UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
FORM 10-Q

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

For the quarterly period ended June 30, 2006

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: 001-31458

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

                                           Maryland                                           
 
                       81-0559116                      
(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) 798-6100                                  
(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 x No o   

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x   Accelerated filer o   Non-accelerated filer o

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

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: 43,999,817 shares outstanding as of August 5, 2006.
 

NEWCASTLE INVESTMENT CORP.
FORM 10-Q

INDEX

       
PAGE 
         
PART I. FINANCIAL INFORMATION
    
         
Item 1.
 
Financial Statements
    
         
   
Consolidated Balance Sheets as of June 30, 2006 (unaudited) and December 31, 2005
  
1
         
   
Consolidated Statements of Income (unaudited) for the three and six months ended June 30, 2006 and 2005
  
2
         
   
Consolidated Statements of Stockholders' Equity (unaudited) for the six months ended June 30, 2006 and 2005
  
3
         
   
Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2006 and 2005
  
4
 
        
   
Notes to Consolidated Financial Statements (unaudited)
  
6
         
Item 2.
  
Management's Discussion and Analysis of Financial Condition and Results of Operations
  
15
         
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
  
32
         
Item 4.
 
Controls and Procedures
  
37
         
PART II.  OTHER INFORMATION
    
         
Item 1.
 
Legal Proceedings
  
38
         
Item 1A.
 
Risk Factors
  
38
 
        
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
  
39
         
Item 3.
 
Defaults upon Senior Securities
  
39
         
Item 4.
 
Submission of Matters to a Vote of Security Holders
  
39
         
Item 5.
 
Other Information
  
39
         
Item 6.
 
Exhibits
  
40
         
SIGNATURES
  
 
  
41


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)

   
June 30, 2006 (Unaudited)
 
December 31,
2005
  
Assets
              
Real estate securities, available for sale
  
$
5,036,880
  
$
4,554,519
  
Real estate related loans, net
    
822,973
   
615,551
 
Residential mortgage loans, net
    
489,096
   
600,682
 
Subprime mortgage loans subject to future repurchase - Note 5
    
286,917
   
-
 
Investments in unconsolidated subsidiaries
    
28,839
   
29,953
 
Operating real estate, net
    
30,008
   
16,673
 
Cash and cash equivalents
    
10,044
   
21,275
 
Restricted cash
    
257,593
   
268,910
 
Derivative assets
    
136,112
   
63,834
 
Receivables and other assets
    
41,013
   
38,302
 
   
$
7,139,475
  
$
6,209,699
  
Liabilities and Stockholders' Equity
              
               
Liabilities
              
CBO bonds payable
  
$
3,521,926
  
$
3,530,384
  
Other bonds payable
    
333,108
   
353,330
 
Notes payable
    
185,639
   
260,441
 
Repurchase agreements
    
1,621,082
   
1,048,203
 
Financing of subprime mortgage loans subject to future repurchase - Note 5
    
286,917
   
-
 
Credit facility
    
50,500
   
20,000
 
Junior subordinated notes payable (security for trust preferred)
    
100,100
   
-
 
Derivative liabilities
    
6,429
   
18,392
 
Dividends payable
    
30,152
   
29,052
 
Due to affiliates
    
6,844
   
8,783
 
Accrued expenses and other liabilities
    
56,430
   
23,111
 
     
6,199,127
   
5,291,696
 
Stockholders' Equity
              
Preferred stock, $0.01 par value, 100,000,000 shares authorized, 2,500,000
             
shares of 9.75% Series B Cumulative Redeemable Preferred Stock and 1,600,000
             
shares of 8.05% Series C Cumulative Redeemable Preferred Stock, liquidation
             
preference $25.00 per share, issued and outstanding
    
102,500
   
102,500
 
Common stock, $0.01 par value, 500,000,000 shares authorized, 43,999,817 and
             
43,913,409 shares issued and outstanding at June 30, 2006 and
              
December 31, 2005, respectively
    
440
   
439
 
Additional paid-in capital
    
784,234
   
782,735
 
Dividends in excess of earnings
    
(12,022
)
  
(13,235
)
Accumulated other comprehensive income
    
65,196
   
45,564
 
     
940,348
   
918,003
 
   
$
7,139,475
  
$
6,209,699
  
 
1

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(dollars in thousands, except share data)  
   
Three Months Ended
June 30,
  
Six Months Ended
June 30,
  
   
2006
 
2005
 
2006
 
2005
  
Revenues
                          
Interest income
  
$
124,209
  
$
86,978
  
$
238,116
  
$
166,014
  
Rental and escalation income
    
774
   
1,715
   
2,782
   
2,979
 
Gain on sale of investments, net
    
5,493
   
3,635
   
7,421
   
5,349
 
Other income, net
    
(1,449
)
  
(263
)
  
4,256
   
1,386
 
     
129,027
   
92,065
   
252,575
   
175,728
 
Expenses
                          
Interest expense
    
87,909
   
55,791
   
164,874
   
104,557
 
Property operating expense
    
949
   
540
   
1,767
   
1,233
 
Loan and security servicing expense
    
1,402
   
1,580
   
3,408
   
3,163
 
Provision for credit losses
    
1,179
   
1,187
   
3,186
   
1,899
 
Provision for losses, loans held for sale - Note 5
    
-
   
-
   
4,127
   
-
 
General and administrative expense
    
1,161
   
1,326
   
2,791
   
2,217
 
Management fee to affiliate
    
3,474
   
3,316
   
6,945
   
6,579
 
Incentive compensation to affiliate
    
2,834
   
883
   
5,686
   
2,855
 
Depreciation and amortization
    
278
   
135
   
477
   
271
 
 
    
