Newcastle Investment Corp.
2010 ANNUAL REPORT
NCT 2010 Fellow Shareholders,
We saw a continued recovery in the credit markets in 2010. As the economy stabilized and the availability of capital
for commercial and residential real estate improved throughout the year, credit spreads tightened and asset values
increased. The capital markets started to provide much needed debt and equity for real estate. For example, the capital
markets financed $12 billion of new commercial loans compared to less than $3 billion in 2009, and CMBS new issu-
ance is expected to reach $45 billion in 2011. The overall REIT universe raised $40 billion of equity and $22 billion
of debt in 2010, representing annual growth of 37% and 76%, respectively.
The resurgence in lending and growth of the capital markets ben-
efited Newcastle in 2010 and should continue to help us going
forward. We expect that these trends will result in new investment
opportunities and at the same time improve our current portfolio
performance. As borrowers are increasingly able to refinance
maturing debt we expect to see lower defaults, higher recoveries
and an increase in the overall valuation of our portfolio. Last year
the value of our $4.3 billion portfolio increased by approximately
$665 million to $3.0 billion.
In our view, credit spreads remain wide and there is a significant
amount of room for improvement. For example, last year, 2005
vintage single A rated commercial mortgage backed securities
tightened by approximately 700 basis points to a spread of 800
basis points over relevant U.S. Treasuries. As markets improve
and risk premiums abate, spreads should continue to tighten.
• Continued to aggressively manage and reposition our portfolio
with a focus on opportunistically reducing credit risk and improv-
ing returns. In 2010, we sold $530 million of assets with an aver-
age rating of single B and an expected return of 5% and purchased
$625 million of assets with an average rating of BB+ and an
expected return of 12%.
We ended the year with a stronger balance sheet and more pre-
dictable operating cash flows. Our $4.3 billion securities and loan
portfolio was match funded with $3.3 billion of non-recourse
debt and the maturity of our assets and our debt was 3.4 years and
3.8 years, respectively. The average cost of our debt is attractive at
3.4%, and our assets generate an average yield of 10.3%. The
portfolio has meaningful credit and valuation upside and given
our non-recourse financings, we are able to hold our assets to
maturity and maximize the recovery of our holdings.
In 2010, we were focused on stabilizing our operations and
rebuilding shareholder value and I am pleased with our perfor-
mance. We earned $657 million or $10.96 per share of GAAP
income and increased book value by $1.5 billion or $28.91 per
share. More importantly, we deleveraged our balance sheet and
stabilized our cash flow to improve the health of the Company.
Highlighted below are the actions that had a significant impact
on our 2010 results and helped us achieve our goals for the year:
• Generated $49 million of net cash flow from operations.
• Repurchased approximately $484 million of our CDO debt at
an average price of 45 cents on the dollar, increasing shareholder
value by $266 million or $4.43 per share.
• Successfully tendered for $91 million, or 60%, of our preferred
stock. We used $16 million of cash in the tender and exchanged
one preferred share for two and a half common shares. We also
paid all of the deferred dividends on our preferred stock. This
was beneficial for all shareholders as the reduction in outstand-
ing preferred shares and the ultimate deleveraging of the com-
mon stock increased the value of both the preferred shares and
the common shares. As a result of this transaction, we also elim-
inated $8 million of ongoing annual dividend expense.
• Repurchased $52 million, or 50%, of our Junior Subordinated
Notes using $10 million of cash and eliminated $4 million of
ongoing annual interest expense.
• Reduced recourse debt by $77 million and ended 2010 with
essentially no recourse debt on our balance sheet. This is a
significant event for the Company and means that virtually
none of our debt is subject to corporate covenants or margin
call risk.
We are off to a good start in 2011. In February, we acquired the
management rights of 17 CDOs previously managed by C-BASS,
leveraging our current operating platform to grow collateral man-
agement fee income and source additional CDO investments in
deals that we manage. Much of the C-BASS CDO debt trades at
a significant discount, and I believe we will be able to source
attractive opportunities within the $3.6 billion face amount of
outstanding debt.
In March, we raised approximately $100 million of equity capital
for new investments. It was great to be back in the market, and
our ability to raise new equity is a testament to our performance
over the past three years.
These recent activities highlight our current focus on new invest-
ment and earnings growth. We will continue to aggressively man-
age our portfolio and look to opportunistically buy back our
CDO debt. We now have enough capital to pursue larger debt
positions and source other accretive investments. We have a strong
deal pipeline and look forward to discussing our investment prog-
ress in the near future.
On behalf of everyone at Newcastle, we thank you for your con-
tinued support. We had a good year, but there is a lot more to do.
We are optimistic about the future, committed to our business and
will continue to work hard to position the Company for success.
Kenneth M. Riis
Chief Executive Officer and President
April 7, 2011
Newcastle Investment Corp.
FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
to
Commission File Number: 001-31458
Newcastle Investment Corp.
(Exact name of registrant as specified in its charter)
Maryland
(State or other jurisdiction of
incorporation or organization)
1345 Avenue of the Americas,
New York, NY
(Address of principal executive offices)
81-0559116
(I.R.S. Employer
Identification No.)
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:
Name of exchange on which registered:
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
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 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 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. Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data
File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes No
Indicate by check mark 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 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 No
The aggregate market value of the common stock held by non-affiliates as of June 30, 2010 (computed based on the closing price on such date
as reported on the NYSE) was: $155 million.
The number of shares outstanding of the registrant’s common stock was 62,027,184 as of February 17, 2011.
CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS
This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform
Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments,
the stability of our earnings, and our financing needs. Forward-looking statements are generally identifiable by use of
forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,”
“anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other
similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations,
describe future plans and strategies, contain projections of results of operations or of financial condition or state other
forward-looking information. Our ability to predict results or the actual outcome of future plans or strategies is inherently
uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable
assumptions, our actual results and performance could differ materially from those set forth in the forward-looking
statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual
results in future periods to differ materially from forecasted results. Factors which could have a material adverse effect on
our operations and future prospects include, but are not limited to:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
reductions in cash flows received from our investments;
our ability to take advantage of opportunities in additional asset classes or types of assets at attractive risk-adjusted
prices;
our ability to deploy capital accretively;
the risks that default and recovery rates on our real estate securities and loan portfolios exceed our underwriting
estimates;
the relationship between yields on assets which are paid off and yields on assets in which such monies can be
reinvested;
the relative spreads between the yield on the assets we invest in and the cost of financing;
changes in economic conditions generally and the real estate and bond markets specifically;
adverse changes in the financing markets we access affecting our ability to finance our investments, or in a manner
that maintains our historic net spreads;
changing risk assessments by lenders that potentially lead to increased margin calls, not extending our repurchase
agreements or other financings in accordance with their current terms or entering into new financings with us;
changes in interest rates and/or credit spreads, as well as the success of any hedging strategy we may undertake in
relation to such changes;
the quality and size of the investment pipeline and the rate at which we can invest our cash, including cash inside
our CDOs;
impairments in the value of the collateral underlying our investments and the relation of any such impairments to
our judgments as to whether changes in the market value of our securities, loans or real estate are temporary or not
and whether circumstances bearing on the value of such assets warrant changes in carrying values;
legislative/regulatory changes, including but not limited to, any modification of the terms of loans;
the availability and cost of capital for future investments;
competition within the finance and real estate industries; and
other risks detailed from time to time below, particularly under the heading “Risk Factors,” and in our other SEC
reports.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements. The factors noted above could cause our actual results to
differ significantly from those contained in any forward-looking statement.
Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect our
management’s views only as of the date of this report. We are under no duty to update any of the forward-looking
statements after the date of this report to conform these statements to actual results.
SPECIAL NOTE REGARDING EXHIBITS
In reviewing the agreements included as exhibits to this Annual Report on Form 10-K, please remember they are included
to provide you with information regarding their terms and are not intended to provide any other factual or disclosure
information about the Company or the other parties to the agreements. The agreements contain representations and
warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely
for the benefit of the other parties to the applicable agreement and:
•
•
should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk
tone of the parties if those statements provide to be inaccurate;
have been qualified by disclosures that were made to the other party in connection with the negotiation of the
applicable agreement, which disclosures are not necessarily reflected in the agreement;
• may apply standards of materiality in a way that is different from what may be viewed as material to you or other
investors; and
• were made only as of the date of the applicable agreement or such other date or dates as may be specified in the
agreement and are subject to more recent developments.
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made
or at any other time. Additional information about the Company may be found elsewhere in this Annual Report on
Form 10-K and the Company’s other public filings, which are available without charge through the SEC’s website at
http://www.sec.gov. See “Where Readers Can Find Additional Information.”
The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for
considering whether additional specific disclosures of material information regarding material contractual provisions are
required to make the statements in this report not misleading.
NEWCASTLE INVESTMENT CORP.
FORM 10-K
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Item 3.
Properties
Legal Proceedings
Item 4.
(Removed and Reserved)
INDEX
PART I
PART II
Item 5.
Item 6.
Item 7.
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
Item 8.
Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm on Internal Control over
Financial Reporting
Consolidated Balance Sheets as of December 31, 2010 and 2009
Consolidated Statements of Operations for the years ended December 31, 2010, 2009
and 2008
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended
December 31, 2010, 2009 and 2008
Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009
and 2008
Notes to Consolidated Financial Statements
Page
1
13
32
32
32
32
32
34
37
63
66
67
68
69
70
71
73
75
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 113
Item 9A.
Controls and Procedures
Management’s Report on Internal Control over Financial Reporting
Item 9B.
Other Information
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Directors, Executive Officers and Corporate Governance
Executive Compensation
PART III
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
PART IV
Item 15.
Exhibits; Financial Statement Schedules
Signatures
113
113
114
114
119
123
124
125
126
127
Item 1. Business.
Overview
PART I
Newcastle Investment Corp. (“Newcastle”) is a real estate investment and finance company. Newcastle invests in, and
actively manages, a portfolio of real estate securities, loans and other real estate related assets. 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, where feasible and appropriate. We emphasize portfolio management, asset quality, liquidity, diversification,
match funded financing and credit risk management.
We conduct our business through the following segments: (i) investments financed with non-recourse collateralized debt
obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments and debt repurchases
financed with recourse debt, (iv) unlevered investments, and (v) corporate. 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 Note 3 to Part
II, Item 8, “Financial Statements and Supplementary Data.”
The following table summarizes our segments at December 31, 2010:
Non-Recourse (A)
Other
CDOs
Non-Recourse (B)
Recourse (C)
Unlevered (D)
Corporate
Inter-segment
Elimination (E)
Total
GAAP
Investments
$ 2,713,044
$ 740,596
$ -
$ 39,397
$ -
$ (34,185) $ 3,458,852
Cash and restricted cash
157,005
-
-
12
33,512
-
190,529
Derivative assets
Other assets
Total assets
7,067
-
-
-
-
-
7,067
29,110
2,906,226
96
740,692
-
-
150
39,559
1,307
34,819
-
(34,185)
30,663
3,687,111
Debt
(3,029,273) (694,787) (4,683) -
(51,253) 34,185
(3,745,811)
Derivative liabilities
(160,660) (16,201) -
-
-
-
(176,861)
Other liabilities
Total liabilites
Preferred stock
GAAP book value
(6,353) (2,092) (2) (96) (3,481) -
(54,734) 34,185
(3,196,286) (713,080)
(96)
(4,685)
(12,024)
(3,934,696)
-
-
-
-
(61,583) -
(61,583)
$ (290,060) $ 27,612
$ (4,685) $ 39,463
$ (81,498) $ -
$ (309,168)
(A) Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the
extent we receive net cash flow distributions from such structures. Furthermore, our economic losses from such structures cannot exceed our
invested equity in them and economically their book value cannot be less than zero. Therefore, impairment recorded in excess of our
investment, which results in negative GAAP book value for a given non-recourse financing structure, cannot economically be incurred and
will eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or termination of such non-recourse
financing structure.
(B) Included in the other non-recourse segment was $403.8 million of Investments and Debt at December 31, 2010, representing the loans
subject to call option of the two subprime securitizations and the corresponding financing.
(C) The $4.7 million recourse debt was secured by $46.3 million of notes issued by Newcastle CDO VI, which was repurchased by Newcastle in
December 2010 and eliminated in consolidation.
(D) The following table summarizes the investments in the unlevered segment as of December 31, 2010:
Real estate securities
Real estate related loans*
Residential mortgage loans
Other investments
$
Outstanding Face Amount
186,081
97,106
1,169
N/A
284,356
$
600
32,475
298
6,024
39,397
$
Carrying Value
Number of Investments
$
25
5
27
1
58
*A mezzanine loan with a $28.0 million face amount and carrying value was repaid in full in February 2011.
(E) Represents the elimination of investments and financings and their related income and expenses between segments as the corresponding
inter-segment investments and financings are presented on a gross basis within each segment.
Our investments currently cover four distinct categories:
1) Real Estate Securities:
We underwrite, acquire and manage a diversified portfolio of credit sensitive
real estate securities, including commercial mortgage backed securities
(CMBS), senior unsecured REIT debt issued by REITs, real estate related
1
securities
asset backed
securities, and
FNMA/FHLMC securities. As of December 31, 2010, our real estate securities
represented 50.5% of our assets.
including
subprime
(ABS),
2) Real Estate Related Loans:
3) Residential Mortgage Loans:
We acquire and originate loans to real estate owners, including B-notes,
mezzanine loans, corporate bank loans, and whole loans. As of December 31,
2010, our real estate related loans represented 21.1% of our assets.
We acquire residential mortgage loans, including manufactured housing loans
and subprime mortgage loans. As of December 31, 2010, our residential
mortgage loans represented 10.3% of our assets.
4) Operating Real Estate:
We acquire and manage direct and indirect interests in operating real estate.
As of December 31, 2010, our operating real estate represented 0.9% of our
assets.
In addition, Newcastle had restricted and unrestricted cash and other miscellaneous net assets, which represented 17.2% of
our assets at December 31, 2010.
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. For its services, our manager is entitled to a management fee and incentive
compensation pursuant to a management agreement. Fortress, through its affiliates, and principals of Fortress collectively
owned 3.8 million shares of our common stock and Fortress, through its affiliates, had options to purchase an additional 1.7
million shares of our common stock, which were issued in connection with our equity offerings, representing approximately
8.6% of our common stock on a fully diluted basis, as of December 31, 2010.
During the year ended December 31, 2010, Newcastle actively pursued opportunities to strengthen our balance sheet. We
executed a number of transactions that reduced our long-term and short-term debt obligations, thereby improving our
liquidity position and increasing value for our common stockholders.
Highlighted below are the significant transactions executed during the year.
•
•
•
•
In January 2010, we entered into an exchange agreement pursuant to which we exchanged $52.1 million face amount
of Newcastle’s junior subordinated notes payable for (i) the payment of $9.7 million of cash, and (ii) the reissuance
of $37.6 million face amount of CDO bonds payable (which had previously been repurchased by Newcastle).
In March 2010, we exchanged 9,091,668 shares of our common stock and $16.0 million of cash for 1,152,679 shares
of Series B Preferred stock, 1,104,000 shares of Series C Preferred stock, and 1,380,000 shares of Series D Preferred
stock.
In April 2010, we completed a securitization transaction to refinance approximately $164.1 million outstanding
principal balance of manufactured housing loans. We issued approximately $134.5 million aggregate principal
amount of asset-backed notes, of which $97.6 million was sold to third parties and $36.9 million was sold to certain
CDOs managed and consolidated by Newcastle. We used the gross proceeds received from the issuance of the notes
to repay the previously existing financing on this portfolio in full, terminate the related interest rate swap contracts,
pay the related transaction costs and increase our unrestricted cash by approximately $14 million.
In December 2010, we completed a series of transactions whereby we repurchased approximately $257 million
current principal balance of Newcastle CDO VI Class I-MM notes (the “Notes”) at a price of 67.5% of par. We
purchased the Notes using a combination of restricted cash, unrestricted cash and proceeds from a new repurchase
facility. The $18.7 million (as of December 31, 2010) repurchase facility has a one-year term and bears interest at a
rate of LIBOR + 1.50%.
2
The following table compares the beginning and the end of year balances of our unrestricted cash, certain of our debt
obligations, preferred and common stocks of Newcastle (dollars in thousands):
Unrestricted cash
$
33,524
$
68,300
December 31, 2010
December 31, 2009
Non-recourse debt obligations (1)
CDO bonds payable (2)
Other bonds payable
Notes payable
Repurchase agreements
Recourse debt obligations
Repurchase agreements
Junior subordinated notes payable
$
$
3,010,868
256,809
4,356
14,049
3,286,082
$
4,058,928
303,697
-
-
$
4,362,625
$
$
4,683
51,253
55,936
71,309
103,264
174,573
$
$
Preferred stocks - Liquidation Preference
$
61,583
$
152,500
Common stock - Shares Outstanding
62,027,184
52,912,513
(1) Excluding the financing of subprime mortgage loans subject to call option which was non-economic as of the applicable date.
(2) $409.0 million of CDO bonds payable outstanding at December 31, 2009 was deconsolidated upon the adoption of a new accounting
pronouncement on January 1, 2010.
3
Our Investment Strategy
Newcastle’s investment strategy focuses predominantly on debt investments secured by real estate. Our investment
guidelines are purposefully broad to enable us to make investments in a wide array of assets, including, but not limited to,
any assets that can be held by real estate investment trusts. 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. 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 generally utilize a match
funded financing strategy, when appropriate and available, and active management as part of our investment strategy. As
discussed in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations –
Market Conditions,” the continued challenging credit and liquidity conditions in the markets have reduced the current
values of substantially all of our investments from historical levels, and has resulted in impairments in certain investments.
The following summarizes our investment portfolio at December 31, 2010 (dollars in millions):
Outstanding Face
Amount
Amortized Cost
Basis (1)
Percentage of
Total Amortized
Cost Basis
Carrying Value
Number of
Investments
Credit (2)
Weighted
Average Life
(years) (3)
Investment (7)
Commercial (4)
CMBS
Mezzanine Loans
B-Notes
Whole Loans
Other Investment (5)
Total Commercial Assets
Residential
Manufactured Housing and Residential
Mortgage Loans
Subprime Securities
Real Estate ABS
FNMA/FHLMC securities
Total Residential Assets
Corporate
REIT Debt
Corporate Bank Loans
Total Corporate Assets
$
1,971
580
233
31
25
2,840
$
1,265
389
155
31
25
1,865
428
353
66
847
3
850
317
309
626
371
161
43
575
3
578
316
208
524
42.7%
13.1%
5.2%
1.0%
0.8%
62.8%
12.5%
5.4%
1.5%
19.4%
0.1%
19.5%
10.7%
7.0%
17.7%
$
1,301
389
155
31
25
1,901
371
178
45
594
3
597
329
208
537
261
17
9
3
1
BB
64%
77%
48%
--
11,287
88
20
704
B-
BB
1
AAA
40
9
BB+
CC
TOTAL / WA
$
4,316
$
2,967
100.0%
$
3,035
3.1
1.9
1.8
2.8
-
2.8
6.6
5.0
3.6
5.7
3.2
5.7
3.5
3.4
3.4
3.4
Reconciliation to GAAP total assets:
Other assets
Subprime mortgage loans subject to call option (6)
Real estate held for sale
Cash and restricted cash
Other
GAAP total assets
WA – Weighted average, in all tables.
404
9
191
48
3,687
$
(1) Net of impairments.
(2) Credit represents the weighted average of minimum rating for rated assets, the loan-to-value ratio (based on the appraised value at the time of
purchase or refinancing) for non-rated commercial assets, or the FICO score for non-rated residential assets and an implied AAA rating for
FNMA/FHLMC securities. Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and
are subject to change (including a “negative watch” assignment) at any time.
(3) Weighted average life is based on the timing of expected principal reduction on the asset.
(4) Excludes eight CDO securities with an aggregate face amount of $123.1 million and a zero basis. Five CDOs bond were issued by third parties and
three CDO bonds were issued by CDO VII, which was deconsolidated, and held as investments by Newcastle.
(5) Represents an equity investment in a real estate owned property.
(6) Our subprime mortgage loans subject to call option are excluded from the statistics because they result from an option, not an obligation, to
repurchase such loans, are noneconomic until such option is exercised, and are offset by an equal liability on the consolidated balance sheet.
4
(7) The following tables summarize certain supplemental data relating to our investments (dollars in tables in thousands):
CMBS
Deal Vintage
(A)
Pre 2004
2004
2005
2006
2007
2010
Total / WA
Average
Minimum
Rating (B) Number
Outstanding
Face Amount
Amortized Cost
Basis
Percentage of
Amortized Cost
Basis
Carrying Value
Delinquency
60+/FC/REO
(C)
Principal
Subordination
(D)
Weighted
Average Life
(years) (E)
BB+
B+
B+
BB+
B+
BB
BB
82
61
37
54
24
3
$
425,785
$
384,726
30.4%
$
362,743
417,733
383,212
492,424
203,871
48,000
245,642
177,506
346,327
66,699
44,460
19.4%
14.0%
27.4%
5.3%
3.5%
205,078
210,487
390,691
86,823
44,912
261
$
1,971,025
$
1,265,360
100.0%
$
1,300,734
5.7%
4.2%
5.3%
4.5%
9.8%
0.0%
5.3%
10.8%
6.0%
8.1%
12.4%
11.5%
2.4%
9.5%
2.3
2.8
3.2
3.5
2.9
9.8
3.1
(A) The year in which the securities were originally issued.
(B) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including
a “negative watch” assignment) at any time. We had approximately $203.7 million of CMBS assets that are on negative watch for possible
downgrade by at least one rating agency as of December 31, 2010.
(C) The percentage of underlying loans that are 60+ days delinquent, or in foreclosure or considered real estate owned (REO).
(D) The percentage of the outstanding face amount of securities that is subordinate to our investments.
(E) Weighted average life is based on the timing of expected principal reduction on the asset.
Mezzanine Loans, B-Notes and Whole Loans
Asset Type
Mezzanine Loans
B-Notes
Whole Loans
Total/WA
Number
17
9
3
29
Outstanding
Face Amount
579,579
$
233,132
30,970
843,681
$
$
Amortized
Cost Basis
388,510
154,760
30,970
574,240
$
Percentage of
Total Amortized
Cost Basis
67.7%
26.9%
5.4%
100.0%
$
Carrying
Value
388,510
154,760
30,970
574,240
$
Weighted Average
First Dollar Loan
to Value (A)
Weighted Average
Last Dollar Loan to
Value (A)
Delinquency
(B)
52.5%
62.2%
0.0%
53.3%
64.0%
76.6%
48.2%
66.9%
13.2%
19.3%
0.0%
14.4%
(A) Loan to value is based on the appraised value at the time of purchase or refinancing.
(B) The percentage of underlying loans that are non-performing, in foreclosure, under bankruptcy filing or considered real estate owned.
Manufactured Housing and Residential Loans
Average
FICO Score
(A)
Outstanding
Face Amount
Amortized
Cost Basis
Percentage
of Total
Amortized
Cost Basis
Carrying
Value
Average
Loan Age
(months)
Original
Balance
Delinquency
90+/FC/RE
O (B)
Cumulative
Loss to
Date
Deal
Manufactured Housing Loans Portfolio I
703
$
152,450
$
123,042
33.2%
$
123,042
111
$
327,855
Manufactured Housing Loans Portfolio II
Residential Loans Portfolio I
Residential Loans Portfolio II
Total / WA
702
715
737
704
212,036
198,275
53.4%
198,275
59,604
46,235
12.5%
46,235
3,795
427,885
$
3,495
371,047
$
0.9%
100.0%
3,495
371,047
$
140
90
74
122
434,743
646,357
83,950
1,492,905
$
1.3%
1.4%
8.2%
0.0%
2.3%
0.0%
6.8%
4.9%
0.3%
0.0%
4.9%
(A) Based on updated FICO scores provided by the loan servicer of the manufactured housing loan portfolios and original FICO scores for the residential
loan portfolios as the loan servicers of the residential loan portfolios do not provide updated FICO scores.
(B) The percentage of loans that are 90+ days delinquent, or in foreclosure or considered real estate owned.
Subprime Securities (A)
Average
Minimum
Rating (C)
B
B
CCC+
CCC+
B+
Vintage (B)
2003
2004
2005
2006
2007 and later
Number of
Securities
15
28
25
10
10
Outstanding
Face Amount
19,154
$
82,845
93,269
83,095
74,943
Security Characteristics
Amortized Cost
Basis
Percentage of Total
Amortized Cost
Basis
$
10,649
28,277
28,341
46,425
47,772
6.6%
17.5%
17.6%
28.7%
29.6%
Carrying Value
10,741
$
30,924
36,520
48,477
51,344
Total / WA
B-
88
$
353,306
$
161,464
100.0%
$
178,006
Principal
Subordination (D)
Excess
Spread (E)
22.6%
16.9%
28.2%
31.6%
19.5%
24.2%
4.0%
3.9%
4.5%
4.8%
3.1%
4.1%
5
Average
Loan Age
(months)
Collateral
Factor (F)
94
80
68
56
40
64
0.10
0.13
0.19
0.39
0.45
0.28
Collateral Characteristics
3 month
CPR (G)
8.8%
9.8%
8.6%
10.1%
7.8%
Delinquency (H)
19.7%
21.0%
33.0%
31.4%
19.7%
9.1%
26.3%
Vintage (B)
2003
2004
2005
2006
2007 and later
Total / WA
Cumulative Losses
to Date
3.2%
3.6%
8.5%
16.6%
13.2%
9.9%
Real Estate ABS
Asset Type
Manufactured Housing
Small Business Loans
Total / WA
Asset Type
Average
Minimum
Rating (C)
BBB+
CCC
BB
Average
Loan Age
(months)
Security Characteristics
Outstanding
Face
Amount
Amortized Cost
Basis
Amount
Percentage of
Total Amortized
Cost Basis
Carrying
Value
Principal
Subordination (D)
Excess
Spread (E)
$
$
35,137
30,228
65,365
$
$
34,101
8,374
42,475
80.3%
19.7%
100.0%
$
$
35,215
9,963
45,178
39.4%
15.1%
28.1%
1.5%
3.4%
2.4%
Number
7
13
20
Collateral Characteristics
Collateral
Factor (F)
3 Month
CPR (G)
Delinquency (H)
Cumulative
Loss to Date
Manufactured Housing
Small Business Loans
Total / WA
138
75
109
0.28
0.54
0.40
6.2%
6.7%
6.4%
2.3%
29.4%
14.8%
12.6%
7.2%
10.1%
(A) Includes subprime retained securities in the securitizations of Subprime Portfolios I and II. For further information on these securitizations, see Note
5 to our consolidated financial statements included herein.
(B) The year in which the securities were issued.
(C) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including
a “negative watch” assignment) at any time. We had approximately $95.5 million of ABS securities that are on negative watch for possible
downgrade by at least one rating agency as of December 31, 2010.
(D) The percentage of the outstanding face amount of securities and residual interests that is subordinate to our investments.
(E) The annualized amount of interest received on the underlying loans in excess of the interest paid on the securities, as a percentage of the outstanding
collateral balance.
(F) The ratio of original unpaid principal balance of loans still outstanding.
(G) Three month average constant prepayment rate.
(H) The percentage of underlying loans that are 90+ days delinquent, in foreclosure, or considered real estate owned.
REIT Debt
Industry
Retail
Diversified
Office
Multifamily
Hotel
Healthcare
Storage
Industrial
Total / WA
Average
Minimum
Rating (A) Number
Outstanding
Face
Amount
Amortized
Cost Basis
Percentage of
Total
Amortized
Cost Basis
Carrying
Value
BBB+
CCC+
BBB-
BBB
BBB-
BBB-
A-
BB-
BB+
10
8
9
3
3
5
1
1
40
$
$
75,665
71,036
80,127
12,765
29,220
41,600
5,000
2,000
317,413
71,962
71,613
81,304
12,818
29,598
41,673
5,052
2,065
316,085
$
$
$
22.8%
22.7%
25.7%
4.0%
9.4%
13.2%
1.6%
0.6%
81,911
67,305
83,869
13,539
30,785
44,215
5,360
1,986
$
100.0% 328,970
6
Corporate Bank Loans
Average
Minimum
Rating (A) Number
Outstanding
Face
Amount
Amortized
Cost Basis
Percentage of
Total
Amortized
Cost Basis
Carrying
Value
CC
CCC-
NR
B
NR
CC
3
2
1
2
1
9
$
35,898
111,764
116,649
18,136
26,990
309,437
$
$
34,021
44,985
86,649
16,326
26,384
208,365
$
16.3%
21.6%
41.6%
7.8%
12.7%
100.0%
$
34,021
44,985
86,649
16,326
26,384
208,365
$
Industry
Real Estate
Media
Resorts
Restaurant
Transportation
Total / WA
(A) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change
(including a “negative watch” assignment) at any time. None of the REIT assets or bank loans were on negative watch for possible downgrade by at
least one rating agency as of December 31, 2010.
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 strive to reduce 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 debt obligations, known
as CDOs. Our CDO financings offer us the structural flexibility to buy and sell certain investments to manage risk and,
subject to certain limitations, to optimize returns.
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. As a result of the continued challenging credit and liquidity conditions in the markets, the
value of the subordinated securities has generally been reduced or, in some cases, eliminated, which could leave our
securities economically in a first loss position. We also invest in loans and securities which represent “first loss” positions;
in other words, they do not benefit from credit support although we believe at acquisition they predominantly benefit from
underlying collateral value in excess of their carrying amounts.
Our Financing and Hedging Activities
We employ leverage as part of our investment strategy. 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 a
result of our negative GAAP equity, our GAAP debt to equity ratio is not a meaningful measure as of December 31, 2010.
As of December 31, 2010 and as of the date of this Annual Report, we have complied with the general investment
guidelines adopted by our board of directors that limit total leverage. We utilize leverage for the sole purpose of financing
our portfolio and not for the purpose of speculating on changes in interest rates.
We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential
fluctuations in the availability of capital. We utilize multiple forms of financing, including collateralized debt obligations
(CDOs), other securitizations, term loans, and trust preferred securities, as well as short term financing in the form of loans
and repurchase agreements. 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, the manager determines
that bearing such risk is advisable or unavoidable.
We attempt to reduce refinancing and interest rate risks 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,
interest rate caps or other financial instruments, or through a combination of these strategies. We believe this allows us to
reduce 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.
7
We have entered into hedging transactions to protect our positions from interest rate fluctuations and other changes in
market conditions, and we may continue to do so, when feasible and appropriate. These transactions predominantly include
interest rate swaps, interest rate caps and may include the purchase or sale of interest rate collars, caps or floors, options,
mortgage derivatives and other hedging instruments, and may be subject to margin calls. 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 its analysis, that bearing such risks is advisable or
unavoidable. 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. We note that new hedging transactions with respect to many types of hedging
instruments may impose liquidity constraints on us or may be uneconomical for us to obtain. As a result, we currently face
meaningful challenges in entering into hedging transactions to protect new investments from interest rate fluctuations and
other changes in market conditions.
Further details regarding our hedging activities are presented in Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk-Fair Value.”
8
Debt Obligations
The following table presents certain summary information regarding our debt obligations and related hedges as of December 31, 2010 (unaudited) (dollars in thousands):
Collateral
Weighted
Average
Funding
Cost (1)
Weighted
Average
Maturity
(Years)
Face Amount
of Floating
Rate Debt
Outstanding
Face Amount
(2)
Amortized Cost
Basis (2)
Carrying Value (2)
Weighted
Average
Maturity
(Years)
Floating Rate
Face Amount
(2)
Aggregate
Notional Amount
of Current
Hedges (3)
3.16%
5.42%
1.16%
1.76%
7.42%
3.39%
3.6
1.5
6.8
0.9
$
2,972,666
171,972
4,356
18,732
$
3,911,985
363,317
4,356
-
$
2,765,735
328,027
4,356
-
$
2,836,265
328,027
4,356
-
24.3
-
-
-
-
3.3
6.6
6.8
-
-
$
1,610,364
38,458
4,356
-
$
1,702,314
129,198
-
-
-
-
3.8
$
3,167,726
$
4,279,658
$
3,098,118
$
3,168,648
3.5
$
1,653,178
$
1,831,512
Debt Obligation
CDO Bonds Payable
Other Bonds Payable
Notes Payable
Repurchase Agreements (4)
Junior Subordinated
Notes Payable
Outstanding
Face Amount Carrying Value
$
3,010,751
258,324
4,356
18,732
$
3,010,868
256,809
4,356
18,732
51,004
51,253
Subtotal debt obligations
3,343,167
3,342,018
Financing on Subprime
Mortgage Loans Subject
to Call Option
406,217
403,793
Total debt obligations
$
3,749,384
$
3,745,811
(1) Including the effect of applicable hedges.
(2)
(3)
Including restricted cash held for reinvestment in CDOs.
Including a $36.4 million notional amount of interest rate cap agreements in CDO X, an $88.0 million notional amount of interest rate swap agreements in CDO VI and a $129.2 million notional amount of
interest rate swap agreements in MH Loans Portfolio II, which were economic hedges not designated as hedges for accounting purposes. Excluding a $126.4 million notional amount interest rate swap
agreement which was a non-economic hedge in CDO VI.
(4) This repurchase agreement was secured by $46.3 million of notes issued by Newcastle CDO VI, which was repurchased by Newcastle in December 2010 and eliminated in consolidation. As of December
31, 2010, the maximum recourse to Newcastle was $4.7 million.
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,” as well as Note 8 to Part II, Item 8, “Financial Statements and Supplementary Data.”
9
Formation
We were formed in June 2002 and had our initial public offering in October 2002.
The following table presents information on shares of our common stock issued since our formation:
Year
Shares Issued
Range of Issue
Prices (1)
Net Proceeds
(millions)
Formation - 2005
2006
2007
2008
2009
2010
December 31, 2010
43,913,409
1,800,408
7,065,362
9,871
123,463
9,114,671
62,027,184
$29.42
$27.75-$31.30
N/A
N/A
$3.13
$51.2
$201.3
$0.1
$0.1
$28.5
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors. Includes prices of shares issued
in exchange for preferred shares.
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 (as defined in our governing documents) 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 manages our operations
under the direction of our board of directors. The manager is responsible for, among other things, (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.
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 (defined as the net income available
10
for common stockholders before the Incentive Compensation, excluding extraordinary items, plus depreciation of operating
real estate, and after adjusting for unconsolidated subsidiaries, if any) 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 2010, 2009 or the second half
of 2008. 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 must be provided with
60 days’ prior notice of any such termination and would 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 difficult and
costly 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
Subject to the approval of our board of directors, we have the 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.
We also may make loans to, or provide guarantees of certain obligations 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 and our investment guidelines 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.
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 advantages
over us, such as greater resources than we possess, or 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. See “Part 1, Item 1A, Risk Factors – We
are subject to significant competition and may not compete successfully.”
Compliance with Applicable Environmental Laws
11
Properties we own (directly or indirectly) 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
released 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
As described above under “The Management Agreement,” we are managed by FIG LLC, an affiliate of Fortress Investment
Group LLC. 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.
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.
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Item 1A. Risk Factors
Risks relating to our management, business and company include, specifically:
Risks Related to the Financial Markets
We do not know what impact the Dodd-Frank Act will have on our business.
On July 21, 2010, the United States enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-
Frank Act” or “Act”). The Dodd-Frank Act affects almost every aspect of the U.S. financial services industry, including
certain aspects of the markets in which we operate. The Act imposes new regulations on us and how we conduct our
business. For example, the Act will impose additional disclosure requirements for public companies and generally require
issuers or originators of asset-backed securities to retain at least five percent of the credit risk associated with the
securitized assets. In addition, the Act will require us to register as an investment advisor with the SEC, which will increase
our regulatory compliance costs and subject us to new restrictions as well as penalties for any future non-compliance with
these regulations. Importantly, many key aspects of the changes imposed by the Act will be established by various
regulatory bodies and other groups over the next several years. As a result, we do not know how significantly the Act will
affect us. It is possible that the Act could, among other things, increase our costs of operating as a public company, impose
restrictions on our ability to securitize assets and reduce our investment returns on securitized assets.
We do not know what impact the U.S. government’s programs to attempt to stabilize the economy and the financial
markets will have on our business. The government’s current efforts to modify terms of outstanding loans
negatively affects our business, financial condition and results of operations.
In recent years, the U.S. government has taken a number of steps to attempt to strengthen the global financial markets and
U.S. economy, including direct government investments in, and guarantees of, troubled financial institutions as well as
government-sponsored programs such as the Term Asset-Backed Securities Loan Facility program (TALF) and the Public
Private Investment Partnership Program (PPIP). The U.S. government is also currently evaluating or implementing an
array of other measures and programs that purport to help improve U.S. financial and market conditions. While conditions
appear to have improved relative to the depths of the global financial crisis, it is not clear whether this improvement is real
or will last for a significant period of time. Moreover, it is not clear what impact the government’s future plans to improve
the global economy and financial markets will have on our business. To date, we have not benefited in a direct, material
way from any government programs, and we may not derive any meaningful benefit from these programs in the future.
Moreover, if any of our competitors are able to benefit from one or more of these initiatives, they may gain a significant
competitive advantage over us.
In addition, the U.S. government has enacted legislation that enables government agencies to modify the terms of a
significant number of residential and other loans to provide relief to borrowers without the applicable investor’s consent.
These modifications allow for outstanding principal to be deferred, interest rates to be reduced, the length of the loan to be
extended or other terms to be changed in ways that can permanently eliminate the cash flow (principal and interest)
associated with a portion of the loan. These modifications are currently reducing, or in the future may reduce, the value of
a number of our mortgage-backed securities and other investments. As a result, such loan modifications are negatively
affecting our business, results of operations and financial condition. In addition, certain market participants propose
reducing the amount of paperwork required by a borrower to modify their loan, which could increase the likelihood of
fraudulent modifications and materially harm the U.S. mortgage market and investors that have exposure to this market.
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 or management compensation earned by our manager and
whose continued service is not guaranteed and the loss of such services could 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.
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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, its officers or other employees spend
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 (as defined in the management agreement). 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 and likely will not receive any incentive
compensation in the future unless it meaningfully increases 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
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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, and this evolution
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 our ability
to pay dividends on both our common stock and preferred stock or have adverse effects on our liquidity or 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. In addition, a change in our investment strategy may increase our use of non-match-
funded financing, increase the guarantee obligations we agree to incur or increase the number of transactions we enter into
with affiliates. 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
Market conditions could negatively impact our business, results of operations and financial condition.
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 and credit losses with respect to our 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.
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 worsened during 2008, and intensified meaningfully during the fourth
quarter of 2008, as a result of the global credit and liquidity crisis, resulting in extraordinarily challenging market
conditions.
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 similar to those we recently experienced
in which an economic slowdown or recession is accompanied by declining real estate values. Declining real estate values
generally reduce the level of new mortgage loan originations, since borrowers often use increases in the value of their
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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, and the loans underlying our securities, if the real estate economy weakens.
Further, declining real estate values significantly increase the likelihood that we will incur losses on our loans and securities
in the event of default because the value of our collateral may be insufficient to cover our basis. Any sustained period of
increased payment delinquencies, foreclosures or losses could adversely affect both our net interest income from loans and
securities 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 our
shareholders. For more information on the impact of market conditions on our business and results of operations see Part II,
Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market
Considerations.”
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 or repurchase, subordinate classes of bonds issued by certain of our
subsidiaries in our CDO financings. Each of our CDO financings contains tests that measure the amount of over
collateralization and excess interest in the transaction. Failure to satisfy these tests would generally 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. In addition, the
redirected funds would be used to pay down financing, which currently bears an attractive rate, thereby reducing our future
earnings from the affected CDO. The ratings assigned to the assets in each CDO affect the results of the tests governing
whether a CDO can distribute cash to the various classes of securities in the CDO. As a result, ratings downgrades of the
assets in a CDO can result in a CDO failing its tests and thereby cause us not to receive cash flows from the affected CDO.
We note that we have approximately $266.2 million of assets in our consolidated CDOs as of December 2010 or February
2011, as appropriate, that are under negative watch for possible downgrade by at least one of the rating agencies. One or
more of the rating agencies could downgrade some or all of these assets at any time, and any such downgrade could
negatively affect – and possibly materially affect – our future cash flows. As of the December 2010 remittance date for
CDOs IV and V and as of the February 2011 remittance date for CDO VI, these CDOs were not in compliance with their
applicable over collateralization tests and, consequently, we are not receiving cash flows from these CDOs (other than
senior management fees and interest distributions from senior classes of bonds we own). Based upon our current
calculations, we expect these CDOs to remain out of compliance for the foreseeable future. Moreover, given current
market conditions, it is possible that all of our CDOs could be out of compliance with their over collateralization tests as of
one or more measurement dates within the next twelve months.
