UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 
FORM 10-Q
 
x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2013
 
or
 
o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
For the transition period from _____________________________ to _____________________________
 
Commission File Number: 001-31458
 
Newcastle Investment Corp.
 (Exact name of registrant as specified in its charter)

Maryland
 
81-0559116
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
1345 Avenue of the Americas, New York, NY
 
10105
(Address of principal executive offices)
 
(Zip Code)
 
(212) 798-6100
(Registrant’s telephone number, including area code)
 
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   x    No   o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x  Yes    No o
 
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 x                           Accelerated filer o                            Non-accelerated filer  o                            (Do not check if a smaller reporting company)
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o    No   x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.
 
Common stock, $0.01 par value per share: 253,025,645 shares outstanding as of May 2, 2013.
 


1
 

 


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 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;
 
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 at attractive risk-adjusted returns, 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.
 
2
 

 


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
         
     
         
     
         
   
1
 
         
   
3
 
         
   
4
 
         
   
5
 
         
   
7
 
         
   
8
 
         
 
44
 
         
 
77
 
         
 
79
 
         
         
     
         
80
 
         
Item 1A.  
80
 
         
 
111
 
         
 
111
 
         
 
111
 
         
 
111
 
         
 
112
 
         
         
 
117
 

3
 

 


PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
             
   
March 31, 2013
       
   
(Unaudited)
   
December 31, 2012
 
Assets
           
Real estate securities, available-for-sale
  $ 2,495,473     $ 1,691,575  
Real estate related loans, held-for-sale, net
    851,525       843,132  
Residential mortgage loans, held-for-investment, net
    317,708       292,461  
Residential mortgage loans, held-for-sale, net
    2,380       2,471  
Investments in excess mortgage servicing rights at fair value
    236,555       245,036  
Investments in equity method investees at fair value
    102,588        
Subprime mortgage loans subject to call option
    406,115       405,814  
Investments in real estate, net of accumulated depreciation
    168,515       169,473  
Intangibles, net of accumulated amortization
    16,218       19,086  
Other investments
    24,907       24,907  
Cash and cash equivalents
    534,772       231,898  
Restricted cash
    11,494       2,064  
Derivative assets
    176       165  
Receivables and other assets
    27,577       17,230  
Total Assets
  $ 5,196,003     $ 3,945,312  
 
               
                 
Liabilities and Stockholders’ Equity
               
Liabilities
               
CDO bonds payable
  $ 1,015,560     $ 1,091,354  
Other bonds and notes payable
    173,723       183,390  
Repurchase agreements
    1,473,586       929,435  
Mortgage notes payable
    120,525       120,525  
Financing of subprime mortgage loans subject to call option
    406,115       405,814  
Junior subordinated notes payable
    51,242       51,243  
Derivative liabilities
    26,612       31,576  
Dividends Payable
    56,596       38,884  
Due to affiliates
    4,611       3,620  
Purchase price payable on investments in excess mortgage servicing rights
    59       59  
Accrued expenses and other liabilities
    17,875       16,352  
Total Liabilities
  $ 3,346,504     $ 2,872,252  
 
               
Commitments and contingencies
               
                 
Stockholders’ Equity
               
Preferred stock, $0.01 par value, 100,000,000 shares authorized, 1,347,321 shares of 9.75% Series B Cumulative Redeemable Preferred Stock, 496,000 shares  of 8.05% Series C Cumulative Redeemable Preferred Stock, and 620,000 shares of 8.375% Series D Cumulative Redeemable Preferred Stock, liquidation preference $25.00 per share, issued and outstanding as of March 31, 2013 and December 31, 2012
  $ 61,583     $ 61,583  
Common stock, $0.01 par value, 500,000,000 shares authorized, 253,025,645 and 172,525,645 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively
    2,530       1,725  
Additional paid-in capital
    2,472,931       1,710,083  
Accumulated deficit
    (790,143 )     (771,095 )
Accumulated other comprehensive income (loss)
    102,598       70,764  
Total Equity
  $ 1,849,499     $ 1,073,060  
                 
Total Liabilities and Stockholders’ Equity
  $ 5,196,003     $ 3,945,312  
 
Statement continues on the next page.
 
1
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
 
The following table presents certain assets of consolidated variable interest entities (VIEs), which are included in the Consolidated Balance Sheets above. The assets in the table below include those assets that can only be used to settle obligations of consolidated VIEs, and are in excess of those obligations. Additionally, the assets in the table below exclude intercompany balances that eliminate in consolidation.
 
   
March 31, 2013
       
   
(Unaudited)
   
December 31, 2012
 
Assets of consolidated VIEs that can only be used to settle obligations of consolidated VIEs
           
Real estate securities, available-for-sale
  $ 563,639     $ 567,685  
Real estate related loans, held-for-sale, net
    754,913       813,301  
Residential mortgage loans, held-for-investment, net
    244,552       292,461  
Subprime mortgage loans subject to call option
    406,115       405,814  
Investments in real estate, net of accumulated depreciation
    6,740       6,672  
Other investments
    18,883       18,883  
Restricted cash
    11,494       2,064  
Receivables and other assets
    7,647       7,535  
Total assets of consolidated VIEs that can only be used to settle obligations of consolidated VIEs
  $ 2,013,983     $ 2,114,415  
 
The following table presents certain liabilities of consolidated VIEs, which are included in the Consolidated Balance Sheets above. The liabilities in the table below include liabilities of consolidated VIEs due to third parties only, and exclude intercompany balances that eliminate in consolidation. The liabilities also exclude amounts where creditors or beneficial interest holders have recourse to the general credit of Newcastle.
 
   
March 31, 2013
       
   
(Unaudited)
     
December 31, 2012
 
               
Liabilities of consolidated VIEs for which creditors or beneficial interest holders do not have recourse to the general credit of Newcastle
             
CDO bonds payable
  $ 1,015,560     $ 1,091,354  
Other bonds and notes payable
    173,723       183,390  
Repurchase agreements
    -       4,244  
Financing of subprime mortgage loans subject to call option
    406,115       405,814  
Derivative liabilities
    26,612       31,576  
Accrued expenses and other liabilities
    6,954       8,365  
Total liabilities of consolidated VIEs for which creditors or beneficial interest holders do not have recourse to the general credit of Newcastle
  $ 1,628,964     $ 1,724,743  
 
See notes to consolidated financial statements
 
2
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(dollars in thousands, except share data)
 
 
   
Three Months Ended
March 31,
 
   
2013
   
2012
 
             
Interest income
  $ 71,367     $ 74,899  
Interest expense
    22,710       30,165  
Net interest income
    48,657       44,734  
                 
Impairment/(Reversal)
               
Valuation allowance (reversal) on loans
    2,234       (9,031 )
Other-than-temporary impairment on securities
    422       5,883  
                 
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)
    117       (3,932 )
      2,773       (7,080 )
                 
Net interest income after impairment/reversal
    45,884       51,814  
                 
Other Revenues
               
Rental income
    12,887       509  
Care and ancillary income
    613        
Total other revenues
    13,500       509  
                 
Other Income (Loss)
               
Gain (loss) on settlement of investments, net
    (3 )     4,823  
Gain on extinguishment of debt
    1,206       20,743  
Change in fair value of investments in excess mortgage servicing rights
    1,858       1,216  
Change in fair value of investments in equity method investees
    969        
Other income (loss), net
    4,567       2,970  
      8,597       29,752  
Expenses
               
Loan and security servicing expense
    1,034       1,098  
Property operating expenses
    8,363       225  
General and administrative expense
    6,911       2,286  
Management fee to affiliate
    9,565       4,976  
Depreciation and amortization
    4,079       2  
      29,952       8,587  
Income from continuing operations
    38,029       73,488  
Income (loss) from discontinued operations
    (16 )     (17 )
Net Income
    38,013       73,471  
Preferred dividends
    (1,395 )     (1,395 )
Income Available for Common Stockholders
  $ 36,618     $ 72,076  
                 
Income Per Share of Common Stock
               
Basic
  $ 0.16     $ 0.68  
Diluted
  $ 0.15     $ 0.68  
                 
Income from continuing operations per share of common stock, after preferred dividends
               
Basic
  $ 0.16     $ 0.68  
Diluted
  $ 0.15     $ 0.68  
                 
Income (loss) from discontinued operations per share of common stock
               
Basic
  $     $  
Diluted
  $     $  
                 
Weighted Average Number of Shares of Common Stock Outstanding
               
Basic
    235,136,756       105,181,009  
Diluted
    240,079,144       105,670,102  
                 
Dividends Declared per Share of Common Stock
  $ 0.22     $ 0.20  
 
See notes to consolidated financial statements
 

3
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(dollars in thousands)
 
 
   
Three Months Ended
 March 31,
 
   
2013
   
2012
 
Net income
  $ 38,013     $ 73,471  
Other comprehensive income (loss):
               
 Net unrealized gain (loss) on securities
    29,454       76,417  
 Reclassification of net realized (gain) loss on securities into earnings
    539       (4,487 )
 Net unrealized gain (loss) on derivatives designated as cash flow hedges
    1,841       8,174  
Reclassification of net realized (gain) loss on derivatives designated as cash flow hedges into earnings
          (211 )
Other comprehensive income (loss)
    31,834       79,893  
Total comprehensive income
  $ 69,847     $ 153,364  

See notes to consolidated financial statements
 
4
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2013
(dollars in thousands)
 

   
Preferred Stock
   
Common Stock
   
Additional Paid-in Capital
   
Accumulated Deficit
   
Accum. Other Comp. Income (Loss)
   
Total Stock-holders’ Equity
 
   
Shares
   
Amount
   
Shares
   
Amount
                         
Stockholders’ equity - December 31, 2012
    2,463,321     $ 61,583       172,525,645     $ 1,725     $ 1,710,083     $ (771,095 )   $ 70,764     $ 1,073,060  
                                                                 
Dividends declared
                                  (57,061 )           (57,061 )
                                                                 
Issuance of common stock
                80,500,000       805       762,848                   763,653  
                                                                 
Net income
                                  38,013             38,013  
                                                                 
Other comprehensive income (loss)
                                        31,834       31,834  
                                                                 
Stockholders’ equity - March 31, 2013
    2,463,321     $ 61,583       253,025,645     $ 2,530     $ 2,472,931     $ (790,143 )   $ 102,598     $ 1,849,499  
 
See notes to consolidated financial statements
 
5
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(dollars in thousands)
 
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
Cash Flows From Operating Activities
           
Net income
  $ 38,013     $ 73,471  
Adjustments to reconcile net income to net cash provided by (used in) operating activities (inclusive of amounts related to discontinued operations):
               
Depreciation and amortization
    4,079       87  
Accretion of discount and other amortization
    (8,539 )     (12,213 )
Interest income in CDOs redirected for reinvestment or CDO bond paydown
    (536 )     (1,230 )
Interest income on investments accrued to principal balance
    (6,181 )     (5,293 )
Interest expense on debt accrued to principal balance
    109       109  
Valuation allowance (reversal) on loans
    2,234       (9,031 )
Other-than-temporary impairment on securities
    539       1,951  
Change in fair value of investments in excess mortgage servicing rights
    (1,858 )     (1,216 )
Change in fair value of investments in equity method investees
    (969 )      
Distributions of earnings from equity method investees
    1,344        
(Gain)/Loss on settlement of investments (net)
    3       (4,823 )
Unrealized gain on non-hedge derivatives and hedge ineffectiveness
    (3,126 )     (2,086 )
Gain on extinguishment of debt
    (1,206 )     (20,743 )
Change in:
               
Restricted cash
    995       286  
Receivables and other assets
    (2,277 )     554  
Due to affiliates
    991        
Accrued expenses and other liabilities
    1,004       (559 )
Net cash provided by (used in) operating activities
    24,619       19,264  
Cash Flows From Investing Activities
               
Principal repayments from repurchased CDO debt
    8,656       4,497  
Principal repayments from CDO securities
    1,290       198  
Principal repayments from non-Agency RMBS
    17,472        
Return of investments in excess mortgage servicing rights
    10,272       2,425  
Principal repayments from loans and non-CDO securities (excluding non-Agency RMBS)
    74,944       22,894  
Purchase of real estate securities
    (871,127 )     (4,340 )
Purchase of real estate loans
    (101,313 )      
Acquisition of investments in excess mortgage servicing rights
          (3,072 )
Additions to investments in real estate
    (259 )      
Contributions to equity method investees
    (109,588 )      
Distributions of capital from equity method investees
    6,625        
Deposit paid on investments
    (2,700 )      
Net cash provided by (used in) investing activities
    (965,728 )     22,602  
 
               
Continued on next page
 
6
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(dollars in thousands)
 
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
Cash Flows From Financing Activities
           
Repurchases of CDO bonds payable
    (9,722 )     (9,159 )
Repayments of other bonds and notes payable
    (9,922 )     (10,450 )
Borrowings under repurchase agreements
    1,379,928       4,117  
Repayments of repurchase agreements
    (835,777 )     (10,133 )
Margin deposits under repurchase agreements
    (62,100 )     (9,634 )
Return of margin deposits under repurchase agreements
    56,788       9,634  
Issuance of common stock
    764,759        
Costs related to issuance of common stock
    (592 )      
Common stock dividends paid
    (37,954 )     (15,777 )
Preferred stock dividends paid
    (1,395 )     (1,395 )
Payment of deferred financing costs
    (30 )      
Net cash provided by (used in) financing activities
    1,243,983       (42,797 )
                 
Net Increase (Decrease) in Cash and Cash Equivalents
    302,874       (931 )
Cash and Cash Equivalents, Beginning of Period
    231,898       157,356  
Cash and Cash Equivalents, End of Period
  $ 534,772     $ 156,425  
Supplemental Disclosure of Cash Flow Information
               
Cash paid during the period for interest expense
  $ 12,953     $ 20,726  
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
  $ 55,666     $ 21,036  
 
See notes to consolidated financial statements
 
7
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(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.
 
Approximately 5.3 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its principals at March 31, 2013.  In addition, Fortress, through its affiliates, held options to purchase approximately 17.7 million shares of Newcastle’s common stock at March 31, 2013.
 
The accompanying consolidated financial statements and related notes of Newcastle have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under U.S. generally accepted accounting principles have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of Newcastle’s financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with Newcastle’s consolidated financial statements for the year ended December 31, 2012 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, 2012.
 
Certain prior period amounts have been reclassified to conform to the current period’s presentation.
 
Recent Accounting Pronouncements
 
In February 2013, the FASB issued new guidance regarding the reporting of reclassifications out of accumulated other comprehensive income. The new guidance does not change current requirements for reporting net income or other comprehensive income in financial statements. However, it requires companies to present the effects on the line items of net income of significant amounts reclassified out of accumulated OCI if the item reclassified is required to be reclassified to net income in its entirety during the same reporting period. Presentation should occur either on the face of the income statement where net income is presented, or in the notes to the financial statements. Newcastle has early adopted this accounting standard and opted to present this information in a note to the financial 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.
 
8
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
2. SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES
 
Newcastle conducts its business through the following segments: (i) investments financed with non-recourse collateralized debt obligations (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered CDOs”), (iii) unlevered investments in excess mortgage servicing rights (“unlevered Excess MSRs”), (iv) investments 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.
 
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.
 
9
 

 


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(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
 
Three Months Ended March 31, 2013
                                                           
Interest income
  $ 31,589     $ 239     $ 10,035     $     $ 16,307     $ 7,285     $ 6,706     $ 72     $ (866 )   $ 71,367  
Interest expense
    7,131                   1,232       12,383       1,878             952       (866 )     22,710  
Net interest income (expense)
    24,458       239       10,035       (1,232 )     3,924       5,407       6,706       (880 )           48,657  
Impairment (reversal)
    3,183                         848             (1,258 )                 2,773  
Other revenues
                      12,997       503                               13,500  
Other income (loss)
    4,497       74       2,827       8                   1,191                   8,597  
Property operating expenses
                      8,116       247                               8,363  
Depreciation and amortization
                      4,022       57                               4,079  
Other operating expenses
    194             221       2,388       719       42       95       13,851             17,510  
Income (loss) from continuing operations
    25,578       313       12,641       (2,753 )     2,556       5,365       9,060       (14,731 )           38,029  
Income (loss) from discontinued operations
                                        (16 )                 (16 )
Net income (loss)
    25,578       313       12,641       (2,753 )     2,556       5,365       9,044       (14,731 )           38,013  
Preferred dividends
                                              (1,395 )           (1,395 )
Income (loss) applicable to common stockholders
  $ 25,578     $ 313     $ 12,641     $ (2,753 )   $ 2,556     $ 5,365     $ 9,044     $ (16,126 )   $     $ 36,618  
                                                                                 
March 31, 2013
                                                                               
                                                                                 
Investments
  $ 1,347,691     $ 5,254     $ 339,143     $ 177,993     $ 708,998     $ 1,634,243     $ 470,509     $     $ (61,847 )   $ 4,621,984  
Cash and restricted cash
    11,494                   10,207                         524,565             546,266  
Derivative assets
                      176                                     176  
Other assets
    7,556       6             7,537       91       9,893       2,350       299       (155 )     27,577  
Total assets
    1,366,741       5,260       339,143       195,913       709,089       1,644,136       472,859       524,864       (62,002 )     5,196,003  
Debt
    (1,015,560 )                 (120,525 )     (641,685 )     (1,473,586 )           (51,242 )     61,847       (3,240,751 )
Derivative liabilities
    (26,612 )                                                     (26,612 )
Other liabilities
    (5,510 )           (280 )     (4,935 )     (1,444 )     (142 )     (854 )     (66,131 )     155       (79,141 )
Total liabilities
    (1,047,682 )           (280 )     (125,460 )     (643,129 )     (1,473,728 )     (854 )     (117,373 )     62,002       (3,346,504 )
Preferred stock
                                              (61,583 )           (61,583 )
GAAP book value
  $ 319,059     $ 5,260     $ 338,863     $ 70,453     $ 65,960     $ 170,408     $ 472,005     $ 345,908     $     $ 1,787,916  
                                                                                 
Investments in equity method investees at fair value
  $     $     $ 102,588     $     $     $     $     $     $     $ 102,588  
Additions to investments in real estate
                      130       129                               259  

10
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(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
 
                                                             
Three Months Ended March 31, 2012
                                                           
Interest income
  $ 54,402     $ 115     $ 2,037     $     $ 18,426     $ 814     $ 523     $ 51     $ (1,469 )   $ 74,899  
Interest expense
    17,636                         12,663       268             954       (1,356 )     30,165  
Net interest income (expense)
    36,766       115       2,037             5,763       546       523       (903 )     (113 )     44,734  
Impairment (reversal)
    (8,531 )                       1,648             (197 )                 (7,080 )
Other revenues
                            509                               509  
Other income (loss)
    29,913       92       1,216                         (1,469 )                 29,752  
Property operating expenses
                            338                         (113 )     225  
Depreciation and amortization
                            2                               2  
Other operating expenses
    241       1       123             844             13       7,138             8,360  
Income (loss) from continuing operations
    74,969       206       3,130             3,440       546       (762 )     (8,041 )           73,488  
Income (loss) from discontinued operations
                                        (17 )                 (17 )
Net income (loss)
    74,969       206       3,130             3,440       546       (779 )     (8,041 )           73,471  
Preferred dividends
                                              (1,395 )           (1,395 )
Income (loss) applicable to common stockholders
  $ 74,969     $ 206     $ 3,130     $     $ 3,440     $ 546     $ (779 )   $ (9,436 )         $ 72,076  
 
(A)
Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the extent Newcastle receives net cash flow distributions from such structures. Furthermore, creditors or beneficial interest holders of these structures have no recourse to the general credit of Newcastle. Therefore, Newcastle’s exposure to the economic losses from such structures is limited to its invested equity in them and economically their book value cannot be less than zero. Therefore, impairment recorded in excess of Newcastle’s investment, which results in negative GAAP book value for a given non-recourse financing structure, cannot economically be incurred and will eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or termination of such non-recourse financing structure.
(B)
Represents unlevered investments in CDO securities issued by Newcastle. These CDOs have been deconsolidated as Newcastle does not have the power to direct the relevant activities of the CDOs.
(C)
The following table summarizes the investments and debt in the other non-recourse segment:
 
   
March 31, 2013
 
   
Investments
   
Debt
 
   
Outstanding
   
Carrying
   
Outstanding
   
Carrying
 
   
Face Amount
   
Value
   
Face Amount*
   
Value*
 
Manufactured housing loan portfolio I
  $ 114,355     $ 96,752     $ 86,490     $ 78,102  
Manufactured housing loan portfolio II
    146,865       144,274       112,046       111,447  
Subprime mortgage loans subject to call options
    406,217       406,115       406,217       406,115  
Real estate securities
    62,633       55,117       43,989       40,021  
Other commercial real estate
    N/A       6,740       6,000       6,000  
    $ 730,070     $ 708,998     $ 654,742     $ 641,685  
 
*
An aggregate face amount of $70.5 million (carrying value of $61.8 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 $1.5 billion of recourse debt is comprised of (i) a $1.3 billion repurchase agreement secured by $1.4 billion carrying value of FNMA/FHLMC securities and (ii) a $158.0 million repurchase agreement secured by $233.8 million carrying value of non-agency residential mortgage backed securities (“RMBS”).
 
11
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
(E)
The following table summarizes the investments in the unlevered other segment:
 
   
March 31, 2013
 
   
Outstanding
Face Amount
   
Carrying
Value
   
Number of
Investments
 
Real estate securities
  $ 592,450     $ 292,337       63  
Real estate related loans
    265,209       96,612       2  
Residential mortgage loans
    112,716       75,536       646  
Other investments
    N/A       6,024       1  
    $ 970,375     $ 470,509       712  
 
(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, and therefore does not consolidate them.
 
In addition, Newcastle’s investments in RMBS, CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. Newcastle monitors these investments and analyzes the potential need to consolidate the related securitization entities pursuant to the VIE consolidation requirements. These analyses require considerable judgment in determining whether an entity is a VIE and determining the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power and economics. The result could be the consolidation of an entity that otherwise would not have been consolidated or the de-consolidation of an entity that otherwise would have been consolidated.
 
As of March 31, 2013, Newcastle has not consolidated these potential VIEs. This determination is based, in part, on the assessment that Newcastle does not have the power to direct the activities that most significantly impact the economic performance of these entities, such as if Newcastle owned a majority of the currently controlling class. In addition, Newcastle is not obligated to provide, and has not provided, any financial support to these entities.
 
Newcastle has not consolidated the entities in which Newcastle holds a 50% interest that made an investment in Excess MSRs. Newcastle has determined that the decisions that most significantly impact the economic performance of these entities will be made collectively by Newcastle and the other investor in the entities. In addition, these entities have sufficient equity to permit the entities to finance their activities without additional subordinated financial support. Based on Newcastle’s analysis, these entities do not meet any of the VIE criteria.
 
Newcastle had variable interests in the following unconsolidated VIE at March 31, 2013, in addition to the subprime securitizations which are described in Note 4:
 
Entity
 
Gross Assets (A)
   
Debt (A) (B)
   
Carrying Value of Newcastle’s Investment (C)
 
Newcastle CDO V
  $ 225,628     $ 241,263     $ 5,254  
 
(A)
Face amount.
(B)
Includes $42.2 million face amount of debt owned by Newcastle with a carrying value of $5.3 million at March 31, 2013.
(C)
This amount represents Newcastle’s maximum exposure to loss from this entity, which was the fair value at March 31, 2013, related to $17.8 million face amount of CDO V Class I, III, and IV-FL  notes.
 
12
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
3. REAL ESTATE SECURITIES
 
The following is a summary of Newcastle’s real estate securities at March 31, 2013, 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
   
Gross Unrealized
               
Weighted Average
 
               
Other-Than-
                           
Number
                     
Maturity
   
Principal
 
Asset Type
 
Outstanding Face
Amount
   
Before Impairment
   
Temporary Impairment
   
After Impairment
   
Gains
   
Losses
   
Carrying Value (A)
   
of Securities
   
Rating
(B)
   
Coupon
   
Yield
   
(Years) (C)
   
Subordination (D)
 
CMBS-Conduit
  $ 338,056     $ 314,424     $ (99,020 )   $ 215,404     $ 54,263     $ (6,752 )   $ 262,915       52     B+       5.54 %     10.33 %     3.2       9.5 %
CMBS- Single Borrower
    124,709       123,409       (12,364 )     111,045       5,818       (1,609 )     115,254       22    
BB
      4.89 %     5.93 %     2.5       9.5 %
CMBS-Large Loan
    5,819       5,643             5,643       205             5,848       1    
BBB-
      6.08 %     12.16 %     0.7       2.0 %
REIT Debt
    50,700       50,055             50,055       4,064             54,119       8    
BBB-
      5.75 %     6.10 %     1.8       N/A  
Non-Agency RMBS (E)
    904,784       604,616       (68,708 )     535,908       49,218       (1,226 )     583,900       93    
CC
      0.75 %     6.55 %     7.3       10.0 %
ABS-Franchise
    10,036       9,329       (7,839 )     1,490       219       (325 )     1,384       3    
CCC-
      5.95 %     3.47 %     4.7       2.7 %
FNMA/FHLMC
    1,309,855       1,396,400             1,396,400       6,130       (2,102 )     1,400,428       83    
AAA
      3.23 %     1.42 %     4.1       N/A  
CDO (F)
    202,232       81,608       (14,861 )     66,747       4,878             71,625       13    
CCC+
      2.86 %     8.12 %     1.4       21.4 %
Total / Average (G)
  $ 2,946,191     $ 2,585,484     $ (202,792 )   $ 2,382,692     $ 124,795     $ (12,014 )   $ 2,495,473       275    
BBB-
      2.84 %     3.92 %     4.7          
 
(A)
See Note 9 regarding the estimation of fair value, which is equal to carrying value for all securities.
 
