UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 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: 172,518,733 shares outstanding as of October 26, 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, or that other assumptions underlying our projected returns prove to be incorrect;
	•	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 debt securities 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 reports filed with or furnished to the Securities and Exchange Commission (the “SEC”).

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 September 30, 2012 (unaudited) and December 31, 2011	1

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

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

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

	Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 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	39

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	71

Item 4.	Controls and Procedures	73

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	74

Item 1A.	Risk Factors	74

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	100

Item 3.	Defaults upon Senior Securities	100

Item 4.	Mine Safety Disclosures	100

Item 5.	Other Information	100

Item 6.	Exhibits	101

SIGNATURES		104

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

	September 30, 2012
	(Unaudited)			December 31, 2011
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available-for-sale	$	591,929		$	1,479,214
Real estate related loans, held-for-sale, net		832,885			807,214
Residential mortgage loans, held-for-investment, net		301,370			331,236
Subprime mortgage loans subject to call option		405,525			404,723
Operating real estate, held-for-sale		7,839			7,741
Other investments		18,883			18,883
Restricted cash		2,829			105,040
Derivative assets		—			1,954
Receivables and other assets		6,432			23,319
		2,167,692			3,179,324
Recourse Financing Structures, Mortgaged Real Estate and Unlevered Assets
Real estate securities, available-for-sale		788,431			252,530
Real estate related loans, held-for-sale, net		9,418			6,366
Residential mortgage loans, held-for-sale, net		2,566			2,687
Investments in excess mortgage servicing rights at fair value		258,347			43,971
Investments in real estate, net of accumulated depreciation		126,798			—
Resident lease intangibles, net of accumulated amortization		14,755			—
Other investments		6,024			6,024
Cash and cash equivalents		229,036			157,356
Derivative assets		224			—
Receivables and other assets		33,571			3,541
		1,469,170			472,475
	$	3,636,862		$	3,651,799
Liabilities and Stockholders’ Equity
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable	$	1,155,080		$	2,403,605
Other bonds and notes payable		197,583			200,377
Repurchase agreements		5,368			6,546
Financing of subprime mortgage loans subject to call option		405,525			404,723
Derivative liabilities		36,519			119,320
Accrued expenses and other liabilities		8,241			16,112
		1,808,316			3,150,683
Recourse Financing Structures, Mortgages and Other Liabilities
Repurchase agreements		599,959			233,194
Mortgage notes payable		88,400			—
Junior subordinated notes payable		51,245			51,248
Dividends payable		38,877			16,707
Due to affiliates		3,351			1,659
Purchase price payable on investments in excess mortgage servicing rights		3,250			3,250
Accrued expenses and other liabilities		9,278			2,969
		794,360			309,027
		2,602,676			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 September 30, 2012 and December 31, 2011		61,583			61,583
Common stock, $0.01 par value, 500,000,000 shares authorized, 172,487,757 and 105,181,009 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively		1,725			1,052
Additional paid-in capital		1,709,905			1,275,792
Accumulated deficit		(788,725	)		(1,073,252	)
Accumulated other comprehensive income (loss)		49,698			(73,086	)
		1,034,186			192,089
	$	3,636,862		$	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 September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011

Interest income	$	82,850		$	72,393		$	240,187		$	218,739
Interest expense		28,411			32,587			88,038			106,502
Net interest income		54,439			39,806			152,149			112,237

Impairment/(Reversal)
Valuation allowance (reversal) on loans		4,094			17,644			(8,160	)		(38,218	)
Other-than-temporary impairment on securities		(236	)		5,537			16,506			14,433

Portion of other-than-temporary impairment on securities recognized in other comprehensive income (loss), net of the reversal of other comprehensive loss into net income (loss)		1,156			(1,531	)		(1,913	)		(838	)
		5,014			21,650			6,433			(24,623	)

Net interest income after impairment/reversal		49,425			18,156			145,716			136,860

Other Revenues
Rental income		6,137			—			6,137			—
Care and ancillary income		1,411			—			1,411			—
Total other revenues		7,548			—			7,548			—

Other Income (Loss)
Gain (loss) on settlement of investments, net		229,239			5,636			232,885			75,334
Gain on extinguishment of debt		2,345			15,917			23,127			60,402
Change in fair value of investments in excess mortgage servicing rights		1,774			—			6,513			—
Other income (loss), net		2,424			(2,751	)		1,650			(12,576	)
		235,782			18,802			264,175			123,160
Expenses
Loan and security servicing expense		1,054			1,198			3,256			3,458
Property operating expenses		4,742			—			4,742			—
General and administrative expense		4,703			1,399			13,193			4,649
Management fee to affiliate		6,852			4,569			17,459			13,313
Depreciation and amortization		2,370			—			2,370			—
		19,721			7,166			41,020			21,420
Income from continuing operations		273,034			29,792			376,419			238,600
Income (loss) from discontinued operations		187			151			712			151
Net Income		273,221			29,943			377,131			238,751
Preferred dividends		(1,395	)		(1,395	)		(4,185	)		(4,185	)
Income Available for Common Stockholders	$	271,826		$	28,548		$	372,946		$	234,566

Income Per Share of Common Stock
Basic	$	1.65		$	0.35		$	2.77		$	3.16
Diluted	$	1.63		$	0.35		$	2.74		$	3.16

Income from continuing operations per share of common stock, after preferred dividends
Basic	$	1.65		$	0.35		$	2.77		$	3.16
Diluted	$	1.63		$	0.35		$	2.74		$	3.16
Income (loss) from discontinued operations per share of common stock
Basic	$	—		$	—		$	—		$	—
Diluted	$	—		$	—		$	—		$	—

Weighted Average Number of Shares of Common Stock Outstanding
Basic		164,237,757			80,425,197			134,619,858			74,168,573
Diluted		166,429,120			80,441,593			135,869,332			74,177,027
Dividends Declared per Share of Common Stock	$	0.22		$	0.15		$	0.62		$	0.25

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 September 30,						Nine Months Ended September 30,
	2012			2011			2012		2011
Net income	$	273,221		$	29,943		$	377,131	$	238,751
Other comprehensive income (loss):
Net unrealized gain (loss) on securities		55,320			(118,326	)		121,609		(16,579	)
Reclassification of net realized (gain) loss on securities into earnings		(4,002	)		(1,605	)		4,411		(59,928	)
Net unrealized gain (loss) on derivatives designated as cash flow hedges		4,742			(6,651	)		16,974		6,424
Reclassification of net realized (gain) loss on derivatives designated as cash flow hedges into earnings		(321	)		670			5,304		12,835
Other comprehensive income (loss)		55,739			(125,912	)		148,298		(57,248	)
Total comprehensive income	$	328,960		$	(95,969	)	$	525,429	$	181,503

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)

FOR THE NINE MONTHS ENDED SEPTEMBER 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		—		—		—		—		—		(92,604	)		—			(92,604	)

Issuance of common stock		—		—		67,306,748		673		434,113		—			—			434,786

Deconsolidation of CDO X:

Deconsolidation of unrealized gain on securities		—		—		—		—		—		—			(59,881	)		(59,881	)

Deconsolidation of unrealized loss on derivatives designated as cash flow hedges		—		—		—		—		—		—			34,367			34,367

Net income		—		—		—		—		—		377,131			—			377,131

Other comprehensive income (loss)		—		—		—		—		—		—			148,298			148,298
Stockholders’ equity - September 30, 2012		2,463,321	$	61,583		172,487,757	$	1,725	$	1,709,905	$	(788,725	)	$	49,698		$	1,034,186

