Form 10-Q

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, 2010

¨	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 ¨ Non-accelerated filer x (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: 62,024,945 shares outstanding as of August 4, 2010.

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 that could materially affect our operations and 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 our ability to maintain 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 or requirements with respect to asset-backed securities that we may issue;

•

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.

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.

NEWCASTLE INVESTMENT CORP.

FORM 10-Q

INDEX


		PAGE
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets as of June 30, 2010 (unaudited) and December 31, 2009	1

	Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2010 and 2009	2

	Consolidated Statements of Stockholders’ Equity (Deficit) (unaudited) for the six months ended June 30, 2010	3

	Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2010 and 2009	4

	Notes to Consolidated Financial Statements (unaudited)	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	49

Item 4.	Controls and Procedures	52

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	53

Item 1A.	Risk Factors	53

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	71

Item 3.	Defaults upon Senior Securities	71

Item 4.	Reserved	71

Item 5.	Other Information	71

Item 6.	Exhibits	72

SIGNATURES		73

PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)


	June 30, 2010 (Unaudited)			December 31, 2009
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available for sale	$	1,872,612		$	1,784,487
Real estate related loans, held for sale, net		671,657			554,367
Residential mortgage loans, held for investment, net		131,084			—
Residential mortgage loans, held for sale, net		258,373			380,123
Subprime mortgage loans subject to call option		403,383			403,006
Restricted cash		145,366			200,251
Receivables and other assets		32,769			36,643

		3,515,244			3,358,877

Recourse Financing Structures and Unlevered Assets
Real estate securities, available for sale		3,467			46,308
Real estate related loans, held for sale, net		23,001			19,495
Residential mortgage loans, held for sale, net		4,182			3,524
Operating real estate, held for sale		9,906			9,966
Cash and cash equivalents		37,684			68,300
Receivables and other assets		1,016			8,158

		79,256			155,751

	$	3,594,500		$	3,514,628

Liabilities and Stockholders’ Equity (Deficit)
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable	$	3,481,618		$	4,058,928
Other bonds payable		275,933			303,697
Notes payable		4,582			—
Financing of subprime mortgage loans subject to call option		403,383			403,006
Derivative liabilities		203,274			203,054
Accrued expenses and other liabilities		7,415			2,992

		4,376,205			4,971,677

Recourse Financing Structures and Other Liabilities
Repurchase agreements		—			71,309
Junior subordinated notes payable		51,256			103,264
Derivative liabilities		—			4,100
Due to affiliates		1,419			1,497
Accrued expenses and other liabilities		3,086			3,433

		55,761			183,603

		4,431,966			5,155,280

Stockholders’ Equity (Deficit)
Preferred stock, $0.01 par value, 100,000,000 shares authorized, 1,347,321 and 2,500,000 shares of 9.75% Series B Cumulative Redeemable Preferred Stock, 496,000 and 1,600,000 shares of 8.05% Series C Cumulative Redeemable Preferred Stock, and 620,000 and 2,000,000 shares of 8.375% Series D Cumulative Redeemable Preferred Stock, liquidation preference $25.00 per share, issued and outstanding as of June 30, 2010 and December 31, 2009, respectively		61,583			152,500
Common stock, $0.01 par value, 500,000,000 shares authorized, 62,024,945 and 52,912,513 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively		620			529
Additional paid-in capital		1,065,362			1,033,520
Accumulated deficit		(1,690,870	)		(2,193,383	)
Accumulated other comprehensive income (loss)		(274,161	)		(633,818	)

		(837,466	)		(1,640,652	)

	$	3,594,500		$	3,514,628

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,
	2010			2009			2010			2009
Interest income	$	74,183		$	87,338		$	144,275		$	211,811
Interest expense		43,141			54,172			88,730			114,716

Net interest income		31,042			33,166			55,545			97,095

Impairment
Valuation allowance (reversal) on loans		(91,534	)		(30,869	)		(187,308	)		90,019
Other-than-temporary impairment on securities		33,925			209,554			98,781			396,136
Portion of other-than-temporary impairment on securities recognized in other comprehensive income (loss), net of the reversal of other comprehensive loss into net income (loss)		15,114			(55,278	)		(22,000	)		(55,278	)

		(42,495	)		123,407			(110,527	)		430,877

Net interest income (loss) after impairment		73,537			(90,241	)		166,072			(333,782	)
Other Income (Loss)
Gain on settlement of investments, net		8,954			17,544			18,631			9,497
Gain on extinguishment of debt		46,728			26,830			95,074			53,675
Other income (loss), net		(2,298	)		10,911			(3,778	)		4,430

		53,384			55,285			109,927			67,602

Expenses
Loan and security servicing expense		1,322			1,370			2,357			2,772
General and administrative expense		1,938			2,965			4,976			4,591
Management fee to affiliate		4,258			4,492			8,735			8,983
Depreciation and amortization		62			73			125			145

		7,580			8,900			16,193			16,491

Income (loss) from continuing operations		119,341			(43,856	)		259,806			(282,671	)
Income (loss) from discontinued operations		13			(142	)		(27	)		(175	)

Net Income (Loss)		119,354			(43,998	)		259,779			(282,846	)
Preferred dividends		(1,395	)		(3,376	)		(4,663	)		(6,751	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid - Note 9		—			—			43,043			—

Income (Loss) Applicable to Common Stockholders	$	117,959		$	(47,374	)	$	298,159		$	(289,597	)

Income (Loss) Per Share of Common Stock
Basic	$	1.90		$	(0.90	)	$	5.16		$	(5.48	)

Diluted	$	1.90		$	(0.90	)	$	5.16		$	(5.48	)

Income (loss) from continuing operations per share of common stock, after preferred dividends and excess of carrying amount of exchanged preferred stock over fair value of consideration paid
Basic	$	1.90		$	(0.90	)	$	5.16		$	(5.48	)

Diluted	$	1.90		$	(0.90	)	$	5.16		$	(5.48	)

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

Diluted	$	—		$	—		$	—		$	—

Weighted Average Number of Shares of Common Stock Outstanding
Basic		62,010,570			52,836,208			57,838,286			52,821,800

Diluted		62,010,570			52,836,208			57,838,286			52,821,800

Dividends Declared per Share of Common Stock	$	—		$	—		$	—		$	—

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

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

FOR THE SIX MONTHS ENDED JUNE 30, 2010

(dollars in thousands)


