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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, 2011

or

 

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

For the transition period from              to             

Commission File Number: 001-31458

Newcastle Investment Corp.

(Exact name of registrant as specified in its charter)

 

Maryland   81-0559116

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1345 Avenue of the Americas, New York, NY   10105
(Address of principal executive offices)   (Zip Code)

(212) 798-6100

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  Yes    No  ¨

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

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨    (Do not check if a smaller reporting company)

Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.

Common stock, $0.01 par value per share: 79,277,184 shares outstanding as of May 1, 2011.


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CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments, the stability of our earnings, and our financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual outcome of future plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from forecasted results. Factors that could have a material adverse effect or our operations and prospects include, but are not limited to:

 

   

reductions in cash flows received from our investments;

 

   

our ability to take advantage of opportunities in additional asset classes or types of assets, at attractive risk-adjusted prices;

 

   

our ability to deploy capital accretively;

 

   

the risks that default and recovery rates on our real estate securities and loan portfolios exceed our underwriting estimates;

 

   

the relationship between yields on assets which are paid off and yields on assets in which such monies can be reinvested;

 

   

the relative spreads between the yield on the assets we invest in and the cost of financing;

 

   

changes in economic conditions generally and the real estate and bond markets specifically;

 

   

adverse changes in the financing markets we access affecting our ability to finance our investments, or in a manner that maintains our historic net spreads;

 

   

changing risk assessments by lenders that potentially lead to increased margin calls, not extending our repurchase agreements or other financings in accordance with their current terms or entering into new financings with us;

 

   

changes in interest rates and/or credit spreads, as well as the success of any hedging strategy we may undertake in relation to such changes;

 

   

the quality and size of the investment pipeline and the rate at which we can invest our cash, including cash inside our CDOs;

 

   

impairments in the value of the collateral underlying our investments and the relation of any such impairments to our judgments as to whether changes in the market value of our securities, loans or real estate are temporary or not and whether circumstances bearing on the value of such assets warrant changes in carrying values;

 

   

legislative/regulatory changes, including, but not limited to, any modification of the terms of loans;

 

   

the availability and cost of capital for future investments;

 

   

competition within the finance and real estate industries; and

 

   

other risks detailed from time to time below, particularly under the heading “Risk Factors,” and in our other SEC reports.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. The factors noted above could cause our actual results to differ significantly from those contained in any forward-looking statement.

Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect our management’s views only as of the date of this report. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.


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SPECIAL NOTE REGARDING EXHIBITS

In reviewing the agreements included as exhibits to this Quarterly Report on Form 10-Q, please remember they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about the Company or the other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:

 

   

should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk tone of the parties if those statements provide to be inaccurate;

 

   

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

 

   

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

 

   

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

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

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


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NEWCASTLE INVESTMENT CORP.

FORM 10-Q

INDEX

 

         PAGE  

PART I.

  FINANCIAL INFORMATION   

Item 1.

  Financial Statements   
  Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010      1   
  Consolidated Statements of Income (unaudited) for the three months ended March 31, 2011 and 2010      2   
  Consolidated Statements of Stockholders’ Equity (Deficit) (unaudited) for the three months ended March 31, 2011      3   
  Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2011 and 2010      4   
  Notes to Consolidated Financial Statements (unaudited)      5   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      27   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      50   

Item 4.

  Controls and Procedures      52   

PART II.

  OTHER INFORMATION   

Item 1.

  Legal Proceedings      53   

Item 1A.

  Risk Factors      53   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      72   

Item 3.

  Defaults upon Senior Securities      72   

Item 4.

  (Removed and Reserved)      72   

Item 5.

  Other Information      72   

Item 6.

  Exhibits      73   

SIGNATURES

     74   


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

 

     March 31, 2011
(Unaudited)
    December 31, 2010  

Assets

    

Non-Recourse VIE Financing Structures

    

Real estate securities, available for sale

   $ 1,994,079      $ 1,859,984   

Real estate related loans, held for sale, net

     764,254        750,130   

Residential mortgage loans, held for investment, net

     121,661        124,974   

Residential mortgage loans, held for sale, net

     246,298        252,915   

Subprime mortgage loans subject to call option

     404,011        403,793   

Operating real estate, held for sale

     8,339        8,776   

Other investments

     18,883        18,883   

Restricted cash

     131,540        157,005   

Derivative assets

     7,535        7,067   

Receivables and other assets

     31,420        29,206   
                
     3,728,020        3,612,733   
                

Recourse Financing Structures and Unlevered Assets

    

Real estate securities, available for sale

     94,587        600   

Real estate related loans, held for sale, net

     4,608        32,475   

Residential mortgage loans, held for sale, net

     277        298   

Other investments

     6,024        6,024   

Cash and cash equivalents

     160,594        33,524   

Receivables and other assets

     3,586        1,457   
                
     269,676        74,378   
                
   $ 3,997,696      $ 3,687,111   
                

Liabilities and Stockholders’ Equity (Deficit)

    

Liabilities

    

Non-Recourse VIE Financing Structures

    

CDO bonds payable

   $ 2,944,193      $ 3,010,868   

Other bonds payable

     246,561        256,809   

Notes payable

     4,296        4,356   

Repurchase agreements

     12,527        14,049   

Financing of subprime mortgage loans subject to call option

     404,011        403,793   

Derivative liabilities

     153,944        176,861   

Accrued expenses and other liabilities

     11,745        8,445   
                
     3,777,277        3,875,181   
                

Recourse Financing Structures and Other Liabilities

    

Repurchase agreements

     83,276        4,683   

Junior subordinated notes payable

     51,252        51,253   

Dividends payable

     930        —     

Due to affiliates

     1,351        1,419   

Accrued expenses and other liabilities

     7,656        2,160   
                
     144,465        59,515   
                
     3,921,742        3,934,696   
                

Stockholders’ Equity (Deficit)

    

Preferred stock, $0.01 par value, 100,000,000 shares authorized, 1,347,321 shares of 9.75% Series B Cumulative Redeemable Preferred Stock, 496,000 shares of 8.05% Series C Cumulative Redeemable Preferred Stock, and 620,000 shares of 8.375% Series D Cumulative Redeemable Preferred Stock, liquidation preference $25.00 per share, issued and outstanding as of March 31, 2011 and December 31, 2010

     61,583        61,583   

Common stock, $0.01 par value, 500,000,000 shares authorized, 79,277,184 and 62,027,184 shares issued and outstanding at March 31, 2011 and

    

December 31, 2010, respectively

     793        620   

Additional paid-in capital

     1,163,604        1,065,377   

Accumulated deficit

     (1,224,429     (1,328,987

Accumulated other comprehensive income (loss)

     74,403        (46,178
                
     75,954        (247,585
                
   $ 3,997,696      $ 3,687,111   
                

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(dollars in thousands, except share data)

 

 

     Three Months Ended March 31,  
     2011     2010  

Interest income

   $ 72,203      $ 70,092   

Interest expense

     38,165        45,589   
                

Net interest income

     34,038        24,503   
                

Impairment (Reversal)

