Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 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). x 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: 105,175,197 shares outstanding as of November 4, 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 September 30, 2011 (unaudited) and December 31, 2010		1

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

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

	Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 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		28

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		54

Item 4.	Controls and Procedures		56

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		57

Item 1A.	Risk Factors		57

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		80

Item 3.	Defaults upon Senior Securities		80

Item 4.	(Removed and Reserved)		80

Item 5.	Other Information		80

Item 6.	Exhibits		81

SIGNATURES			83

PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)


	September 30, 2011 (Unaudited)			December 31, 2010
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available-for-sale	$	1,437,893		$	1,859,984
Real estate related loans, held-for-sale, net		815,140			750,130
Residential mortgage loans, held-for-investment, net		340,489			124,974
Residential mortgage loans, held-for-sale, net		—			252,915
Subprime mortgage loans subject to call option		404,476			403,793
Operating real estate, held-for-sale		7,743			8,776
Other investments		18,883			18,883
Restricted cash		178,121			157,005
Derivative assets		2,383			7,067
Receivables and other assets		23,818			29,206

		3,228,946			3,612,733

Recourse Financing Structures and Unlevered Assets
Real estate securities, available-for-sale		230,463			600
Real estate related loans, held-for-sale, net		6,634			32,475
Residential mortgage loans, held-for-sale, net		3,031			298
Other investments		6,024			6,024
Cash and cash equivalents		205,180			33,524
Receivables and other assets		2,775			1,457

		454,107			74,378

	$	3,683,053		$	3,687,111

Liabilities and Stockholders’ Equity (Deficit)
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable	$	2,428,294		$	3,010,868
Other bonds and notes payable		210,033			261,165
Repurchase agreements		8,764			14,049
Financing of subprime mortgage loans subject to call option		404,476			403,793
Derivative liabilities		132,056			176,861
Payables to brokers, dealers and clearing organizations		37,341			—
Accrued expenses and other liabilities		9,107			8,445

		3,230,071			3,875,181

Recourse Financing Structures and Other Liabilities
Repurchase agreements		212,164			4,683
Junior subordinated notes payable		51,250			51,253
Dividends payable		16,706			—
Due to affiliates		1,532			1,419
Accrued expenses and other liabilities		2,805			2,160

		284,457			59,515

		3,514,528			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 September 30, 2011 and December 31, 2010		61,583			61,583
Common stock, $0.01 par value, 500,000,000 shares authorized, 105,175,197 and 62,027,184 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively		1,052			620
Additional paid-in capital		1,275,765			1,065,377
Accumulated deficit		(1,076,776	)		(1,328,987	)
Accumulated other comprehensive income (loss)		(93,099	)		(46,178	)

		168,525			(247,585	)

	$	3,683,053		$	3,687,111

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(dollars in thousands, except share data)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Interest income	$	72,393		$	81,040		$	218,739		$	225,315
Interest expense		32,587			42,547			106,502			131,277

Net interest income		39,806			38,493			112,237			94,038

Impairment (Reversal)
Valuation allowance (reversal) on loans		17,644			(105,360	)		(38,218	)		(292,668	)
Other-than-temporary impairment on securities		5,537			3,616			14,433			102,397
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)		(1,531	)		6,425			(838	)		(15,575	)

		21,650			(95,319	)		(24,623	)		(205,846	)

Net interest income after impairment/reversal		18,156			133,812			136,860			299,884

Other Income (Loss)
Gain (loss) on settlement of investments, net		5,636			(1,134	)		75,334			17,497
Gain on extinguishment of debt		15,917			46,624			60,402			141,698
Other income (loss), net		(2,751	)		(8,828	)		(12,576	)		(12,606	)

		18,802			36,662			123,160			146,589

Expenses
Loan and security servicing expense		1,198			1,116			3,458			3,473
General and administrative expense		1,399			1,811			4,649			6,912
Management fee to affiliate		4,569			4,258			13,313			12,993

		7,166			7,185			21,420			23,378

Income from continuing operations		29,792			163,289			238,600			423,095
Income (loss) from discontinued operations		151			213			151			186

Net Income		29,943			163,502			238,751			423,281
Preferred dividends		(1,395	)		(1,395	)		(4,185	)		(6,058	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid		—			—			—			43,043

Income Available for Common Stockholders	$	28,548		$	162,107		$	234,566		$	460,266

Income Per Share of Common Stock
Basic	$	0.35		$	2.61		$	3.16		$	7.77

Diluted	$	0.35		$	2.61		$	3.16		$	7.77

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	$	0.35		$	2.61		$	3.16		$	7.77

