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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, 2009

or

 

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

For the transition period from              to             

Commission File Number: 001-31458

 

 

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  ¨

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

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

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

Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  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: 52,808,531 shares outstanding as of May 6, 2009.

 

 

 


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CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

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

 

   

our ability to take advantage of opportunities in additional asset classes at attractive risk-adjusted prices;

 

   

our ability to deploy capital accretively;

 

   

the risks that default and recovery rates on our loan portfolios exceed our underwriting estimates;

 

   

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

 

   

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

 

   

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

 

   

adverse changes in the financing markets we access affecting our ability to finance our investments, or in a manner that maintains our historic net spreads;

 

   

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

 

   

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

 

   

the quality and size of the investment pipeline and the rate at which we can invest our cash, including cash inside our CDOs;

 

   

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

 

   

legislative/regulatory changes, including but not limited to, any modification of the terms of loans;

 

   

reductions in cash flows received from our investments, particularly our CDOs;

 

   

completion of pending investments;

 

   

the availability and cost of capital for future investments;

 

   

competition within the finance and real estate industries; and

 

   

other risks detailed from time to time below, particularly under the heading “Risk Factors,” and in our other SEC reports.

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

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


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SPECIAL NOTE REGARDING EXHIBITS

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

 

   

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

 

   

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

 

   

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

 

   

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

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


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NEWCASTLE INVESTMENT CORP.

FORM 10-Q

INDEX

 

         PAGE
PART I.   FINANCIAL INFORMATION   
Item 1.   Financial Statements   
  Consolidated Balance Sheets as of March 31, 2009 (unaudited) and December 31, 2008    1
  Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2009 and 2008    2
  Consolidated Statements of Stockholders’ Equity (unaudited) for the three months ended March 31, 2009    3
  Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2009 and 2008    4
  Notes to Consolidated Financial Statements (unaudited)    6
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    22
Item 3.   Quantitative and Qualitative Disclosures About Market Risk    40
Item 4.   Controls and Procedures    43
PART II.   OTHER INFORMATION   
Item 1.   Legal Proceedings    44
Item 1A.   Risk Factors    44
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds    62
Item 3.   Defaults upon Senior Securities    62
Item 4.   Submission of Matters to a Vote of Security Holders    62
Item 5.   Other Information    62
Item 6.   Exhibits    63
SIGNATURES    64


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PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

 

     March 31, 2009
(Unaudited)
    December 31, 2008  

Assets

    

Real estate securities, available for sale

   $ 1,453,341     $ 1,668,748  

Real estate related loans held for sale, net

     698,269       843,212  

Residential mortgage loans held for sale, net

     391,853       409,632  

Subprime mortgage loans subject to call option

     399,288       398,026  

Investments in unconsolidated subsidiaries

     349       384  

Operating real estate, held for sale

     10,516       11,866  

Cash and cash equivalents

     56,730       49,746  

Restricted cash

     85,360       44,282  

Receivables and other assets

     38,333       47,727  
                
   $ 3,134,039     $ 3,473,623  
                

Liabilities and Stockholders’ Equity

    

Liabilities

    

CDO bonds payable

   $ 4,328,196     $ 4,359,981  

Other bonds payable

     341,023       380,620  

Repurchase agreements

     130,898       276,472  

Financing of subprime mortgage loans subject to call option

     399,288       398,026  

Junior subordinated notes payable (security for trust preferred)

     100,100       100,100  

Derivative liabilities

     308,946       333,977  

Due to affiliates

     1,497       1,532  

Accrued expenses and other liabilities

     9,375       16,447  
                
     5,619,323       5,867,155  
                

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       152,500  

Common stock, $0.01 par value, 500,000,000 shares authorized, 52,808,531 and 52,789,050 shares issued and outstanding at March 31, 2009 and December 31, 2008, respectively

     528       528  

Additional paid-in capital

     1,033,431       1,033,416  

Dividends in excess of earnings

     (3,511,251 )     (3,272,403 )

Accumulated other comprehensive income (loss)

     (160,492 )     (307,573 )
                
     (2,485,284 )     (2,393,532 )
                
   $ 3,134,039     $ 3,473,623  
                

See notes to consolidated financial statements

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(dollars in thousands, except share data)

 

 

     Three Months Ended
March 31,
 
     2009     2008  

Revenues

    

Interest income

   $ 124,473     $ 132,894  
                
     124,473       132,894  
                

Expenses

    

Interest expense

     60,544       89,375  

Loan and security servicing expense

     1,402       1,730  

Provision for credit losses

     1,907       2,505  

General and administrative expense

     1,626       1,592  

Management fee to affiliate

     4,491       4,597  

Depreciation and amortization

     72       72  
                
     70,042       99,871  
                
     54,431       33,023  
                

Impairment

    

Other-than-temporary impairment

     186,582       46,372  

Loan impairment

     120,526       20,326  
                
     307,108       66,698  
                

Operating Income (Loss)

     (252,677 )     (33,675 )
                

Other Income (Loss)

    

Gain (loss) on settlement of investments, net

     (6,502 )     6,526  

Gain (loss) on extinguishment of debt

     26,845       8,533  

Other income (loss), net

     (6,494 )     (19,308 )

Equity in earnings of unconsolidated subsidiaries

     13       708  
                
     13,862       (3,541 )
                

Income (loss) from continuing operations

     (238,815 )     (37,216 )

Income (loss) from discontinued operations

     (33 )     (3,688 )

Net Income (Loss)

     (238,848 )     (40,904 )

Preferred dividends

     (3,375 )     (3,375 )
                

Income (Loss) Applicable to Common Stockholders

   $ (242,223 )   $ (44,279 )
                

Income (Loss) Per Share of Common Stock

    

Basic

     (4.59 )   $ (0.84 )
                

Diluted

   $ (4.59 )   $ (0.84 )
                

Income (loss) from continuing operations per share of common stock, after preferred dividends

    

Basic

   $ (4.59 )   $ (0.77 )
                

Diluted

   $ (4.59 )   $ (0.77 )
                

Income (loss) from discontinued operations per share of common stock

    

Basic

   $ (0.00 )   $ (0.07 )
                

Diluted

   $ (0.00 )   $ (0.07 )
                

Weighted Average Number of Shares of Common Stock Outstanding

    

Basic

     52,807,232       52,780,319  
                

Diluted

     52,807,232       52,780,319  
                

Dividends Declared per Share of Common Stock

   $ —       $ 0.25  
                

See notes to consolidated financial statements

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)

FOR THE THREE MONTHS ENDED MARCH 31, 2009

(dollars in thousands)

 

 

     Preferred Stock   Common Stock   Additional
Paid-in
Capital
  Dividends in
Excess of
Earnings
    Accum. Other
Comp. Income
(Loss)
    Total
Stockholders’
Equity
 
     Shares   Amount   Shares   Amount        

Stockholders’ equity - December 31, 2008

   6,100,000   $ 152,500   52,789,050   $ 528   $ 1,033,416   $ (3,272,403 )   $ (307,573 )   $ (2,393,532 )

Issuance of common stock to directors

   —       —     19,481     —       15     —         —         15  

Comprehensive income:

                

Net (loss)

   —       —     —       —       —       (238,848 )     —         (238,848 )

Net unrealized (loss) on securities

   —       —     —       —       —       —         (81,665 )     (81,665 )

Reclassification of net realized loss on securities into earnings

   —       —     —       —       —       —         194,813       194,813  

Foreign currency translation

   —       —     —       —       —       —         —         —    

Net unrealized gain on derivatives designated as cash flow hedges

   —       —     —       —       —       —         21,983       21,983  

Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings

   —       —     —       —       —       —         11,950       11,950  
                      

Total comprehensive income (loss)

                   (91,767 )
                                                  

Stockholders’ equity - March 31, 2009

   6,100,000   $ 152,500   52,808,531   $ 528   $ 1,033,431   $ (3,511,251 )   $ (160,492 )   $ (2,485,284 )
                                                  

See notes to consolidated financial statements

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

 

 

     Three Months Ended March 31,  
     2009     2008  

Cash Flows From Operating Activities

    

Net income (loss)

   $ (238,848 )   $ (40,904 )

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities (inclusive of amounts related to discontinued operations):

    

Depreciation and amortization

     78       420  

Accretion of discount and other amortization

     (39,308 )     (10,713 )

Deferred rent

     —         90  

Provision for credit losses

     1,907       2,505  

Provision for losses, loans held for sale

     100,062       —    

Non-cash directors’ compensation

     15       15  

(Gain) loss on settlement of investments

     6,506       (6,951 )

Unrealized (gain) loss on non-hedge derivatives and hedge ineffectiveness

     6,505       20,294  

Other-than-temporary impairment

     186,582       49,872  

Loan impairment

     20,464       20,326  

(Gain) loss on extinguishment of debt

     (26,845 )     (8,533 )

Equity in earnings of unconsolidated subsidiaries

     (13 )     (708 )

Distributions of earnings from unconsolidated subsidiaries

     13       708  

Change in:

    

Restricted cash

     821       2,965  

Receivables and other assets

     8,791       10,609  

Due to affiliates

     (35 )     —    

Accrued expenses and other liabilities

     (621 )     (2,421 )
                

Net cash provided by (used in) operating activities

     26,074       37,574  
                

Cash Flows From Investing Activities

    

Purchase of real estate securities

     (1,800 )     —    

Proceeds from sale of real estate securities

     131,120       1,151,012  

Purchase of and advances on loans

     (13,130 )     —    

Proceeds from settlement of loans

     —         12,386  

Repayments of loan and security principal

     17,339       119,293  

Margin received on derivative instruments

     2,760       38,539  

Return of margin on derivative instruments

     —         (42,037 )

Margin deposits on total rate of return swaps (treated as derivative instruments)

     —         (14,236 )

Return of margin deposits on total rate of return swaps (treated as derivative instruments)

     37       26,325  

Net proceeds from termination of derivative instruments

     —         (33,936 )

Payments on settlement of derivative instruments

     (9,487 )     —    

Purchase and improvement of real estate held for sale

     —         (613 )

Proceeds from sale of real estate held for sale

     1,350       —    

Distributions of capital from unconsolidated subsidiaries

     35       8,977  
                

Net cash provided by (used in) in investing activities

     128,224       1,265,710  
                

Continued on Page 5

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

 

 

     Three Months Ended March 31,  
     2009     2008  

Cash Flows From Financing Activities

    

Repayments of CDO bonds payable

     (638 )     (332,643 )

Repayments of other bonds payable

     (39,516 )     (70,471 )

Borrowings under repurchase agreements

     —         20,818  

Repayments of repurchase agreements

     (145,629 )     (945,246 )

Margin deposits under repurchase agreements

     (3,422 )     —    

Return of margin deposits under repurchase agreements

     3,705       5,457  

Dividends paid

     —         (41,376 )

Payment of deferred financing costs

     (200 )     —    

Restricted cash returned from refinancing activities

     38,386       122,223  

Other

     —         52  
                

Net cash provided by (used in) financing activities

     (147,314 )     (1,241,186 )
                

Net Increase (Decrease) in Cash and Cash Equivalents

     6,984       62,098  

Cash and Cash Equivalents, Beginning of Period

     49,746       55,916  
                

Cash and Cash Equivalents, End of Period

   $ 56,730     $ 118,014  
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid during the period for interest expense

   $ 44,305     $ 82,756  

Cash paid during the period for income taxes

   $ —       $ —    

Supplemental Schedule of Non-Cash Investing and Financing Activities

    

Common stock dividends declared but not paid

   $ —       $ 13,195  

Preferred stock dividends declared but not paid

   $ —       $ 2,250  

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(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 four primary segments: (i) investments financed with non-recourse collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments financed with recourse debt, including FNMA / FHLMC securities, and (iv) unlevered investments.

In the second quarter of 2008, Newcastle changed the structure of its internal organization such that the basis of the composition of its reportable segments changed from investment type to financing type. Management believes this presentation better reflects the benefits and risks of the company’s structure.

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 5.0 million shares of Newcastle’s common stock were held by the Manager, through its affiliates, and the principals of an affiliate of the Manager at March 31, 2009. In addition, the Manager, through its affiliates, held options to purchase approximately 1.6 million shares of Newcastle’s common stock at March 31, 2009.

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, 2008 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, 2008.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

2. INFORMATION REGARDING BUSINESS SEGMENTS

Newcastle conducts its business through four primary segments: (i) investments financed with non-recourse collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments financed with recourse debt, including FNMA / FHLMC securities, and (iv) unlevered investments. In the second quarter of 2008, Newcastle changed the structure of its internal organization such that the basis of the composition of its reportable segments changed from investment type to financing type. Management believes this presentation better reflects the benefits and risks of the company’s structure.