99,186
   
64,758
   
193,261
   
122,774
 
Income before equity in earnings of unconsolidated subsidiaries
    
29,841
   
27,307
   
59,314
   
52,954
 
Equity in earnings of unconsolidated subsidiaries
    
1,215
   
1,438
   
2,410
   
3,524
 
Income taxes on related taxable subsidiaries
    
-
   
(45
)
  
-
   
(278
)
Income from continuing operations
    
31,056
   
28,700
   
61,724
   
56,200
 
Income from discontinued operations
    
(26
)
  
781
   
225
   
1,965
 
Net Income
    
31,030
   
29,481
   
61,949
   
58,165
 
Preferred dividends
    
(2,329
)
  
(1,524
)
  
(4,657
)
  
(3,047
)
Income Available For Common Stockholders
  
$
28,701
  
$
27,957
  
$
57,292
  
$
55,118
  
Net Income Per Share of Common Stock
                          
Basic
  
$
0.65
  
$
0.64
  
$
1.30
  
$
1.27
  
Diluted
  
$
0.65
  
$
0.63
  
$
1.30
  
$
1.26
  
Income from continuing operations per share of common stock, after
                         
preferred dividends
                          
Basic
  
$
0.65
  
$
0.62
  
$
1.29
  
$
1.22
  
Diluted
  
$
0.65
  
$
0.61
  
$
1.29
  
$
1.21
  
Income from discontinued operations per share of common stock
                          
Basic
  
$
(0.00
)
$
0.02
  
$
0.01
  
$
0.05
  
Diluted
  
$
(0.00
)
$
0.02
  
$
0.01
  
$
0.05
  
Weighted Average Number of Shares of
                         
Common Stock Outstanding
                          
Basic
    
43,990,635
   
43,768,381
   
43,967,854
   
43,496,597
 
Diluted
    
44,071,310
   
44,127,381
   
44,067,645
   
43,879,606
 
Dividends Declared per Share of Common Stock
  
$
0.650
  
$
0.625
  
$
1.275
  
$
1.250
  

2

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)
FOR THE SIX MONHTS ENDED JUNE 30, 2006 AND 2005
(dollars in thousands, except share data)

   
Preferred Stock
 
Common Stock
 
 
  
 
  
 
  
 
  
 
 
Shares
 
Amount
 
Shares
 
Amount
 
Additional Paid-in Capital
 
Dividends in
Excess of Earnings
 
Accum. Other Comp. Income
 
Total Stock-holders' Equity
 
Stockholders' equity - December 31, 2005
    
4,100,000
 
$
102,500
    
43,913,409
 
$
439
  
$
782,735
  
$
(13,235
)
$
45,564
  
$
918,003
  
Dividends declared
   
-
   
-
   
-
   
-
   
-
   
(60,736
)
  
-
   
(60,736
)
Exercise of common stock options
    
-
   
-
   
84,000
   
1
   
1,439
   
-
   
-
   
1,440
 
Issuance of common stock to directors
    
-
   
-
   
2,408
   
-
   
60
   
-
   
-
   
60
 
Comprehensive income:
                                                  
Net income
    
-
   
-
   
-
   
-
   
-
   
61,949
   
-
   
61,949
 
Net unrealized (loss) on securities
   
-
   
-
   
-
   
-
   
-
   
-
   
(73,164
)
  
(73,164
)
Reclassification of net realized (gain) on securities into earnings
   
-
   
-
   
-
   
-
   
-
   
-
   
(1,694
)
  
(1,694
)
Foreign currency translation
    
-
   
-
   
-
   
-
   
-
   
-
   
795
   
795
 
Net unrealized gain on derivatives designated as cash flow hedges
    
-
   
-
   
-
   
-
   
-
   
-
   
96,649
   
96,649
 
Reclassification of net realized (gain) on derivatives designated as cash flow hedges into earnings
    
-
   
-
   
-
   
-
   
-
   
-
   
(2,954
)
  
(2,954
)
Total comprehensive income
                                              
81,581
 
Stockholders' equity - June 30, 2006
    
4,100,000
 
$
102,500
    
43,999,817
 
$
440
  
$
784,234
  
$
(12,022
)
$
65,196
  
$
940,348
  
Stockholders' equity - December 31, 2004
    
2,500,000
 
$
62,500
    
39,859,481
 
$
399
  
$
676,015
  
$
(13,969
)
$
71,770
  
$
796,715
  
Dividends declared
   
-
   
-
   
-
   
-
   
-
   
(57,769
)
  
-
   
(57,769
)
Issuance of common stock
    
-
   
-
   
3,300,000
   
33
   
96,537
   
-
   
-
   
96,570
 
Exercise of common stock options
    
-
   
-
   
628,330
   
6
   
9,491
   
-
   
-
   
9,497
 
Issuance of common stock to directors
    
-
   
-
   
2,008
   
-
   
60
   
-
   
-
   
60
 
Comprehensive income:
                                                  
