,556        17,000        9,403        6,935        (24,353
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) before noncontrolling interest

    24,595        23,977        14,148        10,419        (45,880

Net loss (income) attributable to noncontrolling interest

           ––               (187     1,620   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

  $ 24,595      $ 23,977      $ 14,148      $ 10,232      $ (44,260
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) per share:

         

Basic

  $ 0.51      $ 0.51      $ 0.29      $ 0.21      $ (0.90

Diluted

    0.46        0.45        0.27        0.19        (0.90

Weighted average shares outstanding:

         

Basic

    48,157,319        47,370,095        48,106,032        49,449,314        49,119,285   

Diluted

    52,941,981        52,733,552        52,925,924        52,548,104        49,119,285   

Outstanding shares of common stock

    48,658,606        49,311,008        49,345,676        50,562,826        49,994,858   

 

29


Table of Contents
     December 31,  
     2013     2012     2011  

Balance Sheet Data:

      

Cash and cash equivalents

   $ 43,401      $ 27,212      $ 18,468   

Restricted cash

     167,920        208,667        83,815   

Investments in debt securities, available-for-sale

     22,198        21,127        17,817   

Loans, held-for-sale

     14,831        51,602        38,278   

Loans, net

     2,095,250        1,720,789        1,699,187   

Other assets

     86,862        127,673        88,818   
  

 

 

   

 

 

   

 

 

 

Subtotal

     2,430,462        2,157,070        1,946,383   

Assets of Consolidated VIE

      

Restricted cash

     1,950               ––   

Loans, net

     171,427               ––   

Other assets

     3,022               ––   
  

 

 

   

 

 

   

 

 

 

Total assets of Consolidated VIE

     176,399               ––   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 2,606,861      $ 2,157,070      $ 1,946,383   
  

 

 

   

 

 

   

 

 

 

Credit facilities

   $ 332,158      $ 229,941      $ 214,711   

Term debt

     1,412,374        1,221,764        1,073,105   

Repurchase agreements

     67,954        30,583        64,868   

Other liabilities

     26,544        79,965        29,937   
  

 

 

   

 

 

   

 

 

 

Subtotal

     1,839,030        1,562,253        1,382,621   

Liabilities of Consolidated VIE

      

Credit facilities

     120,344        ––        ––   

Subordinated debt

     30,000        ––        ––   

Other liabilities

     1,277        ––        ––   
  

 

 

   

 

 

   

 

 

 

Total liabilities of Consolidated VIE

     151,621        ––        ––   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     1,990,651        1,562,253        1,382,621   
  

 

 

   

 

 

   

 

 

 

NewStar Financial, Inc. stockholders’ equity

     615,552        594,817        563,762   

Retained earnings of Consolidated VIE

     658        ––        ––   
  

 

 

   

 

 

   

 

 

 

Total stockholders’ equity

     616,210        594,817        563,762   
  

 

 

   

 

 

   

 

 

 

Supplemental Data:

      

Investments in debt securities, gross

   $ 25,298      $ 25,298      $ 25,298   

Loans held-for-sale, gross

     14,897        52,120        38,837   

Loans held-for-investment, gross

     2,325,144        1,796,845        1,820,193   
  

 

 

   

 

 

   

 

 

 

Loans and investments in debt securities, gross

     2,365,339        1,874,263        1,884,328   

Unused lines of credit

     326,231        245,483        252,422   

Standby letters of credit

     6,880        4,497        6,462   
  

 

 

   

 

 

   

 

 

 

Total funding commitments

   $ 2,698,450      $ 2,124,243      $ 2,143,212   
  

 

 

   

 

 

   

 

 

 

Loan portfolio

   $ 2,365,339      $ 1,874,263      $ 1,884,328   

Loans owned by the NCOF

     93,263        559,328        517,596   
  

 

 

   

 

 

   

 

 

 

Managed loan portfolio

   $ 2,458,602      $ 2,433,591      $ 2,401,924   
  

 

 

   

 

 

   

 

 

 

Loans held-for-sale, gross

   $ 14,897      $ 52,120      $ 38,837   

Loans held-for-investment, gross

     2,325,144        1,796,845        1,820,193   
  

 

 

   

 

 

   

 

 

 

Total loans, gross

     2,340,041        1,848,965        1,859,030   

Deferred fees, net

     (17,130     (26,938     (57,865

Allowance for loan losses—general

     (18,099     (19,423     (23,022

Allowance for loan losses—specific

     (23,304     (30,213     (40,678
  

 

 

   

 

 

   

 

 

 

Total loans, net

   $ 2,281,508      $ 1,772,391      $ 1,737,465   
  

 

 

   

 

 

   

 

 

 

 

30


Table of Contents
     December 31,  
     2013      2012      2011  

Average Balances (1):

        

Loans and other debt products, gross

   $ 1,988,416       $ 1,893,571       $ 1,776,195   

Interest earning assets (2)

     2,223,908         2,036,526         1,886,165   

Total assets

     2,275,309         2,051,565         1,885,407   

Interest bearing liabilities

     1,627,816         1,414,967         1,286,256   

Equity

     604,742         579,083         560,617   

 

     Year Ended December 31,  
     2013     2012     2011  

Performance Ratios (3):

      

Return on average assets

     1.08     1.17     0.75

Return on average equity

     4.07        4.14        2.52   

Net interest margin, before provision

     3.90        4.34        4.28   

Loan portfolio yield

     6.68        6.54        6.50   

Efficiency ratio

     49.30        46.46        51.81   

Credit Quality and Leverage Ratios (4):

      

Delinquent loan rate (at period end)

     0.22     3.59     5.34

Delinquent loan rate for accruing loans 60 days or more past due (at period end)

     ––     1.17     0.46

Non-accrual loan rate (at period end)

     3.04     4.05     5.61

Non-performing asset rate (at period end)

     3.60     4.77     5.61

Net charge off rate (end of period loans)

     0.77     1.49     2.09

Net charge off rate (average period loans)

     0.91     1.43     2.15

Allowance for credit losses ratio (at period end)

     1.80     2.78     3.52

Debt to equity (at period end)

     3.18     2.49     2.40

Equity to assets (at period end)

     23.64     27.58     28.96

 

(1) Averages are based upon the average daily balance during the period.
(2) Includes loan portfolio, cash, cash equivalents and restricted cash.
(3) See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of the calculation of performance ratios.
(4) See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information related to our credit quality and leverage ratios.

 

31


Table of Contents
Item 7. 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 is contained below and in Item 1A. “Risk Factors” of this report.

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 focus primarily on the direct origination of loans and equipment leases through teams of credit-trained bankers and marketing officers organized around key industry and market segments. Our marketing and direct origination efforts target private equity sponsors, mid-sized companies, corporate executives, regional banks, real estate investors and a variety of other referral sources and financial intermediaries to source new customer relationships and lending opportunities. Our emphasis on direct origination is an important aspect of our marketing and credit strategy because it provides us with direct access to our customers’ management teams and enhances our ability to conduct detailed due diligence and credit analysis of prospective borrowers. It also allows us to negotiate transaction terms directly with borrowers and, as a result, we have significant input into our customers’ financial strategies and capital structures. We also participate in loans as a member of a lending group. The mix of our originations may vary from period to period. We employ highly experienced bankers, marketing officers and credit professionals to identify and structure new lending opportunities and manage customer relationships. We believe that the quality of our professionals, the breadth of their relationships and referral networks, and their ability to develop creative solutions for customers position us to be a valued partner and preferred lender for mid-sized companies.

We operate as a single segment, and we derive revenues from four specialized lending groups that target market segments in which we believe that we have a competitive advantage:

 

   

Leveraged Finance, provides senior, secured cash flow loans and, to a lesser extent, second lien loans, which are primarily used to finance acquisitions of mid-sized companies with annual cash flow (EBITDA) typically between $5 million and $30 million by private equity investment funds managed by established professional alternative asset managers;

 

   

Business Credit, provides senior, secured asset-based loans primarily to fund working capital needs of mid-sized companies with sales typically totaling between $25 million and $500 million;

 

   

Real Estate, manages a portfolio of first mortgage debt which was sourced primarily to finance acquisitions of commercial real estate properties typically valued between $10 million and $50 million by professional commercial real estate investors; and

 

   

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

Market Conditions

As a specialized commercial finance company, we compete in various segments of the loan market to extend credit to mid-sized companies through our national specialized lending platforms. We rely primarily on large banks for warehouse lines of credit to partially fund new loan origination and the capital markets for longer term funding through the issuance of asset-backed notes that are used to refinance bank lines and provide funding with matched duration for our leveraged loan portfolio.

Market conditions in most segments of the loan market that we target remained relatively unchanged in the fourth quarter compared to the prior quarter. Overall middle market loan demand remained steady and new issuance volume of approximately $50 billion in the fourth quarter pushed total loan volume for 2013 to a record $204 billion. Despite record volume, however, the markets remained highly liquid and competitive as volume

 

32


Table of Contents

was dominated by refinancing of existing loans and the supply of new capital outpaced demand for new financing for growth or acquisitions. According to Thomson Reuters, 64% of total middle market lending in 2013 was represented by refinancing activity.

We believe that modest M&A activity and related demand for new financing combined with inflows of capital into loan funds, new CLO issuance, and new fund formation continued to drive a weaker pricing environment as lenders competed for a limited universe of deals. These conditions also led to increasing pressure on deal structures reflected by somewhat higher leverage levels and weaker lender protections. Despite that trend, however, we believe that conditions in the middle market compared favorably to other credit markets including large corporate loans as a hyper-competitive environment pushed yields even lower throughout the year and arrangers loosened deal structures more aggressively. Loan yields in the large corporate market, for example, tightened to 4.6% in December as new middle market loan yields widened to 6.1%. With most of the new money flowing into the loan market from CLO issuance and retail loan funds targeted for broadly syndicated loans, we believe that market conditions will continue to be challenging for large corporate lenders and that the middle market will continue to compare favorably.

In this type of environment, our different lending platforms provide us with certain flexibility to allocate capital and redirect our origination focus to market segments with the most favorable conditions in terms of demand and relative value. As the pricing environment for larger, more liquid loans weakened further in the fourth quarter and loan demand among private equity firms in the lower middle market remained somewhat firmer, we continued to emphasize direct lending to smaller companies during the quarter. We believe that the yields on our new loan origination will continue to reflect a combination of these broad market trends and shifts in the mix of loans we originate.

Conditions in our core funding markets were somewhat mixed, but remained supportive in the fourth quarter as many fixed income investors continued to target structured investment alternatives such as CLOs to meet their return objectives. The market was somewhat more unsettled, however, as regulatory headwinds from the Volcker Rule dampened demand for CLOs among banks as they worked through how the rule would apply to them and how it would impact their ability to continue investing in CLO debt. The broader fixed income markets were active in the quarter as the market adjusted to changes in the Federal Reserve’s monetary policies. As a result, we believe that investors will be more cautious about holding fixed rate debt, leading to less capital flowing into the high yield market in favor of high yielding investments with shorter duration, including floating rate bank loans and CLO bonds. This rotation into floating rate debt was evident in 2013 as investors funded a record $63 billion into mutual funds and ETFs targeting the floating rate loan markets.

