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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 June 30, 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: 52,905,335 shares outstanding as of August 5, 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 June 30, 2009 (unaudited) and December 31, 2008

   1
  

Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2009 and 2008

   2
  

Consolidated Statements of Stockholders’ Equity (Deficit) (unaudited) for the six months ended June 30, 2009

   3
  

Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 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

   61

Item 3.

  

Defaults upon Senior Securities

   61

Item 4.

  

Submission of Matters to a Vote of Security Holders

   61

Item 5.

  

Other Information

   61

Item 6.

  

Exhibits

   62

SIGNATURES

   63


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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)

 

 

     June 30, 2009
(Unaudited)
    December 31, 2008  

Assets

    

Real estate securities, available for sale

   $ 1,568,324      $ 1,668,748   

Real estate related loans, held for sale

     717,078        843,212   

Residential mortgage loans, held for sale

     381,709        409,632   

Subprime mortgage loans subject to call option

     400,474        398,026   

Investments in unconsolidated subsidiaries

     221        384   

Operating real estate, held for sale

     10,266        11,866   

Cash and cash equivalents

     66,628        49,746   

Restricted cash

     77,573        44,282   

Receivables and other assets

     43,024        47,727   
                
   $ 3,265,297      $ 3,473,623   
                

Liabilities and Stockholders’ Equity (Deficit)

    

Liabilities

    

CDO bonds payable

   $ 4,270,103      $ 4,359,981   

Other bonds payable

     329,256        380,620   

Repurchase agreements

     117,478        276,472   

Financing of subprime mortgage loans subject to call option

     400,474        398,026   

Junior subordinated notes payable

     101,700        100,100   

Derivative liabilities

     222,252        333,977   

Due to affiliates

     1,497        1,532   

Accrued expenses and other liabilities

     6,068        16,447   
                
     5,448,828        5,867,155   
                

Stockholders’ Equity (Deficit)

    

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, 52,905,335 and 52,789,050 shares issued and outstanding at June 30, 2009 and December 31, 2008, respectively

     529        528   

Additional paid-in capital

     1,033,506        1,033,416   

Accumulated deficit

     (2,266,325     (3,272,403

Accumulated other comprehensive income (loss)

     (1,103,741     (307,573
                
     (2,183,531     (2,393,532
                
   $ 3,265,297      $ 3,473,623   
                

See notes to consolidated financial statements

 

1


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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(dollars in thousands, except share data)

 

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  

Interest income

   $ 87,338      $ 115,018      $ 211,811      $ 247,912   

Interest expense

     54,172        73,713        114,716        163,088   
                                

Net interest income

     33,166        41,305        97,095        84,824   
                                

Impairment

        

Provision for credit losses on loan pools

     3,557        1,868        5,464        4,373   

Valuation allowance (reversal) on loans (held for sale in 2009)

     (34,426     16,759        86,100        37,085   

Other-than-temporary impairment on securities

     209,554        101,797        396,136        148,169   

Portion of other-than-temporary impairment on securities recognized in other comprehensive income

     (55,278     —          (55,278     —     
                                
     123,407        120,424        432,422        189,627   
                                

Net interest income (loss) after impairment

     (90,241     (79,119     (335,327     (104,803

Other Income (Loss)

        

Gain (loss) on settlement of investments, net

     17,544        (37     11,042        6,489   

Gain on extinguishment of debt

     26,830        —          53,675        8,533   

Other income (loss), net

     10,939        1,427        4,445        (17,881

Equity in earnings (losses) of unconsolidated subsidiaries

     (28     7,062        (15     7,770   
                                
     55,285        8,452        69,147        4,911   
                                

Expenses

        

Loan and security servicing expense

     1,370        1,788        2,772        3,518   

General and administrative expense

     2,965        1,892        4,591        3,484   

Management fee to affiliate

     4,492        4,597        8,983        9,194   

Depreciation and amortization

     73        73        145        145   
                                
     8,900        8,350        16,491        16,341   
                                

Income (loss) from continuing operations

     (43,856     (79,017     (282,671     (116,233

Income (loss) from discontinued operations

     (142     (5,263     (175     (8,951
                                

Net Income (Loss)

     (43,998     (84,280     (282,846     (125,184

Preferred dividends

     (3,376     (3,376     (6,751     (6,751
                                

Income (Loss) Applicable to Common Stockholders

   $ (47,374   $ (87,656   $ (289,597   $ (131,935
                                

Income (Loss) Per Share of Common Stock

        

Basic

   $ (0.90   $ (1.66   $ (5.48   $ (2.50
                                

Diluted

   $ (0.90   $ (1.66   $ (5.48   $ (2.50
                                

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

        

Basic

   $ (0.90   $ (1.56   $ (5.48   $ (2.33
                                

Diluted

   $ (0.90   $ (1.56   $ (5.48   $ (2.33
                                

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

        

Basic

   $ —        $ (0.10   $ —        $ (0.17
                                

Diluted

   $ —        $ (0.10   $ —        $ (0.17
                                

Weighted Average Number of Shares of Common Stock Outstanding

        

Basic

     52,836,208        52,783,006        52,821,800        52,781,662   
                                

Diluted

     52,836,208        52,783,006        52,821,800        52,781,662   
                                

Dividends Declared per Share of Common Stock

   $ —        $ 0.25      $ —        $ 0.50   
                                

See notes to consolidated financial statements

 

2


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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) (Unaudited)

FOR THE SIX MONTHS ENDED JUNE 30, 2009

(dollars in thousands)

 

 

     Preferred Stock    Common Stock    Additional
Paid-in
Capital
   Accumulated
Deficit
    Accum. Other
Comp. Income
(Loss)
    Total
Stockholders’
Equity (Deficit)
 
     Shares    Amount    Shares    Amount          

Stockholders’ equity (deficit) - 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

   —        —      116,285      1      90      —          —          91   

Reclassification adjustment upon adoption of FSP 115-2 and 124-2

   —        —      —        —        —        1,288,924        (1,288,924     —     

Comprehensive income:

                     

Net (loss)

   —        —      —        —        —        (282,846     —          (282,846

Net unrealized gain on securities

   —        —      —        —        —        —          49,531        49,531   

Reclassification of net realized loss on securities into earnings

   —        —      —        —        —        —          331,891        331,891   

Net unrealized gain on derivatives designated as cash flow hedges

   —        —      —        —        —        —          108,817        108,817   

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

   —        —      —        —        —        —          2,517        2,517   
                           

Total comprehensive income (loss)

                        209,910   
                                                       

Stockholders’ equity (deficit) - June 30, 2009

   6,100,000    $ 152,500    52,905,335    $ 529    $ 1,033,506    $ (2,266,325   $ (1,103,741   $ (2,183,531
                                                       

See notes to consolidated financial statements

 

3


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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

 

 

     Six Months Ended June 30,  
     2009     2008  

Cash Flows From Operating Activities

    

Net income (loss)

   $ (282,846   $ (125,184

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

     150        493   

Accretion of discount and other amortization

     (33,612     (20,739

Deferred rent

     —          174   

Provision for credit losses on loan pools

     5,464        4,373   

Valuation allowance on loans held for sale

     86,100        37,085   

Non-cash directors' compensation

     91        75   

(Gain) on sale of investments

     (11,042     (6,913

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

     (4,197     20,376   

Other-than-temporary impairment on securities

     340,858        157,219   

Impairment on real estate held for sale

     250        —     

(Gain) loss on extinguishment of debt

     (53,675     (8,533

Equity in (earnings) losses of unconsolidated subsidiaries

     15        (7,770

Distributions of earnings from unconsolidated subsidiaries

     —          7,770   

Change in:

    

Restricted cash

     1,459        3,196   

Receivables and other assets

     2,328        16,034   

Due to affiliates

     (35     —     

Accrued expenses and other liabilities

     (1,674     (1,874
                

Net cash provided by (used in) operating activities

     49,634        75,782   
                

Cash Flows From Investing Activities

    

Purchase of real estate securities

     (1,800     —     

Proceeds from sale of real estate securities

     135,999        1,151,012   

Proceeds from settlement of loans

     —          12,636   

Purchase of and advances on loans

     (14,723     —     

Repayments of loan and security principal

     51,635        219,447   

Margin received on derivative instruments

     3,550        60,471   

Return of margin on derivative instruments

     —          (52,022

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

     —          (22,200

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

     37        29,891   

Net proceeds from termination of derivative instruments

     (11,610     (37,591

Purchase and improvement of operating real estate

     —          (604

Proceeds from sale of real estate held for sale

     1,350        —     

Distributions of capital from unconsolidated subsidiaries

     48        22,595   
                

Net cash provided by (used in) in investing activities

     164,486        1,383,635   
                

Continued on Page 5

See notes to consolidated financial statements

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

 

 

     Six Months Ended June 30,  
     2009     2008  

Cash Flows From Financing Activities

    

Repayments of CDO bonds payable

     (26,744     (332,643

Repayments of other bonds payable

     (51,472     (100,443

Borrowings under repurchase agreements

     —          20,819   

Repayments of repurchase agreements

     (159,048     (997,991

Return of margin deposits under repurchase agreements

     7,586        78,963   

Margin deposits under repurchase agreement

     (7,303     (72,656

Dividends paid

     —          (57,944

Payment of deferred financing costs

     (1,900     (337

Restricted cash returned from refinancing activities

     41,643        128,866   
                

Net cash provided by (used in) financing activities

     (197,238     (1,333,366
                

Net Increase (Decrease) in Cash and Cash Equivalents

     16,882        126,051   

Cash and Cash Equivalents, Beginning of Period

     49,746        55,916   
                

Cash and Cash Equivalents, End of Period

   $ 66,628      $ 181,967   
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid during the period for interest expense

   $ 87,067      $ 146,339   

Cash paid during the year for federal excise tax

   $ —        $ 316   

Supplemental Schedule of Non-Cash Investing and Financing Activities

    

Common stock dividends declared but not paid

   $ —        $ 13,197   

Preferred stock dividends declared but not paid

   $ —        $ 2,250   

See notes to consolidated financial statements

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 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.

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 June 30, 2009. In addition, the Manager, through its affiliates, held options to purchase approximately 1.6 million shares of Newcastle’s common stock at June 30, 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.

Change in Presentation

Newcastle has changed the format of its consolidated statements of operations for all periods presented to be more consistent with the provisions of Article 9 of Regulation S-X. Article 9 of Regulation S-X is applicable to bank holding companies and Newcastle believes that, as a finance company, Article 9’s provisions are more closely aligned with its operations than those in Article 5, which applies to commercial and industrial companies. This change in format did not have any effect on any of the reported line items within the statements of operations, or on net income (loss) or net income (loss) per share.

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.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2009

(dollars in tables in thousands, except share data)

 

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  

Six Months Ended June 30, 2009

            

Interest income

   $ 166,939      $ 38,859      $ 4,802      $ 1,168      $ 43      $ 211,811   

Interest expense

     73,567        34,917        2,188        —          4,044        114,716   
                                                

Net interest income (expense)

     93,372        3,942        2,614        1,168        (4,001     97,095   

Impairment

     400,721        (6,557     32,471        5,787        —          432,422   

Other income (loss)

     60,418        4,515        4,311        (98     1        69,147   

Depreciation and amortization

     —          —          —          —          145        145   

Other operating expenses

     882        1,870        25        1        13,568        16,346   
                                                

Income (loss) from continuing operations

     (247,813     13,144        (25,571     (4,718     (17,713     (282,671

Income (loss) from discontinued operations

     —          —          —          (175     —          (175
                                                

Net income (loss)

     (247,813     13,144        (25,571     (4,893     (17,713     (282,846

Preferred dividends

     —          —          —          —          (6,751     (6,751
                                                

Income (loss) applicable to common stockholders

   $ (247,813   $ 13,144      $ (25,571   $ (4,893   $ (24,464   $ (289,597
                                                

Three Months Ended June 30, 2009

            

Interest income

   $ 66,176      $ 18,517      $ 2,284      $ 339      $ 22      $ 87,338   

Interest expense

     35,253        15,761        991        —          2,167        54,172   
                                                

Net interest income (expense)

     30,923        2,756        1,293        339        (2,145     33,166   

Impairment

     119,235        (10,153     11,177        3,148        —          123,407   

Other income (loss)

     45,073        10,196        78        (61     (1     55,285   

Depreciation and amortization

     —          —          —          —          73        73   

Other operating expenses

     442        929        3        —          7,453        8,827   
                                                

Income (loss) from continuing operations

     (43,681     22,176        (9,809     (2,870     (9,672     (43,856

Income (loss) from discontinued operations

     —          —          —          (142     —          (142
                                                

Net income (loss)

     (43,681     22,176        (9,809     (3,012     (9,672     (43,998

Preferred dividends

     —          —          —          —          (3,376     (3,376
                                                

Income (loss) applicable to common stockholders

   $ (43,681   $ 22,176      $ (9,809   $ (3,012   $ (13,048   $ (47,374
                                                

June 30, 2009

            

Investments (C)

   $ 2,195,235      $ 735,766      $ 135,040      $ 12,031      $ —        $ 3,078,072   

Cash and restricted cash

     74,644        —          3,200        413        65,944        144,201   

Other assets

     39,382        —          838        82        2,722        43,024   

Debt

     (4,270,103     (729,730     (117,478     —          (101,700     (5,219,011

Derivative liabilities

     (194,392     (24,850     (3,010     —          —          (222,252

Other liabilities

     (1,131     (980     (627     (133     (4,694     (7,565

Preferred stock

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

GAAP book value (D)

   $ (2,156,365   $ (19,794   $ 17,963      $ 12,393      $ (190,228   $ (2,336,031
                                                

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2009

(dollars in tables in thousands, except share data)

 

 

     CDOs (A)     Other
Non-Recourse
(A) (B)
    Recourse     Unlevered     Unallocated     Total  

Six Months Ended June 30, 2008

            

Interest income

   $ 157,600      $ 46,257      $ 27,957      $ 14,966      $ 1,132      $ 247,912   

Interest expense

     104,585        34,436        20,006        302        3,759        163,088   
                                                

Net interest income (expense)

     53,015        11,821        7,951        14,664        (2,627     84,824   

Impairment

     145,422        5,660        2,432        36,113        —          189,627   

Other income (loss)