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

	Nine Months Ended September 30,
	2012			2011
Cash Flows From Operating Activities
Net income	$	377,131		$	238,751

Adjustments to reconcile net income to net cash provided by (used in) operating activities (inclusive of amounts related to discontinued operations):
Depreciation and amortization		2,701			225
Accretion of discount and other amortization		(38,923	)		(33,214	)
Interest income in CDOs redirected for reinvestment or CDO bond paydown		(2,944	)		(8,981	)
Interest income on investments accrued to principal balance		(16,759	)		(14,303	)
Interest expense on debt accrued to principal balance		328			619
Payment of deferred interest		(568	)		—
Deferred interest received		—			1,027
Non-cash directors’ compensation		220			122
Reversal of valuation allowance on loans		(8,160	)		(38,218	)
Other-than-temporary impairment on securities		14,593			13,595
Impairment on real estate held-for-sale		—			433
Change in fair value of investments in excess mortgage servicing rights		(6,513	)		—
Gain on settlement of investments (net) and real estate held-for-sale		(232,885	)		(74,463	)
Unrealized loss on non-hedge derivatives and hedge ineffectiveness		501			14,483
Gain on extinguishment of debt		(23,127	)		(60,402	)

Change in:
Restricted cash		1,741			1,249
Receivables and other assets		1,088			528
Due to affiliates		1,692			113
Accrued expenses and other liabilities		1,618			57
Net cash provided by (used in) operating activities		71,734			41,621

Cash Flows From Investing Activities
Principal repayments from repurchased CDO debt		21,347			57,108
Principal repayments from CDO securities		1,446			9,834
Principal repayments from non-Agency RMBS		12,440			107
Return of investments in excess mortgage servicing rights		13,327			—
Principal repayments from loans and non-CDO securities (excluding non-Agency RMBS)		70,398			65,649
Purchase of real estate securities		(597,769	)		(303,101	)
Purchase of real estate loans		(9,216	)		—
Proceeds from sale of investments		127,000			3,885
Acquisition of investments in excess mortgage servicing rights		(218,642	)		—
Acquisition of investments in real estate		(141,576	)		—
Additions to investments in real estate		(26	)		—
Proceeds from sale of real estate held for sale		—			650
Acquisition of servicing rights		—			(2,268	)
Deposit paid on investments		(25,857	)		—
Payments on settlement of derivative instruments		—			(14,322	)
Net cash provided by (used in) investing activities		(747,128	)		(182,458	)

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

	Nine Months Ended September 30,
	2012			2011
Cash Flows From Financing Activities
Repurchases of CDO bonds payable		(35,695	)		(91,039	)
Issuance of other bonds payable		—			142,736
Repayments of other bonds payable		(33,177	)		(194,379	)
Borrowings under repurchase agreements		407,878			291,818
Repayments of repurchase agreements		(42,291	)		(89,622	)
Margin deposits under repurchase agreements		(43,960	)		(8,597	)
Return of margin deposits under repurchase agreements		43,447			8,597
Borrowings under mortgage notes payable		88,400			—
Issuance of common stock		435,821			211,567
Costs related to issuance of common stock		(840	)		(468	)
Common stock dividends paid		(66,249	)		(7,930	)
Preferred stock dividends paid		(4,185	)		(6,976	)
Payment of deferred financing costs		(1,831	)		(1,581	)
Purchase of derivative instruments		(244	)		—
Restricted cash returned from refinancing activities		—			58,367
Net cash provided by (used in) financing activities		747,074			312,493

Net Increase (Decrease) in Cash and Cash Equivalents		71,680			171,656
Cash and Cash Equivalents, Beginning of Period		157,356			33,524
Cash and Cash Equivalents, End of Period	$	229,036		$	205,180
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense	$	59,384		$	76,730
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	$	37,947		$	15,776
Purchase price payable on investments in excess mortgage servicing rights	$	3,250		$	—
Re-issuance of other bonds and notes payable to third parties upon deconsolidation of CDO	$	29,959		$	5,751

See notes to consolidated financial statements

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 in senior living assets financed with non-recourse debt (“non-recourse senior living”), (v) investments financed with other non-recourse debt (“non-recourse other”), (vi) investments and debt repurchases financed with recourse debt (“recourse”), (vii) other unlevered investments (“unlevered other”) and (viii) 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.

Newcastle is party to management agreements (the “Senior Living Management Agreements”) with subsidiaries (the “Senior Living Managers”) of Fortress, under which the Senior Living Managers manage the day-to-day operations of the senior living assets, subject to the supervision of Newcastle’s officers and board of directors. For their services, the Senior Living Managers are entitled to an annual management fee as defined in, and in accordance with the terms of, the Senior Living Management Agreements.

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 to the underwriters of $6.63 per share for net proceeds of approximately $167.4 million. Certain officers and directors of Newcastle participated in this offering and purchased an aggregate of 450,000 shares at a price of $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 a price of $6.70, which had a fair value of approximately $8.3 million as of the grant date.

Approximately 4.9 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its principals at September 30, 2012. In addition, Fortress, through its affiliates, held options to purchase approximately 11.2 million shares of Newcastle’s common stock at September 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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with Newcastle’s consolidated financial statements for the year ended December 31, 2011 and notes thereto included in Newcastle’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. Capitalized terms used herein, and not otherwise defined, are defined in Newcastle’s consolidated financial statements for the year ended December 31, 2011.

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

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

In June 2011, the FASB issued a new accounting standard that eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity. Instead, an entity will be required to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. Newcastle early-adopted this accounting standard in 2011 and opted to present two separate statements.

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, the definition of an investment company, financial statement presentation, revenue recognition, leases, financial instruments, hedging and contingencies. Some of the proposed changes are significant and could have a material impact on Newcastle’s reporting. Newcastle has not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.

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 in senior living assets financed with non-recourse debt (“non-recourse senior living”), (v) investments financed with other non-recourse debt (“non-recourse other”), (vi) investments and debt repurchases financed with recourse debt (“recourse”), (vii) other unlevered investments (“unlevered other”) and (viii) 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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 Senior Living			Non-Recourse Other (A) (C)			Recourse (D)			Unlevered Other (E)			Corporate			Inter-segment Elimination (F)			Total
Nine Months Ended September 30, 2012
Interest income	$	161,490		$	339	$	16,422		$	—		$	54,753		$	4,981		$	7,234		$	135		$	(5,167	)	$	240,187
Interest expense		49,334			—		—			692			38,597			1,387			—			2,857			(4,829	)		88,038
Net interest income (expense)		112,156			339		16,422			(692	)		16,156			3,594			7,234			(2,722	)		(338	)		152,149

Impairment (reversal)		3,173			—		—			—			3,202			—			58			—			—			6,433
Other revenues		—			—		—			7,548			—			—			—			—			—			7,548
Other income (loss)		256,358			259		6,513			(21	)		—			—			1,066			—			—			264,175
Property operating expenses		—			—		—			4,742			—			—			—			—			—			4,742
Depreciation and amortization		—			—		—			2,370			—			—			—			—			—			2,370
Other operating expenses		713			1		2,180			4,848			2,513			—			35			23,618			—			33,908
Income (loss) from continuing operations		364,628			597		20,755			(5,125	)		10,441			3,594			8,207			(26,340	)		(338	)		376,419
Income (loss) from discontinued operations		—			—		—			—			422			—			(48	)		—			338			712
Net income (loss)		364,628			597		20,755			(5,125	)		10,863			3,594			8,159			(26,340	)		—			377,131
Preferred dividends		—			—		—			—			—			—			—			(4,185	)		—			(4,185	)
Income (loss) applicable to common stockholders	$	364,628		$	597	$	20,755			(5,125	)	$	10,863		$	3,594		$	8,159			(30,525	)	$	—		$	372,946

