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EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - New Residential Investment Corp.ex32-1.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - New Residential Investment Corp.ex32-2.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - New Residential Investment Corp.ex31-2.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - New Residential Investment Corp.ex31-1.htm

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2013

 

or

 

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

 

For the transition period from ________________to ______________

 

Commission File Number: 001-35777

 

New Residential Investment Corp.
(Exact name of registrant as specified in its charter)

 

Delaware

 

45-3449660

(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

1345 Avenue of the Americas, New York, NY   10105
(Address of principal executive offices)   (Zip Code)

 

(212) 798-3150

(Registrant’s telephone number, including area code)


(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes No

 

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

 

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

 

Large accelerated filer Accelerated filer Non-accelerated filer (Do not check if a smaller reporting company) 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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.

 

Common stock, $0.01 par value per share: 253,025,645 shares outstanding as of June 11, 2013.

 

 

 
 

 

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

 

This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments, the stability of our earnings, and our financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual outcome of future plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from forecasted results. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to:

 

·reductions in cash flows received from our investments;

 

·our ability to take advantage of investment opportunities at attractive risk-adjusted prices;

 

·our ability to take advantage of investment opportunities in excess mortgage servicing rights (“Excess MSRs”);

 

·our ability to deploy capital accretively;

 

·our counterparty concentration and default risks in Nationstar Mortgage LLC (“Nationstar”), Springleaf Finance, Inc. (“Springleaf”) and other third-parties;

 

·a lack of liquidity surrounding our investments which could impede our ability to vary our portfolio in an appropriate manner;

 

·the impact that risks associated with subprime mortgage loans and consumer loans, as well as deficiencies in servicing and foreclosure practices, may have on the value of our residential mortgage-backed securities (“RMBS”) and consumer loan portfolios;

 

·the risks that default and recovery rates on our real estate securities, residential mortgage loans and consumer loans deteriorate compared to our underwriting estimates;

 

·changes in prepayment rates on the loans underlying certain of our assets, including, but not limited to, our Excess MSRs;

 

·the risk that projected recapture rates on the portfolios underlying our Excess MSRs are not achieved;

 

·the relationship between yields on assets which are paid off and yields on assets in which such monies can be reinvested;

 

·the relative spreads between the yield on the assets we invest in and the cost of financing;

 

·changes in economic conditions generally and the real estate and bond markets specifically;

 

·adverse changes in the financing markets we access affecting our ability to finance our investments;

 

·the quality and size of the investment pipeline and the rate at which we can invest our cash;

 

 
 

 

·changing risk assessments by lenders that potentially lead to increased margin calls, not extending our repurchase agreements or other financings in accordance with their current terms or entering into new financings with us;

 

·changes in interest rates and/or credit spreads, as well as the success of any hedging strategy we may undertake in relation to such changes;

 

·impairments in the value of the collateral underlying our investments and the relation of any such impairments to our judgments as to whether changes in the market value of our securities or loans are temporary or not and whether circumstances bearing on the value of such assets warrant changes in carrying values;

 

·the availability and cost of capital for future investments;

 

·competition within the finance and real estate industries;

 

·the legislative/regulatory environment, including, but not limited to, the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act, U.S. government programs intended to stabilize the economy, the federal conservatorship of the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and legislation that permits modification of the terms of loans;

 

·our ability to maintain our qualification as a real estate investment trust (“REIT”) for U.S. federal income tax purposes and the potentially onerous consequences that any failure to maintain such qualification would have on our business;

 

·our ability to maintain our exemption from registration under the Investment Company Act of 1940 (the “1940 Act”) and the fact that maintaining such exemption imposes limits on our operations; and

 

·other risks detailed from time to time below, particularly under the heading “Risk Factors,” and in our other reports filed with or furnished to the Securities and Exchange Commission (the “SEC”).

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. The factors noted above could cause our actual results to differ significantly from those contained in any forward-looking statement.

 

Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect our management’s views only as of the date of this report. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.

 

 
 

 

SPECIAL NOTE REGARDING EXHIBITS

 

In reviewing the agreements included as exhibits to this Quarterly Report on Form 10-Q, please remember they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about the Company or the other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:

 

·should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate;

 

·have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;

 

·may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors; and

 

·were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments.

 

Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. Additional information about the Company may be found elsewhere in this Quarterly Report on Form 10-Q and the Company’s other public filings, which are available without charge through the SEC’s website at http://www.sec.gov.

 

The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this report not misleading.

 

 
 

 

NEW RESIDENTIAL INVESTMENT CORP.
FORM 10-Q

 

INDEX

 

  PAGE
   
Part I. Financial Information 1
   
Item 1. Financial Statements 1
   
Consolidated Balance Sheets as of March 31, 2013 (unaudited) and December 31, 2012 1
   
Consolidated Statements of Income (Unaudited) for the Three Months Ended March 31, 2013 and 2012 2
   
Consolidated Statements of Comprehensive Income (Unaudited) for the Three Months Ended March 31, 2013 and 2012 3
   
Consolidated Statement of Changes in Equity for the Three Months Ended March 31, 2013 (Unaudited) 4
   
Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2013 and 2012 5
   
Notes to Consolidated Financial Statements (Unaudited) 6
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 32
   
Item 3. Quantitative and Qualitative Disclosures Abount Market Risk 55
   
Item 4. Controls and Procedures 58
   
Part II. Other Information 59
   
Item 1. Legal Proceedings 59
   
Item 1A. Risk Factors 59
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 88
   
Item 3. Defaults Upon Senior Securities 88
   
Item 4. Mine Safety Disclosures 88
   
Item 5. Other Information 88
   
Item 6. Exhibits 89
   
Signatures 92

 

 
 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

 

   March 31, 2013 (Unaudited)   December 31, 2012 
Assets          
Real estate securities, available-for-sale   $1,318,023   $289,756 
Investments in excess mortgage servicing rights at fair value    236,555    245,036 
Investments in equity method investees at fair value    102,588     
Residential mortgage loans, held-for-investment    35,484     
Other assets    450    84 
   $1,693,100   $534,876 
           
Liabilities and Equity          
           
Liabilities          
Repurchase agreements   $915,058   $150,922 
Due to affiliate    7,784    5,136 
Accrued expenses and other liabilities    2,839    462 
    925,681    156,520 
           
Commitments and contingencies           
           
Equity          
Equity    735,710    362,830 
Accumulated other comprehensive income    31,709    15,526 
Total Equity    767,419    378,356 
   $1,693,100   $534,876 

 

See notes to consolidated financial statements.

 

1
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(dollars in thousands)

 

   Three Months Ended March 31, 
   2013   2012 
         
Interest income   $16,191   $2,037 
Interest expense    899     
Net Interest Income    15,292    2,037 
Change in fair value of investments in excess
mortgage servicing rights
   1,858    1,216 
Change in fair value of investments in equity
method investees
   969     
Other Income    2,827    1,216 
           
Expenses          
General and administrative expenses    2,719    411 
Management fees allocated by Newcastle    2,325    154 
    5,044    565 
           
 Net Income   $13,075   $2,688 

 

See notes to consolidated financial statements.

 

2
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(dollars in thousands)

 

   Three Months Ended
March 31,
 
    2013    2012 
           
Net income   $13,075   $2,688 
Other comprehensive income:           
Net unrealized gain on securities    16,183     
Other comprehensive income    16,183     
           
Comprehensive income   $29,258   $2,688 

  

See notes to consolidated financial statements.

 

3
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 2013

(dollars in thousands)

 

   Equity   Accumulated Other Comprehensive Income (Loss)   Total Equity 
                
Equity - December 31, 2012   $362,830   $15,526   $378,356 
Capital contributions    372,019        372,019 
Contributions in-kind    797,811        797,811 
Capital distributions    (810,025)       (810,025)
Net income    13,075        13,075 
Other comprehensive income        16,183    16,183 
Equity - March 31, 2013   $735,710   $31,709   $767,419 

 

See notes to consolidated financial statements.

 

4
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(dollars in thousands)

 

   Three Months Ended March 31, 
   2013   2012 
Cash Flows From Operating Activities          
Net income   $13,075   $2,688 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Change in fair value of investments in excess mortgage servicing rights    (1,858)   (1,216)
Change in fair value of investments in equity method investees…….    (969)     
Distributions of earnings from equity method investees...    1,344     
Accretion of discount and other amortization    (4,798)    
Changes in:          
Other assets    (366)    
Due to affiliate    2,648    69 
Accrued expenses and other liabilities    2,377    (293)
Other operating cash flows:          
Cash proceeds from investments, in excess of interest income    34,436    2,422 
Net cash proceeds deemed as capital distributions to Newcastle    (45,889)   (3,670)
Net cash provided by (used in) operating activities         
           
Cash Flows From Investing Activities         
           
Cash Flows From Financing Activities         
           
Net Increase (Decrease) in Cash and Cash Equivalents         
           
Cash and Cash Equivalents, Beginning of Period         
           
Cash and Cash Equivalents, End of Period   $   $ 
           
Supplemental Disclosure of Cash Flow Information          
           
Cash paid during the period for interest expense   $868   $ 
           
Supplemental Schedule of Non-Cash Investing and Financing Activities          
Cash proceeds from investments, in excess of interest income   $34,436   $2,422 
Acquisition of investments in excess mortgage servicing rights        3,072 
Acquisition of real estate securities    227,293     
Acquisition of investments in equity method investees at fair value    109,588     
Acquisition of residential mortgage loans, held-for-investment    35,138     
Borrowings under repurchase agreements    768,038     
Repayments of repurchase agreements    3,902     
Capital contributions by Newcastle    372,019    3,072 
Contributions in-kind of real estate securities by Newcastle    797,811     
Capital distributions to Newcastle    810,025    3,670 

 

See notes to consolidated financial statements.

 

5
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

1.     GENERAL

 

New Residential Investment Corp. (formerly known as NIC MSR LLC) (together with its subsidiaries, “New Residential”) is a Delaware corporation that was formed as a limited liability company in September 2011 for the purpose of making real estate related investments and commenced operations on December 8, 2011. On December 20, 2012, New Residential was converted to a corporation. Newcastle Investment Corp. (“Newcastle”) was the sole stockholder of New Residential until the spin-off (Note 12), which was completed on May 15, 2013. Newcastle is listed on the New York Stock Exchange under the symbol “NCT.” As sole stockholder, Newcastle generally did not have any liability for the obligations of New Residential, except as described in Note 7.

 

Following the spin-off, New Residential is an independent publicly traded real estate investment trust (“REIT”) primarily focused on investing in residential mortgage related assets. New Residential is listed on the New York Stock Exchange under the symbol “NRZ”.

 

As of March 31, 2013, New Residential had acquired, directly and through equity method investees, excess mortgage servicing rights (“Excess MSRs”) on eight pools of residential mortgage loans from Nationstar Mortgage LLC (“Nationstar”), a leading residential mortgage servicer. Furthermore, New Residential had acquired real estate securities and residential mortgage loans.

 

New Residential intends to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes for the tax year ending December 31, 2013. As such, New Residential will generally not be subject to U.S. federal corporate income tax on that portion of its net income that is distributed to stockholders if it distributes at least 90% of its REIT taxable income to its stockholders by prescribed dates and complies with various other requirements.

 

New Residential has entered into a management agreement (the “Management Agreement”) with FIG LLC (the “Manager”), an affiliate of Fortress Investment Group LLC (“Fortress”), under which the Manager advises New Residential on various aspects of its business and manages its day-to-day operations, subject to the supervision of New Residential’s board of directors. For its services, the Manager is entitled to management fees and incentive compensation, both defined in, and in accordance with the terms of, the Management Agreement. For a further discussion of the Management Agreement, see Note 10. The Manager also manages Newcastle and investment funds that own a majority of Nationstar.

 

As of March 31, 2013, New Residential operated in three business segments: (i) investments in Excess MSRs, (ii) investments in real estate securities and loans and (iii) corporate.

 

The consolidated financial statements have been prepared on a spin-off basis from the consolidated financial statements and accounting records of Newcastle and reflect New Residential’s historical results of operations, financial position and cash flows, in accordance with U.S. GAAP. As presented in the Consolidated Statements of Cash Flows, New Residential did not have any cash balance during the periods presented. All of its cash activity occurred in Newcastle’s accounts during these periods. The consolidated financial statements may not be indicative of New Residential’s future performance and do not necessarily reflect what its consolidated results of operations, financial position and cash flows would have been had New Residential operated as an independent company during the periods presented.

 

Certain expenses of Newcastle, comprised primarily of a portion of its management fee, have been allocated to New Residential to the extent they were directly associated with New Residential. The portion of the management fee allocated to New Residential represents the product of the management fee rate payable by Newcastle (1.5%) and New Residential’s gross equity, which management believes is a reasonable method for quantifying the expense of the services provided by the employees of the Manager to New Residential. The incremental cost of certain legal, accounting and other expenses related to New Residential’s operations are reflected in the accompanying consolidated financial statements. New Residential and Newcastle do not share any expenses following the spin-off.

 

6
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

The accompanying consolidated financial statements and related notes of New Residential have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under U.S. generally accepted accounting principles have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of New Residential’s financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with New Residential’s consolidated financial statements for the year ended December 31, 2012 and notes thereto included in New Residential’s Registration Statement on Form 10 filed with the Securities and Exchange Commission. Capitalized terms used herein, and not otherwise defined, are defined in New Residential’s consolidated financial statements for the year ended December 31, 2012.