Net income
    
-
   
-
   
-
   
-
   
-
   
58,165
   
-
   
58,165
 
Net unrealized gain on securities
   
-
   
-
   
-
   
-
   
-
   
-
   
25,302
   
25,302
 
Reclassification of net realized (gain) on securities into earnings
   
-
   
-
   
-
   
-
   
-
   
-
   
(1,936
)
  
(1,936
)
Foreign currency translation
    
-
   
-
   
-
   
-
   
-
   
-
   
(2,154
)
  
(2,154
)
Reclassification of net realized foreign currency translation into earnings
    
-
   
-
   
-
   
-
   
-
   
-
   
(626
)
  
(626
)
Net unrealized (loss) on derivatives designated as cash flow hedges
    
-
   
-
   
-
   
-
   
-
   
-
   
(13,849
)
  
(13,849
)
Reclassification of net realized (gain) on derivatives designated as cash flow hedges into earnings
    
-
   
-
   
-
   
-
   
-
   
-
   
1,274
   
1,274
 
Total comprehensive income
                                              
66,176
 
Stockholders' equity - June 30, 2005
    
2,500,000
 
$
62,500
    
43,789,819
 
$
438
  
$
782,103
  
$
(13,573
)
$
79,781
  
$
911,249
  
 
3
 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)
(dollars in thousands)

   
Six Months Ended June 30,
 
   
2006
  
2005
  
Cash Flows From Operating Activities
              
Net income
  
$
61,949
  
$
58,165
  
Adjustments to reconcile net income to net cash provided by (used in) operating activities
              
(inclusive of amounts related to discontinued operations):
              
Depreciation and amortization
    
477
   
445
 
Accretion of discount and other amortization
    
(11,969
)
  
956
 
Equity in earnings of unconsolidated subsidiaries
    
(2,410
)
  
(3,524
)
Distributions of earnings from unconsolidated subsidiaries
    
2,410
   
3,524
 
Deferred rent
    
(1,057
)
  
(1,063
)
Gain on sale of investments
    
(7,784
)
  
(6,972
)
Unrealized gain on non-hedge derivatives and hedge ineffectiveness
    
(4,167
)
  
(2,780
)
Provision for credit losses
    
3,186
   
1,899
 
Provision for losses, loans held for sale
    
4,127
   
-
 
Purchase of loans held for sale - Note 5
    
(1,511,086
)
  
-
 
Sale of loans held for sale - Note 5
    
1,507,588
   
-
 
Non-cash directors' compensation
    
60
   
60
 
Change in:
              
Restricted cash
    
10,958
   
(6,709
)
Receivables and other assets
    
2,633
   
3,986
 
Due to affiliates
    
(1,939
)
  
(5,000
)
Accrued expenses and other liabilities
    
3,687
   
48,756
 
Net cash provided by (used in) operating activities
   
56,663
   
91,743
 
Cash Flows From Investing Activities
              
Purchase of real estate securities
    
(807,396
)
  
(687,864
)
Proceeds from sale of real estate securities
    
273,062
   
56,521
 
Deposit on real estate securities (treated as a derivative)
    
-
   
(17,692
)
Purchase of and advances on loans
    
(407,862
)
  
(406,209
)
Proceeds from settlement of loans
    
-
   
401
 
Repayments of loan and security principal
    
291,759
   
304,401
 
Return of margin deposits on derivative instruments
    
30,350
   
-
 
Margin deposits on total rate of return swaps (treated as derivative instruments)
    
(30,060
)
  
(26,322
)
Return of margin deposits on total rate of return swaps (treated as derivative instruments)
    
23,593
   
-
 
Proceeds from termination of derivative instruments
    
17,955
   
763
 
Proceeds from sale of derivative instruments into Securitization Trust - Note 5
    
5,623
   
-
 
Payments on settlement of derivative instruments
    
-
   
(1,112
)
Purchase and improvement of operating real estate
    
(806
)
  
(192
)
Proceeds from sale of operating real estate
    
-
   
52,329
 
Contributions to unconsolidated subsidiaries
    
(100
)
  
-
 
Distributions of capital from unconsolidated subsidiaries
    
1,214
   
7,539
 
Payment of deferred transaction costs
    
-
   
(39
)
Net cash used in investing activities
    
(602,668
)
  
(717,476
)
               
Continued on Page 5
              
 
4

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)
(dollars in thousands)

   
Six Months Ended June 30,
  
   
2006
  
2005
  
Cash Flows From Financing Activities
              
Issuance of CBO bonds payable
    
-
   
442,034
 
Repayments of CBO bonds payable
    
(10,672
)
  
(6,589
)
Issuance of other bonds payable
    
240,719
   
246,547
 
Repayments of other bonds payable
    
(259,101
)
  
(84,072
)
Repayments of notes payable
    
(74,802
)
  
(177,487
)
Borrowings under repurchase agreements
    
2,305,541
   
316,777
 
Repayments of repurchase agreements
    
(1,732,662
)
  
(130,094
)
Draws under credit facility
    
274,900
   
-
 
Repayments of credit facility
    
(244,400
)
  