    

Valuation allowance (reversal) on loans

     (41,307     (95,774

Other-than-temporary impairment on securities

     3,112        64,856   

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)

     989        (37,114
                
     (37,206     (68,032
                

Net interest income after impairment

     71,244        92,535   

Other Income (Loss)

    

Gain (loss) on settlement of investments, net

     34,092        9,677   

Gain on extinguishment of debt

     11,042        48,346   

Other income (loss), net

     335        (1,480
                
     45,469        56,543   
                

Expenses

    

Loan and security servicing expense

     1,060        1,035   

General and administrative expense

     1,601        3,101   

Management fee to affiliate

     4,189        4,477   
                
     6,850        8,613   
                

Income from continuing operations

     109,863        140,465   

Income (loss) from discontinued operations

     (190     (40
                

Net Income

     109,673        140,425   

Preferred dividends

     (1,395     (3,268

Excess of carrying amount of exchanged preferred stock over fair value of consideration paid

     —          43,043   
                

Income Available for Common Stockholders

   $ 108,278      $ 180,200   
                

Income Per Share of Common Stock

    

Basic

   $ 1.73      $ 3.36   
                

Diluted

   $ 1.73      $ 3.36   
                

Income from continuing operations per share of common stock, after preferred dividends and excess of carrying amount of exchanged preferred stock over fair value of consideration paid

    

Basic

   $ 1.73      $ 3.36   
                

Diluted

   $ 1.73      $ 3.36   
                

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

    

Basic

   $ (0.00   $ (0.00
                

Diluted

   $ (0.00   $ (0.00
                

Weighted Average Number of Shares of Common Stock Outstanding

    

Basic

     62,602,184        53,619,643   
                

Diluted

     62,611,070        53,619,643   
                

Dividends Declared per Share of Common Stock

   $ —        $ —     
                

See notes to consolidated financial statements

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

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

FOR THE THREE MONTHS ENDED MARCH 31, 2011

(dollars in thousands)

 

 

    Preferred Stock     Common Stock     Additional
Paid-in
Capital
    Accumulated
Deficit
    Accum. Other
Comp. Income
(Loss)
    Total
Stock-holders’
Equity
(Deficit)
 
             
  Shares     Amount     Shares     Amount          

Stockholders’ equity (deficit) - December 31, 2010

    2,463,321      $ 61,583        62,027,184      $ 620      $ 1,065,377      $ (1,328,987   $ (46,178   $ (247,585

Preferred dividends declared

    —          —          —          —          —          (5,115     —          (5,115

Issuance of common stock

    —          —          17,250,000        173        98,227        —          —          98,400   

Comprehensive income:

               

Net income

    —          —          —          —          —          109,673        —          109,673   

Net unrealized gain on securities

    —          —          —          —          —          —          126,143        126,143   

Reclassification of net realized (gain) on securities into earnings

    —          —          —          —          —          —          (28,271     (28,271

Net unrealized gain on derivatives designated as cash flow hedges

    —          —          —          —          —          —          18,411        18,411   

Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings

    —          —          —          —          —          —          4,298        4,298   
                     

Total comprehensive income

                  230,254   
                                                               

Stockholders’ equity (deficit) - March 31, 2011

    2,463,321      $ 61,583        79,277,184      $ 793      $ 1,163,604      $ (1,224,429   $ 74,403      $ 75,954   
                                                               

See notes to consolidated financial statements

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

 

 

     Three Months Ended March 31,  
     2011     2010  

Cash Flows From Operating Activities

    

Net income

   $ 109,673      $ 140,425   

Adjustments to reconcile net income to net cash provided by (used in) operating activities (inclusive of amounts related to discontinued operations):

    

Depreciation and amortization

     46        63   

Accretion of discount and other amortization

     (10,771     (1,181

Interest income in CDOs redirected for reinvestment or CDO bonds paydown

     (3,724     (9,101

Interest income on investments accrued to principal balance

     (4,535     —     

Interest expense on debt accrued to principal balance

     410        930   

Deferred interest received

     1,027        —     

Reversal of valuation allowance on loans

     (41,307     (95,774

Other-than-temporary impairment on securities

     4,101        27,742   

Impairment on real estate held for sale

     433        —     

Gain on settlement of investments, net

     (33,158     (9,677

Unrealized loss on non-hedge derivatives and hedge ineffectiveness

     201        1,749   

Gain on extinguishment of debt

     (11,042     (48,346

Change in:

    

Restricted cash

     109        (695

Receivables and other assets

     (40     2,346   

Due to affiliates

     (68     (15

Accrued expenses and other liabilities

     (61     744   
                

Net cash provided by (used in) operating activities

     11,294        9,210   
                

Cash Flows From Investing Activities

    

Purchase of real estate securities

     (89,601     (3

Proceeds from sale of real estate securities

     —          26,022   

Acquisition of servicing rights

     (2,082     —     

Repayments of principal on loans and securities

     37,605        15,770   

Repayments of principal from repurchased CDO debt

     9,726        25   

Margin received on derivative instruments

     —          5,073   

Payments on settlement of derivative instruments

     —          (3,668

Distributions of capital from equity method investees

     —          152   
                

Net cash provided by (used in) investing activities

     (44,352     43,371   
                

Cash Flows From Financing Activities

    

Repurchases of CDO bonds payable

     (1,083     (144

Repayments of other bonds payable

     (10,460     (11,346

Borrowings under repurchase agreements

     79,978        —     

Repayments of repurchase agreements

     (2,907     (58,420

Issuance of common stock

     98,843        —     

Costs related to issuance of common stock

     (58     —     

Cash consideration paid in exchange for junior subordinated notes

     —          (9,715

Cash consideration paid to redeem preferred stock

     —          (16,001

Dividends paid

     (4,185     (18,942

Restricted cash returned from refinancing activities

     —          5,525   
                

Net cash provided by (used in) financing activities

     160,128        (109,043
                

Net Increase (Decrease) in Cash and Cash Equivalents

     127,070        (56,462

Cash and Cash Equivalents, Beginning of Period

     33,524        68,300   
                

Cash and Cash Equivalents, End of Period

   $ 160,594      $ 11,838   
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid during the period for interest expense

   $ 28,759      $ 32,506   

Supplemental Schedule of Non-Cash Investing and Financing Activities

    

Preferred stock dividends declared but not paid

   $ 930      $ 78   

Common stock issued to redeem preferred stock

   $ —        $ 28,457   

Face amount of CDO bonds issued in exchange for previously issued junior subordinated notes of $52,094

   $ —        $ 37,625   

See notes to consolidated financial statements

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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 (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments and debt repurchases financed with recourse debt, (iv) unlevered investments, and (v) corporate. With respect to the first two nonrecourse segments, subject to the passing of certain periodic coverage tests, Newcastle is generally entitled to receive the net cash flows from these structures on a periodic basis.