 

Recent Accounting Pronouncements

 

In February 2013, the FASB issued new guidance regarding the reporting of reclassifications out of accumulated other comprehensive income. The new guidance does not change current requirements for reporting net income or other comprehensive income in the financial statements. However, it requires companies to present the effects on the line items of net income of significant amounts reclassified out of accumulated OCI if the item reclassified is required to be reclassified to net income in its entirety during the same reporting period. Presentation should occur either on the face of the income statement where net income is presented or in the notes to the financial statements. New Residential has early adopted this accounting standard and opted to present this information in a note to the financial statements. No amounts have been reclassified out of OCI during any period presented.

 

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, the definition of an investment company, financial statement presentation, revenue recognition, financial instruments, hedging and contingencies. Some of the proposed changes are significant and could have a material impact on New Residential’s reporting. New Residential has not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.

 

2.     SEGMENT REPORTING

 

New Residential conducts its business through the following segments: (i) direct and indirect investments in Excess MSRs, (ii) investments in real estate securities and loans and (iii) corporate. The corporate segment consists primarily of general and administrative expenses and the allocation of management fees by the stockholder.

 

Summary financial data on New Residential’s segments is given below, together with a reconciliation to the same data for New Residential as a whole:

 

   Excess MSRs  

Real Estate Securities

and Loans

   Corporate   Total 
Three Months Ended March 31, 2013                    
Interest income   $10,035   $6,156   $   $16,191 
Interest expense        899        899 
Net interest income    10,035    5,257        15,292 
Other income    2,827            2,827 
Other operating expenses    62        4,982    5,044 
Net income (loss)   $12,800   $5,257   $(4,982)  $13,075 

 

7
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

   Excess MSRs  

Real Estate Securities

and Loans

   Corporate   Total 
March 31, 2013                    
Investments   $339,143   $1,353,507   $   $1,692,650 
Other assets        450        450 
Total assets    339,143    1,353,957        1,693,100 
Debt        (915,058)       (915,058)
Other liabilities    (174)   (87)   (10,362)   (10,623)
Total liabilities    (174)   (915,145)   (10,362)   (925,681)
GAAP book value   $338,969   $438,812   $(10,362)  $767,419 
                     
Investments in equity method investees at fair value   $102,588           $102,588 

 

   Excess MSRs  

Real Estate Securities

and Loans

   Corporate   Total 
Three Months Ended March 31, 2012                    
Interest income  $2,037   $   $   $2,037 
Interest expense                
Net interest income   2,037            2,037 
Other income   1,216            1,216 
Other operating expenses   386        179    565 
Net Income (loss)  $2,867   $   $(179)  $2,688 

 

3.    INVESTMENTS IN EXCESS MORTGAGE SERVICING RIGHTS AT FAIR VALUE

 

Pool 1. On December 13, 2011, Newcastle announced the completion of the first co-investment between New Residential and Nationstar in Excess MSRs related to mortgage servicing rights acquired by Nationstar. New Residential invested approximately $44 million to acquire a 65% interest in the Excess MSRs on a portfolio of government-sponsored enterprise (“GSE”) residential mortgage loans with an outstanding principal balance of approximately $9.9 billion (“Pool 1”). Nationstar has co-invested on a pari passu basis with New Residential in 35% of the Excess MSRs and will be the servicer of the loans, performing all servicing and advancing functions, and retaining the ancillary income, the servicing obligations and liabilities as the servicer. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by Nationstar, the resulting Excess MSRs will be shared on a pro rata basis by New Residential and Nationstar, subject to certain limitations.

 

Pool 2. On June 5, 2012, Newcastle announced the completion of a co-investment between New Residential and Nationstar in Excess MSRs related to mortgage servicing rights Nationstar acquired from Bank of America. New Residential invested approximately $44 million to acquire a 65% interest in the Excess MSRs on a portfolio of residential mortgage loans with an outstanding principal balance of approximately $10.4 billion (“Pool 2”), comprised of loans in GSE pools. Nationstar has co-invested on a pari passu basis with New Residential in 35% of the Excess MSRs and will be the servicer of the loans, performing all servicing and advancing functions, and retaining the ancillary income, servicing obligations and liabilities as the servicer. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by Nationstar, the resulting Excess MSRs will be shared on a pro rata basis by New Residential and Nationstar, subject to certain limitations.

 

8
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

MARCH 31, 2013 

(dollars in tables in thousands except share data)

 

Pools 3, 4 and 5. On June 29, 2012, Newcastle announced the completion of a co-investment between New Residential and Nationstar in Excess MSRs related to mortgage servicing rights Nationstar acquired from Aurora Bank FSB, a subsidiary of Lehman Brothers Bancorp Inc. New Residential invested approximately $176.5 million to acquire a 65% interest in the Excess MSRs on a portfolio of residential mortgage loans with an outstanding principal balance of approximately $63.7 billion, comprised of approximately 75% non-conforming loans in private label securitizations and approximately 25% conforming loans in GSE pools. The portfolio is comprised of three pools: two GSE loan pools with outstanding principal balances of approximately $9.8 billion (“Pool 3”) and $6.3 billion (“Pool 4”), respectively, and a pool of non-conforming loans in private label securitizations with an outstanding principal balance of approximately $47.6 billion (“Pool 5”). Nationstar has co-invested on a pari passu basis with New Residential in 35% of the Excess MSRs and will be the servicer of the loans, performing all servicing and advancing functions, and retaining the ancillary income, servicing obligations and liabilities as the servicer. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by Nationstar, the resulting Excess MSRs will be shared on a pro rata basis by New Residential and Nationstar, subject to certain limitations.

 

The following is a summary of New Residential’s direct investments in Excess MSRs:

 

       March 31, 2013   Three Months Ended March 31, 2013 
   Unpaid Principal Balance
(“UPB”) of Underlying Mortgages
   Amortized Cost Basis (A)   Carrying Value (B)   Weighted Average Yield   Weighted Average Maturity (Years) (C)   Changes in Fair Value Recorded in Other Income (D) 
MSR Pool 1   $8,021,789   $29,329   $35,333    18.0%   4.8   $266 
MSR Pool 1 - Recapture Agreement       3,676    4,355    18.0%   11.0    174 
MSR Pool 2    9,038,057    32,345    33,695    17.3%   5.0    306 
MSR Pool 2 - Recapture Agreement       4,108    4,880    17.3%   12.0    591 
MSR Pool 3    8,758,689    26,502    30,126    17.6%   4.7    768 
MSR Pool 3 - Recapture Agreement       4,598    4,552    17.6%   11.4    30 
MSR Pool 4    5,586,851    10,809    11,969    17.9%   4.6    141 
MSR Pool 4 - Recapture Agreement       2,763    2,705    17.9%   11.1    (43)
MSR Pool 5    41,917,506    102,718    104,507    17.5%   4.7    (190)
MSR Pool 5 - Recapture Agreement       8,460    4,433    17.5%   11.7    (185)
   $73,322,892   $225,308   $236,555    17.6%   5.4   $1,858 

 

(A)The amortized cost basis of the Recapture Agreements is determined based on the relative fair values of the Recapture Agreements and related Excess MSRs at the time they were acquired.
  
(B)Carrying Value represents the fair value of the pools or Recapture Agreements, as applicable.
  
(C)Weighted Average Maturity represents the weighted average expected timing of the receipt of expected cash flows for this investment.
  
(D)The portion of the change in fair value of the Recapture Agreements relating to loans recaptured to date is reflected in the respective pool.

 

9
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

The table below summarizes the geographic distribution of the underlying residential mortgage loans of the direct investments in Excess MSRs at March 31, 2013:

 

State Concentration  Percentage of Total Outstanding 
California   31.7%
Florida   10.1%
New York   4.4%
Washington   4.3%
Arizona   3.8%
Texas   3.6%
Colorado   3.5%
Maryland   3.4%
New Jersey   3.2%
Virginia   3.0%
Other U.S.   29.0%
    100.0%

 

Geographic concentrations of investments expose New Residential to the risk of economic downturns within the relevant states. Any such downturn in a state where New Residential holds significant investments could affect the underlying borrower’s ability to make the mortgage payment and therefore could have a meaningful, negative impact on the Excess MSRs.

 

4.     INVESTMENTS IN REAL ESTATE SECURITIES

 

During 2013, New Residential acquired $373.8 million face amount of Non-Agency RMBS for approximately $227.3 million. In addition, Newcastle contributed $754.5 million face amount of Agency RMBS to New Residential during this period.

 

The following is a summary of New Residential’s real estate securities at March 31, 2013, all of which are classified as available-for-sale and are, therefore, reported at fair value with changes in fair value recorded in other comprehensive income.

 

           Gross Unrealized           Weighted Average 
   Outstanding Face   Amortized           Carrying   Number of   Rating           Maturity (Years)   Principal Subordination 
Asset Type  Amount   Cost Basis   Gains   Losses   Value (A)   Securities   (B)   Coupon   Yield   (C)   (D) 
                                             
Agency RMBS (F)  $754,496   $797,547   $2,832   $(924)  $799,455    42    AAA     3.29%   1.46%   4.1    N/A 
Non-Agency RMBS   784,259    488,767    30,936    (1,135)   518,568    53    CC     0.67%   6.20%   7.6    7.7%
Total/Weighted Average (E)  $1,538,755   $1,286,314   $33,768   $(2,059)  $1,318,023    95    BB+     1.95%   3.26%   5.9     

 

(A)Fair value, which is equal to carrying value for all securities. See Note 8 regarding the estimation of fair value.
  
(B)Represents the weighted average of the ratings of all securities in each asset type, expressed as an S&P equivalent rating. For each security rated by multiple rating agencies, the lowest rating is used. Ratings provided were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any time.
  
(C)The weighted average maturity is based on the timing of expected principal reduction on the assets.
  
(D)Percentage of the outstanding face amount of securities and residual interests that is subordinate to New Residential’s investments.

 

10
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

(E)The total outstanding face amount of fixed rate securities was $1.1 million, and of floating rate securities was $1.5 billion.
  
(F)Includes securities issued or guaranteed by U.S. Government agencies such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”).

 

During the three months ended March 31, 2013, New Residential recorded no other-than-temporary impairment charge (“OTTI”) related to its real estate securities. The unrealized losses on New Residential’s securities were primarily the result of changes in market factors, rather than issuer-specific credit impairment. New Residential performed analyses in relation to such securities, using management’s best estimate of their cash flows, which support its belief that the carrying values of such securities were fully recoverable over their expected holding period. New Residential has no intent to sell and is not more likely than not to be required to sell these securities. The following table summarizes New Residential’s securities in an unrealized loss position at March 31, 2013:

 

       Gross Unrealized           Weighted Average 
Securities in a Loss Position  Outstanding Current Face   Before Impairment   Other Than Temporary Impairment   After Impairment   Gains   Losses   Carry Value   Number of Securities   Rating   Coupon   Yield   Maturity (Years) 
Less than Twelve Months   $397,038   $332,125   $   $332,125   $   $(2,053)  $330,072    24    BB    1.99%   2.58%   6.7 
Twelve or More Months    7,551    8,074        8,074        (6   8,068    1    AAA    2.77   0.88   4.7 
Total   $404,589   $340,199   $   $340,199   $   $(2,059)  $338,140    25    BB    2.01%   2.54%   6.7 

 

The table below summarizes the geographic distribution of the collateral securing New Residential’s Non-Agency RMBS at March 31, 2013:

 

Geographic Location  Outstanding Face Amount   Percentage of Total Outstanding 
Western U.S.   $292,665    37.3%
Northeastern U.S.    178,621    22.8%
Southeastern U.S.    166,243    21.2%
Midwestern U.S.    87,029    11.1%
Southwestern U.S.    59,696    7.6%
Other U.S.    5    0.0%
   $784,259    100.0%

 

New Residential evaluates the credit quality of its real estate securities, as of the acquisition date, for evidence of credit quality deterioration. As a result, New Residential identified a population of real estate securities for which it was determined that it was probable that New Residential would be unable to collect all contractually required payments. For securities acquired during the three months ended March 31, 2013, the face amount of these real estate securities was $368.7 million, with total expected cash flows of $280.4 million and a fair value of $222.8 million. The following is the outstanding face amount and carrying value for such securities at December 31, 2012 and March 31, 2013:

 

11
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

 

    Outstanding Face Value   Carrying Value 
December 31, 2012   $342,013   $212,129 
March 31, 2013   $692,140   $436,458 

 

The following is a summary of the changes in accretable yield for these securities:

 

   For the Three Months Ended
March 31, 2013
 
Balance at December 31, 2012   $90,077 
Additions    57,568 
Accretion    (4,223)
Reclassifications from non-accretable difference    49,442 
Disposals     
Balance at March 31, 2013   $192,864 

 

5.     INVESTMENTS IN RESIDENTIAL MORTGAGE LOANS

 

On February 27, 2013, New Residential, through a subsidiary, entered into an agreement to co-invest in reverse mortgage loans with a UPB of approximately $83 million as of December 31, 2012. New Residential has invested approximately $35 million to acquire a 70% interest in the reverse mortgage loans. Nationstar has co-invested pari passu with New Residential in 30% of the reverse mortgage loans and will be the servicer of the loans performing all servicing and advancing functions and retaining the ancillary income, servicing obligations and liabilities as the servicer.