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

 

     CDOs (A)     Other
Non-Recourse

(A) (B)
    Recourse     Unlevered     Unallocated     Total  

Three Months Ended March 31, 2009

            

Gross revenues

   $ 100,763     $ 20,342     $ 2,518     $ 829     $ 21     $ 124,473  

Interest expense

     (38,314 )     (19,156 )     (1,197 )     —         (1,877 )     (60,544 )

Depreciation and amortization

     —         —         —         —         (72 )     (72 )

Other operating expenses

     (862 )     (2,426 )     (22 )     (1 )     (6,115 )     (9,426 )

Impairment

     (281,064 )     (2,111 )     (21,294 )     (2,639 )     —         (307,108 )
                                                

Operating income (loss)

     (219,477 )     (3,351 )     (19,995 )     (1,811 )     (8,043 )     (252,677 )

Other income (loss)

     15,345       (5,681 )     4,233       (37 )     2       13,862  
                                                

Income (loss) from continuing operations

     (204,132 )     (9,032 )     (15,762 )     (1,848 )     (8,041 )     (238,815 )

Income (loss) from discontinued operations

     —         —         —         (33 )     —         (33 )
                                                

Net income (loss)

     (204,132 )     (9,032 )     (15,762 )     (1,881 )     (8,041 )     (238,848 )

Preferred dividends

     —         —         —         —         (3,375 )     (3,375 )
                                                

Income (loss) applicable to common stockholders

   $ (204,132 )   $ (9,032 )   $ (15,762 )   $ (1,881 )   $ (11,416 )   $ (242,223 )
                                                

March 31, 2009

            

GAAP

            

Investments (C)

   $ 2,052,344     $ 738,127     $ 148,487     $ 14,557     $ 101     $ 2,953,616  

Cash and restricted cash

     81,641       —         3,914       487       56,048       142,090  

Other assets

     33,016       —         804       76       4,437       38,333  

Debt

     (4,328,196 )     (740,311 )     (130,898 )     —         (100,100 )     (5,299,505 )

Derivative liabilities

     (270,218 )     (35,045 )     (3,683 )     —         —         (308,946 )

Other liabilities

     (1,461 )     (3,121 )     (679 )     (177 )     (5,434 )     (10,872 )

Preferred stock

     —         —         —         —         (152,500 )     (152,500 )
                                                

GAAP book value (D)

   $ (2,432,874 )   $ (40,350 )   $ 17,945     $ 14,943     $ (197,448 )   $ (2,637,784 )
                                                

GAAP book value per share

             $ (49.95 )

Fair Value

            

Assets, fair value (E)

   $ 2,167,001     $ 738,127     $ 153,205     $ 15,120     $ 60,586     $ 3,134,039  

Liabilities, fair value (E)

     (1,098,474 )     (734,081 )     (135,260 )     (177 )     (26,410 )     (1,994,402 )

Preferred stock, at par

     —         —         —         —         (152,500 )     (152,500 )
                                                

Adjusted book value

   $ 1,068,527     $ 4,046     $ 17,945     $ 14,943     $ (118,324 )   $ 987,137  
                                                

Adjusted book value per share (F)

             $ 18.69  

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

     CDOs (A)     Other
Non-Recourse

(A) (B)
    Recourse     Unlevered     Unallocated     Total  

Three Months Ended March 31, 2008

            

Gross revenues

   $ 84,199     $ 24,255     $ 16,410     $ 7,494     $ 536     $ 132,894  

Interest expense

     (57,093 )     (17,896 )     (12,392 )     (115 )     (1,879 )     (89,375 )

Depreciation and amortization

     —         —         —         —         (72 )     (72 )

Other operating expenses

     (412 )     (3,806 )     (19 )     —         (6,187 )     (10,424 )

Impairment

     (60,877 )     (1,222 )     (2,432 )     (2,167 )     —         (66,698 )
                                                

Operating income (loss)

     (34,183 )     1,331       1,567       5,212       (7,602 )     (33,675 )

Other income (loss)

     2,216       —         (5,874 )     707       (590 )     (3,541 )
                                                

Income (loss) from continuing operations

     (31,967 )     1,331       (4,307 )     5,919       (8,192 )     (37,216 )

Income (loss) from discontinued operations

     —         —         —         (3,688 )     —         (3,688 )
                                                

Net income (loss)

     (31,967 )     1,331       (4,307 )     2,231       (8,192 )     (40,904 )

Preferred dividends

     —         —         —         —         (3,375 )     (3,375 )
                                                

Income (loss) applicable to common stockholders

   $ (31,967 )   $ 1,331     $ (4,307 )   $ 2,231     $ (11,567 )   $ (44,279 )
                                                

 

(A) Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the extent Newcastle receives net cash flow distributions from such structures. Furthermore, economic losses from such structures cannot exceed Newcastle’s invested equity in them. Therefore, economically their book value cannot be less than zero, except for the amounts described in note (B) below.
(B) Includes all of the manufactured housing loan financing, of which $19.9 million (carrying value) was recourse as of March 31, 2009.
(C) Investments in the unlevered segment include $10.8 million of real estate securities, $3.5 million of a real estate related loan and $0.3 million of interests in a joint venture at March 31, 2009.
(D) Newcastle cannot economically lose more than its investment amount in any given non-recourse financing structure. Therefore, impairment recorded in excess of such investment, which results in negative GAAP book value for a given non-recourse financing structure, cannot economically be incurred and will eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or termination of such non-recourse financing structure. For non-recourse financing structures with negative GAAP book value, except as noted in (B) above, the aggregate negative GAAP book value which will eventually be recorded as income is $2.5 billion.
(E) Only financial instruments are reflected at fair value; other assets and liabilities are reflected at their carrying value.
(F) Represents GAAP book value as if Newcastle had elected to measure all of its financial instruments at fair value under SFAS 159.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(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:

 

     Real Estate Loan  

Balance at December 31, 2008

   $ 283  

Distributions from unconsolidated subsidiaries

     (46 )

Equity in earnings of unconsolidated subsidiaries

     11  
        

Balance at March 31, 2009

   $ 248  
        

Gain (Loss) on Settlement of Investments, Net and Other Income (Loss), Net

These items are comprised of the following:

 

     Three Months Ended March 31,  
     2009     2008  

Gain (loss) on settlement of investments, net

    

Gain on settlement of real estate securities

   $ 7,388     $ 6,459  

Loss on settlement of real estate securities

     (15,619 )     (942 )

Gain on disposition of loans held for sale

     1,725       1,434  

Realized gain (loss) on termination of derivative instruments

     4       (425 )
                
   $ (6,502 )   $ 6,526  
                

Other income (loss), net

    

Realized (loss) on total rate of return swaps

   $ —       $ (7,145 )

Unrealized (loss) on total rate of return swaps

     —         (4,084 )

Gain (loss) on non-hedge derivative instruments

     3,116       (8,405 )

Unrealized (loss) recognized at de-designation of hedges

     (8,797 )     (444 )

Hedge ineffectiveness

     (828 )     208  

Other income (loss)

     15       562  
                
   $ (6,494 )   $ (19,308 )
                

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(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, 2009, all of which are classified as available for sale and are therefore reported at fair value with changes in fair value recorded in other comprehensive income, except for securities that are other-than-temporarily impaired.

 

          Amortized Cost Basis                        Weighted Average
     Outstanding
Face Amount
   Before
Impairment
   Other-Than-
Temporary
Impairment (A)
    After
Impairment
   Gross Unrealized    Carrying Value    Number
of
Securities
   Rating (B)    Coupon     Yield     Maturity
(Years)

Asset Type

              Gains    Losses                

CMBS-Conduit

   $ 1,463,362    $ 1,375,621    $ (1,050,133 )   $ 325,488    $ 14,137    $ —      $ 339,625    180    BBB-    5.73 %   39.36 %   6.1

CMBS- Single Borrower

     697,916      705,847      (360,820 )     345,027      79,073      —        424,100    69    BB    4.78 %   30.92 %   2.8

CMBS-Large Loan

     89,225      93,635      (57,016 )     36,619      13      —        36,632    12    BB    2.15 %   38.12 %   2.7

CMBS-CDO

     16,000      14,730      (14,730 )     —        —        —        —      1    CC    10.13 %   0.00 %   —  

REIT Debt

     632,967      642,334      (259,983 )     382,351      19,460      —        401,811    62    BB    6.19 %   19.29 %   4.6

ABS-Subprime

     549,521      499,756      (359,611 )     140,145      4,649      —        144,794    120    B    1.79 %   31.20 %   4.3

ABS-Manufactured Housing

     60,690      60,130      (26,073 )     34,057      1,097      —        35,154    9    BB    6.68 %   20.23 %   10.2

ABS-Franchise

     37,602      38,586      (26,014 )     12,572      405      —        12,977    17    BBB-    4.19 %   33.17 %   3.5

FNMA/FHLMC (C)

     49,127      50,801      —         50,801      1,064      —        51,865    2    AAA    5.84 %   5.73 %   2.7
                                                                            

Subtotal/Average (D)

     3,596,410      3,481,440      (2,154,380 )     1,327,060      119,898      —        1,446,958    472    BB+    4.96 %   28.68 %   4.8
                                                                            

Retained Securities (E)

     80,380      73,366      (67,918 )     5,448      —        —        5,448    7    CC    2.62 %   20.00 %   2.3

Residual Interests (E)

     935      29,617      (28,682 )     935      —        —        935    1    NR    0.00 %   30.00 %   0.6
                                                                            

Total/Average

   $ 3,677,725    $ 3,584,423    $ (2,250,980 )   $ 1,333,443    $ 119,898    $ —      $ 1,453,341    480    BB    4.90 %   28.64 %   4.8
                                                                            

 

(A) Represents the cumulative impairment against amortized cost basis recorded through earnings.
(B) Represents the weighted average of the ratings of all securities in each asset type, expressed as an S&P equivalent rating. For each security rated by multiple rating agencies, the lowest rating is used. FNMA/FHLMC securities have an implied AAA rating. Ratings provided were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including the assignment of a “negative outlook” or “credit watch”) at any time.
(C) Amortized cost basis and carrying value include principal receivable of $1.4 million.
(D) The total outstanding face amount of fixed rate securities was $2.6 billion, and of floating rate securities was $1.1 billion.
(E) Represents the retained bonds and equity from Securitization Trust 2006 and Securitization Trust 2007. The residuals do not have stated coupons and therefore their coupons have been treated as zero for purposes of the table.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

Unrealized losses that are considered other-than-temporary are recognized currently in income. During the three months ended March 31, 2009, Newcastle recorded other-than-temporary impairment charges of $186.6 million, with respect to real estate securities. Based on management’s analysis of these securities, the performance of the underlying loans and changes in market factors, Newcastle noted adverse changes in the expected cash flows on certain of these securities, and could not express an intent and ability to hold others until recovery, and concluded that they were other-than-temporarily impaired.

The table below summarizes the geographic distribution of the collateral securing our CMBS at March 31, 2009 (in thousands):

 

Geographic Location

   Outstanding Face Amount    Percentage  

Northeastern U.S.

   $ 531,818    23.5 %

Western U.S.

     529,888    23.4 %

Southeastern U.S.

     462,428    20.4 %

Midwestern U.S.

     295,243    13.0 %

Southwestern U.S.

     240,536    10.6 %

Other

     180,563    8.0 %

Foreign

     26,027    1.1 %
             
   $ 2,266,503    100.0 %
             

Geographic concentrations of investments expose Newcastle to the risk of economic downturns within the relevant regions, particularly given the current unfavorable market conditions. These market conditions may make regions more vulnerable to downturns in certain market factors. Any such downturn in a region where Newcastle holds significant investments could have a material, negative impact on Newcastle.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

4. REAL ESTATE RELATED LOANS HELD FOR SALE, RESIDENTIAL MORTGAGE LOANS HELD FOR SALE AND SUBPRIME MORTGAGE LOANS

The following is a summary of real estate related loans held for sale, residential mortgage loans held for sale and subprime mortgage loans at March 31, 2009. The loans contain various terms, including fixed and floating rates, self-amortizing and interest only. They are generally subject to prepayment.

 

Loan Type

   Outstanding
Face Amount
   Carrying
Value
   Loan
Count
   Wtd. Avg.
Yield
    Weighted
Average
Maturity
(Years) (A)
   Floating Rate
Loans as a %
of Face
Amount
    Delinquent Face
Amount (B)

Mezzanine Loans

   $ 756,427    $ 313,364    23    49.64 %   2.8    86.9 %   $ 39,975

Corporate Bank Loans

     498,543      208,055    14    19.12 %   2.2    100.0 %     49,239

B-Notes

     309,901      108,328    11    36.00 %   2.2    84.3 %     50,000

Whole Loans

     100,538      68,522    4    28.57 %   2.2    97.5 %     —  
                                          

Total Real Estate Related Loans Held for Sale

   $ 1,665,409    $ 698,269    52    36.36 %   2.5    91.0 %   $ 139,214
                                          

Residential Loans

   $ 75,720    $ 53,014    258    6.64 %   5.4    100.0 %   $ 6,363

Manufactured Housing Loans

     457,491      338,839    13,477    15.37 %   7.1    10.7 %     6,019
                                          

Total Residential Mortgage Loans Held for Sale (C)

   $ 533,211    $ 391,853    13,735    14.16 %   6.8    23.4 %   $ 12,382
                                          

Subprime Mortgage Loans Subject to Call Option

   $ 406,217    $ 399,288             
                          

 

(A) The weighted average maturities were calculated based on constant prepayment rates (CPR) of 10% and 30% for the residential loan pools, and 6% and 8% for the manufactured housing loan pools.
(B) Includes loans that are non-performing, in foreclosure, considered real estate owned and real estate related loans under bankruptcy filing.
(C) Carrying value includes interest receivable of $0.3 million for the residential housing loans and principal and interest receivable of $10.9 million for the manufactured housing loans.

The following is a reconciliation of the related loss allowance.