(B)
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.
 
(C)
The weighted average maturity is based on the timing of expected principal reduction on the assets.
 
(D)
Percentage of the outstanding face amount of securities and residual interests that is subordinate to Newcastle’s investments.
 
(E)
Includes (i) the retained bond with a face amount of $4.0 million and a carrying value of $1.4 million from Securitization Trust 2006 (Note 4) and (ii) 53 non-agency RMBS purchased since April 2012 with an aggregate face amount of $784.3 million and a carrying value of $518.6 million as of March 31, 2013, of which an aggregate face amount of $644.7 million and a carrying value of $440.1 million is serviced by Nationstar. The total UPB of the loans underlying these Nationstar serviced non-Agency RMBS was approximately $8.3 billion as of March 31, 2013.
 
(F)
Includes two CDO bonds issued by a third party with a carrying value of $62.5 million, four CDO bonds issued by CDO V (which has been deconsolidated) and held as investments by Newcastle with a carrying value of $5.3 million and seven CDO bonds issued by C-BASS with a carrying value of $3.9 million.
 
(G)
The total outstanding face amount of fixed rate securities was $0.5 billion, and of floating rate securities was $2.4 billion.
 
13
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the three months ended March 31, 2013, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $0.4 million (net of a $0.1 million reversal of other-than-temporary impairment recognized in other comprehensive income) with respect to real estate securities. Based on management’s analysis of these securities, the performance of the underlying loans and changes in market factors, Newcastle noted adverse changes in the expected cash flows on certain of these securities and concluded that they were other-than-temporarily impaired. Any remaining unrealized losses on Newcastle’s securities were primarily the result of changes in market factors, rather than issue-specific credit impairment. Newcastle performed analyses in relation to such securities, using management’s best estimate of their cash flows, which support its belief that the carrying values of such securities were fully recoverable over their expected holding period. The following table summarizes Newcastle’s securities in an unrealized loss position as of March 31, 2013.
 
         
Amortized Cost Basis
   
Gross Unrealized
             
Weighted Average
 
Securities in
 
Outstanding
         
Other-than-
                           
Number
                     
an Unrealized
 
Face
   
Before
   
Temporary
   
After
               
Carrying
   
of
                 
Maturity
 
Loss Position
 
Amount
   
Impairment
   
Impairment
   
Impairment
   
Gains
   
Losses
   
Value
   
Securities
 
Rating
 
Coupon
   
Yield
   
(Years)
 
Less Than Twelve Months
  $ 562,897     $ 509,420     $ (5,236 )   $ 504,184     $     $ (3,230 )   $ 500,954       34  
 BBB
    2.44 %     2.15 %     5.9  
Twelve or More Months
    119,054       118,953       (236 )     118,717             (8,784 )     109,933       24  
 BB-
    4.44 %     4.63 %     1.5  
Total
  $ 681,951     $ 628,373     $ (5,472 )   $ 622,901     $     $ (12,014 )   $ 610,887       58  
 BBB
    2.79 %     2.62 %     5.1  
 
Newcastle performed an assessment of all of its debt securities that are in an unrealized loss position (unrealized loss position exists when a security’s amortized cost basis, excluding the effect of OTTI, exceeds its fair value) and determined the following:

   
March 31, 2013
 
         
Amortized
             
         
Cost Basis
   
Unrealized Losses
 
   
Fair Value
   
After 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
    1,155       1,274       (5,355 )     (119 )
Non credit impaired securities
    609,732       621,627             (11,895 )
Total debt securities in an unrealized loss position
  $ 610,887     $ 622,901     $ (5,355 )   $ (12,014 )
 
(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.
 
14
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
The following table summarizes the activity related to credit losses on debt securities for the three months ended March 31, 2013:
 
Beginning balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income
  $ (4,770 )
         
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
    (594 )
         
Additions for credit losses on securities for which an OTTI was previously recognized without any portion of OTTI recognized in other comprehensive income
     
         
Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at the current measurement date
     
         
Reduction for securities sold during the period
     
         
Reduction for securities deconsolidated during the period
     
         
Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security
    9  
         
Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income
  $ (5,355 )
 
The table below summarizes the geographic distribution of the collateral securing Newcastle’s CMBS and ABS at March 31, 2013 (in thousands):

   
CMBS
   
ABS
 
Geographic Location
 
Outstanding Face
Amount
   
Percentage
   
Outstanding Face Amount
   
Percentage
 
Western U.S.
  $ 114,446       24.4 %   $ 331,852       36.3 %
Northeastern U.S.
    96,067       20.5 %     206,507       22.6 %
Southeastern U.S.
    86,896       18.5 %     192,309       21.0 %
Midwestern U.S.
    63,588       13.6 %     104,717       11.4 %
Southwestern U.S.
    72,915       15.6 %     73,155       8.0 %
Other
    14,730       3.1 %     6,280       0.7 %
Foreign
    19,942       4.3 %           0.0 %
    $ 468,584       100.0 %   $ 914,820       100.0 %
 
Geographic concentrations of investments expose Newcastle to the risk of economic downturns within the relevant regions, particularly given the current unfavorable market conditions. These market conditions may make regions more vulnerable to downturns in certain market factors. Any such downturn in a region where Newcastle holds significant investments could have a material, negative impact on Newcastle.
 
Newcastle evaluates the credit quality of its real estate securities, as of the acquisition date, for evidence of credit quality deterioration. As a result, we identified a population of real estate securities for which it was determined that it was probable that we would be unable to collect all contractually required payments. For securities acquired during the three months ended March 31, 2013, the face amount of these real estate securities was $368.7 million with an aggregate purchase price of approximately $222.8 million and total expected cash flows of $280.4 million.
 
The following is the outstanding face amount and carrying value for securities in which, as of the acquisition date it was determined probable that Newcastle would be unable to collect all contractually required payments, at December 31, 2012 and March 31, 2013.
 
   
Outstanding
Face Amount
   
Carrying Value
 
December 31, 2012
  $ 342,013     $ 212,129  
      March 31, 2013
  $ 692,140     $ 436,458  
 
15
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
The following is a summary of the changes in accretable yield (a portion of the discount) for these securities during the three months ended March 31, 2013.

   
For the three months
ended March 31, 2013
 
Balance at December 31, 2012
  $ 89,636  
Additions
    57,568  
Accretion
    (4,248 )
Reclassifications from nonaccretable difference
    49,553  
Disposals
     
Balance at March 31, 2013
  $ 192,509  
 
4. REAL ESTATE RELATED LOANS, RESIDENTIAL MORTGAGE LOANS AND SUBPRIME MORTGAGE LOANS
 
The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at March 31, 2013.  The loans contain various terms, including fixed and floating rates, self-amortizing and interest only.  They are generally subject to prepayment.
 
                                 
Weighted
   
Floating Rate
       
                     
Wtd.
   
Weighted
   
Average
   
Loans as a %
   
Delinquent
 
   
Outstanding
   
Carrying
   
Loan
   
Avg.
   
Average
   
Maturity
   
of Face
   
Face Amount
 
Loan Type
 
Face Amount
   
Value (A)
   
Count
   
Yield
   
Coupon
   
(Years) (B)
   
Amount
   
(C)
 
Mezzanine Loans
  $ 518,307     $ 432,432       17       9.05 %     8.96 %     1.5       66.6 %   $ 12,000  
Corporate Bank Loans
    582,474       277,831       7       16.65 %     6.70 %     1.8       63.8 %      
B-Notes
    120,872       111,237       5       10.42 %     5.14 %     1.1       81.0 %      
Whole Loans
    30,025       30,025       2       4.82 %     3.80 %     0.9       97.0 %      
Total Real Estate Related Loans Held-for-Sale, Net
  $ 1,251,678     $ 851,525       31       11.56 %     7.42 %     1.6       67.4 %   $ 12,000  
Non-Securitized Manufactured Housing Loan Portfolio I
  $ 569     $ 153       15       68.24 %     7.76 %     0.9       0.0 %   $ 56  
Non-Securitized Manufactured Housing Loan Portfolio II
    2,882       2,227       111       15.47 %     10.04 %     5.4       9.5 %     207  
Total Residential Mortgage Loans Held-for-Sale, Net (D)
  $ 3,451     $ 2,380       126       18.86 %     9.66 %     4.7       7.9 %   $ 263  
                                                                 
Securitized Manufactured Housing Loan Portfolio I (D)(E)
  $ 114,355     $ 96,752       3,073       9.45 %     8.63 %     6.3       0.7 %   $ 1,055  
Securitized Manufactured Housing Loan Portfolio II (D)(E)
    146,865       144,274       5,205       7.54 %     9.64 %     5.5       16.6 %     2,489  
Residential Loans (D)(E)
    54,458       41,198       191       7.40 %     2.44 %     6.0       100.0 %     6,988  
Reverse Mortgage Loans (F)
    58,586       35,484       331       11.81 %     5.15 %     3.9       21.0 %     N/A  
Total Residential Mortgage Loans Held-for-Investment, Net
  $ 374,264     $ 317,708       8,800       8.58 %     7.58 %     5.6       24.6 %   $ 10,532  
Subprime Mortgage Loans Subject to Call Option
  $ 406,217     $ 406,115                                                  
 
(A)
Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $5.2 million for the manufactured housing loans.
(B)
The weighted average maturity is based on the timing of expected principal reduction on the assets.
(C)
Includes loans that are 60 or more days past due (including loans that are in foreclosure, or borrower’s in bankruptcy) or considered real estate owned (“REO”). As of March 31, 2013, $139.2 million face amount of real estate related loans was on non-accrual status.
(D)
Loans acquired at a discount for credit quality.
(E)
The following is an aging analysis of past due residential loans held-for-investment as of March 31, 2013:
 
16
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 

   
30-59 Days
   
60-89 Days
   
Over 90 Days
         
Total Past
         
Total Outstanding
 
   
Past Due
   
Past Due
   
Past Due
   
REO
   
Due
   
Current
   
Face Amount
 
Securitized Manufactured Housing Loan Portfolio I
  $ 570     $ 217     $ 344     $ 494     $ 1,625     $ 112,730     $ 114,355  
Securitized Manufactured Housing Loan Portfolio II
  $ 1,070     $ 467     $ 1,544     $ 478     $ 3,559     $ 143,306     $ 146,865  
Residential Loans
  $ 990     $ 1,335     $ 5,420     $ 233     $ 7,978     $ 46,480     $ 54,458  
 
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.
 
(F)
Represents a portfolio of reverse mortgage loans acquired in February 2013. 80% of these loans have reached a termination event. As a result, the borrower can no longer make draws on these loans.  The weighted average coupon and floating rate loans percentages are as of December 31, 2012.
 
The following is a summary of real estate related loans by maturities at March 31, 2013:
 
   
Outstanding
         
Number of
 
Year of Maturity (1)
 
Face Amount
   
Carrying Value
   
Loans
 
Delinquent (2)
  $ 12,000     $       1  
Period from April 1, 2013 to December 31, 2013
    98,216       43,571       3  
2014
    629,726       340,270       12  
2015
    58,672       55,793       5  
2016
    177,404       175,779       4  
2017
    95,226       86,851       4  
2018
                 
Thereafter
    180,434       149,261       2  
Total
  $ 1,251,678     $ 851,525       31  
 
(1)
Based on the final extended maturity date of each loan investment as of March 31, 2013.
(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
   
Reverse
Mortgage Loans
 
Balance at December 31, 2012
  $ 843,132     $ 2,471     $ 292,461     $  
Purchases / additional fundings
    66,175                   35,138  
Interest accrued to principal balance
    6,181                    
Principal paydowns
    (63,511 )     (148 )     (10,769 )      
Valuation (allowance) reversal on loans
    (1,441 )     6       (799 )      
Accretion of loan discount and other amortization
                961       346  
Other
    989       51       370        
Balance at March 31, 2013
  $ 851,525       2,380     $ 282,224     $ 35,484  
 
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 (A)
 
Balance at December 31, 2012
  $ (182,062 )   $ (1,072 )   $ (22,478 )
Charge-offs
          47       1,621  
Valuation (allowance) reversal on loans
    (1,441 )     6       (799 )
Balance at March 31, 2013
  $ (183,503 )   $ (1,019 )   $ (21,656 )
 
(A)
The allowance for credit losses was determined based on the guidance for loans acquired with deteriorated credit quality.
 
17
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(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 March 31, 2013:

   
Subprime Portfolio
       
      I    
II
   
Total
 
Total securitized loans (unpaid principal balance) (A)
  $ 412,344     $ 548,890     $ 961,234  
Loans subject to call option (carrying value)
  $ 299,176     $ 106,939     $ 406,115  
Retained interests (fair value) (B)
  $ 1,437     $     $ 1,437  
 
(A)
Average loan seasoning of 92 months and 74 months for Subprime Portfolios I and II, respectively, at March 31, 2013.
(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 8.35% as of March 31, 2013.
 
Newcastle has no obligation to repurchase any loans from either of its subprime securitizations. Therefore, it is expected that its exposure to loss is limited to the carrying amount of its retained interests in the securitization entities, as described above.  A subsidiary of Newcastle gave limited representations and warranties with respect to Subprime Portfolio II and is required to pay the difference, if any, between the repurchase price of any loan in such portfolio and the price required to be paid by a third party originator for such loan. Such subsidiary, however, has no assets and does not have recourse to the general credit of Newcastle.
 
The following table summarizes certain characteristics of the underlying subprime mortgage loans, and related financing, in the securitizations as of March 31, 2013:

   
Subprime Portfolio
 
      I    
II
 
Loan unpaid principal balance (UPB)
  $ 412,344     $ 548,890  
Weighted average coupon rate of loans
    5.69 %     5.11 %
Delinquencies of 60 or more days (UPB) (A)
  $ 116,551     $ 204,643  
Net credit losses for the three months ended March 31, 2013
  $ 5,947     $ 10,021  
Cumulative net credit losses
  $ 226,364     $ 266,740  
Cumulative net credit losses as a % of original UPB
    15.1 %     24.5 %
Percentage of ARM loans (B)
    50.8 %     64.6 %
Percentage of loans with original loan-to-value ratio >90%
    10.6 %     17.0 %
Percentage of interest-only loans
    20.3 %     4.1 %
Face amount of debt (C)
  $ 407,585     $ 548,890  
Weighted average funding cost of debt (D)
    0.57 %     1.09 %
 
(A)
Delinquencies include loans 60 or more days past due, in foreclosure, under bankruptcy filing or real estate owned.
(B)
ARM loans are adjustable-rate mortgage loans. An option ARM is an adjustable-rate mortgage that provides the borrower with an option to choose from several payment amounts each month for a specified period of the loan term. None of the loans in the subprime portfolios are option ARMs.
(C)
Excludes face amount of $4 million of retained notes for Subprime Portfolio I at March 31, 2013.
(D)
Includes the effect of applicable hedges.
 
Newcastle received negligible cash inflows from the retained interests of Subprime Portfolios I and II during the three months ended March 31, 2013 and 2012.
 
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.
 
18
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
5.   INVESTMENTS IN EXCESS MORTGAGE SERVICING RIGHTS AND CDO SERVICING RIGHTS
 
The following is a summary of Newcastle’s direct investments in Excess MSRs:

         
March 31, 2013
   
Three Months Ended
March 31, 2013
 
   
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
  $ 8,021,789     $ 29,329     $ 35,333       18.0 %     4.8     $ 266  
MSR Pool 1 - Recapture Agreement
          3,676       4,355       18.0 %     11.0       174  
MSR Pool 2
    9,038,057       32,345       33,695       17.3 %     5.0       306  
MSR Pool 2 - Recapture Agreement
          4,108       4,880       17.3 %     12.0       591  
MSR Pool 3
    8,758,689       26,502       30,126       17.6 %     4.7       768  
MSR Pool 3 - Recapture Agreement
          4,598       4,552       17.6 %     11.4       30  
MSR Pool 4
    5,586,851       10,809       11,969       17.9 %     4.6       141  
MSR Pool 4 - Recapture Agreement
          2,763       2,705       17.9 %     11.1       (43 )
MSR Pool 5
    41,917,506       102,718       104,507       17.5 %     4.7       (190 )
MSR Pool 5 - Recapture Agreement
          8,460       4,433       17.5 %     11.7       (185 )
    $ 73,322,892     $ 225,308     $ 236,555       17.6 %     5.4     $ 1,858  
 
(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.
 
The table below summarizes the geographic distribution of the underlying residential mortgage loans of the Excess MSRs at March 31, 2013:

State Concentration
 
Percentage of Total
Outstanding
 
California
    31.7 %
Florida
    10.1 %
New York
    4.4 %
Washington
    4.3 %
Arizona
    3.8 %
Texas
    3.6 %
Colorado
    3.5 %
Maryland
    3.4 %
New Jersey
    3.2 %
Virginia
    3.0 %
Other U.S.
    29.0 %
      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.
 
19
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
CDO Servicing Rights
 
In February 2011, Newcastle, through one of its subsidiaries, purchased the management rights with respect to certain CBASS Investment Management LLC (“C-BASS”) CDOs pursuant to a bankruptcy proceeding for $2.2 million. Newcastle initially recorded the cost of acquiring the collateral management rights as a servicing asset and subsequently amortizes this asset in proportion to, and over the period of, estimated net servicing income. Servicing assets are assessed for impairment on a quarterly basis, with impairment recognized as a valuation allowance. Key economic assumptions used in measuring any potential impairment of the servicing assets include the prepayment speeds of the underlying loans, default rates, loss severities and discount rates. During the three months ended March 31, 2013 and 2012, respectively, Newcastle recorded $0.1 million and $0.1 million of servicing rights amortization and no servicing rights impairment. As of March 31, 2013, Newcastle’s servicing asset had a carrying value of $1.6 million recorded in Receivables and Other Assets.
 
6.  INVESTMENTS IN EQUITY METHOD INVESTEES
 
During the first quarter of 2013, Newcastle entered into investments in joint ventures (“Excess MSR Joint Ventures”) jointly controlled by Newcastle and Fortress-managed funds investing in Excess MSRs.  Newcastle elected to record these investments at fair value pursuant to the fair value option for financial instruments to provide users of the financial statements with better information regarding the effects of prepayment risk and other market factors.
 
The following table summarizes the investments in equity method investees held by Newcastle at March 31, 2013:
 
   
Newcastle’s Investment
   
Newcastle’s
Ownership Percentage
 
             
Excess MSR Joint Ventures
  $ 102,588       50 %
 
Summarized financial information related to Newcastle’s equity-method investees was as follows:
 
   
March 31, 2013
 
Assets (A)
  $ 275,779  
Debt
     
Other Liabilities
    (70,603 )
Equity
  $ 205,176  
Newcastle’s Investment
  $ 102,588  
Ownership
    50.0 %
 
(A)
Includes $20.8 million of deposits related to investments which have not closed at March 31, 2013.
 
   
Three Months
Ended March 31,
2013
 
Interest income
  $ 5,616  
Other income
    (3,154 )
Expenses
    (524 )
Net Income (Loss)
  $ 1,938  
 
20
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
The following is a summary of Newcastle’s Excess MSR investments made through equity method investees:
 
   
March 31, 2013
               
March 31, 2013
 
   
Unpaid
Principal
Balance(A)
   
Investee
 Interest in
 Excess MSR
   
Newcastle Interest
in Investees
   
Amortized
Cost Basis (B)
   
Carrying
Value (C)
   
Weighted Average
Yield
   
Weighted Average
Maturity
(Years) (D)
 
MSR Pool 6
  $ 11,821,572       66.7 %     50.0 %   $ 42,388     $ 41,453       17.4 %     4.9  
MSR Pool 6 - Recapture Agreement
          66.7 %     50.0 %     10,954       10,972       17.4 %     10.7  
MSR Pool 7
    37,234,201       66.7 %     50.0 %     109,420       109,048       15.2 %     5.1  
MSR Pool 7 - Recapture Agreement
          66.7 %     50.0 %     23,296       23,164       15.2 %     12.0  
MSR Pool 8
    17,104,429       66.7 %     50.0 %     58,748       57,177       15.0 %     5.0  
MSR Pool 8 - Recapture Agreement
          66.7 %     50.0 %     13,312       13,150       15.0 %     11.7  
    $ 66,160,202                     $ 258,118     $ 254,964       15.6 %     6.3  
 
(A) Pool 6 unpaid principal balance is as of March 31, 2013. Pools 7 and 8 unpaid balances are as of February 28, 2013.
(B)
Represents the amortized cost basis of the equity method investees in which Newcastle holds a 50% interest. 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.
(C)
Represents the carrying value of the equity method investees in which Newcastle holds a 50% interest. Carrying value represents the fair value of the pools or Recapture Agreements, as applicable.
(D)
The weighted average maturity represents the weighted average expected timing of the receipt of cash flows of each investment.
 
On January 4, 2013, Newcastle, through a joint venture, co-invested in Excess MSRs on a portfolio of Ginnie Mae residential mortgage loans with a UPB of approximately $13 billion as of November 30, 2012.  Nationstar acquired the related servicing rights from Bank of America in November 2012. Newcastle contributed approximately $28.9 million for a 50% interest in a joint venture which acquired an approximately 67% interest in the Excess MSRs on this portfolio. The remaining interests in the joint venture will be owned by a Fortress-managed fund and the remaining interest of approximately 33% in the Excess MSRs will be owned by Nationstar. As the servicer, Nationstar will perform all servicing and advancing functions, and it will retain the ancillary income, servicing obligations and liabilities associated with this portfolio. 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 on a pro rata basis by the joint venture and Nationstar, subject to certain limitations.
 
On January 6, 2013 Newcastle, through a joint venture, agreed to co-invest in Excess MSRs on a portfolio of four pools of residential mortgage loans with a UPB of approximately $215 billion as of November 30, 2012.  Approximately 53% of the loans in this portfolio are in private label securitizations, and the remainder are owned, insured or guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation or the Government National Mortgage Association (“Ginnie Mae”). Nationstar has agreed to acquire the related servicing rights from Bank of America. Newcastle committed to invest approximately $340 million (based on the November 30, 2012 UPB) for a 50% interest in a joint venture which will acquire an approximately 67% interest in the Excess MSRs on this portfolio. As of March 31, 2013, Newcastle had contibuted approximately $80.7 million to the joint ventures. The remaining interests in the joint venture will be owned by a Fortress-managed fund and the remaining interest of approximately 33% in the Excess MSRs will be owned by Nationstar. As the servicer, Nationstar will perform all servicing and advancing functions, and it will retain the ancillary income, servicing obligations and liabilities associated with this portfolio. 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 on a pro rata basis by the joint venture and Nationstar, subject to certain limitations.  On January 31, 2013, Newcastle completed the first closing of this co-investment. The first closing related to Excess MSRs on loans with an aggregate UPB of approximately $58 billion as of December 31, 2012, that are owned, insured, or guaranteed by Fannie Mae or Freddie Mac. There can be no assurance that Newcastle will complete this investment as anticipated or at all.
 
21
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
The table below summarizes the geographic distribution of the underlying residential mortgage loans of the Excess MSR investments made through equity method investees at March 31, 2013:
 
State Concentration
 
Percentage of Total
Outstanding
 
California
    15.2 %
Florida
    7.9 %
New York
    7.6 %
Texas
    5.9 %
New Jersey
    4.8 %
Washington
    3.4 %
Virginia
    3.0 %
Maryland
    2.8 %
Arizona
    2.5 %
Colorado
    2.4 %
Other U.S.
    44.5 %
      100.0 %
 
(A)
Based on the information provided by the loan servicer as of the most recent remittance.
 