 

Loans for which New Residential has the intent and ability to hold for the foreseeable future, or until maturity or payoff, are classified as held-for-investment. Loans are presented in the consolidated balance sheet at cost net of any unamortized discount (or gross of any unamortized premium). New Residential determines at acquisition whether loans will be aggregated into pools based on common risk characteristics (credit quality, loan type, and date of origination or acquisition); loans aggregated into pools are accounted for as if each pool were a single loan. Income on these loans is recognized similarly to that on securities using a level yield methodology.

 

To the extent that residential mortgage loans are classified as held-for-investment, New Residential must periodically evaluate each of these loans or loan pools for possible impairment. Impairment is indicated when it is deemed probable that New Residential will be unable to collect all amounts due according to the contractual terms of the loan, or for loans acquired at a discount for credit losses, when it is deemed probable that New Residential will be unable to collect as anticipated. Upon determination of impairment, New Residential would establish a specific valuation allowance with a corresponding charge to earnings. New Residential continually evaluates its loans receivable for impairment. New Residential’s residential mortgage loans are aggregated into pools for evaluation based on like characteristics, such as loan type and acquisition date. Pools of loans are evaluated based on criteria such as an analysis of borrower performance, credit ratings of borrowers, loan to value ratios, the estimated value of the underlying collateral, the key terms of the loans and historical and anticipated trends in defaults and loss severities for the type and seasoning of loans being evaluated. This information is used to estimate provisions for estimated unidentified incurred losses on pools of loans. Significant judgment is required in determining impairment and in estimating the resulting loss allowance. Furthermore, New Residential must assess its intent and ability to hold its loan investments on a periodic basis. If New Residential does not have the intent to hold a loan for the foreseeable future or until its expected payoff, the loan must be classified as “held for sale” and recorded at the lower of cost or estimated value.

12
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

The following is a summary of residential mortgage loans at March 31, 2013, all of which are classified as held for investment:

 

Loan Type  Outstanding Face Amount   Carrying Value   Loan Count   Wtd. Avg. Yield   Wtd. Avg. Coupon (A)   Wtd. Avg. Maturity (Years) (B)   Floating Rate Loans as a % of Face Amount   Delinquent Face Amount
Reverse Mortgage Loans  $58,586   $35,484    331    11.81%   5.15%   3.9    21.0%  N/A

  

(A) Represents the stated interest rate on the loans.
   
(B) The weighted average maturity is based on the expected timing of the receipt of cash flows.

 

Activities related to the carrying value of residential mortgage loans are as follows:

 

   For the Three Months Ended March 31, 2013 
Balance at December 31, 2012   $ 
Purchases/additional fundings    35,138 
Accretion of loan discount and other amortization    346 
Balance at March 31, 2013   $35,484 

 

6.     INVESTMENTS IN EQUITY METHOD INVESTEES

 

During the first quarter of 2013, New Residential entered into investments in joint ventures (“Excess MSR joint ventures”) jointly controlled by New Residential and Fortress-managed funds investing in Excess MSRs. New Residential elected to record these investments at fair value pursuant to the fair value option for financial instruments to provide users of the financial statements with better information regarding the effects of prepayment risk and other market factors.

 

The following tables summarize the investments in equity method investees held by New Residential at March 31, 2013:

 

   March 31, 2013 
Assets (A)  $275,779 
Debt    
Other Liabilities   (70,603)
Equity  $205,176 
New Residential’s Investment  $102,588 
New Residential’s Ownership   50.0%

 

(A)Includes $20.8 million of deposits related to investments which have not closed at March 31, 2013.

 

13
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

  

   Three Months Ended March 31, 2013 
Interest income  $5,616 
Other income   (3,154)
Expenses   (524)
Net Income  $1,938 

 

The following is a summary of New Residential’s Excess MSR investments made through equity method investees:

 

   March 31, 2013 
   Unpaid
Principal
Balance
   Investee
Interest in
Excess MSR
   New Residential Interest
in Investees
   Amortized
Cost Basis (A)
   Carrying Value (B)   Weighted Average Yield   Weighted Average Maturity (Years) (C) 
MSR Pool 6  $11,821,572    66.7%   50.0%  $42,388   $41,453    17.4%   4.9 
MSR Pool 6 - Recapture Agreement       66.7%   50.0%   10,954    10,972    17.4%   10.7 
MSR Pool 7   36,440,577    66.7%   50.0%   109,420    109,048    15.2%   5.1 
MSR Pool 7 - Recapture Agreement       66.7%   50.0%   23,296    23,164    15.2%   12.0 
MSR Pool 8   16,613,186    66.7%   50.0%   58,748    57,177    15.0%   5.0 
MSR Pool 8 - Recapture Agreement       66.7%   50.0%   13,312    13,150    15.0%   11.7 
   $64,875,335             $258,118   $254,964    15.6%   6.3 

 

(A)Represents the amortized cost basis of the equity method investees in which New Residential holds a 50% interest. The amortized cost basis of the Recapture Agreements is determined based on the relative fair values of the Recapture Agreements and related Excess MSRs at the time they were acquired.
(B)Represents the carrying value of the equity method investees in which New Residential holds a 50% interest. Carrying value represents the fair value of the pools or Recapture Agreements, as applicable.
(C)The weighted average maturity represents the weighted average expected timing of the receipt of cash flows of each investment.

 

On January 4, 2013, New Residential, through a joint venture, co-invested in Excess MSRs on a portfolio of Government National Mortgage Association (“Ginnie Mae”) residential mortgage loans with a UPB of approximately $13 billion as of November 30, 2012. Nationstar acquired the related servicing rights from Bank of America in November 2012. New Residential contributed approximately $28.9 million for a 50% interest in a joint venture which acquired an approximately 67% interest in the Excess MSRs on this portfolio. The remaining interests in the joint venture will be owned by a Fortress-managed fund and the remaining interest of approximately 33% in the Excess MSRs will be owned by Nationstar. As the servicer, Nationstar will perform all servicing and advancing functions, and it will retain the ancillary income, servicing obligations and liabilities associated with this portfolio. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by Nationstar, the resulting Excess MSRs will be shared on a pro rata basis by the joint venture and Nationstar, subject to certain limitations.

 

14
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

On January 6, 2013 New Residential, through joint ventures, agreed to co-invest in Excess MSRs on a portfolio of four pools of residential mortgage loans with a UPB of approximately $215 billion as of November 30, 2012. Approximately 53% of the loans in this portfolio are in private label securitizations, and the remainder are owned, insured or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Nationstar has agreed to acquire the related servicing rights from Bank of America. New Residential committed to invest approximately $340 million (based on the November 30, 2012 UPB) for a 50% interest in a joint ventures which will acquire an approximately 67% interest in the Excess MSRs on this portfolio. As of March 31, 2013, New Residential had contributed approximately $80.7 million to the joint ventures. The remaining interests in the joint ventures will be owned by Fortress-managed funds and the remaining interest of approximately 33% in the Excess MSRs will be owned by Nationstar. As the servicer, Nationstar will perform all servicing and advancing functions, and it will retain the ancillary income, servicing obligations and liabilities associated with this portfolio. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by Nationstar, the resulting Excess MSRs will be shared on a pro rata basis by the joint ventures and Nationstar, subject to certain limitations. On January 31, 2013, New Residential completed the first closing of this co-investment. The first closing related to Excess MSRs on loans with an aggregate UPB of approximately $58 billion as of December 31, 2012, that are owned, insured, or guaranteed by Fannie Mae or Freddie Mac. There can be no assurance that New Residential will complete this investment as anticipated or at all.

 

The table below summarizes the geographic distribution of the underlying residential mortgage loans of the Excess MSR investments made through equity method investees at March 31, 2013:

 

State Concentration  Percentage of Total Outstanding (A) 
California   15.2%
Florida   7.9%
New York   7.6%
Texas   5.9%
New Jersey   4.8%
Washington   3.4%
Virginia   3.0%
Maryland   2.8%
Arizona   2.5%
Colorado   2.4%
Other U.S.   44.5%
    100.0%

  

(A) Based on the information provided by the loan servicer as of March 31, 2013 for Pool 6 and February 28, 2013 for Pools 7 and 8.

 

15
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

7.     DEBT OBLIGATIONS

 

The following table presents certain information regarding New Residential’s debt obligations at March 31, 2013:

 

                              Collateral 
Repurchase Agreements (A)  Month Issued   Outstanding Face   Carrying Value   Final Stated Maturity  Contractual WAC   WAC   WAL   Outstanding Face   Amortized Cost Basis   Carrying Value   WAL 
                                            
Agency RMBS (D)   Various   $757,029   $757,029   Apr-13   0.45%   0.45%   0.1   $754,496   $797,547   $799,455    4.1 
Non Agency RMBS (B) (C)    Various    158,029    158,029   Apr-13   LIBOR + 2.00%    2.20%   0.1    330,871    208,245    233,813    6.8 
                                                      
        $915,058   $915,058            0.75%   0.1   $1,085,367   $1,005,792   $1,033,268    4.9 

 

(A)These repurchase agreements had approximately $0.1 million of associated accrued interest payable at March 31, 2013. All of these repurchase agreements were renewed subsequent to March 31, 2013.
  
(B)The counterparty of these repurchase agreements is Credit Suisse.
  
(C)Newcastle was the guarantor of these repurchase agreements, which were subject to customary margin call provisions, see Note 12.
  
(D)The counterparties of these repurchase agreements are Goldman Sachs ($343.8 million), Citi ($118.8 million), Nomura ($238.2 million) and Morgan Stanley ($56.2 million).

 

8.     FAIR VALUE OF FINANCIAL INSTRUMENTS

 

U.S. GAAP requires the categorization of the fair value of financial instruments into three broad levels which form a hierarchy.

 

Level 1- Quoted prices in active markets for identical instruments.

 

Level 2- Valuations based principally on other observable market parameters, including

 

·Quoted prices in active markets for similar instruments,

 

·Quoted prices in less active or inactive markets for identical or similar instruments,

 

·Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates), and

 

·Market corroborated inputs (derived principally from or corroborated by observable market data).

 

Level 3- Valuations based significantly on unobservable inputs.

 

New Residential follows this hierarchy for its financial instruments. The classifications are based on the lowest level of input that is significant to the fair value measurement.

 

16
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

The carrying value and fair value of New Residential’s financial assets recorded at fair value on a recurring basis at March 31, 2013 were as follows:

 

           Fair Value 
   Principal Balance or Notional Amount   Carrying Value   Level 2   Level 3   Total 
Assets:                         
Real estate securities, available-for-sale  $1,538,755   $1,318,023   $799,455   $518,568   $1,318,023 
Investments in Excess MSRs (A)   73,322,892    236,555        236,555    236,555 
Investments in equity method investees at fair value (A)   64,875,335    102,588        102,588    102,588 
   $139,736,982   $1,657,166   $799,455   $857,711   $1,657,166 

  

(A)The notional amount represents the total unpaid principal balance of the mortgage loans underlying the Excess MSRs. Generally, New Residential does not receive an excess mortgage servicing amount on nonperforming loans.

 

Investments in Excess MSRs Valuation

 

Fair value estimates of New Residential’s Excess MSRs were based on internal pricing models. The valuation technique is based on discounted cash flows. Significant inputs used in the valuations included expectations of prepayment rates, delinquency rates, recapture rates, the excess mortgage servicing amount of the underlying mortgage loans and discount rates that market participants would use in determining the fair values of mortgage servicing rights on similar pools of residential mortgage loans. New Residential’s management validates significant inputs and outputs of the internal pricing models by comparing them to available independent third party market parameters and models for reasonableness. New Residential believes its valuation methods and the assumptions used are appropriate and consistent with other market participants.

 

In order to evaluate the reasonableness of its fair value determinations, management engages an independent valuation firm to separately measure the fair value of its Excess MSRs. The independent valuation firm determines an estimated fair value range of each pool based on its own models and issues a “fairness opinion” with this range. Management compares the range included in the opinion to the value generated by its internal models. For Excess MSRs acquired prior to the current quarter, the fairness opinion relates to the valuation at the current quarter end date. For Excess MSRs acquired during the current quarter, the fairness opinion relates to the valuation at the time of acquisition. To date, New Residential has not made any significant valuation adjustments as a result of these fairness opinions.

 

For Excess MSRs acquired during the current quarter, New Residential revalues the Excess MSRs at the quarter end date if a payment is received between the acquisition date and the end of the quarter. Otherwise, Excess MSRs acquired during the current quarter are carried at their amortized cost basis if there has been no change in assumptions since acquisition.

 

In addition, in valuing the Excess MSRs, management considered the likelihood of Nationstar being removed as the servicer, which likelihood is considered to be remote. Fair value measurements of the Excess MSRs are sensitive to changes in the assumptions or methodology used to determine fair value, and such changes could result in a significant increase or decrease in the fair value. Significant increases (decreases) in the discount rates, prepayment or delinquency rates in isolation would result in a significantly lower (higher) fair value measurement, whereas significant increases (decreases) in the recapture rates or excess mortgage servicing amount in isolation would result in a significantly higher (lower) fair value measurement. Generally, a change in the delinquency rate assumption is accompanied by a directionally similar change in the assumption used for the prepayment speed.