Newcastle is organized and conducts its operations to qualify as a real estate investment trust (“REIT”) for U.S. federal income tax purposes. As such, Newcastle will generally not be subject to U.S. federal corporate income tax on that portion of its net income that is distributed to stockholders if it distributes at least 90% of its REIT taxable income to its stockholders by prescribed dates and complies with various other requirements.

Newcastle is party to a management agreement (the “Management Agreement”) with FIG LLC (the “Manager”), a subsidiary of Fortress Investment Group LLC (“Fortress”), under which the Manager advises Newcastle on various aspects of its business and manages its day-to-day operations, subject to the supervision of Newcastle’s board of directors. For its services, the Manager receives an annual management fee and incentive compensation, both as defined in the Management Agreement.

In March 2011, Newcastle issued 17,250,000 million shares of its common stock in a public offering at a price to the public of $6.00 per share for net proceeds of approximately $98.4 million. For the purpose of compensating the Manager for its successful efforts in raising capital for Newcastle, in connection with this offering, Newcastle granted options to the Manager to purchase 1,725,000 shares of Newcastle’s common stock at the public offering price, which were valued at approximately $7.0 million.

Approximately 3.8 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its principals at March 31, 2011. In addition, Fortress, through its affiliates, held options to purchase approximately 3.4 million shares of Newcastle’s common stock at March 31, 2011.

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, financial statement presentation, revenue recognition, leases, financial instruments, hedging and fair value. 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.

The accompanying consolidated financial statements and related notes of Newcastle have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under U.S. generally accepted accounting principles have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of Newcastle’s financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with Newcastle’s consolidated financial statements for the year ended December 31, 2010 and notes thereto included in Newcastle’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. Capitalized terms used herein, and not otherwise defined, are defined in Newcastle’s consolidated financial statements for the year ended December 31, 2010.

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

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

2. INFORMATION REGARDING BUSINESS SEGMENTS

Newcastle conducts its business through the following segments: (i) investments financed with non-recourse collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments and debt repurchases financed with recourse debt, (iv) unlevered investments, and (v) corporate. With respect to the first two nonrecourse segments, subject to the passing of certain periodic coverage tests, Newcastle is generally entitled to receive the net cash flows from these structures on a periodic basis.

The corporate segment consists primarily of interest income on short term investments, general and administrative expenses, interest expense on the junior subordinated notes payable and management fees pursuant to the management agreement.

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

 

     Non-Recourse (A)                                
     CDOs     Other Non-
Recourse (B)
    Recourse
(C)
    Unlevered
(D)
    Corporate     Inter-segment
Elimination (E)
    Total  

Three Months Ended March 31, 2011

              

Interest income

   $ 54,828      $ 17,481      $ 147      $ 493      $ 20      $ (766   $ 72,203   

Interest expense

     24,613        13,155        98        —          952        (653     38,165   
                                                        

Net interest income (expense)

     30,215        4,326        49        493        (932     (113     34,038   

Impairment (reversal)

     (38,245     1,154        —          (115     —          —          (37,206

Other income (loss)

     43,107        1,827        —          535        —          —          45,469   

Expenses

     313        744        —          45        5,748        —          6,850   
                                                        

Income (loss) from continuing operations

     111,254        4,255        49        1,098        (6,680     (113     109,863   

Income (loss) from discontinued operations

     —          (282     —          (21     —          113        (190
                                                        

Net income (loss)

     111,254        3,973        49        1,077        (6,680     —          109,673   

Preferred dividends

     —          —          —          —          (1,395     —          (1,395
                                                        

Income (loss) applicable to common stockholders

   $ 111,254      $ 3,973      $ 49      $ 1,077      $ (8,075   $ —        $ 108,278   
                                                        

March 31, 2011

              

Investments

   $ 2,861,595      $ 730,214      $ 88,475      $ 17,021      $ —        $ (34,284   $ 3,663,021   

Cash and restricted cash

     131,540        —          —          5        160,589        —          292,134   

Derivitve assets

     7,535        —          —          —          —          —          7,535   

Other assets

     31,199        221        256        2,192        1,138        —          35,006   
                                                        

Total assets

     3,031,869        730,435        88,731        19,218        161,727        (34,284     3,997,696   
                                                        

Debt

     (2,961,016     (684,856     (83,276     —          (51,252     34,284        (3,746,116

Derivative liabilities

     (139,584     (14,360     —          —          —          —          (153,944

Other liabilities

     (9,990     (1,755     (4,562     (92     (5,283     —          (21,682
                                                        

Total liabilities

     (3,110,590     (700,971     (87,838     (92     (56,535     34,284        (3,921,742
                                                        

Preferred stock

     —          —          —          —          (61,583     —          (61,583
                                                        

GAAP book value

   $ (78,721   $ 29,464      $ 893      $ 19,126      $ 43,609      $ —        $ 14,371   
                                                        

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

     Non-recourse (A)     Recourse     Unlevered     Corporate     Total  
     CDOs     Other Non-
Recourse (B)
         

Three Months Ended March 31, 2010

            

Interest income

   $ 50,943      $ 18,046      $ 859      $ 223      $ 21      $ 70,092   

Interest expense

     28,866        15,039        627        —          1,057        45,589   
                                                

Net interest income (expense)

     22,077        3,007        232        223        (1,036     24,503   

Impairment (reversal)

     (30,846     (37,292     (60     166        —          (68,032

Other income (loss)

     59,722        (1,398     (663     (1,118     —          56,543   

Expenses

     352        678        4        1        7,578        8,613   
                                                

Income (loss) from continuing operations

     112,293        38,223        (375     (1,062     (8,614     140,465   

Income (loss) from discontinued operations

     —          —          —          (40     —          (40
                                                

Net income (loss)

     112,293        38,223        (375     (1,102     (8,614     140,425   

Preferred dividends

     —          —          —          —          (3,268     (3,268

Excess of carrying amount of exchanged preferred stock over fair value of consideration paid

     —          —          —          —          43,043        43,043   
                                                

Income (loss) applicable to common stockholders

   $ 112,293      $ 38,223      $ (375   $ (1,102   $ 31,161      $ 180,200   
                                                

 

(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) Included in the other non-recourse segment were $404.0 million of Investments and Debt, at March 31, 2011, representing the loans subject to call option of the two subprime securitizations and the corresponding financing.
(C) The $83.3 million recourse debt was secured by $83.9 million carrying value of FNMA/FHLMC securities and $41.2 million face amount of notes issued by Newcastle CDO VI, which was repurchased by Newcastle in December 2010 and eliminated in consolidation. $4.6 million of Investments and Other Liabilities represents a security purchased but not yet settled at March 31, 2011.
(D) The following table summarizes the investments in the unlevered segment:

 

     March 31, 2011  
     Outstanding
Face Amount
     Carrying
Value
     Number of
Investments
 

Real estate securities

   $ 215,812       $ 6,112         27   

Real estate related loans

     69,106         4,608         4   

Residential mortgage loans

     1,055         277         26   

Other investments

     N/A         6,024         1   
                          
   $ 285,973       $ 17,021         58   
                          

 

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

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 VII as described below), since it has the power to direct the activities that most significantly impact the CDOs’ economic performance and would absorb a significant portion of their expected losses and receive a significant portion of their expected residual returns, and (ii) the manufactured housing loan financing structures, which are similar to the CDOs in analysis. Newcastle’s CDOs and manufactured housing loan financings are held in special purpose entities whose debt is treated as non-recourse secured borrowings of Newcastle. Newcastle’s subprime securitizations are also considered VIE’s, but Newcastle does not control their activities and no longer receives a significant portion of their returns. These subprime securitizations were not consolidated under the current or prior guidance.