	Preferred Stock					Common Stock			Additional Paid-in		Accumulated			Accum. Other Comp. Income			Total Stockholders’ Equity
	Shares		Amount			Shares	Amount		Capital		Deficit			(Loss)			(Deficit)
Stockholders’ equity (deficit) - December 31, 2009	6,100,000		$	152,500		52,912,513	$	529	$	1,033,520	$	(2,193,383	)	$	(633,818	)	$	(1,640,652	)
Preferred dividends declared	—			—		—		—		—		(19,484	)		—			(19,484	)
Exchange of preferred stock for common stock and cash	(3,636,679	)		(90,917	)	9,091,668		91		31,782		43,043			—			(16,001	)
Issuance of common stock to directors	—			—		20,764		—		60		—			—			60
Deconsolidation of CDO VII:
Cumulative net loss	—			—		—		—		—		219,175			—			219,175
Deconsolidation of unrealized loss on securities	—			—		—		—		—		—			40,715			40,715
Deconsolidation of unrealized loss on derivatives designated as cash flow hedges	—			—		—		—		—		—			28,514			28,514
Comprehensive income:
Net income (loss)	—			—		—		—		—		259,779			—			259,779
Net unrealized gain on securities	—			—		—		—		—		—			262,032			262,032
Reclassification of net realized loss on securities into earnings	—			—		—		—		—		—			54,930			54,930
Net unrealized (loss) on derivatives designated as cash flow hedges	—			—		—		—		—		—			(32,680	)		(32,680	)
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings	—			—		—		—		—		—			6,146			6,146

Total comprehensive income (loss)																		550,207

Stockholders’ equity (deficit) - June 30, 2010	2,463,321		$	61,583		62,024,945	$	620	$	1,065,362	$	(1,690,870	)	$	(274,161	)	$	(837,466	)

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)


	Six Months Ended June 30,
	2010			2009
Cash Flows From Operating Activities
Net income (loss)	$	259,779		$	(282,846	)
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		125			150
Accretion of discount and other amortization		(8,377	)		(29,466	)
Interest income in CDOs redirected for reinvestment or CDO bonds paydown		(3,793	)		(6,447	)
Valuation allowance on loans		(187,308	)		90,019
Non-cash directors’ compensation		60			91
(Gain) loss on sale of investments		(18,631	)		(9,497	)
Unrealized (gain) loss on non-hedge derivatives and hedge ineffectiveness		4,299			(4,197	)
Other-than-temporary impairment on securities		76,781			340,858
Impairment on real estate held for sale		60			250
(Gain) loss on extinguishment of debt		(95,074	)		(53,675	)
Change in:
Restricted cash		(215	)		3,760
Receivables and other assets		2,967			2,343
Due to affiliates		(78	)		(35	)
Accrued expenses and other liabilities		(1,346	)		(1,674	)

Net cash provided by (used in) operating activities		29,249			49,634

Cash Flows From Investing Activities
Purchase of real estate securities		(2,291	)		(1,800	)
Proceeds from sale of real estate securities		48,367			135,999
Purchase of and advances on loans		—			(14,723	)
Repayments of loan and security principal		105,748			51,635
Margin received on derivative instruments		5,073			3,550
Return of margin deposits on total rate of return swaps (treated as derivative instruments)		—			37
Payments on settlement of derivative instruments		(11,394	)		(11,610	)
Proceeds from sale of real estate held for sale		—			1,350
Distributions of capital from equity method investees		159			48

Net cash provided by (used in) investing activities		145,662			164,486

Cash Flows From Financing Activities
Repayments and repurchases of CDO bonds payable		(89,975	)		(23,675	)
Repurchase of CDO bonds payable		(9,927	)		(3,069	)
Issuance of other bonds payable		97,650			—
Repayments of other bonds payable		(124,104	)		(51,472	)
Repayments of repurchase agreements		(71,309	)		(159,048	)
Margin deposits under repurchase agreements		—			(7,303	)
Return of margin deposits under repurchase agreements		—			7,586
Cash consideration paid in exchange for junior subordinated notes		(9,715	)		—
Cash consideration paid to redeem preferred stock		(16,001	)		—
Dividends paid		(19,484	)		—
Payment of deferred financing costs		(1,677	)		(1,900	)
Restricted cash returned from refinancing activities		39,015			41,643

Net cash provided by (used in) financing activities		(205,527	)		(197,238	)

Net Increase (Decrease) in Cash and Cash Equivalents		(30,616	)		16,882
Cash and Cash Equivalents, Beginning of Period		68,300			49,746

Cash and Cash Equivalents, End of Period	$	37,684		$	66,628

Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense	$	65,946		$	87,067
Supplemental Schedule of Non-Cash Investing and Financing Activities
Common stock issued to redeem preferred stock	$	28,457		$	—
Face amount of CDO bonds issued in exchange for previously issued junior subordinated notes of $52,094	$	37,625		$	—

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(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”), a subsidiary of Fortress Investment Group LLC (“Fortress”), 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 3.8 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its principals at June 30, 2010. In addition, Fortress, through its affiliates, held options to purchase approximately 1.7 million shares of Newcastle’s common stock at June 30, 2010.

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, 2009 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, 2009.

Change in Presentation

Newcastle has changed the format of its consolidated balance sheets for all periods presented to reflect the requirements of new guidance which became effective January 1, 2010. This change in format did not have any effect on any of the reported line items within the balance sheets, other than breaking them out by financing type, or on the statement of consolidated equity (deficit).

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, and (iv) unlevered investments.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(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, 2010
Interest income	$	105,721		$	36,806		$	976		$	742		$	30		$	144,275
Interest expense		56,174			29,901			645			356			1,654			88,730

Net interest income (expense)		49,547			6,905			331			386			(1,624	)		55,545
Impairment		(60,308	)		(34,229	)		(60	)		(15,930	)		—			(110,527	)
Other income (loss)		115,730			(3,781	)		(663	)		(1,014	)		(345	)		109,927
Depreciation and amortization		—			—			—			—			125			125
Other operating expenses		789			1,626			4			10			13,639			16,068

Income (loss) from continuing operations		224,796			35,727			(276	)		15,292			(15,733	)		259,806
Income (loss) from discontinued operations		—			—			—			(27	)		—			(27	)

Net income (loss)		224,796			35,727			(276	)		15,265			(15,733	)		259,779
Preferred dividends		—			—			—			—			(4,663	)		(4,663	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid - Note 9		—			—			—			—			43,043			43,043

Income (loss) applicable to common stockholders	$	224,796		$	35,727		$	(276	)	$	15,265		$	22,647		$	298,159


Three Months Ended June 30, 2010
Interest income	$	54,778		$	18,760		$	117		$	519		$	9		$	74,183
Interest expense		27,308			14,862			18			356			597			43,141

