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, 2007

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: 52,769,699 shares outstanding as of May 4, 2007.


NEWCASTLE INVESTMENT CORP.
FORM 10-Q

INDEX

   
PAGE
PART I.
 FINANCIAL INFORMATION
 
     
Item 1.
 Financial Statements
 
     
 
 Consolidated Balance Sheets as of March 31, 2007 (unaudited) and December 31, 2006
1
     
 
 Consolidated Statements of Income (unaudited) for the three months ended March 31, 2007 and 2006
2
     
 
 Consolidated Statements of Stockholders' Equity (unaudited) for the three months ended March 31, 2007 and 2006
3
     
 
 Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2007 and 2006
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
31
     
Item 4.
 Controls and Procedures
36
     
PART II. OTHER INFORMATION
 
   
Item 1.
 Legal Proceedings
37
     
Item 1A. Risk Factors
37
     
Item 2.
 Unregistered Sales of Equity Securities and Use of Proceeds
38
     
Item 3.
 Defaults upon Senior Securities
38
     
Item 4.
 Submission of Matters to a Vote of Security Holders
38
     
Item 5.
 Other Information
38
     
Item 6.
 Exhibits
39
     
SIGNATURES
40
 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

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


 
March 31, 2007 (Unaudited)
 
December 31, 2006
 
Assets
 
 
 
 
 
Real estate securities, available for sale
 
$
5,581,179
 
$
5,581,228
 
Real estate related loans, net
   
2,138,974
   
1,568,916
 
Residential mortgage loans, net
   
752,590
   
809,097
 
Subprime mortgage loans, held for sale
   
1,018,080
   
-
 
Subprime mortgage loans subject to call option - Note 5
   
289,021
   
288,202
 
Investments in unconsolidated subsidiaries
   
22,778
   
22,868
 
Operating real estate, net
   
29,684
   
29,626
 
Cash and cash equivalents
   
3,929
   
5,371
 
Restricted cash
   
267,903
   
184,169
 
Derivative assets
   
51,032
   
62,884
 
Receivables and other assets
   
65,801
   
52,031
 
 
 
$
10,220,971
 
$
8,604,392
 
Liabilities and Stockholders' Equity
         
Liabilities
         
CBO bonds payable
 
$
4,282,503
 
$
4,313,824
 
Other bonds payable
   
649,853
   
675,844
 
Notes payable
   
109,922
   
128,866
 
Repurchase agreements
   
2,198,064
   
760,346
 
Repurchase agreements subject to ABCP facility
   
1,312,209
   
1,143,749
 
Financing of subprime mortgage loans subject to call option - Note 5
   
289,021
   
288,202
 
Credit facility
   
125,500
   
93,800
 
Junior subordinated notes payable (security for trust preferred)
   
100,100
   
100,100
 
Derivative liabilities
   
22,726
   
17,715
 
Dividends payable
   
35,003
   
33,095
 
Due to affiliates
   
5,035
   
13,465
 
Accrued expenses and other liabilities
   
52,085
   
33,406
 
 
   
9,182,021
   
7,602,412
 
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, 1,600,000
         
shares of 8.05% Series C Cumulative Redeemable Preferred Stock and 2,000,000
         
shares of 8.375% Series D Cumulative Redeemable Preferred Stock, liquidation
         
preference $25.00 per share, issued and outstanding
   
152,500
   
102,500
 
Common stock, $0.01 par value, 500,000,000 shares authorized, 48,209,699 and
         
45,713,817 shares issued and outstanding at March 31, 2007 and
         
December 31, 2006, respectively
   
482
   
457
 
Additional paid-in capital
   
908,368
   
833,887
 
Dividends in excess of earnings
   
(10,437
)
 
(10,848
)
Accumulated other comprehensive income (loss)
   
(11,963
)
 
75,984
 
 
   
1,038,950
   
1,001,980
 
 
 
$
10,220,971
 
$
8,604,392
 
 
         
 
1

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(dollars in thousands, except share data)


   
Three Months Ended
March 31,
 
 
 
2007
 
2006
 
Revenues
 
 
 
 
 
  Interest income
 
$
162,221
 
$
113,907
 
  Rental and escalation income
   
1,253
   
2,008
 
  Gain on sale of investments, net
   
2,212
   
1,928
 
  Other income, net
   
743
   
5,705
 
 
   
166,429
   
123,548
 
Expenses
         
  Interest expense
   
116,757
   
76,965
 
  Property operating expense
   
1,036
   
818
 
  Loan and security servicing expense
   
1,983
   
2,006
 
  Provision for credit losses
   
2,036
   
2,007
 
  Provision for losses, loans held for sale - Note 5
   
-
   
4,127
 
  General and administrative expense
   
1,337
   
1,630
 
  Management fee to affiliate
   
3,906
   
3,471
 
  Incentive compensation to affiliate
   
3,688
   
2,852
 
  Depreciation and amortization
   
329
   
199
 
 
   
