Newcastle
Investment Corp.
Annual Report 2011
Newcastle Investment Corp. (NYSE: NCT) is a real estate
investment company that invests in real estate debt and excess
mortgage servicing rights. Newcastle focuses on generating
strong operating results and making new investments to drive
dividend growth. Newcastle is organized and conducts its
operations to qualify as a real estate investment trust (REIT)
and is managed by an affiliate of Fortress Investment Group,
a global investment management firm.
Fellow Shareholders:
2011 was a great year for Newcastle. We posted strong financial results and made continued progress increasing operating cash flows,
deleveraging and optimizing our portfolio. In addition, we made our first investment in excess mortgage servicing rights, an area that
represents exciting growth potential.
We entered 2011 with a strong balance sheet and I am excited about our financial results for the year. We earned $254 million or $3.09 per
share of GAAP income and increased book value by $440 million or $6.22 per share. Core earnings were $118 million or $1.44 per share and
cash flow available for distribution increased by 83% to $77 million from $42 million in 2010.
Since mid 2008, we have focused on building shareholder value by retaining cash to materially deleverage our balance sheet and improve
operating results. In the last three years, we have repurchased more than $975 million of our debt at a significant discount to par and
tendered for 60% of our preferred shares, re-building GAAP book value by $638 million.
With those important elements of progress achieved, our Board voted to reinstate our dividend to common shareholders in 2011, reflecting
its confidence in the financial strength and prospects of our company. We paid a dividend of $0.10 per share in the 2nd quarter and
subsequently increased it by 50% to $0.15 in the 3rd and 4th quarters.
Highlighted below are several contributing factors that allowed us to increase cash available for distribution and reinstate our common
stock dividend:
• Raised $211 million of common equity and invested $193 million of unrestricted cash at an anticipated return of approximately 20%.
• Invested $858 million of restricted cash to purchase $949 million of assets in our CDOs at an average price of 90% of par and an
unleveraged yield of 8%, resulting in leveraged returns of over 20%.
• Repurchased $174 million of CDO debt at an average price of 61% of par.
• Refinanced our $197 million manufactured housing loan portfolio with $160 million of non-recourse debt. With this refinancing, we
reduced our funding cost 160 basis points from 5.30% to 3.70%. For the year, we generated $9 million of cash flow from this portfolio.
The economy continues to stabilize and housing prices seem to be near the bottom. The year started off with rising asset prices and, while
prices weakened later in the year, credit markets remained open and liquidity steadily improved. In our view, this indicates that the recovery
in the credit markets is on solid footing. Although credit spreads widened in 2011, the continued lack of new issue supply in the residential
and commercial real estate debt markets should drive prices higher, resulting in increased valuations of our securities and loan portfolio,
where we see meaningful upside. At year end, the average carrying value of our $3.9 billion real estate securities and loan portfolio was $3.0
billion or 76.8% of par. Since this portfolio is almost entirely match funded with $2.8 billion of mostly non-recourse debt, we have the ability
to hold it to maturity and realize much of that potential upside. The funding cost of our debt is low at 2.7% and our assets yield 9.6%. The
average life of this portfolio is 4 years, and the average life of our financing is 3.4 years. The roughly $1 billion difference between the par
value and the carrying value of our assets represents potential upside for Newcastle and our shareholders, and we are focused on realizing this
value in the years to come.
In December 2011, we completed our first investment in excess mortgage servicing rights and, in March 2012, we announced an agreement
to acquire a large second Excess MSR portfolio. This represents a new investment area for Newcastle and a tremendous opportunity.
A mortgage servicing right (or “MSR”) is a contractual fee payable to a servicer for loan collections, payment processing, and special servicing
of delinquent or troubled loans. A typical MSR fee is 30 to 35 basis points paid on the principal balance of a loan. An Excess MSR represents
the portion of the MSR that is in excess of the base fee charged by the servicer to service the loan (typically 5 to 10 basis points). As an
example, if the MSR fee is 30 basis points and the base fee to service the loan is 10 basis points, the resulting Excess MSR is 20 basis points.
Our investment strategy is to partner with a strong mortgage servicer to acquire Excess MSRs. With this approach, the servicer owns the
MSR and performs all the day-to-day servicing functions, for 10 basis points in our example. We co-invest alongside the servicer in the excess
portion of the MSR (the 20 basis points in our example). The investment opportunity is compelling for 3 primary reasons:
First—there are more sellers of MSRs than there are buyers
Second—there are significant barriers to entry to making investments in Excess MSRs
Third—the investments should generate 15 to 20% returns without leverage
Attractive Supply/Demand Imbalance—The amount of MSRs for sale is large and growing. We estimate that there are more than $700
billion ($4 to $5 billion investment amount) of MSRs currently for sale. Banks, which currently own over 90% of the $10 trillion MSR
market, are under pressure to sell due to changes in bank regulatory and capital requirements. The sale and ownership transfer of MSRs from
banks to non-bank servicers is underway, with over $275 billion in sales to date. We believe this trend will continue, representing a substantial
opportunity for Newcastle.
Significant Barriers to Entry—There are significant barriers to entry to investing in Excess MSRs. At the end of 2011, Newcastle received
a private letter ruling from the Internal Revenue Service categorizing our investment in Excess MSRs as a qualified REIT asset and the
income generated as good REIT income. We are currently the only company with that qualification. To pursue these investments, we have
partnered with Nationstar Mortgage, an affiliate of our manager Fortress Investment Group. Nationstar has a strong servicing track record
and capital to invest alongside us; they are also one of the few non-bank servicers with the ability to originate loans and offer one stop
refinancing services to existing borrowers. This is critical because loans refinanced (or “recaptured”) by Nationstar continue to generate cash
flow to our Excess MSR while loans refinanced by others do not. These factors give us a significant competitive advantage and are key to
successfully investing in Excess MSRs.
Compelling Investment Returns—In December, we invested $44 million to purchase a 65% interest in the Excess MSRs of a $9.9 billion
pool of mortgage loans. We expect total lifetime cash flows to be $92 million or 2.1 times our investment with an average life of 6 years,
resulting in a 20% IRR. In the first few months since we closed, the investment is performing better than expected. Our second Excess MSR
investment, announced in March 2012, totals approximately $170 million and is expected to close in the 2nd quarter. These transactions
demonstrate our ability to invest capital in the MSR market and we are seeing a strong deal pipeline.
We are off to a good start in 2012. We recently announced a 33% increase in our quarterly dividend to $0.20 per share. Our balance sheet is
strong, our operating results are improving and we will continue to focus on new investments to grow. We also see potential upside in the
value difference between the face amount of our securities and loan portfolio and the current carrying value. On behalf of everyone at
Newcastle, we are excited about our business and its prospects and we thank you for your continued support. We had a great year, but we are
in the early innings of a new investment and growth phase. We remain focused and committed to position the company for success.
Kenneth M. Riis
Chief Executive Officer and President
March 21, 2012
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, 2011
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
to
Commission File Number: 001-31458
Newcastle Investment Corp.
(Exact name of registrant as specified in its charter)
Maryland
(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, 2011 (computed based on the closing price on such date
as reported on the NYSE) was: $434 million.
The number of shares outstanding of the registrant’s common stock was 105,181,009 as of February 29, 2012.
CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS
This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform
Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments,
the stability of our earnings, and our financing needs. Forward-looking statements are generally identifiable by use of
forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,”
“anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other
similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations,
describe future plans and strategies, contain projections of results of operations or of financial condition or state other
forward-looking information. Our ability to predict results or the actual outcome of future plans or strategies is inherently
uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable
assumptions, our actual results and performance could differ materially from those set forth in the forward-looking
statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual
results in future periods to differ materially from forecasted results. Factors which could have a material adverse effect on
our operations and future prospects include, but are not limited to:
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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 take advantage of investment opportunities in interests in excess mortgage servicing rights;
our ability to deploy capital accretively;
the risks that default and recovery rates on our real estate securities and loan portfolios deteriorate compared to our
underwriting estimates;
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:
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should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to
one of the parties if those statements provide to be inaccurate;
have been qualified by disclosures that were made to the other party in connection with the negotiation of the
applicable agreement, which disclosures are not necessarily reflected in the agreement;
(cid:120) may apply standards of materiality in a way that is different from what may be viewed as material to you or other
investors; and
(cid:120) 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 “Business – Corporate Governance and Internet Address; 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.
Item 4.
Properties
Legal Proceedings
Mine Safety Disclosures
INDEX
PART I
PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Item 6.
Item 7.
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, 2011 and 2010
Consolidated Statements of Operations for the years ended December 31, 2011, 2010
and 2009
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2011, 2010 and 2009
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended
December 31, 2011, 2010 and 2009
Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010
and 2009
Notes to Consolidated Financial Statements
Page
1
13
36
36
36
36
37
38
41
70
73
74
75
76
77
78
79
80
82
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 127
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
127
127
128
128
133
138
139
141
142
144
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, excess mortgage servicing rights (“excess MSRs”) 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 (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered
CDOs”), (iii) unlevered excess MSRs, (iv) investments financed with other non-recourse debt (“non-recourse other”), (v)
investments and debt repurchases financed with recourse debt (“recourse”), (vi) other unlevered investments (“unlevered
other”) and (vii) corporate. In the fourth quarter of 2011, Newcastle changed the composition of its reportable segments
such that the unlevered segment is further broken down into (i) unlevered CDOs, (ii) unlevered excess MSRs and (iii)
unlevered other. Accordingly, segment information for previously reported periods has been restated to reflect the new
composition of reportable segments. 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, 2011:
Non-
Recourse
CDOs (A)
Unlevered
CDOs (B)
Unlevered
Excess
MSRs
Non-
Recourse
Other (A)(C)
Recourse
(D)
Unlevered
Other (E)
Corporate
Inter-segment
Elimination
(F)
T otal
GAAP
Investments
$2,408,252
$ 3,940
$ 43,971
$ 783,777
$244,916
$ 18,751
$ -
$ (143,018)
$3,360,589
Cash and restricted cash
105,040
-
-
-
-
9
157,347
-
262,396
Derivative assets
1,954
-
-
-
-
-
-
-
1,954
Other assets
T otal assets
23,203
2,538,449
8
3,948
-
43,971
116
783,893
593
245,509
2,085
20,845
1,208
158,555
(353)
(143,371)
26,860
3,651,799
Debt
(2,410,151)
-
-
(748,118)
(233,194)
-
(51,248) 143,018
(3,299,693)
Derivative liabilities
(119,320)
-
-
-
-
-
-
-
(119,320)
Other liabilities
T otal liabilites
(12,705)
(2,542,176)
-
-
(4,186) (3,407)
(4,186) (751,525)
(23)
(233,217)
(49)
(49)
(20,680) 353
(71,928) 143,371
(40,697)
(3,459,710)
Preferred stock
-
-
-
-
-
-
(61,583) -
(61,583)
GAAP book value
$ (3,727)
$ 3,948
$ 39,785
$ 32,368
$ 12,292
$ 20,796
$ 25,044
$ -
$ 130,506
(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, creditors or beneficial interest holders of these structures
have no recourse to the general credit of Newcastle. Therefore, our exposure to the economic losses from such structures is limited to 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) Represents unlevered investments in CDO securities issued by Newcastle. These CDOs have been deconsolidated as we do not have the
power to direct the relevant activities of the CDOs.
(C) The following table summarizes the investments and debt in the other non-recourse segment:
December 31, 2011
Investments
Debt
Manufactured housing loan portfolio I
Manufactured housing loan portfolio II
Residential mortgage loans
Subprime mortgage loans subject to call options
Real estate securities
Operating real estate
Outstanding
Face Amount
$
135,209
178,603
56,377
406,217
67,965
N/A
844,371
$
1
$
Carrying
Value
112,316
175,120
40,380
404,723
43,497
7,741
783,777
$
Outstanding
Face Amount*
Carrying
Value*
$
$
107,032
143,869
54,842
406,217
47,697
6,000
765,657
97,631
142,589
53,771
404,723
43,404
6,000
748,118
$
$
* An aggregate face amount of $157.0 million (carrying value of $143.0 million) of debt represents financing provided by the CDO
segment (and included as investments in the CDO segment), which is eliminated upon consolidation.
(D) The $233.2 million of recourse debt is comprised of (i) $231.0 million of repurchase agreements secured by $244.9 million carrying amount
of FNMA/FHLMC securities and (ii) $2.2 million of repurchase agreements secured by $29.1 million face amount of senior notes issued by
Newcastle CDO VI, which was repurchased by Newcastle in December 2010 and eliminated in consolidation.
(E) The following table summarizes the investments in the unlevered other segment as of December 31, 2011:
Real estate securities
Real estate related loans
Residential mortgage loans
Other investments
Outstanding Face Amount
183,507
$
24,543
5,227
N/A
213,277
$
Carrying Value
$
7,614
6,366
2,687
6,024
22,691
Number of Investments
25
1
170
1
197
$
(F) Represents the elimination of investments and financings and their related income and expenses between the CDO segment and the other
non-recourse segment as the corresponding inter-segment investments and financings are presented on a gross basis within each of these
segments.
Our investments currently cover the following 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
asset backed
securities, and
FNMA/FHLMC securities. As of December 31, 2011, our real estate securities
represented 47.4% of our assets.
including
securities
subprime
(ABS),
2) Real Estate Related Loans:
3) Residential Mortgage Loans:
4) Operating Real Estate:
We acquire and originate loans to real estate owners, including B-notes,
mezzanine loans, corporate bank loans, and whole loans. As of December 31,
2011, our real estate related loans represented 22.3% of our assets.
We acquire residential mortgage loans, including manufactured housing loans
and subprime mortgage loans. As of December 31, 2011, our residential
mortgage loans represented 9.1% of our assets.
We acquire and manage direct and indirect interests in operating real estate.
As of December 31, 2011, our operating real estate represented 0.9% of our
assets.
5) Excess Mortgage Servicing Rights: We made our first investment in excess MSRs in December 2011. As of
December 31, 2011, our interests in these rights represented 1.2% of our
assets.
In addition, Newcastle had restricted and unrestricted cash and other miscellaneous net assets, which represented 19.1% of
our assets at December 31, 2011.
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 4.8 million shares of our common stock and Fortress, through its affiliates, had options to purchase an additional 6.0
million shares of our common stock, which were issued in connection with our equity offerings, representing approximately
9.7% of our common stock on a fully diluted basis, as of December 31, 2011.
During the year ended December 31, 2011, Newcastle actively pursued opportunities to raise capital and make new
investments at attractive yields.
Highlighted below are the significant transactions executed during the year.
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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
2
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will earn, on average, a 20 basis point annual senior management fee on a portion of the total collateral, which was
$1.3 billion at acquisition.
In March 2011, Newcastle issued 17,250,000 shares of its common stock in a public offering at a price to the public
of $6.00 per share for net proceeds of approximately $98.4 million. In September 2011, Newcastle issued 25,875,000
shares of its common stock in a public offering at a price to the public of $4.55 per share for net proceeds of
approximately $112.3 million.
In May 2011, we completed a securitization transaction to refinance approximately $197 million outstanding
principal balance of manufactured housing loans. We issued approximately $160 million aggregate principal amount
of asset-backed notes, of which $143 million was sold to third parties and $17 million was sold to certain CDOs
managed and consolidated by us. In addition, we retained the below investment grade notes and residual interest, and
invested approximately $20 million of unrestricted cash in the new securitization structure. The gross proceeds
received from the issuance of the notes were used to repay the previously existing financing on this portfolio in full,
terminate the related interest rate swap contracts and pay the related transaction costs.
In December 2011, we made our first investment in excess MSRs. We invested $44 million to acquire a 65%
interest in the excess MSRs of a $9.9 billion residential mortgage portfolio. Nationstar Mortgage LLC
(“Nationstar”), a leading residential mortgage servicer that is externally managed by our manager, is the servicer of
the loans and invested alongside Newcastle by acquiring the remaining 35% interest in the excess MSRs. To the
extent any loans in this portfolio are refinanced by Nationstar, subject to certain limitations, we are entitled to
receive our pro rata share of the excess MSRs of the refinanced loans. Newcastle will not have any servicing duties,
advance obligations or liabilities associated with the portfolio.