-
 
Issuance of junior subordinated notes payable
    
100,100
   
-
 
Issuance of common stock
    
-
   
97,680
 
Costs related to issuance of common stock
    
-
   
(1,110
)
Exercise of common stock options
    
1,440
   
9,497
 
Dividends paid
    
(59,636
)
  
(55,313
)
Payment of deferred financing costs
    
(6,653
)
  
(1,083
)
Net cash provided by financing activities
    
534,774
   
656,787
 
Net Increase (Decrease) in Cash and Cash Equivalents
    
(11,231
)
  
31,054
  
Cash and Cash Equivalents, Beginning of Period
    
21,275
   
37,911
 
Cash and Cash Equivalents, End of Period
  
$
10,044
  
$
68,965
  
Supplemental Disclosure of Cash Flow Information
              
Cash paid during the period for interest expense
  
$
156,634
  
$
99,903
  
Cash paid during the period for income taxes
  
$
244
  
$
434
  
Supplemental Schedule of Non-Cash Investing and Financing Activities
              
Common stock dividends declared but not paid
  
$
28,600
  
$
27,369
  
Preferred stock dividends declared but not paid
  
$
1,552
  
$
1,016
  
Deposits used in acquisition of real estate securities (treated as derivatives)
  
$
-
  
$
44,504
  
Foreclosure of loans
  
$
12,200
  
$
-
  
Acquisition and financing of loans subject to future repurchase
  
$
286,315
  
$
-
  
 
5
 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JUNE 30, 2006
(dollars in tables in thousands, except share data)

1. GENERAL

Newcastle Investment Corp. (and its subsidiaries, "Newcastle") is a Maryland corporation that was formed in 2002. Newcastle conducts its business through three primary segments: (i) real estate securities and real estate related loans, (ii) residential mortgage loans, and (iii) operating real estate.

Newcastle is organized and conducts its operations to qualify as a real estate investment trust (“REIT”) for U.S. federal income tax purposes. As such, Newcastle 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.

Newcastle is party to a management agreement (the "Management Agreement") with Fortress Investment Group LLC (the "Manager"), an affiliate, under which the Manager advises Newcastle on various aspects of its business and manages its day-to-day operations, subject to the supervision of Newcastle's board of directors. For its services, the Manager receives an annual management fee and incentive compensation, both as defined in the Management Agreement.

Approximately 2.9 million shares of Newcastle’s common stock were held by an affiliate of the Manager and its principals at June 30, 2006. In addition, an affiliate of the Manager held options to purchase approximately 1.2 million shares of Newcastle’s common stock at June 30, 2006.
 
The accompanying consolidated financial statements and related notes of Newcastle 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 accounting principles generally accepted in the United States have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of Newcastle'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 Newcastle's consolidated financial statements for the year ended December 31, 2005 and notes thereto included in Newcastle’s annual report on Form 10-K filed with the Securities and Exchange Commission. Capitalized terms used herein, and not otherwise defined, are defined in Newcastle’s consolidated financial statements for the year ended December 31, 2005.

6

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JUNE 30, 2006
(dollars in tables in thousands, except share data)

2. INFORMATION REGARDING BUSINESS SEGMENTS

Newcastle conducts its business through three primary segments: real estate securities and real estate related loans, residential mortgage loans, and operating real estate.

The residential mortgage loans segment includes the securitized retained equity and bonds from the Securitization Trust described in Note 5 since they represent a first loss credit position in residential loans.

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

   
RealEstate Securities
and Real Estate Related Loans
 
Residential Mortgage Loans
 
Operating Real Estate
 
Unallocated
 
Total
  
June 30, 2006 and the Six Months then Ended
                                
Gross revenues
  
$
200,458
  
$
49,412
  
$
3,015
  
$
(310
)
$
252,575
  
Operating expenses
    
(1,295
)
  
(9,666
)
  
(1,917
)
  
(15,032
)
  
(27,910
)
Operating income (loss)
    
199,163
   
39,746
   
1,098
   
(15,342
)
  
224,665
 
Interest expense
    
(132,097
)
  
(28,919
)
  
-
   
(3,858
)
  
(164,874
)
Depreciation and amortization
    
-
   
-
   
(341
)
  
(136
)
  
(477
)
Equity in earnings of unconsolidated subsidiaries (A)
    
1,346
   
-
   
1,063
   
1
   
2,410
 
Income (loss) from continuing operations
    
68,412
   
10,827
   
1,820
   
(19,335
)
  
61,724
 
Income from discontinued operations
    
-
   
-
   
225
   
-
   
225
 
Net Income (loss)
  
$
68,412
  
$
10,827
  
$
2,045
  
$
(19,335
)
$
61,949
  
Revenue derived from non-U.S. sources:
                                
Canada
  
$
-
  
$
-
  
$
2,638
  
$
-
  
$
2,638
  
Total assets
  
$
6,203,066
  
$
876,820
  
$
45,851
  
$
13,738
  
$
7,139,475
  
Long-lived assets outside the U.S.:
                                
Canada
  
$
-
  
$
-
  
$
17,272
  
$
-
  
$
17,272
  
December 31, 2005
                                
Total assets
  
$
5,544,818
  
$
606,320
  
$
36,306
  
$
22,255
  
$
6,209,699
  
Long-lived assets outside the U.S.:
                                