131,072
   
94,075
 
Income before equity in earnings of unconsolidated subsidiaries
   
35,357
   
29,473
 
Equity in earnings of unconsolidated subsidiaries
   
847
   
1,195
 
Income from continuing operations
   
36,204
   
30,668
 
Income (loss) from discontinued operations
   
(13
)
 
251
 
Net Income
   
36,191
   
30,919
 
Preferred dividends
   
(2,515
)
 
(2,328
)
Income Available For Common Stockholders
 
$
33,676
 
$
28,591
 
Net Income Per Share of Common Stock
             
Basic
 
$
0.71
 
$
0.65
 
Diluted
 
$
0.70
 
$
0.65
 
Income from continuing operations per share of common stock,
         
   after preferred dividends
         
Basic
 
$
0.71
 
$
0.64
 
Diluted
 
$
0.70
 
$
0.64
 
Income (loss) from discontinued operations per share of common stock
             
Basic
 
$
(0.00
)
$
0.01
 
Diluted
 
$
(0.00
)
$
0.01
 
Weighted Average Number of Shares of Common Stock Outstanding
         
Basic
   
47,572,895
   
43,944,820
 
Diluted
   
47,823,497
   
44,063,940
 
Dividends Declared per Share of Common Stock
 
$
0.690
 
$
0.625
 
 
         
 
         
 
         
 
2



NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(dollars in thousands)  

 
 
 
 
Preferred Stock 
 
 
Common Stock
 
 Additional
Paid-in
Capital 
 
Dividends in Excess of
 Earnings 
 
Accum. Other Comp. Income
(Loss)
 
Total Stock-holders'
Equity
 
     
Shares  
   
Amount  
   
Shares  
   
Amount 
         
Stockholders' equity - December 31, 2006
   
4,100,000
 
$
102,500
   
45,713,817
 
$
457
 
$
833,887
 
$
(10,848
)
$
75,984
 
$
1,001,980
 
Dividends declared
   
-
   
-
   
-
   
-
   
-
   
(35,780
)
 
-
   
(35,780
)
Issuance of common stock
   
-
   
-
   
2,420,000
   
24
   
74,958
   
-
   
-
   
74,982
 
Exercise of common stock options
   
-
   
-
   
75,882
   
1
   
1,270
   
-
   
-
   
1,271
 
Issuance of preferred stock
   
2,000,000
   
50,000
   
-
   
-
   
(1,747
)
 
-
   
-
   
48,253
 
Comprehensive income:
                                 
  Net income
   
-
   
-
   
-
   
-
   
-
   
36,191
   
-
   
36,191
 
  Net unrealized (loss) on securities
   
-
   
-
   
-
   
-
   
-
   
-
   
(65,513
)
 
(65,513
)
  Reclassification of net realized (gain) loss
    on securities into earnings
   
-
   
-
   
-
   
-
   
-
   
-
   
(7,759
)
 
(7,759
)
  Foreign currency translation
   
-
   
-
   
-
   
-
   
-
   
-
   
189
   
189
 
  Net unrealized (loss) on derivatives designated
    as cash flow hedges
   
-
   
-
   
-
   
-
   
-
   
-
   
(15,195
)
 
(15,195
)
  Reclassification of net realized loss
    on derivatives designated as cash flow 
    hedges into earnings
   
-
   
-
   
-
   
-
   
-
   
-
   
331
    331  
  Total comprehensive income (loss)
                                                                 
(51,756
)
Stockholders' equity - March 31, 2007
   
6,100,000
 
$
152,500
   
48,209,699
 
$
482
 
$
908,368
 
$
(10,437
)
$
(11,963
)
$
1,038,950
 
Stockholders' equity - December 31, 2005
   
4,100,000
 
$
102,500
   
43,913,409
 
$
439
 
$
782,735
 
$
(13,235
)
$
45,564
 
$
918,003
 
Dividends declared
   
-
   
-
   
-
   
-
   
-
   
(29,808
)
 
-
   
(29,808
)
Exercise of common stock options
   
-
   
-
   
54,000
   
1
   
1,049
   
-
   
-
   
1,050
 
Comprehensive income:
                                 
  Net income
   
-
   
-
   
-
   
-
   
-
   
30,919
   
-
   
30,919
 
  Net unrealized (loss) on securities
   
-
   
-
   
-
   
-
   
-
   
-
   
(36,554
)
 
(36,554
)
  Reclassification of net realized (gain) on
    securities into earnings
   
