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 March 31, 2011

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

For the transition period from to

Commission File Number: 001-31458

Newcastle Investment Corp.

(Exact name of registrant as specified in its charter)

Maryland

81-0559116

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)


1345 Avenue of the Americas, New York, NY		10105
(Address of principal executive offices)		(Zip Code)

(212) 798-6100

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

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

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

Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.

Common stock, $0.01 par value per share: 79,277,184 shares outstanding as of May 1, 2011.

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 have a material adverse effect or our operations and prospects include, but are not limited to:

•

reductions in cash flows received from our investments;

•

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

•

our ability to deploy capital accretively;

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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 March 31, 2011 (unaudited) and December 31, 2010		1

	Consolidated Statements of Income (unaudited) for the three months ended March 31, 2011 and 2010		2

	Consolidated Statements of Stockholders’ Equity (Deficit) (unaudited) for the three months ended March 31, 2011		3

	Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2011 and 2010		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		50

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		72

Item 3.	Defaults upon Senior Securities		72

Item 4.	(Removed and Reserved)		72

Item 5.	Other Information		72

Item 6.	Exhibits		73

SIGNATURES			74

PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)


	March 31, 2011 (Unaudited)			December 31, 2010
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available for sale	$	1,994,079		$	1,859,984
Real estate related loans, held for sale, net		764,254			750,130
Residential mortgage loans, held for investment, net		121,661			124,974
Residential mortgage loans, held for sale, net		246,298			252,915
Subprime mortgage loans subject to call option		404,011			403,793
Operating real estate, held for sale		8,339			8,776
Other investments		18,883			18,883
Restricted cash		131,540			157,005
Derivative assets		7,535			7,067
Receivables and other assets		31,420			29,206

		3,728,020			3,612,733

Recourse Financing Structures and Unlevered Assets
Real estate securities, available for sale		94,587			600
Real estate related loans, held for sale, net		4,608			32,475
Residential mortgage loans, held for sale, net		277			298
Other investments		6,024			6,024
Cash and cash equivalents		160,594			33,524
Receivables and other assets		3,586			1,457

		269,676			74,378

	$	3,997,696		$	3,687,111

Liabilities and Stockholders’ Equity (Deficit)
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable	$	2,944,193		$	3,010,868
Other bonds payable		246,561			256,809
Notes payable		4,296			4,356
Repurchase agreements		12,527			14,049
Financing of subprime mortgage loans subject to call option		404,011			403,793
Derivative liabilities		153,944			176,861
Accrued expenses and other liabilities		11,745			8,445

		3,777,277			3,875,181

Recourse Financing Structures and Other Liabilities
Repurchase agreements		83,276			4,683
Junior subordinated notes payable		51,252			51,253
Dividends payable		930			—
Due to affiliates		1,351			1,419
Accrued expenses and other liabilities		7,656			2,160

		144,465			59,515

		3,921,742			3,934,696

Stockholders’ Equity (Deficit)
Preferred stock, $0.01 par value, 100,000,000 shares authorized, 1,347,321 shares of 9.75% Series B Cumulative Redeemable Preferred Stock, 496,000 shares of 8.05% Series C Cumulative Redeemable Preferred Stock, and 620,000 shares of 8.375% Series D Cumulative Redeemable Preferred Stock, liquidation preference $25.00 per share, issued and outstanding as of March 31, 2011 and December 31, 2010		61,583			61,583
Common stock, $0.01 par value, 500,000,000 shares authorized, 79,277,184 and 62,027,184 shares issued and outstanding at March 31, 2011 and
December 31, 2010, respectively		793			620
Additional paid-in capital		1,163,604			1,065,377
Accumulated deficit		(1,224,429	)		(1,328,987	)
Accumulated other comprehensive income (loss)		74,403			(46,178	)

		75,954			(247,585	)

	$	3,997,696		$	3,687,111

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(dollars in thousands, except share data)


	Three Months Ended March 31,
	2011			2010
Interest income	$	72,203		$	70,092
Interest expense		38,165			45,589

Net interest income		34,038			24,503

Impairment (Reversal)
Valuation allowance (reversal) on loans		(41,307	)		(95,774	)
Other-than-temporary impairment on securities		3,112			64,856
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)		989			(37,114	)

		(37,206	)		(68,032	)

Net interest income after impairment		71,244			92,535

Other Income (Loss)
Gain (loss) on settlement of investments, net		34,092			9,677
Gain on extinguishment of debt		11,042			48,346
Other income (loss), net		335			(1,480	)

		45,469			56,543

Expenses
Loan and security servicing expense		1,060			1,035
General and administrative expense		1,601			3,101
Management fee to affiliate		4,189			4,477

		6,850			8,613

Income from continuing operations		109,863			140,465
Income (loss) from discontinued operations		(190	)		(40	)

Net Income		109,673			140,425
Preferred dividends		(1,395	)		(3,268	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid		—			43,043

Income Available for Common Stockholders	$	108,278		$	180,200

Income Per Share of Common Stock
Basic	$	1.73		$	3.36

Diluted	$	1.73		$	3.36

Income 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	$	1.73		$	3.36

Diluted	$	1.73		$	3.36

Income (loss) from discontinued operations per share of common stock
Basic	$	(0.00	)	$	(0.00	)

Diluted	$	(0.00	)	$	(0.00	)

Weighted Average Number of Shares of Common Stock Outstanding
Basic		62,602,184			53,619,643

Diluted		62,611,070			53,619,643

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 THREE MONTHS ENDED MARCH 31, 2011

(dollars in thousands)


