FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 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 x 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: 79,300,197 shares outstanding as of August 3, 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 deteriorate compared to 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 June 30, 2011 (unaudited) and December 31, 2010		1

	Consolidated Statements of Income (unaudited) for the three and six months ended June 30, 2011 and 2010		2

	Consolidated Statements of Stockholders’ Equity (Deficit) (unaudited) for the six months ended June 30, 2011		3

	Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 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		53

Item 4.	Controls and Procedures		55

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		56

Item 1A.	Risk Factors		56

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

Item 3.	Defaults upon Senior Securities		75

Item 4.	(Removed and Reserved)		75

Item 5.	Other Information		75

Item 6.	Exhibits		76

SIGNATURES			78

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)


	June 30, 2011 (Unaudited)			December 31, 2010
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available for sale	$	1,585,960		$	1,859,984
Real estate related loans, held for sale, net		793,083			750,130
Residential mortgage loans, held for investment, net		306,505			124,974
Residential mortgage loans, held for sale, net		47,305			252,915
Subprime mortgage loans subject to call option		404,239			403,793
Operating real estate, held for sale		8,335			8,776
Other investments		18,883			18,883
Restricted cash		171,255			157,005
Derivative assets		5,534			7,067
Receivables from brokers, dealers and clearing organizations		4,118			—
Receivables and other assets		23,605			29,206

		3,368,822			3,612,733

Recourse Financing Structures and Unlevered Assets
Real estate securities, available for sale		197,678			600
Real estate related loans, held for sale, net		6,634			32,475
Residential mortgage loans, held for sale, net		3,371			298
Other investments		6,024			6,024
Cash and cash equivalents		100,838			33,524
Receivables and other assets		3,435			1,457

		317,980			74,378

	$	3,686,802		$	3,687,111

Liabilities and Stockholders’ Equity (Deficit)
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable	$	2,451,880		$	3,010,868
Other bonds and notes payable		219,959			261,165
Repurchase agreements		10,829			14,049
Financing of subprime mortgage loans subject to call option		404,239			403,793
Derivative liabilities		126,501			176,861
Payables to brokers, dealers and clearing organizations		38,487			—
Accrued expenses and other liabilities		9,114			8,445

		3,261,009			3,875,181

Recourse Financing Structures and Other Liabilities
Repurchase agreements		107,216			4,683
Junior subordinated notes payable		51,251			51,253
Dividends payable		8,860			—
Due to affiliates		1,518			1,419
Payables to brokers, dealers and clearing organizations		85,278			—
Accrued expenses and other liabilities		2,303			2,160

		256,426			59,515

		3,517,435			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 June 30, 2011 and December 31, 2010		61,583			61,583
Common stock, $0.01 par value, 500,000,000 shares authorized, 79,300,197 and 62,027,184 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively		793			620
Additional paid-in capital		1,163,726			1,065,377
Accumulated deficit		(1,089,548	)		(1,328,987	)
Accumulated other comprehensive income (loss)		32,813			(46,178	)

		169,367			(247,585	)

	$	3,686,802		$	3,687,111

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(dollars in thousands, except share data)


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Interest income	$	74,143		$	74,183		$	146,346		$	144,275
Interest expense		35,750			43,141			73,915			88,730

Net interest income		38,393			31,042			72,431			55,545

Impairment (Reversal)
Valuation allowance (reversal) on loans		(14,555	)		(91,534	)		(55,862	)		(187,308	)
Other-than-temporary impairment on securities		5,784			33,925			8,896			98,781
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)		(296	)		15,114			693			(22,000	)

		(9,067	)		(42,495	)		(46,273	)		(110,527	)

Net interest income after impairment/reversal		47,460			73,537			118,704			166,072
Other Income (Loss)
Gain (loss) on settlement of investments, net		35,606			8,954			69,698			18,631
Gain on extinguishment of debt		33,443			46,728			44,485			95,074
Other income (loss), net		(10,160	)		(2,298	)		(9,825	)		(3,778	)

		58,889			53,384			104,358			109,927

Expenses
Loan and security servicing expense		1,200			1,322			2,260			2,357
General and administrative expense		1,649			2,000			3,250			5,101
Management fee to affiliate		4,555			4,258			8,744			8,735

		7,404			7,580			14,254			16,193

Income from continuing operations		98,945			119,341			208,808			259,806
Income (loss) from discontinued operations		190			13			—			(27	)

Net Income		99,135			119,354			208,808			259,779
Preferred dividends		(1,395	)		(1,395	)		(2,790	)		(4,663	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid		—			—			—			43,043

Income Available for Common Stockholders	$	97,740		$	117,959		$	206,018		$	298,159

Income Per Share of Common Stock
Basic	$	1.23		$	1.90		$	2.90		$	5.16

Diluted	$	1.23		$	1.90		$	2.90		$	5.16

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	$	1.23		$	1.90		$	2.90		$	5.16