Our ability to rebalance will depend upon the availability of suitable securities, market prices, whether the reinvestment
period of the applicable CDO has ended, and other factors that are beyond our control. For example, in prior periods, we
were able to repurchase notes issued by the CDOs and subsequently cancel those notes in accordance with the terms of the
relevant governing documentation. These cancellations assisted the applicable CDO in satisfying its overcollateralization
test as of the next testing date and thereby enabled the cash flow from that CDO to be distributed to the junior classes of
securities (including those held by Newcastle). The trustee of all of our CDOs has informed us that, if we wish to cancel
CDO debt in the future, they will require us to obtain the approval of the noteholders of the applicable CDO. If we are
unable to obtain the requisite noteholder consent, we will be unable to use CDO debt cancellations as a tool to help CDOs
satisfy their overcollateralization tests and thereby maintain the flow of cash from that CDO to Newcastle. As a result,
holders of our common shares and preferred shares should not expect that we will be able to cancel any of our CDO
obligations in the future. While there are other permissible methods to rebalance or otherwise correct CDO test failures,
such methods may be extremely difficult to employ given current market conditions, and we cannot assure you that we will
be successful in our rebalancing efforts. If the liabilities of our CDOs are downgraded by Moody’s to certain predetermined
levels, our discretion to rebalance the applicable CDO portfolios may be negatively impacted. Moreover, if we bring these
coverage tests into compliance, we cannot assure you that they will not fall out of compliance in the future or that we will
be able to correct any noncompliance.
Failure of the over collateralization tests can also cause a “phantom income” issue if cash that constitutes income is diverted
to pay down debt instead of distributed to us. For more information regarding noncompliance with the terms of certain of
our CDO financings in the near future, please see Part II, Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations–Liquidity and Capital Resources” and “–Debt Obligations.”
We may experience an event of default or the removal of us as collateral manager under one or more of our CDOs,
which would negatively affect us in a number of ways.
The documentation governing our CDOs specify certain events of default, which, if they occur, would negatively affect us.
Events of default include, among other things, failure to pay interest on senior classes of securities within the CDO,
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breaches of covenants, representations or warranties, bankruptcy, and failure to satisfy specific over collateralization and
interest coverage tests. If an event of default occurs under any of our CDOs, it would negatively affect our cash flows,
business, results of operations and financial condition.
In addition, we can be removed as manager of a CDO if certain events occur, including the failure to satisfy specific over
collateralization and interest coverage tests, failure to satisfy certain “key man” requirements or an event of default
occurring for the failure to pay interest on the related senior classes of securities of the CDO. If we are removed as
collateral manager, we would no longer receive management fees from — and no longer be able to manage the assets of —
the applicable CDO, which would negatively affect our cash flows, business, results of operations and financial condition.
We note that on November 4, 2009, CDO VII failed additional over collateralization tests. The consequences of failing
these tests are that an event of default has occurred, and we may be removed as the collateral manager under the
documentation governing CDO VII. So long as the event of default continues, we will not be permitted to purchase or sell
any collateral in CDO VII. If we are removed as the collateral manager of CDO VII, we would no longer receive the senior
management fees from such CDO. As of February 17, 2011, we have not been removed as collateral manager. Based upon
our current calculations, we estimate that if we are removed as the collateral manager of CDO VII, the loss of senior
management fees would not have a material negative impact on our cash flows, business, results of operations or financial
condition. However, given current market conditions, it is possible that events of default may occur in other CDOs, and we
could be removed as the collateral manager of those CDOs if certain events of default occur. Moreover, our cash flows,
business, results of operations and/or financial condition could be materially and negatively impacted if certain events of
default occur.
We have assumed the role of manager of numerous CDOs previously managed by a third party, and we may assume
the role of manager of additional CDOs in the future. Each such engagement exposes us to a number of potential
risks.
Changes within our industry may result in CDO collateral managers being replaced. In such instances, we may seek to be
engaged as the collateral manager of CDOs currently managed by third parties. For example, in February 2011, one of our
subsidiaries became the collateral manager of certain CDOs previously managed by C-BASS Investment Management LLC
(“C-BASS”).
While being engaged as the collateral manager of such CDOs potentially enables us to grow our business, it also entails a
number of risks that could harm our reputation, results of operations and financial condition. For example, we purchased
the management rights with respect to the C-BASS CDOs pursuant to a bankruptcy proceeding. As a result, we were not
able to conduct extensive due diligence on the CDO assets even though the distressed credit ratings assigned by the rating
agencies to many classes of securities issued by the CDOs as of the most recent rating date prior to our becoming the
collateral manager of the CDOs. We may willingly or unknowingly assume actual or contingent liabilities for significant
expenses, we may become subject to new laws and regulations with which we are not familiar, and we may become subject
to increased risk of litigation, regulatory investigation or negative publicity. For example, we determined that it would be
prudent to register the subsidiary that became the collateral manager of the C-BASS CDOs as a registered investment
advisor, which increases our future regulatory compliance costs. In addition to defending against litigation and complying
with regulatory requirements, being engaged as collateral manager may require us to invest other resources for various
other reasons, which could detract from our our ability to capitalize on future opportunities. Moreover, being engaged as
collateral manager may require us to integrate complex technological, accounting and management systems, which may be
difficult, expensive and time-consuming and which we may not be successful in integrating into our current systems. In
addition to the risk that we face if we are successful in becoming the manager of additional CDOs, we may attempt but fail
to become the collateral manager of CDOs in the future, which could harm our reputation and subject us to costly litigation.
Finally, if we include the financial performance of the C-BASS CDOs or other CDOs for which we become the collateral
manager in our public filings, we are subject to the risk that, particularly during the period immediately after we become the
collateral manager, this information may prove to be inaccurate or incomplete. The occurrence of any of these negative
integration events could negatively impact our reputation with both regulators and investors, which could, in turn, subject
us to additional regulatory scrutiny and impair our relationships with the investment community. The occurrence of any of
these problems could negatively affect our reputation, financial condition and results of operations.
Our investments have previously been — and in the future may be — subject to significant impairment charges,
which 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
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adjustment to the net carrying value of the investment, which could adversely affect our results of operations in the
applicable period and thereby adversely affect our ability to pay dividends to our stockholders.
As has been widely publicized, the recent market conditions have resulted in a number of financial institutions recording an
unprecedented amount of impairment charges, and we were also affected by these conditions. These challenging conditions
have reduced the market trading activity for many real estate securities, resulting in less liquid markets for those 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.
The lenders under our repurchase agreements may elect not to extend financing to us, which could quickly and
seriously impair our liquidity.
We have historically financed a meaningful portion of our investments not held in CDOs with repurchase agreements,
which are short-term financing arrangements, and we may enter into additional repurchase agreements in the future. 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.
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. As we have experienced recently and may experience in the future, 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, if a repurchase agreement counterparty elects
not to extend our financing, we would be required to 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 December 31, 2010, we had an $18.7
million outstanding balance on a repurchase agreement financing our purchase of certain CDO VI notes. Moreover, all of
our repurchase agreement obligations are with one counterparty. If this counterparty elected not to roll this repurchase
agreement, we may not be able to find a replacement counterparty in a timely manner.
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 CDOs, 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. As a result of the continued challenging credit and liquidity
conditions, the return we are able to earn on our investments and cash available for distribution to our stockholders has
been significantly reduced due to changes in market conditions causing the cost of our financing to increase relative to the
income that can be derived from our assets.
We have limited liquidity. We may become party to agreements that require cash payments at periodic intervals.
Failure to make such required payments may adversely affect our business, financial condition and results of
operations.
We are currently party to repurchase agreements that may require us to post additional margin as collateral at any time
during the term of the agreement, based on the value of the collateral. We may become party to additional financing
agreements that require us to make cash payments at periodic intervals or upon the occurrence of certain events. Events
could occur or circumstances could arise, which we may not be able to foresee, that may cause us to be unable to make any
such cash payments when they become due. Failure to make the payments required under our financing documents would
give the lenders the right to require us to repay all amounts owed to them under the applicable financing immediately.
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We are subject to counterparty default and concentration risks.
In the ordinary course of our business, we enter into various types of financing arrangements with counterparties.
Currently, the majority of our financing arrangements take the form of repurchase agreements, securitization vehicles,
loans, hedge contracts, swaps and other derivative and non-derivative contracts. The terms of these contracts are often
customized and complex, and many of these arrangements occur in markets or relate to products that are not subject to
regulatory oversight.
We are subject to the risk that the counterparty to one or more of these contracts defaults, either voluntarily or involuntarily,
on its performance under the contract. Any such default may occur rapidly and without notice to us. Moreover, if a
counterparty defaults, we may be unable to take action to cover our exposure, either because we lack the contractual ability
or because market conditions make it difficult to take effective action. This inability could occur in times of market stress
consistent with the conditions we are currently experiencing, which are precisely the times when defaults may be most
likely to occur.
In addition, our risk-management processes may not accurately anticipate the impact of market stress or counterparty
financial condition, and as a result, we may not take sufficient action to reduce our risks effectively. Although we monitor
our credit exposures, default risk may arise from events or circumstances that are difficult to detect, foresee or evaluate. In
addition, concerns about, or a default by, one large participant could lead to significant liquidity problems for other
participants, which may in turn expose us to significant losses.
In the event of a counterparty default, particularly a default by a major investment bank, we could incur material losses
rapidly, and the resulting market impact of a major counterparty default could seriously harm our business, results of
operations and financial condition. In the event that one of our counterparties becomes insolvent or files for bankruptcy, our
ability to eventually recover any losses suffered as a result of that counterparty’s default may be limited by the liquidity of
the counterparty or the applicable legal regime governing the bankruptcy proceeding.
In addition, with respect to our CDOs, certain of our derivative counterparties are required to maintain certain ratings to
avoid having to post collateral or transfer the derivative to another counterparty. If the counterparty was downgraded below
these levels they may not be able to satisfy their obligations under the derivative, which could have a material negative
effect on the applicable CDO.
The counterparty risks that we face have increased in complexity and magnitude as a result of the recent insolvency of a
number of major financial institutions (such as Bear Stearns, Lehman Brothers, Merrill Lynch, Citigroup and AIG). For
example, the consolidation and elimination of counterparties has increased our concentration of counterparty risk and
decreased the universe of potential counterparties. We are currently party to repurchase agreements with one counterparty.
If this counterparty elected not to roll this repurchase agreement, we may not be able to find a replacement counterparty. In
addition, counterparties have generally tightened their underwriting standards and increased their margin requirements for
financing, which has negatively impacted us in several ways, including, decreasing the number of counterparties willing to
provide financing to us, decreasing the overall amount of leverage available to us, and increasing the costs of borrowing.
We are not restricted from dealing with any particular counterparty or from concentrating any or all of our transactions with
one counterparty. Any loss suffered by us as a result of a counterparty defaulting, refusing to conduct business with us or
imposing more onerous terms on us would also negatively affect our business, results of operations and financial condition.
Although we seek to match fund our investments to limit refinance risk and lock in net spreads, we do not currently
match fund our investments not held in our CDOs, 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
CDOs, 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 its analysis, our manager determines that bearing such risk is deemed advisable or unavoidable
(this is generally the case with respect to the residential mortgage loans and FNMA/FHLMC in which we invest). 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 for the past two
years and is currently still challenging to obtain, 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.
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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.
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.
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 securities and loans that 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, our ability to finance investments with securitizations or other long-term
non-recourse financing not subject to margin requirements has been impaired since 2007 as a result of recent market
conditions. These conditions make it highly likely that we will have to use less efficient forms of financing for any new
investments, which will likely require a larger portion of our cash flows to be put toward making the initial investment and
thereby reduce the amount of cash available for distribution to our stockholders and funds available for operations and
investments, and which will also likely require us to assume higher levels of risk when financing our investments.
The loans we invest in and the loans underlying the securities 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 would 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.
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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 have recently experienced increased default rates on our commercial and residential mortgage loans.
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 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. These competitors may be willing to accept lower return on their investments or to
compromise underwriting standards and, as a result, our origination volume and profit margins could be adversely affected.
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.
Following the closing of a CDO financing when we have locked in the liability costs for a CDO 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.
During the reinvestment period, we must invest the restricted cash available for reinvestments in our CDOs. 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 CDO, the particular CDO’s returns will be at risk of declining to the extent that yields on the
assets to be acquired decline. 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.
Our returns will be adversely affected when investments held in CDOs 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 CDOs subsequent to the end of the reinvestment period, the proceeds
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are fully utilized to pay down the related CDOs debt. This causes the leverage on the CDO to decrease, thereby lowering
our returns on equity.
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 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.
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
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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.
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 that 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.
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. 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 limited.
Our securities 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 the vast majority 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 and interest rate
swaps. 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 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 past, we have utilized hedging transactions to protect our
positions from interest rate fluctuations, but as a result of current market conditions we face significant obstacles to entering
into new hedging transactions. As a result, we may not be able to protect new investments from interest rate fluctuations to
the same degree as in the past, which could adversely affect our financial condition and results of operations.
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
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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, real estate related loans and hedge
derivatives are marked to market each quarter. 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 2008 through the first
quarter of 2009, credit spreads widened substantially. This widening of credit spreads caused the net unrealized gains on
our securities, loans and derivatives, recorded in accumulated other comprehensive income or retained earnings, and
therefore our book value per share, to decrease and resulted in net losses.
In addition, if the value of our loans subject to financing 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.
Any hedging transactions that we enter into may limit our gains or result in losses.
We have used (and may continue to use, when feasible and appropriate) derivatives to hedge a portion of our interest rate
exposure, and this approach 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 or require that we hedge any specific amount of risk.
From time to time, 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.
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
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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.
Under certain conditions, increases in prepayment rates can adversely affect yields on many of our investments.
The value of the majority of assets in which we invest may be affected by prepayment rates on these 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 CDO investments that are comprised of floating
rate securities, the risk of assets inside our CDOs prepaying increases. Since our CDO 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.
Changes in accounting rules could occur at any time and could impact us in significantly negative ways that we are
unable to predict or protect against.
As has been widely publicized, the SEC and other regulatory bodies that establish the accounting rules applicable to us
have recently proposed or enacted a wide array of changes to current accounting rules. Moreover, these regulators may
propose additional changes in the future of which we are not currently aware. Changes to accounting rules that apply to us
could significantly impact our business or our reported financial performance in negative ways that we cannot predict or
prepare against. We cannot predict whether any changes to current accounting rules will occur or what impact any codified
changes will have on our business, results of operation or financial condition.
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.
Risks Relating to Our REIT Status and Other Matters
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
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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.
Our failure to qualify as a REIT would create issues under a number of our financings and other agreements and
would cause our common and preferred stock to be delisted from the NYSE.
Our failure to qualify as a REIT would create issues under a number of our financing and other agreements. In addition, the
New York Stock Exchange requires, as a condition to the continued listing of our common and preferred shares, that we
maintain our REIT status. Consequently, if we fail to maintain our REIT status, our common and preferred shares would
promptly be delisted from the NYSE, which would decrease the trading activity of such shares. This could make it difficult
to sell shares and could cause the market volume of the shares trading to decline.
If Newcastle was delisted as a result of losing its REIT status and desired to relist its shares on the NYSE, the Company
would have to reapply to the NYSE to be listed as a domestic corporation. As the NYSE’s listing standards for REITs are
less onerous than its standards for domestic corporations, it would be more difficult for the Company to become a listed
company under these heightened standards. Given current conditions, Newcastle may not be able to satisfy the NYSE’s
listing standards for a domestic corporation. As a result, if it were delisted from the NYSE, it may not be able to relist as a
domestic corporation, and thus the Company’s common and preferred shares could not trade on the NYSE.
Dividends payable by REITs do not qualify for the reduced tax rates.
Tax law changes in 2010 extended the 2003 reduction of the maximum tax rate for dividends payable to individuals from
35% to 15% through 2012. 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
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 liquidity and 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 satisfy our liquidity needs, which could
adversely affect the value of our common stock.
As of December 31, 2009, we had a loss carryforward, inclusive of net operating loss and capital loss, of approximately
$908 million. The net operating loss carryforward and capital loss carryforward can generally be used to offset future
ordinary taxable income and capital gain, for up to 20 years and 5 years, respectively. As a result, we do not expect that
there will be any REIT distribution requirements for the year ending December 31, 2010.
26
We may be required to report taxable income for certain investments in excess of the economic income we
ultimately realize from them.
We may acquire debt instruments in the secondary market for less than their face amount. The amount of such discount will
generally be treated as "market discount" for U.S. federal income tax purposes. Accrued market discount is generally
recognized as taxable income over our holding period in the instrument in advance of the receipt of cash. If we collect less
on the debt instrument than our purchase price plus the market discount we had previously reported as income, we may not
be able to benefit from any offsetting loss deductions.
In addition, we may acquire debt investments that are subsequently modified by agreement with the borrower. If the
amendments to the outstanding debt are "significant modifications" under the applicable Treasury regulations, the modified
debt may be considered to have been reissued to us in a debt-for-debt exchange with the borrower. In that event, we may be
required to recognize taxable gain to the extent the principal amount of the modified debt exceeds our adjusted tax basis in
the unmodified debt, even if the value of the debt or the payment expectations have not changed. Following such a taxable
modification, we would hold the modified loan with a cost basis equal to its principal amount for U.S. federal tax purposes.
Moreover, in the event that any debt instruments acquired by us are delinquent as to mandatory principal and interest
payments, or in the event payments with respect to a particular debt instrument are not made when due, we may nonetheless
be required to continue to recognize the unpaid interest as taxable income. Similarly, we may be required to accrue interest
income with respect to subordinate mortgage-backed securities at the stated rate regardless of whether corresponding cash
payments are received.
The IRS tax rules regarding recognizing capital losses and ordinary income for our non-recourse financings,
coupled with current REIT distribution requirements, could result in our recognizing significant taxable net income
without receiving an equivalent amount of cash proceeds from which to make required distributions. This
disconnect could have a serious, negative affect on us.
We may experience issues regarding the characterization of income for tax purposes. For example, we may recognize
significant ordinary income, which we would not be able to offset with capital losses, which could, in turn, increase the
amount of income we would be required to distribute to shareholders in order to maintain our REIT status. This disconnect
could occur in the case of one or more of our non-recourse financing structures, including off balance sheet structures such
as our subprime securitizations and non-consolidated CDOs, where we incur capital losses on the related assets, and
ordinary income from the cancellation of the related non-recourse financing if the ultimate proceeds from the assets are
insufficient to repay such debt. Through December 31, 2010, no such cancellation of CDO debt has been effected as a result
of losses incurred. In the case of our subprime securitizations, $3.4 million of such cancellations had been effected through
December 31, 2010 and we expect such cancellations will continue as losses are realized. This disconnect could also occur
as a result of the repurchase of our outstanding debt at a discount as the gain recorded upon the cancellation of indebtedness
is characterized as ordinary income for tax purposes. We have repurchased our debt at a discount in the past, and we intend
to attempt to do so in the future. During 2009, we repurchased $246.7 million face amount of our outstanding CDO debt at
a discount, and recorded $215.3 million of gain. During 2010, we purchased $483.7 million face amount of our outstanding
CDO debt at a discount, and recorded $265.7 million of gain. In compliance with current tax laws, we have the ability to
defer the ordinary income recorded as a result of the cancellation of indebtedness to future years and have deferred or
intend to defer all or a portion of such gain for 2009 and 2010. While such deferral may postpone the effect of the
disconnect in the ability to offset taxable income and losses, it does not eliminate it. Furthermore, cancellation of
indebtedness income recognized on or after January 1, 2011 cannot be deferred and must generally be recognized as
ordinary income in the year of such cancellation. The elimination of the ability to defer the recognition of cancellation of
indebtedness income introduces additional tax implications that may significantly reduce the economic benefit of
repurchasing our outstanding CDO debt.
If we experienced any of these disconnects, we may not have sufficient cashflow to make the distributions necessary to
satisfy our REIT distribution requirements, which would cause us to lose our REIT status and thereby materially negatively
impact our business, financial condition and potentially impair our ability to continue operating in the future. Under current
market conditions, this type of disconnect between taxable income and cash proceeds would be likely to occur at some
point in the future if the current regulations that create the disconnect are not revised, but we cannot predict at this time
when such a disconnect may occur.
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 intend 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
27
may be adversely affected by the risk factors described herein, particularly in light of current market conditions. In the
event of a continued downturn in our operating results and financial performance relative to previous periods 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, under certain circumstances, up to 90% 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. 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 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 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.
28
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:
•
•
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.
29
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 has fluctuated meaningfully, particularly on a percentage basis, and may fluctuate meaningfully in
the future. Accordingly, 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 has fluctuated significantly over the last three years. Moreover, future share price
fluctuations could likely be subject to similarly wide price fluctuations in the future 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;
• market perception of our current and projected financial condition, potential growth, future earnings and
future cash dividends;
announcements we make regarding dividends;
actual or anticipated fluctuations in our quarterly financial and operating results;
•
•
• market perception or media coverage of our manager or its affiliates;
•
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;
•
•
credit deterioration within our portfolio;
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 or has decreased
significantly 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,
30
settling or paying any resulting judgments related to the lawsuit. Such a lawsuit could also divert the time and attention of
our management from our business and hurt our share price.
We may be unable – or elect not – to pay dividends on our common or preferred shares in the future, which would
negatively impact our business in a number of ways and decrease the price of our common and preferred shares.
We have not paid dividends on our common stock since the third fiscal quarter of 2008. While we are required to make
distributions in order to maintain our REIT status (as described above under “–We may be unable to generate sufficient
revenue from operations to pay our operating expenses and to pay distributions to our stockholders”), we may elect not to
maintain our REIT status, in which case we would no longer be required to make such distributions. Moreover, even if we
do elect to maintain our REIT status, we may elect to comply with the applicable requirements by, after completing various
procedural steps, distributing, under certain circumstances, up to 90% of the required amount in the form of common shares
in lieu of cash. If we elect not to maintain our REIT status or to satisfy any required distributions in common shares in lieu
of cash, such action could negatively affect our business and financial condition as well as the price of both our common
and preferred shares. No assurance can be given that we will pay any dividends on our common shares in the future.
To the extent we have unpaid accrued dividends on our preferred shares, we cannot pay any dividends on our common
shares, pay any consideration to repurchase or otherwise acquire shares of our common stock or redeem any shares of any
series of our preferred stock without redeeming all of our outstanding preferred shares in accordance with the governing
documentation. Consequently, the failure to pay dividends on our preferred shares restricts the actions that we may take
with respect to our common shares and preferred shares. Moreover, if we do not pay dividends on any series of preferred
stock for six or more periods, then holders of each affected series obtain the right to call a special meeting and elect two
members to our board of directors. We cannot predict whether the holders of our preferred stock would take such action or,
if taken, how long the process would take or what impact the two new directors on our board of directors would have on
our company (other than increasing our director compensation costs). However, the election of additional directors would
affect the composition of our board of directors and, thus, could affect the management of our business.
Shares eligible for future sale may adversely affect our common stock price.
Sales of our common stock or other securities in the public or private market, or the perception that these sales may occur,
could cause the market price of our common stock to decline. This could also impair our ability to raise additional capital
through the sale of our equity securities. Under our certificate of incorporation, we are authorized to issue up to
500,000,000 shares of common stock, of which 62,027,184 shares of common stock were outstanding as of December 31,
2010. We cannot predict the size of future issuances of our common stock or other securities or the effect, if any, that
future sales and issuances would have on the market price of our common stock.
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.
31
Item 1B. Unresolved Staff Comments
We have no unresolved staff comments received more than 180 days prior to December 31, 2010.
Item 2. Properties.
As of December 31, 2010, we have no material investments in properties.
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. No material proceedings were terminated during the fourth quarter of
the fiscal year covered by this report.
Item 4. (Removed and Reserved).
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity
Securities.
We have one class of common stock, which 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.
2010
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2009
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
$3.35
$4.18
$3.20
$7.10
High
$0.95
$1.25
$3.94
$3.25
Low
$1.75
$2.00
$2.24
$3.02
Low
$0.25
$0.55
$0.49
$1.30
Last Sale
$3.23
$2.68
$3.10
$6.70
Last Sale
$0.65
$0.66
$2.97
$2.09
Distributions
Declared
$ -
$ -
$ -
$ -
Distributions
Declared
$ -
$ -
$ -
$ -
We may 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, liquidity, capital requirements, REIT requirements and such other factors as our
board of directors deems relevant. As described under Part II, Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Market Considerations,” we recently elected not to declare quarterly dividends on
either our common shares.
On February 17, 2011, the closing sale price for our common stock, as reported on the NYSE, was $8.00. As of February
17, 2011, there were approximately 81 record holders of our common stock. This figure does not reflect the beneficial
ownership of shares held in nominee name.
32
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, 2010.
Plan Category
Equity Compensation Plans Approved
by Security Holders:
Newcastle Investment Corp. Nonqualified
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
Stock Option and Incentive Award Plan
2,498,609 (1)
$26.64
6,347,153 (2)
Equity Compensation Plans Not Approved
by Security Holders:
None
N/A
N/A
N/A
(1)
(2)
Includes options for (i) 1,686,447 shares held by an affiliate of our manager; (ii) 798,162 shares granted to our
manager and assigned to certain of Fortress’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 111,120 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 2010, and of 1,043,118 shares issued to our manager and its affiliates, certain of our directors, and
employees of Fortress, upon the exercise of previously granted options.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
In March 2010, we settled an offer to exchange (the “Exchange Offer”) shares of our common stock and cash for shares of
our preferred stock. The table below provides information about the shares of our preferred stock that we purchased as part
of the Exchange Offer. For more information about the Exchange Offer, see Part II, Item 7, “Management’s Discussion
and Analysis of Financial Condition and Results of Operations — Preferred Stock” or Note 9 to Part II, Item 8, “Financial
Statements and Supplementary Data.” Other than the purchases described in the table below, no purchases of shares of any
class of our equity securities were made by us or on our behalf or by any “affiliated purchaser,” as defined in the SEC’s
rules, during the period covered by this Annual Report.
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
Same as total
Maximum Number (or
Approximate Dollar Value)
of Shares that May Yet Be
Purchased Under the Plans
or Programs
N/A – Exchange Offer
settled in March 2010
Period
March 23, 2010
Total Number of
Shares Purchased
• 1,152,679
Series B
Preferred
shares
Average Price Paid
per Share(1)
• $12.22 per
Series B
Preferred
share
• 1,104,000
Series C
Preferred
shares
• 1,380,000
Series D
Preferred
shares
• $12.22 per
Series C
Preferred
share
• $12.22 per
Series D
Preferred
share
(1) As noted above, we purchased the preferred shares for a combination of common stock and cash. Of the average price
paid per share $7.82 was paid in stock and $4.40 was paid in cash.
33
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, 2010 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
Interest income
Interest expense
Net interest income
2010
Year Ended December 31,
2008
2007
2009
2006
$
300,272
172,219
128,053
$
361,866
218,410
143,456
$
468,867
307,303
161,564
$
680,535
476,932
203,603
$
529,818
374,269
155,549
Impairment, net of the reversal of prior valuation allowances
on loans
(240,858)
548,540
2,991,830
220,321
13,565
Net interest income (loss) after impairment
368,911
(405,084)
(2,830,266)
(16,718)
141,984
Other income (loss)
Expenses
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss)
Preferred dividends
Excess of carrying amount of exchanged preferred stock
over fair value of consideration paid
Income (loss) applicable to common stockholders
Income (loss) per share of common stock, diluted
Income (loss) from continuing operations per share of
common stock, after preferred dividends and excess of carrying
amount of exchanged preferred stock over fair value of
consideration paid, diluted
Weighted average number of shares of common stock
outstanding, diluted
Dividends declared per share of common stock
282,287
29,528
621,670
(8)
621,662
(7,453)
227,399
31,901
(112,809)
32,623
(209,586)
(318)
(209,904)
(13,501)
(2,975,698)
(9,654)
(2,985,352)
(13,501)
(8,885)
39,724
(65,327)
(130)
(65,457)
(12,640)
23,660
38,172
127,472
451
127,923
(9,314)
43,043
657,252
10.96
$
$
-
(223,405)
(4.23)
$
$
-
$
$
(2,998,853)
(56.81)
-
(78,097)
(1.52)
$
$
-
118,609
2.67
$
$
$
10.96
$
(4.22)
$
(56.63)
$
(1.52)
$
2.66
59,949
$
-
52,864
$
-
52,785
0.750
$
51,369
2.850
$
44,417
2.615
$
34
Balance Sheet Data
Non-Recourse VIE Financing Structures
Real estate securities, net
Real estate related loans, net
Residential mortgage loans, held for investment, net
Residential mortgage loans, held for sale, net
Operating real estate
Other investments
Restricted cash
Total assets
Total debt
Total liabilities
Recourse Financing Structures and Unlevered Assets
Real estate securities, net
Real estate related loans, net
Residential mortgage loans, held for sale, net
Operating real estate
Other investments
Cash and cash equivalents
Restricted cash
Total assets
Total debt
Total liabilities
Aggregate
Total assets
Total debt
Total liabilities
Common stockholders' equity (deficit)
Preferred stock
Supplemental Balance Sheet Data
Common shares outstanding
Book value (deficit) per share of common stock
2010
2009
As Of December 31,
2008
2007
2006
$
1,859,984
750,130
124,974
252,915
8,776
18,883
157,005
3,612,733
3,689,875
3,875,181
$
1,784,487
554,367
-
380,123
-
-
200,251
3,358,877
4,765,631
4,971,677
$
1,472,253
696,523
-
406,265
-
-
37,483
3,050,535
5,138,627
5,474,308
$
3,507,813
1,418,382
529,975
-
-
-
65,578
5,963,778
5,755,207
5,863,916
$
4,149,047
792,986
782,077
-
-
-
136,812
6,229,419
5,423,991
5,451,892
600
32,475
298
-
6,024
33,524
-
74,378
55,936
59,515
46,308
19,495
3,524
9,966
-
68,300
-
155,751
174,573
183,603
196,495
146,689
3,367
11,866
-
49,746
6,799
423,088
376,572
392,847
3,687,111
3,745,811
3,934,696
(309,168)
61,583
3,514,628
4,940,204
5,155,280
(1,793,152)
152,500
3,473,623
5,515,199
5,867,155
(2,546,032)
152,500
1,328,071
438,596
104,630
34,399
-
55,916
67,548
2,073,992
1,636,487
1,726,229
8,037,770
7,391,694
7,590,145
295,125
152,500
1,432,181
775,930
27,020
29,626
-
5,371
47,357
2,374,973
2,080,740
2,150,520
8,604,392
7,504,731
7,602,412
899,480
102,500
62,027
(4.98)
$
52,913
(33.89)
$
52,789
(48.23)
$
52,779
5.59
$
45,714
19.68
$
2010
Year Ended December 31,
2008
2007
2009
2006
Other Data
Net interest income less expenses (net of preferred dividends) (1)
$
91,072
$
98,054
$
115,440
$
151,239
$
108,063
(1) Newcastle has five primary variables that impact its operating performance: (i) the current yield earned on its investments that are not included
in non-recourse financing structures (i.e., unlevered investments and investments subject to recourse debt), (ii) the net yield it earns from its
non-recourse financing structures, (iii) the interest expense and dividends incurred under its recourse debt and preferred stock, (iv) its operating
expenses, and (v) its realized and unrealized gains on its investments and its debt obligations, including impairment. Net Interest Income Less
Expenses (Net of Preferred Dividends) is a measure of the operating performance of Newcastle that excludes the fifth variable listed above. It
is used by management to gauge the current performance of Newcastle without taking into account gains and losses, which, although they
represent a part of our recurring operations, are subject to significant variability and are only a potential indicator of future economic
performance. Management views Net Interest Income Less Expenses (Net of Preferred Dividends) as Newcastle’s “core” current earnings,
while gains and losses (including impairment) are simply a potential indicator of future earnings. Management believes that Net Interest
Income Less Expenses (Net of Preferred Dividends) provides investors with useful information regarding Newcastle’s “core” current earnings,
and it enables investors to evaluate Newcastle’s current performance using the same measure that management uses to operate the business.
Net interest income less expenses (net of preferred dividends) 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. For a further
description of the differences between cash flow provided by operating and net income, see “– Liquidity and Capital Resources” above. Our
calculation of net interest income less expenses (net of preferred dividends) may be different from the calculation used by other companies and,
therefore, comparability may be limited.
35
Calculation of Net Interest Income Less Expenses (Net of Preferred Dividends):
Income (loss) applicable to common stockholders
Add (Deduct):
Impairment, net of the reversal of prior valuation
allowances on loans
Other (income) loss
(Income) loss from discontinued operations
Excess of carrying amount of exchanged preferred
stock over fair value of consideration paid
Year Ended December 31,
2010
2009
2008
2007
2006
$
657,252
$
(223,405)
$
(2,998,853)
$
(78,097)
$
118,609
(240,858)
(282,287)
8
548,540
(227,399)
318
2,991,830
112,809
9,654
220,321
8,885
130
13,565
(23,660)
(451)
(43,043)
91,072
$
-
98,054
$
-
115,440
$
-
151,239
$
-
108,063
$
36
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,” and Part I, Item 1A, “Risk Factors.”
General
Newcastle Investment Corp. is a real estate investment and finance company. We invest in, and actively manage, a
portfolio of real estate securities, loans and other real estate related assets. 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, liquidity, diversification, match funded financing and credit risk
management.
As described below, we meaningfully improved on our operating results, liquidity, and book value during 2010.
We currently own a diversified portfolio of 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
REITs, real estate related asset backed securities (ABS) and FNMA/FHLMC securities. Mortgage backed securities are
interests in or obligations secured by pools of mortgage loans. We generally target investments rated A through BB, except
for our FNMA/FHLMC securities which have an implied AAA rating. We also own, directly and indirectly, interests in
loans and pools of loans, including real estate related loans, commercial mortgage loans, residential mortgage loans,
manufactured housing loans and subprime mortgage loans.
We employ leverage as part of our investment strategy. 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 a
result of our negative GAAP equity, our GAAP debt to equity ratio is not a meaningful measure as of December 31, 2010.
As of December 31, 2010, we have complied with the general investment guidelines adopted by our board of directors that
limit total leverage. We utilize leverage for the sole purpose of financing our portfolio and not for the purpose of
speculating on changes in interest rates.
We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential
fluctuations in the availability of capital. We seek to utilize multiple forms of financing including collateralized debt
obligations (CDOs), other securitizations, term loans, and trust preferred securities, as well as short term financing in the
form of loans and repurchase agreements. As we discuss in more detail under “– Market Considerations” below, while
market conditions have improved meaningfully since 2008, the current conditions continue to reduce the array of capital
resources available to us and have made the terms of capital resources we are able to obtain less favorable to us relative to
the terms we were able to obtain prior to the onset of challenging conditions. That said, credit and liquidity conditions have
continued to improve during 2010 and early 2011, and, as a result, we have recently been able to access more types at
capital – and on better terms – than we had been able to access during 2008 and 2009.
We seek to match fund our investments with respect to interest rates and maturities in order to reduce the impact of interest
rate fluctuations on earnings and reduce the risk of refinancing our liabilities prior to the maturity of the investments. We
seek to finance a substantial portion of our real estate securities and loans through the issuance of term debt, which
generally represents obligations issued in multiple classes secured by an underlying portfolio of assets. Specifically, our
CDO financings offer us the structural flexibility to buy and sell certain investments to manage risk and, subject to certain
limitations, to optimize returns.
We conduct our business through the following segments: (i) investments financed with non-recourse collateralized debt
obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments and debt repurchases
financed with recourse debt, (iv) unlevered investments, and (v) corporate. With respect to the first two nonrecourse
segments, Newcastle is generally entitled to receive net cash flows from these structures on a periodic basis. Revenues
attributable to each segment are disclosed below (unaudited) (in thousands).
Non-recourse
For the Year Ended
December 31, 2010
December 31, 2009
December 31, 2008
CDOs
$
226,717
275,938
$
$
307,891
Other
$
$
$
72,773
76,868
88,643
Recourse Unlevered Corporate
68
$
101
$
1,954
$
$
$
$
1,653
1,543
22,672
976
7,416
47,707
$
$
$
Inter-segment
Elimination
(1,915)
$
$
-
$
-
Total
$
300,272
361,866
$
$
468,867
37
Taxation
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. REIT distribution requirements may generally be satisfied up to 90% through stock dividends
rather than cash, subject to limitations based on the value of the stock.
As a REIT, we will generally not be subject to U.S. federal corporate 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 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 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, or we may not be able to pay it. 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. Moreover, if we fail to qualify as a REIT, we would be delisted from the NYSE.
Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that 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, including certain potential developments discussed in Part I, Item 1A, “Risk Factors.”
Market Considerations
Financial Markets in which We Operate
Our ability to generate income is dependent on our ability to invest our capital on a timely basis at attractive levels. The
two primary market factors that affect this ability are (1) credit spreads and (2) the availability of financing on favorable
terms.
Generally speaking, widening credit spreads reduce any unrealized gains on our current investments (or cause or increase
unrealized losses) and increase our costs for new financings, but increase the yields available on potential new investments,
while tightening credit spreads increase the unrealized gains (or reduce unrealized losses) on our current investments and
reduce our costs for new financings, but reduce the yields available on potential new investments. By reducing unrealized
gains (or causing unrealized losses), widening credit spreads also impact our ability to realize gains on existing investments
if we were to sell such assets.
From mid-2007 through early 2009, credit spreads widened substantially. One of the key drivers of the widening of credit
spreads over these years was the continued disruption and liquidity concerns throughout the credit markets. The severity
and scope of the disruption intensified meaningfully during the fourth quarter of 2008 and the first quarter of 2009. In the
latter part of 2009, credit spreads tightened substantially. This trend continued in 2010. This tightening of credit spreads
caused the net unrealized losses on our securities and derivatives to decrease. Despite signs of meaningful improvement,
market conditions remain challenging, could change rapidly, and we cannot predict how recent or future changes in market
conditions will affect our business.
Liquidity
Credit and liquidity conditions have continued to improve during 2010 and early 2011, but conditions are still less
favorable than those we experienced prior to 2007. Recent challenging credit and liquidity conditions have adversely
affected us and the markets in which we operate in a number of ways. For example, it has reduced the market trading
activity for many real estate securities and loans, resulting in less liquid markets for those securities and loans. As the
securities held by us and many other companies in our industry are marked to market at the end of each quarter, the
decreased liquidity and concern over market conditions have resulted in significant reductions in mark to market valuations
of many real estate securities and loans and the collateral underlying them, as well as volatility and uncertainty with respect
to such valuations. These lower valuations, and decreased expectations of future cash flows, have affected us by, among
other things:
38
•
•
•
•
•
decreasing our net book value;
contributing to our decision to record significant impairment charges;
prompting us to negotiate the removal of certain financial covenants from our non-CDO financings;
reducing the amount, which we refer to as cushion, by which we satisfy the over collateralization and interest
coverage tests of our CDOs (sometimes referred to as CDO “triggers”) or contributing to several of our CDOs
failing their over collateralization tests (see “– Liquidity and Capital Resources” and “– Debt Obligations”
below); and
requiring us to pay additional amounts under certain financing arrangements.
In some cases, we have sold, and we may continue to sell, assets at prices below what we believed to be their value in order
to meet liquidity requirements under certain financing arrangements. Failed CDO triggers, impairments resulting from
incurred losses, and asset sales made at prices significantly below face amount while the related debt is being repaid at its
full face amount, as well as the retention of cash, could further contribute to reductions in future earnings, cash flow and
liquidity.
In order to maintain liquidity, we have elected not to declare dividends on our common stock since the third quarter of
2008. With respect to our preferred stock, our improved liquidity position enabled us to pay all accrued and unpaid
dividends on our preferred stock as of January 31, 2011. We may elect to adjust or not to pay any future dividend payments
to reflect our current and expected cash from operations or to satisfy future liquidity needs.
Extent of Market Disruption
Market conditions have meaningfully improved over the last eighteen months, but it is not clear whether a sustained
recovery will occur or, if so, for how long it will last. We do not currently know the full extent to which the continuing
challenging market conditions will affect us or the markets in which we operate. If such conditions persist, particularly with
respect to commercial real estate, we may experience additional impairment charges, potential reductions in cash flows
from our investments and additional challenges in raising capital and obtaining investment or other financing on attractive
terms. Moreover, we will likely need to continue to place a high priority on managing our liquidity. Certain aspects of
these effects are more fully described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition
and Results of Operations – Interest Rate, Credit and Spread Risk” and “– Liquidity and Capital Resources” as well as in
Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”
Formation and Organization
We were formed and had our initial public offering in 2002.
The following table presents information on shares of our common stock issued since our formation:
Year
Shares Issued
Range of Issue
Prices (1)
Net Proceeds
(millions)
Formation - 2005
2006
2007
2008
2009
2010
December 31, 2010
43,913,409
1,800,408
7,065,362
9,871
123,463
9,114,671
62,027,184
$29.42
$27.75-$31.30
N/A
N/A
$3.13
$51.2
$201.3
$0.1
$0.1
$28.5
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors. Includes prices of shares
issued in exchange for preferred stock.
As of December 31, 2010, approximately 3.8 million of our shares of common stock were held by Fortress, through its
affiliates, and principals of Fortress. In addition, Fortress, through its affiliates, held options to purchase approximately 1.7
million shares of our common stock at December 31, 2010.
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
39
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 judgments used in applying each of the
accounting policies described below, as modified periodically to reflect current market conditions. 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
Variable interest entities (“VIEs”) are defined as entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, and only
its primary beneficiary, which is defined as the party who has the power to direct the activities of a VIE that most
significantly impact its economic performance and who has the obligation to absorb losses or the right to receive benefits
from the VIE that could potentially be significant to the VIE.