22
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
7.  INVESTMENTS IN REAL ESTATE AND INTANGIBLES
 
Newcastle recorded investments in real estate and related intangibles at their estimated fair value at acquisition. 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 assets 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 assets will not be recovered, a provision will be recorded to reduce the carrying basis of the assets to their estimated fair value.  The following table summarizes Newcastle’s investments in real estate:
 
   
March 31, 2013
   
December 31, 2012
 
   
Gross Carrying Amount
   
Accumulated Depreciation
   
Net Carrying Value
   
Gross Carrying Amount
   
Accumulated Depreciation
   
Net Carrying Value
 
Senior Living
                                   
Land
  $ 15,993     $     $ 15,993     $ 15,993     $     $ 15,993  
Buildings
    144,676       (2,254 )     142,422       144,676       (1,349 )     143,327  
Building improvements
    2,492       (221 )     2,271       2,433       (124 )     2,309  
Furniture, fixtures and equipment
    1,325       (236 )     1,089       1,257       (85 )     1,172  
Senior Living Total
  $ 164,486     $ (2,711 )   $ 161,775     $ 164,359     $ (1,558 )   $ 162,801  
                                                 
Other Commercial Real Estate
                                               
Land
  $ 1,106     $     $ 1,106     $ 1,106     $     $ 1,106  
Buildings
    6,588       (1,225 )     5,363       6,588       (1,181 )     5,407  
Building improvements
    951       (680 )     271       826       (667 )     159  
Furniture, fixtures and equipment
                                   
Other Commercial Real Estate Total
  $ 8,645     $ (1,905 )   $ 6,740     $ 8,520     $ (1,848 )   $ 6,672  
 
                                               
Total Investments in Real Estate
  $ 173,131     $ (4,616 )   $ 168,515     $ 172,879     $ (3,406 )   $ 169,473  
 
Intangibles
 
The following table summarizes Newcastle’s intangible assets related to its senior living real estate:
 
   
March 31, 2013
   
December 31, 2012
 
   
Gross Carrying Amount
   
Accumulated Amortization
 
Net Carrying Value
   
Gross Carrying Amount
   
Accumulated Amortization
 
Net Carrying Value
 
In-place resident lease intangibles
  $ 22,711     $ (7,043 )   $ 15,668     $ 22,711     $ (4,205 )   $ 18,506  
Non-compete intangibles
    600       (50 )     550       600       (20 )     580  
Total intangibles
  $ 23,311     $ (7,093 )   $ 16,218     $ 23,311     $ (4,225 )   $ 19,086  

23
 

 


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
8.   DEBT OBLIGATIONS
 
The following table presents certain information regarding Newcastle’s debt obligations and related hedges at March 31, 2013:
 
                                               
Collateral
       
Debt Obligation/Collateral
 
Month Issued
 
Outstanding
Face
Amount
   
Carrying
Value
 
Final Stated Maturity
 
Unhedged Weighted
Average
Funding Cost (A)
 
Weighted Average
Funding
Cost (B)
   
Weighted Average Maturity
(Years)
 
Face
Amount
of Floating Rate
Debt
   
Outstanding Face Amount (C)
   
Amortized
Cost Basis (C)
   
Carrying
Value (C)
   
Weighted Average Maturity
(Years)
   
Floating Rate Face Amount (C)
   
Aggregate
Notional
Amount of
Current Hedges (D)
 
CDO Bonds Payable
                                                                               
CDO IV (E)
 
Mar 2004
  $ 71,604     $ 71,537  
Mar 2039
    1.93 %       5.08 %     1.2     $ 60,804     $ 153,780     $ 141,221     $ 140,589       1.6     $ 42,747     $ 60,804  
CDO VI (E)
 
Apr 2005
    91,688       91,689  
Apr 2040
    0.86 %       5.35 %     4.5       88,554       177,513       91,701       119,428       2.8       48,073       88,554  
CDO VIII
 
Nov 2006
    478,289       477,447  
Nov 2052
    0.80 %       2.36 %     1.7       470,689       672,349       489,664       522,209       2.3       349,172       154,100  
CDO IX
 
May 2007
    373,412       374,887  
May 2052
    0.60 %       0.60 %     1.4       373,412       613,694       491,396       503,618       2.6       299,787        
          1,014,993       1,015,560                   2.17 %     1.8       993,459       1,617,336       1,213,982       1,285,844       2.4       739,779       303,458  
Other Bonds and Notes Payable
                                                                                                       
MH Loans Portfolio I (F)
 
Apr 2010
    65,995       62,276  
Jul 2035
    6.31 %       6.31 %     4.1             114,355       96,752       96,752       6.3       851        
MH Loans Portfolio II
 
May 2011
    112,046       111,447  
Dec 2033
    4.47 %       4.47 %     3.9             146,865       144,274       144,274       5.5       24,374        
          178,041       173,723                   5.13 %     4.0             261,220       241,026       241,026       5.9       25,225        
Repurchase Agreements (G)
                                                                                                       
Non-Agency RMBS (H)
 
Various
    158,029       158,029  
 Apr 2013
 
LIBOR+2.00%
    2.20 %     0.1       158,029       330,871       208,446       233,813       6.8       330,871        
FNMA/FHLMC securities (I)
 
Various
    1,315,557       1,315,557  
 Apr 2013
    0.44 %       0.44 %     0.1       1,315,557       1,309,855       1,396,401       1,400,430       4.1       1,309,855        
          1,473,586       1,473,586                   0.63 %     0.1       1,473,586       1,640,726       1,604,847       1,634,243       4.7       1,640,726        
Mortgage Notes Payable
                                                                                                       
BPM Senior Living Facilities
 
Jul 2012
    88,400       88,400  
Aug 2019
    3.44 %       3.44 %     6.0       23,400       N/A       135,251       135,251       N/A             23,400  
Utah Senior Living Facilities
 
Nov 2012
    16,000       16,000  
Oct 2017
 
LIBOR+3.75%
(J)
 
    4.75 %     4.5       16,000       N/A       21,706       21,706       N/A              
Courtyards Senior living facilities
 
Dec 2012
    16,125       16,125  
Oct 2017
 
LIBOR+3.75%
(J)
 
    4.75 %     4.5       16,125       N/A       21,036       21,036       N/A              
          120,525       120,525                   3.79 %     5.6       55,525       N/A       177,993       177,993       N/A             23,400  
Corporate
                                                                                                       
Junior subordinated notes payable
 
Mar 2006
    51,004       51,242  
Apr 2035
    7.574 % (L)       7.40 %     22.1                                            
          51,004       51,242                   7.40 %     22.1                                            
Subtotal debt obligations
        2,838,149       2,834,636                   1.71 %     1.6     $ 2,522,570     $ 3,519,282     $ 3,237,848     $ 3,339,106       3.7     $ 2,405,730     $ 326,858  
Financing on subprime mortgage loans subject to call option
 
(K)
    406,217       406,115                                                                                      
Total debt obligations
      $ 3,244,366     $ 3,240,751                                                                                      
 
(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 $60.8 million and $88.6 million notional amount of interest rate swap agreements in CDO IV and CDO VI, respectively, which were economic hedges not designated as hedges for accounting purposes.
(E)
These CDOs were not in compliance with its applicable over collateralization tests as of March 31, 2013. Newcastle is not receiving cash flows from these CDOs (other than senior management fees and cash flows on senior classes of bonds that were repurchased), since net interest is being used to repay debt, and expects these CDOs to remain out of compliance for the foreseeable future.
(F)
Excluding $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)
These repurchase agreements had $0.1 million of associated accrued interest payable at March 31, 2013. $1.5 billion face amount of these repurchase agreements were renewed subsequent to March 31, 2013.
(H)
The counterparty of these repurchase agreements is Credit Suisse.
(I)
The counterparties on these repurchase agreements are Bank of America ($291.4 million), Barclays ($267.2 million), Citi ($118.8 million), Goldman Sachs ($343.8 million), Morgan Stanley ($56.2 million) and Nomura ($238.2 million). Interest rates on these repurchase agreements are fixed, but will be reset on a short-term basis.
(J)
These financings have a LIBOR floor of 1%.
(K)
Issued in April 2006 and July 2007.  See Note 4 regarding the securitizations of Subprime Portfolios I and II.
(L)
LIBOR + 2.25% after April 2016.
 
24
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(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 March 31, 2013, CDOs IV and VI were not in compliance with their over collateralization tests.
 
In the first three months of 2013, Newcastle repurchased $10.9 million face amount of CDO bonds payable for $9.7 million. As a result, Newcastle extinguished $10.9 million face amount of CDO bonds payable and recorded a gain on extinguishment of debt of $1.2 million.
 
Newcastle’s non-CDO financings contain various customary loan covenants. Newcastle was in compliance with all of the covenants in its non-CDO financings as of March 31, 2013.
 
25
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
9.  FAIR VALUE
 
Fair Value Summary Table
 
The carrying values and fair values of Newcastle’s assets and liabilities at March 31, 2013 were as follows:

   
Principal
                 
Weighted
   
Weighted
 
   
Balance or
                 
Average
   
Average
 
   
Notional
   
Carrying
   
Estimated
     
Yield/Funding
   
Maturity
 
   
Amount
   
Value
   
Fair Value
 
Fair Value Method (A)
 
Cost
   
(Years)
 
Assets
                               
Financial instruments:
                               
Real estate securities, available-for-sale*
  $ 2,946,191     $ 2,495,473     $ 2,495,473  
Broker quotations, counterparty quotations,  pricing services,  pricing models
    3.92 %     4.7  
Real estate related loans, held-for-sale, net
    1,251,678       851,525       867,777  
 Broker quotations, counterparty quotations, pricing services,  pricing models
    11.56 %     1.6  
Residential mortgage loans, held-for-investment, net
    374,264       317,708       324,554  
 Pricing models
    8.58 %     5.6  
Residential mortgage loans, held-for-sale, net
    3,451       2,380       2,380  
 Pricing models
    18.86 %     4.7  
Investments in excess mortgage servicing rights at fair value* (B)
    73,322,892       236,555       236,555  
 Pricing models
    17.60 %     5.4  
Investments in equity method investees at fair value* (B)
    66,160,202       102,588       102,588  
 Pricing models
    15.56 %     6.3  
Investments in real estate and intangibles, net
            184,733       194,878  
 Broker quotations, recent purchase price
               
Subprime mortgage loans subject to call option (C)
    406,217       406,115       406,115  
 (C)
    9.09 %  
(C)
 
Restricted cash*
    11,494       11,494       11,494                    
Cash and cash equivalents*
    534,772       534,772       534,772                    
Non-hedge derivative assets (D)(E)*
    23,400       176       176  
 Counterparty quotations
    N/A    
(D)
 
Other investments
            24,907       13,165  
 Pricing models
               
Receivables and other assets
            27,577       27,577                    
            $ 5,196,003     $ 5,217,504                    
                                           
Liabilities
                                         
Financial instruments:
                                         
CDO bonds payable (G)
  $ 1,014,993     $ 1,015,560     $ 791,641  
 Pricing models
    2.17 %     1.8  
Other bonds and notes payable
    178,041       173,723       180,638  
 Broker quotations, pricing models
    5.13 %     4.0  
Repurchase agreements
    1,473,586       1,473,586       1,473,586  
 Market comparables
    0.63 %     0.1  
Mortgage notes payable
    120,525       120,525       120,525  
 Pricing models
    3.79 %     5.6  
Financing of subprime mortgage loans subject to call option (C)
    406,217       406,115       406,115  
 (C)
    9.09 %  
(C)
 
Junior subordinated notes payable
    51,004       51,242       32,840  
 Pricing models
    7.40 %     22.1  
Interest rate swaps, treated as hedges (E)(F)*
    154,100       10,331       10,331  
 Counterparty quotations
    N/A    
(F)
 
Non-hedge derivatives (D)(E)*
    281,869       16,281       16,281  
 Counterparty quotations
    N/A    
(D)
 
Due to affiliates
            4,611       4,611                    
Dividends payable, accrued expenses and other liabilities
            74,530       74,530                    
            $ 3,346,504     $ 3,111,098                    
 
*Measured at fair value on a recurring basis.
 
26
 

 


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(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)
The notional amount represents the total unpaid principal balance of the mortgage loans. Newcastle does not receive an excess mortgage servicing amount on nonperforming loans for Agency portfolios. The weighted average yield and maturity for the investments in equity method investees represents the yield and maturity of the underlying investments in Excess MSRs.
 
(C)
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.
 
(D)
This represents two interest rate swap agreements with a total notional balance of $281.9 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 March 31, 2013.
 
(E) 
Newcastle’s derivatives fall into two categories. As of March 31, 2013, all derivative liabilities were held within Newcastle’s nonrecourse structures. An aggregate notional balance of $436.0 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. A notional balance of $23.4 million was an asset at period end and therefore is 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) 
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
  $ 154,100       5.04 %   $ (10,331 )
 
(G)
Newcastle notes that the unrealized gain on the liabilities within such structures cannot be fully realized.
 
(H)
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 nonrecourse financing structures is equal to the present value of their expected future net cash flows.
 
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.
 
Newcastle has various processes and controls in place to ensure that fair value is reasonably estimated.  With respect to the broker and pricing service quotations, to ensure these quotes represent a reasonable estimate of fair value, Newcastle’s quarterly procedures include a comparison to the outputs generated from its internal pricing models and transactions
 
27
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
Newcastle has completed with respect to these or similar securities, as well as on its knowledge and experience of these markets. With respect to fair value estimates generated based on Newcastle’s internal pricing models, Newcastle’s management validates the inputs and outputs of the internal pricing models by comparing them to available independent third party market parameters and models for reasonableness. Newcastle believes its valuation methods and the assumptions used are appropriate and consistent with other market participants.
 
For Excess MSRs acquired prior to the current quarter, we obtain a fairness opinion related to the valuation of our Excess MSRs on the existing mortgage pools from an independent valuation firm at the current quarter end date.  For Excess MSRs acquired during the current quarter, we obtain a fairness opinion related to the valuation of our Excess MSRs on the existing mortgage pools at the time of acquisition.  To date, we have not made any significant valuation adjustments as a result of these third party opinions.   
 
Fair value measurements categorized within Level 3 are sensitive to changes in the assumptions or methodology used to determine fair value and such changes could result in a significant increase or decrease in the fair value. For Newcastle’s investments in real estate securities, real estate related loans and residential mortgage loans categorized within Level 3 of the fair value hierarchy, the significant unobservable inputs include the discount rates, assumptions relating to prepayments, default rates and loss severities.  Significant increases (decreases) in any of the discount rates, default rates or loss severities in isolation would result in a significantly lower (higher) fair value measurement.  The impact of changes in prepayment speeds would have differing impacts on fair value, depending on the seniority of the investment. Generally, a change in the default assumption is generally accompanied by directionally similar changes in the assumptions used for the loss severity and the prepayment speed.  For Newcastle’s investments in Excess MSRs, significant unobservable inputs include the discount rate, assumptions relating to prepayments, delinquency rates, recapture rates and excess mortgage servicing amount.  Significant increases (decreases) in the discount rates, prepayments or delinquency rates in isolation would result in a significantly lower (higher) fair value measurement, whereas significant increases (decreases) in the recapture rates or excess mortgage servicing amount in isolation would result in a significantly higher (lower) fair value measurement.  Generally, a change in the delinquency rate assumption is accompanied by directionally similar changes in the assumptions used for the prepayment speed.
 
The following table summarizes such financial assets and liabilities measured at fair value on a recurring basis at March 31, 2013:
 
               
Fair Value
 
   
Principal Balance or
Notional Amount
   
Carrying Value
   
Level 2
   
Level 3A
   
Level 3B
   
Total
 
Assets:
                                   
  Real estate securities, available-for-sale:
                                   
     CMBS
  $ 468,584     $ 384,017     $     $ 327,173     $ 56,844     $ 384,017  
     REIT debt
    50,700       54,119       54,119                   54,119  
     Non-Agency RMBS
    904,784       583,900             559,703       24,197       583,900  
     ABS - other real estate
    10,036       1,384             746       638       1,384  
     FNMA / FHLMC
    1,309,855       1,400,428       1,400,428                   1,400,428  
     CDO
    202,232       71,625             66,371       5,254       71,625  
     Real estate securities total
  $ 2,946,191     $ 2,495,473     $ 1,454,547     $ 953,993     $ 86,933     $ 2,495,473  
     Investments in Excess MSRs (1)
  $ 73,322,892     $ 236,555     $     $     $ 236,555     $ 236,555  
     Investments in equity method investees (1)
  $ 66,160,202     $ 102,588     $     $     $ 102,588     $ 102,588  
Derivative assets:
                                               
   Interest rate caps, not treated as hedges
    23,400       176       176                   176  
          Derivative assets total
  $ 23,400     $ 176     $ 176     $     $     $ 176  
                                                 
Liabilities:
                                               
  Derivative Liabilities:
                                               
     Interest rate swaps, treated as hedges
  $ 154,100     $ 10,331     $ 10,331     $     $     $ 10,331  
     Interest rate swaps, not treated as hedges
    281,869       16,281       16,281                   16,281  
          Derivative liabilities total
  $ 435,969     $ 26,612     $ 26,612     $     $     $ 26,612  
 
(1)
The notional amount represents the total unpaid principal balance of the mortgage loans.  Newcastle does not receive an excess mortgage servicing amount on nonperforming loans for Agency portfolios.
 
28
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
Newcastle’s investments in instruments (excluding the Excess MSRs and investment in equity method investees, see below) measured at fair value on a recurring basis using Level 3 inputs changed during the three months ended March 31, 2013 as follows:
 
   
Level 3A
 
   
CMBS
 
ABS
           
   
Conduit
   
Other
   
Non-Agency RMBS
 
Other
   
Equity/Other
Securities
 
Total
 
Balance at December 31, 2012
  $ 225,575     $ 104,451     $ 330,021     $ 798     $ 65,027     $ 725,872  
Transfers (A)
                                               
Transfers from Level 3B
                1,861                   1,861  
Transfers into Level 3B
          (8,257 )                       (8,257 )
Total gains (losses) (B)
                                               
Included in net income (C)
                                   
Included in other comprehensive income (loss)
    8,544       1,347       14,166       (25 )     1,334       25,366  
Amortization included in interest income
    2,055       161       5,622             998       8,836  
Purchases, sales and repayments
                                               
Purchases
                227,293                   227,293  
Proceeds from sales
                                   
Proceeds from repayments
    (3,219 )     (3,484 )     (19,260 )     (27 )     (988 )     (26,978 )
Balance at March 31, 2013
  $ 232,955     $ 94,218     $ 559,703     $ 746     $ 66,371     $ 953,993  
                                                 
   
Level 3B
 
   
CMBS
 
ABS
               
   
Conduit
   
Other
   
Non-Agency RMBS
 
Other
   
Equity/Other
Securities
 
Total
 
Balance at December 31, 2012
  $ 29,194     $ 17,171     $ 25,954     $ 677     $ 5,998     $ 78,994  
Transfers (A)
                                               
Transfers from Level 3A
          8,257                         8,257  
Transfers into Level 3A
                (1,861 )                 (1,861 )
Total gains (losses) (B)
                                               
Included in net income (C)
    (539 )                             (539 )
Included in other comprehensive income (loss)
    1,271       1,338       (349 )     (9 )     57       2,308  
Amortization included in interest income
    1,120       119       1,435       256       232       3,162  
Purchases, sales and repayments
                                               
Purchases
                                   
Proceeds from sales
                                   
Proceeds from repayments
    (1,087 )           (982 )     (286 )     (1,033 )     (3,388 )
Balance at March 31, 2013
  $ 29,959     $ 26,885     $ 24,197     $ 638     $ 5,254     $ 86,933  
 
(A)
Transfers are assumed to occur at the beginning of the quarter.
(B)
None of the gains (losses) recorded in earnings during the period is attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting date.
(C)
These gains (losses) are recorded in the following line items in the consolidated statements of income:
 
   
Three Months Ended March 31, 2013
 
   
Level 3A
   
Level 3B
 
Gain (loss) on settlement of investments, net
  $     $  
Other income (loss), net
           
OTTI
          (539 )
Total
  $     $ (539 )
Gain (loss) on settlement of investments, net, from investments transferred into Level 3 during the period
  $     $  
 
29
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
Securities Valuation
 
As of March 31, 2013, 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
  $ 468,584     $ 332,092     $ 269,126     $ 58,047     $ 56,844     $ 384,017  
REIT debt
    50,700       50,055       28,321       25,798             54,119  
Non-Agency RMBS
    904,784       535,908       531,929       27,774       24,197       583,900  
ABS - other real estate
    10,036       1,490             746       638       1,384  
FNMA / FHLMC
    1,309,855       1,396,400       1,310,147       90,281             1,400,428  
CDO
    202,232       66,747             66,371       5,254       71,625  
Total
  $ 2,946,191     $ 2,382,692     $ 2,139,523     $ 269,017     $ 86,933     $ 2,495,473  
 
(A)
Net of incurred losses
(B)
Net of discounts (or gross of premiums) and after OTTI, including impairment taken during the period ended March 31, 2013.
(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
   
Weighted Average Significant Input
 
   
Amortized
         
Recorded
   
Gains (Losses)
               
Cumulative
       
   
Cost
         
In Current
   
in Accumulated
   
Discount
   
Prepayment
   
Default
   
Loss
 
   
Basis (B)
   
Fair Value
   
Period
   
OCI
   
Rate
   
Speed (F)
   
Rate
   
Severity
 
CMBS - Conduit
  $ 23,143     $ 29,959     $ 539     $ 6,816       10.0 %     N/A       21.8 %     38.7 %
CMBS - Large loan /single borrower
    26,367       26,885             518       2.5 %     N/A       31.3 %     31.3 %
Non-Agency RMBS
    12,481       24,197             11,716       8.0 %     2.8 %     19.9 %     43.0 %
ABS - other RE
    424       638             214       8.0 %     0.5 %     44.1 %     99.7 %
CDO
    3,179       5,254             2,075       19.8 %     5.0 %     8.2 %     73.0 %
Total
    65,594       86,933       539       21,339                                  
 
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.
 
30
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(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 March 31, 2013:

                     
Valuation
   
Significant Input
 
   
Outstanding
               
Allowance/
   
Range
   
Weighted Average
 
   
Face
   
Carrying
   
Fair
   
(Reversal) In
   
Discount
   
Loss
   
Discount
   
Loss
 
Loan Type
 
Amount
   
Value
   
Value
   
Current Year
   
Rate
   
Severity
   
Rate
   
Severity
 
Mezzanine
  $ 518,307     $ 432,432     $ 445,343     $ (838 )     3.5% - 25.0%       0.0% - 100.0%       9.1%       10.9%      
Bank Loan
    582,474       277,831       277,830       2,285       6.7% - 41.7%       0.0% - 100.0%       16.7%       45.6%  
B-Note
    120,872       111,237       114,437       (6 )     6.0% - 15.0%       0.0%       10.4%       0.0%  
Whole Loan
    30,025       30,025       30,167             4.8% - 6.9%       0.0% - 15.0%       4.8%       14.5%  
Total Real Estate Related
   Loans Held-for-Sale, Net
  $ 1,251,678     $ 851,525     $ 867,777     $ 1,441                                  
                                                                 
                           
Valuation
                                 
   
Outstanding
                   
Allowance/
   
Significant Input (Weighted Average)
 
   
Face
   
Carrying
   
Fair
   
(Reversal) In
   
Discount
   
Prepayment
   
Constant
   
Loss
 
Loan Type
 
Amount
   
Value
   
Value
   
Current Year
   
Rate
   
Speed
   
Default Rate
   
Severity
 
Non-securitized Manufactured
Housing Loans Portfolio I
  $ 569     $ 153     $ 153     $ (3 )     68.2     5.0     11.6     70.0
Non-securitized Manufactured
Housing Loans Portfolio II
    2,882       2,227       2,227       (3 )     15.5     5.0     3.5     75.0
Total Residential Mortgage
Loans Held-for-Sale, Net
  $ 3,451     $ 2,380     $ 2,380     $ (6 )                                
 
Loans which Newcastle has the intent and ability to hold into the foreseeable future are classified as held-for-investment. Loans held-for-investment are carried at the aggregate unpaid principal balance adjusted for any unamortized premium or discount, deferred fees or expenses, an allowance for loan losses, charge-offs and write-downs for impaired loans.
 