Net interest income (expense)		27,470			3,898			99			163			(588	)		31,042
Impairment		(29,462	)		3,063			—			(16,096	)		—			(42,495	)
Other income (loss)		56,008			(2,383	)		—			104			(345	)		53,384
Depreciation and amortization		—			—			—			—			62			62
Other operating expenses		437			948			—			9			6,124			7,518

Income (loss) from continuing operations		112,503			(2,496	)		99			16,354			(7,119	)		119,341
Income (loss) from discontinued operations		—			—			—			13			—			13

Net income (loss)		112,503			(2,496	)		99			16,367			(7,119	)		119,354
Preferred dividends		—			—			—			—			(1,395	)		(1,395	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid - Note 9		—			—			—			—			—			—

Income (loss) applicable to common stockholders	$	112,503		$	(2,496	)	$	99		$	16,367		$	(8,514	)	$	117,959


June 30, 2010
Investments (C) (D)	$	2,591,198		$	745,911		$	—		$	40,556		$	—		$	3,377,665
Cash and restricted cash		145,366			—			—			347			37,337			183,050
Other assets		32,769			—			—			221			795			33,785

Total assets		2,769,333			745,911			—			41,124			38,132			3,594,500

Debt (D)		(3,486,200	)		(679,316	)		—			—			(51,256	)		(4,216,772	)
Derivative liabilities		(184,839	)		(18,435	)		—			—			—			(203,274	)
Other liabilities		(6,649	)		(766	)		—			(771	)		(3,734	)		(11,920	)

Total liabilities		(3,677,688	)		(698,517	)		—			(771	)		(54,990	)		(4,431,966	)

Preferred stock		—			—			—			—			(61,583	)		(61,583	)

GAAP book value (E)	$	(908,355	)	$	47,394		$	—		$	40,353		$	(78,441	)	$	(899,049	)

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)


	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		399,176			(6,557	)		32,471			5,787			—			430,877
Other income (loss)		58,873			4,515			4,311			(98	)		1			67,602
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	)

(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 $1.4 million (carrying value) was recourse as of June 30, 2010.

(C)	The following table summarizes the investments in the unlevered segment as of June 30, 2010:


	Outstanding Face Amount		Carrying Value
Real estate securities	$	175,607	$	3,467
Real estate related loans		236,486		23,001
Residential mortgage loans		5,460		4,182
Operating real estate		N/A		9,906

	$	417,553	$	40,556

(D)	Included in the other non-recourse segment were $403.4 million of Investments and Debt at June 30, 2010, representing the loans subject to call option of the two subprime securitizations and the corresponding financing.

(E)

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 an increase to GAAP book value is $641 million as of June 30, 2010.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

Comprehensive Income

The following table summarizes our comprehensive income for the interim periods presented:


	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2009			2010			2009
Net income (loss)	$	119,354		$	(43,998	)	$	259,779		$	(282,846	)
Net unrealized gain on securities		144,104			131,196			262,032			49,531
Reclassification of net realized loss on securities into earnings		40,144			137,078			54,930			331,891
Net unrealized gain (loss) on derivatives designated as cash flow hedges		(24,152	)		86,834			(32,680	)		108,817
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		1,267			(9,433	)		6,146			2,517

	$	280,717		$	301,677		$	550,207		$	209,910

Variable Interest Entities (“VIEs”)

In June 2009, the FASB issued new guidance which changes the definition of a 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. This guidance is effective for fiscal years beginning after November 15, 2009.

Under the new guidance, a primary beneficiary is defined as the party who has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and will absorb a significant portion of the VIE’s expected losses or receive a significant portion of the expected residual returns as a result of holding variable interests.

The VIEs in which Newcastle has a significant interest include (i) Newcastle’s CDOs, in which Newcastle has been determined to be the primary beneficiary and therefore consolidates them (with the exception of CDO VII as described below), since it has the power to direct the activities that most significantly impact the CDOs’ economic performance and would absorb a significant portion of their expected losses and receive a significant portion of their expected residual returns, and (ii) the manufactured housing loan financing structures, which are similar to the CDOs in analysis. Newcastle’s CDOs and manufactured housing loan financings are held in special purpose entities whose debt is treated as non-recourse secured borrowings of Newcastle. Newcastle’s subprime securitizations are also considered VIE’s, but Newcastle does not control their activities and no longer receives a significant portion of their returns. These subprime securitizations were not consolidated under the current or prior guidance.

In addition, Newcastle’s investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. Newcastle is not obligated to provide, nor has it provided, any financial support to these VIEs. Newcastle monitors these investments and, to the extent Newcastle determines that it potentially owns a majority of the currently controlling class, it analyzes them for potential consolidation. As of June 30, 2010, Newcastle has not consolidated these potential VIEs due to the determination that, based on the nature of Newcastle’s investments and the provisions governing these structures, Newcastle does not have the power to direct the activities that most significantly impact their economic performance. Newcastle will continue to analyze future investments, as well as reconsideration events in existing entities, pursuant to the VIE requirements. These analyses require considerable judgment in determining the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power and economics. 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.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

On January 1, 2010, as a result of the adoption of the new guidance, Newcastle deconsolidated a non-recourse financing structure, CDO VII. Newcastle determined that it does not have the current power to direct the relevant activities of CDO VII as an event of default had occurred and we may be removed as the collateral manager by a single party. The deconsolidation reduced Newcastle’s gross assets by $149.4 million, reduced liabilities by $437.8 million and increased equity by $288.4 million. The deconsolidation also reduced revenues and expenses, but its impact was not material to the net income applicable to common stockholders. As a result of this new guidance, Newcastle has interests in the following unconsolidated VIE at June 30, 2010, in which it has a significant interest, in addition to the subprime securitizations which are described in Note 4:


Entity	Gross Assets (A)		Debt (B)		Carrying Value of Newcastle’s Investment (C)
CDO VII	$	486,633	$	470,489	$	—

(A)	Face amount.

(B)	Includes $60.5 million face amount of debt owned by Newcastle with a carrying value of zero at June 30, 2010.

(C)	Represent’s Newcastle’s maximum exposure to loss from these entities.

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

These items are comprised of the following:


	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2009			2010			2009
Gain (loss) on settlement of investments, net
Gain on settlement of real estate securities	$	14,289		$	18,082		$	28,106		$	25,470
Loss on settlement of real estate securities		(5,335	)		(884	)		(6,196	)		(16,503	)
Gain on disposition of loans held for sale		—			346			—			526
Realized gain (loss) on termination of derivative instruments		—			—			(3,279	)		4

	$	8,954		$	17,544		$	18,631		$	9,497

Other income (loss), net
Gain (loss) on non-hedge derivative instruments	$	(2,383	)	$	10,196		$	(4,131	)	$	13,312
Unrealized (loss) recognized at de-designation of hedges		—			—			—			(8,797	)
Hedge ineffectiveness		(167	)		510			(168	)		(318	)
Other income (loss)		252			205			521			233

	$	(2,298	)	$	10,911		$	(3,778	)	$	4,430

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(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, 2010, all of which are classified as available for sale and are, therefore, reported at fair value with changes in fair value recorded in other comprehensive income, except for securities that are other-than-temporarily impaired.