 

17
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

The following table summarizes certain information regarding the inputs used in valuing the Excess MSRs owned directly and through equity method investees as of March 31, 2013:

 

   Significant Inputs 
Held Directly (Note 3) 

Prepayment

Speed (A)

  

Delinquency

(B)

   Recapture Rate (C)   Excess Mortgage Servicing Amount (D)   Discount Rate 
MSR Pool 1   16.1%   10.0%   35.0%   28 bps    18.0%
MSR Pool 1 - Recapture Agreement   8.0%   10.0%   35.0%   21 bps    18.0%
MSR Pool 2   16.0%   11.0%   35.0%   23 bps    17.3%
MSR Pool 2 - Recapture Agreement   8.0%   10.0%   35.0%   21 bps    17.3%
MSR Pool 3   16.2%   12.1%   35.0%   23 bps    17.6%
MSR Pool 3 - Recapture Agreement   8.0%   10.0%   35.0%   21 bps    17.6%
MSR Pool 4   18.3%   15.8%   35.0%   17 bps    17.9%
MSR Pool 4 - Recapture Agreement   8.0%   10.0%   35.0%   21 bps    17.9%
MSR Pool 5   15.0%   N/A (E)    20.0%   13 bps    17.5%
MSR Pool 5 - Recapture Agreement   8.0%   N/A (E)    20.0%   21 bps    17.5%
Held through Equity Method Investees (Note 6)                         
MSR Pool 6   19.6%   8.8%   35.0%   25 bps    17.4%
MSR Pool 6 - Recapture Agreement   10.0%   6.0%   35.0%   23 bps    17.4%
MSR Pool 7   13.8%   8.4%   35.0%   16 bps    15.2%
MSR Pool 7 - Recapture Agreement   10.0%   5.0%   35.0%   19 bps    15.2%
MSR Pool 8   15.2%   7.4%   35.0%   19 bps    15.0%
MSR Pool 8 - Recapture Agreement   10.0%   5.0%   35.0%   19 bps    

15.0

%

 

(A)Projected annualized weighted average lifetime voluntary and involuntary prepayment rate using a prepayment vector.
  
(B)Projected percentage of mortgage loans in the pool that will miss their mortgage payments.
  
(C)Percentage of voluntarily prepaid loans that are expected to be refinanced by Nationstar.
  
(D)Weighted average total mortgage servicing amount in excess of the basic fee.
  
(E)The Excess MSR will be paid on the total UPB of the mortgage portfolio (including both performing and delinquent loans until REO).

 

All of the assumptions listed have some degree of market observability, based on New Residential’s knowledge of the market, relationships with market participants, and use of common market data sources. Prepayment speed and delinquency rate projections are in the form of “curves” or “vectors” that vary over the expected life of the pool. New Residential uses assumptions that generate its best estimate of future cash flows for each investment in Excess MSRs.

 

When valuing Excess MSRs, New Residential uses the following criteria to determine the significant inputs:

 

·Prepayment Speed: Prepayment speed projections are in the form of a “vector” that varies over the expected life of the pool. The prepayment vector specifies the percentage of the collateral balance that is expected to prepay voluntarily (i.e., pay off) and involuntarily (i.e., default) at each point in the future. The prepayment vector is based on assumptions that reflect factors such as the borrower’s FICO score, loan-to-value ratio, debt-to-income ratio, vintage on a loan level basis, as well as the projected effect on loans eligible for the Home Affordable Refinance Program 2.0 (“HARP 2.0”). Management considers collateral-specific prepayment experience when determining this vector. For the Recapture Agreements and recaptured loans, New Residential also considers industry research on the prepayment experience of similar loan pools (i.e., loan pools composed of refinanced loans). This data is obtained from remittance reports, market data services and other market sources.

 

18
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

·Delinquency Rates: For existing mortgage pools, delinquency rates are based on the recent pool-specific experience of loans that missed their latest mortgage payments. For the Recapture Agreements and recaptured loans, delinquency rates are based on the experience of similar loan pools originated by Nationstar and delinquency experience over the past year. Management believes this time period provides a reasonable sample for projecting future delinquency rates while taking into account current market conditions. Additional consideration is given to loans that are expected to become 30 or more days delinquent.

 

·Recapture Rates: Recapture rates are based on actual average recapture rates experienced by Nationstar on similar mortgage loan pools. Generally, New Residential looks to one year worth of actual recapture rates, which management believes provides a reasonable sample for projecting future recapture rates while taking into account current market conditions.

 

·Excess Mortgage Servicing Amount: For existing mortgage pools, excess mortgage servicing amount projections are based on the actual total mortgage servicing amount in excess of a basic fee. For loans expected to be refinanced by Nationstar and subject to a Recapture Agreement, New Residential considers the excess mortgage servicing amount on loans recently originated by Nationstar over the past year and other general market considerations. Management believes this time period provides a reasonable sample for projecting future excess mortgage servicing amounts while taking into account current market conditions.

 

·Discount Rate: The discount rates used by New Residential are derived from market data on pricing of mortgage servicing rights backed by similar collateral.

 

New Residential uses different prepayment and delinquency assumptions in valuing the Excess MSRs relating to the original loan pools, the Recapture Agreements and the Excess MSRs relating to recaptured loans. The prepayment speed and delinquency rate assumptions differ because of differences in the collateral characteristics, eligibility for the Home Affordable Refinance Program 2.0 (“HARP 2.0”) and expected borrower behavior for original loans and loans which have been refinanced. New Residential uses the same assumptions for recapture and discount rates when valuing Excess MSRs and Recapture Agreements. These assumptions are based on historical recapture experience and market pricing.

 

19
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

Excess MSRs, owned directly, measured at fair value on a recurring basis using Level 3 inputs changed during the three months ended March 31, 2013 as follows:

 

  

Level 3 (A)

 
    

MSR Pool 1

    

MSR Pool 2

    

MSR Pool 3

    

MSR Pool 4

    

MSR Pool 5

    

Total

 
Balance at December 31, 2012   $40,910   $39,322   $35,434   $15,036   $114,334   $245,036 
Transfers (B)                              
Transfers from Level 3(B)                         
Transfers into Level 3(B)                        
Gains (losses) included in net income (C)    440    897    798    98    (375)   1,858 
Interest income    1,970    1,485    1,628    601    4,340    10,024 
Purchases, sales and repayments                              
Purchases                         
Purchase adjustments                         
Proceeds from sales                         
Proceeds from repayments    (3,632)   (3,129)   (3,182)   (1,061)   (9,359)   (20,363)
Balance at March 31, 2013   $39,688   $38,575   $34,678   $14,674   $108,940   $236,555 

 

(A)Includes the recapture agreement for each respective pool.
  
(B)Transfers are assumed to occur at the beginning of the respective period.
  
(C)The gains (losses) recorded in earnings during the period are attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting dates. These gains (losses) represent the change in fair value of the Excess MSRs and are recorded in “Change in fair value of investments in excess mortgage servicing rights” in the consolidated statements of income.

 

Equity Method Investees Valuation

 

Fair value estimates of New Residential’s investments were based on internal pricing models. New Residential estimated the fair value of the assets and liabilities of the underlying entities in which it holds an equity interest. The valuation technique is based on discounted cash flows. Significant inputs represent the inputs required to estimate the fair value of the Excess MSRs held by the entities and include expectations of prepayment rates, delinquency rates, recapture rates, the excess mortgage servicing amount of the underlying mortgage loans, and discount rates that market participants would use in determining the fair values of mortgage servicing rights on similar pools of residential mortgage loans. In addition, in valuing the Excess MSRs, management considered the likelihood of Nationstar being removed as servicer, which likelihood is considered to be remote. Refer to the Investments in Excess MSRs Valuation section above for further details.

 

20
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

New Residential’s investments in equity method investees measured at fair value on a recurring basis using Level 3 inputs changed during the three months ended March 31, 2013 as follows:

 

   Three Months Ended
March 31, 2013
 
Balance at December 31, 2012  $ 
Contributions to equity method investees   109,588 
Distributions of earnings from equity method investees   (1,344)
Distributions of capital from equity method investees   (6,625)
Change in fair value of investments in equity method investees   969 
Balance at March 31, 2013  $102,588 

 

Real Estate Securities Valuation

 

As of March 31, 2013 New Residential’s securities valuation methodology and results are further detailed as follows:

 

Asset Type  Outstanding Face Amount   Amortized Cost Basis   Multiple Quotes (A)   Single Quotes (B)   Total 
                          
Agency RMBS (C)   $754,496   $797,547   $709,173   $90,282   $799,455 
Non-Agency RMBS    784,259    488,767    505,241    13,327    518,568 
   $1,538,755   $1,286,314   $1,214,414   $103,609   $1,318,023 

  

(A)Management generally obtained pricing service quotations or broker quotations from two sources, one of which was generally the seller (the party that sold New Residential the security). Management selected one of the quotes received as being most representative of the fair value and did not use an average of the quotes. Even if New Residential receives two or more quotes on a particular security that come from non-selling brokers or pricing services, it does not use an average because management believes using an actual quote more closely represents a transactable price for the security than an average level. Furthermore, in some cases there is a wide disparity between the quotes New Residential receives. Management believes using an average of the quotes in these cases would not represent the fair value of the asset. Based on New Residential’s own fair value analysis using internal models, management selects one of the quotes which is believed to more accurately reflect fair value. New Residential never adjusts quotes received. These quotations are generally received via email and contain disclaimers which state that they are “indicative” and not “actionable” — meaning that the party giving the quotation is not bound to actually purchase the security at the quoted price.
  
(B)Management was unable to obtain quotations from more than one source on these securities. The one source was generally the seller (the party that sold New Residential the security) or a pricing service.
  
(C)Includes securities issued or guaranteed by U.S. Government agencies such as Fannie Mae or Freddie Mac.

 

Fair value measurements categorized within Level 3 are sensitive to changes in the assumptions or methodology used to determine fair value, and such changes could result in a significant increase or decrease in the fair value. For New Residential’s investments in real estate securities categorized within Level 3 of the fair value hierarchy, the significant unobservable inputs include the discount rates, assumptions related to prepayments, default rates and loss severities. Significant increases (decreases) in any of the discount rates, default rates or loss severities in isolation would result in a significantly lower (higher) fair value measurement. The impact of changes in prepayment speeds would have differing impacts on fair value, depending on the seniority of the investment. Generally, a change in the default assumption is generally accompanied by directionally similar changes in the assumptions used for the loss severity and the prepayment speed.

 

21
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

Fair value estimates of New Residential’s Non-Agency RMBS were based on third party indications as of March 31, 2013 and classified as Level 3. Securities measured at fair value on a recurring basis using Level 3 inputs changed during the three months ended March 31, 2013 as follows:

 

   Level 3 
   Non-Agency 
   RMBS 
      
Balance at December 31, 2012  $289,756 
Transfer (A)     
Transfers from Level 3    
Transfers into Level 3    
      
Total Gains (Losses)     
Included in net income    
Included in comprehensive income (B)   14,267 
      
Amortization included in interest income   4,724 
Purchases, sales and repayments     
Purchases   227,293 
Proceeds from repayments   (17,472)
      
Balance at March 31, 2013  $518,568 

 

(A)Transfers are assumed to occur at the beginning of the respective period.
  
(B)These gains (losses) were included in net unrealized gain (loss) on securities in the consolidated statements of comprehensive income.

 

Loans for Which Fair Value is Only Disclosed

 

The fair value of New Residential’s reverse mortgage loans held-for-investment were estimated based on a discounted cash flow analysis using internal pricing models. The significant inputs to these models include discount rates that management believes market participants would use in determining the fair values on similar pools of reverse mortgage loans. New Residential’s loans held-for-investment are categorized within Level 3 of the fair value hierarchy.

 

As of March 31, 2013, loans which New Residential has the intent and ability to hold into the foreseeable future are classified as held-for-investment. Loans held-for-investment are carried at the aggregate unpaid principal balance adjusted for any unamortized premium or discount, deferred fees or expenses, an allowance for loan losses, charge-offs and write-downs for impaired loans.

 

22
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

The following table summarizes the inputs used in valuing reverse mortgage loans as of March 31, 2013:

 

                   Significant Input
Loan Type  Outstanding Face Amount   Carrying Value   Fair Value   Valuation Allowance/ (Reversal) In Current Year   Discount Rate
                        
Reverse Mortgage Loans  $58,586   $35,484   $37,180   $   10.6%

 

Liabilities for Which Fair Value is Only Disclosed.

 

Repurchase agreements are not measured at fair value in the statement of position; however, management believes that their carrying value approximates fair value. Repurchase agreements are considered to be level 2 in the valuation hierarchy with significant valuation variables including the amount and timing of expected cash flows, interest rates and collateral funding spreads.

 

9.     COMMITMENTS AND CONTINGENCIES

 

Litigation – New Residential may, from time to time, be a defendant in legal actions from transactions conducted in the ordinary course of business. As of March 31, 2013, New Residential is not subject to any material litigation, individually or in the aggregate, nor, to management’s knowledge, is any material litigation currently threatened against New Residential.