 

     Real Estate
Related Loans
    Residential
Mortgage Loans
 

Balance at December 31, 2008

   $ (827,328 )   $ (136,206 )

Provision for credit losses

     —         (1,907 )

Provision for impaired loans

     (117,722 )     (2,804 )

Realized losses

     22,769       1,907  
                

Balance at March 31, 2009

   $ (922,281 )   $ (139,010 )
                

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

Securitization of Subprime Mortgage Loans

The following table presents information on the retained interests in Newcastle’s securitizations of subprime mortgage loans and the sensitivity of their fair value for immediate 10% and 20% adverse changes in the assumptions utilized in calculating such fair value, at March 31, 2009:

 

     Subprime Portfolio  
     I     II  

Total securitized loans (unpaid principal balance) (A)

   $ 684,410     $ 896,362  

Loans subject to call option (carrying value)

   $ 295,964     $ 103,324  

Retained interests (fair value) (B)

   $ 3,079     $ 3,304  

Weighted average life (years) of residual interest

     —         0.6  

Weighted average expected credit losses (C)

     19.9 %     38.1 %

Effect on fair value of retained interests of 10% adverse change

   $ (389 )   $ (421 )

Effect on fair value of retained interests of 20% adverse change

   $ (658 )   $ (681 )

Weighted average constant prepayment rate (D)

     9.2 %     5.5 %

Effect on fair value of retained interests of 10% adverse change

   $ (95 )   $ (117 )

Effect on fair value of retained interests of 20% adverse change

   $ (174 )   $ (186 )

Weighted average discount rate

     19.6 %     23.1 %

Effect on fair value of retained interests of 10% adverse change

   $ (168 )   $ (65 )

Effect on fair value of retained interests of 20% adverse change

   $ (313 )   $ (129 )

 

(A) Average loan seasoning of 43 months and 26 months for Subprime Portfolios I and II, respectively, at March 31, 2009.
(B) The retained interests include residual interests and retained bonds of the securitizations. Their fair value is estimated based on pricing models.
(C) Represents the percentage of losses on the original principal balance of the loans from the date of the respective securitizations (April 2006 and July 2007) to the maturity of the loans.
(D) Represents the weighted average voluntary prepayment rate for the loans from the date of the respective securitizations (April 2006 and July 2007) to the maturity of the 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 certain characteristics of the underlying subprime mortgage loans, and related financing, in the securitizations as of March 31, 2009:

 

     Subprime Portfolio  
     I     II  

Loan unpaid principal balance (UPB)

   $ 684,410     $ 896,362  

Weighted average coupon rate of loans

     7.57 %     7.48 %

Delinquencies of 60 or more days (UPB) (A)

   $ 153,656     $ 236,627  

Net credit losses for the three months ended March 31, 2009

   $ 21,988     $ 12,905  

Cumulative net credit losses

   $ 66,832     $ 32,869  

Cumulative net credit losses as a % of original UPB

     4.45 %     3.02 %

Percentage of ARM loans (B)

     56.7 %     68.5 %

Percentage of loans with loan-to-value ratio >90%

     10.5 %     17.4 %

Percentage of interest-only loans

     25.8 %     4.6 %

Face amount of debt (C)

   $ 624,215     $ 802,131  

Weighted average funding cost of debt (D)

     1.91 %     3.76 %

 

(A) Delinquencies include loans 60 or more days past due, in foreclosure, or real estate owned.
(B) ARM loans are adjustable-rate mortgage loans. An option ARM is an adjustable-rate mortgage that provides the borrower with an option to choose from several payment amounts each month for a specified period of the loan term. None of the loans in the subprime portfolios are an option ARM.
(C) Excludes face amount of $41.6 million and $38.8 million of retained notes for Subprime Portfolios I and II, respectively, at March 31, 2009.
(D) Includes the effect of applicable hedges.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

Newcastle received net cash inflows of $0.3 million and $0.4 million from the retained interests of Subprime Portfolios I and II, respectively, during the three months ended March 31, 2009.

The weighted average yields of the retained notes of Subprime Portfolios I and II were 20.0% and 20.0%, respectively, as of March 31, 2009. The loans subject to call option and the corresponding financing recognize interest income and expense based on the expected weighted average coupons of the loans subject to call option at the call date of 9.24% and 8.68%, for Subprime Portfolios I and II, respectively.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

5. DEBT OBLIGATIONS

The following table presents certain information regarding Newcastle’s debt obligations and related hedges at March 31, 2009:

 

Debt Obligation/Collateral

  Month
Issued
    Outstanding
Face
Amount
  Carrying
Value
  Unhedged
Weighted
Average
Funding Cost (A)
  Final Stated
Maturity
  Weighted
Average
Funding
Cost (B)
  Weighted
Average
Maturity
(Years)
  Face
Amount
of Floating
Rate

Debt
  Collateral
Amortized
Cost Basis (C)
  Collateral
Carrying
Value (C)
  Collateral
Weighted
Average
Maturity
(Years)
  Face
Amount of
Floating Rate
Collateral (C)
  Aggregate
Notional
Amount of
Current
Hedges

CDO Bonds Payable

                         

CDO IV

  Mar 2004     $ 404,835   $ 403,033   2.01%   Mar 2039   3.26%   3.5   $ 381,750   $ 202,741   $ 212,029   4.1   $ 180,957   $ 177,300

CDO V

  Sep 2004       454,500     452,302   1.85%   Sep 2039   3.35%   4.0     442,500     198,677     219,587   4.4     218,061     208,639

CDO VI

  Apr 2005       444,227     442,330   1.00%   Apr 2040   3.37%   4.6     436,790     163,710     173,673   5.3     182,786     242,125

CDO VII

  Dec 2005       418,262     415,551   0.99%   Dec 2050   4.19%   6.4     412,080     114,016     119,928   6.3     108,945     298,355

CDO VIII

  Nov 2006       792,500     791,500   1.21%   Nov 2052   2.13%   4.7     784,900     331,276     340,100   4.0     574,968     161,655

CDO IX

  May 2007       585,750     586,608   1.09%   May 2052   1.78%   5.8     585,750     371,945     389,360   2.8     626,344     91,875

CDO X

  Jul 2007       1,237,750     1,236,872   0.65%   Jul 2052   4.45%   5.9     1,237,750     575,992     622,246   4.4     297,863     957,087
                                                           
      4,337,824     4,328,196       3.30%   5.2     4,281,520     1,958,357     2,076,923   4.4     2,189,924     2,137,036
                                                           

Other Bonds Payable

                         

Manufactured housing
loans (D)

  Jan 2006       124,121     124,121   LIBOR+0.75%   Jan 2009 (D)   4.96%   —       124,121     125,027     125,027   8.1     2,691     —  

Manufactured housing loans (E)

  Aug 2006       218,123     216,902   LIBOR+1.05%   Aug 2011   6.43%   2.0     218,123     213,812     213,812   6.4     46,379     —  
                                                           
      342,244     341,023       5.89%   1.3     342,244     338,839     338,839   7.1     49,070     —  
                                                           

Repurchase Agreements (F)

                         

Real estate related loans

  Mar 2009       78,514     78,514   LIBOR+1.63%   Various   2.13%   0.8     78,514     96,402     96,402   1.4     227,665     —  

Other real estate securities

  Dec 2008       4,582     4,582   LIBOR+2.50%   Various   3.00%   0.9     4,582     —       —     —       —       —  
                                                           
      83,096     83,096       2.18%   0.8     83,096     96,402     96,402   1.4     227,665     —  

FNMA/FHLMC securities

  Rolling       47,802     47,802   LIBOR+0.19%   Apr 2009   4.95%   0.1     47,802     50,800     51,864   2.7     —       43,217
                                                           
      130,898     130,898       3.19%   0.5     130,898     147,202     148,266   1.7     227,665     43,217
                                                           

Corporate

                         

Junior subordinated notes payable (G)

  Mar 2006       100,100     100,100   7.57%(G)   Apr 2036   7.71%   27.0     —       —       —     —       —       —  
                                                           
      100,100     100,100       7.71%   27.0     —       —       —     —       —       —  
                                                           

Subtotal debt obligations

      4,911,066     4,900,217       3.57%   5.2   $ 4,754,662   $ 2,444,398   $ 2,564,028   4.4   $ 2,466,659   $ 2,180,253
                                                           

Financing on subprime mortgage loans subject to call option

  (H )     406,217     399,288                    
                                 

Total debt obligations

    $ 5,317,283   $ 5,299,505                    
                                 

 

(A) Weighted average, including floating and fixed rate classes and excluding the amortization of deferred financing costs.
(B) Including the effect of applicable hedges.
(C) Including restricted cash held for reinvestments in CDOs.
(D) See below.
(E) Of which $20.0 million face amount is recourse financing.
(F) The counterparties on these repurchase agreements include: Goldman Sachs ($47.8 million of FNMA/FHLMC financing), Deutsche Bank ($38.5 million), Credit Suisse ($16.6 million) and Citigroup ($28.0 million). The non-FNMA/FHLMC financings are subject to scheduled repayments, with the final payment to be made in June 2010.
(G) In April 2009, Newcastle entered into an exchange agreement with the holder of the trust preferred securities under which Newcastle will effectively be accruing interest at a rate of 1.0% per annum beginning February 1, 2009 for a maximum of six quarters, after which the rate reverts to 7.574% through April 2016 and at LIBOR + 2.25% after April 2016. For details, see Note 9 below.
(H) Issued in April 2006 and July 2007. See Note 4 regarding the securitizations of Subprime Portfolios I and II.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

In the first quarter of 2009, Newcastle repurchased $30.3 million face amount of three classes of CDO bonds for $3.2 million. As a result, Newcastle extinguished $30.3 million face amount of CDO debt and recorded a gain on extinguishment of debt of $26.9 million in the first quarter of 2009.

In January 2009, the $124.1 million (at March 31, 2009) debt for one of Newcastle’s manufactured housing loan portfolios became callable at the option of the lender. The principal and interest payments from the underlying loans, net of expenses and payments related to interest rate swap contracts, are used to repay the outstanding debt on a monthly basis.

In February 2009, Newcastle renegotiated the terms of a recourse loan agreement financing one of its manufactured housing loan portfolios. Under the amended terms of the agreement, certain debt covenants relating to equity requirements were removed.

In February 2009, Newcastle renegotiated the terms of a repurchase agreement financing its investment in a real estate related loan. Under the amended terms of the repurchase agreement, certain debt covenants relating to a concentration limit and equity requirements, as well as the mark-to-market (margin) requirement were removed.

In March 2009, Newcastle renegotiated the terms of a repurchase agreement financing its investment in a real estate related loan. Under the amended terms of the repurchase agreement, the mark-to-market (margin) provisions and certain financial covenants relating to net worth and leverage ratio were removed. Newcastle also agreed not to enter into any new debt financings subject to margin calls other than to finance FNMA/FHLMC securities.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair Value Summary Table

Newcastle held the following financial instruments at March 31, 2009:

 

    Principal
Balance or
Notional
Amount
  Carrying
Value
  Fair Value   

Fair Value Method (A)

  Weighted
Average
Yield/Funding
Cost
    Weighted
Average
Maturity
(Years)

Assets:

            

Real estate securities, available for sale*

  $ 3,677,725   $ 1,453,341   $ 1,453,341    Broker quotations, counterparty quotations, pricing services, pricing models   28.64 %   4.8

Real estate related loans held for sale

    1,665,409     698,269     698,269    Broker quotations, counterparty quotations, pricing services, pricing models   30.39 %   2.5

Residential mortgage loans held for sale

    533,211     391,853     391,853    Pricing models   14.16 %   6.9

Subprime mortgage loans subject to call option (B)

    406,217     399,288     399,288    (B)   9.09 %   (B)

Liabilities:

            

CDO bonds payable

    4,337,824     4,328,196     826,795    Counterparty quotations, pricing models   3.30 %   6.2

Other bonds payable

    342,244     341,023     296,627    Pricing models   5.89 %   1.3

Repurchase agreements

    130,898     130,898     130,898    Market comparables   3.19 %   0.5

Financing of subprime mortgage loans subject to call option (B)

    406,217     399,288     399,288    (B)   9.09 %   (B)

Junior subordinated notes payable

    100,100     100,100     20,976    Pricing models   7.71 %   2.7

Interest rate swaps, treated as
hedges (C)(E)*

    2,180,253     273,901     273,901    Counterparty quotations   N/A     (C)

Non-hedge derivatives (D)(E)*

    274,635     35,045     35,045    Counterparty quotations   N/A     (D)

 

* Measured at fair value on a recurring basis.
(A) Based on order of priority. In the case of real estate securities and real estate related loans, broker quotations are obtained if available and practicable, otherwise counterparty quotations or pricing service valuations are obtained or, finally, internal pricing models are used. Internal pricing models are only used for (i) securities and loans which are not traded in an active market, and therefore have little or no price transparency, and for which significant unobservable inputs must be used in estimating fair value, or (ii) loans or debt obligations which are private and untraded.
(B) These two items results from an option, not an obligation, to repurchase loans from Newcastle’s subprime mortgage loan securitizations (Note 4), are noneconomic until such option is exercised, and are equal and offsetting.
(C) Represents current swap agreements as follows:

 

Maturing In

  

Weighted Average Month of
Maturity

   Aggregate Notional
Amount
   Weighted Average
Fixed Pay Rate
    Aggregate
Fair Value
 

Agreements which receive 1-Month LIBOR:

          

2011

   December    $ 113,011    5.004 %   $ (10,412 )

2012

   July      22,081    5.388 %     (2,087 )

2014

   October      16,912    5.095 %     (2,394 )

2015

   September      1,288,121    5.256 %     (163,771 )

2016

   May      180,155    5.043 %     (26,662 )

2017

   August      174,034    5.235 %     (34,528 )

Agreements which receive 3-Month LIBOR:

          

2011

   February      32,000    5.078 %     (2,225 )

2014

   June      353,939    4.196 %     (31,822 )
                    
      $ 2,180,253      $ (273,901 )
                    

 