Three Months Ended September 30, 2012
Interest income	$	51,050		$	109	$	9,903		$	—		$	18,290		$	3,213		$	2,383		$	32		$	(2,130	)	$	82,850
Interest expense		14,694			—		—			692			13,263			826			—			954			(2,018	)		28,411
Net interest income (expense)		36,356			109		9,903			(692	)		5,027			2,387			2,383			(922	)		(112	)		54,439

Impairment (reversal)		3,962			—		—			—			499			—			553			—			—			5,014
Other revenues		—			—		—			7,548			—			—			—			—			—			7,548
Other income (loss)		231,825			83		1,774			(21	)		—			—			2,121			—			—			235,782
Property operating expenses		—			—		—			4,742			—			—			—			—			—			4,742
Depreciation and amortization		—			—		—			2,370			—			—			—			—			—			2,370
Other operating expenses		230			—		686			1,650			820			—			10			9,213			—			12,609
Income (loss) from continuing operations		263,989			192		10,991			(1,927	)		3,708			2,387			3,941			(10,135	)		(112	)		273,034
Income (loss) from discontinued operations		—			—		—			—			92			—			(17	)		—			112			187
Net income (loss)		263,989			192		10,991			(1,927	)		3,800			2,387			3,924			(10,135	)		—			273,221
Preferred dividends		—			—		—			—			—			—			—			(1,395	)		—			(1,395	)
Income (loss) applicable to common stockholders	$	263,989		$	192	$	10,991		$	(1,927	)	$	3,800		$	2,387		$	3,924		$	(11,530	)	$	—			271,826
September 30, 2012

Investments	$	1,462,566		$	5,471	$	258,347		$	141,553		$	765,047		$	667,560		$	133,408		$	—		$	(69,182	)		3,364,770
Cash and restricted cash		2,829			—		—			5,980			—			—			—			223,056			—			231,865
Derivative assets		—			—		—			224			—			—			—			—			—			224
Other assets		6,319			8		25,214			4,005			113			2,416			1,904			181			(157	)		40,003
Total assets		1,471,714			5,479		283,561			151,762			765,160			669,976			135,312			223,237			(69,339	)		3,636,862
Debt		(1,160,448	)		—		—			(88,400	)		(672,290	)		(599,959	)		—			(51,245	)		69,182			(2,503,160	)
Derivative liabilities		(36,519	)		—		—			—			—			—			—			—			—			(36,519	)
Other liabilities		(5,757	)		—		(5,390	)		(4,391	)		(2,484	)		(94	)		(67	)		(44,971	)		157			(62,997	)
Total liabilities		(1,202,724	)		—		(5,390	)		(92,791	)		(674,774	)		(600,053	)		(67	)		(96,216	)		69,339			(2,602,676	)
Preferred stock		—			—		—			—			—			—			—			(61,583	)		—			(61,583	)
GAAP book value	$	268,990		$	5,479	$	278,171		$	58,971		$	90,386		$	69,923		$	135,245		$	65,438		$	—			972,603

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

	Non-Recourse CDOs (A)			Unlevered CDOs (B)		Unlevered Excess MSRs		Non-Recourse Senior Living		Non-Recourse Other (A)			Recourse		Unlevered Other			Corporate			Inter-segment Elimination (F)			Total

Nine Months Ended September 30, 2011
Interest income	$	164,523		$	120	$	—	$	—	$	54,421		$	1,626	$	1,933		$	99		$	(3,983	)	$	218,739
Interest expense		67,173			—		—		—		39,660			455		—			2,859			(3,645	)		106,502
Net interest income (expense)		97,350			120		—		—		14,761			1,171		1,933			(2,760	)		(338	)		112,237
Impairment (reversal)		(27,904	)		—		—		—		7,012			—		(3,731	)		—			—			(24,623	)
Other income (loss)		115,425			3,643		—		—		2,561			—		1,531			—			—			123,160
Expenses		779			—		—		—		2,679			—		4			17,958			—			21,420
Income (loss) from continuing operations		239,900			3,763		—		—		7,631			1,171		7,191			(20,718	)		(338	)		238,600
Income (loss) from discontinued operations		—			—		—		—		(131	)		—		(56	)		—			338			151
Net income (loss)		239,900			3,763		—		—		7,500			1,171		7,135			(20,718	)		—			238,751
Preferred dividends		—			—		—		—		—			—		—			(4,185	)		—			(4,185	)
Income (loss) applicable to common stockholders	$	239,900		$	3,763	$	—	$	—	$	7,500		$	1,171	$	7,135		$	(24,903	)	$	—		$	234,566

Three Months Ended September 30, 2011
Interest income	$	53,403		$	97	$	—	$	—	$	18,816		$	1,029	$	941		$	36		$	(1,929	)	$	72,393
Interest expense		19,909			—		—		—		13,329			213		—			953			(1,817	)		32,587
Net interest income (expense)		33,494			97		—		—		5,487			816		941			(917	)		(112	)		39,806
Impairment (reversal)		17,550			—		—		—		3,919			—		181			—			—			21,650
Other income (loss)		18,262			116		—		—		—			—		424			—			—			18,802
Expenses		250			—		—		—		933			—		(111	)		6,094			—			7,166
Income (loss) from continuing operations		33,956			213		—		—		635			816		1,295			(7,011	)		(112	)		29,792
Income (loss) from discontinued operations		—			—		—		—		54			—		(15	)		—			112			151
Net income (loss)		33,956			213		—		—		689			816		1,280			(7,011	)		—			29,943
Preferred dividends		—			—		—		—		—			—		—			(1,395	)		—			(1,395	)
Income (loss) applicable to common stockholders	$	33,956			213	$	—	$	—	$	689		$	816	$	1,280		$	(8,406	)	$	—		$	28,548

(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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SEPTEMBER 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:

	September 30, 2012
	Investments				Debt
	Outstanding		Carrying		Outstanding		Carrying
	Face Amount		Value		Face Amount*		Value*
Manufactured housing loan portfolio I	$	122,453	$	102,745	$	93,926	$	85,145
Manufactured housing loan portfolio II		158,542		155,933		123,797		122,961
Residential mortgage loans		53,384		39,208		11,746		11,746
Subprime mortgage loans subject to call options		406,217		405,525		406,217		405,525
Real estate securities		64,044		53,797		44,959		40,913
Operating real estate		N/A		7,839		6,000		6,000
	$	804,640	$	765,047	$	686,645	$	672,290

*	An aggregate face amount of $78.0 million (carrying value of $69.2 million) of debt represents financing provided by the CDO segment (and included as investments in the CDO segment), which is eliminated upon consolidation.
(D)	The $600.0 million of recourse debt is comprised of (i) a $538.5 million repurchase agreement secured by $577.1 million carrying value of FNMA/FHLMC securities, (ii) a $1.8 million repurchase agreement secured by $26.4 million face amount of senior notes issued by Newcastle CDO VI, which was repurchased by Newcastle and is eliminated in consolidation and (iii) a $59.6 million repurchase agreement secured by $90.4 million carrying value of non-agency residential mortgage backed securities (“RMBS”).
(E)	The following table summarizes the investments in the unlevered other segment:

	September 30, 2012
	Outstanding		Carrying		Number of
	Face Amount		Value		Investments
Real estate securities*	$	322,922	$	115,400		41
Real estate related loans		28,801		9,418		2
Residential mortgage loans		3,735		2,566		133
Other investments		N/A		6,024		1
	$	355,458	$	133,408		177

During the nine months ended September 30, 2012, Newcastle purchased 20 non-agency RMBS with an aggregate face amount of $185.2 million for an aggregate purchase price of approximately $108.3 million, or an average price of 58.5% of par. As of September 30, 2012, these securities had an aggregate face amount of $181.4 million and a carrying value of $109.5 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 CDO V), 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 September 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

On September 12, 2012, Newcastle deconsolidated CDO X subsequent to the completion of the sale of 100% of its interests in CDO X to the sole owner of the senior notes and another third party. The sale and resulting deconsolidation has reduced Newcastle’s gross assets by $1.1 billion, reduced liabilities by $1.2 billion, decreased other comprehensive income by $25.5 million and resulted in a gain on sale of $224.3 million. As of September 30, 2012, Newcastle had no continuing involvement with CDO X.

Newcastle had variable interests in the following unconsolidated VIE at September 30, 2012, in addition to the subprime securitizations which are described in Note 4:

					Carrying Value of Newcastle’s
Entity	Gross Assets (A)		Debt (A) (B)		Investment (C)
Newcastle CDO V	$	286,993	$	295,558	$	5,471

(A)	Face amount.
(B)	Includes $42.7 million face amount of debt owned by Newcastle with a carrying value of $5.5 million at September 30, 2012.
(C)	This amount represents Newcastle’s maximum exposure to loss from this entity, which was the fair value at September 30, 2012, related to $19.2 million face amount of CDO V Class I, III, and IV-FL notes.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 September 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 Face		Before		Other-Than- Temporary Impairment			After		Gross Unrealized					Carrying		Number of		Rating							Maturity (Years)		Principal Subordination
Asset Type	Amount		Impairment		(A)			Impairment		Gains		Losses			Value (B)		Securities		(C)	Coupon			Yield			(D)		(E)
CMBS-Conduit	$	345,236	$	315,954	$	(94,271	)	$	221,683	$	44,782	$	(13,556	)	$	252,909		54	BB-		5.56	%		11.47	%		3.7		10.3	%
CMBS- Single Borrower		125,545		123,876		(12,364	)		111,512		2,941		(3,454	)		110,999		22	BB		4.89	%		5.91	%		2.9		7.2	%
CMBS-Large Loan		13,903		13,541		—			13,541		341		(38	)		13,844		2	A-		4.40	%		8.60	%		0.6		10.7	%
REIT Debt		87,700		86,916		—			86,916		6,373		(229	)		93,060		11	BBB-		5.55	%		5.74	%		2.1		N/A
ABS-Subprime (F)		438,269		310,401		(68,708	)		241,693		19,104		(358	)		260,439		63	CCC-		0.87	%		7.82	%		4.9		14.2	%
ABS-Franchise		10,208		9,754		(7,839	)		1,915		—		(339	)		1,576		3	CCC-		5.89	%		4.13	%		4.9		3.0	%
FNMA/FHLMC		534,801		572,356		—			572,356		5,043		(267	)		577,132		45	AAA		2.80	%		1.33	%		4.3		N/A
CDO (G)		203,707		82,051		(14,861	)		67,190		3,230		(19	)		70,401		13	CCC+		3.04	%		7.81	%		1.8		21.6	%
Total / Average (H)	$	1,759,369	$	1,514,849	$	(198,043	)	$	1,316,806	$	81,814	$	(18,260	)	$	1,380,360		213	BB+		3.21	%		5.34	%		3.8

(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 7 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 $0.4 million from Securitization Trust 2006 (Note 4) and (ii) 21 non-agency RMBS purchased during the nine months ended September 30, 2012 with an aggregate face amount of $308.9 million and a carrying value of $199.9 million as of September 30, 2012.
(G)	Includes two CDO bonds issued by a third party with a carrying value of $60.9 million, four CDO bonds issued by CDO V (which has been deconsolidated) and held as investments by Newcastle with a carrying value of $5.5 million and seven CDO bonds issued by C-BASS with a carrying value of $4.0 million.
(H)	The total outstanding face amount of fixed rate securities was $0.6 billion, and of floating rate securities was $1.2 billion.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 nine months ended September 30, 2012, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $16.5 million (gross of $1.9 million of other-than-temporary impairment recognized in other comprehensive income) with respect to real estate securities. Based on management’s analysis of these securities, the performance of the underlying loans and changes in market factors, Newcastle noted adverse changes in the expected cash flows on certain of these securities and concluded that they were other-than-temporarily impaired. Any remaining unrealized losses on Newcastle’s securities were primarily the result of changes in market factors, rather than issue-specific credit impairment. Newcastle performed analyses in relation to such securities, using management’s best estimate of their cash flows, which support its belief that the carrying values of such securities were fully recoverable over their expected holding period. The following table summarizes Newcastle’s securities in an unrealized loss position as of September 30, 2012.

			Amortized Cost Basis							Gross Unrealized									Weighted Average
Securities in an Unrealized Loss Position	Outstanding Face Amount		Before Impairment		Other-than- Temporary Impairment			After Impairment		Gains		Losses			Carrying Value		Number of Securities		Rating		Coupon			Yield			Maturity (Years)

Less Than Twelve Months	$	183,385	$	161,087	$	(3,988	)	$	157,099	$	—	$	(574	)	$	156,525		16		BBB-		2.21	%		2.69	%		4.6
Twelve or More Months		187,554		179,773		(7,883	)		171,890		—		(17,686	)		154,204		33		BB-		4.82	%		6.21	%		3.0
Total	$	370,939	$	340,860	$	(11,871	)	$	328,989	$	—	$	(18,260	)	$	310,729		49		BB		3.53	%		4.53	%		3.8

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

	September 30, 2012
				Amortized Cost Basis After		Unrealized Losses
		Fair Value		Impairment		Credit (B)			Non-Credit (C)
Securities Newcastle intends to sell	$	—	$	—	$	—			N/A
Securities Newcastle is more likely than not to be required to sell (A)		—		—		—			N/A
Securities Newcastle has no intent to sell and is not more likely than not to be required to sell:
Credit impaired securities		1,433		1,602		(11,735	)		(169	)
Non credit impaired securities		309,296		327,387		—			(18,091	)
Total debt securities in an unrealized loss position	$	310,729	$	328,989	$	(11,735	)	$	(18,260	)

(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)

SEPTEMBER 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 nine months ended September 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		—

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		(259	)

Additions for credit losses on securities for which an OTTI was previously recognized without any portion of OTTI recognized in other comprehensive income		(3,988	)

Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at the current measurement date		7,467

Reduction for securities sold during the period		1,498

Reduction for securities deconsolidated during the period		3,736

Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security		18

Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(11,735	)

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

	CMBS					ABS
Geographic Location	Outstanding Face Amount		Percentage			Outstanding Face Amount		Percentage
Western U.S.	$	122,673		25.3	%	$	147,667		32.9	%
Northeastern U.S.		93,720		19.3	%		94,327		21.1	%
Southeastern U.S.		99,564		20.5	%		104,441		23.3	%
Midwestern U.S.		78,015		16.2	%		47,103		10.5	%
Southwestern U.S.		64,379		13.3	%		48,561		10.8	%
Other		11,183		2.3	%		6,378		1.4	%
Foreign		15,150		3.1	%		—		0.0	%
	$	484,684		100.0	%	$	448,477		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)

SEPTEMBER 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 September 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	$	530,343	$	443,269		17		10.79	%		8.55	%		2.3		67.0	%	$	12,000
Corporate Bank Loans		334,855		180,044		7		20.05	%		9.51	%		1.9		40.7	%		—
B-Notes		207,494		188,748		7		10.79	%		5.51	%		2.4		71.4	%		—
Whole Loans		30,242		30,242		3		5.20	%		3.84	%		1.3		96.3	%		—
Total Real Estate Related Loans
Held-for-Sale, Net	$	1,102,934	$	842,303		34		12.57	%		8.14	%		2.2		60.7	%	$	12,000
Non-Securitized Manufactured Housing Loan Portfolio I	$	591	$	151		16		38.88	%		7.83	%		0.7		0.0	%	$	56
Non-Securitized Manufactured Housing Loan Portfolio II		3,144		2,415		117		15.47	%		10.03	%		5.5		9.2	%		370
Total Residential Mortgage Loans
Held-for-Sale, Net (D)	$	3,735	$	2,566		133		16.85	%		9.68	%		4.7		7.7	%	$	426

Securitized Manufactured Housing Loan Portfolio I	$	122,453	$	102,745		3,268		9.48	%		8.66	%		6.9		0.8	%	$	990
Securitized Manufactured Housing Loan Portfolio II		158,542		155,933		5,534		7.51	%		9.64	%		5.7		16.9	%		2,676
Residential Loans		57,163		42,692		202		7.56	%		2.57	%		6.4		100.0	%		10,380
Total Residential Mortgage Loans Held- for-Investment, Net (D) (E)	$	338,158	$	301,370		9,004		8.19	%		8.09	%		6.2		25.1	%	$	14,046
Subprime Mortgage Loans Subject to Call Option	$	406,217	$	405,525

(A)	Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $4.9 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 September 30, 2012, $136.5 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 September 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	$	839	$	263	$	383	$	344	$	1,829	$	120,624	$	122,453
Securitized Manufactured Housing Loan Portoflio II	$	1,159	$	313	$	1,594	$	769	$	3,835	$	154,707	$	158,542
Residential Loans	$	300	$	1,020	$	8,784	$	576	$	10,680	$	46,483	$	57,163

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)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

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

Year of Maturity ⁽¹⁾		Face Amount		Carrying Value		Loans
Delinquent ⁽²⁾		$	12,000	$	—		1
Period from October 1, 2012 to December 31, 2012			59,644		16,695		1
2013			35,970		27,501		3
2014			394,090		243,428		12
2015			249,537		210,614		7
2016			240,252		238,457		5
2017			95,483		91,321		4
Thereafter			15,958		14,287		1
	Total	$	1,102,934	$	842,303		34

(1)	Based on the final extended maturity date of each loan investment as of September 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		16,759			—			—
Principal paydowns		(89,243	)		(622	)		(29,448	)
Sales		—			—			—
Valuation (allowance) reversal on loans		10,879			482			(3,201	)
Loss on repayment of loans held-for-sale		(1,614	)		—			—
Accretion of loan discount and other amortization		—			—			3,208
Other		461			19			(425	)
Balance at September 30, 2012	$	842,303			2,566		$	301,370

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			870			6,363
Valuation (allowance) reversal on loans		10,879			482			(3,201	)
Balance at September 30, 2012	$	(199,490	)	$	(1,109	)	$	(22,913	)

(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)

SEPTEMBER 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:

			September 30, 2012									Nine Months Ended September 30, 2012
	Unpaid Principal Balance		Amortized Cost Basis (A)		Carrying Value (B)		Weighted Average Yield			Average Maturity (Years) (C)		Changes in Fair Value Recorded in Other Income (Loss) (D)
MSR Pool 1	$	8,761,705	$	31,360	$	36,430		18.0	%		4.7	$	4,902
MSR Pool 1 - Recapture Agreement		—		4,999		5,473		18.0	%		10.6		275
MSR Pool 2		9,734,046		34,729		35,024		17.3	%		4.9		295
MSR Pool 2 - Recapture Agreement		—		5,820		6,251		17.3	%		11.7		431
MSR Pool 3		9,413,001		29,195		31,037		17.6	%		4.7		1,842
MSR Pool 3 - Recapture Agreement		—		5,210		5,091		17.6	%		11.2		(119	)
MSR Pool 4		6,013,872		11,875		12,451		17.9	%		4.6		576
MSR Pool 4 - Recapture Agreement		—		2,952		3,073		17.9	%		11.0		121
MSR Pool 5		45,706,396		116,805		114,779		17.5	%		4.8		(2,026	)
MSR Pool 5 - Recapture Agreement		—		8,522		8,738		17.5	%		12.1		216
	$	79,629,020	$	251,467	$	258,347		17.6	%		5.5	$	6,513

	(A)	The amortized cost basis of the Recapture Agreements is determined based on the relative fair values of the Recapture Agreements and related Excess MSRs at the time they were acquired.
	(B)	Carrying value represents the fair value of the pools or Recapture Agreements, as applicable.
	(C)	The weighted average maturity represents the weighted average expected timing of the receipt of cash flows of each investment.
	(D)	The portion of the 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 invest in Excess MSRs with 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 basic fee (the contractual amount the service is entitled to for performing the servicing duties) 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 rights 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 September 30, 2012, Newcastle funded $39.1 million of the purchase price and expected the remainder of the purchase price payable to Nationstar to be funded in the fourth 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 rights 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

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

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 securitizations with an 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 September 30, 2012:

State Concentration	Percentage of Total Outstanding
California		32.3	%
Florida		10.1	%
Washington		4.3	%
New York		4.2	%
Arizona		4.0	%
Texas		3.6	%
Colorado		3.5	%
Maryland		3.3	%
New Jersey		3.1	%
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 12 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 nine months ended September 30, 2012 and 2011, respectively, Newcastle recorded $0.3 million and $0.2 million of servicing rights amortization and no servicing rights impairment. As of September 30, 2012, Newcastle’s servicing asset had a carrying value of $1.8 million recorded in Receivables and Other Assets.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 September 30, 2012:

	Subprime Portfolio
	I		II		Total
Total securitized loans (unpaid principal balance) (A)	$	434,578	$	573,735	$	1,008,313
Loans subject to call option (carrying value)	$	299,176	$	106,349	$	405,525
Retained interests (fair value) (B)	$	381	$	—	$	381

(A)	Average loan seasoning of 86 months and 68 months for Subprime Portfolios I and II, respectively, at September 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 8.36% as of September 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 September 30, 2012:

	Subprime Portfolio
	I			II
Loan unpaid principal balance (UPB)	$	434,578		$	573,735
Weighted average coupon rate of loans		5.39	%		4.59	%
Delinquencies of 60 or more days (UPB) (A)	$	100,159		$	165,693
Net credit losses for the nine months ended September 30, 2012	$	24,034		$	29,599
Cumulative net credit losses	$	216,903		$	251,452
Cumulative net credit losses as a % of original UPB		14.4	%		23.1	%
Percentage of ARM loans (B)		51.4	%		64.6	%
Percentage of loans with original loan-to-value ratio >90%		10.6	%		17.2	%
Percentage of interest-only loans		21.0	%		4.2	%
Face amount of debt (C)	$	430,578		$	573,735
Weighted average funding cost of debt (D)		0.58	%		1.16	%

(A)	Delinquencies include loans 60 or more days past due, in foreclosure, under bankruptcy filing or real estate owned.
(B)	ARM loans are adjustable-rate mortgage loans. An option ARM is an adjustable-rate mortgage that provides the borrower with an option to choose from several payment amounts each month for a specified period of the loan term. None of the loans in the subprime portfolios are option ARMs.
(C)	Excludes face amount of $4.0 million of retained notes for Subprime Portfolio I at September 30, 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 nine months ended September 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.