(cid:120) As a result of the improvement in our financial condition and liquidity, the Board of Directors reinstated the
quarterly dividend on our common stock beginning in the second quarter of 2011, and declared aggregate common
stock dividends of $0.40 per share, or $39.5 million, for the year ended December 31, 2011.
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.
The following summarizes our consolidated investment portfolio at December 31, 2011 (dollars in millions):
Outstanding
Face Amount
Amortized Cost
Basis (1)
Percentage of
T otal
Amortized
Cost Basis
Carrying Value
Number of
Investments Credit (2)
Weighted
Average Life
(years) (3)
Inve stme nt (7)
I. Re al Estate Re late d Inve stme nts
C ommercial
CMBS
Mezzanine Loans
B-Notes
Whole Loans
CDO Securities (4)
Other Investments (5)
T otal Commercial Assets
Re side ntial
Manufactured Housing and
Residential
Subprime Securities
Real Estate ABS
FNMA/FHLMC securities
T otal Residential Assets
C orporate
REIT Debt
Corporate Bank Loans
T otal Corporate Assets
II. Exce ss Mortgage Se rvicing Rights
$
1,546
609
174
31
88
25
2,473
$
1,124
469
153
31
68
25
1,870
379
246
53
678
232
910
137
283
420
44
328
123
40
491
243
734
136
161
297
44
38.2%
15.9%
5.2%
1.0%
2.3%
0.8%
63.4%
11.1%
4.2%
1.4%
16.7%
8.3%
25.0%
4.6%
5.5%
10.1%
1.5%
$
1,129
469
153
31
56
25
1,863
204
17
5
3
3
1
BB+
73%
61%
48%
BB+
--
328
129
38
495
245
740
135
161
296
44
10,045
63
14
704
B
BBB-
31
AAA
20
6
BB+
CC
1
--
TO TAL / WA
$
3,847
$
2,945
100.0%
$
2,943
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.
405
8
262
34
3,652
$
4.1
2.4
2.8
1.9
3.5
-
3.5
6.6
6.9
7.2
6.7
4.6
6.2
2.4
3.0
2.8
6.0
4.1
(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 at any time.
(3) Weighted average life is based on the timing of expected principal reduction on the asset.
(4) Represents non-consolidated CDO securities, excluding ten securities with a zero value, which had an aggregate face amount of $118 million.
(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.
(7) The following tables summarize certain supplemental data relating to our investments (dollars in tables in thousands):
4
CMBS
Deal
Vintage (A)
Pre 2004
2004
2005
2006
2007
2010
2011
T otal / WA
Average
Minimum
Rating (B) Number
Outstanding
Face Amount
Amortized
Cost Basis
Percentage of
T otal
Amortized
Cost Basis
Carrying
Value
Delinquency
60+/FC/REO
(C)
Principal
Subordination
(D)
Weighted
Average Life
(years) (E)
BB+
BB+
BB+
BB
B-
BB+
BBB
BB+
60
31
29
44
16
4
20
$
301,373
$
283,342
25.2%
$
263,447
143,831
317,865
409,417
121,638
46,798
204,955
113,231
192,387
281,889
35,266
43,499
174,832
10.1%
17.1%
25.1%
3.1%
3.9%
105,349
219,565
275,951
52,362
42,129
15.5%
170,015
204
$
1,545,877
$
1,124,446
100.0%
$
1,128,818
7.3%
2.3%
5.2%
8.1%
16.2%
0.0%
0.0%
6.1%
14.4%
7.7%
8.5%
11.8%
10.9%
3.5%
7.2%
10.3%
1.5
3.4
3.6
3.8
4.3
8.8
8.5
4.1
(A) The year in which the securities were issued.
(B) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any
time. We had $2.3 million of CMBS assets that were on negative watch for possible downgrade by at least one rating agency as of December 31,
2011.
(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.
CDO Securities (A)
Primary
Collateral
T ype
CMBS
CMBS
ABS
Collateral
Manager
T hird Party
Newcastle
Newcastle
T OT AL/WA
Number
1
1
1
3
Average
Minimum
Rating (B)
BBB-
BBB-
CC
BB+
Outstanding
Face
Amount
77,027
5,502
5,500
88,029
$
$
Amortized
Cost
Basis
60,801
4,224
2,600
67,625
$
$
Percentage of
T otal Amortized
Cost Basis
89.9%
6.2%
3.9%
100.0%
Carrying Value
49,296
$
3,940
2,750
55,986
$
Principal
Subordination
(C)
51.7%
29.5%
49.1%
50.2%
(A) Represents non-consolidated CDO securities, excluding ten securities with a zero value, which had an aggregate face amount of $118 million.
(B) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change at any
time.
(C) The percentage of the outstanding face amount of securities that is subordinate to our investments.
Mezzanine Loans, B-Notes and Whole Loans
Asset T ype
Mezzanine Loans
B-Notes
Whole Loans
T otal/WA
Number
17
5
3
25
Outstanding
Face Amount
609,117
$
174,153
30,566
813,836
$
Amortized
Cost Basis
469,326
$
152,535
30,566
652,427
$
Percentage
of T otal
Amortized
Cost Basis
71.9%
23.4%
4.7%
100.0%
Weighted
Average First
Dollar Loan to
Value (A)
Weighted
Average Last
Dollar Loan to
Value (A)
60.8%
50.5%
0.0%
56.3%
73.2%
60.7%
48.2%
69.6%
Delinquency
(B)
2.0%
31.2%
0.0%
8.2%
$
Carrying
Value
469,326
152,535
30,566
652,427
$
(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.
5
Manufactured Housing and Residential Loans
Deal
Manufactured Housing
Loans Portfolio I
Manufactured Housing
Loans Portfolio II
Residential Loans Portfolio I
Residential Loans Portfolio II
T otal / WA
Average
FICO Score
(A)
Outstanding
Face Amount
Amortized
Cost Basis
Percentage
of T otal
Amortized
Cost Basis
Carrying
Value
Average
Loan Age
(years)
Original
Balance
Delinquency
90+/FC/
REO (B)
Cumulative
Loss to
Date
702
$
135,977
$
110,528
33.6%
$
110,528
10.2
$
327,855
1.5%
7.9%
702
714
737
704
183,062
174,331
53.1%
174,331
56,377
40,270
12.3%
40,270
3,779
379,195
$
3,415
328,544
$
1.0%
100.0%
3,415
328,544
$
12.6
8.7
7.3
11.1
434,743
646,357
83,950
1,492,905
$
1.7%
12.1%
0.0%
3.2%
%
6.2%
0.4%
0.0%
5.9%
(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)
S e c urity C ha ra c te ris tic s
Ave ra ge
M inim um
R a ting (C )
Num be r
o f
S e c uritie s
Outs ta nding
F a c e
Am o unt
Am o rtize d
C o s t B a s is
P e rc e nta ge o f
To ta l Am o rtize d
C o s t B a s is
Vinta ge (B )
C a rrying
Va lue
P rinc ipa l
S ubo rdina tio n (D)
Exc e s s
S pre a d (E)
2003
2004
2005
2006
B -
B B -
B -
B +
2007 a nd la te r
C C C
14
9
26
7
7
$
14,063
$
6,805
5.5%
$
8,116
34,567
108,265
57,794
31,325
16,483
41,463
38,588
19,684
13.4%
33.7%
31.4%
16.0%
18,117
42,840
38,626
20,923
To ta l / WA
B
63
$
246,014
$
123,023
100.0%
$
128,622
24.7%
25.2%
32.1%
41.0%
29.7%
32.5%
4.2%
3.7%
4.4%
5.4%
3.5%
4.4%
C o lla te ra l C ha ra c te ris tic s
C o lla te ra l
F a c to r (F )
3 m o nth
C P R (G) De linque nc y (H)
C um ula tive
Lo s s e s to Da te
0.09
0.14
0.18
0.31
0.47
6.2%
9.1%
10.9%
12.7%
10.2%
0.24
10.7%
18.1%
17.5%
28.1%
24.3%
22.9%
24.5%
4.1%
4.1%
11.1%
18.6%
21.1%
12.8%
Ave ra ge
Lo a n Age
(ye a rs )
Vinta ge (B )
2003
2004
2005
2006
2007 a nd la te r
To ta l / WA
9.0
7.6
6.6
5.8
5.3
6.5
Real Estate ABS
Asset T ype
Average
Minimum
Rating (C)
Outstanding Amortized Cost
Percentage of
Security Characteristics
Number
Face
Amount
Basis
Amount
T otal Amortized Carrying
Principal
Excess
Cost Basis
Value
Subordination (D) Spread (E)
Manufactured Housing
Small Business Loans
T otal / WA
BBB+
BB+
BBB-
7
7
14
$
30,232
23,115
53,347
$
$
$
29,454
10,465
39,919
73.8%
26.2%
100.0%
$
30,547
7,560
38,107
$
41.6%
21.9%
33.1%
1.5%
0.8%
1.2%
Asset T ype
Average
Loan Age
(months)
Collateral
Factor (F)
3 Month
CPR (G)
Delinquency (H)
Cumulative
Losses to Date
Collateral Characteristics
Manufactured Housing
Small Business Loans
T otal / WA
12.2
6.8
9.9
0.25
0.50
0.36
6.3%
5.9%
6.1%
2.3%
21.6%
10.6%
13.4%
17.3%
15.1%
(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 at any
time. We had approximately $25.1 million of ABS securities that were on negative watch for possible downgrade by at least one rating agency as of
December 31, 2011.
6
(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
Healthcare
T otal / WA
Average
Minimum
Rating (A)
Number
Outstanding
Face
Amount
Amortized
Cost Basis
Percentage of
T otal
Amortized
Cost Basis
Carrying
Value
A-
CCC+
BBB
BBB
BBB-
BB+
4
4
6
3
3
20
$
34,525
39,286
34,117
12,765
16,700
137,393
$
$
33,712
38,502
34,413
12,794
16,510
135,931
$
$
24.8%
28.3%
25.3%
9.4%
12.2%
36,406
32,866
34,750
13,429
17,845
$
100.0% 135,296
Corporate Bank Loans
Average
Minimum
Rating (A)
Number
Outstanding
Face
Amount
Amortized
Cost Basis
Percentage of
T otal
Amortized
Cost Basis
Carrying
Value
NR
CCC-
NR
B
CC
1
2
1
2
6
$
17,811
110,710
136,156
18,101
282,778
$
$
15,139
25,222
106,156
14,636
161,153
$
9.4%
15.7%
65.9%
9.0%
100.0%
$
15,139
25,222
106,156
14,636
161,153
$
Industry
Real Estate
Media
Resorts
Restaurant
T otal / 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 at any
time. We had $27.9 million of REIT debt and no corporate bank loans that were on negative watch for possible downgrade by at least one rating
agency as of December 31, 2011.
Excess MSRs
Collateral Characteristics:
Initial
Investment
Amount
Carrying
Amount
Original
Principal
Balance
Current
Principal
Balance
WA
Maturity
(months)
Average
Loan Age
(months)
WA
Coupon
Delinquency
30+ (A)
1 Month
CPR (B)
1 Month
CRR (C)
1 Month
CDR (D)
Portfolio I
$
43,742
$
43,971
$
9,908,081
$
9,705,512
6.1%
288
62
7.6%
9.5%
9.4%
0.1%
Collateral Characteristics
(A) The percentage of underlying loans that missed their last payment.
(B) Constant prepayment rate.
(C) Voluntary prepayment rate.
(D) Involuntary prepayment rate.
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 feasible and 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
7
mortgage and asset backed securities, and the issuer’s underlying equity and subordinated debt, in the case of senior
unsecured REIT debt securities. 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
of December 31, 2011 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.
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 – Interest Rate and Credit Spread Sensitive Instruments and Fair Value.”
8
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9
Formation
We were formed in June 2002 and completed 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 - 2006
2007
2008
2009
2010
2011
December 31, 2011
45,713,817
7,065,362
9,871
123,463
9,114,671
43,153,825
105,181,009
$27.75-$31.30
N/A
N/A
$3.13
$4.55 - $6.00
$201.3
$0.1
$0.1
$28.5
$210.8
(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:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
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
(cid:120) 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, loans, excess MSRs 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 2011, 2010, or 2009.
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, mortgage servicers, 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 we may not compete successfully.”
11
Compliance with Applicable Environmental Laws
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.
12
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, as a result of the Act, we were required to register as an investment adviser with the SEC,
which increases our regulatory compliance costs and subjects us to the Investment Advisers Act of 1940, as amended (the
“Advisers Act”). The Advisers Act imposes numerous obligations on registered investment advisers, including record-
keeping, reporting, operational and marketing requirements, disclosure obligations and prohibitions on fraudulent activities.
The SEC is authorized to institute proceedings and impose sanctions for violations of the Advisers Act, ranging from fines
and censure to termination of an investment adviser’s registration. Investment advisers also are subject to certain state
securities laws and regulations. Non-compliance with the Advisers Act or other federal and state securities laws and
regulations could result in investigations, sanctions, disgorgement, fines and reputational damage.
The Act will impose mandatory clearing, exchange-trading and margin requirements on many derivatives transactions
(including formerly unregulated over-the-counter derivatives) in which we may engage. The Act also creates new
categories of regulated market participants, such as “swap-dealers,” “security-based swap dealers,” “major swap
participants” and “major security-based swap participants,” who will be subject to significant new capital, registration,
recordkeeping, reporting, disclosure, business conduct and other regulatory requirements that will give rise to new
administrative costs. In addition, the new regulation of over-the-counter derivatives and a recently-adopted implementing
rule may require us to register with and be regulated by the U.S. Commodity Futures Trading Commission (“CFTC”) as a
commodity pool operator (“CPO”). The Commodity Exchange Act and CFTC regulations impose various requirements on
CPOs, including record-keeping, reporting, operational and marketing requirements, disclosure obligations and prohibitions
on fraudulent activities. Complying with these requirements could increase our expenses and negatively impact our
financial results.
Even if certain new requirements are not directly applicable to us, they may still increase our costs of entering into
transactions with the parties to whom the requirements are directly applicable. Moreover, new exchange-trading and trade
reporting requirements may lead to reductions in the liquidity of derivative transactions, causing higher pricing or reduced
availability of derivatives, or the reduction of arbitrage opportunities for us, which could adversely affect the performance
of certain of our trading strategies. 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 certain U.S. government programs intended to stabilize the economy and the financial
markets will have on our business.
In recent years, the U.S. government has taken a number of steps to attempt to strengthen the 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 continues to evaluate or implement an array of other
measures and programs intended 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. It is not clear what impact the government’s future actions to improve financial and market
conditions 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.
13
Legislation that permits modifications to the terms of outstanding loans has negatively affected our business,
financial condition and results of operations.
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 current or
future investments, including investments in mortgage-backed securities, mortgage servicing rights (“MSRs”) and excess
mortgage servicing rights (“excess MSRs”). 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 a 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. Additional legislation intended
to provide relief to borrowers may be enacted and could further harm our business, results of operations and financial
condition.
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.
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 us 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 that are higher than their economic interests in us 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 us and have no
obligation to offer to us 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 target as its primary investment category investment in U.S. dollar-denominated credit sensitive
real estate related securities reflecting primarily U.S. 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 amount of time our manager, its officers or other employees
spend managing us. In addition, we may engage (subject to our investment guidelines) 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, investments in excess MSRs and senior living facilities, that present an actual, potential or perceived
conflict of interest. It is possible that actual, potential or perceived conflicts could give rise to investor dissatisfaction,
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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, as well as compensation arrangements
that we may enter into with our manager in the future (in connection with new lines of business or other activities), may
incentivize our manager to invest in high risk investments. In addition to its management fee, our manager is currently
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 or, in the case of any future incentive compensation
arrangement, other financial measures on which incentive compensation may be based, may lead our manager to place
undue emphasis on the maximization of such measures 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 since 2008. 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.
It would be difficult and costly for us to terminate our management agreement with our manager. 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 termination by accepting a mutually acceptable
reduction of fees. Our manager will be provided 60 days' prior notice of any termination and will be paid a termination fee
equal to the amount of the management fee earned by the manager during the twelve-month period preceding such
termination. In addition, following any termination of the management agreement, the manager may require us to purchase
its right to receive incentive compensation at a price determined as if our assets were sold for their fair market value (as
determined by an appraisal, taking into account, among other things, the expected future value of the underlying
investments) or otherwise we may continue to pay the incentive compensation to our manager. These provisions may
increase the effective cost to us of terminating the management agreement, thereby adversely affecting our ability to
terminate our manager without cause.