Diluted	$	0.35		$	2.61		$	3.16		$	7.77

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

Diluted	$	—		$	—		$	—		$	—

Weighted Average Number of Shares of Common Stock Outstanding
Basic		80,425,197			62,024,945			74,168,573			59,249,175

Diluted		80,441,593			62,024,945			74,177,027			59,249,175

Dividends Declared per Share of Common Stock	$	0.15		$	—		$	0.25		$	—

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

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

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 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	)
Dividends declared		—		—		—		—		—		(31,612	)		—			(31,612	)
Issuance of common stock		—		—		43,148,013		432		210,388		—			—			210,820
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		—		—		—		—		—		238,751			—			238,751
Net unrealized gain (loss) on securities		—		—		—		—		—		—			(16,579	)		(16,579	)
Reclassification of net realized (gain) loss on securities into earnings		—		—		—		—		—		—			(59,928	)		(59,928	)
Net unrealized gain on derivatives designated as cash flow hedges		—		—		—		—		—		—			6,424			6,424
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		—		—		—		—		—		—			12,835			12,835

Total comprehensive income (loss)																		181,503

Stockholders’ equity (deficit) - September 30, 2011		2,463,321	$	61,583		105,175,197	$	1,052	$	1,275,765	$	(1,076,776	)	$	(93,099	)	$	168,525

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)


	Nine Months Ended September 30,
	2011			2010
Cash Flows From Operating Activities
Net income	$	238,751		$	423,281
Adjustments to reconcile net income to net cash provided by (used in) operating activities (inclusive of amounts related to discontinued operations):
Depreciation and amortization		225			161
Accretion of discount and other amortization		(33,214	)		(11,729	)
Interest income in CDOs redirected for reinvestment or CDO bonds paydown		(8,981	)		(17,985	)
Interest income on investments accrued to principal balance		(14,303	)		(8,077	)
Interest expense on debt accrued to principal balance		619			2,279
Deferred interest received		1,027			44
Non-cash directors’ compensation		122			60
Reversal of valuation allowance on loans		(38,218	)		(292,668	)
Other-than-temporary impairment on securities		13,595			86,822
Impairment on real estate held for sale		433			60
Gain on settlement of real estate held for sale		(61	)		—
Gain on settlement of investments, net		(74,402	)		(17,497	)
Unrealized loss on non-hedge derivatives and hedge ineffectiveness		14,483			13,356
Gain on extinguishment of debt		(60,402	)		(141,698	)
Change in:
Restricted cash		1,249			(1,354	)
Receivables and other assets		528			3,781
Due to affiliates		113			(78	)
Accrued expenses and other liabilities		57			(1,182	)

Net cash provided by (used in) operating activities		41,621			37,576

Cash Flows From Investing Activities
Principal repayments from repurchased CDO debt		57,108			53
Principal repayments on CDO securities		9,834			—
Principal repayments on loans and non-CDO securities		65,756			55,283
Purchase of real estate securities		(303,101	)		(2,291	)
Proceeds from sale of real estate securities		3,885			26,022
Acquisition of servicing rights		(2,268	)		—
Purchase of and advance on loans		—			(6,024	)
Margin received on derivative instruments		—			5,073
Payments on settlement of derivative instruments		(14,322	)		(11,394	)
Proceeds from sale of real estate held for sale		650			840
Distributions of capital from equity method investees		—			161

Net cash provided by (used in) investing activities		(182,458	)		67,723

Cash Flows From Financing Activities
Repurchases of CDO bonds payable		(91,039	)		(11,400	)
Issuance of other bonds payable		142,736			97,650
Repayments of other bonds payable		(194,379	)		(134,027	)
Borrowings under repurchase agreements		291,818			—
Repayments of repurchase agreements		(89,622	)		(71,309	)
Issuance of common stock		211,567			—
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		(14,906	)		(19,484	)
Payment of deferred financing costs		(1,581	)		(1,677	)
Restricted cash returned from refinancing activities		58,367			50,700

Net cash provided by (used in) financing activities		312,493			(115,263	)

Net Increase (Decrease) in Cash and Cash Equivalents		171,656			(9,964	)
Cash and Cash Equivalents, Beginning of Period		33,524			68,300

Cash and Cash Equivalents, End of Period	$	205,180		$	58,336

Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense	$	76,730		$	97,948
Supplemental Schedule of Non-Cash Investing and Financing Activities
Common stock dividends declared but not paid	$	15,776		$	—
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

See notes to consolidated financial statements

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 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.

In September 2011, Newcastle issued 25,875,000 shares of its common stock in a public offering at a price to the public of $4.55 per share for net proceeds of approximately $112.3 million. Certain principals of Fortress and officers of Newcastle participated in this offering and purchased an aggregate of 1,314,780 shares at the offering price. 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 2,587,500 shares of Newcastle’s common stock at the public offering price, which were valued at approximately $5.6 million.