The VIEs in which we have a significant interest include (i) our CDOs, and (ii) our manufactured housing loan financing
structures. Our CDOs were all consolidated under prior guidance; however, under current guidance effective January 1,
2010, we do not have the power to direct the relevant activities of CDO VII, as a result of the event of default which allows
us to be removed as collateral manager of CDO VII and prevents us from purchasing or selling certain collateral within
CDO VII, and therefore we have deconsolidated CDO VII as of January 1, 2010. Similar events of default in the future, if
they occur, could cause us to deconsolidate additional financing structures. Our manufactured housing loan financing
structures were consolidated under prior guidance and continue to be consolidated under the current guidance. However, as
discussed in “- Liquidity and Capital Resources – Debt Obligations”, we completed a securitization transaction to refinance
our Manufactured Housing Loans Portfolio I. We analyzed the securitization under the applicable accounting guidance and
concluded that the securitization transaction should be accounted for as a secured borrowing. As a result, we continue to
recognize the portfolio of manufactured housing loans as pledged assets, which have been classified as loans held for
investment at securitization, and recorded the notes issued to third parties as a secured borrowing.
Our subprime securitizations are also considered VIEs, but we do not control their activities and no longer receive a
significant portion of their returns. These subprime securitizations were not consolidated under the current or prior
guidance.
In addition, our investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs,
depending on their structure. We are not obligated to provide, nor have we provided, any financial support to these VIEs.
We monitor these investments and, to the extent we determine that we potentially own a majority of the currently
controlling class, analyze them for potential consolidation. As of December 31, 2010, we have not consolidated these
potential VIEs due to the determination that, based on the nature of Newcastle’s investments and the provisions governing
these structures, we do not have the power to direct the activities that most significantly impact their economic
performance.
We will continue to analyze future investments, as well as reconsideration events in existing entities, pursuant to the VIE
requirements. 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 that would otherwise not have been consolidated or the non-consolidation of an entity that would
otherwise have been consolidated.
Valuation and Impairment of Securities
We have classified all our real estate securities as available for sale. As such, they are carried at fair value with net
unrealized gains or losses reported as a component of accumulated other comprehensive income, to the extent impairment
losses are considered temporary as described below. Fair value may be based upon broker quotations, counterparty
quotations or pricing services quotations, which provide valuation estimates based upon reasonable market order
indications or a good faith estimate thereof and are subject to significant variability based on market conditions, such as
interest rates, credit spreads and market liquidity. A significant portion of our securities are currently not traded in active
markets and therefore have little or no price transparency. For a further discussion of this trend, see “– Market
Considerations” above. As a result, we have estimated the fair value of these illiquid securities based on internal pricing
models rather than the sources described above. The determination of estimated cash flows used in pricing models is
inherently subjective and imprecise. Changes in market conditions, as well as changes in the assumptions or methodology
used to determine fair value, could result in a significant and immediate increase or decrease in our book equity. For
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.
40
See Note 7 to our consolidated financial statements in Part II, Item 8, “Financial Statements and Supplementary Data” for
information regarding the fair value of our investments, and its estimation methodology, as of December 31, 2010.
Our securities must be categorized by the “level” of inputs used in estimating their fair values. Level 1 would be assets
valued based on quoted prices for identical instruments in active markets. We have no level 1 assets. Level 2 would be
assets valued based on quoted prices in active markets for similar instruments, on quoted prices in less active or inactive
markets, or on other “observable” market inputs. Level 3 would be assets valued based significantly on “unobservable”
market inputs. We have further broken level 3 into level 3A, third party indications, and level 3B, internal models. Fair
value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were
forced to sell assets in a short period to meet liquidity needs, the prices we receive could be substantially less than the
recorded fair values.
We generally classify the broker and pricing service quotations we receive as level 3A inputs, except for certain liquid
securities. They are quoted prices in generally inactive and illiquid markets for identical or similar securities. These
quotations are generally received via email and contain disclaimers which state that they are “indicative” and not
“actionable” – meaning that the party giving the quotation is not bound to actually purchase the security at the quoted price.
These quotations are generally based on models prepared by the brokers, and we have little visibility into the inputs they
use. Based on quarterly procedures we have performed with respect to quotations received from these brokers, including
comparison to the outputs generated from our internal pricing models and transactions we have completed with respect to
these securities, as well as on our knowledge and experience of these markets, we have generally determined that these
quotes represent a reasonable estimate of fair value. For the $1.6 billion of securities valued using quotations as of
December 31, 2010, a 100 basis point change in credit spreads would impact estimated fair value by approximately $41.7
million.
Our estimation of the fair value of level 3B assets (as described below) involves significant judgment. We validated the
inputs and outputs of our models by comparing them to available independent third party market parameters and models for
reasonableness. We believe the assumptions we used are within the range that a market participant would use and factor in
the relative illiquidity, but slight recent improvement in liquidity, currently in the markets. In comparison to the prior year
end, we have generally used lower discount rates as inputs to our models in order to reflect current improved market
conditions. The other inputs to our models, including prepayment spreads, default rates and severity assumptions, have
generally remained consistent with the assumptions used at the prior year end, other than certain modifications we have
made to reflect conditions relevant to specific assets. In 2008 and 2009, Newcastle generally lowered the prepayment
assumptions based on observed reductions in actual prepayment speeds and slower expected future prepayments consistent
with market projections. The slower prepayments were the result of increasing difficulties for borrowers to refinance,
caused by a tightening of underwriting standards, decline in home prices, contraction of available lenders due to bank
failures and a distressed securitization market. Default assumptions were increased due to higher levels of delinquent
underlying loans. Loss severity assumptions were increased based on observed increases in recent loss severities that have
been driven by falling home prices and the increasing number of foreclosures or distressed home sales in the residential
sector and higher losses as a result of the increasing number of foreclosures and bankruptcies of borrowers experienced in
the commercial sector. The discount rate assumption used to value subprime and other asset backed securities was generally
decreased as a result of increased liquidity in the market.
For debt securities valued with internal models, which have an aggregate fair value of $232.0 million as of December 31,
2010, a 10% unfavorable change in our assumptions would result in the following decreases in such aggregate fair value (in
thousands):
Outstanding face amount
Fair value
Effect on fair value with 10% unfavorable change in:
Discount rate
Prepayment rate
Default rate
Loss severity
CMBS
$
570,688
ABS
$
289,786
$
128,603
$
103,409
$
$
$
(3,584)
N/A
(28,132)
(13,907)
$
$
$
$
(3,595)
(862)
(6,444)
(12,443)
The sensitivity analysis is hypothetical and should be used with caution. In particular, the results are calculated by stressing
a particular economic assumption independent of changes in any other assumption; in practice, changes in one factor may
result in changes in another, which might counteract or amplify the sensitivities. Also, changes in the fair value based on a
10% variation in an assumption generally may not be extrapolated because the relationship of the change in the assumption
to the change in fair value may not be linear.
41
We must also assess whether unrealized losses on securities, if any, reflect a decline in value which is other-than-temporary
and, if so, write the impaired security down to its fair value through earnings. A decline in value is deemed to be other-
than-temporary if (i) it is probable that we will be unable to collect all amounts due according to the contractual terms of a
security which was not impaired at acquisition (there is an expected credit loss), or (ii) if we have the intent to sell a
security in an unrealized loss position or it is more likely than not we will be required to sell a security in an unrealized loss
position prior to its anticipated recovery (if any). For the purposes of performing this analysis, we assume the anticipated
recovery period is until the respective security’s expected maturity. Also, for certain securities which represent “beneficial
interests in securitized financial assets,” whenever there is a probable adverse change in the timing or amounts of estimated
cash flows of a security from the cash flows previously projected, an other-than-temporary impairment is considered to
have occurred. These securities are also analyzed for other-than-temporary impairment under the guidelines applicable to
all securities as described herein. We note that primarily all of our securities, except our FNMA/FHLMC securities, fall
within the definition of beneficial interests in securitized financial assets.
Temporary declines in value generally result from changes in market factors, such as market interest rates and credit
spreads, or from certain macroeconomic events, including market disruptions and supply changes, which do not directly
impact our ability to collect amounts contractually due. We continually evaluate the credit status of each of our securities
and the collateral supporting our securities. This evaluation includes a review of the credit of the issuer of the security (if
applicable), the credit rating of the security, the key terms of the security (including credit support), debt service coverage
and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the collateral supporting
such loans, including the effect of local, industry and broader economic trends and factors. These factors include loan
default expectations and loss severities, which are analyzed in connection with a particular security’s credit support, as well
as prepayment rates. These factors are also analyzed in relation to the amount of the unrealized loss and the period elapsed
since it was incurred. The result of this evaluation is considered when determining management’s estimate of cash flows,
particularly with respect to developing the necessary inputs and assumptions. Each security is impacted by different factors
and in different ways; generally the more negative factors which are identified with respect to a given security, the more
likely we are to determine that we do not expect to receive all contractual payments when due with respect to that security.
Significant judgment is required in this analysis.
As of December 31, 2010, we had 185 securities with a carrying amount of $564.1 million that had been downgraded
during 2010 and recorded a net other-than-temporary impairment charge of $85.8 million on these securities in 2010.
However, we do not depend on credit ratings in underwriting our securities, either at acquisition or on an ongoing basis. As
mentioned above, a credit rating downgrade is one factor that we monitor and consider in our analysis regarding other-than-
temporary impairment, but it is not determinative. Our securities generally benefit from the support of one or more
subordinate classes of securities or equity or other forms of credit support. Therefore, credit rating downgrades, even to the
extent they relate to an expectation that a securitization we have invested in, on an overall basis, has credit issues, may not
ultimately impact cash flow estimates for the class of securities in which we are invested.
Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized
loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected
identification of which securities would be sold is also subject to significant judgment, particularly in times of market
illiquidity such as we are currently experiencing.
Revenue Recognition on Securities
Income on 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, we recognize the excess of all cash flows expected
over our investment in the securities as Interest Income on a “loss-adjusted” yield basis. The loss-adjusted yield is
determined based on an evaluation of the credit status of securities, as described in connection with the analysis of
impairment above.
Valuation of Derivatives
Similarly, our derivative instruments are carried at fair value. Fair value is based on counterparty quotations. Newcastle
reports the fair value of derivative instruments gross of cash paid or received pursuant to credit support agreements and fair
value is reflected on a net counterparty basis when Newcastle believes a legal right of offset exists under an enforceable
netting agreement. To the extent they qualify as cash flow hedges, net unrealized gains or losses are reported as a
component of accumulated other comprehensive income; otherwise, the net unrealized gains and losses are reported
currently in income. To the extent they qualify as fair value hedges, net unrealized gains or losses on both the derivative
42
and the related portion of the hedged item are reported currently in income. Fair values of such derivatives are subject to
significant variability based on many of the same factors as the securities discussed above, including counterparty credit
risk. The results of such variability, the effectiveness of our hedging strategies and the extent to which a forecasted hedged
transaction remains probable of occurring, could result in a significant increase or decrease in our GAAP equity and/or
earnings.
Impairment of Loans
We own, directly and indirectly, real estate related, commercial mortgage and residential mortgage loans, including
manufactured housing loans and subprime mortgage loans. To the extent that they are classified as held for investment, we
must periodically evaluate each of these loans or loan pools for possible impairment. Impairment is indicated when it is
deemed probable that we will be unable to collect all amounts due according to the contractual terms of the loan, or, for
loans acquired at a discount for credit losses, when it is deemed probable that we will be unable to collect as anticipated.
Upon determination of impairment, we would establish a specific valuation allowance with a corresponding charge to
earnings. We continually evaluate our loans receivable for impairment. Our residential mortgage loans, including
manufacture housing loans, are aggregated into pools for evaluation based on like characteristics, such as loan type and
acquisition date. Individual loans are evaluated based on an analysis of the borrower’s performance, the credit rating of the
borrower, debt service coverage and loan to value ratios, the estimated value of the underlying collateral, the key terms of
the loan, and the effect of local, industry and broader economic trends and factors. Pools of loans are also evaluated based
on similar criteria, including historical and anticipated trends in defaults and loss severities for the type and seasoning of
loans being evaluated. This information is used to estimate specific impairment charges on individual loans as well as
provisions for estimated unidentified incurred losses on pools of loans. Significant judgment is required both in determining
impairment and in estimating the resulting loss allowance. Furthermore, we must assess our intent and ability to hold our
loan investments on a periodic basis. If we do not have the intent and ability to hold a loan for the foreseeable future or
until its expected payoff, the loan must be classified as “held for sale” and recorded at the lower of cost or estimated value.
Revenue Recognition on Loans Held for Investment
Income on these loans is recognized similarly to that on our securities and is subject to similar uncertainties and
contingencies, which are also analyzed on at least a quarterly basis. For loans acquired at a discount for credit losses, the
net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income,
offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Valuation Allowance. The
provision is determined based on an evaluation of the loans as described under “Impairment of Loans” above. In the fourth
quarter of 2008, we reclassified all our investments in loans as held for sale as we could no longer express the intent and
ability to hold our loan investments through maturity. Subsequent to the refinancing of our Manufactured Housing Loans
Portfolio I in April 2010, we have reclassified the related pool of loans as held for investment since the longer term
financing gives us the ability to hold these loans until maturity. A rollforward of the allowance is included in Note 5 to our
consolidated financial statements in Part II, Item 8, “Financial Statements and Supplementary Data.”
Revenue Recognition on Loans Held for Sale
Real estate related, commercial mortgage and residential mortgage loans that are considered held for sale are carried at the
lower of amortized cost or market value determined on either an individual method basis, or in the aggregate for pools of
similar loans. Interest income is recognized based on the loan’s coupon rate to the extent management believes it is
collectable. Purchase discounts are not amortized as interest incurred during the period the loan is held for sale. A change in
the market value of the loan, to the extent that the value is not above the cost basis, is recorded in Valuation Allowance. A
rollforward of the allowance is included in Note 5 to our consolidated financial statements in Part II, Item 8, “Financial
Statements and Supplementary Data.”
Recent Accounting Pronouncements
In April 2009, the FASB issued new guidance which (i) requires disclosures about the fair value of financial instruments on
an interim basis, (ii) changes the guidance for determining, recording and disclosing other-than-temporary impairment, and
(iii) provides additional guidance for estimating fair value when the volume or level of activity for an asset or liability have
significantly decreased. This guidance was effective for Newcastle as of April 1, 2009. It had a significant impact on our
disclosures, but no material impact on our financial condition, liquidity, or results of operations upon adoption. A
reclassification adjustment of $1.3 billion of loss from Accumulated Deficit to Accumulated Other Comprehensive Income
(Loss) was recorded at adoption but had no net effect on equity. Post-adoption impairment determinations, including the
analysis performed at December 31, 2010, are performed using this new guidance and may result in materially different
conclusions than would have been reached under prior guidance.
43
In June 2009, the FASB issued new guidance on transfers of financial assets, which eliminates the concept of qualified
special purpose entities (QSPEs), changes the requirements for reporting a transfer of a portion of financial assets as a sale,
clarifies other sale accounting criteria and changes the initial measurement of a transferor’s interest in transferred financial
assets. Furthermore, it requires additional disclosures. This guidance is effective for fiscal years beginning after November
15, 2009. The adoption of this guidance did not have a material impact on our financial position, liquidity or results of
operations.
In June 2009, the FASB issued new guidance which changes the definition of a variable interest entity (“VIE”) and changes
the methodology to determine who is the primary beneficiary of, or in other words who consolidates, a VIE. Furthermore, it
eliminates the scope exception for qualified special purpose entities (QSPEs), which are now subject to the VIE
consolidation rules. This guidance is effective for fiscal years beginning after November 15, 2009. Generally, the changes
are expected to cause more entities to be defined as VIEs and to require consolidation by the entity that exercises day-to-
day control over a VIE, such as servicers and collateral managers. As discussed under “Variable Interest Entities” above,
this guidance resulted in changes in our consolidated entities. Changes to consolidation conclusions impact, potentially
materially, our gross assets, liabilities, equity, revenues and expenses but are not material to the net income applicable to
our common stockholders.
The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, financial
statement presentation, revenue recognition, leases, financial instruments, hedging, contingencies and fair value. Some of
the proposed changes are significant and could have a material impact on Newcastle’s reporting. Newcastle has not yet
fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.
Results of Operations
The following table summarizes the changes in our results of operations from year-to-year (dollars in thousands):
Comparison of Results of Operations for the years ended December 31, 2010 and 2009
Interest income
Interest expense
Net interest income
Impairment
Year Ended December 31,
$
2010
300,272
172,219
128,053
$
2009
361,866
218,410
143,456
Increase (Decrease)
%
Amount
$
(61,594)
(46,191)
(15,403)
(17.0%)
(21.1%)
(10.7%)
Valuation allowance (reversal) on loans
Other-than-temporary impairment on securities, net
(339,887)
99,029
(240,858)
15,007
533,533
548,540
(354,894)
(434,504)
(789,398)
Net interest income (loss) after impairment
368,911
(405,084)
773,995
Other Income (Loss)
Gain (loss) on settlement of investments, net
Gain on extinguishment of debt
Other income (loss), net
Expenses
Loan and security servicing expense
General and administrative expense
Management fee to affiliate
52,307
265,656
(35,676)
282,287
4,580
7,696
17,252
29,528
11,438
215,279
682
227,399
5,034
8,899
17,968
31,901
40,869
50,377
(36,358)
54,888
(454)
(1,203)
(716)
(2,373)
Income (loss) from continuing operations
$
621,670
$
(209,586)
$
831,256
N.M. - Not meaningful
N.M
N.M
N.M
N.M
357.3%
23.4%
N.M
24.1%
(9.0%)
(13.5%)
(4.0%)
(7.4%)
396.6%
44
Interest Income
Interest income decreased by $61.6 million primarily due to (i) a $23.1 million decrease as a result of the deconsolidation of
CDO VII, (ii) a $2.2 million decrease as a result of the disposition of securities and loans, (iii) a $5.1 million decrease due
to paydowns of existing securities and loans, (iv) a $1.0 million decrease in the amount of prepayment penalties we
received as a result of the prepayment of securities and loans, and (v) a $40.9 million decrease due to the accretion of
discounts on securities impaired due to non-credit factors recognized as interest income in the first quarter of 2009. Up until
March 31, 2009, GAAP required us to record impairments to write down debt securities to their fair value, rather than just
the portion related to expected credit losses. As a result, we recorded a significant amount of impairments due to non-credit
factors prior to 2009. Therefore, the portion of non-credit impairment, which we expected to recover, contributed to a
significant amount of interest income being recorded through the accretion of discount in the first quarter of 2009.
However, upon the adoption of revised impairment guidance issued by the FASB effective April 1, 2009, we no longer had
to record impairment due to non-credit factors and therefore no longer recorded this significant increase in accretion income
after the first quarter of 2009. The decreases described in items (i) through (v) above were partially offset by a $10.7million
net increase as a result of new investments made offset by interest rate changes.
Interest Expense
Interest expense decreased by $46.2 million primarily due to (i) a $3.3 million decrease as a result of the repayment of
repurchase agreements in connection with the disposition or repayment of certain securities and loans and a $6.7 million
decrease in connection with the repurchase or paydown of CDO debt obligations, (ii) an $18.5 million decrease as a result
of the deconsolidation of CDO VII, (iii) a $3.1 million decrease due to the repayment of debt resulting from paydowns of
existing securities and loans, (iv) a $4.3 million decrease in the interest expense incurred on our junior subordinated notes
due to the modification and exchanges effected in April 2009 and January 2010, (v) a $5.3 million decrease due to changes
in the amortization of a deferred hedge loss and (vi) a $5.1 million net decrease, which was primarily due to changes in
interest rates.
Valuation Allowance on Loans
The valuation allowance on loans decreased by $354.9 million primarily due to improved market conditions, certain
successful loan restructurings and the sales of loans at prices substantially above their carrying value, resulting in a larger
net reversal of valuation allowances on loans during the year ended December 31, 2010.
Other-than-temporary Impairment on Securities, Net
The other-than-temporary impairment on securities decreased by $434.5 million primarily due to improved market
conditions.
Gain (Loss) on Settlement of Investments, Net
The net gain on settlement of investments increased by $40.9 as a result of the increased volume of sales and repayments of
investments at a gain and the lower volume of sales of certain securities and loans at a loss due to liquidity reasons in the
year ended December 31, 2010 compared to the year ended December 31, 2009.
Gain (Loss) on Extinguishment of Debt
The net gain on extinguishment of debt increased by $50.4 million primarily due to the significantly higher amounts of debt
repurchased (although at lower discounts to our basis, such discounts are based on market conditions as well as the level
within the capital structure we are repurchasing) in the year ended December 31, 2010 compared to the year ended
December 31, 2009.
Other Income (Loss), Net
Other income decreased by $36.4 million primarily due to (i) a $20.6 million increase in unrealized loss recognized on
derivative instruments for which the hedged items were no longer probable of occurring (ii) a $16.7 million decrease in fair
value of certain non-hedge derivative instruments, offset by (iii) a $0.9 million increase in miscellaneous fee income.
Loan and Security Servicing Expense
Loan and security servicing expense has remained relatively stable during the year ended December 31, 2010 compared to
the year ended December 31, 2009.
45
General and Administrative Expense
General and administrative expense decreased by $1.2 million primarily due to a decrease in legal and professional
expenses.
Management Fee to Affiliate
Management fees decreased by $0.7 million primarily due to a reduction in gross equity (as defined in the management
agreement) as a result of the exchange of preferred stock in the first quarter of 2010.
Comparison of Results of Operations for the years ended December 31, 2009 and 2008
Interest income
Interest expense
Net interest income
Impairment
$
Year Ended December 31,
2008
2009
468,867
361,866
307,303
218,410
161,564
143,456
$
$
Amount
Increase (Decrease)
%
(22.8%)
(28.9%)
(11.2%)
(107,001)
(88,893)
(18,108)
Valuation allowance on loans
Other-than-temporary impairment on securities, net
15,007
533,533
548,540
994,134
1,997,696
2,991,830
(979,127)
(1,464,163)
(2,443,290)
Net interest income (loss) after impairment
(405,084)
(2,830,266)
2,425,182
Other Income (Loss)
Gain (loss) on settlement of investments, net
Gain on extinguishment of debt
Other income (loss), net
Expenses
Loan and security servicing expense
General and administrative expense
Management fee to affiliate
11,438
215,279
682
227,399
5,034
8,899
17,968
31,901
(58,668)
13,824
(67,965)
(112,809)
6,649
7,586
18,388
32,623
70,106
201,455
68,647
340,208
(1,615)
1,313
(420)
(722)
Income (loss) from continuing operations
$
(209,586)
$
(2,975,698)
$
2,766,112
N.M
N.M
N.M
N.M
119.5%
N.M
N.M
301.6%
(24.3%)
17.3%
(2.3%)
(2.2%)
93.0%
Interest Income
Interest income decreased by $107 million primarily due to (i) a $33.5 million decrease as a result of the disposition of
certain assets and a $4.0 million decrease in connection with the disposition of assets to repay one of our CDO debt
obligations, (ii) a $22.3 million decrease due to paydowns of existing securities and loans, (iii) a $55.4 million net decrease,
which was primarily due to changes in interest rates, although this decrease was partially offset by increased interest
income as a result of the accretion of discounts on impaired securities. The decreases described in items (i) through (iii)
above were partially offset by an $8.2 million increase in the amount of prepayment penalties we received as a result of the
early prepayment of securities and loans.
Interest Expense
Interest expense decreased by $88.9 million primarily due to (i) a $20.7 million decrease as a result of the repayment of
repurchase agreements in connection with the disposition of certain assets and a $9.9 million decrease in connection with
the repayment of certain CDO debt obligations or the repurchase of debt, (iii) a $12.8 million decrease due to repayment of
debt resulting from paydowns of existing securities and loans, (iv) a $57.9 million net decrease, which was primarily due to
changes in interest rates. The decreases described in items (i) through (iii) above were partially offset by an $11.6 million
increase as a result of the amortization of a deferred hedge loss.
46
Valuation Allowance on Loans
The valuation allowance on loans decreased by $979.1 million as the net decline in fair value of loans was only $15.0
million in 2009, compared to a valuation allowance of $994.1 million we recorded in 2008 as a result of the reclassification
of all loans from the “held for investment” category to the “held for sale” category as of December 31, 2008.
Other-than-temporary Impairment on Securities, Net
The other-than-temporary impairment on securities decreased by $1.5 billion in 2009. We continued to record a significant
amount of other-than-temporary impairment as a result of the ongoing global credit crisis, but the amount recorded in 2009
was significantly less than the amount recorded in 2008 due to the significant impairment we recorded in the fourth quarter
of 2008 when we determined that we were not able to express the intent and ability to hold our securities through maturity
or recovery.
Gain (Loss) on Settlement of Investments, Net
The net gain on settlement of investments increased by $70.1 million primarily due to investments, which had previously
been written down through impairments or allowances, being repaid at par.
Gain (Loss) on Extinguishment of Debt
The gain on extinguishment of debt increased by $201.5 million primarily due to the significantly higher amount of debt
repurchased (and at a higher discount) in 2009 compared to 2008.
Other Income (Loss), Net
Other income recorded was not significant in 2009. The net increase of $68.6 million is primarily due to the significant
loss recorded in 2008 as a result of the termination of total rate of return swaps at losses and losses on non-hedge
derivatives.
Loan and Security Servicing Expense
Loan and security servicing expense decreased by $1.6 million primarily due to the principal pay down of our residential
and manufactured housing mortgage loan portfolios.
General and Administrative Expense
General and administrative expense increased by $1.3 million primarily due to increases in legal fees and other professional
fees in connection with our debt restructurings.
Management Fee to Affiliate
Management fees decreased by $0.4 million primarily due to a reduction in gross equity (as defined in the management
agreement) as a result of the return of capital distributions made in 2008.
Liquidity and Capital Resources
Overview
Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to repay
borrowings, fund and maintain investments, and other general business needs. Additionally, to maintain our status as a
REIT under the Code, we must distribute annually at least 90% of our REIT taxable income. We note that we believe we
have already met this requirement through 2010 and that up to 90% of this requirement may be met in future years through
stock dividends, rather than cash, subject to limitations based on the value of our stock. Our primary sources of funds for
liquidity consist of net cash provided by operating activities, sales or repayments of investments, potential refinancing of
existing debt, and the issuance of equity securities, when feasible. Our debt obligations are generally secured directly by our
investment assets, except for the junior subordinated notes payable.
Sources of Liquidity and Uses of Capital
As of the date of this filing, we have sufficient liquid assets to satisfy all of our recourse liabilities other than our junior
subordinated notes payable, which are long-term obligations. With respect to the next twelve months, we expect that our
47
cash on hand combined with our cash flow provided by operations will be sufficient to satisfy our anticipated liquidity
needs with respect to our current investment portfolio, including related financings, hedging activity, potential margin calls
and operating expenses. While it is inherently more difficult to forecast beyond the next twelve months, we currently
expect to meet our long-term liquidity requirements, specifically the repayment of our recourse debt obligations, through
our cash on hand and, if needed, additional borrowings, proceeds received from repurchase agreements and similar
financings, and the liquidation or refinancing of our assets.
These short-term and long-term expectations are forward-looking and subject to a number of uncertainties and assumptions,
which are described below under “–Factors That Could Impact Our Liquidity” as well as Part I, Item 1A, “Risk Factors.” If
our assumptions about our liquidity prove to be incorrect, we could be subject to a shortfall in liquidity in the future, and
this short-fall may occur rapidly and with little or no notice, which would limit our ability to address the shortfall on a
timely basis.
Cash flow provided by operations constitutes a critical component of our liquidity. Essentially, our cash flow provided by
operations is equal to (i) the net cash flow from our CDOs that have not failed their over collateralization or interest
coverage tests, plus (ii) the net cash flow from our non-CDO investments that are not subject to mandatory debt repayment,
including principal and sales proceeds, less (iii) operating expenses (primarily management fees, professional fees and
insurance), and less (iv) interest on the junior subordinated notes payable.
Our cash flow provided by operations differs from our net income (loss) due to these primary factors: (i) accretion of
discount or premium on our real estate securities and loans (including the accrual of interest and fees payable at maturity),
discount on our debt obligations, deferred financing costs, and deferred hedge gains and losses, (ii) gains and losses from
sales of assets financed with CDOs, (iii) the valuation allowance recorded in connection with our loan assets, as well as
other-than-temporary impairment on our securities, (iv) unrealized gains or losses on our non-hedge derivatives, (v) the
non-cash charges associated with our early extinguishment of debt, and (vi) net income (loss) generated within CDOs that
have failed their over collateralization or interest coverage tests. Proceeds from the sale of assets which serve as collateral
for our CDO financings, including gains thereon, are required to be retained in the CDO structure until the related bonds are
retired and are, therefore, not available to fund current cash needs outside of these structures.
Update Liquidity, Capital Resources and Capital Obligations
Certain details regarding our liquidity, current financings and capital obligations as of February 25, 2011 are set forth
below:
• Cash – We had a total of $250.6 million of cash, comprised of unrestricted cash of $57.9 million and $192.7
million of restricted cash held for reinvestment in our CDOs;
• Margin Exposure and Recourse Financings – We have margin exposure on a $17.2 million repurchase agreement
related to the financing of the Newcastle Class I-MM notes (of which only $4.3 million is recourse) and a $63.0
million repurchase agreement related to the financing of FNMA/FHLMC securities.
The following table compares our recourse financings excluding the junior subordinated notes:
Recourse Financings
CDO Securities
Non-FNMA/FHLMC recourse financings
FNMA/FHLMC securities
Total recourse financings
February 25, 2011
4,288
$
4,288
63,029
67,317
$
December 31, 2010
4,683
$
4,683
-
4,683
$
The non-FNMA/FHLMC recourse financings and the FNMA/FHLMC recourse financing will mature in
December 2011 and May 2011, respectively.
It is important for readers to understand that our liquidity, available capital resources and capital obligations could change
rapidly due to a variety of factors, many of which are beyond our control. Set forth below is a discussion of some of the
factors that could impact our liquidity, available capital resources and capital obligations.
Factors That Could Impact Our Liquidity, Capital Resources and Capital Obligations
We refer readers to our discussions in other sections of this report for the following information:
• For a further discussion of recent trends and events affecting our liquidity, see “– Market Considerations” above;
• As described above, under “– Update on Liquidity, Capital Resources and Capital Obligations,” we are subject to
margin calls in connection with our repurchase agreements;
• Our match funded investments are financed long term, and their credit status is continuously monitored, which is
described under "Quantitative and Qualitative Disclosures About Market Risk — Interest Rate Exposure'' below.
48
Our remaining investments, generally financed with short term debt or short term repurchase agreements, are also
subject to refinancing risk upon the maturity of the related debt. See “Debt Obligations” below; and
• For a further discussion of a number of risks that could affect our liquidity, access to capital resources and our
capital obligations, see Part I, Item 1A, “Risk Factors” above.
In addition to the information referenced above, the following factors could also affect our liquidity, access to capital
resources and our capital obligations. As such, if their outcomes do not fall within our expectations, changes in these factors
could negatively affect our liquidity.
•
• Access to Financing from Counterparties – Decisions by investors, counterparties and lenders to enter into
transactions with us will depend upon a number of factors, such as our historical and projected financial
performance, compliance with the terms of our current credit and derivative arrangements, industry and market
trends, the availability of capital and our investors’, counterparties’ and lenders’ policies and rates applicable
thereto, and the relative attractiveness of alternative investment or lending opportunities. Recent conditions and
events have limited the array of capital resources available to us and made the terms of capital resources we are
able to obtain generally less favorable to us relative to the terms we were able to obtain prior to the onset of
challenging conditions. Our core business strategy is dependent upon our ability to finance our real estate
securities, 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 relative to historical levels and demand for such
liabilities remains lower than the demand prior to the onset of challenging market conditions.
Impact of Rating Downgrades on CDO Cash Flows – Ratings downgrades of assets in our CDOs can negatively
impact compliance with the CDOs’ over collateralization tests. Generally, the over collateralization test measures
the principal balance of the specified pool of assets in a CDO against the corresponding liabilities issued by the
CDO. However, based on ratings downgrades, the principal balance of an asset or of a specified percentage of
assets in a CDO may be deemed to be reduced below their current balance to levels set forth in the related CDO
documents for purposes of calculating the over collateralization test. As a result, ratings downgrades can reduce
the assumed principal balance of the assets used in the over collateralization test relative to the corresponding
liabilities in the test, thereby reducing the over collateralization percentage. In addition, actual defaults of assets
would also negatively impact compliance with the over collateralization tests. Failure to satisfy an over
collateralization test could result in the redirection of cashflows, or, in certain cases, in the potential removal of
Newcastle as collateral manager of the affected CDO. See “Debt Obligations” below for a summary of assets on
negative watch for possible downgrade in our CDOs.
Impact of Expected Repayment or Forecasted Sale on Cash Flows – The timing of and proceeds from the
repayment or sale of certain investments may be different than expected or may not occur as expected. Proceeds
from sales of assets in the current illiquid market environment are unpredictable and may vary materially from
their estimated fair value and their carrying value.
•
Investment Portfolio
Our investment portfolio as of December 31, 2010 is detailed in Part I, Item 1, “Business – Our Investment Strategy.”
Debt Obligations
Our debt obligations, as summarized in Note 8 to Part II, Item 8, “Financial Statements and Supplementary Data,” existing
at December 31, 2010 (gross of $3.6 million of discounts) had contractual maturities as follows (unaudited) (in thousands):
2011
2012
2013
2014
2015
Thereafter
Total
Nonrecourse
$
186,021
-
-
-
-
3,507,676
3,693,697
$
Recourse
$
4,683
-
-
-
-
51,004
55,687
$
Total
190,704
-
-
-
-
3,558,680
3,749,384
$
$
Certain of the debt obligations included above are obligations of our consolidated subsidiaries which own the related
collateral. In some cases, including the CDO and Other Bonds Payable, such collateral is not available to other creditors of
ours.
The following table provides additional information regarding short-term borrowings. These short-term borrowings were
used to finance certain of our investments in real estate securities and loans, including FNMA/FHLMC securities, and our
investments in manufactured housing loans. During the year ended December 31, 2010, we repaid all previously
49
outstanding repurchase agreements and other short-term borrowings. In December 2010, we entered into a new repurchase
facility of $19 million to finance the purchase of certain notes issued by Newcastle CDO VI. The new repurchase
agreement has recourse to Newcastle up to twenty-five percent of the then-outstanding balance of the repurchase facility,
which was approximately $4.7 million as of December 31, 2010.
Repurchase agreements
Outstanding Balance at
December 31, 2010
$
18,732
Average Daily Amount
Outstanding
$
16,365
Maximum Amount
Outstanding
$
71,309
Weighted Average
Interest Rate
LIBOR+1.14%
Year Ended December 31, 2010
Short-term other bonds payable
$
-
$
3,091
$
10,246
LIBOR+2.75%
Our non-CDO obligations contain various customary loan covenants. We were in compliance with all of the covenants in
our non-CDO financings as of December 31, 2010.
In March 2006, we acquired a portfolio of 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,
which issued $1.45 billion of notes with 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 (we note that this interest is non-economic if we do not exercise the option,
meaning that it has no impact on us).
In March 2007, we entered into an agreement to acquire a portfolio of subprime mortgage loans (“Subprime Portfolio II”)
with up to $1.7 billion of unpaid principal balance. 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,
which issued $1.0 billion of notes with 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 note that this interest is non-economic, meaning that if we do not exercise the option it
has no impact on us).
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 assets of Newcastle.
During 2010, we repurchased $483.7 million face amount of CDO bonds for $215.8 million and recorded a gain of $265.7
million. During 2009, we repurchased $246.7 million face amount of CDO bonds for $29.9 million and recorded a gain of
$215.3 million. During 2008, we repurchased $24.9 million face amount of CDO bonds for $7.9 million and recorded a
gain of $16.8 million.
During 2008, we had significant asset sales and associated debt repayments and recorded significant impairment, as
reflected in Part II, Item 8, “Financial Statements and Supplementary Data.”
On April 30, 2009, we entered into an exchange agreement with several collateralized debt obligations managed by a third
party pursuant to which we agreed to exchange newly issued junior subordinated notes due in 2035 with an initial aggregate
principal amount of $101.7 million (the "Notes") for $100 million in aggregate liquidation amount of trust preferred
securities that were previously issued by a subsidiary of us (the “TRUPs”) and were owned by the third party. The Notes
accrue interest at a rate of 1.0% per year for a maximum of six quarters, beginning on February 1, 2009 and the aggregate
principal amount of the Notes will increase to $104.9 million by July 31, 2010. Subsequent to that period, the rate reverts to
that which we were required to pay on the TRUPs (7.574% through April 2016 and at a floating rate of 3-month LIBOR
plus 2.25% thereafter). In conjunction with the exchange, the TRUPs were cancelled. This exchange is considered a
50
troubled debt restructuring under GAAP which requires us to account for the effect of the interest modification
prospectively and to record expenses related to the modification immediately through earnings.
On January 29, 2010, Newcastle entered into an Exchange Agreement, dated as of January 29, 2010 (the “Exchange
Agreement”), with Taberna Capital Management, LLC and certain of its affiliates (collectively, “Taberna”), pursuant to
which Newcastle and Taberna agreed to exchange (the “Exchange”) approximately $52.1 million aggregate principal
amount of junior subordinated notes due 2035 for approximately $37.6 million face amount of previously issued CDO
securities and approximately $9.7 million of cash held by Newcastle. In other words, $52.1 million face amount of
Newcastle’s debt, in the form of junior subordinated notes payable, was repurchased and extinguished for GAAP purposes
in exchange for (i) the payment of $9.7 million of cash, and (ii) the reissuance of $37.6 million face amount of CDO bonds
payable (which had previously been repurchased by Newcastle). In connection with the Exchange, Newcastle paid or
reimbursed $0.6 million of expenses incurred by Taberna, various indenture trustees and their respective advisors in
accordance with the terms of the Exchange Agreement. Newcastle accounted for this exchange as a troubled debt
restructuring involving partial repayment of debt. As a result, Newcastle recorded no gain or loss. The following table
presents certain information regarding the Exchange as of the date of the Exchange.
Outstanding face amount
Weighted average coupon
Maturity
Repurchased junior
subordinated notes
$
52,094
7.574% (A)
April 2035
Cash
$
9,715
N/A
Collateral
General credit of Newcastle
(A) LIBOR + 2.25% after April 2016
(B) Weighted average effective interest rate of approximately LIBOR+0.35% after the Exchange.
Consideration
Reissued CDO
bonds
$
37,625
Total
$
47,340
LIBOR + 0.66% (B)
June 2052
Assets within the
respective CDOs
The fair value of the consideration paid approximated the fair value of the repurchased junior subordinated notes of $16.7
million.
On April 15, 2010, Newcastle completed a securitization transaction to refinance its Manufactured Housing Loans Portfolio
I (the “Portfolio”). Newcastle sold approximately $164.1 million outstanding principal balance of manufactured housing
loans to Newcastle MH I LLC (the “Issuer”). The Issuer issued approximately $134.5 million aggregate principal amount
of asset-backed notes (the “Notes”), of which $97.6 million was sold to third parties and $36.9 million was sold to certain
CDOs managed and consolidated by Newcastle. At the closing of the securitization transaction, Newcastle used the gross
proceeds received from the issuance of the Notes to repay the previously existing financing on this portfolio in full,
terminate the related interest rate swap contracts, pay the related transaction costs and increase its unrestricted cash by
approximately $14 million. Under the applicable accounting guidance, the securitization transaction is accounted for as a
secured borrowing. As a result, no gain or loss is recorded for the transaction. Newcastle continues to recognize the
portfolio of manufactured housing loans as pledged assets, which have been classified as loans held for investment at
securitization, and records the notes issued to third parties as a secured borrowing. The associated assets, liabilities,
revenues and expenses are presented in the non-recourse financing structure sections of the consolidated financial
statements.
In December 2010, Newcastle, together with one or more of its wholly owned subsidiaries, completed a series of
transactions whereby we repurchased approximately $257 million current principal balance of Newcastle CDO VI Class I-
MM notes at a price of 67.5% of par. The purchased notes represent all of the outstanding Class I-MM notes of Newcastle
CDO VI (the "notes"). We purchased the notes using a combination of restricted cash, unrestricted cash and proceeds from
a new repurchase facility, entered into in connection with the purchase of a portion of the notes. The repurchase facility has
a one-year term and bears interest at a rate of LIBOR + 1.50%. As of December 31, 2010, the repurchase agreement had an
outstanding balance of $18.7 million, which was secured by $46.3 million current principal balance of the notes. Although
the repurchase facility contains mark to market provisions that require margin to be posted in the event that the value of the
notes decreases, the recourse to Newcastle is limited to twenty-five percent of the then-outstanding balance of the
repurchase facility, which was approximately $4.7 million as of December 31, 2010. In accordance with GAAP, we
recorded an $82 million gain on the extinguishment of this debt and $24.0 million of mark-to-market loss on the related
interest rate swap agreement.
In February 2011, we purchased $63.4 million current principal balance of FNMA/FHLMC one-year ARM securities for
approximately $66.3 million, using $3.3 million of unrestricted cash and financed with a $63.0 million new repurchase
facility. The repurchase facility bears interest at 0.29%, matures in May 2011 and is subject to customary margin
provisions.
