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 September 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 November 2, 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.

The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this report not misleading.

NEWCASTLE INVESTMENT CORP.

FORM 10-Q

INDEX


		PAGE
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

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

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

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

	Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 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		27

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		53

Item 4.	Controls and Procedures		56

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		57

Item 1A.	Risk Factors		57

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		75

Item 3.	Defaults upon Senior Securities		75

Item 4.	Reserved		75

Item 5.	Other Information		75

Item 6.	Exhibits		76

SIGNATURES			77

PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)


	September 30, 2010 (Unaudited)			December 31, 2009
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available for sale	$	1,941,162		$	1,784,487
Real estate related loans, held for sale, net		736,386			554,367
Residential mortgage loans, held for investment, net		127,830			—
Residential mortgage loans, held for sale, net		255,452			380,123
Subprime mortgage loans subject to call option		403,584			403,006
Restricted cash		156,825			200,251
Derivative assets		4,403			—
Receivables and other assets		32,571			36,643

		3,658,213			3,358,877

Recourse Financing Structures and Unlevered Assets
Real estate securities, available for sale		1,117			46,308
Real estate related loans, held for sale, net		32,821			19,495
Residential mortgage loans, held for sale, net		343			3,524
Operating real estate, held for sale		9,066			9,966
Cash and cash equivalents		58,336			68,300
Receivables and other assets		170			8,158

		101,853			155,751

	$	3,760,066		$	3,514,628

Liabilities and Stockholders’ Equity (Deficit)
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable	$	3,393,139		$	4,058,928
Other bonds payable		266,243			303,697
Notes payable		4,516			—
Financing of subprime mortgage loans subject to call option		403,584			403,006
Derivative liabilities		220,447			203,054
Accrued expenses and other liabilities		7,076			2,992

		4,295,005			4,971,677

Recourse Financing Structures and Other Liabilities
Repurchase agreements		—			71,309
Junior subordinated notes payable		51,255			103,264
Derivative liabilities		—			4,100
Due to affiliates		1,419			1,497
Accrued expenses and other liabilities		3,571			3,433

		56,245			183,603

		4,351,250			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 September 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 September 30, 2010 and December 31, 2009, respectively		620			529
Additional paid-in capital		1,065,362			1,033,520
Accumulated deficit		(1,527,368	)		(2,193,383	)
Accumulated other comprehensive income (loss)		(191,381	)		(633,818	)

		(591,184	)		(1,640,652	)

	$	3,760,066		$	3,514,628

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(dollars in thousands, except share data)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Interest income	$	81,040		$	75,222		$	225,315		$	287,033
Interest expense		42,547			52,438			131,277			167,154

Net interest income		38,493			22,784			94,038			119,879

Impairment
Valuation allowance (reversal) on loans		(105,360	)		(6,926	)		(292,668	)		83,093
Other-than-temporary impairment on securities		3,616			130,555			102,397			526,691
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)		6,425			(32,827	)		(15,575	)		(88,105	)

		(95,319	)		90,802			(205,846	)		521,679

Net interest income (loss) after impairment		133,812			(68,018	)		299,884			(401,800	)
Other Income (Loss)
Gain (loss) on settlement of investments, net		(1,134	)		(1,709	)		17,497			7,788
Gain on extinguishment of debt		46,624			132,534			141,698			186,209
Other income (loss), net		(8,828	)		(1,956	)		(12,606	)		2,474

		36,662			128,869			146,589			196,471

Expenses
Loan and security servicing expense		1,116			1,097			3,473			3,869
General and administrative expense		1,775			2,230			6,751			6,821
Management fee to affiliate		4,258			4,492			12,993			13,475
Depreciation and amortization		36			73			161			218

		7,185			7,892			23,378			24,383

Income (loss) from continuing operations		163,289			52,959			423,095			(229,712	)
Income (loss) from discontinued operations		213			79			186			(96	)

Net Income (Loss)		163,502			53,038			423,281			(229,808	)
Preferred dividends		(1,395	)		(3,375	)		(6,058	)		(10,126	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid - Note 9		—			—			43,043			—

Income (Loss) Applicable to Common Stockholders	$	162,107		$	49,663		$	460,266		$	(239,934	)

Income (Loss) Per Share of Common Stock
Basic	$	2.61		$	0.94		$	7.77		$	(4.54	)

Diluted	$	2.61		$	0.94		$	7.77		$	(4.54	)