Despite headwinds at the end of the year, new CLO issuance exceeded $81 billion in 2013, up from $55 billion in 2012 and 2011’s total of $12 billion. After trending down through the first half of the year, CLO credit spreads continued to trend higher through the second half, however, reflecting the impact of a steepening yield curve and regulatory concerns, including an FDIC surcharge for deposit insurance and future risk retention rules in addition to the Volcker Rule. As a result, we believe marginal funding costs will be somewhat range bound at current levels until investors reset rate expectations and resolve regulatory issues. Despite this trend in the pricing environment, we believe that market conditions remain supportive for us to issue new CLOs as demonstrated by the transaction we completed in September 2013. We also believe the availability and cost of warehouse financing among banks has continued to improve as more banks have begun to provide this type of financing and existing providers have increased their lending activity. As a result, we believe that the terms and conditions for financings available to established firms like NewStar have improved, as shown by our ability to refinance our existing corporate debt through a new $200 million financing on significantly improved terms and at lower cost in the second quarter.

Loan demand in the middle market is strongly influenced by the level of refinancing, acquisition activity and private investment, which is driven largely by changes in the perceived risk environment, prevailing borrowing rates and private investment activity. Overall activity increased in the fourth quarter after a seasonally slow third quarter, pushing new loan volume in 2013 to approximately $1.3 billion.

 

33


Table of Contents

We originated nearly $550 million of new loans in the fourth quarter at yields that were generally below our historical averages for comparably rated loans, but consistent with the prior quarter. Yields reflected a combination of continued pricing pressure in a muted M&A volume environment and a continuation of the shift in the mix of origination toward loans directly originated with smaller middle market companies. Pricing remained thin and leverage continued to trend higher in the broad loan market. Conditions in our primary target markets, however, remained somewhat more favorable with pricing and leverage stabilizing at levels that compare favorably to the broader loan market, in which larger corporations typically borrow from syndicates of banks and loans are issued, priced and traded in a bond-style market that is more highly correlated with the high yield debt market.

We believe that demand for new middle market loans and credit products will remain relatively consistent with current levels in the near term and exhibit usual seasonality. Over the long-term, we believe that demand will improve because private equity firms have substantial un-invested capital, which we believe that they will deploy through investment strategies that emphasize investments in mid-sized companies. We also believe that a significant and lasting impact of the credit crisis that began in 2008 has been a reduction in the number and capacity of lenders in the markets in which we compete. As a result of these factors, we anticipate that demand for loans and leases offered by the Company and conditions in our lending markets will remain relatively consistent overall through the balance of 2013, but continue to provide opportunities for us to increase our origination volumes.

Recent Developments

Liquidity

On March 6, 2014, as permitted under our corporate credit facility with Fortress Credit Corp., we requested and received an increase of $28.5 million to the Initial Funding under this credit facility. We borrowed the entire $28.5 million on March 6, 2014.

On December 12, 2013, we entered into an amendment to our credit facility with Wells Fargo Bank, National Association to fund new equipment lease origination. The amendment extended the provision for optional termination of the revolving period from January 16, 2014 to March 17, 2014, and extends the Turbo Event (as defined in the Note Purchase Agreement) from January 16, 2014 to March 17, 2014.

On December 27, 2013, the NCOF paid off the outstanding notes of its term debt securitization at par. As of December 31, 2013, we had purchased $217.9 million of the $276.5 million of outstanding loans previously owned by the NCOF.

On November 26, 2013, we entered into an amendment to our credit facility with Wells Fargo Bank, National Association to fund leveraged finance loans. The amendment increased the commitment amount under the credit facility from $175.0 million to $275.0 million, increased the amount by which the commitment amount may be increased to up to $325.0 million, and modified certain concentration amounts and specified threshold amounts, among other things.

Stock Repurchase Program

On November 19, 2012, our Board of Directors 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 was determined by the Company’s management based on its evaluation of market conditions and other factors. The repurchase program expired on December 31, 2013. As of December 31, 2013, we had repurchased 17,665 shares of our common stock at a weighted average price per share of $12.22.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

NewStar’s basic and diluted income per share for 2013 was $0.51 and $0.46, respectively, on net income of $24.6 million compared to basic and diluted income per share for 2012 of $0.51 and $0.45, respectively, on net income of $24.0 million, and basic and diluted income per share for 2011 of $0.29 and $0.27, respectively, on net

 

34


Table of Contents

income of $14.1 million. Our managed loan portfolio was $2.5 billion at December 31, 2013 compared to $2.4 billion at December 31, 2012 and $2.4 billion at December 31, 2011. As of December 31, 2013, loans owned by Arlington Fund and the NCOF were $172.6 million and $93.3 million, respectively.

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 6.68% for 2013, 6.54% for 2012 and 6.50% for 2011. The increase in loan portfolio yield from 2012 to 2013 was primarily driven by the recognition of deferred paid-in-kind interest on certain impaired loans, and the average yield on loans which were repaid subsequent to December 31, 2012 was lower than the average yield on loans in our average total loan portfolio for 2013. Additionally, subsequent to December 31, 2012, the outstanding balance of lower yielding commercial real estate loans decreased $54.4 million. The increase in loan portfolio yield from 2011 to 2012 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 December 31, 2011, and the average yield on loans which were repaid during 2012 was lower than the average yield on loans in our total loan portfolio. During 2012, the outstanding balance of lower yielding commercial real estate loans decreased $93.9 million.

Net interest margin

Net interest margin, which is net interest income divided by average interest earning assets, was 3.90% for 2013, 4.34% for 2012 and 4.28% for 2011. The primary factors impacting net interest margin for 2013 were the composition of interest earning assets, the recognition of deferred paid-in-kind interest on certain impaired loans, non-accrual loans, changes in three-month LIBOR, credit spreads and cost of borrowings. The primary factors impacting net interest margin for 2012 were accelerated loan deferred fee recognition due to a prepayment of loans, non-accrual loans, changes in three-month LIBOR, credit spreads and cost of borrowings. The primary factors impacting net interest margin for 2011 were non-accrual loans, the accelerated amortization of deferred financing fees and unamortized discount resulting from the call of the 2009-1 CLO, changes in three-month LIBOR, credit spreads and cost of borrowings.

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 49.30% for 2013, 46.46% for 2012 and 51.81% for 2011. The increase in our efficiency ratio for 2013 as compared to 2012 was primarily due to an increase in operating expenses. The decrease in our efficiency ratio during 2012 as compared to 2011 was primarily due to an increase in non-interest income and net interest income, partially offset by an increase in operating expenses during 2012.

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 1.80% at December 31, 2013, 2.78% as of December 31, 2012 and 3.52% as of December 31, 2011. 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, the NCOF portfolio purchase, which was acquired on December 17, 2013 at fair value and no allowance was required at year end, the consolidation of the Arlington Fund as a VIE, for which no allowance was needed at year end, positive credit migration, improving economic conditions, and charge offs of impaired loans. The allowance for credit losses ratio excluding the NCOF portfolio purchase was 1.99% at December 31, 2013. During 2013, we recorded $11.2 million of net specific provision for credit losses on previously identified impaired loans and had net charge offs totaling $17.8 million. At December 31, 2013, the specific allowance for credit losses was $23.3 million, and the general allowance for credit losses was $18.6 million. At December 31, 2012, the specific allowance for credit losses was $30.2 million, and the general allowance for credit losses was $19.8 million. We continually evaluate our

 

35


Table of Contents

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 0.22% as of December 31, 2013 as compared to 3.59% as of December 31, 2012. We expect the delinquent loan rate to correlate to current economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase.

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 1.17% as of December 31, 2012. We did not have any delinquent accruing loans as of December 31, 2013. We expect the delinquent accruing loan rate to correlate to current economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase.

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 3.04% as of December 31, 2013 and 4.05% as of December 31, 2012. As of December 31, 2013 and 2012, the aggregate outstanding balance of non-accrual loans was $70.7 million and $72.7 million, respectively and total outstanding loans and leases held for investment was $2.3 billion and $1.8 billion, respectively. The slight decline in non-accrual loans during 2013 was primarily the result of the resolution of loans classified as non-accrual at December 31, 2012, partially offset by loans being placed on non-accrual during 2013. We expect the non-accrual loan rate to correlate to economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase.

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. The non-performing asset rate was 3.60% as of December 31, 2013 and 4.77% as of December 31, 2012. As of December 31, 2013 and 2012, the sum of the aggregate outstanding balance of non-performing assets was $84.2 million and $86.3 million, respectively. The decline in non-performing assets during 2013 was primarily the result of the resolution of assets classified as non-accrual at December 31, 2012.We expect the non-performing asset rate to correlate to economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase.

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

 

36


Table of Contents

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. Typically a charge off occurs in a period after a loan has been identified as impaired and a specific allowance has been established. For 2013, 2012 and 2011, the net charge off rate was 0.77%, 1.49% and 2.09%, respectively. Charge-offs during 2013, were primarily the result of the resolution of previously impaired loans. We expect the net charge-off rate (end of period loans and leases) to fluctuate 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 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. Typically a charge off occurs in a period after a loan has been identified as impaired and a specific allowance has been established. For 2013, 2012 and 2011, the net charge off rate was 0.91%, 1.43% and 2.15%, respectively. Charge-offs during 2013, were primarily the result of the resolution of previously impaired loans. We expect the net charge-off rate (end of period loans and leases) to fluctuate 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 1.08% for 2013, 1.17% for 2012, and 0.75% for 2011.

Return on average equity

Return on average equity, which is net income divided by average equity, was 4.07% for 2013, 4.14% for 2012, and 2.52% for 2011.

 

37


Table of Contents

Review of Consolidated Results

A summary of NewStar’s consolidated financial results for the years ended December 31, 2013, 2012 and 2011 follows:

 

     Year Ended December 31,  
     2013     2012     2011  
     ($ in thousands)  

Net interest income:

      

Interest income

   $ 127,684      $ 123,945      $ 115,680   

Interest expense

     42,971        35,591        34,953   
  

 

 

   

 

 

   

 

 

 

Net interest income

     84,713        88,354        80,727   

Provision for credit losses

     9,738        12,651        17,312   
  

 

 

   

 

 

   

 

 

 

Net interest income after provision for credit losses

     74,975        75,703        63,415   

Non-interest income:

      

Fee income

     3,670        4,619        3,070   

Asset management income

     2,482        2,984        2,635   

Gain (loss) on derivatives

     (143     (315     242   

Gain on sale of loans

     72        335        128   

Other income (loss)

     7,431        3,948        (2,008
  

 

 

   

 

 

   

 

 

 

Total non-interest income

     13,512        11,571        4,067   

Operating expenses:

      

Compensation and benefits

     32,672        31,139        30,144   

General and administrative expenses

     16,726        15,158        13,787   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     49,398        46,297        43,931   
  

 

 

   

 

 

   

 

 

 

Operating income before income taxes

     39,089        40,977        23,551   

Results of Consolidated Variable Interest Entity:

      

Interest income

     5,321        ––        ––   

Interest expense—credit facilities

     1,879        ––        ––   

Interest expense—Fund membership interest

     1,353        ––        ––   

Other income

     51        ––        ––   

Operating expenses

     78        ––        ––   
  

 

 

   

 

 

   

 

 

 

Net results from Consolidated Variable Interest Entity

     2,062        ––        ––   

Income before income taxes

     41,151        40,977        23,551   

Income tax expense

     16,556        17,000        9,403   
  

 

 

   

 

 

   

 

 

 

Net income

   $ 24,595      $ 23,977      $ 14,148   
  

 

 

   

 

 

   

 

 

 

Comparison of the Years Ended December 31, 2013 and 2012

Interest income. Interest income increased $9.1 million, to $133.0 million for 2013 from $123.9 million for 2012. The increase was primarily due to an increase in average balance of our interest earning assets to $2.2 billion from $2.0 billion, the recognition of $2.0 million of deferred paid-in-kind interest on certain impaired loans, the acceleration of amortization of deferred fees from loans that paid off during 2013, and the consolidation of interest income from Arlington Fund, partially offset by a decrease in the yield on average interest earning assets to 5.98% from 6.09% primarily due to a decrease in contractual interest rates from new loan origination and re-pricing subsequent to December 31, 2012.