Diluted	$	1.23		$	1.90		$	2.90		$	5.16

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

Diluted	$	0.00		$	0.00		$	—		$	(0.00	)

Weighted Average Number of Shares of Common Stock Outstanding
Basic		79,282,480			62,010,570			70,988,410			57,838,286

Diluted		79,282,480			62,010,570			70,992,828			57,838,286

Dividends Declared per Share of Common Stock	$	0.10		$	—		$	0.10		$	—

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

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

FOR THE SIX MONTHS ENDED JUNE 30, 2011

(dollars in thousands)


	Preferred Stock				Common Stock				Additional Paid-in Capital		Accumulated			Accum. Other Comp. Income			Total Stock- holders’ Equity
	Shares		Amount		Shares		Amount		Additional Paid-in Capital		Deficit			(Loss)			(Deficit)
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	)
Dividends declared		—		—		—		—		—		(14,441	)		—			(14,441	)
Issuance of common stock		—		—		17,273,013		173		98,349		—			—			98,522
Deconsolidation of CDO V:
Cumulative net loss		—		—		—		—		—		45,072			—			45,072
Deconsolidation of unrealized gain on securities		—		—		—		—		—		—			(8,026	)		(8,026	)
Deconsolidation of unrealized loss on derivatives designated as cash flow hedges		—		—		—		—		—		—			18,353			18,353
Comprehensive income:
Net income		—		—		—		—		—		208,808			—			208,808
Net unrealized gain on securities		—		—		—		—		—		—			101,747			101,747
Reclassification of net realized (gain) on securities into earnings		—		—		—		—		—		—			(58,323	)		(58,323	)
Net unrealized gain on derivatives designated as cash flow hedges		—		—		—		—		—		—			13,075			13,075
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		—		—		—		—		—		—			12,165			12,165

Total comprehensive income																		277,472

Stockholders’ equity (deficit) - June 30, 2011		2,463,321	$	61,583		79,300,197	$	793	$	1,163,726	$	(1,089,548	)	$	32,813		$	169,367

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

JUNE 30, 2011

(dollars in thousands)


	Six Months Ended June 30,
	2011			2010
Cash Flows From Operating Activities
Net income	$	208,808		$	259,779
Adjustments to reconcile net income to net cash provided by (used in) operating activities (inclusive of amounts related to discontinued operations): Depreciation and amortization		137			125
Accretion of discount and other amortization		(21,807	)		(8,377	)
Interest income in CDOs redirected for reinvestment or CDO bonds paydown		(6,579	)		(12,705	)
Interest income on investments accrued to principal balance		(9,298	)		(3,789	)
Interest expense on debt accrued to principal balance		514			1,645
Deferred interest received		1,027			44
Non-cash directors’ compensation		122			60
Reversal of valuation allowance on loans		(55,862	)		(187,308	)
Other-than-temporary impairment on securities		9,589			76,781
Impairment on real estate held for sale		433			60
Gain on settlement of investments, net		(68,766	)		(18,631	)
Unrealized loss on non-hedge derivatives and hedge ineffectiveness		11,194			4,299
Gain on extinguishment of debt		(44,485	)		(95,074	)
Change in:
Restricted cash		245			3,018
Receivables and other assets		1,076			2,967
Due to affiliates		99			(78	)
Accrued expenses and other liabilities		(73	)		(1,346	)

Net cash provided by (used in) operating activities		26,374			21,470

Cash Flows From Investing Activities
Purchase of real estate securities		(180,245	)		(2,291	)
Proceeds from sale of real estate securities		3,885			26,022
Acquisition of servicing rights		(2,268	)		—
Principal repayments on loans and securities other than third-party CDO		51,933			45,083
Principal repayments on third-party CDO securities		8,865			—
Principal repayments from repurchased CDO debt		48,881			53
Margin received on derivative instruments		—			5,073
Payments on settlement of derivative instruments		(14,322	)		(11,394	)
Distributions of capital from equity method investees		—			159

Net cash provided by (used in) investing activities		(83,271	)		62,705

Cash Flows From Financing Activities
Repurchases of CDO bonds payable		(87,064	)		(9,927	)
Issuance of other bonds payable		142,736			97,650
Repayments of other bonds payable		(184,242	)		(124,104	)
Borrowings under repurchase agreements		108,576			—
Repayments of repurchase agreements		(9,263	)		(71,309	)
Issuance of common stock		98,843			—
Costs related to issuance of common stock		(468	)		—
Cash consideration paid in exchange for junior subordinated notes		—			(9,715	)
Cash consideration paid to redeem preferred stock		—			(16,001	)
Dividends paid		(5,581	)		(19,484	)
Payment of deferred financing costs		(1,546	)		(1,677	)
Restricted cash returned from refinancing activities		62,220			39,776

Net cash provided by (used in) financing activities		124,211			(114,791	)

Net Increase (Decrease) in Cash and Cash Equivalents		67,314			(30,616	)
Cash and Cash Equivalents, Beginning of Period		33,524			68,300

Cash and Cash Equivalents, End of Period	$	100,838		$	37,684

Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense	$	53,169		$	65,946
Supplemental Schedule of Non-Cash Investing and Financing Activities
Common stock dividends declared but not paid	$	7,930		$	—
Preferred stock dividends declared but not paid	$	930		$	—
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
Securities purchased not yet settled	$	85,278		$	—

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars 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 is entitled to an annual management fee and incentive compensation, both as defined in, and in accordance with the terms of, 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 June 30, 2011. In addition, Fortress, through its affiliates, held options to purchase approximately 3.4 million shares of Newcastle’s common stock at June 30, 2011.