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	$	2.61		$	0.94		$	7.77		$	(4.54	)

Diluted	$	2.61		$	0.94		$	7.77		$	(4.54	)

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

Diluted	$	—		$	—		$	—		$	—

Weighted Average Number of Shares of Common Stock Outstanding
Basic		62,024,945			52,905,335			59,249,175			52,850,034

Diluted		62,024,945			52,905,335			59,249,175			52,850,034

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 NINE MONTHS ENDED SEPTEMBER 30, 2010

(dollars in thousands)


	Preferred Stock						Common Stock				Additional Paid-in Capital		Accumulated Deficit			Accum. Other Comp. Income (Loss)			Total Stock-holders’ Equity (Deficit)
	Shares			Amount			Shares		Amount		Additional Paid-in Capital		Accumulated Deficit			Accum. Other Comp. Income (Loss)			Total Stock-holders’ Equity (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)		—			—			—		—		—		423,281			—			423,281
Net unrealized gain on securities		—			—			—		—		—		—			341,566			341,566
Reclassification of net realized loss on securities into earnings		—			—			—		—		—		—			66,047			66,047
Net unrealized (loss) on derivatives designated as cash flow hedges		—			—			—		—		—		—			(48,758	)		(48,758	)
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		—			—			—		—		—		—			14,353			14,353

Total comprehensive income (loss)																				796,489

Stockholders’ equity (deficit) - September 30, 2010		2,463,321		$	61,583			62,024,945	$	620	$	1,065,362	$	(1,527,368	)	$	(191,381	)	$	(591,184	)

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)


	Nine Months Ended September 30,
	2010			2009
Cash Flows From Operating Activities
Net income (loss)	$	423,281		$	(229,808	)
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		161			223
Accretion of discount and other amortization		(19,806	)		(23,657	)
Interest income in CDOs redirected for reinvestment or CDO bonds paydown		(4,609	)		(7,496	)
Valuation allowance on loans		(292,668	)		83,093
Non-cash directors’ compensation		60			91
(Gain) loss on sale of investments		(17,497	)		(7,788	)
Unrealized (gain) loss on non-hedge derivatives and hedge ineffectiveness		13,356			(1,946	)
Other-than-temporary impairment on securities		86,822			438,586
Impairment on real estate held for sale		60			400
(Gain) loss on extinguishment of debt		(141,698	)		(186,208	)
Change in:
Restricted cash		1,025			897
Receivables and other assets		3,781			6,174
Due to affiliates		(78	)		(35	)
Accrued expenses and other liabilities		(1,182	)		(982	)

Net cash provided by (used in) operating activities		51,008			71,544

Cash Flows From Investing Activities
Purchase of real estate securities		(2,291	)		(1,800	)
Proceeds from sale of real estate securities		49,117			135,999
Purchase of and advances on loans		(6,024	)		(14,723	)
Repayments of loan and security principal		150,164			72,544
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		840			1,350
Distributions of capital from equity method investees		161			109

Net cash provided by (used in) investing activities		185,646			185,456

Cash Flows From Financing Activities
Repayments of CDO bonds payable		(130,527	)		(30,943	)
Repurchase of CDO bonds payable		(11,400	)		(19,753	)
Issuance of other bonds payable		97,650			—
Repayments of other bonds payable		(134,027	)		(65,058	)
Repayments of repurchase agreements		(71,309	)		(198,488	)
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		49,872			82,362

Net cash provided by (used in) financing activities		(246,618	)		(233,497	)

Net Increase (Decrease) in Cash and Cash Equivalents		(9,964	)		23,503
Cash and Cash Equivalents, Beginning of Period		68,300			49,746

Cash and Cash Equivalents, End of Period	$	58,336		$	73,249

Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense	$	97,948		$	124,787
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)

SEPTEMBER 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, and (iv) unlevered investments. With respect to the first two nonrecourse segments, Newcastle is generally entitled to receive the net cash flows from these structures on a periodic basis.

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 September 30, 2010. In addition, Fortress, through its affiliates, held options to purchase approximately 1.7 million shares of Newcastle’s common stock at September 30, 2010.

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, financial statement presentation, revenue recognition, leases, financial instruments, hedging and fair value. Some of the proposed changes are significant and could have a material impact on Newcastle’s reporting. Newcastle has not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.