Interest expense. Interest expense increased to $46.2 million for 2013 from $35.6 million for 2012. The increase is primarily due to an increase in the average balance of our interest bearing liabilities and an increase in the average cost of funds, the additional $100.0 million of debt under our amended corporate credit facility, and the consolidation of interest expense from Arlington Fund.

 

38


Table of Contents

Net interest margin. Net interest margin decreased to 3.90% for 2013 from 4.34% for 2012. The decrease in net interest margin was primarily due to an increase in our average interest bearing liabilities, an increase in average cost of funds, and a decrease in the yield on average interest earning assets, partially offset by the recognition of deferred paid-in-kind interest on certain impaired loans, and the acceleration of amortization deferred fees from loans that paid off during 2013. The net interest spread, which represents the difference between gross yield on our interest earning assets and the total cost of our interest bearing liabilities, decreased to 3.14% from 3.57%.

The following table summarizes the yield and cost of interest earning assets and interest bearing liabilities for 2013 and 2012:

 

     Year Ended December 31, 2013     Year Ended December 31, 2012  
     ($ in thousands)  
     Average
Balance
     Interest
Income/
Expense
     Average
Yield/
Cost
    Average
Balance
     Interest
Income/
Expense
     Average
Yield/
Cost
 

Total interest earning assets

   $ 2,223,908       $ 133,005         5.98   $ 2,036,526       $ 123,945         6.09

Total interest bearing liabilities

     1,627,816         46,203         2.84        1,414,967         35,591         2.52   
     

 

 

    

 

 

      

 

 

    

 

 

 

Net interest spread

      $ 86,802         3.14      $ 88,354         3.57
     

 

 

    

 

 

      

 

 

    

 

 

 

Net interest margin

           3.90           4.34
        

 

 

         

 

 

 

Provision for credit losses. The provision for credit losses decreased to $9.7 million for 2013 from $12.7 million for 2012. The decrease in the provision was primarily due to an decrease of $5.5 million of net specific provisions recorded during 2013 as compared to 2012. During 2013, we recorded net specific provisions for impaired loans of $11.2 million compared to $16.7 million recorded during 2012. The decrease in the net specific component of the provision for credit losses was primarily due to the resolution of certain impaired loans which were subsequently charged off and positive credit migration. Our general allowance for credit losses covers probable losses in our loan and lease portfolio with respect to loans and leases that are not impaired and 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. 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 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 and equipment finance products, the data set used to construct probabilities of default in its allowance for loan 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 terms in determining a loan loss in the event of default.

For Business Credit loans, the Company utilizes a proprietary model to risk rate the loans on a monthly basis. This model captures the impact of changes in industry and economic conditions as well as changes in the

 

39


Table of Contents

quality of the borrower’s collateral and financial performance to assign a final risk rating. The Company has also evaluated historical loss trends by risk rating from a comprehensive industry database covering more than twenty-five years of experience of the majority of the asset based lenders operating in the United States. Based upon the monthly risk rating from the model, the reserve is adjusted to reflect the historical average for expected loss from the industry database.

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.

For consolidated variable interest entities that to which the Company is providing transitional capital, we utilize a qualitative analysis which considers the business plans related to the entity, including expected hold periods, the terms of the agreements related to the entity, the Company’s historical credit experience, the credit migration of the entity’s loans in determining expected loss, as well as conditions in the capital markets.

The Company is providing capital on a transitional basis to the Arlington Fund. At December 31, 2013, the expected loss on Arlington Fund was zero and no allowance was recorded. If the duration of the Company’s investment in Arlington Fund or its assumptions regarding conditions in the capital markets were to change, it may be necessary for the Company to record an allowance for credit losses in the future.

The Company’s acquisition of the pool of loans from NCOF on December 17, 2013 was at fair value. At December 31, 2013, there had been no credit deterioration since the acquisition and as such, no allowance related to these loans was deemed necessary. We will reevaluate the need for a credit allowance on a quarterly basis.

The Company periodically reviews its allowance for credit loss methodology to assess any necessary adjustments based upon changing economic and capital market conditions. If the Company determines that 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. There have been no material modifications to the allowance for credit losses methodology during 2013. Given uncertain market conditions, actual losses under the Company’s current or any revised allowance methodology may differ materially from the Company’s estimate.

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.

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. Impaired loans include all non-accrual loans, loans with partial charge-offs and loans which are Troubled Debt Restructurings. 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.

 

40


Table of Contents

Impaired loans at December 31, 2013 were in Leveraged Finance, Real Estate, and Business Credit over a range of industries impacted by the then current economic environment including the following: Media and Communications, Industrial, Commercial Real Estate, Other Business Services, Consumer/Retail, and Building Materials. 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. As of December 31, 2013, we had impaired loans with an aggregate outstanding balance of $271.0 million. Impaired loans with an aggregate outstanding balance of $240.3 million have been restructured and classified as troubled debt restructurings. At December 31, 2013, the Company had a $23.3 million specific allowance for impaired loans with an aggregate outstanding balance of $154.7 million. As of December 31, 2013, we had three restructured impaired loans which had an outstanding balance greater than $20 million. In each of these cases, we added to our position to maximize our potential recovery of the outstanding principal.

Non-interest income. Non-interest income increased $2.0 million, to $13.6 million for 2013 from $11.6 million for 2012. The increase is primarily due to $2.3 million net gains on equity method of accounting interests, and $2.5 million of income from our other real estate owned properties, partially offset by a $1.9 million loss on the value of equity interests in certain impaired borrowers. Beginning in 2013, the income and expenses from our other real estate owned properties were presented on a gross basis in our consolidated statement of operations.

As a result of certain of our troubled debt restructurings, we have received an equity interest in several of our impaired borrowers. 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. 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 may directly impact 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 $3.2 million, to $49.5 million for 2013 from $46.3 million for 2012. Employee compensation and benefits increased $1.5 million primarily due to an increase in headcount and higher incentive compensation accruals, which were partially offset by lower equity compensation expense. General and administrative expenses increased $1.6 million due primarily to $4.0 million of operating expenses from our other real estate owned properties and an increase of $0.4 million in occupancy expense, partially offset by a decrease of $3.1 million in loan workout costs. Beginning in 2013, the income and expenses from our other real estate owned properties were presented on a gross basis in our consolidated statement of operations.

Results of Consolidated Variable Interest Entity. On April 8, 2013, we announced that we had formed a new managed credit fund, NewStar Arlington Fund LLC (“Arlington Fund”) in partnership with an institutional investor to co-invest in middle market commercial loans originated by NewStar. As the managing member of Arlington Fund, we retain full discretion over Arlington Fund’s investment decisions, subject to usual and customary limitations, and earn management fees as compensation for our services. Consolidation of the financial results of Arlington Fund with NewStar’s results of operations and statements financial position began in April 2013.

Although we consolidate all of the assets and liabilities of Arlington Fund, our maximum exposure to loss is limited to our investments in membership interests of the Arlington Fund, our Class B Note receivable, as well as the management fee receivable from Arlington Fund. These items define our economic relationship with Arlington

 

41


Table of Contents

Fund but are eliminated upon consolidation. We manage the assets of Arlington Fund solely for the benefit of its lenders and investors. If we were to liquidate, the assets of Arlington Fund would not be available to our general creditors. Conversely, the investors in the debt of Arlington Fund have no recourse to our general assets. Therefore, we do not consider this debt our obligation.

Income taxes. For 2013 and 2012, we provided for income taxes based on an effective tax rate of 40% and 41%, respectively. Our tax rate for 2013, reflects the consolidation of the results of our variable interest entities.

As of December 31, 2013 and 2012, we had net deferred tax assets of $30.2 million and $42.5 million, respectively. In assessing if we will be able to realize our 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 December 31, 2013. 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 December 31, 2013. As of December 31, 2013, our deferred tax asset was primarily comprised of $20.4 million related to our allowance for credit losses and $8.5 million related to equity compensation.

Comparison of the Years Ended December 31, 2012 and 2011

Interest income. Interest income increased $8.2 million, to $123.9 million for 2012 from $115.7 million for 2011. The increase was primarily due to an increase in average balance of our interest earning assets to $2.0 billion from $1.9 billion, partially offset by a decrease in the yield on average interest earning assets to 6.09% from 6.13%, primarily driven by cash comprising a larger portion of the outstanding balance of average interest earning assets during 2012 as compared to 2011.

Interest expense. Interest expense increased $0.6 million, to $35.6 million for 2012 from $35.0 million for 2011. The increase is primarily due to an increase in average interest bearing liabilities, partially offset by a decrease in accelerated amortization of certain deferred financing fees. During 2011, we called our 2009-1 CLO which resulted in the accelerated amortization of the associated unamortized discount and deferred financing fees totaling $3.0 million.

Net interest margin. Net interest margin increased to 4.34% for 2012 from 4.28% for 2011. The increase in net interest margin was primarily due to a decrease in our average cost of interest bearing liabilities, loan deferred fees recognized due to prepayments of loans, and a decrease in average cost of funds, partially offset by a decrease in our average yield on interest earning assets as cash comprised a larger portion of the outstanding balance of average interest earning assets during 2012. The decrease in average cost of funds is primarily due to the accelerated amortization of deferred financing fees and unamortized discount during 2011 related to our 2009-1 CLO. 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 3.57% from 3.42%.