(D) These include two interest rate swaps with a total notional balance of $274.6 million. The maturity dates of the $106.8 million and $167.9 million interest rate swaps are January 2016 and June 2016, respectively. Newcastle entered into these swap agreements to reduce its exposure to interest rate changes on the floating rate financings of its manufactured housing loan portfolios. These swaps were dedesignated as hedges for hedge accounting purposes.
(E) Newcastle’s derivatives fall into two categories. Derivatives held within Newcastle’s nonrecourse debt structures (primarily CDOs) with an aggregate notional balance of $2.4 billion, all of which were liabilities at period end, are not subject to Newcastle’s credit risk as they are senior to all the debt obligations of the related structure. Derivatives held outside Newcastle’s nonrecourse debt structures with an aggregate notional balance of $75.2 million are primarily 100% collateralized by margin (based on their current fair value) and therefore are not subject to Newcastle’s or its counterparty’s credit risk. As a result, no adjustments have been made to the fair value quotations received related to credit risk. Newcastle’s significant derivative counterparties include Bank of America, Deutsche Bank, Wachovia and Credit Suisse.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

Securities Valuation

As of March 31, 2009, Newcastle’s securities valuation methodology and results are further detailed as follows:

 

               Fair Value

Asset Type

   Outstanding
Face
Amount (A)
   Amortized
Cost
Basis (B)
   Multiple
Quotes (C)
   Single
Quote (D)
   Internal
Pricing
Models (E)
   Total

CMBS

   $ 2,266,503    $ 707,134    $ 480,317    $ 167,086    $ 152,954    $ 800,357

ABS – subprime

     549,521      140,145      34,332      29,769      80,693      144,794

Subprime retained

     80,380      5,448      —        —        5,448      5,448

Subprime residuals

     935      935      —        —        935      935

ABS – other real estate

     98,292      46,629      13,111      22,131      12,889      48,131

FNMA / FHLMC

     49,127      50,801      —        51,865      —        51,865

REIT debt

     632,967      382,351      269,225      132,586      —        401,811
                                         

Total

   $ 3,677,725    $ 1,333,443    $ 796,985    $ 403,437    $ 252,919    $ 1,453,341
                                         

 

(A) Net of incurred losses.
(B) Net of discounts (or gross premiums) and after other-than-temporary impairment, including impairment taken during the period ended March 31,2009.
(C) Management generally obtained broker quotations from two sources, one of which was generally the seller (the party that sold us the security). Management selected one of the quotes received as being most representative of fair value and did not use an average of the quotes. Newcastle’s methodology is to not use quotes from selling brokers, unless those quotes are the only marks available, or unless the quotes provided by other (non-selling) brokers are, in management’s judgment, not representative of fair value. Even if Newcastle receives two or more quotes on a particular security that come from non-selling brokers, it does not use an average because management believes using an actual quote more closely represents a transactable price for the security than an average level. Furthermore, in some cases there is a wide disparity between the quotes Newcastle receives. Management believes using an average of the quotes in these cases would generally not represent the fair value of the asset. Based on Newcastle’s own fair value analysis using internal models, management selects one of the quotes which is believed to more accurately reflect fair value. Newcastle never adjusts quotes received.
(D) Management was unable to obtain quotations from more than one source on these securities. The one source was generally the seller (the party that sold us the security).
(E) Securities whose fair value was estimated based on internal pricing models are further detailed as follows:

 

     Amortized
Cost
Basis
   Fair Value    Impairment
Recorded
In Current
Year
   Unrealized
Gains (Losses)
in Accumulated
OCI
   Assumption Ranges
               Discount
Rate
  Prepayment
Speed (F)
  Cumulative
Default
Rate
  Loss
Severity
                    
                    

CMBS

   $ 134,553    $ 152,954    $ 24,577    $ 18,401    15% - 56%   N/A   0% - 100%   0% - 100%

ABS – subprime

     76,097      80,693      26,968      4,596    20%   3% - 11%   26% - 84%   45% - 90%

Subprime retained

     5,448      5,448      944      —      20%   5%   62% - 69%   55% - 62%

Subprime residuals

     935      935      119      —      30%   5%   69%   62%

ABS – other RE

     12,506      12,889      3,163      383    20%   2%   61%   59%
                                    

Total

   $ 229,539    $ 252,919    $ 55,771    $ 23,380         
                                    

All of the assumptions listed have some degree of market observablity, based on Newcastle’s knowledge of the market, relationships with market participants, and use of common market data sources. Collateral prepayment, default and loss severity projections are in the form of “curves” or “vectors” that vary for each monthly collateral cash flow projection. Methods used to develop these projections vary by asset class (e.g., CMBS projections are developed differently than Home Equity ABS projections) but conform to industry conventions. We use assumptions that generate our best estimate of future cash flows of each respective security.

The prepayment vector specifies the percentage of the collateral balance that is expected to voluntarily pay off at each point in the future. The prepayment vector is based on projections from the a widely published investment bank model which considers factors such as collateral FICO score, loan-to-value ratio, debt-to-income ratio, and vintage on a loan level basis. This vector is scaled up or down to match recent collateral-specific prepayment experience, as obtained from remittance reports and market data services.

Loss severities are based on recent collateral-specific experience with additional consideration given to collateral characteristics. Collateral age is taken into consideration because severities tend to initially increase with collateral age before eventually stabilizing. We typically use projected severities that are higher than the historic experience for collateral that is relatively new (e.g., 2007 vintage origination) to account for this effect. Collateral characteristics such as loan size, lien position, and location (state) also effect loss severity. We consider whether a collateral pool has experienced a significant change in its composition with respect to these factors when assigning severity projections.

Default vectors are determined from the current “pipeline” of loans that are more than 90 days delinquent, in foreclosure, or are real estate owned (REO). These seriously delinquent loans determine the first 24 months of the default vector. Beyond month 24, the default vector transitions to a steady-state value that is generally equal to or greater than that given by the widely published investment bank model.

The discount rates we use are derived from a range of observable pricing on securities backed by similar collateral and offered in a live market. As the markets in which we transact have become less liquid, we have had to rely on fewer data points in this analysis.

 

(F) Lifetime average constant prepayment rate.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

Valuation Hierarchy

Pursuant to SFAS 157, the methodologies used for valuing such instruments have been categorized into three broad levels which form a hierarchy. Newcastle follows this hierarchy for its financial instruments measured at fair value on a recurring basis. The classifications are based on the lowest level of input that is significant to the fair value measurement.

The following table summarizes such financial assets and liabilities at March 31, 2009:

 

               Fair Value
     Principal Balance
or Notional
Amount
   Carrying Value    Level 2    Level 3A    Level 3B    Total

Assets:

                 

Real estate securities, available for sale:

                 

CMBS

   $ 2,266,503    $ 800,357    $ —      $ 647,403    $ 152,954    $ 800,357

ABS – subprime

     549,521      144,794      —        64,101      80,693      144,794

Subprime retained

     80,380      5,448      —        —        5,448      5,448

Subprime residuals

     935      935      —        —        935      935

ABS – other real estate

     98,292      48,131      —        35,242      12,889      48,131

FNMA / FHLMC

     49,127      51,865      51,865      —        —        51,865

REIT debt

     632,967      401,811      —        401,811      —        401,811
                                         
     3,677,725      1,453,341      51,865      1,148,557      252,919      1,453,341
                                         

Liabilities:

                 

Interest rate swaps, treated as hedges

     2,180,253      273,901      273,901      —        —        273,901

Non-hedge derivatives

     274,635      35,045      35,045      —        —        35,045

Newcastle’s investments in instruments measured at fair value using Level 3 inputs changed during the three months ended March 31, 2009 as follows:

 

     Level 3A     Level 3B     Total  

Assets

      

Balance at December 31, 2008

   $ 1,304,776     $ 179,763     $ 1,484,539  

Total gains (losses)

      

Included in net income (loss) (A)

     (143,011 )     (56,023 )     (199,034 )

Included in other comprehensive income (loss)

     93,730       21,039       114,769  

Amortization included in interest income

     39,000       13,360       52,360  

Settlements or repayments

     (34,074 )     (17,084 )     (51,158 )

Transfers between Level 3A and Level 3B

     (111,864 )     111,864       —    

Transfers into Level 3 (B)

     —         —         —    

Transfers out of Level 3 (B)

     —         —         —    
                        

Balance at March 31, 2009

   $ 1,148,557     $ 252,919     $ 1,401,476  
                        

 

(A) These gains (losses) are recorded in the following line items in the consolidated statement of operations:

 

     Three Months Ended
March 31, 2009
 

Gain (loss) on settlement of investments, net

   $ (12,452 )

Other income (loss), net

     —    

Other-than-temporary impairment

     (186,582 )
        

Total

   $ (199,034 )
        

Other-than-temporary impairment recorded in earnings during the three months ended March 31, 2009 is attributable to the change in unrealized losses relating to Level 3 assets still held at March 31, 2009.

 

Gain (loss) on settlement of investments, net, from investments transferred into Level 3 during the period

   $  —  

 

(B) Transfers are assumed to occur at the beginning of the quarter.

During the three months ended March 31, 2009, Newcastle recorded $117.7 million and $2.8 million of impairment on real estate related loans and residential mortgage loans (Note 4), respectively. These loans were written down to fair value at the time of the impairment, based on broker quotations, pricing service quotations or internal pricing models. All the loans were within Level 3 of the fair value hierarchy.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

Derivatives

SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” establishes the accounting and reporting standards for derivative instruments and SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” amends and expands the disclosure requirements of SFAS 133. The disclosure below provides information relating to Newcastle’s uses and reporting of derivative instruments, as well as enhanced qualitative and quantitative disclosures pursuant to these accounting standards.

Newcastle is exposed to certain risks relating to its ongoing business operations. The primary risk managed by Newcastle using derivative instruments is interest rate risk. Newcastle enters into interest rate swap and interest rate cap agreements to reduce the impact of fluctuating interest rates on its earnings. Pursuant to SFAS 133, Newcastle designates certain interest rate swap agreements as cash flow hedges of its floating rate financings.

Newcastle’s derivatives are recorded on its balance sheet as follows:

 

          Fair Value
     Balance sheet location    March 31,
2009
   December 31,
2008

Interest rate swaps, designated as hedging instruments under SFAS 133

   Derivative liabilities    $ 272,184    $ 315,651

Interest (receivable) payable

   Derivative liabilities      1,717      2,394

Interest rate swaps, not designated as hedging instruments under SFAS 133

   Derivative liabilities      35,045      15,932
                
      $ 308,946    $ 333,977
                

The following table summarizes financial information related to derivatives:

 

     March 31,
2009
    December 31,
2008
 

Cash flow hedges

    

Notional amount of interest rate swap agreements

   $ 2,180,253     $ 2,376,420  

Amount of (loss) recognized in OCI on effective portion

     (269,172 )     (312,431 )

Deferred hedge gain (loss) related to anticipated financings, which have subsequently occurred, net of amortization

     908       932  

Deferred hedge gain (loss) related to dedesignation, net of amortization

     (12,126 )     (2,825 )

Expected reclassification of deferred hedges from AOCI into earnings over the next 12 months

     (4,084 )     1,149  

Expected reclassification of current hedges from AOCI into earnings over the next 12 months

     (14,592 )     (19,570 )

Non-hedge Derivatives

    

Notional amount of interest rate swap agreements

     274,635       182,867  

The following table summarizes gains (losses) recorded in relation to derivatives (excluding total rate of return swaps, which are reported separately):

 

    

Income Statement Location of Gain

(Loss) Reclassification from AOCI

   Three Months Ended March 31,  
      2009     2008  

Cash flow hedges

       

Gain (loss) on the ineffective portion

   Other income (loss)    $ (828 )   $ 208  

Gain (loss) immediately recognized at dedesignation

   Other income (loss)      (8,797 )     (445 )

Deferred hedge gain reclassified from AOCI into income, related to anticipated financings

   Interest expense      25       23  

Deferred hedge gain (loss) reclassified from AOCI into income, related to effective portion of dedesignated hedges

   Interest expense      (5,466 )     282  

Non-hedge derivatives gain (loss)

   Other income (loss)      3,116       (8,404 )

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2009

(dollars in tables in thousands, except share data)

 

 

7. EARNINGS PER SHARE

Newcastle is required to present both basic and diluted earnings per share (“EPS”). Basic EPS is calculated by dividing net income available for common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted EPS is calculated by dividing net income available for common stockholders by the weighted average number of shares of common stock outstanding plus the additional dilutive effect of common stock equivalents during each period. Newcastle’s common stock equivalents are its outstanding stock options. During the three months ended March 31, 2009 and 2008, Newcastle had no dilutive common stock equivalents. Net loss applicable to common stockholders is equal to net loss less preferred dividends.

As of March 31, 2009, Newcastle’s outstanding options were summarized as follows:

 

Held by the Manager

   1,612,772

Issued to the Manager and subsequently transferred to certain of the Manager’s employees

   871,837

Held by the independent directors and former directors

   14,000
    

Total

   2,498,609
    

8. COMMITMENTS AND CONTINGENCIES

Loan Commitment— With respect to a commercial construction loan, Newcastle was committed to fund up to an additional $52.7 million at March 31, 2009 subject to certain conditions to be met by the borrowers, of which $13.2 million is to be funded by one of Newcastle’s CDOs.

Litigation—Newcastle is, from time to time, a defendant in legal actions from transactions conducted in the ordinary course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such actions which existed at March 31, 2009, if any, will not materially affect Newcastle’s consolidated results of operations or financial position.

Preferred Dividends in Arrears — As of March 31, 2009, $5.6 million of dividends on Newcastle’s cumulative preferred stock were unpaid and in arrears.