	Amortized Cost Basis																		Weighted Average
	Outstanding Face Amount		Before Impairment		Other-Than- Temporary Impairment (A)			After Impairment		Gross Unrealized					Carrying Value (B)		Number of Securities		Rating (C)	Coupon		Yield		Maturity (Years) (D)	Principal Subordination (E)
Asset Type	Outstanding Face Amount		Before Impairment		Other-Than- Temporary Impairment (A)			After Impairment		Gains		Losses			Carrying Value (B)		Number of Securities		Rating (C)	Coupon		Yield		Maturity (Years) (D)	Principal Subordination (E)
CMBS-Conduit	$	1,492,299	$	1,281,193	$	(486,844	)	$	794,349	$	88,187	$	(124,113	)	$	758,423		196	BB+	5.75	%	11.14	%	3.3	12.1	%
CMBS- Single Borrower		538,964		522,973		(32,494	)		490,479		27,163		(74,862	)		442,780		66	BB-	4.27	%	6.44	%	2.0	8.2	%
CMBS-Large Loan		60,378		60,374		—			60,374		—		(21,165	)		39,209		10	BB	2.09	%	2.14	%	0.9	16.5	%
REIT Debt		389,550		389,115		—			389,115		16,360		(14,672	)		390,803		46	BB+	6.14	%	5.88	%	3.5	N/A
ABS-Subprime (F)		395,087		373,363		(199,820	)		173,543		16,809		(9,101	)		181,251		89	B-	1.68	%	13.40	%	4.4	20.9	%
ABS-Manufactured Housing		49,345		47,961		—			47,961		785		(2,193	)		46,553		9	BBB+	6.68	%	7.26	%	6.0	37.2	%
ABS-Franchise		31,218		31,527		(21,234	)		10,293		342		(2,484	)		8,151		13	CCC+	3.78	%	9.91	%	2.7	15.3	%
FNMA/FHLMC (G)		3,759		4,100		—			4,100		51		—			4,151		1	AAA	5.71	%	3.91	%	3.5	N/A
CDO (H)		79,643		14,734		(14,734	)		—		—		—			—		4	C	4.21	%	0.00	%	—	N/A

Debt Security Total /Average (I)		3,040,243		2,725,340		(755,126	)		1,970,214		149,697		(248,590	)		1,871,321		434	BB	4.89	%	8.74	%	3.1

Equity Securities				1,388		(276	)		1,112		3,646		—			4,758		2

Total			$	2,726,728	$	(755,402	)	$	1,971,326	$	153,343	$	(248,590	)	$	1,876,079	$	436

(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 new accounting guidance on impairment in 2009.

(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 a “negative watch” assignment) at any time.

(D)	The weighted average maturity is based on the timing of expected principal reduction on the assets.

(E)	Percentage of the outstanding face amount of securities that is subordinate to Newcastle’s investments.

(F)	Includes the retained bonds with face amount of $40.5 million and carrying value of $2.1 million from Securitization Trust 2006 and Securitization Trust 2007 (Note 4). The residual interests were fully written off in the first quarter of 2010.

(G)	Amortized cost basis and carrying value include principal receivable of $0.1 million.

(H)	Includes one CDO bond issued by a third party and three CDO bonds issued by CDO VII, which has been deconsolidated, and held as investments by Newcastle.

(I)	The total outstanding face amount of fixed rate securities was $2.2 billion, and of floating rate securities was $0.8 billion.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(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, 2010, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $98.8 million (gross of $22.0 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. Any remaining unrealized losses on Newcastle’s securities were primarily the result of changes in market factors, rather than issue-specific credit impairment. The following table summarizes Newcastle’s securities in an unrealized loss position as of June 30, 2010.


	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	Coupon		Yield		Maturity (Years)
Less Than Twelve Months	$	244,766	$	228,462	$	(81,272	)	$	147,190	$	—	$	(7,241	)		139,949	29	BB+	4.68	%	9.08	%	3.3
Twelve or More Months		1,178,656		1,170,154		(138,654	)		1,031,500		—		(241,349	)		790,151	183	BB	4.85	%	5.68	%	3.0

Total	$	1,423,422	$	1,398,616	$	(219,926	)	$	1,178,690	$	—	$	(248,590	)	$	930,100	212	BB	4.82	%	6.11	%	3.0

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 OTTI, exceeds its fair value) and determined the following:


	June 30, 2010
	Fair Value		Amortized Cost Basis		Unrealized Losses
	Fair Value		Amortized Cost Basis		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		69,574		95,905		(209,952	)		(26,331	)
Non credit impaired securities		860,526		1,082,785		—			(222,259	)

Total debt securities in an unrealized loss position	$	930,100	$	1,178,690	$	(209,952	)	$	(248,590	)

(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, Newcastle must 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 OTTI. This amount is required to be recorded as other-than-temporary impairment through earnings. 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.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

The following table summarizes the activity related to credit losses on debt securities for the six months ended June 30, 2010:


Beginning balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(408,782	)

Additions for credit losses on securities for which an OTTI was not previously recognized		(23,617	)

Increases to credit losses on securities for which an OTTI was previously recognized and a portion of an OTTI was recognized in other comprehensive income		(37,618	)

Additions for credit losses on securities for which an OTTI was previously recognized without any portion of OTTI recognized in other comprehensive income		(42,480	)

Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at June 30, 2010		143,189

Reduction for securities sold during the period		40,590

Reduction for securities deconsolidated during the period		112,409

Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security		6,357

Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(209,952	)

The table below summarizes the geographic distribution of the collateral securing our CMBS and ABS at June 30, 2010 (in thousands):


	CMBS				ABS
Geographic Location	Outstanding Face Amount		Percentage		Outstanding Face Amount		Percentage
Western U.S.	$	521,909	25.0	%	$	133,985	28.2	%
Northeastern U.S.		479,786	22.9	%		87,068	18.3	%
Southeastern U.S.		414,064	19.8	%		110,883	23.3	%
Midwestern U.S.		284,208	13.6	%		63,369	13.3	%
Southwestern U.S.		243,966	11.7	%		50,123	10.5	%
Other		126,406	6.0	%		30,213	6.4	%
Foreign		21,302	1.0	%		9	0.0	%

	$	2,091,641	100.0	%	$	475,650	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.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

4. REAL ESTATE RELATED LOANS, RESIDENTIAL MORTGAGE LOANS AND SUBPRIME MORTGAGE LOANS

All of Newcastle’s loan investments, other than the manufactured housing loans Portfolio I as described below, were classified as held for sale as of June 30, 2010 and December 31, 2009 and marked to the lower of carrying value or fair value. The portfolio of manufactured housing loans, refinanced in April 2010 through a securitization transaction (see Note 5), with a face amount of $159.4 million as of June 30, 2010 was reclassified from held for sale to held for investment for the three months ended June 30, 2010.