 

42


Table of Contents

The following table summarizes the yield and cost of interest earning assets and interest bearing liabilities for 2012 and 2011:

 

     Year Ended December 31, 2012     Year Ended December 31, 2011  
     ($ in thousands)  
     Average
Balance
     Interest
Income/
Expense
     Average
Yield/
Cost
    Average
Balance
     Interest
Income/
Expense
     Average
Yield/
Cost
 

Total interest earning assets

   $ 2,036,526       $ 123,945         6.09   $ 1,886,165       $ 115,680         6.13

Total interest bearing liabilities

     1,414,967         35,591         2.52        1,286,256         34,953         2.72   
     

 

 

    

 

 

      

 

 

    

 

 

 

Net interest spread

      $ 88,354         3.57      $ 80,727         3.42
     

 

 

    

 

 

      

 

 

    

 

 

 

Net interest margin

           4.34           4.28
        

 

 

         

 

 

 

Provision for credit losses. The provision for credit losses decreased to $12.7 million for 2012 from $17.3 million for 2011. The decrease in the provision was primarily due to a decrease of $2.1 million of specific provisions recorded during 2012 as compared to 2011. During 2012, we recorded specific provisions of $16.7 million compared to $18.8 million recorded during 2011. The decrease in the specific component of the provision for credit losses was primarily due to lower outstanding loan balances of impaired loans with a specific allowance since December 31, 2011, positive 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. 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 decreased as compared to December 31, 2011, the percentage of loans in our loan portfolio being evaluated under our general allowance analysis has increased.

Impaired loans at December 31, 2012 were in Real Estate, Leveraged Finance, and Business Credit 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 increased $7.5 million, to $11.6 million for 2012 from $4.1 million for 2011. The increase is primarily due to a $5.4 million loss on the value of equity interests in certain impaired borrowers during 2011, a $2.9 million net loss on equity method of accounting interests during 2011, as compared to a $0.5 million net loss on equity method of accounting interests during 2012, a $1.5 million increase of fee income, and an increase of $0.2 million on the gain on sale of loans, partially offset by a $0.3 million loss on derivatives. During 2012, we also recognized a $2.7 million gain on the repurchase of debt, as compared to a $4.4 million gain for 2011.

As a result of certain of our troubled debt restructurings, we have received equity interests in several of our distressed borrowers. The equity interest in certain impaired borrowers is initially recorded at fair value when the debt is restructured and is subsequently valued at the end of each quarter. 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 may

 

43


Table of Contents

directly impact the remaining net book value of these respective loans. These equity interests may also give rise to 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 $2.4 million, to $46.3 million for 2012 from $43.9 million for 2011. General and administrative expenses increased $1.4 million. General and administrative expenses during 2012 were impacted by a $3.1 million charge, partially offset by a $1.0 million insurance recovery related to a settlement of litigation in connection with the resolution of one of our impaired loans. Although we considered the claims to be without merit, we decided that the settlement of the lawsuit was prudent in order to avoid further expenses to defend the case and to eliminate the risk of exposure as a result of an unfavorable evidentiary ruling that occurred during 2012. Employee compensation and benefits increased $1.0 million primarily due to an increase in headcount and higher incentive compensation accruals, which were partially offset by lower equity compensation expense.

Income taxes. For 2012 and 2011, we provided for income taxes based on an effective tax rate of 41% and 40% for 2012 and 2011, respectively. The effective tax rate for 2011 included the impact of a valuation allowance recorded during 2010 and its reversal during 2011.

 

44


Table of Contents

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 that these sources will be sufficient to fund our current operations, lending activities and other short-term liquidity needs. Subject to market conditions, we continue to explore opportunities for the Company to increase its leverage, including through the issuance of high yield debt securities, convertible debt securities, share repurchases, secured or unsecured senior debt or revolving credit facilities, to support loan portfolio growth and/or strategic acquisitions, which may be material to us. In addition to opportunistic funding related to potential growth initiatives, our future liquidity needs will be determined primarily based on prevailing market and economic conditions, the credit performance of our loan portfolio and loan origination volume. We may need to raise additional capital in the future based on various factors including, but not limited to: faster than expected increases in the level of non-accrual loans; lower than anticipated recoveries or cash flow from operations; and unexpected limitations on our ability to fund certain loans with credit facilities. 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.

During the fourth quarter of 2013, the U.S. economy continued to grow modestly despite uncertainty surrounding ongoing U.S. budget negotiations, as the global economy continues to show signs of stabilization and the Fed announced its plan to taper bond purchases while assuring they would act carefully in allowing interest rates to rise. The economic expansion was reflected in the strength of U.S. debt and equity capital markets. We expect the broader favorable trends in the U.S. to continue in the near future as Treasury and investment grade bond rates remain relatively low and investors focus on allocating capital to riskier, higher yielding, fixed and floating rate asset classes in order to generate additional yield from their investments. The larger, more liquid segments of the securitization markets also continued to display pricing stability and strong volume. With the strengthening of the high yield loan markets as well as the broader securitization market, conditions in the securitization market for loans (the CLO market) have stabilized and remain attractive for issuers such as NewStar, despite some remaining uncertainty surrounding regulatory changes. We believe that the CLO market, which the Company partially relies upon for funding, has stabilized to a point that it will provide a reliable source of capital for companies like NewStar. In addition to these signs of improving market conditions, we believe the Company has substantially greater financial flexibility and increased financing options due to the improvement in our financial performance.

We believe that our ability to access the capital markets, secure new credit facilities, and renew and/or amend our existing credit facilities continues to demonstrate an overall improvement in the market conditions for funding and indicates progress in our ability to obtain financings on improved terms in the future. Despite these signs of improving market conditions and relative stability in recent years, we cannot assure these conditions will continue, and it is possible that the financial markets could experience stress, volatility, and/or illiquidity. If they do, we could face materially higher financing costs and reductions in leverage, which would affect our operating strategy and could materially and adversely affect our financial condition.

Cash and Cash Equivalents

As of December 31, 2013 and 2012, we had $43.4 million and $27.2 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 unrestricted cash to pay down our credit facilities creating undrawn capacity which may be redrawn to meet liquidity needs in the future.

 

45


Table of Contents

Restricted Cash

Separately, we had $167.9 million and $208.7 million of restricted cash as of December 31, 2013 and 2012, 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 December 31, 2013, we could use $58.8 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 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 December 31, 2013.

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, or if an overcollateralization test is present, excess interest spread cash is diverted, and used to de-lever the securitization to bring the ratio back into compliance. 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 December 31, 2013, we had impaired loans with an aggregate outstanding balance of $271.0 million. Impaired loans with an aggregate outstanding balance of $240.3 million have been restructured and classified as troubled debt restructurings. Impaired loans with an aggregate outstanding balance of $70.7 million were on non-accrual status. During 2013, $17.9 million of loans were charged-off. Impaired loans of $5.1 million were greater than 60 days past due and classified as delinquent. During 2013, we recorded $11.2 million of net specific provisions for impaired loans. Included in our specific allowance for impaired loans was $1.2 million related to delinquent loans.

We closely monitor the credit quality of our loans and leases which are 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 December 31, 2013 and 2012 was $41.4 million and $49.6 million, respectively, or 1.78% and 2.76% of loans and leases, gross, respectively. As of December 31, 2013, we also had a $0.5 million allowance for unfunded commitments, resulting in an allowance for credit losses of 1.80%.

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.

 

46


Table of Contents

Activity in the allowance for loan and lease losses for the years ended December 31, 2013, 2012 and 2011 was as follows:

 

     Year Ended December 31,  
   2013     2012     2011  
   ($ in thousands)  

Balance as of beginning of period

   $ 49,636      $ 63,700      $ 84,503   

General provision for loan and lease losses

     (1,544     (3,918     (1,604

Specific provision for loan losses

     11,159        16,653        18,782   

Net charge offs

     (17,848     (26,799     (37,981
  

 

 

   

 

 

   

 

 

 

Balance as of end of period

     41,403        49,636        63,700   

Allowance for losses on unfunded loan commitments

     451        328        412   
  

 

 

   

 

 

   

 

 

 

Allowance for credit losses

   $ 41,854      $ 49,964      $ 64,112   
  

 

 

   

 

 

   

 

 

 

During 2013 we recorded a total provision for credit losses of $9.7 million. The Company decreased its allowance for credit losses 98 basis points to 1.80% of gross loans at December 31, 2013 from 2.78% at December 31, 2012. The allowance for credit losses ratio excluding the NCOF portfolio purchase was 1.99% at December 31, 2013.

Borrowings and Liquidity

As of December 31, 2013 and 2012, we had outstanding borrowings totaling $2.0 billion and $1.5 billion, respectively. Borrowings under our various credit facilities and term debt securitizations are used to partially fund our positions in our loan portfolio.

As of December 31, 2013, 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

   $ 697,000       $ 452,502       $ 244,498         2015 – 2019   

Term debt (1)

     1,431,374         1,412,374         19,000         2017 – 2023   

Repurchase agreements

     67,954         67,954         ––         2017   

Subordinated debt—Fund membership interest

     30,000         30,000         ––      
  

 

 

    

 

 

    

 

 

    

Total

   $ 2,226,328       $ 1,962,830       $ 263,498      
  

 

 

    

 

 

    

 

 

    

 

(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 certain of these covenants could result in a termination event if not cured. At December 31, 2013, 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, charge-off levels, and overcollateralization tests. In addition, we are required to make termination or make-whole payments in the event that certain of our existing credit facilities are prepaid. These termination or make-whole payments, if triggered, could be material to us individually or in the aggregate, and in the case of certain facilities, could be caused by factors outside of our control, including as a result of loan prepayment by the borrowers under the loan facilities that collateralize these credit facilities.

 

47


Table of Contents

Credit Facilities

As of December 31, 2013 we had four credit facilities: (i) a $275 million credit facility with Wells Fargo Bank, National Association (“Wells Fargo”) to fund leveraged finance loans, (ii) a $125 million credit facility with DZ Bank AG Deutsche Zentral-Genossenschaftbank Frankfurt (“DZ Bank”) to fund asset-based loans, (iii) a $75 million credit facility with Wells Fargo to fund asset-based loans, and (iv) a $75 million credit facility with Wells Fargo to fund new equipment lease origination. As of December 31, 2013, Arlington Fund had one credit facility, consisting of a $147.0 million of Class A Notes (as defined below) with Wells Fargo and $28.0 million of Class B Notes (as defined below) with the Company. The liability under the Class B Notes is eliminated in consolidation in accordance with GAAP.

We have a $275.0 million credit facility with Wells Fargo to fund leverage finance loans with the ability to further increase the commitment amount to $325.0 million, subject to lender approval and other customary conditions. On November 26, 2013, we entered into an amendment to this credit facility which among other things increased the commitment amount to $275.0 million from $175.0 million, with the ability to further increase the commitment amount to $325.0 million, and modified the concentration limits. The credit facility had an outstanding balance of $182.5 million and unamortized deferred financing fees of $3.3 million as of December 31, 2013. The facility provides for a revolving reinvestment period which ends on November 5, 2015 with a two-year amortization period. We must comply with various covenants, the breach of which could result in a termination event if not cured. These covenants include, but are not limited to, failure to service debt obligations, failure to maintain minimum levels of liquidity, and failure to meet tangible net worth covenants and overcollateralization tests. At December 31, 2013, we were in compliance with all such covenants. Interest on this facility accrued at a variable rate per annum.