     3,037        (548     (5,434     8,443        (587     4,911   

Depreciation and amortization

     —          —          —          —          145        145   

Other operating expenses

     820        2,603        25        104        12,644        16,196   
                                                

Income (loss) from continuing operations

     (90,190     3,010        60        (13,110     (16,003     (116,233

Income (loss) from discontinued operations

     —          —          —          (8,951     —          (8,951
                                                

Net income (loss)

     (90,190     3,010        60        (22,061     (16,003     (125,184

Preferred dividends

     —          —          —          —          (6,751     (6,751
                                                

Income (loss) applicable to common stockholders

   $ (90,190   $ 3,010      $ 60      $ (22,061   $ (22,754   $ (131,935
                                                

Three Months Ended June 30, 2008

            

Interest income

   $ 73,401      $ 22,002      $ 11,547      $ 7,472      $ 596      $ 115,018   

Interest expense

     47,492        16,540        7,614        187        1,880        73,713   
                                                

Net interest income (expense)

     25,909        5,462        3,933        7,285        (1,284     41,305   

Impairment

     84,545        1,933        —          33,946        —          120,424   

Other income (loss)

     821        (548     440        7,736        3        8,452   

Depreciation and amortization

     —          —          —          —          73        73   

Other operating expenses

     408        1,302        6        104        6,457        8,277   
                                                

Income (loss) from continuing operations

     (58,223     1,679        4,367        (19,029     (7,811     (79,017

Income (loss) from discontinued operations

     —          —          —          (5,263     —          (5,263
                                                

Net income (loss)

     (58,223     1,679        4,367        (24,292     (7,811     (84,280

Preferred dividends

     —          —          —          —          (3,376     (3,376
                                                

Income (loss) applicable to common stockholders

   $ (58,223   $ 1,679      $ 4,367      $ (24,292   $ (11,187   $ (87,656
                                                

 

(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 $16.7 million (carrying value) was recourse as of June 30, 2009.
(C) Investments in the unlevered segment include $8.3 million of real estate securities, $3.6 million of a real estate related loan and $0.2 million of interests in a joint venture at June 30, 2009. The real estate related loan was pledged as collateral for the junior subordinated notes and will be released at the end of the interest rate modification period.
(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 $1.1 billion.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 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

     (47

Equity in earnings of unconsolidated subsidiaries

     (15
        

Balance at June 30, 2009

   $ 221   
        

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

These items are comprised of the following:

 

     Six Months Ended June 30,  
     2009     2008  

Gain (loss) on settlement of investments, net

    

Gain on settlement of real estate securities

   $ 25,470      $ 6,459   

Loss on settlement of real estate securities

     (16,503     (979

Gain on disposition of loans held for sale

     2,071        1,434   

Realized gain (loss) on termination of derivative instruments

     4        (425
                
   $ 11,042      $ 6,489   
                

Other income (loss), net

    

Realized (loss) on total rate of return swaps

   $ —        $ (7,145

Unrealized (loss) on total rate of return swaps

     —          (3,624

Gain (loss) on non-hedge derivative instruments

     13,312        (8,405

Unrealized (loss) recognized at de-designation of hedges

     (8,797     (990

Hedge ineffectiveness

     (318     213   

Other income (loss)

     248        2,070   
                
   $ 4,445      $ (17,881
                

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 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 June 30, 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.

 

Asset Type

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

CMBS-Conduit

   $ 1,637,779    $ 1,462,986    $ (565,829   $ 897,157    $ 10,208    $ (441,168   $ 466,197    200    BBB    5.70   7.47   4.0

CMBS- Single Borrower

     622,971      611,790      (14,853     596,937      276      (254,096     343,117    69    BB    4.43   4.98   2.7

CMBS-Large Loan

     89,225      89,219      (2,086     87,133      —        (57,222     29,911    12    BB    1.98   2.08   2.5

CMBS- CDO

     16,000      14,731      (14,731     —        —        —          —      1    CC    10.13   0.00   —  

REIT Debt

     564,067      563,748      (8,285     555,463      5,586      (93,381     467,668    59    BB+    6.13   5.91   4.5

ABS-Subprime

     502,336      468,222      (263,724     204,498      103      (54,301     150,300    111    B    1.50   9.24   4.2

ABS-Manufactured Housing

     52,172      50,605      —          50,605      26      (13,410     37,221    9    BBB    6.69   7.23   5.8

ABS-Franchise

     36,721      37,237      (18,408     18,829      —        (5,816     13,013    17    BBB-    3.97   3.83   3.1

FNMA/FHLMC (D)

     51,476      52,855      —          52,855      2,024      —          54,879    3    AAA    5.84   5.56   4.0
                                                                             

Subtotal/Average (E)

     3,572,747      3,351,393      (887,916     2,463,477      18,223      (919,394     1,562,306    481    BB+    4.88   6.40   3.9
                                                                             

Retained Securities (F)

     76,059      73,081      (68,958     4,123      —        (1,059     3,064    7    CC    2.39   7.97   1.9

Residual Interests (F)

     365      29,527      (29,162     365      —        —          365    1    NR    0.00   30.00   0.3
                                                                             

Debt Security Total/Average

   $ 3,649,171      3,454,001      (986,036     2,467,965      18,223      (920,453     1,565,735    489    BB+    4.83   6.40   3.8
                                               

Equity Security

        1,111      —          1,111      1,478      —          2,589    1          
                                                             

Total

      $ 3,455,112    $ (986,036   $ 2,469,076    $ 19,701    $ (920,453   $ 1,568,324    490          
                                                             

 

(A) Represents the cumulative impairment against amortized cost basis recorded through earnings, net of the effect of the cumulative adjustment as a result of the adoption of FSP 115-2 and 124-2 (see below).
(B) See Note 6 regarding the estimation of fair value, which is equal to carrying value for all securities.
(C) 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.
(D) Amortized cost basis and carrying value include principal receivable of $0.8 million.
(E) The total outstanding face amount of fixed rate securities was $2.6 billion, and of floating rate securities was $1.0 billion.
(F) 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)

JUNE 30, 2009

(dollars in tables in thousands, except share data)

 

 

Unrealized losses that are considered other-than-temporary are recognized currently in income. During the six months ended June 30, 2009, Newcastle recorded other-than-temporary impairment charges of $396.1 million (gross of $55.3 million of the portion of other-than-temporary impairment recognized in other comprehensive income) 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 concluded that they were other-than-temporarily impaired in accordance with FSP FAS 115-2 and 124-2 (see below). The remaining unrealized losses on Newcastle’s securities are primarily the result of market factors. Pursuant to the FSP, these noncredit unrealized losses are recognized in accumulated other comprehensive income.