5. INVESTMENTS IN SENIOR LIVING FACILITIES

On July 18, 2012, Newcastle completed the acquisition of eight senior housing assets for an aggregate purchase price of approximately $143.3 million plus acquisition-related costs. These assets comprise more than 800 beds in senior living facilities located in California, Oregon, Utah, Arizona and Idaho. In connection with the acquisition of the senior living assets described above, the assets acquired and the liabilities assumed were recorded at fair value. A summary of the initial recording of the acquisition on July 18, 2012, is as follows:

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SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

Investment in real estate	$	127,443
Resident lease intangibles		16,454
Prepaid expenses and other assets		110
Accounts payable, accrued expenses and other payables		(2,431	)
		141,576
Mortgage notes payable		(88,400	)
Net cash paid for acquisition	$	53,176

In determining the allocation of the purchase price between net tangible and identified intangible assets acquired and liabilities assumed, management made estimates of the fair value of the tangible and intangible assets and liabilities using information obtained as a result of pre-acquisition due diligence, marketing, leasing activities, and independent appraisals. The fair value of the tangible assets acquired is determined by valuing the property as if it were vacant. Management allocated the purchase price to net tangible and identified intangible assets acquired and liabilities assumed based on their fair values. The determination of fair value involved the use of significant judgment and estimation.

The following is a summary of the significant accounting policies related to the senior living facilities:

Investments in Real Estate

Newcastle recorded the acquired facilities at their estimated fair value. Depreciation on the senior living facilities is computed using the straight-line method over the estimated useful lives of the assets as follows:

Asset Categories	Estimated Useful Life
Land	N/A
Buildings	40 years
Building improvements	3-10 years
Furniture, fixtures and equipment	3-5 years

Expenditures for ordinary maintenance and repairs are expensed as incurred. Renovations and improvements which improve and/or extend the life of the assets are capitalized and depreciated over their estimated useful lives. Newcastle will periodically assess the carrying value of the senior living facilities to determine if facts and circumstances exist that would suggest that assets might be impaired or that the useful lives should be modified. In the event that an impairment in value occurs and we believe that the carrying amount of the facilities will not be recovered, a provision will be recorded to reduce the carrying basis of the facilities to their estimated fair value. The following table summarizes Newcastle’s investments in senior living real estate as of September 30, 2012:

	Gross Carrying Amount		Accumulated Depreciation			Net Carrying Value
Land	$	11,630	$	—		$	11,630
Buildings		113,519		(580	)		112,939
Building improvements		1,959		(54	)		1,905
Furniture, fixtures and equipment		361		(37	)		324
Total	$	127,469	$	(671	)	$	126,798

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

Resident Lease Intangibles

Resident lease intangibles reflect the fair value of in-place resident leases at acquisition. Newcastle estimates the fair value of in-place leases as (i) the present value of the estimated rents that would have been forgone, offset by variable costs that would have otherwise been incurred during a reasonable lease-up period, as if the acquired units were vacant, and (ii) the estimated absorption costs, such as additional marketing costs that would have been incurred during the lease-up period. The acquisition fair value of the in-place resident lease intangibles is amortized over the average length of stay of the residents at the senior living facilities of 24 months on a straight-line basis. Newcastle will periodically assess the carrying value of the resident lease intangibles to determine if facts and circumstances exist that would suggest that the intangible assets might be impaired or that the useful lives should be modified. In the event an impairment in value occurs and we believe that the carrying amount will not be recovered, a provision will be recorded to reduce the carrying basis of the resident lease intangibles to their estimated fair value.

As of September 30, 2012, Newcastle’s resident lease intangibles are detailed as follows:

		Gross Carrying Amount				Accumulated Amortization				Net Carrying Value
In-place resident lease intangibles		$	16,454			$	(1,699	)		$	14,755

Rental Revenue, Care and Ancillary Income Recognition

Newcastle records rental revenue, care and ancillary income as they become due as provided for in the residents’ leases.

Community Fees

Community fees are non-refundable and initially recorded as deferred revenue and amortized over the average length of stay of the residents using the straight line method.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

6. DEBT OBLIGATIONS

The following table presents certain information regarding Newcastle’s debt obligations and related hedges at September 30, 2012:

								Unhedged								Face		Collateral										Aggregate Notional
Debt Obligation/Collateral	Month Issued		Outstanding Face Amount		Carrying Value		Final Stated Maturity	Weighted Average Funding Cost (A)			Weighted Average Funding Cost (B)			Weighted Average Maturity (Years)		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)		Amount of Current Hedges (D)
CDO Bonds Payable
CDO IV (E)		Mar 2004	$	86,983	$	86,872	Mar 2039		1.81	%		4.99	%		1.6	$	76,103	$	175,752	$	165,292	$	158,371		2.3	$	48,891	$	76,103
CDO VI (E)		Apr 2005		91,469		91,469	Apr 2040		0.87	%		5.35	%		4.9		88,437		208,094		119,483		145,273		3.0		51,154		88,437
CDO VIII		Nov 2006		529,337		528,278	Nov 2052		0.77	%		2.18	%		2.6		521,737		708,193		517,123		538,238		2.8		389,155		154,795
CDO IX		May 2007		446,956		448,461	May 2052		0.57	%		0.57	%		2.6		446,956		672,126		543,431		551,501		2.8		328,276		—
				1,154,745		1,155,080						2.02	%		2.7		1,133,233		1,764,165		1,345,329		1,393,383		2.7		817,476		319,335
Other Bonds and Notes Payable
MH loans Portfolio I (F)		Apr 2010		73,431		69,441	Jul 2035		6.20	%		6.20	%		4.2		—		122,453		102,746		102,746		6.9		978		—
MH loans Portfolio II		May 2011		123,797		122,961	Dec 2033		4.35	%		4.35	%		4.0		—		158,542		155,933		155,933		5.7		26,834		—
Residential Mortgage Loans (G)		Aug 2006		5,181		5,181	Dec 2034		LIBOR+ 0.90%			1.11	%		6.4		5,181		53,384		39,208		39,208		6.6		53,384		—
				202,409		197,583						4.92	%		4.2		5,181		334,379		297,887		297,887		6.3		81,196		—
Repurchase Agreements (H)
CDO securities (I)		Dec 2011		7,157		7,157	Oct 2012		LIBOR+ 2.00%			2.21	%		0.0		7,157		—		—		—		—		—		—
Non-agency RMBS (J)		Jul 2012		59,646		59,646	Oct 2012		LIBOR+ 2.00%			2.21	%		0.0		59,646		127,549		87,580		90,428		2.8		127,549		—
FNMA/FHLMC securities (K)		Various		538,524		538,524	Oct 2012		0.42	%		0.42	%		0.1		538,524		534,801		572,356		577,132		4.3		534,801		—
				605,327		605,327						0.62	%		0.1		605,327		662,350		659,936		667,560		4.0		662,350		—
Mortgage Notes Payable
Senior living facilities		Jul 2012		88,400		88,400	Aug 2019		3.45	%		3.45	%		6.5		23,400		N/A		141,553		141,553		N/A		—		23,400
				88,400		88,400						3.45	%		6.5		23,400		N/A		141,553		141,553		N/A		—		23,400
Corporate
Junior subordinated notes payable		Mar 2006		51,004		51,245	Apr 2035		7.57% (M)			7.41	%		22.6		—		—		—		—		—		—		—
				51,004		51,245						7.41	%		22.6		—		—		—		—		—		—		—
Subtotal debt obligations				2,101,885		2,097,635						2.08	%		2.7	$	1,767,141	$	2,760,894	$	2,444,705	$	2,500,383		3.5	$	1,561,022	$	342,735
Financing on subprime mortgage loans subject to call option		(L)		406,217		405,525
Total debt obligations			$	2,508,102	$	2,503,160