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. With respect to the first two nonrecourse segments, Newcastle is generally entitled to receive the net cash flows from these structures on a periodic basis.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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:


	Non-Recourse									Corporate
	CDOs (A)			Other (A)			Recourse			Unlevered			Other			Total
Nine Months Ended September 30, 2010
Interest income	$	168,150		$	54,952		$	976		$	1,189		$	48		$	225,315
Interest expense		83,209			44,462			645			356			2,605			131,277

Net interest income (expense)		84,941			10,490			331			833			(2,557	)		94,038
Impairment		(146,833	)		(35,323	)		(60	)		(23,630	)		—			(205,846	)
Other income (loss)		153,919			(5,417	)		(663	)		(905	)		(345	)		146,589
Depreciation and amortization		—			—			—			—			161			161
Other operating expenses		1,134			2,394			4			17			19,668			23,217

Income (loss) from continuing operations		384,559			38,002			(276	)		23,541			(22,731	)		423,095
Income (loss) from discontinued operations		—			—			—			186			—			186

Net income (loss)		384,559			38,002			(276	)		23,727			(22,731	)		423,281
Preferred dividends		—			—			—			—			(6,058	)		(6,058	)
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	$	384,559		$	38,002		$	(276	)	$	23,727		$	14,254		$	460,266


Three Months Ended September 30, 2010
Interest income	$	62,429		$	18,146		$	—		$	447		$	18		$	81,040
Interest expense		27,035			14,561			—			—			951			42,547

Net interest income (expense)		35,394			3,585			—			447			(933	)		38,493
Impairment		(86,525	)		(1,094	)		—			(7,700	)		—			(95,319	)
Other income (loss)		38,189			(1,636	)		—			109			—			36,662
Depreciation and amortization		—			—			—			—			36			36
Other operating expenses		345			768			—			7			6,029			7,149

Income (loss) from continuing operations		159,763			2,275			—			8,249			(6,998	)		163,289
Income (loss) from discontinued operations		—			—			—			213			—			213

Net income (loss)		159,763			2,275			—			8,462			(6,998	)		163,502
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	$	159,763		$	2,275		$	—		$	8,462		$	(6,998	)	$	162,107


September 30, 2010
Investments (B) (C)	$	2,727,017		$	737,397		$	—		$	43,347		$	—		$	3,507,761
Cash and restricted cash		156,825			—			—			232			58,104			215,161
Other assets		36,974			—			—			160			10			37,144

Total assets		2,920,816			737,397			—			43,739			58,114			3,760,066

Debt (C)		(3,397,655	)		(669,827	)		—			—			(51,255	)		(4,118,737	)
Derivative liabilities		(200,386	)		(20,061	)		—			—			—			(220,447	)
Other liabilities		(6,349	)		(727	)		—			(542	)		(4,448	)		(12,066	)

Total liabilities		(3,604,390	)		(690,615	)		—			(542	)		(55,703	)		(4,351,250	)

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

GAAP book value (D)	$	(683,574	)	$	46,782		$	—		$	43,197		$	(59,172	)	$	(652,767	)

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)


	Non-Recourse									Corporate
	CDOs (A)			Other (A)			Recourse			Unlevered			Other			Total
Nine Months Ended September 30, 2009
Interest income	$	221,385		$	58,043		$	6,200		$	1,333		$	72		$	287,033
Interest expense		107,475			50,440			3,021			—			6,218			167,154

Net interest income (expense)		113,910			7,603			3,179			1,333			(6,146	)		119,879
Impairment		478,631			(7,876	)		41,365			9,559			—			521,679
Other income (loss)		189,588			2,435			4,270			177			1			196,471
Depreciation and amortization		—			—			—			—			218			218
Other operating expenses		1,318			2,527			30			1			20,289			24,165

Income (loss) from continuing operations		(176,451	)		15,387			(33,946	)		(8,050	)		(26,652	)		(229,712	)
Income (loss) from discontinued operations		—			—			—			(96	)		—			(96	)

Net income (loss)		(176,451	)		15,387			(33,946	)		(8,146	)		(26,652	)		(229,808	)
Preferred dividends		—			—			—			—			(10,126	)		(10,126	)

Income (loss) applicable to common stockholders	$	(176,451	)	$	15,387		$	(33,946	)	$	(8,146	)	$	(36,778	)	$	(239,934	)


Three Months Ended September 30, 2009
Interest income	$	54,446		$	19,184		$	1,398		$	165		$	29		$	75,222
Interest expense		33,908			15,523			833			—			2,174			52,438