	Preferred Stock				Common Stock				Additional Paid-in Capital		Accumulated Deficit			Accum. Other Comp. Income (Loss)			Total Stock-holders’ Equity (Deficit)
	Preferred Stock				Common Stock
	Shares		Amount		Shares		Amount
Stockholders’ equity (deficit) - December 31, 2010		2,463,321	$	61,583		62,027,184	$	620	$	1,065,377	$	(1,328,987	)	$	(46,178	)	$	(247,585	)
Preferred dividends declared		—		—		—		—		—		(5,115	)		—			(5,115	)
Issuance of common stock		—		—		17,250,000		173		98,227		—			—			98,400
Comprehensive income:
Net income		—		—		—		—		—		109,673			—			109,673
Net unrealized gain on securities		—		—		—		—		—		—			126,143			126,143
Reclassification of net realized (gain) on securities into earnings		—		—		—		—		—		—			(28,271	)		(28,271	)
Net unrealized gain on derivatives designated as cash flow hedges		—		—		—		—		—		—			18,411			18,411
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		—		—		—		—		—		—			4,298			4,298

Total comprehensive income																		230,254

Stockholders’ equity (deficit) - March 31, 2011		2,463,321	$	61,583		79,277,184	$	793	$	1,163,604	$	(1,224,429	)	$	74,403		$	75,954

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)


	Three Months Ended March 31,
	2011			2010
Cash Flows From Operating Activities
Net income	$	109,673		$	140,425
Adjustments to reconcile net income to net cash provided by (used in) operating activities (inclusive of amounts related to discontinued operations):
Depreciation and amortization		46			63
Accretion of discount and other amortization		(10,771	)		(1,181	)
Interest income in CDOs redirected for reinvestment or CDO bonds paydown		(3,724	)		(9,101	)
Interest income on investments accrued to principal balance		(4,535	)		—
Interest expense on debt accrued to principal balance		410			930
Deferred interest received		1,027			—
Reversal of valuation allowance on loans		(41,307	)		(95,774	)
Other-than-temporary impairment on securities		4,101			27,742
Impairment on real estate held for sale		433			—
Gain on settlement of investments, net		(33,158	)		(9,677	)
Unrealized loss on non-hedge derivatives and hedge ineffectiveness		201			1,749
Gain on extinguishment of debt		(11,042	)		(48,346	)
Change in:
Restricted cash		109			(695	)
Receivables and other assets		(40	)		2,346
Due to affiliates		(68	)		(15	)
Accrued expenses and other liabilities		(61	)		744

Net cash provided by (used in) operating activities		11,294			9,210

Cash Flows From Investing Activities
Purchase of real estate securities		(89,601	)		(3	)
Proceeds from sale of real estate securities		—			26,022
Acquisition of servicing rights		(2,082	)		—
Repayments of principal on loans and securities		37,605			15,770
Repayments of principal from repurchased CDO debt		9,726			25
Margin received on derivative instruments		—			5,073
Payments on settlement of derivative instruments		—			(3,668	)
Distributions of capital from equity method investees		—			152

Net cash provided by (used in) investing activities		(44,352	)		43,371

Cash Flows From Financing Activities
Repurchases of CDO bonds payable		(1,083	)		(144	)
Repayments of other bonds payable		(10,460	)		(11,346	)
Borrowings under repurchase agreements		79,978			—
Repayments of repurchase agreements		(2,907	)		(58,420	)
Issuance of common stock		98,843			—
Costs related to issuance of common stock		(58	)		—
Cash consideration paid in exchange for junior subordinated notes		—			(9,715	)
Cash consideration paid to redeem preferred stock		—			(16,001	)
Dividends paid		(4,185	)		(18,942	)
Restricted cash returned from refinancing activities		—			5,525

Net cash provided by (used in) financing activities		160,128			(109,043	)

Net Increase (Decrease) in Cash and Cash Equivalents		127,070			(56,462	)
Cash and Cash Equivalents, Beginning of Period		33,524			68,300

Cash and Cash Equivalents, End of Period	$	160,594		$	11,838

Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense	$	28,759		$	32,506
Supplemental Schedule of Non-Cash Investing and Financing Activities
Preferred stock dividends declared but not paid	$	930		$	78
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)

MARCH 31, 2011

(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 the following segments: (i) investments financed with non-recourse collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments and debt repurchases financed with recourse debt, (iv) unlevered investments, and (v) corporate. With respect to the first two nonrecourse segments, subject to the passing of certain periodic coverage tests, 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.

In March 2011, Newcastle issued 17,250,000 million shares of its common stock in a public offering at a price to the public of $6.00 per share for net proceeds of approximately $98.4 million. For the purpose of compensating the Manager for its successful efforts in raising capital for Newcastle, in connection with this offering, Newcastle granted options to the Manager to purchase 1,725,000 shares of Newcastle’s common stock at the public offering price, which were valued at approximately $7.0 million.

Approximately 3.8 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its principals at March 31, 2011. In addition, Fortress, through its affiliates, held options to purchase approximately 3.4 million shares of Newcastle’s common stock at March 31, 2011.

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, 2010 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, 2010.

Certain prior period amounts have been reclassified to conform to the current period’s presentation.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

2. INFORMATION REGARDING BUSINESS SEGMENTS

Newcastle conducts its business through the following segments: (i) investments financed with non-recourse collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments and debt repurchases financed with recourse debt, (iv) unlevered investments, and (v) corporate. With respect to the first two nonrecourse segments, subject to the passing of certain periodic coverage tests, Newcastle is generally entitled to receive the net cash flows from these structures on a periodic basis.