Canada
  
$
-
  
$
-
  
$
16,673
  
$
-
  
$
16,673
  
Three Months Ended June 30, 2006
                                
Gross revenues
  
$
105,265
  
$
23,383
  
$
831
  
$
(452
)
$
129,027
  
Operating expenses
    
(478
)
  
(2,203
)
  
(1,040
)
  
(7,278
)
  
(10,999
)
Operating income (loss)
    
104,787
   
21,180
   
(209
)
  
(7,730
)
  
118,028
 
Interest expense
    
(69,899
)
  
(14,991
)
  
-
   
(3,019
)
  
(87,909
)
Depreciation and amortization
    
-
   
-
   
(210
)
  
(68
)
  
(278
)
Equity in earnings of unconsolidated subsidiaries (A)
    
645
   
-
   
569
   
1
   
1,215
 
Income (loss) from continuing operations
    
35,533
   
6,189
   
150
   
(10,816
)
  
31,056
 
Income from discontinued operations
    
-
   
-
   
(26
)
  
-
   
(26
)
Net Income (loss)
  
$
35,533
  
$
6,189
  
$
124
  
$
(10,816
)
$
31,030
  
Revenue derived from non-U.S. sources:
                                
Canada
  
$
-
  
$
-
  
$
258
  
$
-
  
$
258
  
Six Months Ended June 30, 2005
                                
Gross revenues
  
$
147,061
  
$
25,338
  
$
3,003
  
$
326
  
$
175,728
  
Operating expenses
    
(776
)
  
(4,328
)
  
(1,260
)
  
(11,582
)
  
(17,946
)
Operating income (loss)
    
146,285
   
21,010
   
1,743
   
(11,256
)
  
157,782
 
Interest expense
    
(89,248
)
  
(15,058
)
  
(251
)
  
-
   
(104,557
)
Depreciation and amortization
    
-
   
-
   
(231
)
  
(40
)
  
(271
)
Equity in earnings of unconsolidated subsidiaries (A)
    
1,843
   
-
   
1,403
   
-
   
3,246
 
Income (loss) from continuing operations
    
58,880
   
5,952
   
2,664
   
(11,296
)
  
56,200
 
Income (loss) from discontinued operations
    
-
   
-
   
1,965
   
-
   
1,965
 
Net Income (Loss)
  
$
58,880
  
$
5,952
  
$
4,629
  
$
(11,296
)
$
58,165
  
Revenue derived from non-U.S. sources:
                                
Canada
  
$
-
  
$
-
  
$
8,352
  
$
-
  
$
8,352
  
continued on page 8
                                
 
7
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JUNE 30, 2006
(dollars in tables in thousands, except share data)

   
Real Estate Securities
and Real Estate Related Loans
 
Residential Mortgage Loans
 
Operating Real Estate
 
Unallocated
 
Total
  
Three Months Ended June 30, 2005
                                
Gross revenues
  
$
77,515
  
$
12,644
  
$
1,727
  
$
179
  
$
92,065
  
Operating expenses
    
(453
)
  
(2,325
)
  
(559
)
  
(5,495
)
  
(8,832
)
Operating income (loss)
    
77,062
   
10,319
   
1,168
   
(5,316
)
  
83,233
 
Interest expense
    
(47,918
)
  
(7,780
)
  
(93
)
  
-
   
(55,791
)
Depreciation and amortization
    
-
   
-
   
(115
)
  
(20
)
  
(135
)
Equity in earnings of unconsolidated subsidiaries (A)
    
997
   
-
   
396
   
-
   
1,393
 
Income (loss) from continuing operations
    
30,141
   
2,539
   
1,356
   
(5,336
)
  
28,700
 
Income (loss) from discontinued operations
    
-
   
-
   
781
   
-
   
781
 
Net Income (Loss)
  
$
30,141
  
$
2,539
  
$
2,137
  
$
(5,336
)
$
29,481
  
Revenue derived from non-U.S. sources:
                                
Canada
  
$
-
  
$
-
  
$
4,281
  
$
-
  
$
4,281
  
                                 
(A) Net of income taxes on related taxable subsidiaries.
                  

Unconsolidated Subsidiaries

The following table summarizes the activity affecting the equity held by Newcastle in unconsolidated subsidiaries:

   
Operating Real Estate Subsidiary
 
Real Estate Loan Subsidiary
 
Trust Preferred Subsidiary
  
Balance at December 31, 2005
  
$
12,151
  
$
17,802
  
$
-
  
Contributions to unconsolidated subsidiaries
    
-
   
-
   
100
 
Distributions from unconsolidated subsidiaries
    
(950
)
  
(2,674
)
  
-
 
Equity in earnings of unconsolidated subsidiaries
    
1,063
   
1,346
   
1
 
Balance at June 30, 2006
  
$
12,264
  
$
16,474
  
$
101
  

Summarized financial information related to Newcastle’s unconsolidated subsidiaries was as follows:

   
Operating Real Estate Subsidiary (A) (B)
 
Real Estate Loan Subsidiary (A) (C)
  
   
June 30,
  
December 31,
  
June 30,
  
December 31,
  
   
2006
  
2005
  
2006
  
2005
  
Assets
  
$
77,987
  
$
77,758
  
$
33,135
  
$
35,806
  
Liabilities
    
(53,000
)
  
(53,000
)
  
-
   
-
 
Minority interest
    
(460
)
  