The following table summarizes certain information for residential mortgage loans held-for-investment as of March 31, 2013:
 
                           
Significant Input (Weighted Average)
 
Loan Type
 
Outstanding Face Amount
   
Carrying Value
   
Fair Value
   
Valuation Allowance/
(Reversal) In Current Year
   
Discount Rate
   
Prepayment Speed
   
Constant Default Rate
   
Loss Severity
 
Securitized Manufactured Housing
   Loans Portfolio I
  $ 114,355     $ 96,752     $ 97,192     $ 13       9.5 %     5.0 %     4.0 %     70.0 %
Securitized Manufactured Housing
   Loans Portfolio II
    146,865       144,274       143,048       835       7.5 %     5.0 %     3.5 %     75.0 %
Residential Loans
    54,458       41,198       47,134       (49 )     7.4 %     4.7 %     2.8 %     46.5 %
Reverse Mortgage Loans
    58,586       35,484       37,180             10.6 %     N/A       N/A       N/A  
Total Residential Mortgage Loans, Held-for-Investment, Net
  $ 374,264     $ 317,708     $ 324,554     $ 799                                  
 
31
 

 


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(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 owned directly and through equity method investees as of March 31, 2013:
 
   
Significant Input
 
Held Directly (Note 5)
 
Prepayment Speed (A)
   
Delinquency
(B)
   
Recapture Rate (C)
 
Excess Mortgage
Servicing Amount
(D)
 
Discount Rate
 
MSR Pool 1
    16.1 %     10.0 %     35.0 %
28 bps
    18.0 %
MSR Pool 1 - Recapture Agreement
    8.0 %     10.0 %     35.0 %
21 bps
    18.0 %
MSR Pool 2
    16.0 %     11.0 %     35.0 %
23 bps
    17.3 %
MSR Pool 2 - Recapture Agreement
    8.0 %     10.0 %     35.0 %
21 bps
    17.3 %
MSR Pool 3
    16.2 %     12.1 %     35.0 %
23 bps
    17.6 %
MSR Pool 3 - Recapture Agreement
    8.0 %     10.0 %     35.0 %
21 bps
    17.6 %
MSR Pool 4
    18.3 %     15.8 %     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)         20.0 %
13 bps
    17.5 %
MSR Pool 5 - Recapture Agreement
    8.0 %     N/A(E)         20.0 %
 21 bps
    17.5 %
Held through Equity Method Investees (Note 6)
                           
MSR Pool 6
    19.6 %     8.8 %     35.0 %
25 bps
    17.4 %
MSR Pool 6 - Recapture Agreement
    10.0 %     6.0 %     35.0 %
23 bps
    17.4 %
MSR Pool 7
    13.8 %     8.4 %     35.0 %
16 bps
    15.2 %
MSR Pool 7 - Recapture Agreement
    10.0 %     5.0 %     35.0 %
19 bps
    15.2 %
MSR Pool 8
    15.2 %     7.4 %     35.0 %
19 bps
    15.0 %
MSR Pool 8 - Recapture Agreement
    10.0 %     5.0 %     35.0 %
19 bps
    15.0 %
 
(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”). Management considers collateral-specific prepayment experience when determining this vector. For the Recapture Agreements and recaptured loans, Newcastle also considers industry research on the prepayment experience of similar loan pools (i.e., loan pools composed of refinanced loans). This data is obtained from remittance reports, market data services and other market sources.
 
Delinquency rates are based on the pool-specific experience of loans that missed their latest mortgage payments. For the Recapture Agreements and recaptured loans, delinquency rates are based on the experience of similar loan pools originated by Nationstar and delinquency experience over the past year. Management believes this time period provides a reasonable sample for projecting future delinquency rates while taking into account current market conditions. Additional consideration is given to loans that are expected to become 30 or more days delinquent.
 
32
 

 


NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
Recapture rates are based on actual average recapture rates experienced by Nationstar on similar mortgage loan pools. Generally, Newcastle looks to one year worth of actual recapture rates, which management believes provides a reasonable sample for projecting future recapture rates while taking into account current market conditions.
 
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 originated by Nationstar over the past year and other general market considerations. Management believes this time period provides a reasonable sample for projecting future excess mortgage servicing amounts while taking into account current market conditions.
 
The discount rates Newcastle uses are derived from a range of observable pricing on mortgage servicing rights backed by similar collateral.
 
Newcastle uses different prepayment and delinquency assumptions in valuing the Excess MSRs relating to the original loan pools, the Recapture Agreements and the Excess MSRs relating to recaptured loans. The prepayment speed and delinquency rate assumptions differ because of differences in the collateral characteristics, eligibility for the Home Affordable Refinance Program 2.0 (“HARP 2.0”) and expected borrower behavior for original loans and loans which have been refinanced. Newcastle uses the same assumptions for recapture and discount rates when valuing Excess MSRs and Recapture Agreement. These assumptions are based on historical recapture experience and market pricing.
 
Newcastle’s MSRs investments measured at fair value on a recurring basis using Level 3B inputs changed during the period ended March 31, 2013 as follows:
 
   
Level 3B (A)
 
   
MSR Pool 1
   
MSR Pool 2
   
MSR Pool 3
   
MSR Pool 4
   
MSR Pool 5
   
Total
 
Balance at December 31, 2012
  $ 40,910     $ 39,322     $ 35,434     $ 15,036     $ 114,334     $ 245,036  
Transfers (B)
                                               
Transfers from Level 3A
                                   
Transfers into Level 3A
                                   
Gains (losses) included in net income (C)
    440       897       798       98       (375 )     1,858  
Interest income
    1,970       1,485       1,628       601       4,340       10,024  
Purchases, sales and repayments
                                               
Purchases
                                   
Purchase adjustments
                                   
Proceeds from sales
                                   
Proceeds from repayments
    (3,632 )     (3,129 )     (3,182 )     (1,061 )     (9,359 )     (20,363 )
Balance at March 31, 2013
  $ 39,688     $ 38,575     $ 34,678     $ 14,674     $ 108,940     $ 236,555  
 
(A)
Includes the recapture agreement for each respective pool.
(B)
Transfers are assumed to occur at the beginning of the quarter.
(C)
The gains (losses) recorded in earnings during the period are attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting dates. These gains(losses) are recorded in “Other Income (Loss)” in the consolidated statement of income.
 
Equity Method Investees Valuation
 
Fair value estimates of Newcastle’s investments were based on internal pricing models.  Newcastle estimated the fair value of the assets and liabilities of the underlying entities in which it holds an equity interest.  The valuation technique is based on discounted cash flows.  Significant inputs represent the inputs required to estimate the fair value of the Excess MSRs held by the entities and 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.  Refer to the Excess MSRs Valuation section above for further details.
 
33
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
Newcastle’s investments in equity method investees measured at fair value on a recurring basis using Level 3B inputs changed during the period ended March 31, 2013 as follows:
 
       
   
Three Months
Ended March 31,
2013
 
Balance at December 31, 2012
  $  
Contributions to equity method investees
    109,588  
Distributions of earnings from equity method investees
    (1,344 )
Distributions of capital from equity method investees
    (6,625 )
Change in fair value of investments in equity method investees
    969  
Balance at March 31, 2013
  $ 102,588  
 
Derivatives
 
Newcastle’s derivative instruments are valued using counterparty quotations. These quotations are generally based on valuation models with model inputs that can generally be verified and which do not involve significant judgment. The significant observable inputs used in determining the fair value of our Level 2 derivative contracts are contractual cash flows and market based interest rate curves. Newcastle’s derivatives are recorded on its balance sheet as follows:
 
     
Fair Value
 
     
March 31,
   
December 31,
 
 
Balance sheet location
 
2013
   
2012
 
Derivative Assets
             
Interest rate caps, not designated as hedges
Derivative Assets
    176       165  
      $ 176     $ 165  
Derivative Liabilities
                 
Interest rate swaps, designated as hedges
Derivative Liabilities
  $ 10,331     $ 12,175  
Interest rate swaps, not designated as hedges
Derivative Liabilities
    16,281       19,401  
      $ 26,612     $ 31,576  
 
34
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
The following table summarizes information related to derivatives:
 
   
March 31, 2013
   
December 31, 2012
 
Cash flow hedges
           
Notional amount of interest rate swap agreements
  $ 154,100     $ 154,450  
Amount of (loss) recognized in OCI on effective portion
    (10,207 )     (12,050 )
Deferred hedge gain (loss) related to anticipated financings, which have subsequently occurred, net of amortization
    221       237  
Deferred hedge gain (loss) related to dedesignation, net of amortization
    (195 )     (210 )
Expected reclassification of deferred hedges from AOCI into earnings over the next 12 months
    5       4  
                 
Expected reclassification of current hedges from AOCI into earnings over the next 12 months
    (6,181 )     (6,259 )
                 
Non-hedge Derivatives
               
Notional amount of interest rate swap agreements
    281,869       294,203  
Notional amount of interest rate cap agreements
    23,400       23,400  
 
The following table summarizes gains (losses) recorded in relation to derivatives:
 
     
Three Months Ended
March 31,
 
 
Income statement location
 
2013
   
2012
 
Cash flow hedges
             
   Gain (loss) on the ineffective portion
Other income (loss)
  $     $ 30  
   Gain (loss) immediately recognized at dedesignation
Gain (loss) on sale of investments;
Other income (loss)
          (276 )
   Amount of gain (loss) reclassified from AOCI into
                 
      income, related to effective portion
Interest expense
    (1,865 )     (10,646 )
   Deferred hedge gain reclassified from AOCI into income,
                 
      related to anticipated financings
Interest expense
    16       15  
   Deferred hedge gain (loss) reclassified from AOCI into
                 
      income, related to effective portion of dedesignated hedges
Interest expense
    (16 )     442  
Non-hedge derivatives gain (loss)
Other income (loss)
    3,126       2,056  
 
35
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
Liabilities for Which Fair Value is Only Disclosed
 
The following table summarizes the level of the fair value hierarchy, valuation techniques and inputs used for estimating each class of liabilities not measured at fair value in the statement of financial position but for which fair value is disclosed:
 
Type of Liabilities Not Measured At Fair Value for Which Fair Value Is Disclosed
 
Fair Value Hierarchy
Valuation Techniques and Significant Inputs
CDO bonds payable
 
Level 3
Valuation technique is based on discounted cash flow.
 
Significant inputs include:
●     Underlying security and loan prepayment, default and cumulative loss expectations
●     Amount and timing of expected future cash flows
●     Market yields and credit spreads implied by comparisons to transactions of similar  tranches of CDO debt by the varying levels of subordination
Other bonds and notes payable
 
 
Level 3
Valuation technique is based on discounted cash flow.
 
Significant inputs include:
●      Amount and timing of expected future cash flows
●      Interest rates
●      Broker quotations
●      Market yields and credit spreads implied by comparisons to transactions of similar  tranches of securitized debt by the varying levels of subordination
Repurchase agreements
 
Level 2
Valuation technique is based on market comparables.
 
Significant variables include:
●      Amount and timing of expected future cash flows
●      Interest rates
●      Collateral funding spreads
Mortgage notes payable
 
 
 
Level 3
Valuation technique is based on discounted cash flows.
 
Significant inputs include:
●      Amount and timing of expected future cash flows
●      Interest rates
●     Collateral funding spreads
Junior subordinated notes payable
 
Level 3
Valuation technique is based on discounted cash flow.
 
Significant inputs include:
●      Amount and timing of expected future cash flows
●      Interest rates
●      Market yields and the credit spread of Newcastle
 
10.  EQUITY AND EARNINGS PER SHARE
 
Newcastle is required to present both basic and diluted earnings per share (“EPS”).  Basic EPS is calculated by dividing net income available for common stockholders by the weighted average number of shares of common stock outstanding during each period.  Diluted EPS is calculated by dividing net income available for common stockholders by the weighted average number of shares of common stock outstanding plus the additional dilutive effect of common stock equivalents during each period.  Newcastle’s common stock equivalents are its outstanding stock options.  During the three months ended March 31, 2013 and 2012, based on the treasury stock method, Newcastle had 4,942,388 and 489,093 dilutive common stock equivalents, respectively, resulting from its outstanding options. Net income available for common stockholders is equal to net income less preferred dividends.
 
36
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
In January 2013, Newcastle issued 57,500,000 shares of its common stock in a public offering at a price to the public of $9.35 per share for net proceeds of approximately $526.2 million. Certain principals of Fortress participated in this offering and purchased an aggregate of 213,900 shares at a price of $9.35 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 5,750,000 shares of Newcastle’s common stock at a price of $9.35, which had a fair value of approximately $18.0 million as of the grant date.  The assumptions used in valuing the options were: a 2.0% risk-free rate, a 8.8% dividend yield, 56.2% volatility and a 10 year term.
 
In February 2013, Newcastle issued 23,000,000 shares of its common stock in a public offering at a price to the underwriters of $10.34 per share for net proceeds of approximately $237.4 million. Certain principals of Fortress participated in this offering and purchased an aggregate of 191,000 shares at a price of $10.48 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 2,300,000 shares of Newcastle’s common stock at a price of $10.48, which had a fair value of approximately $8.4 million as of the grant date.  The assumptions used in valuing the options were: a 2.1% risk-free rate, a 7.8% dividend yield, 55.5% volatility and a 10 year term.
 
As of March 31, 2013, Newcastle’s outstanding options were summarized as follows:
 
Held by the Manager
    17,735,338  
Issued to the Manager and subsequently transferred to certain of the Managers employees
    3,711,937  
Issued to the independent directors
    10,000  
Total
    21,457,275  
 
11.  COMMITMENTS AND CONTINGENCIES
 
Litigation  — Newcastle is, from time to time, a defendant in legal actions from transactions conducted in the ordinary course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such actions, individually and in the aggregate, that existed at March 31, 2013, if any, will not materially affect Newcastle’s consolidated results of operations or financial position.
 
Capital Commitments — As of March 31, 2013, Newcastle had outstanding capital commitments related to investments in joint ventures in connection with the acquisition of Excess MSRs and consumer loans.  See Notes 6 and 15, respectively for a description of these commitments.
 
As of March 31, 2013, Newcastle had committed to purchase approximately $48.8 million face amount of real estate related loans for approximately $17.1 million, but had not yet settled this purchase as of March 31, 2013.
 
12.  GAIN (LOSSES) ON SETTLEMENT OF INVESTMENTS, NET AND OTHER INCOME (LOSS), NET
 
These items are comprised of the following:
 
   
Three Months Ended
 March 31,
 
   
2013
   
2012
 
   Gain (loss) on settlement of investments, net
           
   Gain on settlement of real estate securities
  $     $ 6,772  
   Loss on settlement of real estate securities
          (335 )
   Loss on repayment/disposition of loans held-for-sale
          (1,614 )
   Loss on disposal of long-lived assets
    (3 )      
    $ (3 )   $ 4,823  
   Other income (loss), net
               
   Gain (loss) on non-hedge derivative instruments
  $ 3,126     $ 2,056  
   Unrealized (loss) recognized at de-designation of hedges
          (276 )
   Hedge ineffectiveness
          30  
   Collateral management fee income, net
    352       513  
   Other income (loss)
    1,089       647  
    $ 4,567     $ 2,970  
 
37
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
13.  RECLASSIFICATION FROM ACCUMULATED OTHER COMPREHENSIVE INCOME INTO NET INCOME
 
The following table summarizes the amounts reclassified out of accumulated other comprehensive income into net income:
 
Accumulated Other Comprehensive
 
Income Statement
 
Three Months Ended
 
Income Components
 
Location
 
March 31, 2013
 
Net realized gain (loss) on securities
         
Impairment
 
Other-than-temporary impairment on securities, net of portion of other-than-temporary impairment on securities recognized in other compprehensive income
  $ (539 )
Gain on settlement of real estate securities
 
Gain (loss) on settlement of investments, net
     
Loss on settlement of real estate securities
 
Gain (loss) on settlement of investments, net
     
        $ (539 )
             
Net realized gain (loss) on derivatives designated as cash flow hedges
       
Gain (loss) recognized upon de-designation
 
Other income (loss)
  $  
Hedge ineffectiveness
 
Other income (loss)
     
Amortization of deferred gain (loss)
 
Interest expense
     
    Gain (loss) reclassified from AOC1 into income, related to effective portion   Interest expense     (1,865 )
Gain (loss) of termination of derivative instruments
 
Gain (loss) on settlement of investments, net
   
        $ (1,865
             
Total reclassifications
      $ (2,404 )
 
14.  SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES RELATED TO CDOs
 
Newcastle considers all activity in its CDOs’ restricted cash accounts to be non-cash activity for purposes of its consolidated statement of cash flows since transactions conducted with restricted cash have no effect on its cash and cash equivalents.  Supplemental non-cash investing and financing activities relating to CDOs are disclosed below:
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
   Restricted cash generated from sale of securities
  $     $ 13,965  
   Restricted cash generated from paydowns on securities and loans
  $ 83,623     $ 60,466  
   Restricted cash used for purchases of real estate securities
  $     $ 14,689  
   Restricted cash used for purchases of real estate related loans
  $     $ 45,481  
   Restricted cash used for repayments of CDO bonds payable
  $ 65,086     $ 7,710  
   Restricted cash used for purchases of derivative instruments
  $     $ 168  
 
38
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
15.  RECENT ACTIVITIES
 
These financial statements include a discussion of material events that have occurred subsequent to March 31, 2013 (referred to as “subsequent events”) through the issuance of these consolidated financial statements. Events subsequent to that date have not been considered in these financial statements.
 
On March 5, 2013, Newcastle agreed to co-invest in a portfolio of consumer loans with a UPB of approximately $4.2 billion as of December 31, 2012. The portfolio includes over 400,000 personal unsecured loans and personal homeowner loans originated through subsidiaries of HSBC Finance Corporation. On April 1, 2013, Newcastle completed this co-investment through newly formed limited liability companies (collectively, “the consumer loan companies”). The consumer loan companies acquired the portfolio from HSBC Finance Corporation and its affiliates. Newcastle invested approximately $250 million for 30% membership interests in each of the consumer loan companies. Of the remaining 70% of the membership interests, Springleaf Finance, Inc. (“Springleaf”), which is majority-owned by Fortress funds managed by our Manager, acquired 47%, and an affiliate of Blackstone Tactical Opportunities Advisors L.L.C. acquired 23%.  Springleaf will act as the managing member of the consumer loan companies. The consumer loan companies financed $2.2 billion of the approximately $3.0 billion purchase price with asset-backed notes. The consumer loan companies were formed on March 19, 2013, for the purpose of making this investment and commenced operations upon the completion of the investment. After a servicing transition period, Springleaf will be the servicer of the loans and will provide all servicing and advancing functions for the portfolio.
 
On April 9, 2013, Newcastle financed additional non-Agency RMBS with approximately $144 million of repurchase agreements, at a cost of one-month LIBOR plus 200 bps.  The weighted average advance rate for these repurchase agreements is approximately 70%.  These repurchase agreements, which contain customary margin call provisions, have an initial term ending on July 9, 2013.
 
On April 26, 2013, Newcastle announced that its Board of Directors had formally declared the distribution of shares of common stock of New Residential Investment Corp. (“New Residential”), a wholly owned subsidiary of Newcastle. The distribution will complete the spin-off of New Residential from Newcastle. Following the distribution, New Residential will be an independent, publicly-traded real estate investment trust (“REIT”) primarily focused on investing in residential mortgage related assets.  The distribution is expected to occur on May 15, 2013 to Newcastle stockholders of record as of 5:00 p.m., Eastern Time, on May 6, 2013 (see Note 16).
 
39
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
16.  PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION
 
The following unaudited pro forma condensed consolidated financial information was derived from the application of pro forma adjustments to the consolidated financial statements of Newcastle.  These unaudited pro forma condensed consolidated financial statements should be read in conjunction with the other information contained in these financial statements and related notes and with Newcastle’s historical consolidated financial statements.
 
The unaudited pro forma information set forth below reflects the historical information of Newcastle, as adjusted to give effect to the following transaction:
 
 
A spin-off in which Newcastle would separate certain of its investments from the rest of its assets by distributing shares of common stock of New Residential, which is currently a wholly-owned subsidiary of Newcastle.
 
The unaudited pro forma condensed consolidated statements of operations give effect to the spin-off of New Residential as if the spin-off had occurred on January 1, 2012 based on New Residential’s historical consolidated statement of operations. The unaudited pro forma condensed consolidated balance sheet assumes that the spin-off of New Residential occurred on March 31, 2013.
 
In the opinion of management, all adjustments necessary to reflect the effects of the potential transaction described above have been included and are based upon available information and assumptions that Newcastle believes are reasonable.
 
Further, the historical financial information presented herein has been adjusted to give pro forma effect to events that Newcastle believes are factually supportable and which are expected to have a continuing impact on Newcastle’s results. However, such adjustments are estimates and may not prove to be accurate. Information regarding these adjustments is subject to risks and uncertainties that could cause actual results to differ materially from those anticipated.
 
These unaudited pro forma condensed consolidated financial statements are provided for information purposes only. The unaudited pro forma condensed consolidated statements of operations and the unaudited pro forma condensed consolidated balance sheet do not purport to represent what Newcastle’s results of operations would have been had such transactions been consummated on the dates indicated, nor do they represent the financial position or results of operations of either Newcastle or New Residential for any future date or period.
 
40
 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
At March 31, 2013
 
                   
   
Newcastle
   
Pro Forma
   
Newcastle
 
   
Consolidated
   
Adjustments
   
Consolidated
 
   
Historical (A)
   
New Residential
   
Pro Forma
 
Assets
                 
Real estate securities, available-for-sale
  $ 2,495,473     $ (1,598,868 ) (B)   $ 896,605  
Real estate related loans, held-for-sale, net
    851,525             851,525  
Residential mortgage loans, held-for-investment, net
    317,708       (35,484 ) (C)     282,224  
Residential mortgage loans, held-for-sale, net
    2,380             2,380  
Investments in excess mortgage servicing rights at fair value
    236,555       (236,555 ) (C)      
Investments in equity method investees at fair value
    102,588       (102,588 ) (C)      
Subprime mortgage loans subject to call option
    406,115             406,115  
Investments in real estate, net of accumulated depreciation
    168,515             168,515  
Intangibles, net of accumulated amortization
    16,218             16,218  
Other investments
    24,907             24,907  
Cash and cash equivalents
    534,772             534,772  (G)
Restricted cash
    11,494             11,494  
Derivative assets
    176             176  
Receivables and other assets
    27,577       (450 ) (C)     27,127  
 
  $ 5,196,003     $ (1,973,945 )   $ 3,222,058  
Liabilities and Stockholders' Equity
                       
Liabilities
                       
CDO bonds payable
  $ 1,015,560     $     $ 1,015,560  
Other bonds and notes payable
    173,723             173,723  
Repurchase agreements
    1,473,586       (1,182,212 ) (D)     291,374  
Mortgage notes payable
    120,525             120,525  
Financing of subprime mortgage loans subject to call option
    406,115             406,115  
Junior subordinated notes payable
    51,242             51,242  
Derivative liabilities
    26,612             26,612  
Dividends payable
    56,596             56,596  
Due to affiliates
    4,611       (938 ) (E)     3,673  
Purchase price payable on investments in excess mortgage servicing rights
    59       (59 ) (C)      
Accrued expenses and other liabilities
    17,875       (2,780 ) (C)     15,095  
 
  $ 3,346,504     $ (1,185,989 )   $ 2,160,515  
Stockholders' Equity
                       
Preferred stock
  $ 61,583     $     $ 61,583  
Common stock
    2,530             2,530  
Additional paid-in capital
    2,472,931             2,472,931  
Accumulated deficit
    (790,143 )     (756,247 ) (F)     (1,546,390 )
Accumulated other comprehensive income (loss)
    102,598       (31,709 ) (C)     70,889  
    $ 1,849,499     $ (787,956 )   $ 1,061,543  
 
  $ 5,196,003     $ (1,973,945 )   $ 3,222,058  
 
(A)
Represents Newcastle’s historical consolidated balance sheet at March 31, 2013.
(B)
Represents the fair value of New Residential’s real estate securities at March 31, 2013 adjusted to include securities owned by Newcastle at March 31, 2013 and contributed by Newcastle to New Residential subsequent to March 31, 2013.
(C)
Represents New Residential’s assets, liabilities and accumulated other comprehensive income at March 31, 2013.
(D)
Represents New Residential’s repurchase agreements at March 31, 2013 adjusted for the additional repurchase agreements to finance the real estate securities described in (B) above.
(E)
Represents a reduction of Newcastle’s due to affiliates for the allocation of one month of accrued and unpaid management fees from Newcastle to New Residential.
(F)
Represents the distribution of New Residential common stock to Newcastle shareholders.
(G) Represents Newcastle’s cash and cash equivalents at March 31, 2013.  Newcastle will contribute cash to New Residential in connection with the spin-off subsequent to March 31, 2013.
 
