Newcastle Investment Corp.
Annual Report 2007
Newcastle Investment Corp. is a real estate investment and finance company
that owns a diversified portfolio of debt predominantly secured by commercial and
residential real estate. The Company seeks to utilize match funded financing strategies
to increase returns to shareholders and minimize its exposure to refinancing and
interest rate risks. Newcastle is taxed as a real estate investment trust and is managed
by an affiliate of Fortress Investment Group LLC.
2007 Financial Highlights
(dollars in thousands except per share data)
Balance Sheet Data
Real estate securities, available for sale
Real estate related loans, net
Residential mortgage loans, net
Total assets
Debt obligations
Preferred stock
Common stockholders’ equity
Book value per common share
Adjusted net book value per common share(A)
Operating Data
Funds from Operations (FFO)(B)(C)
FFO per common share, diluted(B)(C)
Income (loss) applicable to common stockholders(C)
Net income (loss) per common share, diluted(C)
Weighted average number of common shares outstanding, diluted
Dividends declared for the year ended December 31, 2007
$ 4,835,884
1,856,978
634,605
8,037,770
7,391,694
152,500
295,125
5.59
16.39
(76,976)
(1.50)
(78,097)
(1.52)
$
$
$
$
$
$
51,369,486
$
2.85
(A) Represents our GAAP book value per common share as if we had elected to measure all of our financial assets and
liabilities at fair value under SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities.”
(B) Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a description
of Funds from Operations (FFO).
(C) Includes $202,602, or $3.94 per diluted common share, of other than temporary impairment charges.
Newcastle Investment Corp.
1
Fellow Shareholders:
Newcastle faced many challenges in 2007. Over the years, we have seen a
number of credit cycles and have successfully navigated them with the
combination of a strong credit discipline, a highly diversified balance sheet
and a focus on long-term financing. This down cycle, which began in the
subprime markets in July and quickly spread to other credit markets as
the year wore on, is unsurpassed in our experience in both the ferocity of
the market’s correction as well as the magnitude of its impact on financial
markets around the world.
Many of the excesses in the markets were revealed once the credit markets began to
unravel. Market corrections are never pleasant and this one is no exception. What makes
this experience so different to past corrections is its magnitude. The volume of repriced
assets and the impact on financial institutions worldwide is without precedent. These
are difficult times but present tremendous opportunities for us.
This credit crunch has led to one of the greatest deleveraging events that we have ever
seen. In simple terms, there are many more sellers of assets than there are buyers.
Consequently prices are down, in many cases without regard to performance of the assets.
The dislocation of the markets took a toll on our business last year. Our financial results
were disappointing to say the least—it was the first year since we went public that we
recorded a net loss from operations. Although our portfolio in general performed very
well, there were a handful of investments that performed poorly and that, combined
with an overall markdown of the portfolio, led to financial results that are not up to
our standards.
2
The good news is that our financing strategy played a critical role in helping us manage
the challenging market conditions during this credit crunch. Our strategy is to finance
our investment portfolio largely through the use of long-term, non-callable liabilities
that allow us to match the term of our financing to the expected term of our assets. The
value of non-callable, non mark to market financing structures was never more evident
than in this past year.
As of February 2008, our total balance sheet had approximately $7.0 billion of assets
and $5.8 billion of debt liabilities. Of that, we currently have $4.4 billion of non-recourse
CBO liabilities with an average funding cost of LIBOR + 40 basis points and an average
remaining term to maturity of 6.2 years; these liabilities finance assets with an average
remaining term to maturity of 4.7 years. As these assets prepay or mature, we should be
well positioned to reinvest the proceeds in higher quality assets at higher yields, which
will add to the growth of our earnings.
We have also added greatly to our cash on hand—we have over $120 million of cash
as of February and no outstanding revolver debt. We have reduced our dividend
substantially, which will allow us to continue to add to our liquidity and should position
us well to benefit from the opportunities that this market presents.
Although early in the year, 2008 has already been a year of great volatility and with a
recession that now seems very likely, there is still a great deal of uncertainty in the
financial markets. These are times of stress but also create significant opportunities
for us. We are focused, as always, on maximizing shareholder value and look forward
to having a productive year in 2008.
Thank you for your continued support,
Kenneth M. Riis
Chief Executive Officer and President
Newcastle Investment Corp.
3
300
275
250
225
200
175
150
125
100
75
$300
$275
$250
$225
$200
$175
$150
$125
$100
$75
Dec 02
Dec 03
Dec 04
Dec 05
Newcastle Investment Corp.
NAREIT All REIT
Russell 2000
NAREIT Mortgage REIT
S&P 500
Stock Performance Chart
$300
$275
$250
$225
$200
$175
$150
$125
$100
e
u
l
a
V
x
e
d
n
I
$75
Dec 02
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
* $100 invested on 12/31/02 in stock and index—including reinvestment of dividends.
Fiscal year ending December 31.
Source: SNL Financial LC, Charlottesville, VA
Copyright © 2008
Dec 07
Dec 06
300
275
250
225
200
175
150
125
100
75
4
Newcastle Investment Corp.
2007 Form 10-K
Newcastle Investment Corp. and Subsidiaries
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
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
(Exact name of registrant as specified in its charter)
Newcastle Investment Corp.___________________________
Maryland
(State or other jurisdiction of incorporation
or organization)
81-0559116
(I.R.S. Employer Identification No.)
1345 Avenue of the Americas, New York, NY
(Address of principal executive offices)
10105
(Zip Code)
Registrant’s telephone number, including area code: (212) 798-6100
Securities registered pursuant to Section 12 (b) of the Act:
Title of each class:
Common Stock, $0.01 par value per share
9.75% Series B Cumulative Redeemable Preferred
Stock, $0.01 par value per share
8.05% Series C Cumulative Redeemable Preferred
Stock, $0.01 par value per share
8.375% Series D Cumulative Redeemable Preferred
Stock, $0.01 par value per share
Name of exchange on which registered:
New York Stock Exchange (NYSE)
New York Stock Exchange (NYSE)
New York Stock Exchange (NYSE)
New York Stock Exchange (NYSE)
Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes X No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act.
Yes X No
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.
X Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K ____
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer,
or smaller reporting company. See definition 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 ___ Non-accelerated Filer ___ Smaller Reporting Company ___
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
(Check One):
Yes X No
The aggregate market value of the voting common stock held by non-affiliates as of June 30, 2007 (computed based
on the closing price on such date as reported on the NYSE) was: $1.2 billion.
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: 52,780,429 outstanding as of February 26, 2008.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the Registrant’s definitive proxy statement for the Registrant’s 2008 annual meeting, to be filed
within 120 days after the close of the Registrant’s fiscal year, are incorporated by reference into Part III of
this Annual Report on Form 10-K.
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:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
our ability to take advantage of opportunities in additional asset classes at attractive risk-adjusted prices;
our ability to deploy capital accretively;
the risks that default and recovery rates on our 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 or not extending our
repurchase agreements in accordance with their current terms;
changes in interest rates and/or credit spreads, as well as the success of our hedging strategy 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 CBOs;
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;
completion of pending investments;
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.
NEWCASTLE INVESTMENT CORP.
FORM 10-K
INDEX
PART I
Business
Item 1.
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2.
Item 3.
Item 4.
Properties
Legal Proceedings
Submission of Matters to a Vote of Security Holders
Item 5.
Item 6.
Item 7.
PART II
Market for Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of
Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Item 8.
Report of Independent Registered Public Accounting Firm
Report on Internal Control over Financial Reporting of Independent Registered
Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2007 and December 31, 2006
Consolidated Statements of Operations for the years ended December 31, 2007,
2006 and 2005
Consolidated Statements of Stockholders’ Equity for the years ended December
31, 2007, 2006 and 2005
Consolidated Statements of Cash Flows for the years ended December 31, 2007,
2006 and 2005
Notes to Consolidated Financial Statements
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
Item 9A. Controls and Procedures
Item 9.
Management’s Report on Internal Control over Financial Reporting
Item 9B. Other Information
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11.
Item 12.
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholders Matters
Certain Relationships and Related Transactions, and Director Independence
Item 13.
Item 14.
Principal Accountant Fees and Services
Item 15.
Exhibits; Financial Statement Schedules
Signatures
PART IV
Page
1
12
27
27
27
27
27
29
31
55
59
60
61
62
63
64
66
68
102
102
102
103
104
104
104
104
104
105
106
Item 1. Business.
Overview
PART I
Newcastle Investment Corp. (“Newcastle”) actively manages real estate related investments and related financing vehicles.
We invest with the objective of producing long term, stable returns under varying interest rate and credit cycles, with a
moderate amount of credit risk. Newcastle invests in, and actively manages a portfolio of, real estate securities, loans and
other real estate related assets. In addition, we consider other opportunistic investments which capitalize on our manager’s
expertise and which we believe present attractive risk/return profiles and are consistent with our investment guidelines. We
seek to deliver stable dividends and attractive risk-adjusted returns to our stockholders through prudent asset selection,
active management and the use of match funded financing structures, when appropriate and available, which reduce our
interest rate and financing risks. We make money by optimizing our “net spread,” the difference between the yield on our
investments and the cost of financing these investments. We emphasize portfolio management, asset quality,
diversification, match funded financing and credit risk management.
Our activities cover four distinct categories:
1) Real Estate Securities:
2) Real Estate Related Loans:
3) Residential Mortgage Loans:
4) Operating Real Estate:
We underwrite, acquire and manage a diversified portfolio of moderately
credit sensitive real estate securities, including commercial mortgage backed
securities (CMBS), senior unsecured REIT debt issued by property REITs,
real estate related asset backed securities (ABS) and FNMA/FHLMC
securities. We generally target securities rated A through BB, except for our
FNMA/FHLMC securities which have an implied AAA rating. As of
December 31, 2007, our real estate securities represented 77.8% of our assets,
including 5.0% of our assets which represent subprime securities.
We acquire and originate loans to well capitalized real estate owners with
strong track records and compelling business plans, including B-notes,
mezzanine loans, bank loans, and real estate loans. As of December 31,
2007, our real estate related loans represented 7.0% of our assets.
We acquire residential mortgage loans, including manufactured housing loans
and subprime mortgage loans, that we believe will produce attractive risk-
adjusted returns. As of December 31, 2007, our residential mortgage loans
represented 13.7% of our assets. We do not directly own any subprime
mortgage loans as of year-end.
We acquire and manage direct and indirect interests in operating real estate.
As of December 31, 2007, our operating real estate represented 0.7% of our
assets.
In addition, Newcastle had uninvested cash and other miscellaneous net assets which represented 0.8% of our assets at
December 31, 2007. Further details regarding the revenues, net income (loss) and total assets of each of our segments for
each of the last three fiscal years are presented in Part II, Item 8, “Financial Statements and Supplementary Data.”
Underpinning our investment activities is a disciplined approach to acquiring, financing and actively managing our assets.
Our principal objective is to acquire a highly diversified portfolio of debt investments secured by real estate that has
moderate credit risk and sufficient liquidity. Newcastle primarily utilizes a match funded financing strategy, when
appropriate and available, in order to minimize refinancing and interest rate risks. This means that we seek both to match
the maturities of our debt obligations with the maturities of our investments, in order to minimize the risk that we have to
refinance our liabilities prior to the maturities of our assets, and to match the interest rates on our investments with like-
kind debt (i.e. floating or fixed), in order to reduce the impact of changing interest rates on our earnings. Finally, we
actively manage credit exposure through portfolio diversification and ongoing asset selection and surveillance. Newcastle,
through its manager, has a dedicated team of senior investment professionals experienced in real estate capital markets,
structured finance and asset management. We believe that these critical skills position us well not only to make prudent
investment decisions but also to monitor and manage the credit profile of our investments.
Newcastle’s stock is traded on the New York Stock Exchange under the symbol “NCT”. Newcastle is a real estate
investment trust for federal income tax purposes and is externally managed and advised by an affiliate of Fortress
Investment Group LLC, or Fortress. Fortress is a global alternative investment and asset management firm with
approximately $40 billion in assets under management as of September 30, 2007. Fortress, which was founded in 1998,
became the first global alternative asset manager listed on the New York Stock Exchange (NYSE: FIG) in February 2007.
We believe that our manager’s expertise and significant business relationships with participants in the fixed income,
structured finance and real estate industries has enhanced our access to investment opportunities which may not be broadly
marketed. For its services, our manager is entitled to a management fee and incentive compensation pursuant to a
management agreement. Our manager, through its affiliates, and principals of Fortress owned 5.1 million shares of our
common stock and our manager, through its affiliates, had options to purchase an additional 1.5 million shares of our
common stock, which were issued in connection with our equity offerings, representing approximately 11.9% of our
common stock on a fully diluted basis, as of February 26, 2008.
1
Our Strategy
Newcastle’s investment strategy focuses predominantly on debt investments secured by real estate. We do not have specific
policies as to the allocation among type of real estate related assets or investment categories since our investment decisions
depend on changing market conditions. Instead, we focus on relative value and in-depth risk/reward analysis with an emphasis
on asset quality, liquidity and diversification. Our focus on relative value means that assets which may be unattractive under
particular market conditions may, if priced appropriately to compensate for risks such as projected defaults and prepayments,
become attractive relative to other available investments. We utilize a match funded financing strategy, when appropriate, and
active management to optimize our returns.
The following table summarizes our investment portfolio at December 31, 2007 and adjusted for assets sold through February
25, 2008 (dollars in tables in millions). It excludes subprime mortgage loans subject to call option of $406.2 million and
operating real estate of $40.4 million at December 31, 2007.
Outstanding
Face Amount
December 31, 2007
Assets Sold Through
February 25, 2008 (1)
Adjusted Face
Amount (1)
Percentage of
Adjusted Face
Amount
Number of
Investments
Credit (2)
Weighted
Average Life
(years)
5.7
1.9
1.7
1.4
-
4.3
5.5
3.7
6.2
5.1
4.8
5.6
3.1
4.4
3.3
0.3
3.1
4.2
Commercial
CMBS (3)
Mezzanine Loans (3)
B-Notes (3)
Whole Loans (3)
Investment in Joint Ventures
Total Commercial Assets
Residential
Manufactured Housing and
Residential Mortgage Loans
Subprime Securities (3)
Subprime Residual / Retained
Securities (4)
Real Estate ABS
Total Residential Assets
Corporate
REIT Debt
Corporate Bank Loans
Total Corporate Assets
Other Assets
FNMA/FHLMC
ICH Loans
Total Other Assets
$
2,529
823
398
115
21
3,886
$
248
3
8
25
-
284
$
2,281
820
390
90
21
3,602
645
586
145
106
1,482
921
662
1,583
1,229
85
1,314
-
-
-
-
-
254
9
263
770
-
770
645
586
145
106
1,482
667
653
1,320
459
85
544
32.9%
11.8%
5.6%
1.3%
0.3%
51.9%
9.3%
8.4%
2.1%
1.5%
21.3%
9.6%
9.4%
19.0%
6.6%
1.2%
7.8%
258
23
13
4
2
16,012
122
8
26
67
14
15
46
BBB-
68%
63%
77%
NR
696
BB+
BB+
BBB
BBB-
B
AAA
NR
TOTAL
$
8,265
$
1,317
$
6,948
100.0%
(1) Unaudited.
(2) Credit represents weighted average rating for rated assets, loan-to-value ratio (“LTV”) for non-rated commercial assets,
FICO score for non-rated residential assets and implied AAA for FNMA/FHLMC.
(3) For further information on our portfolio see “Management’s Discussion and Analysis of Financial Condition and Results
of Operations – Statistics.”’
(4) Represents $76.4 million and $68.2 million of face amount of retained bonds and residual interests, respectively, in the
securitizations of Subprime Portfolios I and II (as defined in “– Residential Mortgage Loans” below).
Financing Strategy and Match Funded Discipline
We employ leverage in order to achieve our return objectives. 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. 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 utilize multiple forms of financing, including collateralized bond obligations
(CBOs), other securitizations, term loans (including total rate of return swaps), trust preferred securities, as well as short term
financing in the form of repurchase agreements.
2
Our manager may elect for us to bear a level of refinancing risk on a short term or longer term basis, such as is the case with
investments financed with repurchase agreements, when based on all of the relevant factors, bearing such risk is advisable.
We attempt to reduce interim refinancing risk and to minimize exposure to interest rate fluctuations through the use of match
funded financing structures, when appropriate and available, whereby we seek (i) to match the maturities of our debt
obligations with the maturities of our assets and (ii) to match the interest rates on our investments with like-kind debt (i.e.,
floating rate assets are financed with floating rate debt and fixed rate assets are financed with fixed rate debt), directly or
through the use of interest rate swaps, caps or other financial instruments, or through a combination of these strategies. This
allows us to minimize the risk that we have to refinance our liabilities prior to the maturities of our assets and to reduce the
impact of changing interest rates on our earnings.
Credit Risk Management
Credit risk refers to the ability of each individual borrower under our loans and securities to make required interest and
principal payments on the scheduled due dates. We believe, based on our due diligence process, that these assets offer
attractive risk-adjusted returns with long term principal protection under a variety of default and loss scenarios. We minimize
credit risk by actively monitoring our asset portfolio and the underlying credit quality of our holdings and, where appropriate,
repositioning our investments to upgrade their credit quality and yield. A significant portion of our investments are financed
with collateralized bond obligations, known as CBOs. Our CBO financings offer us structural flexibility to buy and sell certain
investments to manage risk and, subject to certain limitations, to optimize returns.
Further, while the expected yield on our real estate securities, which comprise a meaningful portion of our assets, is sensitive to
the performance of the underlying loans, the first risk of default and loss - referred to as a “first loss position”- is borne by the
more subordinated securities or other features of the securitization transaction, in the case of commercial mortgage and asset
backed securities, and the issuer’s underlying equity and subordinated debt, in the case of senior unsecured REIT debt
securities.
Formation
We were formed in June 2002 as a subsidiary of Newcastle Investment Holdings Corp. Prior to our initial public offering,
Newcastle Investment Holdings contributed to us certain assets and related liabilities in exchange for approximately 16.5
million shares of our common stock. Our operations commenced in July 2002. In May 2003, Newcastle Investment Holdings
distributed to its stockholders all of the shares of our common stock that it owned, and it no longer owns any of our equity.
The following table presents information on shares of our common stock issued since our formation:
Year
Shares Issued
Formation
2002
2003
2004
2005
2006
2007
December 31, 2007
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors.
16,488,517
7,000,000
7,886,316
8,484,648
4,053,928
1,800,408
7,065,362
52,779,179
Range of Issue
Prices (1)
N/A
$13.00
$20.35-$22.85
$26.30-$31.40
$29.60
$29.42
$27.75-$31.30
Net Proceeds
(millions)
N/A
$80.0
$163.4
$224.3
$108.2
$51.2
$201.3
Our Investing Activities
Information regarding our business segments is provided in Part II, Item 7, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and in Note 3 to our consolidated financial statements which appear in Part II,
Item 8, “Financial Statements and Supplementary Data.”
3
The following is a description of our investments as of December 31, 2007.
Real Estate Securities
We own a diversified portfolio of moderately credit sensitive real estate securities, which was comprised of the following
at December 31, 2007 (dollars in thousands):
Asset Type
CMBS-Conduit
CMBS-Large Loan
CMBS-CDO
CMBS-B Note
REIT Debt
ABS-Subprime
ABS-Manufactured Housing
ABS-Franchise
FNMA/FHLMC (A)
Subtotal/Average
Retained Securities (B)
Residual Interests (B)
Total/Average
Weighted Average
Outstanding
Face Amount
$ 1,580,562
Carrying
Value
Number of
Securities
$ 1,317,992 201
650,886
619,619 47
16,000
281,285
920,858
586,083
61,838
45,092
1,229,115
640 1
256,717 43
903,300 92
289,938 122
55,868 9
36,133 17
1,246,265 43
S&P
Equivalent
Rating
BBB
BBB-
CC+
BB+
BBB-
BB+
BBB-
BBB
AAA
5,371,719
4,726,472 575
BBB+
76,380
53,987 6
68,248
$ 5,516,347
55,425 2
583
$ 4,835,884
BBB
NR
BBB+
Yield
Maturity
(Years)
6.47% 6.6
6.58% 2.6
15.00% -
7.30% 5.2
5.95% 5.1
7.38% 3.7
7.47% 5.3
7.35% 4.9
5.28% 3.3
6.24% 4.7
12.85% 7.3
20.00% 7.1
6.46% 4.7
(A) FNMA/FHLMC has an implied AAA rating.
(B) Represents the retained bonds and equity from two securitizations of subprime mortgage loans as described in "Residential
Mortgage Loans" below.
Real Estate Related Loans
We directly owned the following real estate related loans at December 31, 2007 (dollars in thousands):
Loan Type
Mezzanine Loans (1)
Corporate Bank Loans
B-Notes
Whole Loans
ICH Loans
Total
Outstanding
Face Amount
$ 805,460
464,916
397,897
114,935
84,516
$ 1,867,724
Carrying
Value
$ 801,678
460,622
396,477
113,784
84,417
$ 1,856,978
Loan
Count
22
15
15
5
46
103
Weighted Avg.
Yield
Weighted Avg.
Maturity (Years)
8.44%
7.99%
7.70%
10.28%
7.57%
8.24%
1.9
3.6
1.8
1.4
0.3
2.2
(1) One of these loans has an $8.9 million contractual exit fee which Newcastle will begin to accrue when management
believes it is probable that such exit fee will be received.
We also indirectly owned the following interests in real estate related loans at December 31, 2007:
Joint Venture
In 2003, we co-invested, on equal terms, in a joint venture alongside an affiliate of our manager which acquired
a pool of franchise loans collateralized by fee and leasehold interests and other assets. We, and our manager’s
affiliate, each own an approximately 38% interest in the joint venture. The remaining approximately 24%
interest is owned by a third party financial institution. In December 2007, we closed on a sale of a pool of loans
in the joint venture. Our investment totaled $11.0 million at December 31, 2007, of which $9.3 million
represented our share of such investee’s cash balance, and is reflected as an investment in an unconsolidated
subsidiary on our consolidated balance sheet.
Loans Financed via Total Rate of Return Swaps
We have entered into total rate of return swaps with major investment banks to finance certain loans whereby
we receive the sum of all interest, fees and any positive change in value amounts (the total return cash flows)
from a reference asset with a specified notional amount, and pay interest on such notional amount plus any
negative change in value amounts from such asset. These agreements are recorded in Derivative Assets or
Liabilities (as applicable) and treated as non-hedge derivatives for accounting purposes and are therefore
marked to market through income. Net interest received is recorded to Interest Income and the mark to market
is recorded to Other Income. If we owned the reference assets directly, they would not be marked to market
through income. Under the agreements, we are required to post an initial margin deposit to an interest bearing
account and additional margin may be payable in the event of a decline in value of the reference asset. Any
margin on deposit (recorded in Restricted Cash), less any negative change in value amounts, will be returned to
us upon termination of the contract.
4
As of December 31, 2007, Newcastle held an aggregate of $252.7 million notional amount of total rate of
return swaps on 8 reference assets, including an unfunded asset with a notional amount of $38.1 million, on
which it had deposited $43.9 million of margin. These total rate of return swaps had an aggregate fair value
of approximately ($8.8 million), a weighted average receive interest rate of LIBOR +2.77%, a weighted
average pay interest rate of LIBOR +0.59%, and a weighted average swap maturity of 0.5 years.
Residential Mortgage Loans
We own portfolios of residential mortgage loans, including manufactured housing loans, predominantly originated in
2005, and subprime mortgage loans, on properties located in the U.S. The following table sets forth certain
information with respect to our residential mortgage loan portfolios at December 31, 2007 (dollars in thousands):
Loan Type
Outstanding
Face
Amount
Carrying
Value
Loan Count
Weighted Avg.
Yield
Weighted Avg.
Maturity (Years) (1)
Residential loans
$
102,431
$
104,630
Manufactured housing loans
542,125
529,975
Total
$
644,556
$
634,605
328
15,684
16,012
5.67%
8.60%
8.11%
2.8
6.1
5.5
Subprime mortgage loans
subject to call option
$
406,217
$
393,899
(1) The weighted average maturities for the residential loan portfolio and the two manufactured housing loan portfolios
were calculated based on constant prepayment rates (CPR) of 30%, 8% and 9%, respectively .
Subprime Portfolio I
In March 2006, we acquired a portfolio of approximately 11,300 residential mortgage loans, predominantly originated
in 2005, to subprime borrowers (“Subprime Portfolio I”) for $1.50 billion. The loans are being serviced by Nationstar
Mortgage, LLC, an affiliate of our manager, for a servicing fee equal to 0.50% per annum on the unpaid principal
balance of Subprime Portfolio I.
In April 2006, through Newcastle Mortgage Securities Trust 2006-1 (“Securitization Trust 2006”), we closed on a
securitization of Subprime Portfolio I. Securitization Trust 2006 is not consolidated by us. We sold Subprime
Portfolio I and a related interest rate swap to Securitization Trust 2006. Securitization Trust 2006 issued $1.45 billion
of notes. We retained $37.6 million face amount of the investment grade notes and all of the equity issued by
Securitization Trust 2006. The notes have a stated maturity of March 2036. As holder of the equity of Securitization
Trust 2006, we have the option to redeem the notes once the aggregate principal balance of Subprime Portfolio I is
equal to or less than 20% of such balance at the date of the transfer. The proceeds from the securitization were used to
repay the repurchase agreement which financed Subprime Portfolio I prior to the securitization.
The transaction between us and Securitization Trust 2006 qualified as a sale for accounting purposes. However, 20%
of the loans which are subject to a call option by Newcastle (as described above) were not treated as being sold and
are classified as “held for investment” subsequent to the completion of the securitization.
Subprime Portfolio II
In March 2007, we entered into an agreement to acquire a portfolio of approximately 7,300 residential mortgage loans
to subprime borrowers (“Subprime Portfolio II”) of up to $1.7 billion of unpaid principal balance. Following our due
diligence review of the portfolio, we funded $1.3 billion or approximately 75% of the original commitment. The
agreement between the seller and Newcastle required the seller to repurchase any delinquent loans for three months
following our acquisition. The loans are being serviced by Nationstar Mortgage LLC, an affiliate of our manager, for a
servicing fee equal to 0.50% per annum on the unpaid principal balance of Subprime Portfolio II.
In July 2007, through Newcastle Mortgage Securities Trust 2007-1 (“Securitization Trust 2007”), we closed on a
securitization of Subprime Portfolio II. As a result of the repurchase of delinquent loans by the seller, as well as
borrower repayments, the unpaid principal balance of the portfolio upon securitization in July 2007 was $1.1 billion.
Securitization Trust 2007 is not consolidated by us. We sold Subprime Portfolio II to Securitization Trust 2007.
Securitization Trust 2007 issued $1.0 billion of notes. We retained $38.8 million of the investment grade notes and all
of the equity issued by Securitization Trust 2007. The notes have a stated maturity of April 2037. As holder of the
equity of Securitization Trust 2007, we have the option to redeem the notes once the aggregate principal balance of
Subprime Portfolio II is equal to or less than 10% of such balance at the date of the transfer. The proceeds from the
securitization were used to repay the repurchase agreement which financed Suprime Portfolio II prior to the
securitization.
The transaction between us and Securitization Trust 2007 qualified as a sale for accounting purposes. However, 10%
of the loans which are subject to a call option by Newcastle (as described above) were not treated as being sold and
are classified as “held for investment” subsequent to the completion of the securitization.
5
In both transactions, the residual interests and the retained bonds are reported as real estate securities, available for
sale. The retained loans subject to call option and corresponding financing are reported as separate line items on our
balance sheet.
We have no obligation to repurchase any loans from either of our subprime securitizations. Therefore, it is expected
that our exposure to loss is limited to the carrying amount of our 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.
Operating Real Estate
The following table sets forth certain information with respect to our operating real estate as of December 31, 2007
(dollars, others than per square foot amounts, in thousands):
Property Address
Use
Net Rentable
Sq Ft
Major tenants
% of Total
Sq Ft
Leased
Tenant Net
Rentable
Sq Ft
Annual Rent
100 Dundas St. (1)
London, ON
Office
303,082
Bell Canada (2)
A total of 4 tenants
61.5%
4.0%
65.5%
186,515
12,099
198,614
$
1,330
119
1,449
Apple Valley I
1430 Oak Court
Beavercreek, OH
Apple Valley II
4020 Executive Drive
Beavercreek, OH
Apple Valley III
4021-29 Executive Drive
Beavercreek, OH
Dayton Towne Center
1880 Needmore Drive
Dayton, OH
Airport Corporate Center
303 Corporate Center Dr
Vandalia, OH
2 River Place
Dayton, OH
Totals
Office
56,659
A total of 10 tenants
58.0%
32,855
511
Office
29,916
1 tenant
100.0%
29,916
Office
45,299
1 tenant
100.0%
45,299
Retail
33,485
A total of 5 tenants
75.2%
25,197
492
672
163
Office
46,614
A total of 6 tenants
50.3%
23,468
278
Office
46,627
A total of 3 tenants
21.4%
9,958
157
561,682
65.0%
365,307
$
3,722
(1) Monetary amounts for the Canadian property are in U.S. dollars based on December 31, 2007 Canadian dollar exchange ratio of 0.9984 USD
per CAD.
(2) This lease includes a charge for an administration fee of up to 15% of the operating expenses which are reimbursable by the tenant.
Schedule of lease expirations (dollars in thousands):
Year
2008
2009
2010
2011
2012
2017
Leased total
Vacant
Total
Square Feet of
Expiring Leases
Annual Rent of Expiring
Leases (1)
% of Gross Annual Rent
represented by Expiring
Leases
$
833
143
297
672
1,499
278
$
3,722
52,508
11,646
32,986
45,299
200,200
22,667
365,306
196,376
561,682
22.4%
3.8%
8.0%
18.1%
40.3%
7.4%
100.0%
(1) Monetary amounts for the Canadian property are in U.S. dollars based on December 31, 2007 Canadian dollar exchange ratio of 0.9984 USD
per CAD.
6
We also indirectly owned the following interest in operating real estate at December 31, 2007:
Joint Venture
In March 2004, we purchased a 49% interest in a portfolio of convenience and retail gas stores located throughout the
southeastern and southwestern regions of the U.S. The properties are subject to a sale-leaseback arrangement under
long term triple net leases with a 15 year minimum term. We structured this transaction through a joint venture in two
limited liability companies with a private investment fund managed by an affiliate of our manager, pursuant to which
it co-invested on equal terms. One company held assets available for sale, the last of which was sold in September
2005, and one holds assets for investment. In October 2004, the investment’s initial financing was refinanced with a
non-recourse term loan ($51.9 million outstanding at December 31, 2007), which bears interest at a fixed rate of
6.04% and matures in October 2014. At December 31, 2007, we had a $13.4 million investment in this entity.
Our Financing and Hedging Activities
We employ leverage in order to achieve our return objectives. 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 December 31, 2007, our debt to equity ratio as computed based on our consolidated balance sheet
was approximately 16.5 to 1. Our general investment guidelines adopted by our board of directors limit total leverage
(as defined under the governing documents) to a maximum 9.0 to 1 debt to equity ratio. As of December 31, 2007, our
debt to equity ratio as computed under this method was approximately 6.2 to 1. 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 utilize multiple forms of financing including collateralized bond
obligations (CBOs), other securitizations, term loans (including total rate of return swaps), and trust preferred
securities, as well as short term financing in the form of repurchase agreements. Further details regarding the forms of
financing that we are currently able to utilize are presented in Part II, Item 7, “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” under “– Market Considerations” and “– Liquidity and Capital
Resources.”
Our manager may elect for us to bear a level of refinancing risk on a short term or longer term basis, such as is the
case with investments financed with repurchase agreements, when, based on all of the relevant factors, bearing such
risk is advisable.
We attempt to reduce interim refinancing risk and to minimize exposure to interest rate fluctuations through the use of
match funded financing structures, when appropriate, whereby we seek (i) to match the maturities of our debt
obligations with the maturities of our assets and (ii) to match the interest rates on our investments with like-kind debt
(i.e., floating rate assets are financed with floating rate debt and fixed rate assets are financed with fixed rate debt),
directly or through the use of interest rate swaps, caps or other financial instruments, or through a combination of
these strategies. This allows us to minimize the risk that we have to refinance our liabilities prior to the maturities of
our assets and to reduce the impact of changing interest rates on our earnings.
We enter into hedging transactions to protect our positions from interest rate fluctuations and other changes in market
conditions. These transactions predominantly include interest rate swaps, and may include the purchase or sale of
interest rate collars, caps or floors, options, mortgage derivatives and other hedging instruments. These instruments
may be used to hedge as much of the interest rate risk as our manager determines is in the best interest of our
stockholders, given the cost of such hedges and the need to maintain our status as a REIT. Our manager elects to have
us bear a level of interest rate risk that could otherwise be hedged when our manager believes, based on all relevant
facts, that bearing such risks is advisable. We have extensive experience in hedging with these types of instruments.
We engage in hedging for the purpose of protecting against interest rate risk and not for the purpose of speculating on
changes in interest rates.
Further details regarding our hedging activities are presented in Part II, Item 7A, “Quantitative and Qualitative
Disclosures About Market Risk-Fair Value.”
7
Debt Obligations
The following table presents certain summary information regarding our debt obligations and related hedges as of
December 31, 2007 (unaudited) (dollars in thousands):
Debt Obligation
CBO Bonds Payable
Other Bonds Payable
Repurchase Agreements
FNMA/FHLMC
Non-FNMA/FHLMC
Junior Subordinated
Notes Payable
Outstanding
Face
Amount
Carrying
Value
Weighted
Average
Funding
Cost (1)
Weighted
Average
Maturity
(Years)
Face
Amount
of
Floating
Rate Debt
Collateral
Weighted
Average
Maturity
(Years)
Face
Amount
of Floating
Rate Collateral
Aggregate
Notional
Amount of
Current Hedges
(2)
Collateral
Amortized
Cost Basis
$
4,730,528
549,303
$
4,716,535
546,798
5.37%
6.69%
1,206,089
428,273
1,206,089
428,273
100,100
100,100
4.83%
5.46%
7.71%
5.42%
5.9
1.8
0.2
0.5
$
4,571,278
483,130
$
5,308,562
614,392
1,206,089
428,273
1,235,942
438,734
4.5
5.3
3.3
1.9
$
2,261,396
60,013
$
2,227,414
468,668
-
482,457
405,654
-
28.3
-
-
-
-
-
4.6
$
6,688,770
$
7,597,630
4.3
$
2,803,866
$
3,101,736
Subtotal debt obligations
$
7,014,293
$
6,997,795
Financing on Subprime
Mortgage Loans Subject
to Call Option
Total debt obligations
406,217
7,420,510
$
393,899
7,391,694
$
(1) Including the effect of applicable hedges.
(2) Excluding interest rate swaps with an aggregate notional amount of $738.1 million which were de-designated as accounting hedges at December
31, 2007.
Further details regarding our debt obligations are presented in “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Liquidity and Capital Resources.”
Investment Guidelines
Our general investment guidelines, adopted by our board of directors, include:
•
•
•
no investment is to be made which would cause us to fail to qualify as a REIT;
no investment is to be made which would cause us to be regulated as an investment company;
no more than 20% of our total equity, determined as of the date of such investment, is to be invested in any
single asset;
•
our leverage is not to exceed 90% of the sum of our total debt and our total equity; and
• we are not to co-invest with the manager or any of its affiliates unless (i) our co-investment is otherwise in
accordance with these guidelines and (ii) the terms of such co-investment are at least as favorable to us as to
the manager or such affiliate (as applicable) making such co-investment.
In addition, our manager is required to seek the approval of the independent members of our board of directors before
we engage in a material transaction with another entity managed by our manager or any of its affiliates. These
investment guidelines may be changed by our board of directors without the approval of our stockholders.
The Management Agreement
We are party to a management agreement with FIG LLC, an affiliate of Fortress Investment Group LLC, dated June
23, 2003, pursuant to which FIG LLC, our manager, provides for the day-to-day management of our operations.
The management agreement requires our manager to manage our business affairs in conformity with the policies and
the investment guidelines that are approved and monitored by our board of directors. Our manager’s management is
under the direction of our board of directors. The manager is responsible for (i) the purchase and sale of real estate
securities and loans and other real estate related assets, (ii) the financing of our real estate securities and loans and
other real estate related assets, (iii) management of our real estate, including arranging for purchases, sales, leases,
maintenance and insurance, (iv) the purchase, sale and servicing of loans for us, and (v) investment advisory services.
Our manager is responsible for our day-to-day operations and performs (or causes to be performed) such services and
activities relating to our assets and operations as may be appropriate.
8
We pay our manager an annual management fee equal to 1.5% of our gross equity, as defined in the management
agreement. The management agreement provides that we will reimburse our manager for various expenses incurred
by our manager or its officers, employees and agents on our behalf, including costs of legal, accounting, tax, auditing,
administrative and other similar services rendered for us by providers retained by our manager or, if provided by our
manager’s employees, in amounts which are no greater than those which would be payable to outside professionals or
consultants engaged to perform such services pursuant to agreements negotiated on an arm’s-length basis.
To provide an incentive for our manager to enhance the value of our common stock, our manager is entitled to receive
an incentive return (the “Incentive Compensation”) on a cumulative, but not compounding, basis in an amount equal
to the product of (A) 25% of the dollar amount by which (1) (a) our funds from operations, as defined in the
management agreement (before the Incentive Compensation) per share of common stock (based on the weighted
average number of shares of common stock outstanding) plus (b) gains (or losses) from debt restructuring and from
sales of property and other assets per share of common stock (based on the weighted average number of shares of
common stock outstanding), exceed (2) an amount equal to (a) the weighted average of the price per share of common
stock in our initial public offering and the value attributed to the net assets transferred to us by Newcastle Investment
Holdings, and in any of our subsequent offerings (adjusted for prior capital dividends or capital distributions)
multiplied by (b) a simple interest rate of 10% per annum (divided by four to adjust for quarterly calculations)
multiplied by (B) the weighted average number of shares of common stock outstanding. Our manager earned no
incentive compensation during the third and fourth quarters of 2007. As a result of the effect of recording other-than-
temporary impairment, we expect that there will be no incentive compensation payable to our manager for an
indeterminate period of time.
The management agreement provides for automatic one year extensions. Our independent directors review our
manager’s performance annually and the management agreement may be terminated annually upon the affirmative
vote of at least two-thirds of our independent directors, or by a vote of the holders of a majority of the outstanding
shares of our common stock, based upon unsatisfactory performance that is materially detrimental to us or a
determination by our independent directors that the management fee earned by our manager is not fair, subject to our
manager’s right to prevent such a management fee compensation termination by accepting a mutually acceptable
reduction of fees. Our manager will be provided with 60 days’ prior notice of any such termination and will be paid a
termination fee equal to the amount of the management fee earned by our manager during the twelve month period
preceding such termination which may make it more difficult for us to terminate the management agreement.
Following any termination of the management agreement, we shall be entitled to purchase our manager’s right to
receive the Incentive Compensation at a price determined as if our assets were sold for cash at their then current fair
market value (as determined by an appraisal, taking into account, among other things, the expected future value of the
underlying investments) or otherwise we may continue to pay the Incentive Compensation to our manager. In
addition, if we do not purchase our manager’s Incentive Compensation, our manager may require us to purchase the
same at the price discussed above. In addition, the management agreement may be terminated by us at any time for
cause.
Policies With Respect to Certain Other Activities
We have authority to offer our common stock or other equity or debt securities in exchange for property and to
repurchase or otherwise reacquire our shares or any other securities and may engage in such activities in the future.
Our board of directors has authorized us to repurchase up to $100 million shares of our common stock. Although we
have no current intentions of doing so, we may repurchase or otherwise reacquire our common shares if our manager
deems a repurchase to be advisable.
We also may make loans to, or provide guarantees of, our subsidiaries.
Subject to the percentage ownership and gross income and asset tests necessary for REIT qualification, we may invest
in securities of other REITs, other entities engaged in real estate activities or securities of other issuers, including for
the purpose of exercising control over such entities.
We may engage in the purchase and sale of investments.
Our officers and directors may change any of these policies without a vote of our stockholders.
In the event that we determine to raise additional equity capital, our board of directors has the authority, without
stockholder approval (subject to certain NYSE requirements), to issue additional common stock or preferred stock in
any manner and on such terms and for such consideration it deems appropriate, including in exchange for property.
Decisions regarding the form and other characteristics of the financing for our investments are made by our manager
subject to the general investment guidelines adopted by our board of directors.
9
We have financed our assets with the net proceeds of our initial public offering, follow-on offerings, the issuance of
preferred stock, long term secured and unsecured borrowings, a credit facility and short term borrowings under
repurchase agreements. In the future, operations may be financed by future offerings of equity or debt securities, as
well as short term and long term unsecured and secured borrowings. We expect that, in general, we will employ
leverage consistent with the type of assets acquired and the desired level of risk in various investment environments.
Our governing documents do not explicitly limit the amount of leverage that we may employ. Instead, the general
investment guidelines adopted by our board of directors limits total leverage to a maximum 9.0 to 1 debt to equity
ratio. At December 31, 2007, 2006 and 2005, our debt to equity ratio computed under the specified methodology was
approximately 6.2 to 1, 7.5 to 1, and 5.7 to 1, respectively. Our policy relating to the maximum leverage we may
utilize may be changed by our board of directors at any time in the future.
Competition
We are subject to significant competition in seeking investments. We compete with several other companies for
investments, including other REITs, insurance companies and other investors. Some of our competitors have greater
resources than we possess, or have greater access to capital or various types of financing than are available to us, and
we may not be able to compete successfully for investments.
Compliance with Applicable Environmental Laws
Properties we own or may acquire are or would be subject to various foreign, federal, state and local environmental
laws, ordinances and regulations. Under these laws, ordinances and regulations, a current or previous owner of real
estate (including, in certain circumstances, a secured lender that succeeds to ownership or control of a property) may
become liable for the costs of removal or remediation of certain hazardous or toxic substances or petroleum product
releases at, on, under or in its property. These laws typically impose cleanup responsibility and liability without regard
to whether the owner or control party knew of or was responsible for the release or presence of the hazardous or toxic
substances. The costs of investigation, remediation or removal of these substances may be substantial and could
exceed the value of the property. An owner or control party of a site may be subject to common law claims by third
parties based on damages and costs resulting from environmental contamination emanating from a site. Certain
environmental laws also impose liability in connection with the handling of or exposure to asbestos-containing
materials, pursuant to which third parties may seek recovery from owners of real properties for personal injuries
associated with asbestos-containing materials. Our operating costs and values of these assets may be adversely
affected by the obligation to pay for the cost of complying with existing environmental laws, ordinances and
regulations, as well as the cost of complying with future legislation, and our income and ability to make distributions
to our stockholders could be affected adversely by the existence of an environmental liability with respect to our
properties. We endeavor to ensure that properties we own or acquire will be in compliance in all material respects
with all foreign, federal, state and local laws, ordinances and regulations regarding hazardous or toxic substances or
petroleum products.
Employees
We are party to a management agreement with FIG LLC, an affiliate of Fortress Investment Group LLC, pursuant to
which they advise us regarding investments, risk management, and other aspects of our business, and manage our day-
to-day operations. As a result, we have no employees. From time to time, certain of our officers may enter into
written agreements with us that memorialize the provision of certain services; these agreements do not provide for the
payment of any cash compensation to such officers from us. The employees of FIG LLC are not a party to any
collective bargaining agreement.
10
Corporate Governance and Internet Address; Where Readers Can Find Additional Information
We emphasize the importance of professional business conduct and ethics through our corporate governance
initiatives. Our board of directors consists of a majority of independent directors; the Audit, Nominating and
Corporate Governance, and Compensation committees of our board of directors are composed exclusively of
independent directors. We have adopted corporate governance guidelines, and our manager has adopted a code of
business conduct and ethics, which delineate our standards for our officers and directors, and employees of our
manager.