-
   
-
   
-
   
-
   
-
   
-
   
(29
)
 
(29
)
  Foreign currency translation
   
-
   
-
   
-
   
-
   
-
   
-
   
(34
)
 
(34
)
  Net unrealized gain on derivatives designated as
    cash flow hedges
   
-
   
-
   
-
   
-
   
-
   
-
   
56,145
   
56,145
 
  Reclassification of net realized (gain) on
    derivatives designated as cash flow
            hedges into earnings
   
-
   
-
   
-
   
-
   
-
   
-
   
(415
 
)
 
(415
)
  Total comprehensive income
                                                        
50,032
 
Stockholders' equity - March 31, 2006
   
4,100,000
 
$
102,500
   
43,967,409
 
$
440
 
$
783,784
 
$
(12,124
)
$
64,677
 
$
939,277
 
 
                                 
 
3


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

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


 
 
Three Months Ended March 31,
 
 
 
2007
 
2006
 
Cash Flows From Operating Activities
 
 
 
 
 
  Net income
 
$
36,191
 
$
30,919
 
  Adjustments to reconcile net income to net cash provided by (used in) operating activities
         
  (inclusive of amounts related to discontinued operations):
         
       Depreciation and amortization
   
329
   
199
 
       Accretion of discount and other amortization
   
(3,429
)
 
(9,732
)
       Equity in earnings of unconsolidated subsidiaries
   
(847
)
 
(1,195
)
       Distributions of earnings from unconsolidated subsidiaries
   
847
   
1,195
 
       Deferred rent
   
73
   
(837
)
       Gain on sale of investments
   
(2,212
)
 
(2,291
)
       Unrealized gain on non-hedge derivatives and hedge ineffectiveness
   
(471
)
 
(5,673
)
       Provision for credit losses
   
2,036
   
2,007
 
       Provision for losses, loans held for sale
   
-
   
4,127
 
       Purchase of loans held for sale - Notes 4 and 5
   
(992,031
)
 
(1,511,086
)
               
Change in:
         
      Restricted cash
   
(22,645
)
 
8,570
 
      Receivables and other assets
   
(17,233
)
 
5,929
 
      Due to affiliates
   
(8,430
)
 
(4,772
)
      Accrued expenses and other liabilities
   
5,631
   
12,239
 
          Net cash used in operating activities
   
(1,002,191
)
 
(1,470,401
)
               
Cash Flows From Investing Activities
         
      Purchase of real estate securities
   
(225,808
)
 
(168,480
)
      Proceeds from sale of real estate securities
   
51,673
   
54,225
 
          Purchase of and advances on loans
   
(574,698
)
 
(221,173
)
      Repayments of loan and security principal
   
124,559
   
187,188
 
      Margin received on derivative instruments
   
20,946
   
-
 
      Return of margin on derivative instruments
   
(26,691
)
 
-
 
      Margin deposits on total rate of return swaps (treated as derivative instruments)
   
(48,636
)
 
(15,517
)
      Return of margin deposits on total rate of return swaps (treated as derivative instruments)
   
29,316
   
19,866
 
      Proceeds from termination of derivative instruments
   
208
   
-
 
      Proceeds from sale of derivative instrument into Securitization Trust - Note 5
   
-
   
7,356
 
      Purchase and improvement of operating real estate
   
(144
)
 
(179
)
      Contributions to unconsolidated subsidiaries
   
-
   
(100
)
      Distributions of capital from unconsolidated subsidiaries
   
90
   
1,107
 
            Net cash used in investing activities
   
(649,185
)
 
(135,707
)
 
           
Continued on Page 5
         
4


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

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


 
 
Three Months Ended March 31,
 
 
2007
 
2006
 
Cash Flows From Financing Activities
 
 
 
 
 
       Repayments of CBO bonds payable
   
(32,210
)
 
(10,129
)
   Issuance of other bonds payable
   
-
   
237,111
 
   Repayments of other bonds payable
   
(26,407
)
 
(236,372
)
   Repayments of notes payable
   
(18,944
)
 
(39,616
)
   Borrowings under repurchase agreements
   
1,776,665
   
1,817,109
 
   Repayments of repurchase agreements
   
(338,947
)
 
(191,185
)
   Issuance of repurchase agreement subject to ABCP facility
   
216,672
   
-
 
   Repayments of repurchase agreement subject to ABCP facility
   
(48,212
)
 
-
 
   Draws under credit facility
   
308,800
   
90,000
 
   Repayments of credit facility
   
(277,100
)
 
(110,000
)
   Issuance of junior subordinated notes payable
   
-
   
100,100
 
   Issuance of common stock
   
75,746
   
-
 
   Costs related to issuance of common stock
   
(732
)
 