41
 

 

 

 

 

 

 

 

 

 
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
Three Months Ended March 31, 2013
 
   
Newcastle
   
Pro Forma
   
Newcastle
 
   
Consolidated
   
Adjustments
   
Consolidated
 
   
Historical (A)
   
New Residential (B)
   
Pro Forma
 
                   
Interest income
  $ 71,367     $ (16,191 )   $ 55,176  
Interest expense
    22,710       (899 )     21,811  
Net interest income
    48,657       (15,292 )     33,365  
                         
Impairment/(Reversal)
                       
   Valuation allowance (reversal) on loans
    2,234             2,234  
   Other-than-temporary impairment on securities
    422             422  
                         
   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)
    117             117  
      2,773             2,773  
                         
        Net interest income after impairment/reversal
    45,884       (15,292 )     30,592  
                         
Other Revenues
                       
   Rental income
    12,887             12,887  
   Care and ancillary income
    613             613  
        Total other revenues
    13,500             13,500  
                         
Other Income (Loss)
                       
   Gain (loss) on settlement of investments, net
    (3 )           (3 )
   Gain on extinguishment of debt
    1,206             1,206  
   Change in fair value of investments in excess mortgage servicing rights
    1,858       (1,858 )      
   Change in fair value of investments in equity method investees
    969       (969 )      
   Other income (loss), net
    4,567             4,567  
      8,597       (2,827 )     5,770  
Expenses
                       
   Loan and security servicing expense
    1,034             1,034  
   Property operating expenses
    8,363             8,363  
   General and administrative expense
    6,911       (2,719 )     4,192  
   Management fee to affiliate
    9,565       (2,325 )     7,240  
   Depreciation and amortization
    4,079             4,079  
      29,952       (5,044 )     24,908  
Income from continuing operations
    38,029       (13,075 )     24,954  
   Preferred dividends
    (1,395 )           (1,395 )
Income from continuing operations after preferred dividends
  $ 36,634     $ (13,075 )   $ 23,599  
Income from continuing operations per share of common stock, after preferred dividends
                       
 Basic
  $ 0.16             $ 0.10  
 Diluted
  $ 0.15             $ 0.10  (C)
Weighted Average Number of Shares of Common Stock Outstanding
                       
Basic
    235,136,756               235,136,756  
Diluted
    240,079,144               240,079,144  (C)
 
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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2013
(dollars in tables in thousands, except share data)
 
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
12 Months Ended December 31, 2012
 
   
Newcastle
   
Pro Forma
   
Newcastle
 
   
Consolidated
   
Adjustments
   
Consolidated
 
   
Historical (A)
   
New Residential (B)
   
Pro Forma
 
                   
Interest income
  $ 310,459     $ (33,759 )   $ 276,700  
Interest expense
    109,924       (704 )     109,220  
Net interest income
    200,535       (33,055 )     167,480  
                         
Impairment/(Reversal)
                       
   Valuation allowance (reversal) on loans
    (24,587 )           (24,587 )
   Other-than-temporary impairment on securities
    19,359             19,359  
                         
   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)
    (436 )           (436 )
      (5,664 )           (5,664 )
                         
        Net interest income after impairment/reversal
    206,199       (33,055 )     173,144  
                         
Other Revenues
                       
   Rental income
    17,081             17,081  
   Care and ancillary income
    2,994             2,994  
        Total other revenues
    20,075             20,075  
                         
Other Income (Loss)
                       
   Gain (loss) on settlement of investments, net
    232,897             232,897  
   Gain on extinguishment of debt
    24,085             24,085  
   Change in fair value of investments in excess mortgage servicing rights
    9,023       (9,023 )      
   Other income (loss), net
    13,712       (8,400 )     5,312  
      279,717       (17,423 )     262,294  
Expenses
                       
   Loan and security servicing expense
    4,260             4,260  
   Property operating expenses
    12,943             12,943  
   General and administrative expense
    22,942       (5,878 )     17,064  
   Management fee to affiliate
    24,693       (3,353 )     21,340  
   Depreciation and amortization
    6,975             6,975  
      71,813       (9,231 )     62,582  
Income from continuing operations
    434,178       (41,247 )     392,931  
   Preferred dividends
    (5,580 )           (5,580 )
Income from continuing operations after preferred dividends
  $ 428,598     $ (41,247 )   $ 387,351  
Income from continuing operations per share of common stock, after preferred dividends
                       
 Basic
  $ 2.97             $ 2.69  
 Diluted
  $ 2.94             $ 2.66  (C)
Weighted Average Number of Shares of Common Stock Outstanding
                       
Basic
    144,146,370               144,146,370  
Diluted
    145,766,413               145,766,413  (C)
 
(A)
Represents Newcastle’s historical consolidated statement of operations for the three months ended March 31, 2013 and the year ended December 31, 2012.
(B)
Represents New Residential’s historical consolidated statement of operations for the three months ended March 31, 2013 and the year ended December 31, 2012.
(C)
Does not include potential additional diluted shares as a result of changes to outstanding Newcastle options from the spin-off.  The number of additional diluted shares will depend on various factors, including the share prices of Newcastle and New Residential subsequent to the spin-off.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following should be read in conjunction with the unaudited consolidated financial statements and notes thereto included herein, and with Part II, Item 1A, “Risk Factors.”
 
GENERAL
 
Newcastle Investment Corp. is a real estate investment and finance company.  We invest in, and actively manage, a portfolio of real estate securities, loans, excess mortgage servicing rights (“Excess MSRs”), real estate related assets, such as senior living facilities, and other assets.  Our objective is to maximize the difference between the yield on our investments and the cost of financing these investments. We often seek to hedge our interest rate risk.  We emphasize portfolio management, asset quality, liquidity, diversification, match funded financing and credit risk management.
 
We currently own a diversified portfolio of credit sensitive real estate debt investments, including securities and loans, other real estate debt investments, such as Excess MSRs, and other assets. Our portfolio of real estate securities includes commercial mortgage backed securities (CMBS), senior unsecured debt issued by REITs, real estate related asset backed securities (ABS), and FNMA/FHLMC securities. Mortgage backed securities are interests in or obligations secured by pools of mortgage loans.  We generally target investments rated A through BB, except for our FNMA/FHLMC securities, which have an implied AAA rating.  We also own, directly and indirectly, interests in loans and pools of loans, including real estate related loans, commercial mortgage loans, residential mortgage loans, manufactured housing loans, and subprime mortgage loans.
 
We generally employ leverage as part of our investment strategy, though we do not currently use leverage to purchase Excess MSRs.  We do not have a predetermined target debt to equity ratio as we believe the appropriate leverage for the particular assets we are financing depends on the credit quality of those assets. As of March 31, 2013, we had complied with the general investment guidelines adopted by our board of directors that limit total leverage. We utilize leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.
 
We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential fluctuations in the availability of capital.  We seek to utilize multiple forms of financing, including sales of common or preferred equity, collateralized debt obligations (CDOs), other securitizations, term loans, and trust preferred securities, as well as short term financing in the form of loans and repurchase agreements. As we discuss in more detail under “–Market Considerations” below, while market conditions have improved meaningfully since 2008, the current conditions continue to reduce the array of capital resources available to us and have made the terms of capital resources we are able to obtain generally less favorable to us relative to the terms we were able to obtain prior to the onset of challenging conditions. That said, we have recently been able to access more types of capital – and on better terms – than we had been able to access during 2008 and 2009.
 
We  typically seek to match fund our investments with respect to interest rates and maturities in order to reduce the impact of interest rate fluctuations on earnings and reduce the risk of refinancing our liabilities prior to the maturity of the investments.  We seek to finance a substantial portion of our real estate securities and loans through the issuance of term debt, which generally represents obligations issued in multiple classes secured by an underlying portfolio of assets. Specifically, our CDO financings offer us the structural flexibility to buy and sell certain investments to manage risk and, subject to certain limitations, to optimize returns.
 
We conduct our business through the following segments: (i) investments financed with non-recourse collateralized debt obligations (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered CDOs”), (iii) unlevered Excess MSRs, (iv) investments 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, Newcastle is generally entitled to receive net cash flows from these structures on a periodic basis. Revenues attributable to each segment, as restated for previously reported periods, are disclosed below (in thousands).
 
For the Three Months
 
Non-Recourse
   
Unlevered
   
Unlevered
   
Non-recourse
   
Non-Recourse
         
Unlevered
         
Inter-segment
       
Ended March 31,
 
CDOs
   
CDOs
   
Excess MSRs
   
Senior Living
   
Other
   
Recourse
   
Other
   
Corporate
   
Elimination
   
Total
 
2013
  $ 31,589     $ 239     $ 10,035     $ 12,997     $ 16,810     $ 7,285     $ 6,706     $ 72     $ (866 )   $ 84,867  
2012
  $ 54,402     $ 115     $ 2,037     $ 509     $ 18,426     $ 814     $ 523     $ 51     $ (1,469 )   $ 75,408  
 
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Market Considerations
 
Markets in which We Operate
 
Overall Credit Markets
 
Our ability to generate income is dependent on our ability to invest our capital on a timely basis at attractive returns.
 
Two primary market factors that affect our ability to do this in the real estate debt business are (1) credit spreads and (2) the availability of financing on favorable terms.
 
Generally speaking, widening credit spreads reduce any unrealized gains on our current debt investments (or cause or increase unrealized losses) and increase our costs for new financings, but increase the yields available on potential new debt investments, while tightening credit spreads increase the unrealized gains (or reduce unrealized losses) on our current debt investments and reduce our costs for new financings, but reduce the yields available on potential new debt investments. By reducing unrealized gains (or causing unrealized losses), widening credit spreads also impact our ability to realize gains on existing debt investments if we were to sell such assets.
 
From mid-2007 through early 2009, credit spreads widened substantially. One of the key drivers of the widening of credit spreads over these years was the continued disruption and liquidity concerns throughout the credit markets. The severity and scope of the disruption intensified meaningfully during the fourth quarter of 2008 and the first quarter of 2009. In the latter part of 2009, credit spreads tightened substantially and continued to tighten in 2010 and the first half of 2011. However, credit spreads widened in the third quarter of 2011, reflecting the challenging economic environment. These changes in credit spreads caused the net unrealized gains on our securities to increase during the first half of 2011, but these increases were reversed and resulted in net unrealized losses in the second half of 2011. Credit markets improved in the beginning of 2012, however, worldwide economic issues caused investors to become risk adverse which drove spreads wider in the second quarter of 2012.  As 2012 progressed, investor fear subsided and demand began to increase which in turn drove prices higher.  The new securitization market in both the commercial and residential real estate markets picked up dramatically and the new supply was absorbed with ease.  With US economic data improving and rates at all time lows, investor demand for higher yields drove asset prices higher for 2012.  We have seen further increases in prices through the first quarter of 2013. 
 
We utilize multiple forms of financing, depending on their appropriateness and availability, to finance our investments, including sales of common and preferred equity, collateralized debt obligations (CDOs) or other securitizations, term loans, trust preferred securities, and short-term financing in the form of loans and repurchase agreements.   One component of our investment strategy is to use match funded financing structures, such as CDOs, at rates that provide a positive net spread relative to our investment returns.
 
Recent conditions in the credit markets have impaired our ability to match fund investments. During the past several years, financing in the form of securitizations or other long-term non-recourse structures not subject to margin requirements was generally not available or economical, and it remains difficult to obtain under current market conditions.  Lenders have generally tightened their underwriting standards and increased their margin requirements, resulting in a decline in the overall amount of leverage available to us and an increase in our borrowing costs.  These conditions make it highly likely that we will have to use less efficient forms of financing for any new investments, which will likely require a larger portion of our cash flows to be put toward making the initial investment and thereby reduce the amount of cash available for distribution to our stockholders and funds available for operations and investments, and which will also likely require us to assume higher levels of risk when financing our investments.  Moreover, financial market conditions remain volatile and have been adversely affected by the unrest in the Middle East, the earthquake in Japan, the European financial crisis, continuing weakness in the U.S. job market and concern about the United States’ level of indebtedness. Volatility in equity markets could impair our ability to raise debt or equity capital or otherwise finance our business.
 
Excess MSRs
 
We believe that the current environment has created an attractive opportunity to invest in MSRs.  Specifically:
 
 
changes in the regulatory treatment of MSRs for financial institutions subject to Basel III, a revision to the global regulatory capital and liquidity framework for banks, which will impose increased regulatory capital costs on banks for owning MSRs;
 
elevated borrower delinquencies and defaults experienced over the last few years, and increased regulatory oversight, has led to substantially higher costs for mortgage servicers and negatively impacted their profitability; and
 
mortgage servicing has become less attractive to many financial institutions due to increasingly negative publicity and heightened government and regulatory scrutiny.
 
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These dynamics resulted in a pipeline of MSRs for sale by banks and non-bank servicers, as these institutions are under pressure to exit or reduce their exposure to the mortgage servicing business.  As a result, we believe that this relative oversupply of MSRs, combined with a historically low interest rate environment and a challenging credit market, have contributed to an availability of MSRs that are attractively priced.  We closed on our first investment in Excess MSRs in December 2011, continued investing in this sector in 2012 and early 2013, and are exploring opportunities to acquire additional MSRs that provide attractive risk-adjusted returns.
 
Non-Agency RMBS
 
We are also pursuing investments in residential mortgage backed securities (“RMBS”) that have been securitized by either public or private trusts (“non-Agency RMBS”). Since the onset of the financial crisis in 2007, there has been significant volatility in the prices for non-Agency RMBS. This has resulted from a widespread contraction in capital available for this asset class, deteriorating housing fundamentals, and an increase in forced selling by institutional investors (often in response to rating agency downgrades). While the prices of these assets have started to recover from their lows, we believe a meaningful gap still exists between current prices and the recovery value of many non-Agency RMBS. Accordingly, we believe there are opportunities to acquire non-Agency RMBS at attractive risk-adjusted yields, with the potential for meaningful upside if the U.S. economy and housing market continue to strengthen. We believe the value of existing non-Agency RMBS may also rise if the number of buyers returns to pre-2007 levels. As of March 31, 2013, we had acquired non-Agency RMBS with a face amount of approximately $829.8 million for a total purchase price of $515.7 million, or 62.1% of face amount.
 
Senior Living
 
In addition, we believe that the senior living sector currently presents an attractive investment opportunity. Specifically,
 
projected changes in demographics will drive increased demand for senior housing, yet new supply is limited, creating favorable supply-demand fundamentals;
 
targeting smaller portfolios enables us to avoid pricing competition with other active REIT buyers of large portfolios, thereby focusing our acquisitions on quality senior housing assets that provide more competitive pricing fundamentals; and
 
capitalizing on the experience of our manager in the senior living industry, we expect to generate growth in property-level net operating income when operational and structural efficiencies are achieved.
 
We made three acquisitions of senior living assets comprised of 12 properties in 2012. We are exploring opportunities to invest in additional senior living facilities.
 
Our investment guidelines are purposefully broad to enable us to make investments in a wide array of assets, including, but not limited to, any type of assets that can be held by a REIT. We do not have specific policies as to the allocation among types of real estate related, or other, assets or investment categories, since our manager’s investment decisions depend on changing market conditions.
 
Liquidity
 
Credit and liquidity conditions have improved relative to the conditions experienced during the 2008-2009 financial crisis. That said, the challenging credit and liquidity conditions that we experienced during the financial crisis continue to adversely affect us and the markets in which we operate in a number of ways. For example, these conditions have reduced the market trading activity for many real estate securities and loans, resulting in less liquid markets for those securities and loans.  As the securities held by us and many other companies in our industry are marked to market at the end of each quarter, the decreased liquidity and concern over market conditions have resulted in significant reductions in mark to market valuations of many real estate securities and loans and the collateral underlying them, as well as volatility and uncertainty with respect to such valuations.  These lower valuations, and decreased expectations of future cash flows, have affected us by, among other things, reducing the amount, which we refer to as “cushion,” by which we satisfy the over collateralization and interest coverage tests of our CDOs (sometimes referred to as CDO “triggers”) or contributing to several of our CDOs failing their over collateralization tests (see “– Liquidity and Capital Resources” and  “– Debt Obligations” below).
 
Failed CDO triggers, impairments resulting from incurred losses, and asset sales made at prices significantly below face amount while the related debt is being repaid at its full face amount, as well as the retention of cash, could contribute to reductions in future earnings, cash flow and liquidity.
 
With respect to dividends, we have paid all dividends on our preferred stock through April 30, 2013. We declared a quarterly dividend of $0.22 per common share for the first quarter of 2013, which was paid on April 30, 2013.  We may
 
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elect to adjust or not to pay any future dividend payments to reflect our current and expected cash from operations or to satisfy future liquidity needs.
 
Extent of Market Disruption
 
Market conditions have meaningfully improved over the last few years, but it is not clear whether a sustained recovery will occur or, if so, for how long it will last. We do not currently know the full extent to which the continuing challenging market conditions will affect us or the markets in which we operate. If such conditions persist, particularly with respect to commercial real estate, we may experience additional impairment charges, potential reductions in cash flows from our investments and additional challenges in raising capital and obtaining investment or other financing on attractive terms.  Moreover, we will likely need to continue to place a high priority on managing our liquidity. Certain aspects of these effects are more fully described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate, Credit and Spread Risk” and “– Liquidity and Capital Resources” as well as in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”
 

Spin-Off of New Residential

On April 26, 2013, we announced that our Board of Directors formally declared the distribution of shares of common stock of New Residential Investment Corp. (“New Residential”), a wholly owned subsidiary of Newcastle. The distribution will complete the spin-off of New Residential from Newcastle. The distribution is expected to occur on May 15, 2013 to Newcastle stockholders of record as of 5:00 p.m., Eastern Time, on May 6, 2013.

Following the distribution, New Residential will be an independent, publicly-traded REIT (NYSE: NRZ) with an initial portfolio composed of all of our investments in Excess MSRs, the non-Agency RMBS we have acquired since the second quarter of 2012, certain Agency RMBS, residential mortgage loans acquired since the beginning of 2013 and all of our consumer loans. New Residential will be externally managed by our manager pursuant to a new management agreement.

Following the spin-off, we currently expect that Newcastle will pursue, among other investments, additional acquisitions of senior housing assets and strategic opportunities to liquidate its CDOs and restructure its real estate and other debt portfolio. The investment guidelines of each of Newcastle and New Residential are purposefully broad to enable each to make investments in a wide array of assets. For a description of the risks associated with the spin-off, see “Risk Factors” including, but not limited to “Risks Related to the Spin-Off of New Residential.”

 
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APPLICATION OF CRITICAL ACCOUNTING POLICIES
 
Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Actual results could differ from these estimates.  Management believes that the estimates and assumptions utilized in the preparation of the consolidated financial statements are prudent and reasonable. Actual results historically have been in line with management’s estimates and judgments used in applying each of the accounting policies described below, as modified periodically to reflect current market conditions. The following is a summary of our accounting policies that are most effected by judgments, estimates and assumptions.
 
Variable Interest Entities
 
Variable interest entities (“VIEs”) are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, and only by its primary beneficiary, which is defined as the party who has the power to direct the activities of a VIE that most significantly impact its economic performance and who has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.
 
The VIEs in which we have a significant interest include (i) our CDOs, and (ii) our manufactured housing loan financing structures. We do not have the power to direct the relevant activities of CDO V, as a result of an event of default which allows us to be removed as collateral manager of this CDO and prevents us from purchasing or selling certain collateral within this CDO, and therefore we deconsolidated this CDO as of June 17, 2011. Similar events of default in the future, if they occur, could cause us to deconsolidate additional financing structures. We completed two securitization transactions to refinance our Manufactured Housing Loans Portfolios I and II. We analyzed the securitizations under the applicable accounting guidance and concluded that the securitization transactions should be accounted for as secured borrowings. As a result, we continue to recognize the portfolios of manufactured housing loans as pledged assets, which have been classified as loans held-for-investment at securitization, and recorded the notes issued to third parties as secured borrowings.
 
Our subprime securitizations are also considered VIEs, but we do not control their activities and no longer receive a significant portion of their returns, and therefore do not consolidate them.
 
In addition, our investments in RMBS, CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. We monitor these investments and analyze the potential need to consolidate the related securitization entities pursuant to the VIE consolidation requirements. These analyses require considerable judgment in determining whether an entity is a VIE and determining the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power and economics. The result could be the consolidation of an entity that otherwise would not have been consolidated or the de-consolidation of an entity that otherwise would have been consolidated.
 
We have not consolidated the entities in which we hold a 50% interest that made an investment in Excess MSRs.  We have determined that the decisions that most significantly impact the economic performance of these entities will be made collectively by us and the other investor in the entities. In addition, these entities have sufficient equity to permit the entities to finance their activities without additional subordinated financial support. Based on our analysis, these entities do not meet any of the VIE criteria.
 
Valuation of Securities
 
We have classified all our real estate securities as available for sale. As such, they are carried at fair value with net unrealized gains or losses reported as a component of accumulated other comprehensive income, to the extent impairment losses are considered temporary as described below. Fair value may be based upon broker quotations, counterparty quotations or pricing services quotations, which provide valuation estimates based upon reasonable market order indications or a good faith estimate thereof and are subject to significant variability based on market conditions, such as interest rates, credit spreads and market liquidity. A significant portion of our securities are currently not traded in active markets and therefore have little or no price transparency. For a further discussion of this trend, see “– Market Considerations” above. As a result, we have estimated the fair value of these illiquid securities based on internal pricing models rather than the sources described above. The determination of estimated cash flows used in pricing models is inherently subjective and imprecise. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant and immediate increase or decrease in our book equity. For
 
48
 

 

 
securities valued with pricing models, these inputs include the discount rate, assumptions relating to prepayments, default rates and loss severities, as well as other variables.
 
See Note 9 to our consolidated financial statements in Part I, Item 1, “Financial Statements” for information regarding the fair value of our investments, and its estimation methodology, as of March 31, 2013.
 
Our securities must be categorized by the “level” of inputs used in estimating their fair values. Level 1 would be assets valued based on quoted prices for identical instruments in active markets. We have no level 1 assets. Level 2 would be assets valued based on quoted prices in active markets for similar instruments, on quoted prices in less active or inactive markets, or on other “observable” market inputs. Level 3 would be assets valued based significantly on “unobservable” market inputs. We have further broken level 3 into level 3A, third party indications, and level 3B, internal models. Fair value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were forced to sell assets in a short period to meet liquidity needs, the prices we receive could be substantially less than the recorded fair values.
 
We generally classify the broker and pricing service quotations we receive as level 3A inputs, except for certain liquid securities. They are quoted prices in generally inactive and illiquid markets for identical or similar securities. These quotations are generally received via email and contain disclaimers which state that they are “indicative” and not “actionable” – meaning that the party giving the quotation is not bound to actually purchase the security at the quoted price. These quotations are generally based on models prepared by the brokers, and we have little visibility into the inputs they use. Based on quarterly procedures we have performed with respect to quotations received from these brokers, including comparison to the outputs generated from our internal pricing models and transactions we have completed with respect to these securities, as well as on our knowledge and experience of these markets, we have generally determined that these quotes represent a reasonable estimate of fair value. For the $2.4 billion carrying value of securities valued using quotations as of March 31, 2013, a 100 basis point change in credit spreads would impact estimated fair value by approximately $60.0 million.
 
Our estimation of the fair value of level 3B assets (as described below) involves significant judgment. We validated the inputs and outputs of our models by comparing them to available independent third party market parameters and models for reasonableness. We believe the assumptions we used are within the range that a market participant would use and factor in the liquidity conditions currently in the markets. In the period ended March 31, 2013, the inputs to our models, including discount rates, prepayment speeds, default rates and severity assumptions, have generally remained consistent with the assumptions used at December 31, 2012, other than certain modifications we have made to the assumptions to reflect conditions relevant to specific assets.
 
For CMBS and ABS valued with internal models, which have an aggregate fair value of $81.7 million as of March 31, 2013, a 10% unfavorable change in our assumptions would result in the following decreases in such aggregate fair value (in thousands):
 
   
CMBS
   
ABS
 
Outstanding face amount
  $ 129,468     $ 84,848  
                 
Fair value
  $ 56,844     $ 24,835  
                 
Effect on fair value with 10% unfavorable change in:
               
   Discount rate
  $ (795 )   $ (869 )
   Prepayment rate
    N/A     $ (729 )
   Default rate
  $ (2,737 )   $ (2,713 )
   Loss severity
  $ (2,349 )   $ (3,484 )
 
Impairment of Securities
 
We must also assess whether unrealized losses on securities, if any, reflect a decline in value which is other-than-temporary and, if so, write the impaired security down to its fair value through earnings. A decline in value is deemed to be other-than-temporary if (i) it is probable that we will be unable to collect all amounts due according to the contractual terms of a security which was not impaired at acquisition (there is an expected credit loss), or (ii) if we have the intent to sell a security in an unrealized loss position or it is more likely than not we will be required to sell a security in an unrealized loss position prior to its anticipated recovery (if any). For the purposes of performing this analysis, we assume the anticipated recovery period is until the respective security’s expected maturity. Also, for certain securities that represent beneficial interests in securitized financial assets, whenever there is a probable adverse change in the timing or amounts of estimated cash flows of a security from the cash flows previously projected, an other-than temporary impairment will be deemed to have occurred. Our non-Agency RMBS acquired with evidence of deteriorated credit quality for which it was deemed probable, at acquisition, that we would be unable to collect all contractually required payments as they come due, fall
 
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within the scope of loans and debt securities acquired with deteriorated credit quality, as opposed to beneficial interests in securitized financial assets. We note that primarily all of our securities, except our FNMA/FHLMC securities and our non-Agency RMBS acquired with evidence of deteriorated credit quality, fall within the definition of beneficial interests in securitized financial assets. 
 