Newcastle files annual, quarterly and current reports, proxy statements and other information required by the
Securities Exchange Act of 1934, as amended (the ‘‘Exchange Act’’), with the Securities and Exchange Commission
(“SEC”). Readers may read and copy any document that Newcastle files at the SEC’s Public Reference Room located
at 100 F Street, N.E., Washington, D.C. 20549, U.S.A. Please call the SEC at 1-800-SEC-0330 for further information
on the Public Reference Room. Our SEC filings are also available to the public from the SEC’s internet site at
http://www.sec.gov. Copies of these reports, proxy statements and other information can also be inspected at the
offices of the New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005, U.S.A. Our internet site
is http://www.newcastleinv.com. We make available free of charge through our internet site our annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and Forms 3, 4 and 5 filed
on behalf of directors and executive officers and any amendments to those reports filed or furnished pursuant to the
Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the
SEC. Also posted on our website in the ‘‘Investor Relations—Corporate Governance” section are charters for the
company’s Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee as
well as our Corporate Governance Guidelines and our Code of Business Conduct and Ethics governing our directors,
officers and employees. Information on, or accessible through, our website is not a part of, and is not incorporated
into, this report.
11
Item 1A. Risk Factors
Risks relating to our management, business and company include, specifically:
Risks Relating to Our Management
We are dependent on our manager and may not find a suitable replacement if our manager terminates the
management agreement.
We have no employees. Our officers and other individuals who perform services for us are employees of our manager.
We are completely reliant on our manager, which has significant discretion as to the implementation of our operating
policies and strategies, to conduct our business. We are subject to the risk that our manager will terminate the
management agreement and that we will not be able to find a suitable replacement for our manager in a timely
manner, at a reasonable cost or at all. Furthermore, we are dependent on the services of certain key employees of our
manager whose compensation is partially or entirely dependent upon the amount of incentive compensation earned by
our manager and whose continued service is not guaranteed and the loss of such services could temporarily adversely
affect our operations.
There are conflicts of interest in our relationship with our manager.
Our chairman serves as an officer of our manager. Our management agreement with our manager was not negotiated
at arm's-length and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an
unaffiliated third party.
There are conflicts of interest inherent in our relationship with our manager insofar as our manager and its affiliates —
including investment funds, private investment funds, or businesses managed by our manager — invest in real estate
securities, real estate related loans and operating real estate and whose investment objectives overlap with our
investment objectives. Certain investments appropriate for Newcastle may also be appropriate for one or more of
these other investment vehicles. Members of our board of directors and employees of our manager who are our
officers may serve as officers and/or directors of these other entities. In addition, our manager or its affiliates may
have investments in and/or earn fees from such other investment vehicles which are larger than their economic
interests in Newcastle and which may therefore create an incentive to allocate investments to such other investment
vehicles. Our manager or its affiliates may determine, in their discretion, to make a particular investment through
another investment vehicle rather than through Newcastle and have no obligation to offer to Newcastle the
opportunity to participate in any particular investment opportunity. Accordingly, it is possible that we may not be
given the opportunity to participate at all in certain investments made by our affiliates that meet our investment
objectives.
Our management agreement with our manager generally does not limit or restrict our manager or its affiliates from
engaging in any business or managing other pooled investment vehicles that invest in investments that meet our
investment objectives, except that under our management agreement neither our manager nor any entity controlled by
or under common control with our manager is permitted to raise or sponsor any new pooled investment vehicle whose
investment policies, guidelines or plan targets as its primary investment category investment in United States dollar-
denominated credit sensitive real estate related securities reflecting primarily United States loans or assets. Our
manager intends to engage in additional real estate related management and investment opportunities in the future
which may compete with us for investments.
The ability of our manager and its officers and employees to engage in other business activities, subject to the terms of
our management agreement with our manager, may reduce the time our manager spends managing Newcastle. In
addition, we may engage in material transactions with our manager or another entity managed by our manager or one
of its affiliates, including certain financing arrangements and co-investments which present an actual, potential or
perceived conflict of interest, subject to our investment guidelines. It is possible that actual, potential or perceived
conflicts could give rise to investor dissatisfaction, litigation or regulatory enforcement actions. Appropriately dealing
with conflicts of interest is complex and difficult, and our reputation could be damaged if we fail, or appear to fail, to
deal appropriately with one or more potential, actual or perceived conflicts of interest. Regulatory scrutiny of, or
litigation in connection with, conflicts of interest could have a material adverse effect on our reputation which could
materially adversely affect our business in a number of ways, including causing an inability to raise additional funds, a
reluctance of counterparties to do business with us, a decrease in the prices of our common and preferred securities
and a resulting increased risk of litigation and regulatory enforcement actions.
The management compensation structure that we have agreed to with our manager may incentivize our manager to
invest in high risk investments. In addition to its management fee, our manager is entitled to receive incentive
compensation based in part upon our achievement of targeted levels of funds from operations. In evaluating
investments and other management strategies, the opportunity to earn incentive compensation based on funds from
operations may lead our manager to place undue emphasis on the maximization of funds from operations at the
expense of other criteria, such as preservation of capital, in order to achieve higher incentive compensation,
particularly in light of the fact that our manager has not received any incentive compensation during the last two fiscal
quarters and likely will not receive any incentive compensation in the future unless it meaningfully increases
12
Newcastle’s investment returns. Investments with higher yield potential are generally riskier or more speculative than
lower-yielding investments. Moreover, because our manager receives compensation in the form of options in
connection with the completion of our common equity offerings, our manager may be incentivized to cause us to issue
additional common stock, which could be dilutive to existing shareholders.
It would be difficult and costly to terminate our management agreement with our manager.
Termination of the management agreement with our manager would be difficult and costly. The management
agreement may only be terminated annually upon the affirmative vote of at least two-thirds of our independent
directors, or by a vote of the holders of a majority of the outstanding shares of our common stock, based upon (1)
unsatisfactory performance by our manager that is materially detrimental to us or (2) a determination that the
management fee payable to our manager is not fair, subject to our manager's right to prevent such a compensation
termination by accepting a mutually acceptable reduction of fees. Our manager will be provided 60 days' prior notice
of any termination and will be paid a termination fee equal to the amount of the management fee earned by the
manager during the twelve-month period preceding such termination. In addition, following any termination of the
management agreement, the manager may require us to purchase its right to receive incentive compensation at a price
determined as if our assets were sold for their fair market value (as determined by an appraisal, taking into account,
among other things, the expected future value of the underlying investments) or otherwise we may continue to pay the
incentive compensation to our manager. These provisions may increase the effective cost to us of terminating the
management agreement, thereby adversely affecting our ability to terminate our manager without cause.
Our directors have approved very broad investment guidelines for our manager and do not approve each
investment decision made by our manager.
Our manager is authorized to follow very broad investment guidelines. Consequently, our manager has great latitude
in determining the types of assets it may decide are proper investments for us. Our directors periodically review our
investment guidelines and our investment portfolio. However, our board does not review or pre-approve each
proposed investment or our related financing arrangements. In addition, in conducting periodic reviews, the directors
rely primarily on information provided to them by our manager. Furthermore, transactions entered into by our
manager may be difficult or impossible to unwind by the time they are reviewed by the directors even if the
transactions contravene the terms of the management agreement.
We may change our investment strategy without stockholder consent, which may result in our making
investments that entail more risk than our current investments.
Our investment strategy may evolve, in light of existing market conditions and investment opportunities, to continue
to take advantage of opportunistic investments in real estate and real estate related assets, which may involve
additional risks depending upon the nature of such assets and our ability to finance such assets on a short or long term
basis. Investment opportunities that present unattractive risk-return profiles relative to other available investment
opportunities under particular market conditions may become relatively attractive under changed market conditions
and changes in market conditions may therefore result in changes in the investments we target. Decisions to make
investments in new asset categories present risks that may be difficult for us to adequately assess and could therefore
reduce the stability of our dividends or have adverse effects on our financial condition. A change in our investment
strategy may also increase our exposure to interest rate, foreign currency, real estate market or credit market
fluctuations. Our failure to accurately assess the risks inherent in new asset categories or the financing risks
associated with such assets could adversely affect our results of operations and our financial condition.
Risks Relating to Our Business
Deterioration of market conditions may continue to negatively impact our business, results of operations and
financial condition, including liquidity.
The market in which we operate is affected by a number of factors that are largely beyond our control but can
nonetheless have a potentially significant, negative impact on us. These factors include, among other things:
•
Interest rates and credit spreads;
• The availability of credit, including the price, terms and conditions under which it can be obtained;
• The quality, pricing and availability of suitable investments;
• The ability to obtain accurate market-based valuations;
• Loan values relative to the value of the underlying real estate assets;
• Default rates on both commercial and residential mortgages and the amount of the related losses;
• The actual and perceived state of the real estate markets, market for dividend-paying stocks and public
capital markets generally;
• Unemployment rates; and
• The attractiveness of other types of investments relative to investments in real estate or REITs generally.
13
Changes in these factors are difficult to predict, and a change in one factor can affect other factors. For example,
during 2007, increased default rates in the subprime mortgage market played a role in causing credit spreads to widen,
reducing availability of credit on favorable terms, reducing liquidity and price transparency of real estate related
assets, resulting in difficulty in obtaining accurate mark-to-market valuations, and causing a negative perception of the
state of the real estate markets and of REITs generally. These conditions had a significantly negative impact on our
results of operations. We do not currently know the full extent to which this market disruption will affect us or the
markets in which we operate, and we are unable to predict its length or ultimate severity. If the challenging conditions
continue, we may experience further tightening of liquidity, additional impairment charges and increased margin
requirements as well as additional challenges in raising capital and obtaining investment financing on attractive terms.
In addition, if current market conditions continue or deteriorate, we could experience a rapid, significant deterioration
of our liquidity, business, results of operations and financial condition.
A prolonged economic slowdown, a lengthy or severe recession, or declining real estate values could harm our
operations.
We believe the risks associated with our business are more severe during periods of economic slowdown or recession
if these periods are accompanied by declining real estate values. Declining real estate values would likely reduce the
level of new mortgage loan originations, since borrowers often use increases in the value of their existing properties to
support the purchase of or investment in additional properties. Borrowers may also be less able to pay principal and
interest on our loans if the real estate economy weakens. Further, declining real estate values significantly increase
the likelihood that we will incur losses on our loans in the event of default because the value of our collateral may be
insufficient to cover our basis in the loan. Any sustained period of increased payment delinquencies, foreclosures or
losses could adversely affect both our net interest income from loans in our portfolio as well as our ability to originate,
sell and securitize loans, which would significantly harm our revenues, results of operations, financial condition,
liquidity, business prospects and our ability to make distributions to the stockholders.
We may be required to post significant amounts of cash collateral at any time to satisfy our margin
requirements under many of our financing arrangements, which could adversely affect our liquidity, results of
operations and financial condition.
We finance certain of our investments with debt, such as repurchase agreements and total return swaps and
derivatives, that is subject to margin calls. Under the terms of these agreements, the value of assets underlying the
debt is marked-to-market by the lender at the lender’s discretion, including on a daily basis. If the value of the
underlying asset declines, the lender has the ability to require us to post additional margin – cash or other liquid
collateral – to compensate for the decline in value of the asset. (Conversely, if the value of the underlying asset
increases, a portion of the margin we previously posted may be returned to us.) We are typically required to post
additional margin in response to any margin call within 24 hours in order to avoid defaulting under the terms of the
financing arrangement.
We are subject to margin calls at any time, and being forced to post additional margin could adversely affect our
business in a number of ways. Posting additional margin would decrease our cash available to make other, higher
yielding investments (thereby decreasing our return on equity) or to satisfy other obligations, including future margin
calls. For example, during 2007, we were required to post approximately $135 million of additional margin, in large
part as a result of the credit and liquidity crisis and resulting market disruption, and we may be required to post similar
or greater amounts of additional margin during 2008. If we do not have the funds available, or otherwise elect not, to
satisfy any future margin calls, we could be forced to sell one or more investments at a loss. Moreover, we may be
unable, in light of market conditions or other factors, to sell sufficient assets to satisfy the margin requirements within
the timeframe required by lenders, which would entitle them to seize the underlying asset and seek payment from us
for any shortfall between the value of our obligation to the lender and the value of the asset surrendered. Such a
situation would likely result in a rapid deterioration of our financial condition and possibly necessitate a filing for
protection under the United States Bankruptcy Code.
The lenders under our repurchase agreements may elect not to extend financing to us, which could quickly and
seriously impair our liquidity.
We finance a meaningful portion of our investments with repurchase agreements, which are short-term financing
arrangements. Under the terms of these agreements, we sell a security to a counterparty for a specified price and
concurrently agree to repurchase the same security from our counterparty at a later date for a higher specified price.
During the term of the repurchase agreement – generally 30 days – the counterparty makes funds available to us and
holds the security as collateral. Our counterparties can also require us to post additional margin as collateral at any
time during the term of the agreement. When the term of a repurchase agreement ends, we are required to repurchase
the security for the specified repurchase price, with the difference between the sale and repurchase prices serving as
the equivalent of paying interest to the counterparty in return for extending financing to us. If we want to continue to
finance the security with a repurchase agreement, we ask the counterparty to extend – or “roll” – the repurchase
agreement for another term.
14
Our counterparties are not required to roll our repurchase agreements upon the expiration of the stated terms, which
subjects us to a number of risks, mainly with respect to repurchase agreements relating to our non-FNMA/FHLMC
securities. As we have experienced recently and may likely experience in the near term, counterparties electing to roll
our repurchase agreements may charge higher spread and impose more onerous terms upon us, including the
requirement that we post additional margin as collateral. More significantly, in the event that a counterparty elects not
to roll our repurchase obligations with them, if a repurchase agreement counterparty elects not to extend our financing,
we would be required pay the counterparty the full repurchase price on the maturity date and find an alternate source
of financing. Alternate sources of financing may be more expensive, contain more onerous terms or simply may not
be available. If we were unable to pay the repurchase price for any security financed with a repurchase agreement, the
counterparty has the right to sell the underlying security being held as collateral and require us to compensate them for
any shortfall between the value of our obligation to the counterparty and the amount for which the collateral was sold
(which may be sold at a significantly discounted price). As of February 25, 2008, we had $447.3 million and $471.4
million in repurchase agreement obligations (including off balance sheet financing in the form of total return swap)
relating to FNMA/FHLMC securities and non-FNMA/FHLMC securities, respectively, outstanding, $120.0 million of
the repurchase agreements related to non-FNMA/FHLMC securities were due within 90 days. If one or more of our
repurchase agreement counterparties elected not to roll our existing repurchase agreements, such nonrenewal could
increase our cost of financing, significantly reduce our liquidity and force us to sell assets at a loss, each of which
would cause a rapid deterioration in our financial condition and possibly necessitate a filing for protection under the
United States Bankruptcy Code.
We are subject to significant competition and we may not compete successfully.
We are subject to significant competition in seeking investments. We compete with other companies, including other
REITs, insurance companies and other investors, including funds and companies affiliated with our manager. Some
of our competitors have greater resources than we possess or have greater access to capital or various types of
financing structures than are available to us, and we may not be able to compete successfully for investments or
provide attractive investment returns relative to our competitors. Furthermore, competition for investments of the type
to be made by us may lead to the returns available from such investments decreasing, which may further limit our
ability to generate our desired returns. We cannot assure you that other companies will not be formed that compete
with us for investments or otherwise pursue investment strategies similar to ours or that we will be able to complete
successfully against any such companies.
Our determination of how much leverage to apply to our investments may adversely affect our return on our
investments and may reduce cash available for distribution.
We leverage our portfolio through borrowings, generally through the use of credit facilities, warehouse facilities,
repurchase agreements, mortgage loans on real estate, securitizations, including the issuance of CBOs, private or
public offerings of debt by subsidiaries, loans to entities in which we hold, directly or indirectly, interests in pools of
properties or loans, and other borrowings. Our investment policies do not limit the amount of leverage we may incur
with respect to any specific asset or pool of assets, subject to an overall limit on our use of leverage to 90% (as
defined in our governing documents) of the value of our assets on an aggregate basis. Our return on our investments
and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions
cause the cost of our financing to increase relative to the income that can be derived from the assets acquired.
Although we seek to match fund our investments to limit refinance risk and lock in net spreads, we do not
employ this strategy with respect to certain of our investments, which increases the risks related to refinancing
these investments.
A key to our investment strategy is to finance our investments using match funded financing structures, which match
assets and liabilities with respect to maturities and interest rates. This strategy limits our refinance risk, including the
risk of being able to refinance an investment on favorable terms or at all. We generally use match funded financing
structures, such as CBOs, to finance our investments in real estate securities and loans. However, our manager may
elect for us to bear a level of refinancing risk on a short term or longer term basis, such as is the case with investments
financed with repurchase agreements, when, based on all of the relevant factors, bearing such risk is deemed advisable
(this is generally the case with respect to the residential mortgage loans and FNMA/FHLMC we invest in). In
addition, we may be unable, as a result of conditions in the credit markets, to match fund investments. For example,
non-recourse term financing not subject to margin requirements was generally not available or economical during the
last several months and may not be available for an indeterminate period of time, which impairs our ability to match
fund our investments. The decision not, or the inability, to match fund certain investments exposes us to additional
refinancing risks that may not apply to our other investments.
Furthermore, we anticipate that, in most cases, for any period during which our floating rate assets are not match
funded with respect to maturity, the income from such assets may respond more slowly to interest rate fluctuations
than the cost of our borrowings. Because of this dynamic, interest income from such investments may rise more
slowly than the related interest expense, with a consequent decrease in our net income. Interest rate fluctuations
resulting in our interest expense exceeding interest income would result in operating losses for us from these
investments.
15
Accordingly, if we do not or are unable to match fund our investments with respect to maturities and interest rates, we
will be exposed to the risk that we may not be able to finance or refinance our investments on economically favorable
terms or may have to liquidate assets at a loss.
The loans we invest in and the loans underlying the securities and total rate of return swaps we invest in are
subject to delinquency, foreclosure and loss, which could result in losses to us.
Commercial mortgage loans are secured by multifamily or commercial property and are subject to risks of
delinquency and foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by an income-
producing property typically is dependent primarily upon the successful operation of such property rather than upon
the existence of independent income or assets of the borrower. If the net operating income of the property is reduced,
the borrower's ability to repay the loan may be impaired. Net operating income of an income-producing property can
be affected by, among other things: tenant mix, success of tenant businesses, property management decisions, property
location and condition, competition from comparable types of properties, changes in laws that increase operating
expense or limit rents that may be charged, any need to address environmental contamination at the property, the
occurrence of any uninsured casualty at the property, changes in national, regional or local economic conditions
and/or specific industry segments, declines in regional or local real estate values, declines in regional or local rental or
occupancy rates, increases in interest rates, changes in the availability of credit on favorable terms, real estate tax rates
and other operating expenses, changes in governmental rules, regulations and fiscal policies, including environmental
legislation, acts of God, terrorism, social unrest and civil disturbances.
Residential mortgage loans, manufactured housing loans and subprime mortgage loans are secured by single-family
residential property and are also subject to risks of delinquency and foreclosure, and risks of loss. The ability of a
borrower to repay a loan secured by a residential property is dependent upon the income or assets of the borrower. A
number of factors may impair borrowers' abilities to repay their loans, including, among other things, changes in the
borrower’s employment status, changes in national, regional or local economic conditions, changes in interest rates or
the availability of credit on favorable terms, changes in regional or local real estate values, changes in regional or local
rental rates and changes in real estate taxes.
In the event of any default under a loan held directly by us, we will bear a risk of loss of principal to the extent of any
deficiency between the value of the collateral and the outstanding principal and accrued but unpaid interest of the
loan, which could adversely affect our cash flow from operations. Foreclosure of a loan, particularly a commercial
loan, can be an expensive and lengthy process which could negatively affect our anticipated return on the foreclosed
loan.
Mortgage and asset backed securities are bonds or notes backed by loans and/or other financial assets and include
commercial mortgage back securities (CMBS), FNMA/FHLMC securities, and real estate related asset backed
securities (ABS). The ability of a borrower to repay these loans or other financial assets is dependent upon the income
or assets of these borrowers. If a borrower has insufficient income or assets to repay these loans, it will default on its
loan. While we intend to focus on real estate related asset backed securities, there can be no assurance that we will
not invest in other types of asset backed securities.
Our investments in mortgage and asset backed securities will be adversely affected by defaults under the loans
underlying such securities. To the extent losses are realized on the loans underlying the securities in which we invest,
the Company may not recover the amount invested in, or, in extreme cases, any of our investment in, such securities.
We face a heightened risk of delinquency and loss from our investment in subprime mortgage loans.
We face a heightened risk of delinquency and loss from our investment in subprime mortgage loans. Subprime
mortgage loans are generally loans to credit impaired borrowers and borrowers that are ineligible to qualify for loans
from conventional mortgage sources due to loan size, lower credit characteristics or documentation standards. As of
December 31, 2007, our subprime mortgage holdings totaled $399.3 million, or 5% of our assets. Loans to lower
credit grade borrowers generally experience higher-than-average default and loss rates than do loans to borrowers with
better credit characteristics. Material differences in the defaults, loss severities and/or prepayments on the subprime
mortgage loans we acquire (or on the manufactured housing loans we acquire) from what we estimate in connection
with our underwriting of the acquisition of such loans would cause reductions in our income and adversely affect our
operating results, both with respect to unsecuritized loans and loans that we have securitized or otherwise financed on
a long term match funded basis. We cannot assure you that our underwriting criteria will afford adequate protection
against the higher risks associated with loans made to lower credit grade borrowers. If we underestimate the extent of
losses that our loans will incur, then our business, financial condition, liquidity and results of operations will be
adversely impacted.
16
Our investments in debt securities are subject to specific risks relating to the particular issuer of the securities
and to the general risks of investing in subordinated real estate securities.
Our investments in debt securities involve special risks. REITs generally are required to invest substantially in real
estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments
discussed in this report. Our investments in debt are subject to the risks described above with respect to mortgage
loans and MBS and similar risks, including:
•
•
•
•
risks of delinquency and foreclosure, and risks of loss in the event thereof;
the dependence upon the successful operation of and net income from real property;
risks generally incident to interests in real property; and
risks that may be presented by the type and use of a particular property.
Debt securities may be unsecured and may also be subordinated to other obligations of the issuer. We may also invest
in debt securities that are rated below investment grade. As a result, investments in debt securities are also subject to
risks of:
•
•
•
•
•
limited liquidity in the secondary trading market;
substantial market price volatility resulting from changes in prevailing interest rates or credit spreads;
subordination to the prior claims of senior lenders to the issuer;
the possibility that earnings of the debt security issuer may be insufficient to meet its debt service; and
the declining creditworthiness and potential for insolvency of the issuer of such debt securities during periods
of rising interest rates and economic downturn.
These risks may adversely affect the value of outstanding debt securities and the ability of the issuers thereof to repay
principal and interest.
We may not be able to finance our investments on a long term basis on attractive terms, including by means of
securitization, which may require us to seek more costly financing for our investments or to liquidate assets.
When we acquire a portfolio of securities and loans which we finance on a short term basis with a view to
securitization or other long term financing, we bear the risk of being unable to securitize the assets or otherwise
finance them on a long term basis at attractive prices or in a timely matter, or at all. If it is not possible or economical
for us to securitize or otherwise finance such assets on a long term basis, we may be unable to pay down our short
term credit facilities, or be required to liquidate the assets at a loss in order to do so. For example, as a result of the
deterioration in the credit markets during 2007, financing investments with securitizations or other long-term non-
recourse financing not subject to margin requirements was generally not available or economical during the last
several months and may not be possible or economical for the foreseeable future. These conditions make it more
likely that we will have to use less efficient forms of financing, which may require a larger portion of our cash flows
and thereby reduce the amount of cash available for distribution to our stockholders and funds available for operations
and investments, and which may also require us to assume higher levels of risk when financing our investments.
Both during the ramp up phase of a potential CBO financing and following the closing of a CBO financing
when we have locked in the liability costs for a CBO during the reinvestment period, the rate at which we are
able to acquire eligible investments and changes in market conditions may adversely affect our anticipated
returns.
We acquire real estate securities and loans and finance them on a long term basis, typically through the issuance of
collateralized bond obligations. We use short term warehouse lines of credit to finance the acquisition of real estate
securities and loans until a sufficient quantity of assets are accumulated, at which time we may refinance these lines
through a securitization, such as a CBO financing, or other long term financing. As a result, we are subject to the risk
that we will not be able to acquire, during the period that our warehouse facility is available, a sufficient amount of
eligible assets to maximize the efficiency of a collateralized bond obligation financing. In addition, conditions in the
capital markets may make the issuance of a collateralized bond obligation less attractive to us when we do have a
sufficient pool of collateral. If we are unable to issue a collateralized bond obligation to finance these assets, we may
be required to seek other forms of potentially less attractive financing or otherwise to liquidate the assets.
In addition, following each CBO financing we must invest both the net cash raised in the financing as well as cash
proceeds of any prepayment or assets which we determine to sell. Until we are able to acquire sufficient assets, our
returns will reflect income earned on uninvested cash and, having locked in the cost of liabilities for the particular
CBO, the particular CBO’s returns will be at risk of declining to the extent that yields on the assets to be acquired
decline. During 2007, credit spreads on our liabilities widened meaningfully, which could result in declining yields
and returns on our future CBOs.
In general, our ability to acquire appropriate investments depends upon the supply in the market of investments we
deem suitable, and changes in various economic factors may affect our determination of what constitutes a suitable
investment.
17
Our returns will be adversely affected when investments held in CBOs are prepaid or sold subsequent to the
reinvestment period.
Real estate securities and loans are subject to prepayment risk. In addition, we may sell, and realize gains (or losses)
on, investments. To the extent such assets were held in CBOs subsequent to the end of the reinvestment period, the
proceeds are fully utilized to pay down the related CBOs debt. This causes the leverage on the CBO to decrease,
thereby lowering our returns on equity.
The use of CDO financings with coverage tests may have a negative impact on our operating results and cash
flows.
We have retained, and may in the future retain, subordinate classes of bonds issued by certain of our subsidiaries in
our CDO financings. Each of our CBO financings contains tests which measure the amount of over collateralization
and excess interest in the transaction. Failure to satisfy these tests would result in principal and/or interest cash flow
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, failure to
satisfy the coverage tests could adversely affect our operating results and cash flows by temporarily or permanently
directing funds that would otherwise come to us to holders of the senior classes of bonds. Although these coverage
tests are currently being met, we cannot assure you that the coverage tests will continue to be satisfied in the future.
Certain coverage tests (based on the required over collateralization or interest in the related CDO) may also restrict
our ability to receive net income from assets pledged to secure the CDOs. Failure to obtain in future financings
favorable terms with regard to these matters may materially and adversely affect the availability of net cashflow to us.
Our investments may be subject to significant impairment charges, which would adversely affect our results of
operations.
We are required to periodically evaluate our investments for impairment indicators. The value of an investment is
impaired when our analysis indicates that, with respect to a loan, it is probable that we will not be able to collect the
full amount we intended to collect from the loan or, with respect to a security, it is probable that the value of security
is other than temporarily impaired. The judgment regarding the existence of impairment indicators is based on a
variety of factors depending upon the nature of the investment and the manner in which the income related to such
investment calculated for purposes of our financial statements. If we determine that an impairment has occurred, we
are required to make an adjustment to the net carrying value of the investment, which could adversely affect our
results of operations and funds from operations in the applicable period and thereby adversely affect our ability to pay
dividends to our stockholders.
As has been widely publicized, the recent and ongoing credit and liquidity crisis has resulted in a number of financial
institutions recording an unprecedented amount of impairment charges, and we have also been affected by these
conditions. The liquidity crisis has reduced the market trading activity for many real estate securities, resulting in less
liquid markets for those securities. 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 what
we believe are relatively conservative mark-to-market valuations of many real estate securities. These lower
valuations have affected us by, among other things, decreasing our net book value and contributing to our decision to
record other than temporary impairment in each of the last three fiscal quarters of approximately $6 million, $67.9
million and $122.4 million (excluding impairment charges related to the assets sold subsequent to December 31,
2007), respectively.
Our investments in senior unsecured REIT securities are subject to specific risks relating to the particular
REIT issuer and to the general risks of investing in subordinated real estate securities, which may result in
losses to us.
Our investments in REIT securities involve special risks relating to the particular REIT issuer of the securities,
including the financial condition and business outlook of the issuer. REITs generally are required to substantially
invest in operating real estate or real estate related assets and are subject to the inherent risks associated with real
estate related investments discussed in this report.
Our investments in REIT securities are also subject to the risks described above with respect to mortgage loans and
mortgage backed securities and similar risks, including (i) risks of delinquency and foreclosure, and risks of loss in the
event thereof, (ii) the dependence upon the successful operation of and net income from real property, (iii) risks
generally incident to interests in real property, and (iv) risks that may be presented by the type and use of a particular
commercial property.
REIT securities are generally unsecured and may also be subordinated to other obligations of the issuer. We may also
invest in REIT securities that are rated below investment grade. As a result, investments in REIT securities are also
subject to risks of: (i) limited liquidity in the secondary trading market, (ii) substantial market price volatility resulting
from changes in prevailing interest rates, (iii) subordination to the prior claims of banks and other senior lenders to the
18
issuer, (iv) the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest
rates that could cause the issuer to reinvest premature redemption proceeds in lower yielding assets, (v) the possibility
that earnings of the REIT issuer may be insufficient to meet its debt service and dividend obligations and (vi) the
declining creditworthiness and potential for insolvency of the issuer of such REIT securities during periods of rising
interest rates and economic downturn. These risks may adversely affect the value of outstanding REIT securities and
the ability of the issuers thereof to repay principal and interest or make dividend payments.
The real estate related loans and other direct and indirect interests in pools of real estate properties or other
loans that we invest in may be subject to additional risks relating to the structure and terms of these
transactions, which may result in losses to us.
We invest in real estate related loans and other direct and indirect interests in pools of real estate properties or loans
such as mezzanine loans and “B Note” mortgage loans. We invest in mezzanine loans that take the form of
subordinated loans secured by second mortgages on the underlying real property or other business assets or revenue
streams or loans secured by a pledge of the ownership interests of the entity owning real property or other business
assets or revenue streams (or the ownership interest of the parent of such entity). These types of investments involve a
higher degree of risk than long term senior lending secured by business assets or income producing real property
because the investment may become unsecured as a result of foreclosure by a senior lender. In the event of a
bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to
the assets of such entity, or the assets of the entity may not be sufficient to repay our mezzanine loan. If a borrower
defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine
loan will be satisfied only after the senior debt is repaid in full. As a result, we may not recover some or all of our
investment. In addition, mezzanine loans may have higher loan to value ratios than conventional mortgage loans,
resulting in less equity in the property and increasing the risk of loss of principal.
We also invest in mortgage loans (“B Notes”) that while secured by a first mortgage on a single large commercial
property or group of related properties are subordinated to an “A Note” secured by the same first mortgage on the
same collateral. As a result, if an issuer defaults, there may not be sufficient funds remaining for B Note holders. B
Notes reflect similar credit risks to comparably rated commercial mortgage backed securities. In addition, we invest,
directly or indirectly, in pools of real estate properties or loans. However, since each transaction is privately
negotiated, these investments can vary in their structural characteristics and risks. For example, the rights of holders of
B Notes to control the process following a borrower default may vary from transaction to transaction, while
investments in pools of real estate properties or loans may be subject to varying contractual arrangements with third
party co-investors in such pools. Further, B Notes typically are secured by a single property, and so reflect the risks
associated with significant concentration. These investments also are less liquid than commercial mortgage backed
securities.
We may not be able to extend the total return swaps that we enter into in the event that the maturity of the
underlying asset is extended, which could adversely impact our leveraging strategy.
Subject to maintaining our qualification as a REIT, we leverage certain of our investments through the use of total
return swaps. We may wish to renew many of the swaps, which are for specified terms, as they mature, particularly in
the event that the maturity of the underlying asset is extended. However, there is a limited number of providers of
such swaps, and there is no assurance the initial swap providers will choose to renew the swaps, and — if they do not
renew — that we would be able to obtain suitable replacement providers. Providers may choose not to renew our total
return swaps for a number of reasons, including:
•
•
•
•
increases in the provider’s cost of funding;
insufficient volume of business with a particular provider;
a desire by our company to invest in a type of swap that the provider does not view as economically
attractive due to changes in interest rates or other market factors; or
the inability of our company and a provider to agree on terms.
Furthermore, our ability to invest in total return swaps, other than through a taxable REIT subsidiary, or TRS, may be
severely limited by the REIT qualification requirements because total return swaps are not qualifying assets and do
not produce qualifying income for purposes of the REIT asset and income tests.
Investment in non-investment grade loans may involve increased risk of loss.
We acquire and may continue to acquire in the future certain loans that do not conform to conventional loan criteria
applied by traditional lenders and are not rated or are rated as non-investment grade (for example, for investments
rated by Moody’s Investors Service, ratings lower than Baa3, and for Standard & Poor’s, BBB- or below). The non-
investment grade ratings for these loans typically result from the overall leverage of the loans, the lack of a strong
operating history for the properties underlying the loans, the borrowers’ credit history, the properties’ underlying cash
flow or other factors. As a result, these loans have a higher risk of default and loss than conventional loans. Any loss
we incur may reduce distributions to our stockholders. There are no limits on the percentage of unrated or non-
investment grade assets we may hold in our portfolio.
19
Insurance on real estate in which we have interests (including the real estate serving as collateral for our real
estate securities and loans) may not cover all losses.
There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism
or acts of war, that may be uninsurable or not economically insurable. Inflation, changes in building codes and
ordinances, environmental considerations, and other factors, including terrorism or acts of war, also might make the
insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under such circumstances,
the insurance proceeds received might not be adequate to restore our economic position with respect to the affected
real property. As a result of the events of September 11, 2001, insurance companies are limiting and/or excluding
coverage for acts of terrorism in insurance policies. As a result, we may suffer losses from acts of terrorism that are
not covered by insurance.
In addition, the mortgage loans which are secured by certain of the properties in which we have interests contain
customary covenants, including covenants that require property insurance to be maintained in an amount equal to the
replacement cost of the properties. There can be no assurance that the lenders under these mortgage loans will not take
the position that exclusions from coverage for losses due to terrorist acts is a breach of a covenant which, if uncured,
could allow the lenders to declare an event of default and accelerate repayment of the mortgage loans.
Environmental compliance costs and liabilities with respect to our real estate in which we have interests may
adversely affect our results of operations.
Our operating costs may be affected by our obligation to pay for the cost of complying with existing environmental
laws, ordinances and regulations, as well as the cost of complying with future legislation with respect to the assets, or
loans secured by assets, with environmental problems that materially impair the value of the assets. Under various
federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real
property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under, or in such
property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the
presence of such hazardous or toxic substances. In addition, the presence of hazardous or toxic substances, or the
failure to remediate properly, may adversely affect the owner's ability to borrow by using such real property as
collateral. Certain environmental laws and common law principles could be used to impose liability for releases of
hazardous materials, including asbestos-containing materials, into the environment, and third parties may seek
recovery from owners or operators of real properties for personal injury associated with exposure to released asbestos-
containing materials or other hazardous materials. Environmental laws may also impose restrictions on the manner in
which a property may be used or transferred or in which businesses it may be operated, and these restrictions may
require expenditures. In connection with the direct or indirect ownership and operation of properties, we may be
potentially liable for any such costs. The cost of defending against claims of liability or remediating contaminated
property and the cost of complying with environmental laws could adversely affect our results of operations and
financial condition.
Many of our investments are illiquid and this lack of liquidity could significantly impede our ability to vary our
portfolio in response to changes in economic and other conditions or to realize the value at which such
investments are carried if we are required to dispose of them.
The real estate properties that we own and operate and our other direct and indirect investments in real estate and real
estate related assets are generally illiquid. Our investments in unconsolidated subsidiaries are also illiquid. In
addition, the real estate securities that we purchase in connection with privately negotiated transactions are not
registered under the relevant securities laws, resulting in a prohibition against their transfer, sale, pledge or other
disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in accordance
with, those laws. In addition, there are no established trading markets for a majority of our investments. As a result,
our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited.
Our assets have historically been valued based primarily on third party quotations, which are subject to significant
variability based on the liquidity and price transparency created by market trading activity. The ongoing dislocation
in the trading markets has continued to reduce the trading for many real estate securities, resulting in less transparent
prices for those securities. Consequently, it is currently more difficult for us to sell many of our assets now that it has
been historically because, if we were to sell such assets, we will likely not have access to readily ascertainable market
prices when establishing valuations of them. Moreover, currently there is a relatively low market demand for many of
the types of assets that we hold, which may make it extremely difficult to sell assets. If we are required to liquidate all
or a portion of our illiquid investments quickly, we may realize significantly less than the amount at which we have
previously valued these investments.
Interest rate fluctuations and shifts in the yield curve may cause losses.
Our primary interest rate exposures relate to our real estate securities, loans, floating rate debt obligations, interest rate
swaps, and interest rate caps. Changes in interest rates, including changes in expected interest rates or “yield curves,”
affect our business in a number of ways. Changes in the general level of interest rates can affect our net interest
income, which is the difference between the interest income earned on our interest-earning assets and the interest
expense incurred in connection with our interest-bearing liabilities and hedges. Changes in the level of interest rates
20
also can affect, among other things, our ability to acquire real estate securities and loans at attractive prices, the value
of our real estate securities, loans and derivatives and our ability to realize gains from the sale of such assets.
In the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults
may increase and result in credit losses that would adversely affect our liquidity and operating results. Interest rates
are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international
economic and political conditions, and other factors beyond our control.
Our ability to execute our business strategy, particularly the growth of our investment portfolio, depends to a
significant degree on our ability to obtain additional capital. Our financing strategy is dependent on our ability to place
the match funded debt we use to finance our investments at rates that provide a positive net spread. If spreads for such
liabilities widen or if demand for such liabilities ceases to exist, then our ability to execute future financings will be
severely restricted.
Interest rate changes may also impact our net book value as our real estate securities and related hedge derivatives are
marked to market each quarter. Our loan investments and debt obligations are not marked to market. Generally, as
interest rates increase, the value of our fixed rate securities decreases, which will decrease the book value of our
equity.
Furthermore, shifts in the U.S. Treasury yield curve reflecting an increase in interest rates would also affect the yield
required on our real estate securities and therefore their value. For example, increasing interest rates would reduce the
value of the fixed rate assets we hold at the time because the higher yields required by increased interest rates result in
lower market prices on existing fixed rate assets in order to adjust the yield upward to meet the market, and vice versa.
This would have similar effects on our real estate securities portfolio and our financial position and operations to a
change in interest rates generally.
Our investments in real estate securities and loans are subject to changes in credit spreads which could
adversely affect our ability to realize gains on the sale of such investments.
Real estate securities and loans are subject to changes in credit spreads. Credit spreads measure the yield demanded on
securities and loans by the market based on their credit relative to a specific benchmark.
Fixed rate securities and loans are valued based on a market credit spread over the rate payable on fixed rate U.S.
Treasuries of like maturity. Floating rate securities and loans are valued based on a market credit spread over LIBOR
and are affected similarly by changes in LIBOR spreads. Excessive supply of these securities combined with reduced
demand will generally cause the market to require a higher yield on these securities and loans, resulting in the use of a
higher, or "wider," spread over the benchmark rate to value such securities. Under such conditions, the value of our
real estate securities and loan portfolios would tend to decline. Conversely, if the spread used to value such securities
were to decrease, or "tighten," the value of our real estate securities portfolio would tend to increase. Such changes in
the market value of our real estate securities and loan portfolios may affect our net equity, net income or cash flow
directly through their impact on unrealized gains or losses on available for sale securities, and therefore our ability to
realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital. During
2007, credit spreads widened substantially. This widening of credit spreads caused the net unrealized gains on our
securities and derivatives, recorded in accumulated other comprehensive income, and therefore our book value per
share, to decrease and resulted in net unrealized losses.
In addition, if the value of our loans subject to repurchase agreements were to decline, it could affect our ability to
refinance such loans upon the maturity of the related repurchase agreements. Any credit or spread related losses
incurred with respect to our loans would affect us in the same way as similar losses on our real estate securities
portfolio as described above, except that our loans are not marked to market.
In addition, widening credit spreads will generally result in a decrease in the mark to market value of certain
investments which are treated as derivatives on our balance sheet, such as total rate of return swaps. Since changes in
the value of such assets are reflected in our income statement, this would result in a decrease in our net income. To the
extent that we choose to make investments in real estate related assets by means of entering into total rate of return
swaps, our net income will be susceptible to decreases stemming from credit spread changes.
Our hedging transactions may limit our gains or result in losses.
We use derivatives to hedge our interest rate exposure and this has certain risks, including the risk that losses on a
hedge position will reduce the cash available for distribution to stockholders and that such losses may exceed the
amount invested in such instruments. We have adopted a general policy with respect to the use of derivatives, which
generally allows us to use derivatives where appropriate, but does not set forth specific policies and procedures. We
use derivative instruments, including forwards, futures, swaps and options, in our risk management strategy to limit
the effects of changes in interest rates on our operations. A hedge may not be effective in eliminating all of the risks
inherent in any particular position. Our profitability may be adversely affected during any period as a result of the use
of derivatives.
21
There are limits to the ability of hedging strategy to protect us completely against interest rate risks. When rates
change, we expect the gain or loss on derivatives to be offset by a related but inverse change in the value of the items,
generally our liabilities, which we hedge. We cannot assure you, however, that our use of derivatives will offset the
risks related to changes in interest rates. We cannot assure you that our hedging strategy and the derivatives that we
use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses. In
addition, our hedging strategy may limit our flexibility by causing us to refrain from taking certain actions that would
be potentially profitable but would cause adverse consequences under the terms of our hedging arrangements.
In managing our hedge instruments, we consider the effect of the expected hedging income on the REIT qualification
tests that limit the amount of gross income that a REIT may receive from hedging. The REIT provisions of the
Internal Revenue Code limit our ability to hedge. We need to carefully monitor, and may have to limit, our hedging
strategy to assure that we do not realize hedging income, or hold hedges having a value, in excess of the amounts
which would cause us to fail the REIT gross income and asset tests.
Accounting for derivatives under GAAP is extremely complicated. Any failure by us to account for our derivatives
properly in accordance with GAAP in our financial statements could adversely affect our earnings.
Prepayment rates can increase, adversely affecting yields on certain investments, including our residential
mortgage loans.
The value of our assets may be affected by prepayment rates on our residential mortgage loans and other floating rate
assets. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and
other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. In
periods of declining mortgage interest rates, prepayments on loans generally increase. If general interest rates decline
as well, the proceeds of such prepayments received during such periods are likely to be reinvested by us in assets
yielding less than the yields on the assets that were prepaid. In addition, the market value of floating rate assets may,
because of the risk of prepayment, benefit less than fixed rate assets from declining interest rates. Conversely, in
periods of rising interest rates, prepayments on loans generally decrease, in which case we would not have the
prepayment proceeds available to invest in assets with higher yields. Under certain interest rate and prepayment
scenarios we may fail to recoup fully our cost of acquisition of certain investments.
In addition, when market conditions lead us to increase the portion of our CBO investments that are comprised of
floating rate securities, the risk of assets inside our CBOs prepaying increases. Since our CBO financing costs are
locked in, reinvestment of such prepayment proceeds at lower yields than the initial investments, as a result of
changes in the interest rate or credit spread environment, will result in a decrease of the return on our equity and
therefore our net income.
Risks Relating to Our Taxation as a REIT
Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our
stockholders.
We operate in a manner intended to qualify as a REIT for federal income tax purposes. Our ability to satisfy the asset
tests depends upon our analysis of the fair market values of our assets, some of which are not susceptible to a precise
determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income and
quarterly asset requirements also depends upon our ability to successfully manage the composition of our income and
assets on an ongoing basis. Moreover, the proper classification of an instrument as debt or equity for federal income
tax purposes, and the tax treatment of participation interests that we hold in mortgage loans and mezzanine loans, may
be uncertain in some circumstances, which could affect the application of the REIT qualification requirements.