We have a $125.0 million credit facility with DZ Bank that had an outstanding balance of $82.2 million and unamortized fees of $0.7 million as of December 31, 2013. Interest on this facility accrues at a variable rate per annum. As part of the agreement, there is a minimum interest charge of $1.9 million per annum. If the facility is not utilized to cover this minimum requirement, then a make-whole fee is assessed to satisfy the minimum requirement. We are permitted to use the proceeds of borrowings under the credit facility to fund advances under asset-based loan commitments. The commitment amount under the credit facility matures on June 30, 2015.

We have a $75.0 million credit facility with Wells Fargo to fund asset-based loan origination. The credit facility had an outstanding balance of $59.4 million and unamortized deferred financing fees of $0.4 million as of December 31, 2013. Interest on this facility accrues at a variable rate per annum. The credit facility may be increased to an amount up to $150.0 million subject to lender approval and other customary conditions. The credit facility matures on December 7, 2015. We must comply with various covenants, the breach of which could result in a termination event if not cured. These covenants include, but are not limited to, failure to service debt obligations, net worth covenants, interest coverage ratios, minimum excess availability and violations of pool default and charged off tests.

We have a note purchase agreement with Wells Fargo under the terms of which Wells Fargo agreed to provide a $75.0 million credit facility to fund new equipment lease originations. The credit facility matures on November 16, 2016 subject to early termination or extension. We must comply with various covenants, the breach of which could result in a termination event if not cured. These covenants include, but are not limited to, failure to service debt obligations, failure to maintain minimum levels of liquidity, failure to hedge portfolio interest rate risk, failure to meet tangible net worth covenants and violations of pool default and delinquency tests. The credit facility had an outstanding balance of $8.0 million and unamortized deferred financing fees of $0.9 million as of December 31, 2013.

On April 4, 2013, Arlington Fund entered into an agreement establishing $147.0 million of Class A Notes and $28.0 million of Class B Notes to partially fund eligible middle market loan origination. Wells Fargo has committed to fund the Class A Notes as the initial Class A lender and we have committed to fund the Class B Notes as the initial Class B lender. Advances under the Class A Notes and the Class B Notes may be drawn,

 

48


Table of Contents

repaid, and drawn again subject to availability under the a borrowing base. The Class A Notes and the Class B Notes provide for a reinvestment period of one year ending on April 4, 2014, unless a one year extension is requested, followed by a three year amortization period. The Class A Notes had an outstanding balance of $120.3 million and unamortized deferred financing fees of $1.0 million as of December 31, 2013. The liability under the Class B Notes is eliminated in consolidation in accordance with GAAP.

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, January 27, 2012, November 5, 2012, and December 4, 2012. The agreement was amended and restated on May 13, 2013 and further amended on June 3, 2013. The credit facility, as amended, consists of a $200.0 million term note with Fortress Credit Corp. as agent, which consists of the existing outstanding balance of $100.0 million (the “Existing Funding”), an initial funding of $70.0 million (the “Initial Funding”), and two subsequent borrowings, of $5.0 million (the “Delay Draw Term A”) and $25.0 million (the “Delay Draw Term B”). The Existing Funding, the Initial Funding, and the Delay Draw Term A mature on May 11, 2018. The Delay Draw Term B matures on June 3, 2016. The Initial Funding, the Existing Funding and the Delay Draw Term A accrue interest at the London Interbank Offered Rate (LIBOR) plus 4.50% with an interest rate floor of 1.00%. The Delay Draw Term B accrues interest at LIBOR plus 3.375% with an interest rate floor of 1.00%.

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, acquisitions and repurchasing capital stock and dividend payments up to $37.5 million, The $37.5 million may be adjusted upward by the amount of fiscal year-end net income excluding depreciation and amortization expense.

The term note may be prepaid at any time subject to a prepayment fee of 1.00% which is payable in the case of certain prepayments made prior to May 13, 2014. The term note may be prepaid at par in the event of a change of control. As of December 31, 2013, the term note had an outstanding principal balance of $200.0 million and unamortized deferred financing fees of $5.0 million.

Subordinated debt—Fund membership interest

As of December 31, 2013, we had purchased membership interests totaling $5.0 million in Arlington Fund and a third-party investor had purchased membership interests totaling $30.0 million. As a result of consolidating Arlington Fund as a variable interest entity, or VIE, the membership interests representing equity ownership of Arlington Fund are characterized as debt in our consolidated statement of financial position. We apply an imputed interest rate to that debt and records the resulting interest expense in its consolidated statement of operations. The actual return on investments in Arlington Fund’s membership interests may or may not equal the imputed rate applied to the membership interests that are characterized as debt. In the consolidation, we eliminate the economic results of its related portion of the membership interests and the applied interest expense from its results of operations and statements of financial position.

Term Debt Securitizations

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 CLO Trust’s trust certificates. At December 31, 2013, the $164.4 million of outstanding drawn notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $208.2 million. At December 31, 2013, deferred financing fees were $0. The 2006 CLO Trust permitted reinvestment of collateral principal repayments for a five-year period which ended in June 2011. During 2011, we repurchased $7.0 million of the 2006 CLO

 

49


Table of Contents

Trust’s Class C notes, $6.0 million of the 2006 CLO Trust’s Class D notes and $2.0 million of the 2006 CLO Trust’s Class E 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 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. During 2011, Moody’s upgraded its ratings of all of the notes of the 2006 CLO Trust. During the third quarter of 2012, Fitch affirmed its ratings of all of the notes of the 2006 CLO Trust. During the fourth quarter of 2012, Standard and Poor’s upgraded the Class D notes and the Class E notes and affirmed the rating of the Class A-1 notes, the Class A-2 notes, the Class B notes and the Class C notes of the 2006 CLO Trust.

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 2006 CLO Trust is in default under the terms of the indenture, the excess interest spread from the 2006 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 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.

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

 

     Notes and
certificates
originally
issued
     Outstanding
balance
December 31,
2013
     Borrowing
spread to
LIBOR
   

Ratings
(S&P/Moody’s/
Fitch)(1)

     ($ in thousands)      %      

2006 CLO Trust:

          

Class A-1

   $ 320,000       $ 91,007         0.27   AA+/Aaa/AAA

Class A-2

     40,000         12,180         0.28      AA+/Aaa/AAA

Class B

     22,500         22,500         0.38      AA/Aa2/AA

Class C

     35,000         28,000         0.68      BBB+/A3/A

Class D

     25,000         6,250         1.35      B+/Baa3/BBB

Class E

     13,750         4,500         1.75      CCC+/Ba1/BB
  

 

 

    

 

 

      

Total notes

     456,250         164,437        

Class F (trust certificates)

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

 

 

    

 

 

      

Total for 2006 CLO Trust

   $ 500,000       $ 208,187        
  

 

 

    

 

 

      

 

(1) These ratings were initially given in June 2006, are unaudited and are subject to change from time to time. During the first quarter of 2009, Fitch affirmed its ratings. During the first quarter of 2009, Moody’s downgraded the Class C notes, the Class D notes and the Class E notes. During the third quarter of 2009, Moody’s downgraded the Class A-1 notes, the Class A-2 notes and the Class B note. 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. During the fourth quarter of 2011, Moody’s upgraded all of the notes to the ratings shown above. During the third quarter of 2012, Fitch affirmed its ratings. During the fourth quarter of 2012, Standard and Poor’s upgraded the Class D notes and the Class E notes to the ratings shown above and affirmed the rating of the Class A-1 notes, the Class A-2 notes, the Class B notes and the Class C notes (source: Bloomberg Finance L.P.).

 

50


Table of Contents

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 “2007-1 CLO Trust”) and contributed $600 million in loans and investments (including unfunded commitments), or portions thereof, to the 2007-1 CLO Trust. We remain the servicer of the loans. Simultaneously with the initial contributions, the 2007-1 CLO Trust issued $546.0 million of notes to institutional investors. We retained $54.0 million, comprising 100% of the 2007-1 CLO Trust’s trust certificates. At December 31, 2013, the $465.0 million of outstanding drawn notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $519.0 million. At December 31, 2013, deferred financing fees were $1.3 million. The 2007-1 CLO Trust permitted reinvestment of collateral principal repayments for a six-year period which ended in May 2013. During 2012, we repurchased $0.2 million of the 2007-1 CLO Trust’s Class C notes. During 2010, we repurchased $5.0 million of the 2007-1 CLO Trust’s Class D notes. During 2009, we repurchased $1.0 million of the 2007-1 CLO Trust’s Class D notes. During 2009, Moody’s downgraded all of the notes of the 2007-1 CLO Trust. As a result of the downgrade, amortization of the 2007-1 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 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 2007-1 CLO Trust. The downgrade did not have any material consequence as the amortization of the 2007-1 CLO Trust changed from pro rata to sequential after the Moody’s downgrade in 2009. During the second quarter of, 2011, Moody’s upgraded the Class C notes, the Class D notes, and the Class E notes. During 2011, Standard and Poor’s upgraded the Class D notes. During the fourth quarter of 2011, Moody’s upgraded all of the notes of the 2007-1 CLO Trust. During the third quarter of 2012, Fitch affirmed its ratings of all of the notes of the 2007-1 CLO Trust. During the second quarter of 2013, Moody’s upgraded the Class B notes, the Class C notes, the Class D notes, and the Class E notes and affirmed its ratings of the Class A-1 notes and the Class A-2 notes of the 2007-1 CLO Trust.

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 2007-1 CLO Trust is in default under the terms of the indenture, the excess interest spread from the 2007-1 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 defaults in the 2007-1 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.

The following table sets forth selected information with respect to the 2007-1 CLO Trust:

 

     Notes
originally
issued
     Outstanding
balance
December 31,
2013
     Borrowing
spread to
LIBOR
   

Ratings
(S&P/Moody’s/
Fitch)(1)

     ($ in thousands)             

2007-1 CLO Trust

          

Class A-1

   $ 336,500       $ 275,180         0.24   AA+/Aaa/AAA

Class A-2

     100,000         86,564         0.26      AA+/Aaa/AAA

Class B

     24,000         24,000         0.55      AA/Aa1/AA

Class C

     58,500         58,293         1.30      BBB+/A2/A

Class D

     27,000         21,000         2.30      BB-/Baa2/BBB+
  

 

 

    

 

 

      

Total notes

     546,000         465,037        

Class E (trust certificates)

     29,100         29,100         N/A      CCC-/Ba3/BB

Class F (trust certificates)

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

 

 

    

 

 

      

Total for 2007-1 CLO Trust

   $ 600,000       $ 519,037        
  

 

 

    

 

 

      

 

51


Table of Contents

 

(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. 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. During the second quarter of 2011, Moody’s upgraded the Class C notes and the Class D notes. During the second quarter of 2011, Standard and Poor’s upgraded the Class D notes to the rating shown above. During the fourth quarter of 2011, Moody’s upgraded all of the notes. During the third quarter of 2012, Fitch affirmed its ratings. During the second quarter of 2013, Moody’s upgraded the Class B notes, the Class C notes, the Class D notes and the Class E notes to the ratings shown above, and affirmed its ratings of the Class A-1 notes and the Class A-2 notes (source: Bloomberg Finance L.P.).