The corporate segment consists primarily of interest income on short term investments, general and administrative expenses, interest expense on the junior subordinated notes payable and management fees pursuant to the management agreement.

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 (A)
	CDOs			Other Non- Recourse (B)			Recourse (C)			Unlevered (D)			Corporate			Inter-segment Elimination (E)			Total
Three Months Ended March 31, 2011
Interest income	$	54,828		$	17,481		$	147		$	493		$	20		$	(766	)	$	72,203
Interest expense		24,613			13,155			98			—			952			(653	)		38,165

Net interest income (expense)		30,215			4,326			49			493			(932	)		(113	)		34,038
Impairment (reversal)		(38,245	)		1,154			—			(115	)		—			—			(37,206	)
Other income (loss)		43,107			1,827			—			535			—			—			45,469
Expenses		313			744			—			45			5,748			—			6,850

Income (loss) from continuing operations		111,254			4,255			49			1,098			(6,680	)		(113	)		109,863
Income (loss) from discontinued operations		—			(282	)		—			(21	)		—			113			(190	)

Net income (loss)		111,254			3,973			49			1,077			(6,680	)		—			109,673
Preferred dividends		—			—			—			—			(1,395	)		—			(1,395	)

Income (loss) applicable to common stockholders	$	111,254		$	3,973		$	49		$	1,077		$	(8,075	)	$	—		$	108,278


March 31, 2011
Investments	$	2,861,595		$	730,214		$	88,475		$	17,021		$	—		$	(34,284	)	$	3,663,021
Cash and restricted cash		131,540			—			—			5			160,589			—			292,134
Derivitve assets		7,535			—			—			—			—			—			7,535
Other assets		31,199			221			256			2,192			1,138			—			35,006

Total assets		3,031,869			730,435			88,731			19,218			161,727			(34,284	)		3,997,696

Debt		(2,961,016	)		(684,856	)		(83,276	)		—			(51,252	)		34,284			(3,746,116	)
Derivative liabilities		(139,584	)		(14,360	)		—			—			—			—			(153,944	)
Other liabilities		(9,990	)		(1,755	)		(4,562	)		(92	)		(5,283	)		—			(21,682	)

Total liabilities		(3,110,590	)		(700,971	)		(87,838	)		(92	)		(56,535	)		34,284			(3,921,742	)

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

GAAP book value	$	(78,721	)	$	29,464		$	893		$	19,126		$	43,609		$	—		$	14,371

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)


	Non-recourse (A)						Recourse			Unlevered			Corporate			Total
	CDOs			Other Non- Recourse (B)			Recourse			Unlevered			Corporate			Total
Three Months Ended March 31, 2010
Interest income	$	50,943		$	18,046		$	859		$	223		$	21		$	70,092
Interest expense		28,866			15,039			627			—			1,057			45,589

Net interest income (expense)		22,077			3,007			232			223			(1,036	)		24,503
Impairment (reversal)		(30,846	)		(37,292	)		(60	)		166			—			(68,032	)
Other income (loss)		59,722			(1,398	)		(663	)		(1,118	)		—			56,543
Expenses		352			678			4			1			7,578			8,613

Income (loss) from continuing operations		112,293			38,223			(375	)		(1,062	)		(8,614	)		140,465
Income (loss) from discontinued operations		—			—			—			(40	)		—			(40	)

Net income (loss)		112,293			38,223			(375	)		(1,102	)		(8,614	)		140,425
Preferred dividends		—			—			—			—			(3,268	)		(3,268	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid		—			—			—			—			43,043			43,043

Income (loss) applicable to common stockholders	$	112,293		$	38,223		$	(375	)	$	(1,102	)	$	31,161		$	180,200

(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, creditors or beneficial interest holders of these structures have no recourse to the general credit of Newcastle. Therefore, Newcastle’s exposure to the economic losses from such structures is limited to its invested equity in them and economically their book value cannot be less than zero. Therefore, impairment recorded in excess of Newcastle’s 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.

(B)	Included in the other non-recourse segment were $404.0 million of Investments and Debt, at March 31, 2011, representing the loans subject to call option of the two subprime securitizations and the corresponding financing.

(C)

The $83.3 million recourse debt was secured by $83.9 million carrying value of FNMA/FHLMC securities and $41.2 million face amount of notes issued by Newcastle CDO VI, which was repurchased by Newcastle in December 2010 and eliminated in consolidation. $4.6 million of Investments and Other Liabilities represents a security purchased but not yet settled at March 31, 2011.

(D)	The following table summarizes the investments in the unlevered segment:


	March 31, 2011
	Outstanding Face Amount		Carrying Value		Number of Investments
Real estate securities	$	215,812	$	6,112		27
Real estate related loans		69,106		4,608		4
Residential mortgage loans		1,055		277		26
Other investments		N/A		6,024		1

	$	285,973	$	17,021		58

(E)	Represents the elimination of investments and financings and their related income and expenses between segments as the corresponding inter-segment investments and financings are presented on a gross basis within each segment.

Variable Interest Entities (“VIEs”)

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 March 31, 2011, 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 INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

On January 1, 2010, as a result of the adoption of 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.

Newcastle has variable interests in the following unconsolidated VIE at March 31, 2011, 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)
Newcastle CDO VII	$	479,354	$	468,914	$	475

(A)	Face amount.

(B)	Includes $82.3 million face amount of debt owned by Newcastle at March 31, 2011.

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

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

3. REAL ESTATE SECURITIES

The following is a summary of Newcastle’s real estate securities at March 31, 2011, all of which are classified as available for sale and are, therefore, reported at fair value with changes in fair value recorded in other comprehensive income, except for securities that are other-than-temporarily impaired.