 

          Amortized Cost Basis    Gross Unrealized               Weighted Average

Securities in
an Unrealized
Loss Position

   Outstanding
Face
Amount
   Before
Impairment
   Other-than-
Temporary
Impairment
    After
Impairment
   Gains    Losses     Carrying
Value
   Number
of
Securities
   Rating (E)    Coupon     Yield     Maturity
(Years)

Less Than Twelve Months

   $ 741,146    $ 687,688    $ (424,248   $ 263,440    $ —      $ (47,616     215,824    129    B    3.28   9.79   3.1

Twelve or More Months

     2,517,417      2,460,984      (440,656     2,020,328      —        (872,837     1,147,491    313    BB+    5.19   5.39   3.7
                                                                             

Total

   $ 3,258,563    $ 3,148,672    $ (864,904   $ 2,283,768    $ —      $ (920,453   $ 1,363,315    442    BB    4.75   5.90   3.6
                                                                             

In April 2009, the FASB issued FSP FAS 115-2 and 124-2 “Recognition and Presentation of Other-Than-Temporary Impairments.” The FSP changes the guidance for determining, recording and disclosing other-than-temporary impairment (“OTTI”). This guidance applies to debt securities in an unrealized loss position (i.e. their fair value is less than their amortized cost basis) as follows:

 

     

Old Guidance

 

Current Guidance

Must express an intent and ability to hold securities until an expected recovery in value to amortized cost basis, or else record OTTI for the difference between fair value and amortized cost.   Must not have the intent to sell a security nor be in a position where a required sale is more likely than not, or else record OTTI for the difference between fair value and amortized cost.
   
If no recovery to amortized cost basis is expected, must record OTTI in the same amount.   Otherwise, must record OTTI relating to the portion of the unrealized loss which represents a credit loss, if any.

Newcastle performed an assessment of all of its debt securities that are in an unrealized loss position (unrealized loss position exists when a security’s amortized cost basis, excluding the effect of other than temporary impartment, exceeds its fair value) in accordance with the guidance of FSP FAS 115-2 and 124-2 and determined the following:

 

     June 30, 2009  
               Unrealized Losses  
     Fair Value    Amortized
Cost Basis (A)
   Credit (B)     Non-Credit (C)  

Securities Newcastle intends to sell

   $ —      $ —      $ —        N/A   

Securities Newcastle is more likely than not to be required to sell (A)

     —        —        —        N/A   

Securities Newcastle has no intent to sell and is not more likely than not to be required to sell:

          

Credit impaired securities

     165,571      234,094      (864,904   (68,523

Non credit impaired securities

     1,197,744      2,049,674      —        (851,930
                            

Total

     1,363,315      2,283,768      (864,904   (920,453
                            

 

(A) Newcastle may, at times, be more likely than not to be required to sell certain securities for liquidity purposes. While the amount of the securities to be sold may be an estimate, and the securities to be sold have not yet been identified, this FSP requires Newcastle to make its best estimate, which is subject to significant judgment regarding future events, and may differ materially from actual future sales.
(B) Excluding the effect of previously recorded other-than-temporary impairment, which must be reconsidered as a result of this FSP. These amounts, which aggregate $864.9 million, are required to be recorded as other-than-temporary impairment through the income statement. Of this amount, $710.6 million relates to prior periods (and will be recorded as part of the reclassification adjustment upon adoption, as described below) and $154.3 million relates to the three months ended June 30, 2009. In measuring the portion of credit losses, Newcastle’s management estimates the expected cash flow for each of the securities. This evaluation includes a review of the credit status and the performance of the collateral supporting those securities, including the credit of the issuer, key terms of the securities and the effect of local, industry and broader economic trends. Significant inputs in estimating the cash flows include management’s expectations of prepayment speeds, default rates and loss severities. Credit losses are measured as the decline in the present value of the expected future cash flows discounted at the investment’s effective interest rate.
(C) This amount represents unrealized losses on securities that are due to non-credit factors and is required to be recorded through other comprehensive income.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2009

(dollars in tables in thousands, except share data)

 

 

As a result of this reassessment, Newcastle is recording a reclassification adjustment upon adoption of FSP 115-2 and 124-2 of $1.3 billion of loss from Accumulated Deficit to Accumulated Other Comprehensive Income (Loss) and is recording $154.3 million of net other-than-temporary impairment on its securities for the three months ended June 30, 2009. The reclassification adjustment had no impact on total consolidated assets, liabilities or equity and did not impact Newcastle’s liquidity. This represents a substantive reversal of a large portion of the impairment charge recorded in the fourth quarter of 2008, which was originally recorded as a result of Newcastle’s inability to express the intent and ability to hold its securities until an expected recovery in value (if any).

The following table summarizes the activity related to credit losses on debt securities for the quarter ended June 30, 2009:

 

     Three months ended June 30, 2009  

Beginning balance of credit losses on debt securities for which a portion of an other-than-temporary impairment was recognized in other comprehensive income

   $ (363,125

Additions for credit losses on securities for which an OTTI was not previously recognized

     (69,962

Increases to credit losses on securities for which an OTTI was previously recognized and a portion of an other-than-temporary impairment was recognized in other comprehensive income

     (74,560

Additions for credit losses on securities for which an OTTI was previously recognized without any portion of other-than-temporary impairment recognized in other comprehensive income

     (370,166

Reduction for credit losses on securities for which an OTTI was previously recognized and a portion of an other-than-temporary impairment was recognized in other comprehensive income at the beginning but not at the end of the quarter

     12,909   

Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security

     532   
        

Ending balance of credit losses on debt securities for which a portion of an other-than-temporary impairment was recognized in other comprehensive income

   $ (864,372
        

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 impairment has 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. The adoption of EITF 99-20-1 did not have a material impact on Newcastle’s impairment analysis for the six months ended June 30, 2009 because Newcastle generally analyzes cash flows of securities in a manner consistent with market practice.

The table below summarizes the geographic distribution of the collateral securing our CMBS at June 30, 2009 (in thousands):

 

Geographic Location

   Outstanding Face Amount    Percentage  

Northeastern U.S.

   $ 562,885    23.8

Western U.S.

     565,161    23.9

Southeastern U.S.

     471,758    19.9

Midwestern U.S.

     305,683    12.9

Southwestern U.S.

     253,058    10.7

Other

     181,440    7.7

Foreign

     25,990    1.1
             
   $ 2,365,975    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)

JUNE 30, 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 June 30, 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

   $ 755,477    $ 296,542    23    54.15   2.1    86.9   $ 44,955

Corporate Bank Loans

     452,043      273,190    12    10.47   2.4    100.0     52,997

B-Notes

     309,710      80,568    11    51.77   2.0    84.3     95,092

Whole Loans

     102,053      66,778    4    30.66   1.9    97.6     —  
                                          

Total Real Estate Related Loans Held for Sale

   $ 1,619,283    $ 717,078    50    35.05   2.1    90.7   $ 193,044
                                          

Residential Loans

   $ 73,793    $ 46,417    251    14.04   6.1    100.0   $ 6,705

Manufactured Housing Loans

     442,761      335,292    13,089    14.51   7.0    10.7     6,698
                                          

Total Residential Mortgage Loans Held for Sale (C)

   $ 516,554    $ 381,709    13,340    14.45   6.8    23.5   $ 13,403
                                          

Subprime Mortgage Loans Subject to Call Option

   $ 406,217    $ 400,474             
                          

 

(A) The weighted average maturities were calculated based on constant prepayment rates (CPR) of 7% and 30% for the residential loan pools, and 4% and 6% 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 $0.2 million for the residential housing loans and principal and interest receivable of $8.5 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

     —          (5,464

Valuation (allowance) reversal on loans held for sale

     (92,263     6,163   

Realized losses

     62,001        5,464   
                

Balance at June 30, 2009

   $ (857,590   $ (130,043
                

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 June 30, 2009:

 

     Subprime Portfolio  
     I     II  

Total securitized loans (unpaid principal balance) (A)

   $ 639,824      $ 860,417   

Loans subject to call option (carrying value)