Contingent Gain in CDOs — Newcastle has recorded $2.4 billion of losses in its CDOs in excess of its economic exposure which must eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or termination of the CDOs.

Contingent Gain in Other Non-Recourse Financing — Newcastle has recorded $20.5 million of losses in its manufactured housing loan portfolios in excess of its economic exposure which must eventually be reversed through amortization, sales at gains, or as gains at the extinguishment of debt.

9. RECENT ACTIVITIES

These financial statements include a discussion of material events which have occurred subsequent to March 31, 2009 (referred to as “subsequent events”) through May 6, 2009. Events subsequent to that date have not been considered in these financial statements.

In April 2009, Newcastle repurchased $29.5 million face amount of two classes of CDO bonds for $2.4 million. As a result, Newcastle extinguished $29.5 million face amount of CDO debt and recorded a gain on extinguishment of debt of $26.9 million in the second quarter of 2009.

On April 30, 2009, Newcastle entered into an exchange agreement with several collateralized debt obligations managed by a third party pursuant to which Newcastle agreed to exchange newly issued junior subordinated notes due in 2035 with an initial aggregate principal amount of $101.7 million (the “Notes”) for $100 million in aggregate liquidation amount of trust preferred securities that were previously issued by a subsidiary of Newcastle (the “TRUPs”) and were owned by the third party. The Notes accrue interest at a rate of 1.0% per year for a maximum of six quarters, beginning on February 1, 2009. Subsequent to that period, the rate reverts to that which Newcastle was required to pay on the TRUPs (7.574% through April 2016 and at a floating rate of 3-month LIBOR plus 2.25% thereafter). In conjunction with the exchange, the TRUPs were cancelled and Newcastle pledged 100% of its equity interests in NIC TP LLC, a special purpose subsidiary that holds Newcastle’s participation in a loan and related deposit account, which were valued at $3.5 million on March 31, 2009, as collateral. The pledged collateral will be released at the end of the interest rate modification period.

 

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

The following should be read in conjunction with the unaudited consolidated financial statements and notes included herein.

GENERAL

Newcastle Investment Corp. is a real estate investment and finance company. We invest in, and actively manage, a portfolio of real estate securities, loans and other real estate related assets. Our objective is to maximize the difference between the yield on our investments and the cost of financing these investments while hedging our interest rate risk. We emphasize portfolio management, asset quality, diversification, match funded financing and credit risk management.

We currently own a diversified portfolio of credit sensitive real estate debt investments, including securities and loans. Our portfolio of real estate securities includes commercial mortgage backed securities (CMBS), senior unsecured debt issued by property REITs, real estate related asset backed securities (ABS), and FNMA/FHLMC securities. Mortgage backed securities are interests in or obligations secured by pools of mortgage loans. We generally target investments rated A through BB, except for our FNMA/FHLMC securities which have an implied AAA rating. We also own, directly and indirectly, interests in loans and pools of loans, including real estate related loans, commercial mortgage loans, residential mortgage loans, manufactured housing loans, and subprime mortgage loans.

We employ leverage as part of our investment strategy. We do not have a predetermined target debt to equity ratio as we believe the appropriate leverage for the particular assets we are financing depends on the credit quality of those assets. As a result of our negative GAAP equity, our GAAP debt to equity ratio is not a meaningful measure as of March 31, 2009. Our general investment guidelines adopted by our board of directors limit total leverage (as defined under the governing documents) to a maximum 9.0 to 1 debt to equity ratio. As of March 31, 2009, our debt to equity ratio, as computed under this method, was approximately 4.6 to 1.0.

We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential fluctuations in the availability of capital. We utilize multiple forms of financing including collateralized debt obligations (CDOs), other securitizations, term loans, and trust preferred securities, as well as short term financing in the form of loans and repurchase agreements. As we discuss in more detail under “–Market Considerations” below, the ongoing credit and liquidity crisis has limited the array of capital resources available to us and made the terms of capital resources we are able to obtain generally less favorable to us relative to the terms we were able to obtain prior to the crisis. For example, we are currently contractually restricted from entering into new debt financings subject to margin calls other than to finance FNMA/FHLMC securities.

We seek to match fund our investments with respect to interest rates and maturities in order to reduce the impact of interest rate fluctuations on earnings and reduce the risk of refinancing our liabilities prior to the maturity of the investments. We seek to finance a substantial portion of our real estate securities and loans through the issuance of term debt, which generally represents obligations issued in multiple classes secured by an underlying portfolio of assets. Specifically, our CDO financings offer us the structural flexibility to buy and sell certain investments to manage risk and, subject to certain limitations, to optimize returns.

We conduct our business through four primary segments: (i) investments financed with non-recourse collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments financed with recourse debt, including FNMA / FHLMC securities, and (iv) unlevered investments. In the second quarter of 2008, Newcastle changed the structure of its internal organization such that the basis of the composition of its reportable segments changed from investment type to financing type. Revenues attributable to each segment are disclosed below (in thousands).

 

For the Three Months

Ended March 31,

   CDOs    Other
Non-Recourse
   Recourse    Unlevered    Unallocated    Total

2009

   $ 100,763    $ 20,342    $ 2,518    $ 829    $ 21    $ 124,473

2008

   $ 84,199    $ 24,255    $ 16,410    $ 7,494    $ 536    $ 132,894

 

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Market Considerations

Financial Institutions

Many market participants have become increasingly uncertain about the health of a number of financial institutions and the financial system in general. Continuing write-downs and capital related issues affecting financial market participants have contributed to the recent wave of significant events affecting financial institutions, including the insolvency of Lehman Brothers, the government’s placing Fannie Mae, Freddie Mac and AIG under its supervision, the announced distressed sales of all or portions of Bear Stearns, Merrill Lynch, Wachovia and Washington Mutual and the government’s increasing its equity investment in Citigroup. Although the United States and other governments have taken a number of significant steps to improve market conditions and the strength of major financial institutions, such efforts to date have not brought stability or liquidity to the capital markets, and we cannot predict the future conditions of these markets or the impact of such condition on our business.

The consolidation or elimination of Lehman Brothers, Bear Stearns and several other counterparties has increased our concentration of counterparty risk, decreased the universe of potential counterparties and reduced our ability to obtain competitive financing rates and terms. For a more detailed discussion of our counterparty default and concentration risk, see Part I, Item 1A, “Risk Factors – Risks Related to the Financial Services Industry and Financial Markets – We are subject to counterparty default and concentration risk.”

Financial Markets in which We Operate

Our ability to generate income is dependent on our ability to invest our capital on a timely basis at attractive levels. The two primary market factors that affect this ability are (1) credit spreads and (2) the availability of financing on favorable terms.

Generally speaking, widening credit spreads reduce any unrealized gains on our current investments (or cause or increase unrealized losses) and increase our costs for new financings, but increase the yields available on potential new investments, while tightening credit spreads increase the unrealized gains (or reduce unrealized losses) on our current investments and reduce our costs for new financings, but reduce the yields available on potential new investments. By reducing unrealized gains (or causing unrealized losses), widening credit spreads also impact our ability to realize gains on existing investments if we were to sell such assets.

During the first three months of 2009, credit spreads again widened substantially. This widening of credit spreads caused the net unrealized losses on our securities to increase. One of the key drivers of the widening of credit spreads has been the continued disruption and liquidity concerns throughout the credit markets. The severity and scope of the disruption intensified meaningfully during the fourth quarter of 2008 and first quarter of 2009 and caused credit spreads to widen further during this period.

Liquidity

The ongoing credit and liquidity crisis has adversely affected us and the market in which we operate in a number of other ways. For example, it has reduced the market trading activity for many real estate securities and loans, resulting in less liquid markets for those securities and loans. As the securities held by us and many other companies in our industry are marked to market at the end of each quarter, the decreased liquidity and concern over market conditions have resulted in significant reductions in mark to market valuations of many real estate securities and loans and the collateral underlying them. These lower valuations, and decreased expectations of future cash flows, have affected us by, among other things:

 

   

decreasing our net book value;

 

   

contributing to our decision to record significant impairment charges;

 

   

prompting us to negotiate the removal of certain financial covenants from our non-CDO financings;

 

   

reducing the amount, which we refer to as cushion, by which we satisfy the over collateralization tests of our CDOs (sometimes referred to as CDO “triggers”) or contributing to several of our CDOs failing their over collateralization tests (see “– Liquidity and Capital Resources” and “– Debt Obligations” below); and

 

   

requiring us to pay additional amounts under certain financing arrangements.

In some cases, we have sold, and may continue to sell, assets at prices below what we believed to be their value in order to meet liquidity requirements under certain financing arrangements. Failed CDO triggers, impairments resulting from incurred losses, and asset sales at prices significantly below face amount, while the related debt is being repaid at its full face amount, further contribute to reductions in future earnings, cash flow and liquidity. As a result, we expect that our future cash flow from operations will be significantly reduced relative to previous years.

In order to maintain liquidity, we have elected to retain the majority of our investment proceeds (including those from asset sales) in lieu of using those proceeds to make new investments, or to buy back stock or debt, and elected not to declare any common or preferred dividends during the fourth quarter of 2008 or the first quarter of 2009. This approach has increased our liquidity while reducing our operating earnings. We may elect to adjust or not to pay any future dividend payments to reflect our current and expected cash from operations or to satisfy future liquidity needs.

 

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Extent of Market Disruption

We do not currently know the full extent to which this market disruption will affect us or the markets in which we operate, and we are unable to predict its length or ultimate severity. If the disruption continues, we will likely experience further tightening of liquidity, additional impairment charges, challenges in complying with the terms of our financing agreements, increased margin requirements, and additional challenges in raising capital and obtaining investment financing on attractive terms. If we raised capital or issued unsecured debt in the current market, it would be significantly dilutive to our current shareholders.

Future cash flows and our liquidity may be materially impacted if conditions do not improve. Should the current conditions worsen, or persist for an extended period of time, our available capital could be reduced upon the expiration or termination of our capital resources, including through defaults under debt covenants. This could ultimately threaten our ability to continue as a going concern.

Certain aspects of these effects are more fully described in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate, Credit and Spread Risk” and “– Liquidity and Capital Resources” as well as in Part I, Item 3, “Quantitative and Qualitative Disclosures About Market Risk.”

APPLICATION OF CRITICAL ACCOUNTING POLICIES

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

Variable Interest Entities

Financial Accounting Standards Board Interpretation (“FIN”) No. 46R “Consolidation of Variable Interest Entities” clarified the methodology for determining whether an entity is a variable interest entity (“VIE”) and the methodology for assessing who is the primary beneficiary of a VIE. VIEs are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, and only by its primary beneficiary, which is defined as the party who will absorb a majority of the VIE’s expected losses or receive a majority of the expected residual returns as a result of holding variable interests.

The VIEs in which we have a significant interest include (i) our subprime securitizations, which are held in qualifying special purpose entities under SFAS 140 and are therefore exempt from consolidation as VIEs, (ii) our trust preferred subsidiary, which we do not consolidate since we are not the primary beneficiary, as we do not absorb a majority of its expected losses or receive a majority of its expected residual returns and (iii) our CDOs, in which we have been determined to be the primary beneficiary and therefore consolidate them, since we would absorb a majority of their expected losses and receive a majority of their expended residual returns, as determined on the date of formation and on any applicable reconsideration dates. Our CDOs are held in special purpose entities whose debt is treated as a non-recourse secured borrowing of Newcastle.

We will continue to analyze future investments, as well as reconsideration events in existing entities, pursuant to the requirements of FIN 46R. These analyses require considerable judgment in determining the primary beneficiary of a VIE since they involve estimated probability weighting of subjectively determined possible cash flow scenarios. The result could be the consolidation of an entity that would otherwise not have been consolidated or the non-consolidation of an entity that would otherwise have been consolidated.

Valuation and Impairment of Securities

We have classified all our real estate securities as available for sale. As such, they are carried at fair value with net unrealized gains or losses reported as a component of accumulated other comprehensive income, to the extent impairment losses are considered temporary as described below. Fair value may be based upon broker quotations, counterparty quotations or pricing services quotations, which provide valuation estimates based upon reasonable market order indications or a good faith estimate thereof and are subject to significant variability based on market conditions, such as interest rates, credit spreads and market liquidity. A significant portion of our securities are currently not traded in active markets and therefore have little or no price transparency. For a further discussion of this trend, see “– Market Considerations” above. As a result, we have estimated the fair value of these illiquid securities based on internal pricing models rather than broker quotations. The determination of estimated cash flows used in pricing models is inherently subjective and imprecise. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant and immediate increase or decrease in our book equity. For securities valued with pricing models, these inputs include the discount rate, assumptions relating to prepayments, default rates and loss severities, as well as other variables.

 

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See Note 6 to our consolidated financial statements in Part I, Item 1, “Financial Statements and Supplementary Data” for information regarding the fair value of our investments, and its estimation methodology, as of March 31, 2009.

Our estimation of the fair value of level 3B assets (as described below) involves significant judgment. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in our book equity. For securities valued using pricing models, the inputs include the discount rate, assumptions relating to prepayments, default rates and loss severities, as well as other variables. We validated the inputs and outputs of our models by comparing them to available independent third party market parameters and models for reasonableness. We believe the assumptions we used are within the range that a market participant would use and factor in the relative illiquidity currently in the markets. In comparison to the prior year end, we have used slower prepayment speeds, higher default rates and higher severity assumptions as inputs to our pricing models in order to reflect current market conditions. In the first quarter of 2009, Newcastle lowered the prepayment assumptions based on observed reductions in actual prepayment speeds and slower expected future prepayments consistent with market projections. The slower prepayments were the result of increasing difficulties for borrowers to refinance, caused by a tightening of underwriting standards, decline in home prices, contraction of available lenders due to bank failures and a distressed securitization market. Default assumptions were increased due to higher levels of delinquent underlying loans. Loss severity assumptions were increased based on observed increases in recent loss severities that have been driven by falling home prices and the increasing number of foreclosures or distressed home sales in the residential sector and higher losses as a result of the increasing number of foreclosures and bankruptcies of borrowers experienced in the commercial sector.