Accordingly, there can be no assurance that the IRS will not contend that our interests in subsidiaries or other issuers
will not cause a violation of the REIT requirements.
If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any
applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders
would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial
and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an
adverse impact on the value of, and trading prices for, our stock. Unless entitled to relief under certain Internal
Revenue Code provisions, we also would be disqualified from taxation as a REIT for the four taxable years following
the year during which we ceased to qualify as a REIT.
Dividends payable by REITs do not qualify for the reduced tax rates.
Tax law changes in 2003 reduced the maximum tax rate for dividends payable to individuals from 35% to 15%
(through 2010). Dividends payable by REITs, however, are generally not eligible for the reduced rates. Although this
legislation does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates
applicable to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive
investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay
dividends, which could adversely affect the value of the stock of REITs, including our common stock. In addition, the
22
relative attractiveness of real estate in general may be adversely affected by the newly favorable tax treatment given to
corporate dividends, which could affect the value of our real estate assets negatively.
REIT distribution requirements could adversely affect our ability to execute our business plan.
We generally must distribute annually at least 90% of our net taxable income, excluding any net capital gain, in order
for corporate income tax not to apply to earnings that we distribute. We intend to make distributions to our
stockholders to comply with the requirements of the Internal Revenue Code. However, differences in timing between
the recognition of taxable income and the actual receipt of cash could require us to sell assets or borrow funds on a
short-term or long-term basis to meet the 90% distribution requirement of the Internal Revenue Code. Certain of our
assets may generate substantial mismatches between taxable income and available cash. As a result, the requirement
to distribute a substantial portion of our net taxable income could cause us to: (i) sell assets in adverse market
conditions, (ii) borrow on unfavorable terms or (iii) distribute amounts that would otherwise be invested in future
acquisitions, capital expenditures or repayment of debt, in order to comply with REIT requirements. Further, amounts
distributed will not be available to fund investment activities. If we fail to obtain debt or equity capital in the future, it
could limit our ability to grow, which could adversely affect the value of our common stock.
We may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay
distributions to our stockholders.
As a REIT, we are generally required to distribute at least 90% of our REIT taxable income (determined without
regard to the dividends paid deduction and not including net capital losses) each year to our stockholders. To qualify
for the tax benefits accorded to REITs, we have and intend to continue to pay quarterly distributions and to make
distributions to our stockholders in amounts such that we distribute all or substantially all our net taxable income each
year, subject to certain adjustments. However, our ability to make distributions may be adversely affected by the risk
factors described in this Annual Report on Form 10-K, particularly in light of current market conditions. In the event
of a continued downturn in our operating results and financial performance or continued declines in the value of our
asset portfolio, we may be unable to declare or pay quarterly distributions or make distributions to our stockholders,
and we may elect to comply with our REIT distribution requirements by, after completing various procedural steps,
distributing up to 80% (or up to 100%, if shareholders so elect) of the required amount in the form of common shares
in lieu of cash. The timing and amount of distributions are in the sole discretion of our board of directors, which
considers, among other factors, our earnings, financial condition, debt service obligations and applicable debt
covenants, REIT qualification requirements and other tax considerations and capital expenditure requirements as our
board may deem relevant from time to time.
The stock ownership limit imposed by the Internal Revenue Code for REITs and our charter may inhibit
market activity in our stock and restrict our business combination opportunities.
In order for us to maintain our qualification as a REIT under the Internal Revenue Code, not more than 50% in value
of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Internal
Revenue Code to include certain entities) at any time during the last half of each taxable year after our first year. Our
charter, with certain exceptions, authorizes our board of directors to take the actions that are necessary and desirable
to preserve our qualification as a REIT. Unless exempted by our board of directors, no person may own more than 8%
of the aggregate value of our outstanding capital stock, treating classes and series of our stock in the aggregate, or
more than 25% of the outstanding shares of our Series B Preferred Stock, Series C Preferred Stock or our Series D
Preferred Stock. Our board may grant an exemption in its sole discretion, subject to such conditions, representations
and undertakings as it may determine in its sole discretion. These ownership limits could delay or prevent a
transaction or a change in our control that might involve a premium price for our common stock or otherwise be in the
best interest of our stockholders. Our board has granted limited exemptions to an affiliate of our manager, a third party
group of funds managed by Cohen & Steers, and certain affiliates of these entities.
Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.
Even if we remain qualified for taxation as a REIT, we may be subject to certain federal, state and local taxes on our
income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a
result of a foreclosure, and state or local income, property and transfer taxes, such as mortgage recording taxes.
Moreover, if a REIT distributes less than 85% of its taxable income to its stockholders during any calendar year
(including any distributions declared by the last day of the calendar year but paid in the subsequent year), then it is
required to pay an excise tax on 4% of any shortfall between the required 85% and the amount that was actually
distributed. As a result of this rule, Newcastle will likely be required to pay an excise tax in 2008 and may also be
required to do so in 2009. Any of these taxes would decrease cash available for distribution to our stockholders. In
addition, in order to meet the REIT qualification requirements, or to avert the imposition of a 100% tax that applies to
certain gains derived by a REIT from dealer property or inventory, we may hold some of our assets through taxable
REIT subsidiaries. Such subsidiaries will be subject to corporate level income tax at regular rates.
Complying with REIT requirements may cause us to forego otherwise attractive opportunities.
To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other
things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our
23
stockholders and the ownership of our stock. We also may be required to make distributions to stockholders at
disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with the
REIT requirements may hinder our ability to make certain attractive investments.
Complying with REIT requirements may limit our ability to hedge effectively.
The existing REIT provisions of the Internal Revenue Code may substantially limit our ability to hedge our operations
because a significant amount of the income from those hedging transactions is likely to be treated as non-qualifying
income for purposes of both of satisfying REIT gross income tests. In addition, we must limit our aggregate income
from non-qualified hedging transactions, from our provision of services and from other non-qualifying sources, to less
than 5% of our annual gross income (determined without regard to gross income from qualified hedging transactions).
As a result, we may have to limit our use of certain hedging techniques or implement those hedges through total return
swaps. This could result in greater risks associated with changes in interest rates than we would otherwise want to
incur or could increase the cost of our hedging activities. If we fail to comply with these limitations, we could lose our
REIT qualification for U.S. federal income tax purposes, unless our failure was due to reasonable cause and not due to
willful neglect, and we meet certain other technical requirements. Even if our failure was due to reasonable cause, we
might incur a penalty tax.
The “taxable mortgage pool” rules may increase the taxes that we or our stockholders may incur, and may
limit the manner in which we effect future securitizations.
Certain of our securitizations have resulted in the creation of taxable mortgage pools for federal income tax purposes.
As a REIT, so long as we own 100% of the equity interests in a taxable mortgage pool, we would generally not be
adversely affected by the characterization of the securitization as a taxable mortgage pool. Certain categories of
stockholders, however, such as foreign stockholders eligible for treaty or other benefits, stockholders with net
operating losses, and certain tax-exempt stockholders that are subject to unrelated business income tax, could be
subject to increased taxes on a portion of their dividend income from us that is attributable to the taxable mortgage
pool. In addition, to the extent that our stock is owned by tax-exempt “disqualified organizations,” such as certain
government-related entities and charitable remainder trusts that are not subject to tax on unrelated business income,
we may incur a corporate level tax on a portion of our income from the taxable mortgage pool. In that case, we may
reduce the amount of our distributions to any disqualified organization whose stock ownership gave rise to the tax.
Maintenance of our Investment Company Act exemption imposes limits on our operations.
We conduct our operations so as not to become regulated as an investment company under the Investment Company
Act of 1940, as amended. We believe that there are a number of exemptions under the Investment Company Act that
may be applicable to us. The assets that we may acquire, therefore, are limited by the provisions of the Investment
Company Act and the rules and regulations promulgated under the Investment Company Act. In addition, we could,
among other things, be required either (a) to change the manner in which we conduct our operations to avoid being
required to register as an investment company or (b) to register as an investment company, either of which could
adversely affect us and the market price for our stock.
ERISA may restrict investments by plans in our common stock.
A plan fiduciary considering an investment in our common stock should consider, among other things, whether such
an investment is consistent with the fiduciary obligations under ERISA, including whether such investment might
constitute or give rise to a prohibited transaction under ERISA, the Internal Revenue Code or any substantially similar
federal, state or local law and, if so, whether an exemption from such prohibited transaction rules is available.
Maryland takeover statutes may prevent a change of our control. This could depress our stock price.
Under Maryland law, "business combinations" between a Maryland corporation and an interested stockholder or an
affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested
stockholder becomes an interested stockholder. These business combinations include certain mergers, consolidations,
share exchanges, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity
securities or a liquidation or dissolution. An interested stockholder is defined as:
•
•
any person who beneficially owns 10% or more of the voting power of the corporation's outstanding
shares; or
an affiliate or associate of a corporation who, at any time within the two-year period prior to the date in
question, was the beneficial owner of 10% or more of the voting power of the then outstanding stock of
the corporation.
A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction
by which he or she otherwise would have become an interested stockholder.
After the five-year prohibition, any business combination between the Maryland corporation and an interested
stockholder generally must be recommended by the board of directors of the corporation and approved by the
affirmative vote of at least:
24
•
•
80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation
voting together as a single group; and
two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares
held by the interested stockholder with whom or with whose affiliate the business combination is to be
effected or held by an affiliate or associate of the interested stockholder voting together as a single
voting group.
The business combination statute may discourage others from trying to acquire control of us and increase the
difficulty of consummating any offer, including potential acquisitions that might involve a premium price for our
common stock or otherwise be in the best interest of our stockholders.
Our authorized, but unissued common and preferred stock may prevent a change in our control.
Our charter authorizes us to issue additional authorized but unissued shares of our common stock or preferred stock.
In addition, our board of directors may classify or reclassify any unissued shares of common stock or preferred stock
and may set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board may
establish a series of preferred stock that could delay or prevent a transaction or a change in control that might involve
a premium price for our common stock or otherwise be in the best interest of our stockholders.
Our stockholder rights plan could inhibit a change in our control.
We have adopted a stockholder rights agreement. Under the terms of the rights agreement, in general, if a person or
group acquires more than 15% of the outstanding shares of our common stock, all of our other common stockholders
will have the right to purchase securities from us at a discount to such securities' fair market value, thus causing
substantial dilution to the acquiring person. The rights agreement may have the effect of inhibiting or impeding a
change in control not approved by our board of directors and, therefore, could adversely affect our stockholders'
ability to realize a premium over the then-prevailing market price for our common stock in connection with such a
transaction. In addition, since our board of directors can prevent the rights agreement from operating, in the event our
board approves of an acquiring person, the rights agreement gives our board of directors significant discretion over
whether a potential acquirer's efforts to acquire a large interest in us will be successful. Because the rights agreement
contains provisions that are designed to assure that the executive officers, our manager and its affiliates will never,
alone, be considered a group that is an acquiring person, the rights agreement provides the executive officers, our
manager and its affiliates with certain advantages under the rights agreement that are not available to other
stockholders.
Our staggered board and other provisions of our charter and bylaws may prevent a change in our control.
Our board of directors is divided into three classes of directors. Directors of each class are chosen for three-year terms
upon the expiration of their current terms, and each year one class of directors is elected by the stockholders. The
staggered terms of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even
though a tender offer or change in control might be in the best interest of our stockholders. In addition, our charter and
bylaws also contain other provisions that may delay or prevent a transaction or a change in control that might involve
a premium price for our common stock or otherwise be in the best interest of our stockholders.
Risks Related to Our Common Shares
Our share price may fluctuate significantly, and you may not be able to resell your shares at or above the price
at which you purchased them.
The trading price of our common shares could be subject to wide price fluctuations in response to various factors,
including:
• market conditions in the broader stock market in general, or in the REIT or real estate industry in
particular;
•
actual or anticipated fluctuations in our quarterly financial and operating results;
• market perception of our potential growth, future earnings and future cash dividends;
•
•
•
actions by rating agencies;
short sales of our common stock;
issuance of new or changed securities analysts’ reports or recommendations;
• media coverage of us, other REITS or the outlook of the real estate industry;
• major reductions in trading volumes on the exchanges on which we operate;
25
•
legislative or regulatory developments, including changes in the status of our regulatory approvals or
licenses; and
•
litigation and governmental investigations.
These and other factors may cause the market price and demand for our common shares to fluctuate substantially,
which may negatively affect the price or liquidity of our common shares. Moreover, the recent market conditions
have negatively impacted our share price and may do so in the future. When the market price of a stock has been
volatile in the past, holders of that stock have, at times, instituted securities class action litigation against the company
that issued the stock. If any of our shareholders brought a lawsuit against us, we could incur substantial costs
defending the lawsuit. Such a lawsuit could also divert the time and attention of our management from our business
and hurt our share price.
An increase in market interest rates may have an adverse effect on the market price of our common stock.
One of the factors that investors may consider in deciding whether to buy or sell shares of our common stock is our
distribution rate as a percentage of our share price relative to market interest rates. If the market price of our common
stock is based primarily on the earnings and return that we derive from our investments and income with respect to
our investments and our related distributions to stockholders, and not from the market value of the investments
themselves, then interest rate fluctuations and capital market conditions will likely affect the market price of our
common stock. For instance, if market interest rates rise without an increase in our distribution rate, the market price
of our common stock could decrease as potential investors may require a higher distribution yield on our common
stock or seek other securities paying higher distributions or interest. In addition, rising interest rates would result in
increased interest expense on our variable rate debt, thereby adversely affecting cash flow and our ability to service
our indebtedness and pay distributions.
26
Item 1B. Unresolved Staff Comments
We have no unresolved staff comments.
Item 2. Properties.
Our direct investments in properties are described under “Business – Our Investing Activities.”
Our manager leases principal executive and administrative offices located at 1345 Avenue of the Americas, New
York, New York 10105. Its telephone number is (212) 798-6100.
Item 3. Legal Proceedings.
We are not a party to any material legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of our security holders during the fourth quarter of 2007.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of
Equity Securities.
Our common stock has been listed and is traded on the New York Stock Exchange (NYSE) under the symbol “NCT”
since our initial public offering in October 2002. The following table sets forth, for the periods indicated, the high,
low and last sale prices in dollars on the NYSE for our common stock and the distributions we declared with respect
to the periods indicated.
2007
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
$33.49
$31.00
$25.84
$19.08
2006
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
$27.50
$26.30
$28.58
$32.59
Low
$24.75
$24.91
$12.19
$12.15
Low
$23.34
$22.16
$24.60
$26.78
Last Sale
$27.73
$25.07
$17.62
$12.96
Last Sale
$23.92
$25.32
$27.41
$31.32
Distributions
Declared
$0.690
$0.720
$0.720
$0.720
Distributions
Declared
$0.625
$0.650
$0.650
$0.690
We intend to continue to declare quarterly distributions on our common stock. No assurance, however, can be given
that any future distributions will be made or, if made, as to the amounts or timing of any future distributions as such
distributions are subject to our earnings, financial condition, capital requirements and such other factors as our board
of directors deems relevant.
On February 26, 2008, the closing sale price for our common stock, as reported on the NYSE, was $11.11. As of
February 26, 2008, there were approximately 109 record holders of our common stock. This figure does not reflect
the beneficial ownership of shares held in nominee name.
27
Equity Compensation Plan Information
The following table summarizes the total number of outstanding securities in the incentive plan and the number of
securities remaining for future issuance, as well as the weighted average exercise price of all outstanding securities as
of December 31, 2007.
Number of Securities to be
Issued Upon Exercise of
Outstanding Options
Weighted Average
Exercise Price of
Outstanding Options
Number of Securities Remaining
Available for Future Issuance
Under Equity Compensation
Plans
Plan Category
Equity Compensation Plans Approved
by Security Holders:
Newcastle Investment Corp. Nonqualified
Stock Option and Incentive Award Plan
2,498,609 (1)
$27.04
6,448,005 (2)
Equity Compensation Plans Not Approved
by Security Holders:
None
N/A
N/A
N/A
(1)
(2)
Includes options for (i) 1,457,222 shares held by an affiliate of our manager; (ii) 1,027,387 shares granted to
our manager and assigned to certain of the manager’s employees; and (iii) an aggregate of 14,000 shares held
by our directors, other than Mr. Edens.
The maximum available for issuance is equal to 10% of the number of outstanding equity interests, subject to a
maximum of 10,000,000 shares in the aggregate over the term of the plan. The number of securities remaining
available for future issuance is net of an aggregate of 10,268 shares of our common stock awards to our
directors, other than Mr. Edens and Mr. Riis, representing the aggregate annual automatic stock awards to each
such director for 2003 through 2007, and of 1,043,118 shares issued to our manager, certain of our directors,
and employees of our manager upon the exercise of previously granted options.
28
Item 6. Selected Financial Data.
The selected historical consolidated financial information set forth below as of and for each of the five years ended
December 31, 2007 has been derived from our audited historical consolidated financial statements.
The information below should be read in conjunction with Part II, Item 7, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included
in Part II, Item 8, “Financial Statements and Supplementary Data.”
Selected Consolidated Financial Information
(in thousands, except per share data)
Operating Data
Revenues
Interest income
Other income
Expenses
Interest expense
Other expense
Other-than-temporary impairment
Income (loss) before equity in earnings of unconsolidated subsidiaries
Equity in earnings of unconsolidated subsidiaries, net
2007
Year Ended December 31,
2005
2004
2006
2003
$
680,551
7,506
688,057
$
530,006
23,261
553,267
$
348,516
29,697
378,213
$
225,761
23,908
249,669
$
133,183
18,901
152,084
476,988
79,291
556,279
(202,602)
(70,824)
5,390
374,269
57,266
431,535
-
121,732
5,968
226,446
42,529
268,975
-
109,238
5,609
136,398
29,259
165,657
-
84,012
9,957
76,877
20,828
97,705
-
54,379
862
Income (loss) from continuing operations
Income(loss) from discontinued operations
Net income (loss)
Preferred dividends and related accretion
Income (loss) applicable to common stockholders
(65,434)
(23)
(65,457)
(12,640)
(78,097)
$
127,700
223
127,923
(9,314)
118,609
$
114,847
2,108
116,955
(6,684)
110,271
$
93,969
4,446
98,415
(6,094)
92,321
$
55,241
877
56,118
(4,773)
51,345
$
Net income (loss) per share of common stock, diluted
$
(1.52)
$
2.67
$
2.51
$
2.46
$
1.96
Income (loss) from continuing operations per share of common
stock, after preferred dividends, diluted
$
(1.52)
$
2.67
$
2.46
$
2.34
$
1.93
Weighted average number of shares of common stock
outstanding, diluted
51,369
44,417
43,986
37,558
26,141
Dividends declared per share of common stock
$
2.850
$
2.615
$
2.500
$
2.425
$
1.950
Balance Sheet Data
Real estate securities, available for sale
Real estate related loans, net
Residential mortgage loans, net
Operating real estate, net
Cash and cash equivalents
Total assets
Debt
Total liabilities
Common stockholders' equity
Preferred stock
Supplemental Balance Sheet Data
Common shares outstanding
2007
2006
As Of December 31,
2005
2004
2003
$
4,835,884
1,856,978
634,605
34,899
55,916
8,037,770
7,391,694
7,590,145
295,125
152,500
$
5,581,228
1,568,916
809,097
29,626
5,371
8,604,392
7,504,731
7,602,412
899,480
102,500
$
4,554,519
615,551
600,682
16,673
21,275
6,209,699
5,212,358
5,291,696
815,503
102,500
$
3,369,496
591,890
654,784
57,193
37,911
4,932,720
4,021,396
4,136,005
734,215
62,500
$
2,192,727
402,784
586,237
102,995
60,403
3,550,299
2,924,552
3,010,936
476,863
62,500
52,779
45,714
43,913
39,859
31,375
Book value per share of common stock
$
5.59
$
19.68
$
18.57
$
18.42
$
15.20
29
Other Data
Cash Flow provided by (used in):
Operating activities
Investing activities
Financing activities
Funds from Operations (FFO) (1)
2007
2006
2005
2004
2003
Year Ended December 31,
$
(6,510)
$
16,322
$
98,763
$
90,355
$
38,454
33,972
23,083
(76,976)
(1,963,058)
(1,334,746)
(1,332,164)
(1,659,026)
1,930,832
119,421
1,219,347
104,031
1,219,317
1,635,512
86,201
54,380
(1) We believe FFO is one appropriate measure of the operating performance of real estate companies. We also believe that FFO is an
appropriate supplemental disclosure of operating performance for a REIT due to its widespread acceptance and use within the REIT and
analyst communities. Furthermore, FFO is used to compute our incentive compensation to our manager. FFO, for our purposes, represents
net income available for common stockholders (computed in accordance with GAAP), excluding extraordinary items, plus depreciation of our
operating real estate, and after adjustments for unconsolidated subsidiaries, if any. We consider gains and losses on resolution of our
investments to be a normal part of our recurring operations and, therefore, do not exclude such gains and losses when arriving at FFO.
Adjustments for unconsolidated subsidiaries, if any, are calculated to reflect FFO on the same basis. FFO does not represent cash generated
from operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indicator of our
operating performance or as an alternative to cash flow as a measure of our liquidity and is not necessarily indicative of cash available to fund
cash needs. Our calculation of FFO may be different from the calculation used by other companies and, therefore, comparability may be
limited.
Year Ended December 31,
2007
2006
2005
2004
2003
Calculation of Funds From Operations (FFO):
Income (loss) applicable to common stockholders
$
(78,097)
$
118,609
$
110,271
$
92,321
$
51,345
Operating real estate depreciation
Accumulated depreciation on operating real estate sold
1,121
-
812
-
702
(6,942)
2,199
(8,319)
3,035
-
Funds from operations (FFO)
$
(76,976)
$
119,421
$
104,031
$
86,201
$
54,380
30
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following should be read in conjunction with our consolidated financial statements and notes thereto included in
Part II, Item 8, “Financial Statements and Supplementary Data.”
General
Newcastle Investment Corp. actively manages real estate related investments and related financing vehicles. We
invest in, and actively manage, a portfolio of real estate securities, loans and other real estate related assets. In
addition, we consider other opportunistic investments which capitalize on our manager’s expertise and which we
believe present attractive risk/return profiles and are consistent with our investment guidelines. We seek to deliver
stable dividends and attractive risk-adjusted returns to our stockholders through prudent asset selection, active
management and the use of match funded financing structures, when appropriate and available, which reduce our
interest rate and financing risks. Our objective is to maximize the difference between the yield on our investments
and the cost of financing these investments while hedging our interest rate risk. We emphasize portfolio management,
asset quality, diversification, match funded financing and credit risk management.
We currently own a diversified portfolio of moderately credit sensitive real estate debt investments including
securities and loans. Our portfolio of real estate securities includes commercial mortgage backed securities (CMBS),
senior unsecured debt issued by property 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 residential
loans. We also own, directly and indirectly, interests in operating real estate.
We employ leverage in order to achieve our return objectives. 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 December 31, 2007, our debt to equity ratio as computed based on our consolidated balance sheet
was approximately 16.5 to 1. Our general investment guidelines adopted by our board of directors limit total leverage
(as defined under the governing documents) to a maximum 9.0 to 1 debt to equity ratio. As of December 31, 2007, our
debt to equity ratio as computed under this method was approximately 6.2 to 1.
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 have utilized multiple forms of financing including collateralized bond
obligations (CBOs), other securitizations, term loans, a credit facility, and trust preferred securities, as well as short
term financing in the form of repurchase agreements.
We seek to match fund our investments with respect to interest rates and maturities in order to minimize 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 CBO financings offer us the structural flexibility to buy and sell certain investments to
manage risk and, subject to certain limitations, to optimize returns.
Market Considerations
Our ability to maintain our dividends is dependent on our ability to invest our capital on a timely basis at attractive
levels. The primary market factors that bear on this are credit spreads and the availability of financing on favorable
terms.
Generally speaking, widening credit spreads reduce the unrealized gains on our current investments (or cause
unrealized losses) and increase our financing costs, but increase the yields available on potential new investments,
while tightening credit spreads increase the unrealized gains on our current investments and reduce our financing
costs, but reduce the yields available on potential new investments. By reducing unrealized gains (or causing
unrealized losses), widening credit spreads would also impact our ability to realize gains on existing investments if we
were to sell such assets.
2005 - 2006
During 2005 and 2006, credit spreads widened and then tightened, but generally remained at or near historical lows.
As a result, the net unrealized gains on our securities and derivatives, recorded in accumulated other income, and
therefore our book value per share, increased during this period.
In addition, trends in market interest rates continued to impact our operations, although to a lesser degree due to our
match funded financing strategy. During this period, interest rates steadily increased from the historical lows
experienced just prior, partially offsetting the impact of tight credit spreads.
31
2007
During 2007, credit spreads widened substantially. This widening of credit spreads caused the net unrealized gains on
our securities and derivatives, recorded in accumulated other comprehensive income, and therefore our book value per
share, to decrease and resulted in net unrealized losses. One of the key drivers of the widening of credit spreads has
been the disruption in the subprime mortgage lending sector. This disruption has spread rapidly, causing adverse
conditions throughout the credit markets.
Widening credit spreads, while reducing our book value per share, also result in higher yields on new investment
opportunities. However, we must have additional capital available at attractive terms, either through debt financings or
equity offerings, in order to take advantage of these investment opportunities. Since the second half of 2007, we have
been unable to take full advantage of the increased yields available on investments due to a lack of available capital,
and we may continue to experience the same restrictions in 2008. Non-recourse term financing not subject to margin
requirements is generally not available and we must maintain and enhance our current sources of capital in order to
meet our working capital needs. Furthermore, an equity offering at our current common share price would likely not
be accretive as our common dividend yield currently exceeds the yield available on many new investments.
In addition, the recent credit and liquidity crisis has adversely affected the market in which we operate in a number of
other ways. For example, it has reduced the market trading activity for many real estate securities, resulting in less
liquid markets for those securities. 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 what
we believe are relatively conservative mark-to-market valuations of many real estate securities. These lower
valuations have affected us by, among other things, decreasing our net book value and contributing to our decision to
record impairment charges.
Furthermore, Standard & Poor’s and Moody’s have issued a series of credit rating downgrades on a large number of
real estate securities, predominantly subprime securities, including a number that we own. These downgrades do not
currently impact our compliance with the terms of our financings, but it is possible that future downgrades or changes
to the credit ratings process could impact our current and future financings.
We do not currently know the full extent to which this market disruption will affect us or the markets in which we
operate, and we are unable to predict its length or ultimate severity. If the disruption continues, we will likely
experience further tightening of liquidity, additional impairment charges and increased margin requirements, as well
as additional challenges in raising capital and obtaining investment financing on attractive terms.
As of the date of this Annual Report on Form 10-K, based on our cash balances and committed financing, including
our warehouse facilities, as well as proceeds from select asset sales, we believe we have sufficient liquidity to
maintain our ongoing operations in the current market environment. Future cash flows and our liquidity may be
materially impacted if conditions do not substantially improve. Should the current conditions worsen, or persist for an
extended period of time, our available capital could be reduced upon the expiration or termination of our capital
resources.
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” as well as in Part II, Item 7A,
“Quantitative and Qualitative Disclosures About Market Risk.”
Formation and Organization
We were formed in 2002 as a subsidiary of Newcastle Investment Holdings Corp. (referred to herein as Holdings).
Prior to our initial public offering, Holdings contributed to us certain assets and liabilities in exchange for
approximately 16.5 million shares of our common stock. Our operations commenced in July 2002. In May 2003,
Holdings distributed to its stockholders all of the shares of our common stock that it held, and it no longer owns any
of our common equity.
The following table presents information on shares of our common stock issued since our formation:
Year
Shares Issued
Formation
2002
2003
2004
2005
2006
2007
December 31, 2007
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors.
16,488,517
7,000,000
7,886,316
8,484,648
4,053,928
1,800,408
7,065,362
52,779,179
Range of Issue
Prices (1)
N/A
$13.00
$20.35-$22.85
$26.30-$31.40
$29.60
$29.42
$27.75-$31.30
Net Proceeds
(millions)
N/A
$80.0
$163.4
$224.3
$108.2
$51.2
$201.3
32
As of December 31, 2007, approximately 5.1 million of our shares of common stock were held by our manager,
through its affiliates, and principals of Fortress. In addition, our manager, through its affiliates, held options to
purchase approximately 1.5 million shares of our common stock at December 31, 2007.
We are organized and conduct our operations to qualify as a REIT for U.S. federal income tax purposes. As such, we
will generally not be subject to U.S. federal income tax on that portion of our income that is distributed to
stockholders if we distribute at least 90% of our REIT taxable income to our stockholders by prescribed dates and
comply with various other requirements.
We conduct our business by investing in three primary business segments: (i) real estate securities and real estate
related loans, (ii) residential mortgage loans and (iii) operating real estate. Our discontinued operations include the
operations of properties which have been sold or classified as Real Estate Held for Sale pursuant to SFAS No. 144.
Revenues attributable to each segment are disclosed below (unaudited) (in thousands).
Real Estate
Securities and
Real Estate
Related Loans
$
531,177
$
441,965
$
321,889
Residential
Mortgage
Loans
148,435
105,621
48,844
$
$
$
For the Year Ended
December 31, 2007
December 31, 2006
December 31, 2005
Taxation
Operating
Real Estate Unallocated
$
$
$
$
$
$
6,709
5,117
6,772
1,736
564
708
Total
688,057
553,267
378,213
$
$
$
We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as
amended (the "Code"), and we intend to continue to operate in such a manner. Our current and continuing
qualification as a REIT depends on our ability to meet various tax law requirements, including, among others,
requirements relating to the sources of our income, the nature of our assets, the composition of our stockholders, and
the timing and amount of distributions that we make.
As a REIT, we will generally not be subject to U.S. federal corporate income tax on our net income that is currently
distributed to stockholders. We may, however, nevertheless be subject to certain state, local and foreign income and
other taxes, and to U.S. federal income and excise taxes and penalties in certain situations, including taxes on our
undistributed income. In addition, our stockholders may be subject to state, local or foreign taxation in various
jurisdictions, including those in which they or we transact business or reside. The state, local and foreign tax
treatment of us and our stockholders may not conform to the U.S. federal income tax treatment.
If, in any taxable year, we fail to satisfy one or more of the various tax law requirements, we could fail to qualify as a
REIT. If we fail to qualify as a REIT for a particular tax year, our income in that year would be subject to U.S. federal
corporate income tax (including any applicable alternative minimum tax), and we may need to borrow funds or
liquidate certain investments in order to pay the applicable tax, and we would not be compelled by the Code to make
distributions. Unless entitled to relief under certain statutory provisions, we would also be disqualified from treatment
as a REIT for the four taxable years following the year during which qualification is lost.
Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that future economic,
market, legal, tax or other developments may cause us to fail to qualify as a REIT, or may cause our board of directors
to revoke the REIT election.
33
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 have been in line with Management’s estimates and judgements
used in applying each of the accounting policies described below. A summary of our significant accounting policies is
presented in Note 2 to our consolidated financial statements, which appear in Part II, Item 8, “Financial Statements
and Supplementary Data.” The following is a summary of our accounting policies that are most effected by
judgments, estimates and assumptions.
Variable Interest Entities
Financial Accounting Standards Board Interpretation (“FIN”) No. 46R “Consolidation of Variable Interest Entities”
clarified the methodology for determining whether an entity is a variable interest entity (“VIE”) and the methodology
for assessing who is the primary beneficiary of a VIE. 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 its primary beneficiary, which is defined as the party who will
absorb a majority of the VIE’s expected losses or receive a majority of the expected residual returns as a result of
holding variable interests.
Prior to the adoption of FIN 46R, we consolidated our existing CBO transactions (the “CBO Entities”) because we
owned the entire equity interest in each of them, representing a substantial portion of their capitalization, and we
controlled the management and resolution of their assets. We have determined that certain of the CBO Entities are
VIEs and that we are the primary beneficiary of each of these VIEs and have therefore continued to consolidate them.
We will continue to analyze future CBO entities, as well as other investments, pursuant to the requirements of FIN
46R. These analyses require considerable judgment in determining the primary beneficiary of a VIE since they
involve estimated probability weighting of subjectively determined possible cash flow scenarios. The result could be
the consolidation of an entity acquired or formed in the future that would otherwise not have been consolidated or the
non-consolidation of such an entity that would otherwise have been consolidated.
Valuation and Impairment of Securities
We have classified 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. Fair value is based
primarily upon broker quotations, as well as counterparty quotations, which provide valuation estimates based upon
reasonable market order indications or a good faith estimate thereof. These quotations are subject to significant
variability based on market conditions, such as interest rates and credit spreads. Certain of our securities are not
traded in an active market and therefore have little or no price transparency, predominantly the 2006 vintage subprime
securities and the residuals and retained bonds from our two subprime securitizations. As a result, we have estimated
the fair value of these illiquid securities based on internal pricing models rather than broker quotations. As of
December 31, 2007, approximately $378.1 million face amount of securities (or 6.8% of our total securities portfolio)
was valued at $177.5 million based on our pricing models. Changes in market conditions, as well as changes in the
assumptions or methodology used to determine fair value, could result in a significant increase or decrease in our book
equity. For securities valued with pricing models, these inputs include the discount rate, assumptions relating to
prepayments, default rates and loss severities, as well as other variables.
We must also assess whether unrealized losses on securities reflect a decline in value which is other-than-temporary
and, accordingly, write the impaired security down to its value through earnings. For example, a decline in value is
deemed to be other-than-temporary if 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, or if we do not have the ability and intent to
hold a security in an unrealized loss position until its anticipated recovery (if any). 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 when they are 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
34
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. The result of this evaluation is considered in relation to the
amount of the unrealized loss and the period elapsed since it was incurred. Significant judgment is required in this
analysis.
The following table is a summary of the impairment (excluding the impairment charges related to the assets with face
amounts of $255.4 million sold subsequent to December 31, 2007) for the fourth quarter of 2007 and for the year
ended December 31, 2007 (dollars in thousands):
Asset Type
2003 Subprime Securities
2004 Subprime Securities
2005 Subprime Securities
2006 Subprime Securities
2007 Subprime Securities
Subprime Retained Bonds
Subprime Residual Interests
Total Subprime Related
CMBS - CDO
CMBS - Conduit
Total
Number of
Securities
3
3
5
29
2
5
2
49
1
1
Face Amount
3,341
$
35,011
23,850
159,497
4,725
61,358
68,248
356,030
16,000
9,000
Impairment Charge
4th Quarter
2007
$
853
7,948
13,216
58,701
3,067
13,298
12,823
109,906
Year Ended
2007
$
1,868
7,948
13,216
128,021
3,067
13,298
12,823
180,241
10,613
1,894
14,090
1,894
51
$
381,030
$
122,413
$
196,225
Revenue Recognition on Securities
Income on these securities is recognized using a level yield methodology based upon a number of cash flow
assumptions that are subject to uncertainties and contingencies. Such assumptions include the rate and timing of
principal and interest receipts (which may be subject to prepayments and defaults). These assumptions are updated on
at least a quarterly basis to reflect changes related to a particular security, actual historical data, and market changes.
These uncertainties and contingencies are difficult to predict and are subject to future events, and economic and
market conditions, which may alter the assumptions. For securities acquired at a discount for credit losses, 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 Provision for Credit
Losses. The provision is determined based on an evaluation of the credit status of securities, as described in
connection with the analysis of impairment above. A rollforward of the provision, if any, is included in Note 4 to our
consolidated financial statements in Part II, Item 8, “Financial Statements and Supplementary Data.”
Valuation of Derivatives
Similarly, our derivative instruments are carried at fair value pursuant to Statement of Financial Accounting Standards
("SFAS'') No. 133 "Accounting for Derivative Instruments and Hedging Activities,'' as amended. Fair value is based
on counterparty quotations. To the extent they qualify as cash flow hedges under SFAS No. 133, net unrealized gains
or losses are reported as a component of accumulated other comprehensive income; otherwise, they 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. The results
of such variability could be a significant increase or decrease in our book equity and/or earnings.
Impairment of Loans
We purchase, directly and indirectly, real estate related, commercial mortgage and residential mortgage loans,
including manufactured housing loans and subprime mortgage loans, to be 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
35
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.
Revenue Recognition on Loans
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 Provision for
Credit Losses. The provision is determined based on an evaluation of the loans as described under “Impairment of
Loans” above. A rollforward of the provision is included in Note 5 to our consolidated financial statements in Part II,
Item 8, “Financial Statements and Supplementary Data.”
Impairment of Operating Real Estate
We own operating real estate held for investment. We review our operating real estate for impairment annually or
whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Upon determination of impairment, we would record a write-down of the asset, which would be charged to earnings.
Significant judgment is required both in determining impairment and in estimating the resulting write-down. In
addition, when operating real estate is classified as held for sale, it must be recorded at the lower of its carrying
amount or fair value less costs of sale. Significant judgment is required in determining the fair value of such
properties.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (‘‘FASB’’) issued Interpretation No. 48, ‘‘Accounting for
Uncertainty in Income Taxes, an interpretation of SFAS No. 109’’ (‘‘FIN 48’’). FIN 48 requires companies to
recognize the tax benefits of uncertain tax positions only where the position is ‘‘more likely than not’’ to be sustained
assuming examination by tax authorities. The tax benefit recognized is the largest amount of benefit that is greater
than 50 percent likely of being realized upon ultimate settlement. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The adoption of FIN 48 did not have a material impact on our financial condition, liquidity or
results of operations.
In February 2006, the FASB issued Statement of Financial Accounting Standards (‘‘SFAS’’) No. 155, “Accounting
for Certain Hybrid Financial Instruments,” which amends SFAS 133, “Accounting for Derivative Instruments and
Hedging Activities,” and SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities.” SFAS 155 provides, among other things, that (i) for embedded derivatives which
would otherwise be required to be bifurcated from their host contracts and accounted for at fair value in accordance
with SFAS 133 an entity may make an irrevocable election, on an instrument-by-instrument basis, to measure the
hybrid financial instrument at fair value in its entirety, with changes in fair value recognized in earnings and (ii)
concentrations of credit risk in the form of subordination are not considered embedded derivatives. SFAS 155 is
effective for all financial instruments acquired, issued or subject to remeasurement after the beginning of an entity’s
first fiscal year that begins after September 15, 2006. Upon adoption, differences between the total carrying amount of
the individual components of an existing bifurcated hybrid financial instrument and the fair value of the combined
hybrid financial instrument should be recognized as a cumulative effect adjustment to beginning retained earnings.
Prior periods are not restated. The adoption of SFAS 155 did not have a material impact on our financial statements.
In June 2007, Statement of Position No. 07-1, ‘‘Clarification of the Scope of the Audit and Accounting Guide —
Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in
Investment Companies’’ (‘‘SOP 07-1’’) was issued. SOP 07-1 addresses whether the accounting principles of the
Audit and Accounting Guide for Investment Companies may be applied to an entity by clarifying the definition of an
investment company and whether those accounting principles may be retained by a parent company in consolidation
or by an investor in the application of the equity method of accounting. SOP 07-1 eliminates the previously existing
exemption for REITs from being considered investment companies. We are currently evaluating the potential effect
on our financial condition, liquidity and results of operations upon adoption of SOP 07-1. If we, or any of our
subsidiaries, are considered an investment company under this new guidance, it would result in material changes to
our financial statements. The primary change would be the recording of all of our (or our subsidiaries’) investments at
fair value, with changes in fair value being recorded through the income statement. In October 2007, the FASB voted
to indefinitely postpone the adoption of SOP 07-1.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS 157 defines fair value as the
price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market
participants in the market in which the reporting entity transects, establishes a framework for measuring fair value,
and expands disclosures about fair value measurements. SFAS 157 applies to reporting periods beginning after
November 15, 2007. We adopted SFAS 157 on January 1, 2008. To the extent they are measured at fair value, SFAS
157 did not materially change our fair value measurements for any of our existing financial statement elements. SFAS
36
157 did change the reported value for our derivative obligations, but this did not have a material effect on our
liabilities or accumulated other comprehensive income. As a result, except as described below, the adoption of SFAS
157 did not have a material impact on our financial condition, liquidity or results of operations.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial
Liabilities.” SFAS 159 permits entities to choose to measure many financial instruments, and certain other items, at
fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159
applies to reporting periods beginning after November 15, 2007. We adopted SFAS 159 on January 1, 2008. We did
not elect to measure any items at fair value pursuant to the provisions of SFAS 159. As a result, the adoption of SFAS
159 did not have a material impact on our financial condition, liquidity or results of operations.
In December 2007, the American Securitization Forum (“ASF”) issued the “Streamlined Foreclosure and Loss
Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans” (the “ASF Framework”). The
ASF Framework provides guidance for servicers to streamline borrower evaluation procedures and to facilitate the use
of foreclosure and loss prevention efforts in an attempt to reduce the number of U.S. subprime residential mortgage
borrowers who might default in the coming year because the borrowers cannot afford to pay the increased interest rate
after their variable loan rate resets. The ASF Framework is focused on U.S. subprime first-lien adjustable-rate
residential mortgages that have an initial fixed interest rate period of 36 months or less, are included in securitized
pools, were originated between January 1, 2005 and July 31, 2007, and have an initial interest rate reset date between
January 1, 2008 and July 31, 2010.
The ASF Framework requires a borrower to meet specific conditions, primarily related to the ability of the borrower
to meet the initial terms of the loan and obtain refinancing, to qualify for a fast track loan modification under which
the qualifying borrower’s interest rate will be kept at the existing initial rate, generally for five years following the
upcoming reset. To qualify for fast-track modification, a loan must currently be no more than 30 days delinquent and
no more than 60 days delinquent in the past 12 months, have a loan-to-value ratio greater than 97%, be subject to
payment increases greater than 10% upon reset, and be for the primary residence of the borrower.
In January 2008, the SEC’s Office of Chief Accountant (the “OCA”) issued a letter (the “OCA Letter”) addressing
accounting issues that may be raised by the ASF Framework. The OCA Letter expressed the view that if a qualifying
subprime loan is modified pursuant to the ASF Framework and that loan could legally be modified, the OCA will not
object to the continued status of the transferee as a QSPE under SFAS 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, because it would be reasonable to conclude that defaults on such
loans are “reasonably foreseeable” in the absence of any modification.
The servicer for Subprime Portfolios I and II may make loan modifications in accordance with the ASF Framework in
2008, but we do not expect any such modifications to have a material effect on the accounting for our subprime
mortgage loans subject to call options or retained interests in the securitizations of Subprime Portfolios I and II.
Furthermore, we do not expect that the ASF Framework will affect the off balance sheet treatment of the
securitizations of Subprime Portfolios I and II.
In February 2008, the FASB issued FASB Staff Position No. FAS 140-3 (“FSP FAS 140-3”), “Accounting for
Transfers of Financial Assets and Repurchase Financing Transactions.” FSP FAS 140-3 provides guidance on
accounting for a transfer of a financial asset and a repurchase financing. It presumes that an initial transfer of a
financial asset and a repurchase financing are considered part of the same arrangement (a linked transaction) unless
certain criteria are met. If the criteria are not met, the linked transaction would be recorded as a net investment, likely
as a derivative, instead of recording the purchased financial asset on a gross basis along with a repurchase financing.
FSP FAS 140-3 applies to reporting periods beginning after November 15, 2008 and is only applied prospectively to
transactions that occur on or after the adoption date. As a result of the prospective nature of the adoption, we do not
expect the adoption of FSP FAS 140-3 to have a material impact on our financial condition, liquidity or results of
operations, unless we enter into transactions of this type after January 1, 2009.
37
Results of Operations
We raised a significant amount of capital in offerings in each of these years, resulting in additional capital being
deployed to our investments which, in turn, caused changes to our results of operations.