Approximately 4.8 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its principals at September 30, 2011. In addition, Fortress, through its affiliates, held options to purchase approximately 6.0 million shares of Newcastle’s common stock at September 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, with early adoption permitted.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)

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.

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
Nine Months Ended September 30, 2011
Interest income	$	164,523		$	54,421		$	1,626		$	2,053		$	99		$	(3,983	)	$	218,739
Interest expense		67,173			39,660			455			—			2,859			(3,645	)		106,502

Net interest income (expense)		97,350			14,761			1,171			2,053			(2,760	)		(338	)		112,237
Impairment (reversal)		(27,904	)		7,012			—			(3,731	)		—			—			(24,623	)
Other income (loss)		115,425			2,561			—			5,174			—			—			123,160
Expenses		779			2,679			—			4			17,958			—			21,420

Income (loss) from continuing operations		239,900			7,631			1,171			10,954			(20,718	)		(338	)		238,600
Income (loss) from discontinued operations		—			(131	)		—			(56	)		—			338			151

Net income (loss)		239,900			7,500			1,171			10,898			(20,718	)		—			238,751
Preferred dividends		—			—			—			—			(4,185	)		—			(4,185	)

Income (loss) applicable to common stockholders	$	239,900		$	7,500		$	1,171		$	10,898		$	(24,903	)	$	—		$	234,566


Three Months Ended September 30, 2011
Interest income	$	53,403		$	18,816		$	1,029		$	1,038		$	36		$	(1,929	)	$	72,393
Interest expense		19,909			13,329			213			—			953			(1,817	)		32,587

Net interest income (expense)		33,494			5,487			816			1,038			(917	)		(112	)		39,806
Impairment (reversal)		17,550			3,919			—			181			—			—			21,650
Other income (loss)		18,262			—			—			540			—			—			18,802
Expenses		250			933			—			(111	)		6,094			—			7,166

Income (loss) from continuing operations		33,956			635			816			1,508			(7,011	)		(112	)		29,792
Income (loss) from discontinued operations		—			54			—			(15	)		—			112			151

Net income (loss)		33,956			689			816			1,493			(7,011	)		—			29,943
Preferred dividends		—			—			—			—			(1,395	)		—			(1,395	)

Income (loss) applicable to common stockholders	$	33,956		$	689		$	816		$	1,493		$	(8,406	)	$	—		$	28,548

September 30, 2011
Investments	$	2,375,681		$	793,546		$	222,557		$	23,595		$	—		$	(144,603	)	$	3,270,776
Cash and restricted cash		178,121			—			—			8			205,172			—			383,301
Derivative assets		2,383			—			—			—			—			—			2,383
Other assets		23,719			99			640			2,171			300			(336	)		26,593

Total assets		2,579,904			793,645			223,197			25,774			205,472			(144,939	)		3,683,053

Debt		(2,437,058	)		(759,112	)		(212,164	)		—			(51,250	)		144,603			(3,314,981	)
Derivative liabilities		(132,056	)		—			—			—			—			—			(132,056	)
Other liabilities		(43,631	)		(2,817	)		(19	)		(65	)		(21,295	)		336			(67,491	)

Total liabilities		(2,612,745	)		(761,929	)		(212,183	)		(65	)		(72,545	)		144,939			(3,514,528	)

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

GAAP book value	$	(32,841	)	$	31,716		$	11,014		$	25,709		$	71,344		$	—		$	106,942

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)


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

Net interest income (expense)		84,941			10,490			331			833			(2,557	)		94,038
Impairment		(146,833	)		(35,323	)		(60	)		(23,630	)		—			(205,846	)
Other income (loss)		153,919			(5,417	)		(663	)		(905	)		(345	)		146,589
Other operating expenses		1,134			2,394			4			17			19,829			23,378

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

Net income (loss)		384,559			38,002			(276	)		23,727			(22,731	)		423,281
Preferred dividends		—			—			—			—			(6,058	)		(6,058	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid		—			—			—			—			43,043			43,043

Income (loss) applicable to common stockholders	$	384,559		$	38,002		$	(276	)	$	23,727		$	14,254		$	460,266


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

Net interest income (expense)		35,394			3,585			—			447			(933	)		38,493
Impairment		(86,525	)		(1,094	)		—			(7,700	)		—			(95,319	)
Other income (loss)		38,189			(1,636	)		—			109			—			36,662
Other operating expenses		345			768			—			7			6,065			7,185

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

Net income (loss)		159,763			2,275			—			8,462			(6,998	)		163,502
Preferred dividends		—			—			—			—			(1,395	)		(1,395	)

