April 12, 2017 / 4:46 PM / 7 months ago

Fitch Affirms NewStar at 'BB-'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, April 12 (Fitch) Fitch Ratings has affirmed the long- and short-term Issuer Default Ratings (IDR) of NewStar Financial, Inc. (NewStar) at 'BB-' and 'B', respectively. Fitch has also affirmed NewStar's senior unsecured debt at 'BB-' and the subordinated notes at 'B/RR6'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS IDRS, SENIOR AND SUBORDINATED DEBT The rating affirmations reflect NewStar's established business as a direct middle-market lender, the well diversified portfolio of senior secured loans, demonstrated performance track record in middle-market credit, a modest but growing asset management platform, and experienced management team. The ratings also benefit from NewStar's strategic partnership with GSO Capital Partners (GSO), a subsidiary The Blackstone Group L.P. (long-term IDR 'A+'/Stable Outlook) and Franklin Square Capital Partners (Franklin Square; FS Investment Corp. long-term IDR 'BBB-'/Stable Outlook). Fitch believes the partnership enhances the company's overall franchise, improves deal flow and sponsor relationships, and supports NewStar's growth aspirations. NewStar's ratings are constrained by its higher leverage relative to peers, reliance on secured wholesale funding, a weak but improving earnings profile, inconsistent strategic direction over time, and execution risk associated with its planned business strategy. These constraints are set against a backdrop of a highly competitive middle market underwriting environment, which could pressure asset quality and earnings performance in coming years. Over the last several years, NewStar has undertaken several shifts in strategic direction, including the partnership with GSO/Franklin Square in November 2014, the acquisition of Boston-based Feingold O'Keeffe Capital in October 2015, the sale of its asset-based lending business to Sterling National Bank in March 2016 and the sale of the equipment finance business to Radius Bank in December 2016. Fitch views these transactions as a continuation of NewStar's transformation from a bank-styled diversified commercial finance company to a more specialized commercial lender with a focus on managing assets for institutional investors. Fitch believes NewStar's future growth will be driven by its ability to leverage existing sponsor relationships and capitalize on referrals and co-investment opportunities with GSO/Franklin Square. Fitch would view outsized portfolio growth cautiously in the highly competitive underwriting environment, which has resulted in tighter spreads, higher leverage levels and weaker covenant packages, broadly, in the middle market. NewStar's investment portfolio is well-diversified, comprised predominately of senior secured loans, with first-lien loans representing 96.4% of the total portfolio, as of Dec. 31, 2016. Net charge-offs amounted to 0.9% of average loans in 2016, which compares favorably to peak charge-offs of 3.4% in 2010. Loans on non-accrual status amounted to 3% at YE16, down from a peak of 8.1% in 2009. Despite strong asset quality performance, Fitch expects NewStar's credit costs will increase modestly over the near to medium term, reflecting the seasoning of recent growth, as well as the potential for increased debt service burdens for underlying borrowers as interest rates continue to rise. Still, at YE16, NewStar realized modest credit losses associated with only one loan originated post-credit crisis (2009-2016 vintages), amounting to 0.1% of post-crisis originations. Operating performance has benefited from recent divestitures and other cost savings initiatives, but NewStar's financial performance remains weaker relative to peers due higher funding costs, with pre-tax returns on average equity amounting to 7.38% in 2016. Management has made progress on its efforts to streamline operations, reduce costs, and reposition the company as an asset management business. Fitch expects operating performance to improve more meaningfully over time as the capital-light asset management business begins to contribute more to earnings, although run-rate cost rationalization should benefit 2017 earnings to a modest extent. Fitch calculates Newstar's leverage as total debt to tangible equity, with no equity credit afforded to the subordinated notes. On this basis, leverage amounted to 5.63x, as of YE16, compared with 5.48x at YE15. Management has articulated its intention to reduce leverage to a range of 4.4x-4.8x in 2017 given the expectation to transition the company as a direct commercial lender and asset manager, which is meaningfully less balance sheet intensive. Deleveraging over the next 12 months is expected to be achieved through loan repayments and through proceeds from NewStar's recent divestitures. A further reduction in tangible balance sheet leverage over time to the 3.0x-3.5x range would be viewed positively