The following table summarizes the changes in our results of operations from year-to-year (dollars in thousands):
Year-to-Year
Increase (Decrease)
Year-to-Year
Percent Change
Explanation
2007/2006
2006/2005
2007/2006
2006/2005
2007/2006
2006/2005
Interest income
Rental income
Gain on sale of investments
Other income (loss)
Interest expense
Loss on extinguishment of debt
Property operating expense
Loan and security servicing expense
Provision for credit losses
Provision for losses, loans held for sale
Other-than-temporary impairment
General and administrative expense
Management fee to affiliate
Incentive compensation to affiliate
Depreciation and amortization
Equity in earnings of
unconsolidated subsidiaries, net
Income from continuing operations
$
150,545
1,812
1,058
$
181,490
(1,786)
(7,307)
28.4%
37.3%
8.1%
(18,625)
102,719
14,374
1,709
2,775
956
3,198
(202,602)
1,095
3,627
(6,036)
327
2,657
(344.8%)
147,823
658
1,442
951
1,017
4,127
-
787
693
4,618
444
27.4%
2184.5%
44.9%
40.0%
10.1%
77.5%
N/A
22.1%
25.9%
(49.3%)
30.1%
(578)
(193,134)
$
359
12,853
$
(9.7%)
(151.2%)
52.1%
(26.9%)
(36.0%)
96.8%
65.3%
N/A
61.0%
15.9%
12.1%
N/A
N/A
18.9%
5.2%
60.5%
69.3%
6.4%
11.2%
(1)
(2)
(3)
(4)
(1)
(5)
(2)
(1)
(6)
(7)
(8)
(9)
(10)
(10)
(2)
(11)
(1)
(2)
(3)
(4)
(1)
(5)
(2)
(1)
(6)
(7)
(8)
(9)
(10)
(10)
(2)
(11)
(1) Changes in interest income and expense are primarily due to our acquisition and disposition during these
periods of interest bearing assets and related financings, as follows:
Year-to-Year Increase
Interest Income
2007/2006
Interest Expense
2007/2006
$
$
Real estate security and loan portfolios (A)
FNMA/FHLMC securities
Other real estate related loans
Subprime mortgage loan portfolios
Credit facility and junior subordinated notes
Residential mortgage loan portfolios
Other real estate related loans (B)
$
$
(A) Represents our CBO financings and the acquisition of the related collateral in the respective years.
(B) These loans received paydowns during the period which served to offset the amounts listed above.
Year-to-Year Increase
Interest Income
2006/2005
Interest Expense
2006/2005
$
$
76,231
21,441
18,104
33,064
-
8,799
(7,094)
150,545
68,911
25,738
42,899
41,478
-
17,323
9,375
(6,934)
(17,300)
181,490
53,497
20,354
5,293
21,446
(1,556)
5,306
(1,621)
102,719
52,174
24,695
15,342
29,671
11,305
11,313
16,908
(4,557)
(9,028)
147,823
Real estate security and loan portfolios (A)
FNMA/FHLMC securities
Other real estate related loans
Subprime mortgage loan portfolios
Credit facility and junior subordinated notes
Manufactured housing loan portfolios (B)
Other (C)
Residential mortgage loan portfolios (D)
Other real estate related loans (D)
$
$
(A) Represents our CBO financings and the acquisition of the related collateral in the respective years.
(B) Primarily due to the acquisition of a manufactured housing loan pool in the third quarter of 2006.
(C) Primarily due to increasing interest rates on floating rate assets and liabilities owned during the period.
(D) These loans received paydowns during the period which served to offset the amounts listed above.
Changes in loan and security servicing expenses are also primarily due to these acquisitions and paydowns.
(2) These changes are primarily the result of the effect of the termination of a lease (including the acceleration of
lease termination income), the inception of new leases (including the associated free rent period), foreign
currency fluctuations and the acquisition of a $12.2 million portfolio of properties through foreclosure in the first
quarter of 2006.
38
(3) These changes are primarily a result of the volume of sales of real estate securities. Sales of real estate securities
are based on a number of factors including credit, asset type and industry and can be expected to increase or
decrease from time to time. Periodic fluctuations in the volume of sales of securities is dependent upon, among
other things, management's assessment of credit risk, asset concentration, portfolio balance and other factors,
including the amount of unrealized gains available to be realized.
(4) This change is primarily related to changes in the fair value of total rate of return swaps, which we treat as non-
hedge derivatives and mark to market through the income statement, and in the ineffectiveness of derivatives
designated as hedges. In addition, we recorded gains of $5.8 million and $5.5 million during 2007 and 2006,
respectively, on derivatives used to hedge the interim financing of subprime mortgage loans held for sale, which
were offset by the losses described in (7) below.
(5) This change is due to the repayment of the debt related to the ABCP facility and the redemption of securities
issued in three prior CBOs with face amounts totaling $1.4 billion, resulting in $4.7 million of cash costs,
representing early termination payments, and $10.3 million of non-cash charges related to the write-off of
deferred financing fees and expenses.
(6) These increases are primarily due to the acquisition of a manufactured housing loan pool at a discount for credit
quality in 2006.
(7) This change results from the unrealized losses on the two pools of subprime mortgage loans which were
considered held for sale as of June 30, 2007 and March 31, 2006, respectively, and two real estate loans that were
considered held for sale at December 31, 2007. The losses recorded for the pools of subprime mortgage loans
were related to changes in market interest rates and were offset by the gains described in (4) above.
(8) This change is due to other-than-temporary impairment recorded in 2007, primarily related to subprime securities.
(9) The changes in general and administrative expense are primarily increases as a result of increased market data
services, professional fees and excise tax recorded in 2007.
(10) The increases in management fees are a result of our increased size resulting from our equity issuances during
these periods. The changes in incentive compensation are primarily a result of our increased earnings, offset by
impairment charges recorded during 2007.
(11) These changes are primarily the result of a decrease in earnings from an unconsolidated subsidiary which owns
franchise loans, offset by the gain from the sale of certain franchise loans. During the periods presented, our
investment in this unconsolidated subsidiary decreased due to return of capital distributions which resulted in a
corresponding reduction in earnings. The change from 2005 to 2006 was the result of a small improvement in
operating performance.
Liquidity and Capital Resources
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. Our primary
sources of funds for liquidity consist of net cash provided by operating activities, borrowings under loans, and the
issuance of debt and equity securities when advisable. Additional sources of liquidity include investments that are
readily saleable prior to their maturity. Our debt obligations are generally secured directly by our investment assets.
As described below under Debt Obligations, in February 2008, we elected to terminate our credit facility. As of the
date of this Annual Report on Form 10-K, following the termination of our credit facility, management believes that
its cash on hand, when combined with its cash flow provided by operations, and proceeds from the repayment or sale
of investments and borrowings, is sufficient to satisfy its anticipated liquidity needs with respect to its current
investment portfolio. However, we may need to seek additional capital in order to grow our investment
portfolio. During 2007, we had an effective shelf registration statement with the SEC, which allowed us to issue an
unspecified amount of various types of securities, such as common tock, preferred stock, depository shares, debt
securities and warrants from time to time. This shelf registration statement has since become ineffective, and we do
not currently have an effective shelf registration statement on file with the SEC. As a result, we will need to file a new
registration statement with the SEC and have it deemed effective before we will be able to raise debt or equity capital
through public offerings in the future, and this process may take time to complete.
We expect to meet our long term liquidity requirements, specifically the repayment of our debt obligations, through
additional borrowings and the liquidation or refinancing of our assets at maturity. In this regard, we had
unencumbered assets with a carrying value of approximately $202.3 million at February 25, 2008, excluding
unrestricted cash of $120.0 million. We believe that the value of these assets is, and will continue to be, sufficient to
repay our debt at maturity under either scenario. Our ability to meet our long term liquidity requirements relating to
capital required for the growth of our investment portfolio is subject to obtaining additional equity and debt financing.
Decisions by investors and lenders to enter into such 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 arrangements,
39
industry and market trends, the availability of capital and our investors’ and lenders’ policies and rates applicable
thereto, and the relative attractiveness of alternative investment or lending opportunities. 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.
Our ability to execute our business strategy, particularly the growth of our investment portfolio, depends to a
significant degree on our ability to obtain additional capital. Our core business strategy is dependent upon our ability
to finance our real estate securities and loans and other real estate related assets with match funded debt at rates that
provide a positive net spread. Currently spreads for such liabilities have widened and demand for such liabilities has
become extremely limited, therefore restricting our ability to execute future financings. During 2007, this restriction
was exacerbated by our having to post approximately $135 million of cash to satisfy margin requirements, thereby
decreasing our cash available for investment activity.
At December 31, 2007, we had an unrestricted cash balance of $55.9 million of which $28.7 million of cash was
available to invest. As of February 25, 2008, we had $120.0 million of cash available to invest. In addition, we also
had $960.2 million available under various term financing facilities for certain investment categories. Our cash flow
provided by operations differs from our net income 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 interest rate cap premiums, and deferred hedge gains and losses, (ii)
gains and losses from sales of assets financed with CBOs, (iii) depreciation and straight-lined rental income of our
operating real estate, (iv) the provision for credit losses recorded in connection with our loan assets, as well as other-
than-temporary impairment on our securities, (v) unrealized gains or losses on our non-hedge derivatives, particularly
our total rate of return swaps, and (vi) the non-cash charges associated with our early extinguishment of debt.
Proceeds from the sale of assets which serve as collateral for our CBO financings, including gains thereon, are
required to be retained in the CBO structure until the related bonds are retired and are therefore not available to fund
current cash needs outside of these structures. We had $48.5 million and $75.0 million of restricted cash held in CBO
financing structures pending its investment in real estate securities and loans as of December 31, 2007 and February
25, 2008, respectively.
Our match funded investments are financed long term and their credit status is continuously monitored. Therefore,
these investments are expected to generate a generally stable current return, subject to limited interest rate
fluctuations. See "Quantitative and Qualitative Disclosures About Market Risk — Interest Rate Exposure'' below.
Our remaining investments, generally financed with short term repurchase agreements, are also subject to refinancing
risk upon the maturity of the related debt. See “Debt Obligations” below.
With respect to our operating real estate, we expect to incur expenditures of approximately $1.6 million relating to
tenant improvements in connection with the inception of leases and capital expenditures during the year ending
December 31, 2008.
With respect to one of our real estate related loans, we were committed to fund up to an additional $90.0 million at
February 28, 2008, subject to certain conditions to be met by the borrowers.
As described below, under “– Interest Rate, Credit and Spread Risk,” we are subject to margin calls in connection
with our assets financed with repurchase agreements or total rate of return swaps.
See “– Market Considerations” above for a further discussion of recent trends and events affecting our liquidity.
40
Debt Obligations
The following table presents certain information regarding our debt obligations and related hedges as of December 31, 2007 (unaudited) (dollars in thousands):
Debt Obligation/Collateral
CBO Bonds Payable (13)
Portfolio I (4)
Portfolio V
Portfolio VI
Portfolio VII
Portfolio VIII
Portfolio IX
Portfolio X
Portfolio XI
Other Bonds Payable
ICH loans
Manufactured housing loans
Manufactured housing loans
Repurchase Agreements (5) (6)
Other real estate securities (12)
Real estate related loans
Residential mortgage loans
FNMA/FHLMC securities (7)
Month
Issued
Outstanding
Face
Amount
Carrying
Value
Unhedged
Weighted
Average
Funding Cost (1)
Final Stated
Maturity
Weighted
Average
Funding
Cost (2)
Weighted
Average
Maturity
(Years)
Face
Amount
of Floating
Rate Debt
Collateral
Amortized
Cost Basis (3)
Collateral
Carrying Value
(14)
Collateral
Weighted
Average
Maturity
(Years)
Face
Amount
of Floating
Rate Collateral
(3)
Aggregate
Notional
Amount of
Current Hedges
Jul 1999
Mar 2004
Sep 2004
Apr 2005
Dec 2005
Nov 2006
May 2007
Jul 2007
Aug 1998
Jan 2006
Aug 2006
Rolling
Rolling
Rolling
Rolling
$
331,228
414,000
454,500
447,000
442,800
807,500
585,750
1,247,750
4,730,528
$
329,229
411,527
451,651
443,392
439,276
806,927
587,214
1,247,319
4,716,535
5.83%
5.18%
5.14%
4.93%
4.98%
5.08%
4.99%
4.92%
Jul 2038
Mar 2039
Sep 2039
Apr 2040
Dec 2050
Nov 2052
May 2052
Jul 2052
66,173
184,817
298,313
549,303
106,026
240,724
81,523
6.89%
Aug 2030
LIBOR +1.25% Jan 2009
LIBOR +1.25% Aug 2011
66,173
184,117
296,508
546,798
106,026
240,724
81,523
Jan 2008
LIBOR+1.26%
LIBOR+0.74% Various (9)
Jan 2008
LIBOR+0.60%
428,273
1,206,089
1,634,362
428,273
1,206,089
1,634,362
100,100
100,100
100,100
100,100
7,014,293
6,997,795
LIBOR+0.01% Various (8)
7.57% (10)
Apr 2036
6.42%
5.05%
5.15%
5.20%
5.42%
5.33%
5.24%
5.40%
5.37%
6.89%
6.10%
7.02%
6.69%
5.86%
5.38%
5.20%
5.46%
4.83%
5.00%
7.71%
7.71%
5.42%
1.3
4.6
5.2
6.2
7.5
6.1
5.8
7.1
5.9
0.2
1.0
2.7
1.8
0.1
0.8
0.1
0.5
0.2
0.3
$
236,228
382,750
442,500
439,600
436,800
799,900
585,750
1,247,750
4,571,278
$
460,821
448,960
500,178
472,400
495,845
791,453
807,634
1,331,271
5,308,562
$
463,973
404,553
439,054
398,497
396,751
757,868
800,351
1,229,206
4,890,253
-
184,817
298,313
483,130
106,026
240,724
81,523
84,417
204,781
325,194
614,392
22,970
311,134
104,630
84,417
204,781
325,194
614,392
22,970
311,134
104,630
428,273
1,206,089
1,634,362
438,734
1,235,942
1,674,676
438,734
1,246,265
1,684,999
28.3
28.3
-
-
-
-
-
-
3.1
4.5
4.8
5.5
6.9
3.8
2.8
5.2
4.5
0.3
6.5
5.7
5.3
3.1
1.4
2.8
1.9
3.3
2.9
-
-
-
$
202,039
230,380
195,383
121,185
592,207
609,360
310,842
2,261,396
-
$
177,300
208,960
242,620
341,506
161,655
91,979
1,003,394
2,227,414
-
3,482
56,531
60,013
68,807
311,219
102,431
482,457
-
482,457
-
-
-
172,897
295,771
468,668
-
-
-
-
405,654
405,654
-
-
4.6
$
6,688,770
$
7,597,630
$
7,189,644
4.3
$
2,803,866
$
3,101,736
Corporate
Junior subordinated notes payable
Mar 2006
Subtotal debt obligations
Financing on subprime mortgage
loans subject to future call option (11)
Total debt obligations
(11)
406,217
7,420,510
$
393,899
7,391,694
$
(1) Weighted average, including floating and fixed rate classes and excluding the amortization of deferred financing costs.
(2) Including the effect of applicable hedges.
(3) Including restricted cash held in CBOs.
(4) The notional amount of current hedges excludes a swap with a notional amount of $229.9 million which was de-designated as an accounting hedge at December 31, 2007.
(5) Subject to potential mandatory prepayments based on collateral value.
(6) The counterparties on our repurchase agreements include: Bear Stearns ($628.1 million), Lehman Brothers ($485.7 million), JP Morgan ($280.8 million), Deutsche Bank ($137.0 million), Credit Suisse ($62.8 million) and other ($40.0 million).
(7) Aggregate notional amount of current hedges excludes swaps with an aggregate notional amount of $508.2 million which were de-designated as accounting hedges at December 31, 2007.
(8) The longest maturity is April 2008.
(9) The longest maturity is May 2010.
(10) LIBOR + 2.25% after April 2016.
(11) Issued in April 2006 and July 2007. See “– Liquidity and Capital Resources” below regarding the securitizations of Subprime Portfolios I and II.
(12) Debt carrying value exceeds collateral amortized cost basis due to $98.0 million of repurchase agreements secured by investments in Newcastle’s CBO bonds, which are eliminated in consolidation.
(13) See “– Liquidity and Capital Resources” below regarding the collateral composition.
(14) Collateral carrying value represents the aggregate of fair value for real estate securities and amortized cost basis for loans in accordance to GAAP, and restricted cash held in CBOs.
41
Our debt obligations existing at December 31, 2007 (gross of $28.8 million of discounts) have contractual maturities
as follows (unaudited) (in thousands):
2008
2009
2010
2011
2012
Thereafter
Total
$
1,634,362
184,817
-
298,313
-
5,303,018
7,420,510
$
Certain of the debt obligations included above are obligations of our consolidated subsidiaries which own the related
collateral. In some cases, including the CBO and Other Bonds Payable, such collateral is not available to other
creditors of ours.
Our debt obligations contain various customary loan covenants. Such covenants do not, in management’s opinion,
materially restrict our investment strategy or ability to raise capital. We are in compliance with all of our loan
covenants as of December 31, 2007.
Our credit facility contained a covenant that required that we earn positive net income during each period of two
consecutive fiscal quarters. As of December 31, 2007, the facility was undrawn and we were in compliance with this
covenant. Because we had a net loss for the third quarter of 2007, if our net income for the fourth quarter did not
sufficiently offset the third quarter net loss, we would have experienced an event of default under our credit facility. If
this had occurred, we would not have been permitted to borrow under this facility, and the lender would have had the
right to terminate its commitment and to require that any amounts outstanding be paid immediately. In addition,
failure to cure an event of default would have resulted in a default under certain of our other non-CBO financing
agreements. However, the Company had the ability to cure an event of default by terminating the facility at any time.
Failure to cure an event of default would have materially negatively impacted our liquidity if we had not able to obtain
alternate sources of financing.
In February 2008, prior to the tabulation of our fourth quarter 2007 results, we terminated the credit facility. The
credit facility had been unused since July 2007 and the termination released a significant amount of collateral with
which we have generated, and intend to continue to generate, additional liquidity – through selective asset sales or
more efficient financing. As of February 25, 2008, we had $120.0 million of unrestricted cash, which we believe,
along with our other sources of liquidity, is sufficient to satisfy our anticipated liquidity needs with respect to our
current investment portfolio. At the date of termination, no amounts were outstanding under the credit facility (and we
did not incur any material costs related to the termination); at that time, previously incurred and deferred financing
costs of $0.6 million were written off. After terminating the facility, we subsequently determined that the net loss we
incurred in the fourth quarter of 2007, in connection with the recording of other-than-temporary impairment, would
have resulted in a breach of the above described covenant.
One class of CBO bonds, with an aggregate $323.0 million face amount, was issued subject to remarketing procedures
and related agreements whereby such bonds are remarketed and sold on a periodic basis. If the bonds are not
successfully remarketed and sold, the only effect on Newcastle is that the interest rate on the bonds may increase to a
maximum of LIBOR + 0.30%. As of December 31, 2007, the interest rate on these bonds was LIBOR +0.22%. As of
January 24, 2008, the interest rate on $161.5 million face amount of these bonds reset to LIBOR + 0.30% for one year.
In March 2006, we acquired a portfolio of approximately 11,300 subprime mortgage loans (“Subprime Portfolio I”)
for $1.50 billion. In April 2006, Newcastle Mortgage Securities Trust 2006-1 (“Securitization Trust 2006”) closed on
a securitization of Subprime Portfolio I. We do not consolidate Securitization Trust 2006. We sold Subprime Portfolio
I to Securitization Trust 2006. Securitization Trust 2006 issued $1.45 billion of notes. The notes have a stated maturity
of March 2036. We, as holder of the equity of Securitization Trust 2006, have the option to redeem the notes once the
aggregate principal balance of Subprime Portfolio I is equal to or less than 20% of such balance at the date of the
transfer. The transaction between us and Securitization Trust 2006 qualified as a sale for accounting purposes.
However, 20% of the loans which are subject to a call option by us were not treated as being sold. Following the
securitization, we held the following interests in Subprime Portfolio I: (i) the equity of Securitization Trust 2006, (ii)
the retained notes, and (iii) subprime mortgage loans subject to call option and related financing in the amount of
100% of such loans.
In March 2006, we completed the placement of $100.0 million of trust preferred securities through our wholly owned
subsidiary, Newcastle Trust I (the “Preferred Trust”). We own all of the common stock of the Preferred Trust. The
Preferred Trust used the proceeds to purchase $100.1 million of our junior subordinated notes. These notes represent
all of the Preferred Trust’s assets. The terms of the junior subordinated notes are substantially the same as the terms of
the trust preferred securities. The trust preferred securities may be redeemed at par beginning in April 2011. We do
not consolidate the Preferred Trust; as a result, we have reflected the obligation to the Preferred Trust under the
caption Junior Subordinated Notes Payable.
42
In March 2007, we entered into an agreement to acquire a portfolio of approximately 7,300 subprime mortgage loans
(“Subprime Portfolio II”) with up to $1.7 billion of unpaid principal balance. Following our due diligence review of
the portfolio, we funded $1.3 billion or approximately 75% of the original commitment. The agreement between the
seller and us required the seller to repurchase any delinquent loans for three months following our acquisition. In July
2007, Newcastle Mortgage Securities Trust 2007-1 ( “Securitization Trust 2007”) closed on a securitization of
Subprime Portfolio II. As a result of the repurchase of delinquent loans by the seller, as well as borrower repayments,
the unpaid principal balance of the portfolio upon securitization was $1.1 billion. We do not consolidate Securitization
Trust 2007. We sold Subprime Portfolio II to Securitization Trust 2007. Securitization Trust 2007 issued $1.0 billion
of notes. The notes have a stated maturity of April 2037. We, as holder of the equity of Securitization Trust 2007, have
the option to redeem the notes once the aggregate principal balance of Subprime Portfolio II is equal to or less than
10% of such balance at the date of the transfer. The transaction between us and Securitization Trust 2007 qualified as a
sale for accounting purposes. However, 10% of the loans which are subject to a call option by us were not treated as
being sold. Following the securitization, we held the following interests in Subprime Portfolio II: (i) the equity of
Securitization Trust 2007, (ii) the retained notes, and (iii) subprime mortgage loans subject to call option and related
financing in the amount of 100% of such loans.
We have no obligation to repurchase any loans from either of our subprime securitizations. Therefore, it is expected
that our exposure to loss is limited to the carrying amount of our 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.
In May 2007, we completed our tenth CBO financing to term finance an $825.0 million portfolio of real estate related
loans and securities. We issued, through a consolidated subsidiary, $710.5 million of investment grade notes in the
offering. At closing, the investment grade notes had an initial weighted average spread over LIBOR of 0.70% and a
weighted average life of 7 years. Approximately 82%, or $585.8 million, of the investment grade notes are rated AAA
through AA- and were sold to third parties. The remaining $124.7 million of investment grade notes, rated A+ through
BBB-, have been retained and financed. We also retained the below investment grade notes and preferred shares of the
offering.
In June 2007, we redeemed securities issued in two prior CBOs with face amounts totaling $932.0 million. At the
same time, we entered into a repurchase agreement with a major investment bank to interim finance the assets from the
two redeemed CBOs. In July 2007, we completed our eleventh CBO financing to term finance a $1.4 billion portfolio
of real estate related securities. The proceeds from the offering were used to redeem a CBO in July with a face amount
of $444.0 million of issued securities and to repay the repurchase agreement related to the redemption of the two
CDOs in June 2007. Through a consolidated subsidiary, we issued $1,288 million of investment grade notes in the
offering. At closing, the investment grade notes had an initial weighted average spread over LIBOR of 0.36% and a
remaining term to expected maturity of 10 years. Approximately 97% or $1,248 million, of the investment grade notes
were rated AAA through AA and were sold to third parties. The remaining $40.0 million of investment grade notes,
rated A, were retained by us and financed. Newcastle also retained the remaining $112.0 million of the subordinated
capital structure. We incurred $4.7 million of cash expenses on non-cash charges in connection with this
extinguishment of debt. In connection with this transaction, we sold $178.2 million face amount of assets. As a result,
a portion of the costs incurred was offset by the gain on sale from these assets.
In August through October of 2007, we refinanced approximately $1.3 billion of debt subject to the asset backed
commercial paper (ABCP) facility with repurchase agreements, having one to six month maturities with major
investment banks. As a result, we recorded a non-cash expense of $3.5 million related to the write-off of deferred
financing costs and other hedge related items.
In January 2008, we repurchased $16.0 million face amount of a class of CBO bond for $6.7 million. As a result,
$16.0 million face amount of CBO debt was extinguished.
In January and February 2008, we sold face amounts of approximately $762.5 million of FNMA/FHLMC securities
and $501.5 million of non-FNMA/FHLMC securities. Newcastle received paydowns totaling $11.6 million on these
assets in 2008 until the assets were sold. Concurrent with the sales, we terminated the related interest rate swap and
interest rate cap agreements which were de-designated as hedges for accounting purposes at December 31, 2007. As a
result, a portion of the gain on sale from these assets was offset by the loss on the termination of the derivatives.
In January and February 2008, we repaid $758.8 million of repurchase agreements.
In February 2008, we repaid in full the debt associated with our first CBO in the amount of $331.2 million.
As of February 25, 2008, we had $120.0 million of unrestricted cash and $75.0 million of restricted cash held in CBO
financing structures.
43
As of February 25, 2008 we have the following term financing, in the form of repurchase agreements,
available to draw upon with respect to certain investment categories (dollars in millions):
Month Entered
Maximum Available
Feb 2007
Apr 2007
May 2007
$
400.0
400.0
400.0
Drawn
$
62.8
128.9
40.0
Available
$
337.2
271.1
360.0
Maturity
Rolling one year, maximum Feb 2010
Rolling one year
One year, with an option to extend for two additional years for
assets being financed at the time of extension
$
1,200.0
$
231.7
$
968.3
The following table compares the face amount of our liabilities as of December 31, 2007 adjusted for sales through
February 25, 2008 (dollars in millions):
Recourse Financings
Real Estate Securities and Loans (1)
FNMA/FHLMC Securities
Total Recourse Financings
Non-Recourse Financings
CBOs and Other
Total Financings
Recourse Financings as a
Percentage of Total Financings
February 25, 2008
December 31, 2007
$
471
447
918
$
601
1,206
1,807
$
4,901
5,819
$
5,280
7,087
16%
25%
(1) Recourse financings on our real estate securities and loans include off-balance sheet debt (in the form of total return swaps) of $92.8 million at
February 25, 2008 and $172.5 million at December 31, 2007.
The following table summarizes our CBO financings as of December 31, 2007 adjusted for debt repayments through
February 25, 2008 (dollars in thousands). The amounts reflect data at the CBO level which is unconsolidated and thus is
different from the GAAP balance sheet due to intercompany amounts eliminated in consolidation.
Portfolio V Portfolio VI
Portfolio VII
Portfolio VIII
Portfolio IX
Portfolio X (7)
Portfolio XI
Total /
Weighted
Average
Balance Sheet:
Asset Face Amount
$
452,000
$
501,033
$
500,333
$
528,927
$
953,556
$
830,060
$
1,422,028
$
5,187,937
Asset Amortized Cost Basis
Debt Carrying Value
Invested Equity
Collateral Composition (1):
CMBS
REIT Debt
ABS
Bank Loans
Mezzanine Loans
B-Notes
Whole Loans
CDO
Restricted Cash
Total
$
448,960
411,527
37,433
$
$
500,178
451,651
48,527
$
$
$
472,400
443,392
29,008
$
$
495,845
459,276
36,569
$
$
866,610
806,927
59,683
$
$
821,422
637,214
184,208
$
$
$
$
$
$
257,332
87,085
72,541
7,500
-
19,980
-
-
7,562
452,000
305,610
85,904
106,609
-
-
-
-
-
2,910
501,033
325,733
45,000
100,954
20,000
-
-
-
-
8,646
500,333
354,706
70,000
94,468
9,500
-
-
-
-
253
528,927
195,912
61,000
94,124
170,627
255,500
74,989
25,000
76,000
404
953,556
$
$
$
$
$
$
115,250
-
-
194,339
266,673
170,066
59,881
14,250
9,601
830,060
$
1,371,771
1,286,264
85,507
$
$
751,004
336,370
216,604
62,950
-
-
-
36,000
19,100
1,422,028
$
CBO Overview:
Sep-04
Effective Date
Reinvestment Period Ends (2) Mar-09
Jun-07
Optional Call Date (3)
Mar-14
Auction Call Date (4)
Feb-05
Sep-09
Dec-07
Sep-14
Aug-05
Apr-10
May-08
Apr-15
Avg Debt Spread (bps)
53
45
33
Jan-06
Dec-10
Jan-09
Dec-15
38
Mar-07
Nov-11
Dec-09
Nov-16
48
Jul-07
May-12
Jun-10
May-17
39
Dec-07
Jul-12
Aug-10
Jul-17
32
CBO Cashflow Triggers (5) (6):
Over Collateralization
Effective Date
Current
Trigger
Interest Coverage
Current
Trigger
109.4%
108.6%
105.9%
132.7%
106.0%
110.0%
110.2%
107.5%
128.2%
106.0%
113.4%
114.3%
110.9%
123.2%
106.0%
113.2%
111.9%
108.7%
142.8%
106.0%
116.1%
116.8%
108.0%
158.7%
103.0%
109.8%
109.8%
101.5%
117.3%
107.0%
111.9%
111.9%
109.3%
125.0%
106.0%
44
$
4,977,186
4,496,251
480,935
$
$ 2,305,547
685,359
685,300
464,916
522,173
265,035
84,881
126,250
48,476
$
5,187,937
40
112.0%
111.9%
106.5%
132.4%
105.8%
(1) Collateral represents face amounts and includes Newcastle issued CDO bonds of $108.9 million and other bonds of $3 million.
(2) Our CBO 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 payment of the collateral are reinvested. Given
the current market condition where credit spreads are widening, these proceeds may be potentially reinvested at credit spreads higher than initially
invested. In the fourth quarter 2007, we estimated CBO principal payments of $64 million and received actual CBO principal payments of $155
million. For 2008, we currently estimate CBO principal payments of between $200 million and $400 million. This estimate is based on a variety
factors, including historical prepayment experience, market data for future payments and other factors, which are beyond our control. Further, this
calculation varies by asset class. Accordingly, actual results may differ materially from the estimated range provided.
(3) At the option call date, Newcastle, as the equity holder, has the right to payoff the CBO bonds at their related redemption price. The funds needed to
pay the debt could be raised either through a sale or refinancing of the collateral.
(4) At the auction call date, there is a mandatory auction of the assets. If the prices are sufficient to pay off the outstanding CBO bonds, the assets will be
sold and the CBO bonds will be redeemed.
(5) Data as of the December 2007 remittance date and may have changed subsequent to that date.
(6) Each of our CBO financings contains tests which measure the amount of over collateralization and excess interest in the transaction. Failure to satisfy
these tests would result in 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.
(7) $74.8 million face amount of the bonds issued in Portfolio X are financed with repurchase agreements. Refer to "Debt Obligations" above.
Other
We have entered into total rate of return swaps with major investment banks to finance certain loans whereby we receive
the sum of all interest, fees and any positive change in value amounts (the total return cash flows) from a reference asset
with a specified notional amount, and pay interest on such notional plus any negative change in value amounts from such
asset. These agreements are recorded in Derivative Assets or Liabilities (as applicable) and treated as non-hedge
derivatives for accounting purposes and are therefore marked to market through income. Net interest received is recorded
to Interest Income and the mark to market is recorded to Other Income. If we owned the reference assets directly, they
would not be marked to market through income. Under the agreements, we are required to post an initial margin deposit to
an interest bearing account and additional margin may be payable in the event of a decline in value of the reference asset.
Any margin on deposit, less any negative change in value amounts, will be returned to us upon termination of the contract.
As of December 31, 2007 we held an aggregate of $252.7 million notional amount of total rate of return swaps on 8
reference assets, including an unfunded asset with a notional amount of $38.1 million, on which we had deposited $43.9
million of margin. These total rate of return swaps had an aggregate fair value of approximately ($8.8 million), a weighted
average receive interest rate of LIBOR +2.77%, a weighted average pay interest rate of LIBOR +0.59%, and a weighted
average swap maturity of 0.5 years.
Stockholders’ Equity
Common Stock
The following table presents information on shares of our common stock issued since our formation.
Year
Shares
Issued
Range of Issue
Prices per Share (1)
Net Proceeds
(millions)
Options Granted
to Manager
16,488,517
Formation
7,000,000
2002
7,886,316
2003
8,484,648
2004
4,053,928
2005
1,800,408
2006
2007
7,065,362
December 31, 2007 52,779,179
N/A
$13.00
$20.35-$22.85
$26.30-$31.40
$29.60
$29.42
$27.75-$31.30
N/A
$80.0
$163.4
$224.3
$108.2
$51.2
$201.3
N/A
700,000
788,227
837,500
330,000
170,000
698,000
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our
independent directors.
Through December 31, 2007, our manager had assigned, for no value, options to purchase approximately 1.4 million
shares of our common stock to certain of our manager’s employees, of which approximately 0.4 million had been
exercised. In addition, our manager had exercised 0.7 million of its options.
45
As of December 31, 2007, our outstanding options had a weighted average strike price of $27.04 and were summarized as
follows:
Held by our manager
Issued to our manager and subsequently assigned
to certain of our manager's employees
Held by directors and former directors
Total
1,457,222
1,027,387
14,000
2,498,609
Preferred Stock
In March 2003, we issued 2.5 million shares ($62.5 million face amount), of 9.75% Series B Cumulative Redeemable
Preferred Stock (the “Series B Preferred”). In October 2005, we issued 1.6 million shares ($40.0 million face amount) of
8.05% Series C Cumulative Redeemable Preferred Stock (the “Series C Preferred”). In March 2007, we issued 2.0 million
shares ($50.0 million face amount) of 8.375% Series D Cumulative Redeemable Preferred Stock (the “Series D Preferred).
The Series B Preferred, Series C Preferred and Series D Preferred have a $25 liquidation preference, no maturity date and
no mandatory redemption. We have the option to redeem the Series B Preferred beginning in March 2008, the Series C
Preferred beginning in October 2010 and the Series D Preferred beginning in March 2012. If the Series C Preferred and
Series D Preferred cease to be listed on the NYSE or the AMEX, or quoted on the NASDAQ, and we are not subject to the
reporting requirements of the Exchange Act, we have the option to redeem the Series C Preferred or Series D Preferred, as
applicable, at their face amount and, during such time any shares of Series C Preferred or Series D Preferred are
outstanding, the dividend will increase to 9.05% or 9.375% per annum, respectively.
Other Comprehensive Income
During the year ended December 31, 2007, our accumulated other comprehensive income changed due to the following
factors (in thousands):
Accumulated other comprehensive income, December 31, 2006
Net unrealized (loss) on securities
Reclassification of net realized (gain) on securities into earnings
Foreign currency translation
Net unrealized (loss) on derivatives designated as cash flow hedges
Reclassification of net realized loss on derivatives designated as cash
flow hedges into earnings
Accumulated other comprehensive (loss), December 31, 2007
$ 75,984
(429,897)
(20,830)
3,019
(133,004)
2,212
$
(502,516)
Our book equity changes as our real estate securities portfolio and derivatives are marked to market each quarter, among
other factors. The primary causes of mark to market changes are changes in interest rates and credit spreads. During the
year, sharply widening credit spreads and decreasing interest rates have resulted in a net decrease in unrealized gains on
our real estate securities and derivatives, resulting in net unrealized losses. While such an environment resulted in a
decrease in the fair value of our existing securities portfolio and, therefore, reduced our book equity and ability to realize
gains on such existing securities, it did not directly affect our current cash flow or our ability to pay dividends.
See “– Market Considerations” above for a further discussion of recent trends and events affecting our unrealized gains
and losses as well as our liquidity.
Common Dividends Paid
Declared for the Period Ended
March 31, 2005
June 30, 2005
September 30, 2005
December 31, 2005
March 31, 2006
June 30, 2006
September 30, 2006
December 31, 2006
March 31, 2007
June 30, 2007
September 30, 2007
December 31, 2007
Paid
April 2005
July 2005
October 2005
January 2006
April 2006
July 2006
October 2006
January 2007
April 2007
July 2007
October 2007
January 2008
46
Amount Per Share
$0.625
$0.625
$0.625
$0.625
$0.625
$0.650
$0.650
$0.690
$0.690
$0.720
$0.720
$0.720
Cash Flow
Net cash flow provided by (used in) operating activities decreased from $16.3 million for the year ended December 31,
2006 to ($6.5) million for the year ended December 31, 2007. It decreased from $98.8 million for the year ended
December 31, 2005 to $16.3 million for the year ended December 31, 2006. These changes primarily resulted from the
acquisition and settlement of our investments as described above. The decreases in operating cash in 2007 and 2006 are
primarily the result of the purchase of loans held for sale through securitizations, which is classified as an operating
activity although the net cash out flows relating to the securitizations represent an investment in the securitization vehicles.
Investing activities provided (used) $34.0 million, ($2.0) billion and ($1.3) billion during the years ended December 31,
2007, 2006 and 2005, respectively. Investing activities consisted primarily of the investments made in real estate
securities and loans, net of proceeds from the sale or settlement of investments.
Financing activities provided $23.1 million, $1.9 billion and $1.2 billion during the years ended December 31, 2007, 2006
and 2005, respectively. The equity issuances, borrowings and debt issuances described above served as the primary
sources of cash flow from financing activities. Offsetting uses included the payment of related deferred financing costs,
the purchase of hedging instruments, the payment of dividends, and the repayment of debt as described above.
See the consolidated statements of cash flows in our consolidated financial statements included in “Financial Statements
and Supplementary Data” for a reconciliation of our cash position for the periods described herein.
Interest Rate, Credit and Spread Risk
We are subject to interest rate, credit and spread risk with respect to our investments.
Interest Rate Risk
Changes in interest rates, including changes in expected interest rates or “yield curves,” affect our investments in two
distinct ways, each of which is discussed below.
First, changes in interest rates affect our net interest income, which is the difference between the interest income earned on
assets and the interest expense incurred in connection with our debt obligations and hedges.
Our general financing strategy focuses on the use of match funded structures. This means that we seek to match the
maturities of our debt obligations with the maturities of our assets to minimize the risk that we have to refinance our
liabilities prior to the maturities of our assets, and to reduce the impact of changing interest rates on our earnings. In
addition, we generally match fund interest rates on our assets with like-kind debt (i.e., fixed rate assets are financed with
fixed rate debt and floating rate assets are financed with floating rate debt), directly or through the use of interest rate
swaps, caps or other financial instruments, or through a combination of these strategies, which also allows us to reduce the
impact of changing interest rates on our earnings.
However, increases in interest rates can nonetheless reduce our net interest income to the extent that we are not completely
match funded. Furthermore, a period of rising interest rates can negatively impact our return on certain floating rate
investments. Although these investments may be financed with floating rate debt, the interest rate on the debt may reset
prior to, or more frequently than, the interest rate on the assets, causing a decrease in return on equity during a period of
rising interest rates.
Second, changes in the level of interest rates also affect the yields required by the marketplace on debt. Increasing interest
rates would reduce the value of the fixed rate assets we hold at the time because higher required yields result in lower
prices on existing fixed rate assets in order to adjust their yield upward to meet the market.
We generally have the intent and ability to hold our assets until maturity. Such assets are considered available for sale and
may be sold prior to maturity on an opportunistic basis or for other reasons.
Changes in unrealized gains or losses resulting from changes in market interest rates do not directly affect our cash flows,
or our ability to pay a dividend, as the related assets are expected to be held and their fair value is not relevant to their
underlying cash flows. Our assets are largely financed to maturity through long term CBO financings that are not
redeemable as a result of book value changes. As long as these fixed rate assets continue to perform as expected, our cash
flows from these assets would not be affected by increasing interest rates. Changes in unrealized gains or losses would
impact our ability to realize gains on existing investments if they were sold. Furthermore, with respect to changes in
unrealized gains or losses on investments which are carried at fair value, changes in unrealized gains or losses would
impact our net book value and, in the case of non-hedge derivatives, our net income.
Changes in the value of our assets could affect our ability to borrow and access capital. Also, if the value of our assets
subject to repurchase agreements were to decline, it could cause us to fund margin and affect our ability to refinance such
assets upon the maturity of the related repurchase agreements, adversely impacting our rate of return on such securities.
47
Credit Risk
Credit risk refers to the ability of each individual borrower under our loans and securities to make required interest and
principal payments on the scheduled due dates. The commercial mortgage and asset backed securities we invest in are
generally junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of
one or more subordinate classes of securities or other form of credit support (which absorbs losses before the securities in
which we invest) within a securitization transaction. The senior unsecured REIT debt securities we invest in reflect
comparable credit risk. We also invest in loans and securities which represent “first loss” pieces; in other words, they do
not benefit from credit support although we believe they predominantly benefit from underlying collateral value well in
excess of their carrying amounts.
We believe, based on our due diligence process, that these assets offer attractive risk-adjusted returns with long term
principal protection under a variety of default and loss scenarios. We further minimize credit risk by actively monitoring
our asset portfolio and the underlying credit quality of our holdings and, where appropriate, repositioning our investments
to upgrade their credit quality. In the event of a significant rising interest rate environment and/or economic downturn,
loan and collateral defaults may increase and result in credit losses that would adversely affect our liquidity and operating
results. As described above in “- Market Considerations” and elsewhere in this quarterly report, adverse market and credit
conditions have resulted in our recording of other-than-temporary impairment in certain securities, predominantly
subprime securities.
Spread Risk
Credit spreads measure the yield demanded on loans and securities by the market based on their credit relative to U.S.
Treasuries, for fixed rate credit, or LIBOR, for floating rate credit. Our fixed rate loans and securities are valued based on
a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. Our floating rate loans and
securities are valued based on a market credit spread over LIBOR. Excessive supply of such loans and securities combined
with reduced demand will generally cause the market to require a higher yield on such loans and securities, resulting in the
use of a higher (or “wider”) spread over the benchmark rate to value them.
Changes in credit spreads affect our investments in two distinct ways, each of which is discussed below.
First, widening credit spreads would result in higher yields being required by the marketplace on loans and securities. This
widening would reduce the value of the loans and securities we hold at the time because higher required yields result in
lower prices on existing securities in order to adjust their yield upward to meet the market.
The effects of such a decrease in values on our financial position, results of operations and liquidity are discussed above
under “- Interest Rate Risk.”
Our financing strategy is dependent on our ability to place the match funded debt we use to finance our investments at
rates that provide a positive net spread. Currently, spreads for such liabilities have widened and demand for such liabilities
has become extremely limited, therefore restricting our ability to execute future financings.
However, a second impact of widening of credit spreads is that it would also result in increased yields on new investments
we purchase during or subsequent to the widening, thereby benefiting our ongoing investment activities, as we would earn
a higher yield on the same investment amount in comparison to the investing environment prior to such widening. As
noted, in “- Market Considerations” above, we could only take advantage of these investment opportunities if we have
sufficient liquidity and financing is available on favorable terms.
In an environment where spreads are tightening, if spreads tighten on the assets we purchase to a greater degree than they
tighten on the liabilities we issue, our net spread will be reduced.
Margin
Certain of our investments are financed through repurchase agreements or total rate of return swaps which are subject to
margin calls based on the value of such investments. Margin calls resulting from decreases in value related to rising
interest rates are substantially offset by our ability to make margin calls on our interest rate derivatives. We seek to
maintain adequate cash reserves or other sources of available financing to meet any margin calls resulting from decreases
in value related to a reasonably possible (in the opinion of management) widening of credit spreads.
For a further discussion of these risks, see “Quantitative and Qualitative Disclosures About Market Risk” below.
48
Statistics
Newcastle’s $8.3 billion investment portfolio consists primarily of commercial, residential and corporate debt. The
following describes our investment portfolio at December 31, 2007 and adjusted for assets sold through February 25, 2008
(dollars in tables in millions). It excludes subprime mortgage loans subject to call option of $406.2 million and operating
real estate of $40.4 million at December 31, 2007.