   $ 296,989      $ 103,485   

Retained interests (fair value) (B)

   $ 1,746      $ 1,684   

Weighted average life (years) of residual interest

     —          0.3   

Weighted average expected credit losses (C)

     24.4     43.1

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

   $ (195   $ (232

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

   $ (385   $ (410

Weighted average constant prepayment rate (D)

     9.6     3.8

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

   $ (36   $ (33

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

   $ (59   $ (62

Weighted average discount rate

     19.6     22.2

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

   $ (120   $ (21

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

   $ (219   $ (41

 

(A) Average loan seasoning of 46 months and 29 months for Subprime Portfolios I and II, respectively, at June 30, 2009.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2009

(dollars in tables in thousands, except share data)

 

 

(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 June 30, 2009:

 

     Subprime Portfolio  
     I     II  

Loan unpaid principal balance (UPB)

   $ 639,824      $ 860,417   

Weighted average coupon rate of loans

     7.22     7.10

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

   $ 111,751      $ 210,437   

Net credit losses for the six months ended June 30, 2009

   $ 52,686      $ 37,296   

Cumulative net credit losses

   $ 97,530      $ 57,260   

Cumulative net credit losses as a % of original UPB

     6.49     5.26

Percentage of ARM loans (B)

     55.2     67.8

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

     10.5     17.4

Percentage of interest-only loans

     24.8     4.5

Face amount of debt (C)

   $ 602,590      $ 782,926   

Weighted average funding cost of debt (D)

     1.78     2.57

 

(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 $37.2 million and $38.8 million of retained notes for Subprime Portfolios I and II, respectively, at June 30, 2009.
(D) Includes the effect of applicable hedges.

Newcastle received net cash inflows of $0.5 million and $0.8 million from the retained interests of Subprime Portfolios I and II, respectively, during the six months ended June 30, 2009.

The weighted average yields of the retained notes of Subprime Portfolios I and II were 9.65% and 4.88%, respectively, as of June 30, 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)

JUNE 30, 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 June 30, 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      $ 383,685    $ 382,068    1.46%   Mar 2039      3.07   3.3    $ 360,600    $ 382,918    $ 219,780    3.8    $ 184,152    $ 177,300

CDO V

   Sep 2004        454,500      452,438    1.27%   Sep 2039      3.04   3.7      442,500      428,450      232,957    3.9      236,666      208,574

CDO VI (D)

   Apr 2005        439,992      438,210    0.82%   Apr 2040      3.31   4.4      432,444      327,997      181,409    4.1      180,108      242,025

CDO VII (D)

   Dec 2005        414,792      412,125    0.80%   Dec 2050      4.17   6.2      408,499      224,713      134,398    4.3      111,844      298,355

CDO VIII

   Nov 2006        763,000      762,100    1.01%   Nov 2052      2.01   4.4      755,400      406,792      377,993    3.1      573,390      161,655

CDO IX

   May 2007        585,750      586,389    0.89%   May 2052      1.62   5.6      585,750      398,646      395,182    2.3      608,549      91,835

CDO X

   Jul 2007        1,237,750      1,236,773    0.47%   Jul 2052      4.39   5.7      1,237,750      1,019,675      743,846    3.8      286,292      949,393
                                                                      
       4,279,469      4,270,103        3.19   4.9      4,222,943      3,189,191      2,285,565    3.5      2,181,001      2,129,137
                                                                      

Other Bonds Payable

                                  

Manufactured housing loans (E)

   Jan 2006        118,213      118,213    LIBOR+0.75%   Jan 2009  (E)    4.96   —        118,213      124,526      124,526    8.0      2,533      —  

Manufactured housing loans (F)

   Aug 2006        212,075      211,043    LIBOR+1.02%   Aug 2011      6.45   1.9      212,075      210,765      210,765    6.3      44,650      —  
                                                                      
       330,288      329,256        5.92   1.2      330,288      335,291      335,291    7.0      47,183      —  
                                                                      

Repurchase Agreements (G)

                                  

Real estate securities, loans and properties

   Various        72,914      72,914    LIBOR+1.64%   Various      1.95   0.5      72,914      86,251      86,251    1.4      232,918      —  

FNMA/FHLMC securities

   Rolling        44,564      44,564    LIBOR+0.09%   Apr 2009      4.90   0.1      44,564      46,557      48,580    4.0      —        40,931
                                                                      
       117,478      117,478        3.07   0.4      117,478      132,808      134,831    1.8      232,918      40,931
                                                                      

Corporate

                                  

Junior subordinated notes payable (H)

   Mar 2006        101,700      101,700    1.00%(H)   Apr 2035      7.28   26.5      —        —        —      —        —        —  
                                                                      
       101,700      101,700        7.28   26.5      —        —        —      —        —        —  
                                                                      

Subtotal debt obligations

       4,828,935      4,818,537        3.46   5.0    $ 4,670,709    $ 3,657,290    $ 2,755,687    3.7    $ 2,461,102    $ 2,170,068
                                                                      

Financing on subprime mortgage loans subject to call option

   (I     406,217      400,474                           
                                          

Total debt obligations

     $ 5,235,152    $ 5,219,011                           
                                          

 

(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) CDOs VI and VII were not in compliance with their applicable over collateralization tests as of June 30, 2009. Newcastle is not receiving cash flows from these CDOs (other than senior management fees) and expects these CDOs to remain out of compliance for the foreseeable future.
(E) See further description below.
(F) Of which $16.8 million face amount is recourse financing.
(G) The counterparties on these repurchase agreements include: Goldman Sachs ($44.6 million of FNMA/FHLMC financing), Deutsche Bank ($36.8 million), Credit Suisse ($12.1 million) and Citigroup ($24.0 million). The non-FNMA/FHLMC financings are subject to scheduled repayments, with the final payment to be made in June 2010.
(H) 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 to LIBOR + 2.25% after April 2016. Pursuant to the exchange, a real estate loan, which was valued at $3.6 million on June 30, 2009, was pledged as collateral for the junior subordinated notes and will be released at the end of the interest rate modification period. For details, see Note 9 below.
(I) 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)

JUNE 30, 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 debt for one of Newcastle’s manufactured housing loan portfolios ($118.2 million outstanding at June 30, 2009) 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 posting) 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 posting) 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, 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 $26.8 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 and the aggregate principal amount of the Notes will increase to $104.9 million by July 30, 2010. 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 $3.6 million on June 30, 2009, as collateral. The pledged collateral will be released at the end of the interest rate modification period. Under the provisions of SFAS 15, this exchange is considered a troubled debt restructuring which requires Newcastle to account for the effect of the interest modification prospectively and to record the expenses related to the modification immediately through earnings.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 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 June 30, 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*

   $ 3,649,171    $ 1,568,324    $ 1,568,324    Broker quotations, counterparty quotations, pricing services, pricing models    6.40   3.8   

Real estate related loans, held for sale*

     1,619,283      717,078      717,078    Broker quotations, counterparty quotations, pricing services, pricing models    35.05   2.1   

Residential mortgage loans, held for sale*

     516,554      381,709      381,709    Pricing models    14.45   6.8   

Subprime mortgage loans subject to call option (B)

     406,217      400,474      400,474    (B)    9.09   (B

Liabilities:

                

CDO bonds payable

     4,279,469      4,270,103      736,935    Counterparty quotations, pricing models    3.19   4.9   