-
 
   Exercise of common stock options
   
1,271
   
1,050
 
   Issuance of preferred stock
   
50,000
   
-
 
   Costs related to issuance of preferred stock
   
(1,747
)
 
-
 
   Dividends paid
   
(33,872
)
 
(29,828
)
   Payment of deferred financing costs
   
(1,049
)
 
(4,932
)
       Net cash provided by financing activities
   
1,649,934
   
1,623,308
 
               
Net Increase (Decrease) in Cash and Cash Equivalents
   
(1,442
)
 
17,200
 
               
Cash and Cash Equivalents, Beginning of Period
   
5,371
   
21,275
 
               
Cash and Cash Equivalents, End of Period
 
$
3,929
 
$
38,475
 
               
Supplemental Disclosure of Cash Flow Information
         
   Cash paid during the period for interest expense
 
$
101,458
 
$
67,648
 
   Cash paid during the period for income taxes
 
$
-
 
$
244
 
               
Supplemental Schedule of Non-Cash Investing and Financing Activities
             
    Common stock dividends declared but not paid
 
$
33,265
 
$
27,480
 
    Preferred stock dividends declared but not paid
 
$
1,552
 
$
1,552
 
    Foreclosure of loans
 
$
-
 
$
12,200
 
 
5

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2007
(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 FIG LLC (the "Manager"), an affiliate of Fortress Investment Group LLC, 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 the Manager, through its affiliates, and its principals at March 31, 2007. In addition, the Manager, through its affiliates, held options to purchase approximately 1.2 million shares of Newcastle’s common stock at March 31, 2007.
 
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 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 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, 2006 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, 2006.

6


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2007
(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.

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

 
Real Estate Securities
and Real Estate Related Loans
 
Residential
Mortgage
Loans
 
Operating
Real Estate
 
Unallocated
 
Total
 
March 31, 2007 and the Three Months then Ended
 
 
 
 
 
 
 
 
 
 
 
Gross revenues
 
$
135,419
 
$
29,646
 
$
1,284
 
$
80
 
$
166,429
 
Operating expenses
   
(613
)
 
(3,436
)
 
(1,080
)
 
(8,857
)
 
(13,986
)
Operating income (loss)
   
134,806
   
26,210
   
204
   
(8,777
)
 
152,443
 
Interest expense
   
(93,342
)
 
(19,738
)
 
(6
)
 
(3,671
)
 
(116,757
)
Depreciation and amortization
   
-
   
-
   
(256
)
 
(73
)
 
(329
)
Equity in earnings of unconsolidated subsidiaries
   
270
   
-
   
576
   
1
   
847
 
Income (loss) from continuing operations
   
41,734
   
6,472
   
518
   
(12,520
)
 
36,204
 
Income (loss) from discontinued operations
   
-
   
-
   
(13
)
 
-
   
(13
)
Net income (loss)
   
41,734
   
6,472
   
505
   
(12,520
)
 
36,191
 
Preferred dividends
   
-
   
-
   
-
   
(2,515
)
 
(2,515
)
Income (loss) available for common stockholders
 
$
41,734
 
$
6,472
 
$
505
 
$
(15,035
)
$
33,676
 
Revenue derived from non-U.S. sources:
                     
Canada
 
$
-
 
$
-
 
$
730
 
$
-
 
$
730
 
Total assets
 
$
8,031,677
 
$
2,132,769
 
$
48,731
 
$
7,794
 
$
10,220,971
 
Long-lived assets outside the U.S.:
                     
Canada
 
$
-
 
$
-
 
$
16,661
 
$
-
 
$
16,661
 
December 31, 2006
                     
Total assets
 
$
7,366,684
 
$
1,179,547
 
$
48,518
 
$
9,643
 
$
8,604,392
 
Long-lived assets outside the U.S.:
                     
Canada
 
$
-
 
$
-
 
$
16,553
 
$
-
 
$
16,553
 
Three Months Ended March 31, 2006
                     
Gross revenues
 
$
95,193
 
$
26,029
 
$
2,184
 
$
142
 
$
123,548
 
Operating expenses
   
(817
)
 
(7,463
)
 
(877
)
 
(7,754
)
 
(16,911
)
Operating income (loss)
   
94,376
   
18,566
   
1,307
   
(7,612
)
 
106,637
 
Interest expense
   
(62,198
)
 
(13,928
)
 
-
   
(839
)
 
(76,965
)
Depreciation and amortization
   
-
   
-
   
(131
)
 
(68
)
 
(199
)
Equity in earnings of unconsolidated subsidiaries
   
701
   
-
   
494
   
-
   
1,195
 
Income (loss) from continuing operations
   
32,879
   
4,638
   
1,670
   
(8,519
)
 