Temporary declines in value generally result from changes in market factors, such as market interest rates and credit spreads, or from certain macroeconomic events, including market disruptions and supply changes, which do not directly impact our ability to collect amounts contractually due. We continually evaluate the credit status of each of our securities and the collateral supporting our securities. This evaluation includes a review of the credit of the issuer of the security (if applicable), the credit rating of the security, the key terms of the security (including credit support), debt service coverage and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the collateral supporting such loans, including the effect of local, industry and broader economic trends and factors. These factors include loan default expectations and loss severities, which are analyzed in connection with a particular security’s credit support, as well as prepayment rates. These factors are also analyzed in relation to the amount of the unrealized loss and the period elapsed since it was incurred. The result of this evaluation is considered when determining management’s estimate of cash flows, particularly with respect to developing the necessary inputs and assumptions. Each security is impacted by different factors and in different ways; generally the more negative factors which are identified with respect to a given security, the more likely we are to determine that we do not expect to receive all contractual payments when due with respect to that security.
Significant judgment is required in this analysis.
 
As of March 31, 2013, we had 8 securities with a carrying amount of $26.9 million that had been downgraded during the period ended March 31, 2013.  We did not record a net other-than-temporary impairment charge on these securities in the period ended March 31, 2013. However, we do not depend on credit ratings in underwriting our securities, either at acquisition or on an ongoing basis. As mentioned above, a credit rating downgrade is one factor that we monitor and consider in our analysis regarding other-than-temporary impairment, but it is not determinative. Our securities generally benefit from the support of one or more subordinate classes of securities or equity or other forms of credit support. Therefore, credit rating downgrades, even to the extent they relate to an expectation that a securitization we have invested in, on an overall basis, has credit issues, may not ultimately impact cash flow estimates for the class of securities in which we are invested.
 
Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold is also subject to significant judgment, particularly in times of market illiquidity such as we are currently experiencing.
 
Revenue Recognition on Securities
 
Income on our securities is recognized using a level yield methodology based upon a number of cash flow assumptions that are subject to uncertainties and contingencies. Such assumptions include the rate and timing of principal and interest receipts (which may be subject to prepayments and defaults). These assumptions are updated on at least a quarterly basis to reflect changes related to a particular security, actual historical data, and market changes. These uncertainties and contingencies are difficult to predict and are subject to future events, and economic and market conditions, which may alter the assumptions. For securities acquired at a discount for credit losses, we recognize the excess of all cash flows expected over our investment in the securities as Interest Income on a “loss-adjusted” yield basis. The loss-adjusted yield is determined based on an evaluation of the credit status of securities, as described in connection with the analysis of impairment above.
 
Valuation of Derivatives
 
Similarly, our derivative instruments are carried at fair value. Fair value is based on counterparty quotations. Newcastle reports the fair value of derivative instruments gross of cash paid or received pursuant to credit support agreements and fair value is reflected on a net counterparty basis when Newcastle believes a legal right of offset exists under an enforceable netting agreement. To the extent they qualify as cash flow hedges, net unrealized gains or losses are reported as a component of accumulated other comprehensive income; otherwise, the net unrealized gains and losses are reported currently in income. To the extent they qualify as fair value hedges, net unrealized gains or losses on both the derivative and the related portion of the hedged item are reported currently in income. Fair values of such derivatives are subject to significant variability based on many of the same factors as the securities discussed above, including counterparty credit risk. The results of such variability, the effectiveness of our hedging strategies and the extent to which a forecasted hedged transaction remains probable of occurring, could result in a significant increase or decrease in our GAAP equity and/or earnings.
 
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Loans
 
We invest in loans, including, but not limited to, real estate related loans, commercial mortgage loans, residential mortgage loans, manufactured housing loans and subprime mortgage loans. Loans for which we have the intent and ability to hold for the foreseeable future, or until maturity or payoff, are classified as held-for-investment. Loans for which we do not have the intent or the ability to hold for the foreseeable future, or until maturity or payoff, are classified as held-for-sale. Loans are presented in the consolidated balance sheet net of any unamortized discount (or gross of any unamortized premium) and an allowance for loan losses. We determine at acquisition whether loans will be aggregated into pools based on common risk characteristics (credit quality, loan type, and date of origination or acquisition); loans aggregated into pools are accounted for as if each pool were a single loan.
 
Impairment of Loans
 
To the extent that they are classified as held for investment, we must periodically evaluate each of these loans or loan pools for possible impairment. Impairment is indicated when it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the loan, or, for loans acquired at a discount for credit losses, when it is deemed probable that we will be unable to collect as anticipated. Upon determination of impairment, we would establish a specific valuation allowance with a corresponding charge to earnings. We continually evaluate our loans receivable for impairment.
 
Our residential mortgage loans, including manufactured housing loans, are aggregated into pools for evaluation based on like characteristics, such as loan type and acquisition date. Individual loans are evaluated based on an analysis of the borrower’s performance, the credit rating of the borrower, debt service coverage and loan to value ratios, the estimated value of the underlying collateral, the key terms of the loan, and the effect of local, industry and broader economic trends and factors. Pools of loans are also evaluated based on similar criteria, including historical and anticipated trends in defaults and loss severities for the type and seasoning of loans being evaluated. This information is used to estimate specific impairment charges on individual loans as well as provisions for estimated unidentified incurred losses on pools of loans.
 
Significant judgment is required both in determining impairment and in estimating the resulting loss allowance. Furthermore, we must assess our intent and ability to hold our loan investments on a periodic basis. If we do not have the intent to hold a loan for the foreseeable future or until its expected payoff, the loan must be classified as “held for sale” and recorded at the lower of cost or estimated value.
 
Revenue Recognition on Loans Held for Investment
 
Income on these loans is recognized similarly to that on our securities and is subject to similar uncertainties and contingencies, which are also analyzed on at least a quarterly basis. For loans acquired at a discount for credit losses, the net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income, offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Valuation Allowance. The provision is determined based on an evaluation of the loans as described under “– Impairment of Loans” above.
 
Revenue Recognition on Loans Held for Sale
 
Real estate related, commercial mortgage and residential mortgage loans that are considered held for sale are carried at the lower of amortized cost or market value determined on either an individual method basis, or in the aggregate for pools of similar loans. Interest income is recognized based on the loan’s coupon rate to the extent management believes it is collectable. Purchase discounts are not amortized as interest income during the period the loan is held for sale. A change in the market value of the loan, to the extent that the value is not above the average cost basis, is recorded in Valuation Allowance.
 
Investments in Excess Mortgage Servicing Rights (Excess MSRs)
 
Upon acquisition, we have elected to record each of such investments at fair value. We elected to record our investments in Excess MSRs at fair value in order to provide users of the financial statements with better information regarding the effects of prepayment risk and other market factors on the Excess MSRs. Under this election, we record a valuation adjustment on our Excess MSRs investments on a quarterly basis to recognize the changes in fair value in net income as described in Revenue Recognition on Investments in Excess Mortgage Servicing Rights below. As of March 31, 2013, all Excess MSRs investments are classified as held-for-investment as we have the intent and ability to hold the investments for the foreseeable future.
 
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Revenue Recognition on Investments in Excess Mortgage Servicing Rights
 
Investments in Excess MSRs are aggregated into pools as applicable; each pool of Excess MSRs is accounted for in the aggregate. Interest income for Excess MSRs is accreted into interest income on an effective yield or “interest” method, based upon the expected excess servicing amount through the expected life of the underlying mortgages. Changes to expected cash flows result in a cumulative retrospective adjustment, which will be recorded in the period in which the change in expected cash flows occurs. Under the retrospective method, the interest income recognized for a reporting period is measured as the difference between the amortized cost basis at the end of the period and the amortized cost basis at the beginning of the period, plus any cash received during the period. The amortized cost basis is calculated as the present value of estimated future cash flows using an effective yield, which is the yield that equates all past actual and current estimated future cash flows to the initial investment. In addition, our policy is to recognize interest income only on Excess MSRs in existing eligible underlying mortgages. The difference between the fair value of Excess MSRs and their amortized cost basis is recorded as “Change in Fair Value of Investments in Excess Mortgage Servicing Rights.” Fair value is generally determined by discounting the expected future cash flows using discount rates that incorporate the market risks and liquidity premium specific to the Excess MSRs, and therefore may differ from their effective yields.
 
The following tables summarize the estimated change in fair value of our interests in  the Excess MSRs owned directly and through equity method investees as of March 31, 2013 given several parallel shifts in the discount rate, prepayment rate, delinquency rate and recapture rate (dollars in thousands):
 
Fair value at March 31, 2013
  $ 328,898
(A)
 
 
             
                           
Discount rate shift in %
    -20 %     -10 %     +10 %     +20 %
Estimated fair value
  $ 369,207     $ 348,669     $ 313,957     $ 299,166  
Change in estimated fair value:
                               
Amount
  $ 40,309     $ 19,771     $ (14,941 )   $ (29,732 )
%
    12.3 %     6.0 %     -4.5 %     -9.0 %
                                 
Prepayment rate shift in %
    -20 %     -10 %     +10 %     +20 %
Estimated fair value
  $ 362,481     $ 345,524     $ 315,285     $ 301,661  
Change in estimated fair value:
                               
Amount
  $ 33,583     $ 16,626     $ (13,613 )   $ (27,237 )
%
    10.2 %     5.1 %     -4.1 %     -8.3 %
                                 
Delinquency rate shift in %
    -20 %     -10 %     +10 %     +20 %
Estimated fair value
  $ 338,055     $ 333,946     $ 325,728     $ 321,621  
Change in estimated fair value:
                               
Amount
  $ 9,157     $ 5,048     $ (3,170 )   $ (7,277 )
%
    2.8 %     1.5 %     -1.0 %     -2.2 %
                                 
Recapture rate shift in %
    -20 %     -10 %     +10 %     +20 %
Estimated fair value
  $ 320,753     $ 325,524     $ 335,189     $ 339,974  
Change in estimated fair value:
                               
Amount
  $ (8,145 )   $ (3,374 )   $ 6,291     $ 11,076  
%
    -2.5 %     -1.0 %     1.9 %     3.4 %
 
(A)
Excludes our share of the non-Excess MSR net assets of the equity method investees of $10.2 million.
 
The sensitivity analysis is hypothetical and should be used with caution. In particular, the results are calculated by stressing a particular economic assumption independent of changes in any other assumption; in practice, changes in one factor may result in changes in another, which might counteract or amplify the sensitivities. Also, changes in the fair value based on a 10% variation in an assumption generally may not be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear.
 
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Investments in Equity Method Investees
 
We account for our interests in entities over which we exercise significant influence, but with respect to which the requirements for consolidation are not met, as investments in equity method investees. These investments are recorded based on the equity method of accounting, unless we elect to measure them at fair value.
 
We have elected to measure our investments in equity method investees which are invested in Excess MSRs at fair value. The equity method investees have also elected to measure their investments in Excess MSRs at fair value.
 
Purchase Accounting
 
The acquisition of the senior living assets and the liabilities assumed were recorded at fair value. 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 preacquisition due diligence, marketing, leasing activities, and independent appraisals. Management allocated the purchase price to net tangible and identified intangible assets acquired and liabilities assumed based on their fair values as of the acquisition date. The determination of fair value involved the use of significant judgment and estimation.
 
Impairment of Investments in Real Estate and Residential Lease Intangibles
 
We own senior living assets held for investment. Intangibles and long-lived assets are tested for potential impairment annually or when changes in circumstances indicate the carrying value may not be recoverable. Indicators of impairment include material adverse changes in the projected revenues and expenses, significant underperformance relative to historical or projected future operating results, and significant negative industry or economic trends. An impairment is determined to have occurred if the future net undiscounted cash flows expected to be generated is less than the carrying value of an asset.
 
The impairment is measured as the difference between the carrying value and the fair value. Significant judgment is required both in determining impairment and in estimating the fair value. We may use assumptions and estimates derived from a review of our operating results, business projections, expected growth rates, discount rates, and tax rates. We also make certain assumptions about future economic conditions, interest rates, and other market data. Many of the factors used in these assumptions and estimates are outside the control of management, and can change in future periods.
 
Rental Income, Care and Ancillary Income
 
We record rental revenue, care and ancillary income as they become due as provided for in the leases.
 
Recent Accounting Pronouncements
 
In February 2013, the FASB issued new guidance regarding the reporting of reclassifications out of accumulated other comprehensive income. The new guidance does not change current requirements for reporting net income or other comprehensive income in financial statements. However, it requires companies to present the effects on the line items of net income of significant amounts reclassified out of accumulated OCI if the item reclassified is required to be reclassified to net income in its entirety during the same reporting period. Presentation should occur either on the face of the income statement where net income is presented, or in the notes to the financial statements. Newcastle has early adopted this accounting standard and opted to present this information in a note to the financial statements.
 
The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, the definition of an investment company, financial statement presentation, revenue recognition, leases, financial instruments, hedging, and contingencies. Some of the proposed changes are significant and could have a material impact on Newcastle’s reporting. Newcastle has not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.

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RESULTS OF OPERATIONS
 
The following table summarizes the changes in our results of operations for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 (dollars in thousands):
 
   
Three Months Ended
             
   
March 31,
   
Increase (Decrease)
 
   
2013
   
2012
   
Amount
   
%
 
Interest income
  $ 71,367     $ 74,899     $ (3,532 )     (4.7 %)
Interest expense
    22,710       30,165       (7,455 )     (24.7 %)
Net interest income
    48,657       44,734       3,923       8.8 %
Impairment (Reversal)
                               
Valuation allowance (reversal) on loans
    2,234       (9,031 )     11,265       124.7 %
Other-than-temporary impairment on securities, net
    539       1,951       (1,412 )     (72.4 %)
      2,773       (7,080 )     9,853       139.2 %
Net interest income (loss) after impairment/reversal
    45,884       51,814       (5,930 )     (11.4 %)
Other Revenues
    13,500       509       12,991    
N.M.
 
                                 
Other Income (Loss)
                               
Gain (loss) on settlement of investments, net
    (3 )     4,823       (4,826 )     (100.1 %)
Gain on extinguishment of debt
    1,206       20,743       (19,537 )     (94.2 %)
Change in fair value of investments in excess mortgage servicing rights
    1,858       1,216       642    
N.M.
 
Change in fair value of investments in equity method investees
    969             969    
N.M.
 
Other income (loss), net
    4,567       2,970       1,597       53.8 %
      8,597       29,752       (21,155 )     (71.1 %)
Expenses
                               
Loan and security servicing expense
    1,034       1,098       (64 )     (5.8 %)
Property operating expenses
    8,363       225       8,138    
N.M.
 
General and administrative expense
    6,911       2,286       4,625       202.3 %
Management fee to affiliate
    9,565       4,976       4,589       92.2 %
Depreciation and amortization
    4,079       2       4,077    
N.M.
 
      29,952       8,587       21,365       248.8 %
Income (loss) from continuing operations
  $ 38,029     $ 73,488     $ (35,459 )     (48.3 %)
 
N.M. – Not meaningful.
 
Interest Income
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
Interest income decreased by $3.5 million during the three months ended March 31, 2013 compared to the three months ended March 31, 2012 primarily due to a $23.4 million net decrease in interest income as a result of the deconsolidation of CDO X in September 2012, partially offset by $11.9 million and $8.0 million net increases in interest income as a result of new investments and investments in Excess MSRs, respectively.
 
Interest Expense
 
Three Months ended March 31, 2013 compared to the three months ended March 31, 2012
 
Interest expense decreased by $7.5 million primarily due to (i) a $2.2 million decrease in interest expense on debt as a result of the paydowns and repurchases of our CDO debt obligations and the deconsolidation of CDO X in September 2012 and (ii) an $8.4 million decrease in interest expense on derivatives as a result of the termination of interest rate swaps, decreases in swap notional amounts, and changes in interest rates. The decreases described in (i) and (ii) above were partially offset by a $1.2 million increase in mortgage interest expense as a result of the acquisition of senior living assets in July 2012 and a $1.9 million net increase in interest expense primarily due to a higher outstanding balance of repurchase agreement financing on our FNMA/FHLMC securities and non-agency RMBS.
 
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Valuation Allowance (Reversal) on Loans
 
Three Months ended March 31, 2013 compared to the three months ended March 31, 2012
 
The valuation allowance (reversal) on loans changed by $11.3 million primarily due to an $11.9 million change related to our real estate loans during the three months ended March 31, 2013 as compared to the three months ended March 31, 2012.  This change was a result of write-downs recorded in the 2013 period as compared to a reversal of the valuation allowance recorded during the 2012 period as a result of the general improvement in market conditions during the 2012 period.  This change was partially offset by a $0.7 million lower net valuation allowance on our manufactured housing loans and residential mortgage loans in the 2013 period than in the 2012 period as a result of market conditions improving more in the 2013 period than in the 2012 period.
 
Other-than-temporary Impairment on Securities, Net
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
The other-than-temporary impairment on securities decreased by $1.4 million primarily due to market conditions improving in the quarter ended March 2013.  We recorded an impairment charge of $0.5 million on 1 security during the quarter ended March 31, 2013, compared to an impairment charge of $2.0 million on 5 securities during the quarter ended March 31, 2012.
 
Other Revenues
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
The other revenues increased by $13.0 million primarily due to the acquisitions of the senior living assets since July 2012.
 
Gain (Loss) on Settlement of Investments, Net
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
The net gain on settlement of investments decreased by $4.8 million as a result of the decreased volume of sales and repayments of investments during the quarter ended March 31, 2013 as compared to the quarter ended March 31, 2012.  We recorded a net gain of $4.8 million on 10 securities and loans that were sold or paid off during the quarter ended March 31, 2012, compared to a minimal loss on settlement of investments recorded for the quarter ended March 31, 2013.
 
Gain (Loss) on Extinguishment of Debt
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
The gain on extinguishment of debt decreased by $19.5 million due to a lower face amount and a higher average price of debt repurchased in the three months ended March 31, 2013 compared to the three months ended March 31, 2012. We repurchased $10.9 million face amount of our own CDO debt at an average price of 88.8% of par during the three months ended March 31, 2013 compared to $30.0 million face amount of CDO bonds and other bonds payable repurchased at an average price of 30.5% of par during the three months ended March 31, 2012.
 
Change in Fair Value of Investments in Excess Mortgage Servicing Rights
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
The change in fair value of investments in excess mortgage servicing rights increased $0.6 million due to the acquisition of investments since March 2012 and subsequent net increases in value.
 
Change in Fair Value of Investments in Equity Method Investees
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
The change in fair value of investments in equity method investees increased $1.0 million due to the acquisition of these investments in the first quarter of 2013 and subsequent net increases in value.
 
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Other Income (Loss), Net
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
Other income increased by $1.6 million primarily due to (i) a $1.1 million greater increase in the fair value of certain non-hedge interest rate swap agreements as a result of changes in interest rates in the quarter ended March 31, 2013 compared to the quarter ended March 31, 2012 and (ii) an increase in other income related to cash received from a real estate loan.
 
Loan and Security Servicing Expense
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
Loan and security servicing expense remained relatively stable during the three months ended March 31, 2013 compared to the three months ended March 31, 2012.
 
Property Operating Expenses
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
The property operating expenses increased $8.1 million due to the acquisitions of the senior living assets since July 2012.
 
General and Administrative Expense
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
General and administrative expense increased by $4.6 million primarily due to an increase in professional fees related to the potential separation transaction and the investments in consumer loans, senior living assets and other investments.
 
Management Fee to Affiliate
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
Management fees increased by $4.6 million primarily due to (i) an increase in gross equity as a result of our public offerings of common stock in 2012 and 2013, and (ii) an increase in property management fees in connection with the acquisitions of senior living assets since July 2012.
 
Depreciation and Amortization
 
Three months ended March 31, 2013 compared to the three months ended March 31, 2012
 
The depreciation and amortization expense increased $4.1 million due to the acquisitions of the senior living assets since July 2012.
 
LIQUIDITY AND CAPITAL RESOURCES
 
Overview
 
Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, and other general business needs.  Additionally, to maintain our status as a REIT under the Code, we must distribute annually at least 90% of our REIT taxable income. As of December 31, 2011, we had a loss carryforward, inclusive of net operating loss and capital loss, of approximately $896.8 million. The net operating loss carryforward and capital loss carryforward can generally be used to offset future ordinary taxable income and capital gain, for up to twenty years and five years, respectively. As a result, we do not expect that there will be any REIT distribution requirements for the year ended December 31, 2012. In January 2013, we experienced an “ownership change” for purposes of Section 382 of the Code, which limits our ability to utilize our net operating loss and net capital loss carryforwards to reduce our future taxable income and potentially increases our related REIT distribution requirement. We do not believe that the limitation as a result of the January 2013 ownership change will prevent us from satisfying our REIT distribution requirement for the current year and future years. No assurance, however, can be given that we will be able to satisfy our distribution requirement following a current or future ownership change or otherwise. We note that a portion of this requirement may be able to be met in future years through stock dividends, rather than cash, subject to limitations based on the value of our stock.
 
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Our primary sources of funds for liquidity consist of net cash provided by operating activities, sales or repayments of investments, potential refinancing of existing debt, and the issuance of equity securities, when feasible. We have an effective shelf registration statement with the SEC, which allows us to issue common stock, preferred stock, depository shares, debt securities and warrants. Our debt obligations are generally secured directly by our investment assets, except for the junior subordinated notes payable.
 
Sources of Liquidity and Uses of Capital
 
As of the date of this filing, we have sufficient liquid assets, which include unrestricted cash and FNMA/FHLMC securities, to satisfy all of our short-term recourse liabilities. Our junior subordinated notes payable are long-term obligations. With respect to the next twelve months, we expect that our cash on hand combined with our cash flow provided by operations will be sufficient to satisfy our anticipated liquidity needs with respect to our current investment portfolio, including related financings, hedging activity, potential margin calls and operating expenses.  While it is inherently more difficult to forecast beyond the next twelve months, we currently expect to meet our long-term liquidity requirements, specifically the repayment of our recourse debt obligations, through our cash on hand and, if needed, additional borrowings, proceeds received from repurchase agreements and similar financings, proceeds from equity offerings and the liquidation or refinancing of our assets.
 
These short-term and long-term expectations are forward-looking and subject to a number of uncertainties and assumptions, which are described below under “–Factors That Could Impact Our Liquidity, Capital Resources and Capital Obligations” as well as Part I, Item 1A, “Risk Factors.”  If our assumptions about our liquidity prove to be incorrect, we could be subject to a shortfall in liquidity in the future, and this short-fall may occur rapidly and with little or no notice, which would limit our ability to address the shortfall on a timely basis.
 
Cash flow provided by operations constitutes a critical component of our liquidity.  Essentially, our cash flow provided by operations is equal to (i) the net cash flow from our CDOs that have not failed their over collateralization or interest coverage tests, plus (ii) the net cash flow from our non-CDO investments that are not subject to mandatory debt repayment, including excess mortgage servicing income, principal and sales proceeds, (iii) revenues received from our senior living portfolios, less (iv) operating expenses (primarily management fees, property operating expenses, professional fees and insurance), less (v) interest on the junior subordinated notes payable and less (vi) preferred dividends.
 
Our cash flow provided by operations differs from our net income (loss) due to these primary factors: (i) accretion of discount or premium on our real estate securities and loans (including the accrual of interest and fees payable at maturity), discount on our debt obligations, deferred financing costs, and deferred hedge gains and losses, (ii) gains and losses from sales of assets financed with CDOs, (iii) the valuation allowance recorded in connection with our loan assets, as well as other-than-temporary impairment on our securities, (iv) unrealized gains or losses on our non-hedge derivatives and Excess MSRs owned directly and through equity method investees, (v) the non-cash gains or losses associated with our early extinguishment of debt, (vi) depreciation and amortization, and (vii) net income (loss) generated within CDOs that have failed their over collateralization or interest coverage tests. Proceeds from the sale of assets which serve as collateral for our CDO financings, including gains thereon, are required to be retained in the CDO structure until the related bonds are retired and are, therefore, not available to fund current cash needs outside of these structures.
 
Update on Liquidity, Capital Resources and Capital Obligations
 
Certain details regarding our liquidity, current financings and capital obligations as of May 2, 2013 are set forth below:
 
  Unrestricted Cash Available to Invest after Commitments - We are currently fully invested after commitments;
 
 
Margin Exposure and Recourse Financings – We have margin exposure on a $299.3 million repurchase agreement related to the financing of non-Agency RMBS and a $1.3 billion repurchase agreement related to the financing of FNMA/FHLMC securities.
 