51
Each of our CDO financings contains tests that measure the amount of over collateralization and excess interest in the
transaction. At issuance, each of our CDOs passed all of these tests. Failure to satisfy these tests would generally cause (or
has caused) the cash flow that would otherwise be distributed to the more junior classes of securities (including those held
by Newcastle) to be redirected to pay down the most senior class of securities outstanding until the tests are satisfied. As a
result, our cash flow and liquidity are negatively impacted upon such a failure, and the impact could be (and has been)
material. The table set forth below presents data, including the most recent quarterly cash flows received by Newcastle, for
each of our CDOs, and sets forth which of the CDOs have satisfied these tests in the most recent quarter. The amounts set
forth are as of December 31, 2010 unless otherwise noted (dollars in thousands). For those CDOs that have failed their
applicable over collateralization tests, the impact of failing is already reflected in the cash flow set forth in the table. For
those CDOs that have satisfied their applicable over collateralization tests, we could potentially lose substantially all of the
cash flows from those CDOs in future quarters if we fail to satisfy the tests in the future. The amounts in the table reflect
data at the CDO level and thus are different from the GAAP balance sheet due to intercompany amounts eliminated in
Newcastle’s consolidated balance sheet.
52
CDO IV
CDO V
CDO VI
CDO VIII
CDO IX
CDO X
Balance Sheet:
Assets Face Amount
Assets Fair Value
Issued Debt Face Amount (1)
Issued Debt Basis (1)
Quarterly cash receipts (2)
Collateral Composition (3):
CMBS
REIT Debt
ABS
FNMA/FHLMC
Bank Loans
Mezzanine Loans / B-Notes /
Whole Loans
CDO
Residential Loans
Equity Securities
Other Investments
Restricted Cash for Reinvestment
Total
$
Face
218,664
86,507
43,392
-
3,977
9,732
-
-
-
-
-
$
362,272
274,317
291,475
290,779
$
116
Fair Value
147,269
$
92,057
24,041
-
3,808
B+
BBB-
B+
--
CCC-
$
Face
269,994
74,404
66,856
3,140
-
$
414,394
266,812
381,545
380,459
$
143
Fair Value
156,987
$
78,146
28,264
3,415
-
B+
BBB-
B-
AAA
--
$
Face
278,377
59,200
77,707
-
9,353
$
424,637
221,842
345,450
344,298
$
115
Fair Value
113,996
$
60,668
38,036
-
9,142
B
BB+
B
--
CCC+
$
Face
220,981
-
82,543
-
178,173
$
927,008
630,096
678,313
677,250
$
3,746
Fair Value
145,730
$
-
62,566
-
127,572
$
811,277
590,101
530,125
534,172
$
1,374,641
1,048,991
1,224,250
1,222,767
$
3,205
$
6,555
BB
--
B+
--
CCC+
$
Face
62,604
-
3,232
-
203,577
Fair Value
52,703
$
-
2,830
-
158,556
BB+
--
BBB+
--
CCC
CCC-
CCC
--
--
--
--
$
Face
902,239
97,302
190,663
-
29,188
$
Fair Value
684,047
98,100
135,992
-
11,748
BB+
BB-
BB+
--
CCC-
-
67,900
-
-
-
87,349
-
31,755
-
-
-
87,349
--
B-
--
--
--
--
7,142
-
-
-
-
-
BB+
--
--
--
--
--
-
-
-
-
-
-
-
-
-
-
-
-
--
--
--
--
--
--
-
-
-
-
-
-
--
--
--
--
--
--
$ 424,637 $ 221,842 B+
-
-
-
-
-
-
317,340
90,568
-
-
-
37,403
CCC
CCC
--
--
--
--
$ 927,008 $ 630,096 B-
234,746
22,079
-
-
-
37,403
419,504
74,250
3,795
-
18,882
25,433
303,647
20,275
3,493
4,282
18,882
25,433
$ 362,272 $ 274,317 BB-
$ 414,394 $ 266,812 BB-
$ 811,277 $ 590,101 CCC
$ 1,374,641 $ 1,048,991 BB+
Collateral on Negative Watch (4)
$ 32,664
$ 43,003
$ 45,637
$ 10,994
$ -
$ 133,925
CDO Cash Flow Triggers (5):
Over Collateralization (6):
As of December 2010 remittance
Cushion (Deficit) ($)
As of February 2011 remittance
Cushion (Deficit) ($)
Interest Coverage (6):
As of December 2010 remittance
Cushion (Deficit) (%)
As of February 2011 remittance
Cushion (Deficit) (%)
CDO Overview:
Effective
Reinvestment Period End (7)
Optional Call (8)
Auction Call (9)
WA Debt Spread (bps) (10)
Asset Average Life
Debt Average Life
$ (33,908)
$ (30,319)
--
223.1%
--
Sep-04
Passed
Jun-07
Mar-14
54
3.1
2.2
--
165.6%
--
Feb-05
Passed
Dec-07
Sep-14
58
3.4
3.0
See footnotes on next page
$ (178,604)
$ (184,846)
$ 63,954
$ 47,223
$ 119,317
$ 91,474
$ 48,480
$ 50,929
220.1%
272.7%
Mar-07
Nov-11
Dec-09
Nov-16
44
3.7
3.1
194.8%
415.3%
Jul-07
May-12
Jun-10
May-17
58
3.3
4.0
501.6%
122.4%
Dec-07
Jul-12
Aug-10
Jul-17
34
3.6
4.6
305.9%
(38.5%)
Aug-05
Passed
May-08
Apr-15
43
2.8
3.9
53
(1)
Includes only CDO bonds issued to third parties and other Newcastle CDOs.
(2) Represents cash received from each CDO based on all of our interests in such CDO (including senior management fees but excluding principal
received) for the three months ended December 31, 2010. Cash receipts for this period included $2.5 million of non-recurring interest, prepayment
penalty fees, extension fees and yield maintenance fees, and $1.8 million of senior collateral management fees, and may not be indicative of cash
receipts for subsequent periods. See “Cautionary Note Regarding Forward Looking Statements” for risks and uncertainties that could cause our
receipts for subsequent periods to differ materially from these amounts.
(3) Collateral composition is calculated as a percentage of the face amount of collateral and includes CDO bonds of $232.7 million and other bonds of
$205.4 million issued by Newcastle, which are eliminated in consolidation. The fair value of these CDO bonds and other bonds was $74.1 million
and $170.9 million at December 31, 2010, respectively. Also reflected are weighted average credit ratings, which were determined by third party
rating agencies as of a particular date, may not be current and are subject to change (including a “negative watch” assignment) at any time.
(4) Represents the face amount of collateral on negative watch for possible downgrade by at least one rating agency (Moody’s, S&P, or Fitch) as of the
determination date of December 17, 2010 for CDOs IV and V, as these deals only report actual over collateralization excess percentages on a
quarterly basis, and as of the latest determination date of February 25, 2011 for all other CDOs. The amounts include CDO bonds of $53.2 million
issued by Newcastle, which are eliminated in consolidation and not reflected in our investment portfolio segments.
(5) Each of our CDO financings contains tests that measure the amount of over collateralization and excess interest in the transaction. Failure to satisfy
these tests would cause the principal and/or interest cashflow that would otherwise be distributed to more junior classes of securities (including those
held by Newcastle) to be redirected to pay down the most senior class of securities outstanding until the tests are satisfied. As a result, our cash flow
and liquidity are negatively impacted upon such a failure, and the impact could be material. Each CDO contains tests at various over collateralization
and interest coverage percentage levels. The trigger percentages used above represent the first threshold at which cashflows would be redirected as
described in this footnote. The data presented is as of the most recent remittance date on or before December 31, 2010 or February 28, 2011, as
applicable, and may change or have changed subsequent to that date. CDOs IV and V only report on a quarterly basis and, therefore, no updated
February 28, 2011 information is available. In addition, our CDOs may also contain specific over collateralization tests that, if failed, can result in
the occurrence of an event of default or our being removed as collateral manager of the CDO. Failure of the over collateralization tests can also cause
a “phantom income” issue if cash that constitutes income is diverted to pay down debt instead of being distributed to us. As of the December 2010
remittance date for CDOs IV and V and as of the February 2011 remittance date for CDO VI, these CDOs were not in compliance with their
applicable over collateralization tests and, consequently, we were not receiving cash flows from these CDOs (other than senior management fees).
Based upon our current calculations, we expect these portfolios to remain out of compliance for the foreseeable future. Moreover, given current
market conditions, it is possible that all of our CDOs could be out of compliance with their over collateralization tests as of one or more
measurement dates within the next twelve months. Our ability to rebalance will depend upon the availability of suitable securities, market prices,
whether the reinvestment period of the applicable CDO has ended, and other factors that are beyond our control. Such rebalancing efforts may be
extremely difficult given current market conditions and we cannot assure you that we will be successful in our rebalancing efforts. If the liabilities of
our CDOs are downgraded by Moody’s to certain predetermined levels, our discretion to rebalance the applicable CDO portfolios may be negatively
impacted. Moreover, if we bring these coverage tests into compliance, we cannot assure you that they will not fall out of compliance in the future or
that we will be able to correct any noncompliance. For a more detailed discussion of the impact of CDO financings on our cash flows, see Part I,
Item 1A, “Risk Factors – The use of CDO financings with coverage tests may have a negative impact on our operating results and cash flows.
(6) Represents excess or deficiency under the applicable over collateralization or interest coverage tests to the first threshold at which cash flow would
be redirected. We generally do not receive material interest cash flow from the CDO until a deficiency is corrected. Ratings downgrades of assets in
our CDOs can negatively impact compliance with the over collateralization tests. Generally, the over collateralization test measures the principal
balance of the specified pool of assets in a CDO against the corresponding liabilities issued by the CDO. However, based on ratings downgrades, the
principal balance of an asset or of a specified percentage of assets in a CDO may be deemed reduced below their current balance to levels set forth in
the related CDO documents for purposes of calculating the over collateralization test. As a result, ratings downgrades can reduce the principal
balance of the assets used in the over collateralization test relative to the corresponding liabilities in the test, thereby reducing the over
collateralization percentage. In addition, actual defaults of an asset would also negatively impact compliance with the over collateralization tests.
Failure to satisfy an over collateralization test could result in the redirection of cashflows as described in footnote 5 above or, in certain
circumstances, in our removal as manager of the applicable portfolio.
(7) Our CDO financings typically have a 5 year reinvestment period. Generally, after such period ends, principal payments on the collateral are used to
paydown the most senior debt outstanding. Prior to the end of the reinvestment period, principal payments received on the collateral are reinvested.
(8) At the option call date, Newcastle, as the equity holder, has the right to payoff the CDO bonds at their related redemption price.
(9) At the auction call date, there is a mandatory auction of the assets. If the prices are sufficient to pay off the outstanding CDO bonds, the assets will be
sold and the CDO bonds will be redeemed.
(10) Debt spread represents the spread above the benchmark interest rate (LIBOR or U.S. Treasuries) that Newcastle pays on its debt.
54
The following table sets forth further information with respect to the bonds of our consolidated CDO financings as of
December 31, 2010 (dollars in thousands):
Original Face
Amount
Third Parties
Newcastle
CDOs (2)
Newcastle Outside
of its CDOs (3)
Total
Stated Interest
Rate
Current Face Amount (1)
Held By
$
$
$
$
$
$
$
$
253,848
3,037
2,121
5,106
3,579
8,325
9,891
-
-
285,907
297,910
23,500
23,069
4,022
12,188
-
-
360,689
$
-
-
5,568
-
-
-
-
-
-
5,568
$
-
$
-
-
-
-
20,856
-
20,856
$
$
$
-
59,000
23,286
5,103
-
623
2,705
-
-
90,717
$
47,044
-
-
-
-
-
-
-
-
47,044
$
$
-
$
-
-
4,022
-
-
25,000
29,022
$
$
$
1,445
10,125
-
2,553
9,462
-
-
15,355
22,500
61,440
207,689*
-
10,124
10,206
5,547
9,340
-
24,222
32,000
299,128
$
$
$
$
$
$
$
$
$
* $161.4 million of these CDO VI bonds served as collateral for a $108.8 million bank loan owned jointly by two of Newcastle's CDOs
and $46.3 million of CDO VI bonds served as collateral for an $18.7 million repurchase agreement financing.
$
$
$
Class
CDO IV
Class I
Class II-FL
Class II-FX
Class III-FL
Class III-FX
Class IV-FL
Class IV-FX
Class V
Preferred
CDO V
Class I
Class II-FL
Class III-FL
Class IV-FL
Class IV-FX
Class V
Preferred
CDO VI
Class I-MM LT
Class I-B
Class II
Class III-FL
Class III-FX
Class IV-FL
Class IV-FX
Class V
Preferred
CDO VIII (4)
Class I-A
Class I-AR
Class I-B
Class II
Class III
Class IV
Class V
Class VI
Class VII
Class VIII
Class IX-FL
Class IX-FX
Class X
Class XI
Class XII
Preferred
353,250
13,000
7,250
7,500
15,000
9,000
9,000
13,500
22,500
450,000
388,000
23,500
23,000
8,000
12,000
20,500
25,000
500,000
323,000
59,000
33,000
15,000
5,000
9,600
2,400
21,000
32,000
500,000
462,500
60,000
38,000
42,750
42,750
28,500
28,500
27,313
21,375
22,562
6,000
7,600
19,650
26,125
28,500
87,875
950,000
462,500
60,000
4,000
-
20,000
-
28,500
-
-
11,063
6,000
7,600
18,650
-
-
-
618,313
-
$
-
-
29,000
22,750
-
-
-
-
8,250
-
-
-
-
-
-
60,000
$
-
$
-
34,000
13,750
-
-
-
-
-
3,250
-
-
-
24,125
28,500
87,875
191,500
$
55
$
$
$
255,293
13,162
7,689
7,659
13,041
8,325
9,891
15,355
22,500
352,915
297,910
23,500
23,069
8,044
12,188
20,856
25,000
410,567
254,733
59,000
33,410
15,309
5,547
9,963
2,705
24,222
32,000
436,889
462,500
60,000
38,000
42,750
42,750
-
28,500
-
-
22,563
6,000
7,600
18,650
24,125
28,500
87,875
869,813
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
0.40%
0.65%
4.73%
1.00%
5.11%
2.25%
6.34%
8.67%
N/A
0.34%
0.55%
0.90%
1.90%
6.26%
6.94%
N/A
0.25%
0.40%
0.50%
0.80%
5.67%
1.70%
6.55%
7.81%
N/A
0.28%
0.34%
0.36%
0.42%
0.50%
0.60%
0.75%
0.80%
0.90%
1.45%
1.80%
6.80%
2.25%
2.50%
7.50%
N/A
Class
CDO IX (4)
Class A-1
Class A-2
Class B
Class C
Class D
Class E
Class F
Class G
Class H
Class J
Class K
Class L
Class M
Preferred
CDO X (4)
Class A-1
Class A-2
Class A-3
Class B
Class C
Class D
Class E
Class F
Preferred
Original Face
Amount
Third Parties
Newcastle
CDOs (2)
Newcastle Outside
of its CDOs (3)
Total
Stated Interest
Rate
Current Face Amount (1)
Held By
$
$
$
379,500
115,500
37,125
33,000
20,625
24,750
18,562
18,562
21,656
21,656
19,593
23,718
39,187
51,566
825,000
980,000
140,000
99,750
28,000
40,250
22,000
13,500
14,000
62,500
1,400,000
$
$
$
$
$
$
379,500
65,500
35,125
-
-
-
-
-
-
-
-
-
-
-
480,125
980,000
140,000
55,000
-
-
-
-
-
-
1,175,000
-
$
-
-
-
-
-
-
-
8,751
21,656
19,593
-
-
-
50,000
$
-
$
-
10,000
-
39,250
-
-
-
-
49,250
$
$
-
50,000
2,000
-
-
24,750
18,562
11,262
9,305
-
-
23,718
39,187
51,566
230,350
$
-
$
-
-
-
-
22,000
13,500
14,000
62,500
112,000
$
379,500
115,500
37,125
-
-
24,750
18,562
11,262
18,056
21,656
19,593
23,718
39,187
51,566
760,475
$
$
980,000
140,000
65,000
-
39,250
22,000
13,500
14,000
62,500
1,336,250
$
LIBOR + 0.26%
LIBOR + 0.47%
LIBOR + 0.65%
LIBOR + 0.93%
LIBOR + 1.00%
LIBOR + 1.10%
LIBOR + 1.30%
LIBOR + 1.50%
LIBOR + 2.50%
LIBOR + 3.00%
LIBOR + 3.50%
7.50%
8.00%
N/A
LIBOR + 0.26%
LIBOR + 0.35%
LIBOR + 0.60%
LIBOR + 1.25%
LIBOR + 1.75%
LIBOR + 2.50%
LIBOR + 3.00%
9.04%
N/A
(1) The amounts presented in these columns exclude the face amount of any cancelled bonds within an applicable class.
(2) Amounts in this column represent the amount of bonds of the applicable class held by Newcastle’s consolidated CDOs. These bonds are eliminated
in Newcastle’s consolidated balance sheet.
(3) Amounts in this column represent the amount of bonds of the applicable class held as investments by Newcastle outside of its non-recourse financing
structures.
(4) These CDOs issued the following interest only fixed-rate notes with a 5-year maturity from inception:
i.
ii.
iii.
CDO VIII Class S with a notional amount of $33.9 million at 5.41%
CDO IX Class S with a notional amount of $33.5 million at 5.45%
CDO X Class S with a notional amount of $24.2 million at 5.78%
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
Formation - 2005
43,913,409
2006
1,800,408
2007
7,065,362
2008
9,871
2009
123,463
9,114,671
2010
December 31, 2010 62,027,184
$29.42
$27.75 - $31.30
N/A
N/A
$3.13
$51.2
$201.3
$0.1
$0.1
$28.5
2,655,727
170,000
698,000
0
0
0
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors. Includes prices of shares
issued in exchange for preferred stock as of that date.
56
Through December 31, 2010, Fortress had assigned, for no value, options to purchase approximately 1.2 million shares of
our common stock to certain of Fortress’s employees, of which approximately 0.4 million had been exercised. In addition,
Fortress had exercised 0.7 million of its options.
As of December 31, 2010, our outstanding options had a weighted average strike price of $26.64 and were summarized as
follows:
Held by our Manager
Issued to our manager and subsequently assigned
to certain of Fortress's employees
Held by directors and former directors
Total
1,686,447
798,162
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 and the Series C Preferred, and, beginning
in March 2012, we will have the option to redeem the Series D Preferred, at their liquidation preference. 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 liquidation preference 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.
To the extent we have unpaid accrued dividends on our preferred stock, we cannot pay any dividends on our common
shares, pay any consideration to repurchase or otherwise acquire stock of our common stock or redeem any stock of any
series of our preferred stock without redeeming all of our outstanding preferred stock in accordance with the governing
documentation. Moreover, if we do not pay dividends on any series of preferred stock for six or more periods, then holders
of each affected series obtain the right to call a special meeting and elect two members to our board of directors.
Consequently, if we do not make a dividend payment on our preferred stock for six or more quarterly periods, it could
restrict the actions that we may take with respect to our common stock and preferred stock and could affect the composition
of our board and, thus, the management of our business. No assurance can be given that we will pay any dividends on any
series of our preferred stock in the future.
In March 2010, Newcastle settled its offer to exchange (the “Exchange Offer”) shares of its common stock and cash for
shares of its preferred stock. In the aggregate, Newcastle issued 9,091,668 shares of its common stock (approximately
17.2% of Newcastle’s outstanding shares of common stock prior to the issuance of shares in the Exchange Offer). A total of
2,881,694 shares of common stock were issued in exchange for 1,152,679 shares of Series B Preferred stock, a total of
2,759,989 shares of common stock were issued in exchange for 1,104,000 shares of Series C Preferred stock, and a total of
3,449,985 shares of common stock were issued in exchange for 1,380,000 shares of Series D Preferred stock. The shares of
preferred stock acquired by Newcastle in the Exchange Offer were retired upon receipt. After settlement of the Exchange
Offer, 1,347,321 shares of Series B Preferred stock, 496,000 shares of Series C Preferred stock and 620,000 shares of
Series D Preferred stock remain outstanding for trading on the New York Stock Exchange.
The shares of common stock were issued in the Exchange Offer in reliance on the exemption set forth in Section 3(a)(9) of
the Securities Act of 1933, as amended, for securities exchanged by an issuer with its existing security holders exclusively
where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange.
The $43.0 million excess of the $87.5 million carrying value of the exchanged preferred stock over the $44.5 million fair
value of consideration paid (which included $28.5 million of common stock and $16.0 million of cash) was recorded as an
increase to Net Income (Loss) Applicable to Common Stockholders.
As of December 31, 2010, $3.7 million of dividends on Newcastle’s preferred stock were unpaid and in arrears. On January
31, 2011, we paid all current and accrued dividends on our preferred stock as of that date.
57
Accumulated Other Comprehensive Income (Loss)
During the year ended December 31, 2010, our accumulated other comprehensive income (loss) changed due to the
following factors (in thousands):
Gains / Losses on
Cash Flow Hedges
Gains / Losses on
Securities
Total Accumulated Other
Comprehensive Income
(Loss)
Accumulated other comprehensive income (loss), December 31, 2009
$ (180,895) $ (452,923)
$ (633,818)
Deconsolidation of CDO VII
Net unrealized gain (loss) on securities
28,514
40,715
69,229
-
439,496
439,496
Reclassification of net realized (gain) loss on securities into earnings
-
43,442
43,442
Net unrealized gain (loss) on derivatives
(7,313)
-
(7,313)
Reclassification of net realized (gain) loss on derivatives designated as
cash flow hedges into earnings
42,786
-
42,786
Accumulated other comprehensive income (loss), December 31, 2010
$
(116,908)
$
70,730
$
(46,178)
Our GAAP 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 ended December 31, 2010, a net tightening of credit spreads has caused a net decrease in unrealized losses recorded in
accumulated other comprehensive income on our real estate securities. Net unrealized losses on derivatives designated as
cash flow hedges decreased for the year primarily as a result of the deconsolidation of CDO VII and the reclassification of
the mark-to-market losses of certain derivatives into earnings, partially offset by an increase in net unrealized loss as a
result of decreases in long-term rates.
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, 2008
June 30, 2008
September 30, 2008
December 31, 2008
December 31, 2009 (Year)
December 31, 2010 (Year)
Paid
April 2008
July 2008
October 2008
N/A
N/A
N/A
Amount Per Share
$0.25
$0.25
$0.25
$0.00
$0.00
$0.00
Cash Flow
Operating Activities
Net cash flow provided by (used in) operating activities decreased from $74.2 million for the year ended December 31,
2009 to $48.8 million for the year ended December 31, 2010. It decreased from $118.2 million for the year ended
December 31, 2008 to $74.2 million for the year ended December 31, 2009. These changes primarily resulted from the
redirection of interest cash flows in certain of our CDOs as a result of the failure to satisfy certain coverage tests, and the
changes in net interest income of our investments as described above.
Operating Activities – Direct Method Comparison
Cash interest received for investments in securities and loans decreased approximately $58.2 million as a result of a lower
average balance of interest bearing securities and loans of $4.2 billion in 2010 compared to $5.3 billion in 2009, which is
offset by an increase in the weighted average coupon to 5.04% in 2010 from 4.95% in 2009. The lower interest earning
asset balance is primarily a result of paydowns, sales and delinquencies. Furthermore, as a result of increases in defaulted
assets and CDOs failing certain coverage tests, the net interest income redirected for reinvestment or CDO bond paydown
increased by approximately $4.9 million in 2010. Prepayment penalty income decreased by approximately $1.0 million in
2010 due to a lower volume of prepayments in 2010 compared to 2009.
Cash interest paid decreased approximately $35.7 million due to (i) a lower average debt balance of $3.6 billion in 2010
compared to $4.8 billion in 2009 and a decrease in the weighted average coupon to 0.89% in 2010 from 0.94% in 2009 and
(ii) a net decrease in interest payments on our interest rate swaps which experienced a decrease in their average notional
balance to $1.9 billion in 2010 from $2.4 billion in 2009 and an effective pay rate of 5.06% in 2010, unchanged from 2009.
58
General and administrative expenses paid in 2010 decreased approximately $1.2 million primarily due to lower insurance
expense in 2010 compared to 2009.
Investing Activities
Investing activities provided (used) $75.2 million, $172.1 million and $1.7 billion during the years ended December 31,
2010, 2009 and 2008, respectively. Investing activities consisted primarily of the investments made in real estate securities
and loans outside of our CDO financing structures, net of proceeds from the sale or settlement of investments.
Financing Activities
Financing activities provided (used) ($158.9) million, ($227.7) million and ($1.8) billion during the years ended December
31, 2010, 2009 and 2008, respectively. The return of restricted cash from refinancing activities, the refinancing of our
manufactured housing loan portfolio I and a new repurchase facility served as the primary sources of cash flow from
financing activities. Offsetting uses included the repayment of debt as described above, the payment of related deferred
financing costs, the payment of preferred dividends, and the payment related to the exchange of the junior subordinated
notes, as well as the payment related to the preferred stock exchange described under “– Preferred Stock” 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. These risks are further described in
Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”
Off-Balance Sheet Arrangements
As of December 31, 2010, we had the following 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.
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.
• On January 1, 2010, pursuant to new accounting guidance, we deconsolidated CDO VII, which is now effectively an
off-balance sheet financing.
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 have made investments in three equity method investees, two of which are dormant at December 31, 2010 and the
other of which is immaterial to our financial condition, liquidity, and operations.
In each case, our exposure to loss is limited to the carrying (fair) value of our investment.
59
Contractual Obligations
As of December 31, 2010, we had the following material contractual obligations (payments in thousands):
Contract
Terms
CDO bonds payable
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Other bonds payable
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Notes Payable
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Repurchase agreements
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Junior subordinated notes
payable
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Derivative liabilities
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Management agreement
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 adjusted net income available for common stockholders above a certain
threshold. For more information on this agreement, as well as historical
amounts earned, see Note 10 to Part II, Item 8, “Financial Statements and
Supplementary Data.” As a result of not meeting the incentive compensation
threshold, the incentive compensation to the Manager has been discontinued for
an indeterminate period of time.
Subprime loan securitization and
CDO VII
We entered into the securitization of Subprime Portfolios I and II, and also
entered into CDO VII which was subsequently deconsolidated, 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. We
pay annual servicing fees generally equal to 0.375% of the outstanding face
amount of the residential mortgage loans, and 1.00% and 0.625% of the
outstanding face amount of the two portfolios of manufactured housing loans,
respectively. We also pay an incentive fee for one of the portfolios of
manufactured housing loans if the performance of the loans meets certain
thresholds.
Trustee agreements
We have entered into trustee agreements in connection with our securitized
investments, primarily our CDOs. We pay annual fees of between 0.015% and
0.020% of the outstanding face amount of the CDO bonds under these
agreements.
60
Contract
CDO bonds payable (1) (4)
Other bonds payable (1)
Notes Payable (1)
Repurchase agreements (2)
Financing of subprime mortgage loans subject
to future repurchase (3)
Junior subordinated notes payable (1)
Interest rate swaps, treated as hedges (4)
Non-hedge derivative obligations (5)
Management agreement (6)
Subprime loan securitizations
CDO VII
Loan servicing agreements
Trustee agreements
Total
Fixed and Determinable Payments Due by Period
2011
2012-2013
2014-2015
Thereafter
Total
$
25,788
177,222
51
18,732
$
43,184
8,221
101
-
$
41,757
8,221
101
-
$
3,684,033
166,504
5,317
-
$
3,794,762
360,168
5,570
18,732
N/A
3,863
3,902
40,286
16,534
*
*
*
*
286,378
$
N/A
7,726
-
-
33,067
*
*
*
*
92,299
$
N/A
7,726
91,822
-
33,067
*
*
*
*
182,694
$
N/A
77,902
40,851
-
413,343
*
*
*
*
4,387,950
$
N/A
97,217
136,575
40,286
496,011
*
*
*
*
4,949,321
$
* These contracts do not have fixed and determinable payments.
(1) Includes interest based on rates existing at December 31, 2010 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, which have not been term financed, and mature 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 Part II, Item 8, “Financial Statements and Supplementary Data”.
(4) A substantial portion of these agreements are held within our non-recourse financing structures. The amounts reflected assume that these agreements
are terminated at their December 31, 2010 fair value and paid at the contractual maturity of the related interest rate swap agreements.
(5) The amounts reflected assume that these agreements are terminated at their December 31, 2010 fair value on January 1, 2010.
(6) Amounts reflect base management fees for the next 30 years assuming no change in gross equity, as defined, from December 31, 2010.
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.
Net Interest Income Less Expenses (Net of Preferred Dividends)
Newcastle has five primary variables that impact its operating performance: (i) the current yield earned on its investments
that are not included in non-recourse financing structures (i.e., unlevered investments and investments subject to recourse
debt), (ii) the net yield it earns from its non-recourse financing structures, (iii) the interest expense and dividends incurred
under its recourse debt and preferred stock, (iv) its operating expenses, and (v) its realized and unrealized gains on its
investments and its debt obligations, including impairment. Net Interest Income Less Expenses (Net of Preferred
Dividends) is a measure of the operating performance of Newcastle that excludes the fifth variable listed above. It is used
by management to gauge the current performance of Newcastle without taking into account gains and losses, which,
although they represent a part of our recurring operations, are subject to significant variability and are only a potential
indicator of future economic performance. Management views Net Interest Income Less Expenses (Net of Preferred
Dividends) as Newcastle’s “core” current earnings, while gains and losses (including impairment) are simply a potential
indicator of future earnings. Management believes that Net Interest Income Less Expenses (Net of Preferred Dividends)
provides investors with useful information regarding Newcastle’s “core” current earnings, and it enables investors to
evaluate Newcastle’s current performance using the same measure that management uses to operate the business.
Net interest income less expenses (net of preferred dividends) 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. For a further description of the differences between cash flow provided by operations and net income,
see “–Liquidity and Capital Resources” above. Our calculation of net interest income less expenses (net of preferred
dividends) may be different from the calculation used by other companies and, therefore, comparability may be limited.
61
Income (loss) applicable to common stockholders
Add (Deduct):
Impairment (including the reversal of prior valuation allowances on loans)
Other (income) loss
(Income) loss from discontinued operations
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid
Year Ended December 31,
2010
2009
2008
$
657,252
$
(223,405)
$
(2,998,853)
(240,858)
(282,287)
8
(43,043)
91,072
$
548,540
(227,399)
318
-
98,054
$
2,991,830
112,809
9,654
-
115,440
$
62
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 Part II, Item 7, “Management’s Discussion and
Analysis of Financial Condition and Results of Operations – Application of Critical Accounting Policies.”
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, when appropriate and available. This means
that we seek to match the maturities of our debt obligations with the maturities of our assets to reduce 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 we
believe 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 December 31, 2010, a 100 basis point increase in short term interest rates would increase our earnings by
approximately $3.0 million per annum, assuming a static portfolio of current investments and financings.
Second, 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.
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 directly relevant to
their underlying cash flows. Our assets are largely financed to maturity through long term CDO 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 cases of impaired assets and non-hedge derivatives, our net income (loss).
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 short term financing were to decline, it could cause us to fund margin and affect our ability to refinance such
assets upon the maturity of the related financings, adversely impacting our rate of return on such securities.
As of December 31, 2010, a 100 basis point change in short term interest rates would impact our net book value by
approximately $9.6 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. Interest rate swaps
may be subject to margin calls.
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
63
payments to us should the reference rate (typically LIBOR) rise above (cap agreements) or fall below (floor agreements)
the “strike” rate specified in the contract. 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. 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.
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 Exposure.”
As of December 31, 2010, a 25 basis point movement in credit spreads would impact our net book value by approximately
$18.7 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.
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.
Credit Risk
In addition to the above described market risks, Newcastle is subject to 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. As a result of the challenging credit and liquidity conditions, the value of the subordinated securities
has generally been reduced or, in some cases, eliminated, which could leave our securities economically in a first loss
position. 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 at acquisition they predominantly benefit from underlying collateral value in excess of
their carrying amounts.
We seek to reduce credit risk by actively monitoring our asset portfolio and the underlying credit quality of our holdings
and, where appropriate and achievable, 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 annual report, adverse market and credit conditions have resulted in our recording of
other-than-temporary impairment in certain securities and loans.
64
Margin
We are subject to margin calls on our repurchase agreement. Furthermore, we may, from time to time, enter into derivative
agreements or financing arrangements (such as the financing of our FNMA/FHLMC securities) that are subject to margin
calls based on the value of such instruments. We seek to maintain adequate cash reserves and other sources of available
liquidity to meet any margin calls resulting from decreases in value related to a reasonably possible (in the opinion of
management) change in interest rates.
Interest Rate and Credit Spread Risk Sensitive Instruments and Fair Value
Our holdings of such financial instruments, and their fair values and the estimation methodology thereof, are detailed in
Note 7 to Part II, Item 8, “Financial Statements and Supplementary Data.” For information regarding the impact of
prepayment, reinvestment, and expected loss factors on the timing of realization of our investments, please refer to the
consolidated financial statements included therein. For information regarding the impact of changes in these factors on the
value of securities valued with internal models, see Part II, Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Critical Accounting Policies.”
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 “– Market Considerations” above for a further discussion of recent trends and events affecting our liquidity, unrealized
gains and losses.
65
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, 2010 and December 31, 2009
Consolidated Statements of Operations for the years ended December 31, 2010, 2009 and 2008
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2010, 2009 and 2008
Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008
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.
66
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, 2010 and 2009, and the related consolidated statements of operations, stockholders' equity
(deficit), and cash flows for each of the three years in the period ended December 31, 2010. 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 Newcastle Investment Corp. and subsidiaries at December 31, 2010 and 2009, and the consolidated results of
their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with
U.S. generally accepted accounting principles.
As discussed in Notes 2 and 4 to the consolidated financial statements, the Company changed its method of accounting for
other-than-temporary impairment with the adoption of the guidance originally issued in FASB Statement No.115-2 and
124-2, Recognition and Presentation of Other-Than-Temporary Impairments (codified in FASB ASC Topics 320, 310-30,
and 325-40) effective April 1, 2009. As discussed in Notes 2 and 3 to the consolidated financial statements, the Company
changed its method of accounting for variable interest entities with the adoption of guidance originally issued in FASB
Statement No. 167 (codified in FASB ASC Topic 810-10) effective January 1, 2010.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), Newcastle Investment Corp. and subsidiaries’ internal control over financial reporting as of December 31, 2010,
based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated March 3, 2011 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
New York, New York
March 3, 2011
67
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Newcastle Investment Corp.
We have audited Newcastle Investment Corp. and subsidiaries’ internal control over financial reporting as of December 31,
2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Newcastle Investment Corp. and subsidiaries’
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, Newcastle Investment Corp. and subsidiaries maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2010, 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 Newcastle Investment Corp. and subsidiaries as of December 31, 2010 and 2009,
and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for each of the three
years in the period ended December 31, 2010 of Newcastle Investment Corp. and subsidiaries and our report dated March
3, 2011 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
New York, New York
March 3, 2011
68
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available for sale - Note 4
Real estate related loans, held for sale, net - Note 5
Residential mortgage loans, held for investment, net - Note 5
Residential mortgage loans, held for sale, net - Note 5
Subprime mortgage loans subject to call option - Note 5
Operating real estate, held for sale - Note 6
Other investments
Restricted cash
Derivative assets - Note 7
Receivables and other assets
Recourse Financing Structures and Unlevered Assets
Real estate securities, available for sale - Note 4
Real estate related loans, held for sale, net - Note 5
Residential mortgage loans, held for sale, net - Note 5
Operating real estate, held for sale - Note 6
Other investments
Cash and cash equivalents
Receivables and other assets
Liabilities and Stockholders' Equity (Deficit)
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable - Note 8
Other bonds payable - Note 8
Notes payable - Note 8
Repurchase agreements - Note 8
Financing of subprime mortgage loans subject to call option - Note 5
Derivative liabilities - Note 7
Accrued expenses and other liabilities
Recourse Financing Structures and Other Liabilities
Repurchase agreements - Note 8
Junior subordinated notes payable - Note 8
Derivative liabilities - Note 7
Due to affiliates
Accrued expenses and other liabilities
Commitments and contingencies - Notes 9, 10 and 11
Stockholders' Equity (Deficit)
Preferred stock, $0.01 par value, 100,000,000 shares authorized,
1,347,321 and 2,500,000 shares of 9.75% Series B Cumulative Redeemable Preferred Stock 496,000 and
1,600,000 shares of 8.05% Series C Cumulative Redeemable Preferred Stock, and 620,000 and 2,000,000
shares of 8.375% Series D Cumulative Redeemable Preferred Stock liquidation preference $25.00 per share,
issued and outstanding as of December 31, 2010 and December 31, 2009, respectively
Common stock, $0.01 par value, 500,000,000 shares authorized, 62,027,184 and 52,912,513 shares issued
and outstanding at December 31, 2010 and December 31, 2009, respectively
Additional paid-in capital
Accumulated deficit - Note 2
Accumulated other comprehensive income (loss) - Note 2
See notes to consolidated financial statements.
69
December 31,
2010
2009
$
1,859,984
$
1,784,487
750,130
124,974
252,915
403,793
8,776
18,883
157,005
7,067
29,206
3,612,733
554,367
-
380,123
403,006
-
-
200,251
-
36,643
3,358,877
600
46,308
32,475
298
-
6,024
33,524
1,457
74,378
3,687,111
$
19,495
3,524
9,966
193
68,300
7,965
155,751
3,514,628
$
$
3,010,868
256,809
4,356
$
4,058,928
303,697
-
14,049
403,793
176,861
8,445
3,875,181
4,683
51,253
-
1,419
2,160
59,515
3,934,696
-
403,006
203,054
2,992
4,971,677
71,309
103,264
4,100
1,497
3,433
183,603
5,155,280
61,583
152,500
620
1,065,377
(1,328,987)
(46,178)
(247,585)
3,687,111
$
529
1,033,520
(2,193,383)
(633,818)
(1,640,652)
3,514,628
$
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
(dollars in thousands, except share data)
Interest income
Interest expense
Net interest income
Impairment
Valuation allowance (reversal) on loans - Note 5
Other-than-temporary impairment on securities- Note 4
Portion of other-than-temporary impairment on securities recognized
in other comprehensive income (loss), net of the reversal of other comprehensive
loss into net income (loss)
Net interest income (loss) after impairment
Other Income (Loss)
Gain (loss) on settlement of investments, net - Note 2
Gain (loss) on extinguishment of debt - Note 8
Other income (loss), net - Note 2
Expenses
Loan and security servicing expense
General and administrative expense
Management fee to affiliate - Note 10
Income (loss) from continuing operations
Income (loss) from discontinued operations - Note 6
Net Income (Loss)
Preferred dividends
Year Ended December 31,
2010
2009
2008
$
300,272
172,219
128,053
$
361,866
218,410
143,456
$
468,867
307,303
161,564
(339,887)
101,398
15,007
603,768
994,134
1,997,696
(2,369)
(240,858)
368,911
52,307
265,656
(35,676)
282,287
4,580
7,696
17,252
29,528
621,670
(8)
621,662
(7,453)
(70,235)
548,540
-
2,991,830
(405,084)
(2,830,266)
11,438
215,279
682
227,399
5,034
8,899
17,968
31,901
(209,586)
(318)
(209,904)
(13,501)
(58,668)
13,824
(67,965)
(112,809)
6,649
7,586
18,388
32,623
(2,975,698)
(9,654)
(2,985,352)
(13,501)
Excess of carrying amount of exchanged preferred stock over fair value of
consideration paid
43,043
-
-
Income (Loss) Applicable To Common Stockholders
$
657,252
$
(223,405)
$
(2,998,853)
Income (Loss) Per Share of Common Stock
Basic
Diluted
Income (loss) from continuing operations per share of common
stock, after preferred dividends and excess of carrying amount of
exchanged preferred stock over fair value of consideration paid
Basic
Diluted
Income (loss) from discontinued operations per share of common stock
Basic
Diluted
Weighted Average Number of Shares of Common Stock Outstanding
Basic
Diluted
$
10.96
$
(4.23)
$
(56.81)
$
10.96
$
(4.23)
$
(56.81)
$
10.96
$
(4.22)
$
(56.63)
$
10.96
$
(4.22)
$
(56.63)
$
(0.00)
$
(0.01)
$
(0.18)
$
(0.00)
$
(0.01)
$
(0.18)
59,948,827
59,948,827
52,863,993
52,863,993
52,785,305
52,785,305
Dividends Declared per Share of Common Stock
$
-
$
-
$
0.750
70
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
(dollars in thousands, except share data)
Preferred Stock
Common Stock
Stockholders' equity (deficit) - December 31, 2009
Preferred dividends declared
Exchange of preferred stock for common stock and cash
Issuance of common stock to directors
Reclassification adjustment upon adoption of new impairment guidance
Deconsolidation of CDO VII
Cumulative net loss
Unrealized loss on securities
Unrealized loss on derivatives designated as cash flow hedges
Comprehensive income:
Net income (loss)
Net unrealized gain on securities
Reclassification of net realized loss on securities into earnings
Net unrealized (loss) on derivatives designated as cash flow hedges
Reclassification of net realized loss on derivatives designated as
cash flow hedges into earnings
Total comprehensive income (loss)
Stockholders' equity (deficit) - December 31, 2010
Stockholders' equity (deficit) - December 31, 2008
Issuance of common stock to directors
Reclassification adjustment upon adoption of new impairment guidance
Comprehensive income:
Net income (loss)
Net unrealized gain on securities
Reclassification of net realized loss on securities 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 (loss)
Stockholders' equity (deficit) - December 31, 2009
Continued on next page.