On December 18, 2012, we completed a term debt transaction. In conjunction with this transaction we established a separate single-purpose bankruptcy-remote subsidiary, NewStar Commercial Loan Funding 2012-2 LLC (the “2012-2 CLO Trust”) and contributed $325.9 million in loans and investments (including unfunded commitments), or portions thereof, to the 2012-2 CLO Trust. We remain the servicer of the loans. Simultaneously with the initial contributions, the 2012-2 CLO Trust issued $263.3 million of notes to institutional investors. We retained $62.6 million, comprising 100% of the 2012-2 CLO Trust’s trust certificates and subordinated notes. At December 31, 2013, the $263.3 million of outstanding drawn notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $325.9 million. At December 31, 2013, deferred financing fees were $2.9 million. The 2012-2 CLO Trust permits reinvestment of collateral principal repayments for a three-year period ending in January 2016. 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.

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 2012-2 CLO Trust is in default under the terms of the indenture, the excess interest spread from the 2012-2 CLO Trust may not be distributed if the overcollateralization ratio, or other collateral quality tests, are not satisfied. We may have defaults in the 2012-2 CLO Trust in the future. If we do not elect to remove any future defaulted loans, we may not receive excess interest spread payments until the overcollateralization ratio, or other collateral quality tests, are cured.

The following table sets forth selected information with respect to the 2012-2 CLO Trust:

 

     Notes
originally
issued
     Outstanding
balance
December 31,
2013
     Borrowing
spread to
LIBOR
   

Ratings
(Moody’s/
S&P)(1)

     ($ in thousands)             

2012-2 CLO Trust

          

Class A

   $ 190,700       $ 190,700         Libor+1.90   Aaa/AAA

Class B

     26,000         26,000         Libor+3.25   Aa2/N/A

Class C

     35,200         35,200         Libor+4.25   A2/N/A

Class D

     11,400         11,400         Libor+6.25   Baa2/N/A
  

 

 

    

 

 

      

Total notes

   $ 263,300       $ 263,300        

Class E (trust certificates)

     16,300         16,300         N/A      Ba1/N/A

Class F (trust certificates)

     24,100         24,100         N/A      B2/N/A

Subordinated notes

     22,183         22,183         N/A      N/A
  

 

 

    

 

 

      

Total for 2012-2 CLO Trust

   $ 325,883       $ 325,883        
  

 

 

    

 

 

      

 

(1) These ratings were initially given in December 2012, are unaudited and are subject to change from time to time.

 

52


Table of Contents

On September 11, 2013, we completed a term debt transaction through our separate single-purpose bankruptcy-remote subsidiary, NewStar Commercial Loan Funding 2013-1 LLC (the “2013-1 CLO Trust”) and contributed $247.6 million in loans and investments (including unfunded commitments), or portions thereof, to the 2013-1 CLO Trust. We remain the servicer of the loans. Simultaneously with the initial contributions, the 2013-1 CLO Trust issued $338.6 million of notes to institutional investors. We retained $61.4 million, comprising 100% of the 2013-1 CLO Trust’s trust certificates and subordinated notes. At December 31, 2013, the $319.6 million of outstanding drawn notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $381.0 million. At December 31, 2013, deferred financing fees were $5.5 million. The 2013-1 CLO Trust permits reinvestment of collateral principal repayments for a three-year period ending in September 2016. 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.

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 2013-1 CLO Trust is in default under the terms of the indenture, the excess interest spread from the 2013-1 CLO Trust may not be distributed if the overcollateralization ratio, or other collateral quality tests, are not satisfied. We may have defaults in the 2013-1 CLO Trust in the future. If we do not elect to remove any future defaulted loans, we may not receive excess interest spread payments until the overcollateralization ratio, or other collateral quality tests, are cured.

The following table sets forth selected information with respect to the 2013-1 CLO Trust:

 

     Notes
originally
issued
     Outstanding
balance
December 31,
2013
     Borrowing
spread to
LIBOR
    Ratings
(S&P/
Moody’s)(2)
 
     ($ in thousands)               

2013-1 CLO Trust

          

Class A-T

   $ 202,600       $ 202,600         Libor+1.65     AAA/Aaa   

Class A-R

     35,000         16,000         (1     AAA/Aaa   

Class B

     38,000         38,000         Libor+2.30     AA/N/A   

Class C

     36,000         36,000         Libor+3.80     A/N/A   

Class D

     21,000         21,000         Libor+4.55     BBB/N/A   

Class E

     6,000         6,000         Libor+5.30     BBB-/N/A   
  

 

 

    

 

 

      

Total notes

     338,600         319,600        

Class F (trust certificates)

     17,400         17,400         N/A        N/A   

Class G (trust certificates)

     15,200         15,200         N/A        N/A   

Subordinated notes

     28,800         28,800         N/A        N/A   
  

 

 

    

 

 

      

Total for 2013-1 CLO Trust

   $ 400,000       $ 381,000        
  

 

 

    

 

 

      

 

(1) Class A-R Notes will accrue interest at the Class A-R CP Rate so long as they are held by a CP Conduit, and otherwise will accrue interest at the Class A-R LIBOR Rate or, in certain circumstances, the Class A-R Base Rate, but in no event shall interest rate payable pari passu with the Class A-T Notes exceed the Class A-R Waterfall Rate Cap.
(2) These ratings were initially given in September 2013, are unaudited and are subject to change from time to time.

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. 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%. The 2005

 

53


Table of Contents

CLO Trust permitted reinvestment of collateral principal repayments for a three-year period which ended in October 2008. During 2013, we repurchased $5.0 million of the 2005 CLO Trust’s Class C notes and $2.4 million of the Class D notes. During 2012, we repurchased $9.8 million of the 2005 CLO Trust’s Class D notes and $0.9 million of the Class E notes. During 2011, we repurchased $3.9 million of 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. On October 25, 2013, we called the 2005 CLO Trust and redeemed the notes at par. In conjunction with the call, we received a principal distribution of $9.2 million.

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 “2009-1 CLO Trust”) and contributed $225 million in loans and investments (including unfunded commitments), or portions thereof, to the 2009-1 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. Simultaneously with the initial contributions, the 2009-1 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. The 2009-1 CLO Trust was a static pool of loans that did not permit for reinvestment of collateral principal repayments. The 2009-1 CLO Trust was callable without penalty on the distribution date in July 2011 and on each distribution date thereafter. On August 1, 2011, we called the 2009-1 CLO Trust and redeemed the notes without penalty and recognized a total of $3.0 million of interest expense due to the accelerated amortization of deferred financing fees and unamortized discount.

Repurchase Agreement

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 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. On October 2, 2013, we entered into an amendment to this financing arrangement which, among other things, extended the date it had agreed to repurchase all of the commercial mortgage loans by one year to June 7, 2017, provided for $25.5 million of additional advances for existing eligible assets owned by us, allowed for the advance of up to $15.0 million to fund an additional commercial mortgage loan, and released $41.1 million of principal payments to us as unrestricted cash. The facility accrues interest at a variable rate per annum, which was 5.17% as of December 31, 2013. As of December 31, 2013, unamortized deferred financing fees were $1.3 million and the outstanding balance was $68.0 million. During 2013, we made principal payments totaling $3.2 million and borrowed $40.5 million. As part of the amended agreement, there is a minimum aggregate interest margin payment of $9.2 million required to be made over the life of the facility. We cannot control the rate at which the underlying commercial mortgage loans are repaid. 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.

Stock Repurchase Program

On November 19, 2012, our Board of Directors 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 were determined by the company’s management based on its

 

54


Table of Contents

evaluation of market condition and other factors. The repurchase program expired on December 31, 2013. Upon completion of the stock repurchase program, we had repurchased 17,665 shares of its common stock under the program at a weighted average price per share of $12.22.

On September 29, 2011, our Board of Directors 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 expired on September 29, 2012. Upon the expiration of the stock repurchase program, the Company had repurchased 252,450 shares of its common stock at a weighted average price per share of $10.26.

Contractual Obligations

The following table sets forth information relating to our contractual obligations as of December 31, 2013:

 

     Payments due by period         
     Less than 1
year
     1-3 years      3-5 years      More than 5
years
     Total  
     ($ in thousands)  

Credit facilities (1)

   $       $ 149,656       $ 302,846       $ ––      $ 452,502   

Term debt (1)

            25,000         175,000         1,212,373         1,412,373   

Repurchase agreement

     ––         ––         67,954         ––         67,954   

Subordinated debt—Fund membership interest

     ––         ––         30,000         ––         30,000   

Non-cancelable operating leases

     1,452         2,581         2,622         1,175         7,830   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,452       $ 177,237       $ 578,422       $ 1,213,548       $ 1,970,659   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Amounts for credit facilities and term debt presented represent principal amounts due based on contractual maturity dates and do not include interest amounts owed. The actual timing of payments will ultimately vary from the above data due to future fundings and repayments we expect to occur.

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We maintain an overall risk management strategy that may incorporate the use of derivative instruments to minimize significant unplanned fluctuations in earnings caused by interest rate volatility. Our operations are subject to risks resulting from interest rate fluctuations on our interest-earning assets and our interest-bearing liabilities. We seek to provide maximum levels of net interest income, while maintaining acceptable levels of interest rate and liquidity risk. As such, we may enter into interest rate swap and interest rate cap agreements to hedge interest rate exposure to interest rate fluctuations on floating rate funding agreement liabilities that are matched with fixed rate securities. Under the interest rate swap contracts, we agree to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated on an agreed-upon notional principal amount. We record the exchanged amount in net interest income in our statements of operations. Under the interest rate cap contracts, we agree to exchange, at specified intervals, the difference between a specified fixed interest (the cap) and floating interest amounts calculated on an agreed-upon notional principal amount, but only if the floating interest rate exceeds the cap rate. The interest rate caps may not be matched to specific assets or liabilities and would not qualify for hedge accounting.

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.

 

55


Table of Contents

Gains and losses on derivatives not designated as hedges, including any cash payments made or received, are reported as gain or (loss) on derivatives in our consolidated statements of operations.

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. During 2011, the lone remaining outstanding interest rate swap agreement was terminated. We record the contracted interest rate swap net amounts exchanged in interest expense in the accompanying consolidated statements of operations. During 2011, the Company recorded hedge ineffectiveness of $51,841, which is included in loss on derivatives in the Company’s consolidated statements of operations. We did not have any material outstanding derivatives as of December 31, 2013 and 2012.

 

56


Table of Contents

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 instruments.

Our 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. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

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

At December 31, 2013, we had $326.2 million of unused lines of credit. Of these unused lines of credit, unfunded commitments related to revolving credit facilities were $271.9 million and unfunded commitments related to delayed draw term loans were $49.0 million. $5.3 million of the unused revolving 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 $271.9 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 December 31, 2013, we categorized $197.7 million of the unfunded commitments related to revolving credit facilities as contingent. Unrestricted commitments represent commitments that are currently accessible, assuming the borrower is in compliance with certain customary loan terms and conditions. At December 31, 2013, we had $74.2 million of unfunded unrestricted revolving commitments.

During the three months ended December 31, 2013, revolver usage averaged approximately 41%, which is line with the average of 46% 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 months ended December 31, 2013, revolving commitments increased $14.6 million.