Outstanding
Face Amount
December 31, 2007
Assets Sold Through
February 25, 2008 (1)
Adjusted Face
Amount (1)
Percentage of
Adjusted Face
Amount
Number of
Investments
Credit (2)
Weighted
Average Life
(years)
Commercial
CMBS (3)
Mezzanine Loans (4)
B-Notes (4)
Whole Loans (4)
Investment in Joint Ventures
Total Commercial Assets
Residential
Manufactured Housing and
Residential Mortgage Loans
Subprime Securities (5)
Subprime Residual / Retained
Securities (6)
Real Estate ABS
Total Residential Assets
Corporate
REIT Debt
Corporate Bank Loans
Total Corporate Assets
Other Assets
FNMA/FHLMC
ICH Loans
Total Other Assets
$
2,529
823
398
115
21
3,886
$
248
3
8
25
-
284
$
2,281
820
390
90
21
3,602
645
586
145
106
1,482
921
662
1,583
1,229
85
1,314
-
-
-
-
-
254
9
263
770
-
770
645
586
145
106
1,482
667
653
1,320
459
85
544
32.9%
11.8%
5.6%
1.3%
0.3%
51.9%
9.3%
8.4%
2.1%
1.5%
21.3%
9.6%
9.4%
19.0%
6.6%
1.2%
7.8%
258
23
13
4
2
16,012
122
8
26
67
14
15
46
BBB-
68%
63%
77%
NR
696
BB+
BB+
BBB
BBB-
B
AAA
NR
TOTAL
$
8,265
$
1,317
$
6,948
100.0%
5.7
1.9
1.7
1.4
-
4.3
5.5
3.7
6.2
5.1
4.8
5.6
3.1
4.4
3.3
0.3
3.1
4.2
The loans underlying our real estate securities with face amounts of $4.2 billion were diversified by industry as follows at February 25, 2008:
Industry
Residential
Office
Retail
Subprime Residential
Lodging
Cell Tower
Health Care
Diversified
Industrial
Other
% of Adjusted
Face Amount
19.8%
17.5%
18.1%
17.2%
7.3%
6.3%
4.9%
3.3%
2.1%
3.5%
(1) Unaudited.
(2) Credit represents weighted average rating for rated assets, LTV for non-rated commercial assets, FICO score for non-rated
residential assets and implied AAA for FNMA/FHLMC securities.
49
(3) The following table summarizes our CMBS portfolio ($ in millions):
Deal Vintage
(A)
Average
Rating
Number
Pre 2004
2004
2005
2006
2007
Total
BBB+
BBB-
BB+
BBB-
BBB
BBB-
82
59
50
36
31
Adjusted Face
Amount
$
443
436
586
449
367
Percentage of
Adjusted Face
Amount
Delinquency
60+/FC/REO (B)
Weighted Average
Current Credit
Enhancement
Weighted
Average Life
19.4%
19.1%
25.7%
19.7%
16.1%
0.8%
0.1%
0.2%
0.0%
0.0%
0.2%
12.8%
5.2%
4.2%
5.4%
7.3%
6.8%
4.6
6.0
6.7
4.1
6.8
5.7
258
$
2,281
100.0%
(A) The year in which the securities were issued.
(B) The percentage of underlying loans that are 60+ days delinquent, or in foreclosure or considered real estate owned (REO).
(4) The following table summarizes the loan-to-value ratios on our mezzanine loans, B-notes and whole loan portfolio:
Adjusted Face Amount
Number
Weighted Average First $ Loan to Value
Weighted Average Last $ Loan to Value
Delinquency
Mezzanine
B-Note
Whole Loan
$
819,603
$
390,130
$
89,935
Total
1,299,668
$
23
57.0%
68.0%
0.0%
13
46.8%
63.4%
0.0%
4
12.6%
77.4%
0.0%
40
50.9%
67.3%
0.0%
(5) The following table illustrates the exposure by vintage in our subprime securities portfolio as of December 31, 2007:
Collateral Characteristics
Security Characteristics
Deal Vintage
(A)
Deal Age
(months)
Collateral
Factor (B)
Delinquency (C)
2003
2004
2005
2006
2007
Total
52
42
29
17
9
31
0.14
0.18
0.38
0.72
0.91
0.40
3 month
CRR (D)
18.9%
22.0%
27.8%
17.2%
9.4%
Cumulative Losses
to Date
2.1%
1.3%
1.3%
0.8%
0.0%
Weighted
Average
Rating
A
A-
BBB
CCC
BBB-
Number of
Securities
16
30
44
29
3
$
Adjusted Face
Amount (E)
42,066
176,018
200,752
159,497
7,750
Adjusted
GAAP Basis
$
40,236
167,263
186,605
22,303
4,384
Principal
Subordination (F)
23.0%
16.5%
14.8%
4.0%
10.3%
Excess
Spread
1.7%
2.0%
2.9%
2.6%
2.4%
10.0%
13.3%
18.8%
18.6%
9.4%
16.3%
22.3%
1.2%
BB+
122
$
586,083
$
420,791
12.9%
2.4%
(A) The year in which the securities were issued.
(B) The ratio of original unpaid principal balance of loans still outstanding.
(C) The percentage of underlying loans that are 90+ days delinquent, or in foreclosure or considered real estate owned (REO).
(D) Three month average constant voluntary prepayment rate.
(E) Excludes subprime retained securities and residual interests of $144.6 million.
(F) The percentage of the outstanding face amount of securities and residual interests that is subordinate to our investments.
(6) Represents $76.4 million and $68.2 million of face amount of retained bonds and residual interests, respectively, in
the securitizations of Subprime Portfolios I and II.
50
Off-Balance Sheet Arrangements
As of December 31, 2007, we had two material off-balance sheet arrangements. We believe that these off-balance sheet
structures presented the most efficient and least expensive form of financing for these assets at the time they were entered,
and represented the most common market-accepted method for financing such assets.
•
•
In April 2006, we securitized Subprime Portfolio I. The loans were sold to a securitization trust, of which 80% were
treated as a sale, which is an off-balance sheet financing as described in “– Liquidity and Capital Resources.”
In July 2007, we securitized Subprime Portfolio II. The loans were sold to a securitization trust, of which 90% were
treated as a sale, which is an off-balance sheet financing as described in “– Liquidity and Capital Resources.”
We have no obligation to repurchase any loans from either of our subprime securitizations. Therefore, it is expected that
our exposure to loss is limited to the carrying amount of our retained interests in the securitization entities, as described
above. A subsidiary of ours gave limited representations and warranties with respect to the second securitization; however,
it has no assets and does not have recourse to the general credit of Newcastle.
We also had the following arrangements which do not meet the definition of off-balance sheet arrangements, but do have
some of the characteristics of off-balance sheet arrangements.
• We are party to total rate of return swaps which are treated as non-hedge derivatives. For further information on these
investments, see “– Liquidity and Capital Resources.”
• We have made investments in four unconsolidated subsidiaries. See Note 3 to our consolidated financial statements in
“Financial Statements and Supplementary Data.”
In each case, our exposure to loss is limited to the carrying (fair) value of our investment, except for the total rate of return
swaps where our exposure to loss is limited to their fair value plus their notional amount.
Contractual Obligations
As of December 31, 2007, we had the following material contractual obligations (payments in thousands):
Contract
Terms
CBO bonds payable
Described under “Quantitative and Qualitative Disclosures About Market Risk”
Other bonds payable
Described under “Quantitative and Qualitative Disclosures About Market Risk”
Repurchase agreements
Described under “Quantitative and Qualitative Disclosures About Market Risk”
Credit facility
Described under “Quantitative and Qualitative Disclosures About Market Risk”
Junior subordinated notes
payable
Described under “Quantitative and Qualitative Disclosures About Market Risk”
Interest rate swaps, treated as
hedges
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Non-hedge derivative obligations
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
CBO backstop agreements
CBO remarketing agreements
In connection with the remarketing procedure described above, a backstop
agreement was created whereby a third party financial institution is required to
purchase the $323.0 million face amount of bonds at the end of any remarketing
period if such bonds could not be resold in the market by the remarketing agent.
We pay an annual fee of 0.15% of the outstanding face amount of such bonds
under this agreement.
In connection with the remarketing procedures, the remarketing agent is paid an
annual fee of 0.05% of the outstanding face amount of the bonds under the
remarketing agreements.
Subprime loan securitization
We entered into the securitization of Subprime Portfolios I and II as described
under “Liquidity and Capital Resources.”
Loan servicing agreements
We are a party to servicing agreements with respect to our residential mortgage
loans, including manufactured housing loans and subprime mortgage loans, and
our ICH loans. We pay annual fees generally equal to 0.38% of the outstanding
face amount of the residential mortgage loans, 1.00% and 0.625% of the
outstanding face amount of the two portfolios of manufactured housing loans,
respectively, and approximately 0.11% of the outstanding face amount of the
ICH loans under these agreements. We also pay an incentive fee for one of the
portfolios of manufactured housing loans if the performance of the loans meets
certain thresholds. Our subprime loans are held off balance sheet.
51
Trustee agreements
Management agreement
We have entered into trustee agreements in connection with our securitized
investments, primarily our CBOs. We pay annual fees of between 0.015% and
0.020% of the outstanding face amount of the CBO bonds under these
agreements.
Our manager is paid an annual management fee of 1.5% of our gross equity, as
defined, an expense reimbursement, and incentive compensation equal to 25%
of our FFO above a certain threshold. For more information on this agreement,
as well as historical amounts earned, see Note 10 to our audited consolidated
financial statements under Part II, Item 8, “Financial Statements and
Supplementary Data.”
Contract
CBO bonds payable
Other bonds payable
Repurchase agreements (2)
Financing of subprime mortgage loans subject
to future repurchase (3)
Junior subordinated notes payable
Interest rate swaps, treated as hedges
Non-hedge derivative obligations
CBO backstop agreements
CBO remarketing agreements
Subprime loan securitization
Loan servicing agreements
Trustee agreements
Management agreement
Total
Fixed and Determinable Payments Due by Period (1)
2008
2009-2010
2011-2012
Thereafter
Total
$
244,934
32,822
1,594,362
$
489,868
229,739
45,510
$
486,080
320,124
-
$
13,072,772
146,721
-
$
14,293,654
729,406
1,639,872
(3)
7,582
*
*
*
*
*
*
*
*
1,879,700
$
(3)
15,163
*
*
*
*
*
*
*
*
780,280
$
(3)
15,163
*
*
*
*
*
*
*
*
821,367
$
(3)
162,409
*
*
*
*
*
*
*
*
13,381,902
$
(3)
200,317
*
*
*
*
*
*
*
*
16,863,249
$
(1) Includes interest based on rates existing at December 31, 2007 and assuming no prepayments. Obligations that are repayable prior to maturity at the
option of Newcastle are reflected at their contractual maturity dates.
(2) Repurchase agreements maturing within one year of our financial statement date are included in this table assuming no interest.
(3) These obligations represent the related financing on the loans which are subject to future repurchase by Newcastle and are offset by the amount of
such loans. See Note 5 to our audited consolidated financial statements under Part II, Item 8, “Financial Statements and Supplementary Data”.
* These contracts do not have fixed and determinable payments.
Inflation
We believe that our risk of increases in market interest rates on our floating rate debt as a result of inflation is largely
offset by our use of match funding and hedging instruments as described above. See Part II, Item 7A, "Quantitative and
Qualitative Disclosure About Market Risk — Interest Rate Exposure'' below.
Funds from Operations
We believe Funds from Operations (FFO) is one appropriate measure of the operating performance of real estate
companies. We also believe that FFO is an appropriate supplemental disclosure of operating performance for a REIT due
to its widespread acceptance and use within the REIT and analyst communities. Furthermore, FFO is used to compute our
incentive compensation to our manager. FFO, for our purposes, represents net income available for common stockholders
(computed in accordance with GAAP), excluding extraordinary items, plus depreciation of our operating real estate, and
after adjustments for unconsolidated subsidiaries, if any. We consider gains and losses on resolution of our investments to
be a normal part of our recurring operations and, therefore, do not exclude such gains and losses when arriving at FFO.
Adjustments for unconsolidated subsidiaries, if any, are calculated to reflect FFO on the same basis. FFO does not
represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an
alternative to net income as an indicator of our operating performance or as an alternative to cash flow as a measure of
liquidity and is not necessarily indicative of cash available to fund cash needs. Our calculation of FFO may be different
from the calculation used by other companies and, therefore, comparability may be limited.
Funds from Operations (FFO) is calculated as follows (unaudited) (in thousands):
For the Year Ended December 31,
2006
2005
2007
Income (loss) applicable to common stockholders
Operating real estate depreciation
Accumulated depreciation on operating real estate sold
Funds from operations (FFO)
52
$
$
$
(78,097)
1,121
-
(76,976)
118,609
812
-
119,421
$
$
$
110,271
702
(6,942)
104,031
Funds from operations was derived from our segments as follows (unaudited) (in thousands):
Book Equity
December 31, 2007
Average Invested Common
Equity for the Year Ended
December 31, 2007 (2)
FFO for the Year
Ended
December 31, 2007
Real estate securities and
real estate related loans
Residential mortgage loans
Operating real estate
Unallocated (1)
Total (2)
Preferred stock
Accumulated depreciation
Accumulated other
comprehensive income (loss)
Net book equity
$
863,530
135,809
51,922
(247,620)
803,641
152,500
(6,000)
$
(502,516)
447,625
$
$
1,025,974
135,889
50,280
(262,251)
949,892
(45,944)
16,651
3,339
(51,022)
(76,976)
$
$
Return on Invested Common Equity (3)
for the Year Ended December 31,
2006
2007
2005
(4.5)%
12.3%
6.6%
N/A
(8.1)%
16.2%
19.6%
8.3%
N/A
14.9%
17.9%
9.1%
3.5%
N/A
13.4%
(1) Unallocated FFO represents ($10.2 million) of interest expense, ($12.6 million) of preferred dividends and ($28.2
million) of corporate general and administrative expense, management fees and incentive compensation.
(2) Invested common equity is equal to book equity excluding preferred stock, accumulated depreciation and accumulated
other comprehensive income.
(3) FFO divided by average invested common equity.
As a result of the effect of other-than-temporary impairment on our FFO, we expect that there will be no incentive
compensation payable to our manager for an indeterminate amount of time.
Related Party Transactions
In November 2003, we and a private investment fund managed by an affiliate of our manager co-invested and each
indirectly own an approximately 38% interest in a limited liability company that acquired a pool of franchise loans from a
third party financial institution. In December 2007, we closed on a sale of a pool of loans in the joint venture. Our
investment in this entity, reflected as an investment in an unconsolidated subsidiary on our consolidated balance sheet, was
approximately $11.0 million at December 31, 2007, of which $9.3 million represented our share of such investee’s cash
balance. The remaining approximately 24% interest in the limited liability company is owned by the above referenced
third party financial institution.
In March 2004, we and a private investment fund managed by an affiliate of our manager co-invested and each indirectly
own an approximately 49% interest in two limited liability companies that have acquired, in a sale-leaseback transaction, a
portfolio of convenience and retail gas stores from a public company. This investment was financed with nonrecourse
debt at the limited liability company level and our investment in this entity, reflected as an investment in an
unconsolidated subsidiary on our consolidated balance sheet, was approximately $13.4 million at December 31, 2007. In
March 2005, the property management agreement related to these properties was transferred to an affiliate of our manager
from a third party servicer; our allocable portion of the related fees, approximately $20,000 per year for three years, was
not changed.
In January 2005, we entered into a servicing agreement with a portfolio company of a private equity fund advised by an
affiliate of our manager for them to service a portfolio of manufactured housing loans, which was acquired at the same
time. As compensation under the servicing agreement, the portfolio company will receive, on a monthly basis, a net
servicing fee equal to 1.00% per annum on the unpaid principal balance of the loans being serviced. In January 2006, we
closed on a new term financing of this portfolio. In connection with this term financing, we renewed our servicing
agreement at the same terms. The outstanding unpaid principal balance of this portfolio was approximately $215.2 million
at December 31, 2007.
In April 2006, we securitized Subprime Portfolio I and, through Securitization Trust 2006, entered into a servicing
agreement with a subprime home equity mortgage lender (the “Subprime Servicer”) to service this portfolio. In July 2006,
private equity funds managed by an affiliate of our manager completed the acquisition of the Subprime Servicer. As
compensation under the servicing agreement, the Subprime Servicer will receive, on a monthly basis, a net servicing fee
equal to 0.50% per annum on the unpaid principal balance of the portfolio. In March 2007, we, through Securitization
Trust 2007, entered into a servicing agreement with the Subprime Servicer to service Subprime Portfolio II under
substantially the same terms. The outstanding unpaid principal balances of Subprime Portfolios I and II were
approximately $898.5 million and $1.0 billion at December 31, 2007, respectively.
53
In August 2006, we acquired a portfolio of manufactured housing loans. The loans are being serviced by a portfolio
company of a private equity fund advised by an affiliate of our manager. As compensation under the servicing agreement,
the servicer will receive, on a monthly basis, a net servicing fee equal to 0.625% per annum on the unpaid principal
balance of the portfolio plus an incentive fee if the performance of the loans meets certain thresholds. The outstanding
unpaid principal balance of this portfolio was approximately $326.9 million at December 31, 2007.
In September 2006, we were co-lenders with two private investment funds managed by an affiliate of our manager in a
new real estate related loan. The loan is secured by a first mortgage interest on a parcel of land in Arizona. We own a 20%
interest in the loan and the private investment funds own an 80% interest in the loan. Major decisions require the
unanimous approval of the holders of interests in the loan, while other decisions require the approval of a majority of
holders of interests in the loan. In October 2006, we and the private investment funds sold, on a pro-rata basis, a $125.0
million senior participation interest in the loan to an unaffiliated third party, resulting in us owning a 20% interest in the
junior participation interest in the loan. Our investment in this loan was approximately $30.0 million at December 31,
2007.
As of December 31, 2007, we held on our balance sheet total investments of $225.3 million face amount of real estate
securities and related loans issued by affiliates of our manager, and $125.2 million face amount of real estate loans issued
by affiliates of our manager financed under total rate of return swaps, and earned approximately $20.1 million, $18.5
million and $13.7 million of interest on such investments for the years ended December 31, 2007, 2006 and 2005,
respectively.
In each instance described above, affiliates of our manager have an investment in the applicable affiliated fund and receive
from the fund, in addition to management fees, incentive compensation if the fund’s aggregate investment returns exceed
certain thresholds.
54
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market risk is the exposure to loss resulting from changes in interest rates, credit spreads, foreign currency exchange
rates, commodity prices and equity prices. The primary market risks that we are exposed to are interest rate risk and
credit spread risk. These risks are highly sensitive to many factors, including governmental monetary and tax policies,
domestic and international economic and political considerations and other factors beyond our control. All of our
market risk sensitive assets, liabilities and derivative positions are for non-trading purposes only. For a further
understanding of how market risk may effect our financial position or operating results, please refer to
“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Application of Critical
Accounting Policies” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations
– Interest Rate, Credit and Spread Risk.”
Interest Rate Exposure
Changes in interest rates, including changes in expected interest rates or “yield curves,” affect our investments in two
distinct ways, each of which is discussed below.
First, changes in interest rates affect our net interest income, which is the difference between the interest income
earned on assets and the interest expense incurred in connection with our debt obligations and hedges.
Our general financing strategy focuses on the use of match funded structures. This means that we seek to match the
maturities of our debt obligations with the maturities of our assets to minimize the risk that we have to refinance our
liabilities prior to the maturities of our assets, and to reduce the impact of changing interest rates on our earnings. In
addition, we generally match fund interest rates on our assets with like-kind debt (i.e., fixed rate assets are financed
with fixed rate debt and floating rate assets are financed with floating rate debt), directly or through the use of interest
rate swaps, caps or other financial instruments (see below), or through a combination of these strategies, which also
allows us to reduce the impact of changing interest rates on our earnings.
However, increases in interest rates can nonetheless reduce our net interest income to the extent that we are not
completely match funded. Furthermore, a period of rising interest rates can negatively impact our return on certain
floating rate investments. Although these investments may be financed with floating rate debt, the interest rate on the
debt may reset prior to, and in some cases more frequently than, the interest rate on the assets, causing a decrease in
return on equity during a period of rising interest rates.
As of February 25, 2008, a 100 basis point increase in short term interest rates would increase our earnings by
approximately $4.3 million per annum, assuming a static portfolio of current investments and financings.
Changes in the level of interest rates also affect the yields required by the marketplace on debt. Increasing interest
rates would decrease the value of the fixed rate assets we hold at the time because higher required yields result in
lower prices on existing fixed rate assets in order to adjust their yield upward to meet the market.
We generally have the intent and ability to hold our assets until maturity. Such assets are considered available for sale
and may be sold prior to maturity on an opportunistic basis or for other reasons.
Changes in unrealized gains or losses resulting from changes in market interest rates do not directly affect our cash
flows, or our ability to pay a dividend, as the related assets are expected to be held and their fair value is not relevant
to their underlying cash flows. Our assets are largely financed to maturity through long term CBO financings that are
not redeemable as a result of book value changes. As long as these fixed rate assets continue to perform as expected,
our cash flows from these assets would not be affected by increasing interest rates. Changes in unrealized gains or
losses would impact our ability to realize gains on existing investments if they were sold. Furthermore, with respect to
changes in unrealized gains or losses on investments which are carried at fair value, changes in unrealized gains or
losses would impact our net book value and, in the case of non-hedge derivatives, our net income.
Changes in the value of our assets could affect our ability to borrow and access capital. Also, if the value of our assets
subject to repurchase agreements were to decline, it could cause us to fund margin and affect our ability to refinance
such assets upon the maturity of the related repurchase agreements, adversely impacting our rate of return on such
securities.
As of February 25, 2008, a 100 basis point change in short term interest rates would impact our net book value by
approximately $19.3 million, assuming a static portfolio of current investments and financings.
Interest rate swaps are agreements in which a series of interest rate flows are exchanged with a third party
(counterparty) over a prescribed period. The notional amount on which swaps are based is not exchanged. In general,
our swaps are “pay fixed” swaps involving the exchange of floating rate interest payments from the counterparty for
fixed interest payments from us. This can effectively convert a floating rate debt obligation into a fixed rate debt
obligation.
Similarly, an interest rate cap or floor agreement is a contract in which we purchase a cap or floor contract on a
notional face amount. We will make an up-front payment to the counterparty for which the counterparty agrees to
make future payments to us should the reference rate (typically one- or three-month LIBOR) rise above (cap
agreements) or fall below (floor agreements) the “strike” rate specified in the contract. Should the reference rate rise
55
strike rate in a floor, we will earn floor income. Payments on an annualized basis will equal the contractual notional
face amount multiplied by the difference between the actual reference rate and the contracted strike rate.
While a REIT may utilize these types of derivative instruments to hedge interest rate risk on its liabilities or for other
purposes, such derivative instruments could generate income that is not qualified income for purposes of maintaining
REIT status. As a consequence, we may only engage in such instruments to hedge such risks within the constraints of
maintaining our standing as a REIT. We do not enter into derivative contracts for speculative purposes nor as a hedge
against changes in credit risk.
Our hedging transactions using derivative instruments also involve certain additional risks such as counterparty credit
risk, the enforceability of hedging contracts and the risk that unanticipated and significant changes in interest rates
will cause a significant loss of basis in the contract. The counterparties to our derivative arrangements are major
financial institutions with high credit ratings with which we and our affiliates may also have other financial
relationships. As a result, we do not anticipate that any of these counterparties will fail to meet their obligations.
There can be no assurance that we will be able to adequately protect against the foregoing risks and will ultimately
realize an economic benefit that exceeds the related amounts incurred in connection with engaging in such hedging
strategies.
Credit Spread Exposure
Credit spreads measure the yield demanded on loans and securities by the market based on their credit relative to U.S.
Treasuries, for fixed rate credit, or LIBOR, for floating rate credit. Our fixed rate loans and securities are valued based
on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. Our floating rate loans
and securities are valued based on a market credit spread over LIBOR. Excessive supply of such loans and securities
combined with reduced demand will generally cause the market to require a higher yield on such loans and securities,
resulting in the use of a higher (or “wider”) spread over the benchmark rate to value them.
Changes in credit spreads affect our investments in two distinct ways, each of which is discussed below.
First, widening credit spreads would result in higher yields being required by the marketplace on loans and securities.
This widening would reduce the value of the loans and securities we hold at the time because higher required yields
result in lower prices on existing securities in order to adjust their yield upward to meet the market.
The effects of such a decrease in values on our financial position, results of operations and liquidity are discussed
above under “- Interest Rate Risk.”
As of February 25, 2008, a 25 basis point movement in credit spreads would impact our net book value by
approximately $33.4 million, assuming a static portfolio of current investments and financings, but would not directly
affect our earnings or cash flow.
Our financing strategy is dependent on our ability to place the match funded debt we use to finance our investments at
rates that provide a positive net spread. Currently, spreads for such liabilities have widened and demand for such
liabilities has become extremely limited, therefore restricting our ability to execute future financings.
However, a second impact of widening of credit spreads is that it would also result in increased yields on new
investments we purchase during or subsequent to the widening, thereby benefiting our ongoing investment activities,
as we would earn a higher yield on the same investment amount in comparison to the investing environment prior to
such widening. As noted in “- Market Considerations” above, we could only take advantage of these investment
opportunities if we have sufficient liquidity and financing is available on favorable terms.
In an environment where spreads are tightening, if spreads tighten on the assets we purchase to a greater degree than
they tighten the liabilities we issue, our net spread will be reduced.
Margin
Certain of our investments are financed through repurchase agreements or total return swaps which are subject to
margin calls based on the value of such investments. Margin calls resulting from decreases in value related to rising
interest rates are substantially offset by our ability to make margin calls on our interest rate derivatives. We seek to
maintain adequate cash reserves and other sources of available financing to meet any margin calls resulting from
decreases in value related to a reasonably possible (in the opinion of management) widening of credit spreads.
Fair Value
Fair values for a majority of our investments are readily obtainable through broker quotations. For certain of our
financial instruments, fair values are not readily available since there are no active trading markets as characterized by
current exchanges between willing parties or due to market conditions. Accordingly, fair values can only be derived
or estimated for these instruments using various valuation techniques, such as computing the present value of
estimated future cash flows using discount rates commensurate with the risks involved. However, the determination
of estimated future cash flows is inherently subjective and imprecise. We note that minor changes in assumptions or
estimation methodologies can have a material effect on these derived or estimated fair values, and that the fair values
reflected below are indicative of the interest rate and credit spread environments as of December 31, 2007 and do not
take into consideration the effects of subsequent interest rate or credit spread fluctuations.
56
We note that the values of our investments in real estate securities, loans and derivative instruments are sensitive to
changes in market interest rates, credit spreads and other market factors. The value of these investments can vary, and
has varied, materially from period to period.
Trends
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market
Considerations” for a further discussion of recent trends and events affecting our liquidity, unrealized gains and
losses.
Interest Rate and Credit Spread Risk
We held the following interest rate and credit spread risk sensitive instruments at December 31, 2007 (in thousands):
December 31, 2007
December 31, 2006
Principal
Balance or
Notional
Amount
Carrying
Value
Fair Value
Weighted
Average Yield/
Funding Cost
Maturity
Date
Carrying
Value
Fair Value
$
5,516,347
1,867,724
644,556
$
4,835,884
1,856,978
634,605
$
4,835,884
1,768,570
631,327
406,217
-
252,691
4,730,528
549,303
-
1,634,362
393,899
-
(8,807)
393,899
-
(8,807)
4,716,535
546,798
-
1,634,362
4,075,149
539,128
-
1,633,285
6.46%
8.24%
8.11%
(4)
N/A
N/A
5.37%
6.69%
N/A
5.00%
(1)
(2)
(3)
(4)
N/A
(5)
(6)
(7)
Repaid
(8)
$
5,581,228
1,568,916
809,097
$
5,581,228
1,571,412
829,980
288,202
1,262
1,288
4,313,824
675,844
128,866
760,346
288,202
1,262
1,288
4,369,540
676,512
128,866
760,346
-
-
-
N/A
Repaid
1,143,749
1,143,749
406,217
-
100,100
3,101,736
1,115,513
393,899
-
100,100
112,693
7,897
393,899
-
88,863
112,693
7,897
(4)
N/A
7.71%
N/A
N/A
(4)
Terminated
(10)
(11)
(12)
288,202
93,800
100,100
(42,887)
360
288,202
93,800
101,629
(42,887)
360
Assets:
Real estate securities,
available for sale (1)
Real estate related loans (2)
Residential mortgage loans (3)
Subprime mortgage loans subject to
call option (4)
Interest rate caps, treated as hedges
Total rate of return swaps (5)
Liabilities:
CBO bonds payable (6)
Other bonds payable (7)
Notes payable
Repurchase agreements (8)
Repurchase agreements subject to
ABCP facility
Financing of subprime mortgage loans
subject to call option (4)
Credit facility
Junior subordinated notes payable (9)
Interest rate swaps, treated as hedges (10)
Non-hedge derivatives (11)
For further information regarding the impact of prepayment, reinvestment and expected loss factors on the timing of
realization of our investments, please refer to “Management’s Discussion and Analysis of Financial Condition and
Results of Operations – Application of Critical Accounting Policies” and the financial statements included in this
Form 10-K.
(1)
These securities contain various terms, including fixed and floating rates, self-amortizing and interest only.
Their weighted average maturity is 4.7 years. The fair value of these securities is estimated by obtaining
third party broker quotations, if available and practicable, counterparty quotations, and pricing models. A
face amount of approximately $378.1 million of securities was valued at $177.5 million using pricing
models. Inputs for the pricing models include discounts rates, assumptions for prepayments, defaults, and
loss severities, as well as other variables.
(2)
Represents the following loans:
Loan Type
Mezzanine Loans
Corporate Bank Loans
B-Notes
Whole Loans
ICH Loans
Outstanding
Face
Amount
Carrying
Value
Weighted Avg.
Yield
Weighted Average
Maturity (Years)
Floating Rate Loans
as a % of
Carrying Value
Fair Value
$
$
805,460
464,916
397,897
114,935
84,516
1,867,724
801,678
460,622
396,477
113,784
84,417
1,856,978
$
$
8.44%
7.99%
7.70%
10.28%
7.57%
8.24%
1.9
3.6
1.8
1.4
0.3
2.2
88.0%
100.0%
83.3%
100.0%
0.0%
86.7%
$
760,461
430,062
381,793
111,836
84,418
1,768,570
$
The ICH loans were valued by discounting expected future cash flows by a rate derived by applying an
applicable spread over the benchmark rate. The rest of the loans were valued by obtaining third party broker
quotations, if available and practicable, and counterparty quotations.
57
(3)
(4)
(5)
(6)
(7)
(8)
(9)
This aggregate portfolio of residential loans consists of a portfolio of floating rate residential mortgage loans
and two portfolios of substantially fixed rate manufactured housing loans. The $102.4 million portfolio of
residential mortgage loans has a weighted average maturity of 2.8 years. The $542.1 million portfolios of
manufactured housing loans have a weighted average maturity of 6.1 years. These loans were valued by
discounting expected future flows based on current market interest rates and credit spreads.
These two items, related to the securitization of subprime mortgage loans, are equal and offsetting. See
“Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources” for further discussion of these items.
Represents total rate of return swaps which are treated as non-hedge derivatives. The fair value of these
agreements, which is included in Derivative Assets or Liabilities (as applicable – a negative amount
represents a liability), is estimated by obtaining counterparty quotations. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources” for a further
discussion of these swaps.
These bonds were valued based on broker quotations, representing the discounted expected future cash flows
at a yield which reflects current market interest rates and credit spreads. The weighted average maturity of
the CBO bonds payable is 5.9 years. The CBO bonds payable amortize principal prior to maturity based on
collateral receipts, subject to reinvestment requirements.
The ICH bonds amortize principal prior to maturity based on collateral receipts and have a weighted average
maturity of 0.2 years. The manufactured housing loan bonds amortize principal prior to maturity based on
collateral receipts and have a weighted average maturity of 2.0 years. These bonds were valued by
discounting expected future cash flows by a rate calculated based on current market conditions for
comparable financial instruments, including market interest rates and credit spreads.
The repurchase agreements have a weighted average maturity of 0.3 years. These agreements were valued by
reference to current market interest rates and credit spreads.
These notes have a weighted average maturity of 28.3 years. These notes were valued by discounting
expected future cash flows by a rate calculated based on current market conditions for comparable financial
instruments, including market interest rates and credit spreads.
(10)
Represents current swap agreements as follows:
Year of Maturity
Weighted Average
Maturity
Aggregate Notional
Amount
Weighted Average
Fixed Pay Rate
Aggregate Fair Value
Agreements which receive 1-Month LIBOR:
2010
2011
2012
2014
2015
2016
2017
Jun 2010
Jul 2011
Mar 2012
Oct 2014
Oct 2015
Apr 2016
Aug 2017
$
39,763
315,845
142,025
17,700
1,377,286
648,823
174,034
Agreements which receive 3-Month LIBOR:
2011
2014
Feb 2011
Jun 2014
32,000
354,260
3,101,736
$
4.71%
5.21%
5.09%
5.10%
5.26%
5.17%
5.24%
5.08%
4.20%
$
782
10,763
4,181
736
63,285
24,251
8,977
1,079
(1,361)
112,693
$
(11)
The fair value of these agreements is estimated by obtaining counterparty quotations. A positive fair value
represents a liability. We have recorded $1,678 million of gross interest rate swap assets and $114,371
million of liabilities.
These are two essentially offsetting interest rate caps and two essentially offsetting interest rate swaps, each
with notional amounts of $32.5 million, and an interest rate cap with a notional balance of $17.5 million. In
addition, there is an interest rate swap and interest rate cap related to a CBO each with a notional amount of
$229.9 million and the swaps related to the financing of FNMA/FHLMA securities which were de-
designated as hedges for accounting purposes. The maturity date of the purchased swap is July 2009; the
maturity date of the sold swap is July 2014, the maturity date of the $32.5 million caps is July 2038, the
maturity date of the $17.5 million cap is July 2009 and the longest maturity date for the swaps de-designated
as accounting hedges is April 2012. The fair value of these agreements is estimated by obtaining
counterparty quotations. A positive fair value represents a liability; therefore we have a net non-hedge
derivative liability.
58
Item 8. Financial Statements and Supplementary Data.
Index to Financial Statements:
Report of Independent Registered Public Accounting Firm
Report on Internal Control Over Financial Reporting of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2007 and December 31, 2006
Consolidated Statements of Operations for the years ended December 31, 2007, 2006 and 2005
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2007, 2006 and 2005
Consolidated Statements of Cash Flow for the years ended December 31, 2007, 2006 and 2005
Notes to Consolidated Financial Statements
All schedules have been omitted because either the required information is included in our consolidated financial
statements and notes thereto or it is not applicable.
59
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Newcastle Investment Corp.
We have audited the accompanying consolidated balance sheets of Newcastle Investment Corp. and subsidiaries (the
“Company”) as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholders'
equity, and cash flow for each of the three years in the period ended December 31, 2007. These financial statements
are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated
financial position of the Company at December 31, 2007 and 2006, and the consolidated results of their operations
and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S.
generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the Company's internal control over financial reporting as of December 31, 2007, based on criteria established
in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 27, 2008 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
New York, NY
February 27, 2008
60
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Newcastle Investment Corp.
We have audited Newcastle Investment Corp.‘s (the “Company’s”) internal control over financial reporting as of
December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is
responsible for maintaining effective internal control over financial reporting, and for its assessment of the
effectiveness of internal control over financial reporting included in the accompanying Management’s Report on
Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining
an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing
such other procedures as we considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance
with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may
deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as
of December 31, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated balance sheets of the Company as of December 31, 2007 and 2006, and the related
consolidated statements of income, stockholders’ equity, and cash flow for each of the three years in the period ended
December 31, 2007 of the Company and our report dated February 27, 2008 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
New York, NY
February 27, 2008
61
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
Assets
Real estate securities, available for sale - Note 4
Real estate related loans, net - Note 5
Residential mortgage loans, net - Note 5
Subprime mortgage loans subject to call option - Note 5
Investments in unconsolidated subsidiaries - Note 3
Operating real estate, net - Note 6
Cash and cash equivalents
Restricted cash
Derivative assets - Note 7
Receivables and other assets
Liabilities and Stockholders' Equity
Liabilities
CBO bonds payable - Note 8
Other bonds payable - Note 8
Notes payable - Note 8
Repurchase agreements - Note 8
Repurchase agreements subject to ABCP facility - Note 8
Financing of subprime mortgage loans subject to call option - Notes 5 and 8
Credit facility - Note 8
Junior subordinated notes payable (security for trust preferred) - Note 8
Derivative liabilities - Note 7
Dividends payable
Due to affiliates - Note 10
Accrued expenses and other liabilities
Commitments and contingencies - Notes 9, 10 and 11
Stockholders' Equity
Preferred stock, $0.01 par value, 100,000,000 shares authorized,
2,500,000 shares of 9.75% Series B Cumulative Redeemable Preferred Stock,
1,600,000 shares of 8.05% Series C Cumulative Redeemable Preferred Stock, and
2,000,000 shares of 8.375% series D Cumulative Redeemable Preferred Stock,
December 31,
2007
2006
$
4,835,884
$
5,581,228
1,856,978
1,568,916
634,605
393,899
24,477
34,399
55,916
133,126
4,114
64,372
809,097
288,202
22,868
29,626
5,371
184,169
62,884
52,031
$
8,037,770
$
8,604,392
$
4,716,535
$
4,313,824
546,798
-
1,634,362
-
393,899
-
100,100
133,510
40,251
7,741
16,949
675,844
128,866
760,346
1,143,749
288,202
93,800
100,100
17,715
33,095
13,465
33,406
7,590,145
7,602,412
liquidation preference $25.00 per share, issued and outstanding (Series D issued in 2007)
152,500
102,500
Common stock, $0.01 par value, 500,000,000 shares authorized, 52,779,179
and 45,713,817 shares issued and outstanding at
December 31, 2007 and 2006, respectively
Additional paid-in capital
Dividends in excess of earnings - Note 2
Accumulated other comprehensive income (loss) - Note 2
528
1,033,326
(236,213)
(502,516)
447,625
457
833,887
(10,848)
75,984
1,001,980
$
8,037,770
$
8,604,392
See notes to consolidated financial statements.
62
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share data)
Revenues
Interest income
Rental income
Gain on sale of investments, net
Other income (loss), net
Expenses
Interest expense
Loss on extinguishment of debt - Note 8
Property operating expense
Loan and security servicing expense
Provision for credit losses - Note 5
Provision for losses, loans held for sale - Note 5
General and administrative expense
Management fee to affiliate - Note 10
Incentive compensation to affiliate - Note 10
Depreciation and amortization
Year Ended December 31,
2007
2006
2005
$
680,551
6,673
14,056
(13,223)
688,057
$
530,006
4,861
12,998
5,402
553,267
$
348,516
6,647
20,305
2,745
378,213
476,988
15,032
5,514
9,719
10,394
7,325
6,041
17,645
6,209
1,412
556,279
374,269
658
3,805
6,944
9,438
4,127
4,946
14,018
12,245
1,085
431,535
226,446
-
2,363
5,993
8,421
-
4,159
13,325
7,627
641
268,975
Income before other gains (losses)
131,778
121,732
109,238
Other Gains (Losses)
Other-than-temporary-impairment - Note 4
Income (loss) before equity in earnings of unconsolidated subsidiaries
Equity in earnings of unconsolidated subsidiaries - Note 3
Income taxes on related taxable subsidiaries - Note 12
Income (loss) from continuing operations
Income (loss) from discontinued operations - Note 6
Net Income (Loss)
Preferred dividends
(202,602)
(70,824)
5,390
-
(65,434)
(23)
(65,457)
(12,640)
-
121,732
5,968
-
127,700
223
127,923
(9,314)
-
109,238
5,930
(321)
114,847
2,108
116,955
(6,684)
Income (Loss) Applicable To Common Stockholders
$
(78,097)
$
118,609
$
110,271
Net Income (Loss) Per Share of Common Stock
Basic
Diluted
Income (loss) from continuing operations per share of common
stock, after preferred dividends
Basic
Diluted
Income (loss) from discontinued operations per share of common stock
Basic
Diluted
Weighted Average Number of Shares of Common Stock Outstanding
Basic
Diluted
$
(1.52)
$
2.68
$
2.53
$
(1.52)
$
2.67
$
2.51
$
(1.52)
$
2.67
$
2.48
$
(1.52)
$
2.67
$
2.46
$
(0.00)
$
0.01
$
0.05
$
(0.00)
$
0.00
$
0.05
51,369,486
51,369,486
44,268,575
44,417,113
43,671,517
43,985,642
Dividends Declared per Share of Common Stock
$
2.850
$
2.615
$
2.500
See notes to consolidated financial statements.
63
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2007, 2006 and 2005
Stockholders' equity - December 31, 2006
Dividends declared
Issuance of common stock
Issuance of common stock to directors
Exercise of common stock options
Issuance of preferred stock
Comprehensive income:
Net income (loss)
Net unrealized (loss) on securities
Reclassification of net realized (gain) on securities into earnings
Foreign currency translation
Net unrealized (loss) on derivatives designated as cash flow hedges
Reclassification of net realized loss on derivatives designated
cash flow hedges into earnings
Total comprehensive (loss)
Stockholders' equity - December 31, 2007
Stockholders' equity - December 31, 2005
Dividends declared
Issuance of common stock
Issuance of common stock to directors
Exercise of common stock options
Comprehensive income:
Net income
Net unrealized (loss) on securities
Reclassification of net realized (gain) on securities into earnings
Foreign currency translation
Net unrealized gain on derivatives designated as cash flow hedges
Reclassification of net realized (gain) on derivatives designated
cash flow hedges into earnings
Total comprehensive income
Stockholders' equity - December 31, 2006
Preferred Stock
Common Stock
Shares
Amount
Shares
Amount
4,100,000
-
-
-
-
2,000,000
$
102,500
-
-
-
-
50,000
45,713,817
-
6,980,000
2,164
83,198
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
$
457
-
70
-
1
-
-
-
-
-
-
-
Additional
Paid in Capital
Dividends in
Excess of
Earnings
Accumulated
Other Comp.
Income
Total Stock-
holders'
Equity
$
833,887
-
199,707
60
1,442
(1,770)
$
(10,848)
(159,908)
-
-
-
-
$
75,984
-
-
-
-
-
$
1,001,980
(159,908)
199,777
60
1,443
48,230
-
-
-
-
-
-
(65,457)
-
-
-
-
-
(429,897)
(20,830)
3,019
(133,004)
(65,457)
(429,897)
(20,830)
3,019
(133,004)
-
2,212
6,100,000
$
152,500
52,779,179
$
528
$
1,033,326
$
(236,213)
$
(502,516)
4,100,000
-
-
-
-
$
102,500
-
-
-
-
43,913,409
-
1,700,000
2,408
98,000
$
439
-
17
-
1
$
782,735
-
49,376
60
1,716
$
(13,235)
(125,536)
-
-
-
$
45,564
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
127,923
-
-
-
-
-
-
26,242
(282)
(26)
7,773
(3,287)
4,100,000
$
102,500
45,713,817
$
457
$
833,887
$
(10,848)
$
75,984
2,212
(643,957)
447,625
$
$
918,003
(125,536)
49,393
60
1,717
127,923
26,242
(282)
(26)
7,773
(3,287)
158,343
1,001,980
$
Continued on next page.
64
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2007, 2006 and 2005
(dollars in thousands)
Stockholders' equity - December 31, 2004
Dividends declared
Issuance of common stock
Issuance of common stock to directors
Exercise of common stock options
Issuance of preferred stock
Comprehensive income:
Net income
Net unrealized (loss) on securities
Reclassification of net realized (gain) on securities into earnings
Foreign currency translation
Reclassification of net realized foreign currency translation into earnings
Net unrealized gain on derivatives designated as cash flow hedges
Reclassification of net realized loss on derivatives designated as
cash flow hedges into earnings
Total comprehensive income
Stockholders' equity - December 31, 2005
Dividends in
Excess of
Earnings
Accumulated
Other Comp.