(455
)
  
(187
)
  
(202
)
Equity
  
$
24,527
  
$
24,303
  
$
32,948
  
$
35,604
  
Equity held by Newcastle
 
$
12,264
  
$
12,151
  
$
16,474
  
$
17,802
  
 
 
    
Six Months Ended June 30,  
    
Six Months Ended June 30,
 
     
2006
 
 
2005
 
 
2006
 
 
2005
 
Revenues
  
$
3,957
  
$
6,563
  
$
2,723
  
$
3,729
  
Expenses
    
(1,793
)
  
(3,138
)
  
(17
)
  
(22
)
Minority interest
    
(40
)
  
(63
)
  
(15
)
  
(21
)
Net income
  
$
2,124
  
$
3,362
  
$
2,691
  
$
3,686
  
Newcastle's equity in net income
  
$
1,063
  
$
1,681
  
$
1,346
  
$
1,843
  
                           
(A)  
The unconsolidated subsidiaries’ summary financial information is presented on a fair value basis, consistent with their internal basis of accounting.

(B)
Included in the operating real estate segment.

(C)
Included in the real estate securities and real estate related loans segment.
 
For information regarding the trust preferred subsidiary, which is a financing subsidiary with no material net income or cash flow, see Note 6.
8

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JUNE 30, 2006
(dollars in tables in thousands, except share data)
 
3. REAL ESTATE SECURITIES

The following is a summary of Newcastle’s real estate securities at June 30, 2006, all of which are classified as available for sale and are therefore marked to market through other comprehensive income.

   
 
 
 
 
Gross Unrealized
 
 
 
 
 
Weighted Average
 
Asset Type
 
Current Face Amount
 
Amortized Cost Basis
 
Gains
 
Losses
 
Carrying Value
 
Number of
Securities
 
S&P
Equivalent
Rating
 
Coupon
 
Yield
 
Maturity(Years)
  
CMBS-Conduit
  
$
1,468,808
  
$
1,416,883
  
$
16,837
  
$
(43,293
)
$
1,390,427
    
199
   
BBB-
    
5.93
%
  
6.49
%
  
7.46
 
CMBS- CDO
    
23,500
   
20,626
   
1,112
   
(13
)
  
21,725
   
2
   
BB
    
9.26
%
  
11.74
%
  
8.98
 
CMBS-Large Loan
    
648,302
   
645,820
   
5,787
   
(2,129
)
  
649,478
   
64
   
BBB-
    
6.87
%
  
7.03
%
  
2.45
 
CMBS- B-Note
    
246,036
   
233,265
   
2,292
   
(3,475
)
  
232,082
   
29
   
BB-
    
6.86
%
  
7.78
%
  
7.16
 
Unsecured REIT Debt
    
958,152
   
973,166
   
10,311
   
(31,181
)
  
952,296
   
100
   
BBB-
    
6.37
%
  
6.02
%
  
6.50
 
ABS-Manufactured Housing
    
108,593
   
102,281
   
810
   
(4,224
)
  
98,867
   
9
   
B+
    
6.95
%
  
7.95
%
  
6.65
 
ABS-Home Equity
    
611,980
   
603,545
   
6,637
   
(559
)
  
609,623
   
108
   
BBB+
    
7.07
%
  
7.45
%
  
2.75
 
ABS-Franchise
    
76,982
   
76,351
   
1,222
   
(1,331
)
  
76,242
   
21
   
BBB
    
7.23
%
  
8.37
%
  
5.09
 
Agency RMBS
    
929,370
   
934,837
   
193
   
(17,198
)
  
917,832
   
27
   
AAA
    
5.10
%
  
5.08
%
  
4.45
 
Subtotal/Average (A)
    
5,071,723
   
5,006,774
   
45,201
   
(103,403
)
  
4,948,572
   
559
   
BBB+
   
6.22
%
  
6.47
%
  
5.46
 
Retained securities (B)
    
37,555
   
33,900
   
-
   
(171
)
  
33,729
   
3
   
BBB-
   
7.22
%
  
10.98
%
  
4.65
 
Residual interest (B)
    
54,579
   
54,579
   
-
   
-
   
54,579
   
1
   
NR
   
0.00
%
  
18.77
%
  
3.05
 
Total/Average
  
$
5,163,857
  
$
5,095,253
  
$
45,201
  
$
(103,574
)
$
5,036,880
    
563
   
BBB+
   
6.16
%
  
6.63
%
  
5.43
 
                                                               
(A) The total current face amount of fixed rate securities was $4.0 billion, and of floating rate securities was $1.1 billion.
 
(B) Represents the retained bonds and equity from the Securitization Trust as described in Note 5. These securities have been treated as part of the  residential mortgage loan segment - see Note 2. The residual does not have a stated coupon and therefore its coupon has been treated as zero for purposes of the table.
 
Unrealized losses that are considered other than temporary are recognized currently in income. There were no such losses incurred during the six months ended June 30, 2006. The unrealized losses on Newcastle’s securities are primarily the result of market factors, rather than credit impairment, and Newcastle believes their carrying values are fully recoverable over their expected holding period. None of the securities were in default as of June 30, 2006. Newcastle has performed credit analyses in relation to such securities which support its belief that the carrying values of such securities are fully recoverable over their expected holding period. Although management expects to hold these securities until their recovery, there is no assurance that such securities will not be sold or at what price they may be sold.