Asset Type	Outstanding Face Amount		Amortized Cost Basis												Carrying Value (B)		Number of Securities		Weighted Average
			Before Impairment		Other-Than- Temporary Impairment (A)			After Impairment											Rating (C)		Coupon			Yield			Maturity (Years) (D)		Principal Subordination (E)
										Gross Unrealized
										Gains		Losses
CMBS-Conduit	$	1,449,705	$	1,236,527	$	(335,259	)	$	901,268	$	219,440	$	(57,023	)	$	1,063,685		186		BB		5.71	%		11.24	%		3.9		10.1	%
CMBS- Single Borrower		412,952		401,885		(12,364	)		389,521		8,353		(41,531	)		356,343		57		BB		4.14	%		5.78	%		3.0		8.6	%
CMBS-Large Loan		27,798		27,795		—			27,795		—		(3,875	)		23,920		5		BBB-		1.69	%		1.74	%		0.9		19.1	%
REIT Debt		299,523		298,122		—			298,122		19,745		(2,986	)		314,881		38		BBB-		6.13	%		5.99	%		3.4		N/A
ABS-Subprime (F)		326,093		317,066		(160,241	)		156,825		25,762		(3,132	)		179,455		82		B-		1.43	%		11.39	%		5.7		26.4	%
ABS-Manufactured Housing		34,141		33,148		—			33,148		1,842		(367	)		34,623		7		BBB+		6.64	%		7.37	%		4.4		39.9	%
ABS-Franchise		36,885		34,741		(19,413	)		15,328		1,302		(765	)		15,865		14		B+		3.16	%		10.61	%		6.6		24.8	%
FNMA/FHLMC		87,453		91,371		—			91,371		410		(134	)		91,647		13		AAA		3.13	%		2.02	%		4.7		N/A
CDO (G)		168,613		20,451		(14,877	)		5,574		44		—			5,618		12		C		2.21	%		34.74	%		0.2		N/A

Debt Security Total /Average (H)		2,843,163		2,461,106		(542,154	)		1,918,952		276,898		(109,813	)		2,086,037		414		BB		4.69	%		8.75	%		3.7

Equity Securities				1,388		(276	)		1,112		1,517		—			2,629		2

Total			$	2,462,494	$	(542,430	)	$	1,920,064	$	278,415	$	(109,813	)	$	2,088,666	$	416

(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 a face amount of $12.6 million and a carrying value of $1.1 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)	Includes seven CDO bonds issued by C-BASS, a CDO bond issued by a third party and four CDO bonds issued by CDO VII, which has been deconsolidated, held as investments by Newcastle.

(H)	The total outstanding face amount of fixed rate securities was $2.0 billion, and of floating rate securities was $0.8 billion.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the three months ended March 31, 2011, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $3.1 million (gross of ($1.0) million 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 March 31, 2011.


			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	$	162,599	$	159,485	$	(26,788	)	$	132,697	$	—	$	(1,672	)		131,025		29	BBB+		3.66	%		4.81	%		5.6
Twelve or More Months		695,626		691,502		(12,580	)		678,922		—		(108,141	)		570,781		110	BB-		4.70	%		5.26	%		2.6

Total	$	858,225	$	850,987	$	(39,368	)	$	811,619	$	—	$	(109,813	)	$	701,806		139	BB		4.50	%		5.19	%		3.2

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:


	March 31, 2011
	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		44,765		50,722		(34,120	)		(5,957	)
Non credit impaired securities		657,041		760,897		—			(103,856	)

Total debt securities in an unrealized loss position	$	701,806	$	811,619	$	(34,120	)	$	(109,813	)

(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)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

The following table summarizes the activity related to credit losses on debt securities for the three months ended March 31, 2011:



Beginning balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income		$(60,688	)

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

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		(2,738	)

Additions for credit losses on securities for which an OTTI was previously recognized without any portion of OTTI recognized in other comprehensive income		(18,533	)

Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at the current measurement date		27,702

Reduction for securities sold during the period		17,912

Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security		2,225



Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(34,120	)

As of March 31, 2011, Newcastle had $127.6 million of restricted cash held in CDO financing structures pending its reinvestment in real estate securities and loans.

The table below summarizes the geographic distribution of the collateral securing Newcastle’s CMBS and ABS at March 31, 2011 (in thousands):


	CMBS					ABS
Geographic Location	Outstanding Face Amount		Percentage			Outstanding Face Amount		Percentage
Western U.S.	$	529,568		28.0	%	$	106,702		26.9	%
Northeastern U.S.		433,213		22.9	%		77,249		19.4	%
Southeastern U.S.		338,208		17.9	%		86,087		21.7	%
Midwestern U.S.		295,882		15.6	%		55,518		14.0	%
Southwestern U.S.		237,954		12.6	%		42,564		10.7	%
Other		8,913		0.5	%		28,995		7.3	%
Foreign		46,717		2.5	%		4		0.0	%

	$	1,890,455		100.0	%	$	397,119		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)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

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

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 March 31, 2011 and December 31, 2010 and marked to the lower of carrying value or fair value.