In addition, Newcastle’s investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. Newcastle is not obligated to provide, nor has it provided, any financial support to these VIEs. Newcastle monitors these investments and, to the extent Newcastle determines that it potentially owns a majority of the currently controlling class, it analyzes them for potential consolidation. As of March 31, 2011, Newcastle has not consolidated these potential VIEs due to the determination that, based on the nature of Newcastle’s investments and the provisions governing these structures, Newcastle does not have the power to direct the activities that most significantly impact their economic performance.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

On January 1, 2010, as a result of the adoption of new guidance, Newcastle deconsolidated a non-recourse financing structure, CDO VII. Newcastle determined that it does not have the current power to direct the relevant activities of CDO VII as an event of default had occurred and we may be removed as the collateral manager by a single party.

Newcastle has variable interests in the following unconsolidated VIE at March 31, 2011, in addition to the subprime securitizations which are described in Note 4:

 

Entity

   Gross Assets (A)      Debt (B)      Carrying Value of Newcastle’s
Investment (C)
 

Newcastle CDO VII

   $ 479,354       $ 468,914       $ 475   

 

(A) Face amount.
(B) Includes $82.3 million face amount of debt owned by Newcastle at March 31, 2011.
(C) Represents Newcastle’s maximum exposure to loss from these entities.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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, 2011, all of which are classified as available for sale and are, therefore, reported at fair value with changes in fair value recorded in other comprehensive income, except for securities that are other-than-temporarily impaired.

 

Asset Type

  Outstanding
Face
Amount
    Amortized Cost Basis                 Carrying
Value (B)
    Number
of
Securities
    Weighted Average  
    Before
Impairment
    Other-Than-
Temporary
Impairment
(A)
    After
Impairment
                    Rating
(C)
    Coupon     Yield     Maturity
(Years)
(D)
    Principal
Subordination
(E)
 
          Gross Unrealized                
          Gains     Losses                

CMBS-Conduit

  $ 1,449,705      $ 1,236,527      $ (335,259   $ 901,268      $ 219,440      $ (57,023   $ 1,063,685        186        BB        5.71     11.24     3.9        10.1

CMBS- Single Borrower

    412,952        401,885        (12,364     389,521        8,353        (41,531     356,343        57        BB        4.14     5.78     3.0        8.6

CMBS-Large Loan

    27,798        27,795        —          27,795        —          (3,875     23,920        5        BBB-        1.69     1.74     0.9        19.1

REIT Debt

    299,523        298,122        —          298,122        19,745        (2,986     314,881        38        BBB-        6.13     5.99     3.4        N/A   

ABS-Subprime (F)

    326,093        317,066        (160,241     156,825        25,762        (3,132     179,455        82        B-        1.43     11.39     5.7        26.4

ABS-Manufactured Housing

    34,141        33,148        —          33,148        1,842        (367     34,623        7        BBB+        6.64     7.37     4.4        39.9

ABS-Franchise

    36,885        34,741        (19,413     15,328        1,302        (765     15,865        14        B+        3.16     10.61     6.6        24.8

FNMA/FHLMC

    87,453        91,371        —          91,371        410        (134     91,647        13        AAA        3.13     2.02     4.7        N/A   

CDO (G)

    168,613        20,451        (14,877     5,574        44        —          5,618        12        C        2.21     34.74     0.2        N/A   
                                                                                                 

Debt Security Total /Average (H)

    2,843,163        2,461,106        (542,154     1,918,952        276,898        (109,813     2,086,037        414        BB        4.69     8.75     3.7     
                                                       

Equity Securities

      1,388        (276     1,112        1,517        —          2,629        2             
                                                                   

Total

    $ 2,462,494      $ (542,430   $ 1,920,064      $ 278,415      $ (109,813   $ 2,088,666      $ 416             
                                                                   

 

(A) Represents the cumulative impairment against amortized cost basis recorded through earnings, net of the effect of the cumulative adjustment as a result of the adoption of new accounting guidance on impairment in 2009.
(B) See Note 6 regarding the estimation of fair value, which is equal to carrying value for all securities.
(C) Represents the weighted average of the ratings of all securities in each asset type, expressed as an S&P equivalent rating. For each security rated by multiple rating agencies, the lowest rating is used. FNMA/FHLMC securities have an implied AAA rating. Ratings provided were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including a “negative watch” assignment) at any time.
(D) The weighted average maturity is based on the timing of expected principal reduction on the assets.
(E) Percentage of the outstanding face amount of securities that is subordinate to Newcastle’s investments.
(F) Includes the retained bonds with a face amount of $12.6 million and a carrying value of $1.1 million from Securitization Trust 2006 and Securitization Trust 2007 (Note 4). The residual interests were fully written off in the first quarter of 2010.
(G) Includes seven CDO bonds issued by C-BASS, a CDO bond issued by a third party and four CDO bonds issued by CDO VII, which has been deconsolidated, held as investments by Newcastle.
(H) The total outstanding face amount of fixed rate securities was $2.0 billion, and of floating rate securities was $0.8 billion.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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, 2011, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $3.1 million (gross of ($1.0) million of other-than-temporary impairment recognized in other comprehensive income) with respect to real estate securities. Based on management’s analysis of these securities, the performance of the underlying loans and changes in market factors, Newcastle noted adverse changes in the expected cash flows on certain of these securities and concluded that they were other-than-temporarily impaired. Any remaining unrealized losses on Newcastle’s securities were primarily the result of changes in market factors, rather than issue-specific credit impairment. The following table summarizes Newcastle’s securities in an unrealized loss position as of March 31, 2011.