Net interest income (expense)		20,538			3,661			565			165			(2,145	)		22,784
Impairment		79,455			(1,319	)		8,894			3,772			—			90,802
Other income (loss)		130,715			(2,080	)		(41	)		275			—			128,869
Depreciation and amortization		—			—			—			—			73			73
Other operating expenses		436			657			5			—			6,721			7,819

Income (loss) from continuing operations		71,362			2,243			(8,375	)		(3,332	)		(8,939	)		52,959
Income (loss) from discontinued operations		—			—			—			79			—			79

Net income (loss)		71,362			2,243			(8,375	)		(3,253	)		(8,939	)		53,038
Preferred dividends		—			—			—			—			(3,375	)		(3,375	)

Income (loss) applicable to common stockholders	$	71,362		$	2,243		$	(8,375	)	$	(3,253	)	$	(12,314	)	$	49,663

(A)

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


	Outstanding Face Amount		Carrying Value
Real estate securities	$	156,613	$	1,117
Real estate related loans		226,956		32,821
Residential mortgage loans		1,268		343
Operating real estate		N/A		9,066

	$	384,837	$	43,347

(C)	Included in the other non-recourse segment were $403.6 million of Investments and Debt at September 30, 2010, representing the loans subject to call option of the two subprime securitizations and the corresponding financing.

(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, the aggregate negative GAAP book value which will eventually be recorded as an increase to GAAP book value is $497.0 million as of September 30, 2010.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Net income (loss)	$	163,502		$	53,038		$	423,281		$	(229,808	)
Net unrealized gain on securities		79,534			179,546			341,566			229,077
Reclassification of net realized loss on securities into earnings		11,117			99,437			66,047			431,328
Net unrealized gain (loss) on derivatives designated as cash flow hedges		(16,078	)		(20,303	)		(48,758	)		88,514
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		8,207			3,484			14,353			6,001

	$	246,282		$	315,202		$	796,489		$	525,112

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 September 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 de-consolidation of an entity that would otherwise have been consolidated.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 September 30, 2010, in which it has a significant interest, in addition to the subprime securitizations which are described in Note 4:


					Carrying Value of Newcastle’s
Entity	Gross Assets (A)		Debt (B)		Investment (C)
CDO VII	$	485,441	$	470,565	$	—

(A)	Face amount.

(B)	Includes $61.1 million face amount of debt owned by Newcastle with a carrying value of zero at September 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 September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Gain (loss) on settlement of investments, net
Gain on settlement of real estate securities	$	638		$	304		$	28,744		$	25,774
Loss on settlement of real estate securities		(1,772	)		(1,910	)		(7,968	)		(18,413	)
Loss on repayment of real estate securities		—			(103	)		—			(103	)
Gain on disposition of loans held for sale		—			—			—			526
Realized gain (loss) on termination of derivative instruments		—			—			(3,279	)		4

	$	(1,134	)	$	(1,709	)	$	17,497		$	7,788

Other income (loss), net
Gain (loss) on non-hedge derivative instruments	$	(1,861	)	$	(2,080	)	$	(5,992	)	$	11,232
Unrealized (loss) recognized at de-designation of hedges		(7,279	)		—			(7,279	)		(8,797	)
Hedge ineffectiveness		83			(171	)		(85	)		(489	)
Other income (loss)		229			295			750			528

	$	(8,828	)	$	(1,956	)	$	(12,606	)	$	2,474

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 September 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	$	1,528,976	$	1,299,535	$	(455,597	)	$	843,938	$	118,386	$	(96,442	)	$	865,882		199		BB+		5.75	%		11.54	%		3.4		10.2	%
CMBS- Single Borrower		495,133		480,603		(32,494	)		448,109		25,433		(66,199	)		407,343		65		B+		3.99	%		6.73	%		2.2		8.8	%
CMBS-Large Loan		45,734		45,729		—			45,729		—		(16,672	)		29,057		7		BB		1.96	%		2.02	%		0.9		14.8	%
REIT Debt		376,055		375,286		—			375,286		21,517		(11,748	)		385,055		44		BB+		6.13	%		5.90	%		3.4		N/A
ABS-Subprime (F)		378,819		364,026		(190,904	)		173,122		24,482		(6,682	)		190,922		89		B-		1.57	%		15.88	%		4.4		21.9	%
ABS-Manufactured Housing		48,275		46,935		—			46,935		1,410		(782	)		47,563		9		BBB		6.67	%		7.26	%		5.7		37.6	%
ABS-Franchise		30,709		30,972		(22,047	)		8,925		262		(1,207	)		7,980		13		CCC+		3.74	%		7.66	%		2.1		15.4	%
FNMA/FHLMC (G)		3,415		3,718		—			3,718		64		—			3,782		1		AAA		5.70	%		3.84	%		3.3		N/A
CDO (H)		80,462		14,734		(14,734	)		—		—		—			—		4		C		4.18	%		0.00	%		—		N/A