Shares
Amount
Shares
$
152,500
-
(90,917)
-
-
52,912,513
-
9,091,668
23,003
-
Additional
Paid in Capital
Accumulated
Deficit
Accumulated
Other Comp.
Income (Loss)
Total Stock-
holders' Equity
(Deficit)
$
1,033,520
-
31,782
75
-
$
(2,193,383)
(19,484)
43,043
-
-
$
(633,818)
-
-
-
-
$
(1,640,652)
(19,484)
(16,001)
75
-
Amount
529
$
-
91
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
219,175
-
-
621,662
-
-
-
-
40,715
28,514
-
439,496
43,442
(7,313)
-
42,786
219,175
40,715
28,514
621,662
439,496
43,442
(7,313)
42,786
1,140,073
(247,585)
$
2,463,321
$
61,583
62,027,184
$
620
$
1,065,377
$
(1,328,987)
$
(46,178)
6,100,000
-
(3,636,679)
-
-
-
-
-
-
-
-
-
-
6,100,000
-
-
-
-
-
-
-
$
152,500
-
-
52,789,050
123,463
-
-
-
-
-
-
-
-
-
-
-
$
528
1
-
-
-
-
-
-
$
1,033,416
104
-
$
(3,272,403)
-
$
(307,573)
-
1,288,924
(1,288,924)
$
(2,393,532)
105
-
-
-
-
-
-
(209,904)
-
-
-
-
306,626
522,625
123,926
(209,904)
306,626
522,625
123,926
-
9,502
9,502
752,775
(1,640,652)
$
6,100,000
$
152,500
52,912,513
$
529
$
1,033,520
$
(2,193,383)
$
(633,818)
71
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
(dollars in thousands, except share data)
Stockholders' equity (deficit) - December 31, 2007
Dividends declared
Issuance of common stock to directors
Comprehensive income:
Net income (loss)
Net unrealized gain (loss) on securities
Reclassification of net realized loss 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 income (loss)
Stockholders' equity (deficit) - December 31, 2008
Preferred Stock
Common Stock
Shares
Amount
Shares
Amount
Additional
Paid in Capital
Accumulated
Deficit
Accumulated
Other Comp.
Income (Loss)
Total Stock-
holders' Equity
(Deficit)
6,100,000
-
-
$
152,500
-
-
52,779,179
-
9,871
$
528
-
-
$
1,033,326
-
90
$
(236,213)
(50,838)
-
$
(502,516)
-
-
$
447,625
(50,838)
90
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
(2,985,352)
-
-
-
-
-
(1,587,049)
2,001,786
(5,037)
(230,891)
(2,985,352)
(1,587,049)
2,001,786
(5,037)
(230,891)
-
16,134
16,134
(2,790,409)
(2,393,532)
$
6,100,000
$
152,500
52,789,050
$
528
$
1,033,416
$
(3,272,403)
$
(307,573)
72
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
STATEMENT OF CASH FLOWS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in thousands, except per share data)
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
Interest income in CDOs redirected for reinvestment or CDO bonds paydown
Interest on debt added to principal
Deferred rent
Valuation allowance on loans - Note 5
Non-cash directors' compensation
(Gain) loss on sale of investments
Unrealized (gain) loss on non-hedge derivatives and hedge ineffectiveness
Other-than-temporary impairment on securities- Note 4
Impairment on real estate held for sale
(Gain) loss on extinguishment of debt - Note 8
Equity in (earnings) losses of equity method investees
Distributions of earnings from equity method investees
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
Deposit on acquisition of servicing rights
Proceeds from sale of real estate securities
Purchase of and advances on loans
Proceeds from settlement of loans
Principal fundings on loan commitments
Repayments of loan and security principal
Margin received on derivative instruments
Return of margin 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)
Payments on settlement of derivative instruments
Purchase and improvement of real estate held for sale
Proceeds from sale of real estate held for sale
Distributions of capital from equity method investees
Net cash provided by (used in) investing activities
Continued on next page.
Year Ended December 31,
2009
2008
2010
$
621,662
$
(209,904)
$
(2,985,352)
262
(31,517)
(25,975)
2,964
-
(339,887)
75
(52,307)
36,564
99,029
260
(265,656)
(94)
94
151
4,577
(78)
(1,278)
48,846
(4,059)
(100)
26,022
(6,024)
-
-
64,681
5,073
-
-
-
(11,394)
-
840
193
75,232
295
(28,066)
(20,984)
2,402
-
15,007
105
(11,438)
55
533,533
550
(215,279)
(420)
420
4,142
4,370
(35)
(584)
74,169
(1,800)
-
131,120
(14,588)
-
-
63,934
3,550
-
-
37
(11,610)
-
1,350
91
172,084
637
(28,100)
(4,318)
-
183
994,134
90
44,580
94,011
1,997,696
10,049
(13,824)
(8,157)
10,261
5,571
13,104
(6,209)
(6,182)
118,174
(67,733)
-
1,428,524
-
33,978
(1,180)
310,548
105,576
(92,196)
(59,194)
103,028
(101,250)
(603)
11,226
21,988
1,692,712
See notes to consolidated financial statements.
73
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Cash Flows From Financing Activities
Repayments of CDO bonds payable
Repurchases of CDO bonds payable
Issuance of other bonds payable
Repayments of other bonds payable
Repayments of repurchase agreements
Borrowings under repurchase agreements
Margin deposits under repurchase agreements
Return of margin deposits under repurchase agreements
Cash consideration paid in exchange for junior subordinated notes
Cash consideration paid to redeem preferred stock
Dividends paid
Payment of deferred financing costs
Restricted cash returned from refinancing activities
Net cash provided by (used in) financing activities
Net Increase (Decrease) in Cash and Cash Equivalents
Cash and Cash Equivalents, Beginning of Period
Cash and Cash Equivalents, End of Period
Supplemental Disclosure of Cash Flow Information
Year Ended December 31,
2009
2008
2010
-
(72,718)
97,650
(143,678)
(71,491)
18,914
-
-
(9,715)
(16,001)
(19,484)
(1,677)
59,346
(158,854)
(34,776)
68,300
-
(27,422)
-
(77,360)
(205,163)
-
(7,303)
7,586
-
-
-
(200)
82,163
(227,699)
18,554
49,746
(334,140)
-
-
(167,542)
(1,444,163)
85,749
(109,196)
114,371
-
-
(91,087)
(337)
129,289
(1,817,056)
(6,170)
55,916
$
33,524
$
68,300
$
49,746
Cash paid during the period for interest expense
$
125,582
$
161,254
$
271,845
Cash paid (refunded) during the period for federal excise tax
$
-
$
(316)
$
316
Supplemental Schedule of Non-Cash Investing and Financing Activities
Issuance of junior subordinated notes in exchange of previously issued trust
preferred securities
Common stock issued to redeem preferred stock
Face amount of CDO bonds issued in exchange for previously issued junior
subordinated notes of $52,094
Loans reclassified as other investments
$
-
$
28,457
100,000
$
$
-
$
-
$
-
$
$
37,625
24,907
$
-
$
-
$
-
$
-
74
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(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 the following segments: (i) investments financed with non-recourse collateralized
debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments and debt repurchases
financed with recourse debt, (iv) unlevered investments, and (v) corporate. With respect to the first two non-recourse
segments, subject to the passing of certain coverage tests periodically, Newcastle is generally entitled to receive the net
cash flows from these structures on a periodic basis.
The following table presents information on shares of Newcastle’s common stock issued subsequent to its formation:
Year
Shares Issued
Range of Issue
Prices (1)
Net Proceeds
(millions)
Formation - 2005
2006
2007
2008
2009
2010
December 31, 2010
43,913,409
1,800,408
7,065,362
9,871
123,463
9,114,671
62,027,184
$29.42
$27.75-$31.30
N/A
N/A
$3.13
$51.2
$201.3
$0.1
$0.1
$28.5
(1) Exclude prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors. Includes prices of
shares issued in exchange for preferred stock.
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 (“Fortress”) under which the Manager advises Newcastle on various aspects of
its business and manages its day-to-day operations, subject to the supervision of Newcastle’s board of directors. For its
services, the Manager receives an annual management fee and incentive compensation, both as defined in the Management
Agreement. For a further discussion of the Management Agreement, see Note 10.
Approximately 3.8 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and principals
of Fortress at December 31, 2010. In addition, Fortress, through its affiliates, held options to purchase approximately 1.7
million shares of Newcastle’s common stock at December 31, 2010.
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 as well as those entities deemed to be variable interest entities (“VIEs”) in
which Newcastle is determined to be the primary beneficiary. 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 must be consolidated only by its
primary beneficiary, which is defined as the party who, along with its affiliates and agents, has a potentially significant
interest in the entity and controls such entity’s significant decisions. Newcastle’s CDO subsidiaries and its manufactured
housing loan financing structures (Note 8) are special purpose entities which are considered VIEs of which Newcastle is the
primary beneficiary (except as noted in Note 8). Therefore, the debt issued by such entities is considered a non-recourse
secured borrowing of Newcastle. The subprime securitization trusts (Note 5) are VIEs of which Newcastle is not the
primary beneficiary. Therefore, the debt issued by such entities is essentially off balance sheet financing.
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.
75
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Newcastle’s investments in equity method investees were not significant at December 31, 2010, 2009 or 2008. Regarding
investments in entities over which Newcastle does not meet the requirements for consolidation and does not exercise
significant influence, Newcastle records these investments at cost, subject to impairment.
Change in Presentation ⎯ Newcastle has changed the format of its consolidated balance sheets for all periods presented to
reflect the requirements of new guidance which became effective January 1, 2010. This change in format did not have any
effect on any of the reported line items within the balance sheets, other than breaking them out by financing type, or on the
statement of consolidated equity (deficit).
Revision of Prior Year Presentation ⎯ Newcastle considers all activity in its CDOs’ restricted cash accounts to be non-
cash activity for purposes of its consolidated statement of cash flows since transactions conducted with restricted cash have
no effect on its cash and cash equivalents. Certain revisions to Newcastle’s statement of cash flows for the year ended
December 31, 2009 have been made for purposes of consistency with other periods because certain restricted cash activities
related to Newcastle’s CDOs were previously included on the face of the 2009 statement of cash flows. These restricted
cash activities had no effect on Newcastle’s net cash flow as presented in prior periods; the effect on 2009 total cash flows
from operating, investing and financing activities was approximately ($10.0) million, ($34.3) million and $44.3 million,
respectively. Newcastle did not previously provide supplemental disclosure about its non-cash CDO activity. Newcastle
has included below supplemental disclosure of this non-cash activity for each of the three years in the period ended
December 31, 2010 in “Cash and Cash Equivalents and Restricted Cash.” Management determined that the revisions to the
cash flow activity related to the year ended December 31, 2009 and the revisions to the footnote disclosures for
supplemental cash flow information, which both had no effect on net cash flow, are not material to the prior years’
presentation.
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.
The following table summarizes Newcastle’s accumulated other comprehensive income:
December 31,
2010
2009
(452,923)
(180,895)
(633,818)
$
$
Net unrealized gains (losses) on securities
Net unrealized gains (losses) on derivatives designated as cash flow hedges
Accumulated other comprehensive income (loss)
76
$
70,730
(116,908)
(46,178)
$
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
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 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). Newcastle discontinues the accretion of discounts and amortization of premium on loans if they are reclassified
from held for investment to held for sale. 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 a reduction to the 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 $7.2 million, $8.2 million and $0.0 million in 2010, 2009, and
2008, respectively.
Impairment of Securities and Loans ⎯ Newcastle continually evaluates securities and loans for impairment. Securities
and loans are considered to be other-than-temporarily impaired, for financial reporting purposes, generally 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 retained beneficial
interests in securitizations, when Newcastle determines that it is probable that it will be unable to collect as anticipated.
The evaluation of a security’s estimated cash flows 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
securities or loans. Furthermore, Newcastle must have the intent and ability to hold loans whose fair value is below
carrying value until such fair value recovers, or until maturity, or else a write down to fair value must be recorded.
Similarly for securities, Newcastle must record a write down if we have the intent to sell a given security in an unrealized
loss position, or if it is more likely than not that we will be required to sell such a security. 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 security or 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 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 and put on nonaccrual status. Actual losses may differ from
Newcastle’s estimates. Newcastle may resume accrual of income on a security or loan if, in management’s opinion, full
collection is probable. 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. Newcastle charges off the corresponding loan allowance when it determines the loans to be
uncollectable.
77
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Gain (Loss) on Settlement of Investments, Net and Other Income (Loss), Net – These items are comprised of the
following:
Gain (loss) on settlement of investments, net
Gain on settlement of real estate securities
Loss on settlement of real estate securities
Gain on disposition of loans held for sale
Loss on disposition of loans held for sale
Realized gain (loss) of termination of derivative instruments
Other income (loss), net
Realized gain (loss) on total rate of return swaps
Gain (loss) on non-hedge derivative instruments
Unrealized gain (loss) recognized at de-designation of hedges
Hedge ineffectiveness
Equity in earnings of equity method investees
Other income (loss)
EXPENSE RECOGNITION
Year-Ended December 31,
2010
2009
2008
$
64,778
(9,192)
-
-
(3,279)
$
29,663
(18,644)
526
(111)
4
$
12,555
(16,645)
1,434
(41,924)
(14,088)
$
52,307
$
11,438
$
(58,668)
-
$
(1,240)
(35,905)
580
94
795
-
$
15,446
(15,223)
(278)
420
317
$
(46,923)
(18,451)
(14,730)
180
8,157
3,802
$
(35,676)
$
682
$
(67,965)
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, if any, are included in Derivative Assets, and 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. Newcastle reports the fair value of derivative instruments gross of cash paid or received pursuant to
credit support agreements and fair value is reflected on a net counterparty basis when Newcastle believes a legal right of
offset exists under an enforceable netting agreement. 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 total rate of return
swaps. 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 has hedged (and may continue to hedge, when feasible and
appropriate) 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.
78
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
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.
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 earnings. 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.
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 (Loss). These
derivatives may, to some extent, be economically effective as hedges.
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 reduces such risk by limiting its counterparties to major financial institutions.
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 derivative counterparties outside of its non-recourse financing structures. Newcastle’s
major derivative counterparties include Bank of America, Credit Suisse, Wells Fargo and Deutsche Bank.
Management Fees 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, to the extent impairment losses are considered temporary. At
disposition, the net realized gain or loss is determined on the basis of the cost of the specific investments and is included in
79
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
earnings. Unrealized losses on securities are charged to earnings if they reflect a decline in value that is other-than-
temporary, as described above.
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. Loans which Newcastle does not have the intent
and ability to hold into 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.
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 CDOs pending reinvestment
CDO bond sinking funds
CDO trustee accounts
December 31,
2010
2009
$
150,185
2,939
3,881
$
194,282
2,040
3,929
$
157,005
$
200,251
Supplemental non-cash investing and financing activities relating to CDOs are disclosed below:
Restricted cash generated from sale of securities
Restricted cash generated from sale of real estate related loans
Restricted cash generated from paydowns on securities and loans
Restricted cash used for purchases of real estate securities
Restricted cash used for purchases of real estate related loans
Restricted cash used for repayments of CDO bonds payable
Restricted cash used for repurchases of CDO bonds payable
Restricted cash used for purchases of derivative instruments
Year Ended December 31,
2009
2008
2010
$
$
$
$
$
$
$
$
249,549
53,020
511,276
368,893
107,708
202,037
143,046
5,187
132,578
$
26,961
$
433,918
$
297,632
$
$
-
$
59,741
$
2,525
$
-
175,468
$
62,782
$
194,114
$
182,555
$
$
134,639
$
-
$
7,943
$
-
Stock Options ⎯ The fair value of the options issued as compensation to the Manager for its successful efforts in raising
capital for Newcastle 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 ⎯ Newcastle’s accounting policy for its preferred stock is described in Note 9.
80
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Accretion of Discount and Other Amortization ⎯ As reflected on the Consolidated Statements of Cash Flows, this item is
comprised of the following:
Accretion of net discount on securities and loans
$
(39,469)
$
(52,925)
$
(35,819)
2010
2009
2008
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
337
3,432
4,183
7,004
8,409
9,446
6,157
2,442
(880)
$
(31,517)
$
(28,066)
$
(28,100)
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 April 2009, the FASB issued new guidance which (i) requires disclosures
about the fair value of financial instruments on an interim basis, (ii) changes the guidance for determining, recording and
disclosing other-than-temporary impairment, and (iii) provides additional guidance for estimating fair value when the
volume or level of activity for an asset or liability have significantly decreased. This guidance was effective for Newcastle
as of April 1, 2009. It had a significant impact on Newcastle’s disclosures, but no material impact on its financial condition,
liquidity, or results of operations upon adoption. A reclassification adjustment of $1.3 billion of loss from Accumulated
Deficit to Accumulated Other Comprehensive Income (Loss) was recorded at adoption but had no net effect on equity.
Post-adoption impairment determinations, including the analysis performed at December 31, 2010, are performed using this
new guidance and may result in materially different conclusions than would have been reached under prior guidance.
In June 2009, the FASB issued new guidance on transfers of financial assets which eliminates the concept of qualified
special purpose entities (QSPEs), changes the requirements for reporting a transfer of a portion of financial assets as a sale,
clarifies other sale accounting criteria and changes the initial measurement of a transferor’s interest in transferred financial
assets. Furthermore, it requires additional disclosures. This guidance is effective for fiscal years beginning after November
15, 2009. The adoption of this guidance did not have a material impact on Newcastle’s financial position, liquidity or
results of operations.
In June 2009, the FASB issued new guidance which changes the definition of a variable interest entity (“VIE”) and changes
the methodology to determine who is the primary beneficiary of, or in other words who consolidates, a VIE. Furthermore, it
eliminates the scope exception for qualified special purpose entities (QSPEs), which are now subject to the VIE
consolidation rules. This guidance is effective for fiscal years beginning after November 15, 2009. Generally, the changes
are expected to cause more entities to be defined as VIE’s and to require consolidation by the entity that exercises day-to-
day control over a VIE, such as servicers and collateral managers. The adoption of this guidance lead to the deconsolidation
of one of Newcastle’s CDOs, CDO VII (Note 8). The deconsolidation reduced Newcastle’s gross assets and gross liabilities
by $149.4 million and $437.8 million, respectively, and increased equity by $288.4 million. The deconsolidation also
reduced revenues and expenses, but its impact was not material to the net income applicable to common stockholders.
The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, financial
statement presentation, revenue recognition, leases, financial instruments, hedging, contingencies and fair value. Some of
the proposed changes are significant and could have a material impact on Newcastle’s reporting. Newcastle has not yet
fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.
81
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
3. SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES
Newcastle conducts its business through the following segments: (i) investments financed with non-recourse collateralized
debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments and debt repurchases
financed with recourse debt, (iv) unlevered investments, and (v) corporate. With respect to the first two non-recourse
segments, subject to the passing of certain coverage tests periodically, Newcastle is generally entitled to receive the net
cash flows from these structures on a periodic basis.
The corporate segment consists primarily of interest income on short term investments, general and administrative
expenses, interest expense on the junior subordinated notes payable (Note 8) and management fees pursuant to the
Management Agreement (Note 10).
Summary financial data on Newcastle’s segments is given below, together with a reconciliation to the same data for
Newcastle as a whole:
Non-Recourse (A)
CDOs
Other Non-
Recourse (B)
Recourse (C)
Unlevered
(D)
Corporate
Inter-segment
Elimination (E)
Total
Year Ended December 31, 2010
Interest income
Interest expense
Net interest income (expense)
Impairment, net of the reversal of prior
valuation allowances on loans
$ 226,717
$ 72,773
$ 976
$ 1,653
$ 68
$ (1,915) $ 300,272
108,437
60,635
656
356
3,980
(1,845) 172,219
118,280
12,138
320
1,297
(3,912) (70) 128,053
(173,223) (38,561) (60) (29,014) -
-
(240,858)
Other income (loss)
289,158
(5,491) (663) (794) 77
-
282,287
Expenses
Income (loss) from continuing operations
1,483
579,178
3,149
42,059
4
(287) 29,714
29,528
-
(28,924) (70) 621,670
(197) 25,089
Income (loss) from discontinued operations
-
(271) -
193
-
70
(8)
Net income (loss)
Preferred dividends
Excess of carrying amount of exchanged
preferred stock over fair value of
consideration paid
Income (loss) applicable to common
stockholders
December 31, 2010
Investments
Cash and restricted cash
Derivative assets
Other assets
Total assets
Debt
Derivative liabilities
Other liabilities
Total liabilities
Preferred stock
GAAP book value
Continued on next page
579,178
41,788
(287) 29,907
(28,924) -
621,662
-
-
-
-
(7,453) -
(7,453)
-
-
-
-
43,043
-
43,043
$ 579,178
$ 41,788
$ (287) $ 29,907
$ 6,666
$ -
$ 657,252
$ 2,713,044
157,005
7,067
29,110
2,906,226
$ 740,596
-
-
96
740,692
$ -
-
-
-
-
$ 39,397
12
-
150
39,559
$ -
33,512
-
1,307
34,819
$ (34,185) $ 3,458,852
190,529
-
7,067
-
30,663
-
3,687,111
(34,185)
(3,029,273) (694,787) (4,683) -
-
(160,660)
(96)
(6,353)
(96)
(3,196,286)
-
-
-
(2)
(4,685)
-
(16,201)
(2,092)
(713,080)
-
(51,253) 34,185
-
-
(3,481) -
(54,734) 34,185
(61,583) -
(3,745,811)
(176,861)
(12,024)
(3,934,696)
(61,583)
$ (290,060) $ 27,612
$ (4,685) $ 39,463
$ (81,498) $ -
$ (309,168)
82
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Non-Recourse (A)
CDOs
Other Non-
Recourse (B)
Recourse
Unlevered
(D)
Corporate
Total
Year Ended December 31, 2009
Interest income
Interest expense
Net interest income (expense)
Impairment, net of reversal of prior valuation
allowances on loans
$ 275,938
$ 76,868
$ 7,416
$ 1,543
$ 101
$ 361,866
140,674
65,734
3,763
-
8,239
218,410
135,264
11,134
3,653
1,543
(8,138) 143,456
513,234
(24,212) 50,142
9,376
-
548,540
Other income (loss)
216,128
6,650
4,311
309
1
227,399
Expenses
Income (loss) from continuing operations
1,619
3,386
(163,461) 38,610
33
31,901
(42,211) (7,744) (34,780) (209,586)
26,643
220
Income (loss) from discontinued operations
-
-
-
(318) -
(318)
Net income (loss)
(163,461) 38,610
(42,211) (8,062) (34,780) (209,904)
Preferred dividends
Income (loss) applicable to common stockholders
December 31, 2009
Investments
Cash and restricted cash
Other assets
Total assets
Debt
Derivative liabilities
Other liabilities
Total liabilities
Preferred stock
GAAP book value
-
(13,501) (13,501)
$ (163,461) $ 38,610 $ (42,211) $ (8,062) $ (48,281) $ (223,405)
-
-
-
$ 2,389,325
202,461
36,643
2,628,429
$ 732,658
-
-
732,658
$ 72,808
3,056
605
76,469
$ 6,678
461
4
7,143
$ -
67,700
2,229
69,929
$ 3,201,469
273,678
39,481
3,514,628
(103,264) (4,940,204)
(4,058,928) (706,703) (71,309) -
(207,154)
-
(180,365)
-
(7,922)
(165) (4,245)
(2,197)
(5,155,280)
(165) (107,509)
(4,241,490)
(152,500)
(152,500)
-
-
(4,100)
(520)
(75,929)
-
(22,689)
(795)
(730,187)
-
$ (1,613,061) $ 2,471
$ 540
$ 6,978
$ (190,080) $ (1,793,152)
Non-Recourse (A)
CDOs
Other Non-
Recourse
Recourse
Unlevered
Corporate
Total
Year Ended December 31, 2008
Interest income
Interest expense
$ 307,891
$ 88,643
$ 47,707
$ 22,672
$ 1,954
$ 468,867
198,980
66,229
33,903
675
7,516
307,303
Net interest income (expense)
108,911
22,414
13,804
21,997
(5,562) 161,564
Impairment
Other income (loss)
Expenses
2,585,272
112,930
133,316
160,312
-
2,991,830
(37,128) (17,215) (67,296) 9,413
(583) (112,809)
1,563
4,793
40
402
25,825
32,623
Income (loss) from continuing operations
(2,515,052) (112,524) (186,848) (129,304) (31,970) (2,975,698)
Income (loss) from discontinued operations
-
-
-
(9,654) -
(9,654)
Net income (loss)
(2,515,052) (112,524) (186,848) (138,958) (31,970) (2,985,352)
Preferred dividends
Income (loss) applicable to common stockholders
-
(13,501) (13,501)
$ (2,515,052) $ (112,524) $ (186,848) $ (138,958) $ (45,471) $ (2,998,853)
-
-
-
(A) Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the extent
Newcastle receives net cash flow distributions from such structures. Furthermore, creditors or beneficial interest holders of these structures have
no recourse to the general credit of Newcastle. Therefore, Newcastle’s exposure to the economic losses from such structures is limited to its
invested equity in them and economically their book value cannot be less than zero. Therefore, impairment recorded in excess of Newcastle’s
investment, which results in negative GAAP book value for a given non-recourse financing structure, cannot economically be incurred and will
eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or termination of such non-recourse financing
structure.
Included in the other non-recourse segment were $403.8 million and $403.0 million of Investments and Debt at December 31, 2010 and 2009,
respectively, representing the loans subject to call option of the two subprime securitizations and the corresponding financing.
(B)
(C) The $4.7 million recourse debt was secured by $46.3 million of notes issued by Newcastle CDO VI, which was repurchased by Newcastle in
December 2010 and eliminated in consolidation.
83
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
(D) The following table summarizes the investments in the unlevered segment:
Real estate securities
Real estate related loans
Residential mortgage loans
Other investments
Outstanding
Face Amount
186,081
$
97,106
1,169
N/A
284,356
$
December 31, 2010
Carrying
Value
$
*
600
32,475
298
6,024
39,397
$
Number of
Investments
25
5
27
1
58
December 31, 2009
Carrying
Value
Outstanding
Face Amount
145,513
$
44,585
-
N/A
190,098
$
$
$
2,263
4,222
-
193
6,678
Number of
Investments
27
2
-
1
30
*A mezzanine loan with a $28.0 million of face amount and carrying value was repaid in full in February 2011.
(E) Represents the elimination of investments and financings and their related income and expenses between segments as the corresponding inter-
segment investments and financings are presented on a gross basis within each segment.
Variable Interest Entities (“VIEs”)
The VIEs in which Newcastle has a significant interest include (i) Newcastle’s CDOs, in which Newcastle has been
determined to be the primary beneficiary and therefore consolidates them (with the exception of CDO VII as described
below), since it has the power to direct the activities that most significantly impact the CDOs’ economic performance and
would absorb a significant portion of their expected losses and receive a significant portion of their expected residual
returns, and (ii) the manufactured housing loan financing structures, which are similar to the CDOs in analysis. Newcastle’s
CDOs and manufactured housing loan financings are held in special purpose entities whose debt is treated as non-recourse
secured borrowings of Newcastle. Newcastle’s subprime securitizations are also considered VIE’s, but Newcastle does not
control their activities and no longer receives a significant portion of their returns. These subprime securitizations were not
consolidated under the current or prior guidance.
In addition, Newcastle’s investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs,
depending on their structure. Newcastle is not obligated to provide, nor has it provided, any financial support to these VIEs.
Newcastle monitors these investments and, to the extent Newcastle determines that it potentially owns a majority of the
currently controlling class, it analyzes them for potential consolidation. As of December 31, 2010, Newcastle has not
consolidated these potential VIEs due to the determination that, based on the nature of Newcastle’s investments and the
provisions governing these structures, Newcastle does not have the power to direct the activities that most significantly
impact their economic performance. Newcastle will continue to analyze future investments, as well as reconsideration
events in existing entities, pursuant to the VIE requirements. These analyses require considerable judgment in determining
the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power
and economics. The result could be the consolidation of an entity that would otherwise not have been consolidated or the
de-consolidation of an entity that would otherwise have been consolidated.
On January 1, 2010, as a result of the adoption of the new guidance, Newcastle deconsolidated a non-recourse financing
structure, CDO VII. Newcastle determined that it does not have the current power to direct the relevant activities of CDO
VII as an event of default had occurred and we may be removed as the collateral manager by a single party. The
deconsolidation reduced Newcastle’s gross assets by $149.4 million, reduced liabilities by $437.8 million and increased
equity by $288.4 million. The deconsolidation also reduced revenues and expenses, but its impact was not material to the
net income applicable to common stockholders.
Newcastle has interests in the following unconsolidated VIE at December 31, 2010, in addition to the subprime
securitizations which are described in Note 4:
Entity
Gross Assets (A)
Debt (B)
Carrying Value of Newcastle's
Investment (C)
CDO VII
$
478,223
$
469,463
$
-
(A) Face amount.
(B) Includes $66.7 million face amount of debt owned by Newcastle with a carrying value of zero at December 31, 2010.
(C) Represent’s Newcastle’s maximum exposure to loss from these entities.
84
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(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, 2010 and 2009, all of which are classified as available for sale and are therefore
reported at fair value with changes in fair value recorded in other comprehensive income, except for securities that are other-than-temporarily impaired.
December 31, 2010
Asset Type
CMBS-Conduit
CMBS- Single Borrower
CMBS-Large Loan
REIT Debt
ABS-Subprime (F)
ABS-Manufactured Housing
ABS-Franchise
FNMA/FHLMC (G)
CDO (H)
Debt Security Total/Average (I)
Equity Securities
Total
December 31, 2009
Asset Type
CMBS-Conduit
CMBS- Single Borrower
CMBS-Large Loan
REIT Debt
ABS-Subprime (F)
ABS-Manufactured Housing
ABS-Franchise
FNMA/FHLMC (G)
CDO (H)
Debt Security Total/Average (I)
Equity Securities
Total
Outstanding
Face Amount
1,531,520
$
409,190
30,315
317,413
353,306
35,137
30,228
3,140
123,126
2,833,375
$
Outstanding
Face Amount
1,733,585
$
620,010
88,556
518,215
524,489
51,276
34,730
45,494
16,000
3,632,355
$
Before
Impairment
1,308,320
$
397,567
30,311
316,085
353,432
34,101
30,421
3,358
14,877
2,488,472
1,388
2,489,860
$
Before
Impairment
1,530,456
$
601,990
90,308
520,805
526,996
49,795
35,144
47,690
14,731
3,417,915
1,388
3,419,303
$
See notes on following page
Amortized Cost Basis
Other-Than-
Temporary-
Impairment (A)
$
(455,985)
(14,853)
-
-
(191,968)
-
(22,047)
-
(14,877)
(699,730)
Gross Unrealized
Weighted Average
After
Impairment
852,335
$
382,714
30,311
316,085
161,464
34,101
8,374
3,358
-
1,788,742
$
Gains
161,695
3,484
-
17,809
23,752
1,498
2,352
56
-
210,646
Losses
$
(66,346)
(58,431)
(5,028)
(4,924)
(7,210)
(384)
(763)
-
-
(143,086)
$
Carrying Value
(B)
947,684
327,767
25,283
328,970
178,006
35,215
9,963
3,414
-
1,856,302
Number of
Securities
196
59
6
40
88
7
13
1
8
418
Rating
(C)
BB
BB-
BBB+
BB+
B-
BBB+
CCC
AAA
C
BB-
Coupon
Yield
5.70% 11.60%
5.65%
3.96%
1.69%
1.74%
5.98%
6.15%
1.54% 11.78%
6.65%
7.36%
3.76% 25.49%
3.79%
5.70%
0.00%
2.82%
9.15%
4.80%
Maturity
(Years)
(D)
3.3
2.5
1.1
3.5
5.0
4.3
2.8
3.2
-
3.3
Principal
Subordination
(E)
9.8%
7.5%
22.4%
N/A
24.2%
39.4%
15.1%
N/A
N/A
(276)
(700,006)
$
1,112
1,789,854
$
3,170
213,816
$
-
(143,086)
$
4,282
1,860,584
$
2
420
Amortized Cost Basis
Other-Than-
Temporary-
Impairment (A)
$
(688,917)
(47,088)
(19,864)
(8,285)
(337,355)
-
(19,345)
-
(14,731)
(1,135,585)
Gross Unrealized
Weighted Average
After
Impairment
841,539
$
554,902
70,444
512,520
189,641
49,795
15,799
47,690
-
2,282,330
$
Gains
53,270
4,224
-
15,795
8,135
652
188
2,181
-
84,445
$
Losses
(263,340)
(170,288)
(29,132)
(41,668)
(24,517)
(5,975)
(3,680)
-
-
(538,600)
$
Carrying Value
(B)
631,469
388,838
41,312
486,647
173,259
44,472
12,307
49,871
-
1,828,175
Number of
Securities
212
69
12
59
111
9
17
3
1
493
Rating
(C)
BB+
BB-
B+
BB+
B-
BBB+
B
AAA
C
BB
Yield
Coupon
9.77%
5.73%
5.70%
4.20%
2.27%
1.67%
6.12%
5.97%
1.47% 13.13%
7.23%
6.69%
6.75%
3.78%
5.54%
5.83%
0.00%
6.21%
7.81%
4.81%
Maturity
(Years)
(D)
3.4
2.3
1.2
4.2
4.3
5.4
3.0
3.8
-
3.4
Principal
Subordination
(E)
10.50%
8.70%
11.10%
N/A
18.20%
36.80%
17.70%
N/A
N/A
-
(1,135,585)
$
1,388
2,283,718
$
1,478
85,923
$
(246)
(538,846)
$
2,620
1,830,795
$
2
495
85
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
(A) Represents the cumulative impairment against amortized cost basis recorded through earnings, net of the effect of the cumulative adjustment as a
result of the adoption of new accounting guidance on impairment in 2009.
(B) See Note 7 regarding the estimation of fair value, which is equal to carrying value for all securities.
(C) Represents the weighted average of the ratings of all securities in each asset type, expressed as an S&P equivalent rating. For each security rated
by multiple rating agencies, the lowest rating is used. FNMA/FHLMC securities have an implied AAA rating. Ratings provided were determined
by third party rating agencies as of a particular date, may not be current and are subject to change (including a “negative watch” assignment) at
any time.
(D) The weighted average maturity is based on the timing of expected principal reduction on the assets.
(E) Percentage of the outstanding face amount of securities and residual interests that is subordinate to Newcastle’s investments.
(F)
Includes the retained bonds with face amount of $20.9 million and carrying value of $1.1 million from Securitization Trust 2006 and
Securitization Trust 2007 (Note 5). The residual interests were fully written off in the first quarter of 2010.
(G) Amortized cost basis and carrying value include principal receivable of $0.04 million and $1.7 million, as of December 31, 2010 and 2009,
respectively.
(H) Includes five CDO bonds issued by a third party and three CDO bonds issued by CDO VII, which has been deconsolidated, and held as
investment by Newcastle.
(I) As of December 31, 2010 and 2009, the total outstanding face amount of fixed rate securities was $2.1 billion and $2.7 billion, respectively, and
of floating rate securities was $728.1 million and $971.6 million, respectively.
Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the years ended
December 31, 2010, 2009 and 2008, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $101.4
million, $603.8 million and $2.0 billion, respectively, with respect to real estate securities (gross of $2.4 million and $70.2
million of other-than-temporary impartment recognized in Other Comprehensive Income in 2010 and 2009, respectively).
Based on management’s analysis of these securities, the performance of the underlying loans and changes in market factors,
Newcastle noted adverse changes in the expected cash flows on certain of these securities and concluded that they were
other-than-temporarily impaired. Any remaining unrealized losses as of each balance sheet date on Newcastle’s securities
were primarily the result of changes in market factors, rather than issuer-specific credit impairment. Newcastle performed
analyses in relation to such securities, using management’s best estimate of their cash flows, which support its belief that
the carrying values of such securities were fully recoverable over their expected holding period. Such market factors
include changes in market interest rates and credit spreads, or certain macroeconomic events, including market disruptions
and supply changes, which did not directly impact our ability to collect amounts contractually due. Management
continually evaluates the credit status of each of Newcastle’s securities and the collateral supporting those securities. This
evaluation includes a review of the credit of the issuer of the security (if applicable), the credit rating of the security, the
key terms of the security (including credit support), debt service coverage and loan to value ratios, the performance of the
pool of underlying loans and the estimated value of the collateral supporting such loans, including the effect of local,
industry and broader economic trends and factors. These factors include loan default expectations and loss severities, which
are analyzed in connection with a particular security’s credit support, as well as prepayment rates. The result of this
evaluation is considered when determining management’s estimate of cash flows and 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 summarizes Newcastle’s securities in an unrealized loss position as of December 31, 2010.
Securities in
an Unrealized
Loss Position
Less Than
Twelve Months
Twelve or
More Months
Total
Outstanding
Face
Amount
Amortized Cost Basis
Other-than-
Temporary
Impairment
After
Impairment
Before
Impairment
Gross Unrealized
Weighted Average
Gains
Losses
Carrying
Value
Number
of
Securities
Rating
Coupon Yield
Maturity
(Years)
$
101,129
$
108,628
$
(32,156)
$
76,472
$
-
$
(813)
$
75,659
23
BB+
4.77% 6.67%
807,978
909,107
$
805,616
914,244
$
(32,598)
(64,754)
$
773,018
849,490
$
-
-
$
(142,273)
(143,086)
$
630,745
706,404
$
128
151
BB-
BB-
4.67% 5.23%
4.68% 5.36%
3.4
2.9
3.0
86
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Newcastle performed an assessment of all of its debt securities that are in an unrealized loss position (unrealized loss
position exists when a security’s amortized cost basis, excluding the effect of OTTI, exceeds its fair value) and determined
the following:
Securities Newcastle intends to sell
Securities Newcastle is more likely than not to be required to sell (A)
Securities Newcastle has no intent to sell and is not more likely
than not to be required to sell:
Credit impaired securities
Non credit impaired securities
Total debt securities in an unrealized loss position
December 31, 2010
Amortized Cost Basis
Unrealized Losses
$
Fair Value
19,313
-
After Impairment
Credit (B)
Non-Credit (C)
$
4,432
-
$
(54,708)
-
N/A
N/A
55,457
650,947
725,717
$
68,087
781,403
853,922
$
(60,688)
-
(115,396)
$
(12,630)
(130,456)
(143,086)
$
(A) Newcastle may, at times, be more likely than not to be required to sell certain securities for liquidity purposes. While the amount of the securities
to be sold may be an estimate, and the securities to be sold have not yet been identified, Newcastle must make its best estimate, which is subject to
significant judgment regarding future events, and may differ materially from actual future sales.
(B) This amount is required to be recorded as other-than-temporary impairment through earnings. In measuring the portion of credit losses,
Newcastle’s management estimates the expected cash flow for each of the securities. This evaluation includes a review of the credit status and the
performance of the collateral supporting those securities, including the credit of the issuer, key terms of the securities and the effect of local,
industry and broader economic trends. Significant inputs in estimating the cash flows include management’s expectations of prepayment speeds,
default rates and loss severities. Credit losses are measured as the decline in the present value of the expected future cash flows discounted at the
investment’s effective interest rate.
(C) This amount represents unrealized losses on securities that are due to non-credit factors and is required to be recorded through other
comprehensive income.
As a result of new impairment guidance effective in 2009, Newcastle recorded a reclassification adjustment of $1.3 billion of
loss from Accumulated Deficit to Accumulated Other Comprehensive Income (Loss). This represents a substantive reversal
of a large portion of the impairment charge recorded in the fourth quarter of 2008, which was originally recorded as a result
of Newcastle’s inability to express the intent and ability to hold its securities until an expected recovery in value (if any).
The following table summarizes the activity related to credit losses on debt securities:
Period from Adoption
of New Guidance
Through December
31, 2009
2010
Beginning balance of credit losses on debt securities for which a portion of an OTTI was recognized
in other comprehensive income
$
(408,782)
$
(363,125)
Additions for credit losses on securities for which an OTTI was not previously recognized
(12,156)
(157,783)
Increases to credit losses on securities for which an OTTI was previously recognized and a
portion of an OTTI was recognized in other comprehensive income
Additions for credit losses on securities for which an OTTI was previously recognized without
any portion of OTTI recognized in other comprehensive income
Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive
income at current measurement date
Reduction for securities sold during the period
Reduction for securities deconsolidated during the period
Reduction for increases in cash flows expected to be collected that are recognized over the remaining
life of the security
Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in
other comprehensive income
(8,175)
(99,589)
(25,520)
(84,855)
228,871
48,965
112,408
268,468
3,774
-
3,701
24,328
$
(60,688)
$
(408,782)
The securities are encumbered by the CDO bonds payable and certain repurchase agreements (Note 8) at December 31,
2010.
87
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
As of December 31, 2010 and 2009, Newcastle had $150.2 million and $194.3 million of restricted cash, respectively, held
in CDO financing structures pending its reinvestment in real estate securities and loans.