Our directors have approved very broad investment guidelines for our manager and do not approve each
investment decision made by our manager.
Our manager is authorized to follow very broad investment guidelines. Consequently, our manager has great latitude in
determining the types of assets it may decide are proper investments for us. Our directors periodically review our
investment guidelines and our investment portfolio. However, our board does not review or pre-approve each proposed
investment or our related financing arrangements. In addition, in conducting periodic reviews, the directors rely primarily
on information provided to them by our manager. Furthermore, transactions entered into by our manager may be difficult or
impossible to unwind by the time they are reviewed by the directors even if the transactions contravene the terms of the
management agreement.
We may change our investment strategy without stockholder consent, which may result in our making investments
that entail more risk than our current investments.
Our investment strategy may evolve in light of existing market conditions and investment opportunities, and this evolution
may involve additional risks depending upon the nature of the assets in which we invest 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
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categories or the financing risks associated with such assets could adversely affect our results of operations and our
financial condition.
We are actively exploring new business opportunities, which may be unsuccessful, divert managerial attention or
require significant financial resources, which could have a negative impact on our financial results.
Consistent with our broad investment guidelines and our investment objectives, we have acquired and are actively
exploring additional opportunities to acquire excess MSRs and additional classes of operating real estate, including senior
living facilities. See “—We invest in excess MSRs, and such investments could have a negative impact on our financial
results,” and “—We may invest in senior living facilities, which are subject to various risks that could have a negative
impact on our financial results.”
Although we currently believe that we will have significant opportunities to acquire such assets in the future, these
opportunities may not materialize. We also believe investing in such assets will provide us attractive risk-adjusted returns,
but, assuming we are successful in acquiring these assets, they may not achieve the returns we anticipate and may not even
be profitable. Moreover, these investments may not be successful, given that we do not have significant experience in
owning these types of assets, or for other reasons. Further, these new business opportunities may divert managerial
attention from more profitable opportunities, and they may require significant financial resources. Any or all of the
foregoing could have a negative impact on our financial results.
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;
•
Prepayment speeds, delinquency rates and legislative/regulatory changes with respect to our investments in excess
MSRs;
• 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. Since then, market conditions have generally improved, but they could deteriorate in the future.
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
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 our net interest income from loans and
securities in our portfolio and our income from excess mortgage servicing rights, 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
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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 coverage tests applicable to our CDO financings 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
us) 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 had approximately $128.2 million of assets in our consolidated CDOs as of December 2011 or February 2012, 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 2011 remittance date for CDO IV and as of the
February 2012 remittance date for CDO VI, these CDOs were not in compliance with their applicable over collateralization
tests and, consequently, we are not receiving residual cash flows from these CDOs. However, we continue to receive senior
management fees and cash flow 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, one strategy we have
employed to facilitate compliance with over collateralization tests has been to repurchase notes issued by our CDOs and
subsequently cancel them in accordance with the terms of the relevant governing documentation. However, there can be no
assurance that the trustee of our CDOs will not impose guidelines for such cancelations that would make it more difficult or
impossible to employ this strategy 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
Investors Service 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 be removed 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 specifies 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,
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 could 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 could negatively affect our cash flows, business, results of operations and financial condition.
On June 17, 2011, CDO V 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
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V. So long as the event of default continues, we will not be permitted to purchase or sell any collateral in CDO V. If we are
removed as the collateral manager of CDO V, we would no longer receive the senior management fees from such CDO. As
of February 29, 2012, 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 V, the loss of senior management fees would not have a material
negative impact on our cash flows, business, results of operations or financial condition. 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 many classes of securities issued by the CDOs were
rated as “distressed” by the rating agencies 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 adviser, which has
increased our 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 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 the 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 was calculated
for purposes of our financial statements. If we determine that an impairment has occurred, we are required to make an
adjustment to the net carrying value of the investment, which could adversely affect our results of operations 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.
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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 their 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 for any shortfall between the value of our obligation to the counterparty and the amount for which the collateral
was sold (which may be a significantly discounted price). As of December 31, 2011, we had $239.7 million outstanding
under repurchase agreement financings. Moreover, all of our repurchase agreement obligations are with two counterparties.
If any of our counterparties elected not to roll these repurchase agreements, 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. During the recent financial crisis, the return we were able to
earn on our investments and cash available for distribution to our stockholders was 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.
While our liquidity position has improved, we cannot assure you that we will be able to sustain our improved liquidity
position.
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.
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
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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 a counterparty was downgraded below
these levels, it may not be able to satisfy its obligations under the derivative, which could have a material negative effect on
the applicable CDO.
Furthermore, with respect to our investments in excess MSRs, we are subject to the risks of the mortgage servicer. To the
extent that it is terminated as the mortgage servicer of the underlying mortgage loan pool, or files for bankruptcy, our
ability to receive excess mortgage servicing fees or eventually recover our investment would be severely impacted. See “—
We will be dependent on mortgage servicers to service the mortgage loans underlying any mortgage servicing rights that
we acquire.”
The counterparty risks that we face have increased in complexity and magnitude as a result of the insolvency of a number
of major financial institutions (such as Bear Stearns and Lehman Brothers). 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 two counterparties. If any of our counterparties
elected not to roll these repurchase agreements, 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
a few counterparties. 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.
We may not match fund certain of our investments, which may increase the risks associated with these investments.
One component of our investment strategy is to use match funded financing structures for our investments, which match
assets and liabilities with respect to maturities and interest rates. When available, this strategy mitigates the risk of not
being able to refinance an investment on favorable terms or at all. However, our manager may elect for us to bear a level of
refinancing risk on a short-term or longer-term basis, as in the case of investments financed with repurchase agreements,
when, based on its analysis, our manager determines that bearing such risk is advisable or unavoidable (which is generally
the case with respect to the residential mortgage loans and FNMA/FHLMC securities in which we invest). In addition, we
may be unable, as a result of conditions in the credit markets, to match fund our investments. For example, non-recourse
term financing not subject to margin requirements was generally not available or economical for the past three years and is
currently still difficult to obtain, which impairs our ability to match fund our investments. Moreover, we may not be able to
enter into interest rate swaps. A decision not to, or the inability to, match fund certain investments exposes us to additional
risks.
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.
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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 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.
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, we may not
recover the amount invested in, or, in extreme cases, any of our investment in such securities.
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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:
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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:
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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 invest in excess MSRs, and such investments could have a negative impact on our financial results.
Subject to maintaining our qualification as a REIT and our exemption from the Investment Company Act of 1940, as
amended (the “Investment Company Act”), we have purchased and may continue to purchase excess MSRs with
Nationstar, which is a leading residential mortgage servicer that is externally managed by our manager. We may also
purchase excess MSRs directly from Nationstar or enter into similar transaction with other bank or non-bank servicers.
Excess MSRs are interests in mortgage servicing rights, representing a portion of the fee paid to mortgage servicers. The
fee that a mortgage servicer is entitled to receive for servicing a pool of mortgages generally exceeds the reasonable
compensation that would be charged in an arm’s-length transaction. For example, government-sponsored entities
(“GSEs”), such as the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corp.
(“FHLMC”), generally require mortgage servicers to be paid a minimum servicing fee that significantly exceeds the amount
a servicer would charge in an arm’s-length transaction. The portion of the fee in excess of what would be charged in an
arm’s-length transaction is commonly referred to as the excess mortgage servicing fee.
We record excess MSRs on our balance sheet at fair value, and changes in their fair value are reflected in our consolidated
results of operations. The determination of the fair value of excess MSRs requires our management to make numerous
estimates and assumptions that could materially differ from actual results. Such estimates and assumptions include, without
limitation, estimates of the future cash flows from the excess mortgage servicing fees, which in turn are based upon
assumptions about interest rates as well as prepayment rates, delinquencies and foreclosure rates of the underlying
mortgage loans.
The ultimate realization of the value of excess MSRs, which are measured at fair value on a recurring basis, may be
materially different than the fair values of such excess MSRs as may be reflected in our consolidated statement of financial
position as of any particular date. The use of different estimates or assumptions in connection with the valuation of these
assets could produce materially different fair values for such assets, which could have a material adverse effect on our
consolidated financial position, results of operations and cash flows. Accordingly, there may be material uncertainty about
the fair value of any excess MSRs we acquire.
The values of excess MSRs are highly sensitive to changes in interest rates. Historically, the value of excess MSRs has
increased when interest rates rise and decreased when interest rates decline due to the effect those changes in interest rates
have on prepayment estimates. We may pursue various hedging strategies to seek to reduce our exposure to adverse
changes in interest rates. Our hedging activity will vary in scope based on the level and volatility of interest rates, the type
of assets held and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us.
To the extent we do not utilize derivatives to hedge against changes in the fair value of excess MSRs, our balance sheet,
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results of operations and cash flows would be susceptible to significant volatility due to changes in the fair value of, or cash
flows from, excess MSRs as interest rates change.
Prepayment speeds significantly affect the value of excess MSRs. Prepayment speed is the measurement of how quickly
borrowers pay down the unpaid principal balance of their loans or how quickly loans are otherwise brought current,
modified, liquidated or charged off. When we purchase excess MSRs, we base the price we pay and the rate of
amortization of those assets on, among other things, our projection of the cash flows from the related pool of mortgage
loans. Our expectation of prepayment speeds is a significant assumption underlying those cash flow projections. If
prepayment speeds are significantly greater than expected, the carrying value of excess MSRs could exceed their estimated
fair value. If the fair value of excess MSRs decreases, we would be required to record a non-cash charge, which would have
a negative impact on our financial results. Furthermore, a significant increase in prepayment speeds could materially reduce
the ultimate cash flows we receive from excess MSRs, and we could ultimately receive substantially less than what we paid
for such assets.
Moreover, delinquency rates have a significant impact on the value of excess MSRs. An increase in delinquencies will
generally result in lower revenue because typically we will only collect servicing fees from GSEs or mortgage owners for
performing loans. The price we pay for excess MSRs is based on, among other things, our projections of the cash flows
from related pools of mortgage loans. Our expectation of delinquencies is a significant assumption underlying those cash
flow projections. If delinquencies are significantly greater than expected, the estimated fair value of the excess MSRs could
be diminished. As a result, we could suffer a loss, which would have a negative impact on our financial results.
Furthermore, MSRs are subject to numerous federal, state and local laws and regulations and may be subject to various
judicial and administrative decisions imposing various requirements and restrictions on our business. If the servicer,
actually or allegedly failed to comply with applicable laws, rules or regulations, it could be terminated as the servicer,
which could have a material adverse effect on our business, financial condition, results of operations or cash flows.
Our ability to acquire excess MSRs will be subject to the applicable REIT qualification tests, and we may have to hold
these interests through taxable REIT subsidiaries, which would negatively impact our returns from these assets.
We will be dependent on mortgage servicers to service the mortgage loans underlying any mortgage servicing rights
that we acquire.
Our investments in MSRs or excess MSRs are dependent on the mortgage servicer to perform the servicing obligations. As
a result, we could be materially and adversely affected if the servicer is terminated, or is unable to adequately service the
underlying mortgage loans due to:
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its failure to comply with applicable laws and regulation;
its failure to perform its loss mitigation obligations;
a downgrade in its servicer rating;
its failure to perform adequately in its external audits;
a failure in its operational systems or infrastructure;
regulatory scrutiny regarding foreclosure processes lengthening foreclosure timelines;
a GSE’s or a whole-loan owner’s transfer of servicing to another party; or
any other reason.
In addition, a bankruptcy by any mortgage servicer that services the mortgage loans underlying any mortgage servicing
rights that we have acquired or may acquire in the future could result in:
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the validity and priority of our ownership in the mortgage servicing rights being challenged in a
bankruptcy proceeding;
payments made by such servicer to us, or obligations incurred by it, being avoided by a court under
federal or state preference laws or federal or state fraudulent conveyance laws;
a re-characterization of any sale of mortgage servicing rights or other assets to us as a pledge of such
assets in a bankruptcy proceeding; or
any agreement pursuant to which we purchased the mortgage servicing rights being rejected in a
bankruptcy proceeding.
Any of the foregoing events could have a material and adverse effect on us.
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GSE initiatives and other actions may adversely affect returns from investments in MSRs or excess MSRs.
On January 17, 2011, the Federal Housing Finance Agency announced that it has instructed FNMA and FHLMC to study
possible alternatives to the current residential mortgage servicing and compensation system used for single-family
mortgage loans. It is too early to determine what the GSEs, including FNMA and FHLMC, may propose as alternatives to
current servicing compensation practices, or when any such alternatives would become effective. Although we do not
expect MSRs that have already been created to be subject to any changes implemented by FNMA and FHLMC, it is
possible that, because of the significant role of FNMA and FHLMC in the secondary mortgage market, any changes they
implement could become prevalent in the mortgage servicing industry generally. Other industry stakeholders or regulators
may also implement or require changes in response to the perception that the current mortgage servicing practices and
compensation do not appropriately serve broader housing policy objectives. These proposals are still evolving. To the
extent the GSEs implement reforms that materially affect the market for conforming loans, there may be secondary effects
on the subprime and Alt-A markets. These reforms may have a material adverse effect on the economics or performance of
any excess MSRs or MSRs that we may acquire in the future.
Changes to the minimum servicing fee for GSE loans could occur at any time and could impact us in significantly
negative ways that we are unable to predict or protect against.
Currently, when a loan is sold into the secondary market for FNMA and FHLMC loans, the servicer is generally required to
retain a minimum servicing fee (“MSF”) of 25 basis points of the outstanding principal balance for fixed rate mortgages.
As has been widely publicized, in September 2011, the Federal Housing Finance Agency (FHFA) announced that a Joint
Initiative on Mortgage Servicing Compensation was seeking public comment on two alternative mortgage servicing
compensation structures detailed in a discussion paper. Changes to MSF could significantly impact our business in
negative ways that we cannot predict or protect against. For example, a removal of MSF could radically change the
mortgage servicing industry and could severely limit the excess MSRs that will be available for us to invest in. We cannot
predict whether any changes to current MSF rules will occur or what impact any changes will have on our business, results
of operations, liquidity or financial condition.
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, mortgage servicers, 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 returns 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 that are suitable for 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
are fully utilized to pay down the related CDO’s debt. This causes the leverage on the CDO to decrease, thereby lowering
our returns on equity.
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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. 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 have acquired and may continue to acquire in the future certain loans that do not conform to conventional loan criteria
applied by traditional lenders and are not rated or are rated as non-investment grade (for example, for investments rated by
Moody’s Investors Service, ratings lower than Baa3, and for Standard & Poor’s, BBB- or below). The non-investment
grade ratings for these loans typically result from the overall leverage of the loans, the lack of a strong operating history for
the properties underlying the loans, the borrowers’ credit history, the properties’ underlying cash flow or other factors. As a
result, these loans have a higher risk of default and loss than conventional loans. Any loss we incur may reduce
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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 have limited or excluded 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 than it has been historically
because, if we were to sell such assets, we would 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 our 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
funded debt we use to finance our investments at rates that provide a positive net spread. If spreads for such liabilities
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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.
We may invest in senior living facilities, which are subject to various risks that could have a negative impact on our
financial results.
Subject to maintaining our qualification as a REIT, we may invest in senior living facilities. In connection with any such
investment, we expect that we would engage a third party (possibly an affiliate of our manager) to manage the operations of
these facilities, for which we would pay a management fee. The income from any senior living facilities would be
dependent on the ability of the managers of such facilities to successfully manage these properties. The managers would
compete with other companies on a number of different levels, including: the quality of care provided, reputation, the
physical appearance of a facility, price and range of services offered, alternatives for healthcare delivery, the supply of
competing properties, physicians, staff, referral sources, location, the size and demographics of the population in
surrounding areas, and the financial condition of tenants and managers. A manager’s inability to successfully compete with
other companies on one or more of the foregoing levels could adversely affect the senior living facility and materially
reduce the income we would receive from an investment in such facility.
In addition, private, federal and state payment programs as well as the effect of laws and regulations may also have a
significant impact on the profitability of such facilities. The failure of a manager to comply with any of these laws could
result in the loss of accreditation, denial of reimbursement, imposition of fines, suspension or decertification from federal
and state healthcare programs, loss of license or closure of the facility. These events, among others, could result in the loss
of part or all of any investment we make in a senior living facility.