Debt Security Total /Average (I)		2,987,578		2,661,538		(715,776	)		1,945,762		191,554		(199,732	)		1,937,584		431		BB		4.87	%		9.37	%		3.2

Equity Securities				1,388		(276	)		1,112		3,583		—			4,695		2

Total			$	2,662,926	$	(716,052	)	$	1,946,874	$	195,137	$	(199,732	)	$	1,942,279	$	433

(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 $30.3 million and carrying value of $1.8 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)

SEPTEMBER 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 nine months ended September 30, 2010, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $102.4 million (gross of $15.6 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 September 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	$	114,447	$	94,170	$	(10,828	)	$	83,342	$	—	$	(3,216	)		80,126		18		BB+		5.66	%		12.48	%		4.7
Twelve or More Months		955,004		950,461		(62,718	)		887,743		—		(196,516	)		691,227		153		BB-		4.75	%		5.36	%		3.1

Total	$	1,069,451	$	1,044,631	$	(73,546	)	$	971,085	$	—	$	(199,732	)	$	771,353		171		BB-		4.85	%		5.97	%		3.3

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:


	September 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		62,514		82,979		(68,157	)		(20,465	)
Non credit impaired securities		708,839		888,106		—			(179,267	)

Total debt securities in an unrealized loss position	$	771,353	$	971,085	$	(68,157	)	$	(199,732	)

(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)

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)

SEPTEMBER 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 nine months ended September 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		(14,697	)

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		(10,450	)

Additions for credit losses on securities for which an OTTI was previously recognized without any portion of OTTI recognized in other comprehensive income		(10,797	)

Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at September 30, 2010		211,643

Reduction for securities sold during the period		48,965

Reduction for securities deconsolidated during the period		112,408

Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security		3,553


Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(68,157	)

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


	CMBS					ABS
Geographic Location	Outstanding Face Amount		Percentage			Outstanding Face Amount		Percentage
Western U.S.	$	553,217		26.7	%	$	127,841		27.9	%
Northeastern U.S.		487,545		23.6	%		84,065		18.4	%
Southeastern U.S.		414,549		20.0	%		106,559		23.3	%
Midwestern U.S.		305,601		14.8	%		61,574		13.4	%
Southwestern U.S.		229,490		11.1	%		48,302		10.6	%
Other		56,272		2.7	%		29,453		6.4	%
Foreign		23,169		1.1	%		9		0.0	%

	$	2,069,843		100.0	%	$	457,803		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)

SEPTEMBER 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 September 30, 2010 and December 31, 2009 and marked to the lower of carrying value or fair value. A portfolio of manufactured housing loans, which was refinanced in April 2010 through a securitization transaction (see Note 5), was reclassified from held for sale to held for investment during the nine months ended September 30, 2010.

The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at September 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	$	658,103	$	368,267		19		15.70	%		3.98	%		2.0		83.9	%	$	87,382
Corporate Bank Loans		301,102		195,800		9		16.60	%		8.60	%		3.6		62.7	%		—
B-Notes		283,132		149,167		10		15.88	%		4.37	%		1.6		78.7	%		95,092
Whole Loans		102,228		55,973		4		7.45	%		2.85	%		11.5		98.1	%		71,162

Total Real Estate Related Loans Held for Sale, Net	$	1,344,565	$	769,207		42		15.36	%		5.01	%		3.0		79.1	%	$	253,636

Manufactured Housing Loans Portfolio I	$	155,005	$	127,830		4,022		9.62	%		8.74	%		7.8		1.2	%	$	1,318

Residential Mortgage Loans, Held for Investment, Net	$	155,005	$	127,830		4,022		9.62	%		8.74	%		7.8		1.2	%	$	1,318