The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at March 31, 2011. 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	$	530,664	$	394,656		16		13.22	%		4.77	%		2.3		84.4	%	$	51,615
Corporate Bank Loans		277,660		184,265		7		15.96	%		8.68	%		3.4		56.4	%		—
B-Notes		233,132		159,069		9		14.85	%		4.01	%		1.6		74.1	%		45,091
Whole Loans		30,872		30,872		3		5.27	%		3.95	%		3.0		94.3	%		—

Total Real Estate Related Loans Held for Sale, Net	$	1,072,328	$	768,862		35		13.89	%		5.59	%		2.4		75.2	%	$	96,706

Manufactured Housing Loans Portfolio I, Held for Investment, Net (D)	$	146,882	$	121,661		3,830		9.56	%		8.70	%		7.7		1.1	%	$	1,246

Residential Loans	$	62,695	$	50,095		221		5.41	%		2.42	%		6.5		100.0	%	$	6,541
Manufactured Housing Loans		1,055		277		26		47.61	%		8.38	%		0.7		0.0	%		406
Manufactured Housing Loans Portfolio II		204,675		196,203		6,882		8.01	%		9.69	%		6.1		17.3	%		3,568

Total Residential Mortgage Loans Held for Sale, Net	$	268,425	$	246,575		7,129		7.53	%		7.99	%		6.1		36.5	%	$	10,515

Subprime Mortgage Loans Subject to Call Option	$	406,217	$	404,011

(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 60 or more days past due, in foreclosure, under bankruptcy, or considered real estate owned. As of March 31, 2011, $134.0 million face amount of real estate related loans was on non-accrual status.

(D)	The following is an aging analysis of past due residential loans held-for-investment as of March 31, 2011:


	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Repossessed		Total Past Due		Current		Total Outstanding Face Amount
Manufactured Housing Loans Portoflio I	$	579	$	412	$	161	$	673	$	1,825	$	145,057	$	146,882

Newcastle’s management monitors the credit quality of the Manufactured Housing Loans Portfolio I primarily by using the ageing analysis, current trends in delinquencies and the actual loss incurrence rate.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

The following is a summary of real estate related loans by maturities at March 31, 2011:


Year of Maturity ⁽¹⁾	Outstanding Face Amount		Carrying Value		Number of Loans
Delinquent ⁽²⁾	$	96,706	$	45,417		4
Period from April 1, 2011 to December 31, 2011		168,997		140,581		6
2012		142,810		73,736		5
2013		29,474		21,683		3
2014		295,273		230,561		8
2015		209,465		165,847		6
2016		111,678		75,349		2
Thereafter		17,925		15,688		1

Total	$	1,072,328	$	768,862		35

(1)	Based on the final extended maturity date of each loan investment as of March 31, 2011.

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

Activities relating to the carrying value of our real estate loans and residential mortgage loans are as follows:


	Held for Sale						Held for Investment
	Real Estate Related Loans			Residential Mortgage Loans			Residential Mortgage Loans
December 31, 2010	$	782,605		$	253,213		$	124,974
Purchases / additional fundings		111,667			—			—
Interest accrued to principal balance		4,535			—			—
Principal paydowns		(172,271	)		(6,704	)		(3,326	)
Valuation (allowance) reversal on loans		41,539			153			(385	)
Accretion of loan discount and other amortization		—			—			343
Other		787			(87	)		55

March 31, 2011	$	768,862		$	246,575		$	121,661

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 (B)
Balance at December 31, 2010	$	(321,591	)	$	(25,193	)	$	(21,350	)
Charge-offs (A)		25,344			1,313			1,072
Valuation (allowance) reversal on loans		41,539			153			(385	)

Balance at March 31, 2011	$	(254,708	)	$	(23,727	)	$	(20,663	)

(A)	The charge-offs for real estate related loans represent a loan which was written off during the period.

(B)	The allowance for credit losses was determined based on the guidance for loans acquired with deteriorated credit quality.

Securitization of Subprime Mortgage Loans

The following table presents information on the retained interests in Newcastle’s securitizations of subprime mortgage loans at March 31, 2011:


	Subprime Portfolio
	I		II
Total securitized loans (unpaid principal balance) (A)	$	512,691	$	679,180
Loans subject to call option (carrying value)	$	299,176	$	104,835
Retained interests (fair value) (B)	$	1,087	$	—

(A)	Average loan seasoning of 68 months and 50 months for Subprime Portfolios I and II, respectively, at March 31, 2011.

(B)	The retained interests include retained bonds of the securitizations. Their fair value is estimated based on pricing models. Newcastle’s residual interests were written off in the first quarter of 2010. The weighted average yield of the retained bonds was 8.08% as of March 31, 2011.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

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 March 31, 2011:


	Subprime Portfolio
	I			II
Loan unpaid principal balance (UPB)	$	512,691		$	679,180
Weighted average coupon rate of loans		5.76	%		5.24	%
Delinquencies of 60 or more days (UPB) (A)	$	110,526		$	196,958
Net credit losses for the three months ended March 31, 2011	$	8,071		$	12,588
Cumulative net credit losses	$	171,480		$	180,224
Cumulative net credit losses as a % of original UPB		11.42	%		16.57	%
Percentage of ARM loans (B)		52.9	%		65.6	%
Percentage of loans with original loan-to-value ratio >90%		10.70	%		17.20	%
Percentage of interest-only loans		22.6	%		4.2	%
Face amount of debt (C)	$	507,499		$	671,756
Weighted average funding cost of debt (D)		1.37	%		1.47	%

(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 option ARMs.

(C)	Excludes face amount of $5.2 million and $7.4 million of retained notes for Subprime Portfolios I and II, respectively, at March 31, 2011.

(D)	Includes the effect of applicable hedges.

Newcastle received negligible cash inflows from the retained interests of Subprime Portfolios I and II, during the three months ended March 31, 2011 and $0.1 million and $0.2 million from I and II, respectively, during the three months ended March 31, 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.