Furthermore, the ability to successfully manage a senior living facility depends on occupancy levels. Any senior living
facility in which we invest may have relatively flat or declining occupancy levels due to falling home prices, declining
incomes, stagnant home sales and other economic factors. In addition, the senior housing segment may continue to
experience a decline in occupancy due to the weak economy and the associated decision of certain residents to vacate a
facility and instead be cared for at home. A material decline in occupancy levels and revenues may make it more difficult
for the manager of any senior living facility in which we invest to successfully generate income for us. Alternatively, to
avoid a decline in occupancy, a manager may reduce the rates charged, which would also reduce our revenues and therefore
negatively impact the ability to generate income.
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.
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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 any 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, that 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.
The REIT provisions of the Internal Revenue Code of 1986, as amended, or the Code, limit our ability to hedge. 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. 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 that would cause us to fail the REIT gross income and asset tests.
Accounting for derivatives under U.S. generally accepted accounting principles, or 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, the Financial Accounting Standards Board and other regulatory bodies that
establish the accounting rules applicable to us have recently proposed or enacted a wide array of changes to accounting
rules. Moreover, in the future these regulators may propose additional changes that we do not currently anticipate.
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 protect 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 operations, liquidity or financial
condition.
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Environmental compliance costs and liabilities with respect to 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 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.
Lawsuits, investigations and indemnification claims could result in significant liabilities and reputational harm,
which could materially adversely affect our results of operations, financial condition and liquidity.
From time to time, we may be involved in lawsuits or investigations or receive claims for indemnification. Our efforts to
resolve any such lawsuits, investigations or claims could be very expensive and highly damaging to our reputation, even if
the underlying claims are without merit. We could potentially be found liable for significant damages or indemnification
obligations. Such developments could have a material adverse effect on our business, 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 us as a REIT for federal income tax purposes. Our ability to satisfy the asset
tests depends upon our analysis of the fair market values of our assets, some of which are not susceptible to a precise
determination, and for which we do 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 Internal Revenue Service, or IRS, will not contend that our interests in subsidiaries or other issuers
violate 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 provisions of the Code, we also
would be disqualified from taxation as a REIT for the four taxable years following the year during which we initially
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 (the “NYSE”) 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.
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If we were delisted as a result of losing our REIT status and desired to relist our shares on the NYSE, we 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 us to become a listed company under these
heightened standards. Given current conditions, we might not be able to satisfy the NYSE’s listing standards for a
domestic corporation. As a result, if we were delisted from the NYSE, we might not be able to relist as a domestic
corporation, in which case our common and preferred shares could not trade on the NYSE.
The failure of assets subject to repurchase agreements to qualify as real estate assets could adversely affect our
ability to qualify as a REIT.
We may enter into financing arrangements that are structured as sale and repurchase agreements pursuant to which we
would nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase these
assets at a later date in exchange for a purchase price. Economically, these agreements are financings that are secured by
the assets sold pursuant thereto. We believe that, for purposes of the REIT asset and income tests, we should be treated as
the owner of the assets that are the subject of any such sale and repurchase agreement, notwithstanding that those
agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible,
however, that the IRS could assert that we did not own the assets during the term of the sale and repurchase agreement, in
which case we might fail to qualify as a REIT.
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 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 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, 2010, we had a loss carryforward, inclusive of net operating loss and capital loss, of approximately
$1.05 billion. The net operating loss carryforward and capital loss carryforward can generally be used to offset future
ordinary taxable income and capital gain, for up to twenty years and five years, respectively. As a result, we do not expect
that there will be any REIT distribution requirements for the year ending December 31, 2011, except as described below.
Our ability to utilize net operating loss carryforwards and certain built-in losses to reduce our future taxable income
and related REIT distribution requirements may become limited by provisions of the Code, thereby jeopardizing
our ability to maintain our status as a REIT.
In order to maintain our tax status 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 gains) each year to our
stockholders. To qualify for the tax benefits accorded to REITs, we intend to make distributions to our stockholders such
that we distribute all or substantially all our net taxable income (if any) each year, subject to certain adjustments. However,
our ability to meet this distribution requirement and maintain our status as a REIT may be adversely affected if certain
provisions of the Code prevent us from utilizing our net operating loss carryforwards and certain built-in losses to reduce
our taxable income, thereby increasing both our taxable income and the related REIT distribution requirement to a level that
we are unable to satisfy. Specifically, the Code limits the ability of a company that undergoes an “ownership change” to
utilize its net operating loss carryforwards and certain built-in losses to offset taxable income earned in years after the
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ownership change. An ownership change occurs if, during a three-year testing period, more than 50% of the stock of a
company is acquired by one or more persons (or certain groups of persons) who own, directly or constructively, 5% or
more of the stock of such company. An ownership change can occur as a result of a public offering of stock, as well as
through secondary market purchases of our stock and certain types of reorganization transactions.
Generally, if an ownership change occurs, the annual limitation on the use of net operating loss carryforwards and certain
built-in losses is equal to the product of the applicable long-term tax exempt rate and the value of the company’s stock
immediately before the ownership change. If we were to undergo an ownership change as a result of a stock offering or
otherwise, depending on the aggregate value of our stock and the level of the applicable federal tax rate at the time of the
ownership change, we might be unable to use our net operating loss carryforwards and built-in losses to offset our taxable
income, and we would therefore be required to distribute larger amounts to our stockholders in order to maintain our status
as a REIT. No assurance can be given that we will be able to satisfy our distribution requirement following an ownership
change or otherwise. If we were to fail to satisfy our distribution requirement, it 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.
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 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 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 effect 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 would, in turn, increase the
amount of income we would be required to distribute to shareholders in order to maintain our REIT status. We expect that
this disconnect will 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, 2011, no such cancellation of CDO debt had been effected
as a result of losses incurred. However, we expect that such cancellation of indebtedness within our CDOs, consolidated or
non-consolidated, may occur in the future. In the case of our subprime securitizations, $32.3 million of such cancellations
had been effected through December 31, 2011, and we expect such cancellations will continue as losses are realized. This
disconnect could also occur, and has occurred, 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 and 2010, we repurchased
$787.8 million face amount of our outstanding CDO debt and junior subordinated notes at a discount, and recorded $521.1
million of gain. In compliance with tax laws, we had the ability to defer the ordinary income recorded as a result of this
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 on 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. During the year ended
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December 31, 2011, we repurchased $193.2 million face amount of our outstanding CDO debt and notes payable at a
discount and recorded $82.2 million of gain for tax purposes (of which only $66.1 million gain relating to $171.8 million
face amount of debt repurchased was recognized for GAAP purposes). 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.
When we experience any of these disconnects, and to the extent that a distribution through stock dividends is not viable, 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 might 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 of our net taxable income each year, subject to certain adjustments. However, our ability to make
distributions may be adversely affected by the risk factors described herein, particularly in light of current market
conditions. In the event of a sustained downturn in our operating results and financial performance relative to previous
periods or sustained 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, a portion 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 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 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 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
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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 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 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 were due to reasonable cause, we might incur a penalty tax.
The “taxable mortgage pool” rules may increase the taxes that we or our stockholders may incur, and may limit the
manner in which we effect future securitizations.
Certain of our securitizations have resulted in the creation of taxable mortgage pools for federal income tax purposes. As a
REIT, so long as we own 100% of the equity interests in a taxable mortgage pool, we would generally not be adversely
affected by the characterization of the securitization as a taxable mortgage pool. Certain categories of stockholders,
however, such as foreign stockholders eligible for treaty or other benefits, stockholders with net operating losses, and
certain tax-exempt stockholders that are subject to unrelated business income tax, could be subject to increased taxes on a
portion of their dividend income from us that is attributable to the taxable mortgage pool. In addition, to the extent that our
stock is owned by tax-exempt “disqualified organizations,” such as certain government-related entities and charitable
remainder trusts that are not subject to tax on unrelated business income, we could incur a corporate level tax on a portion
of our income from the taxable mortgage pool. In that case, we might 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.
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.
The SEC recently solicited public comment on a wide range of issues relating to Section 3(c)(5)(C) of the Investment
Company Act, including the nature of the assets that qualify for purposes of the exemption and whether mortgage REITs
should be regulated in a manner similar to investment companies. There can be no assurance that the laws and regulations
governing the Investment Company Act status of REITs, or SEC guidance regarding these exemptions, will not change in a
manner that adversely affects our operations. If the SEC takes action that could result in our or our subsidiaries’ failure to
maintain an exception or exemption from the Investment Company Act, we could, among other things, be required either to
(a) change the manner in which we conduct our operations to avoid being required to register as an investment company,
(b) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (c) register as
an investment company (which, among other things, would require us to comply with the leverage constraints applicable to
investment companies), any of which could negatively affect the value of our common stock, the sustainability of our
business model, and our ability to make distributions to our shareholders, which could, in turn, materially and adversely
affect us and the market price of our shares.
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 the Employee Retirement Income Security Act of 1974, as
amended, or ERISA, including whether such investment might constitute or give rise to a prohibited transaction under
ERISA, the Code or any substantially similar federal, state or local law and, if so, whether an exemption from such
prohibited transaction rules is available.
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Maryland takeover statutes may prevent a change of our control, which 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:
(cid:120)
(cid:120)
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:
(cid:120)
(cid:120)
80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation voting
together as a single group; and
two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held
by the interested stockholder with whom or with whose affiliate the business combination is to be effected or
held by an affiliate or associate of the interested stockholder voting together as a single voting group.
The business combination statute may discourage others from trying to acquire control of us and increase the difficulty of
consummating any offer, including potential acquisitions that might involve a premium price for our common stock or
otherwise be in the best interest of our stockholders.
Our authorized, but unissued common and preferred stock may prevent a change in our control.
Our charter authorizes us to issue additional authorized but unissued shares of our common stock or preferred stock. In
addition, our board of directors may classify or reclassify any unissued shares of our 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 ensure 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 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.
34
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:
(cid:120) market conditions in the broader stock market in general, or in the REIT or real estate industry in particular;
(cid:120)
our ability to make investments with attractive risk-adjusted returns, including, without limitation,
investments in excess MSRs or senior living facilities;
(cid:120) 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;
(cid:120)
(cid:120)
(cid:120) market perception or media coverage of our manager or its affiliates;
actions by rating agencies;
(cid:120)
short sales of our common stock;
(cid:120)
issuance of new or changed securities analysts’ reports or recommendations;
(cid:120)
(cid:120) media coverage of us, other REITs or the outlook of the real estate industry;
(cid:120) major reductions in trading volumes on the exchanges on which we operate;
(cid:120)
(cid:120)
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.
(cid:120)
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 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,
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.
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, a portion of the
required amount in the form of shares of our common stock 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.
We do not currently have unpaid accrued dividends on our preferred shares. However, to the extent we do, 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.
35
We may in the future choose to pay dividends in our own stock, in which case you could be required to pay income
taxes in excess of the cash dividends you receive.
We may in the future distribute taxable dividends that are payable in cash and shares of our common stock at the election of
each stockholder. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend
as ordinary income to the extent of our current and accumulated earnings and profits for federal income tax purposes. As a
result, stockholders may be required to pay income taxes with respect to such dividends in excess of the cash dividends
received. If a U.S. stockholder sells the stock that it receives as a dividend in order to pay this tax, the sale proceeds may be
less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time
of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. tax with
respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a
significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on
dividends, it may put downward pressure on the trading price of our common stock.
It is unclear whether and to what extent we will be able to pay taxable dividends in cash and stock. Moreover, various
aspects of such a taxable cash/stock dividend are uncertain and have not yet been addressed by the IRS. No assurance can
be given that the IRS will not impose additional requirements in the future with respect to taxable cash/stock dividends,
including on a retroactive basis, or assert that the requirements for such taxable cash/stock dividends have not been met.
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 105,181,009 shares of common stock were outstanding as of December 31,
2011. 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.
Item 1B. Unresolved Staff Comments
We have no unresolved staff comments received more than 180 days prior to December 31, 2011.
Item 2. Properties.
As of December 31, 2011, 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. Mine Safety Disclosures
None.
36
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.
2011
High
Low
Last Sale
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
$8.85
$6.48
$6.65
$5.12
$5.82
$4.18
$4.05
$3.56
$6.04
$5.78
$4.07
$4.65
2010
High
Low
Last Sale
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
$3.35
$4.18
$3.20
$7.10
$1.75
$2.00
$2.24
$3.02
$3.23
$2.68
$3.10
$6.70
Distributions
Declared
$
-
$
0.10
$
0.15
$
0.15
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.
On February 22, 2012, the closing sale price for our common stock, as reported on the NYSE, was $5.48. As of February
22, 2012, there were approximately 73 record holders of our common stock. This figure does not reflect the beneficial
ownership of shares held in nominee name.
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, 2011.
Number of Securities to be
Issued Upon Exercise of
Outstanding Options
Weighted Average
Exercise Price of
Outstanding Options
Number of Securities
Remaining Available for Future
Issuance Under Equity
Compensation Plans
Plan Category
Equity C ompe nsation Plans Approve d
by Se curity Holde rs:
Newcastle Investment Corp. Nonqualified
Stock Option and Incentive Award Plan
6,813,109 (1)
$13.02
2,013,533 (2)
Equity C ompe nsation Plans Not Approve d
by Se curity Holde rs:
None
N/A
N/A
N/A
(1)
(2)
Includes options for (i) 5,998,947 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 16,000 shares granted to 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 and no award shall be granted on or after June 6, 2012 (but awards
granted may extend beyond this date). The number of securities remaining available for future issuance is net of an aggregate of
130,240 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 2011, 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.
37
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, 2011 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
Impairment (Reversal)
2011
Year Ended December 31,
2009
2008
2010
2007
$
292,296
138,035
154,261
$
300,272
172,219
128,053
$
361,866
218,410
143,456
$
468,867
307,303
161,564
$
680,535
476,932
203,603
677
(240,858)
548,540
2,991,830
220,321
Net interest income (loss) after impairment / reversal
153,584
368,911
(405,084)
(2,830,266)
(16,718)
Other Income (Loss)
Expenses
135,790
30,233
282,287
29,528
227,399
31,901
(112,809)
32,623
(8,885)
39,724
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
259,141
306
259,447
(5,580)
621,670
(8)
621,662
(7,453)
(209,586)
(318)
(209,904)
(13,501)
(2,975,698)
(9,654)
(2,985,352)
(13,501)
(65,327)
(130)
(65,457)
(12,640)
-
253,867
$
43,043
657,252
$
-
(223,405)
$
-
$
(2,998,853)
-
(78,097)
$
Income (loss) per share of common stock, diluted
$
3.09
$
10.96
$
(4.23)
$
(56.81)
$
(1.52)
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
$
3.09
$
10.96
$
(4.22)
$
(56.63)
$
(1.52)
outstanding, diluted
81,990
59,949
52,864
52,785
51,369
Dividends declared per share of common stock
$
0.40
$
-
$
-
$
0.75
$
2.85
38
Balance S heet Data
Non-Recourse VIE Financing Structures
Real estate securities, available-for-sale
Real estate related loans, held-for-sale, net
Residential mortgage loans, held-for-investment, net
Residential mortgage loans, held-for-sale, net
Other investments
Restricted cash
Total assets
Total debt
Total liabilities
Recourse Financing Structures and Unlevered Assets
Real estate securities, available-for-sale
Real estate related loans, held-for-sale, net
Residential mortgage loans, held-for-sale, net
Investments in excess mortgage servicing rights at fair value
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
S upplemental Balance S heet Data
Common shares outstanding
Book value (deficit) per share of common stock
Other Data
Core earnings (1)
2011
2010
As Of December 31,
2009
2008
2007
$
1,479,214
807,214
331,236
-
18,883
105,040
3,179,324
3,015,251
3,150,683
$
1,859,984
750,130
124,974
252,915
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
252,530
6,366
2,687
43,971
6,024
157,356
-
472,475
284,442
309,027
600
32,475
298
-
6,024
33,524
-
74,378
55,936
59,515
46,308
19,495
3,524
-
-
68,300
-
155,751
174,573
183,603
196,495
146,689
3,367
-
-
49,746
6,799
423,088
376,572
392,847
1,328,071
438,596
104,630
-
-
55,916
67,548
2,073,992
1,636,487
1,726,229
3,651,799
3,299,693
3,459,710
130,506
61,583
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
8,037,770
7,391,694
7,590,145
295,125
152,500
105,181
1.24
$
62,027
(4.98)
$
52,913
(33.89)
$
52,789
(48.23)
$
52,779
5.59
$
$
118,448
$
91,072
$
98,054
$
115,440
$
151,239
(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, derivatives and debt obligations, including impairment. “Core earnings,”
which was referred to as “Net Interest Income Less Expenses (Net of Preferred Dividends)” in our prior filings, is a non-GAAP measure of the
operating performance of Newcastle that excludes the fifth variable listed above and is equal to net interest income less expenses and preferred
dividends. 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 this measure as Newcastle’s “core” current earnings, while gains and losses (including impairment)
are simply a potential indicator of future earnings. Management believes that this measure 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.