 

Indemnifications – In the normal course of business, New Residential and its subsidiaries enter into contracts that contain a variety of representations and warranties and that provide general indemnifications. New Residential’s maximum exposure under these arrangements is unknown as this would involve future claims that may be made against New Residential that have not yet occurred. However, based on Newcastle’s and its own experience, New Residential expects the risk of material loss to be remote.

 

Capital Commitments As of March 31, 2013, New Residential had outstanding capital commitments related to investments in joint ventures in connection with the acquisition of Excess MSRs and consumer loans. See Notes 6 and 12, respectively, for a description of these commitments.

 

10.     TRANSACTIONS WITH AFFILIATES AND AFFILIATED ENTITIES

 

New Residential has entered into a management agreement (Note 12) with the Manager, an affiliate of Fortress. Pursuant to the Management Agreement, the Manager, under the supervision of New Residential’s board of directors, formulates investment strategies, arranges for the acquisition of assets and associated financing, monitors the performance of New Residential’s assets and provides certain advisory, administrative and managerial services in connection with the operations of New Residential. For performing these services, the Manager receives from New Residential a management fee and incentive compensation, as defined in the Management Agreement. In addition to the management fee and incentive compensation, New Residential is also responsible for reimbursing the Manager for certain expenses paid by the Manager on behalf of New Residential.

 

Prior to entering into a Management Agreement with FIG LLC, management fees were allocated by and due to Newcastle based on the equity used in funding the acquisition of Excess MSRs and other assets. These management fees were equal to 1.5% of gross equity, as defined in the Management Agreement between Newcastle and FIG LLC.

 

23
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

Due to affiliate is comprised of the following amounts due to Newcastle:

 

   March 31, 2013   December 31, 2012 
           
Management fees payable  $5,717   $3,392 
Reimbursable expenses payable   2,067    1,744 
   $7,784   $5,136 

 

See Notes 1, 3 and 12 for a discussion of transactions with Nationstar. As of March 31, 2013, New Residential held on its balance sheet a total face amount of $644.7 million of Non-Agency RMBS serviced by Nationstar. The total UPB of the loans underlying these Nationstar serviced Non-Agency RMBS was approximately $8.3 billion as of March 31, 2013.

 

11.     INCOME TAXES

 

New Residential intends to qualify as a REIT for the tax year ending December 31, 2013. A REIT is generally not subject to U.S. federal corporate income tax on that portion of its income that is distributed to stockholders if it distributes at least 90% of its REIT taxable income to its stockholders by prescribed dates and complies with various other requirements. New Residential was a wholly owned subsidiary of Newcastle until May 15, 2013 and, as a qualified REIT subsidiary, was a disregarded entity until such date. As a result, no provision or liability for U.S. federal or state income taxes has been included in the accompanying consolidated financial statements for the periods ended March 31, 2013 or 2012.

 

12.     RECENT ACTIVITIES

 

These financial statements include a discussion of material events that have occurred subsequent to March 31, 2013 (referred to as “subsequent events”) through the issuance of these consolidated financial statements. Events subsequent to that date have not been considered in these financial statements.

 

On March 5, 2013, New Residential agreed to co-invest in a portfolio of consumer loans with a UPB of approximately $4.2 billion as of December 31, 2012. The portfolio includes over 400,000 personal unsecured loans and personal homeowner loans originated through subsidiaries of HSBC Finance Corporation. On April 1, 2013, New Residential completed this co-investment through newly formed limited liability companies (collectively, “the consumer loan companies”). The consumer loan companies acquired the portfolio from HSBC Finance Corporation and its affiliates. New Residential invested approximately $250 million for 30% membership interests in each of the consumer loan companies. Of the remaining 70% of the membership interests, Springleaf Finance, Inc. (“Springleaf”), which is majority-owned by Fortress funds managed by New Residential’s Manager, acquired 47%, and an affiliate of Blackstone Tactical Opportunities Advisors L.L.C. acquired 23%. Springleaf will act as the managing member of the consumer loan companies. The consumer loan companies financed $2.2 billion of the approximately $3.0 billion purchase price with asset-backed notes. The consumer loan companies were formed on March 19, 2013, for the purpose of making this investment and commenced operations upon the completion of the investment. After a servicing transition period, Springleaf will be the servicer of the loans and will provide all servicing and advancing functions for the portfolio. Consumer loans will be treated as a separate segment. Included in general and administrative expenses for the three months ended March 31, 2013 is approximately $2.5 million of professional fees related to consumer loans.

 

On April 9, 2013, New Residential financed additional Non-Agency RMBS with approximately $144 million of repurchase agreements, at a cost of one-month LIBOR plus 200 bps. The weighted average advance rate for these repurchase agreements was approximately 70%. These repurchase agreements, which contain customary margin call provisions, have an initial term ending on July 9, 2013.

 

24
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

On April 19, 2013, the Master Repurchase Agreement between NIC RMBS LLC and Credit Suisse Securities LLC was amended. Under the terms of the amendment, Newcastle was terminated as the Guarantor and replaced by New Residential on May 15, 2013.

 

On April 26, 2013, Newcastle announced that its board of directors had formally declared the distribution of shares of common stock of New Residential, a then wholly owned subsidiary of Newcastle. Following the spin-off, New Residential is an independent, publicly-traded REIT primarily focused on investing in residential mortgage related assets. The spin-off was completed on May 15, 2013 and New Residential began trading on the New York Stock Exchange under the symbol “NRZ”. The spin-off transaction was effected as a taxable pro rata distribution by Newcastle of all the outstanding shares of common stock of New Residential to the stockholders of record of Newcastle as of May 6, 2013. The stockholders of Newcastle as of the record date received one share of New Residential common stock for each share of Newcastle common stock held.

 

On April 29, 2013, New Residential’s certificate of incorporation was amended so that its authorized capital stock now consists of 2,000,000,000 shares of common stock, par value $0.01 per share, and 100,000,000 shares of preferred stock, par value $0.01 per share. After completion of the spin-off, there are 253,025,645 outstanding shares of common stock which is based on the number of Newcastle’s shares of common stock outstanding on May 6, 2013 and a distribution ratio of one share of New Residential common stock for each share of Newcastle common stock.

 

Effective May 15, 2013, the Manager is entitled to receive annual incentive compensation in an amount equal to the product of (A) 25% of the dollar amount by which (1) (a) New Residential’s funds from operations before the incentive compensation per share of common stock, plus (b) gains (or losses) from debt restructuring and gains (or losses) from sales of property and other assets per share of common stock, exceed (2) an amount equal to (a) the weighted average of the book value per share of the equity transferred by Newcastle on the distribution date and the prices per share of New Residential’s common stock in any offerings (adjusted for prior capital dividends or capital distributions) multiplied by (b) a simple interest rate of 10% per annum, multiplied by (B) the weighted average number of shares of common stock outstanding. “Funds from operations” means net income (computed in accordance with GAAP), excluding gains (losses) from debt restructuring and gains (or losses) from sales of property, plus depreciation on real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. Funds from operations will be computed on an unconsolidated basis. The computation of funds from operations may be adjusted at the direction of New Residential’s independent directors based on changes in, or certain applications of, GAAP. Funds from operations is determined from the date of the spin-off and without regard to Newcastle’s prior performance. Funds from operations does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income as an indication of New Residential’s performance or to cash flows as a measure of liquidity or the ability to make distributions.

 

Effective May 15, 2013, the Manager is entitled to receive a management fee in the amount equal to 1.5% per annum of New Residential’s gross equity calculated and payable monthly in arrears in cash. Gross equity is generally the equity transferred by Newcastle on the distribution date, plus total net proceeds from stock offerings, plus certain capital contributions to subsidiaries, less capital distributions and repurchases of common stock.

 

On May 15, 2013, New Residential had a cash balance of $181.6 million.

 

On May 20, 2013, New Residential acquired, through a joint venture, an interest in Excess MSRs from Nationstar on a portfolio of mortgage loans with an UPB of approximately $23 billion as of March 31, 2013. New Residential has committed to invest approximately $40.2 million to acquire a one-third interest in the Excess MSRs. Nationstar is the servicer of the loans and has retained a one-third interest in the Excess MSRs; a Fortress managed fund has acquired the remaining one-third interest. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by Nationstar, the resulting Excess MSRs will be included in the portfolio, subject to certain limitations. New Residential, Nationstar and the Fortress fund will share equally in these Excess MSRs.

 

25
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

Effective upon the spin-off, New Residential has a Nonqualified Stock Option and Incentive Award Plan (the “Plan”) which provides for the grant of equity-based awards, including restricted stock, stock options, stock appreciation rights, performance awards, tandem awards and other equity-based and non equity based awards, in each case to the Manager, and to the directors, officers, employees, service providers, consultants and advisor of the Manager who perform services for New Residential, and to New Residential’s directors, officers, service providers, consultants and advisors. New Residential has initially reserved 30,000,000 shares of its common stock for issuance under the Plan; on the first day of each fiscal year beginning during the ten-year term of the Plan in and after calendar year 2014, that number will be increased by a number of shares of New Residential’s common stock equal to 10% of the number of shares of common stock newly issued by New Residential during the immediately preceding fiscal year (and, in the case of fiscal year 2013, after the effective date of the Plan). New Residential’s board of directors may also determine to issue options to the Manager that are not subject to the Plan, provided that the number of shares underlying any options granted to the Manager in connection with capital raising efforts would not exceed 10% of the shares sold in such offering and would be subject to NYSE rules.

 

Prior to the spin-off, Newcastle had issued options to the Manager in connection with capital raising activities. In connection with the spin-off, 21.5 million options that were held by FIG LLC, (the Manager), or by the directors, officers or employees of the Manager, were converted into an adjusted Newcastle option and a new New Residential option. The exercise price of each adjusted Newcastle option and New Residential option was set to collectively maintain the intrinsic value of the Newcastle option immediately prior to the spin-off and to maintain the ratio of the exercise price of the adjusted Newcastle option and the New Residential option, respectively, to the fair market value of the underlying shares as of the spin-off date, in each case based on the five day average closing price subsequent to the spin-off date.

 

26
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

New Residential’s outstanding options at May 15, 2013 consisted of the following:

 

   Number of Options   Strike Price   Maturity Date
    6,000   $9.35   05/30/13
    116,380    10.91   07/16/13
    304,604    12.28   12/01/13
    328,350    14.17   01/09/14
    343,275    13.86   05/25/14
    162,500    16.95   11/22/14
    330,000    15.97   01/12/15
    2,000    16.68   08/01/15
    170,000    15.87   11/01/16
    242,000    16.90   01/23/17
    456,000    14.96   04/11/17
    1,676,833    3.29   03/29/21
    2,539,833    2.49   09/27/21
    2,000    2.74   12/20/21
    1,897,500    3.41   04/03/22
    2,300,000    3.67   05/21/22
    2,530,000    3.67   07/31/22
    5,750,000    5.12   01/11/23
    2,300,000    5.74   02/15/23
Total/WA    21,457,275   $5.35 

 

On June 3, 2013, New Residential granted options to its independent directors to purchase 8,000 shares of New Residential’s stock at a price of $6.79.

 

On June 6, 2013, New Residential financed additional Non-Agency RMBS with approximately $47.0 million of repurchase agreements, at a cost of one-month LIBOR plus 160 bps. The weighted average advance rate for these repurchase agreements was approximately 65%. These repurchase agreements, which contain customary margin call provisions, have an initial term ending on June 28, 2013.

 

Subsequent to March 31, 2013, New Residential acquired approximately $156.4 million face amount of Non-Agency RMBS for approximately $122.0 million. New Residential also purchased $97.5 million of Agency RMBS for approximately $103.0 million. Newcastle contributed an additional $265.6 million face amount of Agency RMBS subsequent to March 31, 2013 with a fair value of approximately $281.2 million as of the contribution date. These additional agency RMBS were financed with $267.0 million of repurchase agreements.

 

New Residential declared a quarterly dividend of $0.07 per common share for the quarter ended June 30, 2013, which will be paid in July 2013.

 

13.     PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION

 

The following unaudited pro forma condensed consolidated financial information was derived from the application of pro forma adjustments to the consolidated financial statements of New Residential. The unaudited pro forma condensed consolidated financial statements should be read in conjunction with the other information contained in these financial statements and related notes and with New Residential’s historical consolidated financial statements.

 

27
  

 

NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

Condensed consolidated financial statements should be read in conjunction with the other information contained in these financial statements and related notes and with New Residential’s historical consolidated financial statements.

 

The unaudited pro forma information set forth below reflects the historical information of New Residential with certain adjustments. The unaudited pro forma condensed consolidated balance sheet has been adjusted to give effect to all of the transactions described below as if each had occurred on March 31, 2013, see Note 12. The unaudited pro forma condensed consolidated statement of income only includes adjustments to reflect (i) interest income from the Agency RMBS acquired subsequent to March 31, 2013; (ii) interest expense from the financing of Agency RMBS; and (iii) interest expense from the financing of certain Non-Agency RMBS, subsequent to March 31, 2013, in each case as if the transactions giving rise to (i), (ii) and (iii) had occurred on January 1, 2013. Accordingly, the unaudited pro forma condensed consolidated statement of income excludes adjustments for (i) earnings from the consumer loan co-investment transaction; (ii) earnings from the additional Excess MSR transactions; and (iii) interest income from investments in non-Agency RMBS.