 

          Amortized Cost Basis     Gross Unrealized                 Weighted Average  

Securities in

an Unrealized

Loss Position

  Outstanding
Face
Amount
    Before
Impairment
    Other-than-
Temporary
Impairment
    After
Impairment
    Gains     Losses     Carrying
Value
    Number
of
Securities
    Rating   Coupon     Yield     Maturity
(Years)
 

Less Than Twelve Months

  $ 162,599      $ 159,485      $ (26,788   $ 132,697      $ —        $ (1,672     131,025        29      BBB+     3.66     4.81     5.6   

Twelve or More Months

    695,626        691,502        (12,580     678,922        —          (108,141     570,781        110      BB-     4.70     5.26     2.6   
                                                                                           

Total

  $ 858,225      $ 850,987      $ (39,368   $ 811,619      $ —        $ (109,813   $ 701,806        139      BB     4.50     5.19     3.2   
                                                                                           

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, 2011  
     Fair Value      Amortized
Cost Basis
     Unrealized Losses  
           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

     44,765         50,722         (34,120     (5,957

Non credit impaired securities

     657,041         760,897         —          (103,856
                                  

Total debt securities in an unrealized loss position

   $ 701,806       $ 811,619       $ (34,120   $ (109,813
                                  

 

(A) Newcastle may, at times, be more likely than not to be required to sell certain securities for liquidity purposes. While the amount of the securities to be sold may be an estimate, and the securities to be sold have not yet been identified, Newcastle must make its best estimate, which is subject to significant judgment regarding future events, and may differ materially from actual future sales.
(B) This amount is required to be recorded as other-than-temporary impairment through earnings. In measuring the portion of credit losses, Newcastle’s management estimates the expected cash flow for each of the securities. This evaluation includes a review of the credit status and the performance of the collateral supporting those securities, including the credit of the issuer, key terms of the securities and the effect of local, industry and broader economic trends. Significant inputs in estimating the cash flows include management’s expectations of prepayment speeds, default rates and loss severities. Credit losses are measured as the decline in the present value of the expected future cash flows discounted at the investment’s effective interest rate.
(C) This amount represents unrealized losses on securities that are due to non-credit factors and is required to be recorded through other comprehensive income.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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, 2011:

 

Beginning balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income

     $(60,688

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

     —     

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

     (2,738

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

     (18,533

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

     27,702   

Reduction for securities sold during the period

     17,912   

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

     2,225   
        

Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income

   $ (34,120
        

As of March 31, 2011, Newcastle had $127.6 million of restricted cash held in CDO financing structures pending its reinvestment in real estate securities and loans.

The table below summarizes the geographic distribution of the collateral securing Newcastle’s CMBS and ABS at March 31, 2011 (in thousands):

 

     CMBS     ABS  

Geographic Location

   Outstanding Face Amount      Percentage     Outstanding Face Amount      Percentage  

Western U.S.

   $ 529,568         28.0   $ 106,702         26.9

Northeastern U.S.

     433,213         22.9     77,249         19.4

Southeastern U.S.

     338,208         17.9     86,087         21.7

Midwestern U.S.

     295,882         15.6     55,518         14.0

Southwestern U.S.

     237,954         12.6     42,564         10.7

Other

     8,913         0.5     28,995         7.3

Foreign

     46,717         2.5     4         0.0
                                  
   $ 1,890,455         100.0   $ 397,119         100.0
                                  

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

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

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

All of Newcastle’s loan investments, other than the Manufactured Housing Loans Portfolio I as described below, were classified as held for sale as of March 31, 2011 and December 31, 2010 and marked to the lower of carrying value or fair value.

The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at March 31, 2011. The loans contain various terms, including fixed and floating rates, self-amortizing and interest only. They are generally subject to prepayment.

 

Loan Type

  Outstanding
Face Amount
    Carrying
Value (A)
    Loan
Count
    Wtd. Avg.
Yield
    Weighted
Average
Coupon
    Weighted
Average
Maturity
(Years) (B)
    Floating Rate
Loans as a %
of Face
Amount
    Delinquent Face
Amount (C)
 

Mezzanine Loans

  $ 530,664      $ 394,656        16        13.22     4.77     2.3        84.4   $ 51,615   

Corporate Bank Loans

    277,660        184,265        7        15.96     8.68     3.4        56.4     —     

B-Notes

    233,132        159,069        9        14.85     4.01     1.6        74.1     45,091   

Whole Loans

    30,872        30,872        3        5.27     3.95     3.0        94.3     —     
                                                               

Total Real Estate Related Loans Held for Sale, Net

  $ 1,072,328      $ 768,862        35        13.89     5.59     2.4        75.2   $ 96,706   
                                                               

Manufactured Housing Loans Portfolio I, Held for Investment, Net (D)

  $ 146,882      $ 121,661        3,830        9.56     8.70     7.7        1.1   $ 1,246   
                                                               

Residential Loans

  $ 62,695      $ 50,095        221        5.41     2.42     6.5        100.0   $ 6,541   

Manufactured Housing Loans

    1,055        277        26        47.61     8.38     0.7        0.0     406   

Manufactured Housing Loans Portfolio II

    204,675        196,203        6,882        8.01     9.69     6.1        17.3     3,568   
                                                               

Total Residential Mortgage Loans Held for Sale, Net

  $ 268,425      $ 246,575        7,129        7.53     7.99     6.1        36.5   $ 10,515   
                                                               

Subprime Mortgage Loans Subject to Call Option

  $ 406,217      $ 404,011               
                           

 

(A) Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $7.0 million for the manufactured housing loans.
(B) The weighted average maturity is based on the timing of expected principal reduction on the assets.
(C) Includes loans that are 60 or more days past due, in foreclosure, under bankruptcy, or considered real estate owned. As of March 31, 2011, $134.0 million face amount of real estate related loans was on non-accrual status.
(D) The following is an aging analysis of past due residential loans held-for-investment as of March 31, 2011:

 

    30-59 Days
Past Due
    60-89 Days
Past Due
    Over 90 Days Past
Due
    Repossessed     Total Past
Due
    Current     Total Outstanding
Face Amount
 

Manufactured Housing Loans Portoflio I

  $ 579      $ 412      $ 161      $ 673      $ 1,825      $ 145,057      $ 146,882   

Newcastle’s management monitors the credit quality of the Manufactured Housing Loans Portfolio I primarily by using the ageing analysis, current trends in delinquencies and the actual loss incurrence rate.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

The following is a summary of real estate related loans by maturities at March 31, 2011:

Year of Maturity (1)

   Outstanding
Face Amount
     Carrying
Value
     Number of
Loans
 

Delinquent (2)

   $ 96,706       $ 45,417         4   

Period from April 1, 2011 to December 31, 2011

     168,997         140,581         6   

2012

     142,810         73,736         5   

2013

     29,474         21,683         3   

2014

     295,273         230,561         8   

2015

     209,465         165,847         6   

2016

     111,678         75,349         2   

Thereafter

     17,925         15,688         1   
                          

Total

   $ 1,072,328       $ 768,862         35   
                          

 

(1) Based on the final extended maturity date of each loan investment as of March 31, 2011.
(2) Includes loans that are non-performing, in foreclosure, or under bankruptcy.

Activities relating to the carrying value of our real estate loans and residential mortgage loans are as follows:

 

     Held for Sale     Held for Investment  
     Real Estate Related
Loans
    Residential Mortgage
Loans
    Residential Mortgage
Loans
 

December 31, 2010

   $ 782,605      $ 253,213      $ 124,974   

Purchases / additional fundings

     111,667        —          —     

Interest accrued to principal balance

     4,535        —          —     

Principal paydowns

     (172,271     (6,704     (3,326

Valuation (allowance) reversal on loans

     41,539        153        (385

Accretion of loan discount and other amortization

     —          —          343   

Other

     787        (87     55   
                        

March 31, 2011

   $ 768,862      $ 246,575      $ 121,661   
                        

The following is a rollforward of the related loss allowance.