Core earnings 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
activities and net income, see Part II, Item 7, “Management’s Discussed Analysis of Financial Condition and Results of Operations – Liquidity
and Capital Resources” below. Our calculation of core earnings may be different from the calculation used by other companies and, therefore,
comparability may be limited. Set forth below is a reconciliation of core earnings to the most directly comparable GAAP financial measure.
39
Calculation of core earnings:
Income (loss) applicable to common stockholders
Add (deduct):
Impairment (reversal)
Other (income) loss
(Income) loss from discontinued operations
Excess of carrying amount of exchanged preferred
stock over fair value of consideration paid
Core earnings
Year Ended December 31,
2011
2010
2009
2008
2007
$
253,867
$
657,252
$
(223,405)
$
(2,998,853)
$
(78,097)
677
(135,790)
(306)
(240,858)
(282,287)
8
548,540
(227,399)
318
2,991,830
112,809
9,654
220,321
8,885
130
-
118,448
$
(43,043)
91,072
$
-
98,054
$
-
115,440
$
-
151,239
$
40
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, excess mortgage servicing rights (“excess MSRs”) 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, our operating results and book value improved meaningfully during 2011.
We currently own a diversified portfolio of credit sensitive real estate debt investments, including securities, loans and
excess MSRs. 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
of December 31, 2011, we had complied with the general investment guidelines adopted by our board of directors that limit
total leverage. We utilize leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on
changes in interest rates.
We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential
fluctuations in the availability of capital. We seek to utilize multiple forms of financing including collateralized debt
obligations (CDOs), other securitizations, term loans, and trust preferred securities, as well as short term financing in the
form of loans and repurchase agreements. As we discuss in more detail under “– Market Considerations” below, while
market conditions have improved meaningfully since 2008, the current conditions continue to reduce the array of capital
resources available to us and have made the terms of capital resources we are able to obtain generally less favorable to us
relative to the terms we were able to obtain prior to the onset of challenging conditions. Specifically, the economic
environment and capital markets have become volatile in the latter half of 2011. That said, we have recently been able to
access more types of capital – and on better terms – than we had been able to access during 2008 and 2009.
We seek to match fund our investments with respect to interest rates and maturities in order to reduce the impact of interest
rate fluctuations on earnings and reduce the risk of refinancing our liabilities prior to the maturity of the investments. We
seek to finance a substantial portion of our real estate securities and loans through the issuance of term debt, which
generally represents obligations issued in multiple classes secured by an underlying portfolio of assets. Specifically, our
CDO financings offer us the structural flexibility to buy and sell certain investments to manage risk and, subject to certain
limitations, to optimize returns.
We conduct our business through the following segments: (i) investments financed with non-recourse collateralized debt
obligations (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered
CDOs”), (iii) unlevered excess MSRs, (iv) investments financed with other non-recourse debt (“non-recourse other”), (v)
investments and debt repurchases financed with recourse debt (“recourse”), (vi) other unlevered investments (“unlevered
other”) and (vii) corporate. With respect to the non-recourse CDOs and non-recourse other segments, Newcastle is
generally entitled to receive net cash flows from these structures on a periodic basis. Revenues attributable to each segment,
as restated for previously reported periods, are disclosed below (in thousands).
For the Year Ended
CDOs
CDOs
Non-Recourse Unlevered
Unlevered
Excess MSRs
Non-Recourse
Other
Recourse
Unlevered
Other
Corporate
Inter-segment
Elimination
T otal
December 31, 2011
$
218,131
$
344
$
1,260
$
73,364
$
2,234
$
2,636
$
167
$
(5,840)
$
292,296
December 31, 2010
$
226,717
$
-
$
-
$
72,773
$
976
$
1,653
$
68
$
(1,915)
$
300,272
December 31, 2009
$
275,938
$
-
$
-
$
76,868
$
7,416
$
1,543
$
101
$
-
$
361,866
41
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. A portion of the REIT distribution requirements may be able to be satisfied 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 our ability to do this 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 and continued to tighten in 2010 and the first half of 2011.
However, credit spreads have widened in the second half of 2011, reflecting the currently challenging economic
environment. These changes in credit spreads caused the net unrealized losses on our securities and derivatives to decrease
from 2009 through early 2011 and became net unrealized gains. However, this trend reversed during the second half of
2011. Market conditions remain challenging, could change rapidly, and we cannot predict how recent or future changes in
market conditions will affect our business.
We utilize multiple forms of financing, depending on their appropriateness and availability, to finance our investments,
including collateralized debt obligations (CDOs) or other securitizations, private or public offerings of debt, term loans,
trust preferred securities, and short-term financing in the form of loans and repurchase agreements. One component of our
investment strategy is to use match funded financing structures, such as CDOs, at rates that provide a positive net spread
relative to our investment returns.
Recent conditions in the credit markets have impaired our ability to match fund investments. During the past two years,
financing in the form of securitizations or other long-term non-recourse structures not subject to margin requirements was
generally not available or economical, and it remains difficult to obtain under current market conditions. Lenders have
generally tightened their underwriting standards and increased their margin requirements, resulting in a decline in the
42
overall amount of leverage available to us and an increase in our borrowing costs. These conditions make it highly likely
that we will have to use less efficient forms of financing for any new investments, which will likely require a larger portion
of our cash flows to be put toward making the initial investment and thereby reduce the amount of cash available for
distribution to our stockholders and funds available for operations and investments, and which will also likely require us to
assume higher levels of risk when financing our investments. Moreover, financial market conditions remain volatile and
have been adversely affected by the unrest in the Middle East, the earthquake in Japan, the European financial crisis,
continuing weakness in the U.S. job market and concern about the United States’ level of indebtedness. Volatility in equity
markets could impair our ability to raise debt or equity capital or otherwise finance our business.
We believe that the current environment has created an attractive opportunity to invest in MSRs. Specifically:
(cid:120)
(cid:120)
changes in the regulatory treatment of MSRs for financial institutions subject to Basel III, a revision to the global
regulatory capital and liquidity framework for banks, which will impose increased regulatory capital costs on
banks for owning MSRs;
elevated borrower delinquencies and defaults experienced over the last few years, and increased regulatory
oversight, has led to substantially higher costs for mortgage servicers and negatively impacted their profitability;
and
(cid:120) mortgage servicing has become less attractive to many financial institutions due to increasingly negative publicity
and heightened government and regulatory scrutiny.
These dynamics resulted in a pipeline of MSRs for sale by banks and non-bank servicers, as these institutions are under
pressure to exit or reduce their exposure to the mortgage servicing business. As a result, we believe that this relative
oversupply of MSRs, combined with a historically low interest rate environment and a challenging credit market, have
contributed to an availability of MSRs that are attractively priced. We closed on our first investment in excess MSRs in
December 2011 and are exploring opportunities to acquire additional MSRs that provide attractive risk-adjusted returns.
Liquidity
Credit and liquidity conditions improved during 2010 and 2011. The onset of the challenging credit and liquidity conditions
during the financial crisis have adversely affected us and the markets in which we operate in a number of ways. For
example, these conditions have reduced the market trading activity for many real estate securities and loans, resulting in
less liquid markets for those securities and loans. As the securities held by us and many other companies in our industry
are marked to market at the end of each quarter, the decreased liquidity and concern over market conditions have resulted in
significant reductions in mark to market valuations of many real estate securities and loans and the collateral underlying
them, as well as volatility and uncertainty with respect to such valuations. These lower valuations, and decreased
expectations of future cash flows, have affected us by, among other things:
(cid:120)
(cid:120)
(cid:120)
decreasing our net book value;
contributing to our decision to record significant impairment charges; and
reducing the amount, which we refer to as “cushion,” by which we satisfy the over collateralization and interest
coverage tests of our CDOs (sometimes referred to as CDO “triggers”) or contributing to several of our CDOs
failing their over collateralization tests (see “– Liquidity and Capital Resources” and “– Debt Obligations”
below).
Failed CDO triggers, impairments resulting from incurred losses, and asset sales made at prices significantly below face
amount while the related debt is being repaid at its full face amount, as well as the retention of cash, could further
contribute to reductions in future earnings, cash flow and liquidity.
With respect to dividends, we have paid all dividends on our preferred stock through January 31, 2012. In order to maintain
liquidity, we elected not to declare any dividends on our common stock from late 2008 through early 2011. However, based
on the above described improvements in the markets over the last two years, and the corresponding improvement in our
financial condition and liquidity, we elected to declare a quarterly dividend of $0.10 per common share for the second
quarter of 2011, and a quarterly dividend of $0.15 per common share for each of the third and fourth quarters of 2011.
Dividends on our common shares are paid at the beginning of the quarter succeeding the quarter to which they relate. 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 few years, but it is not clear whether a sustained recovery will
occur or, if so, for how long it will last. We do not currently know the full extent to which the continuing challenging
43
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 completed 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 - 2006
2007
2008
2009
2010
2011
December 31, 2011
45,713,817
7,065,362
9,871
123,463
9,114,671
43,153,825
105,181,009
$27.75-$31.30
N/A
N/A
$3.13
$4.55 - $6.00
$201.3
$0.1
$0.1
$28.5
$210.8
(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, 2011, approximately 4.8 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 6.0
million shares of our common stock at December 31, 2011.
Application of Critical Accounting Policies
Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated
financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles
(“GAAP”). The preparation of financial statements in conformity with GAAP requires the use of estimates and
assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities
and the reported amounts of revenue and expenses. Actual results could differ from these estimates. Management believes
that the estimates and assumptions utilized in the preparation of the consolidated financial statements are prudent and
reasonable. Actual results historically have been in line with management’s estimates and judgments used in applying each
of the accounting policies described below, as modified periodically to reflect current market conditions. 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
by its primary beneficiary, which is defined as the party who has the power to direct the activities of a VIE that most
significantly impact its economic performance and who has the obligation to absorb losses or the right to receive benefits
from the VIE that could potentially be significant to the VIE.
The VIEs in which we have a significant interest include (i) our CDOs, and (ii) our manufactured housing loan financing
structures. Our CDOs were all consolidated under prior guidance; however, under current guidance, which became
effective January 1, 2010, we do not have the power to direct the relevant activities of CDO V, as a result of an event of
default which allows us to be removed as collateral manager of this CDO and prevents us from purchasing or selling certain
collateral within this CDO, and therefore we have deconsolidated this CDO as of June 17, 2011. Similar events of default in
the future, if they occur, could cause us to deconsolidate additional financing structures. Our manufactured housing loan
financing structures were consolidated under prior guidance and continue to be consolidated under the current guidance.
However, we completed two securitization transactions to refinance our Manufactured Housing Loans Portfolios I and II.
We analyzed the securitizations under the applicable accounting guidance and concluded that the securitization transactions
44
should be accounted for as secured borrowings. As a result, we continue to recognize the portfolios of manufactured
housing loans as pledged assets, which have been classified as loans held-for-investment at securitization, and recorded the
notes issued to third parties as secured borrowings.
Our subprime securitizations are also considered VIEs, but we do not control their activities and no longer receive a
significant portion of their returns. 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, 2011, we have not consolidated these
potential VIEs due to the determination that, based on the nature of our 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.
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, 2011.
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 $1.5 billion carrying value of securities valued using quotations
as of December 31, 2011, a 100 basis point change in credit spreads would impact estimated fair value by approximately
$50.7 million.
45
Our estimation of the fair value of level 3B assets (as described below) involves significant judgment. We validated the
inputs and outputs of our models by comparing them to available independent third party market parameters and models for
reasonableness. We believe the assumptions we used are within the range that a market participant would use and factor in
the liquidity conditions currently in the markets. In comparison to the prior year end, we have generally used lower
discount rates as inputs to our models for ABS and CMBS-large loan/single borrower securities in order to reflect current
market conditions. The other inputs to our models, including prepayment speeds, 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.
Similar changes to assumptions were made in 2010. In 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 CMBS and ABS securities valued with internal models, which have an aggregate fair value of $249.5 million as of
December 31, 2011, 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
ABS
$
374,030
$
162,617
$
180,100
$
69,400
$
$
$
(6,637)
N/A
(8,016)
(7,117)
$
$
$
$
(2,594)
(791)
(5,382)
(8,668)
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.
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,
46
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, 2011, we had 80 securities with a carrying amount of $243.8 million that had been downgraded during
2011 and recorded a net other-than-temporary impairment charge of $1.7 million on these securities in 2011. 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
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
manufactured housing loans, are aggregated into pools for evaluation based on like characteristics, such as loan type and
acquisition date. Individual loans are evaluated based on an analysis of the borrower’s performance, the credit rating of the
borrower, debt service coverage and loan to value ratios, the estimated value of the underlying collateral, the key terms of
the loan, and the effect of local, industry and broader economic trends and factors. Pools of loans are also evaluated based
on similar criteria, including historical and anticipated trends in defaults and loss severities for the type and seasoning of
loans being evaluated. This information is used to estimate specific impairment charges on individual loans as well as
provisions for estimated unidentified incurred losses on pools of loans. Significant judgment is required both in determining
impairment and in estimating the resulting loss allowance. Furthermore, we must assess our intent and ability to hold our
47
loan investments on a periodic basis. If we do not have the intent to hold a loan for the foreseeable future or until its
expected payoff, the loan must be classified as “held for sale” and recorded at the lower of cost or estimated value.
Revenue Recognition on Loans Held for Investment
Income on these loans is recognized similarly to that on our securities and is subject to similar uncertainties and
contingencies, which are also analyzed on at least a quarterly basis. For loans acquired at a discount for credit losses, the
net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income,
offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Valuation Allowance. The
provision is determined based on an evaluation of the loans as described under “– Impairment of Loans” above. 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 Investments in Excess Mortgage Servicing Rights
Investments in excess MSRs are aggregated into pools as applicable; each pool of excess MSRs is accounted for in the
aggregate. Excess MSRs are accreted into interest income on an effective yield or “interest” method, based upon the
expected excess servicing income through the expected life of the underlying mortgages. Changes to expected cash flows
result in a cumulative retrospective adjustment, which will be recorded in the period in which the change in expected cash
flows occurs. Under the retrospective method, the interest income recognized for a reporting period would be measured as
the difference between the amortized cost basis at the end of the period and the amortized cost basis at the beginning of the
period, plus any cash received during the period. The amortized cost basis is calculated as the present value of estimated
future cash flows using an effective yield, which is the yield that equates all past actual and current estimated future cash
flows to the initial investment. In addition, our policy is to recognize interest income only on excess MSRs in existing
eligible underlying mortgages. The difference between the fair value of excess MSRs and their amortized cost basis is
recorded as “Other Income” or “Other Losses”, as applicable. Fair value is generally determined by discounting the
expected future cash flows using discount rates that incorporate the market risks and liquidity premium specific to the
excess MSRs, and therefore may differ from their effective yields.
For excess MSRs valued with internal models as of December 31, 2011, a 10% unfavorable change in our assumptions
would result in the following decreases in fair value (in thousands):
Fair value
Effect on fair value with 10% unfavorable change in:
Discount rate
Prepayment rate
Constant default rate
Delinquency rate
Recapture rate
$
43,971
$
$
$
$
$
(1,892)
(1,799)
(500)
(481)
(1,086)
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.
Revenue Recognition on Loans Held for Sale
Real estate related, commercial mortgage and residential mortgage loans that are considered held for sale are carried at the
lower of amortized cost or market value determined on either an individual method basis, or in the aggregate for pools of
similar loans. Interest income is recognized based on the loan’s coupon rate to the extent management believes it is
collectable. Purchase discounts are not amortized as interest income during the period the loan is held for sale. A change in
the market value of the loan, to the extent that the value is not above the 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.”