Income (loss) applicable to common stockholders	$	159,763		$	2,275		$	—		$	8,462		$	(8,393	)	$	162,107

(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:


	September 30, 2011
	Investments				Debt
	Outstanding Face Amount		Carrying Value		Outstanding Face Amount*		Carrying Value*
Manufactured housing loan portfolio I	$	139,116	$	115,357	$	111,052	$	101,443
Manufactured housing loan portfolio II		184,615		180,926		149,622		148,181
Residential mortgage loans		57,612		40,806		56,079		55,008
Subprime mortgage loans subject to call options		406,217		404,476		406,217		404,476
Real estate securities		69,121		44,238		48,504		44,004
Operating real estate		N/A		7,743		6,000		6,000

	$	856,681	$	793,546	$	777,474	$	759,112

*	An aggregate face amount of $158.8 million (carrying value of $144.6 million) of debt represents financing provided by the CDO segment (and included as investments in the CDO segment), which is eliminated upon consolidation.

(C)

The $212.2 million of recourse debt is comprised of (i) $209.3 million of repurchase agreement secured by $222.6 million carrying value of FNMA/FHLMC securities and (ii) $2.9 million of repurchase agreement secured by $32.5 million face amount of senior notes issued by Newcastle CDO VI, which was repurchased by Newcastle in December 2010 and eliminated in consolidation.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)

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


	September 30, 2011
	Outstanding Face Amount		Carrying Value		Number of Investments
Real estate securities	$	165,669	$	7,906		24
Real estate related loans		69,634		6,634		4
Residential mortgage loans		6,182		3,031		193
Other investments		N/A		6,024		1

	$	241,485	$	23,595		222

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

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 September 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.

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 September 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	$	324,653	$	324,712	$	4,562

(A)	Face amount.

(B)	Includes $41.7 million face amount of debt owned by Newcastle at September 30, 2011.

(C)

This amount represents Newcastle’s maximum exposure to loss from this entity, which was the fair value at September 30, 2011 for $6.1 million face amount of CDO V Class I notes. Newcastle repurchased these notes in the quarter ended September 30, 2011 and recorded these as investments in Real Estate Securities.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)

3. REAL ESTATE SECURITIES

The following is a summary of Newcastle’s real estate securities at September 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.


	Outstanding Face Amount		Amortized Cost Basis																Weighted Average
			Before Impairment		Other-Than- Temporary Impairment (A)			After Impairment							Carrying Value (B)		Number of Securities		Rating (C)	Coupon			Yield			Maturity (Years) (D)		Principal Subordination (E)
										Gross Unrealized
Asset Type										Gains		Losses
CMBS-Conduit	$	1,284,683	$	1,083,125	$	(204,159	)	$	878,966	$	89,119	$	(82,215	)	$	885,870		169	BB		5.65	%		10.63	%		4.0		10.8	%
CMBS- Single Borrower		200,385		194,802		(12,364	)		182,438		3,519		(18,283	)		167,674		35	BB		4.84	%		5.96	%		3.4		6.7	%
CMBS-Large Loan		7,546		7,544		—			7,544		—		(454	)		7,090		2	A		1.64	%		1.84	%		0.7		11.8	%
REIT Debt		137,393		136,760		—			136,760		5,263		(7,672	)		134,351		20	BB+		5.83	%		5.69	%		2.7		N/A
ABS-Subprime (F)		270,430		230,742		(86,694	)		144,048		14,479		(7,623	)		150,904		64	B+		1.28	%		10.47	%		6.5		30.8	%
ABS-Manufactured Housing		31,446		30,614		—			30,614		1,541		(246	)		31,909		7	BBB+		6.62	%		7.52	%		3.7		41.1	%
ABS-Franchise		21,177		21,764		(10,895	)		10,869		475		(3,243	)		8,101		7	BBB-		3.15	%		6.21	%		10.4		24.6	%
FNMA/FHLMC		210,673		221,915		—			221,915		966		(323	)		222,558		26	AAA		2.76	%		1.41	%		4.6		N/A
CDO (G)		207,287		82,754		(14,861	)		67,893		100		(10,655	)		57,338		13	B-		2.90	%		7.96	%		1.6		N/A

Debt Security Total /Average (H)		2,371,020		2,010,020		(328,973	)		1,681,047		115,462		(130,714	)		1,665,795		343	BB+		4.57	%		8.26	%		4.0

Equity Securities				1,388		(276	)		1,112		1,449		—			2,561		2

Total			$	2,011,408	$	(329,249	)	$	1,682,159	$	116,911	$	(130,714	)	$	1,668,356	$	345

(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. Newcastle used an implied AAA rating for the FNMA/FHLMC securities. 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 $1.2 million from Securitization Trust 2006 (Note 4).