 

     Held For Sale     Held For Investment  
     Real Estate
Related Loans
    Residential Mortgage
Loans
    Residential Mortgage
Loans (B)
 

Balance at December 31, 2010

   $ (321,591   $ (25,193   $ (21,350

Charge-offs (A)

     25,344        1,313        1,072   

Valuation (allowance) reversal on loans

     41,539        153        (385
                        

Balance at March 31, 2011

   $ (254,708   $ (23,727   $ (20,663
                        

 

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

Securitization of Subprime Mortgage Loans

The following table presents information on the retained interests in Newcastle’s securitizations of subprime mortgage loans at March 31, 2011:

 

     Subprime Portfolio  
     I      II  

Total securitized loans (unpaid principal balance) (A)

   $ 512,691       $ 679,180   

Loans subject to call option (carrying value)

   $ 299,176       $ 104,835   

Retained interests (fair value) (B)

   $ 1,087       $ —     

 

(A) Average loan seasoning of 68 months and 50 months for Subprime Portfolios I and II, respectively, at March 31, 2011.
(B) The retained interests include retained bonds of the securitizations. Their fair value is estimated based on pricing models. Newcastle’s residual interests were written off in the first quarter of 2010. The weighted average yield of the retained bonds was 8.08% as of March 31, 2011.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

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; however, it 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, 2011:

 

     Subprime Portfolio  
     I     II  

Loan unpaid principal balance (UPB)

   $ 512,691      $ 679,180   

Weighted average coupon rate of loans

     5.76     5.24

Delinquencies of 60 or more days (UPB) (A)

   $ 110,526      $ 196,958   

Net credit losses for the three months ended March 31, 2011

   $ 8,071      $ 12,588   

Cumulative net credit losses

   $ 171,480      $ 180,224   

Cumulative net credit losses as a % of original UPB

     11.42     16.57

Percentage of ARM loans (B)

     52.9     65.6

Percentage of loans with original loan-to-value ratio >90%

     10.70     17.20

Percentage of interest-only loans

     22.6     4.2

Face amount of debt (C)

   $ 507,499      $ 671,756   

Weighted average funding cost of debt (D)

     1.37     1.47

 

(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 $5.2 million and $7.4 million of retained notes for Subprime Portfolios I and II, respectively, at March 31, 2011.
(D) Includes the effect of applicable hedges.

Newcastle received negligible cash inflows from the retained interests of Subprime Portfolios I and II, during the three months ended March 31, 2011 and $0.1 million and $0.2 million from I and II, respectively, during the three months ended March 31, 2010.

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

Servicing Rights

In February 2011, Newcastle, through one of its subsidiaries, purchased the management rights with respect to certain CBASS Investment Management LLC (“C-BASS”) CDOs pursuant to a bankruptcy proceeding for $2.2 million. Newcastle initially recorded the cost of acquiring the collateral management rights as a servicing asset and subsequently amortized 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, 2011, Newcastle recorded $41,767 of servicing rights amortization and no servicing rights impairment. As of March 31, 2011, Newcastle’s servicing asset had a carrying value of $2.1 million recorded in Receivables and Other Assets.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

5. DEBT OBLIGATIONS

The following table presents certain information regarding Newcastle’s debt obligations and related hedges at March 31, 2011:

 

                                                  Collateral        

Debt
Obligation/Collateral

  Month
Issued
    Outstanding
Face
Amount
    Carrying
Value
    Unhedged
Weighted
Average
Funding

Cost (A)
  Final
Stated
Maturity
    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      $ 243,416      $ 242,885      1.20%     Mar 2039        3.20     1.9      $ 230,648      $ 303,186      $ 271,545      $ 256,566        3.3      $ 103,174      $ 131,500   

CDO V (E)

    Sep 2004        336,884        335,977      1.03%     Sep 2039        3.29     2.7        324,506        372,390        288,362        278,502        3.6        139,722        187,080   

CDO VI (E)

    Apr 2005        90,822        90,822      0.88%     Apr 2040        5.35     4.1        88,073        344,963        189,022        219,680        3.2        110,410        88,073   

CDO VIII

    Nov 2006        618,313        617,371      0.85%     Nov 2052        2.11     2.7        610,713        778,005        548,242        599,376        3.6        461,955        161,655   

CDO IX

    May 2007        480,125        483,739      0.67%     May 2052        1.57     2.8        480,125        655,623        526,614        543,001        2.8        427,285        91,498   

CDO X

    Jul 2007        1,175,000        1,173,399      0.61%     Jul 2052        3.72     4.5        1,175,000        1,296,177        969,157        1,063,961        4.3        220,418        912,801   
                                                                                             
      2,944,560        2,944,193            2.99     3.4        2,909,065        3,750,344        2,792,942        2,961,086        3.7        1,462,964        1,572,607   
                                                                                             

Other Bonds Payable

                           

MH loans Portfolio I (F)

    Apr 2010        82,097        80,930      4.76%     Jul 2035        5.38     3.4        —          146,882        121,661        121,661        7.7        1,617        —     

MH loans Portfolio II

    Aug 2006        165,768        165,631      LIBOR+ 0.88%     Aug 2011        5.26     0.4        165,768        204,675        196,203        196,203        6.1        35,401        124,135   
                                                                                             
      247,865        246,561            5.30     1.3        165,768        351,557        317,864        317,864        6.7        37,018        124,135   
                                                                                             

Notes Payable

                           

Residential Mortgage Loans (G)

    Aug 2004        4,296        4,296      LIBOR+ 0.90%     Dec 2034        1.14     6.7        4,296        4,296        4,296        4,296        6.7        4,296        —     
                                                                                             
      4,296        4,296            1.14     6.7        4,296        4,296        4,296        4,296        6.7        4,296        —     
                                                                                             

Repurchase Agreements

                           

Real estate securities, loans and properties (H)

    Dec 2010        16,703        16,703      LIBOR+ 1.50%     Dec 2011        1.74     0.7        16,703        —          —          —          —          —          —     

FNMA/FHLMC securities (I)

    Various        79,100        79,100      0.29%     Jun 2011        0.29     0.3        —          80,177        83,688        83,911        4.7        80,177        —     
                                                                                             
      95,803        95,803            0.54     0.3        16,703        80,177        83,688        83,911        4.7        80,177        —     
                                                                                             

Corporate

                           

Junior subordinated notes payable

    Mar 2006        51,004        51,252      7.57%(K)     Apr 2035        7.42     24.1        —          —          —          —          —          —          —     
                                                                                             
      51,004        51,252            7.42     24.1        —          —          —          —          —          —          —     
                                                                                             

Subtotal debt obligations

      3,343,528        3,342,105            3.15     3.5      $ 3,095,832      $ 4,186,374      $ 3,198,790      $ 3,367,157        4.0      $ 1,584,455      $ 1,696,742   
                                                                                             

Financing on subprime mortgage loans subject to call option

    (J     406,217        404,011                         
                                       

Total debt obligations

    $ 3,749,745      $ 3,746,116                         
                                       

 