Other bonds payable

     330,288      329,256      253,157    Pricing models    5.92   1.2   

Repurchase agreements

     117,478      117,478      117,478    Market comparables    3.07   0.3   

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

     406,217      400,474      400,474    (B)    9.09   (B

Junior subordinated notes payable

     101,700      101,700      26,024    Pricing models    7.28   26.5   

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

     2,170,068      197,402      197,402    Counterparty quotations    N/A      (C

Non-hedge derivatives (D)(E)*

     265,533      24,850      24,850    Counterparty quotations    N/A      (D

 

* Measured at fair value on a recurring basis.
(A) Methods are listed in 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    $ 111,754    5.004   $ (8,598

2012

   July      21,012    5.388     (1,698

2014

   October      16,738    5.093     (1,684

2015

   September      1,280,501    5.255     (121,813

2016

   May      180,155    5.043     (18,618

2017

   August      174,034    5.235     (21,974

Agreements which receive 3-Month LIBOR:

          

2011

   February      32,000    5.078     (1,979

2014

   June      353,874    4.196     (21,038
                    
      $ 2,170,068      $ (197,402
                    

 

(D) These include two interest rate swaps with a total notional balance of $265.5 million. The maturity dates of the $102.3 million and $163.2 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 $72.9 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)

JUNE 30, 2009

(dollars in tables in thousands, except share data)

 

 

Securities Valuation

As of June 30, 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

   $ 2,365,975    $ 1,581,227    $ 549,135    $ 157,513    $ 132,577    $ 839,225

ABS – subprime

     502,336      204,498      56,307      18,579      75,414      150,300

Subprime retained

     76,059      4,123      —        —        3,064      3,064

Subprime residuals

     365      365      —        —        365      365

ABS – other real estate

     88,893      69,434      18,093      21,520      10,621      50,234

FNMA / FHLMC

     51,476      52,855      —        54,879      —        54,879

REIT debt

     564,067      555,463      223,502      244,166      —        467,668
                                         

Debt security total

   $ 3,649,171      2,467,965      847,037      497,657      222,041      1,565,735
                     

Equity security

        1,111      —        —        2,589      2,589
                                     

Total

      $ 2,469,076    $ 847,037    $ 497,657    $ 224,630      1,568,324
                                     

 

(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 June 30, 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

   $ 263,208    $ 132,577    $ 179,241    $ (130,631   20% - 82%    N/A    0% - 100%    0% - 100%

ABS – subprime

     105,642      75,414      50,885      (30,228   20%    1% - 13%    21% - 92%    50% - 100%

Subprime retained

     4,123      3,064      2,669      (1,059   20%    3%    60% - 74%    65% - 70%

Subprime residuals

     365      365      599      —        30%    3%    74%    65%

ABS – other RE

     14,902      10,621      3,793      (4,281   20%    2%    59%    69%
                                        

Debt security total

   $ 388,240    $ 222,041    $ 237,187    $ (166,199           

Equity security

     1,111      2,589         1,478              
                                        

Total

   $ 389,351    $ 224,630    $ 237,187    $ (164,721           
                                        

All of the assumptions listed have some degree of market observability, 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 significantly 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.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2009

(dollars in tables in thousands, except share data)

 

 

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.

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 June 30, 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

   $ 2,365,975    $ 839,225    $ —      $ 706,648    $ 132,577    $ 839,225

ABS – subprime

     502,336      150,300      —        74,886      75,414      150,300

Subprime retained

     76,059      3,064      —        —        3,064      3,064

Subprime residuals

     365      365      —        —        365      365

ABS – other real estate

     88,893      50,234      —        39,613      10,621      50,234

FNMA / FHLMC

     51,476      54,879      54,879      —        —        54,879

REIT debt

     564,067      467,668      —        467,668      —        467,668
                                         

Debt security total

     3,649,171      1,565,735      54,879      1,288,815      222,041      1,565,735
                     

Equity security

        2,589      —        —        2,589      2,589
                                     

Total

      $ 1,568,324    $ 54,879    $ 1,288,815    $ 224,630    $ 1,568,324
                                     

Liabilities:

                 

Interest rate swaps, treated as hedges

     2,170,068      197,402      197,402      —        —        197,402

Non-hedge derivatives

     265,533      24,850      24,850      —        —        24,850

Newcastle’s investments in instruments measured at fair value using Level 3 inputs changed during the six months ended June 30, 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)

     (124,929     (211,150     (336,079

Reclassification related to the adoption of FSP 115-2 included in Other Comprehensive income (loss)

     979,089        309,835        1,288,924   

Included in other comprehensive income (loss)

     (737,725     (169,117     (906,842

Amortization included in interest income

     43,087        17,455        60,542   

Settlements or repayments

     (40,423     (37,216     (77,639

Transfers between Level 3A and Level 3B

     (135,060     135,060        —     

Transfers into Level 3 (B)

     —          —          —     

Transfers out of Level 3 (B)

     —          —          —     
                        

Balance at June 30, 2009

   $ 1,288,815      $ 224,630      $ 1,513,445   
                        

 

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

 

     Six Months Ended
June 30, 2009
 

Gain (loss) on settlement of investments, net

   $ 4,779   

Other income (loss), net

     —     

Other-than-temporary impairment

     (340,858
        

Total

   $ (336,079
        

Other-than-temporary impairment recorded in earnings during the six months ended June 30, 2009 is attributable to the change in unrealized losses relating to Level 3 assets still held at June 30, 2009.

 

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

   $ 0.00

 

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

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2009

(dollars in tables in thousands, except share data)

 

 

During the six months ended June 30, 2009, Newcastle recorded $92.3 million and ($6.2) million of valuation allowance (reversal) 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. For real estate related loans, the most significant inputs used in the valuations are the amount and timing of expected future cash flows, market yields and the estimated collateral value of such loan investments. For residential mortgage loans, significant inputs include management’s expectations of prepayment speeds, default rates, loss severities and discount rates that market participants would use in determining the fair values of similar pools of residential mortgage loans.

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 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. For derivative instruments that are designated and qualify as a cash flow hedge (i.e. hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss, and net payments received or made, on the derivative instrument are reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings during the period of change.

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

 

          Fair Value
     Balance sheet location    June 30,
2009
   December 31,
2008

Interest rate swaps, designated as hedging instruments under SFAS 133

   Derivative liabilities    $ 197,402    $ 317,757

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

   Derivative liabilities      24,850      16,220
                
      $ 222,252    $ 333,977
                

The following table summarizes information related to derivatives:

 

     June 30,
2009
    December 31,
2008
 

Cash flow hedges

    

Notional amount of interest rate swap agreements

   $ 2,170,068      $ 2,376,420   

Amount of (loss) recognized in OCI on effective portion

     (193,043     (312,431

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

     883        932   

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

     (10,828     (2,825

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

     (4,726     1,149   

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

     (92,827     (19,570

Non-hedge Derivatives

    

Notional amount of interest rate swap agreements

     265,533        182,867   

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2009

(dollars in tables in thousands, except share data)

 

 

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

 

          Six Months Ended June 30,  
    

Income statement location

   2009     2008  

Cash flow hedges

       

Gain (loss) on the ineffective portion

   Other income (loss)    $ (318   $ 213   

Gain (loss) immediately recognized at dedesignation

   Other income (loss)      (8,797     (990

Amount of gain (loss) reclassified from AOCI into income, related to effective portion

   Interest expense      (48,701     (27,267

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

   Interest expense      49        46   

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

   Interest expense      (6,763     722   

Non-hedge derivatives gain (loss)

   Other income (loss)      13,312        (8,405

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 six months ended June 30, 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 June 30, 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 entered into an agreement effective June 30, 2009 with the other parties to the loan. As a result, as of June 30, 2009, Newcastle and its CDOs do not have any future funding commitment with respect to this loan.