           
Gross Unrealized
 
 
 
 
 
Weighted Average
    
Securities in an Unrealized Loss Position
  
Current Face Amount
 
Amortized Cost Basis
 
Gains
 
Losses
 
Carrying Value
 
Number of
Securities
 
S&P
Equivalent
Rating
 
Coupon
 
Yield
 
Maturity (Years)
  
Less Than Twelve Months
  
$
1,803,484
  
$
1,764,310
  
$
-
  
$
(33,942
)
$
1,730,368
    
205
   
BBB
    
6.14
%
  
6.50
%
  
6.51
 
Twelve or More Months
    
1,499,149
   
1,504,400
   
-
   
(69,632
)
  
1,434,768
   
168
   
BBB+
    
5.54
%
  
5.38
%
  
6.33
 
Total
  
$
3,302,633
  
$
3,268,710
  
$
-
  
$
(103,574
)
$
3,165,136
    
373
   
BBB+
   
5.86
%
  
5.99
%
  
6.43
  

As of June 30, 2006, Newcastle had $149.0 million of restricted cash held in CBO financing structures pending its investment in real estate securities and loans.

9
 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JUNE 30, 2006
(dollars in tables in thousands, except share data)
4. REAL ESTATE RELATED LOANS, RESIDENTIAL MORTGAGE LOANS AND SUBPRIME MORTGAGE LOANS

The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at June 30, 2006. The loans contain various terms, including fixed and floating rates, self-amortizing and interest only. They are generally subject to prepayment.

Loan Type
 
Current
Face Amount
 
Carrying
Value
 
Loan
Count
 
Wtd. Avg. Yield
 
Weighted Average Maturity
(Years) (D)
 
Delinquent Carrying Amount (E)
  
B-Notes
  
$
95,965
  
$
95,115
    
5
   
7.68
%
  
4.58
 
$
-
  
Mezzanine Loans (A)
    
556,688
   
556,401
   
10
   
9.01
%
  
2.14
   
-
 
Bank Loans
    
18,237
   
18,237
   
2
   
7.87
%
  
1.62
   
-
 
Real Estate Loans
    
21,431
   
20,779
   
1
   
20.02
%
  
1.59
   
-
 
ICH Loans (B)
    
133,417
   
132,441
   
76
   
8.64
%
  
1.37
   
6,068
 
Total Real Estate Related Loans
  
$
825,738
  
$
822,973
    
94
   
9.05
%
  
2.27
 
$
6,068
  
                                       
Residential Loans
  
$
233,151
  
$
238,740
    
667
   
6.16
%
  
2.80
 
$
5,156
  
Manufactured Housing Loans
    
262,694
   
250,356
   
6,549
   
8.23
%
  
6.31
   
1,208
 
Total Residential Mortgage Loans
 
$
495,845
  
$
489,096
    
7,216
   
7.22
%
  
4.66
 
$
6,364
  
Subprime Mortgage Loans Subject
                                      
to Future Repurchase (C)
  
$
299,176
  
$
286,917
                          
 
(A)
One of these loans has a contractual exit fee which Newcastle will begin to accrue if and when management believes it is probable that such exit fee will be received.
 
(B)
In October 2003, pursuant to FIN No. 46, Newcastle consolidated an entity which holds a portfolio of commercial mortgage loans which has been securitized. This investment, which is referred to as the ICH CMO, was previously treated as a non-consolidated residual interest in such securitization. The primary effect of the consolidation is the requirement that Newcastle reflect the gross loan assets and gross bonds payable of this entity in its financial statements.

(C)
See Note 5.

(D)
The weighted average maturities for the residential loan portfolio and the manufactured housing loan portfolio were calculated based on constant prepayment rates (CPR) of approximately 30% and 9%, respectively.

(E)
This face amount of loans is 60 or more days delinquent.

The following is a reconciliation of loss allowance.

   
Real Estate Related Loans
 
Residential Mortgage Loans
  
Balance at December 31, 2005
  
$
4,226
  
$
3,207
  
Provision for credit losses
    
292
   
2,894
 
Realized losses
    
(2,931
)
  
(2,442
)
Balance at June 30, 2006
  
$
1,587
  
$
3,659
  
10
 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JUNE 30, 2006
(dollars in tables in thousands, except share data)
 
Newcastle has entered into arrangements with a major investment bank to finance certain loans whereby Newcastle receives the sum of all interest, fees and any positive change in value amounts (the total return cash flows) from a reference asset with a specified notional amount, and pays interest on such notional plus any negative change in value amounts from such asset. These agreements are recorded in Derivative Assets and treated as non-hedge derivatives for accounting purposes and are therefore marked to market through income. Net interest received is recorded to Interest Income and the mark to market is recorded to Other Income. If Newcastle owned the reference assets directly, they would not be marked to market. Under the agreements, Newcastle is required to post an initial margin deposit to an interest bearing account and additional margin may be payable in the event of a decline in value of the reference asset. Any margin on deposit (recorded in Restricted Cash), less any negative change in value amounts, will be returned to Newcastle upon termination of the contract.
 