 

·New Residential’s cash balance as of May 16, 2013 adjusted for subsequent purchases, sales and financings.
·Consumer loan co-investment transaction through equity method investees on April 1, 2013.
·Acquisition and settlement of additional Excess MSRs, directly and through equity method investees subsequent to March 31, 2013.
·Commitments to acquire additional Excess MSRs through equity method investees subsequent to March 31, 2013, see Notes 6 and 9.
·Acquisition of additional Non-Agency RMBS with a face amount of $156.4 million for approximately $122.0 million subsequent to March 31, 2013 net of sales.
·Acquisition of additional Agency RMBS with a face amount of $97.5 million for approximately $103.0 million subsequent to March 31, 2013.
·Newcastle’s contribution of an additional $265.6 million face amount of Agency RMBS subsequent to March 31, 2013.
·Entry into an additional $290.0 million of Repurchase Agreements related to additional Agency RMBS subsequent to March 31, 2013.
·Entry into an additional $187.8 million of Repurchase Agreements related to additional Non-Agency RMBS subsequent to March 31, 2013.

 

New Residential’s decision to include or exclude an adjustment in the unaudited pro forma condensed consolidated statement of income was based on whether such adjustment would be factually supportable and historically based, as set forth in more detail below.

 

With respect to Agency RMBS, Newcastle held substantial investments in Agency RMBS during the entire period covered by the pro forma statement of income. Although Newcastle did not own the exact securities contributed to New Residential for the entire period presented, management considers Agency RMBS to be fungible because, among other factors, they are guaranteed by the U.S. government and thus have consistent credit characteristics. As a result, New Residential determined that adjustments related to these securities are factually supportable.

 

In contrast to Agency RMBS, the yields of Non-Agency RMBS can have significant variances as a result of differences in the collateral and credit characteristics of each asset. Newcastle did not hold the specific Non-Agency RMBS contributed to New Residential during the entire period presented, and Newcastle does not have records relating to the performance of these assets prior to their acquisition. As a result, management believes that adjustments for the interest income from the Non-Agency RMBS would not be factually supportable.

 

The investments in equity method investees were made in newly formed entities with no historical operations. Neither New Residential nor Newcastle owned any of the underlying excluded investments prior to their acquisition by the investee entities. Furthermore, the underlying loans were not serviced by an affiliate of New Residential’s manager prior to their acquisition. As a result, Newcastle does not have records relating to the performance of these loans prior to the acquisition of the related investments.

 

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NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

In addition, the composition of the loan pools and the loans underlying the Excess MSRs and consumer loan investees necessarily differ from the composition of the respective pools during the period covered by the pro forma statement of income due to prepayment and default activity prior to acquisition. As a result, an adjustment related to these investees was not considered factually supportable.

 

In the opinion of management, all adjustments necessary to reflect the effects of the transactions described in the notes to the unaudited pro forma condensed consolidated balance sheet and pro forma condensed statement of income have been included and are based upon available information and assumptions that New Residential believes are reasonable.

 

Further, the historical financial information presented herein has been adjusted to give pro forma effect to events that New Residential believes are factually supportable and which are expected to have a continuing impact on New Residential’s results. However, such adjustments are estimates and may not prove to be accurate. Information regarding these adjustments is subject to risks and uncertainties that could cause actual results to differ materially from those anticipated.

 

These unaudited pro forma condensed consolidated financial statements are provided for information purposes only. The unaudited pro forma condensed consolidated statement of income and consolidated balance sheet do not purport to represent what New Residential’s results of operations and/or financial condition would have been had such transactions been consummated on the dates indicated, nor do they represent the financial position or results of operations of New Residential for any future date.

 

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NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
At March 31, 2013

 

   March 31, 2013
(Unaudited) (A)
  

Pro Forma

Adjustments

  

New Residential

Pro Forma

 
Assets               
Real estate securities, available-for-sale  $1,318,023   $501,815(B)  $1,819,838 
Investments in excess mortgage servicing rights at fair value   236,555    2,453(C)   239,008 
Investments in equity method investees, excess mortgage servicing rights, at fair value   102,588    268,133(D)   370,721 
Investments in equity method investees, consumer loans, at fair value       247,971(E)   247,971 
Residential mortgage loans, held-for-investment   35,484        35,484 
Cash and cash equivalents       102,936(F)   102,936 
Other assets   450        450 
   $1,693,100   $1,123,308   $2,816,408 
                
Liabilities and Equity               
                
Liabilities               
Repurchase agreements  $915,058   $477,840(G)  $1,392,898 
Payable related to the investments in equity method investees, excess
mortgage servicing rights
       198,855(H)   198,855 
Due to affiliate   7,784        7,784 
Accrued expenses and other liabilities   2,839        2,839 
    925,681    676,695    1,602,376 
                
Commitments and contingencies               
                
Equity               
Common Stock, $0.01 par value, 2,000,000,000 shares authorized, 253,025,645 issued and outstanding on a pro forma basis       2,530(I)   2,530 
Accumulated Equity   735,710    444,083(J)   1,179,793 
Accumulated other comprehensive income   31,709        31,709 
Total Equity   767,419    446,613    1,214,032 
   $1,693,100   $1,123,308   $2,816,408 

 

(A)Represents New Residential’s historical consolidated balance sheet at March 31, 2013.
(B)Represents the carrying value of securities contributed by Newcastle to New Residential and the acquisition of additional Agency and Non-Agency RMBS subsequent to March 31, 2013 net of sales.
(C)Represents the investment in additional excess mortgage servicing rights subsequent to March 31, 2013.
(D)Represents the investment in additional equity method investees, excess mortgage servicing rights, subsequent to March 31, 2013.
(E)Represents the investments in equity method investees, consumer loans, subsequent to March 31, 2013.
(F)Represents New Residential’s cash balance as of May 15, 2013 adjusted for subsequent purchases, sales and financings.
(G)Represents the additional repurchase agreements to finance the real estate securities described in (B) above, net of paydowns through June 10, 2013.
(H)Represents commitments of New Residential’s investments in equity method investees.
(I)Represents 253,025,645 shares of common stock at a par value of $0.01 per share. The number of shares of common stock is based on Newcastle’s shares of common stock outstanding on May 6, 2013 and a distribution ratio of one share of New Residential common stock for each share of Newcastle common stock.
(J)Represents New Residential’s accumulated equity, including the additional contributions from Newcastle to New Residential subsequent to March 31, 2013, less the par value of the shares of common stock set forth in (I) above.

 

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NEW RESIDENTIAL INVESTMENT CORP. AND SUBSIDIARIES (formerly known as NIC MSR LLC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2013

(dollars in tables in thousands, except share data)

 

UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME

 

   Three Months Ended
March 31, 2013
(A)
   Pro Forma Adjustments   New Residential Pro Forma 
                
Interest income  $16,191   $4,226(B)  $20,417 
Interest expense   899    2,754(C)   3,653 
Net Interest Income   15,292    1,472    16,764 
                
Change in fair value of investments in excess mortgage servicing rights   1,858        1,858 
Change in fair value of investments in equity method investees   969        969 
Other Income   2,827        2,827 
                
Expenses               
General and administrative expenses   2,719        2,719 
Management fees allocated by Newcastle   2,325    71(D)   2,396 
    5,044    71    5,115 
                
Net Income  $13,075   $1,401   $14,476 
                
Net Income Per Share               
Basic   N/A        $0.06(E)
Diluted   N/A        $0.06(F)
                
Weighted average number of shares outstanding               
Basic   N/A         235,136,756(E)
Diluted   N/A         240,079,144(F)

 

(A)Represents New Residential’s historical consolidated statement of income for the three months ended March 31, 2013.
(B)Represents additional interest income from Agency RMBS acquired during the quarter ended March 31, 2013 and subsequent to March 31, 2013. The interest income was computed based on the weighted average accounting yield of the securities of 1.43%. A 1/8% increase (decrease) in the benchmark interest rate would result in an increase (decrease) in interest income of approximately $0.4 million for the three months ended March 31, 2013.
(C)Represents additional interest expense from additional repurchase agreements used to finance the real estate securities acquired subsequent to March 31, 2013. The interest expense was computed based on the actual terms of the repurchase agreements. A 1/8% increase (decrease) in the benchmark interest rate would result in an increase (decrease) in interest expense of approximately $0.4 million for the three months ended March 31, 2013.
(D)Represents additional management fees related to the capital transactions noted herein.
(E)Pro forma basic earnings per share and weighted average number of basic shares outstanding reflect an estimated number of shares of common stock outstanding based upon Newcastle’s weighted average number of basic shares outstanding for the three months ended March 31, 2013 (based on a distribution ratio of one share of New Residential common stock for each share of Newcastle common stock).
(F)Pro forma diluted earnings per share and weighted average number of diluted shares outstanding reflect shares of common stock that may be issued in connection with awards granted prior to the distribution under Newcastle equity plans based on the distribution ratio noted above in (E). While the actual dilutive impact will depend on various factors, we believe the estimate yields a reasonable approximation of the dilutive impact of the Newcastle equity plans and is based upon Newcastle’s weighted average number of diluted shares outstanding.

  

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following should be read in conjunction with the unaudited consolidated financial statements and notes thereto included herein, and with Part II, Item 1A, “Risk Factors.”

 

GENERAL

 

New Residential is a newly listed public REIT primarily focused on investing in residential mortgage related assets. We are externally managed by an affiliate of Fortress. Our goal is to drive strong risk-adjusted returns primarily through investments in residential real estate related investments including, but not limited to, Excess MSRs, RMBS and residential mortgage loans. New Residential’s investment guidelines are purposefully broad to enable us to make investments in a wide array of assets, including mortgage servicing advances and non-real estate related assets such as consumer loans. We generally target assets that generate significant current cash flows and/or have the potential for meaningful capital appreciation. We aim to generate attractive returns for our stockholders without the excessive use of financial leverage.

 

Our initial holdings upon the spin-off included all of Newcastle’s co-investments in Excess MSRs, a portion of its Agency RMBS, all of the Non-Agency RMBS it acquired (other than through securitization vehicles) since the beginning of 2012, all of the mortgage loans it acquired since the beginning of 2013 and all of the consumer loans it acquired through the date of the spin-off. Our initial holdings also include cash. A majority of our assets consist of qualifying real estate assets for purposes of Section 3(c)(5)(C) of the 1940 Act, including investments in Agency RMBS. Our asset allocation and target assets may change over time, depending on our Manager’s investment decisions in light of prevailing market conditions. The assets in our initial portfolio are described in more detail below under “—Results of Operations—Initial Portfolio.”

 

On May 15, 2013, Newcastle completed the distribution of shares of New Residential to Newcastle stockholders of record as of May 6, 2013. Following the distribution, New Residential is an independent, publicly-traded REIT (NYSE: NRZ).

 

Market CONsiderations

 

We believe that unfolding developments in the U.S. residential housing market are generating significant investment opportunities. The U.S. residential market is vast: the value of the housing market totaled $18 trillion as of March 31, 2013, including approximately $10 trillion of outstanding mortgages, according to Inside Mortgage Finance. In the aftermath of the U.S. financial crisis, the residential mortgage industry is undergoing major structural changes that are transforming the way mortgages are originated, owned and serviced. We believe these changes are creating a compelling set of investment opportunities.

 

We also believe that New Residential is one of only a select number of market participants that have the combination of capital, industry expertise and key business relationships we think are necessary to take advantage of this opportunity. We intend to focus on the investment opportunities described below, as well as other opportunities that may arise as the residential mortgage market evolves.

 

Excess MSRs

 

In our view, the mortgage servicing sector presents a number of compelling investment opportunities. An MSR provides a mortgage servicer with the right to service a pool of mortgages in exchange for a portion of the interest payments made on the underlying mortgages. This amount typically ranges from 25 to 50 bps times the UPB of the mortgages. As of March 31, 2013, approximately 83% of MSRs were owned by banks. We expect this number to decline as banks face pressure to reduce their MSR exposure as a result of heightened capital reserve requirements under Basel III, regulatory scrutiny and a more challenging servicing environment.

 

As banks sell MSRs, there is an opportunity for entities such as New Residential to participate through co-investment in the corresponding Excess MSRs. An MSR is made up of two components: a basic fee and an Excess MSR. The basic fee is the amount of compensation for the performance of servicing duties, and the Excess MSR is the amount that exceeds the basic fee. For example, if an MSR is 30 bps and the basic fee is 5 bps, then the Excess MSR is 25 bps. As the owner of an Excess MSR, we are not required to assume any servicing duties, advance obligations or liabilities associated with the portfolios underlying our investment.

 

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There are a number of reasons why we believe Excess MSRs are a compelling investment opportunity:

 

·Supply-Demand Imbalance. Since 2010, banks have sold or committed to sell MSRs totaling more than $1 trillion of the approximately $10 trillion mortgage market. As a result of the regulatory and other pressures facing bank servicers, we believe the volume of MSRs sales is likely to be substantial for some period of time. We estimate that MSRs on approximately $300 billion of mortgages are currently for sale, requiring a capital investment of approximately $2 billion based on current pricing dynamics, and approximately $2 trillion of MSRs could be sold over the next several years. In addition, approximately $1.5 trillion of new loans are expected to be created annually. We believe this creates an opportunity to enter into “flow arrangements”, whereby loan originators agree to sell Excess MSRs on a recurring basis (often monthly or quarterly) on newly originated loans. We believe many non-bank servicers, who are constrained by capital, will continue to sell a portion of the Excess MSR.
   