For securities valued with internal models, which have an aggregate fair value of $252.9 million as of March 31, 2009, a 10% unfavorable change in our assumptions would result in the following decreases in such aggregate fair value:

 

     CMBS     ABS  

Outstanding face amount

   $ 404,633     $ 520,122  

Fair value

   $ 152,954     $ 99,965  

Effect on fair value with 10% unfavorable change in:

    

Discount rate

   $ (9,829 )   $ (3,539 )

Prepayment rate

     N/A     $ (1,554 )

Default rate

   $ (9,097 )   $ (8,433 )

Loss severity

   $ (13,805 )   $ (11,930 )

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

Pursuant to SFAS 157, as described below, our securities must be categorized by the “level” of inputs used in estimating their fair values. Level 1 would be assets valued based on quoted prices for identical instruments in active markets; we have no level 1 assets. Level 2 would be assets valued based on quoted prices in active markets for similar instruments, on quoted prices in less active or inactive markets, or on other “observable” market inputs. Level 3 would be assets valued based significantly on “unobservable” market inputs. We have further broken level 3 into level 3A, third party indications, and level 3B, internal models. Fair value under SFAS 157 represents an exit price in the normal course of business, not a forced liquidation price. If we were forced to sell assets in a short period to meet liquidity needs, the prices we receive could be substantially less than the recorded fair values.

We generally classify the broker quotations we receive as level 3A inputs, except for certain liquid securities. They are quoted prices in generally inactive and illiquid markets for identical or similar securities. These quotations are generally received via email and contain disclaimers which state that they are “indicative” and not “actionable” – meaning that the party giving the quotation is not bound to actually purchase the security at the quoted price. These quotations are generally based on models prepared by the brokers and we have little visibility into the inputs they use. Based on procedures we have performed with respect to prior quotations received from these brokers in comparison to the outputs generated from our internal pricing models and transactions we have completed with respect to these securities, as well as on our knowledge and experience of these markets, we have generally determined that these quotes represent a reasonable estimate of fair value. In addition, management performs its own quarterly analysis of fair value, based on internal pricing models, to confirm that each of the quotations received represented a reasonable estimate of fair value as defined under SFAS 157. For securities valued using quotations, a 100 basis point change in credit spreads would impact estimated fair value at period and by approximately $39.7 million.

We must also assess whether unrealized losses on securities, if any, reflect a decline in value which is other-than-temporary and, if so, write the impaired security down to its fair value through earnings. A decline in value is deemed to be other-than-

 

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temporary if it is probable that we will be unable to collect all amounts due according to the contractual terms of a security which was not impaired at acquisition, or if we do not have the ability and intent to hold a security in an unrealized loss position until its anticipated recovery (if any). For the purposes of performing this analysis, we assume the anticipated recovery period is until the respective security’s expected maturity. As of March 31, 2009, we determined that we could not express the intent and ability to hold all of our securities which are in an unrealized loss position until their anticipated recovery. Also, for those securities within the scope of EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” as amended by FSP EITF 99-20-1, whenever there is a probable adverse change in the timing or amounts of estimated cash flows of a security from the cash flows previously projected, an other-than-temporary impairment is considered to have occurred. Securities within the scope of EITF 99-20 are also analyzed for other-than-temporary impairment under the guidelines applicable to all securities as described herein. We note that primarily all of our securities, except our FNMA/FHLMC securities, fall within the scope of EITF 99-20.

Temporary declines in value generally result from changes in market factors, such as market interest rates and credit spreads, or from certain macroeconomic events, including market disruptions and supply changes, which do not directly impact our ability to collect amounts contractually due. We continually evaluate the credit status of each of our securities and the collateral supporting our securities. This evaluation includes a review of the credit of the issuer of the security (if applicable), the credit rating of the security, the key terms of the security (including credit support), debt service coverage and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the collateral supporting such loans, including the effect of local, industry and broader economic trends and factors. These factors include loan default expectations and loss severities, which are analyzed in connection with a particular security’s credit support, as well as prepayment rates. These factors are also analyzed in relation to the amount of the unrealized loss and the period elapsed since it was incurred. The result of this evaluation is considered when determining management’s estimate of cash flows, particularly with respect to developing the necessary inputs and assumptions. Each security is impacted by different factors and in different ways; generally the more negative factors which are identified with respect to a given security, the more likely we are to determine that we do not expect to receive all contractual payments when due with respect to that security. Significant judgment is required in this analysis.

During the three months ended March, 31, 2009, we had 157, or $414.8 million carrying amount of, securities that were downgraded. All of these securities were determined to be other-than-temporarily impaired during this period. However, we do not depend on credit ratings in underwriting our securities, either at acquisition or on an ongoing basis. As mentioned above, a credit rating downgrade is one factor that we monitor and consider in our analysis regarding other-than-temporary impairment, however it is not determinative. Our securities generally benefit from the support of one or more subordinate classes of securities or equity or other forms of credit support. Therefore, credit rating downgrades, even to the extent they relate to an expectation that a securitization we have invested in, on an overall basis, has credit issues, may not ultimately impact cash flow estimates for the class of securities in which we are invested.

Furthermore, the analysis of whether we have the intent and ability to hold the securities until recovery can also be subject to significant judgment, particularly in times of market illiquidity such as we are currently experiencing. If we sell assets for liquidity reasons, without a significant change in facts and circumstances, with respect to which we had previously expressed an intent and ability to hold, this could “taint” the reliability of our expressed intent and ability and cause us to record significant incremental impairments in the future.

Revenue Recognition on Securities

Income on these securities is recognized using a level yield methodology based upon a number of cash flow assumptions that are subject to uncertainties and contingencies. Such assumptions include the rate and timing of principal and interest receipts (which may be subject to prepayments and defaults). These assumptions are updated on at least a quarterly basis to reflect changes related to a particular security, actual historical data, and market changes. These uncertainties and contingencies are difficult to predict and are subject to future events, and economic and market conditions, which may alter the assumptions. For securities acquired at a discount for credit losses, the net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income, offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Provision for Credit Losses. The provision is determined based on an evaluation of the credit status of securities, as described in connection with the analysis of impairment above.

Valuation of Derivatives

Similarly, our derivative instruments are carried at fair value pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 133 “Accounting for Derivative Instruments and Hedging Activities,” as amended. Fair value is based on counterparty quotations. To the extent they qualify as cash flow hedges under SFAS No. 133, net unrealized gains or losses are reported as a component of accumulated other comprehensive income; otherwise, they are reported currently in income. To the extent they qualify as fair value hedges, net unrealized gains or losses on both the derivative and the related portion of the hedged item are reported currently in income. Fair values of such derivatives are subject to significant variability based on many of the same factors as the securities discussed above, including counterparty risk. The results of such variability could be a significant increase or decrease in our book equity and/or earnings.

 

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Impairment of Loans

We purchase, directly and indirectly, real estate related, commercial mortgage and residential mortgage loans, including manufactured housing loans and subprime mortgage loans. We must periodically evaluate each of these loans or loan pools for possible impairment. Impairment is indicated when it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the loan, or, for loans acquired at a discount for credit losses, when it is deemed probable that we will be unable to collect as anticipated. Upon determination of impairment, we would establish a specific valuation allowance with a corresponding charge to earnings. We continually evaluate our loans receivable for impairment. Our residential mortgage loans, including manufactured housing loans, are aggregated into pools for evaluation based on like characteristics, such as loan type and acquisition date. Individual loans are evaluated based on an analysis of the borrower’s performance, the credit rating of the borrower, debt service coverage and loan to value ratios, the estimated value of the underlying collateral, the key terms of the loan, and the effect of local, industry and broader economic trends and factors. Pools of loans are also evaluated based on similar criteria, including historical and anticipated trends in defaults and loss severities for the type and seasoning of loans being evaluated. This information is used to estimate specific impairment charges on individual loans as well as provisions for estimated unidentified incurred losses on pools of loans. Significant judgment is required both in determining impairment and in estimating the resulting loss allowance. Furthermore, we must assess our intent and ability to hold our loan investments on a periodic basis. If we do not have the intent to hold a loan for the foreseeable future or until its expected payoff, the loan must be classified as “held for sale” and recorded at the lower of cost or estimated fair value. As of March 31, 2009, we determined that we could not express the intent and ability to hold all of our loans which are in an unrealized loss position for the foreseeable future or until their expected pay off.

Revenue Recognition on Loans Held for Investment

Income on these loans is recognized similarly to that on our securities and is subject to similar uncertainties and contingencies, which are also analyzed on at least a quarterly basis. For loan pools acquired at a discount for credit losses, the net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income, offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Provision for Credit Losses. The provision is determined based on an evaluation of the loans as described under “Impairment of Loans” above. A rollforward of the provision is included in Note 4 to our consolidated financial statements included herein.

Revenue Recognition on Loans Held for Sale

Real estate related, commercial mortgage and residential mortgage loans that are considered held for sale are carried at the lower of amortized cost or market value determined on either an individual method basis, or in the aggregate for pools of similar loans. Interest income is recognized to the extent cash is received whereas valuation allowance is recorded in Loan Impairment.

Recent Accounting Pronouncements

In February 2008, the FASB issued FASB Staff Position No. FAS 140-3 (“FSP FAS 140-3”), “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” FSP FAS 140-3 provides guidance on accounting for a transfer of a financial asset and a repurchase financing. It presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (a linked transaction) unless certain criteria are met. If the criteria are not met, the linked transaction would be recorded as a net investment, likely as a derivative, instead of recording the purchased financial asset on a gross basis along with a repurchase financing. FSP FAS 140-3 applies to reporting periods beginning after November 15, 2008 and is only applied prospectively to transactions that occur on or after the adoption date. As a result of the prospective nature of the adoption, we do not expect the adoption of FSP FAS 140-3 to have a material impact on our financial condition, liquidity or results of operations, unless we enter into transactions of this type after January 1, 2009. We did not enter into any such transactions during the first quarter of 2009.

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities.” SFAS 161 applies to reporting periods beginning after November 15, 2008. SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities. It does not change the accounting for such activities. As a result, while the adoption of SFAS 161 has changed our disclosures, it did not have a material impact on our financial condition, liquidity or results of operations.

In September 2008, the FASB issued exposure drafts of two proposed standards, “Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140,” and “Amendments to FASB Interpretation No. 46(R).” These proposed standards would fundamentally change the requirements to consolidate (or deconsolidate) special purpose and variable interest entities and would be effective for us in 2010. We are currently evaluating the potential impact of these proposed standards on us. If the adoption of these proposal standards caused us to deconsolidate our CDOs, we would record a gain to the extent that we have taken impairment on assets within a given CDO in excess of our investment in such CDO. This gain would likely be very substantial.

In January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20.” This FSP amends EITF No. 99-20 to achieve more consistent determination of whether an other-than-temporary impairmenthas occurred, with the same objective as SFAS 115. In particular, it changed a requirement to analyze a security’s estimated cash flows from a market participant’s perspective to an analysis from the perspective of the holder. It is effective for periods ending

 

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after December 15, 2008 and is applied prospectively. Due to the prospective nature of its adoption, the adoption of FSP EITF 99-20-1 did not have a material impact on our financial condition, liquidity or results of operations. It did not have a material impact on our impairment analyses subsequent to adoption because we generally analyze cash flows of securities in a manner consistent with market practice.

In April 2009, the FASB issued three FSPs related to fair value and impairment, FSP FAS 107-1 and APB 28-1 “Interim Disclosures about Fair Value of Financial Instruments,” FSP FAS 115-2 and FAS 124-2 “Recognition and Presentation of Other-Than-Temporary Impairments,” and FSP FAS 157-4 “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” These FSPs (i) require disclosures about the fair value of financial instruments on an interim basis, (ii) change the guidance for determining, recording and disclosing other-than-temporary impairment, and (iii) provide additional guidance for estimating fair value when the volume or level of activity for an asset or liability have significantly decreased. These FSPs will be effective for Newcastle in the second quarter of 2009. We anticipate that they will have a significant impact on our disclosures, but no material impact on our financial condition, liquidity, or results of operations upon adoption. We are still evaluating the potential impact on future impairment determinations.

RESULTS OF OPERATIONS

The following table summarizes the changes in our results of operations from the three months ended March 31, 2008 to the three months ended March 31, 2009 (dollars in thousands):

 

     Amount Change     Percent Change     Explanations of
Material
Changes
 

Interest income

   $ (8,421 )   (6.3 )%   (1 )

Interest expense

     (28,831 )   (32.3 )%   (1 )

Loan and security servicing expense

     (328 )   (19.0 )%   (1 )

Provision for credit losses

     (598 )   (23.9 )%   (2 )

General and administrative expense

     34     2.1 %   (3 )

Management fee to affiliate

     (106 )   (2.3 )%   (4 )

Depreciation and amortization

     —       0.0 %   N/A  

Other-than-temporary impairment

     140,210     N.M.     (5 )

Loan impairment

     100,200     N.M.     (5 )

Gain (loss) on sale of investments, net

     (13,028 )   (199.6 )%   (6 )

Gain (loss) on extinguishment of debt

     18,312     N.M.     (7 )

Other income (loss), net

     12,814     N.M.     (8 )

Equity in earnings of unconsolidated subsidiaries

     (695 )   (98.2 )%   (9 )
                

Income (loss) from continuing operations

   $ (201,599 )   541.7 %  
                

 

N.M.—Not meaningful

 

(1) Changes in interest income and expense are primarily related to our acquisition and disposition during these periods of interest bearing assets and related financings, as follows:

 

     Period to Period Increase (Decrease)  
     Interest Income     Interest Expense  

Disposition of securities and loans

   $ (8,052 )   $ (7,951 )

Repayment of debt obligations and related dispositions

     (5,003 )     (3,152 )

Paydowns

     (7,178 )     (1,513 )

Other (see below)

     11,812       (16,215 )
                
   $ (8,421 )   $ (28,831 )
                

Changes in Other are primarily due to changes in interest rates and the increased interest income recorded in the first quarter of 2009 as a result of accretion of discounts of the impaired securities.

