UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2012

£ 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 S 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 S 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 S 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 S

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: 124,178,801 shares outstanding as of May 8, 2012.

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 which could have a material adverse effect on our operations and future 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 or at all;
	—	our ability to take advantage of investment opportunities in interests in excess mortgage servicing rights;
	—	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 to one of the parties if those statements provide to be inaccurate;

	—	have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;

	—	may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors; and

	—	were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments.

Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. Additional information about the Company may be found elsewhere in this Quarterly Report on Form 10-Q and the Company’s other public filings, which are available without charge through the SEC’s website at http://www.sec.gov.

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

NEWCASTLE INVESTMENT CORP.

FORM 10-Q

INDEX

		PAGE

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011	1

	Consolidated Statements of Income (unaudited) for the three months ended March 31, 2012 and 2011	2

	Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2012 and 2011	3

	Consolidated Statement of Stockholders’ Equity (unaudited) for the three months ended March 31, 2012	4

	Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2012 and 2011	5

	Notes to Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	58

Item 4.	Controls and Procedures	60

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	61

Item 1A.	Risk Factors	61

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	85

Item 3.	Defaults upon Senior Securities	85

Item 4.	Mine Safety Disclosures	85

Item 5.	Other Information	85

Item 6.	Exhibits	86

SIGNATURES		88

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

	March 31, 2012
	(Unaudited)			December 31, 2011
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available-for-sale	$	1,536,251		$	1,479,214
Real estate related loans, held-for-sale, net		838,818			807,214
Residential mortgage loans, held-for-investment, net		321,347			331,236
Subprime mortgage loans subject to call option		404,979			404,723
Operating real estate, held-for-sale		7,739			7,741
Other investments		18,883			18,883
Restricted cash		107,875			105,040
Derivative assets		1,832			1,954
Receivables and other assets		22,147			23,319
		3,259,871			3,179,324
Recourse Financing Structures and Unlevered Assets
Real estate securities, available-for-sale		248,638			252,530
Real estate related loans, held-for-sale, net		—			6,366
Residential mortgage loans, held-for-sale, net		2,775			2,687
Investments in excess mortgage servicing rights at fair value		42,587			43,971
Other investments		6,024			6,024
Cash and cash equivalents		156,425			157,356
Receivables and other assets		3,226			3,541
		459,675			472,475
	$	3,719,546		$	3,651,799
Liabilities and Stockholders’ Equity
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable	$	2,365,537		$	2,403,605
Other bonds and notes payable		190,091			200,377
Repurchase agreements		5,644			6,546
Financing of subprime mortgage loans subject to call option		404,979			404,723
Derivative liabilities		108,774			119,320
Accrued expenses and other liabilities		15,723			16,112
		3,090,748			3,150,683
Recourse Financing Structures and Other Liabilities
Repurchase agreements		228,080			233,194
Junior subordinated notes payable		51,247			51,248
Dividends payable		21,966			16,707
Due to affiliates		1,659			1,659
Accrued expenses and other liabilities		2,824			6,219
		305,776			309,027
		3,396,524			3,459,710
Stockholders’ Equity
Preferred stock, $0.01 par value, 100,000,000 shares authorized, 1,347,321 shares of 9.75% Series B Cumulative Redeemable Preferred Stock, 496,000 shares of 8.05% Series C Cumulative Redeemable Preferred Stock, and 620,000 shares of 8.375% Series D Cumulative Redeemable Preferred Stock, liquidation preference $25.00 per share, issued and outstanding as of March 31, 2012 and December 31, 2011		61,583			61,583
Common stock, $0.01 par value, 500,000,000 shares authorized, 105,181,009 shares issued and outstanding at March 31, 2012 and December 31, 2011		1,052			1,052
Additional paid-in capital		1,275,792			1,275,792
Accumulated deficit		(1,022,212	)		(1,073,252	)
Accumulated other comprehensive income (loss)		6,807			(73,086	)
		323,022			192,089
	$	3,719,546		$	3,651,799

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(dollars in thousands, except share data)

	Three Months Ended March 31,
	2012			2011

Interest income	$	74,899		$	72,203
Interest expense		30,165			38,165
Net interest income		44,734			34,038
Impairment (Reversal)
Valuation allowance (reversal) on loans		(9,031	)		(41,307	)
Other-than-temporary impairment on securities		5,883			3,112
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)		(3,932	)		989
		(7,080	)		(37,206	)

Net interest income after impairment/reversal		51,814			71,244

Other Income (Loss)
Gain (loss) on settlement of investments, net		4,823			34,092
Gain on extinguishment of debt		20,743			11,042
Other income (loss), net		4,186			335
		29,752			45,469
Expenses
Loan and security servicing expense		1,098			1,060
General and administrative expense		2,285			1,601
Management fee to affiliate		4,976			4,189
		8,359			6,850
Income from continuing operations		73,207			109,863
Income (loss) from discontinued operations		264			(190	)
Net Income		73,471			109,673
Preferred dividends		(1,395	)		(1,395	)
Income Available for Common Stockholders	$	72,076		$	108,278
Income Per Share of Common Stock
Basic	$	0.68		$	1.73
Diluted	$	0.68		$	1.73
Income from continuing operations per share of common stock, after preferred dividends
Basic	$	0.68		$	1.73
Diluted	$	0.68		$	1.73
Income (loss) from discontinued operations per share of common stock
Basic	$	—		$	—
Diluted	$	—		$	—
Weighted Average Number of Shares of Common Stock Outstanding
Basic		105,181,009			62,602,184
Diluted		105,670,102			62,611,070
Dividends Declared per Share of Common Stock	$	0.20		$	—

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(dollars in thousands, except share data)

	Three Months Ended March 31,
	2012			2011
Net income	$	73,471		$	109,673
Other comprehensive income (loss):
Net unrealized gain (loss) on securities		76,417			126,143
Reclassification of net realized (gain) loss on securities into earnings		(4,487	)		(28,271	)
Net unrealized gain (loss) on derivatives designated as cash flow hedges		8,174			18,411
Reclassification of net realized (gain) loss on derivatives designated as cash flow hedges into earnings		(211	)		4,298
Other comprehensive income (loss)		79,893			120,581
Total comprehensive income	$	153,364		$	230,254

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)

FOR THE THREE MONTHS ENDED MARCH 31, 2012

(dollars in thousands)

	Preferred Stock				Common Stock				Additional Paid-in		Accumulated			Accum. Other Comp. Income			Total Stock- holders’
	Shares		Amount		Shares		Amount		Capital		Deficit			(Loss)			Equity
Stockholders’ equity - December 31, 2011		2,463,321	$	61,583		105,181,009	$	1,052	$	1,275,792	$	(1,073,252	)	$	(73,086	)	$	192,089
Dividends declared		—		—		—		—		—		(22,431	)		—			(22,431	)
Net income		—		—		—		—		—		73,471			—			73,471
Other comprehensive income (loss)		—		—		—		—		—		—			79,893			79,893
Stockholders’ equity - March 31, 2012		2,463,321	$	61,583		105,181,009	$	1,052	$	1,275,792	$	(1,022,212	)	$	6,807		$	323,022

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

	Three Months Ended March 31,
	2012			2011
Cash Flows From Operating Activities
Net income	$	73,471		$	109,673
Adjustments to reconcile net income to net cash provided by (used in) operating activities (inclusive of amounts related to discontinued operations):
Depreciation and amortization		87			46
Accretion of discount and other amortization		(12,213	)		(10,771	)
Interest income in CDOs redirected for reinvestment or CDO bond paydown		(1,230	)		(3,724	)
Interest income on investments accrued to principal balance		(5,293	)		(4,535	)
Interest expense on debt accrued to principal balance		109			410
Deferred interest received		—			1,027
Valuation allowance (reversal) on loans		(9,031	)		(41,307	)
Other-than-temporary impairment on securities		1,951			4,101
Impairment on real estate held-for-sale		—			433
Change in fair value on investments in excess mortgage servicing rights		(1,216	)		—
Gain on settlement of investments (net) and real estate held-for-sale		(4,823	)		(33,158	)
Unrealized (gain) loss on non-hedge derivatives and hedge ineffectiveness		(2,086	)		201
Gain on extinguishment of debt		(20,743	)		(11,042	)
Change in:
Restricted cash		286			109
Receivables and other assets		554			(40	)
Due to affiliates		—			(68	)
Accrued expenses and other liabilities		(559	)		(61	)
Net cash provided by (used in) operating activities		19,264			11,294
Cash Flows From Investing Activities
Principal repayments from repurchased CDO debt		4,497			9,726
Principal repayments from CDO securities		198			—
Return of investments in excess mortgage servicing rights		2,425			—
Principal repayments from loans and non-CDO securities		22,894			37,605
Purchase of real estate securities		(4,340	)		(89,601	)
Acquisition of investments in excess mortgage servicing rights		(3,072	)		—
Acquisition of servicing rights		—			(2,082	)
Net cash provided by (used in) investing activities		22,602			(44,352	)
Cash Flows From Financing Activities
Repurchases of CDO bonds payable		(9,159	)		(1,083	)
Repayments of other bonds payable		(10,450	)		(10,460	)
Borrowings under repurchase agreements		4,117			79,978
Repayments of repurchase agreements		(10,133	)		(2,907	)
Issuance of common stock		—			98,843
Costs related to issuance of common stock		—			(58	)
Common stock dividends paid		(15,777	)		—
Preferred stock dividends paid		(1,395	)		(4,185	)
Net cash provided by (used in) financing activities		(42,797	)		160,128
Net Increase (Decrease) in Cash and Cash Equivalents		(931	)		127,070
Cash and Cash Equivalents, Beginning of Period		157,356			33,524
Cash and Cash Equivalents, End of Period	$	156,425		$	160,594
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense	$	20,726		$	28,759
Supplemental Schedule of Non-Cash Investing and Financing Activities
Common stock dividends declared but not paid	$	21,036		$	—
Preferred stock dividends declared but not paid	$	930		$	930

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(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 (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered CDOs”), (iii) unlevered investments in excess mortgage servicing rights (“unlevered Excess MSRs”), (iv) investments financed with other non-recourse debt (“non-recourse other”), (v) investments and debt repurchases financed with recourse debt (“recourse”), (vi) other unlevered investments (“unlevered other”) and (vii) corporate. With respect to the non-recourse CDOs and non-recourse other 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 April 2012, Newcastle issued 18,975,000 shares of its common stock in a public offering at a price to the public of $6.22 per share for net proceeds of approximately $115.2 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 1,897,500 shares of Newcastle’s common stock at the public offering price, which had a fair value of approximately $5.6 million.

Approximately 4.4 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its principals at March 31, 2012. In addition, Fortress, through its affiliates, held options to purchase approximately 6.0 million shares of Newcastle’s common stock at March 31, 2012.

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, 2011 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, 2011.

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 became effective for Newcastle on January 1, 2012. The adoption of this guidance did not have a material impact on Newcastle’s financial position, liquidity or results of operations.

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. Newcastle early-adopted this accounting standard in 2011 and opted to present two separate statements.

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, the definition of an investment company, 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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

2. SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES

Newcastle conducts its business through the following segments: (i) investments financed with non-recourse collateralized debt obligations (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered CDOs”), (iii) unlevered investments in excess mortgage servicing rights (“unlevered Excess MSRs”), (iv) investments financed with other non-recourse debt (“non-recourse other”), (v) investments and debt repurchases financed with recourse debt (“recourse”), (vi) other unlevered investments (“unlevered other”) and (vii) corporate. With respect to the non-recourse CDOs and non-recourse other 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.

In the fourth quarter of 2011, Newcastle changed the composition of its reportable segments such that the unlevered segment is further broken down into (i) unlevered CDOs, (ii) unlevered Excess MSRs and (iii) unlevered other. Management believes the additional segments better reflect its investments in deconsolidated CDOs and its new investment in Excess MSRs. Segment information for previously reported periods in the accompanying financial statements has been restated to reflect this change to the composition of its segments.

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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Summary financial data on Newcastle’s segments is given below, together with a reconciliation to the same data for Newcastle as a whole:

	Non-Recourse CDOs (A)			Unlevered CDOs (B)		Unlevered Excess MSRs			Non-Recourse Other (A) (C)			Recourse (D)			Unlevered Other (E)			Corporate			Inter-segment Elimination (F)			Total
Three Months Ended March 31, 2012
Interest income	$	54,402		$	115	$	2,037		$	18,426		$	814		$	523		$	51		$	(1,469	)	$	74,899
Interest expense		17,636			—		—			12,663			268			—			954			(1,356	)		30,165
Net interest income (expense)		36,766			115		2,037			5,763			546			523			(903	)		(113	)		44,734
Impairment (reversal)		(8,531	)		—		—			1,648			—			(197	)		—			—			(7,080	)
Other income (loss)		29,913			92		1,216			—			—			(1,469	)		—			—			29,752
Expenses		241			1		123			843			—			13			7,138			—			8,359
Income (loss) from continuing operations		74,969			206		3,130			3,272			546			(762	)		(8,041	)		(113	)		73,207
Income (loss) from discontinued operations		—			—		—			168			—			(17	)		—			113			264
Net income (loss)		74,969			206		3,130			3,440			546			(779	)		(8,041	)		—			73,471
Preferred dividends		—			—		—			—			—			—			(1,395	)		—			(1,395	)
Income (loss) applicable to common stockholders	$	74,969		$	206	$	3,130		$	3,440		$	546		$	(779	)	$	(9,436	)	$	—		$	72,076
March 31, 2012

Investments	$	2,488,278		$	3,978	$	42,587		$	781,932		$	240,624		$	12,835		$	—		$	(142,193	)	$	3,428,041
Cash and restricted cash		107,875			—		—			—			—			—			156,425			—			264,300
Derivative assets		1,832			—		—			—			—			—			—			—			1,832
Other assets		22,040			7		—			107			616			1,998			959			(354	)		25,373
Total assets		2,620,025			3,985		42,587			782,039			241,240			14,833			157,384			(142,547	)		3,719,546
Debt		(2,371,181	)		—		—			(737,263	)		(228,080	)		—			(51,247	)		142,193			(3,245,578	)
Derivative liabilities		(108,774	)		—		—			—			—			—			—			—			(108,774	)
Other liabilities		(12,702	)		—		(371	)		(3,021	)		(21	)		(47	)		(26,364	)		354			(42,172	)
Total liabilities		(2,492,657	)		—		(371	)		(740,284	)		(228,101	)		(47	)		(77,611	)		142,547			(3,396,524	)
Preferred stock		—			—		—			—			—			—			(61,583	)		—			(61,583	)
GAAP book value	$	127,368		$	3,985	$	42,216		$	41,755		$	13,139		$	14,786		$	18,190		$	—		$	261,439

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

	Non-Recourse CDOs (A)			Unlevered CDOs (B)		Unlevered Excess MSRs		Non-Recourse Other (A)			Recourse		Unlevered Other			Corporate			Inter-segment Elimination (F)			Total
Three Months Ended March 31, 2011
Interest income	$	54,828		$	11	$	—	$	17,481		$	147	$	482		$	20		$	(766	)	$	72,203
Interest expense		24,613			—		—		13,155			98		—			952			(653	)		38,165
Net interest income (expense)		30,215			11		—		4,326			49		482			(932	)		(113	)		34,038
Impairment (reversal)		(38,245	)		—		—		1,154			—		(115	)		—			—			(37,206	)
Other income (loss)		43,107			75		—		1,827			—		460			—			—			45,469
Expenses		313			—		—		744			—		45			5,748			—			6,850
Income (loss) from continuing operations		111,254			86		—		4,255			49		1,012			(6,680	)		(113	)		109,863
Income (loss) from discontinued operations		—			—		—		(282	)		—		(21	)		—			113			(190	)
Net income (loss)		111,254			86		—		3,973			49		991			(6,680	)		—			109,673
Preferred dividends		—			—		—		—			—		—			(1,395	)		—			(1,395	)
Income (loss) applicable to common stockholders	$	111,254		$	86	$	—	$	3,973		$	49	$	991		$	(8,075	)	$	—		$	108,278

	(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)	Represents unlevered investments in CDO securities issued by Newcastle. These CDOs have been deconsolidated as Newcastle does not have the power to direct the relevant activities of the CDOs.

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

	March 31, 2012
	Investments				Debt
	Outstanding		Carrying		Outstanding		Carrying
	Face Amount		Value		Face Amount*		Value*
Manufactured housing loan portfolio I	$	130,488	$	108,839	$	103,026	$	93,829
Manufactured housing loan portfolio II		171,858		168,837		137,425		136,300
Residential mortgage loans		55,640		40,229		54,107		53,036
Subprime mortgage loans subject to call options		406,217		404,979		406,217		404,979
Real estate securities		67,512		51,309		47,384		43,119
Operating real estate		N/A		7,739		6,000		6,000
	$	831,715	$	781,932	$	754,159	$	737,263

	*	An aggregate face amount of $156.0 million (carrying value of $142.2 million) of debt represents financing provided by the CDO segment (and included as investments in the CDO segment), which is eliminated upon consolidation.

	(D)	The $228.1 million of recourse debt is comprised of (i) a $226.2 million repurchase agreement secured by $240.6 million carrying value of FNMA/FHLMC securities and (ii) a $1.9 million repurchase agreement secured by $27.9 million face amount of senior notes issued by Newcastle CDO VI, which was repurchased by Newcastle and is eliminated in consolidation.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

(E)

The following table summarizes the investments in the unlevered other segment:

	March 31, 2012
	Outstanding Face Amount		Carrying Value		Number of Investments
Real estate securities	$	141,493	$	4,036		20
Residential mortgage loans		4,696		2,775		156
Other investments		N/A		6,024		1
	$	146,189	$	12,835		177

(F)

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 CDOs V and VII), 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 are not consolidated.

In addition, Newcastle’s investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. Newcastle is not obligated to provide, nor has it provided, any financial support to these VIEs. Newcastle monitors these investments and, to the extent Newcastle determines that it potentially owns a majority of the currently controlling class, it analyzes them for potential consolidation. As of March 31, 2012, Newcastle has not consolidated these potential VIEs due to the determination that, based on the nature of Newcastle’s investments and the provisions governing these structures, Newcastle does not have the power to direct the activities that most significantly impact their economic performance.

Newcastle had variable interests in the following unconsolidated VIE at March 31, 2012, 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		$	300,576			$	302,332			$	3,978

(A)	Face amount.
(B)	Includes $42.0 million face amount of debt owned by Newcastle with a carrying value of $4.0 million at March 31, 2012.
(C)	This amount represents Newcastle’s maximum exposure to loss from this entity, which was the fair value at March 31, 2012, related to $5.4 million face amount of CDO V Class I notes.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

3. REAL ESTATE SECURITIES

The following is a summary of Newcastle’s real estate securities at March 31, 2012, all of which are classified as available-for-sale and are, therefore, reported at fair value with changes in fair value recorded in other comprehensive income, except for securities that are other-than-temporarily impaired.

			Amortized Cost Basis																Weighted Average
					Other- Than-					Gross Unrealized
Asset Type	Outstanding Face Amount		Before Impairment		Temporary Impairment (A)			After Impairment		Gains		Losses			Carrying Value (B)		Number of Securities		Rating (C)		Coupon			Yield			Maturity (Years) (D)		Principal Subordination (E)
CMBS-Conduit	$	1,301,842	$	1,112,189	$	(170,023	)	$	942,166	$	123,177	$	(53,746	)	$	1,011,597		161		BB+		5.58	%		10.95	%		4.1		11.2	%
CMBS- Single Borrower		185,438		180,581		(12,364	)		168,217		4,183		(11,416	)		160,984		33		BB		5.03	%		6.24	%		3.2		6.7	%
CMBS-Large Loan		14,964		14,305		—			14,305		608		(49	)		14,864		2		BBB+		5.07	%		8.86	%		1.0		10.1	%
REIT Debt		120,288		119,552		—			119,552		6,051		(2,746	)		122,857		18		BB+		5.72	%		5.72	%		2.4		N/A
ABS-Subprime (F)		255,524		205,060		(78,232	)		126,828		12,827		(7,622	)		132,033		63		B		1.14	%		9.46	%		7.0		32.4	%
ABS-Manufactured Housing		29,045		28,173		—			28,173		2,227		(77	)		30,323		7		BBB+		6.61	%		7.35	%		3.9		42.3	%
ABS-Franchise		22,696		19,988		(9,635	)		10,353		194		(3,819	)		6,728		6		C		3.55	%		4.90	%		13.7		21.8	%
FNMA/FHLMC		226,808		237,607		—			237,607		3,193		(176	)		240,624		32		AAA		2.41	%		1.55	%		4.6		N/A
CDO (G)		206,323		83,204		(14,861	)		68,343		88		(3,552	)		64,879		13		CCC+		3.01	%		7.94	%		1.4		22.1	%
Total / Average (H)	$	2,362,928		2,000,659	$	(285,115	)	$	1,715,544	$	152,548	$	(83,203	)	$	1,784,889		335		BB+		4.53	%		8.48	%		4.1

(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 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 and residual interests 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 two CDO bonds issued by a third party with a carrying value of $58.1 million, four CDO bonds issued by CDO V (which has been deconsolidated) and held as investments by Newcastle with a carrying value of $4.0 million and seven CDO bonds issued by C-BASS with a carrying value of $2.8 million.

(H)	The total outstanding face amount of fixed rate securities was $1.6 billion, and of floating rate securities was $736 million.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the three months ended March 31, 2012, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $5.9 million (gross of $3.9 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. Newcastle performed analyses in relation to such securities, using management’s best estimate of their cash flows, which support its belief that the carrying values of such securities were fully recoverable over their expected holding period. The following table summarizes Newcastle’s securities in an unrealized loss position as of March 31, 2012.

			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	$	228,157	$	194,327	$	(15,264	)	$	179,063	$	—	$	(15,321	)		163,742		27		BB		4.59	%		8.56	%		4.3
Twelve or More Months		616,685		580,011		(2,721	)		577,290		—		(67,882	)		509,408		89		BB		4.45	%		6.49	%		3.3
Total	$	844,842	$	774,338	$	(17,985	)	$	756,353	$	—	$	(83,203	)	$	673,150		116		BB		4.49	%		6.98	%		3.6

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

	March 31, 2012
			Amortized Cost Basis After		Unrealized Losses
	Fair Value		Impairment		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		37,244		42,883		(17,379	)		(5,639	)
Non credit impaired securities		635,906		713,470		—			(77,564	)
Total debt securities in an unrealized loss position	$	673,150	$	756,353	$	(17,379	)	$	(83,203	)

(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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

The following table summarizes the activity related to credit losses on debt securities for the three months ended March 31, 2012:

Beginning balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(20,207	)

Additions for credit losses on securities for which an OTTI was not previously recognized		(462	)

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		(75	)

Additions for credit losses on securities for which an OTTI was previously recognized without any portion of OTTI recognized in other comprehensive income		(7,489	)

Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at the current measurement date		9,299

Reduction for securities sold during the period		1,498

Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security		57

Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(17,379	)

As of March 31, 2012, Newcastle had $97.6 million of restricted cash held in CDO financing structures pending its reinvestment in real estate securities and loans.

The table below summarizes the geographic distribution of the collateral securing Newcastle’s CMBS and ABS at March 31, 2012 (in thousands):

	CMBS					ABS
Geographic Location	Outstanding Face Amount		Percentage			Outstanding Face Amount		Percentage
Western U.S.	$	589,565		39.3	%	$	80,001		26.0	%
Northeastern U.S.		257,609		17.2	%		59,249		19.3	%
Southeastern U.S.		296,367		19.7	%		76,282		24.8	%
Midwestern U.S.		158,212		10.5	%		48,690		15.9	%
Southwestern U.S.		126,838		8.4	%		33,265		10.8	%
Other		16,899		1.1	%		9,778		3.2	%
Foreign		56,754		3.8	%		—		0.0	%
	$	1,502,244		100.0	%	$	307,265		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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

4. REAL ESTATE RELATED LOANS, RESIDENTIAL MORTGAGE LOANS, SUBPRIME MORTGAGE LOANS, CDO SERVICING RIGHTS AND INVESTMENTS IN EXCESS MORTGAGE SERVICING RIGHTS

The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at March 31, 2012. 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	$	584,234	$	462,197		16		10.14	%		8.57	%		2.4		69.8	%	$	12,000
Corporate Bank Loans		295,638		183,526		6		19.40	%		9.59	%		2.9		52.2	%		—
B-Notes		187,017		162,635		6		11.67	%		5.13	%		2.9		68.0	%		53,995
Whole Loans		30,460		30,460		3		5.19	%		3.89	%		1.7		95.6	%		—
Total Real Estate Related Loans Held-for-Sale, Net	$	1,097,349	$	838,818		31		12.28	%		8.13	%		2.6		65.4	%	$	65,995
Non-Securitized Manufactured Housing Loan Portfolio I	$	711	$	193		19		39.05	%		8.09	%		0.7		0.0	%	$	166
Non-Securitized Manufactured Housing Loan Portfolio II		3,985		2,582		137		15.50	%		10.12	%		5.5		7.7	%		668
Total Residential Mortgage Loans Held-for-Sale, Net (D)	$	4,696	$	2,775		156		17.14	%		9.81	%		4.8		6.5	%	$	834
Securitized Manufactured Housing Loan Portfolio I	$	130,488	$	108,839		3,447		9.49	%		8.66	%		7.4		0.9	%	$	1,657
Securitized Manufactured Housing Loan Portfolio II		171,858		168,837		5,908		7.55	%		9.64	%		5.8		17.2	%		2,681
Residential Loans		59,419		43,671		210		7.57	%		2.47	%		6.7		100.0	%		7,362
Total Residential Mortgage Loans Held-for-Investment, Net (D) (E)	$	361,765	$	321,347		9,565		8.21	%		8.11	%		6.5		24.9	%	$	11,700
Subprime Mortgage Loans Subject to Call Option	$	406,217	$	404,979