Servicing Rights

In February 2011, Newcastle, through one of its subsidiaries, purchased the management rights with respect to certain CBASS Investment Management LLC (“C-BASS”) CDOs pursuant to a bankruptcy proceeding for $2.2 million. Newcastle initially recorded the cost of acquiring the collateral management rights as a servicing asset and subsequently amortized this asset in proportion to, and over the period of, estimated net servicing income. Servicing assets are assessed for impairment on a quarterly basis, with impairment recognized as a valuation allowance. Key economic assumptions used in measuring any potential impairment of the servicing assets include the prepayment speeds of the underlying loans, default rates, loss severities and discount rates. During the three months ended March 31, 2011, Newcastle recorded $41,767 of servicing rights amortization and no servicing rights impairment. As of March 31, 2011, Newcastle’s servicing asset had a carrying value of $2.1 million recorded in Receivables and Other Assets.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

5. DEBT OBLIGATIONS

The following table presents certain information regarding Newcastle’s debt obligations and related hedges at March 31, 2011:


																		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 (D)
CDO Bonds Payable
CDO IV (E)		Mar 2004		$	243,416	$	242,885	1.20%		Mar 2039		3.20	%		1.9	$	230,648	$	303,186	$	271,545	$	256,566		3.3	$	103,174	$	131,500
CDO V (E)		Sep 2004			336,884		335,977	1.03%		Sep 2039		3.29	%		2.7		324,506		372,390		288,362		278,502		3.6		139,722		187,080
CDO VI (E)		Apr 2005			90,822		90,822	0.88%		Apr 2040		5.35	%		4.1		88,073		344,963		189,022		219,680		3.2		110,410		88,073
CDO VIII		Nov 2006			618,313		617,371	0.85%		Nov 2052		2.11	%		2.7		610,713		778,005		548,242		599,376		3.6		461,955		161,655
CDO IX		May 2007			480,125		483,739	0.67%		May 2052		1.57	%		2.8		480,125		655,623		526,614		543,001		2.8		427,285		91,498
CDO X		Jul 2007			1,175,000		1,173,399	0.61%		Jul 2052		3.72	%		4.5		1,175,000		1,296,177		969,157		1,063,961		4.3		220,418		912,801

					2,944,560		2,944,193					2.99	%		3.4		2,909,065		3,750,344		2,792,942		2,961,086		3.7		1,462,964		1,572,607

Other Bonds Payable
MH loans Portfolio I (F)		Apr 2010			82,097		80,930	4.76%		Jul 2035		5.38	%		3.4		—		146,882		121,661		121,661		7.7		1,617		—
MH loans Portfolio II		Aug 2006			165,768		165,631	LIBOR+ 0.88%		Aug 2011		5.26	%		0.4		165,768		204,675		196,203		196,203		6.1		35,401		124,135

					247,865		246,561					5.30	%		1.3		165,768		351,557		317,864		317,864		6.7		37,018		124,135

Notes Payable
Residential Mortgage Loans (G)		Aug 2004			4,296		4,296	LIBOR+ 0.90%		Dec 2034		1.14	%		6.7		4,296		4,296		4,296		4,296		6.7		4,296		—

					4,296		4,296					1.14	%		6.7		4,296		4,296		4,296		4,296		6.7		4,296		—

Repurchase Agreements
Real estate securities, loans and properties (H)		Dec 2010			16,703		16,703	LIBOR+ 1.50%		Dec 2011		1.74	%		0.7		16,703		—		—		—		—		—		—
FNMA/FHLMC securities (I)		Various			79,100		79,100	0.29%		Jun 2011		0.29	%		0.3		—		80,177		83,688		83,911		4.7		80,177		—

					95,803		95,803					0.54	%		0.3		16,703		80,177		83,688		83,911		4.7		80,177		—

Corporate
Junior subordinated notes payable		Mar 2006			51,004		51,252	7.57%(K)		Apr 2035		7.42	%		24.1		—		—		—		—		—		—		—

					51,004		51,252					7.42	%		24.1		—		—		—		—		—		—		—

Subtotal debt obligations					3,343,528		3,342,105					3.15	%		3.5	$	3,095,832	$	4,186,374	$	3,198,790	$	3,367,157		4.0	$	1,584,455	$	1,696,742

Financing on subprime mortgage loans subject to call option		(J	)		406,217		404,011

Total debt obligations				$	3,749,745	$	3,746,116

(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 $88.1 million, $40.6 million and $124.1 million notional amount of interest rate swap agreements in CDO VI, CDO X and MH loans portfolio II, respectively, which were economic hedges not designated as hedges for accounting purposes.

(E)

These CDOs were not in compliance with their applicable over collateralization tests as of March 31, 2011. Newcastle is not receiving cash flows from these CDOs (other than senior management fees and cash flows on senior classes of bonds which were repurchased) 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.

(G)	Notes payable issued to CDO VII, which is eliminated in consolidation.

(H)	The counterparty of this repurchase agreement is Bank of America. It is secured by $41.2 million face amount of notes issued by Newcastle CDO VI, which is eliminated on consolidation. The maximum recourse to Newcastle is $4.2 million.

(I)	The counterparty on these repurchase agreements is Bank of America.

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

(K)	LIBOR + 2.25% after April 2016.