Income
Total Stock-
holders'
Equity
$
71,770
-
-
-
-
-
$
796,715
(116,221)
96,482
67
11,694
38,517
Preferred Stock
Common Stock
Shares
2,500,000
-
-
-
-
1,600,000
Amount
$
62,500
-
-
-
-
40,000
Shares
39,859,481
-
3,300,000
2,008
751,920
-
Amount
399
$
-
33
-
7
-
Additional
Paid in Capital
$
676,015
-
96,449
67
11,687
(1,483)
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
$
(13,969)
(116,221)
-
-
-
-
116,955
-
-
-
-
-
-
-
(67,077)
(16,015)
(1,089)
(626)
56,426
2,175
116,955
(67,077)
(16,015)
(1,089)
(626)
56,426
2,175
90,749
918,003
$
4,100,000
$
102,500
43,913,409
$
439
$
782,735
$
(13,235)
$
45,564
See notes to consolidated financial statements.
65
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(dollars in thousands)
Cash Flows From Operating Activities
Net income (loss)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating
activities (inclusive of amounts related to discontinued operations):
Depreciation and amortization
Accretion of discount and other amortization
Equity in earnings of unconsolidated subsidiaries
Distributions of earnings from unconsolidated subsidiaries
Deferred rent
Gain on sale of investments
Unrealized (gain) loss on non-hedge derivatives and hedge ineffectiveness
Loss on extinguishment of debt - Note 8
Provision for credit losses - Note 5
Provision for losses, loans held for sale - Note 5
Other-than-temporary impairment - Note 4
Purchase of loans held for sale - Note 5
Sale of loans held for sale - Note 5
Non-cash directors' compensation
Change in:
Restricted cash
Receivables and other assets
Due to affiliates
Accrued expenses and other liabilities
Net cash provided by (used in) operating activities
Cash Flows From Investing Activities
Purchase of real estate securities
Proceeds from sale of real estate securities
Deposit on real estate securities (treated as a derivative)
Purchase of and advances on loans
Proceeds from settlement of loans
Repayments of loan and security principal
Margin received on derivative instruments
Margin deposited on derivative instruments
Margin deposits on total rate of return swaps (treated as derivative instruments)
Return of margin deposits on total rate of return swaps
(treated as derivative instruments)
Proceeds from termination of derivative instruments
Proceeds from sale of derivative instruments into securitization trusts - Note 5
Payments on settlement of derivative instruments
Purchase and improvement of operating real estate
Proceeds from sale of operating real estate
Contributions to unconsolidated subsidiaries
Distributions of capital from unconsolidated subsidiaries
Payment of deferred transaction costs
Change in restricted cash from investment in new CBOs
Net cash provided by (used in) investing activities
Year Ended December 31,
2007
2006
2005
$
(65,457)
$
127,923
$
116,955
1,412
(26,709)
(5,390)
3,286
234
(14,218)
14,586
10,278
10,723
7,325
202,602
(1,089,202)
969,747
60
(2,106)
(10,879)
(5,724)
(7,078)
(6,510)
(448,684)
237,892
-
(941,045)
29,197
1,169,032
98,744
(129,757)
(60,085)
63,941
26,807
-
-
(2,964)
-
(379)
874
-
(9,601)
33,972
1,085
(15,365)
(5,968)
5,968
(1,274)
(13,359)
(4,284)
-
9,438
4,127
-
(1,511,086)
1,411,530
60
1,400
(8,985)
4,682
10,430
16,322
(1,295,067)
318,007
-
(1,643,062)
24,750
579,166
50,701
(50,799)
(55,922)
81,619
16,426
5,623
-
(1,585)
-
(125)
7,210
-
-
818
(2,645)
(5,930)
5,930
(2,539)
(20,811)
(2,839)
-
8,421
-
-
-
-
67
(7,980)
218
(180)
9,278
98,763
(1,463,581)
60,254
(57,149)
(584,270)
1,901
698,002
-
-
(53,518)
-
1,338
-
(1,112)
(182)
52,333
-
11,277
(39)
-
(1,963,058)
(1,334,746)
Continued on next page.
66
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(dollars in thousands)
Cash Flows From Financing Activities
Issuance of CBO bonds payable
Repayments of CBO bonds payable
Issuance of other bonds payable
Repayments of other bonds payable
Repayments of notes payable
Borrowings under repurchase agreements
Repayments of repurchase agreements
Margin deposits under repurchase agreement
Issuance of repurchase agreements subject to ABCP facility
Repayments of repurchase agreements subject to ABCP facility
Draws under credit facility
Repayments of credit facility
Issuance of junior subordinated notes payable
Issuance of common stock
Costs related to issuance of common stock
Exercise of common stock options
Issuance of preferred stock
Costs related to issuance of preferred stock
Dividends paid
Payment of deferred financing costs
Change in restricted cash from refinancing of CBO
Net cash provided by financing activities
Net Increase (Decrease) in Cash and Cash Equivalents
Cash and Cash Equivalents, Beginning of Period
Cash and Cash Equivalents, End of Period
Year Ended December 31,
2007
2006
2005
1,835,071
(1,443,138)
-
(130,587)
(128,866)
4,951,437
(4,077,421)
(5,457)
247,409
(1,391,158)
382,800
(476,600)
-
200,165
(358)
1,443
50,000
(1,770)
(152,752)
(2,273)
165,138
23,083
50,545
5,371
55,916
$
807,464
(18,889)
631,988
(305,428)
(131,575)
3,953,324
(4,241,181)
-
1,143,749
-
570,400
(496,600)
100,100
50,014
(581)
1,717
-
-
(121,493)
(12,177)
-
880,570
(10,241)
246,547
(114,780)
(391,559)
815,840
(258,257)
-
-
-
62,000
(42,000)
-
97,680
(1,198)
11,694
40,000
(1,483)
(113,097)
(2,369)
-
1,930,832
(15,904)
21,275
5,371
$
1,219,347
(16,636)
37,911
21,275
$
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense
Cash paid during the period for income taxes
Supplemental Schedule of Non-cash Investing and Financing Activities
Common stock dividends declared but not paid
Preferred stock dividends declared but not paid
Deposits used in acquisition of real estate securities (treated as derivatives)
Foreclosure of loans
Acquisition and financing of loans subject to call option
Retained bonds and equity in securitization
$
447,212
$
-
$
$
335,545
244
$
$
213,070
448
38,001
$
$
2,250
$
-
$
285
$
102,381
31,543
$
$
1,552
$
-
$
14,780
$
286,315
$
27,446
$
1,606
$
82,334
$
-
$
-
$
81,677
$
96,058
$
-
See notes to consolidated financial statements.
67
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
1. ORGANIZATION
Newcastle Investment Corp. (and its subsidiaries, “Newcastle”) is a Maryland corporation that was formed in
2002. Newcastle conducts its business through three primary segments: (i) real estate securities and real estate
related loans, (ii) residential mortgage loans, and (iii) operating real estate.
The following table presents information on shares of Newcastle’s common stock issued subsequent to its
formation:
Year
Shares Issued
Formation
2002
2003
2004
2005
2006
2007
December 31, 2007
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our independent
16,488,517
7,000,000
7,886,316
8,484,648
4,053,928
1,800,408
7,065,362
52,779,179
Range of Issue
Prices (1)
N/A
$13.00
$20.35-$22.85
$26.30-$31.40
$29.60
$29.42
$27.75-$31.30
Net Proceeds
(millions)
N/A
$80.0
$163.4
$224.3
$108.2
$51.2
$201.3
directors.
Newcastle is organized and conducts its operations to qualify as a real estate investment trust (“REIT”) under the
Internal Revenue Code of 1986, as amended (the “Code”). 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”),
an affiliate of Fortress Investment Group LLC, 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. For a further discussion of the Management Agreement, see Note 10.
Approximately 5.1 million shares of Newcastle’s common stock were held by the Manager, through its affiliates,
and principals of Fortress at December 31, 2007. In addition, the Manager, through its affiliates, held options to
purchase approximately 1.5 million shares of Newcastle’s common stock at December 31, 2007.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Basis of Accounting – The accompanying consolidated financial statements are prepared in accordance with U.S.
generally accepted accounting principles ("GAAP''). The consolidated financial statements include the accounts
of Newcastle and its consolidated subsidiaries. All significant intercompany transactions and balances have been
eliminated. Newcastle consolidates those entities in which it has an investment of 50% or more and has control
over significant operating, financial and investing decisions of the entity.
Financial Accounting Standards Board Interpretation (“FIN”) No. 46R “Consolidation of Variable Interest
Entities” clarified the methodology for determining whether an entity is a variable interest entity (“VIE”) and the
methodology for assessing who is the primary beneficiary of a VIE. 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 its primary beneficiary, which is defined as the
party who will absorb a majority of the VIE’s expected losses or receive a majority of the expected residual
returns as a result of holding variable interests. The application of FIN 46R did not result in a change in
Newcastle’s accounting for any entities. Newcastle’s CBO subsidiaries are considered VIEs of which Newcastle
is the primary beneficiary.
68
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
For entities over which Newcastle exercises significant influence, but which do not meet the requirements for
consolidation, Newcastle uses the equity method of accounting whereby it records its share of the underlying
income of such entities. Newcastle owns an equity method investment in two limited liability companies (Note 3)
which are investment companies and therefore maintain their financial records on a fair value basis. Newcastle
has retained such accounting relative to its investments in such companies pursuant to the Emerging Issues Task
Force (“EITF”) Issue No. 85-12 “Retention of Specialized Accounting for Investments in Consolidation.” In
addition, Newcastle owns (or owned) equity method investments in two entities which issued trust preferred
securities and asset backed commercial paper (Note 8).
Risks and Uncertainties ⎯ In the normal course of business, Newcastle encounters primarily two significant
types of economic risk: credit and market. Credit risk is the risk of default on Newcastle’s securities, loans,
derivatives, and leases that results from a borrower's, derivative counterparty's or lessee's inability or
unwillingness to make contractually required payments. Market risk reflects changes in the value of investments
in securities, loans and derivatives or in real estate due to changes in interest rates, spreads or other market
factors, including the value of the collateral underlying loans and securities and the valuation of real estate held
by Newcastle. Management believes that the carrying values of its investments are reasonable taking into
consideration these risks along with estimated collateral values, payment histories, and other borrower
information.
Additionally, Newcastle is subject to significant tax risks. If Newcastle were to fail to qualify as a REIT in any
taxable year, Newcastle would be subject to U.S. federal corporate income tax (including any applicable
alternative minimum tax), which could be material. Unless entitled to relief under certain statutory provisions,
Newcastle would also be disqualified from treatment as a REIT for the four taxable years following the year
during which qualification is lost.
Use of Estimates ⎯ The preparation of financial statements in conformity with GAAP requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those estimates.
Comprehensive Income ⎯ Comprehensive income is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances, excluding those resulting from investments
by and distributions to owners. For Newcastle’s purposes, comprehensive income represents net income, as
presented in the statements of operations, adjusted for unrealized gains or losses on securities available for sale
and derivatives designated as cash flow hedges and net foreign currency translation adjustments. The following
table summarizes Newcastle’s accumulated other comprehensive income:
Net unrealized gains (losses) on securities
Net unrealized gains (losses) on derivatives designated as cash flow hedges
Net foreign currency translation adjustments
Accumulated other comprehensive income (loss)
December 31,
2007
2006
$
(407,986)
$
42,742
(99,567)
5,037
31,224
2,018
$
(502,516)
$
75,984
REVENUE RECOGNITION
Real Estate Securities and Loans Receivable ⎯ Newcastle invests in securities, including commercial mortgage
backed securities, senior unsecured debt issued by property REITS, real estate related asset backed securities and
FNMA/FHLMC securities. Newcastle also invests in loans, including real estate related loans, commercial
mortgage loans, residential mortgage loans, manufactured housing loans and subprime mortgage loans.
Newcastle determines 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. Loans receivable are presented in the consolidated balance sheet
net of any unamortized discount (or gross of any unamortized premium) and an allowance for loan losses.
Discounts or premiums are accreted into interest income on an effective yield or “interest” method, based upon a
69
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
comparison of actual and expected cash flows, through the expected maturity date of the security or loan.
Depending on the nature of the investment, changes to expected cash flows may result in a prospective change to
yield or a retrospective change which would include a catch up adjustment. For loans acquired at a discount for
credit quality, the difference between contractual cash flows and expected cash flows at acquisition is not
accreted (nonaccretable difference). Interest income with respect to non-discounted securities or loans is
recognized on an accrual basis. Deferred fees and costs, if any, are recognized as interest income over the terms
of the securities or loans using the interest method. Upon settlement of securities and loans, the excess (or
deficiency) of net proceeds over the net carrying value of such security or loan is recognized as a gain (or loss) in
the period of settlement. Interest income includes prepayment penalties received of $2.3 million, $5.9 million and
$3.2 million in 2007, 2006, 2005, respectively.
Impairment of Securities and Loans ⎯ Newcastle continually evaluates securities and loans for impairment.
This evaluation includes the following, as applicable: (i) review of the credit of the issuer or the borrower, (ii)
review of the credit rating of the security, (iii) review of the key terms of the security or loan, (iv) review of the
performance of the loan or underlying loans, including debt service coverage and loan to value ratios, (v) analysis
of the value of the collateral for the loan or underlying loans, (vi) analysis of the effect of local, industry and
broader economic factors, and (vii) analysis of historical and anticipated trends in defaults and loss severities for
similar loans. Securities and loans are considered to be impaired, for financial reporting purposes, when it is
probable that Newcastle will be unable to collect all principal or interest when due according to the contractual
terms of the original agreements, or, for securities or loans purchased at a discount for credit quality or that
represent beneficial interests in securitizations, when Newcastle determines that it is probable that it will be
unable to collect as anticipated. In addition, for securities recorded as “available for sale,” a write down to fair
value is recorded when a decline in value below cost basis is deemed to be “other-than-temporary.” For loans
purchased at a discount for credit quality, if Newcastle determines that it is probable that it will collect more than
previously anticipated, the yield accrued on such loan or security is adjusted upward, on a prospective basis.
Upon determination of impairment, Newcastle establishes specific valuation allowances for loans or records a
direct write down for securities based on the estimated fair value of the underlying collateral using a discounted
cash flow analysis or based on an observable market value. Newcastle also establishes allowances for estimated
unidentified incurred losses on pools of loans. The allowance for each security or loan is maintained at a level
believed adequate by management to absorb probable losses, based on periodic reviews of actual and expected
losses. It is Newcastle’s policy to establish an allowance for uncollectible interest on performing securities or
loans that are past due more than 90 days or sooner when, in the judgment of management, the probability of
collection of interest is deemed to be insufficient to warrant further accrual. Upon such a determination, those
loans are deemed to be non-performing. Actual losses may differ from Newcastle’s estimate. Subsequent to a
determination of impairment, and a related write down, income is accrued on an effective yield method from the
new carrying value to the related expected cash flows, with cash received treated as a reduction of basis.
Gain on Sale of Investments, Net and Other Income (Loss), Net – These items are comprised of the following:
Gain on sale of investments, net
Gain on sale of real estate securities
Loss on sale of real estate securities
Realized gain (loss) of termination of derivative instruments
Other gain (loss)
Other income (loss), net
Unrealized gain (loss) on total rate of return swaps
Unrealized gain (loss) on non-hedge derivative instruments
Unrealized gain (loss) recognized at de-designation
Hedge ineffectiveness
Realized gain (loss) on CBO warehouse
Other income (loss)
Year-Ended December 31,
2007
2006
2005
$
20,545
(6,390)
(222)
123
$
9,168
(2,114)
5,973
(29)
$
24,014
(3,371)
(338)
-
$
14,056
$
12,998
$
20,305
$
(9,716)
6,059
(9,239)
(1,468)
-
1,141
$
(1,315)
6,178
-
24
-
515
$
2,101
976
-
164
(677)
181
$
(13,223)
$
5,402
$
2,745
70
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
EXPENSE RECOGNITION
Interest Expense ⎯ Newcastle finances its investments using both fixed and floating rate debt, including
securitizations, loans, repurchase agreements, and other financing vehicles. Certain of this debt has been issued at
discounts. Discounts are accreted into interest expense on the interest method through the expected maturity date
of the financing.
Deferred Costs and Interest Rate Cap Premiums ⎯ Deferred costs consist primarily of costs incurred in
obtaining financing which are amortized into interest expense over the term of such financing using the interest
method. Interest rate cap premiums, which are included in Derivative Assets, are amortized as described below.
Derivatives and Hedging Activities ⎯ All derivatives are recognized as either assets or liabilities on the balance
sheet and measured at fair value. Fair value adjustments affect either stockholders' equity or net income
depending on whether the derivative instrument qualifies as a hedge for accounting purposes and, if so, the nature
of the hedging activity. For those derivative instruments that are designated and qualify as hedging instruments,
Newcastle designates the hedging instrument, based upon the exposure being hedged, as either a cash flow hedge,
a fair value hedge or a hedge of a net investment in a foreign operation.
Derivative transactions are entered into by Newcastle solely for risk management purposes, except for real estate
securities portfolio deposits as described in Note 4 and the total rate of return swaps described in Note 5. Such
total rate of return swaps are essentially financings of certain reference assets which are treated as derivatives for
accounting purposes. The decision of whether or not a given transaction/position (or portion thereof) is hedged is
made on a case-by-case basis, based on the risks involved and other factors as determined by senior management,
including restrictions imposed by the Code among others. In determining whether to hedge a risk, Newcastle may
consider whether other assets, liabilities, firm commitments and anticipated transactions already offset or reduce
the risk. All transactions undertaken as hedges are entered into with a view towards minimizing the potential for
economic losses that could be incurred by Newcastle. Generally, all derivatives entered into are intended to
qualify as hedges under GAAP, unless specifically stated otherwise. To this end, terms of hedges are matched
closely to the terms of hedged items.
Description of the risks being hedged
1) Interest rate risk, existing debt obligations – Newcastle generally hedges the risk of interest rate
fluctuations with respect to its borrowings, regardless of the form of such borrowings, which require
payments based on a variable interest rate index. Newcastle generally intends to hedge only the risk
related to changes in the benchmark interest rate (LIBOR or a Treasury rate). In order to reduce such
risks, Newcastle may enter into swap agreements whereby Newcastle would receive floating rate
payments in exchange for fixed rate payments, effectively converting the borrowing to fixed rate.
Newcastle may also enter into cap agreements whereby, in exchange for a premium, Newcastle would be
reimbursed for interest paid in excess of a certain cap rate.
2) Interest rate risk, anticipated transactions – Newcastle may hedge the aggregate risk of interest rate
fluctuations with respect to anticipated transactions, primarily anticipated borrowings. The primary risk
involved in an anticipated borrowing is that interest rates may increase between the date the transaction
becomes probable and the date of consummation. Newcastle generally intends to hedge only the risk
related to changes in the benchmark interest rate (LIBOR or a Treasury rate). This is generally
accomplished through the use of interest rate swaps.
3) Interest rate risk, fair value of investments – Newcastle occasionally hedges the fair value of investments
acquired outside of its warehouse agreements (Note 4) prior to such investments being included in a
CBO financing (Note 8). The primary risk involved is the risk that the fair value of such an investment
will change between the acquisition date and the date the terms of the related financing are “locked in.”
Newcastle generally intends to hedge only the risk related to changes in the benchmark interest rate
(LIBOR or a Treasury rate). This is generally accomplished through the use of interest rate swaps.
71
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
Cash flow hedges
To qualify for cash flow hedge accounting, interest rate swaps and caps must meet certain criteria, including (1)
the items to be hedged expose Newcastle to interest rate risk, (2) the interest rate swaps or caps are highly
effective in reducing Newcastle’s exposure to interest rate risk, and (3) with respect to an anticipated transaction,
such transaction is probable. Correlation and effectiveness are periodically assessed based upon a comparison of
the relative changes in the fair values or cash flows of the interest rate swaps and caps and the items being hedged
or using regression analysis on an ongoing basis to assess retrospective and prospective hedge effectiveness.
For derivative instruments that are designated and qualify as a cash flow hedge (i.e. hedging the exposure to
variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or
loss, and net payments received or made, on the derivative instrument are reported as a component of other
comprehensive income and reclassified into earnings in the same period or periods during which the hedged
transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative
change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings
during the period of change. The premiums paid for interest rate caps, treated as cash flow hedges, are amortized
into interest expense based on the estimated value of such cap for each period covered by such cap.
With respect to interest rate swaps which have been designated as hedges of anticipated financings, periodic net
payments are recognized currently as adjustments to interest expense; any gain or loss from fluctuations in the
fair value of the interest rate swaps is recorded as a deferred hedge gain or loss in accumulated other
comprehensive income and treated as a component of the anticipated transaction. In the event the anticipated
refinancing failed to occur as expected, the deferred hedge credit or charge would be recognized immediately in
income. Newcastle’s hedges of such financings were terminated upon the consummation of such financings.
Newcastle has dedesignated certain of its hedge derivatives, and in some cases redesignated all or a portion
thereof as hedges. As a result of these dedesignations, in the cases where the originally hedged items were still
owned by Newcastle, the unrealized gain or loss was recorded in OCI as a deferred hedge gain or loss and is
being amortized over the life of the hedged item.
Fair Value Hedges
Any unrealized gains or losses, as well as net payments received or made, on these derivative instruments are
recorded currently in income, as are any unrealized gains or losses on the associated hedged items related to
changes in interest rates.
Non-Hedge Derivatives
With respect to interest rate swaps and caps that have not been designated as hedges, any net payments under, or
fluctuations in the fair value of, such swaps and caps have been recognized currently in Other Income.
72
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
Classification
Newcastle’s derivatives are recorded on its balance sheet as follows:
December 31,
Derivative Assets
Interest rate caps (A)
Interest rate swaps (A)
Total rate of return swaps
Non-hedge derivatives (B)
Derivative Liabilities
Interest rate swaps (A)
Interest (receivable) payable
Total rate of return swaps
Non-hedge derivatives (B)
(A) Treated as hedges
(B) Interest rate swaps and caps
2007
-
$
1,627
-
2,487
4,114
$
2006
$
$
$
$
114,357
(99)
8,807
10,445
133,510
$
$
1,262
59,551
1,288
783
62,884
16,664
(92)
-
1,143
17,715
The following table summarizes financial information related to derivatives (excluding the total rate of return
swaps, which are reported separately) :
Cash flow hedges
Notional amount
Interest rate cap agreements
Interest rate swap agreements
Deferred hedge gain (loss) related to anticipated financings,
net of amortization
Deferred hedge gain (loss) related to dedesignation,
net of amortization
Expected reclassification of deferred hedges from AOCI into
earnings over the next 12 months
Expected reclassification of current hedges from AOCI into
earnings over the next 12 months
Fair value hedges
Notional amount
Non-hedge Derivatives
December 31,
2007
2006
$
-
3,101,736
$
334,971
3,937,544
1,026
6,450
2,806
(1,585)
(2,554)
(1,251)
(29,588)
18,887
-
5,575
Notional amount of interest rate cap and swap agreements
1,115,513
147,500
The following table summarizes gains (losses) recorded in relation to derivatives (excluding the total rate of return
swaps, which are reported separately):
Cash flow hedges
Gain (loss) on the ineffective portion
Gain (loss) immediately recognized at dedesignation
$
(1,662)
(9,315)
$
49
5,133
$
164
342
2007
Year Ended December 31,
2006
2005
Fair value hedges
Gain (loss) on the effective portion (A)
Gain (loss) on the ineffective portion
Non-hedge derivatives gain (loss)
168
(48)
6,059
(333)
(22)
6,178
7
-
976
(A) Offset by the unrealized gain (loss) on the associated hedged items which is recognized in earnings.
73
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
Newcastle’s derivative financial instruments contain credit risk to the extent that its bank counterparties may be
unable to meet the terms of the agreements. Newcastle minimizes such risk by limiting its counterparties to highly
rated major financial institutions with good credit ratings. In addition, the potential risk of loss with any one party
resulting from this type of credit risk is monitored. Management does not expect any material losses as a result of
default by other parties. Newcastle does not require collateral; however, Newcastle does call margin from its
counterparties when applicable. Newcastle’s major swap counterparties include Bank of America, Bear Stearns,
Deutsche Bank and other major investment banks.
Management Fees and Incentive Compensation to Affiliate ⎯ These represent amounts due to the Manager
pursuant to the Management Agreement. For further information on the Management Agreement, see Note 10.
BALANCE SHEET MEASUREMENT
Investment in Real Estate Securities ⎯ Newcastle has classified its investments in securities as available for
sale. Securities available for sale are carried at market value with the net unrealized gains or losses reported as a
separate component of accumulated other comprehensive income. At disposition, the net realized gain or loss is
determined on the basis of the cost of the specific investments and is included in earnings. Unrealized losses on
securities are charged to earnings if they reflect a decline in value that is other-than-temporary. A decline in
value is considered other-than-temporary if either (a) it is deemed probable that Newcastle will be unable to
collect all amounts anticipated to be collected at acquisition, or (b) Newcastle does not have the ability and intent
to hold such investment until a forecasted market price recovery.
Investment in Loans ⎯ Loans receivable are presented net of any unamortized discount (or gross of any
unamortized premium), including any fees received, and an allowance for loan losses. Substantially all of
Newcastle’s loans receivable are classified as held for investment. Loans which Newcastle has the intent and
ability to sell in the foreseeable future are considered held-for-sale and are carried at the lower of amortized cost
or market value.
Investment in Operating Real Estate ⎯ Operating real estate is recorded at cost less accumulated depreciation.
Depreciation is computed on a straight-line basis. Buildings are depreciated over 40 years. Major improvements
are capitalized and depreciated over their estimated useful lives. Fees and costs incurred in the successful
negotiation of leases are deferred and amortized on a straight-line basis over the terms of the respective leases.
Expenditures for repairs and maintenance are expensed as incurred. Newcastle reviews its real estate assets for
impairment annually or whenever events or changes in circumstances indicate that the carrying value of an asset
may not be recoverable. Long-lived assets to be disposed of by sale, which meet certain criteria, are reclassified
to Real Estate Held for Sale and measured at the lower of their carrying amount or fair value less costs of sale.
The results of operations for such an asset, assuming such asset qualifies as a “component of an entity” as
defined, are retroactively reclassified to Income (Loss) from Discontinued Operations for all periods presented.
Foreign Currency Investments ⎯ Assets and liabilities relating to foreign investments are translated using
exchange rates as of the end of each reporting period. The results of Newcastle’s foreign operations are translated
at the weighted average exchange rate for each reporting period. Translation adjustments are included as a
component of accumulated other comprehensive income until realized.
Cash and Cash Equivalents and Restricted Cash ⎯ Newcastle considers all highly liquid short term
investments with maturities of 90 days or less when purchased to be cash equivalents. Substantially all amounts
on deposit with major financial institutions exceed insured limits. Restricted cash consisted of:
Held in CBOs pending reinvestment (Note 8)
$
48,475
$
123,886
December 31,
2007
2006
Total rate of return swap margin accounts
Bond sinking funds
Trustee accounts
Reserve accounts
Derivative margin accounts
Restricted property operating accounts
43,871
66
18,289
26
22,335
64
46,760
101
10,031
1,539
1,794
58
$
133,126
$
184,169
74
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
Stock Options ⎯ Newcastle accounts for stock options granted in accordance with SFAS No. 123, "Accounting
for Stock-Based Compensation'' as revised in December 2004 and amended by EITF Issue No. 96-18
“Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction
with Selling, Loans or Services.” The fair value of the options issued as compensation to the Manager for its
successful efforts in raising capital for Newcastle in 2007, 2006 and 2005 was recorded as an increase in
stockholders’ equity with an offsetting reduction of capital proceeds received. Options granted to Newcastle’s
directors were accounted for using the fair value method.
Preferred Stock ⎯ In March 2003, Newcastle issued 2.5 million shares ($62.5 million face amount) of its 9.75%
Series B Cumulative Redeemable Preferred Stock (the “Series B Preferred”). In October 2005, Newcastle issued
1.6 million shares ($40.0 million face amount) of its 8.05% Series C Cumulative Redeemable Preferred Stock
(the “Series C Preferred”). In March 2007, Newcastle issued 2.0 million shares ($50.0 million face amount) of its
8.375% Series D Cumulative Redeemable Preferred Stock (the “Series D Preferred”). The Series B Preferred,
Series C Preferred and Series D Preferred are non-voting, have a $25 per share liquidation preference, no maturity
date and no mandatory redemption. Newcastle has the option to redeem the Series B Preferred beginning in
March 2008, the Series C Preferred beginning in October 2010, and the Series D Preferred beginning in March
2012, at their face amount. If the Series C Preferred or Series D Preferred cease to be listed on the NYSE or the
AMEX, or quoted on the NASDAQ, and Newcastle is not subject to the reporting requirements of the Exchange
Act, Newcastle has the option to redeem the Series C Preferred or Series D Preferred, as applicable, at their face
amount and, during such time any shares of Series C Preferred or Series D Preferred are outstanding, the dividend
will increase to 9.05% or 9.375% per annum, respectively.
In connection with the issuance of the Series B Preferred, Series C Preferred and Series D Preferred, Newcastle
incurred approximately $2.4 million, $1.5 million, and $1.8 million of costs, respectively, which were netted
against the proceeds of such offerings. If any series of preferred stock were redeemed, the related costs would be
recorded as an adjustment to income available for common stockholders at that time.
Accretion of Discount and Other Amortization ⎯ As reflected on the Consolidated Statements of Cash Flow,
this item is comprised of the following:
Accretion of net discount on securities and loans
$
(38,048)
$
(27,657)
$
(13,432)
2007
2006
2005
Amortization of net discount on debt obligations
Amortization of deferred financing costs and interest rate cap premiums
Amortization of net deferred hedge gains and losses - debt
Amortization of deferred hedge loss - leases
7,394
4,407
(462)
-
7,328
4,434
401
129
4,574
4,417
1,587
209
$
(26,709)
$
(15,365)
$
(2,645)
Securitization of Subprime Mortgage Loans ⎯ Newcastle’s accounting policy for its securitization of subprime
mortgage loans is disclosed in Note 5.
Recent Accounting Pronouncements ⎯ In June 2006, the Financial Accounting Standards Board (“FASB”)
issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, as interpretation of FASB Statement
No. 109” (“FIN 48”). FIN 48 requires companies to recognize the tax benefits of uncertain tax positions only
where the position is “more likely than not” to be sustained assuming examination by tax authorities. The tax
benefit recognized is the largest amount of benefit that is greater than 50 percent likely of being realized upon
ultimate settlement. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN
48 did not have have a material impact on Newcastle’s financial condition, liquidity or results of operations.
In February 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 155,
“Accounting for Certain Hybrid Financial Instruments”, which amends SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities,” and SFAS 140, “Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities”. SFAS 155 provides, among other things, that (i) for embedded
derivatives which would otherwise be required to be bifurcated from their host contracts and accounted for at fair
value in accordance with SFAS 133 an entity may make an irrevocable election, on an instrument-by-instrument
75
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
basis, to measure the hybrid financial instrument at fair value in its entirety, with changes in fair value recognized
in earnings and (ii) concentrations of credit risk in the form of subordination are not considered embedded
derivatives. SFAS 155 is effective for all financial instruments acquired, issued or subject to remeasurement after
the beginning of an entity’s first fiscal year that begins after September 15, 2006. Upon adoption, differences
between the total carrying amount of the individual components of an existing bifurcated hybrid financial
instrument and the fair value of the combined hybrid financial instrument should be recognized as a cumulative
effect adjustment to beginning retained earnings. Prior periods are not restated. The adoption of SFAS 155 did not
have a material impact on Newcastle’s financial condition, liquidity or results of operations.
In June 2007, Statement of Position No. 07-1, “Clarification of the Scope of the Audit and Accounting Guide
Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in
Investment Companies” (“SOP 07-1”) was issued. SOP 07-1 addresses whether the accounting principles of the
Audit and Accounting Guide for Investment Companies may be applied to an entity by clarifying the definition of
an investment company and whether those accounting principles may be retained by a parent company in
consolidation or by an investor in the application of the equity method of accounting. SOP 07-1 eliminated the
previously existing exemption for REITs from being investment companies. Newcastle is currently evaluating the
potential impact upon adoption of SOP 07-1. If Newcastle, or any of its subsidiaries, are considered an investment
company under this new guidance, it would result in material changes to Newcastle’s financial statements. The
primary change would be the recording of all of Newcastle’s (or its subsidiaries’) investments at fair value, with
changes in fair value being recorded through the income statement. In October 2007, the FASB voted to
indefinitely postpone the adoption of SOP 07-1.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS 157 defines fair value as
the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants in the market in which the reporting entity transects, establishes a framework for measuring
fair value, and expands disclosures about fair value measurements. SFAS 157 applies to reporting periods
beginning after November 15, 2007. Newcastle adopted SFAS 157 on January 1, 2008. To the extent they are
measured at fair value, SFAS 157 did not materially change Newcastle’s fair value measurements for any of its
existing financial statement elements. SFAS 157 did change the reported fair value of Newcastle’s derivative
obligations, but this did not have a material effect on its liabilities or accumulated other comprehensive income.
As a result, except as described below, the adoption of SFAS 157 did not have a material impact on Newcastle’s
financial condition, liquidity or results of operations.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial
Liabilities.” SFAS 159 permits entities to choose to measure many financial instruments, and certain other items,
at fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate
comparisons between entities that choose different measurement attributes for similar types of assets and
liabilities. SFAS 159 applies to reporting periods beginning after November 15, 2007. Newcastle adopted SFAS
159 on January 1, 2008. Newcastle did not elect to measure any items at fair value pursuant to the provisions of
SFAS 159. As a result, the adoption of SFAS 159 did not have a material impact on Newcastle’s financial
condition, liquidity or results of operations.
In February 2008, the FASB issued FASB Staff Position No. FAS 140-3 (“FSP FAS 140-3”), “Accounting for
Transfers of Financial Assets and Repurchase Financing Transactions.” FSP FAS 140-3 provides guidance on
accounting for a transfer of a financial asset and a repurchase financing. It presumes that an initial transfer of a
financial asset and a repurchase financing are considered part of the same arrangement (a linked transaction)
unless certain criteria are met. If the criteria are not met, the linked transaction would be recorded as a net
investment, likely as a derivative, instead of recording the purchased financial asset on a gross basis along with a
repurchase financing. FSP FAS 140-3 applies to reporting periods beginning after November 15, 2008 and is only
applied prospectively to transactions that occur on or after the adoption date. As a result of the prospective nature
of the adoption, Newcastle does not expect the adoption of FSP FAS 140-3 to have a material impact on its
financial condition, liquidity or results of operations, unless Newcastle enters into transactions of this type after
January 1, 2009.
76
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
3.
INFORMATION REGARDING BUSINESS SEGMENTS AND UNCONSOLIDATED SUBSIDIARIES
Newcastle conducts its business through three primary segments: real estate securities and real estate related
loans, residential mortgage loans and operating real estate. Details of Newcastle’s investments in such segments
can be found in Notes 4, 5 and 6.
The residential mortgage loans segment includes the securitized retained equity and bonds from Securitization
Trust 2006 and Securitization Trust 2007 described in Note 5 since they represent first loss credit positions in
residential loans.
The unallocated portion consists primarily of interest on short term investments, general and administrative
expenses, interest expense on the credit facility and junior subordinated notes payable and management fees and
incentive compensation 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:
December 31, 2007 and the Year then Ended
Gross revenues
Operating expenses
Operating income (loss)
Interest expense
Loss on extinguishment of debt
Other-than-temporary impairment
Depreciation and amortization
Equity in earnings of unconsolidated subsidiaries
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss)
Preferred dividends
Real Estate
Securities and
Real Estate
Related Loans
Residential
Mortgage
Loans
Operating
Real Estate
Unallocated
Total
$ 531,177 $ 148,435 $ 6,709
(5,695)
(23,091)
(4,390)
1,014
125,344
526,787
(56)
(92,933)
(373,835)
-
-
(15,032)
-
(15,760)
(186,842)
(1,121)
-
-
2,404
-
2,978
2,241
16,651
(45,944)
(23)
-
-
2,218
16,651
(45,944)
-
-
-
$ 1,736
(29,671)
(27,935)
(10,164)
-
-
(291)
8
(38,382)
-
(38,382)
(12,640)
$ 688,057
(62,847)
625,210
(476,988)
(15,032)
(202,602)
(1,412)
5,390
(65,434)
(23)
(65,457)
(12,640)
Income (loss) applicable to common stockholders
$
(45,944)
$
16,651
$
2,218
$
(51,022)
$
(78,097)
Revenue derived from non-US sources:
Canada
Total assets
Long-lived assets outside the US:
Canada
December 31, 2006 and the Year then Ended
Gross revenues
Operating expenses
Operating income (loss)
Interest expense
Loss on extinguishment of debt
Depreciation and amortization
Equity in earnings of unconsolidated subsidiaries
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss)
Preferred dividends
Income (loss) available for common stockholders
Revenue derived from non-US sources:
Canada
Total assets
Long-lived assets outside the US:
Canada
$ - $ - $ 3,117
$ - $ 3,117
$ 6,823,061
$ 1,103,321
$ 53,065
$ 58,323
$ 8,037,770
$ - $ - $ 21,438
$ - $ 21,438
$ 441,965 $ 105,621 $ 5,117
(4,059)
(17,844)
(2,961)
1,058
87,777
439,004
-
(66,181)
(296,368)
-
-
-
(812)
-
-
2,550
-
3,412
2,796
21,596
146,048
223
-
-
3,019
21,596
146,048
-
-
-
$
3,019
$
21,596
$
146,048
$ 564
(30,659)
(30,095)
(11,720)
(658)
(273)
6
(42,740)
-
(42,740)
(9,314)
$
(52,054)
$ 553,267
(55,523)
497,744
(374,269)
(658)
(1,085)
5,968
127,700
223
127,923
(9,314)
$
118,609
$ - $ - $ 3,671
$ - $ 3,671
$ 7,366,684 $ 1,179,547 $ 48,518
$ 9,643
$ 8,604,392
$ - $ - $ 16,553
$ - $ 16,553
77
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
Real Estate
Securities and
Real Estate
Related Loans
Residential
Mortgage
Loans
Operating
Real Estate
Unallocated
Total
December 31, 2005 and the Year then Ended
Gross revenues
Operating expenses
Operating income (loss)
Interest expense
Depreciation and amortization
Equity in earnings of unconsolidated subsidiaries (A)
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss)
Preferred dividends
Income (loss) available for common stockholders
Revenue derived from non-US sources:
Canada
Total assets
Long-lived assets outside the US:
Canada
(A) Net of income taxes on related taxable subsidiaries.
$ 321,889 $ 48,844 $ 6,772
(2,456)
(10,384)
(4,163)
4,316
38,460
317,726
(251)
(29,754)
(196,026)
(528)
-
-
2,281
-
3,328
5,818
8,706
125,028
2,108
-
-
7,926
8,706
125,028
-
-
-
$
7,926
$
8,706
$
125,028
$ 378,213
$ 708
(24,885) (41,888)
(24,177) 336,325
(415) (226,446)
(113) (641)
5,609
-
(24,705) 114,847
-
2,108
(24,705) 116,955
(6,684) (6,684)
110,271
$
(31,389)
$
$ - $ - $ 12,157
$ -
$ 12,157
$ 5,544,818 $ 606,320 $ 36,306
$ 22,255
$ 6,209,699
$ - $ - $ 16,673
$ -
$ 16,673
78
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
Unconsolidated Subsidiaries
Newcastle has four unconsolidated subsidiaries which it accounts for under the equity method.
The following table summarizes the activity for significant subsidiaries affecting the equity held by Newcastle in unconsolidated
subsidiaries:
Balance at December 31, 2005
Contributions to unconsolidated subsidiaries
Distributions from unconsolidated subsidiaries
Equity in earnings of unconsolidated subsidiaries
Balance at December 31, 2006
Contributions to unconsolidated subsidiaries
Distributions from unconsolidated subsidiaries
Equity in earnings of unconsolidated subsidiaries
Balance at December 31, 2007
Operating Real
Estate
Real Estate Loan
$ 12,151 $ 17,802
-
-
(11,041)
(2,173)
2,550
3,488
$ 12,528 $ 10,249
-
-
(2,612)
(1,541)
2,404
3,347
$ 10,984
$ 13,391
Summarized financial information related to Newcastle’s unconsolidated subsidiaries was as follows:
Operating
Real Estate (A)
December 31,
Real Estate Loan (B)
December 31,
2007
$ 79,213
2006
$ 78,381
2005
$ 77,758
2007
$ 22,093
2006
$ 20,615
2005
$ 35,806
(51,929) (52,856) (53,000) -
-
-
(502) (470) (455) (125)
(116) (202)
$ 26,782
$ 25,055
$ 24,303
$ 21,968
$ 20,499
$ 35,604
Assets
Liabilities
Minority interest
Equity
Equity held by Newcastle
$ 13,391
$ 12,528
$ 12,151
$ 10,984
$ 10,249
$ 17,802
(C)
Revenues
Expenses
Minority interest
Net income
2007
$ 8,273
2006
$ 8,626
2005
$ 10,196
2007
$ 6,755
2006
$ 7,048
2005
$ 6,738
(3,375) (3,430) (4,896) (23)
(32) (42)
(90) (96) (97) (38)
(40) (39)
$ 4,808
$ 5,100
$ 5,203
$ 6,694
$ 6,976
$ 6,657
Newcastle's equity in net income
$ 2,404
$ 2,550
$ 2,602
$ 3,347
$ 3,488
$ 3,328
The unconsolidated subsidiaries’ summary financial information above is presented on a fair value basis,
consistent with their internal basis of accounting.
(A) Included in the operating real estate segment.
(B) Included in the real estate securities and real estate related loans segment.
(C) As of December 31, 2007, $9.3 million of this investment represented Newcastle’s share of the investee’s
cash balance.
79
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
Operating Real Estate Subsidiary
In March 2004 Newcastle purchased a 49% interest in a portfolio of convenience and retail gas stores located
throughout the southeastern and southwestern regions of the U.S. The properties are subject to a sale-leaseback
arrangement under long term triple net leases with a 15 year minimum term. Newcastle structured this transaction
through a joint venture in two limited liability companies with a private investment fund managed by an affiliate of
its manager, pursuant to which such affiliate co-invested on equal terms. One company held assets available for
sale, the last of which was sold in September 2005, and one holds assets for investment. In October 2004, the
investment’s initial financing was refinanced with a nonrecourse term loan ($51.9 million outstanding at December
31, 2007), which bears interest at a fixed rate of 6.04% and matures in October 2014. Newcastle has no additional
capital commitment to the limited liability companies.
Real Estate Loan Subsidiary
In November 2003, Newcastle and a private investment fund managed by an affiliate of the Manager co-invested
and each indirectly own an approximately 38% interest in DBNC Peach Manager LLC, a limited liability company
that has acquired a pool of franchise loans collateralized by fee and leasehold interests and other assets from a third
party financial institution. The remaining approximately 24% interest in the limited liability company is owned by
the above-referenced third party financial institution. Newcastle has no additional capital commitment to the limited
liability company.
Each of these limited liability companies is an investment company and therefore maintains its financial records on
a fair value basis. Newcastle has retained such accounting relative to its investment in such limited liability
companies, which are accounted for under the equity method at fair value.
Trust Preferred Subsidiary
As of December 31, 2007, Newcastle’s investment in the Trust Preferred Subsidiary was $0.1 million. For
Information regarding the trust preferred subsidiary, which is a financing subsidiary with no material net income or
cash flow, see Note 8.
ABCP Subsidiary
As of December 31, 2007, Newcastle had no investment in this subsidiary. For information regarding the ABCP
Subsidiary, which is a financing subsidiary with no material net income or net cash flow, see Note 8.
80
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
4.
REAL ESTATE SECURITIES
The following is a summary of Newcastle’s real estate securities at December 31, 2007 and 2006, 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.