(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)	Excluding (i) restricted cash held in CDOs to be used for principal and interest payments of CDO debt, and (ii) operating cash in senior living entities.
(D)	Including a $23.4 million notional amount of interest rate cap agreement for the mortgage notes payable and a $76.1 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)	CDO VI was not in compliance with its applicable over collateralization tests as of September 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 CDO VI to remain out of compliance for the foreseeable future.
(F)	Excluding $20.5 million face amount of other bonds payable relating to MH loans Portfolio I sold to certain Newcastle CDOs, which were eliminated in consolidation.
(G)	Excluding $6.6 million face amount of notes payable relating to residential mortgage loans sold to a Newcastle CDO, which were eliminated in consolidation.
(H)	These repurchase agreements had $0.1 million of associated accrued interest payable at September 30, 2012. $395.3 million face amount of these repurchase agreements were renewed subsequent to September 30, 2012.
(I)	The counterparty of this repurchase agreement is Bank of America. It is secured by $26.4 million face amount of senior notes issued by Newcastle CDO VI, which is eliminated in consolidation. The maximum recourse to Newcastle is $1.8 million.
(J)	The counterparty of these repurchase agreements is Credit Suisse.
(K)	The counterparties on these repurchase agreements are Bank of America, Citi, and Goldman Sachs. Interest rates on these repurchase agreements are fixed, but will be reset on a short-term basis.
(L)	Issued in April 2006 and July 2007. See Note 4 regarding the securitizations of Subprime Portfolios I and II.
(M)	LIBOR + 2.25% after April 2016.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 September 30, 2012, CDO VI was not in compliance with its over collateralization tests.

In the first nine months of 2012, Newcastle repurchased $34.1 million face amount of CDO bonds payable for $10.8 million. As a result, Newcastle extinguished $34.1 million face amount of CDO bonds payable and recorded a gain on extinguishment of debt of $23.1 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 September 30, 2012.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

7. FAIR VALUE

Fair Value Summary Table

The carrying values and fair values of Newcastle’s assets and liabilities at September 30, 2012 were as follows:

	Principal							Weighted			Weighted
	Balance or				Estimated			Average			Average
	Notional		Carrying		Fair			Yield/Funding			Maturity
	Amount		Value		Value		Fair Value Method (A)	Cost			(Years)
Assets
Non-Recourse VIE Financing Structures (F)
Financial instruments:
Real estate securities, available-for-sale*	$	731,415	$	591,929	$	591,929	Broker quotations, counterparty quotations, pricing services, pricing models		8.64	%		3.5
Real estate related loans, held-for-sale, net		1,074,133		832,885		840,122	Broker quotations, counterparty quotations, pricing services, pricing models		12.63	%		2.2
Residential mortgage loans, held-for-investment, net		338,158		301,370		302,073	Pricing models		8.19	%		6.2
Subprime mortgage loans subject to call option (B)		406,217		405,525		405,525	(B)		9.09	%		(B)
Restricted cash*		2,829		2,829		2,829
Operating real estate, held-for-sale				7,839		7,839
Other investments				18,883		18,883
Receivables and other assets				6,432		6,432
			$	2,167,692	$	2,175,632
Recourse Financing Structures, Mortgaged Real Estate and Unlevered Assets
Financial instruments:
Real estate securities, available-for-sale*	$	1,027,954	$	788,431	$	788,431	Broker quotations, counterparty quotations, pricing services, pricing models		3.01	%		3.9
Real estate related loans, held-for-sale, net		28,801		9,418		9,418	Broker quotations, counterparty quotations, pricing services, pricing models		6.51	%		1.8
Residential mortgage loans, held-for-sale, net		3,735		2,566		2,566	Pricing models		16.85	%		4.7
Investments in excess mortgage servicing rights at fair value *(H)		79,629,020		258,347		258,347	Pricing models		17.60	%		5.5
Cash and cash equivalents*		229,036		229,036		229,036
Non-hedge derivative assets (D)(E)*		23,400		224		224	Counterparty quotations		N/A			(D)
Investments in real estate and				141,553		143,300	Based on recent purchase price in July 2012
resident lease intangibles, net
Other investments				6,024		6,024
Receivables and other assets				33,571		33,571
			$	1,469,170	$	1,470,917

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

	Principal Balance							Weighted			Weighted
	or				Estimated			Average			Average
	Notional		Carrying		Fair			Yield/Funding			Maturity
	Amount		Value		Value		Fair Value Method (A)	Cost			(Years)
Liabilities
Non-Recourse VIE Financing Structures (F) (G)
Financial instruments:
CDO bonds payable	$	1,154,745	$	1,155,080	$	802,107	Pricing models		2.02	%		2.7
Other bonds and notes payable		202,409		197,583		204,991	Broker quotations, pricing models		4.92	%		4.2
Repurchase agreements		5,368		5,368		5,368	Market comparables		2.21	%		0.0
Financing of subprime mortgage loans subject to call option (B)		406,217		405,525		405,525	(B)		9.09	%		(B)
Interest rate swaps, treated as hedges (C)(E)*		154,795		14,009		14,009	Counterparty quotations		N/A			(C)
Non-hedge derivatives (D)(E)*		296,532		22,510		22,510	Counterparty quotations		N/A			(D)
Accrued expenses and other liabilities				8,241		8,241
			$	1,808,316	$	1,462,751
Recourse Financing Structures, Mortgages and Other Liabilities (G)
Financial instruments:
Repurchase agreements	$	599,959	$	599,959	$	599,959	Market comparables		0.60	%		0.1
Mortgage notes payable		88,400		88,400		88,400	Pricing models		3.45	%		6.5
Junior subordinated notes payable		51,004		51,245		31,588	Pricing models		7.41	%		22.6
Due to affiliates				3,351		3,351
Dividends payable, accrued expenses and other liabilities				51,405		51,405
			$	794,360	$	774,703

*Measured at fair value on a recurring basis.

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 swap agreements which receive 1-Month LIBOR:
2016	Apr	$ 154,795	5.04%	$ (14,009)

(D)	This represents two interest rate swap agreements with a total notional balance of $296.5 million, maturing in March 2014 and March 2015, respectively, and an interest rate cap agreement with a notional balance of $23.4 million, maturing in August 2019. Newcastle entered into these agreements to reduce its exposure to interest rate changes on the floating rate financings of CDO IV, CDO VI and the senior living assets. These derivative agreements were not designated as hedges for accounting purposes as of September 30, 2012.