48
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 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 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 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.
In May 2011, the FASB issued new guidance regarding the measurement and disclosure of fair value, which will become
effective for us on January 1, 2012. We have not yet completed our assessment of the potential impact of this guidance.
In June 2011, the FASB issued a new accounting standard that eliminates the current option to report other comprehensive
income and its components in the statement of stockholders’ equity. Instead, an entity will be required to present items of
net income and other comprehensive income in one continuous statement or in two separate, but consecutive,
statements. We have early-adopted this accounting standard and have opted to present two separate statements.
The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, the definition
of an investment company, financial statement presentation, revenue recognition, leases, financial instruments, hedging,
and contingencies. Some of the proposed changes are significant and could have a material impact on Newcastle’s
reporting. Newcastle has not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as
the standards are finalized.
49
Results of Operations
The following tables summarize 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, 2011 and 2010
Interest income
Interest expense
Net interest income
Impairment
Year Ended December 31,
$
2011
292,296
138,035
154,261
$
2010
300,272
172,219
128,053
$
Amount
Increase (Decrease)
%
(2.7%)
(19.8%)
20.5%
(7,976)
(34,184)
26,208
Valuation allowance (reversal) on loans
Other-than-temporary impairment on securities, net
(15,163)
15,840
677
(339,887)
99,029
(240,858)
324,724
(83,189)
241,535
Net interest income (loss) after impairment
153,584
368,911
(215,327)
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
M anagement fee to affiliate
78,181
66,110
(8,501)
135,790
4,649
7,295
18,289
30,233
52,307
265,656
(35,676)
282,287
4,580
7,696
17,252
29,528
25,874
(199,546)
27,175
(146,497)
69
(401)
1,037
705
95.5%
(84.0%)
100.3%
(58.4%)
49.5%
(75.1%)
76.2%
(51.9%)
1.5%
(5.2%)
6.0%
2.4%
Income (loss) from continuing operations
$
259,141
$
621,670
$
(362,529)
(58.3%)
Interest Income
Interest income decreased by $8.0 million during the year ended December 31, 2011 compared to the year ended December
31, 2010 primarily due to (i) a $12.6 million decrease in interest income as a result of the deconsolidation of CDO V in
June 2011, (ii) a $6.6 million decrease in prepayment penalties we received as a result of the lower volume of the
prepayment of securities and loans in the year ended December 31, 2011, offset by (iii) an $11.2 million increase in interest
income as a result of new investments made, partially offset by paydowns and changes in interest rates.
Interest Expense
Interest expense decreased by $34.2 million primarily due to (i) a $7.6 million decrease in interest expense attributable to
the deconsolidation of CDO V, (ii) a $5.8 million decrease in interest expense on debt as a result of the paydowns and
repurchases of our CDO debt obligations, (iii) a $16.6 million decrease in interest expense on derivatives as a result of the
termination of interest rate swaps, decreases in swap notional amounts and changes in interest rates and (iv) a $6.5 million
decrease in the amortization of deferred hedge losses. The decreases described in (i) to (iv) above were partially offset by a
$2.3 million increase in interest expense on other bonds payable and repurchase agreements due to the refinancing of our
manufactured housing loan portfolios and a higher outstanding balance of repurchase agreement financing on our
FNMA/FHLMC securities.
Valuation Allowance (Reversal) on Loans
The valuation allowance (reversal) on loans changed by $324.7 million primarily due to (i) a significantly larger net
increase in fair values, by $278.0 million, on our real estate related loans during the year ended December 31, 2010
compared to the year ended December 31, 2011 as a result of market conditions improving more in the 2010 period than in
the 2011 period and (ii) a larger net reversal of valuation allowance on our manufactured housing loans and residential
mortgage loans, by $46.7 million, in the 2010 period compared to 2011 period due to the reclassification of our
manufactured housing loan portfolio I, manufactured housing loan portfolio II and residential mortgage loans from held-
for-sale to held-for-investment in April 2010, May 2011 and September 2011, respectively. This change in fair values and
the reclassification impacted the amount of valuation allowance we were able to reverse during those periods.
50
In addition, the reversal of previously established valuation allowances will likely decline over time as the reversal is
subject to (i) a continued improvement in loan valuations and (ii) the amount of previously established allowances that have
not yet been reversed.
Other-than-temporary Impairment on Securities, Net
The other-than-temporary impairment on securities decreased by $83.2 million primarily due to improved market
conditions. We recorded an impairment charge of $15.8 million on 30 securities during the year ended December 31, 2011,
compared to an impairment charge of $99.0 million on 115 securities during the year ended December 31, 2010.
Gain (Loss) on Settlement of Investments, Net
The net gain on settlement of investments increased by $25.9 million as a result of the increased volume of sales and
repayments of investments. We recorded a net gain of $78.2 million on 95 securities, loans and derivatives that were sold,
paid off or terminated during the year ended December 31, 2011, compared to a net gain of $52.3 million on 65 securities,
loans and derivatives that were sold, paid off or terminated during the year ended December 31, 2010.
Gain (Loss) on Extinguishment of Debt
The gain on extinguishment of debt decreased by $199.5 million due to a lower face amount and a higher average price of
debt repurchased in the year ended December 31, 2011 compared to the year ended December 31, 2010.
We repurchased $171.8 million face amount of our own CDO debt and other bond payable at an average price of 61.2% of
par during the year ended December 31, 2011 compared to $483.7 million face amount of CDO bonds repurchased at an
average price of 44.6% of par during the year ended December 31, 2010.
Other Income (Loss), Net
Other loss decreased by $27.2 million primarily due to (i) a $22.0 million decrease in unrealized losses recognized on
certain interest rate swap agreements, which were de-designated as accounting hedges as the hedged items were no longer
probable of occurring, (ii) a $4.5 million increase in fair value of certain non-hedge derivative instruments and (iii) a $2.0
million increase in management fees, included in Other Income, in 2011 related to our acquisition of the collateral
management rights with respect to certain C-BASS CBOs in February 2011. The decreases in other loss were partially
offset by a $1.5 million increase in hedge ineffectiveness recognized on certain interest rate swap agreements and a $0.2
million increase in other income.
Loan and Security Servicing Expense
Loan and security servicing expense remained relatively stable during the year ended December 31, 2011 compared to the
year ended December 31, 2010.
General and Administrative Expense
General and administrative expense decreased by $0.4 million primarily due to a $0.9 million decrease in directors and
officers liability insurance expense, offset by a net $0.5 million increase in legal and professional fees due to the acquisition
of excess MSRs investments and public offerings in the year ended December 31, 2011.
Management Fee to Affiliate
Management fees increased by $1.0 million during the year ended December 31, 2011 compared to the year ended
December 31, 2010 due to a net increase in gross equity as a result of our public offerings of common stock in March 2011
and September 2011, partially offset by the return of capital distributions made on our preferred stock in 2010.
51
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
$
Amount
Increase (Decrease)
%
(17.0%)
(21.1%)
(10.7%)
(61,594)
(46,191)
(15,403)
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
M anagement 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)
N.M
N.M
N.M
N.M
357.3%
23.4%
N.M
24.1%
(9.0%)
(13.5%)
(4.0%)
(7.4%)
Income (loss) from continuing operations
$
621,670
$
(209,586)
$
831,256
396.6%
N.M. - Not meaningful
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 $10.7
million 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.
52
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.
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.
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 2011 and that a portion of this requirement may be able to be met in future years
through stock dividends, rather than cash, subject to limitations based on the value of our stock. Our primary sources of
funds for liquidity consist of net cash provided by operating activities, sales or repayments of investments, potential
refinancing of existing debt, and the issuance of equity securities, when feasible. We have an effective shelf registration
statement with the SEC, which allows us to issue common stock, preferred stock, depository shares, debt securities and
warrants. Our debt obligations are generally secured directly by our investment assets, except for the junior subordinated
notes payable.
53
Sources of Liquidity and Uses of Capital
As of the date of this filing, we have sufficient liquid assets, which include unrestricted cash and FNMA/FHLMC
securities, to satisfy all of our short-term recourse liabilities. Our junior subordinated notes payable are long-term
obligations. With respect to the next twelve months, we expect that our cash on hand combined with our cash flow provided
by operations will be sufficient to satisfy our anticipated liquidity needs with respect to our current investment portfolio,
including related financings, hedging activity, potential margin calls and operating expenses. While it is inherently more
difficult to forecast beyond the next twelve months, we currently expect to meet our long-term liquidity requirements,
specifically the repayment of our recourse debt obligations, through our cash on hand and, if needed, additional borrowings,
proceeds received from repurchase agreements and similar financings, and the liquidation or refinancing of our assets.
These short-term and long-term expectations are forward-looking and subject to a number of uncertainties and assumptions,
which are described below under “–Factors That Could Impact Our Liquidity, Capital Resources and Capital Obligations”
as well as Part I, Item 1A, “Risk Factors.” If our assumptions about our liquidity prove to be incorrect, we could be subject
to a shortfall in liquidity in the future, and this short-fall may occur rapidly and with little or no notice, which would limit
our ability to address the shortfall on a timely basis.
Cash flow provided by operations constitutes a critical component of our liquidity. Essentially, our cash flow provided by
operations is equal to (i) the net cash flow from our CDOs that have not failed their over collateralization or interest
coverage tests, plus (ii) the net cash flow from our non-CDO investments that are not subject to mandatory debt repayment,
including 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 gains or 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 on Liquidity, Capital Resources and Capital Obligations
Certain details regarding our liquidity, current financings and capital obligations as of February 29, 2012 are set forth
below:
(cid:120)
Cash – We had a total of $285.5 million of cash, comprised of $152.1 million of unrestricted cash and $133.4
million of restricted cash held for reinvestment in our CDOs;
(cid:120) Margin Exposure and Recourse Financings – We have margin exposure on a $7.8 million repurchase agreement
related to the financing of the Newcastle Class I-MM notes (of which only $1.9 million is recourse) and a $227.7
million repurchase agreement related to the financing of FNMA/FHLMC securities.
The following table compares our recourse financings excluding the junior subordinated notes (in thousands):
Recourse Financings
CDO Securities
Non-FNMA/FHLMC recourse financings
FNMA/FHLMC securities
Total recourse financings
February 29, 2012 December 31, 2011 December 31, 2010
4,683
$
4,683
-
4,683
1,946
1,946
227,650
229,596
2,182
2,182
231,012
233,194
$
$
$
$
$
The non-FNMA/FHLMC recourse financings and the FNMA/FHLMC recourse financing will mature in June
2012 and March 2012, 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:
(cid:120)
For a further discussion of recent trends and events affecting our liquidity, see “– Market Considerations” above;
54
(cid:120) As described above, under “– Update on Liquidity, Capital Resources and Capital Obligations,” we are subject to
margin calls in connection with our repurchase agreements;
(cid:120) Our match funded investments are financed long term, and their credit status is continuously monitored, which is
described under "Quantitative and Qualitative Disclosures About Market Risk — Interest Rate Exposure'' below.
Our remaining investments, generally financed with short term debt or short term repurchase agreements, are also
subject to refinancing risk upon the maturity of the related debt. See “– Debt Obligations” below; and
For a further discussion of a number of risks that could affect our liquidity, access to capital resources and our
capital obligations, see Part I, Item 1A, “Risk Factors” above.
(cid:120)
In addition to the information referenced above, the following factors could affect our liquidity, access to capital resources
and our capital obligations. As such, if their outcomes do not fall within our expectations, changes in these factors could
negatively affect our liquidity.
(cid:120)
(cid:120)
(cid:120)
Access to Financing from Counterparties – Decisions by investors, counterparties and lenders to enter into
transactions with us will depend upon a number of factors, such as our historical and projected financial
performance, compliance with the terms of our current credit and derivative arrangements, industry and market
trends, the availability of capital and our investors’, counterparties’ and lenders’ policies and rates applicable
thereto, and the relative attractiveness of alternative investment or lending opportunities. Recent conditions and
events have limited the array of capital resources available to us and made the terms of capital resources we are
able to obtain generally less favorable to us relative to the terms we were able to obtain prior to the onset of
challenging conditions. Our business strategy is dependent upon our ability to finance our real estate securities,
loans and other real estate related assets at rates that provide a positive net spread. Currently, spreads for such
liabilities have widened relative to historical levels and demand for such liabilities remains lower than the demand
prior to the onset of challenging market conditions.
Impact of Rating Downgrades on CDO Cash Flows – Ratings downgrades of assets in our CDOs can negatively
impact compliance with the CDOs’ over collateralization tests. Generally, the over collateralization test measures
the principal balance of the specified pool of assets in a CDO against the corresponding liabilities issued by the
CDO. However, based on ratings downgrades, the principal balance of an asset or of a specified percentage of
assets in a CDO may be deemed to be reduced below their current balance to levels set forth in the related CDO
documents for purposes of calculating the over collateralization test. As a result, ratings downgrades can reduce
the assumed principal balance of the assets used in the over collateralization test relative to the corresponding
liabilities in the test, thereby reducing the over collateralization percentage. In addition, actual defaults of assets
would also negatively impact compliance with the over collateralization tests. Failure to satisfy an over
collateralization test could result in the redirection of cashflows, or, in certain cases, in the potential removal of
Newcastle as collateral manager of the affected CDO. See “– Debt Obligations” below for a summary of assets on
negative watch for possible downgrade in our CDOs.
Impact of Expected Repayment or Forecasted Sale on Cash Flows – The timing of and proceeds from the
repayment or sale of certain investments may be different than expected or may not occur as expected. Proceeds
from sales of assets in the current illiquid market environment are unpredictable and may vary materially from
their estimated fair value and their carrying value.
Investment Portfolio
Our investment portfolio as of December 31, 2011 is detailed in Part I, Item 1, “Business – Our Investment Strategy.”
In December 2011, we made our first investment in excess mortgage servicing rights. We invested $44 million to acquire a
65% interest in the excess mortgage servicing rights of a $9.9 billion residential mortgage portfolio. Nationstar, a leading
residential mortgage servicer that is externally managed by our manager, is the servicer of the loans and invested alongside
Newcastle by acquiring the remaining 35% interest in the excess mortgage servicing rights. To the extent any loans in this
portfolio are refinanced by Nationstar, subject to certain limitations, we are entitled to receive our pro rata share of the
excess mortgage servicing rights of the refinanced loans. We will not have any servicing duties, advance obligations or
liabilities associated with the portfolio.
55
Debt Obligations
Our debt obligations, as summarized in Note 8 to Part II, Item 8, “Financial Statements and Supplementary Data,” existing
at December 31, 2011 (gross of $4.8 million of discounts) had contractual maturities as follows (in thousands):
2012
2013
2014
2015
2016
Thereafter
Total
Nonrecourse
6,546
$
-
-
-
-
3,013,717
3,020,263
$
Recourse
$
$
233,194
-
-
-
-
51,004
284,198
Total
239,740
-
-
-
-
3,064,721
3,304,461
$
$
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.
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, 2011.
The following table provides additional information regarding short-term borrowings. In 2011, these short-term borrowings
were used to finance our investments in FNMA/FHLMC securities and the purchase of certain notes issued by Newcastle
CDO VI. In prior years, 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. The FNMA/FHLMC
repurchase agreements have full recourse to Newcastle and the CDO VI repurchase agreement has recourse to Newcastle
for up to twenty-five percent of the outstanding balance of the repurchase facility, which was approximately $2.2 million as
of December 31, 2011. The weighted average difference between the face amount of assets and the face amount of
available financing for the FNMA/FHLMC repurchase agreements and the CDO VI repurchase agreement were 5% and
40%, respectively, during the year ended December 31, 2011. Margin calls are based on the fair value of the collaterals
(dollars in thousands).
Outstanding
Balance at
December 31,
2011
Repurchase agreements
$
239,740
Three Months Ended December 31, 2011
Year Ended December 31, 2011
Average
Daily
Amount
Outstanding
$
219,987
Maximum
Amount
Outstanding
$
242,074
Weighted
Average
Interest Rate
0.41%
Average
Daily
Amount
Outstanding
$
150,692
Maximum
Amount
Outstanding
$
242,074
Weighted
Average
Interest Rate
0.45%
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). As of December 31, 2011, the equity was valued at zero and the retained notes had a
carrying value of $1.2 million.