30,668
 
Income from discontinued operations
   
-
   
-
   
251
   
-
   
251
 
Net income (loss)
   
32,879
   
4,638
   
1,921
   
(8,519
)
 
30,919
 
Preferred dividends
   
-
   
-
   
-
   
(2,328
)
 
(2,328
)
Income (loss) available for common stockholders
 
$
32,879
 
$
4,638
 
$
1,921
 
$
(10,847
)
$
28,591
 
Revenue derived from non-U.S. sources:
                     
Canada
 
$
-
 
$
-
 
$
2,380
 
$
-
 
$
2,380
 
continued on page 8
                               
 
7


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2007
(dollars in tables in thousands, except share data)


Unconsolidated Subsidiaries
The following table summarizes the activity for significant subsidiaries affecting the equity held by Newcastle in unconsolidated subsidiaries:
   
Operating Real Estate
 
Real Estate Loan
 
Balance at December 31, 2006
 
$
12,528
 
$
10,249
 
  Contributions to unconsolidated subsidiaries
   
-
   
-
 
  Distributions from unconsolidated subsidiaries
   
(371
)
 
(706
)
  Equity in earnings of unconsolidated subsidiaries
   
576
   
409
 
Balance at March 31, 2007
 
$
12,733
 
$
9,952
 
               

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

   
Operating Real Estate (A) (B)
 
Real Estate Loan (A) (C)
 
   
March 31,
 
December 31,
 
March 31,
 
December 31,
 
   
2007
 
2006
 
2007
 
2006
 
Assets
 
$
78,568
 
$
78,381
 
$
20,018
 
$
20,615
 
Liabilities
   
(52,625
)
 
(52,856
)
 
-
   
-
 
Minority interest
   
(477
)
 
(470
)
 
(113
)
 
(116
)
Equity
 
$
25,466
 
$
25,055
 
$
19,905
 
$
20,499
 
Equity held by Newcastle
 
$
12,733
 
$
12,528
 
$
9,952
 
$
10,249
 
                           
 
 
 Three Months Ended March 31,
 
Three Months Ended March 31,
 
     
2007
   
2006
   
2007
   
2006
 
Revenues
 
$
2,018
 
$
1,835
 
$
828
 
$
1,417
 
Expenses
   
(844
)
 
(828
)
 
(5
)
 
(8
)
Minority interest
   
(22
)
 
(19
)
 
(5
)
 
(8
)
Net income
 
$
1,152
 
$
988
 
$
818
 
$
1,401
 
Newcastle's equity in net income
 
$
576
 
$
494
 
$
409
 
$
701
 
                           
                           
 
(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.
 
8


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2007
(dollars in tables in thousands, except share data)
 


3. REAL ESTATE SECURITIES

The following is a summary of Newcastle’s real estate securities at March 31, 2007, all of which are classified as available for sale and are therefore marked to market through other comprehensive income.
 
 
 
 
 
 
 
Gross Unrealized
 
 
 
 
 
Weighted Average
 
 
Current Face Amount
 
Amortized
Cost Basis
 
Gains
 
Losses
 
Carrying
Value
 
Number of
Securities
 
S&P
Equivalent
Rating
 
Coupon
 
Yield
 
Maturity (Years)
 
CMBS-Conduit
 
$
1,477,085
 
$
1,433,659
 
$
25,025
 
$
(16,348
)
$
1,442,336
   
201
   
BBB
   
5.83%
 
 
6.52%
 
 
6.72
 
CMBS-Large Loan
   
681,548
   
682,070
   
2,833
   
(976
)
 
683,927
   
50
   
BBB-
   
6.82%
 
 
6.85%
 
 
2.40
 
CMBS- CDO
   
23,500
   
20,825
   
1,236
   
(890
)
 
21,171
   
2
   
BB
   
9.41%
 
 
11.86%
 
 
7.67
 
CMBS- B-Note
   
280,243
   
268,346
   
5,352
   
(428
)
 
273,270
   
41
   
BB
   
6.58%
 
 
7.51%
 
 
5.80
 
Unsecured REIT Debt
   
953,895
   
966,772
   
18,855
   
(7,380
)
 
978,247
   
96
   
BBB-
   
6.36%
 
 
6.07%
 
 
5.97
 
ABS-Manufactured Housing
   
80,839
   
76,695
   
2,176
   
(1,591
)
 
77,280
   
9
   
BBB-
   
6.68%
 
 
7.80%
 
 
6.37
 
ABS-Home Equity
   
698,710
   
683,836
   
469
   
(54,672
)
 