(A) Weighted average, including floating and fixed rate classes and including the amortization of deferred financing costs.
(B) Including the effect of applicable hedges.
(C) Including restricted cash held for reinvestment in CDOs.
(D) Including a $36.4 million notional amount of interest rate cap agreements in CDO X and a $88.1 million, $40.6 million and $124.1 million notional amount of interest rate swap agreements in CDO VI, CDO X and MH loans portfolio II, respectively, which were economic hedges not designated as hedges for accounting purposes.
(E) These CDOs were not in compliance with their applicable over collateralization tests as of March 31, 2011. Newcastle is not receiving cash flows from these CDOs (other than senior management fees and cash flows on senior classes of bonds which were repurchased) and expects these CDOs to remain out of compliance for the foreseeable future.
(F) Excluding $36.9 million of debt sold to certain Newcastle CDOs, which was eliminated in consolidation.
(G) Notes payable issued to CDO VII, which is eliminated in consolidation.
(H) The counterparty of this repurchase agreement is Bank of America. It is secured by $41.2 million face amount of notes issued by Newcastle CDO VI, which is eliminated on consolidation. The maximum recourse to Newcastle is $4.2 million.
(I) The counterparty on these repurchase agreements is Bank of America.
(J) Issued in April 2006 and July 2007. See Note 4 regarding the securitizations of Subprime Portfolios I and II.
(K) LIBOR + 2.25% after April 2016.

In the first three months of 2011, Newcastle repurchased $12.1 million face amount of CDO bonds for $1.1 million. As a result, Newcastle extinguished $12.1 million face amount of CDO debt and recorded a gain on extinguishment of debt of $11.0 million.

 

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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair Value Summary Table

Newcastle held the following financial instruments at March 31, 2011:

 

    Principal
Balance or
Notional
Amount
    Carrying
Value
    Fair Value    

Fair Value Method (A)

  Weighted
Average
Yield/Funding
Cost
    Weighted
Average
Maturity
(Years)
 

Assets

           

Non-Recourse VIE Financing Structures (F)

           

Financial instruments:

           

Real estate securities, available for sale*

  $ 2,542,817      $ 1,994,079      $ 1,994,079      Broker quotations, counterparty quotations, pricing services, pricing models     8.99     4.0   

Real estate related loans, held for sale, net

    1,003,222        764,254        769,362      Broker quotations, counterparty quotations, pricing services, pricing models     13.70     2.5   

Residential mortgage loans, held for investment, net

    146,882        121,661        126,457      Pricing models     9.56     7.7   

Residential mortgage loans, held for sale, net

    267,370        246,298        246,298      Pricing models     7.48     6.2   

Subprime mortgage loans subject to call option (B)

    406,217        404,011        404,011      (B)     9.09     (B

Restricted cash*

    131,540        131,540        131,540         

Derivative assets, treated as hedges (C)(E)*

    104,205        4,829        4,829      Counterparty quotations     N/A        (C

Non-hedge derivative assets (D)(E)*

    36,428        2,706        2,706      Counterparty quotations     N/A        (D

Operating real estate, held for sale

      8,339        8,339         

Other investments

      18,883        18,883         

Receivables and other assets

      31,420        31,420         
                       
    $ 3,728,020      $ 3,737,924         
                       

Recourse Financing Structures and Unlevered Assets

           

Financial instruments:

           

Real estate securities, available for sale*

  $ 300,346      $ 94,587      $ 94,587      Broker quotations, counterparty quotations, pricing services, pricing models     4.11     1.5   

Real estate related loans, held for sale, net

    69,106        4,608        4,608      Broker quotations, counterparty quotations, pricing services, pricing models     45.41     0.8   

Residential mortgage loans, held for sale, net

    1,055        277        277      Pricing models     47.61     0.7   

Cash and cash equivalents*

    160,594        160,594        160,594         

Other investments

      6,024        6,024         

Receivables and other assets

      3,586        3,586         
                       
    $ 269,676      $ 269,676         
                       

 

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Table of Contents

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

    Principal
Balance or
Notional
Amount
    Carrying
Value
    Fair Value    

Fair Value Method (A)

  Weighted
Average
Yield/Funding
Cost
    Weighted
Average
Maturity
(Years)
 

Liabilities

           

Non-Recourse VIE Financing Structures (F) (G)

           

Financial instruments:

           

CDO bonds payable

  $ 2,944,560      $ 2,944,193      $ 1,887,700      Pricing models     2.99     3.4   

Other bonds payable

    247,865        246,561        240,145      Pricing models     5.30     1.3   

Notes payable

    4,296        4,296        3,589      Broker quotation     1.14     6.7   

Repurchase agreements

    12,527        12,527        12,527      Market comparables     1.74     0.7   

Financing of subprime mortgage loans subject to call option (B)

    406,217        404,011        404,011      (B)     9.09     (B

Interest rate swaps, treated as hedges (C )(E)*

    1,303,301        113,001        113,001      Counterparty quotations     N/A        (C

Non-hedge derivatives (D)(E)*

    378,987        40,943        40,943      Counterparty quotations     N/A        (D

Accrued expenses and other liabilities

      11,745        11,745         
                       
    $ 3,777,277      $ 2,713,661         
                       

Recourse Financing Structures and Other Liabilities (G)

           

Financial instruments:

           

Repurchase agreements

  $ 83,276      $ 83,276      $ 83,276      Market comparables     0.36     0.3   

Junior subordinated notes payable

    51,004        51,252        35,067      Pricing models     7.42     24.1   

Due to affiliates

      1,351        1,351         

Accrued expenses and other liabilities

      8,586        8,586         
                       
    $ 144,465      $ 128,280         
                       

 

* Measured at fair value on a recurring basis.

 

17


Table of Contents

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

(A) Methods are listed in order of priority. In the case of real estate securities and real estate related loans, broker quotations are obtained if available and practicable, otherwise counterparty quotations or pricing service valuations are obtained or, finally, internal pricing models are used. Internal pricing models are only used for (i) securities and loans that are not traded in an active market, and, therefore, have little or no price transparency, and for which significant unobservable inputs must be used in estimating fair value, or (ii) loans or debt obligations which are private and untraded.
(B) These two items result from an option, not an obligation, to repurchase loans from Newcastle’s subprime mortgage loan securitizations (Note 4), are noneconomic until such option is exercised, and are equal and offsetting.
(C) Represents derivative agreements as follows:

 

Year of Maturity

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

Interest rate cap agreements which receive 1-Month LIBOR:

          

2015

     Sep       $ 21,000         2.26   $ 783   

2016

     Jul         77,905         2.66     3,696   

2017

     Jan         5,300         1.86     350   
                      
      $ 104,205         $ 4,829   
                      

Interest rate swap agreements which receive 1-Month LIBOR:

          

2011

     Dec       $ 91,498         5.00   $ (2,869

2014

     Nov         15,604         5.09     (1,760

2015

     Apr         564,030         5.44     (43,975

2016

     May         180,155         5.04     (19,728

2017

     Aug         133,434         5.24     (20,028

Interest rate swap agreements which receive 3-Month LIBOR:

          

2014

     Jul         318,580         4.22     (24,641
                      
      $ 1,303,301         $ (113,001
                      

 

(D) This represents eight interest rate swap agreements with a total notional balance of $379.0 million, maturing between June 2016 and September 2017, and three interest rate cap agreements with a total notional balance of $36.4 million, maturing in August 2017 and January 2019. Newcastle entered into these hedge agreements to reduce its exposure to interest rate changes on the floating rate financings of its Manufactured Housing Loan Portfolio II and on the floating rate financings of CDO X. These derivative agreements were not designated as hedges for accounting purposes as of March 31, 2011.
(E) Newcastle’s derivatives fall into two categories. As of March 31, 2011, all derivatives were held within Newcastle’s nonrecourse debt structures (primarily CDOs). An aggregate notional balance of $1.7 billion, which were liabilities at period end, are not subject to Newcastle’s credit risk as they are senior to all the debt obligations of the related CDO. An aggregate notional balance of $140.6 million were assets at period end and therefore are subject to the counterparty’s credit risk. No adjustments have been made to the fair value quotations received related to credit risk as a result of the counterparty’s “AA” credit rating. Newcastle’s significant derivative counterparties include Bank of America, Credit Suisse, Wells Fargo and Deutsche Bank.
(F) Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the extent Newcastle receives net cash flow distributions from such structures. Furthermore, creditors or beneficial interest holders of these structures have no recourse to the general credit of Newcastle. Therefore, Newcastle’s exposure to the economic losses from such structures is limited to its invested equity in them and economically their book value cannot be less than zero. As a result, the fair value of Newcastle’s net investments in these non-recourse financing structures is equal to the present value of their expected future net cash flows.
(G) Newcastle notes that the unrealized gain on the liabilities within such structures cannot be fully realized.

 

18


Table of Contents

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

Valuation Hierarchy

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

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

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

 

   

Quoted prices in active markets for similar instruments,

 

   

Quoted prices in less active or inactive markets for identical or similar instruments,

 

   

Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates), and

 

   

Market corroborated inputs (derived principally from or corroborated by observable market data).

Level 3 – Valuations based significantly on unobservable inputs.

 

   

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

 

   

Level 3B – Valuations based on internal models with significant unobservable inputs.

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

The following table summarizes such financial assets and liabilities measured at fair value on a recurring basis at March 31, 2011:

 

     Principal Balance
or Notional
Amount
            Fair Value  
        Carrying Value      Level 2      Level 3A (1)      Level 3B (2)      Total  

Assets:

                 

Real estate securities, available for sale:

                 

CMBS

   $ 1,890,455       $ 1,443,948       $ —         $ 1,274,921       $ 169,027       $ 1,443,948   

REIT debt

     299,523         314,881         314,881         —           —           314,881   

ABS - subprime

     326,093         179,455         —           78,869         100,586         179,455   

ABS - other real estate

     71,026         50,488         —           43,121         7,367         50,488   

FNMA / FHLMC

     87,453         91,647         91,647         —           —           91,647   

CDO

     168,613         5,618         —           —           5,618         5,618   
                                                     

Debt security total

   $ 2,843,163         2,086,037         406,528         1,396,911         282,598         2,086,037   
                       

Equity securities

        2,629         —           —           2,629         2,629   
                                               

Real estate securities total

      $ 2,088,666       $ 406,528       $ 1,396,911       $ 285,227       $ 2,088,666   
                                               

Derivative assets:

                 

Interest rate caps, treated as hedges

   $ 104,205       $ 4,829       $ 4,829       $ —         $ —         $ 4,829   

Interest rate caps, not treated as hedges

     36,428         2,706         2,706         —           —           2,706   
                                                     

Derivative assets total

   $ 140,633       $ 7,535       $ 7,535       $ —         $ —         $ 7,535   
                                                     

Liabilities:

                 

Derivative Liabilities:

                 

Interest rate swaps, treated as hedges

   $ 1,303,301       $ 113,001       $ 113,001       $ —         $ —         $ 113,001   

Interest rate swaps, not treated as hedges

     378,987         40,943         40,943         —           —           40,943   
                                                     

Derivative liabilities total

   $ 1,682,288       $ 153,944       $ 153,944       $ —         $ —         $ 153,944   
                                                     

 

(1) Third party pricing sources with significant unobservable inputs.
(2) Internal models with significant unobservable inputs.

 

19


Table of Contents

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

Newcastle’s investments in instruments measured at fair value on a recurring basis using Level 3 inputs changed during the three months ended March 31, 2011 as follows:

 

     Level 3A  
     CMBS     ABS     Equity/Other
Securities
    Total  
     Conduit     Other     Subprime     Other      

Balance at December 31, 2010

   $ 840,227      $ 331,904      $ 83,582      $ 36,193      $ —        $ 1,291,906   

Transfers (A)

            

Transfers from Level 3B

     5,032        —          6,806        —          —          11,838   

Transfers into Level 3B

     —          —          (14,794     —          —          (14,794

Total gains (losses) (B)

            

Included in net income (C)

     16,928        (1,590     (1,179     —          —          14,159   

Included in other comprehensive income (loss)

     18,425        22,715        128        367        —          41,635   

Amortization included in interest income

     6,494        1,151        1,665        54        —          9,364   

Purchases, sales and settlements

            

Purchases

     84,193        25,146        8,365        7,548        —          125,252   

Proceeds from sales

     (23,415     (10,609     —          —          —          (34,024

Proceeds from repayments

     (31,861     (9,819     (5,704     (1,041     —          (48,425
                                                

Balance at March 31, 2011

   $ 916,023      $ 358,898      $ 78,869      $ 43,121      $ —        $ 1,396,911   
                                                
     Level 3B  
     CMBS     ABS     Equity/Other
Securities
    Total  
     Conduit     Other     Subprime     Other      

Balance at December 31, 2010

   $ 107,457      $ 21,146      $ 94,424      $ 8,985      $ 4,282      $ 236,294   

Transfers (A)

            

Transfers from Level 3A

     —          —          14,794        —          —          14,794   

Transfers into Level 3A

     (5,032     —          (6,806     —          —          (11,838

Total gains (losses) (B)

            

Included in net income (C)

     12,557        722        824        27        —          14,130   

Included in other comprehensive income (loss)

     48,642        206        5,961        (1,058     (1,609     52,142   

Amortization included in interest income

     4,719        28        3,220        399        187        8,553   

Purchases, sales and settlements

            

Purchases

     —          —          25        —          5,387        5,412   

Proceeds from sales

     (16,051     (721     (8,219     (348     —          (25,339

Proceeds from repayments

     (4,630     (16     (3,637     (638     —          (8,921
                                                

Balance at March 31, 2011

   $ 147,662      $ 21,365      $ 100,586      $ 7,367      $ 8,247      $ 285,227   
                                                

 

(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 dates.
(C) These gains (losses) are recorded in the following line items in the consolidated statement of income: