UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 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).

S Yes No £

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

Large accelerated filer £ Accelerated filer 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: 172,487,757 shares outstanding as of August 7, 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, including, without limitation, senior living facilities, at attractive risk-adjusted prices or at all;
•	our ability to take advantage of investment opportunities in interests in excess mortgage servicing rights (“Excess MSRs”);
•	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;
•	changes in prepayment rates on the loans underlying certain of our assets, including, but not limited to, our Excess MSRs;
•	the risk that projected recapture rates on the portfolios underlying our Excess MSRs are not achieved;
•	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 collateralized debt obligations (“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 June 30, 2012 (unaudited) and December 31, 2011	1

	Consolidated Statements of Income (unaudited) for the three and six months ended June 30, 2012 and 2011	2

	Consolidated Statements of Comprehensive Income (unaudited) for the three and six months ended June 30, 2012 and 2011	3

	Consolidated Statement of Stockholders’ Equity (unaudited) for the six months ended June 30, 2012	4

	Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2012 and 2011	5

	Notes to Consolidated Financial Statements (unaudited)	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	64

Item 4.	Controls and Procedures	66

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	67

Item 1A.	Risk Factors	67

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	91

Item 3.	Defaults upon Senior Securities	91

Item 4.	Mine Safety Disclosures	91

Item 5.	Other Information	91

Item 6.	Exhibits	92

SIGNATURES		95

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

	June 30, 2012
	(Unaudited)			December 31, 2011
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available-for-sale	$	1,505,791		$	1,479,214
Real estate related loans, held-for-sale, net		891,953			807,214
Residential mortgage loans, held-for-investment, net		311,097			331,236
Subprime mortgage loans subject to call option		405,247			404,723
Operating real estate, held-for-sale		7,737			7,741
Other investments		18,883			18,883
Restricted cash		62,692			105,040
Derivative assets		966			1,954
Receivables from brokers, dealers and clearing organizations		30,632			—
Receivables and other assets		21,021			23,319
		3,256,019			3,179,324
Recourse Financing Structures and Unlevered Assets
Real estate securities, available-for-sale		532,609			252,530
Real estate related loans, held-for-sale, net		—			6,366
Residential mortgage loans, held-for-sale, net		2,946			2,687
Investments in excess mortgage servicing rights at fair value		265,132			43,971
Other investments		6,024			6,024
Cash and cash equivalents		102,647			157,356
Receivables and other assets		28,313			3,541
		937,671			472,475
	$	4,193,690		$	3,651,799
Liabilities and Stockholders’ Equity
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable	$	2,350,648		$	2,403,605
Other bonds and notes payable		179,001			200,377
Repurchase agreements		5,538			6,546
Financing of subprime mortgage loans subject to call option		405,247			404,723
Derivative liabilities		101,809			119,320
Payables to brokers, dealers and clearing organizations		20,560			—
Accrued expenses and other liabilities		14,228			16,112
		3,077,031			3,150,683
Recourse Financing Structures and Other Liabilities
Repurchase agreements		317,972			233,194
Junior subordinated notes payable		51,246			51,248
Dividends payable		30,366			16,707
Due to affiliates		8,448			1,659
Purchase price payable on investments in excess mortgage servicing rights		31,382			3,250
Payables to brokers, dealers and clearing organizations		68,296			—
Accrued expenses and other liabilities		6,219			2,969
		513,929			309,027
		3,590,960			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 June 30, 2012 and December 31, 2011		61,583			61,583
Common stock, $0.01 par value, 500,000,000 shares authorized, 147,187,757 and 105,181,009 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively		1,472			1,052
Additional paid-in capital		1,542,806			1,275,792
Accumulated deficit		(1,022,604	)		(1,073,252	)
Accumulated other comprehensive income (loss)		19,473			(73,086	)
		602,730			192,089
	$	4,193,690		$	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						Six Months Ended
	June 30,						June 30,
	2012			2011			2012			2011

Interest income	$	82,438		$	74,143		$	157,337		$	146,346
Interest expense		29,462			35,750			59,627			73,915
Net interest income		52,976			38,393			97,710			72,431
Impairment (Reversal)
Valuation allowance (reversal) on loans		(3,223	)		(14,555	)		(12,254	)		(55,862	)
Other-than-temporary impairment on securities		10,859			5,784			16,742			8,896
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)		863			(296	)		(3,069	)		693
		8,499			(9,067	)		1,419			(46,273	)

Net interest income after impairment/reversal		44,477			47,460			96,291			118,704

Other Income (Loss)
Gain (loss) on settlement of investments, net		(1,177	)		35,606			3,646			69,698
Gain on extinguishment of debt		39			33,443			20,782			44,485
Change in fair value of investments in excess mortgage servicing rights		3,523			—			4,739			—
Other income (loss), net		(3,744	)		(10,160	)		(774	)		(9,825	)
		(1,359	)		58,889			28,393			104,358
Expenses
Loan and security servicing expense		1,104			1,200			2,202			2,260
General and administrative expense		6,205			1,649			8,490			3,250
Management fee to affiliate		5,631			4,555			10,607			8,744
		12,940			7,404			21,299			14,254
Income from continuing operations		30,178			98,945			103,385			208,808
Income (loss) from discontinued operations		261			190			525			—
Net Income		30,439			99,135			103,910			208,808
Preferred dividends		(1,395	)		(1,395	)		(2,790	)		(2,790	)
Income Available for Common Stockholders	$	29,044		$	97,740		$	101,120		$	206,018
Income Per Share of Common Stock
Basic	$	0.21		$	1.23		$	0.84		$	2.90
Diluted	$	0.21		$	1.23		$	0.84		$	2.90
Income from continuing operations per share of common stock, after preferred dividends
Basic	$	0.21		$	1.23		$	0.84		$	2.90
Diluted	$	0.21		$	1.23		$	0.84		$	2.90
Income (loss) from discontinued operations per share of common stock
Basic	$	—		$	—		$	—		$	—
Diluted	$	—		$	—		$	—		$	—
Weighted Average Number of Shares of Common Stock Outstanding
Basic		134,115,335			79,282,480			119,648,172			70,988,410
Diluted		135,172,953			79,282,480			120,421,528			70,992,828
Dividends Declared per Share of Common Stock	$	0.20		$	0.10		$	0.40		$	0.10

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(dollars in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012		2011
Net income	$	30,439		$	99,135		$	103,910	$	208,808
Other comprehensive income (loss):
Net unrealized gain (loss) on securities		(10,128	)		(24,396	)		66,289		101,747
Reclassification of net realized (gain) loss on securities into earnings		12,900			(30,052	)		8,413		(58,323	)
Net unrealized gain (loss) on derivatives designated as cash flow hedges		4,058			(5,336	)		12,232		13,075
Reclassification of net realized (gain) loss on derivatives designated as cash flow hedges into earnings		5,836			7,867			5,625		12,465
Other comprehensive income (loss)		12,666			(51,917	)		92,559		68,964
Total comprehensive income	$	43,105		$	47,218		$	196,469	$	277,772

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)

FOR THE SIX MONTHS ENDED JUNE 30, 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		—		—		—		—		—		(53,262	)		—			(53,262	)
Issuance of common stock		—		—		42,006,748		420		267,014		—			—			267,434
Net income		—		—		—		—		—		103,910			—			103,910
Other comprehensive income (loss)		—		—		—		—		—		—			92,559			92,559
Stockholders’ equity - June 30, 2012		2,463,321	$	61,583		147,187,757	$	1,472	$	1,542,806	$	(1,022,604	)	$	19,473		$	602,730

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

	Six Months Ended June 30,
	2012			2011
Cash Flows From Operating Activities
Net income	$	103,910		$	208,808
Adjustments to reconcile net income to net cash provided by (used in) operating activities (inclusive of amounts related to discontinued operations):
Depreciation and amortization		174			137
Accretion of discount and other amortization		(25,860	)		(21,807	)
Interest income in CDOs redirected for reinvestment or CDO bond paydown		(2,445	)		(6,579	)
Interest income on investments accrued to principal balance		(10,914	)		(9,298	)
Interest expense on debt accrued to principal balance		218			514
Deferred interest received		—			1,027
Non-cash directors' compensation		220			122
Reversal of valuation allowance on loans		(12,254	)		(55,862	)
Other-than-temporary impairment on securities		13,673			9,589
Impairment on real estate held-for-sale		—			433
Change in fair value of investments in excess mortgage servicing rights		(4,739	)		—
Gain on settlement of investments (net) and real estate held-for-sale		(3,646	)		(68,766	)
Unrealized loss on non-hedge derivatives and hedge ineffectiveness		2,476			11,194
Gain on extinguishment of debt		(20,782	)		(44,485	)
Change in:
Restricted cash		364			245
Receivables and other assets		(4,371	)		1,076
Due to affiliates		334			99
Accrued expenses and other liabilities		2,977			(73	)
Net cash provided by (used in) operating activities		39,335			26,374
Cash Flows From Investing Activities
Principal repayments from repurchased CDO debt		12,567			48,881
Principal repayments from CDO securities		527			8,865
Principal repayments from non-Agency RMBS		4,173			70
Return of investments in excess mortgage servicing rights		4,820			—
Principal repayments from loans and non-CDO securities (excluding non-Agency RMBS)		38,115			51,863
Purchase of real estate securities		(227,670	)		(180,245	)
Proceeds from sale of real estate securities		—			3,885
Acquisition of investments in excess mortgage servicing rights		(190,510	)		—
Acquisition of servicing rights		—			(2,268	)
Deposit paid on investment in excess mortgage servicing rights		(16,801	)		—
Payments on settlement of derivative instruments		—			(14,322	)
Net cash provided by (used in) investing activities		(374,779	)		(83,271	)

Continued on page 6

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

JUNE 30, 2012

(dollars in thousands)

	Six Months Ended June 30,
	2012			2011
Cash Flows From Financing Activities
Repurchases of CDO bonds payable		(9,177	)		(87,064	)
Issuance of other bonds payable		—			142,736
Repayments of other bonds payable		(21,684	)		(184,242	)
Borrowings under repurchase agreements		102,194			108,576
Repayments of repurchase agreements		(18,424	)		(9,263	)
Issuance of common stock		268,050			98,843
Costs related to issuance of common stock		(621	)		(468	)
Common stock dividends paid		(36,813	)		—
Preferred stock dividends paid		(2,790	)		(5,581	)
Payment of deferred financing costs		—			(1,546	)
Restricted cash returned from refinancing activities		—			62,220
Net cash provided by (used in) financing activities		280,735			124,211
Net Increase (Decrease) in Cash and Cash Equivalents		(54,709	)		67,314
Cash and Cash Equivalents, Beginning of Period		157,356			33,524
Cash and Cash Equivalents, End of Period	$	102,647		$	100,838
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense	$	40,390		$	53,169
Supplemental Schedule of Non-Cash Investing and Financing Activities
Preferred stock dividends declared but not paid	$	930		$	930
Common stock dividends declared but not paid	$	29,436		$	7,930
Securities purchased not yet settled	$	68,296		$	85,278
Purchase price payable on investments in excess mortgage servicing rights	$	31,382		$	—
Deposit on senior housing assets due to affiliates	$	5,930		$	—

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

1. GENERAL

Newcastle Investment Corp. (and its subsidiaries, “Newcastle”) is a Maryland corporation that was formed in 2002. Newcastle conducts its business through the following segments:(i) investments financed with non-recourse collateralized debt obligations (“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 as of the grant date.

In May 2012, Newcastle issued 23,000,000 shares of its common stock in a public offering at a price to the public of $6.71 per share for net proceeds of approximately $152.0 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 2,300,000 shares of Newcastle’s common stock at the public offering price, which had a fair value of approximately $7.6 million as of the grant date.

In July 2012, Newcastle issued 25,300,000 shares of its common stock in a public offering at a price, net of underwriting discounts and commissions, to the underwriters of $6.63 per share for net proceeds of approximately $167.4 million, after deducting the expenses for this offering. Certain officers and directors of Newcastle participated in this offering and purchased an aggregate of 450,000 shares at $6.70 per share. For the purpose of compensating the Manager for its successful efforts in raising capital for Newcastle, in connection with this offering, Newcastle granted options to the Manager to purchase 2,530,000 shares of Newcastle’s common stock at $6.70, which had a fair value of approximately $8.3 million as of the grant date.

Approximately 4.4 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its principals at June 30, 2012. In addition, Fortress, through its affiliates, held options to purchase approximately 8.5 million shares of Newcastle’s common stock at June 30, 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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

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.

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)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

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

	Non- Recourse CDOs (A)			Unlevered CDOs (B)		Unlevered Excess MSRs			Non- Recourse Other (A) (C)			Recourse (D)			Unlevered Other (E)			Corporate			Inter- segment Elimination (F)			Total
Six Months Ended June 30, 2012
Interest income	$	110,440		$	230	$	6,519		$	36,463		$	1,768		$	4,851		$	103		$	(3,037	)	$	157,337
Interest expense		34,640			—		—			25,334			561			—			1,903			(2,811	)		59,627
Net interest income (expense)		75,800			230		6,519			11,129			1,207			4,851			(1,800	)		(226	)		97,710
Impairment (reversal)		(789	)		—		—			2,703			—			(495	)		—			—			1,419
Other income (loss)		24,533			176		4,739			—			—			(1,055	)		—			—			28,393
Expenses		483			1		1,494			1,693			—			25			17,603			—			21,299
Income (loss) from continuing operations		100,639			405		9,764			6,733			1,207			4,266			(19,403	)		(226	)		103,385
Income (loss) from discontinued operations		—			—		—			330			—			(31	)		—			226			525
Net income (loss)		100,639			405		9,764			7,063			1,207			4,235			(19,403	)		—			103,910
Preferred dividends		—			—		—			—			—			—			(2,790	)		—			(2,790	)
Income (loss) applicable to common stockholders	$	100,639		$	405	$	9,764		$	7,063		$	1,207		$	4,235		$	(22,193	)	$	—		$	101,120

Three Months Ended June 30, 2012
Interest income	$	56,038		$	115	$	4,482		$	18,037		$	954		$	4,328		$	52		$	(1,568	)	$	82,438
Interest expense		17,004			—		—			12,671			293			—			949			(1,455	)		29,462
Net interest income (expense)		39,034			115		4,482			5,366			661			4,328			(897	)		(113	)		52,976
Impairment (reversal)		7,742			—		—			1,055			—			(298	)		—			—			8,499
Other income (loss)		(5,380	)		84		3,523			—			—			414			—			—			(1,359	)
Expenses		242			—		1,371			850			—			12			10,465			—			12,940
Income (loss) from continuing operations		25,670			199		6,634			3,461			661			5,028			(11,362	)		(113	)		30,178
Income (loss) from discontinued operations		—			—		—			162			—			(14	)		—			113			261
Net income (loss)		25,670			199		6,634			3,623			661			5,014			(11,362	)		—			30,439
Preferred dividends		—			—		—			—			—			—			(1,395	)		—			(1,395	)
Income (loss) applicable to common stockholders	$	25,670		$	199	$	6,634		$	3,623		$	661		$	5,014		$	(12,757	)	$	—		$	29,044

June 30, 2012
Investments	$	2,509,771		$	3,957	$	265,132		$	772,025		$	403,392		$	134,230		$	—		$	(141,088	)	$	3,947,419
Cash and restricted cash		62,692			—		9,278			—			—			—			93,369			—			165,339
Derivative assets		966			—		—			—			—			—			—			—			966
Other assets		51,457			6		16,815			196			958			4,344			6,543			(353	)		79,966
Total assets		2,624,886			3,963		291,225			772,221			404,350			138,574			99,912			(141,441	)		4,193,690
Debt		(2,356,186	)		—		—			(725,336	)		(317,972	)		—			(51,246	)		141,088			(3,309,652	)
Derivative liabilities		(101,809	)		—		—			—			—			—			—			—			(101,809	)
Other liabilities		(31,861	)		—		(33,031	)		(2,927	)		(65,777	)		(2,601	)		(43,655	)		353			(179,499	)
Total liabilities		(2,489,856	)		—		(33,031	)		(728,263	)		(383,749	)		(2,601	)		(94,901	)		141,441			(3,590,960	)
Preferred stock		—			—		—			—			—			—			(61,583	)		—			(61,583	)
GAAP book value	$	135,030		$	3,963	$	258,194		$	43,958		$	20,601		$	135,973		$	(56,572	)	$	—		$	541,147

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables 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

Six Months Ended June 30, 2011
Interest income	$	111,399		$	23	$	—	$	35,006		$	597	$	992		$	63		$	(1,734	)	$	146,346
Interest expense		47,285			—		—		25,990			242		—			1,906			(1,508	)		73,915
Net interest income (expense)		64,114			23		—		9,016			355		992			(1,843	)		(226	)		72,431
Impairment (reversal)		(44,158	)		—		—		1,797			—		(3,912	)		—			—			(46,273	)
Other income (loss)		98,234			3,527		—		1,490			—		1,107			—			—			104,358
Expenses		639			—		—		1,636			—		115			11,864			—			14,254
Income (loss) from continuing operations		205,867			3,550		—		7,073			355		5,896			(13,707	)		(226	)		208,808
Income (loss) from discontinued operations		—			—		—		(185	)		—		(41	)		—			226			—
Net income (loss)		205,867			3,550		—		6,888			355		5,855			(13,707	)		—			208,808
Preferred dividends		—			—		—		—			—		—			(2,790	)		—			(2,790	)
Income (loss) applicable to common stockholders	$	205,867		$	3,550	$	—	$	6,888		$	355	$	5,855		$	(16,497	)	$	—		$	206,018

Three Months Ended June 30, 2011
Interest income	$	56,571		$	12	$	—	$	17,525		$	450	$	510		$	43		$	(968	)	$	74,143
Interest expense		22,672			—		—		12,835			144		—			954			(855	)		35,750
Net interest income (expense)		33,899			12		—		4,690			306		510			(911	)		(113	)		38,393
Impairment (reversal)		(5,913	)		—		—		643			—		(3,797	)		—			—			(9,067	)
Other income (loss)		55,127			3,452		—		(337	)		—		647			—			—			58,889
Expenses		326			—		—		892			—		70			6,116			—			7,404
Income (loss) from continuing operations		94,613			3,464		—		2,818			306		4,884			(7,027	)		(113	)		98,945
Income (loss) from discontinued operations		—			—		—		97			—		(20	)		—			113			190
Net income (loss)		94,613			3,464		—		2,915			306		4,864			(7,027	)		—			99,135
Preferred dividends		—			—		—		—			—		—			(1,395	)		—			(1,395	)
Income (loss) applicable to common stockholders	$	94,613		$	3,464	$	—	$	2,915		$	306	$	4,864		$	(8,422	)	$	—		$	97,740

	(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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

(C)

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

	June 30, 2012
	Investments				Debt
	Outstanding Face		Carrying		Outstanding Face		Carrying
	Amount		Value		Amount*		Value*
Manufactured housing loan portfolio I	$	125,948	$	105,225	$	98,268	$	89,282
Manufactured housing loan portfolio II		165,494		162,402		130,949		129,968
Residential mortgage loans		54,744		40,007		53,266		52,195
Subprime mortgage loans subject to call options		406,217		405,247		406,217		405,247
Real estate securities		66,762		51,407		46,862		42,644
Operating real estate		N/A		7,737		6,000		6,000
	$	819,165	$	772,025	$	741,562	$	725,336

	*	An aggregate face amount of $154.8 million (carrying value of $141.1 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 $318.0 million of recourse debt is comprised of (i) a $316.1 million repurchase agreement secured by $337.6 million carrying value of FNMA/FHLMC securities and (ii) a $1.9 million repurchase agreement secured by $27.3 million face amount of senior notes issued by Newcastle CDO VI, which was repurchased by Newcastle and is eliminated in consolidation.
	(E)	The following table summarizes the investments in the unlevered other segment:

	June 30, 2012
	Outstanding Face Amount		Carrying Value		Number of Investments
Real estate securities*	$	318,909	$	125,260		30
Residential mortgage loans		4,322		2,946		144
Other investments		N/A		6,024		1
	$	323,231	$	134,230		175

	*	During the three months ended June 30, 2012, Newcastle purchased 10 non-agency residential mortgage backed (“RMBS”) securities with an aggregate face amount of $181.6 million for an aggregate purchase price of approximately $122.4 million, or an average price of 67.4% of par. As of June 30, 2012, these securities had an aggregate face amount of $177.4 million and a carrying value of $119.5 million.
	(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 June 30, 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 June 30, 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		$	298,549			$	298,995			$	3,957

(A)	Face amount.
(B)	Includes $42.3 million face amount of debt owned by Newcastle with a carrying value of $4.0 million at June 30, 2012.
(C)	This amount represents Newcastle’s maximum exposure to loss from this entity, which was the fair value at June 30, 2012, related to $5.3 million face amount of CDO V Class I notes.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

3. REAL ESTATE SECURITIES

The following is a summary of Newcastle’s real estate securities at June 30, 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
	Outstanding				Other- Than- Temporary												Number									Maturity		Principal
	Face		Before		Impairment			After		Gross Unrealized					Carrying		of		Rating							(Years)		Subordination
Asset Type	Amount		Impairment		(A)			Impairment		Gains		Losses			Value (B)		Securities		(C)	Coupon			Yield			(D)		(E)
CMBS-Conduit	$	1,279,728	$	1,098,922	$	(168,256	)	$	930,666	$	112,293	$	(46,483	)	$	996,476		159	BB+		5.55	%		10.71	%		3.9		11.7	%
CMBS- Single Borrower		175,346		170,879		(12,364	)		158,515		3,869		(10,426	)		151,958		31	BB		5.24	%		6.54	%		3.2		6.8	%
CMBS-Large Loan		14,938		14,404		—			14,404		434		(50	)		14,788		2	BBB+		5.06	%		8.89	%		0.7		10.1	%
REIT Debt		120,288		119,542		—			119,542		5,685		(2,130	)		123,097		18	BB+		5.72	%		5.72	%		2.2		N/A
ABS-Subprime (F)		421,669		321,385		(76,547	)		244,838		13,935		(6,033	)		252,740		70	CCC		0.89	%		8.91	%		5.5		24.7	%
ABS-Manufactured Housing		27,722		26,890		—			26,890		2,138		(74	)		28,954		7	BBB+		6.59	%		7.38	%		3.7		42.9	%
ABS-Franchise		11,121		10,835		(8,451	)		2,384		34		(391	)		2,027		4	CCC-		5.56	%		5.45	%		4.9		3.2	%
FNMA/FHLMC		377,220		400,531		—			400,531		3,127		(266	)		403,392		37	AAA		2.48	%		1.39	%		4.7		N/A
CDO (G)		206,124		83,374		(14,861	)		68,513		25		(3,570	)		64,968		13	CCC+		3.03	%		7.76	%		1.2		21.0	%
Total / Average (H)	$	2,634,156		2,246,762	$	(280,479	)	$	1,966,283	$	141,540	$	(69,423	)	$	2,038,400		341	BB+		4.16	%		7.79	%		3.9

(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 (i) the retained bonds with a face amount of $4.0 million and a carrying value of $1.1 million from Securitization Trust 2006 (Note 4) and (ii) 10 non-agency RMBS purchased during the three months ended June 30, 2012 with an aggregate face amount of $177.4 million and a carrying value of $119.5 million as of June 30, 2012.
(G)	Includes two CDO bonds issued by a third party with a carrying value of $58.3 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 $1.0 billion.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the six months ended June 30, 2012, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $16.7 million (gross of $3.1 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 June 30, 2012.

			Amortized Cost Basis																Weighted Average
Securities in an Unrealized	Outstanding				Other- than-					Gross							Number
Loss	Face		Before		Temporary			After		Unrealized					Carrying		of										Maturity
Position	Amount		Impairment		Impairment			Impairment		Gains		Losses			Value		Securities		Rating		Coupon			Yield			(Years)
Less Than Twelve Months	$	283,224	$	274,738	$	(11,209	)	$	263,529	$	—	$	(4,980	)		258,549		27		A		3.14	%		3.66	%		5.1
Twelve or More Months		704,267		644,904		(16,707	)		628,197		—		(64,443	)		563,754		96		BB		4.43	%		6.90	%		3.1
Total	$	987,491	$	919,642	$	(27,916	)	$	891,726	$	—	$	(69,423	)	$	822,303		123		BBB-		4.06	%		5.94	%		3.7

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

	June 30, 2012
			Amortized Cost Basis		Unrealized Losses
	Fair Value		After Impairment		Credit (B)			Non-Credit (C)
Securities Newcastle intends to sell	$	4,456	$	4,456	$	(11,502	)		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		48,274		52,063		(26,752	)		(3,789	)
Non credit impaired securities		774,029		839,663		—			(65,634	)
Total debt securities in an unrealized loss position	$	826,759	$	896,182	$	(38,254	)	$	(69,423	)

(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)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

The following table summarizes the activity related to credit losses on debt securities for the six months ended June 30, 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		(6,800	)

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		(242	)

Additions for credit losses on securities for which an OTTI was previously recognized without any portion of OTTI recognized in other comprehensive income		(8,669	)

Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at the current measurement date		7,188

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		480

Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(26,752	)

As of June 30, 2012, Newcastle had $63.4 million of restricted cash and net receivables from brokers, dealers and clearing organizations held in CDO financing structures pending its reinvestment in real estate securities and loans.

The table below summarizes the geographic distribution of the collateral securing Newcastle’s CMBS and ABS at June 30, 2012 (in thousands):

	CMBS					ABS
Geographic Location	Outstanding Face Amount		Percentage			Outstanding Face Amount		Percentage
Western U.S.	$	574,813		39.1	%	$	125,608		27.3	%
Northeastern U.S.		253,261		17.2	%		94,256		20.4	%
Southeastern U.S.		293,247		20.0	%		116,819		25.4	%
Midwestern U.S.		156,504		10.7	%		61,673		13.4	%
Southwestern U.S.		122,175		8.3	%		53,022		11.5	%
Other		16,823		1.1	%		9,134		2.0	%
Foreign		53,189		3.6	%		—		0.0	%
	$	1,470,012		100.0	%	$	460,512		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)

JUNE 30, 2012

(dollars in tables 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 June 30, 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	$	608,953	$	486,572		17		10.20	%		7.90	%		2.1		71.2	%	$	12,000
Corporate Bank Loans		300,663		189,328		6		19.62	%		9.70	%		2.3		51.1	%		1,397
B-Notes		207,981		185,701		7		11.32	%		5.51	%		2.5		71.4	%		—
Whole Loans		30,352		30,352		3		5.17	%		3.87	%		1.5		95.9	%		—
Total Real Estate Related Loans Held-for-Sale, Net	$	1,147,949	$	891,953		33		12.26	%		7.83	%		2.2		66.6	%	$	13,397
Non-Securitized Manufactured Housing Loan Portfolio I	$	640	$	169		18		39.15	%		8.01	%		0.7		0.0	%	$	45
Non-Securitized Manufactured Housing Loan Portfolio II		3,682		2,777		126		15.48	%		10.10	%		5.7		8.0	%		524
Total Residential Mortgage Loans Held-for-Sale, Net (D)	$	4,322	$	2,946		144		16.84	%		9.79	%		5.0		6.8	%	$	569

Securitized Manufactured Housing Loan Portfolio I	$	125,948	$	105,225		3,352		9.48	%		8.67	%		6.9		0.9	%	$	978
Securitized Manufactured Housing Loan Portfolio II		165,494		162,402		5,733		7.54	%		9.64	%		5.8		17.0	%		3,370
Residential Loans		58,523		43,470		207		7.67	%		2.56	%		6.5		100.0	%		7,914
Total Residential Mortgage Loans Held- for-Investment, Net (D) (E)	$	349,965	$	311,097		9,292		8.21	%		8.10	%		6.3		25.1	%	$	12,262
Subprime Mortgage Loans Subject to Call Option	$	406,217	$	405,247

(A)	Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $5.4 million for the manufactured housing loans.
(B)	The weighted average maturity is based on the timing of expected principal reduction on the assets.
(C)	Includes loans that are 60 or more days past due (including loans that are in foreclosure, or borrower’s in bankruptcy) or considered real estate owned (“REO”). As of June 30, 2012, $71.6 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 June 30, 2012:

	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		REO		Total Past Due		Current		Total Outstanding Face Amount
Securitized Manufactured Housing Loan Portoflio I	$	467	$	344	$	401	$	233	$	1,445	$	124,503	$	125,948
Securitized Manufactured Housing Loan Portoflio II	$	1,399	$	838	$	1,370	$	1,162	$	4,769	$	160,725	$	165,494
Residential Loans	$	400	$	267	$	6,831	$	816	$	8,314	$	50,209	$	58,523

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)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

The following is a summary of real estate related loans by maturities at June 30, 2012:

Year of Maturity ⁽¹⁾	Outstanding Face Amount		Carrying Value		Number of Loans
Delinquent ⁽²⁾	$	13,397	$	611		2
Period from July 1, 2012 to December 31, 2012		63, 454		—		2
2013		36,068		27,246		3
2014		406,229		283,207		10
2015		242,801		202,585		6
2016		274,102		272,306		5
2017		95,602		91,536		4
Thereafter		16,296		14,462		1
Total	$	1,147,949	$	891,953		33

(1)	Based on the final extended maturity date of each loan investment as of June 30, 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
Balance at December 31, 2011	$	813,580		$	2,687		$	331,236
Purchases / additional fundings		91,481			—			—
Interest accrued to principal balance		10,914			—			—
Principal paydowns		(36,922	)		(302	)		(19,708	)
Sales		—			—			—
Valuation (allowance) reversal on loans		14,398			559			(2,703	)
Loss on repayment of loans held-for-sale		(1,614	)		—			—
Accretion of loan discount and other amortization		—			—			2,165
Other		116			2			107
Balance at June 30, 2012	$	891,953			2,946		$	311,097

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			602			4,295
Valuation (allowance) reversal on loans		14,398			559			(2,703	)
Balance at June 30, 2012	$	(195,971	)	$	(1,300	)	$	(24,483	)

(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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

Investments in Excess Mortgage Servicing Rights

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

			June 30, 2012									Six Months Ended June 30, 2012
	Unpaid Principal Balance		Amortized Cost Basis		Carrying Value (A)		Weighted Average Yield			Average Maturity (Years) (B)		Changes in Fair Value Recorded in Other Income (Loss) (C)
MSR Pool 1	$	9,120,148	$	32,465	$	37,613		18.0	%		4.7	$	4,151
MSR Pool 1 - Recapture Agreement		—		6,111		6,067		18.0	%		10.5		588
MSR Pool 2		9,942,371		36,934		36,934		17.3	%		4.7		—
MSR Pool 2 - Recapture Agreement		—		5,904		5,904		17.3	%		11.9		—
MSR Pool 3		9,739,715		31,421		31,421		17.6	%		4.7		—
MSR Pool 3 - Recapture Agreement		—		5,221		5,221		17.6	%		11.3		—
MSR Pool 4		6,210,442		12,638		12,638		17.9	%		4.6		—
MSR Pool 4 - Recapture Agreement		—		2,969		2,969		17.9	%		11.1		—
MSR Pool 5		46,945,452		117,844		117,844		17.5	%		4.8		—
MSR Pool 5 - Recapture Agreement		—		8,521		8,521		17.5	%		12.3		—
	$	81,958,128	$	260,028	$	265,132		17.6	%		5.5	$	4,739

(A) Fair value.

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

(C) The portion of change in fair value of the recapture agreement relating to loans recaptured to date is reflected in the respective pool.

In December 2011, Newcastle entered into an agreement (“MSR Agreement I”) with Nationstar Mortgage LLC (“Nationstar”), a leading residential mortgage servicer majority-owned by funds managed by Newcastle’s manager, to purchase Excess MSRs from Nationstar. Nationstar acquired the mortgage servicing rights on a pool of government-sponsored enterprise (“GSE”) residential mortgage loans with an outstanding principal balance of approximately $9.9 billion (“MSR Pool 1”) 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 Pool 1. Pursuant to MSR Agreement I, Nationstar performs all servicing functions and advancing functions related to MSR Pool 1 for a base servicing fee of 6 bps. Therefore, the remainder, or “excess mortgage servicing amount” is initially equal to a weighted average of 29 bps. Newcastle acquired the right to receive 65% of the excess mortgage servicing amount on MSR Pool 1 and, subject to certain limitations and pursuant to a loan replacement agreement (the “Recapture Agreement”), 65% of the Excess MSRs on certain future mortgage loans originated by Nationstar, that represent refinancings of loans in MSR Pool 1 (which loans then become part of MSR Pool 1) 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.

On June 5, 2012, Newcastle announced the completion of a co-investment with Nationstar related to their acquisition of mortgage servicing assets from Bank of America, National Association. Newcastle has invested approximately $44 million to acquire a 65% interest in the Excess MSRs on a portfolio of residential mortgage loans with an outstanding principal balance of approximately $10.4 billion (“MSR Pool 2”), comprised of conforming loans in GSE pools. Nationstar has co-invested pari passu with Newcastle in 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. As of June 30, 2012, Newcastle funded $11.0 million of the purchase price and expected the remainder of the purchase price payable to Nationstar to be funded in the third quarter of 2012 pursuant to the payment terms of the agreement.

On June 29, 2012, Newcastle announced the completion of a co-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 invested approximately $176.5 million to acquire a 65% interest in the Excess MSRs on a portfolio of residential mortgage loans with an outstanding principal balance of approximately $63.7 billion, comprised of approximately 75% non-conforming loans in private label securitizations and approximately 25% conforming loans in GSE pools. The portfolio is comprised of three pools: a pool of non-conforming loans in private label securities with an

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

outstanding principal balance of approximately $47.6 billion (“MSR Pool 5”), and two GSE loan pools with outstanding principal balances of approximately $6.3 billion (“MSR Pool 4”) and $9.8 billion (“MSR Pool 3”), respectively. Nationstar has co-invested pari passu with Newcastle in 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 table below summarizes the geographic distribution of the underlying residential mortgage loans of the Excess MSRs at June 30, 2012:

State Concentration	Percentage of Total Outstanding
California		32.5	%
Florida		10.0	%
Washington		4.3	%
New York		4.1	%
Arizona		4.0	%
Texas		3.5	%
Colorado		3.5	%
Maryland		3.3	%
New Jersey		3.2	%
Virginia		3.0	%
Other U.S.		28.6	%
		100.0	%

(A)

Based on the information provided by the loan servicer as of the most recent remittance.

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 agreements to acquire an additional portfolio of Excess MSRs.

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 six months ended June 30, 2012 and 2011, respectively, Newcastle recorded $0.2 million and $0.1 million of servicing rights amortization and no servicing rights impairment. As of June 30, 2012, Newcastle’s servicing asset had a carrying value of $1.9 million recorded in Receivables and Other Assets.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables 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 June 30, 2012:

	Subprime Portfolio
	I		II		Total
Total securitized loans (unpaid principal balance) (A)	$	447,144	$	585,022	$	1,032,166
Loans subject to call option (carrying value)	$	299,176	$	106,071	$	405,247
Retained interests (fair value) (B)	$	1,117	$	—	$	1,117

(A)	Average loan seasoning of 83 months and 65 months for Subprime Portfolios I and II, respectively, at June 30, 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 8.40% as of June 30, 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 June 30, 2012:

	Subprime Portfolio
	I			II
Loan unpaid principal balance (UPB)	$	447,144		$	585,022
Weighted average coupon rate of loans		5.24	%		4.61	%
Delinquencies of 60 or more days (UPB) (A)	$	98,807		$	153,706
Net credit losses for the six months ended June 30, 2012	$	17,963		$	22,916
Cumulative net credit losses	$	210,832		$	244,769
Cumulative net credit losses as a % of original UPB		14.0	%		22.5	%
Percentage of ARM loans (B)		51.5	%		64.7	%
Percentage of loans with original loan-to-value ratio >90%		10.8	%		17.2	%
Percentage of interest-only loans		21.3	%		4.3	%
Face amount of debt (C)	$	443,144		$	585,022
Weighted average funding cost of debt (D)		0.61	%		1.22	%

(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 million of retained notes for Subprime Portfolio I at June 30, 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 six months ended June 30, 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)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

5. DEBT OBLIGATIONS

The following table presents certain information regarding Newcastle’s debt obligations and related hedges at June 30, 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	$	94,912	$	94,774	Mar 2039		1.85%		4.96	%		1.7	$	83,617	$	188,784	$	178,159	$	167,159		2.2	$	51,438	$	83,617
CDO VI (E)	Apr 2005		91,359		91,359	Apr 2040		0.90%		5.35	%		5.1		88,376		213,627		123,951		142,506		3.0		54,968		88,376
CDO VIII	Nov 2006		567,613		566,434	Nov 2052		0.79%		2.10	%		2.8		560,013		729,131		538,300		551,905		2.8		438,747		155,132
CDO IX	May 2007		478,905		480,426	May 2052		0.61		0.61	%		2.6		478,905		695,919		569,341		572,351		2.8		373,904		-
CDO X	Jul 2007		1,120,000		1,117,655	Jul 2052		0.59%		3.38	%		4.0		1,120,000		1,235,436		951,744		998,116		4.5		214,451		811,054
			2,352,789		2,350,648					2.65	%		3.4		2,330,911		3,062,897		2,361,495		2,432,037		3.4		1,133,508		1,138,179
Other Bonds and Notes Payable
MH loans Portfolio I (F)	Apr 2010		61,345		60,685	Jul 2035		5.44%		5.44	%		2.9		-		125,948		105,225		105,225		6.9		1,095		-
MH loans Portfolio II (F)	May 2011		113,936		113,007	Dec 2033		3.90%		3.90	%		3.4		-		165,494		162,402		162,402		5.8		28,121		-
Residential Mortgage Loans (G)	Aug 2006		5,309		5,309	Dec 2034	LIBOR+ 0.90%			1.15	%		6.6		5,309		54,744		40,007		40,007		6.7		54,744		-
			180,590		179,001					4.34	%		3.3		5,309		346,186		307,634		307,634		6.3		83,960		-
Repurchase Agreements
Real estate securities, loans and properties (H)	Dec 2011		7,384		7,384	Oct 2012	LIBOR+ 2.00%			2.25	%		0.3		7,384		-		-		-		-		-		-
FNMA/FHLMC securities (I)	Various		316,126		316,126	Aug 2012		0.42%		0.42	%		0.1		316,126		315,646		337,810		337,610		4.7		315,646		-
			323,510		323,510					0.46	%		0.1		323,510		315,646		337,810		337,810		4.7		315,646		-
Corporate
Junior subordinated notes payable	Mar 2006		51,004		51,246	Apr 2035		7.57%(K)		7.41	%		22.8		-		-		-		-		-		-		-
			51,004		51,246					7.41	%		22.8		-		-		-		-		-		-		-
Subtotal debt obligations			2,907,893		2,904,405					2.59	%		3.3	$	2,659,730	$	3,724,729	$	3,006,771	$	3,077,313		3.8	$	1,533,114	$	1,138,179
Financing on subprime mortgage loans subject to call option	(J)		406,217		405,247
Total debt obligations		$	3,314,110	$	3,309,652

(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 $83.6 million and $88.4 million notional amount of interest rate swap agreements in CDO IV and CDO VI, respectively, which were economic hedges not designated as hedges for accounting purposes.
(E)	These CDOs were not in compliance with their applicable over collateralization tests as of June 30, 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 $48.0 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 $27.3 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)

JUNE 30, 2012

(dollars in tables 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 June 30, 2012, CDOs IV and VI were not in compliance with their applicable over collateralization tests.

In the first six months of 2012, Newcastle repurchased $30.1 million face amount of CDO bonds payable for $9.2 million. As a result, Newcastle extinguished $30.1 million face amount of CDO bonds payable and recorded a gain on extinguishment of debt of $20.8 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 June 30, 2012.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables 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 June 30, 2012 were as follows:

	Principal							Weighted			Weighted
	Balance or							Average			Average
	Notional		Carrying		Estimated		Fair Value	Yield/Funding			Maturity
	Amount		Value		Fair Value		Method (A)	Cost			(Years)
Assets
Non-Recourse VIE Financing Structures (F)
Financial instruments:
Real estate securities, available-for-sale*	$	1,895,695	$	1,505,791	$	1,505,791	Broker quotations, counterparty quotations, pricing services, pricing models		9.47	%		4.1
Real estate related loans, held-for-sale, net		1,147,949		891,953		898,618	Broker quotations, counterparty quotations, pricing services, pricing models		12.26	%		2.2
Residential mortgage loans, held-for-investment, net		349,965		311,097		308,810	Pricing models		8.21	%		6.3
Subprime mortgage loans subject to call option (B)		406,217		405,247		405,247	(B)		9.09	%		(B)
Restricted cash*		62,692		62,692		62,692
Derivative assets, treated as hedges (C)(E)*		122,665		504		504	Counterparty quotations		N/A			(C)
Non-hedge derivative assets (D)(E)*		42,428		462		462	Counterparty quotations		N/A			(D)
Operating real estate, held-for-sale				7,737		7,737
Other investments				18,883		18,883
Receivables and other assets				51,653		51,653
			$	3,256,019	$	3,260,397
Recourse Financing Structures and Unlevered Assets
Financial instruments:
Real estate securities, available-for-sale*	$	738,461	$	532,609	$	532,609	Broker quotations, counterparty quotations, pricing services, pricing models		3.20	%		3.5
Residential mortgage loans, held-for-sale, net		4,322		2,946		2,946	Pricing models		16.84	%		5.0
Investments in excess mortgage servicing rights at fair value *(H)		81,958,128		265,132		265,132	Pricing models		17.6	%		5.5
Cash and cash equivalents*		102,647		102,647		102,647
Other investments				6,024		6,024
Receivables and other assets				28,313		28,313
			$	937,671	$	937,671

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

	Principal							Weighted			Weighted
	Balance or							Average			Average
	Notional		Carrying		Estimated		Fair Value	Yield/Funding			Maturity
	Amount		Value		Fair Value		Method (A)	Cost			(Years)
Liabilities
Non-Recourse VIE Financing Structures (F) (G)
Financial instruments:
CDO bonds payable	$	2,352,789	$	2,350,648	$	1,539,213	Pricing models		2.65	%		3.4
Other bonds and notes payable		180,590		179,001		181,773	Broker quotations, pricing models		4.34	%		3.3
Repurchase agreements		5,538		5,538		5,538	Market comparables		2.25	%		0.3
Financing of subprime mortgage loans subject to call option (B)		406,217		405,247		405,247	(B)		9.09	%		(B)
Interest rate swaps, treated as hedges (C)(E)*		766,859		70,226		70,226	Counterparty quotations		N/A			(C)
Non-hedge derivatives (D)(E)*		339,990		31,583		31,583	Counterparty quotations		N/A			(D)
Accrued expenses and other liabilities				34,788		34,788
			$	3,077,031	$	2,268,368
Recourse Financing Structures and Other Liabilities (G)
Financial instruments:
Repurchase agreements	$	317,972	$	317,972	$	317,972	Market comparables		0.43	%		0.1
Junior subordinated notes payable		51,004		51,246		31,594	Pricing models		7.41	%		22.8
Due to affiliates				8,448		8,448
Dividends payable, accrued expenses and other liabilities				136,263		136,263
			$	513,929	$	494,277

*Measured at fair value on a recurring basis.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

(A)	Methods are listed in order of priority. In the case of real estate securities and real estate related loans, broker quotations are obtained if available and practicable, otherwise counterparty quotations or pricing service valuations are obtained or, finally, internal pricing models are used. Internal pricing models are only used for (i) securities and loans that are not traded in an active market, and, therefore, have little or no price transparency, and for which significant unobservable inputs must be used in estimating fair value, or (ii) loans or debt obligations which are private and untraded.

(B)	These two items result from an option, not an obligation, to repurchase loans from Newcastle’s subprime mortgage loan securitizations (Note 4), are noneconomic until such option is exercised, and are equal and offsetting.

(C)	Represents derivative agreements as follows:

Year of Maturity		Weighted Average Month of Maturity		Aggregate Notional Amount		Weighted Average Fixed Pay Rate / Cap Rate			Aggregate Fair Value Asset / (Liability)

Interest rate cap agreements which receive 1-Month LIBOR:
	2015		Nov	$	39,460		2.10	%	$	115
	2016		Jul		77,905		2.66	%		354
	2017		Jan		5,300		1.86	%		35
				$	122,665				$	504
Interest rate swap agreements which receive 1-Month LIBOR:
	2014		Nov	$	14,898		5.08	%	$	(1,603	)
	2015		May		438,529		5.42	%		(18,719	)
	2016		May		165,132		5.04	%		(17,121	)
	2017		Aug		148,300		5.28	%		(32,783	)
				$	766,859				$	(70,226	)

(D)	This represents five interest rate swap agreements with a total notional balance of $340.0 million, maturing between March 2014 and November 2017, 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 June 30, 2012.

(E)	Newcastle’s derivatives fall into two categories. As of June 30, 2012, all derivatives were held within Newcastle’s nonrecourse CDO structures. An aggregate notional balance of $1.3 billion, which were liabilities at period end, are only subject to the credit risks of the respective CDO structures. As they are senior to all the debt obligations of the respective CDOs and the fair value of each of the 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 $165.1 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. Generally, Newcastle does not receive an excess mortgage servicing amount on nonperforming loans.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

Valuation Hierarchy

The methodologies used for valuing such instruments have been categorized into three broad levels, which form a hierarchy.

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

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

	•	Quoted prices in active markets for similar instruments,
	•	Quoted prices in less active or inactive markets for identical or similar instruments,
	•	Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates), and
	•	Market corroborated inputs (derived principally from or corroborated by observable market data).

Level 3 - Valuations based significantly on unobservable inputs.

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

Newcastle follows this hierarchy for its financial instruments measured at fair value on a recurring basis. The classifications are based on the lowest level of input that is significant to the fair value measurement.

The following table summarizes such financial assets and liabilities measured at fair value on a recurring basis at June 30, 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	$	1,470,012	$	1,163,222	$	—	$	929,807	$	233,415	$	1,163,222
REIT debt		120,288		123,097		123,097		—		—		123,097
ABS - subprime		421,669		252,740		—		183,947		68,793		252,740
ABS - other real estate		38,843		30,981		—		29,875		1,106		30,981
FNMA / FHLMC		377,220		403,392		403,392		—		—		403,392
CDO		206,124		64,968		—		61,011		3,957		64,968
Real estate securities total	$	2,634,156	$	2,038,400	$	526,489	$	1,204,640	$	307,271	$	2,038,400
Investments in Excess MSRs (1)	$	81,958,128	$	265,132	$	—	$	—	$	265,132	$	265,132

Derivative assets:
Interest rate caps, treated as hedges	$	122,665	$	504	$	504	$	—	$	—	$	504
Interest rate caps, not treated as hedges		42,428		462		462		—		—		462
Derivative assets total	$	165,093	$	966	$	966	$	—	$	—	$	966

Liabilities:
Derivative Liabilities:
Interest rate swaps, treated as hedges	$	766,859	$	70,226	$	70,226	$	—	$	—	$	70,226
Interest rate swaps, not treated as hedges		339,990		31,583		31,583		—		—		31,583
Derivative liabilities total	$	1,106,849	$	101,809	$	101,809	$	—	$	—	$	101,809

(1)	The notional amount represents the total unpaid principal balance of the mortgage loans. Generally, Newcastle does not receive an excess mortgage servicing amount on nonperforming loans.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables 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 six months ended June 30, 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			4,057			—			—			—			10,113
Transfers into Level 3B		(35,796	)		(14,105	)		(11,057	)		(5	)		—			(60,963	)
Total gains (losses) (B)
Included in net income (C)		1,202			—			—			—			—			1,202
Included in other comprehensive income (loss)		47,119			3,564			2,632			1,354			8,111			62,780
Amortization included in interest income		15,639			740			3,174			(43	)		2,216			21,726
Purchases, sales and repayments
Purchases		6,007			—			134,829			—			—			140,836
Proceeds from sales		(24,551	)		—			—			—			—			(24,551	)
Proceeds from repayments		(27,591	)		(1,252	)		(11,772	)		(2,619	)		(1,363	)		(44,597	)
Balance at June 30, 2012	$	804,368		$	125,439		$	183,947		$	29,875		$	61,011		$	1,204,640

	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		35,796			14,105			11,057			5			—			60,963
Transfers into Level 3A		(6,056	)		(4,057	)		—			—			—			(10,113	)
Total gains (losses) (B)
Included in net income (C)		(6,663	)		(396	)		1,536			(4,092	)		—			(9,615	)
Included in other comprehensive income (loss)		3,533			1,049			(329	)		2,165			(18	)		6,400
Amortization included in interest income		5,966			261			3,946			139			207			10,519
Purchases, sales and repayments
Purchases		39,757			—			—			—			—			39,757
Proceeds from sales		(6,677	)		—			(3,295	)		(3,743	)		—			(13,715	)
Proceeds from repayments		(14,170	)		(9,133	)		(6,603	)		(287	)		(171	)		(30,364	)
Balance at June 30, 2012	$	192,108		$	41,307		$	68,793		$	1,106		$	3,957		$	307,271

	(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:

	Six Months Ended June 30, 2012
	Level 3A			Level 3B
Gain (loss) on settlement of investments, net	$	1,204		$	4,056
Other income (loss), net		—			—
OTTI		(2	)		(13,671	)
Total	$	1,202		$	(9,615	)

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)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

Securities Valuation

As of June 30, 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	$	1,470,012	$	1,103,585	$	825,826	$	103,981	$	233,415	$	1,163,222
REIT debt		120,288		119,542		38,131		84,966		—		123,097
ABS - subprime		421,669		244,838		150,321		33,626		68,793		252,740
ABS - other real estate		38,843		29,274		28,954		921		1,106		30,981
FNMA / FHLMC		377,220		400,531		242,144		161,248		—		403,392
CDO		206,124		68,513		2,750		58,261		3,957		64,968
Total	$	2,634,156	$	1,966,283	$	1,288,126	$	443,003	$	307,271	$	2,038,400

(A)	Net of incurred losses.
(B)	Net of discounts (or gross of premiums) and after OTTI, including impairment taken during the period ended June 30, 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:

					Impairment		Unrealized Gains			Assumption Ranges
	Amortized				Recorded		(Losses) in							Cumulative
	Cost				In Current		Accumulated			Discount		Prepayment		Default		Loss
	Basis (B)		Fair Value		Period		OCI			Rate		Speed (F)		Rate		Severity
CMBS - Conduit	$	165,184	$	192,108	$	12,802	$	26,924			10%		N/A		0% - 100%		0% - 100%
CMBS - Large loan / single borrower		42,490		41,307		—		(1,183	)		5% - 10%		N/A		0% - 100%		0% - 100%
ABS - subprime		59,062		68,793		804		9,731			8%		0% - 10%		24% - 88%		60% - 100%
ABS - other RE		1,086		1,106		64		20			8%		1% - 4%		30% - 46%		90% - 100%
CDO		4,259		3,957		—		(302	)		14%		4%		14%		80%
Total	$	272,081	$	307,271	$	13,670	$	35,190

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)

JUNE 30, 2012

(dollars in tables 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 June 30, 2012:

							Valuation
	Outstanding						Allowance/			Significant Input Ranges
	Face		Carrying		Fair		(Reversal) In			Discount	Loss
Loan Type	Amount		Value		Value		Current Year			Rate	Severity
Mezzanine	$	608,953	$	486,572	$	493,221	$	(1,788	)	8.0% - 15.0%		0.0% - 100.0%
Bank Loan		300,663		189,328		189,328		(12,064	)	7.7% - 29.0%		0.0% - 68.0%
B-Note		207,981		185,701		185,701		(546	)	6.2% - 15.0%		0.0%
Whole Loan		30,352		30,352		30,368		—		5.1% - 7.1%		0.0%
Total Real Estate Related Loans Held-for-Sale, Net	$	1,147,949	$	891,953	$	898,618	$	(14,398	)

							Valuation
							Allowance/
	Outstanding						(Reversal)			Significant Input Ranges
	Face		Carrying		Fair		In			Discount			Prepayment			Constant			Loss
Loan Type	Amount		Value		Value		Current Year			Rate			Speed			Default Rate			Severity
Non-securitized Manufactured Housing Loans Portfolio I	$	640	$	169	$	169	$	14			39.2	%		0.0	%		52.9	%		75.0	%
Non-securitized Manufactured Housing Loans Portfolio II		3,682		2,777		2,777		(573	)		15.5	%		5.0	%		3.5	%		80.0	%
Total Residential Mortgage Loans Held-for-Sale, Net	$	4,322	$	2,946	$	2,946	$	(559	)

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 June 30, 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	$	125,948	$	105,225	$	105,441	$	810			9.5%		4.0%		4.0%		75.0%
Securitized Manufactured Housing Loans Portfolio II		165,494		162,402		159,737		2,074			7.5%		5.0%		3.5%		80.0%
Residential Loans		58,523		43,470		43,632		(181	)		4.7% - 7.9%		0.0% - 5.0%		0.0% - 3.0%		0.0% - 50.0%
Total Residential Mortgage Loans, Held-for-Investment, Net	$	349,965	$	311,097	$	308,810	$	2,703

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables 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, delinquency rates, recapture rates, the excess mortgage servicing amount of the underlying mortgage loans, and discount rates that market participants would use in determining the fair values of mortgage servicing rights 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 June 30, 2012:

	Significant Input Ranges
	Prepayment Speed (A)			Delinquency (B)			Recapture Rate (C)			Excess Mortgage Servicing Amount (D)	Discount Rate
MSR Pool 1		20.0	%		10.0	%		35.0	%	29 bps		18.0	%
MSR Pool 1 - Recapture Agreement		8.0	%		10.0	%		35.0	%	21 bps		18.0	%
MSR Pool 2		18.0	%		11.0	%		35.0	%	23 bps		17.3	%
MSR Pool 2 - Recapture Agreement		8.0	%		10.0	%		35.0	%	21 bps		17.3	%
MSR Pool 3		18.0	%		12.0	%		35.0	%	23 bps		17.6	%
MSR Pool 3 - Recapture Agreement		8.0	%		10.0	%		35.0	%	21 bps		17.6	%
MSR Pool 4		19.0	%		16.0	%		35.0	%	17 bps		17.9	%
MSR Pool 4 - Recapture Agreement		8.0	%		10.0	%		35.0	%	21 bps		17.9	%
MSR Pool 5		15.0	%		N/A	(E)		35.0	%	13 bps		17.5	%
MSR Pool 5 - Recapture Agreement		8.0	%		N/A	(E)		35.0	%	21 bps		17.5	%

	(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 are expected to miss their mortgage payments.
	(C)	Percentage of voluntarily prepaid loans that are expected to be refinanced by Nationstar.
	(D)	Weighted average total mortgage servicing amount in excess of the base servicing fee.
	(E)	The Excess MSR will be paid on the total UPB of the mortgage portfolio (including both performing and delinquent loans until REO)

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 investment in Excess MSRs.

The prepayment vector specifies the percentage of the collateral balance that is expected to prepay voluntarily (i.e. pay off) and involuntarily (i.e. default) 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 the recent pool-specific experience of loans that missed their most recent mortgage payments, with additional consideration given to loans that are expected to become 30 or more days delinquent.

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 the actual total mortgage servicing amount in excess of a base servicing fee. 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 rights backed by similar collateral.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables 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 June 30, 2012 as follows:

	Level 3B (A)
	MSR Pool 1			MSR Pool 2			MSR Pool 3		MSR Pool 4		MSR Pool 5		Total
Balance at December 31, 2011	$	43,971		$	—		$	—	$	—	$	—	$	43,971
Transfers (B)
Transfers from Level 3A		—			—			—		—		—		—
Transfers into Level 3A		—			—			—		—		—		—
Gains (losses) included in net income (C)		4,739			—			—		—		—		4,739
Interest income		3,884			488			424		168		1,552		6,516
Purchases, sales and repayments
Purchases		—			43,872			36,218		15,439		124,813		220,342
Purchase adjustments		(178	)		(1,522	)		—		—		—		(1,700	)
Proceeds from sales		—			—			—		—		—		—
Proceeds from repayments		(8,736	)		—			—		—		—		(8,736	)
Balance at June 30, 2012	$	43,680		$	42,838		$	36,642	$	15,607	$	126,365	$	265,132

(A)

Includes the recapture agreement for each respective pool.

(B)

Transfers are assumed to occur at the beginning of the quarter.

(C)

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 or similar 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, delinquency rates, recapture rates and excess mortgage servicing amount. Significant increases (decreases) in the discount rates, prepayments 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 delinquency rate assumption is accompanied by directionally similar changes in the assumptions used for the prepayment speed.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables 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
		June 30,		December 31,
	Balance sheet location	2012		2011

Derivative Assets
Interest rate caps, designated as hedges	Derivative Assets	$	504	$	1,092
Interest rate caps, not designated as hedges	Derivative Assets		462		862
		$	966	$	1,954
Derivative Liabilities
Interest rate swaps, designated as hedges	Derivative Liabilities	$	70,226	$	90,025
Interest rate swaps, not designated as hedges	Derivative Liabilities		31,583		29,295
		$	101,809	$	119,320

The following table summarizes information related to derivatives:

	June 30, 2012			December 31, 2011
Cash flow hedges
Notional amount of interest rate swap agreements	$	766,859		$	848,434
Notional amount of interest rate cap agreements		122,665			104,205
Amount of (loss) recognized in OCI on effective portion		(51,397	)		(69,908	)
Deferred hedge gain (loss) related to anticipated financings, which have subsequently occurred, net of amortization		269			299
Deferred hedge gain (loss) related to dedesignation, net of amortization		(1,515	)		(893	)
Expected reclassification of deferred hedges from AOCI into earnings over the next 12 months		799			1,688

Expected reclassification of current hedges from AOCI into earnings over the next 12 months		(28,666	)		(35,348	)

Non-hedge Derivatives
Notional amount of interest rate swap agreements		339,990			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 June 30,						Six Months Ended June 30,
	Income statement location	2012			2011			2012			2011
Cash flow hedges
Gain (loss) on the ineffective portion	Other income (loss)	$	453		$	17		$	483		$	300
Gain (loss) immediately recognized at dedesignation	Gain (loss) on sale of investments; Other income (loss)		(6,760	)		(8,481	)		(7,036	)		(13,796	)
Amount of gain (loss) reclassified from AOCI into income, related to effective portion	Interest expense		(10,290	)		(17,517	)		(20,936	)		(38,708	)
Deferred hedge gain reclassified from AOCI into income, related to anticipated financings	Interest expense		15			14			30			28
Deferred hedge gain (loss) reclassified from AOCI into income, related to effective portion of dedesignated hedges	Interest expense		456			583			898			1,302
Non-hedge derivatives gain (loss)	Other income (loss)		2,021			(2,528	)		4,077			2,303

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables 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 six months ended June 30, 2012 and 2011, based on the treasury stock method, Newcastle had 773,356 and 4,418 dilutive common stock equivalents, respectively, resulting from its outstanding options. Net income available for common stockholders is equal to net income less preferred dividends. During the three months ended June 30, 2012 and 2011, based on the treasury stock method, Newcastle had 1,057,618 and no dilutive common stock equivalents, respectively, resulting from its outstanding options.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

approximately $5.6 million as of the grant date. The assumptions used in valuing the options were: a 1.3% risk-free rate, a 12.9% dividend yield, 149.4% volatility and a 4.7 year expected term.

In May 2012, Newcastle issued 23,000,000 shares of its common stock in a public offering at a price to the public of $6.71 per share for net proceeds of approximately $152.0 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 2,300,000 shares of Newcastle’s common stock at the public offering price, which had a fair value of approximately $7.6 million as of the grant date. The assumptions used in valuing the options were: a 1.05% risk-free rate, a 11.9% dividend yield, 148.4% volatility and a 4.8 year expected term.

In June 2012, Newcastle filed a shelf registration statement with the SEC covering common stock, preferred stock, depositary shares, debt securities and warrants.

As of June 30, 2012, Newcastle’s outstanding options were summarized as follows:

Held by the manager			8,521,447
Issued to the manager and subsequently transferred to certain of the manager’s employees			2,473,162
Issued to the independent directors			16,000
Total			11,010,609

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 June 30, 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 June 30, 2012, Newcastle has recorded $131.6 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.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2012

(dollars in tables in thousands, except share data)

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

These items are comprised of the following:

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Gain (loss) on settlement of investments, net
Gain on settlement of real estate securities	$	2,913		$	38,778		$	9,685		$	72,935
Loss on settlement of real estate securities		(4,090	)		(3,238	)		(4,425	)		(5,023	)
Gain on repayment/disposition of loans held-for-sale		—			66			—			1,786
Loss on repayment/disposition of loans held-for-sale		—			—			(1,614	)		—
	$	(1,177	)	$	35,606		$	3,646		$	6