December 31, 2007
Asset Type
CMBS-Conduit
CMBS-Large Loan
CMBS-CDO
CMBS- B-Note
REIT Debt
ABS-Subprime
ABS-Manufactured Housing
ABS-Franchise
FNMA/FHLMC (A)
Subtotal/Average (B)
Retained Securities (C)
Residual Interests (C)
Total/Average
Outstanding
Face Amount
1,580,562
$
650,886
16,000
281,285
920,858
586,083
61,838
45,092
1,229,115
5,371,719
76,380
68,248
5,516,347
$
$
Amortized Cost
Basis
1,521,467
649,762
14,730
270,320
934,526
574,912
59,931
45,202
1,236,721
5,307,571
70,652
68,248
5,446,471
$
Gross Unrealized
Weighted Average
Other-Than-
Temporary-
Impairment (D)
Gains
$
$
$
(3,848)
(200)
(14,090)
-
(3,443)
(154,121)
-
-
(779)
(176,481)
(13,298)
(12,823)
(202,602)
4,771
333
-
1,405
4,535
-
88
-
10,971
22,103
-
-
22,103
Carrying Value
1,317,992
$
619,619
640
256,717
903,300
289,938
55,868
36,133
1,246,265
4,726,472
53,987
55,425
4,835,884
$
Number of
Securities
201
47
1
43
92
122
9
17
43
575
6
2
583
S&P
Equivalent
Rating
BBB
BBB-
CC+
BB+
BBB-
BB+
BBB-
BBB
AAA
BBB+
BBB
NR
BBB+
Coupon
5.89%
6.98%
10.60%
6.85%
6.33%
6.93%
6.68%
7.69%
5.30%
6.16%
7.32%
0.00%
6.10%
Yield
6.47%
6.58%
15.00%
7.30%
5.95%
7.38%
7.47%
7.35%
5.28%
6.24%
12.85%
20.00%
6.46%
Maturity
(Years)
6.6
2.6
-
5.2
5.1
3.7
5.3
4.9
3.3
4.7
7.3
7.1
4.7
Losses
(204,398)
(30,276)
-
(15,008)
(32,318)
(130,853)
(4,151)
(9,069)
(648)
(426,721)
(3,367)
-
(430,088)
$
$
$
(A) FNMA/FHLMC securities have an implied AAA rating.
(B) The total outstanding face amount of fixed rate securities was $4.4 billion, and of floating rate securities was $1.1 billion.
(C) Represents the retained bonds and equity from Securitization Trust 2006 and Securitization Trust 2007 as described in Note 5. These securities have been treated as part of the residential
mortgage loan segment - see Note 3. The residuals do not have stated coupons and therefore their coupons have been treated as zero for purposes of the table.
(D) Represents the cumulative write down against amortized cost basis through earnings.
Unrealized losses that are considered other-than-temporary are recognized currently in income. There were no such losses incurred during the years ended December 2006 or 2005. During the
year ended December 31, 2007, Newcastle recorded other-than-temporary impairment charges of $196.2 million relating to 49 subprime securities, 1 CDO security and 1 CMBS with an
aggregate face amount of $381.0 million at December 31, 2007. In addition, Newcastle recorded impairment in the fourth quarter of 2007 of $6.4 million related to sale of $255.6 face amount
of securities in the first quarter of 2008. Management closely monitors market valuations and, based on the results of recent market events, has considered that these securities are other-than-
temporarily impaired under the guidance provided by the FASB. The remaining unrealized losses on Newcastle’s securities are primarily the result of market factors, rather than credit
impairment, and Newcastle has performed credit analyses (described in Note 2) in relation to such securities which support its belief that the carrying values of such securities are fully
recoverable over their expected holding period.
Outstanding
Face Amount
Amortized Cost
Basis
Other-Than-
Temporary-
Impairment
Gains
Losses
Carrying Value
Number of
Securities
S&P
Equivalent
Rating
Coupon Yield
Maturity
(Years)
Gross Unrealized
Weighted Average
Securities in an Unrealized Loss Position
Less Than Twelve Months
Twelve or More Months
Total
$
$
1,754,151
1,688,613
3,442,764
$
$
1,704,633
1,679,613
3,384,246
-
$
-
$
-
-
$
-
$
-
$
$
(171,655)
(258,433)
(430,088)
81
$
$
1,532,978
1,421,180
2,954,158
191
211
402
BBB-
BBB+
BBB
6.51% 6.68%
5.90% 5.76%
6.21% 6.22%
5.3
5.4
5.4
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
December 31, 2006
Asset Type
Outstanding Face
Amount
$
$
Amortized Cost
Basis
1,421,069
712,655
20,820
270,257
1,017,280
76,347
713,135
76,264
1,182,946
5,490,773
44,930
5,535,703
$
1,469,298
714,617
23,500
282,677
1,004,540
80,839
729,292
76,777
1,177,779
5,559,319
44,930
5,604,249
Gross Unrealized
Weighted Average
Gains
Losses
$
$
Carrying Value
$
1,452,789
719,225
21,958
276,190
1,025,040
77,700
710,331
76,707
1,176,358
5,536,298
44,930
5,581,228
$
Number of
Securities
202
53
2
41
101
9
124
22
35
589
1
590
S&P
Equivalent
Rating
BBB
BBB-
BB
BB
BBB-
BBB-
BBB+
BBB
AAA
BBB+
NR
BBB+
Coupon
5.84%
6.85%
9.47%
6.85%
6.36%
6.68%
7.15%
7.28%
5.22%
6.20%
0.00%
6.15%
Yield
6.51%
7.02%
12.03%
7.51%
6.06%
7.79%
7.89%
8.21%
5.19%
6.50%
18.77%
6.60%
Maturity
(Years)
6.9
2.6
7.7
6.0
6.2
6.5
2.7
4.8
4.3
5.0
2.5
5.0
(9,745)
(421)
(127)
(208)
(11,163)
(391)
(7,481)
(1,270)
(8,732)
(39,538)
-
(39,538)
41,465
6,991
1,265
6,141
18,923
1,744
4,677
1,713
2,144
85,063
-
85,063
$
$
$
CMBS-Conduit
CMBS-Large Loan
CMBS-CDO
CMBS- B-Note
REIT Debt
ABS-Manufactured Housing
ABS-Subprime
ABS-Franchise
FNMA/FHLMC
Subtotal/Average (A)
Residual interest (B)
Total/Average
(A) The total outstanding face amount of fixed rate securities was $4.4 billion, and of floating rate securities was $1.2 billion.
(B) Represents the equity from Securitization Trust 2006 as described in Note 5. This security has been treated as part of the residential
mortgage loan segment - see Note 3. The residual does not have a stated coupon and therefore its coupon has been treated as zero for
purposes of the table.
The securities are encumbered by the CBO bonds payable and certain repurchase agreements (Note 8) at December
31, 2007.
As of December 31, 2007 and 2006, Newcastle had $48.5 million and $123.9 million of restricted cash, respectively,
held in CBO financing structures pending its investment in real estate securities and loans.
Newcastle may enter into short term warehouse agreements pursuant to which it makes deposits with major
investment banks for the right to purchase real estate securities and real estate related loans prior to their being
financed with CBOs. This type of warehouse agreement is treated as a non-hedge derivative for accounting purposes
and is therefore marked to market through current income. No income related to these agreements was recorded in
2007 or 2006 and the income recorded on these agreements was approximately $2.4 million in 2005.
82
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
5. 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.
The loans contain various terms, including fixed and floating rates, self-amortizing and interest only. They are
generally subject to prepayment.
December 31, 2007
December 31, 2006
Loan Type
Mezzanine Loans (A)
Corporate Bank Loans
B-Notes
Whole Loans
ICH Loans
Total Real Estate Related
Loans (B)
Residential Loans
Manufactured Housing
Loans
Total Residential
Mortgage Loans
Outstanding
Face Amount
$
805,460
464,916
397,897
114,935
84,516
$
Carrying Value
(C)
801,678
460,622
396,477
113,784
84,417
Loan
Count
22
15
15
5
46
Wtd. Avg.
Yield
8.44%
7.99%
7.70%
10.28%
7.57%
$
1,867,724
$
1,856,978
$
102,431
$
104,630
103
328
8.24%
5.67%
542,125
529,975
15,684
8.60%
$
644,556
$
634,605
16,012
8.11%
Subprime Mortgage Loans
subject to Call Option (F)
$
406,217
$
393,899
Weighted
Average
Maturity
(Years) (D)
1.9
3.6
1.8
1.4
0.3
Delinquent
Carrying
Amount (E)
$
0
0
0
0
0
Outstanding
Face Amount
$
906,907
233,793
248,240
61,240
123,390
$
Carrying Value
(C)
904,686
233,895
246,798
61,703
121,834
2.2
2.8
6.1
5.5
$
0
$
1,573,570
$
1,568,916
$
4,048
$
168,649
$
172,839
5,005
643,912
636,258
$
9,053
$
812,561
$
809,097
(A) One of these loans has an $8.9 million contractual exit fee which Newcastle will begin to accrue when
management believes it is probable that such exit fee will be received.
(B) Loans which are more than 3% of the total current carrying value at December 31, 2007 (or $56 million) are
as follows:
Individual Mezzanine Loan
$
87,664
$
87,664
Individual Bank Loan
Individual Bank Loan
Individual Mezzanine Loan
Individual Mezzanine Loan
Individual B-Note
Individual Mezzanine Loan
Others
67,000
73,000
70,000
61,720
60,539
59,651
67,005
73,000
70,000
61,662
60,539
59,651
1,388,150
1,377,457
$
1,867,724
$
1,856,978
96
103
1
1
1
1
1
1
1
7.10%
6.70%
7.45%
7.60%
16.30%
7.23%
7.54%
8.18%
8.24%
3.3
6.7
3.5
1.0
0.1
0.7
0.3
2.2
2.2
(C) The aggregate United States federal income tax basis for such assets at December 31, 2007 was
approximately equal to their book basis except for the securitized subprime mortgage loans which are fully
consolidated for tax purposes.
(D) The weighted average maturities for the residential loan portfolio and the two manufactured housing loan
portfolios were calculated based on constant prepayment rates (CPR) of approximately 30%, 8% and 9%,
respectively.
(E) This face amount of loans is 60 or more days past due, in foreclosure or real estate owned, representing 4.2%
and 0.9% of the total outstanding face amount of the Residential Loans and the Manufactured Housing
Loans, respectively.
(F) See below.
Newcastle has determined that a whole loan and a corporate bank loan with face amounts of $25.0 million and
$4.3 million, respectively, were held for sale at December 31, 2007. As a result, Newcastle marked these loans to
the lower of cost or market value, resulting in a loss of $1.5 million for the year ended December 31, 2007.
83
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
The following is a reconciliation of loss allowance:
Real Estate Related
Loans
Residential Mortgage
Loans
Balance at December 31, 2005
$
(4,226)
$
(3,207)
Provision for credit losses
Realized losses
(1,154)
3,230
(8,284)
4,235
Balance at December 31, 2006
$
(2,150)
$
(7,256)
Provision for credit losses
Realized losses
(700)
2,250
(9,694)
10,033
Balance at December 31, 2007
$
(600)
$
(6,917)
Newcastle has entered into total rate of return swaps with major investment banks to finance certain loans
whereby Newcastle receives the sum of all interest, fees and any positive change in value amounts (the total
return cash flows) from a reference asset with a specified notional amount, and pays interest on such notional plus
any negative change in value amounts from such asset. These agreements are recorded in Derivative Assets or
Liabilities (as applicable) and treated as non-hedge derivatives for accounting purposes and are therefore marked
to market through income. Net interest received is recorded to Interest Income and the mark to market is
recorded to Other Income. If Newcastle owned the reference assets directly, they would not be marked to market
through income. Under the agreements, Newcastle is required to post an initial margin deposit to an interest
bearing account and additional margin may be payable in the event of a decline in value of the reference asset.
Any margin on deposit (recorded in Restricted Cash), less any negative change in value amounts, will be returned
to Newcastle upon termination of the contract.
As of December 31, 2007, Newcastle held an aggregate of $252.7 million notional amount of total rate of return
swaps on 8 reference assets, including an unfunded asset with a notional amount of $38.1 million, on which it had
deposited $43.9 million of margin. These total rate of return swaps had an aggregate fair value of approximately
($8.8 million), a weighted average receive interest rate of LIBOR +2.77%, a weighted average pay interest rate of
LIBOR +0.59%, and a weighted average swap maturity of 0.5 years.
The average carrying amount of Newcastle’s real estate related loans was approximately $1.97 billion, $995.8
million and $594.1 million during 2007, 2006 and 2005, respectively, on which Newcastle earned approximately
$69.2 million, $67.3 million and $54.7 million of gross revenues, respectively.
The average carrying amount of Newcastle’s residential mortgage loans was approximately $701.2 million,
$783.2 million and $764.2 million during 2007, 2006 and 2005, respectively, on which Newcastle earned
approximately $148.4 million, $105.6 million and $48.8 million of gross revenues, respectively.
The loans are encumbered by various debt obligations as described in Note 8.
Real estate owned (“REO”) as a result of foreclosure on loans is included in Receivables and Other Assets, and is
recorded at the lower of cost or fair value. No material REO was owned as of December 31, 2007 or 2006.
Securitization of Subprime Mortgage Loans
Subprime Portfolio I
In March 2006, Newcastle, through a consolidated subsidiary, acquired a portfolio of approximately 11,300
residential mortgage loans, predominantly originated in 2005, to subprime borrowers (“Subprime Portfolio I”) for
$1.50 billion. The loans are being serviced by Nationstar Mortgage, LLC, an affiliate of the Manager, for a
servicing fee equal to 0.50% per annum on the unpaid principal balance of Subprime Portfolio I.
At March 31, 2006, these loans were considered “held for sale” and carried at the lower of cost or fair value. A
write down of $4.1 million was recorded to Provision for Losses, Loans Held for Sale in March 2006 related to
these loans, related to market factors. Furthermore, the acquisition of loans held for sale is considered an
operating activity for statement of cash flow purposes. An offsetting cash inflow from the sale of such loans (as
described below) was recorded as an operating cash flow in April 2006. This acquisition was initially funded
with a repurchase agreement which bore interest at LIBOR + 0.50%. Newcastle entered into an interest rate swap
84
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
in order to hedge its exposure to the risk of changes in market interest rates with respect to the financing of
Subprime Portfolio I. This swap did not qualify as a hedge for accounting purposes and was therefore marked to
market through income. An unrealized mark to market gain of $5.5 million was recorded to Other Income in
connection with this swap in March 2006.
In April 2006, Newcastle, through Newcastle Mortgage Securities Trust 2006-1 (“Securitization Trust 2006”),
closed on a securitization of Subprime Portfolio I. Securitization Trust 2006 is not consolidated by Newcastle.
Newcastle sold Subprime Portfolio I and a related interest rate swap to Securitization Trust 2006. Securitization
Trust 2006 issued $1.45 billion of notes. Newcastle retained $37.6 million face amount of the low investment
grade notes and all of the equity issued by Securitization Trust 2006. The notes have a stated maturity of March
2036. Newcastle, as holder of the equity of Securitization Trust 2006, has the option to redeem the notes once the
aggregate principal balance of Subprime Portfolio I is equal to or less than 20% of such balance at the date of the
transfer. The proceeds from the securitization were used to repay the repurchase agreement which financed
Subprime Portfolio I prior to the securitization.
The key assumptions utilized in measuring the $62.4 million fair value of the equity, or residual interest, in the
Securitization Trust at the date of securitization were as follows:
Weighted average life (years) of residual interest
Expected credit losses
Weighted average constant prepayment rate
Discount rate
3.1
5.3%
28.0%
18.8%
The transaction between Newcastle and Securitization Trust 2006 qualified as a sale for accounting purposes,
resulting in a net gain of approximately $40,000 being recorded in April 2006. However, 20% of the loans which
are subject to a call option by Newcastle were not treated as being sold and are classified as “held for investment”
subsequent to the completion of the securitization.
Subprime Portfolio II
In March 2007, Newcastle entered into an agreement to acquire a portfolio of approximately 7,300 residential
mortgage loans to subprime borrowers (“Subprime Portfolio II”) for up to $1.7 billion of unpaid principal
balance. Following its due diligence review, Newcastle funded $1.3 billion or approximately 75% of the original
commitment. The agreement between the seller and Newcastle required the seller to repurchase any delinquent
loans for three months following Newcastle’s acquisition. The loans are being serviced by Nationstar Mortgage
LLC, an affiliate of the Manager, for a servicing fee equal to 0.50% per annum on the unpaid principal balance of
the Subprime Portfolio II.
At June 30, 2007, these loans were considered “held for sale” and carried at the lower of cost or fair value. A
write down of $5.8 million due to changes in market interest rates was recorded to Provisions for Losses, Loans
Held for Sale in June 2007 related to these loans. This acquisition was initially funded with a repurchase
agreement which bore interest at LIBOR + 0.60%. Newcastle entered into an interest rate swap in order to hedge
its exposure to the risk of changes in market interest rates with respect to Subprime Portfolio II. In April 2007,
this swap was de-designated as a hedge for accounting purposes and a non-hedge derivative gain of $5.8 million
was recorded to Other Income in the second quarter of 2007. The swap was terminated in June 2007.
In July 2007, Newcastle, through Newcastle Mortgage Securities Trust 2007-1 (“Securitization Trust 2007”),
closed on a securitization of Subprime Portfolio II. As a result of the repurchase of delinquent loans by the seller,
as well as borrower repayments, the unpaid principal balance of the portfolio upon securitization in July 2007 was
$1.1 billion. Securitization Trust 2007 is not consolidated by Newcastle. Newcastle sold Subprime Portfolio II to
Securitization Trust 2007. Securitization Trust 2007 issued $1.02 billion face amount of notes and entered into an
interest rate swap agreement to hedge its exposure to the risk of changes in market interest rates. Newcastle
retained $38.8 million face amount of the investment grade notes and all of the equity issued by Securitization
Trust 2007. The notes have a stated maturity of April 2037. Newcastle, as holder of the equity of Securitization
Trust 2007, has the option to redeem the notes once the aggregate principal balance of Subprime Portfolio II is
equal to or less than 10% of such balance at the date of the transfer. The proceeds from the securitization were
used to repay the repurchase agreement which financed Subprime Portfolio II prior to the securitization.
The transaction between Newcastle and Securitization Trust 2007 qualified as a sale for accounting purposes,
resulting in a gain in the amount of $0.1 million recorded to earnings in July 2007. However, 10% of the loans
which are subject to call option by Newcastle were not treated as being sold and are classified as “held for
investment” subsequent to the completion of the securitization.
85
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
At securitization, the key assumptions utilized in measuring the $46.7 million fair value of the equity, or residual
interest, to call date in the Securitization Trust 2007 were as follows:
Weighted average life (years) of residual interest
Expected credit losses
Weighted average constant prepayment rate
Discount rate
3.8
8.0%
30.1%
22.5%
The weighted average yield of the $38.8 million face amount of retained notes was 10.6% as of the date of
securitization. The loans subject to call option and the corresponding financing will recognize interest income and
expense based on the expected weighted average coupon of the loans subject to call option at the call date.
In both transactions, the residual interests and the retained bonds are reported as real estate securities, available
for sale. The retained loans subject to call option and corresponding financing are reported as separate line items
on Newcastle’s balance sheet.
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 presents information on the retained interests in securitizations of Subprime Portfolios I and
II, which includes the residual interests and the retained notes described above, and the sensitivity of their fair
value to call date for immediate 10% and 20% adverse changes in the assumptions utilized in calculating such fair
value, at December 31, 2007:
Total securitized loans (unpaid principal balance) (A)
Loans subject to call option (carrying value)
Retained interests (fair value) (B)
Subprime Portfolio
I
$
$
$
898,456
291,280
48,964
II
$
1,019,905
$
102,619
$
60,448
Weighted average life (years) of residual interest
6.5
7.5
Weighted average expected credit losses (C)
Effect on fair value of retained interests of 10% adverse change
Effect on fair value of retained interests of 20% adverse change
$
$
7.5%
(5,809)
(11,696)
$
$
13.7%
(11,895)
(17,350)
Weighted average constant prepayment rate (D)
Effect on fair value of retained interests of 10% adverse change
Effect on fair value of retained interests of 20% adverse change
$
$
21.9%
(2,470)
(5,934)
$
$
19.7%
(8,152)
(9,863)
Weighted average discount rate
Effect on fair value of retained interests of 10% adverse change
Effect on fair value of retained interests of 20% adverse change
$
$
14.1%
(1,657)
(3,212)
$
$
15.1%
(8,672)
(10,300)
(A) Average loan seasoning of 28 months and 11 months for Subprime Portfolios I and II, respectively, at December 31, 2007.
(B) The retained interests include residual interests and retained bonds of the securitizations. Their fair value is estimated based on pricing
models.
(C) Represents the percentage of losses on the original principal balance of the loans at the time of securitization (April 2006 and July 2007)
to the maturity of the loans.
(D) Represents the weighted average voluntary prepayment rate for the loans from the date of securitization to maturity of such loans.
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% or 20% 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.
86
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
The following table summarizes certain characteristics of the underlying loans in the securitizations as of
December 31, 2007:
Loan unpaid principal balance (UPB)
Delinquencies of 60 or more days (UPB)
Net credit losses for year ended
December 31, 2007
December 31, 2006
Cumulative net credit losses
Cumulative net credit losses as a % of original UPB
Percentage of ARM loans (A)
Percentage of loans with loan-to-value ratio >90%
Percentage of interest-only loans
Subprime Portfolio
I
$
$
898,456
117,270
II
$
1,019,905
$
40,914
$
$
$
3,514
57
3,571
0.24%
61.9%
10.3%
28.4%
-
$
N/A
-
$
0.00%
69.5%
17.5%
4.5%
(A) 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 an option ARM.
Delinquencies include loans 60 or more days past due, in foreclosure or real estate owned, representing 13.1%
and 4.0% of the total unpaid principal balance of Subprime Portfolios I and II, respectively.
Cash flows related to the two securitizations were as follows:
Year Ended December 31, 2007
Proceeds from securitization
Net cash inflows from retained interests
Year Ended December 31, 2006
Proceeds from securitization
Net cash inflows from retained interests
Suprime Portfolio
I
II
N/A
$
23,670
$
$
969,747
15,293
$
$
1,411,530
28,511
N/A
N/A
The weighted average yields of the retained notes of Subprime Portfolios I and II were 11.2% and 15%,
respectively, as of December 31, 2007. 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 Portfolios I and II, respectively.
In December 2007, the American Securitization Forum (“ASF”) issued the “Streamlined Foreclosure and Loss
Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans” (the “ASF Framework”). The
ASF Framework provides guidance for servicers to streamline borrower evaluation procedures and to facilitate
the use of foreclosure and loss prevention efforts in an attempt to reduce the number of U.S. subprime residential
mortgage borrowers who might default in the coming year because the borrowers cannot afford to pay the
increased interest rate after their variable loan rate resets. The ASF Framework is focused on U.S. subprime first-
lien adjustable-rate residential mortgages that have an initial fixed interest rate period of 36 months or less, are
included in securitized pools, were originated between January 1, 2005 and July 31, 2007, and have an initial
interest rate reset date between January 1, 2008 and July 31, 2010.
The ASF Framework requires a borrower to meet specific conditions, primarily related to the ability of the
borrower to meet the initial terms of the loan and obtain refinancing, to qualify for a fast track loan modification
under which the qualifying borrower’s interest rate will be kept at the existing initial rate, generally for five years
following the upcoming reset. To qualify for fast-track modification, a loan must currently be no more than 30
days delinquent and no more than 60 days delinquent in the past 12 months, have a loan-to-value ratio greater
than 97%, be subject to payment increases greater than 10% upon reset, and be for the primary residence of the
borrower.
In January 2008, the SEC’s Office of Chief Accountant (the “OCA”) issued a letter (the “OCA Letter”)
addressing accounting issues that may be raised by the ASF Framework. The OCA Letter expressed the view that
if a qualifying subprime loan is modified pursuant to the ASF Framework and that loan could legally be modified,
87
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
the OCA will not object to the continued status of the transferee as a QSPE under SFAS 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, because it would be reasonable to
conclude that defaults on such loans are “reasonably foreseeable” in the absence of any modification.
The servicer for Subprime Portfolios I and II may make loan modifications in accordance with the ASF
Framework in 2008, but Newcastle does not expect any such modifications to have a material effect on its
accounting for its subprime mortgage loans subject to call options or its retained interests in the securitizations of
Subprime Portfolios I and II. Furthermore, Newcastle does not expect that the ASF Framework will affect the off
balance sheet treatment of the securitizations of Subprime Portfolios I and II.
6. OPERATING REAL ESTATE
The following is a reconciliation of operating real estate assets and accumulated depreciation:
Operating Real Estate
Balance at December 31, 2005
Foreclosed loans
Improvements
Foreign currency translation
Fully depreciated assets
Depreciation
Balance at December 31, 2006
Improvements
Foreign currency translation
Fully depreciated assets
Depreciation
Balance at December 31, 2007
Gross
Accumulated
Depreciation
Net
$ 20,209 $ (3,536)
12,486
1,301
(32)
(150)
-
$ 16,673
- 12,486
- 1,301
7 (25)
150
-
(809) (809)
$ 33,814 $ (4,188)
$ 29,626
3,123
3,462
-
-
- 3,123
2,794
(668)
-
-
(1,144) (1,144)
$ 40,399 $ (6,000)
$ 34,399
During the periods presented, Newcastle’s operating real estate was comprised of Canadian properties, Belgian
properties, foreclosed domestic properties and an investment in an unconsolidated subsidiary which owns
domestic properties.
The following is a schedule of the future minimum rental payments to be received under non-cancelable operating
leases:
2008
2009
2010
2011
2012
$
3,460
2,832
2,632
2,264
701
11,889
$
In March 2005, Newcastle closed on the sale of a property in the Canadian portfolio and recorded a gain of
approximately $0.4 million, net of $0.9 million of prepayment penalties on the related debt.
In June 2005, Newcastle closed on the sale of a property in the Canadian portfolio and recorded a gain (net of
Canadian taxes) of approximately $0.9 million, net of $2.1 million of prepayment penalties on the related debt.
In June 2005, Newcastle closed on the sale of the last property in the Belgian portfolio and recorded a loss of
approximately $0.7 million.
Pursuant to SFAS No. 144, Newcastle has retroactively recorded the operations, including the gain or loss, of all
sold or “held for sale” properties in Income from Discontinued Operations for all periods presented.
88
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
The following table summarizes the financial information for the discontinued operations:
Year Ended December 31,
2007
2006
2005
Interest and other income
$
17
$
18
$
4,744
Net gain on sale
Gross revenues
Interest expense
Other expenses
Net income
56
73
-
96
419
437
-
214
780
5,524
804
2,612
$
(23)
$
223
$
2,108
No income tax related to discontinued operations was recorded for the years ended December 31, 2007, 2006 or 2005.
The following table sets forth certain information regarding the operating real estate portfolio:
Type of Property
Location
Net Rentable
Sq. Ft. (A) Acquisition Date
Year Built/
Renovated
(A)
Canada Portfolio
Office Building
Ohio Portfolio
Office Building
Office Building
Office Building
Retail
Office Building
Office Building
London, ON
303,082
Oct 98
Beavercreek, OH
Beavercreek, OH
Beavercreek, OH
Dayton, OH
Vandalia, OH
Dayton, OH
56,659
29,916
45,299
33,485
46,614
46,627
Mar 06
Mar 06
Mar 06
Mar 06
Mar 06
Mar 06
1982
1986
1986
1986
1989
1987
1985
December 31, 2007
Portfolio
Initial Cost (B)
Costs Capitalized
Subsequent to
Acquisition (B)
Gross
Carrying
Amount
Accumulated
Depreciation
Net Carrying
Value (C)
Occupancy
(A)
Canada Portfolio
Ohio Portfolio
$
23,033
12,486
$
3,547
1,333
$
26,580
13,819
$
(5,142)
(858)
$
21,438
12,961
65.5%
65.0%
No encumbrances were recorded as of December 31, 2007.
(A) Unaudited.
(B) For the Canada portfolio, adjusted for changes in foreign currency exchange rates, which aggregated $3.5 million of gain and
an immaterial amount of gain between land, building and improvements in 2007 and 2006, respectively.
(C) The aggregate United States federal income tax basis for such assets at December 31, 2007 was equal to its net carrying value.
89
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values for a majority of Newcastle’s investments are readily obtainable through broker quotations. For
certain of Newcastle’s financial instruments, fair values are not readily available since there are no active trading
markets as characterized by current exchanges between willing parties or due to market conditions. Accordingly,
fair values can only be derived or estimated for these instruments using various valuation techniques, such as
computing the present value of estimated future cash flows using discount rates commensurate with the risks
involved. However, the determination of estimated future cash flows is inherently subjective and imprecise. It
should be noted that minor changes in assumptions or estimation methodologies can have a material effect on
these derived or estimated fair values, and that the fair values reflected below are indicative of the interest rate
and credit spread environments as of December 31, 2007 and do not take into consideration the effects of
subsequent interest rate or credit spread fluctuations.
The carrying values and estimated fair values of Newcastle's financial instruments at December 31, 2007 and
2006 were as follows:
December 31, 2007
December 31, 2006
Principal Balance or
Notional Amount
Carrying Value
Estimated Fair
Value
Carrying Value
Estimated Fair
Value
Assets:
Real estate securities, available for sale
Real estate related loans
Residential mortgage loans
Subprime mortgage loans subject to future repurchase
Interest rate caps, treated as hedges (A)
Total return swaps (A)
$
5,516,347
1,867,724
644,556
406,217
-
252,691
$
4,835,884
1,856,978
634,605
393,899
-
(8,807)
$
4,835,884
1,768,570
631,327
393,899
-
(8,807)
$
5,581,228
1,568,916
809,097
288,202
1,262
1,288
$
5,581,228
1,571,412
829,980
288,202
1,262
1,288
Liabilities:
CBO bonds payable
Other bonds payable
Notes payable
Repurchase agreements
Repurchase agreements subject to ABCP
Financing of subprime mortgage loans subject to
future repurchase
Credit facility
Junior subordinated notes payable
Interest rate swaps, treated as hedges (B)
Non-hedge derivative obligations (C)
4,730,528
549,303
-
1,634,362
-
406,217
-
100,100
3,101,736
1,115,513
4,716,535
546,798
-
1,634,362
-
393,899
-
100,100
112,693
7,897
4,075,149
539,128
-
1,633,285
-
393,899
-
88,863
112,693
7,897
4,313,824
675,844
128,866
760,346
1,143,749
288,202
93,800
100,100
(42,887)
360
4,369,540
676,512
128,866
760,346
1,143,749
288,202
93,800
101,629
(42,887)
360
(A) Included in Derivative Assets or Liabilities, as applicable. A positive number represents an asset. The longest cap maturity is March
2009. The longest total rate of return swap maturity is February 2009.
(B) Included in Derivative Assets or Liabilities, as applicable. A positive number represents a liability. The longest swap maturity is
November 2017.
(C) Included in Derivative Assets or Liabilities, as applicable. A positive number represents a liability. The longest maturity is July 2038.
90
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
The methodologies used and key assumptions made to estimate fair value are as follows:
Real Estate Securities, Available for Sale ⎯ The fair value of these securities is estimated by obtaining third
party broker quotations, if available and practicable, counterparty quotations, and pricing models. A face amount
of approximately $378.1 million of securities or 6.8% of the total face amount of Newcastle’s real estate
securities portfolio was valued at $177.5 million using pricing models. Inputs for Newcastle’s pricing models
include discount rates, assumptions for prepayments, default rates, and severities, as well as other variables.
Real Estate Related Loans ⎯ The ICH loans were valued by discounting expected future cash flows by applying
an applicable spread over the benchmark rate. The rest of the loans were valued by obtaining third party broker
quotations, if available and practicable, and counterparty quotations.
Residential Mortgage Loans ⎯ These loans were valued by discounting expected future cash flows based on
current market interest rates and credit spreads.
Subprime Mortgage Loans Subject to Future Repurchase and related Financing—These two items, related to
the securitization of subprime mortgage loans, are equal and offsetting. They are further described in Note 5.
Interest Rate Cap and Swap Agreements, Total Rate of Return Swaps and Non-Hedge Derivative
Obligations ⎯ The fair value of these agreements is estimated by obtaining counterparty quotations. The total
rate of return swaps are more fully described in Note 5.
CBO Bonds Payable ⎯ These bonds were valued based on broker quotations, representing the discounted
expected future cash flows at a yield which reflects current market interest rates and credit spreads.
Other Bonds Payable ⎯ These bonds were valued by discounting expected future cash flows by a rate calculated
based on current market conditions for comparable financial instruments, including market interest rates and
credit spreads.
Repurchase Agreements ⎯ These agreements were valued by reference to current market interest rates and
credit spreads.
Junior Subordinated Notes Payable— These notes were valued by discounting expected future cash flows by a
rate calculated based on current market conditions for comparable financial instruments, including market interest
rates and credit spreads.
91
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
8. DEBT OBLIGATIONS
The following table presents certain information regarding Newcastle’s debt obligations and related hedges:
Outstanding
Face
Amount
Carrying
Value
Unhedged
Weighted
Average
Funding Cost (1)
Final Stated
Maturity
Weighted
Average
Funding
Cost (2)
Weighted
Average
Maturity
(Years)
Face
Amount
of Floating Rate
Debt
Collateral
Amortized
Cost Basis (3)
Collateral
Weighted
Average
Maturity
(Years)
Face
Amount
of
Floating Rate
Collateral (3)
Aggregate
Notional
Amount of
Current Hedges
Current
Face
Amount
Carrying
Value
December 31, 2007
December 31, 2006
Debt Obligation/Collateral
CBO Bonds Payable (13)
Portfolio I (4)
Portfolio II
Portfolio III
Portfolio IV
Portfolio V
Portfolio VI
Portfolio VII
Portfolio VIII
Portfolio IX
Portfolio X
Portfolio XI
Other Bonds Payable
ICH loans
Manufactured housing loans
Manufactured housing loans
Notes Payable
Residential mortgage loans
Repurchase Agreements (5) (6)
Other real estate securities (12)
Real estate related loans
Residential mortgage loans
FNMA/FHLMC securities (7)
Corporate
Credit facility
Junior subordinated notes payable
Subtotal debt obligations
Financing on subprime mortgage
loans subject to call option (11)
Total debt obligations
Month
Issued
Jul 1999
Apr 2002
Mar 2003
Sep 2003
Mar 2004
Sep 2004
Apr 2005
Dec 2005
Nov 2006
May 2007
Jul 2007
Aug 1998
Jan 2006
Aug 2006
$
331,228
-
-
-
414,000
454,500
447,000
442,800
807,500
585,750
1,247,750
$
329,229
-
-
-
411,527
451,651
443,392
439,276
806,927
587,214
1,247,319
4,730,528
4,716,535
66,173
184,817
298,313
549,303
66,173
184,117
296,508
546,798
5.83%
0.00%
0.00%
0.00%
5.18%
5.14%
4.93%
4.98%
5.08%
4.99%
4.92%
Jul 2038
Repaid
Repaid
Repaid
Mar 2039
Sep 2039
Apr 2040
Dec 2050
Nov 2052
May 2052
Jul 2052
6.89%
LIBOR+1.25%
LIBOR+1.25%
Aug 2030
Jan 2009
Aug 2011
6.42%
0.00%
0.00%
0.00%
5.05%
5.15%
5.20%
5.42%
5.33%
5.24%
5.40%
5.37%
6.89%
6.10%
7.02%
6.69%
Nov 2004
-
-
Repaid
-
Rolling
Rolling
Rolling
Rolling
May 2006
Mar 2006
106,026
240,724
81,523
428,273
1,206,089
1,634,362
-
100,100
100,100
106,026
240,724
81,523
428,273
1,206,089
1,634,362
-
100,100
100,100
7,014,293
6,997,795
LIBOR+1.26%
LIBOR+0.74%
LIBOR+0.60%
Jan 2008
Various (9)
Jan 2008
LIBOR+0.01%
Various (8)
LIBOR+1.60%
7.57% (10)
Terminated
Apr 2036
5.86%
5.38%
5.20%
5.46%
4.83%
5.00%
6.20%
7.71%
7.71%
5.42%
(11)
406,217
393,899
$
7,420,510
$
7,391,694
1.3
-
-
-
4.6
5.2
6.2
7.5
6.1
5.8
7.1
5.9
0.2
1.0
2.7
1.8
-
0.1
0.8
0.1
0.5
0.2
0.3
-
28.3
28.3
$
236,228
-
-
-
382,750
442,500
439,600
436,800
799,900
585,750
1,247,750
$
460,821
-
-
-
448,960
500,178
472,400
495,845
791,453
807,634
1,331,271
4,571,278
5,308,562
-
184,817
298,313
483,130
84,417
204,781
325,194
614,392
-
-
106,026
240,724
81,523
428,273
1,206,089
1,634,362
-
-
-
22,970
311,134
104,630
438,734
1,235,942
1,674,676
-
-
-
3.1
-
-
-
4.5
4.8
5.5
6.9
3.8
2.8
5.2
4.5
0.3
6.5
5.7
5.3
-
3.1
1.4
2.8
1.9
3.3
2.9
-
-
-
-
$
-
-
-
202,039
230,380
195,383
121,185
592,207
609,360
310,842
-
$
-
-
-
177,300
208,960
242,620
341,506
161,655
91,979
1,003,394
$
398,366
444,000
472,000
460,000
414,000
454,500
447,000
442,800
807,500
-
-
$
395,646
441,660
468,944
456,250
411,014
451,137
442,870
438,894
807,409
-
-
2,261,396
2,227,414
4,340,166
4,313,824
-
3,482
56,531
60,013
-
172,897
295,771
468,668
101,925
213,172
364,794
679,891
101,925
211,738
362,181
675,844
-
-
128,866
128,866
68,807
311,219
102,431
482,457
-
482,457
-
-
-
-
-
-
-
405,654
405,654
-
-
-
181,059
553,944
25,343
760,346
1,143,749
1,904,095
93,800
100,100
193,900
181,059
553,944
25,343
760,346
1,143,749
1,904,095
93,800
100,100
193,900
4.6
$
6,688,770
$
7,597,630
4.3
$
2,803,866
$
3,101,736
7,246,918
7,216,529
299,176
288,202
$
7,546,094
$
7,504,731
(1) Weighted average, including floating and fixed rate classes and excluding the amortization of deferred financing costs.
(2) Including the effect of applicable hedges.
(3) Including restricted cash held in CBOs.
(4) The notional amount of current hedges excludes a swap with a notional amount of $229.9 million which was de-designated as an accounting hedge at December 31, 2007.
(5) Subject to potential mandatory prepayments based on collateral value.
(6) The counterparties on our repurchase agreements include: Bear Stearns ($628.1 million), Lehman Brothers ($485.7 million), JP Morgan ($280.8 million), Deutsche Bank ($137.0 million), Credit Suisse ($62.8 million) and other ($40.0 million).
(7) Aggregate notional amount of current hedges excludes swaps with an aggregate notional amount of $508.2 million which were de-designated as accounting hedges at December 31, 2007.
(8) The longest maturity is April 2008.
(9) The longest maturity is May 2010.
(10) LIBOR + 2.25% after April 2016.
(11) Issued in April 2006 and July 2007. See Note 5 regarding the securitizations of Subprime Portfolios I and II.
(12) Debt carrying value exceeds collateral amortized cost basis due to $98.0 million of repurchase agreements secured by investments in Newcastle’s CBO bonds, which are eliminated in consolidation.
(13) Collateral is comprised of real estate securities and loans.
Certain of the debt obligations included above are obligations of consolidated subsidiaries of Newcastle which own the related collateral. In some cases, including the CBO and Other Bonds Payable, such
collateral is not available to other creditors of Newcastle.
92
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
CBO Bonds Payable
One class of CBO bonds, with an aggregate $323.0 million face amount, was issued subject to remarketing
procedures and related agreements whereby such bonds are remarketed and sold on a periodic basis. If the bonds
are not successfully remarketed and sold, the only effect on Newcastle is that the interest rate on the bonds may
increase to a maximum of LIBOR + 0.30%. As of December, 31, 2007, the interest rate on these bonds was
LIBOR +0.22%. As of January 24, 2008, the interest rate on $161.5 million face amount of these bonds reset to
LIBOR + 0.30% for one year.
In June and July 2007, Newcastle refinanced three prior CBO issuances with a single CBO issuance which
aggregated $1,248 million of issued debt. Newcastle incurred $4.7 million of cash expenses and $8.2 million of
non-cash charges in connection with this extinguishment of debt.
Junior Subordinated Notes Payable
In March 2006, Newcastle completed the placement of $100 million of trust preferred securities through its
wholly owned subsidiary, Newcastle Trust I (the “Preferred Trust”). Newcastle owns all of the common stock of
the Preferred Trust. The Preferred Trust used the proceeds to purchase $100.1 million of Newcastle’s junior
subordinated notes. These notes represent all of the Preferred Trust’s assets. The terms of the junior subordinated
notes are substantially the same as the terms of the trust preferred securities. The trust preferred securities mature
in April 2036, but may be redeemed at par beginning in April 2011. Under the provisions of FIN 46R, Newcastle
determined that the holders of the trust preferred securities were the primary beneficiaries of the Preferred Trust.
As a result, Newcastle did not consolidate the Preferred Trust and has reflected the obligation to the Preferred
Trust under the caption Junior Subordinated Notes Payable in its consolidated balance sheet and will account for
its investment in the common stock of the Preferred Trust, which is reflected in Investments in Unconsolidated
Subsidiaries in the consolidated balance sheet, under the equity method of accounting (Note 3).
Repurchase Agreements Subject to ABCP Facility
In December 2006, Newcastle closed a $2 billion asset backed commercial paper (ABCP) facility through its
wholly owned subsidiary, Windsor Funding Trust. This facility provided Newcastle with the ability to finance its
FNMA/FHLMC securities with ABCP. Newcastle owns all of the trust certificates of the Windsor Funding Trust.
Windsor Funding Trust used the proceeds of the issuance to enter into a repurchase agreement with Newcastle to
purchase interests in Newcastle’s FNAM/FHLMC securities. The repurchase agreements represent Windsor
Funding Trust’s only asset. The interest rate on the repurchase agreement is effectively the weighted average
interest rate on the ABCP. Under the provisions of FIN 46R, Newcastle determined that the noteholders were the
primary beneficiaries of the Windsor Funding Trust. As a result, Newcastle did not consolidate the Windsor
Funding Trust and has reflected its obligation pursuant to the asset backed commercial paper facility under the
caption Repurchase Agreements Subject to ABCP Facility. In August through November 2007, Newcastle
refinanced this debt with repurchase agreements. As a result, a non-cash expense of $3.5 million was recorded
related to the write-off of deferred financing costs and other hedge related items.
Maturity Table
Newcastle’s debt obligations (gross of $28.8 million of discounts at December 31, 2007) have contractual
maturities as follows:
2008
2009
2010
2011
2012
Thereafter
$
1,634,362
184,817
-
298,313
-
5,303,018
7,420,510
$
93
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
Debt Covenants
Newcastle’s debt obligations contain various customary loan covenants. Such covenants do not, in management’s
opinion, materially restrict Newcastle’s investment strategy or ability to raise capital. Newcastle is in compliance
with all of its loan covenants as of December 31, 2007.
Newcastle’s credit facility contained a covenant that required that it earns positive net income during each period
of two consecutive fiscal quarters. As of December 31, 2007, the facility was undrawn and Newcastle was in
compliance with this covenant. Because Newcastle had a net loss for the third quarter of 2007, if its net income
for the fourth quarter did not sufficiently offset the third quarter net loss, it would have experienced an event of
default under the credit facility. If this had occurred, it would not have been permitted to borrow under this
facility, and the lender would have had the right to terminate its commitment and to require that any amounts
outstanding be paid immediately. In addition, failure to cure an event of default would have resulted in a default
under certain of our other non-CBO financing agreements. However, Newcastle had the ability to cure an event of
default by terminating the facility at any time. Failure to cure an event of default would have materially
negatively impacted its liquidity if it had not able to obtain alternate sources of financing.