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 or acquisitions in corporate loans or for tenant improvements in commercial real estate loans. During the three months ended December 31, 2013, delayed draw credit facility commitments decreased $8.6 million.

Standby letters of credit are conditional commitments issued by us 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 credit to our borrowers. At December 31, 2013 we had $6.9 million of standby letters of credit.

 

57


Table of Contents

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. At December 31, 2013 and December 31, 2012, the fair value of the interest rate mitigation products was $0.

Critical Accounting Policies

Accounting policies involving significant estimates and assumptions by management, which have, or could have, a material impact on our financial statements, are considered critical accounting policies. The following are our critical accounting policies:

Allowance for credit losses

A general allowance is provided for loans and leases that are not impaired and for which no specific impairment has been identified. 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 and equipment finance products, the data set used to construct probabilities of default in its allowance for loan 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 terms in determining a loan loss in the event of default.

For Business Credit loans, the Company utilizes a proprietary model to risk rate the loans on a monthly basis. This model captures the impact of changes in industry and economic conditions as well as changes in the quality of the borrower’s collateral and financial performance to assign a final risk rating. The Company has also evaluated historical loss trends by risk rating from a comprehensive industry database covering more than twenty-five years of experience of the majority of the asset based lenders operating in the United States. Based upon the monthly risk rating from the model, the reserve is adjusted to reflect the historical average for expected loss from the industry database.

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.

For consolidated variable interest entities to which the Company is providing transitional capital, we utilize a qualitative analysis which considers the business plans related to the entity, including expected hold periods,

 

58


Table of Contents

the terms of the agreements related to the entity, the Company’s historical credit experience, the credit migration of the entity’s loans in determining expected loss, as well as conditions in the capital markets.

The Company periodically reviews its allowance for credit loss methodology to assess any necessary adjustments based upon changing economic and capital market conditions. If the Company determines that 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. There have been no material modifications to the allowance for credit losses methodology during 2013. Given uncertain market conditions, actual losses under the Company’s current or any revised allowance methodology may differ materially from the Company’s estimate.

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.

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. Impaired loans include all non-accrual loans, loans with partial charge-offs and loans which are Troubled Debt Restructurings. 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. The allowance for credit losses is based on a loan-by-loan build-up of inherent losses on loans, gross. We also maintain an allowance for losses on unfunded loan commitments, namely loan commitments and letters of credit that are reported in other liabilities on the balance sheet. The combined balance of the allowance for loan losses and the allowance for unfunded commitments is referred to as the allowance for credit losses. As of December 31, 2013, we had an allowance for credit losses of $41.9 million, with specific allowances totaling $23.3 million.

Impaired loans at December 31, 2013 were in Real Estate, Leveraged Finance, and Business Credit 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.

Loans deemed to be uncollectible are charged off and the allowance is reduced by the charged off balance of the loan. The provision for credit losses and recoveries on loans previously charged off are added to the allowance.

Valuation of deferred tax assets

We recognize deferred tax assets and liabilities resulting from the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit

 

59


Table of Contents

carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We regularly review our deferred tax assets to assess their potential realization and whether or not a valuation allowance is necessary. In performing these reviews we make estimates about future profits and tax planning strategies that would affect future taxable income and the realization of these deferred tax assets. A change in these assumptions could result in a difference in valuation and impact our results of operations. Based upon our assessment, we believe that a valuation allowance was not necessary as of December 31, 2013.

On January 1, 2007, the Company adopted ASC 740 (Accounting for Uncertainty in Income Taxes—An interpretation of FASB Statement No. 109). ASC 740 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. A company can only recognize the tax position in the financial statements if the position is more-likely-than-not to be upheld on audit, based only on the technical merits of the tax position. If the recognition threshold is met, the tax benefit is measured at the largest amount that is more than 50% likely of being realized upon ultimate settlement. At December 31, 2013, the Company did not have any significant unrecognized tax benefits, and there have been no material changes since adoption. The Company does not expect any significant changes within the next 12 months.

ASC 740 also addresses how interest and penalties should be accrued for uncertain tax positions, requiring that interest expense should be recognized in the first period interest would be accrued under the tax law. The Company classifies all interest and penalties on recognized tax benefits as a part of income tax expense.

The Company files U.S. federal and state income tax returns. As of December 31, 2013, the Company is subject to examination by the Internal Revenue Service and most state tax authorities for tax years after December 31, 2009. A few states remain subject to examination for the year ended December 31, 2009.

Fair Value

The Company utilizes fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. The Company differentiates between those assets and liabilities required to be carried at fair value at every reporting period (“recurring”) and those assets and liabilities that are only required to be adjusted to fair value under certain circumstances (“nonrecurring”). Cash and cash equivalents, investments in debt securities, available-for-sale, and derivatives are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other financial assets on a nonrecurring basis, such as loans held-for-sale, loans held-for-investment, and other real estate owned. These nonrecurring fair value adjustments typically involve application of the lower of cost or market accounting or write-downs of individual assets. Further, the notes to the consolidated financial statements include information about the extent to which fair value is used to measure assets and liabilities and the valuation methodologies used.

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.

 

60


Table of Contents

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.

For assets and liabilities recorded at fair value, it is the Company’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in ASC 820. When available, the Company utilizes quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that use primarily market-based or independently sourced market parameters, including interest rate yield curves, prepayment speeds, option volatilities and other assumptions. However, in certain cases, when market observable inputs for model-based valuation techniques may not be readily available, the Company is required to make judgments about assumptions market participants would use in estimating the fair value of the financial instrument. The models used by the Company to determine fair value adjustments are periodically evaluated by management for relevance under current facts and circumstances.

The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, the Company would use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement.

Revenue recognition

Interest income is recorded on the accrual basis in accordance with the terms of the respective loan and debt product. The accrual of interest on loans and other debt products is discontinued when principal or interest payments are past due by 90 days or more or when, in the opinion of management, it is probable we will be unable to collect contractual principal and interest in the normal course of business. If loans are placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest income on non-accrual loans is subsequently recognized only to the extent that cash is received and the principal balance is deemed collectible.

Nonrefundable fees and related direct costs associated with the origination or purchase of loans and other debt products are deferred and netted against balances outstanding. The net deferred fees or costs are recognized as an adjustment to interest income over the contractual life of the loans using a method which approximates the effective interest method. In connection with the prepayment of a loan or other debt product, a partial amount of the remaining unamortized net deferred fees, costs, premiums or discounts are accelerated and recognized as interest income. The amortization of fees is discontinued on non-accrual loans. Depending on the terms of a loan or other debt product, we may charge a prepayment fee and recognize it in the period of the prepayment. We accrete any discount and amortize any premium from purchased debt products or acquired loans in a business combination into interest income as a yield adjustment over the contractual life. Syndication, arrangement and structuring fees are recognized in the period the service is completed as a component of non-interest income.

Stock-based compensation

Effective January 1, 2006, we adopted ASC 718 (Share-Based Payment), which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values on the grant date. We adopted ASC 718 using the prospective method.

For awards granted, modified, repurchased or cancelled after January 1, 2006, we estimate the fair value of stock-based awards using the Black-Scholes valuation model, which requires the input of subjective assumptions,

 

61


Table of Contents

including expected term and expected price volatility. Changes in these assumptions can materially affect the calculated fair value of stock-based compensation and the related expense to be recognized. Further, for awards that contain performance measures and conditions, we make an assessment, based on management’s judgment, of the probability of these conditions being satisfied, which affects the timing and the amount of expense to be recognized. If our judgment as to whether these conditions are probable of occurrence are not appropriate, the financial statements could be materially affected.

Equity method of accounting

As the result of a troubled debt restructuring, we may acquire a portion of the equity in the borrower. In certain cases where we have the ability to exercise significant influence over the borrower, we account for our equity interest under the equity method of accounting. Under the equity method of accounting, we recognize our proportional share of the borrower’s net income as determined under U.S. generally accepted accounting principles (“GAAP”) in our results of operations. In cases where the equity of the underlying company has no value, and the borrower incurs losses, we will apply our proportional share of the GAAP loss against the principal of the outstanding loan to the borrower.

Valuation of investments in debt securities

We review the fair value of our other debt products quarterly. The fair value of our investments in debt securities, non-investment grade securities and residual securities, are based on independent third-party quoted market prices, when available, at the reporting date for those or similar investments. When no market is available, we estimate fair value using various valuation methodologies, including cash flow analysis and internally generated financial models that incorporate significant assumptions and judgments, as well as qualitative factors.

Even if the general accuracy of our valuation models are validated, there are no assurances that our valuations are accurate because of the high number of variables that affect cash flows associated with these complex cash flow structures, which differ on each securitization. Valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships that drive the results of the model. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily ascertainable market value, the fair value of investments may differ significantly from the values that would have been used had a market existed for the investments, and the differences could be material. In addition, if our estimates or assumptions with respect to these assets prove to be incorrect, we may be required to write down some or all of the value of these assets.

A debt product is considered impaired when the fair value of the debt product declines below its amortized cost. The cost basis of the investment is then written down to fair value. If management determines the impairment to be temporary, it is recorded in other comprehensive income, a component of stockholders’ equity. If management determines the impairment to be other than temporary, it is recorded as an offset to other income on our statements of operations. From time to time we may become aware of cash flow or credit issues with respect to our other debt products and these other debt products are then monitored by management to determine if a write-down is appropriate.

Although we view write-downs of our other debt products as a normal and anticipated aspect of our business, material write-downs of the fair value of our other debt products could adversely affect our results of operations and financial condition. Our allowance for credit losses does not cover write-downs because we classify these assets as available-for-sale securities.

The description of certain instruments as “debt securities” is intended to describe the accounting treatment of those instruments and is not a characterization of those instruments as securities for any other purpose.

 

62


Table of Contents
Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to changes in market values of our loans held-for-sale, which are carried at lower of cost or market, and our investment in debt securities, available-for-sale and derivatives, which are carried at fair value. Fair value is defined as the market price for those securities for which a market quotation is readily available and for all other investments and derivatives, fair value is determined pursuant to a valuation policy and a consistent valuation process. Where a market quotation is not readily available, we estimate fair value using various valuation methodologies, including cash flow analysis, as well as qualitative factors.

As of December 31, 2013 and 2012, investments in debt securities available-for-sale totaled $22.2 million and $21.1million, respectively. At December 31, 2013 and 2012, our net unrealized gain on those debt securities totaled $1.0 million and $0.2 million, respectively. Any unrealized gain or loss on these investments is included in Other Comprehensive Income in the equity section of the balance sheet, until realized.

Interest rate risk represents a market risk exposure to us. Interest rate risk is measured as the potential volatility to our net interest income caused by changes in market interest rates.

As of December 31, 2013, approximately 3% of the loans in our portfolio were at fixed rates and approximately 97% were at variable rates. Additionally, for the loans at variable rates, approximately 86% contain an interest rate floor. Our credit facilities and term debt securitizations all bear interest at variable rates without interest rate floors, however, our corporate credit facility contains an interest rate floor set at a rate of 1.00%.