The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at June 30, 2010. 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 (A)		Loan Count	Wtd. Avg. Yield		Weighted Average Coupon		Weighted Average Maturity (Years) (B)	Floating Rate Loans as a % of Face Amount		Delinquent Face Amount (C)
Mezzanine Loans	$	716,286	$	313,879	20	23.21	%	4.73	%	2.1	85.4	%	$	132,795
Corporate Bank Loans		306,909		205,631	9	14.95	%	8.50	%	3.6	64.8	%		—
B-Notes		283,830		125,092	10	20.59	%	4.35	%	2.0	78.5	%		132,413
Whole Loans		85,110		50,056	4	8.75	%	3.30	%	4.0	97.6	%		—

Total Real Estate Related Loans Held for Sale, Net	$	1,392,135	$	694,658	43	19.25	%	5.40	%	2.5	80.2	%	$	265,208

Manufactured Housing Loans Portfolio I	$	159,355	$	131,084	4,120	9.64	%	8.75	%	7.8	1.2	%	$	1,421

Residential Mortgage Loans, Held for Investment, Net	$	159,355	$	131,084	4,120	9.64	%	8.75	%	7.8	1.2	%	$	1,421

Residential Loans	$	66,275	$	50,548	231	3.89	%	2.40	%	5.9	100.0	%	$	6,307
Manufactured Housing Loans		1,665		563	41	47.30	%	8.43	%	0.7	0.0	%		936
Manufactured Housing Loans Portfolio II		227,197		211,444	7,534	8.76	%	9.72	%	5.9	17.3	%		2,692

Total Residential Mortgage Loans Held for Sale, Net	$	295,137	$	262,555	7,806	7.91	%	8.07	%	5.9	35.8	%	$	9,935

Subprime Mortgage Loans Subject to Call Option	$	406,217	$	403,383

(A)	Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $7.5 million for the manufactured housing loans.

(B)	The weighted average maturity is based on the timing of expected principal reduction on the assets.

(C)	Includes loans that are non-performing, in foreclosure, under bankruptcy, or considered real estate owned.

The following is a summary of real estate related loans by maturities at June 30, 2010:


Year of Maturity ⁽¹⁾	Outstanding Face Amount		Carrying Value		Number of Loans
Delinquent ⁽²⁾	$	265,209	$	20,372	8
Period from July 1, 2010 to December 31, 2010		141,482		63,401	3
2011		531,614		343,442	16
2012		132,195		62,995	5
2013		17,077		4,375	2
2014		125,672		60,056	3
2015		160,029		122,473	5
Thereafter		18,857		7,544	1

Total	$	1,392,135		684,658	43

(1)	Based on the final extended maturity date of each loan investment as of June 30, 1010.

(2)	Includes loans that are non-performing, in foreclosure, or under bankruptcy.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

The following is a reconciliation of the related loss allowance.


	Held For Sale						Held For Investment
	Real Estate Related Loans			Residential Mortgage Loans			Residential Mortgage Loans
Balance at December 31, 2009	$	(822,409	)	$	(96,409	)	$	—
Charge-offs (A)		32,432			5,004			—
Deconsolidation of CDO VII		5,263			—			—
Transfer to held for investment		—			21,884			(21,884	)
Recoveries		—			—			—
Valuation (allowance) reversal on loans		153,265			34,712			(669	)

Balance at June 30, 2010	$	(631,449	)	$	(34,809	)	$	(22,553	)

(A)	The charge-offs of $32.4 million in real estate related loans for the six months ended June 30, 2010 represent three loans which were either sold, restructured or paid off at a discounted price during the period.

Securitization of Subprime Mortgage Loans

The following table presents information on the retained interests in Newcastle’s securitizations of subprime mortgage loans at June 30, 2010:


	Subprime Portfolio
	I		II
Total securitized loans (unpaid principal balance) (A)	$	556,930	$	733,920
Loans subject to call option (carrying value)	$	299,176	$	104,207
Retained interests (fair value) (B)	$	1,947	$	129

(A)	Average loan seasoning of 59 months and 41 months for Subprime Portfolios I and II, respectively, at June 30, 2010.

(B)	The retained interests include retained bonds of the securitizations. Newcastle’s residual interests were written off in the first quarter of 2010. Fair value is estimated based on pricing models.

The following table summarizes certain characteristics of the underlying subprime mortgage loans, and related financing, in the securitizations as of June 30, 2010:


	Subprime Portfolio
	I			II
Loan unpaid principal balance (UPB)	$	556,930		$	733,920
Weighted average coupon rate of loans		6.57	%		6.27	%
Delinquencies of 60 or more days (UPB) (A)	$	132,426		$	246,915
Net credit losses for the six months ended June 30, 2010	$	18,874		$	37,136
Cumulative net credit losses	$	144,401		$	140,383
Cumulative net credit losses as a % of original UPB		9.61	%		12.90	%
Percentage of ARM loans (B)		53.3	%		66.1	%
Percentage of loans with original loan-to-value ratio >90%		10.40	%		17.20	%
Percentage of interest-only loans		22.9	%		4.0	%
Face amount of debt (C)	$	540,517		$	709,806
Weighted average funding cost of debt (D)		1.60	%		1.72	%

(A)	Delinquencies include loans 60 or more days past due, in foreclosure, under bankruptcy filing 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 $16.4 million and $24.1 million of retained notes for Subprime Portfolios I and II, respectively, at June 30, 2010.

(D)	Includes the effect of applicable hedges.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

Newcastle received net cash inflows of $0.2 million and $0.4 million from the retained interests of Subprime Portfolios I and II, respectively, during the six months ended June 30, 2010 and $0.5 million and $0.8 million from I and II, respectively, during the six months ended June 30, 2009.