·Attractive Pricing. MSRs are currently being sold at a material discount to historical pricing levels. While prices have rebounded from the lows, we estimate prices in many cases are down nearly 50% from their peak. At current prices, we believe investments in Excess MSRs can generate attractive returns without leverage.
   
·Significant Barrier to Entry. Non-servicers cannot own the basic fee component of an MSR directly and would therefore need to co-invest with a servicer in order to invest in an Excess MSR. The number of strong, scalable non-bank servicers is limited. Moreover, in the case of Excess MSRs on Agency pools, the servicer must be Agency-approved. As a result, non-servicers seeking to invest in Excess MSRs generally face a significant barrier to entering the market, particularly if they do not have a relationship with a quality servicer. We believe New Residential’s track record of investing in Excess MSRs and its established relationship with Nationstar give us a competitive advantage over other investors.

 

As a wholly owned subsidiary of Newcastle, New Residential pioneered investments in Excess MSRs. We believe we are the most active REIT in the sector. For details about New Residential’s investments in Excess MSRs, see “—Results of Operations—Initial Portfolio—Excess MSRs” below.

 

RMBS

 

RMBS are securities created through the securitization of a pool of residential mortgage loans. Currently, approximately $6 trillion of the $10 trillion of residential mortgages outstanding has been securitized, according to Inside Mortgage Finance as of June 2012. Of the securitized mortgages, approximately $5 trillion are Agency RMBS, which are RMBS issued or guaranteed by a U.S. Government agency, such as Ginnie Mae, or by a GSE, such as Fannie Mae or Freddie Mac. The balance has been securitized by either public or private trusts (“private label securitizations”), and these securities are referred to as Non-Agency RMBS.

 

Since the onset of the financial crisis in 2007, there has been significant volatility in the prices for Non-Agency RMBS. This has resulted from a widespread contraction in capital available for this asset class, deteriorating housing fundamentals, and an increase in forced selling by institutional investors (often in response to rating agency downgrades). While the prices of these assets have started to recover from their lows, we believe a meaningful gap still exists between current prices and the recovery value of many Non-Agency RMBS.

 

Accordingly, we believe there are opportunities to acquire Non-Agency RMBS at attractive risk-adjusted yields, with the potential for meaningful upside if the U.S. economy and housing market continue to strengthen. We believe the value of existing Non-Agency RMBS may also rise if the number of buyers returns to pre-2007 levels. Furthermore, we believe that in many Non-Agency RMBS vehicles there is a meaningful discrepancy between the value of the Non-Agency RMBS and the value of the underlying collateral. We intend to pursue strategies to enable us to capitalize on the value differential between the securities and the underlying loans. For details about New Residential’s investments in Non-Agency RMBS, see “—Results of Operations—Initial Portfolio—Non-Agency RMBS” below.

 

The non-Agency RMBS we may acquire could be secured by fixed-rate mortgages, adjustable-rate mortgages or hybrid adjustable-rate mortgages. The mortgage loan collateral may be classified as “conforming” or “nonconforming,” depending on a variety of factors.

 

We also invest in Agency RMBS, which we believe complement our Excess MSR and Non-Agency RMBS investments. Agency RMBS offer more stable cash flows and historically have been subject to lower credit risk and greater price stability than the other types of residential mortgage investments we target. The large majority of our portfolio is adjustable rate mortgages. They have a short duration and typically more stable cash flows. For details about New Residential’s investments in Agency RMBS, see “—Results of Operations—Initial Portfolio—Agency RMBS” below.

 

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APPLICATION OF CRITICAL ACCOUNTING POLICIES

 

Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Actual results could differ from these estimates. Management believes that the estimates and assumptions utilized in the preparation of the consolidated financial statements are prudent and reasonable. Actual results historically have been in line with management’s estimates and judgments used in applying each of the accounting policies described below, as modified periodically to reflect current market conditions. The following is a summary of our accounting policies that are most affected by judgments, estimates and assumptions.

 

Excess MSRs

 

Upon acquisition, we elected to record each investment in Excess MSRs at fair value. We elected to record our investments in Excess MSRs at fair value in order to provide users of the financial statements with better information regarding the effects of prepayment risk and other market factors on the Excess MSRs.

 

GAAP establishes a framework for measuring fair value of financial instruments and a set of related disclosure requirements. A three-level valuation hierarchy has been established based on the transparency of inputs to the valuation of a financial instrument as of the measurement date. The three levels are defined as follows:

 

Level 1—Quoted prices in active markets for identical instruments.

 

Level 2—Valuations based principally on other observable market parameters, including:

 

·Quoted prices in active markets for similar instruments,
   
·Quoted prices in less active or inactive markets for identical or similar instruments,
   
·Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates), and
   
·Market corroborated inputs (derived principally from or corroborated by observable market data).

 

Level 3—Valuations based significantly on unobservable inputs.

 

The level in the fair value hierarchy within which a fair value measurement or disclosure in its entirety is based on the lowest level of input that is significant to the fair value measurement or disclosure in its entirety.

 

Our Excess MSRs are categorized as Level 3 under the GAAP hierarchy. The inputs used in the valuation of Excess MSRs include prepayment speed, delinquency rate, recapture rate, excess mortgage servicing amount and discount rate. The determination of estimated cash flows used in pricing models is inherently subjective and imprecise. The methods used to estimate fair value may not result in an amount that is indicative of net realizable value or reflective of future fair values. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in fair value. Management validates significant inputs and outputs of our models by comparing them to available independent third party market parameters and models for reasonableness. We believe the assumptions we use are within the range that a market participant would use, and factor in the liquidity conditions in the markets. Any changes to the valuation methodology will be reviewed by management to ensure the changes are appropriate.

 

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In order to evaluate the reasonableness of its fair value determinations, management engages an independent valuation firm to separately measure the fair value of its Excess MSRs pools. The independent valuation firm determines an estimated fair value range based on its own models and issues a “fairness opinion” with this range. Management compares the range included in the opinion to the values generated by its internal models. For Excess MSRs acquired prior to the current quarter, the fairness opinion relates to the valuation at the current quarter end date. For Excess MSRs acquired during the current quarter, the fairness opinion relates to the valuation at the time of acquisition. To date, New Residential has not made any significant valuation adjustments as a result of these fairness opinions.

 

For Excess MSRs acquired during the current quarter, New Residential revalues the Excess MSRs at the quarter end date if a payment is received between the acquisition date and the end of the quarter. Otherwise, Excess MSRs acquired during the current quarter are carried at their amortized cost basis if there has been no change in assumptions since acquisition.

 

Investments in Excess MSRs are aggregated into pools as applicable; each pool of Excess MSRs is accounted for in the aggregate. Interest income for Excess MSRs is accreted using an effective yield or “interest” method, based upon the expected income from the Excess MSRs through the expected life of the underlying mortgages. Changes to expected cash flows result in a cumulative retrospective adjustment, which will be recorded in the period in which the change in expected cash flows occurs. Under the retrospective method, the interest income recognized for a reporting period would be measured as the difference between the amortized cost basis at the end of the period and the amortized cost basis at the beginning of the period, plus any cash received during the period. The amortized cost basis is calculated as the present value of estimated future cash flows using an effective yield, which is the yield that equates all past actual and current estimated future cash flows to the initial investment. In addition, our policy is to recognize interest income only on Excess MSRs in existing eligible underlying mortgages.

 

Under the fair value election, the difference between the fair value of Excess MSRs and their amortized cost basis is recorded as “Change in fair value of investments in excess mortgage servicing rights,” as applicable. Fair value is generally determined by discounting the expected future cash flows using discount rates that incorporate the market risks and liquidity premium specific to the Excess MSRs, and therefore may differ from their effective yields.

 

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The following tables summarize the estimated change in fair value of our interests in the Excess MSRs owned directly and through equity method investees as of March 31, 2013 given several parallel shifts in the discount rate, prepayment rate, delinquency rate and recapture rate (dollars in thousands):

  

Fair value at March 31, 2013  $328,898(A)               

 

Discount rate shift in %   -20%   -10%   +10%    +20% 
Estimated fair value  $369,207   $348,669   $313,957   $299,166 
Change in estimated fair value:                    
Amount  $40,309   $19,771   $(14,941)  $(29,732)
%   12.3%   6.0%   -4.5%   -9.0%

 

Prepayment rate shift in %   -20%   -10%   +10%    +20% 
Estimated fair value  $362,481   $345,524   $315,285   $301,661 
Change in estimated fair value:                    
Amount  $33,583   $16,626   $(13,613)  $(27,237)
%   10.2%   5.1%   -4.1%   -8.3%

 

Delinquency rate shift in %   -20%   -10%   +10%    +20% 
Estimated fair value  $338,055   $333,946   $325,728   $321,621 
Change in estimated fair value:                    
Amount  $9,157   $5,048   $(3,170)  $(7,277)
%   2.8%   1.5%   -1.0%   -2.2%

 

Recapture rate shift in %   -20%   -10%   +10%    +20% 
Estimated fair value  $320,753   $325,524   $335,189   $339,974 
Change in estimated fair value:                    
Amount  $(8,145)  $(3,374)  $6,291   $11,076 
%   -2.5%   -1.0%   1.9%   3.4%

 

(A)Excludes our share of the non-Excess MSR net assets of the equity method investees of $10.2 million.

 

The sensitivity analysis is hypothetical and should be used with caution. In particular, the results are calculated by stressing a particular economic assumption independent of changes in any other assumption; in practice, changes in one factor may result in changes in another, which might counteract or amplify the sensitivities. Also, changes in the fair value based on a 10% variation in an assumption generally may not be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear.

 

RMBS

 

Our Non-Agency and Agency RMBS are classified as available-for-sale. As such, they will be carried at fair value, with net unrealized gains or losses reported as a component of accumulated other comprehensive income, to the extent impairment losses are considered temporary, as described below.

 

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We expect that any RMBS we acquire will be categorized under Level 2 or Level 3 of the GAAP hierarchy described above under “—Application of Critical Account Policies—Excess MSRs,” depending on the observability of the inputs. Fair value may be based upon broker quotations, counterparty quotations, pricing services quotations or internal pricing models. The significant inputs used in the valuation of our securities include the discount rate, prepayment speeds, default rates and loss severities, as well as other variables.

 

The determination of estimated cash flows used in pricing models is inherently subjective and imprecise. The methods used to estimate fair value may not be indicative of net realizable value or reflective of future fair values. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in fair value. Management validates significant inputs and outputs of our models by comparing them to available independent third party market parameters and models for reasonableness. We believe the assumptions we use are within the range that a market participant would use, and factor in the liquidity conditions in the markets. Any changes to the valuation methodology will be reviewed by management to ensure the changes are appropriate.

 

Pursuant to ASC 320-10-35, we must also assess whether unrealized losses on securities, if any, reflect a decline in value that is other-than-temporary and, if so, record an other-than-temporary impairment through earnings. A decline in value is deemed to be other-than-temporary if (i) it is probable that we will be unable to collect all amounts due according to the contractual terms of a security that was not impaired at acquisition (there is an expected credit loss), or (ii) if we have the intent to sell a security in an unrealized loss position or it is more likely than not that we will be required to sell a security in an unrealized loss position prior to its anticipated recovery (if any). For the purposes of performing this analysis, we will assume the anticipated recovery period is until the expected maturity of the applicable security. Also, for securities that represent beneficial interests in securitized financial assets within the scope of ASC 325-40, whenever there is a probable adverse change in the timing or amounts of estimated cash flows of a security from the cash flows previously projected, an other-than-temporary impairment will be deemed to have occurred. Our Non-Agency RMBS acquired with evidence of deteriorated credit quality for which it was probable, at acquisition, that we would be unable to collect all contractually required payments receivable, fall within the scope of ASC 310-30, as opposed to ASC 325-40. All of our other Non-Agency RMBS, those not acquired with evidence of deteriorated credit quality, fall within the scope of ASC 325-40.

 

Pursuant to ASC 835-30-35, income on these securities is recognized using a level yield methodology based upon a number of cash flow assumptions that are subject to uncertainties and contingencies. Such assumptions include the rate and timing of principal and interest receipts (which may be subject to prepayments and defaults). These assumptions are updated on at least a quarterly basis to reflect changes related to a particular security, actual historical data, and market changes. These uncertainties and contingencies are difficult to predict and are subject to future events, and economic and market conditions, which may alter the assumptions. For securities acquired at a discount for credit losses, we recognize the excess of all cash flows expected over our investment in the securities as Interest Income on a “loss adjusted yield” basis. The loss-adjusted yield is determined based on an evaluation of the credit status of securities, as described in connection with the analysis of impairment above.

 

Loans

 

We invest in loans, including but not limited to, residential mortgage loans. Loans for which we have the intent and ability to hold for the foreseeable future, or until maturity or payoff, are classified as held-for-investment. Loans are presented in the consolidated balance sheet at cost net of any unamortized discount (or gross of any unamortized premium). We determine at acquisition whether loans will be aggregated into pools based on common risk characteristics (credit quality, loan type, and date of origination or acquisition); loans aggregated into pools are accounted for as if each pool were a single loan.