Residential Loans	$	65,246	$	49,469		228		6.00	%		2.49	%		6.8		100.0	%	$	5,837
Manufactured Housing Loans		1,268		343		31		46.99	%		8.30	%		0.7		0.0	%		562
Manufactured Housing Loans Portfolio II		220,027		205,983		7,325		8.58	%		9.72	%		5.9		17.4	%		3,755

Total Residential Mortgage Loans Held for Sale, Net	$	286,541	$	255,795		7,584		8.13	%		8.07	%		6.1		36.1	%	$	10,154

Subprime Mortgage Loans Subject to Call Option	$	406,217	$	403,584

(A)	Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $7.0 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 September 30, 2010:


Year of Maturity ⁽¹⁾	Outstanding Face Amount		Carrying Value		Number of Loans
Delinquent ⁽²⁾	$	253,636	$	24,907		7
Period from October 1, 2010 to December 31, 2010		51,614		46,193		1
2011		494,824		374,078		15
2012		158,310		87,149		6
2013		17,018		14,753		2
2014		125,672		54,846		3
2015		200,923		152,020		6
Thereafter		42,568		15,261		2

Total	$	1,344,565		769,207		42

(1)	Based on the final extended maturity date of each loan investment as of September 30, 2010.

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

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

The following is a rollforward 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)		55,681			6,478			813
Deconsolidation of CDO VII		5,263			—			—
Transfer to held for investment		—			21,884			(21,884	)
Valuation (allowance) reversal on loans		257,877			35,662			(871	)

Balance at September 30, 2010	$	(503,588	)	$	(32,385	)	$	(21,942	)

(A)	The charge-offs of $55.7 million in real estate related loans for the nine months ended September 30, 2010 represent five 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 September 30, 2010:


	Subprime Portfolio
	I		II
Total securitized loans (unpaid principal balance) (A)	$	540,192	$	714,113
Loans subject to call option (carrying value)	$	299,176	$	104,408
Retained interests (fair value) (B)	$	1,677	$	84

(A)	Average loan seasoning of 62 months and 44 months for Subprime Portfolios I and II, respectively, at September 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.

Newcastle has no obligation to repurchase any loans from either of its subprime securitizations. Therefore, it is expected that its exposure to loss is limited to the carrying amount of its retained interests in the securitization entities, as described above. A subsidiary of Newcastle gave limited representations and warranties with respect to Subprime Portfolio II; however, it has no assets and does not have recourse to the general credit of Newcastle.

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


	Subprime Portfolio
	I			II
Loan unpaid principal balance (UPB)	$	540,192		$	714,113
Weighted average coupon rate of loans		6.20	%		5.88	%
Delinquencies of 60 or more days (UPB) (A)	$	114,386		$	222,056
Net credit losses for the nine months ended September 30, 2010	$	29,189		$	50,741
Cumulative net credit losses	$	154,716		$	153,987
Cumulative net credit losses as a % of original UPB		10.30	%		14.15	%
Percentage of ARM loans (B)		53.0	%		65.8	%
Percentage of loans with original loan-to-value ratio >90%		10.60	%		17.10	%
Percentage of interest-only loans		22.9	%		4.1	%
Face amount of debt (C)	$	528,402		$	695,587
Weighted average funding cost of debt (D)		1.47	%		1.58	%

(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 $11.8 million and $18.5 million of retained notes for Subprime Portfolios I and II, respectively, at September 30, 2010.

(D)	Includes the effect of applicable hedges.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

Newcastle received net cash inflows of $0.3 million and $0.5 million from the retained interests of Subprime Portfolios I and II, respectively, during the nine months ended September 30, 2010 and $0.7 million and $1.1 million from I and II, respectively, during the nine months ended September 30, 2009.

The weighted average yield of the retained notes of Subprime Portfolios I and II was 23.1%, as of September 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)

SEPTEMBER 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 September 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)		Aggregat Notional Amount of Hedges (D)
CDO Bonds Payable
CDO IV (E)		Mar 2004		$	336,084	$	335,170		1.23%		Mar 2039		2.92	%		2.5	$	312,286	$	398,584	$	325,780	$	292,298		2.8	$	163,224	$	153,600
CDO V		Sep 2004			371,751		370,477		1.03%		Sep 2039		3.10	%		2.5		359,751		423,609		305,556		268,830		3.3		154,572		188,228
CDO VI (E)		Apr 2005			362,921		361,668		0.68%		Apr 2040		3.40	%		3.5		360,259		439,754		212,410		214,365		2.6		127,170		214,486
CDO VIII		Nov 2006			618,313		617,838		0.89%		Nov 2052		2.14	%		3.1		610,713		819,334		545,203		568,363		3.5		524,374		161,655
CDO IX		May 2007			530,125		534,299		0.67%		May 2052		1.49	%		4.2		530,125		760,547		523,026		535,939		3.6		545,495		91,606
CDO X		Jul 2007			1,175,000		1,173,687		0.64%		Jul 2052		4.33	%		4.7		1,175,000		1,314,003		976,431		1,003,552		3.6		240,632		1,049,629