(E)	Newcastle’s derivatives fall into two categories. As of September 30, 2012, all derivatives were held within Newcastle’s nonrecourse structures. An aggregate notional balance of $451.3 million, 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 $23.4 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)

SEPTEMBER 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 September 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	$	484,684	$	377,752	$	—	$	329,088	$	48,664	$	377,752
REIT debt		87,700		93,060		93,060		—		—		93,060
ABS - subprime		438,269		260,439		—		220,816		39,623		260,439
ABS - other real estate		10,208		1,576		—		854		722		1,576
FNMA / FHLMC		534,801		577,132		577,132		—		—		577,132
CDO		203,707		70,401		—		64,930		5,471		70,401
Real estate securities total	$	1,759,369	$	1,380,360	$	670,192	$	615,688	$	94,480	$	1,380,360
Investments in Excess MSRs (1)	$	79,629,020	$	258,347	$	—	$	—	$	258,347	$	258,347
Derivative assets:
Interest rate caps, not treated as hedges		23,400		224		224		—		—		224
Derivative assets total	$	23,400	$	224	$	224	$	—	$	—	$	224

Liabilities:
Derivative Liabilities:
Interest rate swaps, treated as hedges	$	154,795	$	14,009	$	14,009	$	—	$	—	$	14,009
Interest rate swaps, not treated as hedges		296,532		22,510		22,510		—		—		22,510
Derivative liabilities total	$	451,327	$	36,519	$	36,519	$	—	$	—	$	36,519

(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)

SEPTEMBER 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 nine months ended September 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			10,178			—			—			20,291
Transfers into Level 3B		(10,748	)		(14,105	)		(11,057	)		(5	)		—			(35,915	)
CDO X deconsolidation		(634,036	)		(40,172	)		(70,607	)		(25,883	)		—			(770,698	)
Total gains (losses) (B)
Included in net income (C)		1,190			—			(8	)		—			—			1,182
Included in other comprehensive income (loss)		28,071			9,596			14,913			(650	)		13,341			65,271
Amortization included in interest income		22,608			1,164			6,457			(11	)		3,985			34,203
Purchases, sales and repayments
Purchases		71,968			—			228,832			—			—			300,800
Proceeds from sales		(24,551	)		—			—			—			—			(24,551	)
Proceeds from repayments		(37,732	)		(2,996	)		(24,033	)		(3,785	)		(4,443	)		(72,989	)
Balance at September 30, 2012	$	239,109		$	89,979		$	220,816		$	854		$	64,930		$	615,688

	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		10,748			14,105			11,057			5			—			35,915
Transfers into Level 3A		(6,056	)		(4,057	)		(10,178	)		—			—			(20,291	)
CDO X deconsolidation		(133,624	)		—			(16,097	)		(291	)		—			(150,012	)
Total gains (losses) (B)
Included in net income (C)		(1,941	)		(396	)		836			(4,092	)		—			(5,593	)
Included in other comprehensive income (loss)		(12,004	)		980			(1,766	)		2,123			1,508			(9,159	)
Amortization included in interest income		8,016			339			5,651			164			304			14,474
Purchases, sales and repayments
Purchases		44,119			—			—			—			—			44,119
Proceeds from sales		(18,708	)		—			(3,295	)		(3,743	)		—			(25,746	)
Proceeds from repayments		(17,372	)		(15,585	)		(9,066	)		(363	)		(280	)		(42,666	)
Balance at September 30, 2012	$	13,800		$	34,864		$	39,623		$	722		$	5,471		$	94,480

	(A)	Transfers are assumed to occur at the beginning of the quarter. CDO X was deconsolidated on September 12, 2012.
	(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:

		Nine Months Ended September 30, 2012
		Level 3A			Level 3B
Gain (loss) on settlement of investments, net	$	1,196		$	8,986
Other income (loss), net		—			—
OTTI		(14	)		(14,579	)
Total	$	1,182		$	(5,593	)

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)

SEPTEMBER 30, 2012

(dollars in tables in thousands, except share data)

Securities Valuation

As of September 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	$	484,684	$	346,736	$	296,337	$	32,751	$	48,664	$	377,752
REIT debt		87,700		86,916		22,747		70,313		—		93,060
ABS - subprime		438,269		241,693		185,490		35,326		39,623		260,439
ABS - other real estate		10,208		1,915		—		854		722		1,576
FNMA / FHLMC		534,801		572,356		511,248		65,884		—		577,132
CDO		203,707		67,190		3,960		60,970		5,471		70,401
Total	$	1,759,369	$	1,316,806	$	1,019,782	$	266,098	$	94,480	$	1,380,360

(A)	Net of incurred losses
(B)	Net of discounts (or gross of premiums) and after OTTI, including impairment taken during the period ended September 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	$	7,083	$	13,800	$	208	$	6,717			10%		N/A		13% - 100%		27% - 100%
CMBS - Large loan / single borrower		36,115		34,864		—		(1,251	)		5% - 9%		N/A		0% - 100%		0% - 100%
ABS - subprime		29,176		39,623		719		10,447			8%		0% - 13%		24% - 85%		60% - 100%
ABS - other RE		745		722		64		(23	)		8%		1% - 4%		30% - 46%		95% - 100%
CDO		4,246		5,471		—		1,225			10% - 35%		5%		13%		80%
Total		77,365		94,480		991		17,115

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.

Table of Contents

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 September 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	$	530,343	$	443,269	$	449,847	$	7,158		8.0% - 25.0%		0.0% - 100.0%
Bank Loan		334,855		180,044		180,044		(13,969	)	6.2% - 31.7%		0.0% - 100.0%
B-Note		207,494		188,748		189,393		(4,068	)	6.2% - 15.0%		0.0%
Whole Loan		30,242		30,242		30,256		—		5.1% - 7.1%		0.0% - 15.0%
Total Real Estate Related Loans Held-for-Sale, Net	$	1,102,934	$	842,303	$	849,540	$	(10,879	)

							Valuation
	Outstanding						Allowance/ (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	$	591	$	151	$	151	$	16			38.9	%		0.0	%		52.9	%		75.0	%
Non-securitized Manufactured Housing Loans Portfolio II		3,144		2,415		2,415		(498	)		15.5	%		5.0	%		3.5	%		80.0	%
Total Residential Mortgage Loans Held-for-Sale, Net	$	3,735	$	2,566	$	2,566	$	(482	)

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 September 30, 2012:

							Valuation
							Allowance/
							(Reversal)
	Outstanding						In			Significant Input Ranges
Loan Type	Face Amount		Carrying Value		Fair Value		Current Year			Discount Rate		Prepayment Speed		Constant Default Rate		Loss Severity
Securitized Manufactured Housing Loans Portoflio I	$	122,453	$	102,745	$	102,844	$	135			9.5%		4.0%		4.0%		75.0%
Securitized Manufactured Housing Loans Portfolio II		158,542		155,933		156,187		3,094			7.5%		5.0%		3.5%		80.0%

Residential Loans		57,163		42,692		43,042		(28	)		5.0% - 7.8%		0.0% - 5.0%		0.0% - 3.0%		0.0% - 50.0%
Total Residential Mortgage Loans, Held-for-Investment, Net	$	338,158	$	301,370	$	302,073	$	3,201

Table of Contents

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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. The valuation technique is based on discounted cash flows. 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 September 30, 2012:

	Significant Input Ranges
	Prepayment Speed (A)			Delinquency (B)			Recapture Rate (C)			Excess Mortgage Servicing Amount (D)	Discount Rate
MSR Pool 1		18.2	%		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		17.4	%		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		17.5	%		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 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 basic 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 speed projections are in the form of a “vector” that varies over the expected life of the pool. 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 assumptions that reflect factors such as the borrower’s FICO score, loan-to-value ratio, debt-to-income ratio, vintage on a loan level basis, as well as the projected 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. For the Recapture Agreements and recaptured loans, Newcastle also considers industry research on the prepayment experience of similar loan pools. This data is obtained from remittance reports, market data services and other market sources.

Delinquency rates are based on the recent pool-specific experience of loans that missed their most recent mortgage payments. For the Recapture Agreements and recaptured loans, delinquency rates are based on the experience of similar loan pools recently originated by Nationstar and recent delinquency experience. Additional consideration is 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 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 basic fee. For loans expected to be refinanced by Nationstar and subject to a Recapture Agreement, Newcastle considers the excess mortgage servicing amount on loans recently originated by Nationstar and other general market considerations.

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

Table of Contents

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 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 September 30, 2012 as follows:

Level 3B (A)

MSR Pool 1

MSR Pool 2