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.

In May 2011, the FASB issued new guidance regarding the measurement and disclosure of fair value, which will become effective for Newcastle on January 1, 2012. Newcastle has not yet completed its assessment of the potential impact of this guidance.

In June 2011, the FASB issued a new accounting standard that eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity. Instead, an entity will be required to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. The standard will become effective for Newcastle on January 1, 2012. Newcastle will adopt this standard in the first quarter of 2012.

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 contingencies. 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.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars 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
Six Months Ended June 30, 2011
Interest income	$	111,399		$	35,006		$	597		$	1,015		$	63		$	(1,734	)	$	146,346
Interest expense		47,285			25,990			242			—			1,906			(1,508	)		73,915

Net interest income (expense)		64,114			9,016			355			1,015			(1,843	)		(226	)		72,431
Impairment (reversal)		(44,158	)		1,797			—			(3,912	)		—			—			(46,273	)
Other income (loss)		98,234			1,490			—			4,634			—			—			104,358
Expenses		639			1,636			—			115			11,864			—			14,254

Income (loss) from continuing operations		205,867			7,073			355			9,446			(13,707	)		(226	)		208,808
Income (loss) from discontinued operations		—			(185	)		—			(41	)		—			226			—

Net income (loss)		205,867			6,888			355			9,405			(13,707	)		—			208,808
Preferred dividends		—			—			—			—			(2,790	)		—			(2,790	)

Income (loss) applicable to common stockholders	$	205,867		$	6,888		$	355		$	9,405		$	(16,497	)	$	—		$	206,018


Three Months Ended June 30, 2011
Interest income	$	56,571		$	17,525		$	450		$	522		$	43		$	(968	)	$	74,143
Interest expense		22,672			12,835			144			—			954			(855	)		35,750

Net interest income (expense)		33,899			4,690			306			522			(911	)		(113	)		38,393
Impairment (reversal)		(5,913	)		643			—			(3,797	)		—			—			(9,067	)
Other income (loss)		55,127			(337	)		—			4,099			—			—			58,889
Expenses		326			892			—			70			6,116			—			7,404

Income (loss) from continuing operations		94,613			2,818			306			8,348			(7,027	)		(113	)		98,945
Income (loss) from discontinued operations		—			97			—			(20	)		—			113			190

Net income (loss)		94,613			2,915			306			8,328			(7,027	)		—			99,135
Preferred dividends		—			—			—			—			(1,395	)		—			(1,395	)

Income (loss) applicable to common stockholders	$	94,613		$	2,915		$	306		$	8,328		$	(8,422	)	$	—		$	97,740


June 30, 2011
Investments	$	2,489,435		$	771,825		$	194,460		$	19,247		$	—		$	(96,950	)	$	3,378,017
Cash and restricted cash		171,255			—			—			4			100,834			—			272,093
Derivitve assets		5,534			—			—			—			—			—			5,534
Other assets		27,567			156			278			2,250			912			(5	)		31,158

Total assets		2,693,791			771,981			194,738			21,501			101,746			(96,955	)		3,686,802

Debt		(2,468,431	)		(715,431	)		(107,216	)		—			(51,251	)		96,955			(3,245,374	)
Derivative liabilities		(126,501	)		—			—			—			—			—			(126,501	)
Other liabilities		(45,540	)		(2,061	)		(85,284	)		(60	)		(12,615	)		—			(145,560	)

Total liabilities		(2,640,472	)		(717,492	)		(192,500	)		(60	)		(63,866	)		96,955			(3,517,435	)

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

GAAP book value	$	53,319		$	54,489		$	2,238		$	21,441		$	(23,703	)	$	—		$	107,784

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars in thousands, except share data)


	CDOs (A)			Other Non-Recourse (A) (B)			Recourse			Unlevered			Unallocated			Total
Six Months Ended June 30, 2010
Interest income	$	105,721		$	36,806		$	976		$	742		$	30		$	144,275
Interest expense		56,174			29,901			645			356			1,654			88,730

Net interest income (expense)		49,547			6,905			331			386			(1,624	)		55,545
Impairment		(60,308	)		(34,229	)		(60	)		(15,930	)		—			(110,527	)
Other income (loss)		115,730			(3,781	)		(663	)		(1,014	)		(345	)		109,927
Other operating expenses		789			1,626			4			10			13,764			16,193