629,633
   
122
   
BBB+
   
7.13%
 
 
7.82%
 
 
2.35
 
ABS-Franchise
   
82,669
   
82,230
   
1,114
   
(3,250
)
 
80,094
   
22
   
BBB
   
7.46%
 
 
8.21%
 
 
4.62
 
Agency RMBS (C)
   
1,348,562
   
1,356,668
   
3,871
   
(5,597
)
 
1,354,942
   
42
   
AAA
   
5.29%
 
 
5.26%
 
 
4.33
 
Subtotal/Average (A)
   
5,627,051
   
5,571,101
   
60,931
   
(91,132
)
 
5,540,900
   
585
   
A-
   
6.16%
 
 
6.45%
 
 
4.88
 
Residual interest (B)
   
40,279
   
40,279
   
-
   
-
   
40,279
   
1
   
NR
   
0.00%
 
 
18.77%
 
 
2.29
 
Total/Average
 
$
5,667,330
 
$
5,611,380
 
$
60,931
 
$
(91,132
)
$
5,581,179
   
586
   
BBB+
   
6.12%
 
 
6.53%
 
 
4.86
 
                                                               
 
(A)
The total current face amount of fixed rate securities was $4.5 billion, and of floating rate securities was $1.2 billion.
   
(B) Represents the 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.
   
(C)
Agency RMBS have an implied AAA rating.
 
Unrealized losses that are considered other than temporary are recognized currently in income. There were no such losses incurred during the three months ended March 31, 2007. 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 had principal in default as of March 31, 2007. 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
 
$
1,390,610
 
$
1,364,801
 
$
-
 
$
(54,184
)
$
1,310,617
   
208
   
A-
   
6.36%
 
 
6.77%
 
 
4.54
 
Twelve or More Months
   
1,477,400
   
1,489,045
   
-
   
(36,948
)
 
1,452,097
   
170
   
A
   
5.62%
 
5.46%
 
 
5.32
 
Total
 
$
2,868,010
 
$
2,853,846
 
$
-
 
$
(91,132
)
$
2,762,714
   
378
   
A-
   
5.98%
 
 
6.09%
 
 
4.94
 
                                                               

As of March 31, 2007, Newcastle had $166.1 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)
MARCH 31, 2007


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 March 31, 2007. 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) (E)
   
Delinquent Carrying Amount
(F) 
 
Mezzanine Loans (A)
 
$
1,223,656
 
$
1,219,082
   
26
   
9.25%
 
 
2.77
 
$
-
 
Bank Loans
   
347,226
   
347,056
   
11
   
8.06%
 
 
4.40
   
-
 
B-Notes
   
345,960
   
344,613
   
12
   
8.20%
 
 
2.66
   
-
 
Whole Loans
   
107,881
   
108,348
   
4
   
10.30%
 
 
1.98
   
-
 
ICH Loans (B)
   
121,649
   
119,875
   
68
   
7.63%
 
 
0.89
   
3,284
 
Total Real Estate Related Loans
 
$
2,146,372
 
$
2,138,974
   
121
   
8.85%
 
 
2.87
 
$
3,284
 
                                     
Residential Loans
 
$
140,549
 
$
144,168
   
423
   
6.39%
 
 
2.79
 
$
4,203
 
Manufactured Housing Loans
   
617,924
   
608,422
   
17,660
   
8.56%
 
 
5.79
   
6,293
 
Total Residential Mortgage Loans
 
$
758,473
 
$
752,590
   
18,083
   
8.14%
 
 
5.23
 
$
10,496
 
Subprime Mortgage Loans Held for Sale (D)
 
$
1,049,285
 
$
1,018,080
   
4,402
   
7.82%
 
 
2.54
 
$
-
 
Subprime Mortgage Loans Subject to Call Option (C)
 
$
299,176
 
$
289,021
                         
 
                                     
                                       
 
(A)  
One of these loans has an $8.9 million contractual exit fee which Newcastle will begin to accrue 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)  
In March 2007, Newcastle, through a consolidated subsidiary, entered into an agreement to acquire a portfolio of residential mortgage loans to subprime borrowers (the “Subprime Portfolio II”). Based upon the due diligence review, which was completed in April 2007, the final loan portfolio is $1.3 billion of unpaid principal balance. At March 31, 2007, $1.0 billion of loans have been purchased and are considered “held for sale” and carried at the lower of cost or fair value. No write down was recorded related to these loans. Furthermore, the acquisition of loans held for sale is considered an operating activity for statement of cash flow purposes. 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 II. This swap is marked to market through income with the related portion of the hedged item, to the extent that the purchase has been consummated and the swap qualifies as a fair value hedge for accounting purposes, also marked to market through income. The unfunded portion of the loan is treated as a non-hedge derivative for accounting purposes and is marked to market through income. The carrying value of the loans at March 31, 2007 included approximately $10.0 million related to principal receivable, interest receivable and basis adjustments.