(G)	Includes two CDO bonds issued by a third party with a carrying value of $50.1 million, four CDO bonds issued by CDO V (which has been deconsolidated) held as investments by Newcastle with a carrying value of $4.6 million and seven CDO bonds issued by C-BASS with a carrying value of $2.6 million.

(H)	The total outstanding face amount of fixed rate securities was $1.6 billion, and of floating rate securities was $0.8 billion.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)

Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the nine months ended September 30, 2011, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $14.4 million (gross of $0.8 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 September 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	$	785,986	$	683,937	$	(29,093	)	$	654,844	$	—	$	(65,688	)		589,156		82		BBB		4.60	%		7.93	%		5.4
Twelve or
More Months		444,603		439,840		(7,439	)		432,401		—		(65,026	)		367,375		81		BB		5.04	%		5.50	%		2.4

Total	$	1,230,589	$	1,123,777	$	(36,532	)	$	1,087,245	$	—	$	(130,714	)	$	956,531		163		BBB-		4.76	%		6.96	%		4.3

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


	September 30, 2011
			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		29,270		33,153		(35,034	)		(3,883	)
Non credit impaired securities		927,261		1,054,092		—			(126,831	)

Total debt securities in an unrealized loss position	$	956,531	$	1,087,245	$	(35,034	)	$	(130,714	)

(A)

Newcastle may, at times, be more likely than not to be required to sell certain securities for liquidity purposes. While the amount of the securities to be sold may be an estimate, and the securities to be sold have not yet been identified, Newcastle must make its best estimate, which is subject to significant judgment regarding future events, and may differ materially from actual future sales.

(B)

This amount is required to be recorded as other-than-temporary impairment through earnings. In measuring the portion of credit losses, Newcastle’s management estimates the expected cash flow for each of the securities. This evaluation includes a review of the credit status and the performance of the collateral supporting those securities, including the credit of the issuer, key terms of the securities and the effect of local, industry and broader economic trends. Significant inputs in estimating the cash flows include management’s expectations of prepayment speeds, default rates and loss severities. Credit losses are measured as the decline in the present value of the expected future cash flows discounted at the investment’s effective interest rate.

(C)	This amount represents unrealized losses on securities that are due to non-credit factors and is required to be recorded through other comprehensive income.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)

The following table summarizes the activity related to credit losses on debt securities for the nine months ended September 30, 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			(5,198)

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			(682)

Additions for credit losses on securities for which an OTTI was previously recognized without any portion of OTTI recognized in other comprehensive income			(25,798)

Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at the current measurement date			12,229

Reduction for securities sold during the period			37,833

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			1,016



Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income			$(35,034)

As of September 30, 2011, Newcastle had $176.4 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 September 30, 2011 (in thousands):


	CMBS					ABS
Geographic Location	Outstanding Face Amount		Percentage			Outstanding Face Amount		Percentage
Western U.S.	$	570,296		38.2	%	$	80,959		25.1	%
Northeastern U.S.		267,648		17.9	%		59,840		18.4	%
Southeastern U.S.		275,104		18.4	%		73,302		22.7	%
Midwestern U.S.		171,334		11.5	%		49,060		15.2	%
Southwestern U.S.		132,349		8.9	%		33,510		10.4	%
Other		16,564		1.1	%		26,382		8.2	%
Foreign		59,319		4.0	%		—		0.0	%

	$	1,492,614		100.0	%	$	323,053		100.0	%

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

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)

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

The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at September 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	$	560,563	$	443,361		16		11.13	%		7.01	%		2.3		72.8	%	$	63,615
Corporate Bank Loans		277,541		159,878		6		20.76	%		9.11	%		3.0		52.8	%		—
B-Notes		255,085		187,865		9		15.35	%		4.46	%		1.8		76.4	%		45,091
Whole Loans		30,670		30,670		3		4.34	%		3.90	%		2.1		94.9	%		—

Total Real Estate Related Loans Held-for-Sale, Net	$	1,123,859	$	821,774		34		13.71	%		6.87	%		2.4		69.3	%	$	108,706

Non-Securitized Manufactured Housing Loan Portfolio I	$	775	$	200		22		47.86	%		8.32	%		0.7		0.0	%	$	78
Non-Securitized Manufactured Housing Loan Portfolio II		5,407		2,831		171		15.59	%		10.19	%		5.0		8.1	%		1,826

Total Residential Mortgage Loans Held-for-Sale, Net	$	6,182	$	3,031		193		17.72	%		9.96	%		4.5		7.1	%	$	1,904