					3,394,194		3,393,139						3.11	%		3.7		3,348,134		4,155,831		2,888,406		2,883,347		3.4		1,755,467		1,859,204

Other Bonds Payable
MH loans Portfolio I (F)		Apr 2010			90,071		88,673		4.75%		Jul 2035		5.37	%		3.6		—		155,005		127,830		127,830		7.8		1,821		—
MH loans Portfolio II		Aug 2006			177,904		177,570		LIBOR+ 0.88%		Aug 2011		6.11	%		0.8		177,904		220,027		205,983		205,983		5.9		38,181		134,426

					267,975		266,243						5.86	%		1.7		177,904		375,032		333,813		333,813		6.7		40,002		134,426

Notes Payable
Residential Mortgage Loans (G)		Aug 2004			4,516		4,516		LIBOR+ 0.90%		Dec 2034		1.25	%		7.1		4,516		4,516		4,516		4,516		7.1		4,516		—

					4,516		4,516						1.25	%		7.1		4,516		4,516		4,516		4,516		7.1		4,516		—

Corporate
Junior subordinatednotes payable		Mar 2006			51,004		51,255		7.57% (I)		Apr 2035		7.42	%		24.6		—		—		—		—		—		—		—

					51,004		51,255						7.42	%		24.6		—		—		—		—		—		—		—

Subtotal debt obligations					3,717,689		3,715,153						3.36	%		3.9	$	3,530,554	$	4,535,379	$	3,226,735	$	3,221,676		3.7	$	1,799,985	$	1,993,630

Financing on subprime mortgage loans subject to call option		(H	)		406,217		403,584

Total debt obligations				$	4,123,906	$	4,118,737

(A)	Weighted average, including floating and fixed rate classes and including the amortization of deferred financing costs.

(B)	Including the effect of applicable hedges.

(C)	Including restricted cash held for reinvestment in CDOs.

(D)	Including a $36.4 million notional amount of interest rate cap agreements in CDO X and a $134.4 million notional amount of interest rate swap agreements in MH loans portfolio II, which were not designated as hedges for accounting purposes.

(E)	CDOs IV and VI were not in compliance with their applicable over collateralization tests as of September 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.

(F)	Excluding $36.9 million of debt sold to certain Newcastle CDOs, which was eliminated in consolidation. See further description below.

(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)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

See Note 2 regarding the deconsolidation of CDO VII.

In the first nine months of 2010, Newcastle repurchased $168.0 million face amount of CDO bonds for $25.6 million. As a result, Newcastle extinguished $168.0 million face amount of CDO debt and recorded a gain on extinguishment of debt of $141.7 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. Newcastle 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)

SEPTEMBER 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 September 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*	$	2,830,965	$	1,941,162	$	1,941,162	Broker quotations, counterparty quotations, pricing services, pricing models		9.33	%		3.39
Real estate related loans, held for sale, net		1,117,609		736,386		736,708	Broker quotations, counterparty quotations, pricing services, pricing models		15.29	%		3.26
Residential mortgage loans, held for investment, net		155,005		127,830		128,034	Pricing models		9.62	%		7.8
Residential mortgage loans, held for sale, net		285,273		255,452		255,452	Pricing models		8.08	%		6.09
Subprime mortgage loans subject to call option (B)		406,217		403,584		403,584	(B)		9.09	%		(B	)
Restricted cash*		156,825		156,825		156,825
Derivative assets, treated as hedges (C)(E)*		104,205		2,782		2,782	Counterparty quotations		N/A			(C	)
Non-hedge derivative assets (D)(E)*		36,428		1,621		1,621	Counterparty quotations		N/A			(D	)
Receivables and other assets				32,571		32,571