(E)  
The weighted average maturities for the residential loan portfolio and the two manufactured housing loan portfolios were calculated based on constant prepayment rates (CPR) of 30%, 8% and 9%, respectively.

(F)  
This face amount of loans is 60 or more days past due, in foreclosure or real estate owned, representing 3.0% and 1.0% of the total current face amounts of the Residential Loans and the Manufactured Housing Loans, respectively.
 
The following is a reconciliation of loss allowance.

   
Real Estate
Related Loans
 
Residential
Mortgage Loans
 
Balance at December 31, 2006
 
$
(2,150
)
$
(7,256
)
Provision for credit losses
   
(100
)
 
(1,936
)
Realized losses
   
-
   
2,955
 
Balance at March 31, 2007
 
$
(2,250
)
$
(6,237
)
 
10


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2007
(dollars in tables in thousands, except share data)


Newcastle has entered into total rate of return swaps with major investment banks 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 March 31, 2007, Newcastle held an aggregate of $418.9 million notional amount of total rate of return swaps on 7 reference assets on which it had deposited $66.1 million of margin. These total rate of return swaps had an aggregate fair value of approximately $1.3 million, a weighted average receive interest rate of LIBOR + 2.24 %, a weighted average pay interest rate of LIBOR + 0.65 %, and a weighted average swap maturity of 1.05 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 I”) for $1.50 billion. The loans are being serviced by Nationstar Mortgage, LLC, an affiliate of the Manager, for a servicing fee equal to 0.50% per annum on the unpaid principal balance of the Subprime Portfolio I.

In April 2006, Newcastle, through Newcastle Mortgage Securities Trust 2006-1 (the “Securitization Trust”), closed on a securitization of the Subprime Portfolio I. The Securitization Trust is not consolidated by Newcastle. Newcastle sold the Subprime Portfolio I 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 I 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. However, 20% of the loans which are subject to call option 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 I: (i) the equity of the Securitization Trust, recorded in Real Estate Securities, Available for Sale, (ii) the retained notes as described above, which have been financed with a repurchase agreement, and (iii) subprime mortgage loans subject to call option and related financing in the amount of 100% of such loans.

11


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2007
(dollars in tables in thousands, except share data)


The following table presents information on the retained interests in the securitization of the Subprime Portfolio I, which include the residual interest and the retained notes described above, and the sensitivity of their fair value to call date for immediate 10% and 20% adverse changes in the assumptions utilized in calculating such fair value, at March 31, 2007:
 

Total securitized loans (unpaid principal balance)
 
$
1,105,213
 
Loans subject to call option (carrying value)
 
$
289,021
 
Retained interests (fair value)
 
$
69,382
 
Weighted average life (years) of residual interest
   
2.29
 
Expected credit losses (A)
   
5.2%
 
  Effect on fair value of retained interests of 10% adverse change
 
$
(2,482
)
  Effect on fair value of retained interests of 20% adverse change
 
$
(5,224
)
         
Weighted average constant prepayment rate (B)
   
30.5%
 
  Effect on fair value of retained interests of 10% adverse change
 
$
(3,441
)
  Effect on fair value of retained interests of 20% adverse change
 
$
(5,605
)
         
Discount rate
   
18.8%
 
  Effect on fair value of retained interests of 10% adverse change
 
$
(2,242
)
  Effect on fair value of retained interests of 20% adverse change
 
$
(4,391
)
         
 
(A)      
Represents the percentage of losses on the original principal balance of the loans at the time of securitization (April 2006) to the maturity of the loans.
(B)       
Represents the weighted average prepayment rate for the loans as of March 31, 2007 until maturity of such loans.
 
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% 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 the securitized loans as of March 31, 2007 and net credit losses for the period then ended:

  Loan unpaid principal balance (UPB)
 
$
1,105,213
 
  Delinquencies of 60 or more days (UPB)
 
$
47,107
 
  Net credit losses
 
$
197
 

Delinquencies include loans 60 or more days past due, in foreclosure or real estate owned, representing 4.3% of the total unpaid principal balance. Newcastle received net cash inflows of $2.9 million from the retained interests during the three months ended March 31, 2007.

The weighted average yield of the retained notes was 11.06% and the weighted average funding cost of the related repurchase agreement was 5.73% as of March 31, 2007. The loans subject to call option and the corresponding financing recognize interest income and expense based on the expected weighted average coupon of the loans subject to call option at the call date of 9.24%. At March 31, 2007 included in retained interests is the unamortized cost of retained notes of $34.6 million with a fair value of $29.1 million based on dealer quotations.
 
12


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2007
(dollars in tables in thousands, except share data)


6. RECENT ACTIVITIES

In January 2007, Newcastle issued 2.42 million shares of its common stock in a public offering at a price to the public of $31.30 per share for net proceeds of approximately $75.0 million. For the purpose of compensating the Manager for its successful efforts in raising capital for Newcastle, in connection with this offering, Newcastle granted options to the Manager to purchase 242,000 shares of Newcastle’s common stock at the public offering price, which were valued at approximately $0.8 million.

In January and February 2007, certain of the Manager’s employees exercised options to acquire 75,882 shares of Newcastle’s common stock for net proceeds of $1.3 million.

In January 2007, Newcastle entered into a $700 million non-recourse warehouse agreement with a major investment bank to finance a portfolio of real estate related loans and securities prior to them being financed with a CBO. The financing primarily bore interest at LIBOR + 0.50% and was terminated simultaneously with the closing of the CBO financing in May 2007.

In February 2007, Newcastle filed a new registration statement with the SEC to replace the previous shelf registration statement to issue various types of securities, such as common stock, preferred stock, depositary shares, debt securities and warrants.  The new shelf registration statement covers an unspecified amount of securities that can be offered.  

In February 2007, Newcastle entered into a $400 million facility in the form of a repurchase agreement with a major investment bank to finance our investments in real estate related loans from time to time. The repurchase agreement has a rolling maturity of one year, with a maximum maturity of February 2010. The financing bears interest at LIBOR plus an applicable spread which varies depending on the type of assets.

In March 2007, Newcastle issued 2.0 million shares ($50.0 million face amount) of its 8.375% Series D Cumulative Redeemable Preferred Stock (the “Series D Preferred”) for net proceeds of approximately $48.4 million.  The Series D Preferred is non-voting, has a $25 per share liquidation preference, no maturity date and no mandatory redemption.  Newcastle has the option to redeem the Series D Preferred beginning in March 2012.

In March 2007, Newcastle entered into an agreement to acquire a portfolio of approximately 7,300 residential mortgage loans to subprime borrowers (the “Subprime Portfolio II”) for up to $1.70 billion of unpaid principal balance. Based upon the due diligence review, which was completed in April 2007, the final loan portfolio is $1.3 billion of unpaid principal balance.  Furthermore, Newcastle is entitled to an early payment default protection under which the seller will repurchase mortgage loans that fail to make the first, second or third monthly payment due after the respective purchase dates. At March 31, 2007, $1.0 billion of loans have been purchased and are considered “held for sale” for accounting purposes. This acquisition was initially funded with a repurchase agreement which bore interest at LIBOR + 0.60%. 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 II. The loans are being serviced by Nationstar Mortgage LLC, an affiliate of the Manager, for a servicing fee equal to 0.50% per annum on the unpaid principal balance of the Subprime Portfolio II. 

In April 2007, Newcastle issued 4.56 million shares of its common stock in a public offering at a price to the public of $27.75 per share for net proceeds of approximately $124.9 million. For the purpose of compensating the Manager for its successful efforts in raising capital for Newcastle, in connection with this offering, Newcastle granted options to the Manager to purchase 456,000 shares of Newcastle’s common stock at the public offering price, which were valued at approximately $1.2 million.

In May 2007, Newcastle completed its tenth CBO financing to term finance $825.0 million portfolio of real estate related loans and securities. Newcastle issued, through a consolidated subsidiary, $710.5 million of investment grade notes in the offering. At closing, the investment grade notes have an initial weighted average spread over LIBOR of 0.70% and a weighted average life of 7 years. Approximately 82%, or $585.8 million, of the investment grade notes are rated AAA through AA- and were sold to third parties. The remaining $124.7 million of investment grade notes rated A+ through BBB- have been retained and financed. Newcastle has also retained the below investment grade notes and preferred shares of the offering.
 
In April 2007, Newcastle entered into a facility, in the form of repurchase agreement, with a major investment bank to finance acquisitions of real estate related loans from time to time.  The facility provides for the financing of assets of up to $400.0 million and bears interest at LIBOR plus an applicable spread, which varies depending on the type of assets being financed.  The facility has a rolling one year maturity.
 
13


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2007
(dollars in tables in thousands, except share data)


7. DERIVATIVE INSTRUMENTS

The following table summarizes the notional amounts and fair (carrying) values of Newcastle's derivative financial instruments, excluding the total rate of return swap arrangements described in Note 4, as of March 31, 2007.
 
   
Notional Amount
 
Fair Value
 
Longest Maturity
 
Interest rate swaps, treated as hedges (A)