In the first three months of 2011, Newcastle repurchased $12.1 million face amount of CDO bonds for $1.1 million. As a result, Newcastle extinguished $12.1 million face amount of CDO debt and recorded a gain on extinguishment of debt of $11.0 million.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair Value Summary Table

Newcastle held the following financial instruments at March 31, 2011:


	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*	$	2,542,817	$	1,994,079	$	1,994,079	Broker quotations, counterparty quotations, pricing services, pricing models		8.99	%		4.0
Real estate related loans, held for sale, net		1,003,222		764,254		769,362	Broker quotations, counterparty quotations, pricing services, pricing models		13.70	%		2.5
Residential mortgage loans, held for investment, net		146,882		121,661		126,457	Pricing models		9.56	%		7.7
Residential mortgage loans, held for sale, net		267,370		246,298		246,298	Pricing models		7.48	%		6.2
Subprime mortgage loans subject to call option (B)		406,217		404,011		404,011	(B)		9.09	%		(B	)
Restricted cash*		131,540		131,540		131,540
Derivative assets, treated as hedges (C)(E)*		104,205		4,829		4,829	Counterparty quotations		N/A			(C	)
Non-hedge derivative assets (D)(E)*		36,428		2,706		2,706	Counterparty quotations		N/A			(D	)
Operating real estate, held for sale				8,339		8,339
Other investments				18,883		18,883
Receivables and other assets				31,420		31,420

			$	3,728,020	$	3,737,924

Recourse Financing Structures and Unlevered Assets
Financial instruments:
Real estate securities, available for sale*	$	300,346	$	94,587	$	94,587	Broker quotations, counterparty quotations, pricing services, pricing models		4.11	%		1.5
Real estate related loans, held for sale, net		69,106		4,608		4,608	Broker quotations, counterparty quotations, pricing services, pricing models		45.41	%		0.8
Residential mortgage loans, held for sale, net		1,055		277		277	Pricing models		47.61	%		0.7
Cash and cash equivalents*		160,594		160,594		160,594
Other investments				6,024		6,024
Receivables and other assets				3,586		3,586

			$	269,676	$	269,676

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)


	Principal Balance or Notional Amount		Carrying Value		Fair Value		Fair Value Method (A)	Weighted Average Yield/Funding Cost			Weighted Average Maturity (Years)
Liabilities
Non-Recourse VIE Financing Structures (F) (G)
Financial instruments:
CDO bonds payable	$	2,944,560	$	2,944,193	$	1,887,700	Pricing models		2.99	%		3.4
Other bonds payable		247,865		246,561		240,145	Pricing models		5.30	%		1.3
Notes payable		4,296		4,296		3,589	Broker quotation		1.14	%		6.7
Repurchase agreements		12,527		12,527		12,527	Market comparables		1.74	%		0.7
Financing of subprime mortgage loans subject to call option (B)		406,217		404,011		404,011	(B)		9.09	%		(B	)
Interest rate swaps, treated as hedges (C )(E)*		1,303,301		113,001		113,001	Counterparty quotations		N/A			(C	)
Non-hedge derivatives (D)(E)*		378,987		40,943		40,943	Counterparty quotations		N/A			(D	)
Accrued expenses and other liabilities				11,745		11,745

			$	3,777,277	$	2,713,661

Recourse Financing Structures and Other Liabilities (G)
Financial instruments:
Repurchase agreements	$	83,276	$	83,276	$	83,276	Market comparables		0.36	%		0.3
Junior subordinated notes payable		51,004		51,252		35,067	Pricing models		7.42	%		24.1
Due to affiliates				1,351		1,351
Accrued expenses and other liabilities				8,586		8,586

			$	144,465	$	128,280

*	Measured at fair value on a recurring basis.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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	%	$	783
2016		Jul		77,905		2.66	%		3,696
2017		Jan		5,300		1.86	%		350

			$	104,205				$	4,829

Interest rate swap agreements which receive 1-Month LIBOR:
2011		Dec	$	91,498		5.00	%	$	(2,869	)
2014		Nov		15,604		5.09	%		(1,760	)
2015		Apr		564,030		5.44	%		(43,975	)
2016		May		180,155		5.04	%		(19,728	)
2017		Aug		133,434		5.24	%		(20,028	)
Interest rate swap agreements which receive 3-Month LIBOR:
2014		Jul		318,580		4.22	%		(24,641	)

			$	1,303,301				$	(113,001	)

(D)

This represents eight interest rate swap agreements with a total notional balance of $379.0 million, maturing between June 2016 and September 2017, and three interest rate cap agreements with a total notional balance of $36.4 million, maturing in August 2017 and January 2019. 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 as of March 31, 2011.

(E)

Newcastle’s derivatives fall into two categories. As of March 31, 2011, all derivatives were held within Newcastle’s nonrecourse debt structures (primarily CDOs). An aggregate notional balance of $1.7 billion, 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. An aggregate notional balance of $140.6 million were assets at period end and therefore are subject to the counterparty’s credit risk. No adjustments have been made to the fair value quotations received related to credit risk as a result of the counterparty’s “AA” credit rating. Newcastle’s significant derivative counterparties include Bank of America, Credit Suisse, Wells Fargo and Deutsche Bank.

(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, creditors or beneficial interest holders of these structures have no recourse to the general credit of Newcastle. Therefore, Newcastle’s exposure to the economic losses from such structures is limited to its invested equity in them and economically their book value cannot be less than zero. 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)

MARCH 31, 2011

(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.

Level 1 – Quoted prices in active markets for identical instruments.

Level 2 – Valuations based principally on other observable market parameters, including

•

Quoted prices in active markets for similar instruments,

•

Quoted prices in less active or inactive markets for identical or similar instruments,

•

Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates), and

•

Market corroborated inputs (derived principally from or corroborated by observable market data).

Level 3 – Valuations based significantly on unobservable inputs.

•

Level 3A – Valuations based on third party indications (broker quotes, counterparty quotes or pricing services) which were, in turn, based significantly on unobservable inputs or were otherwise not supportable as Level 2 valuations.