			$	3,658,213	$	3,658,739

Recourse Financing Structures and Unlevered Assets
Financial instruments:
Real estate securities, available for sale*	$	156,613	$	1,117	$	1,117	Broker quotations, counterparty quotations, pricing services, pricing models		138.55	%		0.3
Real estate related loans, held for sale, net		226,956		32,821		32,821	Broker quotations, counterparty quotations, pricing services, pricing models		17.05	%		1.72
Residential mortgage loans, held for sale, net		1,268		343		343	Pricing models		46.99	%		0.7
Cash and cash equivalents*		58,336		58,336		58,336
Operating real estate, held for sale				9,066		9,066
Receivables and other assets				170		170

			$	101,853	$	101,853

Liabilities
Non-Recourse VIE Financing Structures (F)(G)
Financial instruments:
CDO bonds payable	$	3,394,194	$	3,393,139	$	2,104,822	Pricing models		3.12	%		3.7
Other bonds payable		267,975		266,243		247,127	Pricing models		5.86	%		1.7
Notes payable		4,516		4,516		3,672	Broker quotation		1.25	%		7.1
Financing of subprime mortgage loans subject to call option (B)		406,217		403,584		403,584	(B)		9.09	%		(B	)
Interest rate swaps, treated as hedges (C)(E)*		1,718,571		200,386		200,386	Counterparty quotations		N/A			(C	)
Non-hedge derivatives (D)(E)*		134,426		20,061		20,061	Counterparty quotations		N/A			(D	)
Accrued expenses and other liabilities				7,076		7,076

			$	4,295,005	$	2,986,728

Recourse Financing Structures and Other Liabilities (G)
Financial instruments:
Junior subordinated notes payable	$	51,004	$	51,255	$	21,603	Pricing models		7.42	%		24.6
Due to affiliates				1,419		1,419
Accrued expenses and other liabilities				3,571		3,571

			$	56,245	$	26,593

*	Measured at fair value on a recurring basis.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 derivative agreements as follows:


Year of Maturity	Weighted Average Month of Maturity		Aggregate Notional Amount		Weighted Average Fixed Pay Rate / Cap Rate			Aggregate Fair Value Asset / (Liability)
Interest rate cap agreements which receive 1-Month LIBOR:
2015		Sep	$	21,000		2.26	%	$	441
2016		Jul		77,905		2.66	%		2,128
2017		Jan		5,300		1.86	%		213

			$	104,205				$	2,782

Interest rate swap agreements which receive 1-Month LIBOR:
2011		Dec	$	91,606		5.00	%	$	(4,965	)
2014		Oct		15,914		5.09	%		(2,414	)
2015		Sep		915,034		5.31	%		(93,678	)
2016		May		180,155		5.04	%		(27,212	)
2017		Aug		174,034		5.24	%		(37,669	)
Interest rate swap agreements which receive 3-Month LIBOR:
2014		Jul		341,828		4.20	%		(34,448	)

			$	1,718,571				$	(200,386	)

(D)

This represents an interest rate swap with a notional balance of $134.4 million, maturing in June 2016 and three interest rate cap agreements with a total notional balance of $36.4 million, maturing in August 2017 and January 2019, respectively. Newcastle entered into these hedge agreements to reduce its exposure to interest rate changes on the floating rate financings of its manufactured housing loan portfolio II and on the floating rate financings of CDO X. These derivative agreements were not designated as hedges for 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, Wells Fargo 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.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

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 September 30, 2010:


	Principal Balance or Notional Amount				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	$	2,069,843	$	1,302,282	$	—	$	1,120,862	$	181,420	$	1,302,282
REIT debt		376,055		385,055		385,055		—		—		385,055
ABS - subprime		378,819		190,922		—		95,457		95,465		190,922
ABS - other real estate		78,984		55,543		—		48,589		6,954		55,543
FNMA / FHLMC		3,415		3,782		3,782		—		—		3,782
CDO		80,462		—		—		—		—		—

Debt security total	$	2,987,578		1,937,584		388,837		1,264,908		283,839		1,937,584

Equity securities				4,695		—		—		4,695		4,695

Real estate securities total			$	1,942,279	$	388,837	$	1,264,908	$	288,534	$	1,942,279

Derivative assets:
Interest rate caps, treated as hedges	$	104,205	$	2,782	$	2,782	$	—	$	—	$	2,782
Interest rate caps, not treated as hedges		36,428		1,621		1,621		—		—		1,621

Derivative assets total	$	140,633	$	4,403	$	4,403	$	—	$	—	$	4,403

Liabilities:
Derivative Liabilities:
Interest rate swaps, treated as hedges

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