Change in loan and security servicing expense is primarily due to paydowns.

 

(2) This change is primarily the result of the classification of loans as held for sale in the fourth quarter of 2008 as we could no longer express the intent and ability to hold our loan investments through maturity. For the three months ended March 31, 2009, the actual losses incurred in our pools of residential mortgage loans were recorded to Provision for Credit Losses whereas a write down to the lower of cost or fair value was recorded to Loan Impairment.
(3) This change is primarily to due to an increase in insurance expense, partially offset by a refund of excise tax paid in 2008.
(4) Management fees have remained relatively stable as we did not raise capital through common or preferred stock offerings during these periods. As a result of impairment charges, we will not incur incentive compensation to our manager for an indefinite period of time.

 

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(5) The changes are due to the impairment charges recorded as a result of the continued credit market turmoil and us not being able to express the intent and ability to hold our investments through maturity or recovery, which led us to record write downs to primarily all of the securities and loans.
(6) This change is predominantly the result of the sales of loans and securities in an unrealized loss position in the first quarter of 2009 due to the worsening credit and liquidity crisis.
(7) This change is primarily due to increased gains on the repurchase of our own debt.
(8) This change is primarily due to an increase in the fair value of our interest rate swaps not designated as accounting hedges in the first quarter of 2009, which we mark to market through the statement of operations, and the unrealized loss recorded on the total rate of return swaps held in the first quarter of 2008.
(9) This change is primarily due to the sale of our interests in the operating real estate joint venture in 2008.

LIQUIDITY AND CAPITAL RESOURCES

Overview

Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, and other general business needs. Additionally, to maintain our status as a REIT under the Code, we must distribute annually at least 90% of our REIT taxable income. We note that up to 90% of this requirement may be met in future years through stock dividends, rather than cash, subject to limitations based on the value of our stock. Our primary sources of funds for liquidity consist of net cash provided by operating activities, sales or repayments of investments, potential refinancing of existing debt and the issuance of equity securities, when available. Our debt obligations are generally secured directly by our investment assets.

Sources of Liquidity and Uses of Capital

With respect to the next twelve months, we expect that our cash on hand, when combined with our cash flow provided by operations, and proceeds from the potential repayment or sale of investments will be sufficient to satisfy our anticipated liquidity needs with respect to our current investment portfolio, including related financings, hedges and operating expenses. While it is inherently more difficult to forecast beyond the next twelve months, we currently expect to meet our long term liquidity requirements, specifically the repayment of our debt obligations, through additional borrowings, proceeds received from repurchase agreements and similar financings, and the liquidation or refinancing of our assets.

These short-term and long-term expectations are forward-looking and subject to a number of uncertainties and assumptions, which are described below under “– Factors That Could Impact Our Liquidity” as well as Part II, Item 1A, “Risk Factors.” If our assumptions about our liquidity prove to be incorrect, we could be subject to a shortfall in liquidity in the future, and this short-fall may occur rapidly and with little or no notice, which would limit our ability to address the shortfall on a timely basis.

Cash flow provided by operations constitutes a critical component of our liquidity. Essentially, our cash flow provided by operations is equal to (i) the net cash flow from our CDOs that have not failed their over collateralization tests, plus (ii) the net cash flow from our non-CDO investments that are not subject to mandatory debt repayment, including principal and sales proceeds, less (iii) operating expenses (primarily management fees, professional fees and insurance), and less (iv) interest on the junior subordinated notes payable (the trust preferred securities).

Our cash flow provided by operations differs from our net income (loss) due to these primary factors: (i) accretion of discount or premium on our real estate securities and loans (including the accrual of interest and fees payable at maturity), discount on our debt obligations, deferred financing costs and interest rate cap premiums, and deferred hedge gains and losses, (ii) gains and losses from sales of assets financed with CDOs, (iii) the provision for credit losses and impairments recorded in connection with our loan assets, as well as other-than-temporary impairment on our securities, (iv) unrealized gains or losses on our non-hedge derivatives, (v) the non-cash charges associated with our early extinguishment of debt, and (vi) net income (loss) generated within CDOs that have failed triggers and one of the manufactured housing loan portfolios that became callable in January 2009 and therefore do not remit cash to us. Proceeds from the sale of assets which serve as collateral for our CDO financings, including gains thereon, are required to be retained in the CDO structure until the related bonds are retired and are therefore not available to fund current cash needs outside of these structures.

Update on Liquidity, Capital Resources and Capital Obligations

Certain details regarding our liquidity, current financings and capital obligations as of May 6, 2009 are set forth below:

 

   

Cash – We had unrestricted cash of $53.8 million. In addition, we had $34.3 million of restricted cash for reinvestments in our CDOs;

 

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Margin Exposure – We have no financings subject to margin calls, other than one repurchase agreement with a face amount of $46.4 million which finances our FNMA/FHLMC investments and four interest rate swap agreements with an aggregate notional amount of $74.4 million;

 

 

Construction Loan Funding Commitment – We have outstanding recourse funding commitments with respect to a commercial construction loan of up to an additional $37.9 million (excluding commitments owned by our CDOs), subject to certain conditions to be met by the borrowers. This remaining commitment is expected to be funded over the next 16 months; and

 

 

Recourse Financings – Substantially all of our assets, other than our FNMA/FHLMC investments, are currently financed with term debt subject to amortization payments, as opposed to short-term debt such as repurchase agreements, which could be subject to margin requirements or termination. The following table compares the face amount of our recourse financings, excluding the trust preferred securities:

 

     May 6, 2009    March 31, 2009    December 31, 2008

        Recourse Financings

        

        Real Estate Securities and Loans

   $ 81,044    $ 83,096    $ 102,977

        Manufactured Housing Loans

     19,012      20,012      51,118

        FNMA/FHLMC Securities

     46,445      47,802      173,495
                    

        Total Recourse Financings

   $ 146,501    $ 150,910    $ 327,590
                    
The following table summarizes the scheduled repayments of our recourse financings as of May 6, 2009:

        May 7, 2009 to June 30, 2009 (A)

   $ 55,445      

        3rd Quarter 2009

     12,965      

        4th Quarter 2009

     23,750      

        1st Quarter 2010

     26,329      

        2nd Quarter 2010

     23,000      

        3rd Quarter 2010

     3,000      

        4th Quarter 2010

     2,012      
            

        Total Recourse Financings

   $ 146,501      
            

 

(A) Includes $46.4 million of financing on FNMA/FHLMC securities, which is expected to be “rolled” (refinanced at similar terms) upon maturity.

It is important for readers to understand that our liquidity, available capital resources and capital obligations could change rapidly due to a variety of factors, many of which are beyond our control. Set forth below is a discussion of some of the factors that could impact our liquidity, available capital resources and capital obligations.

Factors That Could Impact Our Liquidity, Capital Resources and Capital Obligations

We refer readers to our discussions in other sections of this report for the following information:

 

 

For a further discussion of recent trends and events affecting our liquidity, see “– Market Considerations” above;

 

 

As described below, under “– Interest Rate, Credit and Spread Risk,” we are subject to margin calls in connection with our derivatives related to the non-recourse financing structures;

 

 

Our match funded investments are financed long term, and their credit status is continuously monitored, which is described under “Quantitative and Qualitative Disclosures About Market Risk — Interest Rate Exposure” below. Our remaining investments, generally financed with short term debt or short term repurchase agreements, are also subject to refinancing risk upon the maturity of the related debt. See “Debt Obligations” below; and

 

 

For a further discussion of a number of risks that could affect our liquidity, access to capital resources and our capital obligations, see Part II, Item 1A, “Risk Factors”.

In addition to the information referenced above, the following factors could also affect our liquidity, access to capital resources and our capital obligations. As such, if their outcomes do not fall within our expectations, changes in these factors could result in a liquidity shortfall.

 

 

Access to Financing from Counterparties – Decisions by investors, counterparties and lenders to enter into transactions with us will depend upon a number of factors, such as our historical and projected financial performance, compliance with the terms of our current credit and derivative arrangements, industry and market trends, the availability of capital and our investors’, counterparties’ and lenders’ policies and rates applicable thereto, and the relative attractiveness of alternative investment or lending opportunities. We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential fluctuations in the availability of capital. Our core business strategy is dependent upon our ability to finance our real estate securities, loans and other real estate related assets with match funded debt at rates that provide a positive net spread. Currently, spreads for such liabilities have widened and demand for such liabilities has become extremely limited, therefore restricting our ability to execute future financings. This restriction can be exacerbated by the requirement to post margin on existing obligations.

 

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Impact of Rating Downgrades on CDO Cash Flows – Ratings downgrades of assets in our CDOs can negatively impact compliance with the over collateralization tests. Generally, the over collateralization test measures the principal balance of the specified pool of assets in a CDO against the corresponding liabilities issued by the CDO. However, based on ratings downgrades, the principal balance of an asset or of a specified percentage of assets in a CDO may be deemed to be reduced below their current balance to levels set forth in the related CDO documents for purposes of calculating the over collateralization test. As a result, ratings downgrades can reduce the assumed principal balance of the assets used in the over collateralization test relative to the corresponding liabilities in the test, thereby reducing the over collateralization percentage. In addition, actual defaults of assets would also negatively impact compliance with the over collateralization tests. Failure to satisfy an over collateralization test could result in the redirection of cashflows, or, in certain cases, in the potential removal of Newcastle as collateral manager.

 

 

Impact of Expected Repayment or Forecasted Sale on Cash Flows – The timing of and proceeds from the repayment or sale of certain investments may be different than expected or may not occur as expected. Proceeds from sales of assets in the current illiquid market environment are unpredictable and may vary materially from their estimated fair value and their carrying value.

Investment Portfolio

The following summarizes our investment portfolio at March 31, 2009 (dollars in millions).

 

     Outstanding Face
Amount
   Amortized Cost
Basis (1)
   Percentage of
Amortized Cost
Basis
    Number of
Investments
   Credit
(2)
    Weighted
Average Life
(years) (3)

Investment (5)

               

Commercial

               

CMBS

   $ 2,267    $ 707    29.3 %   262    BB+     4.9

Mezzanine Loans

     756      313    13.0 %   23    66 %   2.8

B-Notes

     310      108    4.5 %   11    60 %   2.2

Whole Loans

     100      69    2.9 %   4    54 %   2.2
                             

Total Commercial Assets

     3,433      1,197    49.7 %        4.1
                             

Residential

               

Manufactured Housing and

               

Residential Mortgage Loans

     533      381    15.8 %   13,735    694     6.8

Subprime Securities

     550      140    5.8 %   120    B     4.3

Subprime Retained Securities and Residuals

     81      6    0.3 %   8    CC/650     2.3

Real Estate ABS

     98      47    1.9 %   26    BB+     7.6
                             
     1,262      574    23.8 %        5.5
                             

FNMA/FHLMC securities

     49      49    2.0 %   2    AAA     2.7
                             

Total Residential Assets

     1,311      623    25.8 %        5.4
                             

Corporate

               

REIT Debt

     633      382    15.8 %   62    BB     4.6

Corporate Bank Loans

     499      209    8.7 %   14    CCC+     2.2
                             

Total Corporate Assets

     1,132      591    24.5 %        3.6
                             

TOTAL / WA

   $ 5,876    $ 2,411    100.0 %        4.3
                             

Reconciliation to GAAP total assets:

               

Net unrealized gains recorded in accumulated other comprehensive income

        120          

Other assets

               

Subprime mortgage loans subject to call option (4)

        399          

Real estate held for sale

        11          

Cash and restricted cash

        142          

Other

        51          
                   

GAAP total assets

      $ 3,134          
                   

 

WA – Weighted average, in all tables.

(1) Net of impairments.
(2) Credit represents weighted average of minimum rating for rated assets, LTV (based on the appraised value at the time of purchase) for non-rated commercial assets, FICO score for non-rated residential assets and an implied AAA rating for FNMA/FHLMC securities. Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including the assignment of a “negative outlook” or “credit watch”) at any time.
(3) The weighted average lives of our Mezzanine Loans, B-Notes and Whole Loans are based on the fully extended maturity dates.

(4)

Our subprime mortgage loans subject to call option are excluded from the statistics because they result from an option, not an obligation, to repurchase such loans, are noneconomic until such option is exercised, and are offset by an equal liability on the consolidated balance sheet.