 

Income on these loans is recognized similarly to that on our securities using a level yield methodology and is subject to similar uncertainties and contingencies, which are also analyzed on at least a quarterly basis.

 

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Impairment of Loans

 

To the extent that they are classified as held-for-investment, we must periodically evaluate each of these loans or loan pools for possible impairment. Impairment is indicated when it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the loan, or for loans acquired at a discount for credit losses, when it is deemed probable that we will be unable to collect as anticipated. Upon determination of impairment, we would establish a specific valuation allowance with a corresponding charge to earnings. We continually evaluate our loans receivable for impairment. Our residential mortgage loans are aggregated into pools for evaluation based on like characteristics, such as loan type and acquisition date. Pools of loans are evaluated based on criteria such as an analysis of borrower performance, credit ratings of borrowers, loan to value ratios, the estimated value of the underlying collateral, the key terms of the loans and historical and anticipated trends in defaults and loss severities for the type and seasoning of loans being evaluated. This information is used to estimate provisions for estimated unidentified incurred losses on pools of loans. Significant judgment is required in determining impairment and in estimating the resulting loss allowance. Furthermore, we must assess our intent and ability to hold our loan investments on a periodic basis. If we do not have the intent to hold a loan for the foreseeable future or until its expected payoff, the loan must be classified as “held for sale” and recorded at the lower of cost or estimated value.

 

Investment Consolidation

 

The analysis as to whether to consolidate an entity is subject to a significant amount of judgment. Some of the criteria considered are the determination as to the degree of control over an entity by its various equity holders, the design of the entity, how closely related the entity is to each of its equity holders, the relation of the equity holders to each other and a determination of the primary beneficiary in entities in which we have a variable interest. These analyses involve estimates, based on the assumptions of management, as well as judgments regarding significance and the design of entities.

 

Variable interest entities (“VIEs”) are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, and only by its primary beneficiary, which is defined as the party who has the power to direct the activities of a VIE that most significantly impact its economic performance and who has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.

 

Our investments in Non-Agency RMBS are variable interests. We monitor these investments and analyze the potential need to consolidate the related securitization entities pursuant to the VIE consolidation requirements.

 

These analyses require considerable judgment in determining whether an entity is a VIE and determining the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power and economics. The result could be the consolidation of an entity that otherwise would not have been consolidated or the de-consolidation of an entity that otherwise would have been consolidated.

 

We have not consolidated the securitization entities that issued our Non-Agency RMBS. This determination is based, in part, on our assessment that we do not have the power to direct the activities that most significantly impact the economic performance of these entities, such as if we owned a majority of the currently controlling class. In addition, we are not obligated to provide, and have not provided, any financial support to these entities.

 

We have not consolidated the entities in which we hold a 50% interest that made an investment in Excess MSRs. We have determined that the decisions that most significantly impact the economic performance of these entities will be made collectively by us and the other investor in the entities. In addition, these entities have sufficient equity to permit the entities to finance their activities without additional subordinated financial support. Based on our analysis, these entities do not meet any of the VIE criteria under ASC 810-10-15-14.

 

Investments in Equity Method Investees

 

We account for our interests in entities over which we exercise significant influence, but with respect to which the requirements for consolidation are not met, as investments in equity method investees. These investments are recorded based on the equity method of accounting, unless we elect to measure them at fair value.

 

Pursuant to ASC 825-10-25, we have elected to measure our investments in equity method investees which are invested in Excess MSRs at fair value. The equity method investees have also elected to measure their investments in Excess MSRs at fair value pursuant to ASC 825-10-25.

 

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Income Taxes

 

Our financial results are generally not expected to reflect provisions for current or deferred income taxes. We intend to operate in a manner that allows us to qualify for taxation as a REIT. As a result of our expected REIT qualification, we do not generally expect to pay U.S. federal or state and local corporate level taxes. Many of the REIT requirements, however, are highly technical and complex. If we were to fail to meet the REIT requirements, we would be subject to U.S. federal, state and local income and franchise taxes.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

In February 2013, the FASB issued new guidance regarding the reporting of reclassifications out of accumulated other comprehensive income. The new guidance does not change current requirements for reporting net income or other comprehensive income in the financial statements. However, it requires companies to present the effects on the line items of net income of significant amounts reclassified out of accumulated OCI if the item reclassified is required to be reclassified to net income in its entirety during the same reporting period. Presentation should occur either on the face of the income statement where net income is presented or in the notes to the financial statements. New Residential has early adopted this accounting standard and opted to present this information in a note to the financial statements.

 

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, the definition of an investment company, financial statement presentation, revenue recognition, financial instruments, hedging, and contingencies. Some of the proposed changes are significant and could have a material impact on our financial reporting. We will evaluate the potential impact of these proposals as the standards are finalized.

 

We are an emerging growth company as defined in the JOBS Act, and we have irrevocably elected not to take advantage of the delayed adoption of new or revised accounting standards applicable to public companies. We will therefore be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

 

RESULTS OF OPERATIONS

 

The following table summarizes the changes in our results of operations for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 (dollars in thousands):

 

   Three Months Ended March 31,   Increase (Decrease) 
   2013   2012   Amount   % 
                 
Interest income  $16,191   $2,037   $14,154    694.8%
Interest expense   899        899    N.M. 
Net Interest Income   15,292    2,037    13,255    650.7%
                     
Change in fair value of investments in excess mortgage servicing rights   1,858    1,216    642    52.8%
Change in fair value of investments in equity method investees   969        969    N.M. 
Other Income   2,827    1,216    1,611    132.5%
                     
Expenses                    
General and administrative expenses   2,719    411    2,308    561.6%
Management fees allocated by Newcastle   2,325    154    2,171    1409.7%
    5,044    565    4,479    792.7%
                     
Net Income  $13,075   $2,688   $10,387    386.4%

 

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Interest Income

 

Three months ended March 31, 2013 compared to the three months ended March 31, 2012

 

Interest income increased by $14.2 million during the three months ended March 31, 2013 compared to the three months ended March 31, 2012 primarily due to increases in interest income as a result of new investments in real estate securities and investments in excess mortgage servicing rights.

 

Interest Expense

 

Three months ended March 31, 2013 compared to the three months ended March 31, 2012

 

Interest expense increased by $0.9 million due to repurchase agreement financing entered into since March 2012 on our Agency RMBS and Non-Agency RMBS.

 

Change in Fair Value of Investments in Excess Mortgage Servicing Rights

 

Three months ended March 31, 2013 compared to the three months ended March 31, 2012

 

The change in fair value of investments in excess mortgage servicing rights increased $0.6 million due to the acquisition of investments since March 2012 and subsequent net increases in value.

 

Change in Fair Value of Investments in Equity Method Investees

 

Three months ended March 31, 2013 compared to the three months ended March 31, 2012

 

The change in fair value of investments in equity method investees increased $1.0 million due to the acquisition of these investments in the first quarter of 2013 and subsequent net increases in value.

 

General and Administrative Expense

 

Three months ended March 31, 2013 compared to the three months ended March 31, 2012

 

General and administrative expense increased by $2.3 million primarily due to an increase in professional fees primarily related to the investment in consumer loans.

 

Management Fees to Affiliate

 

Three months ended March 31, 2013 compared to the three months ended March 31, 2012

 

Management fees allocated by Newcastle increased by $2.2 million primarily due to an increase in our equity, as a result of capital contributions from Newcastle.

 

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Initial Portfolio

 

Our initial holdings upon the spin-off include all of Newcastle’s co-investments in Excess MSRs, a portion of its Agency RMBS, all of the Non-Agency RMBS it acquired (other than through securitization vehicles) since the beginning of 2012, all of the mortgage loans it acquired since the beginning of 2013 and all of the consumer loans it acquired through the date of the spin-off. Our initial holdings also include cash. A majority of our assets consist of qualifying real estate assets for purposes of Section 3(c)(5)(C) of the 1940 Act, including investments in Agency RMBS. Our asset allocation and target assets may change over time, depending on our Manager’s investment decisions in light of prevailing market conditions. The assets in our initial portfolio are described in more detail below.

 

Excess MSRs

 

As of March 31, 2013, we had approximately $339.1 million estimated carrying value of Excess MSRs (held directly and through joint ventures), including deposits on investments that have not closed through joint ventures. As of March 31, 2013, our completed investments represent a 33% to 65% interest in the Excess MSRs (either directly or through joint ventures) on eight pools of mortgage loans with an aggregate UPB of approximately $139 billion. Nationstar is the servicer of the loans underlying all of our investments in Excess MSRs to date, and it earns a basic fee in exchange for providing all servicing functions. In addition, Nationstar retains a 33% to 35% interest in the Excess MSRs and all ancillary income associated with the portfolios. We do not have any servicing duties, liabilities or obligations associated with the servicing of the portfolios underlying any of our investments. Each of our investments to date is subject to a recapture agreement with Nationstar. Under the recapture agreements, we are generally entitled to a pro rata interest in the Excess MSRs on any initial or subsequent refinancing by Nationstar of a loan in the original portfolio. In other words, we are generally entitled to a pro rata interest in the Excess MSRs on both (i) a loan resulting from a refinancing by Nationstar of a loan in the original portfolio, and (ii) a loan resulting from a refinancing by Nationstar of a previously recaptured loan.

 

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The following table summarizes the collateral characteristics of the loans underlying our direct Excess MSR investments as of March 31, 2013:

 

       Collateral Characteristics 
   Current Carrying Amount   Original
Principal
Balance
   Current
Principal
Balance
   Number
of Loans
   WA
FICO
Score
(A)
   WA Coupon   WA Maturity (months)   Average Loan
Age (months)
   Adjustable
Rate
Mortgage %
(B)
   1 Month
CPR (D)
   1 Month
CRR (E)
   1 Month CDR (F)   1 Month
Recapture
Rate
 
Pool 1                                                                 
Original Pool  $32,360   $9,940,385   $7,309,445    50,281    680    5.8%   279    77    19.4%   29.1%   25.9%   4.3%   47.7%
Recaptured Loans   2,973        712,344    3,516    749    4.3%   319    7    0.2%   1.7%   1.7%   0.0%   0.0%
Recapture Agreements   4,355                                                 
    39,688    9,940,385    8,021,789    53,797    686    5.7%   283    71    17.7%   27.3%   24.3%   3.9%   47.5%
                                                                  
Pool 2                                                                 
Original Pool   31,685    10,383,891    8,614,840    44,555    675    5.1%   317    67    10.9%   27.6%   24.1%   4.6%   57.5%
Recaptured Loans   2,010        423,217    2,030    755    4.2%   332    3    0.0%   0.3%   0.3%   0.0%   0.0%
Recapture Agreements   4,880                                                 
    38,575    10,383,891    9,038,057    46,585    679    5.0%   318    64    10.4%   26.8%   23.4%   4.4%   57.5%
                                                                  
Pool 3                                                                 
Original Pool   29,421    9,844,114    8,594,053    53,113    677    4.5%   288    90    37.9%   18.6%   15.4%   3.8%   48.5%
Recaptured Loans   705        164,636    961    752    4.1%   331    2    0.1%   0.0%   0.0%   0.0%   0.0%
Recapture Agreements   4,552                                                 
    34,678    9,844,114    8,758,689    54,074    678    4.5%   289    88    37.2%   18.4%   15.2%   3.7%   48.5%
                                                                  
Pool 4                                                                 
Original Pool   11,739    6,250,549    5,533,266    27,486    673    3.6%   311    81    58.0%   17.4%   8.5%   9.6%   39.2%
Recaptured Loans   230        53,585    268    756    4.2%   345    3    8.1%   0.3%   0.3%   0.0%   0.0%
Recapture Agreements   2,705                                                 
    14,674    6,250,549    5,586,851    27,754    674    3.6%   311    80    57.5%   17.3%   8.4%   9.6%   39.2%
                                                                  
Pool 5                                                                 
Original Pool   104,437    47,572,905    41,901,133    178,958    652    4.7%   290    86    56.7%   15.9%   5.1%   11.4%   2.1%
Recapture Loans   70        16,373    63    749    3.6%   333    2    5.9%   0.0%   0.0%   0.0%   0.0%
Recapture Agreements   4,433                                                 
    108,940    47,572,905    41,917,506    179,021    652    4.7%   290    86    56.7%   15.9%   5.1%   11.4%   2.1%
Total/WA  $236,555   $83,991,844   $73,322,892    361,231    664    4.7%   294    81    44.4%   18.9%   10.9%   8.7%   36.0%

 

Continued on next page.

 

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   Collateral Characteristics 
   Uncollected
Payments (C)
   Delinquency 30 Days (C)   Delinquency 60 Days (C)   Delinquency 90+ Days (C)   Loans in
Foreclosure
   Real
Estate
Owned
   Loans in
Bankruptcy
 
Pool 1                                   
Original Pool   9.2%   5.1%   1.8%   1.1%   4.3%   0.9%   2.7%
Recaptured Loans   0.1%   0.2%   0.0%   0.0%   0.0%   0.0%   0.0%
Recapture Agreements                            
    8.4%   4.7%   1.6%   1.0%   3.9%   0.8%   2.5%
                                    
Pool 2                                   
Original Pool   13.4%   4.5%   1.9%   1.5% </