Securitized Manufactured Housing Loan Portfolio I	$	139,116	$	115,357		3,640		9.53	%		8.69	%		7.5		1.0	%	$	1,628
Securitized Manufactured Housing Loan Portfolio II		184,615		180,926		6,289		7.56	%		9.66	%		6.0		17.4	%		2,035
Residential Loans		61,391		44,206		218		6.67	%		2.34	%		7.2		100.0	%		7,135

Total Residential Mortgage Loans Held-for-Investment, Net (D)	$	385,122	$	340,489		10,147		8.11	%		8.14	%		6.7		24.6	%	$	10,798

Subprime Mortgage Loans Subject to Call Option	$	406,217	$	404,476

(A)	Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $5.4 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 September 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 September 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
Securitized Manufactured Housing Loan Portoflio I	$	1,465	$	243	$	705	$	680	$	3,093	$	136,023	$	139,116
Securitized Manufactured Housing Loan Portoflio II	$	1,635	$	487	$	770	$	778	$	3,670	$	180,945	$	184,615
Residential Loans	$	438	$	—	$	7,135	$	—	$	7,573	$	53,818	$	61,391

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’s investments in real estate related loans and non-securitized manufactured housing loans were classified as held-for-sale as of September 30, 2011 and December 31, 2010. Loans held-for-sale are marked to the lower of carrying value or fair value.

Newcastle’s investment in the securitized manufactured housing loan portfolio I was classified as held-for-investment as of September 30, 2011 and December 31, 2010. Newcastle’s investment in the manufactured housing loan portfolio II was classified as held-for-sale as of December 31, 2010. However, subsequent to the refinancing of a portion of the manufactured housing loan portfolio II in May 2011, Newcastle reclassified the securitized portion of the related pool of loans from held-for-sale to held-for-investment since the longer term financing provided it the ability to hold these loans for the foreseeable future. In connection with the securitizations of the manufactured housing loan portfolios, 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.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)

Newcastle’s investment in the residential loans was classified as held-for-sale as of December 31, 2010. In the third quarter of 2011, in light of its current capital and liquidity positions, Newcastle re-evaluated its intent and ability to hold its investment in residential loans and determined that it has the intent and ability to hold this investment to maturity and reclassified this investment as held-for-investment as of September 30, 2011.

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


Year of Maturity ⁽¹⁾	Outstanding Face Amount		Carrying Value		Number of Loans
Delinquent ⁽²⁾	$	108,706	$	45,516		5
Period from October 1, 2011 to December 31, 2011		80,178		68,984		2
2012		123,073		57,403		4
2013		29,354		19,063		3
2014		295,273		207,338		8
2015		215,475		173,450		6
2016		254,512		234,805		5
Thereafter		17,288		15,215		1

Total	$	1,123,859	$	821,774		34

(1)	Based on the final extended maturity date of each loan investment as of September 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		339,850			—			—
Interest accrued to principal balance		14,303			—			—
Principal paydowns		(234,418	)		(8,563	)		(21,128	)
Sales		(125,141	)		—			—
Transfer to held-for-investment		—			(238,721	)		238,721
Valuation (allowance) reversal on loans		43,697			(2,900	)		(2,579	)
Accretion of loan discount and other amortization		—			—			1,223
Other		878			2			(722	)

September 30, 2011	$	821,774		$	3,031		$	340,489

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		—			21,364			(21,364	)
Charge-offs (A)		26,853			3,553			4,035
Valuation (allowance) reversal on loans		43,697			(2,900	)		(2,579	)

Balance at September 30, 2011	$	(251,041	)	$	(3,176	)	$	(41,258	)

(A)	The charge-offs for real estate related loans represent three 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 September 30, 2011:


	Subprime Portfolio
	I		II		Total
Total securitized loans (unpaid principal balance) (A)	$	488,009	$	637,069	$	1,125,078
Loans subject to call option (carrying value)	$	299,176	$	105,300	$	404,476
Retained interests (fair value) (B)	$	1,194	$	—	$	1,194

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)

(A)	Average loan seasoning of 74 months and 56 months for Subprime Portfolios I and II, respectively, at September 30, 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 9.3% as of September 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 September 30, 2011:


	Subprime Portfolio
	I			II
Loan unpaid principal balance (UPB)	$	488,009		$	637,069
Weighted average coupon rate of loans		5.47	%		4.91	%
Delinquencies of 60 or more days (UPB) (A)	$	109,669		$	176,129
Net credit losses for the nine months ended September 30, 2011	$	23,440		$	42,723
Cumulative net credit losses	$	186,849		$	210,359
Cumulative net credit losses as a % of original UPB		12.4	%		19.3	%
Percentage of ARM loans (B)		52.6	%		65.3	%
Percentage of loans with original loan-to-value ratio >90%		10.7	%		17.2	%
Percentage of interest-only loans		22.4	%		4.2	%
Face amount of debt (C)	$	484,009		$	637,069
Weighted average funding cost of debt (D)		1.27	%		1.36	%

(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 September 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 nine months ended September 30, 2011 and $0.3 million and $0.5 million from Subprime Portfolios I and II, respectively, during the nine months ended September 30, 2010.