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
56
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). As of December 31, 2011, the equity and retained notes had a zero carrying value.
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 2011, we repurchased $171.8 million face amount of CDO bonds and notes payable for $105.2 million and recorded
a gain of $66.1 million. 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.
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
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 (dollars in thousands).
Outstanding face amount
Weighted average coupon
Maturity
Repurchased junior
subordinated notes
$
52,094
7.574% (A)
Cash
$
9,715
N/A
April 2035
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 “2010 Issuer”). The 2010 Issuer 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. 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
57
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. As of December 31, 2011,
the repurchase agreement had an outstanding balance of $8.7 million, which was secured by $29.1 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 $2.2 million as of December 31, 2011. The
repurchase facility matures in June 2012 and bears interest at a rate of LIBOR + 1.75%. 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 2010.
On May 4, 2011, we completed a securitization transaction to refinance Manufactured Housing Loans Portfolio II. We sold
approximately $197.0 million outstanding principal balance of manufactured housing loans to Newcastle Investment Trust
2011-MH 1 (the “2011 Issuer”), an indirect wholly-owned subsidiary of Newcastle. The 2011 Issuer issued approximately
$159.8 million aggregate principal amount of investment grade notes, of which $142.8 million was sold to third parties and
$17.0 million was sold to one of the CDOs managed and consolidated by us. In addition, we retained the below investment
grade notes and residual interest. As a result, we invested approximately $20.0 million of unrestricted cash in the new
securitization structure. The notes issued to third parties had an average expected maturity of 3.8 years and bore interest at
an average rate of 3.23% per annum at issuance. At the closing of the securitization transaction, we used the gross proceeds
received from the issuance of the notes to repay the previously existing debt in full, terminate the related interest rate swap
contracts and pay the related transaction costs. 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. 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 record 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.
During 2011, we purchased $251.5 million principal balance of FNMA/FHLMC securities (primarily one-year ARMs) for
approximately $263.8 million, using $13.5 million of unrestricted cash and financed with $250.3 million of repurchase
agreements. These repurchase agreements have an aggregate outstanding balance of $231.0 million at December 31, 2011,
bear interest at 0.43%, mature in February 2012, and are subject to customary margin provisions.
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, 2011 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 (in thousands).
58
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Includes only CDO bonds issued to third parties and held by Newcastle’s consolidated CDOs.
(1)
(2) Represents net cash received from each CDO based on all of our interests in such CDO (including senior management fees but
excluding principal received from senior CDO bonds owned by Newcastle) for the three months ended December 31, 2011. Cash
receipts for this period included $1.5 million of senior collateral management fees, and may not be indicative of cash receipts for
subsequent periods. Excluded from the quarterly net cash receipts was $8.8 million of unrestricted cash received from principal
repayments on senior CDO bonds owned by Newcastle. This cash represents a return of principal and the realization of the
difference between par and the discounted purchase price of these bonds. See “Cautionary Note Regarding Forward Looking
Statements” for risks and uncertainties that could cause our receipts for subsequent periods to differ materially from these amounts.
(3) Collateral composition is calculated as a percentage of the face amount of collateral and includes CDO bonds of $210.6 million and
other bonds and notes payable of $103.3 million issued by Newcastle, and bank loans of $118.0 million, collateralized by Newcastle
CDO VI bonds, real estate properties and a third party CDO security, which are eliminated in consolidation. The fair value of these
CDO bonds, other bonds and notes payable, and bank loans was $67.8 million, $81.8 million, and $91.9 million at December 31,
2011, respectively. Also reflected are weighted average credit ratings, which were determined by third party rating agencies as of a
particular date, may not be current and are subject to change at any time.
(4) Represents the face amount of collateral on negative watch for possible downgrade by at least one rating agency (Moody’s, S&P, or
Fitch) as of the determination date in December 2011 for CDO IV, as this CDO only reports actual over collateralization excess
percentages on a quarterly basis, and as of the latest determination date in February 2012 for all other CDOs. The amount does not
include any bonds issued by Newcastle, which are eliminated in consolidation and not reflected in our investment portfolio
disclosure.
(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, 2011 or February 29, 2012, as applicable, and may
change or have changed subsequent to that date. CDO IV only reports on a quarterly basis and, therefore, no updated February 2012
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 2011 remittance date for CDO IV and as of the February 2012 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 and cash flows on senior classes of bonds we own). 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 – Risks Relating to our Business – The coverage tests applicable to our CDO financings may have a negative impact on our
operating results and cash flows”.
(6) Represents excess or deficiency under the applicable over collateralization or interest coverage tests to the first threshold at which
cash flow would be redirected. We generally do not receive material cash flow from the junior classes of a CDO until a deficiency is
corrected. Ratings downgrades of assets in our CDOs can negatively impact compliance with the over collateralization tests.
Generally, the over collateralization test measures the principal balance of the specified pool of assets in a CDO against the
corresponding liabilities issued by the CDO. However, based on ratings downgrades, the principal balance of an asset or of a
specified percentage of assets in a CDO may be deemed reduced below their current balance to levels set forth in the related CDO
documents for purposes of calculating the over collateralization test. As a result, ratings downgrades can reduce the principal
balance of the assets used in the over collateralization test relative to the corresponding liabilities in the test, thereby reducing the
over collateralization percentage. In addition, actual defaults of an asset would also negatively impact compliance with the over
collateralization tests. Failure to satisfy an over collateralization test could result in the redirection of cashflows as described in
footnote 5 above or, in certain circumstances, in our removal as manager of the applicable portfolio.
(7) Our CDO financings typically have a 5 year reinvestment period. Generally, after such period ends, principal payments on the
collateral are used to paydown the most senior debt outstanding. Prior to the end of the reinvestment period, principal payments
received on the collateral are reinvested.
(8) At the option call date, Newcastle, as the equity holder, has the right to payoff the CDO bonds at their related redemption price.
(9) At the auction call date, there is a mandatory auction of the assets pursuant to which the collateral manager will solicit bids for the
CDO assets. If the aggregate amount of bids is sufficient to pay off the outstanding CDO bonds set forth in the CDO governing
document, the assets will be sold and the CDO bonds will be redeemed. However, if the aggregate amount of the bids is insufficient
to pay off the outstanding CDO bonds set forth in the CDO governing document, the assets will not be sold and the redemption of
CDO bonds will not occur.
(10) Debt spread represents the spread above the benchmark interest rate (LIBOR or U.S. Treasuries) that Newcastle pays on its debt.
60
The following table sets forth further information with respect to the bonds of our consolidated CDO financings as of
December 31, 2011 (dollars in thousands):
Current Face Amount (1)
Held By
Original Face
Amount
Third Parties
Newcastle Newcastle Outside
CDOs (2)
of its CDOs (3)
Total
Stated Interest
Rate
$
$
$
$
$
$
$
$
$
$
$
*
$
$
$
$
$
* Of the $130.6 million CDO VI Class I-MM bonds, $101.5 million served as collateral for a $64.3 million bank loan owned jointly
by two of Newcastle's CDOs and $29.1 million served as collateral for a $8.7 million repurchase agreement financing.
$
$
$
$
60,508
10,000
2,000
2,500
10,623
-
-
16,731
22,500
124,862
130,636
-
10,200
10,314
5,869
9,526
-
26,183
32,000
224,728
16,518
-
34,000
13,750
20,000
-
-
-
-
3,250
-
-
-
24,125
17,000
87,875
216,518
139,475
13,000
7,250
7,500
12,085
8,325
9,891
16,731
22,500
236,757
160,227
59,000
33,661
15,471
5,869
10,161
2,888
26,183
32,000
345,460
458,374
59,464
38,000
42,750
42,750
-
28,500
-
-
22,563
6,000
7,600
18,650
24,125
28,500
87,875
865,151
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
0.25%
0.40%
0.50%
0.80%
5.67%
1.70%
6.55%
7.81%
N/A
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
LIBOR +
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 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 VI
Class I-M M LT
Class I-B
Class II
Class III-FL
Class III-FX
Class IV-FL
Class IV-FX
Class V
Preferred
CDO VIII
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
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
27,312
21,375
22,563
6,000
7,600
19,650
26,125
28,500
87,875
950,000
78,967
3,000
-
5,000
1,462
8,325
9,891
-
-
106,645
$
-
-
5,250
-
-
-
-
-
-
5,250
$
$
-
59,000
23,461
5,157
-
635
2,888
-
-
91,141
$
29,591
-
-
-
-
-
-
-
-
29,591
441,856
59,464
4,000
-
-
-
28,500
-
-
11,063
6,000
7,600
18,650
-
-
-
577,133
-
$
-
-
29,000
22,750
-
-
-
-
8,250
-
-
-
-
11,500
-
71,500
$
61
$
$
$
$
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
Current Face Amount (1)
Held By
Original Face
Amount
Third Parties
Newcastle Newcastle Outside
CDOs (2)
of its CDOs (3)
Total
Stated Interest
Rate
$
$
$
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
30,000
-
-
-
-
-
-
1,150,000
-
$
-
-
-
-
-
-
-
8,751
21,656
19,593
-
-
-
50,000
$
-
$
-
-
-
32,250
22,000
-
-
-
54,250
$
-
$
50,000
2,000
-
-
24,750
18,562
11,262
9,305
-
-
23,718
39,187
51,566
230,350
$
-
$
-
-
-
-
-
13,500
14,000
62,500
90,000
$
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
30,000
-
32,250
22,000
13,500
14,000
62,500
1,294,250
$
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. These bonds are eliminated in Newcastle’s consolidated balance sheet.
(4) These CDOs issued the following interest only fixed-rate notes with a 5-year maturity from inception:
i.
ii.
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 (1)
Net Proceeds
(millions)
Formation - 2006
2007
2008
2009
2010
2011
December 31, 2011
45,713,817
7,065,362
9,871
123,463
9,114,671
43,153,825
105,181,009
$27.75-$31.30
N/A
N/A
$3.13
$4.55 - $6.00
$201.3
$0.1
$0.1
$28.5
$210.8
(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.
62
Through December 31, 2011, 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, 2011, our outstanding options issued prior to 2011 had a weighted average strike price of $26.64 and
our outstanding options issued in 2011 had a weighted average strike price of $5.13. Our options outstanding were
summarized as follows:
Held by the Manager
Issued to the Manager and subsequently transferred
to certain of Fortress's employees
Issued to the independent directors
Total
December 31,
2011
2010
5,998,947
1,686,447
798,162
798,162
16,000
6,813,109
14,000
2,498,609
In March 2011, we issued 17,250,000 shares of our common stock in a public offering at a price to the public of $6.00 per
share for net proceeds of approximately $98.4 million. For the purpose of compensating the manager for its successful
efforts in raising capital for us, in connection with this offering, we granted options to the manager to purchase 1,725,000
shares of our common stock at the public offering price, which were valued at approximately $7.0 million.
In September 2011, we issued 25,875,000 shares of our common stock in a public offering at a price to the public of $4.55
per share for net proceeds of approximately $112.3 million. Certain principals of Fortress and certain of our officers
participated in this offering and purchased an aggregate of 1,314,780 shares at the offering price. For the purpose of
compensating the manager for its successful efforts in raising capital for us, in connection with this offering, we granted
options to the manager to purchase 2,587,500 shares of our common stock at the public offering price, which were valued at
approximately $5.6 million as of the grant date.
As of December 31, 2011, approximately 4.8 million shares of our common stock were held by Fortress, through its
affiliates, and its principals.
Preferred Stock
In 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 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 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, a total of 2,759,989
shares of common stock were issued in exchange for 1,104,000 shares of Series C Preferred, and a total of 3,449,985 shares
of common stock were issued in exchange for 1,380,000 shares of Series D Preferred. The shares of preferred stock
63
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, 496,000 shares of Series C Preferred and 620,000 shares of Series D Preferred 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.
All accrued dividends on our preferred stock have been paid through January 31, 2012.
Accumulated Other Comprehensive Income (Loss)
During the year ended December 31, 2011, our accumulated other comprehensive income (loss) changed due to the
following factors (in thousands):
Gains/ Losses
on Cash Flow
Hedges
Gains / Losses
on Securities
T otal Accumulated
Other
Comprehensive
Income (Loss)
Accumulated other comprehensive income (loss), December, 31, 2010
$ (116,908)
$ 70,730
$ (46,178)
Deconsolidation of unrealized gain on securities in CDO V
Deconsolidation of unrealized loss on derivatives designated as
cash flow hedges in CDO V
Net unrealized gain (loss) on securities
Reclassification of net realized (gain) loss on securities into earnings
Net unrealized gain (loss) on derivatives designated as cash flow hedges
Reclassification of net realized (gain) loss on derivatives designated
as cash flow hedges into earnings
-
(8,026)
(8,026)
18,353
-
18,353
-
(4,786)
(4,786)
-
15,514
(60,503)
-
(60,503)
15,514
12,540
-
12,540
Accumulated other comprehensive income (loss), December 31, 2011
$
(70,501)
$
(2,585)
$
(73,086)
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, 2011, a net widening of credit spreads has caused the net unrealized gains recorded in
accumulated other comprehensive income on our real estate securities to turn into unrealized losses. Net unrealized losses
on derivatives designated as cash flow hedges decreased for the year, primarily as a result of (i) the de-designation of
certain cash flow hedges, (ii) the deconsolidation of CDO V and (iii) increases in long-term interest 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
Cash Flow
Operating Activities
Declared for the Period Ended
December 31, 2009 (Year)
December 31, 2010 (Year)
June 30, 2011
September 30, 2011
December 31, 2011
Paid
N/A
N/A
July 2011
October 2011
January 2012
Amount Per Share
$0.00
$0.00
$0.10
$0.15
$0.15
Net cash flow provided by operating activities increased from $48.9 million for the year ended December 31, 2010 to $57.0
million for the year ended December 31, 2011. It decreased from $74.2 million for the year ended December 31, 2009 to
$48.9 million for the year ended December 31, 2010. These changes are attributable to the factors described below:
64
2011 compared to 2010
(cid:120)
(cid:120)
Interest received on securities and loans decreased approximately $30.6 million as a result of a lower average
balance of interest earning securities and loans of $3.7 billion in 2011 compared to $4.4 billion in 2010. The lower
interest earning asset balance is primarily a result of paydowns, sales and deconsolidation of CDO V. This was
offset by an increase in the weighted average interest rate to 5.25% in 2011 from 5.03% in 2010.
Furthermore, as a result of the reduction of defaulted assets through sales or restructuring, improvements in the
results of certain CDO over collateralization tests and the deconsolidation of CDO V, the net interest income
redirected for reinvestment or CDO bond paydown decreased by approximately $15.7 million in 2010, resulting in
an increase in recorded interest income.
(cid:120) An increase of $0.9 million in deferred interest received for the year ended December 31, 2011 compared to the
(cid:120)
year ended December 31, 2010 as a result of a CDO passing certain over-collateralization tests.
C-BASS collateral management fees, loan restructuring fees and excess mortgage servicing fees of approximately
$3.8 million received in the year ended December 31, 2011. This investment was made in February 2011.
(cid:120) A decrease in prepayment penalty income of $7.2 million for the year ended December 31, 2011 compared to the
(cid:120)
year ended December 31, 2010.
Interest paid on debt obligations decreased approximately $26.5 million as a result of (i) a lower average debt
balance of $3.1 billion in 2011 compared to $3.8 billion in 2010, primarily due to the deconsolidation of CDO V
and the repurchase of CDO VI Class I-MM notes, (ii) a net decrease in interest payments on our interest rate swaps
which experienced a decrease in their average aggregate notional balance from $1.9 billion in 2010 to $1.5 billion
in 2011. The decreases in (i) and (ii) above were partially offset by an increase in the weighted average coupon to
1.06% for the year ended December 31, 2011 from 0.94% for the year ended December 31, 2010 and an increase
in the weighted average effective pay rate on our interest rate swaps from 4.78% in 2010 to 4.83% in 2011.
(cid:120) Management fees paid increased approximately $1.0 million in 2011 compared to 2010 due to an increase in gross
equity as a result of our public offerings of common stock in March 2011 and September 2011, partially offset by
the return of capital distributions made on our preferred stock in 2010.