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

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

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


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

Net interest income (expense)		27,470			3,898			99			163			(588	)		31,042
Impairment		(29,462	)		3,063			—			(16,096	)		—			(42,495	)
Other income (loss)		56,008			(2,383	)		—			104			(345	)		53,384
Other operating expenses		437			948			—			9			6,186			7,580

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

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

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

(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)	The following table summarizes the investments and debt in the other non-recourse segment:


	June 30, 2011
	Investments				Debt
	Outstanding Face Amount		Carrying Value		Outstanding Face Amount		Carrying Value
Manufactured housing loan portfolio I	$	143,255	$	118,788	$	115,017	$	105,384
Manufactured housing loan portfolio II		191,009		187,717		155,793		154,254
Subprime mortgage loans subject to call options		406,217		404,239		406,217		404,239
Real estate securities		71,278		52,746		50,000		45,516
Operating real estate		N/A		8,335		6,038		6,038

	$	811,759	$	771,825	$	733,065	$	715,431

(C)

The $107.2 million of recourse debt is comprised of (i) $103.6 million of repurchase agreement secured by $108.9 million carrying value of FNMA/FHLMC securities and (ii) $3.6 million of repurchase agreement secured by $35.7 million face amount of senior notes issued by Newcastle CDO VI, which was repurchased by Newcastle in December 2010 and eliminated in consolidation. $85.3 million of Investments and Other Liabilities represent FNMA/FHLMC securities purchased but not yet settled at June 30, 2011.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars in thousands, except share data)

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


	June 30, 2011
	Outstanding Face Amount		Carrying Value		Number of Investments
Real estate securities	$	124,036	$	3,218		20
Real estate related loans		69,634		6,634		4
Residential mortgage loans		7,566		3,371		228
Other investments		N/A		6,024		1

	$	201,236	$	19,247		253

(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 V 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 VIEs, but Newcastle does not control their activities and no longer receives a significant portion of their returns. These subprime securitizations were not consolidated under the current or prior guidance.

In addition, Newcastle’s investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. Newcastle is not obligated to provide, nor has it provided, any financial support to these VIEs. Newcastle monitors these investments and, to the extent Newcastle determines that it potentially owns a majority of the currently controlling class, it analyzes them for potential consolidation. As of June 30, 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.

In April 2011, Newcastle sold its retained interests in Newcastle CDO VII, a non-consolidated VIE of Newcastle. As a result of the sale of Newcastle’s retained interests in CDO VII and the subsequent liquidation of the VIE, CDO VII has been removed from our non-consolidated VIE disclosure as of June 30, 2011.

On June 17, 2011, Newcastle deconsolidated a non-recourse financing structure, CDO V. Newcastle determined that it does not currently have the power to direct the relevant activities of CDO V as an event of default had occurred and Newcastle may be removed as the collateral manager by a single party. The deconsolidation has reduced Newcastle’s gross assets by $301.6 million, reduced liabilities by $357.0 million and increased equity by $55.4 million. The deconsolidation also reduced revenues and expenses from June 17, 2011 onwards, but its impact was not material to net income applicable to common stockholders.

Newcastle had variable interests in the following unconsolidated VIE at June 30, 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 V	$	337,618	$	336,875	$	—

(A)	Face amount.

(B)	Includes $35.2 million face amount of debt owned by Newcastle at June 30, 2011.

(C)	Represents Newcastle’s maximum exposure to loss from this entity.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars in thousands, except share data)

3. REAL ESTATE SECURITIES

The following is a summary of Newcastle’s real estate securities at June 30, 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	$	1,224,367	$	1,043,674	$	(235,513	)	$	808,161	$	141,515	$	(44,984	)	$	904,692		165	BB		5.68	%		10.97	%		3.8		10.4	%
CMBS- Single Borrower		273,242		266,556		(12,364	)		254,192		4,558		(14,844	)		243,906		44	BB		5.04	%		6.20	%		3.6		7.8	%
CMBS-Large Loan		7,555		7,552		—			7,552		—		(378	)		7,174		2	A		1.63	%		1.79	%		1.0		11.7	%
REIT Debt		172,393		171,683		—			171,683		11,171		(3,399	)		179,455		26	BB+		5.94	%		5.81	%		3.2		N/A
ABS-Subprime (F)		264,944		226,937		(86,643	)		140,294		16,234		(3,535	)		152,993		63	B+		1.26	%		10.35	%		6.2		29.7	%
ABS-Manufactured Housing		32,727		31,779		—			31,779		1,771		(295	)		33,255		7	BBB+		6.63	%		7.40	%		3.8		40.6	%
ABS-Franchise		24,399		21,944		(10,745	)		11,199		740		(1,981	)		9,958		7	BB+		3.49	%		9.13	%		8.3		32.6	%
FNMA/FHLMC		185,273		194,067		—			194,067		603		(210	)		194,460		21	AAA		2.89	%		1.52	%		4.6		N/A
CDO (G)		193,463		72,332		(14,861	)		57,471		—		(2,250	)		55,221		12	CCC+		2.81	%		7.28	%		1.6		N/A

Debt Security Total /Average (H)		2,378,363		2,036,524		(360,126	)		1,676,398		176,592		(71,876	)		1,781,114		347	BB+		4.66	%		8.33	%		3.9

Equity Securities				1,388		(276	)		1,112		1,412		—			2,524		2

Total			$	2,037,912	$	(360,402	)	$	1,677,510	$	178,004	$	(71,876	)	$	1,783,638	$	349

(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 $4.0 million and a carrying value of $1.0 million from Securitization Trust 2006 (Note 4).

(G)	Includes seven CDO bonds issued by C-BASS with a carrying value of $2.5 million, two CDOs bond issued by third parties with a carrying value of $52.7 million and three CDO bonds issued by CDO V, which has been deconsolidated, held as investments by Newcastle with a zero carrying value.

(H)	The total outstanding face amount of fixed rate securities was $1.7 billion, and of floating rate securities was $0.7 billion.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars in thousands, except share data)

Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the six months ended June 30, 2011, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $8.9 million (gross of ($0.7) 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 June 30, 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	$	417,850	$	378,802	$	(4,104	)	$	374,698	$	—	$	(14,775	)		359,923		45	BBB+		3.72	%		6.00	%		5.5
Twelve or More Months		445,512		442,506		(5,366	)		437,140		—		(57,101	)		380,039		82	BB		5.13	%		5.50	%		2.5

Total	$	863,362	$	821,308	$	(9,470	)	$	811,838	$	—	$	(71,876	)	$	739,962		127	BBB-		4.45	%		5.73	%		3.9

Newcastle performed an assessment of all of its debt securities that are in an unrealized loss position (unrealized loss position exists when a security’s amortized cost basis, excluding the effect of OTTI, exceeds its fair value) and determined the following:


	June 30, 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		30,811		34,986		(8,755	)		(4,176	)
Non credit impaired securities		709,151		776,852		—			(67,700	)

Total debt securities in an unrealized loss position	$	739,962	$	811,838	$	(8,755	)	$	(71,876	)

(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)

JUNE 30, 2011

(dollars in thousands, except share data)

The following table summarizes the activity related to credit losses on debt securities for the six months ended June 30, 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			(2,558)

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			(952)

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

Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at the current measurement date			12,300

Reduction for securities sold during the period			36,737

Reduction for securities deconsolidated during the period			6,254

Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security			152


Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income			$(8,755)

As of June 30, 2011, Newcastle had $168.0 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 June 30, 2011 (in thousands):


	CMBS					ABS
Geographic Location	Outstanding Face Amount		Percentage			Outstanding Face Amount		Percentage
Western U.S.	$	412,041		27.4	%	$	81,185		25.2	%
Northeastern U.S.		373,264		24.8	%		59,768		18.6	%
Southeastern U.S.		269,134		17.9	%		71,952		22.3	%
Midwestern U.S.		228,703		15.1	%		46,929		14.6	%
Southwestern U.S.		179,952		12.0	%		34,258		10.6	%
Other		16,358		1.1	%		27,978		8.7	%
Foreign		25,712		1.7	%		—		0.0	%

	$	1,505,164		100.0	%	$	322,070		100.0	%

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

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars 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 Portfolios I and II as described below, were classified as held for sale as of June 30, 2011 and December 31, 2010 and marked to the lower of carrying value or fair value. Manufactured Housing Loan Portfolios I and II were refinanced in April 2010 and May 2011, respectively, through securitizations and were reclassified from held for sale to held for investment since April 2010 and May 2011, respectively. In connection with the securitization transactions, Newcastle gave representations and warranties with respect to the manufactured housing loans sold to the securitization trusts. To the extent a breach of any such representations and warranties materially and adversely affects the value or enforceability of the related loans, Newcastle will be required to repurchase such loans from the respective securitization trusts.

The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at June 30, 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	$	529,882	$	413,007		16		11.08	%		6.48	%		2.3		71.2	%	$	51,615
Corporate Bank Loans		272,558		168,502		6		18.46	%		9.04	%		3.3		53.8	%		—
B-Notes		255,147		187,436		9		14.03	%		4.43	%		2.0		76.4	%		45,091
Whole Loans		30,772		30,772		3		4.79	%		3.87	%		2.8		94.6	%		—

Total Real Estate Related Loans Held for Sale, Net	$	1,088,359	$	799,717		34		13.08	%		6.57	%		2.5		68.7	%	$	96,706

Manufactured Housing Loan Portfolio I	$	143,255	$	118,788		3,739		9.54	%		8.70	%		7.7		1.1	%	$	1,910
Manufactured Housing Loan Portfolio II		191,009		187,717		6,461		7.59	%		9.67	%		6.1		17.4	%		1,091

Total Residential Mortgage Loans Held for Investment, Net (D)	$	334,264	$	306,505		10,200		8.35	%		9.25	%		6.8		10.4	%	$	3,001

Residential Loans	$	62,167	$	47,305		219		5.58	%		2.41	%		7.3		100.0	%	$	7,055
Manufactured Housing Loans I		972		254		24		47.94	%		8.54	%		0.7		0.0	%		328
Manufactured Housing Loans II		6,594		3,117		204		15.69	%		10.27	%		4.7		8.3	%		2,735

Total Residential Mortgage Loans Held for Sale, Net	$	69,733	$	50,676		447		6.41	%		3.24	%		7.0		89.9	%	$	10,118

Subprime Mortgage Loans Subject to Call Option	$	406,217	$	404,239

(A)	Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $5.5 million for the manufactured housing loans.

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

(C)	Includes loans that are 60 or more days past due, in foreclosure, under bankruptcy, or considered real estate owned. As of June 30, 2011, $134.6 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 June 30, 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 Loan Portoflio I	$	849	$	679	$	528	$	703	$	2,759	$	140,496	$	143,255
Manufactured Housing Loan Portoflio II	$	957	$	488	$	278	$	325	$	2,048	$	188,961	$	191,009

Newcastle’s management monitors the credit qualities of the Manufactured Housing Loan Portfolios I and II primarily by using aging analyses, current trends in delinquencies and actual loss incurrence rates.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars in thousands, except share data)

The following is a summary of real estate related loans by maturities at June 30, 2011:


Year of Maturity ⁽¹⁾	Outstanding Face Amount		Carrying Value		Number of Loans
Delinquent ⁽²⁾	$	96,706	$	45,486		4
Period from July 1, 2011 to December 31, 2011		131,168		108,745		4
2012		123,073		56,152		4
2013		29,414		21,368		3
2014		295,273		218,989		8
2015		210,591		168,362		6
2016		184,525		164,817		4
Thereafter		17,609		15,798		1

Total	$	1,088,359	$	799,717		34

(1)	Based on the final extended maturity date of each loan investment as of June 30, 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		269,850			—			—
Interest accrued to principal balance		9,298			—			—
Principal paydowns		(233,874	)		(7,482	)		(12,199	)
Sales		(86,349	)		—			—
Transfer to held for investment		—			(194,515	)		194,515
Valuation (allowance) reversal on loans		57,334			(444	)		(1,028	)
Accretion of loan discount and other amortization		—			—			781
Other		853			(96	)		(538	)

June 30, 2011	$	799,717		$	50,676		$	306,505

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	)
Transfer to held for investment		—			2,677			(2,677	)
Charge-offs (A)		26,657			2,514			2,430
Valuation (allowance) reversal on loans		57,334			(444	)		(1,028	)

Balance at June 30, 2011	$	(237,600	)	$	(20,446	)	$	(22,625	)

(A)	The charge-offs for real estate related loans represent two loans which were written off or sold 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 June 30, 2011:


	Subprime Portfolio
	I		II		Total
Total securitized loans (unpaid principal balance) (A)	$	499,374	$	655,607	$	1,154,981
Loans subject to call option (carrying value)	$	299,176	$	105,063	$	404,239
Retained interests (fair value) (B)	$	1,010	$	—	$	1,010

(A)	Average loan seasoning of 71 months and 53 months for Subprime Portfolios I and II, respectively, at June 30, 2011.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars in thousands, except share data)

(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 7.68% as of June 30, 2011.

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 and is required to pay the difference, if any, between the repurchase price of any loan in such portfolio and the price required to be paid by a third party originator for such loan. Such subsidiary, however, 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 June 30, 2011:


	Subprime Portfolio
	I			II
Loan unpaid principal balance (UPB)	$	499,374		$	655,607
Weighted average coupon rate of loans		5.64	%		5.09	%
Delinquencies of 60 or more days (UPB) (A)	$	107,958		$	179,471
Net credit losses for the six months ended June 30, 2011	$	16,843		$	29,447
Cumulative net credit losses	$	180,252		$	197,083
Cumulative net credit losses as a % of original UPB		12.0	%		18.1	%
Percentage of ARM loans (B)		52.7	%		65.4	%
Percentage of loans with original loan-to-value ratio >90%		10.6	%		17.3	%
Percentage of interest-only loans		22.3	%		4.1	%
Face amount of debt (C)	$	495,258		$	655,607
Weighted average funding cost of debt (D)		1.27	%		1.37	%

(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 $4.0 million of retained notes for Subprime Portfolio I at June 30, 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 six months ended June 30, 2011 and $0.2 million and $0.4 million from Subprime Portfolios I and II, respectively, during the six months ended June 30, 2010.