The table below summarizes the geographic distribution of the collateral securing our CMBS and ABS at December 31,
2010:
Geographic Location
Outstanding Face Amount
CMBS
$
ABS
Outstanding Face Amount
$
553,263
466,251
394,461
300,336
218,660
15,400
22,654
1,971,025
Percentage
28.1%
23.7%
20.0%
15.2%
11.1%
0.8%
1.1%
100.0%
115,762
79,263
90,899
58,348
44,872
29,522
5
418,671
Percentage
27.7%
18.9%
21.7%
13.9%
10.7%
7.1%
0.0%
100.0%
$
$
Western U.S.
Northeastern U.S.
Southeastern U.S.
Midwestern U.S.
Southwestern U.S.
Other
Foreign
Geographic concentrations of investments expose Newcastle to the risk of economic downturns within the relevant regions,
particularly given the current unfavorable market conditions. These market conditions may make regions more vulnerable
to downturns in certain market factors. Any such downturn in a region where Newcastle holds significant investments could
have a material, negative impact on Newcastle.
5. REAL ESTATE RELATED LOANS, RESIDENTIAL MORTGAGE LOANS AND SUBPRIME MORTGAGE
LOANS
All of Newcastle’s loan investments, other than Manufactured Housing Loans Portfolio I as described below, were
classified as held for sale as of December 31, 2010 and 2009 and marked to the lower of carrying value or fair value. A
portfolio of manufactured housing loans, which was refinanced in April 2010 through a securitization transaction (see Note
8) was reclassified from held for sale to held for investment during 2010.
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, 2010
December 31, 2009
Outstanding
Face Amount
579,579
$
309,437
233,132
30,970
Carrying
Value (A)
388,510
$
208,365
154,760
30,970
Loan
Count
17
9
9
3
Wtd. Avg.
Yield
13.48%
15.63%
15.14%
5.11%
Wtd. Avg.
Coupon
4.30%
8.69%
4.01%
3.97%
$
1,153,118
$
782,605
38
14.05%
5.41%
$
151,281
$
124,974
3,936
9.59%
$
63,399
1,169
$
49,862
298
223
27
5.61%
47.46%
8.72%
2.48%
8.41%
212,036
203,053
7,101
8.30%
9.71%
$
276,604
$
253,213
$
7,351
7.81%
8.05%
Weighted
Average
Maturity
(Years) (B)
1.9
3.4
1.8
2.8
Floating Rate
Loans as a
Percentage of
Face Amount
92.6%
62.3%
74.1%
94.0%
$
Delinquent
Face Amount
(C)
76,359
-
45,092
-
$
Carrying
Value
240,185
198,828
79,427
55,422
Wtd. Avg.
Yield
43.64%
7.08%
36.48%
24.01%
2.3
7.7
6.6
0.7
5.8
6.0
80.8%
$
121,451
$
573,862
28.09%
1.1%
$
1,872
N/A
100.0%
0.0%
$
5,636
480
$
53,995
122,095
N/A
5.25%
11.62%
17.3%
3,781
207,557
11.01%
36.2%
$
9,897
$
383,647
10.37%
$
406,217
$
403,793
$
403,006
Loan Type
Mezzanine Loans
Corporate Bank Loans
B-Notes
Whole Loans
Total Real Estate Related
Loans Held for Sale, net (D)
Manufactured Housing Loans
Portfolio I, Held for
Investment, Net (F)
Residential Loans
Manufactured Housing Loans
Manufactured Housing Loans
Portfolio II
Total Residential
Mortgage Loans Held for
Sale, Net (E)
Subprime Mortgage Loans
subject to Call Option
88
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
(A) The aggregate United States federal income tax basis for such assets at December 31, 2010 was approximately $1.4 billion, excluding the
securitized subprime mortgage loans and the real estate related loans in CDO VII which are fully consolidated for tax purposes.
(B) The weighted average maturity is based on the timing of expected principal reduction on the assets.
(C) Includes loans that are non-performing, in foreclosure, under bankruptcy filing or considered real estate owned. As of December 31, 2010, $158.8
million face amount of real estate related loans was on non-accrual status.
(D) Loans which are more than 3% of the total current carrying value (or $23.5 million) at December 31, 2010 are as follows:
Loan Type
Individual Bank Loan
Individual Mezzanine Loan
Individual Mezzanine Loan
Individual B-Note Loan
Individual Mezzanine Loan
Individual Mezzanine Loan
Individual Mezzanine Loan
Individual Bank Loan
Individual B-Note Loan
Individual Whole Loan
Individual Mezzanine Loan
Individual B-Note
Individual Bank Loan
Others
(2)
(3)
(4)
(4)
(5)
(4)
(4)
(4)
(4)
(6)
(4)
(4)
(3)
(7)
Outstanding
Face Amount Carrying Value
Loan
Count
Yield (1)
Coupon (1)
Weighted Average
Maturity (Years)
December 31, 2010
$
116,649
$
86,649
70,000
87,664
56,481
51,615
53,510
38,987
91,807
33,500
29,117
38,510
36,642
26,990
70,000
68,751
47,010
44,978
39,545
37,218
36,952
29,589
29,117
28,642
27,416
26,384
421,646
210,354
$
1,153,118
$
782,605
1
1
1
1
1
1
1
1
1
1
1
1
1
25
38
24.85%
5.71%
15.00%
15.00%
15.00%
18.00%
10.00%
8.74%
15.00%
5.00%
20.00%
15.00%
8.67%
13.41%
14.05%
15.55%
3.26%
4.76%
2.89%
8.20%
3.51%
1.95%
2.27%
2.76%
3.74%
5.24%
6.23%
9.75%
4.33%
5.41%
4.33
0.08
2.33
1.75
3.58
2.50
0.67
3.30
1.17
2.83
2.50
4.04
1.58
1.87
2.31
Interest accrued to principal balance over life to maturity with a discontinued payoff option prior to maturity.
(1) Weighted average yield and weighted average coupon for Others.
(2)
(3) These two loans were repaid in full in January and February 2011.
(4)
(5) Defaulted.
(6)
(7) Various terms of payment.
Interest only payments over life to maturity and balloon principal payment upon maturity.
Interest only payment over life to maturity with a discounted payoff option prior to loan maturity.
(E) Carrying value includes interest receivable of $0.1 million for the residential loans and principal and interest receivable of $7.0 million for the
manufactured housing loans as of December 31, 2010.
(F) The following is an aging analysis of past due residential loans held-for-investment as of December 31, 2010:
30-59 Days
Past Due
60-89 Days
Past Due
Over 90 Days Past
Due
Repossessed
Total Past
Due
Current
Total Outstanding
Face Amount
Manufactured Housing
Loans Portoflio I
$
771
$
287
$
372
$
1,213
$
2,643
$
148,638
$
151,281
Newcastle’s management monitors the credit quality of the Manufactured Housing Loans Portfolio I primarily by using the ageing analaysis,
current trends in delinquencies and the actual loss incurrence rate.
The following is a summary of real estate related loans by maturity at December 31, 2010:
Outstanding
Year of Maturity (1)
Delinquent (2)
2011
2012
2013
2014
2015
Thereafter
Total
$
Face Amount Carrying Value
44,978
$
370,411
108,054
21,113
61,193
160,608
16,248
782,605
121,452
447,162
178,145
29,533
129,575
204,993
42,258
1,153,118
$
89
Number of
Loans
5
12
7
3
3
6
2
38
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
(1) Based on the final extended maturity date of each loan investment as of December 31, 2010.
(2)
Includes loans that are non-performing, in foreclosure, or under bankruptcy.
Activities relating to the carrying value of our real estate loans and residential mortgage loans are as follows:
Held for Sale
Held for Investment
December 31, 2007
Purchases / Additional fundings
Principal paydowns
Sales
Provision for credit losses
Provision for impaired loans
Accretion of loan discount and other amortization
Transfer to held for sale
Provision for losses, loans held for sale
Gain on disposition of loans held for sale
Loss on disposition of loans held for sale
Other
December 31, 2008
Additional fundings
Principal paydowns (A)
Sales
Valuation (allowance) reversal on loans
Other
December 31, 2009
Purchases / additional fundings
Interest accrued to principal balance
Principal paydowns
Sales
Transfer to held for investment
Transfer to other investments
Valuation (allowance) reversal on loans
Accretion of loan discount and other amortization
Deconsolidation of CDO VII
Other
December 31, 2010
$
Real Estate Related Loans Residential Mortgage Loans Real Estate Related Loans
$ - $ -
1,856,978
-
-
154,459
-
-
(171,870)
-
-
(119,115)
-
-
(200)
-
-
(351,902)
-
-
21,840
535,954
1,389,933
(1,389,933)
(126,322)
(506,231)
-
1,434
-
(41,924)
-
-
$
$
Residential Mortgage Loans
$ 634,605
(90,831)
(8,257)
(1,222)
2,845
(535,954)
-
-
-
(1,186)
$
-
-
-
-
-
-
-
$
-
-
(10,916)
-
135,942
-
(960)
1,035
-
(127)
124,974
$
-
-
-
(257)
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
$
-
409,632
-
(54,177)
-
29,557
(1,365)
383,647
-
-
(34,781)
-
(135,942)
-
41,227
-
-
(938)
253,213
843,212
10,777
(207,299)
(28,781)
(44,564)
517
573,862
113,733
12,535
(136,078)
(51,225)
-
(24,907)
299,620
-
(5,453)
518
782,605
$
$
$
$
(A) Includes $1.4 million carrying value of two bank loans converted to equity securities during the year ended December 31, 2009.
The following is a rollforward of the related loss allowance:
Held for Sale
Real Estate Related Loans
Residential Mortgage Loans
Held for Investment
Residential Mortgage Loans (B)
Balance at December 31, 2008
$
(827,328)
$
(136,206)
$
-
Charge-offs (A)
Valuation (allowance) reversal on loans
49,483
(44,564)
10,240
29,557
-
-
Balance at December 31, 2009
$
(822,409)
$
(96,409)
$
-
Charge-offs (A)
Deconsolidation of CDO VII
Transfer to held for investment
Valuation (allowance) reversal on loans
195,935
5,263
-
299,620
8,105
-
21,884
41,227
1,494
-
(21,884)
(960)
Balance at December 31, 2010
$
(321,591)
$
(25,193)
$
(21,350)
(A) The charge-offs for real estate related loans represent nine loans which were sold, restructured, paid off at a discounted price or reclassified as
other investments during the period.
(B) The allowance for credit losses was determined based on the guidance for loans acquired with deteriorated credit quality.
The average carrying amount of Newcastle’s real estate related loans was approximately $670.7 million, $668.4 million and
$1.7 billion during 2010, 2009 and 2008, respectively, on which Newcastle earned approximately $53.3 million, $53.8
million and $124.4 million of gross interest revenues, respectively.
90
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
The average carrying amount of Newcastle’s residential mortgage loans was approximately $388.1 million, $380.2 million
and $570.0 million during 2010, 2009 and 2008, respectively, on which Newcastle earned approximately $37.8 million,
$42.6 million and $56.0 million of gross interest 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, 2010 or 2009.
Securitization of Subprime Mortgage Loans
Newcastle acquired and securitized two portfolios of subprime residential mortgage loans (“Subprime Portfolio I” and
“Subprime Portfolio II”), through subsidiaries, as summarized in the table below. Both portfolios are being serviced by an
affiliate of the Manager for a servicing fee equal to 0.50% per annum on their respective unpaid principal balances.
Both portfolios were securitized through special purpose entities (“Securitization Trust 2006” and (“Securitization Trust
2007”) which are not consolidated by Newcastle. Newcastle retained a portion of the notes issued by, and all of the equity
of, both entities. Newcastle, as holder of the equity (or residual interest), has the option (a call option) to redeem the notes
once the aggregate principal balance of Subprime Portfolio I or Subprime Portfolio II is equal to or less than 20% or 10%,
respectively, of such balance at the date of the transfer. The transactions between Newcastle and each securitization trust
qualified as sales for accounting purposes. However, 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 securitizations. 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. The call options are “out of the money,” meaning that the price Newcastle would have to pay to
acquire such loans exceeds their fair value at this time, and there is no requirement to exercise such options.
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.
Subprime Portfolio
Date of acquisition
Original number of loans (approximate)
Predominant origination date of loans
Original face amount of purchase
Pre-securitization loan write-down
Gain on pre-securitization hedge
Gain on sale
Securitization date
Face amount of loans at securitization
Face amount of notes sold by trust
Stated maturity of notes
Face amount of notes retained by Newcastle
Fair value of equity retained by Newcastle
Key assumptions in measuring such fair value (A):
Weighted average life (years)
Expected credit losses
Weighted average constant prepayment rate
Discount rate
(A) As of the date of transfer.
II
March 2007
7,300
2006
$1.3 billion
($5.8 million)
$5.8 million
$0.1 million
July 2007
$1.1 billion
$1.0 billion
April 2037
$38.8 million
$46.7 million (A)
3.8
8.0%
30.1%
22.5%
I
March 2006
11,300
2005
$1.5 billion
($4.1 million)
$5.5 million
Less than $0.1 million
April 2006
$1.5 billion
$1.4 billion
March 2036
$37.6 million
$62.4 million (A)
3.1
5.3%
28.0%
18.8%
91
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
The following table presents information on the retained interests in the securitizations of Subprime Portfolios I and II at
December 31, 2010:
Subprime Portfolio
I
II
Total securitized loans (unpaid principal balance) (A)
$
526,326
$
693,580
Loans subject to call option (carrying value)
$
299,176
$
104,617
Retained interests (fair value) (B)
$
1,075
$
73
(A) Average loan seasoning of 65 months and 47 months for Subprime Portfolios I and II, respectively, at December 31, 2010.
(B) The retained interests include retained bonds of the securitizations. Their fair value is estimated based on pricing models. Newcastle’s residual
interests were written off in 2010. The weighted average yield of the retained notes was 6.25% as of December 31, 2010.
The following table summarizes certain characteristics of the underlying subprime mortgage loans, and related financing, in
the securitizations as of December 31, 2010 (unaudited, except stated otherwise):
Subprime Portfolio
I
II
Loan unpaid principal balance (UPB) (A)
Weighted average coupon rate of loans
Delinquencies of 60 or more days (UPB) (B)
Net credit losses for year ended
December 31, 2010
December 31, 2009
Cumulative net credit losses
Cumulative net credit losses as a % of original UPB
Percentage of ARM loans (C)
Percentage of loans with loan-to-value ratio >90%
Percentage of interest-only loans
Face amount of debt (A) (D)
Weighted average funding cost of debt (E)
$
$
$
$
$
$
$
$
$
$
526,326
5.98%
116,825
37,881
80,684
163,409
10.88%
52.9%
10.6%
22.6%
517,983
1.43%
$
$
693,580
5.56%
212,822
64,389
83,283
167,636
15.41%
65.7%
17.2%
4.1%
680,981
1.53%
(A) Audited.
(B) Delinquencies include loans 60 or more days past due, in foreclosure, under bankruptcy filing or real estate owned.
(C) ARM loans are adjustable-rate mortgage loans. An option ARM is an adjustable-rate mortgage that provides the borrower with an option to
choose from several payment amounts each month for a specified period of the loan term. None of the loans in the subprime portfolios are option
ARMs.
(D) Excludes face amount of $8.3 million and $12.6 million of retained notes for Subprime Portfolios I and II, respectively, at December 31, 2010.
(E)
Includes the effect of applicable hedges.
Cash flows related to the two securitizations were as follows:
Net cash inflows from retained interests
Year Ended December 31, 2010
Year Ended December 31, 2009
Year Ended December 31, 2008
Suprime Portfolio
I
II
$
315
$
629
$
878
$
1,461
$
6,010
$
12,684
92
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
6. OPERATING REAL ESTATE, HELD FOR SALE
Newcastle has committed to a plan, and is actively working, to sell all of its operating real estate. As a result, all of the real
estate has been classified as held for sale at December 31, 2010 and 2009 and marked to the lower of cost or market value
based on a discounted cash flow analysis, resulting in a recorded loss of $0.0 million and $0.3 million for the years ended
December 31, 2010 and 2009, respectively. All of the related operations, including these losses, have been classified as
discontinued operations for all periods presented.
The following table summarizes the financial information for the discontinued operations:
Interest income
Rental income
Expenses
Impairment
Net gain on sale
Other income
Net income (loss)
Year Ended December 31,
2009
$
-
2,106
2,106
1,916
190
(550)
-
42
(318)
2010
$
-
2,135
2,135
1,910
225
(260)
-
27
(8)
2008
6
$
4,995
5,001
4,632
369
(10,049)
18
8
(9,654)
$
$
$
No income tax related to discontinued operations was recorded for the years ended December 31, 2010, 2009 or 2008.
The following table sets forth certain information regarding the operating real estate portfolio as of December 31, 2010:
Type of Property
Location
Ohio Portfolio
Office Building
Office Building
Office Building
Office Building
Beavercreek, OH
Beavercreek, OH
Beavercreek, OH
Vandalia, OH
(A) Unaudited.
Net
Rentable Sq.
Ft. (A)
Acquisition
Date
Year Built/
Renovated (A)
Initial Cost
Costs Capitalized
Subsequent to
Acquisition
Occupancy (A)
57,115
29,916
45,500
47,539
180,070
Mar 06
Mar 06
Mar 06
Mar 06
1986
1986
1986
1987
$
2,673
2,727
2,624
1,592
$
390
132
383
165
65.6%
100.0%
100.0%
39.7%
$
9,616
$
1,070
73.2%
The aggregate United States federal income tax basis for Newcastle’s operating real estate at December 31, 2010 was
approximately $8.9 million. The operating real estate portfolio was pledged as collateral in one of Newcastle’s non-
recourse financing structures at December 31, 2010.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value may be based upon broker quotations, counterparty quotations or pricing services quotations, which provide
valuation estimates based upon reasonable market order indications or a good faith estimate thereof and are subject to
significant variability based on market conditions, such as interest rates, credit spreads and market liquidity. A significant
portion of Newcastle’s loans, securities and debt obligations are currently not traded in active markets and therefore have
little or no price transparency. As a result, Newcastle has estimated the fair value of these illiquid instruments based on
internal pricing models rather than quotations. The determination of estimated cash flows used in pricing models is
inherently subjective and imprecise. Changes in market conditions, as well as changes in the assumptions or methodology
used to determine fair value, could result in a significant change to estimated fair values. 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,
2010 and do not take into consideration the effects of subsequent changes in market or other factors.
93
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Fair Value Summary Table
The carrying values and estimated fair values of Newcastle's financial instruments at December 31, 2010 and 2009 were as follows:
Assets
Non-Recourse VIE Financing Structures (F)
Financial instruments:
Real estate securities, available for sale*
Principal
Balance or
Notional
Amount
Carrying
Value
Estimated
Fair Value
Fair Value Method (A)
Weighted
Average
Yield/Funding
Cost
Weighted
Average
Maturity
(Years)
Carrying
Value
Estimated
Fair Value
December 31, 2010
December 31, 2009
$
2,647,294
$
1,859,984
$
1,859,984
Broker quotations, counterparty quotations,
pricing services, pricing models
9.15%
3.49
$
1,784,487
$
1,784,487
Real estate related loans, held for sale, net
1,056,012
750,130
754,589
Broker quotations, counterparty quotations,
pricing services, pricing models
14.20%
2.46
554,367
554,367
Residential mortgage loans, held for investment, net
Residential mortgage loans, held for sale, net
Subprime mortgage loans subject to call option (B)
Restricted cash*
Derivative assets, treated as hedges (C)(E)*
Non-hedge derivative assets (D)(E)*
Operating real estate, held for sale
Other investments
Receivables and other assets
Recourse Financing Structures and Unlevered Assets
Financial instruments:
Real estate securities, available for sale*
151,281
275,436
406,217
157,005
104,205
36,428
124,974
252,915
403,793
157,005
4,537
2,530
8,776
18,883
29,206
3,612,733
$
128,369
252,915
403,793
157,005
4,537
2,530
8,776
18,883
29,206
3,620,587
$
Pricing models
Pricing models
(B)
Counterparty quotations
Counterparty quotations
9.59%
7.77%
9.09%
N/A
N/A
7.71
5.99
(B)
(C)
(D)
-
380,123
403,006
200,251
-
-
-
-
36,643
3,358,877
$
-
380,123
403,006
200,251
-
-
-
-
36,643
3,358,877
$
$
186,081
$
600
$
600
Broker quotations, counterparty quotations,
pricing services, pricing models
42.43%
0.15
$
46,308
$
46,308
Real estate related loans, held for sale, net
97,106
32,475
32,475
Broker quotations, counterparty quotations,
pricing services, pricing models
10.49%
0.64
19,495
19,495
Residential mortgage loans, held for sale, net
Cash and cash equivalents*
Operating real estate, held for sale
Other investments
Receivables and other assets
*Measured at fair value on a recurring basis.
1,169
33,524
298
33,524
-
6,024
1,457
74,378
$
298
33,524
-
6,024
1,457
74,378
$
94
Pricing models
47.46%
0.7
3,524
68,300
9,966
193
7,965
155,751
$
3,524
68,300
9,966
193
7,965
155,751
$
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Principal
Balance or
Notional
Amount
Carrying
Value
Estimated
Fair Value
Fair Value Method (A)
Weighted
Average
Yield/Funding
Cost
Weighted
Average
Maturity
(Years)
Carrying
Value
Estimated
Fair Value
December 31, 2010
December 31, 2009
Liabilities
Non-Recourse VIE Financing Structures (F) (G)
Financial instruments:
CDO bonds payable
Other bonds payable
Notes payable
Repurchase agreements
Financing of subprime mortgage loans subject to call
option (B)
Interest rate swaps, treated as hedges (C )(E)*
Non-hedge derivatives (D)(E)*
Accrued expenses and other liabilities
Recourse Financing Structures and Other Liabilities (G)
Financial instruments:
Repurchase agreements
Junior subordinated notes payable
Interest rate swaps, treated as hedges (C )(E)*
Due to affiliates
Accrued expenses and other liabilities
$
3,010,751
258,324
4,356
14,049
406,217
$
3,010,868
256,809
4,356
14,049
403,793
$
1,845,419
244,792
3,624
14,049
403,793
Counterparty quotations, pricing models
Pricing models
Broker quotation
Market comparables
(B)
1,473,669
343,570
136,575
40,286
8,445
3,875,181
$
136,575
40,286
8,445
2,696,983
$
Counterparty quotations
Counterparty quotations
$
4,683
51,004
-
$
$
4,683
51,253
-
1,419
2,160
59,515
4,683
34,817
-
1,419
2,160
43,079
$
$
Market comparables
Pricing models
Counterparty quotations
3.16%
5.42%
1.16%
1.76%
9.09%
N/A
N/A
1.76%
7.42%
N/A
3.6
1.5
6.8
0.9
(B)
(C)
(D)
0.9
24.3
N/A
$
4,058,928
303,697
-
-
403,006
$
1,346,406
251,397
-
-
403,006
173,937
29,117
2,992
4,971,677
$
173,937
29,117
2,992
2,206,855
$
$
$
71,309
103,264
4,100
1,497
3,433
183,603
71,309
33,005
4,100
1,497
3,433
113,344
$
$
(A) Methods are listed in order of priority. In the case of real estate securities and real estate related loans, broker quotations are obtained if available and practicable, otherwise counterparty quotations or
pricing service valuations are obtained or, finally, internal pricing models are used. Internal pricing models are only used for (i) securities and loans which are not traded in an active market, and therefore
have little or no price transparency, and for which significant unobservable inputs must be used in estimating fair value, or (ii) loans or debt obligations which are private and untraded.
(B) These two items results from an option, not an obligation, to repurchase loans from Newcastle’s subprime mortgage loan securitizations (Note 5), are noneconomic until such option is exercised, and are
equal and offsetting.
Notes continued on next page.
95
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
(C) Represents derivative agreements as follows:
Year of Maturity
Weighted Average
Month of Maturity
Aggregate Notional
Amount
Weighted Average Fixed
Pay Rate / Cap Rate
Aggregate Fair Value
Asset / (Liability)
Interest rate cap agreements which receive 1-Month LIBOR above the cap rates:
$
$
$
$
2015
2016
2017
Sep
Jul
Jan
21,000
77,905
5,300
104,205
Interest rate swap agreements which receive 1-Month LIBOR:
2011
2014
2015
2016
2017
Dec
Nov
Apr
May
Aug
$
91,555
15,757
685,412
180,155
174,034
Interest rate swap agreements which receive 3-Month LIBOR:
2014
Jul
$
326,756
1,473,669
2.26%
2.66%
1.86%
5.00%
5.09%
5.45%
5.04%
5.24%
4.21%
737
3,472
328
4,537
$
(3,902)
(1,979)
(52,263)
(22,193)
(28,184)
$
(28,054)
(136,575)
(D) This represents two interest rate swap agreements with a notional balances of $129.2 million and $214.4 million, maturing in June 2016 and
March 2015, respectively, and three interest rate cap agreements with a total notional balance of $36.4 million, maturing in August 2017 and
January 2019. Newcastle entered into these hedge agreements to reduce its exposure to interest rate changes on the floating rate financings of its
Manufactured Housing Loan Portfolio II and on the floating rate financings of CDO X. These derivative agreements were not designated as
hedges for accounting purposes.
(F) Newcastle’s derivatives fall into two categories. As of December 31, 2010, all derivatives were held within Newcastle’s nonrecourse debt
structures (primarily CDOs). An aggregate notional balance of $1.8 billion, which were liabilities at period end, are not subject to Newcastle’s
credit risk as they are senior to all the debt obligations of the related CDO. An aggregate notional balance of $140.6 million were assets at period
end and therefore are subject to the counterparty’s credit risk. No adjustments have been made to the fair value quotations received related to
credit risk as a result of the counterparty’s “AA” credit rating. Newcastle’s significant derivative counterparties include Bank of America, Credit
Suisse, Wells Fargo and Deutsche Bank.
(G) Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the extent
Newcastle receives net cash flow distributions from such structures. Furthermore, creditors or beneficial interest holders of these structures have
no recourse to the general credit of Newcastle. Therefore, Newcastle’s exposure to the economic losses from such structures is limited to its
invested equity in them and economically their book value cannot be less than zero. As a result, the fair value of Newcastle’s net investments in
these non-recourse financing structures is equal to the present value of their expected future net cash flows.
(H) Newcastle notes that the unrealized gain on the liabilities within such structures cannot be fully realized.
Valuation Hierarchy
The methodologies used for valuing such instruments have been categorized into three broad levels as follows:
Level 1 - Quoted prices in active markets for identical instruments.
Level 2 - Valuations based principally on other observable market parameters, including
• Quoted prices in active markets for similar instruments,
• Quoted prices in less active or inactive markets for identical or similar instruments,
• Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities,
credit risks and default rates), and
• Market corroborated inputs (derived principally from or corroborated by observable market data).
Level 3 - Valuations based significantly on unobservable inputs.
• Level 3A - Valuations based on third party indications (broker quotes, counterparty quotes or pricing services)
which were, in turn, based significantly on unobservable inputs or were otherwise not supportable as Level 2
valuations.
• Level 3B - Valuations based on internal models with significant unobservable inputs.
These levels form a hierarchy. Newcastle follows this hierarchy for its financial instruments measured at fair value on a
recurring basis. The classifications are based on the lowest level of input that is significant to the fair value measurement.
96
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
The following table summarizes financial assets and liabilities measured at fair value on a recurring basis at December 31,
2010:
Principal Balance or
Notional Amount
Carrying Value
Level 2
Level 3A (1)
Level 3B (2)
Total
Fair Value
Assets:
Real estate securities, available for sale:
CMBS
REIT debt
ABS - subprime
ABS - other real estate
FNMA / FHLMC
CDO
Debt security total
Equity securities
Real estate securities total
Derivative assets:
Interest rate caps, treated as hedges
Interest rate caps, not treated as hedges
Derivative assets total
Liabilities:
Derivative Liabilities:
Interest rate swaps, treated as hedges
Interest rate swaps, not treated as hedges
Derivative liabilities total
$
$
$
$
$
$
1,971,025
317,413
353,306
65,365
3,140
123,126
2,833,375
104,205
36,428
140,633
1,300,734
328,970
178,006
45,178
3,414
-
1,856,302
4,282
1,860,584
4,537
2,530
7,067
-
$
328,970
-
-
3,414
-
332,384
-
332,384
$
4,537
2,530
7,067
$
$
$
$
$
$
$
$
1,473,669
343,570
1,817,239
$
$
136,575
40,286
176,861
$
$
136,575
40,286
176,861
1,172,131
-
83,582
36,193
-
-
1,291,906
-
1,291,906
128,603
-
94,424
8,985
-
-
232,012
4,282
236,294
1,300,734
328,970
178,006
45,178
3,414
-
1,856,302
4,282
1,860,584
-
$
-
$
-
-
$
-
$
-
-
$
-
$
-
-
$
-
$
-
$
$
4,537
2,530
7,067
$
$
136,575
40,286
176,861
$
$
$
$
(1) Third party pricing sources with significant unobservable inputs.
(2)
Internal models with significant unobservable inputs.
Newcastle’s investments in instruments measured at fair value on a recurring basis using Level 3 inputs changed as follows:
Balance at January 1, 2009
Total gains (losses) (C)
Included in net income (loss) (D)
Reclassification related to the adoption of new impairment
guidance included in other comprehensive income (loss)
Included in other comprehensive income (loss)
Amortization included in interest income
Purchases
Proceeds from sales
Proceeds from repayments
Transfers between Level 3A and Level 3B
Transfers into Level 3 (A)
Transfers out of Level 3 (A) (B)
Level 3A
1,304,776
$
Assets
Level 3B
179,763
$
Total
1,484,539
$
(128,682)
(401,563)
(530,245)
979,089
(499,307)
56,801
293,244
(93,180)
(178,046)
(156,720)
-
(510,534)
309,835
25,045
30,088
-
(30,939)
(42,113)
156,720
-
-
1,288,924
(474,262)
86,889
293,244
(124,119)
(220,159)
-
-
(510,534)
Balance at December 31, 2009
1,067,441
226,836
1,294,277
97
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Balance at January 1, 2010
Transfers (A)
Transfers from Level 3B
Transfers into Level 3B
CDO VII Deconsolidation
Total gains (losses) (C)
Included in net income (loss) (D)
Included in other comprehensive income (loss)
Amortization included in interest income
Purchases, sales and settlements
Purchases
Proceeds from sales
Proceeds from repayments
Balance at December 31, 2010
Balance at January 1, 2010
Transfers (A)
Transfers from Level 3A
Transfers into Level 3A
CDO VII Deconsolidation
Total gains (losses) (C)
Included in net income (loss) (D)
Included in other comprehensive income (loss)
Amortization included in interest income
Purchases, sales and settlements
Purchases
Proceeds from sales
Proceeds from repayments
Balance at December 31, 2010
CMBS
Level 3A Assets
ABS
Conduit
$
536,092
Other
397,407
$
Subprime
$
87,883
Other
46,059
$
Equity/Other
Securities
$
-
Total
1,067,441
$
5,528
(54,816)
(32,858)
17,645
198,146
16,663
20,511
(22,177)
(3,379)
3,508
79,436
7,131
-
(16,015)
(10,685)
59
1,455
7,515
-
-
-
(345)
7,354
179
-
-
-
-
-
-
26,039
(93,008)
(46,922)
20,867
286,391
31,488
279,095
(88,645)
(36,623)
840,227
$
34,478
(49,260)
(135,751)
331,904
$
44,894
(6,478)
(25,046)
83,582
$
-
(11,525)
(5,529)
36,193
$
-
-
-
$
-
358,467
(155,908)
(202,949)
1,291,906
$
CMBS
Level 3B Assets
ABS
Conduit
Other
Subprime
Other
Equity/Other
Securities
Total
$
95,376
$
32,744
$
85,377
$
10,719
$
2,620
$
226,836
54,816
(5,528)
(48,665)
(83,128)
107,272
17,204
22,177
(20,511)
-
26,959
55,781
1,207
16,015
-
(17,890)
(9,374)
31,469
11,843
-
-
(457)
(3,488)
4,163
483
-
-
-
(422)
1,938
-
93,008
(26,039)
(67,012)
(69,453)
200,623
30,737
-
(2,066)
(27,824)
107,457
$
14,414
(21,646)
(89,979)
21,146
$
-
(1,063)
(21,953)
94,424
$
-
-
(2,435)
8,985
$
146
-
-
4,282
$
14,560
(24,775)
(142,191)
236,294
$
(A) Transfers are assumed to occur at the beginning of the quarter.
(B) As a result of the increased liquidity and price transparency of the REIT debt securities, management transferred such securities into Level 2
under the fair value hierarchy in the fourth quarter of 2009
(C) None of the gains (losses) recorded in earnings during the periods is attributable to the change in unrealized gains (losses) relating to Level 3
assets still held at the reporting dates.
(D) These gains (losses) are recorded in the following line items in the consolidated statements of operations:
Year Ended December 31,
2010
Level 3A
Level 3B
2009
Level 3
Gain (loss) on settlement of investments, net
Other income (loss), net
OTTI
Total
Gain (loss) on sale of investments, net, from
investments transferred into Level 3 during
the period
$
$
$
23,775
-
(2,908)
20,867
26,668
-
(96,121)
(69,453)
$
$
$
6,672
(3,384)
(533,533)
(530,245)
$
-
$
-
$
-
98
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Securities Valuation
As of December 31, 2010, Newcastle’s securities valuation methodology and results are further detailed as follows:
Outstanding
Face
Amount (A)
Amortized
Cost
Basis (B)
$
$
1,971,025
317,413
353,306
65,365
3,140
123,126
2,833,375
$
1,265,359
316,085
161,464
42,475
3,358
-
1,788,741
Fair Value
Single
Quote (D)
$
323,139
84,002
40,810
-
3,414
-
451,365
Internal
Pricing
Models (E)
$
128,603
-
94,424
8,985
-
-
232,012
Multiple
Quotes (C)
$
848,992
244,968
42,772
36,193
-
-
1,172,925
Total
$
1,300,734
328,970
178,006
45,178
3,414
-
1,856,302
1,112
1,789,853
$
-
1,172,925
$
-
451,365
$
4,282
236,294
$
4,282
1,860,584
$
Asset Type
CMBS
REIT debt
ABS - subprime
ABS - other real estate
FNMA / FHLMC
CDO
Debt Security Total
Equity Securities
Total
(A) Net of incurred losses.
(B) Net of discounts (or gross premiums) and after OTTI, including impairment taken during the period ended December 31, 2010.
(C) Management generally obtained pricing service quotations or broker quotations from two sources, one of which was generally the seller (the party
that sold us the security). Management selected one of the quotes received as being most representative of fair value and did not use an average of
the quotes. Newcastle’s methodology is to not use quotes from selling brokers, unless those quotes are the only marks available, or unless the
quotes provided by other (non-selling) brokers or pricing services are, in management’s judgment, not representative of fair value. Even if
Newcastle receives two or more quotes on a particular security that come from non-selling brokers or pricing services, it does not use an average
because management believes using an actual quote more closely represents a transactable price for the security than an average level.
Furthermore, in some cases there is a wide disparity between the quotes Newcastle receives. Management believes using an average of the quotes
in these cases would generally not represent the fair value of the asset. Based on Newcastle’s own fair value analysis using internal models,
management selects one of the quotes which is believed to more accurately reflect fair value. Newcastle never adjusts quotes received.
(D) Management was unable to obtain quotations from more than one source on these securities. The one source was generally the seller (the party
that sold us the security) or a pricing service.
(E) Securities whose fair value was estimated based on internal pricing models are further detailed as follows:
Asset Type
CMBS - conduit
CMBS - Large loan
/ single borrower
ABS - subprime
ABS - other real estate
CDO
Debt security total
Equity securities
Amortized
Cost
Basis (B)
Fair
Value
Impairment
Recorded in
Current Year
Unrealized
Gains (Losses)
in Accum. OCI
Assumption Ranges
Discount
Rate
Prepayment
Speed (F)
Cumulative
Default Rate
Loss
Severity
$
86,727
$
107,457
$
73,508
$
20,730
12.0%
N/A
4% - 82% 31% - 100%
22,895
81,576
6,744
-
197,942
1,112
21,146
94,424
8,985
-
232,012
4,282
-
9,772
3,487
146
86,913
276
8% - 14%
10.0%
10.0%
N/A
(1,749)
12,848
2,241
-
34,070
3,170
N/A
0% - 100%
0% - 100%
0% - 8% 32% - 92% 60% - 100%
54% - 90%
0% - 5% 33% - 75%
100.0%
100.0%
N/A
Total
$
199,054
$
236,294
$
87,189
$
37,240
All of the assumptions listed have some degree of market observability, based on Newcastle’s knowledge of the market, relationships with market
participants, and use of common market data sources. Collateral prepayment, default and loss severity projections are in the form of “curves” or
“vectors” that vary for each monthly collateral cash flow projection. Methods used to develop these projections vary by asset class (e.g., CMBS
projections are developed differently than Home Equity ABS projections) but conform to industry conventions. Newcastle uses assumptions that
generate its best estimate of future cash flows of each respective security.
The prepayment vector specifies the percentage of the collateral balance that is expected to voluntarily pay off at each point in the future. The
prepayment vector is based on projections from the a widely published investment bank model which considers factors such as collateral FICO
score, loan-to-value ratio, debt-to-income ratio, and vintage on a loan level basis. This vector is scaled up or down to match recent collateral-
specific prepayment experience, as obtained from remittance reports and market data services.
Loss severities are based on recent collateral-specific experience with additional consideration given to collateral characteristics. Collateral age is
taken into consideration because severities tend to initially increase with collateral age before eventually stabilizing. Newcastle typically uses
projected severities that are higher than the historic experience for collateral that is relatively new to account for this effect. Collateral
characteristics such as loan size, lien position, and location (state) also effect loss severity. Newcastle considers whether a collateral pool has
experienced a significant change in its composition with respect to these factors when assigning severity projections.
99
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Default vectors are determined from the current “pipeline” of loans that are more than 90 days delinquent, in foreclosure, or are real estate owned
(REO). These significantly delinquent loans determine the first 24 months of the default vector. Beyond month 24, the default vector transitions to
a steady-state value that is generally equal to or greater than that given by the widely published investment bank model.
The discount rates Newcastle uses are derived from a range of observable pricing on securities backed by similar collateral and offered in a live
market. As the markets in which Newcastle transacts have become less liquid, Newcastle has had to rely on fewer data points in this analysis.
(F) Projected annualized average prepayment rate.
Loan Valuation
Loans which Newcastle does not have the ability to hold into the foreseeable future are classified as held-for-sale. As a
result, these held-for-sale loans are carried at the lower of amortized cost or fair value and are therefore recorded at fair
value on a non-recurring basis. During the year ended December 31, 2010, Newcastle recorded ($299.6) million and
($40.3) million of valuation allowance (reversal) on real estate related loans and residential mortgage loans (Note 5),
respectively. These loans were written down to fair value at the time of the impairment, based on broker quotations, pricing
service quotations or internal pricing models. All the loans were within Level 3 of the fair value hierarchy. For real estate
related loans, the most significant inputs used in the valuations are the amount and timing of expected future cash flows,
market yields and the estimated collateral value of such loan investments. For residential mortgage loans, significant inputs
include management’s expectations of prepayment speeds, default rates, loss severities and discount rates that market
participants would use in determining the fair values of similar pools of residential mortgage loans.
The following tables summarize the fair value information for real estate related loans and residential mortgage loans as of
December 31, 2010:
Loan Type
Mezzanine
Bank Loan
B-Note
Whole Loan
Total Real Estate Related
Loans Held for Sale, Net
Outstanding
Face
Amount
$
579,579
309,437
233,132
30,970
$
Carrying
Value
388,510
208,365
154,760
30,970
$
Fair
Value
392,256
209,054
154,760
30,994
Valuation
Allowance/
(Reversal) In
Current Year
$
(196,085)
(15,309)
(96,534)
8,308
Significant Input Ranges
Discount
Rate
5.7% - 40.4%
5.4% - 24.9%
15.0% - 18.0%
5.0% - 7.8%
Loss
Severity
0% - 100%
0.0% - 59.8 %
0% - 100%
0% - 0.0%
$
1,153,118
$
782,605
$
787,064
$
(299,620)
Outstanding
Face
Amount
Carrying
Value
Fair
Value
$
63,399
1,169
212,036
$
49,862
298
203,053
$
49,862
298
203,053
Valuation
Allowance/
(Reversal) In
Current Year
(1,710)
$
4
(39,521)
Discount
Rate
5% - 5.87%
47.46%
8.30%
Significant Input Ranges
Prepayment
Speed
0% - 6%
3.0%
6.0%
Cumulative
Default Rate
3.3% - 100%
4.0%
3.5%
Loss
Severity
0% - 40%
75.0%
75.0%
$
276,604
$
253,213
$
253,213
$
(41,227)
Loan Type
Residential Loans
Manufactured Housing Loans I
Manufactured Housing Loans II
Total Residential Mortgage
Loans Held for Sale, Net
Derivatives
Newcastle’s derivative instruments are valued using counterparty quotations. These quotations are generally based on
valuation models with model inputs that can generally be verified and which do not involve significant judgment. The
significant observable inputs used in determining the fair value of our Level 2 derivative contracts are contractual cash
flows and market based interest rate curves.