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

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 nine months ended September 30, 2011, Newcastle recorded $0.2 million of servicing rights amortization and no servicing rights impairment. As of September 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)

SEPTEMBER 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 September 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		$	109,607	$	109,387		Mar 2039	1.65%		4.90	%		2.5	$	98,254	$	212,723	$	200,522	$	183,418		2.7	$	67,543	$	98,254
CDO VI (E)		Apr 2005			91,032		91,032		Apr 2040	0.88%		5.35	%		4.0		88,191		265,328		144,499		164,501		3.1		76,785		88,191
CDO VIII		Nov 2006			598,313		596,922		Nov 2052	0.82%		2.12	%		2.5		590,713		749,396		533,653		544,526		3.1		443,534		161,655
CDO IX		May 2007			480,125		482,812		May 2052	0.59%		1.49	%		2.6		480,125		677,030		553,492		561,183		2.8		389,370		91,401
CDO X		Jul 2007			1,150,000		1,148,141		Jul 2052	0.60%		3.71	%		5.0		1,150,000		1,236,925		941,547		915,296		4.8		229,126		880,250

					2,429,077		2,428,294					2.99	%		3.8		2,407,283		3,141,402		2,373,713		2,368,924		3.7		1,206,358		1,319,751

Other Bonds and Notes Payable (F)
MH loans Portfolio I		Apr 2010			74,129		73,175		Jul 2035	5.41%		5.41	%		3.2		—		139,116		115,357		115,357		7.5		1,391		—
MH loans Portfolio II (G)		May 2011			132,609		131,223		Dec 2033	3.81%		3.81	%		3.6		—		184,615		180,926		180,926		6.0		32,067		—
Residential Mortgage Loans (H)		Aug 2006			5,635		5,635		Dec 2034	LIBOR+ 0.90%		1.14	%		7.5		5,635		57,612		40,806		40,806		7.4		57,612		—

					212,373		210,033					4.30	%		3.6		5,635		381,343		337,089		337,089		6.8		91,070		—

Repurchase Agreements
Real estate securities, loans and properties (I)		Dec 2010			11,686		11,686		Dec 2011	LIBOR+ 1.50%		1.74	%		0.2		11,686		—		—		—		—		—		—
FNMA/FHLMC securities (J)		Various			209,242		209,242		Nov 2011	0.31%		0.31	%		0.2		209,242		210,673		222,557		222,557		4.6		210,673		—

					220,928		220,928					0.39	%		0.2		220,928		210,673		222,557		222,557		4.6		210,673		—

Corporate
Junior subordinated notes payable		Mar 2006			51,004		51,250		Apr 2035	7.57%(L)		7.41	%		23.6		—		—		—		—		—		—		—

					51,004		51,250					7.41	%		23.6		—		—		—		—		—		—		—

Subtotal debt obligations					2,913,382		2,910,505					2.96	%		3.8	$	2,633,846	$	3,733,418	$	2,933,359	$	2,928,570		4.2	$	1,508,101	$	1,319,751

Financing on subprime mortgage loans subject to call option		(K	)		406,217		404,476

Total debt obligations				$	3,319,599	$	3,314,981

(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 available for reinvestment in CDOs.

(D)	Including a $36.4 million notional amount of interest rate cap agreements in CDO X and a $98.3 million and $88.2 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 September 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), since net interest is being used to repay debt, and expects these CDOs to remain out of compliance for the foreseeable future.

(F)	Excluding $36.9 million and $17.0 million face amount of other bonds payable relating to MH loans Portfolio I and Portfolio II, respectively, and $50.4 million face amount of notes payable relating to residential mortgage loans 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 $32.5 million face amount of senior notes issued by Newcastle CDO VI, which is eliminated on consolidation. The maximum recourse to Newcastle is $2.9 million.

(J)	The counterparties on these repurchase agreements are Bank of America and Goldman Sachs. Interest rates on these repurchase agreements are fixed, but will be reset on a short-term basis.

(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.

Each CDO financing is subject to tests that measure the amount of over collateralization and excess interest in the transaction. Failure to satisfy these tests would cause the principal and/or interest cashflow that would otherwise be distributed to more junior classes of securities (including those held by Newcastle) to be redirected to pay

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2011

(dollars in thousands, except share data)

down the most senior class of securities outstanding until the tests are satisfied. As a result, our cash flow and liquidity are negatively impacted upon such a failure. As of September 30, 2011, CDOs IV and VI were not in compliance with their applicable over collateralization tests.