The weighted average yield of the retained notes of Subprime Portfolios I and II was 27.6%, as of June 30, 2010. 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 Portfolio’s I and II, respectively.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(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, 2010:


														Collateral
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		Outstanding Face Amount (C)		Amortized Cost Basis (C)		Carrying Value (C)		Weighted Average Maturity (Years)	Floating Rate Face Amount (C)		Aggregate Notional Amount of Current Hedges
CDO Bonds Payable
CDO IV (D)	Mar 2004		$	360,666	$	359,669	1.44%	Mar 2039	3.01	%	2.7	$	336,684	$	411,503	$	340,073	$	291,739	3.0	$	168,289	$	163,700
CDO V	Sep 2004			387,220		385,807	1.26%	Sep 2039	3.10	%	2.7		375,220		443,457		320,761		276,183	3.3		162,351		188,298
CDO VI (D)	Apr 2005			410,885		409,530	0.86%	Apr 2040	3.21	%	3.8		402,875		450,569		226,427		215,549	2.6		137,876		214,595
CDO VIII	Nov 2006			618,313		618,059	0.98%	Nov 2052	2.25	%	3.3		610,713		829,325		491,458		505,294	3.6		533,850		161,655
CDO IX	May 2007			530,125		534,731	0.35%	May 2052	1.67	%	4.4		530,125		759,356		472,430		487,601	2.7		522,900		91,651
CDO X	Jul 2007			1,175,000		1,173,822	0.63%	Jul 2052	4.46	%	5.1		1,175,000		1,322,198		983,399		962,696	3.5		268,305		932,231

				3,482,209		3,481,618			3.19	%	4.0		3,430,617		4,216,408		2,834,548		2,739,062	3.2		1,793,571		1,752,130

Other Bonds Payable
MH loans Portfolio I (E)	Apr 2010			93,913		92,385	4.74%	Jul 2035	5.36	%	3.7		—		159,355		131,084		131,084	7.8		1,964		—
MH loans Portfolio II (F)	Aug 2006			183,985		183,548	LIBOR+ 0.89%	Aug 2011	6.10	%	1.0		183,985		227,197		211,444		211,444	5.9		39,437		—

				277,898		275,933			5.85	%	1.9		183,985		386,552		342,528		342,528	6.7		41,401		—

Notes Payable (G)
Residential Mortgage Loans	Aug 2004			4,582		4,582	LIBOR+ 0.90%	Dec 2034	1.25	%	6.0		4,582		4,582		4,582		4,582	6.0		4,582		—

				4,582		4,582			1.25	%	6.0		4,582		4,582		4,582		4,582	6.0		4,582		—

Corporate
Junior subordinated notes payable	Mar 2006			51,004		51,256	7.57% (I)	Apr 2035	7.42	%	24.8		—		—		—		—	—		—		—

				51,004		51,256			7.42	%	24.8		—		—		—		—	—		—		—

Subtotal debt obligations				3,815,693		3,813,389			3.44	%	4.1	$	3,619,184	$	4,607,542	$	3,181,658	$	3,086,172	3.5	$	1,839,554	$	1,752,130

Financing on subprime mortgage loans subject to call option	(H	)		406,217		403,383

Total debt obligations			$	4,221,910	$	4,216,772

(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 reinvestment in CDOs.

(D)	CDOs IV and VI were not in compliance with their applicable over collateralization tests as of June 30, 2010. 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 $1.4 million face amount is recourse financing and was subsequently repaid in full in July 2010.

(G)	Notes payable issued to CDO VII, which was eliminated in consolidation through December 31, 2009.

(H)	Issued in April 2006 and July 2007. See Note 4 regarding the securitizations of Subprime Portfolios I and II.

(I)	LIBOR + 2.25% after April 2016.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

See Note 2 regarding the deconsolidation of CDO VII.

In the first six months of 2010, Newcastle repurchased $119.9 million face amount of CDO bonds for $24.1 million. As a result, Newcastle extinguished $119.9 million face amount of CDO debt and recorded a gain on extinguishment of debt of $95.1 million.

On January 29, 2010, Newcastle entered into an Exchange Agreement, dated as of January 29, 2010 (the “Exchange Agreement”), with Taberna Capital Management, LLC and certain of its affiliates (collectively, “Taberna”), pursuant to which Newcastle and Taberna agreed to exchange (the “Exchange”) approximately $52.1 million aggregate principal amount of junior subordinated notes due 2035 for approximately $37.6 million face amount of previously issued CDO securities and approximately $9.7 million of cash held by Newcastle. In other words, $52.1 million face amount of Newcastle’s debt, in the form of junior subordinated notes payable, was repurchased and extinguished for GAAP purposes in exchange for (i) the payment of $9.7 million of cash and (ii) the reissuance of $37.6 million face amount of CDO bonds payable (which had previously been repurchased by Newcastle). In connection with the Exchange, Newcastle paid or reimbursed $0.6 million of expenses incurred by Taberna, various indenture trustees and their respective advisors in accordance with the terms of the Exchange Agreement. Newacastle accounted for this exchange as a troubled debt restructuring involving the partial repayment of debt. As a result, Newcastle recorded no gain or loss. The following table presents certain information regarding the exchange, as of the date of the exchange:

Consideration

Repurchased junior
subordinated notes

Cash

Reissued CDO bonds

Total

Outstanding face amount

52,094

9,715

37,625

47,340

Weighted average coupon

7.574

% (A)

N/A

LIBOR + 0.66

% (B)

Maturity

April 2035

June 2052

Collateral

General credit of
Newcastle

Assets within the
respective CDOs

(A)	LIBOR + 2.25% after April 2016

(B)	Weighted average effective interest rate of approximately LIBOR+0.35% after the Exchange.

The fair value of the consideration paid approximated the fair value of the repurchased junior subordinated notes of $16.7 million.

In March 2010, Newcastle sold $22.8 million face amount of FHLMC securities and repaid the corresponding repurchase agreements in the amount of $22.6 million. Concurrent with the sales, Newcastle terminated the related interest rate swap agreements. As a result, the gain on sale recorded from these assets was offset by the loss on the termination of the derivatives.

On April 15, 2010, Newcastle completed a securitization transaction to refinance its Manufactured Housing Loans Portfolio I (the “Portfolio”). Newcastle sold approximately $164.1 million outstanding principal balance of manufactured housing loans to Newcastle MH I LLC (the “Issuer”). The Issuer issued approximately $134.5 million aggregate principal amount of asset-backed notes (the “Notes”), of which $97.6 million was sold to third parties and $36.9 million was sold to certain CDOs managed and consolidated by Newcastle. At the closing of the securitization transaction, Newcastle used the gross proceeds received from the issuance of the Notes to repay the previously existing financing on this portfolio in full, terminate the related interest rate swap contracts, pay the related transaction costs and increase its unrestricted cash by approximately $14 million. Under the applicable accounting guidance, the securitization transaction is accounted for as a secured borrowing. As a result, no gain or loss is recorded for the transaction. Newcastle continues to recognize the portfolio of manufactured housing loans as pledged assets, which have been classified as loans held for investment at securitization, and records the notes issued to third parties as a secured borrowing. The associated assets, liabilities, revenues and expenses are presented in the non-recourse financing structure sections of the consolidated financial statements.