100
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Newcastle’s derivatives are recorded on its balance sheet as follows:
Fair Value
December 31, December 31,
Balance sheet location
2010
2009
Derivative Assets
Interest rate caps, designated as hedges
Interest rate caps, not designated as hedges
Derivative Assets
Derivative Assets
$
4,537
2,530
-
$
-
$
7,067
$
-
Derivative Liabilities
Interest rate swaps, designated as hedges
Interest rate swaps, not designated as hedges
Derivative Liabilities
Derivative Liabilities
$
136,575
40,286
$
178,037
29,117
$
176,861
$
207,154
The following table summarizes information related to derivatives:
December 31,
2010
2009
Cash flow hedges
Notional amount of interest rate swap agreements
Notional amount of interest rate cap agreements
Amount of (loss) recognized in OCI on effective portion
$
1,473,669
104,205
(118,608)
$
2,099,435
-
(173,683)
Deferred hedge gain (loss) related to anticipated financings,
which have subsequently occurred, 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
357
1,343
2,289
832
(8,045)
(4,234)
(63,541)
(90,666)
Non-hedge Derivatives
Notional amount of interest rate swap agreements
Notional amount of interest rate cap agreements
343,570
36,428
296,243
-
The following table summarizes gains (losses) recorded in relation to derivatives:
Income Statement
Location
Other Income (Loss)
Gain (Loss) on Sale
of Investments,
Other Income (Loss)
Year Ended December 31,
2009
2008
2010
$
580
$
(278)
$
180
(39,184)
(15,223)
(14,730)
Interest Expense
(83,869)
(100,046)
(62,013)
Interest Expense
475
101
Interest Expense
Other Income (Loss)
(5,471)
(1,240)
(9,547)
15,446
(18,451)
94
786
Cash flow hedges
Gain (loss) on the ineffective portion
Gain (loss) immediately recognized at dedesignation
Amount of gain (loss) reclassified from AOCI into income,
related to effective portion
Deferred hedge gain reclassified from AOCI into income,
related to anticipated financings
Deferred hedge gain (loss) reclassified from AOCI into
income, related to effective portion of dedesignated hedges
Non-hedge derivatives gain (loss)
101
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(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:
Debt Obligation/Collateral
Month Issued
Outstanding
Face
Amount
Carrying
Value
Unhedged
Weighted
Average
Funding Cost (A)
$
285,907
360,689
90,717
N/A
618,313
480,125
1,175,000
$
285,211
359,603
90,717
N/A
617,611
484,172
1,173,554
3,010,751
3,010,868
1.19%
1.02%
0.89%
N/A
0.89%
0.65%
0.64%
Final Stated
Maturity
Mar 2039
Sep 2039
Apr 2040
Dec 2050
Nov 2052
May 2052
Jul 2052
86,352
171,972
258,324
4,356
4,356
18,732
N/A
18,732
51,004
51,004
85,071
171,738
256,809
4,356
4,356
18,732
N/A
18,732
51,253
51,253
4.76%
LIBOR+0.88%
Jul 2035
Aug 2011
LIBOR+0.90%
Dec 2034
LIBOR+1.50%
N/A
Dec 2011
N/A
7.57% (J)
Apr 2035
Mar 2004
Sep 2004
Apr 2005
Dec 2005
Nov 2006
May 2007
Jul 2007
Apr 2010
Aug 2006
Aug 2004
Dec 2010
N/A
Mar 2006
3,343,167
3,342,018
(K)
406,217
403,793
$
3,749,384
$
3,745,811
December 31, 2010
December 31, 2009
Collateral
Weighted
Average
Funding
Cost (B)
Weighted
Average
Maturity
(Years)
Face
Amount
of Floating Rate
Debt
Outstanding
Face Amount
(C)
Amortized
Cost Basis (C)
Carrying
Value (C)
Weighted
Average
Maturity
(Years)
Floating Rate
Face Amount (C)
Aggregate
Notional
Amount of
Current Hedges
(D)
Outstanding
Face
Amount
Carrying
Value
2.99%
3.13%
5.34%
N/A
2.14%
1.55%
4.25%
3.16%
5.37%
5.44%
5.42%
1.16%
1.16%
1.76%
N/A
1.76%
7.42%
7.42%
3.39%
2.1
3.0
4.4
N/A
2.8
3.8
4.5
3.6
3.5
0.6
1.5
6.8
6.8
0.9
N/A
0.9
24.3
24.3
$
270,315
348,501
88,012
N/A
610,713
480,125
1,175,000
$
362,272
414,394
424,637
N/A
768,538
651,831
1,290,313
$
305,960
295,660
195,096
N/A
517,708
494,975
956,336
$
275,535
267,796
221,842
N/A
547,141
509,206
1,014,745
2,972,666
3,911,985
2,765,735
2,836,265
-
171,972
171,972
4,356
4,356
151,281
212,036
363,317
4,356
4,356
124,974
203,053
328,027
4,356
4,356
124,974
203,053
328,027
4,356
4,356
18,732
N/A
18,732
N/A
-
-
N/A
-
-
N/A
-
-
-
-
-
-
-
-
-
-
3.1
3.4
2.8
N/A
3.4
2.6
3.7
3.3
7.7
5.8
6.5
6.8
6.8
-
N/A
-
-
-
$
134,972
145,430
112,168
N/A
489,816
446,124
281,854
$
139,600
187,156
88,012
N/A
161,655
91,555
1,034,336
$
369,477
447,287
437,669
411,550
729,313
497,000
1,175,000
$
368,111
445,498
436,111
408,972
728,383
497,777
1,174,076
1,610,364
1,702,314
4,067,296
4,058,928
1,710
36,748
38,458
4,356
4,356
N/A
-
-
-
-
-
129,198
129,198
-
-
-
-
-
-
N/A
107,003
197,397
304,400
-
-
31,672
39,637
71,309
102,500
102,500
107,003
196,694
303,697
-
-
31,672
39,637
71,309
103,264
103,264
3.8
$
3,167,726
$
4,279,658
$
3,098,118
$
3,168,648
3.5
$
1,653,178
$
1,831,512
4,545,505
4,537,198
406,217
403,006
$
4,951,722
$
4,940,204
CDO Bonds Payable
CDO IV (E)
CDO V (E)
CDO VI (E)
CDO VII (F)
CDO VIII
CDO IX
CDO X
Other Bonds Payable
MH Loans Portfolio I (G)
MH Loans Portfolio II
Notes Payable
Residential Mortgage Loans (H)
Repurchase Agreements
Real estate securities, loans and
properties (I)
FNMA/FHLMC securities
Corporate
Junior subordinated notes payable
Subtotal debt obligations
Financing on subprime mortgage
loans subject to call option
Total debt obligations
(A) Weighted average, including floating and fixed rate classes and excluding the amortization of deferred financing costs.
(B)
(C)
(D)
Including the effect of applicable hedges.
Including restricted cash held for reinvestment in CDOs.
Including a $36.4 million notional amount of interest rate cap agreements in CDO X, an $88.0 million and a $129.2 million notional amounts of interest rate swap agreements in CDO VI and MH Loans Portfolio II, respectively,
which were economic hedges not designated as hedges for accounting purposes. Excluding a $126.4 million notional amount interest rate swap agreement which was a non-economic hedge in CDO VI.
(E) These CDOs were not in compliance with their applicable over collateralization tests as of December 31, 2010. Newcastle is not receiving cash flows from these CDOs (other than senior management fees) and expects these
CDOs to remain out of compliance for the foreseeable future.
(F) Deconsolidated on January 1, 2010.
(G) Excluding $36.9 million of debt sold to certain Newcastle CDOs, which was eliminated in consolidation. See further description below.
(H) Notes payable issued to CDO VII, which was eliminated in consolidation prior to January 1, 2010.
(I)
The counterparty of this repurchase agreement is Bank of America. It is secured by $46.3 million face amount of notes issued by Newcastle CDO VI, which is eliminated on consolidation. The maximum recourse to Newcastle is
$4.7 million.
LIBOR + 2.25% after April 2016.
Issued in April 2006 and July 2007. See Note 5 regarding the securitizations of Subprime Portfolios I and II.
(J)
(K)
102
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Certain of the debt obligations included above are obligations of consolidated subsidiaries of Newcastle which own the
related collateral. In some cases, including the CDO and Other Bonds Payable, such collateral is not available to other
creditors of Newcastle.
CDO Bonds Payable
In February 2008, Newcastle repaid in full the debt associated with its first CDO.
During 2008, Newcastle repurchased $24.9 million face amount of CDO bonds for $7.9 million and recorded a gain of
$16.8 million. During 2009, Newcastle repurchased $246.7 million of CDO bonds for $29.9 million and recorded a gain of
$215.3 million. During 2010, Newcastle repurchased $483.7 million of CDO bonds for $215.8 million and recorded a gain
of $265.7 million.
In December 2010, Newcastle, together with one or more of its wholly owned subsidiaries, completed a series of
transactions whereby it repurchased approximately $257 million current principal balance of Newcastle CDO VI Class I-
MM notes at a price of 67.5% of par. The purchased notes represent all of the outstanding Class I-MM notes of Newcastle
CDO VI (the "notes"). Newcastle purchased the notes using a combination of restricted cash, unrestricted cash and
proceeds from a new repurchase facility, entered into in connection with the purchase of a portion of the notes. The
repurchase facility has a one-year term and bears interest at a rate of LIBOR + 1.50%. As of December 31, 2010, the
repurchase agreement had an outstanding balance of $18.7 million, which was secured by $46.3 million current principal
balance of the notes. Although the repurchase facility contains mark to market provisions that require margin to be posted
in the event that the value of the notes decreases, the recourse to Newcastle is limited to twenty-five percent of the then-
outstanding balance of the repurchase facility, which was approximately $4.7 million as of December 31, 2010. In
accordance with GAAP, Newcastle recorded an $82 million gain on the extinguishment of debt and $24.0 million of mark-
to-market loss on the related interest rate swap agreement.
In late 2009, CDO VII failed additional over collateralization tests. The consequences of failing these tests are that an
event of default has occurred and Newcastle may be removed as the collateral manager under the documentation governing
CDO VII. So long as the event of default continues, Newcastle will not be permitted to purchase or sell any collateral in
CDO VII. If Newcastle is removed as the collateral manager of CDO VII, it would no longer receive the senior
management fees from such CDO. As of February 17, 2011, Newcastle has not been removed as collateral
manager. Newcastle does not expect the failure of these additional tests to have a material negative impact on its cash
flows, business, results of operations or financial condition. As a result of this failure and new accounting guidance, CDO
VII was deconsolidated effective January 1, 2010.
As of February 17, 2011, CDOs IV, V and VI were not in compliance with their applicable over collateralization tests and,
consequently, Newcastle was not receiving cash flows from these CDOs currently (other than senior management fees and
interest distributions from senior classes of bonds Newcastle owns). Based upon Newcastle’s current calculations,
Newcastle expects these four portfolios to remain out of compliance for the foreseeable future. Moreover, given current
market conditions, it is possible that all of Newcastle’s CDOs could be out of compliance with their over collateralization
tests as of one or more measurement dates within the next twelve months.
Other Bonds Payable
On April 15, 2010, Newcastle completed a securitization transaction to refinance its Manufactured Housing Loans Portfolio
I (the “Portfolio”). Newcastle sold approximately $164.1 million outstanding principal balance of manufactured housing
loans to Newcastle MH I LLC (the “Issuer”). The Issuer issued approximately $134.5 million aggregate principal amount
of asset-backed notes (the “Notes”), of which $97.6 million was sold to third parties and $36.9 million was sold to certain
CDOs managed and consolidated by Newcastle. At the closing of the securitization transaction, Newcastle used the gross
proceeds received from the issuance of the Notes to repay the previously existing financing on this portfolio in full,
terminate the related interest rate swap contracts, pay the related transaction costs and increase its unrestricted cash by
approximately $14 million. Under the applicable accounting guidance, the securitization transaction is accounted for as a
secured borrowing. As a result, no gain or loss is recorded for the transaction. Newcastle continues to recognize the
portfolio of manufactured housing loans as pledged assets, which have been classified as loans held for investment at
securitization, and records the notes issued to third parties as a secured borrowing. The associated assets, liabilities,
revenues and expenses are presented in the non-recourse financing structure sections of the consolidated financial
statements.
103
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
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 owned 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
represented all of the Preferred Trust’s assets. The terms of the junior subordinated notes were substantially the same as the
terms of the trust preferred securities.
On April 30, 2009, Newcastle entered into an exchange agreement with several collateralized debt obligations managed by
a third party pursuant to which Newcastle agreed to exchange newly issued junior subordinated notes due in 2035 with an
initial aggregate principal amount of $101.7 million (the "Notes") for $100 million in aggregate liquidation amount of trust
preferred securities that were previously issued by a subsidiary of Newcastle (the “TRUPs”) and were owned by the third
party. The Notes accrue interest at a rate of 1.0% per year for a maximum of six quarters, beginning on February 1, 2009
and the aggregate principal amount of the Notes will increase to $104.9 million by July 30, 2010. Subsequent to that period,
the rate reverts to that which Newcastle was required to pay on the TRUPs (7.574% through April 2016 and at a floating
rate of 3-month LIBOR plus 2.25% thereafter). In conjunction with the exchange, the TRUPs were cancelled. Under the
provisions of ASC 470-60, “Troubled Debt Restructurings by Debtors”, this exchange was considered a troubled debt
restructuring which required Newcastle to account for the effect of the interest modification prospectively and to record the
expenses related to the modification immediately through earnings.
On January 29, 2010, Newcastle entered into an Exchange Agreement (the “Exchange Agreement”) with Taberna Capital
Management, LLC and certain of its affiliates (collectively, “Taberna”), pursuant to which Newcastle and Taberna agreed
to exchange (the “Exchange”) approximately $52.1 million aggregate principal amount of junior subordinated notes due
2035 for approximately $37.6 million face amount of previously issued CDO securities and approximately $9.7 million of
cash held by Newcastle. In other words, $52.1 million face amount of Newcastle’s debt, in the form of junior subordinated
notes payable, was repurchased and extinguished for GAAP purposes in exchange for (i) the payment of $9.7 million of
cash and (ii) the reissuance of $37.6 million face amount of CDO bonds payable (which had previously been repurchased
by Newcastle). In connection with the Exchange, Newcastle paid or reimbursed $0.6 million of expenses incurred by
Taberna, various indenture trustees and their respective advisors in accordance with the terms of the Exchange Agreement.
Newcastle accounted for this exchange as a troubled debt restructuring involving the partial repayment of debt. As a result,
Newcastle recorded no gain or loss. The following table presents certain information regarding the exchange, as of the date
of the exchange:
Outstanding face amount
Weighted average coupon
Maturity
Repurchased junior
subordinated notes
$
52,094
7.574% (A)
April 2035
Cash
$
9,715
N/A
Collateral
General credit of Newcastle
(A) LIBOR + 2.25% after April 2016
(B) Weighted average effective interest rate of approximately LIBOR+0.35% after the Exchange.
Consideration
Reissued CDO
bonds
$
37,625
Total
$
47,340
LIBOR + 0.66% (B)
June 2052
Assets within the
respective CDOs
The fair value of the consideration paid approximated the fair value of the repurchased junior subordinated notes of $16.7
million.
104
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
Maturity Table
Newcastle’s debt obligations (gross of $3.6 million of discounts at December 31, 2010) have contractual maturities as
follows:
2011
2012
2013
2014
2015
Thereafter
Total
Debt Covenants
Nonrecourse
186,021
$
-
-
-
-
3,507,676
3,693,697
$
Recourse
$
4,683
-
-
-
-
51,004
55,687
$
Total
190,704
-
-
-
-
3,558,680
3,749,384
$
$
Newcastle’s non-CDO financings contain various customary loan covenants. Newcastle was in compliance with all of the
covenants in its non-CDO financings as of February 17, 2011.
9. EQUITY AND EARNINGS PER SHARE
Earnings per Share
Newcastle is required to present both basic and diluted earnings per share (“EPS”). Basic EPS is calculated by dividing net
income (loss) applicable to 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 2010, 2009 and 2008, Newcastle
had no dilutive common stock equivalents (common stock equivalents are not dilutive in periods of net loss or when all of
the exercise prices exceed the current market price). Net income (loss) applicable to common stockholders is equal to net
income (loss) less preferred dividends, plus the excess of the carrying amount of exchanged preferred stock over the fair
value of consideration paid (see “Preferred Stock” below).
Option Plan
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, 2010, 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). These 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 Fortress 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.
105
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
As of December 31, 2010, Newcastle’s outstanding options were summarized as follows:
Held by our Manager
Issued to our manager and subsequently assigned
to certain of Fortress's employees
Held by directors and former directors
Total
1,686,447
798,162
14,000
2,498,609
The following table summarizes Newcastle’s outstanding options at December 31, 2010. Note that the last sales price on
the New York Stock Exchange for Newcastle’s common stock in the year ended December 31, 2010 was $6.70 per share.
Recipient
Directors
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Exercised (C)
Outstanding
Date of
Grant/Exercise
Various
2002
2003
2004
2005
2006
2007
Prior to 2008
Number of Options
18,000
700,000
788,227
837,500
330,000
170,000
698,000
(1,043,118)
2,498,609
Weighted Average
Exercise Price (A)
$16.98
$12.60
$20.99
$26.66
$29.20
$29.02
$28.58
$15.70
$26.64
Fair Value At Grant
Date (Millions) (B)
Not Material
$0.4
$1.2
$1.6
$1.1
$0.5
$2.0
(A) The strike prices are subject to adjustment in connection with return of capital dividends. A portion of Newcastle’s 2008 dividends was deemed
return of capital dividends. The effect on the strike prices was not significant.
(B) 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 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 these options was estimated based on the simplified term
method. This simplified method was used because Newcastle did not have sufficient historical data to conclude on the appropriate expected life of
its options and because historical data to date was consistent with the simplified term method.
(C) The Manager assigned certain of its options to Fortress’s 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
Total Unexercised
Inception to Date
17,500
164,197
226,125
90,750
65,025
234,565
798,162
670,620 of the total options exercised were by the Manager. 368,498 of the total options exercised were by employees of
Fortress subsequent to their assignment. 4,000 of the total options exercised were by directors.
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 and the Series C Preferred, and, beginning in March 2012, Newcastle will have the
option to redeem the Series D Preferred, at their liquidation preference. 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
106
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
requirements of the Exchange Act, Newcastle has the option to redeem the Series C Preferred or Series D Preferred, as
applicable, at their liquidation preference 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.
In March 2010, Newcastle settled its offer to exchange (the “Exchange Offer”) shares of its common stock and cash for
shares of its preferred stock. In the aggregate, Newcastle issued 9,091,668 shares of its common stock (approximately
17.2% of Newcastle’s outstanding shares of common stock prior to the issuance of shares in the Exchange Offer). A total of
2,881,694 shares of common stock were issued in exchange for 1,152,679 shares of Series B Preferred Stock, a total of
2,759,989 shares of common stock were issued in exchange for 1,104,000 shares of Series C Preferred Stock, and a total of
3,449,985 shares of common stock were issued in exchange for 1,380,000 shares of Series D Preferred Stock. The shares of
Preferred Stock acquired by Newcastle in the Exchange Offer were retired upon receipt. After settlement of the Exchange
Offer, 1,347,321 shares of Series B Preferred Stock, 496,000 shares of Series C Preferred Stock and 620,000 shares of
Series D Preferred Stock remain outstanding for trading on the New York Stock Exchange.
The $43.0 million excess of the $87.5 million carrying value of the exchanged preferred stock over the $44.5 million fair
value of consideration paid (which included $28.5 million of common stock and $16.0 million of cash) was recorded as an
increase to Net Income (Loss) Applicable to Common Stockholders.
As of December 31, 2010, $3.7 million of preferred dividends were in arrears. These dividends in arrears are included as
part of preferred dividends on the consolidated statements of operations, since they represent a claim on earnings superior
to common stockholders, but have not been accrued as Dividends Payable, since they have not been declared. On January
31, 2011, Newcastle paid all current and accrued dividends on its preferred stock.
10. MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS
Manager
Newcastle is party to a Management Agreement with its Manager which provides for automatically renewing one-year
terms subject to certain termination rights. 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, including adjustments for return of
capital dividends.
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 (defined as the net income available
for common stockholders before Incentive Compensation, excluding extraordinary items, plus depreciation of operating
real estate and after adjustments for unconsolidated subsidiaries, if any) 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 return of 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
107
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
number of shares of common stock outstanding. As a result of the effect of recording other-than-temporary impairment,
Newcastle expects that there will be no Incentive Compensation payable to the Manager for an indeterminate period of
time.
Management Fee………………………
Expense Reimbursement…………….
Incentive Compensation………………
Amounts Incurred (in millions)
2009
$17.5
0.5
-
2008
$17.9
0.5
-
2010
$16.8
0.5
-
At December 31, 2010, Fortress, through its affiliates, and principals of Fortress, owned 3.8 million shares of Newcastle’s
common stock and Fortress, through its affiliates, had options to purchase an additional 1.7 million shares of Newcastle’s
common stock (Note 9).
In 2009, principals of Fortress sold an aggregate of 1.1 million common shares of Newcastle to third parties at market
prices.
At December 31, 2010 and 2009, Due To Affiliates is comprised of $1.4 million and $1.5 million, respectively, of
management fees and expense reimbursements payable to the Manager.
Other Affiliates
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
$526.3 million and $693.6 million at December 31, 2010, respectively.
In April 2010, Newcastle, through two of its CDOs, made a cash investment of $75.0 million in a new real estate related
loan to a portfolio company of a private equity fund managed by an affiliate of Newcastle’s manager. Newcastle’s
chairman is an officer of the borrower. This investment improves the applicable CDOs’ results under some of their
respective tests, and is expected to yield approximately 22%. The loan will initially mature in April 2013, with two one-
year extensions, and is secured by subordinated interests in the properties of the borrower. Interest on the loan will be
accrued and deferred until maturity.
In January 2011, Newcastle, through two of its CDOs, made a cash investment of approximately $47 million in a portion of
a new secured loan to a portfolio company of a private equity fund managed by Newcastle’s manager. Newcastle’s
chairman and secretary are officers or directors of the borrower. The terms of the loan were negotiated by a third party
bank who acted as agent for the creditors on the loan. At closing, Newcastle received an origination fee on the loan equal
to 2% of the amount of cash it loaned to the portfolio company, which was the same fee received by other creditors on the
loan. In February 2011, the portfolio company repaid the loan in full.
As of December 31, 2010, Newcastle held on its balance sheet total investments of $267.3 million face amount of real
estate securities and related loans issued by affiliates of the Manager. Newcastle earned approximately $22.2 million, $15.1
million and $20.4 million of interest on investments issued by affiliates of the Manager for the years ended December 31,
2010, 2009 and 2008, 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.
11. COMMITMENTS AND CONTINGENCIES
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
108
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
$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, 2010, if any, will not materially affect Newcastle’s consolidated results of
operations or financial position.
Environmental Costs ⎯ As a commercial real estate owner, Newcastle is subject to potential environmental costs. At
December 31, 2010, 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. See Note 8.
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.
Preferred Dividends in Arrears ⎯ As of December 31, 2010 and December 31, 2009, $3.7 million and $15.8 million,
respectively, of dividends on Newcastle’s cumulative preferred stock were unpaid and in arrears. All current and accrued
dividends on Newcastle’s cumulative preferred stock were paid in full on January 31, 2011.
Contingent Gain in CDOs ⎯ Newcastle cannot economically lose more than its investment amount in any given non-
recourse financing structure. Therefore, impairment recorded in excess of such investment, which results in negative GAAP
book value for a given non-recourse financing structure, cannot economically be incurred. For non-recourse financing
structures with negative GAAP book value, the aggregate negative GAAP book value will eventually be recorded as an
increase to GAAP book value. As of December 31, 2010, Newcastle has recorded $356.8 million of losses in its CDOs in
excess of its economic exposure which must eventually be reversed through amortization, sales at gains, or as reductions to
accumulated deficit at the deconsolidation or termination of the CDOs.
12. INCOME TAXES
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. Up to 90% of this distribution requirement may be met through stock dividends rather than
cash, subject to limitations based on the value of Newcastle’s stock.
Since Newcastle distributed 100% of its 2010, 2009 and 2008 REIT taxable income (if any), no provision has been made
for U.S. federal corporate income taxes in the accompanying consolidated financial statements.
Common stock distributions relating to 2010, 2009, and 2008 were taxable as follows:
Dividends Per Share
Book Basis
$0.000
$0.000
$0.750
Tax Basis
$0.000
$0.000
$0.750
Ordinary/
Qualified Income
0.00%
0.00%
46.31%
Capital
Gains
None
None
None
Return of Capital
0.00%
0.00%
53.69%
2010
2009
2008
During 2010 and 2009, Newcastle repurchased an aggregate of $730.4 million face amount of its outstanding CDO debt at
a discount and recorded $480.9 million of aggregate gain. The gain recorded upon such cancellation of indebtedness is
characterized as ordinary income for tax purposes. In compliance with current tax laws, Newcastle has the ability to defer
such ordinary income to future years and has deferred or intends to defer all or a portion of such gain for 2010 and 2009.
However, cancellation of indebtedness income recognized on or after January 1, 2011 cannot be deferred and must
109
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
generally be recognized as ordinary income in the year of such cancellation. In addition, Newcastle may recognize material
ordinary income from the cancellation of debt within its non-recourse financing structures, including its subprime
securitizations, while losses on the related collateral may be recognized as capital losses. Through December 31, 2010, $3.4
million of debt in Newcastle’s subprime securitizations has been cancelled as a result of losses incurred on the underlying
assets in the securitization trusts.
As of December 31, 2009, Newcastle had a loss carryforward, inclusive of net operating loss and capital loss, of $908
million. The net operating loss carryforward and capital loss carryforward can generally be used to offset future ordinary
taxable income and taxable capital gains, for up to 20 years and 5 years, respectively. The amounts of net operating loss
carryforward and net long-term capital loss carryforward as of December 31, 2010 are subject to the finalization of the
2010 tax returns.
13. SUBSEQUENT EVENTS
These financial statements include a discussion of material events which have occurred subsequent to December 31, 2010
(referred to as “subsequent events”) through the issuance of these consolidated financial statements. Events subsequent to
that date have not been considered in these financial statements.
In January 2011, Newcastle, through two of its CDOs, made a cash investment of approximately $47 million in a portion of
a new secured loan to a portfolio company of a private equity fund managed by Newcastle’s manager. Newcastle’s
chairman and secretary are officers or directors of the borrower. The terms of the loan were negotiated by a third party
bank who acted as agent for the creditors on the loan. At closing, Newcastle received an origination fee on the loan equal
to 2% of the amount of cash it loaned to the portfolio company, which was the same fee received by other creditors on the
loan. In February 2011, the portfolio company repaid the loan in full.
In February 2011, Newcastle, through one of its subsidiaries, purchased the management rights with respect to certain C-
BASS Investment Management LLC (“C-BASS”) CDOs pursuant to a bankruptcy proceeding for $2.2 million. As a result,
Newcastle became the collateral manager of certain CDOs previously managed by C-BASS and will earn, on average, a 20
basis point annual senior management fee on a portion of the total collateral, which is currently $1.3 billion. Newcastle is
currently evaluating the potential accounting impact of this transaction. If any of the CDO entities are required to be
consolidated, the effects of such consolidation on Newcastle’s assets and liabilities could be material.
In February 2011, two mezzanine loan investments with a total outstanding principal balance of $88.8 million were paid off
in full. The payoff increased Newcastle’s restricted cash available for reinvestment in two CDOs by $60.8 million and its
unrestricted cash by $28.0 million.
In February 2011, Newcastle purchased $63.4 million current principal balance of FNMA/FHLMC one-year ARM
securities for approximately $66.3 million, using $3.3 million of unrestricted cash and financed with a $63.0 million new
repurchase facility. The repurchase facility bears interest at 0.29%, matures in May 2011 and is subject to customary
margin call provisions.
110
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(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.
2010
Interest income
Interest expense
Net interest income (expense)
Impairment, net of the reversal of prior valuation allowances on loans
Other income (loss) (B)
Expenses
Income (loss) from continuing operations
Income (loss) from discontinued operations
Preferred dividends
Excess of carrying amount of exchanged preferred stock over fair value
of consideration paid
Income (loss) applicable to common stockholders
Net income (loss) per share of common stock
Quarter Ended
March 31 (A)
June 30 (A)
$
70,092
45,589
24,503
(68,032)
56,543
8,613
140,465
(40)
(3,268)
$
74,183
43,141
31,042
(42,495)
53,384
7,580
119,341
13
(1,395)
$
September 30 (A)
81,040
42,547
38,493
(95,319)
36,662
7,185
163,289
213
(1,395)
December 31
Year Ended
December 31
$
74,957
40,942
34,015
(35,012)
135,698
6,150
198,575
(194)
(1,395)
$
300,272
172,219
128,053
(240,858)
282,287
29,528
621,670
(8)
(7,453)
$
43,043
180,200
$
-
117,959
$
-
162,107
$
-
196,986
43,043
657,252
$
Basic
Diluted
$
$
3.36
3.36
$
$
1.90
1.90
$
$
2.61
2.61
$
$
3.18
3.18
$
$
10.96
10.96
Income (loss) 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
$
$
3.36
3.36
$
$
1.90
1.90
$
$
2.61
2.61
$
$
3.18
3.18
$
$
10.96
10.96
Basic
Diluted
$
-
$
-
$
-
$
-
$
-
$
-
$
$
(0.01)
(0.01)
$
-
$
-
Weighted average number of shares of common stock outstanding
Basic
Diluted
2009
Interest income
Interest expense
Net interest income (expense)
Impairment, net of the reversal of prior valuation allowances on loans
Other income (loss) (B)
Expenses
Income (loss) from continuing operations
Income (loss) from discontinued operations
Preferred dividends
Income (loss) applicable to common stockholders
Net income (loss) per share of common stock
Basic
Diluted
Income (loss) 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
53,620
53,620
62,011
62,011
62,025
62,025
62,025
62,025
59,949
59,949
March 31 (A)
June 30 (A)
$
$
124,473
60,544
63,929
307,470
12,317
7,591
(238,815)
(33)
(3,375)
(242,223)
Quarter Ended
87,338
54,172
33,166
123,407
55,285
8,900
(43,856)
(142)
(3,376)
(47,374)
$
September 30 (A)
75,222
52,438
22,784
90,802
128,869
7,892
52,959
79
(3,375)
49,663
$
December 31
Year Ended
December 31
$
$
74,833
51,256
23,577
26,861
30,928
7,518
20,126
(222)
(3,375)
16,529
361,866
218,410
143,456
548,540
227,399
31,901
(209,586)
(318)
(13,501)
(223,405)
$
$
$
$
$
$
(4.59)
(4.59)
$
$
(0.90)
(0.90)
$
$
0.94
0.94
$
$
0.31
0.31
$
$
(4.23)
(4.23)
$
$
(4.59)
(4.59)
$
$
(0.90)
(0.90)
$
$
0.94
0.94
$
$
0.32
0.32
$
$
(4.22)
(4.22)
Basic
Diluted
$
-
$
-
$
-
$
-
$
-
$
-
$
$
(0.01)
(0.01)
$
$
(0.01)
(0.01)
Weighted average number of shares of common stock outstanding
Basic
Diluted
52,807
52,807
52,836
52,836
52,905
52,905
52,905
52,905
52,864
52,864
(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).
Including equity in earnings of unconsolidated subsidiaries.
(B)
111
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010, 2009 AND 2008
(dollars in tables in thousands, except per share data)
The following table summarizes the unaudited quarterly financial information on Newcastle’s statement of cash flows, in
conjunction with the revised presentation discussed in Note 2. Future interim filings will present the statement of cash
flows consistent with this presentation.
2010
Quarter Ended
March 31
June 30
September 30
December 31
Year Ended
December 31
Net cash provided by operating activities
$
9,210
$
12,260
$
16,106
$
11,270
$
48,846
Net cash provided by investing activities
Net cash provided by (used in) financing activities
Net Increase (Decrease) in Cash and Cash Equivalents
Cash and Cash Equivalents, Beginning of Period
43,346
(109,018)
(56,462)
68,300
19,306
(5,720)
25,846
11,838
5,018
(472)
20,652
37,684
7,562
(43,644)
(24,812)
58,336
75,232
(158,854)
(34,776)
68,300
Cash and Cash Equivalents, End of Period
$
11,838
$
37,684
$
58,336
$
33,524
$
33,524
2009
Quarter Ended
March 31
June 30
September 30
December 31
Year Ended
December 31
Net cash provided by operating activities
$
23,549
$
22,241
$
18,757
$
9,622
$
74,169
Net cash provided by investing activities
Net cash provided by (used in) financing activities
Net Increase (Decrease) in Cash and Cash Equivalents
Cash and Cash Equivalents, Beginning of Period
128,224
(144,789)
6,984
49,746
14,731
(27,074)
9,898
56,730
16,855
(28,991)
6,621
66,628
12,274
(26,845)
(4,949)
73,249
172,084
(227,699)
18,554
49,746
Cash and Cash Equivalents, End of Period
$
56,730
$
66,628
$
73,249
$
68,300
$
68,300
112
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,
2010. 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, 2010, 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.”
113
Item 9B. Other Information.
None.
Item 10. Directors, Executive Officers and Corporate Governance.
Directors
PART III
Set forth below is certain biographical information for our directors, as well as the month and year each director was first
elected.
Wesley R. Edens
Chairman of the board of directors since inception
Age: 49
Mr. Edens has been Chairman of our board of directors since inception.
Mr. Edens also served as our Chief Executive Officer from our
inception until February 2007. Mr. Edens is a principal and a Co-
Chairman of the board of directors of Fortress Investment Group LLC,
an affiliate of our manager. Mr. Edens has been a principal and a
member of the Management Committee of Fortress since co-founding
Fortress in May 1998. Mr. Edens is responsible for the private equity
and publicly traded alternative investment businesses of Fortress
Investment Group LLC. He is also Chairman of the board of directors of
each of Aircastle Limited, Brookdale Senior Living Inc., Eurocastle
Investment Limited, GateHouse Media, Inc., RailAmerica Inc.,
Seacastle Inc. and Mapeley Limited, Chairman and Chief Executive
Officer of Newcastle Investment Holdings LLC (the predecessor of
Newcastle) and a director of GAGFAH S.A. and Penn National Gaming
Inc. Mr. Edens was the Chief Executive Officer of Global Signal Inc.
from February 2004 to April 2006 and Chairman of the board of
directors from October 2002 to January 2007. Mr. Edens serves or has
served in various capacities in the following five current or former
registered investment companies: Chairman, Chief Executive Officer
and Trustee of Fortress Registered Investment Trust and Fortress
Investment Trust II; Chairman and Chief Executive Officer of Fortress
Brookdale Investment Fund LLC and Fortress Pinnacle Investment
Fund LLC and Chief Executive Officer of RIC Coinvestment Fund GP
LLC. Prior to forming Fortress Investment Group LLC, Mr. Edens was
a partner and a managing director of BlackRock Financial Management
Inc., where he headed BlackRock Asset Investors, a private equity fund.
In addition, Mr. Edens was formerly a partner and a managing director
of Lehman Brothers. As a result of his past experiences, Mr. Edens has
private equity finance and management expertise and a deep familiarity
with our Company. These factors and his other qualifications and skills,
led our board of directors to conclude that Mr. Edens should be elected
to serve as a director.
114
Kevin J. Finnerty
Director since August 2005
Age: 56
Stuart A. McFarland
Director since October 2002
Age: 64
Mr. Finnerty has been a member of our board of directors and a member
of the Audit Committee, Nominating and Corporate Governance
Committee and Compensation Committee of our board of directors
since August 2005. Mr. Finnerty has been a director of Newcastle
Investment Holdings LLC (the predecessor of Newcastle) since its
inception in 1998. Mr. Finnerty is the Founding Partner of Galton
Capital Group, a residential mortgage credit fund manager. Mr.
Finnerty is a former founder and the Managing Partner of F.I. Capital
Management, an investment company focused on agency-mortgage
related strategies. Previously, Mr. Finnerty was a Managing Director at
J.P. Morgan Securities Inc., where he headed the Residential Mortgage
Securities Department. Mr. Finnerty joined Chase Securities Inc. in
December of 1999. Prior to joining Chase Securities Inc., Mr. Finnerty
worked at Union Bank of Switzerland from November 1996 until
February 1998, where he headed the Mortgage Backed Securities
Department, and at Freddie Mac from January 1999 until June 1999,
where he was a Senior Vice President. Between 1986 and 1996, Mr.
Finnerty was with Bear Stearns & Co. Inc., where he was a Senior
Managing Director and ultimately headed the MBS Department and
served as a member of the board of directors from 1993 until 1996. Mr.
Finnerty was Co-Chair of the North American People Committee at
JPMorganChase and Chairman of the Mortgage and Asset-Backed
Division of the Bond Market Association for the year 2003. Mr.
Finnerty’s knowledge, skill, expertise and experience as described
above, as well as his deep familiarity with our Company, led the board
of directors to conclude that Mr. Finnerty should be elected to serve as a
director.
Mr. McFarland has been a member of our board of directors since
October 2002 and a member of the Audit Committee, Nominating and
Corporate Governance Committee and Compensation Committee of our
board of directors since November 2002. Mr. McFarland was a director
of Newcastle Investment Holdings LLC (the predecessor of Newcastle)
from May 1998 until October 2002. Mr. McFarland was Chairman of
Federal City Bancorp, Inc., a Managing Partner of Federal City Capital
Advisors, LLC and President and Chief Executive Officer of Pedestal
Inc., an internet secondary mortgage market trading exchange. Mr.
McFarland was Executive Vice President and General Manager of GE
Capital Mortgage Services and President and CEO of GE Capital Asset
Management Corporation from 1990 to 1995. Prior to GE Capital, Mr.
McFarland was President and CEO of Skyline Financial Services Corp.
Before joining Skyline, Mr. McFarland was President and CEO of
National Permanent Federal Savings Bank in Washington, D.C. Prior to
that, Mr. McFarland was Executive Vice President - Operations and
Chief Financial Officer with Fannie Mae (Federal National Mortgage
Association). From 1972 to 1981, he was President and Director of
Ticor Mortgage Insurance Company in Los Angeles, California. Mr.
McFarland presently serves as a Director of the Brandywine Funds, the
HELIOS Brookfield Funds and
the RMK/HELIOS Funds. Mr.
McFarland also serves as a Director and Member of the Executive
Committee of the Center for Housing Policy and is a member of the
Trustees Council of the National Building. Mr. McFarland’s knowledge,
skill, expertise and experience as described above, as well as his deep
familiarity with our Company, led the board of directors to conclude
that Mr. McFarland should be elected to serve as a director.
115
David K. McKown
Director since November 2002
Age: 73
Peter M. Miller
Director since February 2003
Age: 55
Kenneth M. Riis
Director since February 2007
Age: 51
Mr. McKown has been a member of our board of directors and a
member of
the Audit Committee, Nominating and Corporate
Governance Committee and Compensation Committee of our board of
directors since November 2002. Mr. McKown is a member of the board
of directors for Global Partners LP, where he serves on the Conflicts
Committee, the Compensation Committee and the Audit Committee and
is a member of Safety Insurance Group’s board of directors where he
serves on the Nominating and Corporate Governance Committee, the
Compensation Committee and the Audit Committee. Mr. McKown also
serves as a director of Friends of Post Office Square, POWDR Corp.,
Local TV LLC and Foxco TV LLC. Mr. McKown has been a senior
advisor to Eaton Vance Management, an investment fund manager
located in Boston, Massachusetts, since May 2000. Mr. McKown retired
from the BankBoston, N.A. in 2000 as a Group Executive. Mr.
McKown was a trustee of Equity Office Properties Trust from July 1997
to May 2006 where he served on the Executive, Compensation and
Option and Conflicts Committees. Mr. McKown was also a director at
American Investment Bank. Mr. McKown holds advisory directorships
with Eiger Fund and Alliance Energy, Inc. Mr. McKown’s knowledge,
skill, expertise and experience as described above, as well as his deep
familiarity with our Company, led the board of directors to conclude
that Mr. McKown should be elected to serve as a director.
Mr. Miller has been a member of our board of directors and a member
of the Audit Committee, Nominating and Corporate Governance
Committee, and Compensation Committee of our board of directors
since February 2003. Mr. Miller is CEO of Whitehead Miller Advisors,
Inc., a financial advisory firm focusing on financial and business
restructuring and capital raising assignments for middle market public
and private companies in the U.S. and Latin America. From 2008
through 2009, Mr. Miller was a Principal of MatlinPatterson Global
Advisors LLC. From 2004 through 2008, Mr. Miller was a Managing
Director at Dresdner Kleinwort Securities LLC and the Head of Latin
American Credit Asset Management in New York. Previously, he was at
ING Financial Markets LLC for 15 years, where, most recently, he was
a Managing Director and Head of their Latin Debt Advisory Group. Mr.
Miller joined ING after seven years at Bankers Trust where he held
various positions in the Latin American Merchant Banking Group. Mr.
Miller’s knowledge, skill, expertise and experience as described above,
as well as his deep familiarity with our Company, led the board of
directors to conclude that Mr. Miller should be elected to serve as a
director.
Mr. Riis was appointed Chief Executive Officer by our board of
directors on February 21, 2007. On that date, Mr. Riis was also
unanimously elected as one of our directors. Mr. Riis has been our
President since our inception and a Managing Director of our manager,
an affiliate of Fortress Investment Group LLC, since December 2001.