In the first nine months of 2011, Newcastle repurchased $155.1 million face amount of CDO bonds and notes payable for $94.3 million. As a result, Newcastle extinguished $155.1 million face amount of CDO debt and notes payable and recorded a gain on extinguishment of debt of $60.4 million.

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair Value Summary Table

Newcastle held the following financial instruments at September 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*	$	1,994,678	$	1,437,893	$	1,437,893	Broker quotations, counterparty quotations, pricing services, pricing models		9.28	%		4.3
Real estate related loans, held-for-sale, net		1,054,225		815,140		822,484	Broker quotations, counterparty quotations, pricing services, pricing models		13.63	%		2.5
Residential mortgage loans, held-for-investment, net		385,122		340,489		341,291	Pricing models		8.11	%		6.7
Subprime mortgage loans subject to call option (B)		406,217		404,476		404,476	(B)		9.09	%		(B	)
Restricted cash*		178,121		178,121		178,121
Derivative assets, treated as hedges (C)(E)*		104,205		1,384		1,384	Counterparty quotations		N/A			(C	)
Non-hedge derivative assets (D)(E)*		36,428		999		999	Counterparty quotations		N/A			(D	)
Operating real estate, held-for-sale				7,743		7,743
Other investments				18,883		18,883
Receivables and other assets				23,818		23,818

			$	3,228,946	$	3,237,092

Recourse Financing Structures and Unlevered Assets
Financial instruments:
Real estate securities, available-for-sale*	$	376,342	$	230,463	$	230,463	Broker quotations, counterparty quotations, pricing services, pricing models		1.80	%		2.8
Real estate related loans, held-for-sale, net		69,634		6,634		6,634	Broker quotations, counterparty quotations, pricing services, pricing models		24.30	%		1.2
Residential mortgage loans, held-for-sale, net		6,182		3,031		3,031	Princing models		17.72	%		4.5
Cash and cash equivalents*		205,180		205,180		205,180
Other investments				6,024		6,024
Receivables and other assets				2,775		2,775

			$	454,107	$	454,107

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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	$	2,429,077	$	2,428,294	$	1,528,994	Pricing models		2.99	%		3.8
Other bonds and notes payable		212,373		210,033		213,454	Pricing models, broker quotation		4.30	%		3.6
Repurchase agreements		8,764		8,764		8,764	Market comparables		1.74	%		0.2
Financing of subprime mortgage loans subject to call option (B)		406,217		404,476		404,476	(B)		9.09	%		(B	)
Interest rate swaps, treated as hedges (C)(E)*		992,673		99,531		99,531	Counterparty quotations		N/A			(C	)
Non-hedge derivatives (D)(E)*		316,922		32,525		32,525	Counterparty quotations		N/A			(D	)
Accrued expenses and other liabilities				46,448		46,448

			$	3,230,071	$	2,334,192

Recourse Financing Structures and Other Liabilities (G)
Financial instruments:
Repurchase agreements	$	212,164	$	212,164	$	212,164	Market comparables		0.33	%		0.2
Junior subordinated notes payable		51,004		51,250		30,613	Pricing models		7.41	%		23.6
Due to affiliates				1,532		1,532
Accrued expenses and other liabilities				19,511		19,511

			$	284,457	$	263,820

*	Measured at fair value on a recurring basis.

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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	%	$	192
2016		Jul		77,905		2.66	%		1,084
2017		Jan		5,300		1.86	%		108

			$	104,205				$	1,384

Interest rate swap agreements which receive 1-Month LIBOR:
2011		Dec	$	91,401		5.00	%	$	(738	)
2014		Nov		15,313		5.08	%		(2,009	)
2015		Apr		531,770		5.44	%		(35,956	)
2016		May		180,155		5.04	%		(22,857	)
2017		Aug		174,034		5.24	%		(37,971	)

			$	992,673				$	(99,531	)

(D)

This represents two interest rate swap agreements with a total notional balance of $316.9 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 September 30, 2011.

(E)

Newcastle’s derivatives fall into two categories. As of September 30, 2011, all derivatives were held within Newcastle’s nonrecourse CDO structures. An aggregate notional balance of $1.3 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. In addition, the credit ratings of two of Newcastle’s derivative counterparties were downgraded in the quarter ended September 30, 2011. However, such downgrades had no impact on the fair value or on the respective CDOs as all of these derivatives were a liability payable to the counterparties. 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)

SEPTEMBER 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 September 30, 2011:

Principal Balance
or Notional

Fair Value

Amount

Carrying Value

Level 2

Level 3A (1)

Level 3B (2)

Total

Assets:

Real estate securities, available-for-sale:

CMBS

1,492,614

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