 

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(5) The following tables summarize certain supplemental data relating to our investments (dollars in thousands):

CMBS

 

Deal Vintage (A)

   Average
Minimum
Rating (B)
   Number    Outstanding
Face Amount
   Amortized
Cost Basis
   Percentage of
Amortized
Cost Basis
    Delinquency
60+/FC/REO (C)
    Principal
Subordination (D)
    Weighted
Average Life
(years)

Pre 2004

   BBB+    77    $ 401,008    $ 162,989    23.0 %   2.2 %   11.3 %   3.7

2004

   BB+    59      435,044      156,058    22.1 %   1.3 %   5.2 %   5.0

2005

   BBB-    50      567,890      94,539    13.4 %   1.0 %   5.5 %   6.0

2006

   BB    39      453,507      204,920    29.0 %   0.5 %   5.5 %   3.4

2007

   BB+    37      409,054      88,628    12.5 %   1.4 %   9.2 %   6.2
                                              

Total / WA

   BB+    262    $ 2,266,503    $ 707,134    100.0 %   1.2 %   7.1 %   4.9
                                              

 

(A) The year in which the securities were issued.
(B) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including the assignment of a “negative outlook” or “credit watch”) at any time.
(C) The percentage of underlying loans that are 60+ days delinquent, or in foreclosure or considered real estate owned (REO).
(D) The percentage of the outstanding face amount of securities that is subordinate to our investments.

Mezzanine Loans, B-Notes and Whole Loans

 

     Mezzanine     B-Note     Whole Loan     Total / WA  

Outstanding Face Amount

   $ 756,427     $ 309,901     $ 100,538     $ 1,166,866  

Amortized Cost Basis

   $ 313,364     $ 108,328     $ 68,506     $ 490,198  

Number

     23       11       4       38  

Weighted Average First $ Loan to Value (A)

     55.3 %     48.1 %     0.0 %     48.6 %

Weighted Average Last $ Loan to Value (A)

     66.1 %     59.9 %     54.4 %     63.4 %

Delinquency (B)

     5.3 %     16.1 %     0.0 %     7.7 %

 

(A) Loan to value is based on the appraised value at the time of purchase.
(B) The percentage of underlying loans that are non-performing, in foreclosure, under bankruptcy filing or considered real estate owned.

Manufactured Housing Loans

 

Deal

   Outstanding
Face Amount
   Amortized
Cost Basis
   Percentage
of Amortized
Cost Basis
    Weighted
Average
Loan Age
(months)
   Original
Balance
   Delinquency
90+/FC/REO (A)
    Actual
Cumulative
Loss to
Date
 

Portfolio I

   $ 185,895    $ 122,174    37.3 %   91    $ 327,855    1.3 %   4.3 %

Portfolio II

     271,596      205,783    62.7 %   120      434,743    1.0 %   2.6 %
                                            

Total / WA

   $ 457,491    $ 327,957    100.0 %   108    $ 762,598    1.1 %   3.3 %
                                            

 

(A) The percentage of loans that are 90+ days delinquent, or in foreclosure or considered real estate owned (REO).

Subprime Securities (A)

 

     Security Characteristics  

Vintage (B)

   Average
Minimum
Rating (C)
   Number of
Securities
   Outstanding
Face Amount
   Amortized
Cost Basis
   Percentage of
Amortized
Cost Basis
    Principal
Subordination (D)
    Excess
Spread (E)
 

2003

   BBB+    15    $ 26,638    $ 12,962    9.2 %   20.0 %   4.0 %

2004

   BB+    30      108,877      36,928    26.4 %   12.8 %   4.4 %

2005

   CCC+    46      205,900      35,851    25.6 %   16.4 %   5.2 %

2006

   CCC    19      143,224      28,549    20.4 %   15.3 %   4.4 %

2007

   BB-    10      64,882      25,854    18.4 %   26.8 %   4.5 %
                                          

Total / WA

   B    120    $ 549,521    $ 140,144    100.0 %   16.8 %   4.7 %
                                          

 

     Collateral Characteristics  

Vintage (B)

   Average
Loan Age
(months)
   Collateral
Factor (F)
   3 month
CPR (G)
    Delinquency (H)     Cumulative Losses
to Date
 

2003

   72    0.12    10.0 %   12.6 %   2.4 %

2004

   59    0.15    10.1 %   17.1 %   2.3 %

2005

   46    0.30    20.0 %   30.3 %   6.0 %

2006

   33    0.60    15.7 %   32.8 %   5.9 %

2007

   28    0.76    15.9 %   31.6 %   4.1 %
                            

Total / WA

   44    0.39    15.9 %   27.7 %   4.8 %
                            

 

(A) Excludes subprime retained securities and residual interests.
(B) The year in which the securities were issued.
(C) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including the assignment of a “negative outlook” or “credit watch”) at any time.

 

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(D) The percentage of the outstanding face amount of securities and residual interests that is subordinate to our investments.
(E) The annualized amount of interest received on the underlying loans in excess of the interest paid on the securities, as a percentage of the outstanding collateral balance.
(F) The ratio of original unpaid principal balance of loans still outstanding.
(G) Three month average constant prepayment rate.
(H) The percentage of underlying loans that are 90+ days delinquent, or in foreclosure or considered real estate owned (REO).

Subprime Retained Securities and Residual Interests

Represents $5.4 million and $0.9 million of amortized cost basis of retained bonds and residual interests, respectively, in the securitizations of Subprime Portfolios I and II. For further information on these securitizations, see Note 4 to our consolidated financial statements included herein.

REIT Debt

 

Industry

   Average
Minimum
Rating (A)
    Number    Outstanding
Face
Amount
   Amortized
Cost Basis
   Percentage of
Amortized
Cost Basis
 

Retail

   B+     19    $ 222,835    $ 121,632    31.8 %

Diversified

   BB   14      151,463      78,845    20.6 %

Office

   BBB     12      130,219      92,627    24.2 %

Multifamily

   BBB     5      28,765      21,642    5.7 %

Hotel

   BBB   4      37,220      23,475    6.1 %

Healthcare

   BBB   4      36,600      25,563    6.7 %

Storage

   A   1      5,000      4,214    1.1 %

Industrial

   BB     3      20,865      14,353    3.8 %
                               

Total / WA

   BB     62    $ 632,967    $ 382,351    100.0 %
                               

Corporate Bank Loans

 

Industry

   Average
Minimum
Rating (A)
    Number    Outstanding
Face
Amount
   Amortized
Cost Basis
   Percentage of
Amortized
Cost Basis
 

Real Estate

   CCC+     3    $ 115,299    $ 56,406    27.1 %

Media

   CCC+     2      112,000      22,770    11.0 %

Retail

   B   1      98,688      45,347    21.8 %

Resorts

   BB   1      76,505      43,417    20.9 %

Restaurant

   CCC     2      38,026      11,445    5.5 %

Gaming

   CC     3      29,557      5,192    2.5 %

Transportation

   NR     1      27,000      22,140    10.6 %

Theatres

   B     1      1,468      1,338    0.6 %
                               

Total / WA

   CCC+     14    $ 498,543    $ 208,055    100.0 %
                               

 

(A) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including the assignment of a “negative outlook” or “credit watch”) at any time.

Debt Obligations

Our debt obligations, as summarized in Note 5 to our consolidated financial statements included herein, existing at March 31, 2009 (gross of $17.8 million of discounts) had contractual maturities as follows (in thousands):

 

     Nonrecourse    Recourse    Total

Period from April 1, 2009 through December 31, 2009

   $ 124,121    $ 96,569    $ 220,690

2010

     —        54,341      54,341

2011

     198,111      —        198,111

2012

     —        —        —  

2013

     —        —        —  

2014

     —        —        —  

Thereafter

     4,744,041      100,100      4,844,141
                    

Total

   $ 5,066,273    $ 251,010    $ 5,317,283
                    

Certain of the debt obligations included above are obligations of our consolidated subsidiaries which own the related collateral. In some cases, including the CDO and Other Bonds Payable, such collateral is not available to other creditors of ours.

Our non-CDO debt obligations contain various customary loan covenants. We were in compliance with all the covenants in our non-CDO financings as of March 31, 2009.

 

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Our Other Bonds Payable are collateralized by two portfolios of manufactured housing loans. In January 2009, the $124.1 million (at March 31, 2009) debt for one of the portfolios of manufactured housing loans became callable at the option of the lender, and is reflected as due on April 1 in the table above. The principal and interest payments from the underlying loans, net of expenses and payments related to interest rate swap contracts, are used to repay the outstanding debt on a monthly basis.

In the first quarter of 2009, we repurchased $30.3 million face amount of three classes of CDO bonds for $3.2 million. As a result, we extinguished $30.3 million face amount of CDO debt and recorded a gain on extinguishment of debt of $26.9 million.

In February 2009, we renegotiated the terms of a recourse loan agreement financing one of our manufactured housing loan portfolios. Under the amended terms of the agreement, certain debt covenants relating to equity requirements were removed.

In February 2009, we renegotiated the terms of a repurchase agreement financing our investment in a real estate related loan. Under the amended terms of the repurchase agreement, certain debt covenants relating to a concentration limit and equity requirements, as well as the mark-to-market (margin) requirement were removed.

In March 2009, we renegotiated the terms of a repurchase agreement financing our investment in a real estate related loan. Under the amended terms of the repurchase agreement, the mark-to-market (margin) provisions and certain financial covenants relating to net worth and leverage ratio were removed. Newcastle also agreed not to enter into any new debt financings subject to margin calls other than to finance FNMA/FHLMC securities.

In April 2009, we repurchased $29.5 million face amount of two classes of CDO bonds for $2.4 million. As a result, we extinguished $29.5 million face amount of CDO debt and recorded a gain on extinguishment of debt of $26.9 million in the second quarter of 2009.

On April 30, 2009, we entered into an exchange agreement with several collateralized debt obligations managed by a third party pursuant to which we agreed to exchange newly issued junior subordinated notes due in 2035 with an initial aggregate principal amount of $101.7 million (the “Notes”) for $100 million in aggregate liquidation amount of trust preferred securities that were previously issued by a subsidiary of us (the “TRUPs”) and were owned by the third party. The Notes accrue interest at a rate of 1.0% per year for a maximum of six quarters, beginning on February 1, 2009. Subsequent to that period, the rate reverts to that which we were required to pay on the TRUPs (7.574% through April 2016 and at a floating rate of 3-month LIBOR plus 2.25% thereafter). In conjunction with the exchange, the TRUPs were cancelled and we pledged 100% of our equity interests in NIC TP LLC, a special purpose subsidiary that holds our participation in a loan and related deposit account, which were valued at $3.5 million on March 31, 2009, as collateral. The pledged collateral will be released at the end of the interest rate modification period.

 

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Table of Contents

The following table summarizes our CDO financings as of March 31, 2009 (dollars in thousands). The amounts reflect data at the CDO level which is unconsolidated and thus is different from the GAAP balance sheet due to intercompany amounts eliminated in consolidation.

 

     CDO IV     CDO V     CDO VI     CDO VII     CDO VIII    CDO IX     CDO X     Total / Weighted
Average
 

Balance Sheet:

                               

Asset Face Amount

   $ 453,397       $ 507,790       $ 493,154       $ 514,442       $ 907,595        $ 823,767       $ 1,442,585       $ 5,142,730  

Asset Amortized Cost Basis

   $ 211,775       $ 205,806       $ 163,709       $ 119,326       $ 409,802        $ 386,195       $ 651,860       $ 2,148,473  

Debt Carrying Value

     412,144         452,302         442,330         456,958         791,500          636,608         1,287,078         4,478,920  
                                                                               

Invested Equity(1)

   $ —         $ —         $ —         $ —         $ —          $ —         $ —         $ —   (2)
                                                                               

Quarterly Segment Basis Operating

                               

Income(2)

   $ 9,185       $ 9,303       $ 6,197       $ 4,027       $ 7,024        $ 6,730       $ 19,121       $ 61,587  

Quarterly Net Cash Receipts(3)

   $ 1,601       $ 1,691       $ 608       $ 160       $ 6,423        $ 5,541       $ 4,453       $ 20,477  

Collateral Composition(4):

                               

CMBS

     58.4 %   BB+       65.4 %   BB+       64.5 %   BBB     64.8 %   BBB     17.4 %   BB      10.7 %   BBB     51.3 %   BBB     43.5 %

REIT Debt

     22.6 %   BBB     15.3 %   BBB     10.4 %   BBB       13.1 %   BBB       3.3 %   C      0.0 %   —         21.1 %   BB     12.3 %

ABS

     14.5 %   A       16.5 %   BB+       17.1 %   B+       19.8 %   B+       8.6 %   B+      0.0 %   —         16.7 %   BB       12.7 %

Bank Loans

     2.1 %   B       0.0 %   —         7.9 %   B       2.1 %   B+       17.6 %   B—        25.4 %   CCC+       4.9 %   CCC       9.7 %

Mezzanine Loans / B-Notes

     2.1 %   BB+       0.0 %   —         0.0 %   —         0.0 %   —         42.8 %   CCC+      60.5 %   B—         0.0 %   —         17.5 %

CDO

     0.0 %   —         0.0 %   —         0.0 %   —         0.0 %   —         10.1 %   B      1.7 %   BB     3.1 %   CC       2.9 %

Restricted Cash

     0.3 %   —         2.8 %   —         0.1 %   —         0.2 %   —         0.2 %   —        1.7 %   —         2.9 %   —         1.4 %
                                                                                                         

Total

     100.0 %   BBB     100.0 %   BB+       100.0 %   BB+       100.0 %   BBB     100.0 %   B—        100.0 %   B—         100.0 %   BB       100.0 %
                                                                                                         

CDO Overview:

                               

Effective Date

     Sep-04         Feb-05         Aug-05         Jan-06         Mar-07          Jul-07         Dec-07      

Reinvestment Period Ends(5)

     Mar-09         Sep-09         Apr-10         Dec-10         Nov-11          May-12         Jul-12      

Optional Call Date(6)

     Jun-07         Dec-07         May-08  </