As of June 30, 2006, Newcastle held an aggregate of $415.3 million notional amount of total rate of return swaps on 8 reference assets on which it had deposited $78.9 million of margin. These total rate of return swaps had an aggregate fair value of approximately $44,000, a weighted average receive interest rate of LIBOR + 2.89%, a weighted average pay interest rate of LIBOR + 0.59%, and a weighted average maturity of 1.4 years.
 
5. SECURITIZATION OF SUBPRIME MORTGAGE LOANS

In March 2006, Newcastle, through a consolidated subsidiary, acquired a portfolio of approximately 11,300 residential mortgage loans to subprime borrowers (the “Subprime Portfolio”) for $1.50 billion. The loans are being serviced by Centex Home Equity Company, LLC for a servicing fee equal to 0.50% per annum on the unpaid principal balance of the Subprime Portfolio. At March 31, 2006, these loans were considered “held for sale” and carried at the lower of cost or fair value. A write down of $4.1 million was recorded to Provision for Losses, Loans Held for Sale in March 2006 related to these loans, related to market factors. Furthermore, the acquisition of loans held for sale is considered an operating activity for statement of cash flow purposes. An offsetting cash inflow from the sale of such loans (as described below) was recorded as an operating cash flow in April 2006. This acquisition was initially funded with an approximately $1.47 billion repurchase agreement which bore interest at LIBOR + 0.50%. Newcastle entered into an interest rate swap in order to hedge its exposure to the risk of changes in market interest rates with respect to the financing of the Subprime Portfolio. This swap did not qualify as a hedge for accounting purposes and was therefore marked to market through income. An unrealized mark to market gain of $5.5 million was recorded to Other Income in connection with this swap in March 2006.

In April 2006, Newcastle, through Newcastle Mortgage Securities Trust 2006-1 (the “Securitization Trust”), closed on a securitization of the Subprime Portfolio. The Securitization Trust is not consolidated by Newcastle. Newcastle sold the Subprime Portfolio and the related interest rate swap to the Securitization Trust. The Securitization Trust issued $1.45 billion of debt (the “Notes”). Newcastle retained $37.6 million face amount of the low investment grade Notes and all of the equity issued by the Securitization Trust. The Notes have a stated maturity of March 25, 2036. Newcastle, as holder of the equity of the Securitization Trust, has the option to redeem the Notes once the aggregate principal balance of the Subprime Portfolio is equal to or less than 20% of such balance at the date of the transfer. The proceeds from the securitization were used to repay the repurchase agreement described above.
 
The transaction between Newcastle and the Securitization Trust qualified as a sale for accounting purposes, resulting in a net gain of approximately $40,000 being recorded in April 2006. However, 20% of the loans which are subject to future repurchase by Newcastle were not treated as being sold and are classified as “held for investment” subsequent to the completion of the securitization. Following the securitization, Newcastle held the following interests in the Subprime Portfolio, all valued at the date of securitization: (i) the $62.4 million equity of the Securitization Trust, recorded in Real Estate Securities, Available for Sale, (ii) the $33.7 million of retained bonds ($37.6 million face amount), recorded in Real Estate Securities, Available for Sale, which have been financed with a $28.0 million repurchase agreement, and (iii) subprime mortgage loans subject to future repurchase of $286.3 million and related financing in the amount of 100% of such loans.
11

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JUNE 30, 2006
(dollars in tables in thousands, except share data)

The key assumptions utilized in measuring the $62.4 million fair value of the equity, or residual interest, in the Securitization Trust at the date of securitization were as follows:

 
Weighted average life (years) of residual interest
    
3.1
  
 
Expected credit losses
   
5.3
%
 
Weighted average constant prepayment rate
   
28.0
%
 
Discount rate
    
18.8
%

The following table presents information on the retained interests in the securitization of the Subprime Portfolio, which include the residual interest and the retained bonds described above, and the sensitivity of their fair value to immediate 10% and 20% adverse changes in the assumptions utilized in calculating such fair value, at June 30, 2006:

 
Total securitized loans (unpaid principal balance)
  
$
1,412,181
  
 
Loans subject to future repurchase (carrying value)
  
$
286,917
  
 
Retained interests (fair value)
  
$
88,308
  
           
 
Weighted average life (years) of residual interest
    
3.1
 
           
 
Expected credit losses
    
5.3
%
 
Effect on fair value of retained interests of 10% adverse change
  
$
(2,466
)
 
Effect on fair value of retained interests of 20% adverse change
  
$
(4,989
)
           
 
Weighted average constant prepayment rate
   
28.0
%
 
Effect on fair value of retained interests of 10% adverse change
  
$
(4,009
)
 
Effect on fair value of retained interests of 20% adverse change
  
$
(6,394
)
           
 
Discount rate
   
18.8
%
 
Effect on fair value of retained interests of 10% adverse change
  
$
(2,666
)
 
Effect on fair value of retained interests of 20% adverse change
  
$
(5,224
)

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. Further, the sensitivity analysis is performed without considering the offsetting effect of the financial instruments utilized to hedge risks inherent in the retained interests. Also, changes in the fair value based on a 10% or 20% 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.

The following table summarizes principal amounts outstanding and delinquencies of securitized loans as of June 30, 2006 and net credit losses for the period then ended:
 
Loan unpaid principal balance (UPB)
  
$
1,412,181
  
 
Delinquencies of 60 or more days (UPB)
  
$