•

Level 3B – Valuations based on internal models with significant unobservable inputs.

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 March 31, 2011:


	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	$	1,890,455	$	1,443,948	$	—	$	1,274,921	$	169,027	$	1,443,948
REIT debt		299,523		314,881		314,881		—		—		314,881
ABS - subprime		326,093		179,455		—		78,869		100,586		179,455
ABS - other real estate		71,026		50,488		—		43,121		7,367		50,488
FNMA / FHLMC		87,453		91,647		91,647		—		—		91,647
CDO		168,613		5,618		—		—		5,618		5,618

Debt security total	$	2,843,163		2,086,037		406,528		1,396,911		282,598		2,086,037

Equity securities				2,629		—		—		2,629		2,629

Real estate securities total			$	2,088,666	$	406,528	$	1,396,911	$	285,227	$	2,088,666

Derivative assets:
Interest rate caps, treated as hedges	$	104,205	$	4,829	$	4,829	$	—	$	—	$	4,829
Interest rate caps, not treated as hedges		36,428		2,706		2,706		—		—		2,706

Derivative assets total	$	140,633	$	7,535	$	7,535	$	—	$	—	$	7,535

Liabilities:
Derivative Liabilities:
Interest rate swaps, treated as hedges	$	1,303,301	$	113,001	$	113,001	$	—	$	—	$	113,001
Interest rate swaps, not treated as hedges		378,987		40,943		40,943		—		—		40,943

Derivative liabilities total	$	1,682,288	$	153,944	$	153,944	$	—	$	—	$	153,944

(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)

MARCH 31, 2011

(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 three months ended March 31, 2011 as follows:


	Level 3A
	CMBS						ABS						Equity/Other Securities			Total
	Conduit			Other			Subprime			Other			Equity/Other Securities			Total
Balance at December 31, 2010	$	840,227		$	331,904		$	83,582		$	36,193		$	—		$	1,291,906
Transfers (A)
Transfers from Level 3B		5,032			—			6,806			—			—			11,838
Transfers into Level 3B		—			—			(14,794	)		—			—			(14,794	)
Total gains (losses) (B)
Included in net income (C)		16,928			(1,590	)		(1,179	)		—			—			14,159
Included in other comprehensive income (loss)		18,425			22,715			128			367			—			41,635
Amortization included in interest income		6,494			1,151			1,665			54			—			9,364
Purchases, sales and settlements
Purchases		84,193			25,146			8,365			7,548			—			125,252
Proceeds from sales		(23,415	)		(10,609	)		—			—			—			(34,024	)
Proceeds from repayments		(31,861	)		(9,819	)		(5,704	)		(1,041	)		—			(48,425	)

Balance at March 31, 2011	$	916,023		$	358,898		$	78,869		$	43,121		$	—		$	1,396,911


	Level 3B
	CMBS						ABS						Equity/Other Securities			Total
	Conduit			Other			Subprime			Other			Equity/Other Securities			Total
Balance at December 31, 2010	$	107,457		$	21,146		$	94,424		$	8,985		$	4,282		$	236,294
Transfers (A)
Transfers from Level 3A		—			—			14,794			—			—			14,794
Transfers into Level 3A		(5,032	)		—			(6,806	)		—			—			(11,838	)
Total gains (losses) (B)
Included in net income (C)		12,557			722			824			27			—			14,130
Included in other comprehensive income (loss)		48,642			206			5,961			(1,058	)		(1,609	)		52,142
Amortization included in interest income		4,719			28			3,220			399			187			8,553
Purchases, sales and settlements
Purchases		—			—			25			—			5,387			5,412
Proceeds from sales		(16,051	)		(721	)		(8,219	)		(348	)		—			(25,339	)
Proceeds from repayments		(4,630	)		(16	)		(3,637	)		(638	)		—			(8,921	)

Balance at March 31, 2011	$	147,662		$	21,365		$	100,586		$	7,367		$	8,247		$	285,227

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

(B)	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.

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


	Three Months Ended March 31, 2011
	Level 3A			Level 3B
Gain (loss) on settlement of investments, net	$	15,566		$	16,824
Other income (loss), net		—			—
OTTI		(1,407	)		(2,694	)

Total	$	14,159		$	14,130

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

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

Securities Valuation

As of March 31, 2011, Newcastle’s securities valuation methodology and results are further detailed as follows:


					Fair Value
Asset Type	Outstanding Face Amount		Amortized Cost Basis (A)		Multiple Quotes (B)		Single Quote (C)		Internal Pricing Models (D)		Total
CMBS	$	1,890,455	$	1,318,584	$	861,331	$	413,590	$	169,027	$	1,443,948
REIT debt		299,523		298,122		228,942		85,939		—		314,881
ABS – subprime		326,093		156,825		58,169		20,700		100,586		179,455
ABS – other real estate		71,026		48,476		43,121		—		7,367		50,488
FNMA / FHLMC		87,453		91,371		58,865		32,782		—		91,647
CDO		168,613		5,574		—		—		5,618		5,618

Debt security total	$	2,843,163		1,918,952		1,250,428		553,011		282,598		2,086,037

Equity securities				1,112		—		—		2,629		2,629

Total			$	1,920,064	$	1,250,428	$	553,011	$	285,227	$	2,088,666

(A)	Net of discounts (or gross of premiums) and after OTTI, including impairment taken during the period ended March 31, 2011.

(B)

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 or pricing services 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 or pricing services, 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.

(C)	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.

(D)	Securities whose fair value was estimated based on internal pricing models are further detailed as follows:

Amortized
Cost Basis (A)

Fair
Value

Impairment
Recorded
In Current
Period

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