In February 2008, prior to the tabulation of its fourth quarter 2007 results, Newcastle terminated the credit
facility. The credit facility had been unused since July 2007 and the termination released a significant amount of
collateral with which it has generated, and intends to continue to generate, additional liquidity – through selective
asset sales or more efficient financing. As of February 25, 2008, Newcastle had $120.0 million of unrestricted
cash, which it believes, along with its other sources of liquidity, is sufficient to satisfy its anticipated liquidity
needs with respect to its current investment portfolio. At the date of termination, no amounts were outstanding
under the credit facility (and Newcastle did not incur any material costs related to the termination); at that time,
previously incurred and deferred financing costs of $0.6 million were written off. After terminating the facility,
Newcastle subsequently determined that the net loss it incurred in the fourth quarter of 2007, in connection with
the recording of other-than-temporary impairment, would have resulted in a breach of the above described
covenant.
9. STOCK OPTION PLAN 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 stock
options. During 2007, 2006 and 2005, based on the treasury stock method, Newcastle had 113,960, 148,538 and
314,125 dilutive common stock equivalents, respectively, resulting from its outstanding options. Net income
available for common stockholders is equal to net income less preferred dividends.
In June 2002, Newcastle (with the approval of the board of directors) adopted a nonqualified stock option and
incentive award plan (the "Newcastle Option Plan'') for officers, directors, consultants and advisors, including the
Manager and its employees. The maximum available for issuance is equal to 10% of the number of outstanding
equity interests of Newcastle, subject to a maximum of 10,000,000 shares in the aggregate over the term of the
plan.
Upon joining the board, the non-employee directors have been, in accordance with the Newcastle Option Plan,
automatically granted options to acquire an aggregate of 18,000 shares of common stock. The fair value of such
options was not material at the date of grant.
Through December 31, 2007, for the purpose of compensating the Manager for its successful efforts in raising
capital for Newcastle, the Manager has been granted options representing the right to acquire 3,523,727 shares of
common stock, with strike prices subject to adjustment as necessary to preserve the value of such options in
connection with the occurrence of certain events (including capital dividends and capital distributions made by
Newcastle). The Manager options represented an amount equal to 10% of the shares of common stock of
Newcastle sold in its public offerings and the value of such options was recorded as an increase in stockholders’
equity with an offsetting reduction of capital proceeds received. The options granted to the Manager, which may
be assigned by the Manager to its employees, were fully vested on the date of grant and one thirtieth of the
options become exercisable on the first day of each of the following thirty calendar months, or earlier upon the
occurrence of certain events, such as a change in control of Newcastle or the termination of the Management
Agreement. The options expire ten years from the date of issuance.
94
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
The following table summarizes Newcastle’s outstanding options at December 31, 2007. Note that the last sales
price on the New York Stock Exchange for Newcastle’s common stock in the year ended December 31, 2007 was
$12.96.
Recipient
Directors
Manager (B)
Manager (B)
Manager (B)
Manager (B)
Manager (B)
Manager (B)
Excercised (B)
Excercised (B)
Outstanding
Date of
Grant/Exercise
Various
2002
2003
2004
2005
2006
2007
Prior to 2007
2007
Number of Options
18,000
700,000
788,227
837,500
330,000
170,000
698,000
(959,920)
(83,198)
2,498,609
Weighted Average
Exercise Price
$17.38
$13.00
$21.39
$27.06
$29.60
$29.42
$28.98
$15.55
$17.34
$27.04
Fair Value At Grant
Date (Millions)
Not Material
$0.4 (A)
$1.2 (A)
$1.6 (A)
$1.1 (A)
$0.5 (A)
$2.0 (A)
(A) The fair value of the options was estimated using a lattice-based option valuation model. Since the
Newcastle Option Plan has characteristics significantly different from those of traded options, and since the
assumptions used in such model, particularly the volatility assumption, are subject to significant judgment
and variability, the actual value of the options could vary materially from management’s estimate. The
assumptions used in such model for the last three years were as follows:
Date of Grant
January 2005
November 2006
January 2007
April 2007
Volatility
21%
21%
21%
21%
Dividend Yield
8.45%
8.84%
8.82%
9.95%
Expected Life
(Years)
10
5
5
5
Risk-Free Rate
4.27%
4.69%
4.77%
4.65%
The volatility assumption for these options was estimated based primarily on the historical volatility of
Newcastle’s common stock and management’s expectations regarding future volatility. The expected life
assumption for options issued subsequent to January 2005 was estimated based on the simplified term
method. This simplified method was used because Newcastle does not have sufficient historical data to
conclude on the appropriate expected life of its options and because historical data to date is consistent with
the simplified term method.
(B) The Manager assigned certain of its options to its employees as follows:
Date of Grant
2002
2003
2004
2005
2006
2007
Range of
Strike Prices
$13.00
$20.35-$22.85
$25.75-$31.40
$29.60
$29.42
$27.75-$31.30
Total
Inception to Date
269,500
332,555
321,382
125,785
76,160
270,503
Total
1,395,885
670,620 of the total options exercised were by the Manager. 368,498 of the total options exercised were by
employees of the Manager subsequent to their assignment. 4,000 of the total options exercised were by
directors.
95
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
10. MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS
Manager
Newcastle entered into the Management Agreement with the Manager in June 2002, as amended, which provided
for an initial term of one year with automatic one year extensions, subject to certain termination rights. After the
initial one year term, the Manager's performance is reviewed annually and the Management Agreement may be
terminated by Newcastle by payment of a termination fee, as defined in the Management Agreement, equal to the
amount of management fees earned by the Manager during the twelve consecutive calendar months immediately
preceding the termination, upon the affirmative vote of at least two-thirds of the independent directors, or by a
majority vote of the holders of common stock. Pursuant to the Management Agreement, the Manager, under the
supervision of Newcastle’s board of directors, formulates investment strategies, arranges for the acquisition of
assets, arranges for financing, monitors the performance of Newcastle's assets and provides certain advisory,
administrative and managerial services in connection with the operations of Newcastle. For performing these
services, Newcastle pays the Manager an annual management fee equal to 1.5% of the gross equity of Newcastle,
as defined.
The Management Agreement provides that Newcastle will reimburse the Manager for various expenses incurred
by the Manager or its officers, employees and agents on Newcastle's behalf, including costs of legal, accounting,
tax, auditing, administrative and other similar services rendered for Newcastle by providers retained by the
Manager or, if provided by the Manager's employees, in amounts which are no greater than those which would be
payable to outside professionals or consultants engaged to perform such services pursuant to agreements
negotiated on an arm's-length basis.
To provide an incentive for the Manager to enhance the value of the common stock, the Manager is entitled to
receive an incentive return (the "Incentive Compensation'') on a cumulative, but not compounding, basis in an
amount equal to the product of (A) 25% of the dollar amount by which (1) (a) the Funds from Operations, as
defined (before the Incentive Compensation) of Newcastle per share of common stock (based on the weighted
average number of shares of common stock outstanding) plus (b) gains (or losses) from debt restructuring and
from sales of property and other assets per share of common stock (based on the weighted average number of
shares of common stock outstanding), exceed (2) an amount equal to (a) the weighted average of the price per
share of common stock in the IPO and the value attributed to the net assets transferred to Newcastle by its
predecessor, and in any subsequent offerings by Newcastle (adjusted for prior capital dividends or capital
distributions) multiplied by (b) a simple interest rate of 10% per annum (divided by four to adjust for quarterly
calculations) multiplied by (B) the weighted average number of shares of common stock outstanding.
2007
Management Fee .................................................... $17.1
0.5
Expense Reimbursement ........................................
6.2
Incentive Compensation ........................................
2006
$13.5
0.5
12.2
2005
$12.8
0.5
7.6
Amounts Incurred (in millions)
At December 31, 2007, the Manager, through its affiliates, and principals of Fortress, owned 5.1 million shares of
Newcastle’s common stock and the Manager, through its affiliates, had options to purchase an additional 1.5
million shares of Newcastle’s common stock (Note 9).
At December 31, 2007, Due To Affiliates is comprised of $6.2 million of incentive compensation payable and
$1.5 million of management fees and expense reimbursements payable to the Manager.
Other Affiliates
In November 2003, Newcastle and a private investment fund managed by an affiliate of its manager co-invested
and each indirectly own an approximately 38% interest in a limited liability company (Note 3) that has acquired a
pool of franchise loans from a third party financial institution. Newcastle’s investment in this entity, reflected as
an investment in an unconsolidated subsidiary on Newcastle’s consolidated balance sheet, was approximately
$11.0 million at December 31, 2007. The remaining approximately 24% interest in the limited liability company
is owned by the above-referenced third party financial institution.
In March 2004, Newcastle and a private investment fund managed by an affiliate of Newcastle’s manager co-
invested and each indirectly own an approximately 49% interest in two limited liability companies (Note 3) that
have acquired, in a sale-leaseback transaction, a portfolio of convenience and retail gas stores from a public
96
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
company. This investment was financed with nonrecourse debt at the limited liability company level and
Newcastle’s investment in this entity, reflected as an investment in an unconsolidated subsidiary on Newcastle’s
consolidated balance sheet, was approximately $13.4 million at December 31, 2007. In March 2005, the property
management agreement related to these properties was transferred to an affiliate of Newcastle’s manager from a
third party servicer; Newcastle’s allocable portion of the related fees, approximately $20,000 per year for three
years, was not changed.
In January 2005, Newcastle entered into a servicing agreement with a portfolio company of a private equity fund
advised by an affiliate of Newcastle’s manager for them to service a portfolio of manufactured housing loans
(Note 5), which was acquired at the same time. As compensation under the servicing agreement, the portfolio
company will receive, on a monthly basis, a net servicing fee equal to 1.00% per annum on the unpaid principal
balance of the loans being serviced. In January 2006, Newcastle closed on a new term financing of this portfolio.
In connection with this term financing, Newcastle renewed its servicing agreement at the same terms. The
outstanding unpaid principal balance of this portfolio was approximately $215.2 million at December 31, 2007.
In April 2006, Newcastle securitized Subprime Portfolio I and, through Securitization Trust 2006, entered into a
servicing agreement with a subprime home equity mortgage lender (the “Subprime Servicer”) to service this
portfolio. In July 2006, private equity funds managed by an affiliate of Newcastle’s manager completed the
acquisition of the Subprime Servicer. As compensation under the servicing agreement, the Subprime Servicer will
receive, on a monthly basis, a net servicing fee equal to 0.5% per annum on the unpaid principal balance of the
portfolio. In March 2007, through Securitization Trust 2007, Newcastle entered into a servicing agreement with
the Subprime Servicer to service Subprime Portfolio II under substantially the same terms. The outstanding
unpaid principal balances of Subprime Portfolios I and II were approximately $898.5 million and $1.0 billion at
December 31, 2007, respectively.
In August 2006, Newcastle acquired a portfolio of manufactured housing loans. The loans are being serviced by a
portfolio company of a private equity fund advised by an affiliate of Newcastle’s manager. As compensation
under the servicing agreement, the servicer will receive, on a monthly basis, a net servicing fee equal to 0.625%
per annum on the unpaid principal balance of the portfolio plus an incentive fee if the performance of the loans
meets certain thresholds. The outstanding unpaid principal balance of this portfolio was approximately $326.9
million at December 31, 2007.
In September 2006, Newcastle was a co-lender with two private investment funds managed by an affiliate of
Newcastle’s manager in a new real estate related loan. The loan is secured by a first mortgage interest on a parcel
of land in Arizona. Newcastle owns a 20% interest in the loan and the private investment funds own an 80%
interest in the loan. Major decisions require the unanimous approval of the holders of interests in the loan, while
other decisions require the approval of a majority of holders of interests in the loan. Newcastle and its affiliated
investment funds are each entitled to transfer all or any portion of their respective interests in the loan to third
parties. In October 2006, Newcastle and the private investment funds sold, on a pro-rata basis, a $125.0 million
senior participation interest in the loan to an unaffiliated third party, resulting in Newcastle owning a 20% interest
in the junior participation interest in the loan. Newcastle’s investment in this loan was approximately $30.0
million at December 31, 2007.
As of December 31, 2007, Newcastle held on its balance sheet total investments of $225.3 million face amount of
real estate securities and related loans issued by affiliates of its manager, and $125.2 million face amount of real
estate loans issued by affiliates of its manager financed under total rate of return swaps, and earned approximately
$20.1 million, $18.5 million and $13.7 million of interest on such investments for the years ended December 31,
2007, 2006 and 2005, respectively.
In each instance described above, affiliates of Newcastle’s manager have an investment in the applicable
affiliated fund and receive from the fund, in addition to management fees, incentive compensation if the fund’s
aggregate investment returns exceed certain thresholds.
97
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
11. COMMITMENTS AND CONTINGENCIES
Remarketing Agreements ⎯ One class of CBO bonds (Note 8), with an aggregate $323.0 million face amount,
was issued subject to remarketing procedures and related agreements whereby such bonds are remarketed and
sold on a periodic basis. If the bonds are not successfully remarketed and sold, the only effect on Newcastle is
that the interest rate on the bonds may increase to a maximum of LIBOR + 0.30%. As of December 31, 2007, the
interest rate on these bonds was LIBOR +0.22%. As of January 24, 2008, the interest rate on $161.5 million face
amount of these bonds reset to LIBOR + 0.30% for one year.
In connection with the remarketing procedures described above, a backstop agreement was created whereby a
third party financial institution is required to purchase the $323.0 million face amount of bonds at the end of any
remarketing period if such bonds could not be resold in the market by the remarketing agent. Newcastle pays an
annual fee of 0.15% of the outstanding face amount of such bonds under this agreement.
In addition, the remarketing agent is paid an annual fee of 0.05% of the outstanding face amount of such bonds
under the remarketing agreements.
Loan Commitment— With respect to one of its real estate related loans, Newcastle was committed to fund up to
an additional $101.0 million at December 31, 2007, subject to certain conditions to be met by the borrowers.
Stockholder Rights Agreement ⎯ Newcastle has adopted a stockholder rights agreement (the "Rights
Agreement''). Pursuant to the terms of the Rights Agreement, Newcastle will attach to each share of common
stock one preferred stock purchase right (a "Right''). Each Right entitles the registered holder to purchase from
Newcastle a unit consisting of one one-hundredth of a share of Series A Junior Participation Preferred Stock, par
value $0.01 per share, at a purchase price of $70 per unit. Initially, the Rights are not exercisable and are attached
to and transfer and trade with the outstanding shares of common stock. The Rights will separate from the
common stock and will become exercisable upon the acquisition or tender offer to acquire a 15% beneficial
ownership interest by an acquiring person, as defined. The effect of the Rights Agreement will be to dilute the
acquiring party's beneficial interest. Until a Right is exercised, the holder thereof, as such, will have no rights as a
stockholder of Newcastle.
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 which existed at December 31, 2007, if any, will not materially affect Newcastle’s
consolidated results of operations or financial position (Note 8).
Environmental Costs ⎯ As a commercial real estate owner, Newcastle is subject to potential environmental
costs. At December 31, 2007, management of Newcastle is not aware of any environmental concerns that would
have a material adverse effect on Newcastle's consolidated financial position or results of operations.
Debt Covenants ⎯ Newcastle's debt obligations contain various customary loan covenants. Such covenants do
not, in management's opinion, materially restrict Newcastle's investment strategy or ability to raise capital at this
time. Newcastle is in compliance with all of its loan covenants at December 31, 2007 (Note 8).
Exit Fee ⎯ One of Newcastle’s loan investments provides for an $8.9 million contractual exit fee which
Newcastle will begin to accrue for if and when management believes it is probable that such exit fee will be
received.
Subprime Securitizations ⎯ Newcastle has no obligation to repurchase any loans from either of its subprime
securitizations. Therefore, it is expected that Newcastle’s exposure to loss is limited to the carrying amount of its
retained interests in the securitization entities (Note 5). A subsidiary of Newcastle’s gave limited representations
and warranties with respect to the second securitization; however, it has no assets and does not have recourse to
the general credit of Newcastle.
Total Rate of Return Swaps ⎯ Newcastle’s exposure to loss on these swaps is limited to their fair value plus
their notional amount (Note 5).
Stock Repurchase ⎯ In August 2007, Newcastle’s board of directors approved a potential repurchase of up to
$100 million of Newcastle’s common stock. As of February 26, 2008, no shares have been repurchased.
98
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
12. INCOME TAXES AND DIVIDENDS
Newcastle Investment Corp. is organized and conducts its operations to qualify as a REIT under the Code. A REIT
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.
Since Newcastle distributed 100% of its 2007, 2006 and 2005 REIT taxable income, no provision has been made for
U.S. federal corporate income taxes in the accompanying consolidated financial statements, except in connection
with Newcastle’s taxable REIT subsidiary (“TRS”). As a result of the timing of distributions of 2007 REIT taxable
income, Newcastle expects to pay approximately $0.4 million of federal excise tax.
Distributions relating to 2007, 2006, and 2005 were taxable as follows:
Dividends Per Share (A)
Book Basis
$2.850
Tax Basis
$2.850
Ordinary/
Qualified Income
100.00%
Capital
Gains
-
Return of Capital
None
$2.615
$2.500
$2.948
$2.540
100.00%
-
86.41%
13.59%
None
None
2007
2006
2005
(A) Any excess of book basis dividends over tax basis dividends would generally be carried forward to the next year for tax purposes.
Dividends in Excess of Earnings includes ($14.5 million) related to the operations of Newcastle’s predecessor.
Newcastle has elected to treat NC Circle Holdings II LLC as a taxable REIT subsidiary (“TRS”), effective February
27, 2004. NC Circle Holdings II LLC owned a portion of Newcastle’s investment in a portfolio of convenience
and retail gas stores as described in Note 3. For taxable income generated by NC Circle Holdings II LLC,
Newcastle has provided for relevant income taxes based on a blended statutory rate of 40%. Newcastle accounts for
income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. No such material differences have been recognized through
December 31, 2007.
13. SUBSEQUENT EVENTS
In January 2008, Newcastle repurchased $16.0 million face amount of a class of CBO bond for $6.7 million. As a
result, Newcastle extinguished $16.0 million face amount of CBO debt.
In January and February 2008, Newcastle sold face amounts of approximately $762.5 million of FNMA/FHLMC
securities and $501.5 million of non-FNMA/FHLMC securities. Newcastle received paydowns totaling $11.6
million on these assets in 2008 until the assets were sold. Concurrent with the sales, Newcastle terminated the
related interest rate swap and interest rate cap agreements which were de-designated as hedges for accounting
purposes at December 31, 2007. As a result, a portion of the gain on sale from these assets was offset by the loss on
the termination of the derivatives.
In January and February 2008, Newcastle repaid $758.8 million of repurchase agreements.
In February 2008, Newcastle repaid in full the debt associated with our first CBO in the amount of $331.2 million.
The table below summarizes our gains (losses) recorded in connection with these transactions (dollars in thousands):
Related to asset sales (1)
Related to the termination of derivatives and debt extinguishment
Termination of interest rate swaps
Termination of total return swaps
Debt extinguishment
Total gains (losses)
(1) Including the losses on certain derivatives.
99
4th Quarter
2007
$
(15,573)
1st Quarter
2008
$
1,324
(1,614)
$
(17,187)
(2,540)
(3,161)
8,144
3,767
$
Total
(14,249)
$
(4,154)
(3,161)
8,144
(13,420)
$
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
14. SUMMARY QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
The following is unaudited summary information on Newcastle’s quarterly operations.
2007
Quarter Ended
Gross Revenues
Operating expenses
Operating income
Interest expense
Loss on extinguishment of debt
Other-than-temporary impairment
Depreciation and amortization
Equity in earnings of unconsolidated subsidiaries (B)
Income (loss) from continuing operations
Income (loss) from discontinued operations
Preferred dividends
Income applicable to common stockholders
Net Income per share of common stock
Basic
Diluted
Income from continuing operations per share of common
stock, after preferred dividends and related accretion
Basic
Diluted
Income (loss) from discontinued operations per share of common stock
Basic
Diluted
Weighted average number of shares of common stock outstanding
Basic
Diluted
2006
Gross Revenues
Operating expenses
Operating income
Interest expense
Loss on extinguishment of debt
Depreciation and amortization
Equity in earnings of unconsolidated subsidiaries (B)
Income from continuing operations
Income (loss) from discontinued operations
Preferred dividends
Income available for common stockholders
Net Income per share of common stock
Basic
Diluted
Income from continuing operations per share of common
stock, after preferred dividends and related accretion
Basic
March 31 (A)
June 30 (A)
$
$
$
$
$
December 31
Year Ended
December 31
166,429
(14,116)
152,313
(116,757)
-
-
(199)
847
36,204
(13)
(2,515)
33,676
205,921
(22,129)
183,792
(133,917)
(7,280)
(5,953)
(342)
819
37,119
(6)
(3,375)
33,738
September 30 (A)
168,865
(11,862)
157,003
(117,434)
(7,752)
(67,860)
(359)
488
(35,914)
17
(3,375)
(39,272)
146,842
(14,740)
132,102
(108,880)
-
(128,789)
(512)
3,236
(102,843)
(21)
(3,375)
(106,239)
688,057
(62,847)
625,210
(476,988)
(15,032)
(202,602)
(1,412)
5,390
(65,434)
(23)
(12,640)
(78,097)
$
$
$
$
$
$
$
0.71
0.70
$
$
0.64
0.64
$
$
(0.74)
(0.74)
$
$
(2.01)
(2.01)
$
$
(1.52)
(1.52)
$
$
0.71
0.70
$
$
0.64
0.64
$
$
(0.74)
(0.74)
$
$
(2.01)
(2.01)
$
$
(1.52)
(1.52)
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
47,573
47,823
52,274
52,467
52,779
52,779
52,779
52,779
51,369
51,369
Quarter Ended
Year Ended
March 31 (A)
June 30 (A)
$
123,548
(16,911)
$
129,685
(10,999)
$
September 30 (A)
144,094
(13,032)
December 31
December 31
$
155,940
(14,581)
$
553,267
(55,523)
106,637
(76,965)
-
(199)
1,195
30,668
251
(2,328)
118,686
(87,909)
(658)
(278)
1,215
31,056
(26)
(2,329)
131,062
(100,239)
-
(290)
1,506
32,039
(12)
(2,328)
141,359
(109,156)
-
(318)
2,052
33,937
10
(2,329)
497,744
(374,269)
(658)
(1,085)
5,968
127,700
223
(9,314)
$
28,591
$
28,701
$
29,699
$
31,618
$
118,609
$
0.65
$
0.65
$
0.68
$
0.70
$
2.68
$
0.65
$
0.65
$
0.67
$
0.70
$
2.67
$
0.64
$
0.65
$
0.68
$
0.70
$
2.67
Diluted
$
0.64
$
0.65
$
0.67
$
0.70
$
2.67
Income (loss) from discontinued operations per share of common stock
Basic
Diluted
Weighted average number of shares of common stock outstanding
Basic
Diluted
$
0.01
$
0.01
43,945
44,064
$0.00
$0.00
43,991
44,071
$0.00
$
0.00
$
0.01
$0.00
$
0.00
$
0.00
44,000
44,137
45,129
45,385
44,269
44,417
100
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 and 2005
(dollars in tables in thousands, except per share data)
2005
Gross Revenues
Operating expenses
Operating income
Interest expense
Depreciation and amortization
Equity in earnings of unconsolidated subsidiaries (B)
Income from continuing operations
Income (loss) from discontinued operations
Preferred dividends
Income available for common stockholders
Net Income per share of common stock
Basic
Diluted
Income from continuing operations per share of common
stock, after preferred dividends and related accretion
Basic
Diluted
Income (loss) from discontinued operations per share of common stock
Basic
Diluted
Weighted average number of shares of common stock outstanding
Basic
Diluted
March 31 (A)
June 30 (A)
September 30 (A)
December 31
Quarter Ended
Year Ended
December 31
$
83,663
(9,114)
$
92,065
(8,832)
$
99,850
(12,934)
$
102,635
(11,008)
$
378,213
(41,888)
74,549
83,233
86,916
91,627
336,325
(48,766)
(136)
1,853
27,500
1,184
(1,523)
27,161
$
(55,791)
(135)
1,393
28,700
781
(1,524)
27,957
$
(58,681)
(182)
1,061
29,114
86
(1,523)
27,677
$
(63,208)
(188)
1,302
29,533
57
(2,114)
27,476
$
(226,446)
(641)
5,609
114,847
2,108
(6,684)
110,271
$
$
0.63
$
0.64
$
0.63
$
0.63
$
2.53
$
0.62
$
0.63
$
0.63
$
0.63
$
2.51
$
0.60
$
0.62
$
0.63
$
0.63
$
2.48
$
0.59
$
0.61
$
0.63
$
0.63
$
2.46
$
0.03
$
0.02
$
0.00
$
0.00
$
0.05
$
0.03
$
0.02
$
0.00
$
0.00
$
0.05
43,222
43,629
43,768
44,127
43,790
44,121
43,897
44,059
43,672
43,986
(A) The Income Available for Common Stockholders shown agrees with Newcastle’s quarterly report(s) on Form
10-Q as filed with the Securities and Exchange Commission. However, individual line items may vary from
such report(s) due to the operations of properties sold, or classified as held for sale, during subsequent
periods being retroactively reclassified to Income for Discontinued Operations for all periods presented (Note
5).
(B) Net of income taxes on related taxable subsidiaries.
101
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
(a) Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s
Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and 15d –15(e) under the Securities Exchange
Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. The
Company’s disclosure controls and procedures are designed to provide reasonable assurance that information is
recorded, processed, summarized and reported accurately and on a timely basis. Based on such evaluation, the
Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such
period, the Company’s disclosure controls and procedures are effective.
(b) Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control
over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Acts)
during the most recent fiscal quarter to which this report relates that have materially affected, or are reasonably
likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial
reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Securities
Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, the Company’s principal
executive and principal financial officers and effected by the Company’s board of directors, management and other
personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with accounting principles generally accepted in the United
States and includes those policies and procedures that:
•
•
•
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the
transactions and dispositions of the assets of the Company;
provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with accounting principles generally accepted in the United
States, and that receipts and expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use or disposition of the Company’s assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect all
misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls
may become inadequate because of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31,
2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on our assessment, management concluded that, as of December 31, 2007, the Company’s internal control over
financial reporting was effective.
The Company’s independent registered public accounting firm has issued an audit report on the effectiveness of the
Company’s internal control over financial reporting. This report appears at the beginning of “Financial Statements
and Supplementary Data.”
By: /s/ Kenneth M. Riis
Kenneth M. Riis
Chief Executive Officer
By: /s/ Debra A. Hess
Debra A. Hess
Chief Financial Officer
102
Item 9B. Other Information.
None.
103
Item 10. Directors, Executive Officers AND Corporate Governance.
PART III
Incorporated by reference to our definitive proxy statement for the 2008 annual meeting of stockholders to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as
amended, within 120 days after the fiscal year ended December 31, 2007.
Item 11. Executive Compensation.
Incorporated by reference to our definitive proxy statement for the 2008 annual meeting of stockholders to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as
amended, within 120 days after the fiscal year ended December 31, 2007.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
Incorporated by reference to our definitive proxy statement for the 2008 annual meeting of stockholders to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as
amended, within 120 days after the fiscal year ended December 31, 2007.
Item 13. Certain Relationships and Related Transactions, Director Independence.
Incorporated by reference to our definitive proxy statement for the 2008 annual meeting of stockholders to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as
amended, within 120 days after the fiscal year ended December 31, 2007.
Item 14. Principal Accountant Fees and Services.
Incorporated by reference to our definitive proxy statement for the 2008 annual meeting of stockholders to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as
amended, within 120 days after the fiscal year ended December 31, 2007.
104
PART IV
Item 15. Exhibits; Financial Statement Schedules.
(a) and (c) Financial statements and schedules:
See “Financial Statements and Supplementary Data.”
(b) Exhibits filed with this Form 10-K:
3.1 Articles of Amendment and Restatement (incorporated by reference to the Registrant’s
Registration Statement on Form S-11 (File No. 333-90578), Exhibit 3.1).
3.2 Articles Supplementary relating to the Series B Preferred Stock (incorporated by reference to the
Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2003, Exhibit 3.3).
3.3 Articles Supplementary relating to the Series C Preferred Stock (incorporated by reference to the
Registrant’s Report on Form 8-K, Exhibit 3.3, filed on October 25, 2005).
3.4 Articles Supplementary relating to the Series D Preferred Stock (incorporated by reference to the
Registrant’s Report on Form 8-A, Exhibit 3.1, filed on March 14, 2007).
3.5 Amended and Restated By-laws (incorporated by reference to the Registrant’s Current Report on
Form 8-K, Exhibit 3.1, filed on May 5, 2006).
4.1 Rights Agreement between the Registrant and American Stock Transfer and Trust Company, as
Rights Agent, dated October 16, 2002 (incorporated by reference to the Registrant’s Quarterly
Report on Form 10-Q for the period ended September 30, 2003, Exhibit 4.1).
10.1 Amended and Restated Management and Advisory Agreement by and among the Registrant and
FIG LLC (formerly known as Fortress Investment Group LLC), dated June 23 2003 (incorporated
by reference to the Registrant’s Statement on Form S-11 (File No. 333-106135), Exhibit 10.1).
10.2 Newcastle Investment Corp. Nonqualified Stock Option and Incentive Award Plan Amended and
Restated Effective as of February 11, 2004 (incorporated by reference to the Registrant’s Annual
Report on Form 10-K for the year ended December 31, 2005, Exhibit 10.2).
12.1 Statements re: Computation of Ratios.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent accountants.
31.1 Certification of Chief Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2 Certification of Chief Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
105
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, as amended, the
Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:
NEWCASTLE INVESTMENT CORP.
February 29, 2008
By: /s/ Wesley R. Edens
Wesley R. Edens
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below
by the following person on behalf of the Registrant and in the capacities and on the dates indicated.
February 29, 2008
By: /s/ Kenneth M. Riis
Kenneth M. Riis
Chief Executive Officer
February 29, 2008
By: /s/ Debra A. Hess
Debra A. Hess
Chief Financial Officer
February 29, 2008
By: /s/ Kevin J. Finnerty
Kevin J. Finnerty
Director
February 29, 2008
By: /s/ Stuart A. McFarland
Stuart A. McFarland
Director
February 29, 2008
By: /s/ David K. McKown
David K. McKown
Director
February 29, 2008
By: /s/ Peter M. Miller
Peter M. Miller
Director
106
Exhibit Index
3.1 Articles of Amendment and Restatement (incorporated by reference to the Registrant’s
Registration Statement on Form S-11 (File No. 333-90578), Exhibit 3.1).
3.2 Articles Supplementary relating to the Series B Preferred Stock (incorporated by reference to the
Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2003, Exhibit 3.3).
3.3 Articles Supplementary relating to the Series C Preferred Stock (incorporated by reference to the
Registrant’s Report on Form 8-K, Exhibit 3.3, filed on October 25, 2005).
3.4 Articles Supplementary relating to the Series D Preferred Stock (incorporated by reference to the
Registrant’s Report on Form 8-A, Exhibit 3.1, filed on March 14, 2007).
3.5 Amended and Restated By-laws (incorporated by reference to the Registrant’s Current Report on
Form 8-K (Exhibit 3.1, filed on May 5, 2006).
4.1 Rights Agreement between the Registrant and American Stock Transfer and Trust Company, as
Rights Agent, dated October 16, 2002 (incorporated by reference to the Registrant’s Quarterly
Report on Form 10-Q for the period ended September 30, 2002, Exhibit 4.1).
10.1 Amended and Restated Management and Advisory Agreement by and among the Registrant and
FIG LLC (formerly known as Fortress Investment Group LLC), dated June 23, 2003
(incorporated by reference to the Registrant’s Statement on Form S-11 (File No. 333-106135),
Exhibit 10.1).
10.2 Newcastle Investment Corp. Nonqualified Stock Option and Incentive Award Plan Amended and
Restated Effective as of February 11, 2004 (incorporated by reference to the Registrant’s Annual
Report on Form 10-K for the year ended December 31, 2005, Exhibit 10.2).
12.1 Statements re: Computation of Ratios.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent accountants.
31.1 Certification of Chief Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2 Certification of Chief Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 12.1
RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED DIVIDENDS
AND RATIO OF EARNINGS TO FIXED CHARGES
The following table sets forth our ratio of earnings to combined fixed charges and preferred dividends and our ratio of
earnings to fixed charges for each of the periods indicated:
Year Ended December 31,
2007 (A)
2006
2005
2004
2003
Ratio of Earnings to
Combined Fixed Charges and
Preferred Dividends
0.84
Ratio of Earnings to Fixed Charges
0.86
1.31
1.34
1.46
1.51
1.62
1.69
1.62
1.72
(A) The 2007 deficiencies in each ratio are $77.7 million and $65.1 million, respectively. The 2007 results included
impairment charges. Excluding such charges, the ratios would have exceeded 1 to 1.
For purposes of calculating the above ratios, (i) earnings represent “Income before equity in earnings of
unconsolidated subsidiaries” from our consolidated statements of operations, as adjusted for fixed charges and
distributions from unconsolidated subsidiaries, and (ii) fixed charges represent “Interest expense” from our
consolidated statements of operations. The ratios are based solely on historical financial information.
These ratios are affected by increasing interest rates. As a result of our match funded financing strategy, increasing
interest rates are expected to generally result in an increase to interest expense without a material effect on net income,
thereby negatively impacting these ratios.
Exhibit 21.1
NEWCASTLE INVESTMENT CORP. SUBSIDIARIES
STATE/COUNTRY OF
INCORPORATION/FORMATION
--------------------------------------------
1. 2520 Ridgewood GP, LLC
2. Commercial Asset Holdings LLC
3. DBNC Peach Holding LLC
4. DBNC Peach I Trust
5. DBNC Peach LLC
6. DBNCF Circle LLC
7. DBNCH Circle LLC
8. Fortress Asset Trust
9. Fortress CBO Holdings I Inc.
10. Fortress CBO Investments I Corp.
11. Fortress CBO Investments I, Ltd.
12. Fortress Realty Holdings, Inc.
13. Impac 1998-C1Carthage Texas, LLC
14. Impac CMB Trust 1998-C1
15. Impac Commercial Assets Corporation
16. Impac Commercial Capital Corporation
17. Impac Commercial Holdings, Inc.
18. Karl S.A.
19. LIV Holdings LLC
20. NC Circle Holdings II LLC
21. NC Circle Holdings LLC
22. NCT Holdings II LLC
23. NCT Holdings LLC
24. Newcastle 2005-1 Asset-Backed Note LLC
25. Newcastle 2006-1 Asset-Backed Note LLC
26. Newcastle 2006-1 Depositor LLC
27. Newcastle CDO Holdings LLC
28. Newcastle CDO I Corp.
29. Newcastle CDO I, Ltd.
30. Newcastle CDO II Corp.
31. Newcastle CDO II Holdings LLC
32. Newcastle CDO II, Ltd.
33. Newcastle CDO III Corp.
34. Newcastle CDO III Holdings LLC
35. Newcastle CDO III, Ltd.
36. Newcastle CDO IV Corp.
37. Newcastle CDO IV Holdings LLC
38. Newcastle CDO IV, Ltd.
39. Newcastle CDO IX 1 Limited
40. Newcastle CDO IX Holdings LLC
41. Newcastle CDO IX LLC
42. Newcastle CDO V Corp.
43. Newcastle CDO V Holdings LLC
44. Newcastle CDO V, Ltd.
45. Newcastle CDO VI , Ltd.
46. Newcastle CDO VI Corp.
47. Newcastle CDO VI Holding, LLC
48. Newcastle CDO VII Corp.
Texas
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Cayman Islands
Ontario
Texas
Delaware
California
California
Maryland
Belgium
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Cayman Islands
Delaware
Delaware
Cayman Islands
Delaware
Delaware
Cayman Islands
Delaware
Delaware
Cayman Islands
Cayman Islands
Delaware
Delaware
Delaware
Delaware
Cayman Islands
Cayman Islands
Delaware
Delaware
Delaware
Exhibit 21.1
NEWCASTLE INVESTMENT CORP. SUBSIDIARIES
STATE/COUNTRY OF
INCORPORATION/FORMATION
49. Newcastle CDO VII Holdings LLC
50. Newcastle CDO VII, Limited
51. Newcastle CDO VIII 1, Limited
52. Newcastle CDO VIII 2, Limited
53. Newcastle CDO VIII Holdings LLC
54. Newcastle CDO VIII LLC
55. Newcastle CDO X Holdings LLC
56. Newcastle CDO X Limited
57. Newcastle CDO X LLC
58. Newcastle Foreign TRS Ltd.
59. Newcastle MH I LLC
60. Newcastle Mortgage Securities LLC
61. Newcastle Mortgage Securities Trust 2004-1
62. Newcastle Mortgage Securities Trust 2006-1
63. Newcastle Mortgage Securities Trust 2007-1
64. Newcastle Trust I
65. NIC 2 River Place LLC
66. NIC 4 River Place LLC
67. NIC Airport Corporate Center LLC
68. NIC Apple Valley I LLC
69. NIC Apple Valley II LLC
70. NIC Apple Valley III LLC
71. NIC BR LLC
72. NIC CNL LLC
73. NIC CR LLC
74. NIC CRA LLC
75. NIC CSR LLC
76. NIC Dayton Towne Center LLC
77. NIC DB LLC
78. NIC DBRepo LLC
79. NIC DP LLC
80. NIC GCMRepo LLC
81. NIC GR LLC
82. NIC GS LLC
83. NIC GSE LLC
84. NIC Holdings I LLC
85. NIC KZ LLC
86. NIC Mezz LLC
87. NIC NK LLC
88. NIC OTC LLC
89. NIC TRS Holdings, Inc.
90. NIC TRS LLC
91. NIC WL II LLC
92. NIC WL LLC
93. Steinhage B.V.
94. Windsor Funding Trust
95. Windsor Trust
Delaware
Cayman Islands
Cayman Islands
Cayman Islands
Delaware
Delaware
Delaware
Cayman Islands
Delaware
Cayman Islands
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Netherlands
Delaware
Delaware
EXHIBIT 23.1
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the Registration Statement (Form S-3 No. 333-140840) of Newcastle
Investment Corp. and in the related Prospectus of our reports dated February 27, 2008, with respect to the
consolidated financial statements of Newcastle Investment Corp., and the effectiveness of internal control over
financial reporting of Newcastle Investment Corp., included in this Annual Report (Form 10-K) for the year ended
December 31, 2007.
/s/ Ernst & Young LLP
New York, NY
February 27, 2008
EXHIBIT 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Kenneth M. Riis, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Newcastle Investment Corp.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d – 15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d – 15(f))
for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting
that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal
quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
February 29, 2008
(Date)
/s/ Kenneth M. Riis
Kenneth M. Riis
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Debra A. Hess, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Newcastle Investment Corp.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d–15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d – 15(f))
for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting
that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal
quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
February 29, 2008
(Date)
/s/ Debra A. Hess
Debra A. Hess
Chief Financial Officer
EXHIBIT 32.1
CERTIFICATION OF CEO PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Newcastle Investment Corp. (the "Company") for
the annual period ended December 31, 2007 as filed with the Securities and Exchange Commission on the
date hereof (the "Report"), Kenneth M. Riis, as Chief Executive Officer of the Company, hereby certifies,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that, to the best of his knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange
Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.
/s/ Kenneth M. Riis
Kenneth M. Riis
Chief Executive Officer
February 29, 2008
This certification accompanies the Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and
shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the
Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has
been provided to the Company and will be retained by the Company and furnished to the Securities and
Exchange Commission or its staff upon request.
EXHIBIT 32.2
CERTIFICATION OF CFO PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Newcastle Investment Corp. (the "Company") for
the annual period ended December 31, 2007 as filed with the Securities and Exchange Commission on the
date hereof (the "Report"), Debra A. Hess, as Chief Financial Officer of the Company, hereby certifies,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that, to the best of her knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange
Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.
/s/ Debra A. Hess
Debra A. Hess
Chief Financial Officer
February 29, 2008
This certification accompanies the Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and
shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the
Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has
been provided to the Company and will be retained by the Company and furnished to the Securities and
Exchange Commission or its staff upon request.
End of Filing
Corporate Information
B OA R D O F DI R E C T O R S
C O R P O R AT E O F F IC E R S
C O R P O R AT E H E A D Q UA R T E R S
Kenneth M. Riis
Chief Executive Officer and President
Jonathan Ashley
Chief Operating Officer
Debra A. Hess
Chief Financial Officer
Phillip J. Evanski
Chief Investment Officer
Randal A. Nardone
Secretary
Lilly H. Donohue
Assistant Secretary
Wesley R. Edens
Chairman of the Board
Chairman and Chief Executive Officer
Fortress Investment Group LLC
Kevin J. Finnerty(1)
Founder and Managing Partner
F.I. Capital Management
Stuart A. McFarland (1)
Chairman
Federal City Bancorp, Inc.
David K. McKown (1)
Senior Advisor
Eaton Vance Management
Peter M. Miller(1)
Principal
MatlinPatterson Global
Advisors LLC
Kenneth M. Riis
Managing Director
FIG LLC
(1) Member of Audit Committee, Nominating and Corporate Governance Committee and Compensation Committee
Newcastle Investment Corp. submitted a timely CEO certification to the New York Stock Exchange (NYSE) in
2007 pursuant to NYSE Listed Company Manual Section 303A.12(a) stating that its CEO was not aware of any
violations of the NYSE corporate governance listing standards.
Newcastle Investment Corp. filed timely CEO and CFO cer tifications with the Securities and Exchange
Commission pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 regarding Newcastle’s annual report
on Form 10-K for the year ended December 31, 2007. These certifications were filed as exhibits 31.1 and 31.2
to such Form 10-K.
Forward-Looking Statements
This repor t contains cer tain “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 and 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,” “con-
tinue” 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
effect 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 state-
ments 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, changes in economic conditions generally and the real estate
and bond markets specifically, changes in the financing markets we access that affect our ability to finance our
real estate securities portfolios in general or particular real estate related assets, changes in interest rates and/
or credit spreads and the success of our hedging strategy in relation to such changes, the availability and cost of
capital for future investments, the rate at which we can invest our cash in suitable investments and legislative/
regulatory changes (including in respect of rules applicable to REITs) as well as other risks detailed from time to
time in our SEC reports. You should not place undue reliance on forward-looking statements contained in this
report. Such forward-looking statements speak only as of the date of this report. We expressly disclaim any
obligation to release publicly any updates or revisions to any forward-looking statements contained herein to
reflect any change in our expectations with regard thereto or change in events, conditions or circumstances on
which any statement is based.
April, 2008
Newcastle Investment Corp.
c/o Fortress Investment Group LLC
1345 Avenue of the Americas, 46th Floor
New York, NY 10105
(212) 798-6100
Legal Counsel
Skadden, Arps, Slate, Meagher & Flom LLP
Four Times Square
New York, NY 10036-6522
Independent Auditors
Ernst & Young LLP
Five Times Square
New York, NY 10036-6530
Stock Transfer Agent and Registrar
American Stock Transfer & Trust Company
59 Maiden Lane
Plaza Level
New York, NY 10038
(800) 937-5449
Stock Exchange Listing
Newcastle Investment Corp.’s
common stock is listed on the
New York Stock Exchange (symbol: NCT)
Annual Meeting of Stockholders
May 22, 2008, 10:00 a.m. PDT
Sheraton Suites San Diego
Rhapsody Room
701 A Street
San Diego, CA 92101
Investor Information Services
Lilly H. Donohue
Director, Investor Relations
Newcastle Investment Corp.
c/o Fortress Investment Group LLC
1345 Avenue of the Americas, 46th Floor
New York, NY 10105
Tel: (212) 798-6118
Fax: (212) 798-6060
e-mail: ldonohue@fortress.com
Newcastle Investment Corp. web site
http://www.newcastleinv.com
printed on recycled paper
Newcastle Investment Corp.
c/o Fortress Investment Group LLC
1345 Avenue of the Americas, 46th Floor
New York, NY 10105
(212) 798-6100
www.newcastleinv.com