from a ratings perspective. On Dec. 6, 2016, the board of directors authorized the programmatic repurchase of up to $30 million of common stock. The current program is expected to expire on Dec. 31, 2017. The board also instituted its first quarterly cash dividend on Feb. 14, 2017, amounting to $0.02 per share. Fitch views the strategic use of excess liquidity through the share repurchases and dividend as appropriate, given the firm has remained prudent in its capital deployment in the current competitive underwriting environment. Fitch expects NewStar will continue to make accretive share repurchases to continue so long as the current share price is below the firm's enterprise value per share. NewStar's funding profile remains highly reliant on wholesale funding, comprised of medium-term warehouse credit facilities, term securitizations, corporate unsecured debt, and subordinated debt. Fitch views the firm's access to the unsecured markets favorably, but the debt is relatively expensive. As of Dec. 31, 2016, 18.6% of NewStar's outstanding debt was unsecured, represented by $380 million in senior unsecured notes outstanding, with a coupon of 7.25% and $300 million of subordinated debt, with a coupon of 8.25%. At YE16, NewStar's average cost of funds was 4.65%, compared with 4.35% at YE15, given a modest widening of CLO spreads. The rating of the subordinated debt is two-notches below NewStar's long-term IDR, reflecting Fitch's assessment of the instrument's respective non-performance and relative loss severity risk profile. The two-notches represent incremental risk relative to the IDR, which is a function of increased loss severity due to subordination and heightened risk of non-performance relative to other (e.g. senior) obligations. The Stable Outlook reflects Fitch's expectation for modest improvement in operating performance, and the maintenance solid asset quality performance, appropriate leverage, sufficient liquidity and adequate interest coverage over the medium term. RATING SENSITIVITIES IDRS, SENIOR AND SUBORDINATED DEBT Fitch views positive rating momentum for NewStar as limited over the Outlook horizon given the time it will take to reposition the company into an asset management business and execution risks associated with that strategy. However, positive rating momentum could develop over time, driven by execution of the stated strategy, stable asset quality performance of recent vintages, improved profitability, and ability to realize synergies from the GSO/Franklin Square relationship. Reduced leverage and improved funding flexibility could also contribute to positive rating momentum. Conversely, negative rating momentum could be driven by material deterioration in asset quality performance, migration away from the primary focus on senior secured, an increase in leverage beyond management's articulated range, and/or an inability to improve earnings performance over time. The provision of financial support to non-recourse funding vehicles (i.e. credit facilities, repurchase agreements and term securitizations), or actions that impair NewStar's liquidity position, could also contribute to negative rating momentum. The ratings of the senior unsecured debt and subordinated debt are sensitive to changes in NewStar's IDR. The ratings of the senior unsecured debt are also sensitive to the level of unencumbered balance sheet assets available for unsecured creditors. A decline in the level of unencumbered asset coverage combined with a material increase in secured debt could result in the notching between the IDR and the senior unsecured debt. Founded in 2004 and based in Boston, MA, NewStar is a specialty commercial finance company with a focus on direct lending to U.S. middle-market companies. Through its asset management platform, NewStar also offers a range of investment products employing credit-oriented strategies focused on middle-market loans and liquid, tradeable credit. As of Dec. 31, 2016, NewStar had managed assets of $6.7 billion, including $3.6 billion of loans and credit investments on balance sheet. The company's stock is traded on the NASDAQ under the ticker 'NEWS'. Fitch has affirmed the ratings as follows: NewStar Financial, Inc. --Long-term IDR at 'BB-'; --Short-term IDR at 'B'; --Senior unsecured debt at 'BB-'; --Subordinated debt at 'B/RR6'. The Rating Outlook is Stable. Contact: Primary Analyst Johann Juan Director +1-312-368-3339 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Chelsea Richardson Associate Director +1-212-612-7899 Committee Chairperson Meghan Neenan, CFA Managing Director +1-212-908-9121 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com; Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: elizabeth.fogerty@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Global Non-Bank Financial Institutions Rating Criteria (pub. 10 Mar 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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