(A)	Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $5.8 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 (including loans that are in foreclosure, or borrower’s in bankruptcy) or considered real estate owned (“REO”). As of March 31, 2012, $124.1 million face amount of real estate related loans was on non-accrual status.
(D)	Loans acquired at a discount for credit quality.
(E)	The following is an aging analysis of past due residential loans held-for-investment as of March 31, 2012:

	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	$	270	$	552	$	480	$	625	$	1,927	$	128,561	$	130,488
Securitized Manufactured Housing Loan Portoflio II	$	1,095	$	383	$	1,652	$	646	$	3,776	$	168,082	$	171,858
Residential Loans	$	1,068	$	107	$	6,553	$	702	$	8,430	$	50,989	$	59,419

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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

The following is a summary of real estate related loans by maturities at March 31, 2012:

	Outstanding				Number of
Year of Maturity ⁽¹⁾	Face Amount		Carrying Value		Loans
Delinquent ⁽²⁾	$	65,995	$	41,440		2
Period from April 1, 2012 to December 31, 2012		63,454		277		2
2013		36,137		26,933		3
2014		351,598		238,607		9
2015		238,898		197,135		7
2016		274,936		273,139		5
2017		49,702		46,490		2
Thereafter		16,629		14,797		1
Total	$	1,097,349	$	838,818		31

(1)	Based on the final extended maturity date of each loan investment as of March 31, 2012.
(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, 2011	$	813,580		$	2,687		$	331,236
Purchases / additional fundings		45,481			—			—
Interest accrued to principal balance		5,293			—			—
Principal paydowns		(34,476	)		(148	)		(9,756	)
Sales		—			—			—
Valuation (allowance) reversal on loans		10,482			197			(1,648	)
Loss on repayment of loans held-for-sale		(1,614	)		—			—
Accretion of loan discount and other amortization		—			—			1,029
Other		72			39			486
March 31, 2012	$	838,818		$	2,775		$	321,347

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, 2011	$	(228,017	)	$	(2,461	)	$	(26,075	)
Charge-offs (A)		17,648			382			2,447
Valuation (allowance) reversal on loans		10,482			197			(1,648	)
Balance at March 31, 2012	$	(199,887	)	$	(1,882	)	$	(25,276	)

(A)	The charge-offs for real estate related loans represent a loan which was paid off at a discounted price during the period.
(B)	The allowance for credit losses was determined based on the guidance for loans acquired with deteriorated credit quality.

CDO 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 three months ended March 31, 2012 and 2011, respectively, Newcastle recorded $0.08 million and $0.04 million of servicing rights amortization and no servicing rights impairment. As of March 31, 2012, Newcastle’s servicing asset had a carrying value of $2.0 million recorded in Receivables and Other Assets.

Investments in Excess Mortgage Servicing Rights

In December 2011, Newcastle entered into an agreement (“MSR Agreement I”) with Nationstar Mortgage LLC (“Nationstar”), an affiliate of Newcastle’s manager, to purchase Excess MSRs from Nationstar. Nationstar acquired the mortgage servicing rights on a pool of agency residential mortgage loans with an outstanding principal balance of

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

approximately $9.9 billion (“MSR Portfolio I”) on September 30, 2011. Nationstar is entitled to receive an initial weighted average total mortgage servicing amount of 35 basis points (bps) on the performing unpaid principal balance, as well as any ancillary income from MSR Portfolio I. Pursuant to MSR Agreement I, Nationstar performs all servicing functions and advancing functions related to MSR Portfolio I for a base mortgage servicing fee of 6 bps. Therefore, the remainder, or “Excess MSRs” are initially equal to a weighted average of 29 bps. Newcastle acquired the right to receive 65% of the excess mortgage servicing amount on MSR Portfolio I and, subject to certain limitations and pursuant to a loan replacement agreement (the “Recapture Agreement”), 65% of the excess mortgage servicing amount on certain future mortgage loans originated by Nationstar, that represent refinancings of loans in MSR Portfolio I (which loans then become part of MSR Portfolio I) for $43.7 million. Nationstar has co-invested, pari passu with Newcastle, in 35% of the Excess MSRs. Nationstar, as servicer, also retains the ancillary income, the servicing obligations and liabilities as the servicer. If Nationstar is terminated as the servicer, Newcastle’s right to receive its portion of the excess mortgage servicing amount is also terminated. To the extent that Nationstar is terminated as the servicer and receives a termination payment, Newcastle is entitled to a pro rata share, or 65%, of such termination payment.

The following is a summary of Newcastle’s Excess MSRs:

	March 31, 2012									Three Months Ended March 31, 2012
	Amortized Cost Basis		Carrying Value (A)		Weighted Average Yield			Weighted Average Maturity (Years) (B)		Changes in Fair Value Recorded in Other Income (Loss)
MSR Portfolio I	$	34,897	$	36,280		20.0	%		4.6	$	1,215
MSR Portfolio I - Recapture Agreement		6,107		6,307		20.0	%		10.2		1
	$	41,004	$	42,587		20.0	%		6.0	$	1,216

(A)	Fair value.
(B)	The weighted average maturity is based on the timing of expected return of investments.

The table below summarizes the geographic distribution of the underlying residential mortgage loans of the Excess MSRs at March 31, 2012 (in thousands):

	Outstanding					Nonperforming (A)
State Concentration	Unpaid Principal Amount		Percentage of Total Outstanding			Unpaid Principal Amount		Percentage of Total Nonperforming
California	$	1,829,213		19.4	%	$	144,163		21.5	%
Florida		1,050,543		11.1	%		77,858		11.6	%
Texas		619,198		6.6	%		23,556		3.5	%
Arizona		452,872		4.8	%		40,219		6.0	%
Virginia		325,998		3.5	%		17,337		2.6	%
Washigton		306,343		3.2	%		26,395		3.9	%
New Jersey		297,264		3.2	%		26,771		4.0	%
Maryland		290,700		3.1	%		19,130		2.9	%
Illinois		280,735		3.0	%		24,595		3.7	%
Nevada		262,206		2.8	%		33,743		5.0	%
Other U.S.		3,719,200		39.3	%		235,738		35.3	%
	$	9,434,272		100.0	%	$	669,505		100.0	%

(A)	Represent loans that missed their most recent payment and therefore Newcastle did not receive its excess servicing amount.

Geographic concentrations of investments expose Newcastle to the risk of economic downturns within the relevant states. Any such downturn in a state where Newcastle holds significant investments could affect the underlying borrower’s ability to make the mortgage payment and therefore could have a meaningful, negative impact on Newcastle’s Excess MSRs.

See note 11 regarding the agreement to acquire an additional portfolio of Excess MSRs.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Securitization of Subprime Mortgage Loans

The following table presents information on the retained interests in Newcastle’s securitizations of subprime mortgage loans at March 31, 2012:

	Subprime Portfolio
	I		II		Total
Total securitized loans (unpaid principal balance) (A)	$	460,432	$	601,132	$	1,061,564
Loans subject to call option (carrying value)	$	299,176	$	105,803	$	404,979
Retained interests (fair value) (B)	$	1,043	$	—	$	1,043

(A)	Average loan seasoning of 80 months and 62 months for Subprime Portfolios I and II, respectively, at March 31, 2012.
(B)	The retained interests include retained bonds of the securitizations. The fair value of which is estimated based on pricing models. Newcastle’s residual interests were written off in 2010. The weighted average yield of the retained bonds was 8.39% as of March 31, 2012.

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 March 31, 2012:

	Subprime Portfolio
	I			II
Loan unpaid principal balance (UPB)	$	460,432		$	601,132
Weighted average coupon rate of loans		5.27	%		4.63	%
Delinquencies of 60 or more days (UPB) (A)	$	111,208		$	171,102
Net credit losses for the three months ended March 31, 2012	$	9,822		$	11,106
Cumulative net credit losses	$	202,691		$	232,959
Cumulative net credit losses as a % of original UPB		13.5	%		21.4	%
Percentage of ARM loans (B)		51.9	%		64.9	%
Percentage of loans with original loan-to-value ratio >90%		10.7	%		17.1	%
Percentage of interest-only loans		21.9	%		4.4	%
Face amount of debt (C)	$	456,432		$	601,132
Weighted average funding cost of debt (D)		0.61	%		1.31	%

(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 March 31, 2012.
(D)	Includes the effect of applicable hedges.

Newcastle received negligible cash inflows from the retained interests of Subprime Portfolios I and II during the three months ended March 31, 2012 and 2011.

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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

5. DEBT OBLIGATIONS

The following table presents certain information regarding Newcastle’s debt obligations and related hedges at March 31, 2012:

													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	$	104,019	$	103,853	Mar 2039	1.77%	4.90%		2.0	$	92,666	$	204,263	$	193,371	$	180,966		2.3	$	62,037	$	92,666
CDO VI (E)	Apr 2005		91,250		91,250	Apr 2040	0.89%	5.35%		3.1		88,315		216,854		126,376		145,348		3.3		56,748		88,315
CDO VIII	Nov 2006		572,049		570,767	Nov 2052	0.80%	2.10%		2.7		564,449		728,926		535,191		552,075		3.2		440,148		155,465
CDO IX	May 2007		480,125		481,813	May 2052	0.57%	0.57%		2.6		480,125		692,742		564,634		568,214		3.2		373,819		—
CDO X	Jul 2007		1,120,000		1,117,854	Jul 2052	0.58%	3.52%		4.5		1,120,000		1,260,004		954,666		997,130		4.7		220,931		842,485
			2,367,443		2,365,537			2.71%		3.5		2,345,555		3,102,789		2,374,238		2,443,733		3.7		1,153,683		1,178,931
Other Bonds and Notes Payable
MH loans Portfolio I (F)	Apr 2010		66,103		65,345	Jul 2035	5.43%	5.43%		3.0		—		130,488		108,839		108,839		7.4		1,170		—
MH loans Portfolio II (F)	May 2011		120,412		119,340	Dec 2033	3.87%	3.87%		3.4		—		171,858		168,837		168,837		5.8		29,493		—
Residential Mortgage Loans (G)	Aug 2006		5,406		5,406	Dec 2034	LIBOR+ 0.90%	1.14%		6.7		5,406		55,640		40,229		40,229		6.8		55,640		—
			191,921		190,091			4.33%		3.4		5,406		357,986		317,905		317,905		6.6		86,303		—
Repurchase Agreements
Real estate securities, loans and properties (H)	Dec 2011		7,525		7,525	Jun 2012	LIBOR+ 1.75%	1.99%		0.3		7,525		—		—		—		—		—		—
FNMA/FHLMC securities (I)	Various		226,199		226,199	May 2012	0.38%	0.38%		0.2		226,199		226,808		240,624		240,624		4.6		226,808		—
			233,724		233,724			0.43%		0.2		233,724		226,808		240,624		240,624		4.6		226,808		—
Corporate
Junior subordinated notes payable	Mar 2006		51,004		51,247	Apr 2035	7.57% (K)	7.41%		23.1		—		—		—		—		—		—		—
			51,004		51,247			7.41%		23.1		—		—		—		—		—		—		—
Subtotal debt obligations			2,844,092		2,840,599			2.71%		3.6	$	2,584,685	$	3,687,583	$	2,932,767	$	3,002,262		4.1	$	1,466,794	$	1,178,931
Financing on subprime mortgage loans subject to call option	(J)		406,217		404,979
Total debt obligations		$	3,250,309	$	3,245,578

(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 $42.4 million notional amount of interest rate cap agreements in CDO X and a $92.7 million and $88.3 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 March 31, 2012. Newcastle is not receiving cash flows from these CDOs (other than senior management fees and cash flows on senior classes of bonds that 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 $48.7 million face amount of notes payable relating to residential mortgage loans sold to certain Newcastle CDOs, which were eliminated in consolidation.
(G)	Notes payable issued to CDO V, that are no longer eliminated since the deconsolidation of CDO V.
(H)	The counterparty of this repurchase agreement is Bank of America. It is secured by $27.9 million face amount of senior notes issued by Newcastle CDO VI, which is eliminated in consolidation. The maximum recourse to Newcastle is $1.9 million.
(I)	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.
(J)	Issued in April 2006 and July 2007. See Note 4 regarding the securitizations of Subprime Portfolios I and II.
(K)	LIBOR + 2.25% after April 2016.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

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 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 March 31, 2012, CDOs IV and VI were not in compliance with their applicable over collateralization tests.

In the first three months of 2012, Newcastle repurchased $30.0 million face amount of CDO bonds payable for $9.2 million. As a result, Newcastle extinguished $30.0 million face amount of CDO bonds payable and recorded a gain on extinguishment of debt of $20.7 million.

Newcastle’s non-CDO financings contain various customary loan covenants. Newcastle was in compliance with all of the covenants in its non-CDO financings as of March 31, 2012.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair Value Summary Table

The carrying values and fair values of Newcastle’s financial instruments at March 31, 2012 were as follows:

	Principal Balance or Notional Amount		Carrying Value		Estimated 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*	$	1,952,640	$	1,536,251	$	1,536,251	Broker quotations, counterparty quotations, pricing services, pricing models		9.47	%		4.4
Real estate related loans, held-for-sale, net		1,097,349		838,818		845,329	Broker quotations, counterparty quotations, pricing services, pricing models		12.28	%		2.6
Residential mortgage loans, held-for-investment, net		361,765		321,347		320,182	Pricing models		8.21	%		6.5
Subprime mortgage loans subject to call option (B)		406,217		404,979		404,979	(B)		9.09	%	(B)
Restricted cash*		107,875		107,875		107,875
Derivative assets, treated as hedges (C)(E)*		122,755		1,029		1,029	Counterparty quotations		N/A		(C)
Non-hedge derivative assets (D)(E)*		42,428		803		803	Counterparty quotations		N/A		(D)
Operating real estate, held-for-sale				7,739		7,739
Other investments				18,883		18,883
Receivables and other assets				22,147		22,147
			$	3,259,871	$	3,264,903
Recourse Financing Structures and Unlevered Assets
Financial instruments:
Real estate securities, available-for-sale*	$	410,288	$	248,638	$	248,638	Broker quotations, counterparty quotations, pricing services, pricing models		2.56	%		3.0
Residential mortgage loans, held-for-sale, net		4,696		2,775		2,775	Pricing models		17.14	%		4.8
Investments in excess mortgage servicing rights at fair value *(H)		9,434,272		42,587		42,587	Pricing models		20.00	%		6.0
Cash and cash equivalents*		156,425		156,425		156,425
Other investments				6,024		6,024
Receivables and other assets				3,226		3,226
			$	459,675	$	459,675

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

	Principal Balance or Notional Amount		Carrying Value		Estimated 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	$	2,367,443	$	2,365,537	$	1,522,029	Pricing models	2.71		%	3.5
Other bonds and notes payable		191,921		190,091		192,574	Broker quotations, pricing models		4.33	%		3.4
Repurchase agreements		5,644		5,644		5,644	Market comparables		1.99	%		0.3
Financing of subprime mortgage loans subject to call option (B)		406,217		404,979		404,979	(B)		9.09	%		(B)
Interest rate swaps, treated as hedges (C)(E)*		832,767		81,618		81,618	Counterparty quotations		N/A			(C)
Non-hedge derivatives (D)(E)*		306,077		27,156		27,156	Counterparty quotations		N/A			(D)
Accrued expenses and other liabilities				15,723		15,723
			$	3,090,748	$	2,249,723
Recourse Financing Structures and Other Liabilities (G)
Financial instruments:
Repurchase agreements	$	228,080	$	228,080	$	228,080	Market comparables		0.39	%		0.2
Junior subordinated notes payable		51,004		51,247		33,638	Pricing models		7.41	%		23.1
Due to affiliates				1,659		1,659
Dividends payable, accrued expenses and other liabilities				24,790		24,790
			$	305,776	$	288,167

*Measured at fair value on a recurring basis.

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MARCH 31, 2012

(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		Nov	$	39,550		2.10	%	$	250
2016		Jul		77,905		2.66	%		708
2017		Jan		5,300		1.86	%		71
			$	122,755				$	1,029
Interest rate swap agreements which receive 1-Month LIBOR:
2014		Nov	$	15,034		5.08	%	$	(1,726	)
2015		May		469,734		5.43	%		(24,123	)
2016		May		173,965		5.04	%		(19,665	)
2017		Aug		174,034		5.24	%		(36,104	)
			$	832,767				$	(81,618	)

(D)	This represents two interest rate swap agreements with a total notional balance of $306.1 million, maturing in March 2014 and March 2015, respectively, and four interest rate cap agreements with a total notional balance of $42.4 million, maturing in March 2013, August 2017 and January 2019. Newcastle entered, respectively, 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 March 31, 2012.

(E)	Newcastle’s derivatives fall into two categories. As of March 31, 2012, all derivatives were held within Newcastle’s nonrecourse CDO structures. An aggregate notional balance of $1.1 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 CDOs’ total investments exceeded the fair value of each of the CDOs’ derivative liabilities, no credit valuation adjustments were recorded. An aggregate notional balance of $165.2 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.

(H)	The notional amount represents the total unpaid principal balance of the mortgage loans on which Newcastle is entitled to receive 65% of the excess mortgage servicing amount on performing loans.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(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 March 31, 2012:

					Fair Value
	Principal Balance or Notional Amount		Carrying Value		Level 2		Level 3A		Level 3B		Total
Assets:
Real estate securities, available-for-sale:
CMBS	$	1,502,244	$	1,187,445	$	—	$	1,008,497	$	178,948	$	1,187,445
REIT debt		120,288		122,857		122,857		—		—		122,857
ABS - subprime		255,524		132,033		—		62,231		69,802		132,033
ABS - other real estate		51,741		37,051		—		30,950		6,101		37,051
FNMA / FHLMC		226,808		240,624		240,624		—		—		240,624
CDO		206,323		64,879		—		60,901		3,978		64,879
Real estate securities total	$	2,362,928	$	1,784,889	$	363,481	$	1,162,579	$	258,829	$	1,784,889
Investments in Excess MSRs (1)	$	9,434,272	$	42,587	$	—	$	—	$	42,587	$	42,587
Derivative assets:
Interest rate caps, treated as hedges	$	122,755	$	1,029	$	1,029	$	—	$	—	$	1,029
Interest rate caps, not treated as hedges		42,428		803		803		—		—		803
Derivative assets total	$	165,183	$	1,832	$	1,832	$	—	$	—	$	1,832

Liabilities:
Derivative Liabilities:
Interest rate swaps, treated as hedges	$	832,767	$	81,618	$	81,618	$	—	$	—	$	81,618
Interest rate swaps, not treated as hedges		306,077		27,156		27,156		—		—		27,156
Derivative liabilities total	$	1,138,844	$	108,774	$	108,774	$	—	$	—	$	108,774

(1)	The notional amount represents the total unpaid principal balance of the mortgage loans on which Newcastle is entitled to receive 65% of the excess mortgage servicing amount on performing loans.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Newcastle’s investments in instruments (excluding the Excess MSRs, see below) measured at fair value on a recurring basis using Level 3 inputs changed during the three months ended March 31, 2012 as follows:

	Level 3A
	CMBS						ABS						Equity/Other
	Conduit			Other			Subprime			Other			Securities			Total
Balance at December 31, 2011	$	816,283		$	132,435		$	66,141		$	31,188		$	52,047		$	1,098,094
Transfers (A)
Transfers from Level 3B		6,056			—			—			—			—			6,056
Transfers into Level 3B		—			(14,105	)		(11,057	)		—			—			(25,162	)
Total gains (losses) (B)
Included in net income (C)		(1	)		—			—			—			—			(1	)
Included in other comprehensive income (loss)		62,865			3,324			870			1,087			8,173			76,319
Amortization included in interest income		7,882			331			1,122			(83	)		1,194			10,446
Purchases, sales and settlements
Purchases		6,007			—			8,682			—			—			14,689
Proceeds from sales		—			—			—			—			—			—
Proceeds from repayments		(11,965	)		(615	)		(3,527	)		(1,242	)		(513	)		(17,862	)
Balance at March 31, 2012	$	887,127		$	121,370		$	62,231		$	30,950		$	60,901		$	1,162,579

	Level 3B
	CMBS						ABS						Equity/Other
	Conduit			Other			Subprime			Other			Securities			Total
Balance at December 31, 2011	$	140,622		$	39,478		$	62,481		$	6,919		$	3,939		$	253,439
Transfers (A)
Transfers from Level 3A		—			14,105			11,057			—			—			25,162
Transfers into Level 3A		(6,056	)		—			—			—			—			(6,056	)
Total gains (losses) (B)
Included in net income (C)		3,634			(329	)		1,187			(5	)		—			4,487
Included in other comprehensive income (loss)		(8,592	)		788			(1,265	)		(749	)		1			(9,817	)
Amortization included in interest income		3,030			157			1,854			79			103			5,223
Purchases, sales and settlements
Purchases		—			—			—			—			—			—
Proceeds from sales		(5,418	)		—			(2,215	)		—			—			(7,633	)
Proceeds from repayments		(2,750	)		279			(3,297	)		(143	)		(65	)		(5,976	)
Balance at March 31, 2012	$	124,470		$	54,478		$	69,802		$	6,101		$	3,978		$	258,829

	(A)	Transfers are assumed to occur at the beginning of the quarter.
	(B)	None of the gains (losses) recorded in earnings during the period is attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting date.
	(C)	These gains (losses) are recorded in the following line items in the consolidated statements of income:

	Three Months Ended March 31, 2012
	Level 3 A			Level 3 B
Gain (loss) on settlement of investments, net	$	—		$	6,437
Other income (loss), net		—			—
OTTI		(1	)		(1,950	)
Total	$	(1	)	$	4,487
Gain (loss) on settlement of investments, net, from investments transferred into Level 3 during the period	$	—		$	—

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Securities Valuation

As of March 31, 2012, Newcastle’s securities valuation methodology and results are further detailed as follows:

					Fair Value
	Outstanding		Amortized						Internal
	Face		Cost		Multiple		Single		Pricing
Asset Type	Amount (A)		Basis (B)		Quotes (C)		Quote (D)		Models (E)		Total

CMBS	$	1,502,244	$	1,124,688	$	847,838	$	160,659	$	178,948	$	1,187,445
REIT debt		120,288		119,552		77,512		45,345		—		122,857
ABS - subprime		255,524		126,828		44,878		17,353		69,802		132,033
ABS - other real estate		51,741		38,526		30,329		621		6,101		37,051
FNMA / FHLMC		226,808		237,607		153,103		87,521		—		240,624
CDO		206,323		68,343		2,750		58,151		3,978		64,879
Total	$	2,362,928	$	1,715,544	$	1,156,410	$	369,650	$	258,829	$	1,784,889

(A)	Net of incurred losses
(B)	Net of discounts (or gross of premiums) and after OTTI, including impairment taken during the period ended March 31, 2012.
(C)	Management generally obtained pricing service quotations or broker quotations from two sources, one of which was generally the seller (the party that sold us the security). Management selected one of the quotes received as being most representative of fair value and did not use an average of the quotes. Even if Newcastle receives two or more quotes on a particular security that come from non-selling brokers or pricing services, it does not use an average because management believes using an actual quote more closely represents a transactable price for the security than an average level. Furthermore, in some cases there is a wide disparity between the quotes Newcastle receives. Management believes using an average of the quotes in these cases would generally not represent the fair value of the asset. Based on Newcastle’s own fair value analysis using internal models, management selects one of the quotes which is believed to more accurately reflect fair value. Newcastle never adjusts quotes received. These quotations are generally received via email and contain disclaimers which state that they are “indicative” and not “actionable” – meaning that the party giving the quotation is not bound to actually purchase the security at the quoted price.
(D)	Management was unable to obtain quotations from more than one source on these securities. The one source was generally the seller (the party that sold us the security) or a pricing service.
(E)	Securities whose fair value was estimated based on internal pricing models are further detailed as follows:

										Assumption Ranges
	Amortized Cost		Fair		Impairment Recorded In Current		Unrealized Gains (Losses) in Accumulated			Discount		Prepayment		Default		Loss
	Basis (B)		Value		Period		OCI			Rate		Speed (F)		Rate		Severity
CMBS - Conduit	$	107,431	$	124,470	$	1,471	$	17,039			12%		N/A		5%-100%		16%-100%
CMBS - Large loan / single borrower		56,728		54,478		—		(2,250	)		1%-12%		N/A		0%-100%		0%-100%
ABS - subprime		61,006		69,802		479		8,796			8%		0%-11%		24%-87%		60%-100%
ABS - other RE		8,641		6,101		—		(2,540	)		8%		1%-4%		33%-63%		79%-95%
CDO		4,261		3,978		—		(283	)		14%		4%		17%		83%
Total	$	238,067	$	258,829	$	1,950	$	20,762

	All of the assumptions listed have some degree of market observability, based on Newcastle’s knowledge of the market, relationships with market participants, and use of common market data sources. Collateral prepayment, default and loss severity projections are in the form of “curves” or “vectors” that vary for each monthly collateral cash flow projection. Methods used to develop these projections vary by asset class (e.g., CMBS projections are developed differently than home equity ABS projections) but conform to industry conventions. Newcastle uses assumptions that generate its best estimate of future cash flows of each respective security.

	The prepayment vector specifies the percentage of the collateral balance that is expected to voluntarily pay off at each point in the future. The prepayment vector is based on projections from a widely published investment bank model which considers factors such as collateral FICO score, loan-to-value ratio, debt-to-income ratio, and vintage on a loan level basis. This vector is scaled up or down to match recent collateral-specific prepayment experience, as obtained from remittance reports and market data services.

	Loss severities are based on recent collateral-specific experience with additional consideration given to collateral characteristics. Collateral age is taken into consideration because severities tend to initially increase with collateral age before eventually stabilizing. Newcastle typically uses projected severities that are higher than the historic experience for collateral that is relatively new to account for this effect. Collateral characteristics such as loan size, lien position, and location (state) also effect loss severity. Newcastle considers whether a collateral pool has experienced a significant change in its composition with respect to these factors when assigning severity projections.

	Default rates are determined from the current “pipeline” of loans that are more than 90 days delinquent, in foreclosure, or are real estate owned (REO). These significantly delinquent loans determine the first 24 months of the default vector. Beyond month 24, the default vector transitions to a steady-state value that is generally equal to or greater than that given by the widely published investment bank model.

	The discount rates Newcastle uses are derived from a range of observable pricing on securities backed by similar collateral and offered in a live market. As the markets in which Newcastle transacts have become less liquid, Newcastle has had to rely on fewer data points in this analysis.

(F)	Projected annualized average prepayment rate.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Loan Valuation

Loans which Newcastle does not have the ability or intent to hold into the foreseeable future are classified as held-for-sale. As a result, these held-for-sale loans are carried at the lower of amortized cost or fair value and are therefore recorded at fair value on a non-recurring basis. These loans were written down to fair value at the time of the impairment, based on broker quotations, pricing service quotations or internal pricing models. All the loans were within Level 3 of the fair value hierarchy. For real estate related loans, the most significant inputs used in the valuations are the amount and timing of expected future cash flows, market yields and the estimated collateral value of such loan investments. For residential mortgage loans, significant inputs include management’s expectations of prepayment speeds, default rates, loss severities and discount rates that market participants would use in determining the fair values of similar pools of residential mortgage loans.

The following tables summarize certain information for real estate related loans and residential mortgage loans held-for-sale as of March 31, 2012:

										Significant Input Ranges
Loan Type	Outstanding Face Amount		Carrying Value		Fair Value		Valuation Allowance/ (Reversal) In Current Year			Discount Rate		Loss Severity
Mezzanine	$	584,234	$	462,197	$	468,556	$	(733	)		8.0% -15.0%		0.0% - 100.0%
Bank Loan		295,638		183,526		183,660		(11,299	)		8.4% - 24.9%		0.0% - 70.0%
B-Note		187,017		162,635		162,635		1,550			6.3% - 15.0%		0.0%
Whole Loan		30,460		30,460		30,478		—			5.1% - 7.1%		0.0% - 15.0%
Total Real Estate Related Loans Held-for-Sale, Net	$	1,097,349	$	838,818	$	845,329	$	(10,482	)

										Significant Input Ranges
Loan Type	Outstanding Face Amount		Carrying Value		Fair Value		Valuation Allowance/ (Reversal) In Current Year			Discount Rate			Prepayment Speed			Default Rate			Loss Severity
Non-securitized Manufactured Housing Loans Portfolio I	$	711	$	193	$	193	$	5			39.1	%		0.0	%		52.9	%		75.0	%
Non-securitized Manufactured Housing Loans Portfolio II		3,985		2,582		2,582		(202	)		15.5	%		5.0	%		6.6	%		80.0	%
Total Residential Mortgage Loans Held-for-Sale, Net	$	4,696	$	2,775	$	2,775	$	(197	)

Loans which Newcastle has the intent and ability to hold into the foreseeable future are classified as held-for-investment. Loans held-for-investment are carried at the aggregate unpaid principal balance adjusted for any unamortized premium or discount, deferred fees or expenses, an allowance for loan losses, charge-offs and write-downs for impaired loans.

The following table summarizes certain information for residential mortgage loans held-for-investment as of March 31, 2012:

										Significant Input Ranges
Loan Type	Outstanding Face Amount		Carrying Value		Fair Value		Valuation Allowance/ (Reversal) In Current Year			Discount Rate		Prepayment Speed		Constant Default Rate		Loss Severity
Securitized Manufactured Housing Loans Portoflio I	$	130,488	$	108,839	$	109,875	$	680		9.5%		3.0%		4.0%		75.0%
Securitized Manufactured Housing Loans Portfolio II		171,858		168,837		165,691		1,069			7.6%		5.0%		3.5%		80.0%
Residential Loans		59,419		43,671		44,616		(101	)		4.7%-7.8%		0.0%-5.0%		0.0%-3.0%		0.0%-50.0%
Total Residential Mortgage Loans, Held-for-Investment, Net	$	361,765	$	321,347	$	320,182	$	1,648

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Excess MSRs Valuation

Fair value estimates of Newcastle’s Excess MSRs were based on internal pricing models. Significant inputs used in the valuations included expectations of prepayment rates, delinquencies, default rates and recapture rates of the underlying mortgage loans, and discount rates that market participants would use in determining the fair values of servicing assets on similar pools of residential mortgage loans. In addition, in valuing the Excess MSRs, management considered the likelihood of Nationstar being removed as servicer, which likelihood is considered to be remote.

The following table summarizes certain information regarding the inputs used in valuing the Excess MSRs as of March 31, 2012:

	Significant Input Ranges
	Prepayment Rate (A)			Delinquency Rate (B)			Recapture Rate (C)			Excess Mortgage Servicing Amount (D)		Discount Rate
Portfolio I	20.0		%	10.0		%	35.0		%	29 bps		20.0		%
Portfolio I - Recapture Agreement		8.0	%		10.0	%		35.0	%		21 bps		20.0	%

(A)	Projected annualized weighted average lifetime voluntary and involuntary prepayment rate using a prepayment vector.
(B)	Projected percentage of mortgage loans in the pool that will miss their mortgage payments.
(C)	Percentage of voluntarily prepaid loans that are expected to be refinanced by Nationstar.
(D)	Weighted average mortgage servicing amount in excess of the base mortgage servicing fee.

All of the assumptions listed have some degree of market observability, based on Newcastle’s knowledge of the market, relationships with market participants, and use of common market data sources. Prepayment rates are in the form of “curves” or “vectors” that vary over the expected life of the pool. Newcastle uses assumptions that generate its best estimate of future cash flows for each Excess MSR investment.

The prepayment vector specifies the percentage of the collateral balance that is expected to voluntarily and involuntarily (i.e. default) pay off at each point in the future. The prepayment vector is based on projections that consider factors such as the underlying borrower’s FICO score, loan-to-value ratio, debt-to-income ratio, vintage on a loan level basis, as well as the potential effect on loans eligible for the Home Affordable Refinance Program 2.0 (“HARP 2.0”). This vector is scaled up or down to match recent collateral-specific prepayment experience, as obtained from remittance reports, market data services and other market factors.

Delinquency rates are based on recent pool-specific experience of loans that misled their most recent mortgage payments, with additional consideration given to the current “pipeline” of loans that are 30 days or more delinquent, in foreclosure, or are real estate owned (REO).

Recapture rates are based on recent actual average recapture rates experienced by Nationstar on similar GSE mortgage loan pools.

For existing mortgage pools, excess mortgage servicing amount projections are based on actual mortgage servicing amount. For loans that are yet to be refinanced by Nationstar, Newcastle considers the excess mortgage servicing amount on loans recently originated by Nationstar and generally assumes lower excess mortgage servicing amount than the historic experience.

The discount rates Newcastle uses are derived from a range of observable pricing on mortgage servicing assets backed by similar collateral.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Newcastle’s MSRs investments measured at fair value on a recurring basis using Level 3B inputs changed during the period ended March 31, 2012 as follows:

	Level 3B
	Portfolio I			Portfolio I - Recapture Agreement			Total
Balance at December 31, 2011	$	37,637		$	6,334		$	43,971
Transfers (A)
Transfers from Level 3		—			—			—
Transfers into Level 3		—			—			—
Total gains (losses)
Included in net income (B)		1,215			1			1,216
Amortization included in interest income		2,037			—			2,037
Purchases, sales and settlements
Purchase adjustments		(150	)		(28	)		(178	)
Proceeds from sales		—			—			—
Proceeds from repayments		(4,459	)		—			(4,459	)
Balance at March 31, 2012	$	36,280		$	6,307		$	42,587

	(A)	Transfers are assumed to occur at the beginning of the quarter.
	(B)	The gains (losses) recorded in earnings during the period are attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting dates. These gains(losses) are recorded in “Other Income (Loss)” in the consolidated statement of income.

Newcastle has various processes and controls in place to ensure that fair value is reasonably estimated. With respect to the broker and pricing service quotations, to ensure these quotes represent a reasonable estimate of fair value, Newcastle’s quarterly procedures include a comparison to the outputs generated from its internal pricing models and transactions Newcastle has completed with respect to these securities, as well as on its knowledge and experience of these markets. With respect to fair value estimates generated based on Newcastle’s internal pricing models, Newcastle’s management validates the inputs and outputs of the internal pricing models by comparing them to available independent third party market parameters and models for reasonableness. Newcastle believes its valuation methods and the assumptions used are appropriate and consistent with other market participants.

Fair value measurements categorized within Level 3 are sensitive to changes in the assumptions or methodology used to determine fair value and such changes could result in a significant increase or decrease in the fair value. For Newcastle’s investments in real estate securities, real estate related loans and residential mortgage loans categorized within Level 3 of the fair value hierarchy, the significant unobservable inputs include the discount rates, assumptions relating to prepayments, default rates and loss severities. Significant increases (decreases) in any of the discount rates, default rates or loss severities in isolation would result in a significantly lower (higher) fair value measurement. The impact of changes in prepayment speeds would have differing impacts on fair value, depending on the seniority of the investment. Generally, a change in the default assumption is generally accompanied by directionally similar changes in the assumptions used for the loss severity and the prepayment speed. For Newcastle’s investments in Excess MSRs, significant unobservable inputs include the discount rate, assumptions relating to prepayments, default rates, delinquency rates, recapture rates and excess mortgage servicing amount. Significant increases (decreases) in the discount rates, prepayments, default rates or delinquency rates in isolation would result in a significantly lower (higher) fair value measurement, whereas significant increases (decreases) in the recapture rates or excess mortgage servicing amount in isolation would result in a significantly higher (lower) fair value measurement. Generally, a change in the default assumption is accompanied by directionally similar changes in the assumptions used for the loss severity and the prepayment speed.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Derivatives

Newcastle’s derivative instruments are valued using counterparty quotations. These quotations are generally based on valuation models with model inputs that can generally be verified and which do not involve significant judgment. The significant observable inputs used in determining the fair value of our Level 2 derivative contracts are contractual cash flows and market based interest rate curves. Newcastle’s derivatives are recorded on its balance sheet as follows:

		Fair Value
		March 31,		December 31,
	Balance sheet location	2012		2011

Derivative Assets
Interest rate caps, designated as hedges	Derivative Assets	$	1,029	$	1,092
Interest rate caps, not designated as hedges	Derivative Assets		803		862
		$	1,832	$	1,954
Derivative Liabilities
Interest rate swaps, designated as hedges	Derivative Liabilities	$	81,618	$	90,025
Interest rate swaps, not designated as hedges	Derivative Liabilities		27,156		29,295
		$	108,774	$	119,320

The following table summarizes information related to derivatives:

	March 31, 2012			December 31, 2011
Cash flow hedges
Notional amount of interest rate swap agreements	$	832,767		$	848,434
Notional amount of interest rate cap agreements		122,755			104,205
Amount of (loss) recognized in OCI on effective portion		(61,763	)		(69,908	)
Deferred hedge gain (loss) related to anticipated financings, which have subsequently occurred, net of amortization		284			299
Deferred hedge gain (loss) related to dedesignation, net of amortization		(1,059	)		(893	)
Expected reclassification of deferred hedges from AOCI into earnings over the next 12 months		1,745			1,688

Expected reclassification of current hedges from AOCI into earnings over the next 12 months		(33,762	)		(35,348	)

Non-hedge Derivatives
Notional amount of interest rate swap agreements		306,077			316,600
Notional amount of interest rate cap agreements		42,428			36,428

The following table summarizes gains (losses) recorded in relation to derivatives:

		Three Months Ended March 31,
	Income statement location			2012			2011
Cash flow hedges
Gain (loss) on the ineffective portion	Other income (loss)		$	30		$	283
Gain (loss) immediately recognized at dedesignation	Gain (loss) on sale of investments; Other income (loss)			(276	)		(5,315	)
Amount of gain (loss) reclassified from AOCI into income, related to effective portion	Interest expense			(10,646	)		(21,191	)
Deferred hedge gain reclassified from AOCI into income, related to anticipated financings	Interest expense			15			14
Deferred hedge gain (loss) reclassified from AOCI into income, related to effective portion of dedesignated hedges	Interest expense			442			719
Non-hedge derivatives gain (loss)	Other income (loss)			2,056			4,831

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

Liabilities for Which Fair Value is Only Disclosed

The following table summarizes the level of the fair value hierarchy, valuation techniques and inputs used for estimating each class of liabilities not measured at fair value in the statement of financial position but for which fair value is disclosed:

Type of Liabilities Not Measured At Fair Value for Which Fair Value Is Disclosed	Fair Value Hierarchy	Valuation Techniques and Significant Inputs
CDO bonds payable	Level 3	Valuation technique is based on discounted cash flow. Significant inputs include: • Underlying security and loan prepayment, default and cumulative loss expectations • Amount and timing of expected future cash flows • Market yields and credit spreads implied by comparisons to transactions of similar tranches of CDO debt by the varying levels of subordination
Other bonds and notes payable	Level 3	Valuation technique is based on discounted cash flow. Significant inputs include: • Amount and timing of expected future cash flows • Interest rates • Broker quotation • Market yields and credit spreads implied by comparisons to transactions of similar tranches of securitized debt by the varying levels of subordination
Repurchase agreements	Level 2	Valuation technique is based on market comparables. Significant inputs include: • Amount and timing of expected future cash flows • Interest rates • Collateral funding spreads
Junior subordinated notes payable	Level 3	Valuation technique is based on discounted cash flow. Significant inputs include: • Amount and timing of expected future cash flows • Interest rates • Market yields and the credit spread of Newcastle

7. EQUITY AND EARNINGS PER SHARE

Newcastle is required to present both basic and diluted earnings per share (“EPS”). Basic EPS is calculated by dividing net income available for common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted EPS is calculated by dividing net income available for common stockholders by the weighted average number of shares of common stock outstanding plus the additional dilutive effect of common stock equivalents during each period. Newcastle’s common stock equivalents are its outstanding stock options. During the three months ended March 31, 2012 and 2011, based on the treasury stock method, Newcastle had 489,093 and 8,886 dilutive common stock equivalents, respectively, resulting from its outstanding options. Net income available for common stockholders is equal to net income less preferred dividends.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

As of March 31, 2012, Newcastle’s outstanding options were summarized as follows:

Held by the Manager			5,998,947
Issued to the Manager and subsequently transferred to certain of the Manager’s employees			798,162
Issued to the independent directors			16,000
Total			6,813,109

8. COMMITMENTS AND CONTINGENCIES

Litigation — Newcastle is, from time to time, a defendant in legal actions from transactions conducted in the ordinary course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such actions, individually and in the aggregate, that existed at March 31, 2012, if any, will not materially affect Newcastle’s consolidated results of operations or financial position.

Contingent Gain in CDOs — Newcastle cannot economically lose more than its investment amount in any given non-recourse financing structure. Therefore, impairment recorded in excess of such investment, which results in negative GAAP book value for a given non-recourse financing structure, cannot economically be incurred. For non-recourse financing structures with negative GAAP book value, the aggregate negative GAAP book value will eventually be recorded as an increase to GAAP book value. As of March 31, 2012, Newcastle has recorded $121.7 million of losses in its CDOs in excess of its economic exposure which must eventually be reversed through amortization, sales at gains, or as reductions to accumulated deficit at the deconsolidation or termination of the CDOs.

9. GAIN (LOSSES) ON SETTLEMENT OF INVESTMENTS, NET AND OTHER INCOME (LOSS), NET

These items are comprised of the following:

	Three Months Ended March 31,
	2012			2011
Gain (loss) on settlement of investments, net
Gain on settlement of real estate securities	$	6,772		$	34,157
Loss on settlement of real estate securities		(335	)		(1,785	)
Gain on repayment/disposition of loans held-for-sale		—			1,720
Loss on repayment /disposition of loans held-for sale		(1,614	)		—
	$	4,823		$	34,092
Other income (loss), net
Gain (loss) on non-hedge derivative instruments	$	2,056		$	4,831
Unrealized (loss) recognized at de-designation of hedges		(276	)		(5,315	)
Increase in fair value of investments in excess mortgage servicing rights		1,216			—
Hedge ineffectiveness		30			283
Collateral management fee income, net		513			536
Other income (loss)		647			—
	$	4,186		$	335

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2012

(dollars in thousands, except share data)

10. SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES RELATED TO CDOs

Newcastle considers all activity in its CDOs’ restricted cash accounts to be non-cash activity for purposes of its consolidated statement of cash flows since transactions conducted with restricted cash have no effect on its cash and cash equivalents. Supplemental non-cash investing and financing activities relating to CDOs are disclosed below:

	Three Months Ended March 31,
	2012		2011
Restricted cash generated from sale of securities	$	13,965	$	61,052
Restricted cash generated from paydowns on securities and loans	$	60,466	$	211,786
Restricted cash used for purchases of real estate securities	$	14,689	$	126,163
Restricted cash used for purchases of real estate related loans	$	45,481	$	111,667
Restricted cash used for repayments of CDO bonds payable	$	7,710	$	54,104
Restricted cash used for repurchases of derivative instruments	$	168	$	—

11. RECENT ACTIVITIES

These financial statements include a discussion of material events that have occurred subsequent to March 31, 2012 (referred to as “subsequent events”) through the issuance of these consolidated financial statements. Events subsequent to that date have not been considered in these financial statements.

On March 6, 2012, Newcastle entered into definitive agreements to acquire an investment in Excess MSRs in connection with Nationstar’s acquisition of mortgage servicing assets from Aurora Bank FSB, a subsidiary of Lehman Brothers Bancorp Inc. Newcastle expects to invest approximately $170 million to acquire an approximately 65% interest in the Excess MSRs on a portfolio of residential mortgage loans with an outstanding principal balance of approximately $63 billion, comprised of approximately 75% non-conforming loans in private label securitizations and approximately 25% conforming loans in GSE pools. Nationstar will co-invest pari passu with Newcastle in approximately 35% of the Excess MSRs and will be the servicer of the loans performing all servicing and advancing functions, and retaining the ancillary income, servicing obligations and liabilities as the servicer. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by Nationstar, the resulting Excess MSRs will be shared pro rata by Newcastle and Nationstar, subject to certain limitations. The investment is expected to close in the second quarter of 2012 and is subject to regulatory and third-party approvals.

In March 2012, Newcastle repurchased $30.0 million face amount of Newcastle CDO bonds for $9.2 million. As a result, Newcastle extinguished $30.0 million of CDO debt and recorded a gain on extinguishment of debt of $20.7 million in the first quarter of 2012.

See Note 7 regarding the public offering of Newcastle’s common stock in April 2012.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following should be read in conjunction with the unaudited consolidated financial statements and notes thereto included herein, and with Part II, Item 1A, “Risk Factors.”

GENERAL

Newcastle Investment Corp. is a real estate investment and finance company. We invest in, and actively manage, a portfolio of real estate securities, loans, excess mortgage servicing rights (“Excess MSRs”) and other real estate related assets. Our objective is to maximize the difference between the yield on our investments and the cost of financing these investments while hedging our interest rate risk. We emphasize portfolio management, asset quality, liquidity, diversification, match funded financing and credit risk management.

We currently own a diversified portfolio of credit sensitive real estate debt investments, including securities and loans, and other real estate debt investments such as Excess MSRs. Our portfolio of real estate securities includes commercial mortgage backed securities (CMBS), senior unsecured debt issued by REITs, real estate related asset backed securities (ABS), and FNMA/FHLMC securities. Mortgage backed securities are interests in or obligations secured by pools of mortgage loans. We generally target investments rated A through BB, except for our FNMA/FHLMC securities, which have an implied AAA rating. We also own, directly and indirectly, interests in loans and pools of loans, including real estate related loans, commercial mortgage loans, residential mortgage loans, manufactured housing loans, and subprime mortgage loans.

We employ leverage as part of our investment strategy. We do not have a predetermined target debt to equity ratio as we believe the appropriate leverage for the particular assets we are financing depends on the credit quality of those assets. As of March 31, 2012, we had complied with the general investment guidelines adopted by our board of directors that limit total leverage. We utilize leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.

We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential fluctuations in the availability of capital. We seek to utilize multiple forms of financing, including collateralized debt obligations (CDOs), other securitizations, term loans, and trust preferred securities, as well as short term financing in the form of loans and repurchase agreements. As we discuss in more detail under “–Market Considerations” below, while market conditions have improved meaningfully since 2008, the current conditions continue to reduce the array of capital resources available to us and have made the terms of capital resources we are able to obtain generally less favorable to us relative to the terms we were able to obtain prior to the onset of challenging conditions. Specifically, the economic environments and capital markets have become volatile in recent months. That said, we have recently been able to access more types of capital – and on better terms – than we had been able to access during 2008 and 2009.

We seek to match fund our investments with respect to interest rates and maturities in order to reduce the impact of interest rate fluctuations on earnings and reduce the risk of refinancing our liabilities prior to the maturity of the investments. We seek to finance a substantial portion of our real estate securities and loans through the issuance of term debt, which generally represents obligations issued in multiple classes secured by an underlying portfolio of assets. Specifically, our CDO financings offer us the structural flexibility to buy and sell certain investments to manage risk and, subject to certain limitations, to optimize returns.

We conduct our business through the following segments: (i) investments financed with non-recourse collateralized debt obligations (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered CDOs”), (iii) unlevered Excess MSRs, (iv) investments financed with other non-recourse debt (“non-recourse other”), (v) investments and debt repurchases financed with recourse debt (“recourse”), (vi) other unlevered investments (“unlevered other”) and (vii) corporate. With respect to the non-recourse CDOs and non-recourse other segments, Newcastle is generally entitled to receive net cash flows from these structures on a periodic basis. Revenues attributable to each segment, as restated for previously reported periods, are disclosed below (in thousands).

For the Three Months Ended March 31,	Non-Recourse CDOs		Unlevered CDOs		Unlevered Excess MSRs		Non-Recourse Other		Recourse		Unlevered Other		Corporate		Inter-segment Elimination			Total
2012	$	54,402	$	115	$	2,037	$	18,426	$	814	$	523	$	51	$	(1,469	)	$	74,899
2011	$	54,828	$	11	$	—	$	17,481	$	147	$	482	$	20	$	(766	)	$	72,203

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Market Considerations

Financial Markets in which We Operate

Our ability to generate income is dependent on our ability to invest our capital on a timely basis at attractive levels. The two primary market factors that affect our ability to do this are (1) credit spreads and (2) the availability of financing on favorable terms.

Generally speaking, widening credit spreads reduce any unrealized gains on our current investments (or cause or increase unrealized losses) and increase our costs for new financings, but increase the yields available on potential new investments, while tightening credit spreads increase the unrealized gains (or reduce unrealized losses) on our current investments and reduce our costs for new financings, but reduce the yields available on potential new investments. By reducing unrealized gains (or causing unrealized losses), widening credit spreads also impact our ability to realize gains on existing investments if we were to sell such assets.

From mid-2007 through early 2009, credit spreads widened substantially. One of the key drivers of the widening of credit spreads over these years was the continued disruption and liquidity concerns throughout the credit markets. The severity and scope of the disruption intensified meaningfully during the fourth quarter of 2008 and the first quarter of 2009. In the latter part of 2009, credit spreads tightened substantially and continued to tighten in 2010 and the first half of 2011. However, credit spreads have widened since the third quarter of 2011, reflecting the challenging economic environment. These changes in credit spreads caused the net unrealized gains on our securities to increase during the first half of 2011, but these increases were reversed and resulted in net unrealized losses in the second half of 2011. Market conditions improved moderately in the first quarter of 2012 but remain challenging and could change rapidly. We cannot predict how recent or future changes in market conditions will affect our business.

We utilize multiple forms of financing, depending on their appropriateness and availability, to finance our investments, including collateralized debt obligations (CDOs) or other securitizations, private or public offerings of debt, term loans, trust preferred securities, and short-term financing in the form of loans and repurchase agreements. One component of our investment strategy is to use match funded financing structures, such as CDOs, at rates that provide a positive net spread relative to our investment returns.

Recent conditions in the credit markets have impaired our ability to match fund investments. During the past several years, financing in the form of securitizations or other long-term non-recourse structures not subject to margin requirements was generally not available or economical, and it remains difficult to obtain under current market conditions. Lenders have generally tightened their underwriting standards and increased their margin requirements, resulting in a decline in the overall amount of leverage available to us and an increase in our borrowing costs. These conditions make it highly likely that we will have to use less efficient forms of financing for any new investments, which will likely require a larger portion of our cash flows to be put toward making the initial investment and thereby reduce the amount of cash available for distribution to our stockholders and funds available for operations and investments, and which will also likely require us to assume higher levels of risk when financing our investments. Moreover, financial market conditions remain volatile and have been adversely affected by the unrest in the Middle East, the earthquake in Japan, the European financial crisis, continuing weakness in the U.S. job market and concern about the United States’ level of indebtedness. Volatility in equity markets could impair our ability to raise debt or equity capital or otherwise finance our business.

We believe that the current environment has created an attractive opportunity to invest in MSRs. Specifically:

	•	changes in the regulatory treatment of MSRs for financial institutions subject to Basel III, a revision to the global regulatory capital and liquidity framework for banks, which will impose increased regulatory capital costs on banks for owning MSRs;
	•	elevated borrower delinquencies and defaults experienced over the last few years, and increased regulatory oversight, has led to substantially higher costs for mortgage servicers and negatively impacted their profitability; and
	•	mortgage servicing has become less attractive to many financial institutions due to increasingly negative publicity and heightened government and regulatory scrutiny.

These dynamics resulted in a pipeline of MSRs for sale by banks to non-bank servicers, as these institutions are under pressure to exit or reduce their exposure to the mortgage servicing business. As a result, we believe that this relative oversupply of MSRs, combined with a historically low interest rate environment and a challenging credit market, have contributed to an availability of MSRs that are attractively priced. We closed on our first investment in Excess MSRs in December 2011 and are exploring opportunities to acquire additional Excess MSRs that provide attractive risk-adjusted returns.

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Liquidity

Credit and liquidity conditions improved during 2010 and 2011, and the early part of 2012 relative to the conditions experienced during the recent financial crisis. That said, the challenging credit and liquidity conditions that we experienced during the financial crisis continue to adversely affect us and the markets in which we operate in a number of ways. For example, these conditions have reduced the market trading activity for many real estate securities and loans, resulting in less liquid markets for those securities and loans. As the securities held by us and many other companies in our industry are marked to market at the end of each quarter, the decreased liquidity and concern over market conditions have resulted in significant reductions in mark to market valuations of many real estate securities and loans and the collateral underlying them, as well as volatility and uncertainty with respect to such valuations. These lower valuations, and decreased expectations of future cash flows, have affected us by, among other things:

	•	decreasing our net book value;
	•	contributing to our decision to record significant impairment charges; and
	•	reducing the amount, which we refer to as “cushion”, by which we satisfy the over collateralization and interest coverage tests of our CDOs (sometimes referred to as CDO “triggers”) or contributing to several of our CDOs failing their over collateralization tests (see “– Liquidity and Capital Resources” and “– Debt Obligations” below).

Failed CDO triggers, impairments resulting from incurred losses, and asset sales made at prices significantly below face amount while the related debt is being repaid at its full face amount, as well as the retention of cash, could further contribute to reductions in future earnings, cash flow and liquidity.

With respect to dividends, we have paid all dividends on our preferred stock through April 30, 2012. We declared a quarterly dividend of $0.20 per common share for the first quarter of 2012, which was paid in April 2012. We may elect to adjust or not to pay any future dividend payments to reflect our current and expected cash from operations or to satisfy future liquidity needs.

Extent of Market Disruption / Recovery

Market conditions have meaningfully improved over the last two years, but it is not clear whether a sustained recovery will occur or, if so, for how long it will last. We do not currently know the full extent to which the continuing challenging market conditions will affect us or the markets in which we operate. If such conditions continue, particularly with respect to commercial real estate, we may experience additional impairment charges, potential reductions in cash flows from our investments and additional challenges in raising capital and obtaining investment or other financing on attractive terms. Moreover, we will likely need to continue to place a high priority on managing our liquidity. Certain aspects of these effects are more fully described in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate, Credit and Spread Risk” and “– Liquidity and Capital Resources” as well as in Part I, Item 3, “Quantitative and Qualitative Disclosures About Market Risk.”

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Actual results could differ from these estimates. Management believes that the estimates and assumptions utilized in the preparation of the consolidated financial statements are prudent and reasonable. Actual results historically have been in line with management’s estimates and judgments used in applying each of the accounting policies described below, as modified periodically to reflect current market conditions. The following is a summary of our accounting policies that are most effected by judgments, estimates and assumptions.

Variable Interest Entities

Variable interest entities (“VIEs”) are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, and only by its primary beneficiary, which is defined as the party who has the power to direct the activities of a VIE that most significantly impact its economic performance and who has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.

The VIEs in which we have a significant interest include (i) our CDOs, and (ii) our manufactured housing loan financing structures. Currently, we do not have the power to direct the relevant activities of CDO V, as a result of the event of default which allows us to be removed as collateral manager of CDO V and prevents us from purchasing or selling collateral within

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CDO V, and therefore we have deconsolidated CDO V as of June 17, 2011. Similar events of default in the future, if they occur, could cause us to deconsolidate additional financing structures. Our manufactured housing loan financing structures are consolidated. However, we completed two securitization transactions to refinance our Manufactured Housing Loan Portfolios I and II. We analyzed the securitizations under the applicable accounting guidance and concluded that the securitization transactions should be accounted for as secured borrowings. As a result, we continue to recognize the portfolios of manufactured housing loans as pledged assets, which have been classified as loans held-for-investment at securitization, and recorded the notes issued to third parties as secured borrowings.

Our subprime securitizations are also considered VIEs, but we do not control their activities and no longer receive a significant portion of their returns. These subprime securitizations were not consolidated under the current or prior guidance.

In addition, our investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. We are not obligated to provide, nor have we provided, any financial support to these VIEs. We monitor these investments and, to the extent we determine that we potentially own a majority of the currently controlling class, analyze them for potential consolidation. As of March 31, 2012, we have not consolidated these potential VIEs due to the determination that, based on the nature of our investments and the provisions governing these structures, we do not have the power to direct the activities that most significantly impact their economic performance.

We will continue to analyze future investments, as well as reconsideration events in existing entities, pursuant to the VIE requirements. These analyses require considerable judgment in determining the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power and economics. The result could be the consolidation of an entity that would otherwise not have been consolidated or the de-consolidation of an entity that would otherwise have been consolidated.

Valuation and Impairment of Securities

We have classified all our real estate securities as available-for-sale. As such, they are carried at fair value with net unrealized gains or losses reported as a component of accumulated other comprehensive income, to the extent impairment losses are considered temporary as described below. Fair value may be based upon broker quotations, counterparty quotations or pricing services quotations, which provide valuation estimates based upon reasonable market order indications or a good faith estimate thereof and are subject to significant variability based on market conditions, such as interest rates, credit spreads and market liquidity. A significant portion of our securities are currently not traded in active markets and therefore have little or no price transparency. For a further discussion of this trend, see “– Market Considerations” above. As a result, we have estimated the fair value of these illiquid securities based on internal pricing models rather than the sources described above. The determination of estimated cash flows used in pricing models is inherently subjective and imprecise. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant and immediate increase or decrease in our book equity. For securities valued with pricing models, these inputs include the discount rate, assumptions relating to prepayments, default rates and loss severities, as well as other variables.

See Note 6 to our consolidated financial statements in Part I, Item 1, “Financial Statements and Supplementary Data” for information regarding the fair value of our investments, and its estimation methodology, as of March 31, 2012.

Our securities must be categorized by the “level” of inputs used in estimating their fair values. Level 1 would be assets valued based on quoted prices for identical instruments in active markets. We have no level 1 assets. Level 2 would be assets valued based on quoted prices in active markets for similar instruments, on quoted prices in less active or inactive markets, or on other “observable” market inputs. Level 3 would be assets valued based significantly on “unobservable” market inputs. We have further broken level 3 into level 3A, third party indications, and level 3B, internal models. Fair value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were forced to sell assets in a short period to meet liquidity needs, the prices we receive could be substantially less than the recorded fair values.

We generally classify the broker and pricing service quotations we receive as level 3A inputs, except for certain liquid securities. They are quoted prices in generally inactive and illiquid markets for identical or similar securities. These quotations are generally received via email and contain disclaimers which state that they are “indicative” and not “actionable” – meaning that the party giving the quotation is not bound to actually purchase the security at the quoted price. These quotations are generally based on models prepared by the brokers and we have little visibility into the inputs they use. Based on quarterly procedures we have performed with respect to quotations received from these brokers, including comparison to the outputs generated from our internal pricing models and transactions we have completed with respect to these securities, as well as on our knowledge and experience of these markets, we have generally determined that these quotes represent a reasonable estimate of fair value. For the $1.5 billion carrying value of securities valued using quotations

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as of March 31, 2012, a 100 basis point change in credit spreads would impact estimated fair value by approximately $60.2 million.

Our estimation of the fair value of level 3B assets (as described below) involves significant judgment. We validated the inputs and outputs of our models by comparing them to available independent third party market parameters and models for reasonableness. We believe the assumptions we used are within the range that a market participant would use, and factor in the liquidity conditions currently in the markets. In the first three months of 2012, the inputs to our models, including discount rates, prepayment speeds, default rates and severity assumptions, have generally remained consistent with the assumptions used at year-end, other than certain modifications we have made to the assumptions to reflect conditions relevant to specific assets.

For CMBS and ABS securities valued with internal models, which have an aggregate fair value of $254.9 million as of March 31, 2012, a 10% unfavorable change in our assumptions would result in the following decreases in such aggregate fair value (in thousands):

	CMBS			ABS
Outstanding face amount	$	342,885		$	176,301

Fair value	$	178,948		$	75,903

Effect on fair value with 10% unfavorable change in:
Discount rate	$	(4,586	)	$	(2,562	)
Prepayment rate		N/A		$	(577	)
Default rate	$	(8,421	)	$	(4,394	)
Loss severity	$	(5,400	)	$	(7,527	)

This sensitivity analysis is hypothetical and should be used with caution. In particular, the results are calculated by stressing a particular economic assumption independent of changes in any other assumption; in practice, changes in one factor may result in changes in another, which might counteract or amplify the sensitivities. Also, changes in the fair value based on a 10% variation in an assumption generally may not be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear.

We must also assess whether unrealized losses on securities, if any, reflect a decline in value which is other-than-temporary and, if so, write the impaired security down to its fair value through earnings. A decline in value is deemed to be other-than-temporary if (i) it is probable that we will be unable to collect all amounts due according to the contractual terms of a security which was not impaired at acquisition (there is an expected credit loss), or (ii) if we have the intent to sell a security in an unrealized loss position or it is more likely than not we will be required to sell a security in an unrealized loss position prior to its anticipated recovery (if any). For the purposes of performing this analysis, we assume the anticipated recovery period is until the respective security’s expected maturity. Also, for certain securities which represent “beneficial interests in securitized financial assets,” whenever there is a probable adverse change in the timing or amounts of estimated cash flows of a security from the cash flows previously projected, an other-than-temporary impairment is considered to have occurred. These securities are also analyzed for other-than-temporary impairment under the guidelines applicable to all securities as described herein. We note that primarily all of our securities, except our FNMA/FHLMC securities, fall within the definition of beneficial interests in securitized financial assets.