The presence of interest rate floors in our loan agreements results in assets with hybrid fixed and floating rate loan characteristics. Provided that the contractual interest rate remains at or below the interest rate floor, a performing loan will typically behave as a fixed rate instrument. If contractual interest rates are in excess of the interest rate floor, a performing loan will typically behave as a floating rate instrument. In a low interest rate environment, floors provide a benefit as we are able to earn additional income equal to the difference between the stated rate of the interest rate floor and the corresponding contractual rate. If interest rates rise, the potential benefit provided by interest rate floors would decrease resulting in lower net interest income. The cost of our variable rate debt would increase, while interest income from loans with interest rate floors would not change until interest rates exceed the stated rate of the interest rate floors or upon the re-pricing or principal repayment of the loans.

The following table shows the hypothetical estimated change in net interest income over a 12-month period based on a static, instantaneous parallel shift in interest rates applied to our portfolio and cash and cash equivalents as of December 31, 2013. Our modeling is based on contractual terms and does not consider prepayment or changes in the composition of our portfolio or our current capital structure. It further generalizes that both variable rate assets and liabilities are indexed to a flat 3 month LIBOR yield curve. Although we believe these measurements are representative of our interest rate sensitivity, we can give no assurance that actual results would not differ materially from our modeled outcomes.

 

     Rate Change
(Basis Points)
     Estimated Change in
Net Interest Income
Over 12 Months
 
            ($ in thousands)  

Decrease of

     100       $ 12,600   

Increase of

     100         (11,360

Increase of

     200         (8,530

Increase of

     300         (4,030

The estimated changes in net interest income reflect the potential effect of interest rate floors on loans totaling approximately $1.9 billion. Due to the presence of these interest rate floors, as interest rates begin to rise

 

63


Table of Contents

from current levels, the cost of our variable rate debt increases. The interest rate on performing loans will remain fixed until the contractual rate exceeds the stated rate on the interest rate floors. Consequently, the result is a negative net interest income impact as interest rates initially increase until they reach an inflection point. Beyond this inflection point, which is typically close to the portfolios weighted average stated floor rate, the benefit of rising rates begins to accrue to us as the interest rate on performing loans starts to adjust upward.

 

64


Table of Contents
Item 8. Financial Statements and Supplementary Data

NEWSTAR FINANCIAL, INC.

INDEX TO FINANCIAL STATEMENTS

 

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

     66   

Report of Independent Registered Public Accounting Firm

     67   

Consolidated Balance Sheets as of December 31, 2013 and 2012

     68   

Consolidated Statements of Operations for the years ended December 31, 2013, 2012 and 2011

     69   

Consolidated Statements of Comprehensive Income for the years ended December 31, 2013, 2012 and 2011

     70   

Consolidated Statement of Changes in Stockholders’ Equity for the years ended December  31, 2013, 2012 and 2011

     71   

Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011

     72   

Notes to Consolidated Financial Statements

     73   

 

65


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

NewStar Financial, Inc.:

We have audited NewStar Financial, Inc.’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). NewStar Financial, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, NewStar Financial, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of NewStar Financial, Inc. as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2013, and our report dated March 14, 2014 expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Boston, Massachusetts

March 14, 2014

 

66


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

NewStar Financial, Inc.:

We have audited the accompanying consolidated balance sheets of NewStar Financial, Inc. and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NewStar Financial, Inc. and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control -Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Boston, Massachusetts

March 14, 2014

 

67


Table of Contents

NEWSTAR FINANCIAL, INC.

CONSOLIDATED BALANCE SHEETS

 

     December 31,
2013
    December 31,
2012
 
    

($ in thousands, except share

and par value amounts)

 

Assets:

    

Cash and cash equivalents

   $ 43,401      $ 27,212   

Restricted cash

     167,920        208,667   

Investments in debt securities, available-for-sale

     22,198        21,127   

Loans held-for-sale, net

     14,831        51,602   

Loans and leases, net

     2,095,250        1,720,789   

Deferred financing costs, net

     21,386        19,064   

Interest receivable

     7,415        9,003   

Property and equipment, net

     833        433   

Deferred income taxes, net

     30,238        42,463   

Income tax receivable

     2,007        4,311   

Other assets

     24,983        52,399   
  

 

 

   

 

 

 

Subtotal

     2,430,462        2,157,070   

Assets of Consolidated Variable Interest Entity:

    

Restricted cash

     1,950        0   

Loans, net

     171,427        0   

Deferred financing costs, net

     997        0   

Interest receivable

     1,079        0   

Other assets

     946        0   
  

 

 

   

 

 

 

Total assets of Consolidated Variable Interest Entity

     176,399        0   
  

 

 

   

 

 

 

Total assets

   $ 2,606,861      $ 2,157,070   
  

 

 

   

 

 

 

Liabilities:

    

Credit facilities

   $ 332,158      $ 229,941   

Term debt

     1,412,374        1,221,764   

Repurchase agreements

     67,954        30,583   

Accrued interest payable

     6,333        3,330   

Accounts payable

     588        404   

Other liabilities

     19,623        76,231   
  

 

 

   

 

 

 

Subtotal

     1,839,030        1,562,253   

Liabilities of Consolidated Variable Interest Entity:

    

Credit facilities

     120,344        0   

Accrued interest payable—credit facilities

     434        0   

Subordinated debt—Fund membership interest

     30,000        0   

Accrued interest payable—Fund membership interest

     843        0   
  

 

 

   

 

 

 

Total liabilities of Consolidated Variable Interest Entity

     151,621        0   
  

 

 

   

 

 

 

Total liabilities

     1,990,651        1,562,253   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Preferred stock, par value $0.01 per share (5,000,000 shares authorized; no shares outstanding)

     0        0   

Common stock, par value $0.01 per share:

    

Shares authorized: 145,000,000 in 2013 and 2012;

    

Shares outstanding 48,658,606 in 2013 and 49,311,008 in 2012

     487        493   

Additional paid-in capital

     655,143        646,299   

Retained earnings (accumulated deficit)

     2,624        (20,726

Common stock held in treasury, at cost $0.01 par value; 4,642,202 in 2013 and 3,646,290 in 2012

     (43,271     (31,243

Accumulated other comprehensive income (loss), net

     569        (6
  

 

 

   

 

 

 

Total NewStar Financial, Inc. stockholders’ equity

     615,552        594,817   

Retained earnings of Consolidated Variable Interest Entity

     658        0   
  

 

 

   

 

 

 

Total stockholders’ equity

     616,210        594,817   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,606,861      $ 2,157,070   
  

 

 

   

 

 

 

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

 

68


Table of Contents

NEWSTAR FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year Ended December 31,  
         2013                 2012                 2011        
   ($ in thousands, except per share amounts)  

Net interest income:

      

Interest income

   $ 127,684      $ 123,945      $ 115,680   

Interest expense

     42,971        35,591        34,953   
  

 

 

   

 

 

   

 

 

 

Net interest income

     84,713        88,354        80,727   

Provision for credit losses

     9,738        12,651        17,312   
  

 

 

   

 

 

   

 

 

 

Net interest income after provision for credit losses

     74,975        75,703        63,415   

Non-interest income:

      

Fee income

     3,670        4,619        3,070   

Asset management income—related party

     2,482        2,984        2,635   

Gain (loss) on derivatives

     (143     (315     242   

Gain on sale of loans

     72        335        128   

Other income (loss)

     7,431        3,948        (2,008
  

 

 

   

 

 

   

 

 

 

Total non-interest income

     13,512        11,571        4,067   

Operating expenses:

      

Compensation and benefits

     32,672        31,139        30,144   

General and administrative expenses

     16,726        15,158        13,787   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     49,398        46,297        43,931   
  

 

 

   

 

 

   

 

 

 

Operating income before income taxes

     39,089        40,977        23,551   

Results of Consolidated Variable Interest Entity:

      

Interest income

     5,321        0        0   

Interest expense— credit facilities

     1,879        0        0   

Interest expense—Fund membership interest

     1,353        0        0   

Other income

     51        0        0   

Operating expenses

     78        0        0   
  

 

 

   

 

 

   

 

 

 

Net results from Consolidated Variable Interest Entity

     2,062        0        0   

Income before income taxes

     41,151        40,977        23,551   

Income tax expense

     16,556        17,000        9,403   
  

 

 

   

 

 

   

 

 

 

Net income

   $ 24,595      $ 23,977      $ 14,148   
  

 

 

   

 

 

   

 

 

 

Basic income per share

   $ 0.51      $ 0.51      $ 0.29   

Diluted income per share

     0.46        0.45        0.27   

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

 

69


Table of Contents

NEWSTAR FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

     Year Ended December 31,  
         2013                  2012                  2011        
   ($ in thousands, except per share amounts)  

Net income

   $ 24,595       $ 23,977       $ 14,148   

Other comprehensive income (loss), net of tax:

        

Net unrealized securities gains (losses), net of tax expense (benefit) of $345, $1,244 and $(1,119), respectively

     499         1,840         (1,658

Net unrealized derivative gains, net of tax expense of $53, $115 and $125, respectively

     76         152         198   
  

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss)

     575         1,992         (1,460
  

 

 

    

 

 

    

 

 

 

Comprehensive income

   $ 25,170       $ 25,969       $ 12,688   
  

 

 

    

 

 

    

 

 

 

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

 

70


Table of Contents

NEWSTAR FINANCIAL, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

 

    NewStar Financial, Inc. Stockholders’ Equity     Common
Stockholders’
Equity
 
    Preferred
Stock
    Common
Stock
    Additional
Paid-in
Capital
    Retained
Earnings
(Accumulated
Deficit)
    Treasury
Stock
    Accumulated
Other
Comprehensive
Income
(Loss), net
    Retained
Earnings of
Consolidated
VIE
   
    ($ in thousands)  

Balance at January 1, 2011

  $ 0      $ 506      $ 626,177      $ (58,851   $ (13,115   $ (538   $ 0      $ 554,179   

Net income

    0       0       0       14,148        0       0       0        14,148   

Other comprehensive income

    0        0       0        0       0       (1,460 )     0        (1,460

Net shares reacquired from employee transactions

    0        (2     272        0        (2,274     0        0        (2,004

Tax benefit from vesting of restricted common stock awards

    0        0        121        0        0        0        0        121   

Repurchase of common stock

    0        (10     10        0        (10,031     0        0        (10,031

Amortization of restricted common stock awards

    0        0        6,446        0        0        0        0        6,446   

Amortization of stock option awards

    0        0        2,363        0        0        0        0        2,363   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2011

    0        494        635,389        (44,703     (25,420     (1,998     0        563,762   

Net income

    0       0       0       23,977        0       0       0        23,977   

Other comprehensive loss

    0        0       0       0       0       1,992       0        1,992   

Issuance of restricted stock

    0       1        (1     0       0       0       0        0  

Net shares reacquired from employee transactions

    0        (2 )     0       0       (3,227 )     0       0        (3,229

Tax benefit from vesting of restricted common stock awards

    0        0       2,320        0       0       0       0        2,320   

Repurchase of common stock

    0        (2 )     2       0       (2,596 )     0       0        (2,596

Exercise of common stock options