The loans subject to call option and the corresponding financing recognize interest income and expense based on the expected weighted average coupons of the loans subject to call option at the call date of 9.24% and 8.68% for Subprime Portfolio’s I and II, respectively.

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 amortizes 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 six months ended June 30, 2011, Newcastle recorded $0.1 million of servicing rights amortization and no servicing rights impairment. As of June 30, 2011, Newcastle’s servicing asset had a carrying value of $2.2 million recorded in Receivables and Other Assets.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars in thousands, except share data)

5. DEBT OBLIGATIONS

The following table presents certain information regarding Newcastle’s debt obligations and related hedges at June 30, 2011:


																		Collateral
Debt Obligation/ Collateral	Month Issued			Outstanding Face Amount		Carrying Value		Final Stated Maturity		Unhedged Weighted Average Funding Cost (A)	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		$	112,449	$	112,227		Mar 2039	1.52%		4.89	%		2.0	$	101,096	$	224,762	$	212,269	$	194,038		3.0	$	76,541	$	101,096
CDO VI (E)		Apr 2005			90,927		90,927		Apr 2040	0.83%		5.35	%		4.2		88,132		314,263		159,253		191,449		3.3		79,825		88,132
CDO VIII		Nov 2006			618,313		617,105		Nov 2052	0.77%		2.04	%		2.8		610,713		741,974		528,322		554,833		3.4		433,957		161,655
CDO IX		May 2007			480,125		483,307		May 2052	0.54%		1.45	%		2.9		480,125		691,642		572,861		586,222		2.8		405,682		91,450
CDO X		Jul 2007			1,150,000		1,148,314		Jul 2052	0.54%		3.77	%		4.8		1,150,000		1,273,145		986,336		1,040,086		4.4		244,372		898,743

					2,451,814		2,451,880					2.99	%		3.8		2,430,066		3,245,786		2,459,041		2,566,628		3.7		1,240,377		1,341,076

Other Bonds and Notes Payable (F)
MH loans Portfolio I		Apr 2010			78,094		77,036		Jul 2035	5.39%		5.39	%		3.3		—		143,255		118,788		118,788		7.7		1,544		—
MH loans Portfolio II (G)		May 2011			138,780		137,201		Dec 2033	3.78%		3.78	%		3.7		—		191,009		187,717		187,717		6.1		33,174		—
Residential Mortgage Loans (H)		Aug 2006			5,722		5,722		Dec 2034	LIBOR+ 0.90%		1.09	%		7.9		5,722		5,722		5,722		5,722		7.9		5,722		—

					222,596		219,959					4.27	%		3.7		5,722		339,986		312,227		312,227		6.8		40,440		—

Repurchase Agreements
Real estate securities, loans and properties (I)		Dec 2010			14,438		14,438		Dec 2011	LIBOR+ 1.50%		1.69	%		0.5		14,438		—		—		—		—		—		—
FNMA/FHLMC securities (J)		Various			103,607		103,607		Aug 2011	0.29%		0.29	%		0.2		—		104,009		108,788		109,181		4.7		104,009		—

					118,045		118,045					0.46	%		0.2		14,438		104,009		108,788		109,181		4.7		104,009		—

Corporate
Junior subordinated notes payable		Mar 2006			51,004		51,251		Apr 2035	7.57%(L)		7.41	%		23.8		—		—		—		—		—		—		—

					51,004		51,251					7.41	%		23.8		—		—		—		—		—		—		—

Subtotal debt obligations					2,843,459		2,841,135					3.06	%		4.0	$	2,450,226	$	3,689,781	$	2,880,056	$	2,988,036		4.0	$	1,384,826	$	1,341,076

Financing on subprime mortgage loans subject to call option		(K	)		406,217		404,239

Total debt obligations				$	3,249,676	$	3,245,374

(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 $101.1 million and $88.1 million notional amount of interest rate swap agreements in CDO IV and CDO VI, 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 June 30, 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 and $28.6 million of other bonds payable relating to MH loans Portfolio I and Portfolio II, respectively, retained by Newcastle or sold to certain Newcastle CDOs, which were eliminated in consolidation.

(G)	See Note 12.

(H)	Notes payable issued to CDO V, which is no longer eliminated since the deconsolidation of CDO V.

(I)	The counterparty of this repurchase agreement is Bank of America. It is secured by $35.7 million face amount of senior notes issued by Newcastle CDO VI, which is eliminated on consolidation. The maximum recourse to Newcastle is $3.6 million.

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

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

(L)	LIBOR + 2.25% after April 2016.