Temporary declines in value generally result from changes in market factors, such as market interest rates and credit spreads, or from certain macroeconomic events, including market disruptions and supply changes, which do not directly impact our ability to collect amounts contractually due. We continually evaluate the credit status of each of our securities and the collateral supporting our securities. This evaluation includes a review of the credit of the issuer of the security (if applicable), the credit rating of the security, the key terms of the security (including credit support), debt service coverage and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the collateral supporting such loans, including the effect of local, industry and broader economic trends and factors. These factors include loan default expectations and loss severities, which are analyzed in connection with a particular security’s credit support, as well as prepayment rates. These factors are also analyzed in relation to the amount of the unrealized loss and the period elapsed since it was incurred. The result of this evaluation is considered when determining management’s estimate of cash flows, particularly with respect to developing the necessary inputs and assumptions. Each security is impacted by different factors and in different ways; generally the more negative factors which are identified with respect to a given security, the more likely we are to determine that we do not expect to receive all contractual payments when due with respect to that security. Significant judgment is required in this analysis.

As of March 31, 2012, we had 26 securities, with a carrying amount of $146.5 million, that had been downgraded during the three months ended March 31, 2012, and recorded a net other-than-temporary impairment charge of $1.3 million on these securities in 2012. However, we do not depend on credit ratings in underwriting our securities, either at acquisition or

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on an ongoing basis. As mentioned above, a credit rating downgrade is one factor that we monitor and consider in our analysis regarding other-than-temporary impairment, but it is not determinative. Our securities generally benefit from the support of one or more subordinate classes of securities or equity or other forms of credit support. Therefore, credit rating downgrades, even to the extent they relate to an expectation that a securitization we have invested in, on an overall basis, has credit issues, may not ultimately impact cash flow estimates for the class of securities in which we are invested.

Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold is also subject to significant judgment, particularly in times of market illiquidity such as we are currently experiencing.

Revenue Recognition on Securities

Income on these securities is recognized using a level yield methodology based upon a number of cash flow assumptions that are subject to uncertainties and contingencies. Such assumptions include the rate and timing of principal and interest receipts (which may be subject to prepayments and defaults). These assumptions are updated on at least a quarterly basis to reflect changes related to a particular security, actual historical data, and market changes. These uncertainties and contingencies are difficult to predict and are subject to future events, and economic and market conditions, which may alter the assumptions. For securities acquired at a discount for credit losses, we recognize the excess of all cash flows expected over our investment in the securities as Interest Income on a “loss adjusted yield” basis. The loss-adjusted yield is determined based on an evaluation of the credit status of securities, as described in connection with the analysis of impairment above.

Valuation of Derivatives

Similarly, our derivative instruments are carried at fair value. Fair value is based on counterparty quotations. Newcastle reports the fair value of derivative instruments gross of cash paid or received pursuant to credit support agreements and fair value is reflected on a net by counterparty basis when Newcastle believes a legal right of offset exists under an enforceable netting agreement. To the extent they qualify as cash flow hedges, net unrealized gains or losses are reported as a component of accumulated other comprehensive income; otherwise, the net unrealized gains and losses are reported currently in income. To the extent they qualify as fair value hedges, net unrealized gains or losses on both the derivative and the related portion of the hedged item are reported currently in income. Fair values of such derivatives are subject to significant variability based on many of the same factors as the securities discussed above, including counterparty credit risk. The results of such variability, the effectiveness of our hedging strategies and the extent to which a forecasted hedged transaction remains probable of occurring, could result in a significant increase or decrease in our GAAP equity and/or earnings.

Impairment of Loans

We own, directly and indirectly, real estate related, commercial mortgage and residential mortgage loans, including manufactured housing loans and subprime mortgage loans. To the extent that they are classified as held-for-investment, we must periodically evaluate each of these loans or loan pools for possible impairment. Impairment is indicated when it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the loan, or, for loans acquired at a discount for credit losses, when it is deemed probable that we will be unable to collect as anticipated. Upon determination of impairment, we would establish a specific valuation allowance with a corresponding charge to earnings. We continually evaluate our loans receivable for impairment. Our residential mortgage loans, including manufactured housing loans, are aggregated into pools for evaluation based on like characteristics, such as loan type and acquisition date. Individual loans are evaluated based on an analysis of the borrower’s performance, the credit rating of the borrower, debt service coverage and loan to value ratios, the estimated value of the underlying collateral, the key terms of the loan, and the effect of local, industry and broader economic trends and factors. Pools of loans are also evaluated based on similar criteria, including historical and anticipated trends in defaults and loss severities for the type and seasoning of loans being evaluated. This information is used to estimate specific impairment charges on individual loans as well as provisions for estimated unidentified incurred losses on pools of loans. Significant judgment is required both in determining impairment and in estimating the resulting loss allowance. Furthermore, we must assess our intent and ability to hold our loan investments on a periodic basis. If we do not have the intent to hold a loan for the foreseeable future or until its expected payoff, the loan must be classified as “held-for-sale” and recorded at the lower of cost or estimated fair value.

Revenue Recognition on Loans Held-for-investment

Income on these loans is recognized similarly to that on our securities and is subject to similar uncertainties and contingencies, which are also analyzed on at least a quarterly basis. For loans acquired at a discount for credit losses, the net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income,

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offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Valuation Allowance. The provision is determined based on an evaluation of the loans as described under “Impairment of Loans” above.

Revenue Recognition on Investments in Excess Mortgage Servicing Rights

Investments in Excess MSRs are aggregated into pools as applicable; each pool of Excess MSRs is accounted for in the aggregate. Interest income for Excess MSRs is accreted on an effective yield or “interest” method, based upon the expected excess servicing income through the expected life of the underlying mortgages. Changes to expected cash flows result in a cumulative retrospective adjustment, which will be recorded in the period in which the change in expected cash flows occurs. Under the retrospective method, the interest income recognized for a reporting period would be measured as the difference between the amortized cost basis at the end of the period and the amortized cost basis at the beginning of the period, plus any cash received during the period. The amortized cost basis is calculated as the present value of estimated future cash flows using an effective yield, which is the yield that equates all past actual and current estimated future cash flows to the initial investment. In addition, our policy is to recognize interest income only on Excess MSRs in existing eligible underlying mortgages. The difference between the fair value of Excess MSRs and their amortized cost basis is recorded as “Other Income” or “Other Losses”, as applicable. Fair value is generally determined by discounting the expected future cash flows using discount rates that incorporate the market risks and liquidity premium specific to the Excess MSRs, and therefore may differ from their effective yields.

The following tables summarize the estimated change in fair value of the Excess MSRs as of March 31, 2012 given several parallel shifts in the discount rate, prepayment rate, delinquency rate and recapture rate (dollars in thousands):

Fair value at March 31, 2012	$	42,587

Discount rate shift in %		-20%			-10%			+10%			+20%
Estimated fair value	$	47,020		$	44,668		$	40,733		$	39,072
Change in estimated fair value:
Amount	$	4,433		$	2,081		$	(1,854	)	$	(3,515	)
%		10.4	%		4.9	%		-4.4	%		-8.3	%

Prepayment rate shift in %		-20%			-10%			+10%			+20%
Estimated fair value	$	47,111		$	44,762		$	40,568		$	38,690
Change in estimated fair value:
Amount	$	4,524		$	2,175		$	(2,019	)	$	(3,897	)
%		10.6	%		5.1	%		-4.7	%		-9.2	%

Delinquency rate shift in %		-20%			-10%			+10%			+20%
Estimated fair value	$	43,727		$	43,157		$	42,017		$	41,447
Change in estimated fair value:
Amount	$	1,140		$	570		$	(570	)	$	(1,140	)
%		2.7	%		1.3	%		-1.3	%		-2.7	%

Recapture rate shift in %		-20%			-10%			+10%			+20%
Estimated fair value	$	41,351		$	41,966		$	43,176		$	43,723
Change in estimated fair value:
Amount	$	(1,236	)	$	(621	)	$	589		$	1,136
%		-2.9	%		-1.5	%		1.4	%		2.7	%

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Revenue Recognition on Loans Held-for-sale

Real estate related, commercial mortgage and residential mortgage loans that are considered held-for-sale are carried at the lower of amortized cost or market value determined on either an individual method basis, or in the aggregate for pools of similar loans. Interest income is recognized based on the loan’s coupon rates to the extent management believes it is collectible. Purchase discounts are not amortized as interest income during the period the loans are held-for-sale. A change in the market value of the loans, to the extent that the value is not above the cost basis, is recorded in Valuation Allowance.

Recent Accounting Pronouncements

In May 2011, the FASB issued new guidance regarding the measurement and disclosure of fair value, which become effective for Newcastle on January 1, 2012. The adoption of this guidance did not have a material effect on Newcastle’s financial position, liquidity, or results of operations.

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. We early-adopted this accounting standard in 2011 and opted to present two separate statements.

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, the definition of an investment company, 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.

RESULTS OF OPERATIONS

The following table summarizes the changes in our results of operations for the three months ended March 31, 2012 compared to the three months ended March 31, 2011 (dollars in thousands):

	Three Months Ended March 31,						Increase (Decrease)
	2012			2011			Amount			%
Interest income	$	74,899		$	72,203		$	2,696			3.7	%
Interest expense		30,165			38,165			(8,000	)		(21.0	%)
Net interest income		44,734			34,038			10,696			31.4	%

Impairment (Reversal)
Valuation allowance (reversal) on loans		(9,031	)		(41,307	)		32,276			78.1	%
Other-than-temporary impairment on securities, net		1,951			4,101			(2,150	)		(52.4	%)
		(7,080	)		(37,206	)		30,126			81.0	%

Net interest income (loss) after impairment/reversal		51,814			71,244			(19,430	)		(27.3	%)

Other Income (Loss)
Gain (loss) on settlement of investments, net		4,823			34,092			(29,269	)		(85.9	%)
Gain on extinguishment of debt		20,743			11,042			9,701			87.9	%
Other income (loss), net		4,186			335			3,851			1149.6	%
		29,752			45,469			(15,717	)		(34.6	%)
Expenses
Loan and security servicing expense		1,098			1,060			38			3.6	%
General and administrative expense		2,285			1,601			684			42.7	%
Management fee to affiliate		4,976			4,189			787			18.8	%
		8,359			6,850			1,509			22.0	%
Income (loss) from continuing operations	$	73,207		$	109,863		$	(36,656	)		(33.4	%)

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Interest Income

Three months ended March 31, 2012 compared to the three months ended March 31, 2011

Interest income increased by $2.7 million during the three months ended March 31, 2012 compared to the three months ended March 31, 2011 primarily due to a $7.8 million increase in interest income as a result of new investments made, partially offset by a $5.1 million decrease in interest income as a result of the deconsolidation of CDO V in June 2011, paydowns and changes in interest rates.

Interest Expense

Three Months ended March 31, 2012 compared to the three months ended March 31, 2011

Interest expense decreased by $8.0 million primarily due to (i) a $1.6 million decrease in interest expense on debt as a result of the paydowns and repurchases of our CDO debt obligations and the deconsolidation of CDO V, (ii) a $7.0 million decrease in interest expense on derivatives as a result of the termination of interest rate swaps, decreases in swap notional amounts, changes in interest rates and the deconsolidation of CDO V. The decreases described in (i) to (ii) above were partially offset by a $0.6 million increase in interest expense on other bonds payable and repurchase agreements due to the refinancing of our manufactured housing loan portfolios and a higher outstanding balance of repurchase agreement financing on our FNMA/FHLMC securities.

Valuation Allowance on Loans

Three Months ended March 31, 2012 compared to the three months ended March 31, 2011

The valuation allowance (reversal) on loans changed by $32.3 million primarily due to (i) a $31.1 million larger net increase in fair values of our real estate related loans during the three months ended March 31, 2011 compared to the three months ended March 31, 2012 as a result of market conditions improving more in the 2011 period than in the 2012 period and (ii) a $1.2 million larger net reversal of valuation allowance on our manufactured housing loans and residential mortgage loans in the 2011 period than in the 2012 period due to the reclassification of our manufactured housing loan portfolio II and residential mortgage loans from held-for-sale to held-for-investment in May 2011 and September 2011, respectively. This change in fair values and the reclassification impacted the amount of valuation allowance we were able to reverse during those periods.

In addition, the reversal of previously established valuation allowances will likely decline over time as the reversal is subject to (i) a continued improvement in loan valuations and (ii) the amount of previously established allowances that have not yet been reversed.

Other-than-temporary Impairment on Securities, Net

Three months ended March 31, 2012 compared to the three months ended March 31, 2011

The other-than-temporary impairment on securities decreased by $2.2 million primarily due to improved market conditions. We recorded an impairment charge of $1.9 million on 5 securities during the quarter ended March 31, 2012, compared to an impairment charge of $4.1 million on 7 securities during the quarter ended March 31, 2011.

Gain (Loss) on Settlement of Investments, Net

Three months ended March 31, 2012 compared to the three months ended March 31, 2011

The net gain on settlement of investments decreased by $29.3 million as a result of the decreased volume of sales at a gain an