In April 2010, Newcastle repaid in full all of its outstanding repurchase agreements.

In July 2010, Newcastle repaid in full the remaining $1.4 million of recourse debt on its Manufactured Housing Loan Portfolio II.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(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, 2010:


	Principal Balance or Notional Amount		Carrying Value		Fair Value		Fair Value Method (A)	Weighted Average Yield/Funding Cost		Weighted Average Maturity (Years)
Assets
Non-Recourse VIE Financing Structures (F)
Financial instruments:
Real estate securities, available for sale*	$	2,864,635	$	1,872,612	$	1,872,612	Broker quotations, counterparty quotations, pricing services, pricing models	8.69	%	3.3
Real estate related loans, held for sale, net		1,155,949		671,657		671,657	Broker quotations, counterparty quotations, pricing services, pricing models	18.73	%	2.8
Residential mortgage loans, held for investment, net		159,355		131,084		131,444	Pricing models	9.64	%	7.8
Residential mortgage loans, held for sale, net		289,677		258,373		258,373	Pricing models	7.95	%	5.9
Subprime mortgage loans subject to call option (B)		406,217		403,383		403,383	(B)	9.09	%	(B	)
Restricted cash*		145,366		145,366		145,366
Receivables and other assets				32,769		32,769

			$	3,515,244	$	3,515,604

Recourse Financing Structures and Unlevered Assets
Financial instruments:
Real estate securities, available for sale*	$	175,608	$	3,467	$	3,467	Broker quotations, counterparty quotations, pricing services, pricing models	38.09	%	0.3
Real estate related loans, held for sale, net		236,186		23,001		23,001	Broker quotations, counterparty quotations, pricing services, pricing models	34.54	%	1.3
Residential mortgage loans, held for sale, net		5,460		4,182		4,182	Pricing models	8.25	%	2.13
Cash and cash equivalents*		37,684		37,684		37,684
Operating real estate, held for sale				9,906		9,906
Receivables and other assets				1,016		1,016

			$	79,256	$	79,256

Liabilities
Non-Recourse VIE Financing Structures (F) (G)
Financial instruments:
CDO bonds payable	$	3,482,209	$	3,481,618	$	2,143,736	Pricing models	3.19	%	4.0
Other bonds payable ($1.4 million face amount is recourse)		277,899		275,933		254,844	Pricing models	5.85	%	1.9
Notes payable		4,582		4,582		3,732	Broker quotation	1.25	%	6.0
Financing of subprime mortgage loans subject to call option (B)		406,217		403,383		403,383	(B)	9.09	%	(B	)
Interest rate swaps, treated as hedges (C )(E)*		1,752,130		184,839		184,839	Counterparty quotations	N/A		(C	)
Non-hedge derivatives (D)(E)*		139,825		18,435		18,435	Counterparty quotations	N/A		(D	)
Accrued expenses and other liabilities				7,415		7,415

			$	4,376,205	$	3,016,384

Recourse Financing Structures and Other Liabilities (G)
Financial instruments:
Junior subordinated notes payable	$	51,004	$	51,256	$	16,963	Pricing models	7.42	%	24.8
Due to affiliates				1,419		1,419
Accrued expenses and other liabilities				3,086		3,086

			$	55,761	$	21,468

*	Measured at fair value on a recurring basis.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

(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 that 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 result 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:


Year of Maturity	Weighted Average Month of Maturity	Aggregate Notional Amount		Weighted Average Fixed Pay Rate		Aggregate Fair Value Liability, Net
Agreements which receive 1-Month LIBOR:
2011	Dec	$	91,651	5.00	%	$	(5,621	)
2014	Oct		16,073	5.09	%		(2,153	)
2015	Sep		938,219	5.31	%		(91,080	)
2016	May		180,155	5.04	%		(24,267	)
2017	Aug		174,034	5.24	%		(31,599	)
Agreements which receive 3-Month LIBOR:
2014	Jun		351,998	4.20	%		(30,119	)

		$	1,752,130			$	(184,839	)

(D)

This represents an interest rate swap with a notional balance of $139.8 million, maturing in June 2016. Newcastle entered into this swap agreement to reduce its exposure to interest rate changes on the floating rate financings of its manufactured housing loan portfolio II. This swap was not designated as a hedge for hedge accounting purposes.

(E)

Newcastle’s derivatives fall into two categories. Derivatives held within Newcastle’s nonrecourse debt structures (primarily CDOs), 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 CDO. 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.

(F)

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, our economic losses from such structures cannot exceed Newcastle’s invested equity in them. Therefore, economically, their net book value cannot be less than zero and as a result, the fair value of Newcastle’s net investments in these non-recourse financing structures is equal to the present value of their expected future net cash flows.

(G)	Newcastle notes that the unrealized gain on the liabilities within such structures cannot be fully realized.

Valuation Hierarchy

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 measured at fair value on a recurring basis at June 30, 2010:


	Principal Balance or Notional Amount		Carrying Value		Fair Value
	Principal Balance or Notional Amount		Carrying Value		Level 2		Level 3A (1)		Level 3B (2)		Total
Assets:
Real estate securities, available for sale:
CMBS	$	2,091,641	$	1,240,412	$	—	$	1,089,606	$	150,806	$	1,240,412
REIT debt		389,550		390,803		390,803		—		—		390,803
ABS - subprime		395,087		181,251		—		89,693		91,558		181,251
ABS - other real estate		80,563		54,704		—		47,058		7,646		54,704
FNMA / FHLMC		3,759		4,151		4,151		—		—		4,151
CDO		79,643		—		—		—		—		—

Debt security total		3,040,243		1,871,321		394,954		1,226,357		250,010		1,871,321

Equity securities				1,112		—		—		4,758		4,758

Total			$	1,872,433	$	394,954	$	1,226,357	$	254,768	$	1,876,079

Liabilities:
Interest rate swaps, treated as hedges		1,752,130		184,839		184,839		—		—		184,839
Non-hedge derivatives		139,825		18,435		18,435		—		—		18,435

(1)	Third party pricing sources with significant unobservable inputs.