In the first six months of 2011, Newcastle repurchased $135.1 million face amount of CDO bonds and notes payable for $90.3 million. As a result, Newcastle extinguished $135.1 million face amount of CDO debt and notes payable and recorded a gain on extinguishment of debt of $44.5 million.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars in thousands, except share data)

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair Value Summary Table

Newcastle held the following financial instruments at June 30, 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*	$	2,055,400	$	1,585,960	$	1,585,960	Broker quotations, counterparty quotations, pricing services, pricing models		9.20	%		4.1
Real estate related loans, held for sale, net		1,018,725		793,083		799,533	Broker quotations, counterparty quotations, pricing services, pricing models		13.03	%		2.6
Residential mortgage loans, held for investment, net		334,264		306,505		309,712	Pricing models		8.35	%		6.8
Residential mortgage loans, held for sale, net		62,167		47,305		47,305	Pricing models		5.58	%		7.6
Subprime mortgage loans subject to call option (B)		406,217		404,239		404,239	(B)		9.09	%		(B	)
Restricted cash*		171,255		171,255		171,255
Derivative assets, treated as hedges (C)(E)*		104,205		3,377		3,377	Counterparty quotations		N/A			(C	)
Non-hedge derivative assets (D)(E)*		36,428		2,157		2,157	Counterparty quotations		N/A			(D	)
Operating real estate, held for sale				8,335		8,350
Other investments				18,883		18,883
Receivables and other assets				27,723		27,723

			$	3,368,822	$	3,378,494

Recourse Financing Structures and Unlevered Assets
Financial instruments:
Real estate securities, available for sale*	$	322,963	$	197,678	$	197,678	Broker quotations, counterparty quotations, pricing services, pricing models		1.76	%		2.8
Real estate related loans, held for sale, net		69,634		6,634		6,634	Broker quotations, counterparty quotations, pricing services, pricing models		19.28	%		0.9
Residential mortgage loans, held for sale, net		7,566		3,371		3,371	Pricing models		18.12	%		4.2
Cash and cash equivalents*		100,838		100,838		100,838
Other investments				6,024		6,024
Receivables and other assets				3,435		3,435

			$	317,980	$	317,980

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars 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	$	2,451,814	$	2,451,880	$	1,538,810	Pricing models		2.99	%		3.8
Other bonds and notes payable		222,596		219,959		224,497	Pricing models, broker quotation		4.27	%		3.7
Repurchase agreements		10,829		10,829		10,829	Market comparables		1.69	%		0.5
Financing of subprime mortgage loans subject to call option (B)		406,217		404,239		404,239	(B)		9.09	%		(B	)
Interest rate swaps, treated as hedges (C)(E)*		1,011,215		94,901		94,901	Counterparty quotations		N/A			(C	)
Non-hedge derivatives (D)(E)*		345,438		31,600		31,600	Counterparty quotations		N/A			(D	)
Accrued expenses and other liabilities				47,601		47,601

			$	3,261,009	$	2,352,477

Recourse Financing Structures and Other Liabilities (G)
Financial instruments:
Repurchase agreements	$	107,216	$	107,216	$	107,216	Market comparables		0.34	%		0.2
Junior subordinated notes payable		51,004		51,251		37,549	Pricing models		7.41	%		23.8
Due to affiliates				1,518		1,518
Accrued expenses and other liabilities				96,441		96,441

			$	256,426	$	242,724

*	Measured at fair value on a recurring basis.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2011

(dollars 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	%	$	504
2016		Jul		77,905		2.66	%		2,619
2017		Jan		5,300		1.86	%		254

			$	104,205				$	3,377

Interest rate swap agreements which receive 1-Month LIBOR:
2011		Dec	$	91,450		5.00	%	$	(1,825	)
2014		Nov		15,456		5.08	%		(1,895	)
2015		Apr		550,120		5.44	%		(40,774	)
2016		May		180,155		5.04	%		(21,183	)
2017		Aug		174,034		5.24	%		(29,224	)

			$	1,011,215				$	(94,901	)

(D)

This represents two interest rate swap agreements with a total notional balance of $345.4 million, maturing in March 2014 and March 2015, 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 CDO IV, CDO VI and CDO X. These derivative agreements were not designated as hedges for accounting purposes as of June 30, 2011.

(E)

Newcastle’s derivatives fall into two categories. As of June 30, 2011, all derivatives were held within Newcastle’s nonrecourse CDO structures. An aggregate notional balance of $1.4 billion, which were liabilities at period end, are only subject to the credit risks of the respective CDO structures. As they are senior to all the debt obligations of the respective CDOs and the fair value of each of the CDO’s investments exceeded the fair value of the CDO’s derivative liabilities, no credit valuation adjustments were recorded. 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 and Wells Fargo.

(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)

JUNE 30, 2011

(dollars 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 June 30, 2011:


					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	$	1,505,164	$	1,155,772	$	—	$	984,596	$	171,176	$	1,155,772
REIT debt		172,393		179,455		179,455		—		—		179,455
ABS - subprime		264,944		152,993		—		71,422		81,571		152,993
ABS - other real estate		57,126		43,213		—		33,958		9,255		43,213
FNMA / FHLMC		185,273		194,460		194,460		—		—		194,460	<

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