The following table compares our recourse financings excluding the junior subordinated notes (in thousands):
 
Recourse Financings
 
May 2, 2013
   
March 31, 2013
   
December 31, 2012
 
CDO Securities
  $     $     $ 1,415  
                         
   Non-agency RMBS
  299.278       158,029       150,922  
   Non-FNMA/FHLMC recourse financings
    299.278       158,029       152,337  
                         
FNMA/FHLMC securities
    1,307,794       1,315,557       772,855  
   Total recourse financings
  $ 1.607,072     $ 1,473,586     $ 925,192  
 
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The non-agency RMBS recourse financing will mature in July 2013. The FNMA/FHLMC recourse financing will mature in May 2013.
 
 
Mortgage Notes Payable – We have $120.5 million mortgage notes payable related to the financing of the senior living assets.  These financings are secured by first lien security interests in the senior living properties, have no recourse to the general credit of Newcastle and will mature between October 2017 and August 2019.
 
We have not incurred any financing on our investments in Excess MSRs.  Our liquidity will be impacted by our decision and ability to borrow and access capital to finance any existing and future Excess MSR investments.
 
It is important for readers to understand that our liquidity, available capital resources and capital obligations could change rapidly due to a variety of factors, many of which are beyond our control.  Set forth below is a discussion of some of the factors that could impact our liquidity, available capital resources and capital obligations.
 
Factors That Could Impact Our Liquidity, Capital Resources and Capital Obligations
 
We refer readers to our discussions in other sections of this report for the following information:
 
 
For a further discussion of recent trends and events affecting our liquidity, see “– Market Considerations” above;
 
As described above, under “– Update on Liquidity, Capital Resources and Capital Obligations,” we are subject to margin calls in connection with our repurchase agreements;
 
Our match funded investments are financed long term, and their credit status is continuously monitored, which is described under “Quantitative and Qualitative Disclosures About Market Risk — Interest Rate Exposure’’ below.  Our remaining investments, generally financed with short term debt or short term repurchase agreements, are also subject to refinancing risk upon the maturity of the related debt.  See “– Debt Obligations” below; and
 
For a further discussion of a number of risks that could affect our liquidity, access to capital resources and our capital obligations, see Part I, Item 1A, “Risk Factors” above.
 
In addition to the information referenced above, the following factors could affect our liquidity, access to capital resources and our capital obligations. As such, if their outcomes do not fall within our expectations, changes in these factors could negatively affect our liquidity.
 
 
Access to Financing from Counterparties – Decisions by investors, counterparties and lenders to enter into transactions with us will depend upon a number of factors, such as our historical and projected financial performance, compliance with the terms of our current credit and derivative arrangements, industry and market trends, the availability of capital and our investors’, counterparties’ and lenders’ policies and rates applicable thereto, and the relative attractiveness of alternative investment or lending opportunities.  Recent conditions and events have limited the array of capital resources available to us and made the terms of capital resources we are able to obtain generally less favorable to us relative to the terms we were able to obtain prior to the onset of challenging conditions. Our business strategy is dependent upon our ability to finance our real estate securities, loans and other real estate related assets at rates that provide a positive net spread.  Currently, spreads for such liabilities have widened relative to historical levels and demand for such liabilities remains lower than the demand prior to the onset of challenging market conditions.
 
Impact of Rating Downgrades on CDO Cash Flows – Ratings downgrades of assets in our CDOs can negatively impact compliance with the CDOs’ over collateralization tests. Generally, the over collateralization test measures the principal balance of the specified pool of assets in a CDO against the corresponding liabilities issued by the CDO. However, based on ratings downgrades, the principal balance of an asset or of a specified percentage of assets in a CDO may be deemed to be reduced below their current balance to levels set forth in the related CDO documents for purposes of calculating the over collateralization test.  As a result, ratings downgrades can reduce the assumed principal balance of the assets used in the over collateralization test relative to the corresponding liabilities in the test, thereby reducing the over collateralization percentage. In addition, actual defaults of assets would also negatively impact compliance with the over collateralization tests. Failure to satisfy an over collateralization test could result in the redirection of cashflows, or, in certain cases, in the potential removal of Newcastle as collateral manager of the affected CDO. See “– Debt Obligations” below for a summary of assets on negative watch for possible downgrade in our CDOs.
 
Impact of Expected Repayment or Forecasted Sale on Cash Flows – The timing of and proceeds from the repayment or sale of certain investments may be different than expected or may not occur as expected. Proceeds from sales of assets in the current illiquid market environment are unpredictable and may vary materially from their estimated fair value and their carrying value.
 
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Investment Portfolio
 
The following summarizes our consolidated investment portfolio at March 31, 2013 (dollars in millions).
 
   
Outstanding
Face Amount
   
Amortized
Cost Basis (1)
   
Percentage of
Total
Amortized
Cost Basis
   
Carrying
Value
   
Number of
Investments
   
Credit (2)
   
Weighted
Average Life
(years) (3)
 
Investment (11)
                                         
I. New Residential Investment Corp. Assets
 (New Residential)
                                     
   Excess MSRs Investments (4)
    329       319       7.9 %     329       8             5.7  
   Non-Agency RMBS (5)
    784       489       12.0 %     519       53    
CC
      7.6  
   FNMA/FHLMC Securities (6)
    1,020       1,079       26.6 %     1,080       53    
AAA
      4.1  
   Reverse Mortgage Loans
    59       35       0.9 %     35       331             3.9  
Total New Residential Assets
    2,192       1,922       47.4 %     1,963                       5.6  
                                                         
II. Commercial Real Estate Debt & Other Assets
                                                 
 Commercial Assets
                                                       
   CMBS
  $ 469     $ 332       8.2 %   $ 384       75    
BB-
      3.0  
   Mezzanine Loans
    518       432       10.6 %     432       17       77 %     1.5  
   B-Notes
    121       111       2.7 %     111       5       77 %     1.1  
   Whole Loans
    30       30       0.7 %     30       2       48 %     0.9  
   CDO Securities (7)
    94       67       1.7 %     72       5    
BB
      3.0  
   Other Investments (8)
    25       25       0.6 %     25       1              
   Total Commercial Assets
    1,257       997       24.5 %     1,054                       2.1  
                                                         
 Residential Assets
                                                       
   MH and Residential Loans
    319       279       6.9 %     279       8,595       704       5.9  
   Non-Agency RMBS
    121       47       1.2 %     65       40    
CCC
      4.8  
   Real Estate ABS
    10       1       0.0 %     1       3    
CCC-
      4.7  
      450       327       8.1 %     345                       5.6  
   FNMA/FHLMC securities
    290       305       7.5 %     308       30    
AAA
      4.3  
   Total Residential Assets
    740       632       15.6 %     653                       5.1  
                                                         
 Corporate Assets
                                                       
   REIT Debt
    51       50       1.2 %     54       8    
BBB-
      1.8  
   Corporate Bank Loans
    582       278       6.9 %     278       7    
CC
      1.8  
   Total Corporate Assets
    633       328       8.1 %     332                       1.8  
                                                         
Senior Living Properties Investments(9)
    188       178       4.4 %     178       12              
                                                         
Total Commercial Real Estate Debt &
 Other Assets
    2,818       2,135       52.6 %     2,217                       2.9  
TOTAL / WA
  $ 5,010     $ 4,057       100.0 %   $ 4,180                       4.1  
                                                         
Reconciliation to GAAP total assets:
                                                       
  Subprime mortgage loans subject to call option (10)
                      405                          
      Other commercial real estate
                            7                          
      Cash and restricted cash
                            546                          
      Other
                            58                          
GAAP total assets
                          $ 5,196                          
 
WA – Weighted average, in all tables.
 
 
(1)
Net of impairment.
 
(2)
Credit represents the weighted average of minimum rating for rated assets, the loan-to-value ratio (based on the appraised value at the time of purchase or refinancing) for non-rated commercial assets, or the FICO score for non-rated residential assets and an implied AAA rating for FNMA/FHLMC securities. Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any time.
 
(3)
Weighted average life is based on the timing of expected principal reduction on the asset.
  (4) Represents excess MSR investments made directly and through equity method investees, excluding our share of the non-excess MSR net assets of the equity method investees.
 
(5)
Represents non-Agency RMBS purchased outside of our CDOs since April 2012. These non-Agency RMBS will be assets of New Residential subsequent to the spin-off.
 
(6)
Represents Agency RMBS contributed to New Residential Investment Corp. (including contributions made subsequent to March 31, 2013.)
 
(7)
Represents non-consolidated CDO securities, excluding eight securities with a zero value, which had an aggregate face amount of $108 million.
59
 

 

 
 
(8)
Represents an equity investment in a real estate owned property.
 
(9)
Face amount of senior living property investments represents the gross carrying amount, which excludes accumulated depreciation and amortization.
 
(10)
Our subprime mortgage loans subject to call option are excluded from the statistics because they result from an option, not an obligation, to repurchase such loans, are noneconomic until such option is exercised, and are offset by an equal liability on the consolidated balance sheet.
 
(11)
The following tables summarize certain supplemental data relating to our investments (dollars in tables in thousands):
 
Excess MSRs
 
The following table summarizes the collateral characteristics of the loans underlying our direct Excess MSR investments at March 31, 2013.  For each of these pools, we invested in a 65% interest in the Excess MSRs :
 
         
Collateral Characteristics
 
   
Current Carrying Amount
   
Original
Principal
 Balance
   
Current
Principal
 Balance
   
Number
of Loans
   
WA
FICO
Score
(A)
   
WA Coupon
   
WA Maturity (months)
   
Average Loan
Age (months)
   
Adjustable
Rate
Mortgage %
(B)
   
1 Month
CPR (C)
   
1 Month
CRR (D)
   
1 Month CDR (E)
   
1 Month
Recapture
Rate
 
Pool 1
                                                                             
Original Pool
  $ 32,360     $ 9,940,385     $ 7,309,445       50,281       680       5.8 %     279       77       19.4 %     29.1 %     25.9 %     4.3 %     47.7 %
Recaptured Loans
    2,973             712,344       3,516       749       4.3 %     319       7       0.2 %     1.7 %     1.7 %     0.0 %     0.0 %
Recapture
    Agreements
    4,355                                                                          
      39,688       9,940,385       8,021,789       53,797       686       5.7 %     283       71       17.7 %     27.3 %     24.3 %     3.9 %     47.5 %
                                                                                                         
Pool 2
                                                                                                       
Original Pool
    31,685       10,383,891       8,614,840       44,555       675       5.1 %     317       67       10.9 %     27.6 %     24.1 %     4.6 %     57.5 %
Recaptured Loans
    2,010             423,217       2,030       755       4.2 %     332       3       0.0 %     0.3 %     0.3 %     0.0 %     0.0 %
Recapture
   Agreements
    4,880                                                                          
      38,575       10,383,891       9,038,057       46,585       679       5.0 %     318       64       10.4 %     26.8 %     23.4 %     4.4 %     57.5 %
                                                                                                         
Pool 3
                                                                                                       
Original Pool
    29,421       9,844,114       8,594,053       53,113       677       4.5 %     288       90       37.9 %     18.6 %     15.4 %     3.8 %     48.5 %
Recaptured Loans
    705             164,636       961       752       4.1 %     331       2       0.1 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture
   Agreements
    4,552                                                                          
      34,678       9,844,114       8,758,689       54,074       678       4.5 %     289       88       37.2 %     18.4 %     15.2 %     3.7 %     48.5 %
                                                                                                         
Pool 4
                                                                                                       
Original Pool
    11,739       6,250,549       5,533,266       27,486       673       3.6 %     311       81       58.0 %     17.4 %     8.5 %     9.6 %     39.2 %
Recaptured Loans
    230             53,585       268       756       4.2 %     345       3       8.1 %     0.3 %     0.3 %     0.0 %     0.0 %
Recapture
    Agreements
    2,705                                                                          
      14,674       6,250,549       5,586,851       27,754       674       3.6 %     311       80       57.5 %     17.3 %     8.4 %     9.6 %     39.2 %
                                                                                                         
Pool 5
                                                                                                       
Original Pool
    104,437       47,572,905       41,901,133       178,958       652       4.7 %     290       86       56.7 %     15.9 %     5.1 %     11.4 %     2.1 %
Recapture Loans
    70             16,373       63       749       3.6 %     333       2       5.9 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture
    Agreements
    4,433                                                                          
      108,940       47,572,905       41,917,506       179,021       652       4.7 %     290       86       56.7 %     15.9 %     5.1 %     11.4 %     2.1 %
Total/WA
  $ 236,555     $ 83,991,844     $ 73,322,892       361,231       664       4.7 %     294       81       44.4 %     18.9 %     10.9 %     8.7 %     36.0 %
 
Continued on next page.

60
 

 


   
Collateral Characteristics
 
   
Uncollected
Payments (F)
   
Delinquency
30 Days (F)
   
Delinquency 60 Days (F)
   
Delinquency 90+ Days (F)
   
Loans in
Foreclosure
   
Real
Estate
Owned
   
Loans in
Bankruptcy
 
Pool 1
                                         
Original Pool
    9.2 %     5.1 %     1.8 %     1.1 %     4.3 %     0.9 %     2.7 %
Recaptured Loans
    0.1 %     0.2 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture Agreements
                                         
      8.4 %     4.7 %     1.6 %     1.0 %     3.9 %     0.8 %     2.5 %
                                                         
Pool 2
                                                       
Original Pool
    13.4 %     4.5 %     1.9 %     1.5 %     7.7 %     0.6 %     5.1 %
Recaptured Loans
    0.0 %     0.1 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture Agreements
                                         
      12.8 %     4.3 %     1.8 %     1.4 %     7.3 %     0.6 %     4.9 %
                                                         
Pool 3
                                                       
Original Pool
    13.4 %     4.1 %     1.4 %     1.1 %     7.7 %     2.1 %     3.2 %
Recaptured Loans
    0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture Agreements
                                         
      13.1 %     4.0 %     1.4 %     1.1 %     7.6 %     2.1 %     3.1 %
                                                         
Pool 4
                                                       
Original Pool
    17.5 %     3.5 %     1.5 %     1.1 %     11.5 %     1.9 %     4.4 %
Recaptured Loans
    0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture Agreements
                                         
      17.3 %     3.5 %     1.5 %     1.1 %     11.4 %     1.9 %     4.4 %
                                                         
Pool 5
                                                       
Original Pool
    27.0 %     9.5 %     2.1 %     4.0 %     16.9 %     2.3 %     4.7 %
Recapture Loans
    0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture Agreements
                                         
      27.0 %     9.5 %     2.1 %     4.0 %     16.9 %     2.3 %     4.7 %
Total/WA
    20.8 %     7.2 %     1.9 %     2.8 %     12.8 %     1.9 %     4.3 %
 
(A)
Weighted average FICO scores are reported based on information provided by the loan servicer on a monthly basis. The loan servicer generally updates the FICO score on a monthly basis.
(B) 
Adjustable Rate Mortgage % represents the percentage of the total principal balance of the pool that corresponds to adjustable rate mortgages.
(C) 
Constant prepayment rate represents the annualized rate of the prepayments during the month as a percentage of the total principal balance of the pool.
(D)
1 Month CRR, or the voluntary prepayment rate, represents the annualized rate of the voluntary prepayments during the month as a percentage of the total principal balance of the pool.
(E)
1 Month CDR, or the involuntary prepayment rate, represents the annualized rate of the involuntary prepayments (defaults) during the month as a percentage of the total principal balance of the pool.
(F)
Uncollected Payments represents the percentage of the total principal balance of the pool that corresponds to loans for which the most recent payment was not made. Delinquency 30 Days, Delinquency 60 Days and Delinquency 90+ Days represent the percentage of the total principal balance of the pool that corresponds to loans that are delinquent by 30-59 days, 60-89 days or more than 90 days, respectively.
 
61
 

 


The following table summarizes the collateral characteristics of the loans underlying Excess MSR investments made through equity method investees at March 31, 2013. For each of these pools, we own a 50% interest in an entity that invested in a 67% interest in the Excess MSRs.
 
         
Collateral Characteristics
 
   
Current Carrying Amount
   
Original
Principal
 Balance
   
Current
Principal
 Balance
   
Number
of Loans
   
WA
FICO
Score
(A)
   
WA Coupon
   
WA Maturity (months)
   
Average
Loan
Age
(months)
   
Adjustable
Rate
Mortgage %
(B)
   
1 Month
CPR (C)
   
1 Month
CRR (D)
   
1 Month CDR (E)
   
1 Month
Recapture
Rate
 
Pool 6
                                                                             
Original Pool
    41,329       12,987,190       11,795,608       80,783       662       5.6 %     310       50       0.0 %     26.8 %     23.2 %     4.6 %     5.2 %
Recaptured Loans
    124             25,964       132       714       3.5 %     358       1       0.0 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture Agreements
    10,972                                                                          
      52,425       12,987,190       11,821,572       80,915       662       5.6 %     310       50       0.0 %     26.8 %     23.2 %     4.6 %     5.2 %
                                                                                                         
Pool 7
                                                                                                       
Original Pool
    109,048       37,965,199       37,234,201       264,617       711       5.2 %     286       76       23.2 %     18.6 %     18.2 %     0.4 %     N/A  
Recaptured Loans
                                  0.0 %                 0.0 %     0.0 %     0.0 %     0.0 %     N/A  
Recapture Agreements
    23,164                                                                          
      132,212       37,965,199       37,234,201       264,617       711       5.2 %     286       76       23.2 %     18.6 %     18.2 %     0.4 %     N/A  
                                                                                                         
Pool 8
                                                                                                       
Original Pool
    57,177       17,622,383       17,104,429       110,075       719       5.5 %     295       68       14.1 %     28.4 %     26.9 %     2.1 %     N/A  
Recapture Loans
                                  0.0 %                 0.0 %     0.0 %     0.0 %     0.0 %     N/A  
Recapture Agreements
    13,150                                                                          
      70,327       17,622,383       17,104,429       110,075       719       5.5 %     295       68       14.1 %     28.4 %     26.9 %     2.1 %     N/A  
Total/WA
  $ 254,964     $ 68,574,772     $ 66,160,202       455,607       704       5.3 %     293       69       16.7 %     22.6 %     21.3 %     1.6 %     5.2 %
 
Continued on next page.

62
 

 


   
Collateral Characteristics
 
   
Uncollected
Payments (F)
   
Delinquency
30 Days (F)
   
Delinquency 60 Days (F)
   
Delinquency 90+ Days (F)
   
Loans in
Foreclosure
   
Real
Estate
Owned
   
Loans in
Bankruptcy
 
Pool 6
                                         
Original Pool
    11.1 %     5.5 %     1.4 %     2.4 %     6.2 %     0.5 %     2.1 %
Recaptured Loans
    0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture Agreements
                                         
      11.1 %     5.5 %     1.4 %     2.4 %     6.2 %     0.5 %     2.1 %
                                                         
Pool 7
                                                       
Original Pool (G)
    13.0 %     1.1 %     0.5 %     6.1 %     6.5 %     0.0 %     3.8 %
Recaptured Loans
    0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture Agreements
                                         
      13.0 %     1.1 %     0.5 %     6.1 %     6.5 %     0.0 %     3.8 %
                                                         
Pool 8
                                                       
Original Pool (G)
    11.6 %     3.2 %     1.2 %     5.6 %     4.3 %     0.0 %     3.1 %
Recapture Loans
    0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %     0.0 %
Recapture Agreements
                                         
      11.6 %     3.2 %     1.2 %     5.6 %     4.3 %     0.0 %     3.1 %
Total/WA
    12.3 %     2.4 %     0.8 %     5.3 %     5.9 %     0.1 %     3.3 %
 
(A)
Weighted average FICO scores are reported based on information provided by the loan servicer on a monthly basis. The loan servicer generally updates the FICO score on a monthly basis.
(B)
Adjustable Rate Mortgage % represents the percentage of the total principal balance of the pool that corresponds to adjustable rate mortgages.
(C)
Constant prepayment rate represents the annualized rate of the prepayments during the month as a percentage of the total principal balance of the pool.
(D)
1 Month CRR, or the voluntary prepayment rate, represents the annualized rate of the voluntary prepayments during the month as a percentage of the total principal balance of the pool.
(E)
1 Month CDR, or the involuntary prepayment rate, represents the annualized rate of the involuntary prepayments (defaults) during the month as a percentage of the total principal balance of the pool.
(F)
Uncollected Payments represents the percentage of the total principal balance of the pool that corresponds to loans for which the most recent payment was not made. Delinquency 30 Days, Delinquency 60 Days and Delinquency 90+ Days represent the percentage of the total principal balance of the pool that corresponds to loans that are delinquent by 30-59 days, 60-89 days or more than 90 days, respectively.
(G)
Collateral information shown as of February 28, 2013.
 
63
 

 


Non-Agency RMBS (A)
 
   
Security Characteristics
 
Vintage (B)
 
Average
 Minimum
 Rating (C)
   
Number of
Securities
   
Outstanding
Face Amount
   
Amortized
Cost Basis
   
Percentage of
Total
Amortized Cost
Basis
   
Carrying
Value
   
Principal
Subordination
(D)
   
Excess
Spread (E)
 
Pre 2004
 
CCC-
      14     $ 28,115     $ 21,804       4.5 %   $ 23,328       19.6 %     3.8 %
2004
   B-       6       45,763       25,000       5.1 %     29,551       17.6 %     3.7 %
2005
 
CC
      3       35,749       21,443       4.4 %     21,785       12.2 %     2.1 %
2006
 
CC
      15       451,500       278,658       57.0 %     292,475       5.1 %     3.4 %
2007 and later
 
CC
      15       223,132       142,144       29.0 %     151,429       8.8 %     3.4 %
Total/WA
 
CC
      53     $ 784,259     $ 489,049       100.0 %   $ 518,568       7.7 %     3.4 %
 
   
Collateral Characteristics
 
Vintage (B)
 
Average Loan Age
(years)
   
Collateral
Factor (F)
   
3 month CPR
(G)
   
Delinquency (H)
   
Cumulative Losses to
Date
 
Pre 2004
    10.0       0.07       10.7 %     18.0 %     3.4 %
2004
    8.8       0.09       8.4 %     20.3 %     4.0 %
2005
    7.8       0.15       12.7 %     21.0 %     13.9 %
2006
    6.8       0.28       14.7 %     31.0 %     24.3 %
2007 and later
    6.3       0.41       13.9 %     33.7 %     28.5 %
Total / WA
    6.9       0.29       13.9 %     30.2 %     23.1 %
 
(A)
Represents non-Agency RMBS purchased outside of our CDOs since April 2012. These non-Agency RMBS will be assets of New Residential subsequent to the spin-off.
(B)
The year in which the securities were issued.
(C)
Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any time. We had no assets that were on negative watch for possible downgrade by at least one rating agency as of March 31, 2013.
(D)
The percentage of the outstanding face amount of securities and residual interests that is subordinate to our investments.
(E)
The annualized amount of interest received on the underlying loans in excess of the interest paid on the securities, as a percentage of the outstanding collateral balance.
(F)
The ratio of original unpaid principal balance of loans still outstanding.
(G)
Three month average constant prepayment rate.
(H)
The percentage of underlying loans that are 90+ days delinquent, or in foreclosure or considered real estate owned (REO).
 
CMBS
 
Deal Vintage (A)
 
Average
Minimum
Rating (B)
   
Number
   
Outstanding Face Amount
   
Amortized Cost Basis
   
Percentage of Total Amortized Cost Basis
   
Carrying Value
   
Delinquency
60+/FC/REO
(C)
   
Principal Subordination (D)
   
Weighted Average Life (years) (E)
 
Pre 2004
  B       16     $ 57,478     $ 51,805       15.6 %   $ 49,148       11.7 %     18.3 %     0.9  
2004
 
BB+
      17       79,419       69,408       20.9 %     72,392       1.6 %     5.4 %     1.7  
2005
 
BB-
      9       80,133       30,398       9.2 %     53,176       5.1 %     6.6 %     2.5  
2006
  B+       21       148,397       95,690       28.8 %     109,372       9.0 %     13.7 %     3.0  
2007
 
CCC+
      4       15,237       2,540       0.8 %     5,098       4.9 %     6.8 %     1.4  
2010
 
BB
      3       35,000       33,037       9.9 %     38,209       0.0 %     2.0 %     7.6  
2011
 
BB+
      5       52,920       49,214       14.8 %     56,620       0.0 %     3.8 %     5.2  
Total / WA
 
BB-
      75     $ 468,584     $ 332,092       100.0 %   $ 384,015       5.6 %     9.4 %     3.0  
 
(A)
The year in which the securities were issued.
(B)
Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any time. We had no CMBS assets that were on negative watch for possible downgrade by at least one rating agency as of March 31, 2013.
(C)
The percentage of underlying loans that are 60+ days delinquent, in foreclosure or considered real estate owned (REO).
(D)
The percentage of the outstanding face amount of securities that is subordinate to our investments.
(E)
Weighted average life is based on the timing of expected principal reduction on the asset.
 