(2)	Internal models with significant unobservable inputs.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

Newcastle’s investments in instruments measured at fair value on a recurring basis using Level 3 inputs changed during the six months ended June 30, 2010 as follows:


	Level 3A
	CMBS						ABS						Equity/Other Securities			Total
	Conduit			Other			Subprime			Other			Equity/Other Securities			Total
Balance at December 31, 2009	$	536,092		$	397,407		$	87,883		$	46,059		$	—		$	1,067,441
Transfers (C)
Transfers from Level 3B		310			1,637			—			—			—			1,947
Transfers into Level 3B		(39,541	)		(17,427	)		(10,538	)		—			—			(67,506	)
CDO VII Deconsolidation		(32,858	)		(3,379	)		(10,685	)		—			—			(46,922	)
Total gains (losses) (A)
Included in net income (loss) (B)		5,614			300			59			—			—			5,973
Included in other comprehensive income (loss)		102,163			56,903			(2,103	)		4,183			—			161,146
Amortization included in interest income		6,384			3,557			4,621			87			—			14,649
Purchases, sales and settlements
Purchases		127,029			17,958			39,013			—			—			184,000
Proceeds from sales		(25,679	)		(6,934	)		(6,478	)		—			—			(39,091	)
Proceeds from repayments		(4,385	)		(35,545	)		(12,079	)		(3,271	)		—			(55,280	)

Balance at June 30, 2010	$	675,129		$	414,477		$	89,693		$	47,058		$	—		$	1,226,357


	Level 3B
	CMBS						ABS						Equity/Other Securities			Total
	Conduit			Other			Subprime			Other			Equity/Other Securities			Total
Balance at December 31, 2009	$	95,376		$	32,744		$	85,377		$	10,719		$	2,620		$	226,836
Transfers (C)
Transfers from Level 3A		39,541			17,427			10,538			—			—			67,506
Transfers into Level 3A		(310	)		(1,637	)		—			—			—			(1,947	)
CDO VII Deconsolidation		(48,665	)		—			(17,890	)		(457	)		—			(67,012	)
Total gains (losses) (A)
Included in net income (loss) (B)		(67,616	)		9,459			(5,092	)		(2,675	)		(279	)		(66,203	)
Included in other comprehensive income (loss)		71,980			69,428			26,194			1,083			2,414			171,099
Amortization included in interest income		7,417			153			4,892			272			—			12,734
Purchases, sales and settlements
Purchases		—			—			—			—			3			3
Proceeds from sales		(435	)		(21,646	)		(1,063	)		—			—			(23,144	)
Proceeds from repayments		(13,995	)		(38,415	)		(11,398	)		(1,296	)		—			(65,104	)

Balance at June 30, 2010	$	83,293		$	67,513		$	91,558		$	7,646		$	4,758		$	254,768

(A)	None of the gains (losses) recorded in earnings during the period is attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting dates.

(B)


	Six Months Ended June 30, 2010
	Level 3A			Level 3B
Gain (loss) on settlement of investments, net	$	6,705		$	9,844
Other income (loss), net		—			—
OTTI		(732	)		(76,047	)

Total	$	5,973		$	(66,203	)

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

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

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

Securities Valuation

As of June 30, 2010, Newcastle’s securities valuation methodology and results are further detailed as follows:


	Outstanding Face Amount (A)		Amortized Cost Basis (B)		Fair Value
Asset Type	Outstanding Face Amount (A)		Amortized Cost Basis (B)		Multiple Quotes (C)		Single Quote (D)		Internal Pricing Models (E)		Total
CMBS	$	2,091,641	$	1,345,202	$	923,193	$	166,413	$	150,806	$	1,240,412
REIT debt		389,550		389,115		348,953		41,850		—		390,803
ABS – subprime		395,087		173,543		45,888		43,805		91,558		181,251
ABS – other real estate		80,563		58,254		4,426		42,632		7,646		54,704
FNMA / FHLMC		3,759		4,100		—		4,151		—		4,151
CDO		79,643		—		—		—		—		—

Debt security total	$	3,040,243		1,970,214		1,322,460		298,851		250,010		1,871,321

Equity securities				1,112		—		—		4,758		4,758

Total			$	1,971,326	$	1,322,460	$	298,851	$	254,768		1,876,079

(A)	Net of incurred losses.

(B)	Net of discounts (or gross of premiums) and after OTTI, including impairment taken during the period ended June 30, 2010.

(C)

Management generally obtained pricing service quotations or 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) or a pricing service.

(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
	Amortized Cost Basis		Fair Value		Impairment Recorded In Current Year		Unrealized Gains (Losses) in Accumulated OCI			Discount Rate	Prepayment Speed (F)	Cumulative Default Rate	Loss Severity
CMBS – Conduit	$	95,795	$	83,293	$	63,605	$	(12,502	)	18%	N/A	3% - 73%	31% - 51%
CMBS – Large loan / Single borrower		59,999		67,513		—		7,514		7% - 16%	N/A	0% - 100%	0% - 100%
ABS – subprime		84,022		91,558		5,520		7,536		10%	2% - 9%	26% - 91%	60% - 100%
ABS – other RE		8,486		7,646		2,675		(840	)	15%	0% - 8%	40% - 73%	57% - 90%
CDO		—		—		3		—		N/A	N/A	100%	100%

Debt security total	$	248,302	$	250,010	$	71,803	$	1,708
Equity securities		1,112		4,758		276		3,646

Total	$	249,414	$	254,768	$	72,079	$	5,354

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. Newcastle uses assumptions that generate its 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 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. Newcastle typically uses 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. Newcastle considers whether a collateral pool has experienced a significant change in its composition with respect to these factors when assigning severity projections.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

Default rates 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.

The discount rates Newcastle uses 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 Newcastle transacts have become less liquid, Newcastle has had to rely on fewer data points in this analysis.

(F)	Projected annualized average prepayment rate.

Loan Valuation

Loans which Newcastle does not have the ability to hold into the foreseeable future are classified as held-for-sale. As a result, these held-for-sale loans are carried at the lower of amortized cost or fair value and are therefore recorded at fair value on a non-recurring basis. During the six months ended June 30, 2010, Newcastle recorded ($153.3) million and ($34.7) 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.

The following tables summarize the fair value information of real estate related loans and residential mortgage loans:


	Outstanding Face Amount		Carrying Value		Fair Value		Valuation Allowance/ (Reversal) In Current Year			Significant Input Ranges
Loan Type	Outstanding Face Amount		Carrying Value		Fair Value		Valuation Allowance/ (Reversal) In Current Year			Discount Rate	Loss Severity
Mezzanine	$	716,286	$	313,879	$	313,879	$	(80,683	)	15.0% - 62.7%	0.0% - 100.0%
Bank Loan		306,909		205,631		205,631		(14,722	)	8.9% - 22.5%	0.0% - 58.0%
B-Note		283,830		125,092		125,092		(66,168	)	17.0% - 25.0%	0.0% - 100.0%
Whole Loan		85,110		50,056		50,056		8,308		1.8% - 19.6%	0.0% - 50.0%

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