Mr. Riis is also the President of Newcastle Investment Holdings LLC
(the predecessor of Newcastle). From November 1996 to December
2001, Mr. Riis was an independent consultant for our manager as well
as other financial companies. From 1989 to 1996, Mr. Riis was a
Principal and Managing Director of the real estate finance group at
Donaldson, Lufkin & Jenrette. Mr. Riis’s knowledge, skill, expertise
and experience as described above, as well as his deep familiarity with
our Company, led the board of directors to conclude that Mr. Riis
should be elected to serve as a director.
116
Executive Officers
The following table shows the names and ages of our present executive officers and certain other corporate officers and the
positions held by each individual. A description of the business experience of each for at least the past five years follows
the table.
Name
Wesley R. Edens ...................................
Kenneth M. Riis ....................................
Brian C. Sigman....................................
Phillip J. Evanski ..................................
Jonathan Ashley ....................................
Randal A. Nardone................................
Age
Position
Chairman of the board of directors
Chief Executive Officer and President
Chief Financial Officer and Treasurer
Chief Investment Officer
Chief Operating Officer
Secretary
49
51
33
42
45
55
Wesley R. Edens For information regarding Mr. Edens, see above.
Kenneth M. Riis For information regarding Mr. Riis, see above.
Brian C. Sigman has been our Chief Financial Officer since August 2008. Mr. Sigman is a Managing Director of our
manager, an affiliate of Fortress Investment Group LLC. Mr. Sigman served as our Vice President of Finance from 2006 to
2008. Prior to that time, Mr. Sigman served as our Assistant Controller from 2003 through 2006. From 1999 to 2003, Mr.
Sigman was a Senior Auditor at Ernst & Young LLP.
Phillip J. Evanski has been our Chief Investment Officer since June 2006. Mr. Evanski is a Managing Director of our
manager, an affiliate of Fortress Investment Group LLC. Mr. Evanski was previously with Nomura Securities since 2004
where he was a Managing Director and Head of CMBS Trading and Syndicate. Prior to that, Mr. Evanski was a Senior
Vice President and Principal for Realm Business Solutions, Inc. From 1999 to 2000, he was a Vice President at JP Morgan
in London with responsibility for Structured Product Syndicate and Trading. Prior to that, Mr. Evanski was a Senior Vice
President and Head of the Asset Securitization Group for Donaldson, Lufkin & Jenrette between 1998 and 1999 in London.
From 1992 to 1998 Mr. Evanski was a Senior Vice President and Head of CMBS Trading and Syndicate for Donaldson,
Lufkin & Jenrette in New York.
Jonathan Ashley has been our Chief Operating Officer since our inception. Mr. Ashley is a Managing Director of our
manager, an affiliate of Fortress Investment Group LLC, since its formation in May 1998. Mr. Ashley is also a Vice
President and the Chief Operating Officer of Newcastle Investment Holdings LLC (the predecessor of Newcastle). Mr.
Ashley previously worked for Union Bank of Switzerland from May 1997 to May 1998. Prior to joining Union Bank of
Switzerland, Mr. Ashley worked for an affiliate of BlackRock Financial Management, Inc. from April 1996 to May 1997.
Prior to joining BlackRock, Mr. Ashley worked at Morgan Stanley, Inc. in its Real Estate Investment Banking Group. Prior
to joining Morgan Stanley, Mr. Ashley was in the Structured Finance Group at the law firm of Skadden, Arps, Slate,
Meagher & Flom LLP.
Randal A. Nardone has been our Secretary since our inception. Mr. Nardone is a principal and a member of the board of
directors of Fortress Investment Group LLC. Mr. Nardone has been a principal and a member of the Management
Committee of Fortress since co-founding Fortress in 1998. Mr. Nardone is a director of Brookdale Senior Living, Inc., Alea
Group Holding (Bermuda) Ltd., GAGFAH S.A. and Eurocastle Investment Limited. Mr. Nardone is also a Vice President
and the Secretary of Newcastle Investment Holdings LLC (the predecessor of Newcastle). Mr. Nardone was previously a
managing director of UBS from May 1997 to May 1998. Prior to joining UBS in 1997, Mr. Nardone was a principal of
BlackRock Financial Management, Inc. Prior to joining BlackRock, Mr. Nardone was a partner and a member of the
executive committee at the law firm of Thacher Proffitt & Wood.
Involvement in Certain Legal Proceedings
There are no legal proceedings ongoing as to which any director, officer or affiliate of the Company, or, to the knowledge
of the Company, any owner of record or beneficially of more than five percent of any class of voting securities of the
Company, or any associate of any such director, officer, affiliate of the Company, or security holder is a party adverse to us
or any of our subsidiaries or has a material interest adverse to us or any of our subsidiaries.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Exchange Act requires directors, executive officers and persons beneficially owning more than ten
percent of a registered class of a company’s equity securities to file reports of ownership and changes in ownership on
Forms 3, 4, and 5 with the SEC and the NYSE.
117
To our knowledge, based solely on review of the copies of such reports furnished to us during the year ended December 31,
2010, all reports required to be filed by our directors, executive officers and greater-than-ten-percent owners were in
compliance with the Section 16(a) filing requirements.
Code of Ethics
We have adopted Corporate Governance Guidelines and a Code of Business Conduct and Ethics, which delineate our
standards for our officers and directors, and employee of our manager, and affiliate of Fortress Investment Group LLC. We
have also adopted a Code of Ethics for Principal Executive Officers and Senior Financial Officers, which sets forth specific
policies to guide the Company’s senior officers in the performance of their duties. This code supplements the Code of
Business Conduct and Ethics described above. These policies are available free of charge on our website,
www.newcastleinv.com.
Nominating and Corporate Governance Committee
Our board of directors has a standing Nominating and Corporate Governance Committee composed exclusively of
independent directors. The current members of the Nominating and Corporate Governance Committee are Messrs.
Finnerty, McFarland, McKown and Miller (Chairman), each of whom has been determined by our board of directors to be
an independent director in accordance with the rules of the New York Stock Exchange. The functions of the Nominating
and Corporate Governance Committee include, without limitation, the following: (a) recommending to the board
individuals qualified to serve as directors of the Company and on committees of the board; (b) advising the board with
respect to board composition, procedures and committees; (c) advising the board with respect to the corporate governance
principles applicable to the Company; and (d) overseeing the evaluation of the board. The charter of the Nominating and
Corporate Governance Committee is available on our website, at www.newcastleinv.com. You may also obtain the charter
by writing the Company at 1345 Avenue of the Americas, 46th Floor, New York, New York 10105, Attention: Investor
Relations.
The Nominating and Corporate Governance Committee, as required by the Company’s Bylaws, will consider director
candidates recommended by stockholders. In considering candidates submitted by stockholders, the Nominating and
Corporate Governance Committee will take into consideration the needs of the board of directors and the qualifications of
the candidate and may take into consideration the number of shares held by the recommending stockholder and the length
of time that such shares have been held.
The Company’s Bylaws provide certain procedures that a stockholder must follow to nominate persons for election to the
board of directors. Nominations for director at an annual stockholder meeting must be submitted in writing to the
Company’s Secretary at Newcastle Investment Corp., 1345 Avenue of the Americas, 46th Floor, New York, New York
10105. The Secretary must receive the notice of a stockholder’s intention to introduce a nomination at an annual
stockholders meeting (together with certain required information set forth in the Company’s Bylaws) not later than the
close of business on the 90th day nor earlier than the close of business on the 120th day prior to the first anniversary of the
preceding year’s annual meeting; or in the event that the date of the annual meeting is advanced or delayed by more than 30
days from such anniversary date, not earlier than the close of business on the 120th day prior to the date of mailing of the
notice for such annual meeting and not later than the close of business on the later of the 90th day prior to the date of
mailing of the notice for such annual meeting or the 10th day following the day on which public announcement of the date
of such meeting is first made by the Company.
The Nominating and Corporate Governance Committee believes that the qualifications for serving as a director of the
Company are possession, taking into account such person’s familiarity with the Company, of such knowledge, experience,
skills, expertise, integrity and diversity as would enhance the board’s ability to manage and direct the affairs and business
of the Company, including, when applicable, the ability of committees of the board to fulfill their duties and/or to satisfy
any independence requirements imposed by law, regulation or NYSE listing requirement.
In addition to considering a director-candidate’s background and accomplishments, the process for identifying and
evaluating all nominees includes a review of the current composition of the board of directors and the evolving needs of our
business. The Nominating and Corporate Governance Committee will identify potential nominees by asking current
directors and executive officers to notify the Committee if they become aware of suitable candidates. The Nominating and
Corporate Governance Committee also may, from time to time, engage firms that specialize in identifying director
candidates. As described above, the Committee will also consider candidates recommended by stockholders. Our
evaluation of nominees does not necessarily vary depending on whether or not the nominee was nominated by a
stockholder. In considering candidates submitted by stockholders, the Nominating and Corporate Governance Committee
may take into consideration the number of shares held by the recommending stockholder and the length of time that such
shares have been held. We do not have a formal policy with regard to the consideration of diversity in identifying director-
118
nominees, but the Nominating and Corporate Governance Committee strives to nominate individuals with a variety of
complementary skills.
Audit Committee
Our board of directors has a standing Audit Committee composed exclusively of independent directors. The current
members of the Audit Committee are Messrs. Finnerty, McFarland (Chairman), McKown and Miller, each of whom has
been determined by our board of directors to be independent in accordance with the rules of the New York Stock Exchange
and the SEC’s audit committee independence standards. The purpose of the Audit Committee is to provide assistance to
the board in fulfilling its legal and fiduciary obligations with respect to matters involving the accounting, auditing, financial
reporting, internal control and legal compliance functions of the Company and its subsidiaries, including, without
limitation, assisting the board’s oversight of (a) the integrity of the Company’s financial statements; (b) the Company’s
compliance with legal and regulatory requirements; (c) the Company’s independent registered public accounting firm’s
qualifications and independence; and (d) the performance of the Company’s independent registered public accounting firm
and the Company’s internal audit function. The Audit Committee is also responsible for appointing the Company’s
independent registered public accounting firm and approving the terms of the registered public accounting firm’s services.
The Audit Committee operates pursuant to a charter, which is available on our website, www.newcastleinv.com. You may
also obtain the charter by writing the Company at 1345 Avenue of the Americas, 46th Floor, New York, New York 10105,
Attention: Investor Relations.
The board has determined that Mr. McFarland qualifies as an ‘‘Audit Committee Financial Expert’’ as defined by the rules
of the SEC. As noted above, our board of directors has determined that Mr. McFarland is independent under NYSE and
SEC standards.
Item 11. Executive Compensation.
We are party to a management agreement with an affiliate of Fortress Investment Group LLC, pursuant to which our
manager provides for the day-to-day management of our operations.
The management agreement requires our manager to manage our business affairs under the direction of our board of
directors and in conformity with the policies and the investment guidelines that are approved and monitored by our board of
directors. Our manager is responsible for, among other things, (i) the purchase and sale of real estate securities, real estate
related loans and other real estate related assets, (ii) the financing of such investments, (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 also responsible for our day-to-day operations and performs
(or causes to be performed) such other services and activities relating to our assets and operations as may be appropriate.
We pay our manager an annual management fee equal to 1.5% of our gross equity. Gross equity, as defined in the
management agreement, is generally equal to the aggregate of the net proceeds from all equity offerings made by the
Company, reduced for any return of capital distributions made by the Company, and adjusted for any stock splits, stock
dividends or similar transactions. In computing the management fee for a particular period, the weighted average gross
equity of the Company for that period is used, weighted based upon the number of days a particular transaction impacted
gross equity during the period and upon the size of such transaction(s). The management fee for 2010 was computed as the
weighted average gross equity for 2010 multiplied by 1.5%.
To provide an incentive for our manager to enhance the value of our Common Stock, our manager is entitled to receive an
annual 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 (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 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 book value per share of Common Stock of the net assets transferred to us on or prior to July 12,
2002, by Newcastle Investment Holdings Corp., and the price per share of Common Stock 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 multiplied by (B) the weighted average number of shares of our Common Stock outstanding during such period.
Our manager earned no incentive compensation during 2010 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
termination by accepting a mutually acceptable reduction of fees. Our manager would be provided with 60 days’ prior
119
notice of any such termination and 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 have the option to purchase our
manager’s right to receive the Incentive Compensation at a cash price equal to the amount of the Incentive Compensation
that would be paid to the manager 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, were we to 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.
Because our management agreement provides that our manager will assume principal responsibility for managing our
affairs, our officers, in their capacities as such, do not receive any cash compensation directly from us. However, in their
capacities as officers or employees of our manager, or its affiliates, they devote such portion of their time to our affairs as is
required for the performance of the duties of our manager under the management agreement. Our manager has informed us
that, because the services performed by its officers or employees in their capacities as such are not performed exclusively
for us, it cannot segregate and identify that portion of the compensation awarded to, earned by or paid to our named
executive officers by the manager that relates solely to their services to us. We may, from time to time, at the discretion of
the Compensation Committee of the board of directors, grant options to purchase shares of our Common Stock or other
equity interests in us to our officers.
Below is a summary of the fees and other amounts earned by our manager in connection with services performed for us
during fiscal year 2010.
Management Fee (1) ..................................................................................................................................................... $ 16.8 million
0.5 million
Expense Reimbursements(2) ........................................................................................................................................ $
None
Incentive Compensation(3) ..........................................................................................................................................
None
Stock Options..............................................................................................................................................................
2010
(1) We pay our manager an annual management fee equal to 1.5% of our gross equity, as defined in our management agreement. Our manager uses the
proceeds from its management fee in part to pay compensation to its officers and employees who, notwithstanding that certain of them also are our
officers, receive no cash compensation directly from us.
(2)
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; certain of such
services are provided by our manager. The management agreement provides that such costs shall not be reimbursed in excess of $500,000 per
annum. We also pay all of our operating expenses, except those specifically required to be borne by our manager under the management
agreement. Our manager is responsible for all costs incident to the performance of its duties under the management agreement, including
compensation of our manager’s employees, rent for facilities and other “overhead” expenses. The expenses required to be paid by us include, but
are not limited to, issuance and transaction costs incident to the acquisition, disposition and financing of our investments, legal and auditing fees
and expenses, the compensation and expenses of our independent directors, the costs associated with the establishment and maintenance of any
credit facilities and other indebtedness of ours (including commitment fees, legal fees, closing costs, etc.), expenses associated with other securities
offerings of ours, the costs of printing and mailing proxies and reports to our stockholders, costs incurred by employees of our manager for travel
on our behalf, costs associated with any computer software or hardware that is used solely for us, costs to obtain liability insurance to indemnify
our directors and officers, the compensation and expenses of our transfer agent and fees payable to the NYSE.
(3)
Our manager is entitled to receive the Incentive Compensation pursuant to the terms of the management agreement with us. The purpose of the
Incentive Compensation is to provide an additional incentive for our manager to achieve targeted levels of funds from operations (including gains
and losses) and to increase our stockholder value. Our board of directors may request that our manager accept all or a portion of its Incentive
Compensation in shares of our Common Stock, and our manager may elect, in its discretion, to accept such payment in the form of shares, subject
to limitations that may be imposed by the rules of the NYSE or otherwise.
As of February 22, 2011, Fortress through its affiliates, and principals of Fortress, owned 3,838,359 shares of our Common
Stock and Fortress, through its affiliates owned options to purchase an additional 1,686,447 shares of our Common Stock,
which were issued in connection with our equity offerings, representing approximately 8.6% of our Common Stock on a
fully diluted basis.
120
Grants of Plan-Based Awards in 2010
No options or other plan-based awards were granted to an affiliate of our manager during 2010.
Outstanding Option Awards As of December 31, 2010
Name
Wesley R. Edens (1) ...............................................
Randal A. Nardone(1) ............................................
Kenneth M. Riis....................................................
Brian C. Sigman....................................................
Phillip Evanski......................................................
Jonathan Ashley....................................................
Number of
Securities
Underlying
Unexercised Options
Exercisable
14,000
35,880
220,907
239,250
250,125
118,625
239,250
104,975
148,225
315,210
14,000
35,880
220,907
239,250
250,125
118,625
239,250
104,975
148,225
315,210
17,500
80,500
57,438
57,750
60,375
28,437
57,750
29,750
42,350
58,140
425
605
1,140
13,600
19,360
31,920
19,694
19,800
20,700
9,750
19,800
10,200
14,520
13,680
Number of
Securities
Underlying
Unexercised Options
Unexercisable
Option
Exercise Price
12.60
19.95
22.45
25.90
25.35
31.00
29.20
29.02
30.90
27.35
12.60
19.95
22.45
25.90
25.35
31.00
29.20
29.02
30.90
27.35
12.60
19.95
22.45
25.90
25.35
31.00
29.20
29.02
30.90
27.35
29.02
30.90
27.35
29.02
30.90
27.35
22.45
25.90
25.35
31.00
29.20
29.02
30.90
27.35
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
Option
Expiration
Date
10/10/2012
07/16/2013
12/01/2013
01/09/2014
05/25/2014
11/22/2014
01/12/2015
11/01/2016
01/23/2017
04/11/2017
10/10/2012
07/16/2013
12/01/2013
01/09/2014
05/25/2014
11/22/2014
01/12/2015
11/01/2016
01/23/2017
04/11/2017
10/10/2012
07/16/2013
12/01/2013
01/09/2014
05/25/2014
11/22/2014
01/12/2015
11/01/2016
01/23/2017
04/11/2017
11/01/2016
1/23/2017
4/11/2017
11/01/2016
01/23/2017
04/11/2017
12/01/2013
01/09/2014
05/25/2014
11/22/2014
01/12/2015
11/01/2016
01/23/2017
04/11/2017
(1)
Represents options held as of December 31, 2010, by FOE I. Mr. Edens and Mr. Nardone, as beneficial owners of FOE I, may be considered to
have, together with the other beneficial owners of FOE I, shared voting and investment power with respect to the shares issuable upon the exercise
of options held by FOE I. Each of Mr. Edens and Mr. Nardone disclaims beneficial ownership of the options held by and of the shares received
upon the exercise of options held by FOE I except, in each case, to the extent of his pecuniary interest therein.
121
Director Compensation Table
Stock
Name
Awards(1)
0
Wesley R. Edens ........................................................................................................... $
Kenneth M. Riis............................................................................................................ $
0
Kevin J. Finnerty(2) ....................................................................................................... $ 15,000 $ 30,000
Stuart A. McFarland...................................................................................................... $ 30,000 $ 15,000
David K. McKown........................................................................................................ $ 30,000 $ 15,000
Peter M. Miller.............................................................................................................. $ 30,000 $ 15,000
0 $
0 $
Fees Earned
or Paid
in Cash
Option
Awards
Total
0
— $
— $
0
— $ 45,000
— $ 45,000
— $ 45,000
— $ 45,000
(1)
(2)
Pursuant to our Stock Incentive Plan, each non-employee director received an automatic annual award of our Common Stock effective on the first
business day after our annual meeting of stockholders valued at $15,000 based on the per share closing price of our Common Stock on the New
York Stock Exchange on the date of such grant. In 2010, such directors accordingly received 5,191 shares of Common Stock.
In 2010, Mr. Finnerty elected to receive $15,000 of compensation for his services as a director in the form of Common Stock in lieu of cash.
Potential Payments Upon Termination or Change-in-Control
According to the terms of our Stock Incentive Plan and related award agreements, options and tandem awards granted
pursuant to the plan shall become immediately and fully vested and exercisable upon a change in control. However, no
optionholder will be entitled to receive any payment or other items of value upon a change in control.
Newcastle Investment Corp. Nonqualified Stock Option and Incentive Award Plan
We have adopted the Newcastle Investment Corp. Nonqualified Stock Option and Incentive Award Plan, referred to herein
as the Stock Incentive Plan, to provide incentives to attract and retain the highest qualified directors, officers, employees,
advisors, consultants and other personnel. The Stock Incentive Plan is administered by our Compensation Committee. The
maximum number of shares of our Common Stock reserved and available for issuance for our first fiscal year was
5,000,000 shares. For each year thereafter, the maximum number of shares available for issuance under the Stock Incentive
Plan is that number of shares equal to 15% of the number of our outstanding equity interests, but in no event more than
10,000,000 shares in the aggregate over the term of the plan. No stock option may be granted to our manager (or its
designee) in connection with any issuance by us of equity securities in excess of ten percent (10%) of the number of equity
securities then being issued. The Stock Incentive Plan permits the granting of options to purchase Common Stock that do
not qualify as incentive stock options under section 422 of the Internal Revenue Code.
As the administrator of the Stock Incentive Plan, the Compensation Committee has the authority to establish terms and
procedures related to all option grants made under the plan. For example, the exercise price of each option is determined in
accordance with procedures approved by the Compensation Committee and may be less than 100% of the fair market value
of our Common Stock subject to such option on the date of grant. Under the current policy approved by the Compensation
Committee, we grant our manager, through affiliates, options only in connection with our equity offerings. In the event that
we offer common stock to the public, we simultaneously grant to our manager or an affiliate of our manager a number of
options equal to 10% of the aggregate number of shares being offering in such offering at an exercise price per share equal
to the public offering price per share; provided that if there is no fixed public offering price, we will grant such options at
an exercise price per share equal to the price per share that we sold the Common Stock to the underwriters in such offering.
In each case, the options are exercisable as to 1/30 of the shares subject to the option on the first day of each of the 30
calendar months following the first month after the date of the grant.
As a general matter, the Stock Incentive Plan provides that the Compensation Committee has the power to determine at
what time or times each option may be exercised and, subject to the provisions of the Stock Incentive Plan, the period of
time, if any, after retirement, death, disability or termination of employment during which options may be exercised.
Options may become vested and exercisable in installments, and the exercisability of options may be accelerated by the
Compensation Committee. Upon exercise of options, the option exercise price must be paid in full either in cash or by
certified or bank check or other instrument acceptable to the Compensation Committee or, if the Compensation Committee
so permits, by delivery of shares of Common Stock already owned by the optionee or, to the extent permitted by applicable
law, by delivery of a promissory note. The exercise price may also be delivered to us by a broker pursuant to irrevocable
instructions to the broker from the optionee.
At the discretion of the Compensation Committee, options granted under the Stock Incentive Plan may include a “re-load”
feature pursuant to which an optionee exercising an option by the delivery of shares of Common Stock would automatically
be granted an additional stock option (with an exercise price equal to the fair market value of the Common Stock on the
date the additional stock option is granted) to purchase that number of shares of Common Stock equal to the number
delivered to exercise the original stock option. The purpose of this feature is to enable participants to exercise options using
previously owned shares of Common Stock while continuing to maintain their previous level of equity ownership in us.
122
The Compensation Committee may also grant stock appreciation rights, restricted stock, performance awards, tandem
awards and other stock and non-stock-based awards under the Stock Incentive Plan. These awards will be subject to such
conditions and restrictions as the Compensation Committee may determine, which may include the achievement of certain
performance goals or continued employment with us through a specific period.
As of February 22, 2011, our manager, through an affiliate, had been granted options to purchase 3,523,727 shares, which
were issued in connection with our equity offerings from 2002 through February 22, 2011. Portions of these options have
been and may be assigned from time to time to employees of our manager or its affiliates. In addition, we may grant tandem
options to our employees that correspond on a one-to-one basis with the options granted to our manager, such that exercise
by an employee of the option would result in the corresponding option held by our manager being cancelled.
These manager options, which were granted to an affiliate of our manager in connection with the manager’s efforts related
to our offerings, provide a means of performance-based compensation in order to provide an additional incentive for our
manager to enhance the value of our Common Stock. We have no ownership interest in our manager. FOE I is the sole
member of our manager. The beneficial owners of FOE I include Messrs. Wesley R. Edens, Peter L. Briger, Jr., Robert I.
Kauffman, Randal A. Nardone and Michael E. Novogratz. As of February 22, 2011, Mr. Nardone was an executive officer
of the Company.
The Stock Incentive Plan provides for automatic annual awards of shares of our Common Stock valued at $15,000, based
on the closing price of our shares on the NYSE on the date of grant, to our non-officer or non-employee directors. In
addition, each new independent member of our board of directors is granted an initial one-time grant of an option for 2,000
shares with an exercise price equal to fair market value on the date of grant.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
For purposes of this filing, a “beneficial owner” means any person who, directly or indirectly, through any contract,
arrangement, understanding, relationship or otherwise has or shares:
(i)
(ii)
voting power, which includes the power to vote, or to direct the voting of, shares of our Common Stock; and/or
investment power, which includes the power to dispose, or to direct the disposition of, shares of our Common
Stock.
A person is also deemed to be the beneficial owner of a security if that person has the right to acquire beneficial ownership
of such security at any time within 60 days.
Listed in the following table and the notes thereto is certain information with respect to the beneficial ownership of shares
of our Common Stock as of February 22, 2011, by each person known by us to be the beneficial owner of more than five
percent of our Common Stock, and by each of our directors, director nominees and executive officers, both individually and
as a group.
Name and Address of Beneficial Owner(1)
Wesley R. Edens ( 3 )( 6 ) ........................................................................................................................
Kevin J. Finnerty( 4 ) ............................................................................................................................
Stuart A. McFarland( 4 ) .......................................................................................................................
David K. McKown( 4 ) .........................................................................................................................
Peter M. Miller( 4 ) ...............................................................................................................................
Kenneth M. Riis( 4 ) .............................................................................................................................
Brian C. Sigman( 4 ) .............................................................................................................................
Phillip J. Evanski( 4 ) ............................................................................................................................
Jonathan Ashley( 4 ) .............................................................................................................................
Randal A. Nardone( 5 )( 6 ) ......................................................................................................................
All directors, nominees and executive officers as a group..................................................................
Amount and Nature
of Beneficial
Ownership
Percent of
Class(2)
3,502,941
283,841
31,780
31,780
46,040
614,990
2,170
71,380
156,855
3,133,756
5,163,357
5.5%
*%
*%
*%
*%
1.0%
*%
*%
*%
4.9%
8.0%
*
(1)
(2)
(3)
Denotes less than 1%.
The address of FOE I and all officers and directors listed above are in the care of Fortress Investment Group LLC, 1345 Avenue of the Americas,
46th Floor, New York, New York 10105.
Percentage amount assumes the exercise by such persons of all options to acquire shares of our Common Stock that are exercisable within 60 days
of February 22, 2011, and no exercise by any other person.
Includes 790,765 shares held by Mr. Edens, 1,025,729 shares and 1,686,447 shares issuable upon the exercise of options held by FOE I. Mr. Edens
disclaims beneficial ownership of the shares held by FOE I and of the shares issuable upon the exercise of options held by FOE I except, in each
case, to the extent of his pecuniary interest therein. Does not include 100,000 shares held by a charitable trust of which Mr. Edens’s spouse is sole
123
(4)
(5)
trustee and Mr. Edens disclaims beneficial ownership of the shares held by this charitable trust; does not include 100,000 shares held by a
charitable trust of which Mr. Edens is a trustee in respect of which, however, Mr. Edens disclaims beneficial ownership.
Includes with respect to each of these individuals the following number of shares issuable upon the exercise of options that are currently
exercisable or exercisable within 60 days of February 22, 2011: Riis – 489,990; Sigman – 2,170; Evanski – 64,880; Ashley – 128,144; Finnerty –
2,000; McFarland – 4,000; McKown – 4,000; and Miller – 4,000.
Includes 421,580 shares held by Mr. Nardone, 1,025,729 shares held by FOE II and 1,686,447 shares issuable upon the exercise of options held by
FOE I. Mr. Nardone disclaims beneficial ownership of the shares held by FOE I and of the shares issuable upon the exercise of options held by
FOE I except, in each case, to the extent of his pecuniary interest therein.
(6) Mr. Edens and Mr. Nardone, as beneficial owners of FOE I, may be considered to have, together with the other beneficial owners of FOE I, shared
voting and investment power with respect to the shares held by FOE I and the shares issuable upon the exercise of options held by FOE I.
Item 13. Certain Relationships and Related Transactions, Director Independence.
In April 2006, we securitized a portfolio of subprime residential mortgage loans, which we refer to as “Subprime Portfolio
I” and, through the related securitization trust (“Securitization Trust 2006”), entered into a servicing agreement with Centex
Home Equity Company, LLC, 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 entered into a
servicing agreement with the Subprime Servicer to service a second portfolio subprime residential mortgage loans
(“Subprime Portfolio II”) under substantially the same terms through another securitization trust (“Securitization Trust
2007”). The outstanding unpaid principal balances of Subprime Portfolios I and II were approximately $526.3 million and
$693.6 million at December 31, 2010, respectively.
In April 2010, we made a cash investment of $75.0 million through two of our CDOs in a new real estate related loan to a
portfolio company of a private equity fund managed by an affiliate of our manager. Our chairman is an officer of the
borrower. This investment improves the applicable CDOs’ results under some of their respective tests, and is expected to
yield approximately 22%. The loan will initially mature in April 2013, with two one-year extensions, and is secured by
subordinated interests in the properties of the borrower. Interest on the loan will be accrued and deferred until maturity.
In January 2011, we made a cash investment of approximately $47 million through two of our CDOs in a portion of a new
secured loan to a portfolio company of a private equity fund managed by our manager. Our chairman and secretary are
officers or directors of the borrower. The terms of the loan were negotiated by a third party bank who acted as agent for the
creditors on the loan. At closing, we received an origination fee on the loan equal to 2% of the amount of cash it loaned to
the portfolio company, which was the same fee received by other creditors on the loan. In February 2011, the portfolio
company repaid the loan in full.
As of December 31, 2010, we held on our balance sheet total face amount investments of $267.3 million in real estate
securities and related loans issued by affiliates of our manager. We earned approximately $22.2 million, $15.1 million and
$20.4 million of interest on such investments for the years ended December 31, 2010, 2009 and 2008, 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.
We are party to a management agreement with an affiliate of Fortress Investment Group LLC, pursuant to which 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 Chairman also serves as an officer of our manager.
The officers and directors of the Company review, approve and ratify transactions with related parties pursuant to the
procedures outlined in the Company’s policy on related party transactions, which was formally adopted in February 2011.
When considering potential transactions involving a related party that may require board approval, our officers notify our
board of directors in writing of the proposed transaction, provide a brief background of the transaction and schedule a
meeting with the full board of directors to review the matter. At such meetings, our President, Chief Financial Officer and
other members of management, as appropriate, provide information to the board of directors regarding the proposed
transaction, after which the board of directors and management discuss the transaction and the implications of engaging a
related party as opposed to an unrelated third party. If the board of directors (or specified directors as required by applicable
legal requirements) determines that the transaction is in the best interests of the Company, it will vote to approve the
Company’s entering into the transaction with the applicable related party, which vote is evidenced by a written resolution of
the board of directors.
FOE I is the sole member of FIG LLC, our manager. The beneficial owners of FOE I include Messrs. Wesley R. Edens,
Peter L. Briger, Jr., Robert I. Kauffman, Randal A. Nardone and Michael E. Novogratz.
124
Determination of Director Independence
At least a majority of the directors serving on the board of directors must be independent. For a director to be considered
independent, our board of directors must determine that the director does not have any direct or indirect material
relationship with the Company. The board of directors has established categorical standards to assist it in determining
director independence, which conform to the independence requirements under the NYSE listing rules. Under the
categorical standards, a director will be independent unless:
(a) within the preceding three years: (i) the director was employed by the Company or its manager; (ii) an
immediate family member of the director was employed by the Company or its manager as an executive
officer; (iii) the director or an immediate family member of the director received more than $120,000 per year
in direct compensation from the Company, its manager or any controlled affiliate of its manager (other than
director or committee fees and pension or other forms of deferred compensation for prior service (provided
such compensation is not contingent on continued service)); (iv) the director was employed by or affiliated with
the independent registered public accounting firm of the Company or its manager; (v) an immediate family
member of the director was employed by the independent registered public accounting firm of the Company or
its manager as a partner, principal or manager; or (vi) an executive officer of the Company or its manager was
on the compensation committee of a company which employed the director, or which employed an immediate
family member of the director as an executive officer; or
he or she is an executive officer of another company that does business with the Company and the annual sales
to, or purchases from, the Company is the greater of $1 million, or two percent of such other company’s
consolidated gross annual revenues.
(b)
Whether directors meet these categorical independence tests will be reviewed and will be made public annually prior to our
annual meeting of stockholders. The board of directors may determine, in its discretion, that a director is not independent
notwithstanding qualification under the categorical standards. The board of directors has determined that each of Messrs.
Finnerty, McFarland, McKown and Miller are independent for purposes of NYSE Rule 303A and each such director has no
material relationship with the Company. In making such determination, the board of directors took into consideration, (i) in
the case of Mr. Finnerty, that Mr. Finnerty is an independent director and stockholder of Newcastle Investment Holdings
LLC (the predecessor of Newcastle), an entity managed by the Company’s manager, and Mr. Finnerty received a loan in
the amount of $500,000 from each of Messrs. Edens and Nardone in 2009 and (ii) that certain directors have invested in the
securities of private investment funds or companies managed by the Company’s manager.
Item 14. Principal Accounting Fees and Services.
During the years ended 2010 and 2009, we engaged Ernst & Young LLP to provide us with audit and tax services. Services
provided included the examination of annual financial statements, limited review of unaudited quarterly financial
information, review and consultation regarding filings with the Securities and Exchange Commission and the Internal
Revenue Service, assistance with management’s evaluation of internal accounting controls, consultation on financial and
tax accounting and reporting matters, and verification procedures as required by collateralized bond obligations. Fees for
2010 and 2009 were as follows:
Year
2010..................................................................................... $ 1,526,000
2009..................................................................................... $ 1,529,300
130,482
66,000
Audit-Related Fees
— $
— $
Tax-Related Fees
Audit Fees
All Other Fees
—
—
Audit Fees. Audit fees are fees billed for the consolidated financial statements, including the audit of internal control over
financial reporting and the review of the Company’s quarterly reports form 10-Q, as well as required audits of certain
subsidiaries, consultation on audit related matters and required review of SEC filings.
Audit-Related Fees. Audit-related fees principally included attest services not required by statute or regulation.
Tax Fees. Tax fees for the years ended December 31, 2010 and 2009 related to tax planning and compliance and return
preparation.
All Other Fees. None.
The Audit Committee has considered all services provided by the independent registered public accounting firm to us and
concluded this involvement is compatible with maintaining the auditors’ independence.
The Audit Committee is responsible for appointing the Company’s independent registered public accounting firm and
approving the terms of the independent registered public accounting firm’s services. All engagements for services in 2010
were pre-approved by the Audit Committee. The Audit Committee has a policy requiring the pre-approval of all audit and
permissible non-audit services to be provided by the independent registered public accounting firm.
125
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 8, 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).
4.2
4.3
4.4
Junior Subordinated Indenture between Newcastle Investment Corp. and The Bank of New York Mellon Trust
Company, National Association, dated April 30, 2009 (incorporated by reference to the Registrant’s Report
on Form 8-K, Exhibit 4.1, filed on May 4, 2009).
Pledge and Security Agreement between Newcastle Investment Corp. and The Bank of New York Mellon
Trust Company, National Association, as trustee, dated April 30, 2009 (incorporated by reference to the
Registrant’s Report on Form 8-K, Exhibit 4.2, filed on May 4, 2009).
Pledge, Security Agreement and Account Control Agreement among Newcastle Investment Corp., NIC TP
LLC, as pledgor, and The Bank of New York Mellon Trust Company, National Association, as bank and
trustee, dated April 30, 2009 (incorporated by reference to the Registrant’s Report on Form 8-K, Exhibit 4.3,
filed on May 4, 2009).
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).
10.3 Exchange Agreement between Newcastle Investment Corp. and Taberna Preferred Funding IV, Ltd., Taberna
Preferred Funding V, Ltd., Taberna Preferred Funding VI, Ltd. and Taberna Preferred Funding VII, Ltd.,
dated April 30, 2009 (incorporated by reference to the Registrant’s Report on Form 8-K, Exhibit 10.1, filed on
May 4, 2009).
10.4 Exchange Agreement, dated as of January 29, 2010, by and among Newcastle Investment Corp., Taberna
Capital Management, LLC, Taberna Preferred Funding IV, Ltd., Taberna Preferred Funding V, Ltd., Taberna
Preferred Funding VI, Ltd. and Taberna Preferred Funding VII, Ltd. (incorporated by reference to the
Registrant’s Report on Form 8-K, Exhibit 10.1, filed on February 2, 2010).
12.1 Statements re: Computation of Ratios.
21.1 Subsidiaries of the Registrant.
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.
126
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:
SIGNATURES
NEWCASTLE INVESTMENT CORP.
By: /s/ Wesley R. Edens
Wesley R. Edens
Chairman of the Board
March 3, 2011
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.
By: /s/ Kenneth M. Riis
Kenneth M. Riis
Director and Chief Executive Officer
March 3, 2011
By: /s/ Brian C. Sigman
Brian C. Sigman
Chief Financial Officer and Principal Accounting Officer
March 3, 2011
By: /s/ Kevin J. Finnerty
Kevin J. Finnerty
Director
March 3, 2011
By: /s/ Stuart A. McFarland
Stuart A. McFarland
Director
March 3, 2011
By: /s/ David K. McKown
David K. McKown
Director
March 3, 2011
By: /s/ Peter M. Miller
Peter M. Miller
Director
March 3, 2011
127
SPECIAL NOTE REGARDING EXHIBITS
In reviewing the agreements included as exhibits to this Annual Report on Form 10-K, please remember they are included
to provide you with information regarding their terms and are not intended to provide any other factual or disclosure
information about the Company or the other parties to the agreements. The agreements contain representations and
warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely
for the benefit of the other parties to the applicable agreement and:
•
•
should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk
tone of the parties if those statements provide to be inaccurate;
have been qualified by disclosures that were made to the other party in connection wit the negotiation of the
applicable agreement, which disclosures are not necessarily reflected in the agreement;
• may apply standards of materiality in a way that is different from what may be viewed as material to you or other
investors; and
• were made only as of the date of the applicable agreement or such other date or dates as may be specified in the
agreement and are subject to more recent developments.
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made
or at any other time. Additional information about the Company may be found elsewhere in this Annual Report on
Form 10-K and the Company’s other public filings, which are available without charge through the SEC’s website at
http://www.sec.gov. See “Where You Can Find More Information.”
The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for
considering whether additional specific disclosures of material information regarding material contractual provisions are
required to make the statements in this report not misleading.
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.
March 3, 2011
(Date)
/s/ Kenneth M. Riis
Kenneth M. Riis
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Brian C. Sigman, 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.
March 3, 2011
(Date)
/s/ Brian C. Sigman
Brian C. Sigman
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, 2010 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
March 3, 2011
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, 2010 as filed with the Securities and Exchange Commission on the date
hereof (the "Report"), Brian C. Sigman, 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 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/ Brian C. Sigman
Brian C. Sigman
Chief Financial Officer
March 3, 2011
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
The following graph compares the cumulative total return for our common stock (stock price change plus rein-
vested dividends) with the comparable return of four indices: NAREIT All REIT, NAREIT Mortgage REIT,
Russell 2000, and S&P 500. The graph assumes an investment of $100 in the Company’s common stock and in
each of the indices on December 31, 2005 and that all dividends were reinvested. The past performance of our
common stock is not an indication of future performance.
Newcastle Investment Corp.
Stock Performance Chart
$150
$125
$100
$75
$50
$25
$0
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
12/31/10
Newcastle Investment Corp.
Russell 2000
S&P 500
NAREIT All REIT
NAREIT Mortgage REIT
Corporate Information
Board of Directors
Corporate Officers
Corporate Headquarters
Kenneth M. Riis
Chief Executive Officer and President
Jonathan Ashley
Chief Operating Officer
Brian C. Sigman
Chief Financial Officer
Phillip J. Evanski
Chief Investment Officer
Randal A. Nardone
Secretary
Wesley R. Edens
Chairman of the Board
Principal and Co-Chairman
Fortress Investment Group LLC
Kevin J. Finnerty(1)
Founding Partner
Galton Capital Group
Stuart A. McFarland(1)
Managing Partner
Federal City Capital Advisors, LLC
David K. McKown(1)
Senior Advisor
Eaton Vance Management
Peter M. Miller(1)
Chief Executive Officer
Whitehead Miller Advisors, Inc.
Kenneth M. Riis
Managing Director
FIG LLC
(1) Member of Audit Committee, Nominating
and Corporate Governance Committee
and Compensation Committee
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
Independent Registered Public
Accounting Firm
Ernst & Young LLP
Five Times Square
New York, NY 10036-6530
Shareholder Services, Transfer Agent
and Registrar
American Stock Transfer & Trust Company, LLC
6201 15th Avenue
Brooklyn, NY 11219
(800) 937-5449
Stock Exchange Listing
Newcastle Investment Corp.’s common stock
is listed on the New York Stock Exchange
(symbol: NCT)
Investor Relations
Newcastle Investment Corp.
Investor Relations
1345 Avenue of Americas, 47th floor
New York, NY 10105
(212) 479-5295
Newcastle Investment Corp. filed timely CEO and CFO certifications 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, 2010. These certifications
were filed as exhibits 31.1 and 31.2 to such Form 10-K.
printed on recycled paper
www.newcastleinv.com
NCT 2010