64
 

 


Mezzanine Loans, B-Notes and Whole Loans
 
Asset Type
 
Number
   
Outstanding
Face Amount
   
Amortized
Cost Basis
   
Percentage of
Total
Amortized
Cost Basis
   
Carrying Value
   
Weighted Average
First Dollar Loan
to Value (A)
   
Weighted Average
Last Dollar to Loan
Value (A)
   
Delinquency
(B)
 
Mezzanine Loans
    17     $ 518,307     $ 432,432       75.4 %   $ 432,432       66.6 %     77.0 %     2.3 %
B-Notes
    5       120,872       111,237       19.4 %     111,237       66.2 %     76.7 %     0.0 %
Whole Loans
    2       30,025       30,025       5.2 %     30,025       0.0 %     48.4 %     0.0 %
Total/WA
    24     $ 669,204     $ 573,694       100.0 %   $ 573,694       63.5 %     75.7 %     1.8 %
 
(A)
Loan to value is based on the appraised value at the time of purchase or refinancing.
(B)
The percentage of underlying loans that are non-performing, in foreclosure, under bankruptcy filing or considered real estate owned.
 
CDO Securities (A) 
 
Collateral Manager
 
Primary
Collateral
Type
 
Number
 
Average
Minimum
Rating (B)
 
Outstanding
Face
Amount
   
Amortized
Cost
Basis
   
Percentage of Total
Amortized Cost
Basis
   
Carrying Value
   
Principal
Subordination
(C)
 
Third Party
 
 CMBS
    1  
 CC
  $ 5,500     $ 3,204       4.8 %   $ 3,905       55.5 %
Newcastle
 
 CMBS
    3  
 CCC
    17,827       3,179       4.8 %     5,254       15.8 %
Newcastle
 
 ABS
    1  
 BBB
    70,984       60,364       90.4 %     62,466       52.7 %
TOTAL/WA
        5  
 BB
  $ 94,311     $ 66,747       100.0 %   $ 71,625       45.9 %
 
(A)
Represents non-consolidated CDO securities, excluding eight securities with a zero value, which had an aggregate face amount of $108 million.
(B)
Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any time. We had no CDO assets that were on negative watch for possible downgrade by at least one rating agency as of March 31, 2013.
(C)
The percentage of the outstanding face amount of securities that is subordinate to our investments.
 
Manufactured Housing and Residential Loans
 
Deal
 
Average
FICO
Score
(A)
   
Outstanding
Face Amount
   
Amortized
Cost Basis
   
Percentage
of Total
Amortized
Cost Basis
   
Carrying
Value
   
Average
Loan
Age
(years)
   
Original
Balance
   
Delinquency
90+/FC/REO
(B)
   
Cumulative
Loss to
Date
 
Manufactured Housing Loans Portfolio I
    703     $ 114,924     $ 94,723       33.9 %   $ 94,723       11.4     $ 327,855       0.8 %     9.1 %
                                                                         
Manufactured Housing Loans Portfolio II
    702       149,747       143,494       51.4 %     143,494       13.8       434,739       1.5 %     7.5 %
                                                                         
Residential Loans Portfolio I
    712       50,680       37,565       13.4 %     37,565       9.9       646,357       11.2 %     0.5 %
                                                                         
Residential Loans Portfolio II
    737       3,779       3,520       1.3 %     3,520       8.6       83,950       0.0 %     0.0 %
Total / WA
    704     $ 319,130     $ 279,302       100.0 %   $ 279,302       12.3     $ 1,492,901       2.7 %     6.9 %
 
(A)
Based on updated FICO scores provided by the loan servicer of the manufactured housing loan portfolios and original FICO scores for the residential loan portfolios as the loan servicers of the residential loan portfolios do not provide updated FICO scores.
(B)
The percentage of loans that are 90+ days delinquent, or in foreclosure or considered real estate owned (REO).
 
Non-Agency RMBS (A)
 
   
Security Characteristics
 
                                                 
Vintage (B)
 
Average
Minimum
Rating (C)
   
Number of Securities
   
Outstanding Face
Amount
   
Amortized Cost Basis
   
Percentage of
Total Amortized
Cost Basis
   
Carrying Value
   
Principal
Subordination (D)
   
Excess
Spread (E)
 
Pre 2004
 
CCC+
      6     $ 5,460     $ 2,451       5.2 %   $ 3,817       27.5 %     3.4 %
2004
 
CCC
      6       11,572       2,757       5.9 %     5,827       5.9 %     2.6 %
2005
 
CC
      18       53,044       7,978       17.0 %     13,373       16.5 %     3.8 %
2006
   B+       5       37,716       25,073       53.5 %     31,325       41.8 %     4.1 %
2007
 
CCC-
      5       12,733       8,600       18.4 %     10,990       24.9 %     3.8 %
Total / WA
 
CCC
      40     $ 120,525     $ 46,859       100.0 %   $ 65,332       24.8 %     3.8 %
 
65
 

 

 
   
Collateral Characteristics
 
Vintage (B)
 
Average Loan Age
(years)
   
Collateral
Factor (F)
   
3 Month CPR (G)
   
Delinquency (H)
   
Cumulative Losses to Date
 
Pre 2004
    9.7       0.05       7.7 %     19.0 %     2.6 %
2004
    8.8       0.13       14.1 %     13.5 %     2.9 %
2005
    8.0       0.20       11.3 %     28.4 %     11.0 %
2006
    7.0       0.26       11.2 %     22.7 %     21.8 %
2007
    6.3       0.39       10.6 %     28.4 %     24.9 %
Total / WA
    7.7       0.23       11.3 %     24.8 %     14.9 %
 
Real Estate ABS
 
 
Security Characteristics
 
 
Average
       
Outstanding
   
Amortized
   
Percentage of
                   
 
Minimum
       
Face
   
Cost Basis
   
Total
   
Carrying
   
Principal
   
Excess
 
Asset Type
Rating (C)
 
Number
   
Amount
   
Amount
   
Amortized Basis
   
Value
   
Subordination (D)
   
Spread (E)
 
                                             
Small Business Loans
 CCC-
    3     $ 10,036     $ 1,490       100.0 %   $ 1,384       2.7 %     0.6 %
Total / WA
 CCC-
    3     $ 10,036     $ 1,490       100.0 %   $ 1,384       2.7 %     0.6 %
                                                           
 
Collateral Characteristics
                         
 
Average
                                                       
 
Loan Age
 
Collateral
 
3 Month
           
Cumulative
                         
Asset Type
(years)
 
Factor (F)
 
CPR (G)
   
Delinquency (H)
   
Loss to Date
                         
                                                           
Small Business Loans
                10.0
    0.21       0.7 %     38.3 %     21.5 %                        
Total / WA
                10.0
    0.21       0.7 %     38.3 %     21.5 %                        
 
 
(A)
Represents non-agency RMBS purchased prior to April 2012 that will be retained by Newcastle Investment Corp. subsequent to the spin-off of New Residential. This includes subprime retained securities in the securitizations of Subprime Portfolios I and II. For further information on these securitizations, see Note 4 to our consolidated financial statements included herein.
 
(B)
The year in which the securities were issued.
 
(C)
Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any time. We had no ABS assets that were on negative watch for possible downgrade by at least one rating agency as of March 31, 2013.
 
(D)
The percentage of the outstanding face amount of securities and residual interests that is subordinate to our investments.
 
(E)
The annualized amount of interest received on the underlying loans in excess of the interest paid on the securities, as a percentage of the outstanding collateral balance.
 
(F)
The ratio of original unpaid principal balance of loans still outstanding.
 
(G)
Three month average constant prepayment rate.
 
(H)
The percentage of underlying loans that are 90+ days delinquent, or in foreclosure or considered real estate owned (REO).
 
REIT Debt
 
Industry
 
Average
Minimum
Rating (A)
   
Number
   
Outstanding
Face Amount
   
Amortized
Cost Basis
   
Percentage of Total
Amortized Cost
Basis
   
Carrying
Value
 
                                               
Retail
  A-       1     $ 4,500     $ 4,019       8.0 %   $ 5,025  
Diversified
  B-       1       12,000       11,991       24.0 %     12,510  
Office
 
BBB
      1       5,000       5,017       10.0 %     5,164  
Multifamily
 
BBB+
      2       12,500       12,497       25.0 %     13,079  
Healthcare
 
BBB
      3       16,700       16,531       33.0 %     18,341  
Total / WA
 
BBB-
      8     $ 50,700     $ 50,055       100.0 %   $ 54,119  
 
Corporate Bank Loans
 
Industry
 
Average
Minimum
Rating (A)
   
Number
   
Outstanding
Face Amount
   
Amortized
Cost Basis
   
Percentage of
Total Amortized
Cost Basis
   
Carrying
Value
 
                                     
Media
 
CCC-
      2       346,052       126,062       45.4 %     126,062  
Resorts
 
NR
      3       210,859       135,172       48.6 %     135,172  
Restaurant
  B       2       25,563       16,597       6.0 %     16,597  
Total / WA
 
CC
      7     $ 582,474     $ 277,831       100.0 %   $ 277,831  
 
(A)
Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any time. We had no corporate assets that were on negative watch for possible downgrade by at least one rating agency as of March 31, 2013.
 
66
 

 

 
Senior Living Portfolio
                                               
                                                     
Investment characteristics:
                                               
                               
Costs
   
Accumulated
             
                   
Gross
         
Capitalized
   
Depreciation/
             
       
Number of
   
Number of
   
Initial
   
Purchase
   
Sebsequent to
   
Amortization and
   
Carrying
   
Outstanding
 
Portfolio
 
Acquisition Date
 
 Communities
   
Beds
   
Investment (A)
   
Price
   
Acquisition
   
Closing Adjustments
   
value (B)
   
Debt
 
BPM
 
July 2012
    8       836     $ 149,267     $ 143,300     $ 292     $ 8,341     $ 135,251     $ (88,400 )
Utah
 
November 2012
    3       359     $ 24,002     $ 22,578     $ 118     $ 990     $ 21,706     $ (16,000 )
Courtyards
 
      December 2012
    1       221     $ 22,415     $ 21,500     $ 10     $ 474     $ 21,036     $ (16,125 )
          12       1,416     $ 195,684     $ 187,378     $ 420     $ 9,805     $ 177,993     $ (120,525 )
 
Performance information:
                       
               
Average Revenue
 
   
Average Occupancy
   
Per Occupied Bed (C)
 
   
Three Months
         
Three Months
       
   
Ended
         
Ended
       
Portfolio
 
March 31, 2013
   
At Acquisition
   
March 31, 2013
   
At Acquisition
 
BPM
    89.9 %     87.7 %   $ 4,234     $ 4,208  
Utah
    80.1 %     82.0 %   $ 2,396     $ 2,428  
Courtyards
    90.6 %     88.8 %   $ 2,436     $ 2,385  
 
(A)
 
Purchase price plus related acquisition costs.
(B)
 
Combined GAAP carrying value of long-lived assets and intangible assets, net of accumulated depreciation and amortization.
(C)
 
Total monthly revenue divided by the average number of occupied beds.
 
Debt Obligations
 
Our debt obligations, as summarized in Note 8 to our consolidated financial statements included herein, existing at March 31, 2013 (gross of $3.6 million of discounts) had contractual maturities as follows (in thousands):
 
   
Nonrecourse
   
Recourse
   
Total
 
Period from April 1, 2013 through December 31, 2013
  $ 543     $ 1,473,586     $ 1,474,129  
2014
    1,713             1,713  
2015
    2,274             2,274  
2016
    2,305             2,305  
2017
    32,763             32,763  
2018
    1,855             1,855  
Thereafter
    1,729,327             1,729,327  
Total
  $ 1,770,780     $ 1,473,586     $ 3,244,366  
 
Certain of the debt obligations included above are obligations of our consolidated subsidiaries which own the related collateral.  In some cases, including the CDO Bonds Payable and Other Bonds Payable, such collateral is not available to other creditors of ours.
 
Our non-CDO debt obligations contain various customary loan covenants. We were in compliance with all of the covenants in our non-CDO financings as of March 31, 2013.
 
The following table provides additional information regarding short-term borrowings. These short-term borrowings were used to finance certain of our investments in FNMA/FHLMC securities, non-agency RMBS and our investments in certain senior notes issued by Newcastle CDO VI. The FNMA/FHLMC and non-agency RMBS repurchase agreements have full recourse to Newcastle.  The CDO VI repurchase agreement was repaid in full in January 2013. The weighted average differences between the fair value of the assets and the face amount of available financing for the FNMA/FHLMC repurchase agreements and non-agency RMBS repurchase agreements were 5% and 33%, respectively, during the three months ended March 31, 2013.
 
67
 

 

 
         
Three Months Ended March 31, 2013
 
   
Outstanding
Balance at
March 31, 2013
 
Average Daily Amount Outstanding
 
Maximum Amount Outstanding
 
Weighted Average Interest Rate
 
Repurchase agreements
  $ 1,473,586 *   $ 1,050,612     $ 1,485,673       0.71 %
 
*All of which was recourse to us.
 
In the first three months of 2013, we purchased $609.4 million principal balance of FNMA/FHLMC securities (primarily one-year ARMs) for approximately $643.8 million, using $32.0 million of unrestricted cash and financed with $611.8 million of repurchase agreements. These repurchase agreements bear interest at 0.42%, mature in April 2013, and are subject to customary margin call provisions.
 
On April 9, 2013, we financed additional non-Agency RMBS with approximately $144 million of repurchase agreements, at a cost of one-month LIBOR plus 200 bps. The weighted average advance rate for these repurchase agreements is approximately 70%. These repurchase agreements, which contain customary margin call provisions, have an initial term ending on July 9, 2013.
 
In the first three months of 2013, we repurchased $10.9 million face amount of CDO bonds for $9.7 million. As a result, we extinguished $10.9 million face amount of CDO debt and recorded a gain on extinguishment of debt of $1.2 million.
 
Each of our CDO financings contains tests that measure the amount of over collateralization and excess interest in the transaction. At issuance, each of our CDOs passed all of these tests. Failure to satisfy these tests would generally cause (or has caused) the cash flow that would otherwise be distributed to the 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, and the impact could be (and has been) material. The table set forth below presents data, including the most recent quarterly cash flows received by Newcastle, for each of our CDOs, and sets forth which of the CDOs have satisfied these tests in the most recent quarter. The amounts set forth are as of March 31, 2013 unless otherwise noted (dollars in thousands). For those CDOs that have failed their applicable over collateralization tests, the impact of failing is already reflected in the cash flow set forth in the table. For those CDOs that have satisfied their applicable over collateralization tests, we could potentially lose substantially all of the cash flows from those CDOs in future quarters if we fail to satisfy the tests in the future. The amounts in the table reflect data at the CDO level and thus are different from the GAAP balance sheet due to intercompany amounts eliminated in Newcastle’s consolidated balance sheet.
 
68
 

 

 
   
CDO IV
         
CDO VI
         
CDO VIII
         
CDO IX
       
Balance Sheet:
                                                                       
Assets Face Amount
        $ 153,780                 $ 177,513                 $ 820,930                 $ 705,060        
Assets Fair Value
          140,589                   119,428                   635,606                   557,337        
                                                                                 
Issued Debt Face Amount (1)
          76,854                   91,688                   549,789                   423,412        
Derivative Net Liabilites Fair Value
          2,376                   13,666                   10,207                          
Cash Receipts:
                                                                               
Quarterly net cash receipts (2)
        $ 324                 $ 109                 $ 5,547                 $ 8,302        
                                                                                 
Collateral Composition (3):
 
Face
   
Fair Value
         
Face
   
Fair Value
         
Face
   
Fair Value
         
Face
   
Fair Value
       
CMBS
  $ 113,277     $ 101,954    
BB-
    $ 104,466     $ 74,479    
BB
    $ 145,341     $ 121,373    
BB-
    $ 80,701     $ 84,901    
BB
 
REIT Debt
    21,500       22,509    
BBB
      29,200       31,610    
BB+
                                 
ABS
    9,271       6,454     B-       43,847       13,339    
CC
      69,689       59,996     B       3,059       3,094    
BBB+
 
Bank Loans
                                    224,771       144,734    
C
      185,194       122,081    
C
 
Mezzanine Loans / B-Notes / Whole Loans
    9,732       9,672    
BB+
                      314,379       281,849    
CCC
      345,093       298,425    
CCC
 
CDO
                                    66,750       27,654    
C
      68,351       35,455    
CCC+
 
Residential Loans
                                                    3,779       3,400    
NR
 
Other Investments
                                                    18,883       9,981      
Cash for Reinvestment
                                                               
Total
  $ 153,780     $ 140,589    
BB-
    $ 177,513     $ 119,428     B+     $ 820,930     $ 635,606    
CCC
    $ 705,060     $ 557,337    
CCC
 
                                                                                                 
Collateral on Negative
 Watch (4)
  $                     $                     $                     $                  
                                                                                                 
CDO Cash Flow Triggers (5):
                                                                                               
Over Collateralization (6):
                                                                                               
As of Mar-2013 remittance Cushion (Deficit) ($)
          $ (4,117 )                   $ (179,515 )                   $ 78,797                     $ 139,681          
                                                                                                 
As of Apr-2013 remittance Cushion (Deficit) ($)
          N/A                   $ (179,218 )                   $ 83,665                     $ 145,501          
Interest Coverage (6):
                                                                                               
As of Mar-2013 remittance Cushion (Deficit) (%)
            46.0 %                     (211.4 %)                     384.4 %                     536.0 %        
                                                                                                 
As of Apr-2013 remittance Cushion (Deficit) (%)
          N/A                   (280.9 %)                 375.9 %                   488.7 %        
CDO Overview:
                                                                                               
Effective
         
Sep-04
                   
Aug-05
                   
Mar-07
                   
Jul-07
         
Reinvestment Period End (7)
         
Passed
                   
Passed
                   
Passed
                   
Passed
         
Optional Call (8)
         
Passed
                   
Passed
                   
Passed
                   
Passed
         
Auction Call (9)
         
Mar-14
                   
Apr-15
                   
Nov-16
                   
May-17
         
WA Debt Spread (bps) (10)
            90                       50                       52                       66          
 
See notes on next page.

69
 

 


(1)
Includes CDO bonds issued to third parties and held by Newcastle’s consolidated CDOs.
 
(2)
Represents net cash received from each CDO based on all of our interests in such CDO (including senior management fees but excluding principal received from senior CDO bonds owned by Newcastle) for the three months ended March 31, 2013.  Cash receipts for this period include $0.8 million of senior collateral management fees, and may not be indicative of cash receipts for subsequent periods. Excluded from the quarterly net cash receipts was $8.7 million of unrestricted cash received from principal repayments on senior CDO bonds owned by Newcastle.  This cash represents a return of principal and the realization of the difference between par and the discounted purchase price of these bonds. See “Cautionary Note Regarding Forward Looking Statements” for risks and uncertainties that could cause our receipts for subsequent periods to differ materially from these amounts.
 
(3)
Collateral composition is calculated as a percentage of the face amount of collateral and includes CDO bonds of $126.7 million and other bonds and notes payable of $20.5 million issued by Newcastle, and bank loans of $92.7 million, collateralized by Newcastle CDO VI bonds, real estate properties and a third party CDO security, which are eliminated in consolidation. The fair value of these CDO bonds, other bonds and notes payable, and bank loans was $55.8 million, $18.5 million and $85.6 million at March 31, 2013, respectively. Also reflected are weighted average credit ratings, which were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any time.
 
(4)
Represents the face amount of collateral on negative watch for possible downgrade by at least one rating agency (Moody’s, S&P or Fitch) as of the determination date in March 2013 for all CDOs. The amount does not include any bonds issued by Newcastle, which are eliminated in consolidation and not reflected in the investment portfolio disclosures.
 
(5)
Each of our CDO financings contains 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, and the impact could be material. Each CDO contains tests at various over collateralization and interest coverage percentage levels. The trigger percentages used above represent the first threshold at which cashflows would be redirected as described in this footnote. The data presented is as of the most recent remittance date on or before March 31, 2013 and may change or have changed subsequent to that date. In addition, our CDOs may also contain specific over collateralization tests that, if failed, can result in the occurrence of an event of default or our being removed as collateral manager of the CDO. Failure of the over collateralization tests can also cause a “phantom income” issue if cash that constitutes income is diverted to pay down debt instead of being distributed to us. As of the March 2013 remittance date, we were not receiving cash flows from CDO IV and CDO VI (other than senior management fees and cash flows on senior classes of bonds we own).  Based upon our current calculations, we expect CDOs IV and VI to remain out of compliance for the foreseeable future. Moreover, given current market conditions, it is possible that all of our CDOs could be out of compliance with their over collateralization tests as of one or more measurement dates within the next twelve months. Our ability to rebalance will depend upon the availability of suitable securities, market prices, whether the reinvestment period of the applicable CDO has ended, and other factors that are beyond our control. Such rebalancing efforts may be extremely difficult given current market conditions and we cannot assure you that we will be successful in our rebalancing efforts. If the liabilities of our CDOs are downgraded by Moody’s to certain predetermined levels, our discretion to rebalance the applicable CDO portfolios may be negatively impacted. Moreover, if we bring these coverage tests into compliance, we cannot assure you that they will not fall out of compliance in the future or that we will be able to correct any noncompliance. For a more detailed discussion of the impact of CDO financings on our cash flows, see Part II, Item 1A, “Risk Factors – Risks Relating to our Business – The coverage tests applicable to our CDO financings may have a negative impact on our operating results and cash flows.”
 
(6)
Represents excess or deficiency under the applicable over collateralization or interest coverage tests to the first threshold at which cash flow would be redirected. We generally do not receive material cash flow from the junior classes of a CDO until a deficiency is corrected. Ratings downgrades of assets in our CDOs can negatively impact compliance with the over collateralization tests.  Generally, the over collateralization test measures the principal balance of the specified pool of assets in a CDO against the corresponding liabilities issued by the CDO. However, based on ratings downgrades, the principal balance of an asset or of a specified percentage of assets in a CDO may be deemed reduced below their current balance to levels set forth in the related CDO documents for purposes of calculating the over collateralization test. As a result, ratings downgrades can reduce the principal balance of the assets used in the over collateralization test relative to the corresponding liabilities in the test, thereby reducing the over collateralization percentage.  In addition, actual defaults of an asset would also negatively impact compliance with the over collateralization tests.  Failure to satisfy an over collateralization test could result in the redirection of cashflows as described in footnote 5 above or, in certain circumstances, in our removal as manager of the applicable portfolio.
 
(7)
Our CDO financings typically have a 5-year reinvestment period. Generally, after such period ends, principal payments on the collateral are used to paydown the most senior debt outstanding. Prior to the end of the reinvestment period, principal payments received on the collateral are reinvested.
 
(8)
At the option call date, Newcastle, as the equity holder, has the right to payoff the CDO bonds at their related redemption price.
 
(9)
At the auction call date, there is a mandatory auction of the assets pursuant to which the collateral manager will solicit bids for the CDO assets. If the aggregate amount of the bids are sufficient to pay off the outstanding CDO bonds set forth in the CDO governing document, the assets will be sold and the CDO bonds will be redeemed. However, if the aggregate amount of the bids is insufficient to pay off the outstanding CDO bonds set forth in the CDO governing document, the assets will not be sold and the redemption of CDO bonds will not occur. 
 
(10)
Debt spread represents the spread above the benchmark interest rate (LIBOR or U.S. Treasuries) that Newcastle pays on its debt.
 
70
 

 


The following table sets forth further information with respect to the bonds of our consolidated CDO financings as of March 31, 2013 (dollars in thousands):
 
         
Current Face Amount (1)
         
         
Held By
             
   
Original Face
         
Newcastle
   
Newcastle Outside
       
Stated Interest
 
Class
 
Amount
   
Third Parties
   
CDOs (2)
   
of its CDOs (3)
   
Total
 
Rate
 
CDO IV
                                     
Class I
  $ 353,250     $ 44,631           $ 34,198     $ 78,829  
 LIBOR +
    0.40 %
Class II-FL
    13,000       3,000             10,000       13,000  
 LIBOR +
    0.65 %
Class II-FX
    7,250             5,250       2,000       7,250         4.73 %
Class III-FL
    7,500       5,000             2,500       7,500  
 LIBOR +
    1.00 %
Class III-FX
    15,000       1,325             10,760       12,085         5.11 %
Class IV-FL
    9,000       8,173                   8,173  
 LIBOR +
    2.25 %
Class IV-FX
    9,000       9,475                   9,475         6.34 %
Class V
    13,500                   18,625       18,625         8.67 %
Preferred
    22,500                   22,500       22,500         N/A  
    $ 450,000     $ 71,604     $ 5,250     $ 100,583     $ 177,437            
CDO VI
                                                 
Class I-MM
  $ 323,000     $     $     $ 114,024 *   $ 114,024  
 LIBOR +
    0.25 %
Class I-B
    59,000       59,000                   59,000  
 LIBOR +
    0.40 %
Class II
    33,000       23,679             10,295       33,974  
 LIBOR +
    0.50 %
Class III-FL
    15,000       5,225