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 June 30, 2009, if any, will not materially affect Newcastle’s consolidated results of operations or financial position.

Preferred Dividends in Arrears — As of June 30, 2009, $9.0 million of dividends on Newcastle’s cumulative preferred stock were unpaid and in arrears.

Contingent Gain in CDOs — Newcastle has recorded $1.1 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 $3.0 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 June 30, 2009 (referred to as “subsequent events”) through the issuance of these consolidated financial statements on August 10, 2009. Events subsequent to that date have not been considered in these financial statements.

 

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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 June 30, 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 June 30, 2009, our debt to equity ratio, as computed under this method, was approximately 4.5 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 up to a specified amount of 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 Six Months

Ended June 30,

   CDOs    Other
Non-Recourse
   Recourse    Unlevered    Unallocated    Total

2009

   $ 166,939    $ 38,859    $ 4,802    $ 1,168    $ 43    $ 211,811

2008

   $ 157,600    $ 46,257    $ 27,957    $ 14,966    $ 1,132    $ 247,912

 

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Market Considerations

Financial Institutions

Many market participants remain 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 six months of 2009, credit spreads 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 six months 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 and interest coverage 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 two quarters 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 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. Moreover, we will likely need to continue to place a high priority on managing our liquidity. 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.

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, and (ii) 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 GAAP 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 June 30, 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 GAAP 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 two quarters 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 debt securities valued with internal models, which have an aggregate fair value of $222.0 million as of June 30, 2009, a 10% unfavorable change in our assumptions would result in the following decreases in such aggregate fair value:

 

     CMBS     ABS  

Outstanding face amount

   $ 896,170      $ 469,944   

Fair value

   $ 132,577      $ 89,464   

Effect on fair value with 10% unfavorable change in:

    

Discount rate

   $ (5,656   $ (3,341

Prepayment rate

     N/A      $ (1,449

Default rate

   $ (10,810   $ (7,219

Loss severity

   $ (11,511   $ (11,563

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-temporary if (i) 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 (there is an expected credit loss), or (ii) if we have the intent to sell a security in an unrealized loss position or it is more likely than not we will be required to sell a security in an unrealized loss position prior to

 

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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. 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 six months ended June 30, 2009, we had 186, or $427.1 million carrying amount of, securities that were downgraded and recorded a net other-than-temporary impairment charge of $104.9 million on these securities in the second quarter of 2009. 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 it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold is also be subject to significant judgment, particularly in times of market illiquidity such as we are currently experiencing.

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. Newcastle reports the fair value of derivative instruments gross of cash paid or received pursuant to credit support agreements and is reflected on a net by counterparty basis when Newcastle believes a legal right of setoff exists under an enforceable netting agreement. 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 GAAP equity and/or earnings.

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

 

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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 June 30, 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 a change in the market value of loans, to the extent that the value is not above the cost basis, is recorded in Valuation Allowance.

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 half 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 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 impairment has 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 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

 

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the volume or level of activity for an asset or liability have significantly decreased. These FSPs were effective for Newcastle as of April 1, 2009. They had a significant impact on our disclosures, but no material impact on our financial condition, liquidity, or results of operations upon adoption. A reclassification adjustment of $1.3 billion of loss from Accumulated Deficit to Accumulated Other Comprehensive Income (Loss) was recorded at adoption of FSP FAS 115-2 and 124-2 but had no net effect on equity. Post-adoption impairment determinations, including the analysis performed at June 30, 2009, are performed using this new guidance and may result in materially different conclusions than would have been reached under prior guidance.

In June 2009, the FASB issued SFAS No. 166 “Accounting for Transfers of Financial Assets-an amendment of FASB Statement No. 140” SFAS 166 eliminates the concept of qualified special purpose entities (QSPEs), changes the requirements for reporting a transfer of a portion of financial assets as a sale, clarifies other sale accounting criteria and changes the initial measurement of a transferor’s interest in transferred financial assets. Furthermore, it requires additional disclosures. SFAS 166 is effective for fiscal year beginning after November 15, 2009. We are currently evaluating the potential impact of SFAS 166 will have on us.

In June 2009, the FASB issued SFAS No. 167 “Amendment to FASB Interpretation No. 46(R).” SFAS 167 changes the definition of a variable interest entity (“VIE”) and changes the methodology to determine who is the primary beneficiary of, or in other words who consolidates, a VIE. Furthermore, it eliminates the scope exception for qualified special purpose entities (QSPEs), which are now subject to the VIE consolidation rules. SFAS 167 is effective for fiscal year beginning after November 15, 2009. Generally, the changes are expected to cause more entities to be defined as VIE’s and to require consolidation by the entity that exercises day-to-day control over a VIE, such as servicers and collateral managers. We are currently evaluating the potential impact of SFAS 167 on us. If the adoption of this standard caused us to deconsolidate any of our CDOs or other non-recourse financing structures, we would record a gain to the extent that we have taken impairments on assets within a given VIE in excess of our investment in such VIE. This gain could be material. To the extent the adoption resulted in the consolidation of VIEs that are currently not consolidated, the impact could be material to our gross assets, liabilities, revenues and expenses but would not be material to the net income or equity applicable to our common stockholders.

RESULTS OF OPERATIONS

The following table summarizes the changes in our results of operations from the three and six months ended June 30, 2008 to the three and six months ended June 30, 2009 (dollars in thousands):

 

     Three Months     Six Months     Explanations of
Material

Changes
 
     Amount Change     Percent Change     Amount Change     Percent Change    

Interest income

   $ (27,680   (24.1 )%    $ (36,101   (14.6 )%    (1

Interest expense

     (19,541   (26.5 )%      (48,372   (29.7 )%    (1

Provision for credit losses on loan pools

     1,689      90.4     1,091      24.9   (2

Valuation allowance on loans held for sale

     (51,185   N.M.        49,015      N.M.      (2

Other-than-temporary impairment on securities, net

     52,479      N.M.        192,689      N.M.      (3

Gain (loss) on settlement of investments, net

     17,581      N.M.        4,553      70.2   (4

Gain (loss) on extinguishment of debt

     26,830      N.M.        45,142      N.M.      (5

Other income (loss), net

     9,512      N.M.        22,326      N.M.      (6

Equity in earnings of unconsolidated subsidiaries

     (7,090   (100.4 )%      (7,785   (100.2 )%    (7

Loan and security servicing expense

     (418   (23.4 )%      (746   (21.2 )%    (1

General and administrative expense

     1,073      56.7     1,107      31.8   (8

Management fee to affiliate

     (105   (2.3 )%      (211   (2.3 )%    (9

Depreciation and amortization

     —        0.0     —        0.0   N/A   
                              

Income (loss) from continuing operations

   $ 35,161      44.5   $ (166,438   143.2  
                              

 

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:

 

     Three Months     Six Months  
     Period to Period Increase (Decrease)     Period to Period Increase (Decrease)  
     Interest Income     Interest Expense     Interest Income     Interest Expense  

Disposition of securities and loans

   $ (5,166   $ (4,381   $ (13,218   $ (12,332

Repayment of debt obligations and related dispositions

     —          —          (4,004     (3,152

Paydowns

     (6,050     (3,020     (11,667     (7,270

Other (see below)

     (16,464     (12,140     (7,212     (25,618
                                
   $ (27,680   $ (19,541   $ (36,101   $ (48,372
                                

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 on the impaired securities.

Changes in loan and security servicing expense are primarily due to dispositions and paydowns.

 

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(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 six months ended June 30, 2009, the actual losses incurred in our pools of residential mortgage loans were recorded to Provision for Credit Losses on Loan Pools whereas the change in fair value was recorded to Valuation Allowance on Loans Held for Sale. The change for the three months ended June 30, 2009 is a result of a net increase in the valuation of the loans, primarily due to an increase in the valuation of a loan which was paid down at par subsequent to June 30, 2009.
(3) This change is due to the impairment charges recorded as a result of the continued credit market turmoil, which led us to record write downs to primarily all of our securities.
(4) This change is predominantly the result of the gains recorded on paydown at par of loans and securities previously written down, partially offset by the loss on sales of certain securities and loans.
(5) This change is primarily due to increased gains on the repurchase of our own debt.
(6) This change is primarily due to an increase in the fair value of our interest rate swaps not designated as accounting hedges in the six months ended June 30, 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.
(7) This change is primarily due to the sale of our interests in the operating real estate joint venture in 2008.
(8) This change is primarily to due to increases in legal fees related to the trust preferred modification and insurance expense, partially offset by a refund of excise tax paid in 2008.
(9) 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.

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

As of the date if this filing, we currently have sufficient cash on hand to satisfy all of our non-agency recourse liabilities (excluding our trust preferred securities, which are long-term obligations). With respect to the next twelve months, we expect that our cash on hand combined with our cash flow provided by operations will be sufficient to satisfy our anticipated liquidity needs with respect to our current investment portfolio, including related financings, hedges, potential margin calls 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 our cash on hand and, if needed, additional borrowings, proceeds received from repurchase agreements and similar financings, 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 and interest coverage 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.

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 valuation allowance 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 their over collateralization tests 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.

 

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Update on Liquidity, Capital Resources and Capital Obligations

Certain details regarding our liquidity, current financings and capital obligations as of August 5, 2009 are set forth below:

 

 

Cash – We had unrestricted cash of $69.1 million. In addition, we had $126.6 million of restricted cash for reinvestments in our CDOs;

 

 

Margin Exposure – We have no financings subject to margin calls, other than one repurchase agreement with a face amount of $43.7 million which finances our FNMA/FHLMC investments and four interest rate swap agreements with an aggregate notional amount of $72.2 million;

 

 

Construction Loan Funding Commitment – In June 2009, we entered into an agreement with the other lender parties to the commercial construction loan to terminate all future funding commitments. As a result, as of June 30, 2009, we no longer have any future funding commitments with respect to this loan; 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:

 

     August 5, 2009    June 30, 2009    December 31, 2008

Recourse Financings

        

Real Estate Securities, Loans and Properties

   $ 51,873    $ 72,914    $ 102,977

Manufactured Housing Loans

     15,650      16,764      51,118

FNMA/FHLMC Securities

     43,703      44,564      173,495
                    

Total Recourse Financings

   $ 111,226    $ 134,242    $ 327,590
                    

The following table summarizes the scheduled repayments of our recourse financings as of August 5, 2009:

August 6, 2009 to September 30, 2009 (A)

   $ 52,703      

4th Quarter 2009

     11,500      

1st Quarter 2010

     19,373      

2nd Quarter 2010

     23,000      

3rd Quarter 2010

     3,000      

4th Quarter 2010

     1,650      
            

Total Recourse Financings

   $ 111,226      
            

 

(A) Includes $43.7 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. As we discuss in more detail under “– Market Considerations”

 

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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 up to a specified amount of FNMA/FHLMC securities. 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.

 

 

Impact of Rating Downgrades on CDO Cash Flows – Ratings downgrades of assets in our CDOs can negatively impact compliance with the CDOs’ 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 of the affected CDO. We note that we currently have approximately $1 billion of CMBS assets that are under review by S&P and are under downgrade watch. S&P could downgrade some or all of these CMBS assets at any time, and any such downgrade could affect – and possibly materially affect – our future cash flows.

 

 

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 June 30, 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

   $ 2,366    $ 1,581      44.4   282    BBB –    3.6

Mezzanine Loans

     755      297      8.3   23    68   2.1

B-Notes

     310      81      2.3   11    60   2.0

Whole Loans

     102      67      1.9   4    45   1.9
                              

Total Commercial Assets

     3,533      2,026      56.9        3.1
                              

Residential

              

Manufactured Housing and Residential Mortgage Loans

     517      373      10.5   13,340    694      6.8

Subprime Securities

     502      205      5.8   111    B      4.2

Subprime Retained Securities and Residuals

     76      4      0.1   8    CC/650      1.9

Real Estate ABS

     89      69      1.9   26    BBB      4.7
                              
     1,184      651      18.3        5.2
                              

FNMA/FHLMC securities

     52      52      1.5   3    AAA      4.0
                              

Total Residential Assets

     1,236      703      19.8        5.2
                              

Corporate

              

REIT Debt

     564      555      15.6   59    BB+      4.5

Corporate Bank Loans

     452      273      7.7   12    CCC      2.4
                              

Total Corporate Assets

     1,016      828      23.3        3.6
                              

TOTAL / WA

   $ 5,785    $ 3,557      100.0        3.6
                              

Reconciliation to GAAP total assets:

              

Net unrealized loss recorded in accumulated other comprehensive income

        (901         

Other assets

              

Subprime mortgage loans subject to call option (4)

        400            

Real estate held for sale

        10            

Cash and restricted cash

        145            

Other

        54            
                    

GAAP total assets

      $ 3,265            
                    

 

WA – Weighted average, in all tables.

 

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(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) Weighted average life represents the timing of expected principal payments on the asset. For an asset with an expected loss, weighted average life represents the timing of all remaining expected cash flows, both principal and interest payments.
(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.
(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    $ 400,963    $ 393,643    24.9   2.9   11.7   3.5

2004

   BB+    61      446,969      367,993    23.3   2.8   5.4   4.2

2005

   BBB-    55      608,759      288,451    18.2   1.7   6.0   3.8

2006

   BBB-    49      461,555      319,283    20.2   1.4   9.7   3.2

2007

   BB    40      447,729      211,857    13.4   2.3   10.7   3.1
                                              

Total / WA

   BBB-    282    $ 2,365,975    $ 1,581,227    100.0   2.1   8.5   3.6
                                              

 

(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

   $ 755,477      $ 309,710      $ 102,053      $ 1,167,240   

Amortized Cost Basis

   $ 296,542      $ 80,568      $ 66,763      $ 443,873   

Number

     23        11        4        38   

Weighted Average First $ Loan to Value (A)

     55.8     48.0     0.0