2010 compared to 2009
(cid:120)
(cid:120)
(cid:120)
(cid:120)
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 $4.4 billion in 2010 compared to $5.5 billion in
2009, which is offset by an increase in the weighted average coupon to 5.03% in 2010 from 4.96% 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 $3.8 billion in
2010 compared to $4.8 billion in 2009 and a decrease in the weighted average coupon to 0.94% in 2010 from
1.04% 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, offset by an increase in the
weighted average effective pay rate from 4.60% in 2009 to 4.78% in 2010.
(cid:120) 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) ($226.1) million, $76.4 million and $172.1 million during the years ended December
31, 2011, 2010 and 2009, respectively. Investing activities consisted primarily of the investments made in real estate
securities, excess MSRs investments, and loans outside of our CDO financing structures, net of proceeds from the sale or
settlement of investments.
Financing Activities
Financing activities provided (used) $292.9 million, ($160.1) million and ($227.7) million during the years ended
December 31, 2011, 2010 and 2009, respectively. The public offerings of common stock, return of restricted cash from
refinancing activities, refinancing of our manufactured housing loan portfolio and borrowings under repurchase agreements
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 common and 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.
65
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, 2011, 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.
(cid:120)
(cid:120)
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.
(cid:120) On June 17, 2011, we deconsolidated CDO V, 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.
(cid:120) We have made investments in three equity method investees, two of which are dormant at December 31, 2011 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.
Contractual Obligations
As of December 31, 2011, 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 and 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”
66
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 V
We entered into the securitization of Subprime Portfolios I and II, and also entered
into CDO V, which was subsequently deconsolidated, as described under “–
Liquidity and Capital Resources.”
Loan servicing agreements
Trustee 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% of the outstanding face
amount of each of the two portfolios of manufactured housing loans. We also pay
an incentive fee for one of the portfolios of manufactured housing loans if the
performance of the loans meets certain thresholds.
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.
Contract
CDO bonds payable (1)
Other bonds and 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 V
Loan servicing agreements
T rustee agreements
T otal
Fixed and Determinable Payments Due by Period
2012
2013-2014
2015-2016
T hereafter
T otal
$
18,212
8,724
239,740
$
33,571
17,448
-
$
33,571
17,448
-
$
2,968,494
356,127
-
$
3,053,848
399,747
239,740
N/A
3,863
-
29,295
19,404
*
*
*
*
319,238
$
N/A
7,726
1,849
-
38,808
*
*
*
*
99,402
$
N/A
6,616
50,506
-
38,808
*
*
*
*
146,949
$
N/A
93,498
37,670
-
485,104
*
*
*
*
3,940,893
$
N/A
111,703
90,025
29,295
582,124
*
*
*
*
4,506,482
$
* These contracts do not have fixed and determinable payments.
(1) Includes interest based on rates existing at December 31, 2011 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) These agreements are held within our non-recourse financing structures. The amounts reflected assume that these agreements are terminated at their
December 31, 2011 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, 2011 fair value on January 1, 2012.
(6) Amounts reflect base management fees for the next 30 years assuming no change in gross equity, as defined, from December 31, 2011.
Inflation
Virtually all of our assets and liabilities are financial in nature. As a result, interest rates and other factors affect our
performance more so than inflation, although inflation rates can often have a meaningful influence over the direction of
interest rates. Furthermore, our financial statements are prepared in accordance with GAAP and our distributions are
determined by our board of directors primarily based on our taxable income, and, in each case, our activities and balance
sheet are measured with reference to historical cost and/or fair market value without considering inflation. See Part II, Item
7A, "Quantitative and Qualitative Disclosure About Market Risk — Interest Rate Exposure'' below.
67
Core Earnings
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, derivatives and debt obligations, including impairment. “Core earnings,” which was referred to as “Net
Interest Income Less Expenses (Net of Preferred Dividends)” in our prior filings, is a non-GAAP measure of the operating
performance of Newcastle that excludes the fifth variable listed above and is equal to net interest income less expenses and
preferred dividends. 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 this measure as Newcastle’s “core”
current earnings, while gains and losses (including impairment) are simply a potential indicator of future earnings.
Management believes that this measure 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.
Core earnings 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 core earnings may be different from the calculation used by other companies and, therefore,
comparability may be limited.
Set forth below is a reconciliation of core earnings to the most directly comparable GAAP financial measure (in thousands).
Income (loss) applicable to common stockholders
Add (Deduct):
Impairment (reversal)
Other (income) loss
(Income) loss from discontinued operations
Excess of carrying amount of exchanged preferred stock over fair value of consideration
Core earnings
Cash Available For Distributions (“CAD”)
Year Ended December 31,
2011
2010
2009
$
253,867
$
657,252
$
(223,405)
677
(135,790)
(306)
-
$
118,448
(240,858)
(282,287)
8
(43,043)
91,072
$
548,540
(227,399)
318
-
98,054
$
Newcastle determines its common dividends based significantly on cash available for distribution, which is net cash flow
from operations plus principal repayments less return of capital and preferred dividends. We believe that CAD is useful for
investors because it is a meaningful measure of our operating liquidity. Management uses CAD as an important input in
determining Newcastle’s dividends. It represents GAAP net cash provided by operating activities adjusted for essentially
two factors:
(i)
Principal payments received from Newcastle’s investments in repurchased CDO debt and CDO securities
in excess of the portion which represents a return of Newcastle’s invested capital. Although these net
principal repayments are reported as investing activities for GAAP purposes, they actually represent a
portion of Newcastle’s return on these investments (or yield), rather than a return of Newcastle’s invested
capital.
Preferred dividends. Although these dividends are reported as financing activities for GAAP purposes,
they represent a recurring use of Newcastle’s operating cash flow similar to interest payments on debt.
(ii)
CAD is limited in its usefulness because it excludes principal repayments from non(cid:486)CDO investments (since these principal
repayments tend to represent primarily returns of capital and/or are required to be used to directly pay down Newcastle’s
debt). Furthermore, net cash provided by operating activities, a primary element of CAD, includes timing differences based
on changes in accruals. CAD does not represent cash generated from operating activities in accordance with GAAP and
should not be considered an alternative to net income as an indicator of our operating performance or as an alternative to
cash flow as a measure of our liquidity and is not necessarily indicative of cash available to fund cash needs. Our
calculation of CAD may be different from the calculation used by other companies and therefore comparability may be
limited.
68
Set forth below is a reconciliation of CAD to the most directly comparable GAAP liquidity measure (in thousands).
Net cash provided by (used in) operating activities
$
57,031
$
48,890
$
74,169
Year Ended December 31,
2010
2009
2011
Add (Deduct):
Principal repayments from repurchased CDO debt
Principal repayments from CDO securities
Return of capital included above (1)
Preferred dividends (2)
Cash available for distribution
Other data from the consolidated statements of cash flows:
Net cash provided by (used in) investing activities
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
65,912
10,728
(51,148)
(5,580)
76,943
$
1,211
-
(550)
(7,453)
42,098
$
-
-
-
(13,501)
60,668
$
Year Ended December 31,
2010
2011
(226,135)
292,936
123,832
$
$
$
$
$
$
76,443
(160,109)
(34,776)
2009
172,084
(227,699)
18,554
$
$
$
(1) Represents the portion of principal repayments from repurchased CDO debt and from CDO securities computed based on the ratio of Newcastle’s
purchase price of such debt or securities to the aggregate principal payments expected to be received from such debt or securities.
(2) Represents preferred dividends to be paid on an accrual basis.
69
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.
One component of our financing strategy includes 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 seek to 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, 2011, a 100 basis point increase in short term interest rates would increase our earnings by
approximately $0.4 million per annum, based on the current net floating rate exposure from our investments, financings and
interest rate derivatives.
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, 2011, a 100 basis point change in short term interest rates would impact our net book value by
approximately $11.9 million, based on the current net floating rate exposure from our investments, financings and interest
rate derivatives.
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.
70
Similarly, an interest rate cap or floor agreement is a contract in which we purchase a cap or floor contract on a notional
face amount. We will make an up-front payment to the counterparty for which the counterparty agrees to make future
payments to us should the reference rate (typically 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, 2011, a 25 basis point movement in credit spreads would impact our net book value by approximately
$19.4 million, assuming a static portfolio of current investments and financings, but would not directly affect our earnings
or cash flow.
Our financing strategy is dependent on our ability to place the match funded debt we use to finance our investments at rates
that provide a positive net spread. Currently, spreads for such liabilities have widened and demand for such liabilities has
become extremely limited, therefore restricting our ability to execute future financings.
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. 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 in “Management’s Discussion
and Analysis of Financial Condition and Result of Operations – Market Considerations” and elsewhere in this annual
71
report, adverse market and credit conditions have resulted in our recording of other-than-temporary impairment in certain
securities and loans.
Prepayment Speed Exposure
Prepayment speeds significantly affect the value of excess MSRs. Prepayment speed is the measurement of how quickly
borrowers pay down the unpaid principal balance of their loans or how quickly loans are otherwise brought current,
modified, liquidated or charged off. The price we pay in acquiring MSRs investments will be based on, among other
things, our projection of the cash flows from the related pool of mortgage loans. Our expectation of prepayment speeds is a
significant assumption underlying those cash flow projections. If prepayment speeds are significantly greater than expected,
the carrying value of excess MSRs could exceed their estimated fair value. If the fair value of excess MSRs decreases, we
would be required to record a non-cash charge, which would have a negative impact on our financial results. Furthermore, a
significant increase in prepayment speeds could materially reduce the ultimate cash flows we receive from excess MSRs,
and we could ultimately receive substantially less than what we paid for such assets.
We seek to reduce our exposure to prepayment through the structuring of our investments in excess MSRs. For example,
pursuant to the terms of the excess MSR agreement we entered into in December 2011, in the event that mortgage loans are
prepaid in full and Nationstar originates the new mortgage loans, subject to certain limitations, we are entitled to the pro
rata share of the excess mortgage servicing fees of such “recaptured” loans.
Margin
We are subject to margin calls on our repurchase agreements. Furthermore, we may, from time to time, be a party to
derivative agreements or financing arrangements 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 – Application of 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Considerations”
for a further discussion of recent trends and events affecting our liquidity, unrealized gains and losses.
72
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, 2011 and December 31, 2010
Consolidated Statements of Operations for the years ended December 31, 2011, 2010 and 2009
Consolidated Statements of Comprehensive Income for the years ended December 31, 2011, 2010 and 2009
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2011, 2010 and 2009
Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009
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.
73
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, 2011 and 2010, and the related consolidated statements of operations, comprehensive
income, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2011.
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, 2011 and 2010, and the consolidated results of
their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with
U.S. generally accepted accounting principles.
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 (communicated
through ASU 2009-17) 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, 2011,
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 15, 2012 expressed an unqualified opinion thereon.
New York, New York
March 15, 2012
/s/ Ernst & Young LLP
74
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Newcastle Investment Corp. and Subsidiaries
We have audited Newcastle Investment Corp. and Subsidiaries’ internal control over financial reporting as of December 31,
2011, 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, 2011, 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, 2011 and
2010, and the related consolidated statements of operations, comprehensive income, stockholders’ equity (deficit), and cash
flows for each of the three years in the period ended December 31, 2011 of Newcastle Investment Corp. and Subsidiaries
and our report dated March 15, 2012 expressed an unqualified opinion thereon.
New York, New York
March 15, 2012
/s/ Ernst & Young LLP
75
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
Asse ts
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
Investments in excess mortgage serciving rights at fair value - Note 5
Other investments
Cash and cash equivalents
Receivables and other assets
Liabilitie s and Stockholde rs' Equity (De ficit)
Liabilitie s
Non-Recourse VIE Financing Structures
CDO bonds payable - Note 8
Other bonds and 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
Dividends Payable
Due to affiliates
Accrued expenses and other liabilities
Commitments and contingencies - Notes 9, 10 and 11
Stockholde rs' Equity (De ficit)
Preferred stock, $0.01 par value, 100,000,000 shares authorized,
1,347,321 shares of 9.75% Series B Cumulative Redeemable Preferred Stock, 496,000 shares
of 8.05% Series C Cumulative Redeemable Preferred Stock, and 620,000 shares of 8.375%
Series D Cumulative Redeemable Preferred Stock, liquidation preference $25.00 per share,
issued and outstanding as of December 31, 2011 and 2010
Common stock, $0.01 par value, 500,000,000 shares authorized, 105,181,009 and
62,027,184 shares issued and outstanding at December 31, 2011 and 2010, respectively
Additional paid-in capital
Accumulated deficit - Note 2
Accumulated other comprehensive income (loss) - Note 2
See notes to consolidated financial statements.
76
De ce mbe r 31,
2011
2010
$
1,479,214
$
1,859,984
807,214
331,236
-
404,723
7,741
18,883
105,040
1,954
23,319
3,179,324
750,130
124,974
252,915
403,793
8,776
18,883
157,005
7,067
29,206
3,612,733
252,530
600
6,366
2,687
43,971
6,024
157,356
3,541
472,475
3,651,799
$
32,475
298
-
6,024
33,524
1,457
74,378
3,687,111
$
$
2,403,605
200,377
$
3,010,868
261,165
6,546
404,723
119,320
16,112
3,150,683
233,194
51,248
16,707
1,659
6,219
309,027
3,459,710
14,049
403,793
176,861
8,445
3,875,181
4,683
51,253
-
1,419
2,160
59,515
3,934,696
61,583
61,583
1,052
1,275,792
(1,073,252)
(73,086)
192,089
3,651,799
$
620
1,065,377
(1,328,987)
(46,178)
(247,585)
3,687,111
$
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009
(dollars in thousands, except share data)
Interest income
Interest expense
Net interest income
Impairme nt (Re ve rsal)
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)
Ye ar Ende d De ce mbe r 31,
2011
2010
2009
$
292,296
138,035
154,261
$
300,272
172,219
128,053
$
361,866
218,410
143,456
(15,163)
12,955
(339,887)
101,398
15,007
603,768
2,885
677
(2,369)
(240,858)
(70,235)
548,540
Net interest income (loss) after impairment/reversal
153,584
368,911
(405,084)
O the r Income (Loss)
Gain (loss) on settlement of investments, net - Note 2
Gain on extinguishment of debt - Note 8
Other income (loss), net - Note 2
Expe nse s
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
Ne t Income (Loss)
Preferred dividends
78,181
66,110
(8,501)
135,790
4,649
7,295
18,289
30,233
259,141
306
259,447
(5,580)
52,307
265,656
(35,676)
282,287
4,580
7,696
17,252
29,528
621,670
(8)
621,662
(7,453)
11,438
215,279
682
227,399
5,034
8,899
17,968
31,901
(209,586)
(318)
(209,904)
(13,501)
Excess of carrying amount of exchanged preferred stock over fair value of
consideration paid
-
43,043
-
Income (Loss) Applicable To Common Stockholde rs
$
253,867
$
657,252
$
(223,405)
Income (Loss) Pe r Share of Common Stock
Basic
Diluted
$
3.09
$
10.96
$
(4.23)
$
3.09
$
10.96
$
(4.23)
Income (loss) from continuing ope rations pe r share of common
stock, afte r pre fe rre d divide nds and e xce ss of carrying amount of
e xchange d pre fe rre d stock ove r fair value of conside ration paid
Basic
Diluted
Income (loss) from discontinue d ope rations pe r share of common stock
Basic
Diluted
We ighte d Ave rage Numbe r of Share s of C ommon Stock O utstanding
Basic
Diluted
$
3.09
$
10.96
$
(4.22)
$
3.09
$
10.96
$
(4.22)
$
-
$
-
$
(0.01)
$
-
$
-
$
(0.01)
81,983,973
81,990,297
59,948,827
52,863,993
59,948,827
52,863,993
Divide nds De clare d pe r Share of Common Stock
$
0.40
$
-
$
-
77
Years Ended December 31,
2010
621,662
$
2011
259,447
$
$
2009
(209,904)
(4,786)
(60,503)
15,514
439,496
43,442
(7,313)
306,626
522,625
123,926
12,540
(37,235)
222,212
$
42,786
518,411
1,140,073
$
9,502
962,679
752,775
$
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009
(dollars in thousands)
Net income
Other comprehensive income (loss):
Net unrealized gain (loss) on securities
Reclassification of net realized (gain) loss on securities into earnings
Net unrealized gain (loss) on derivatives designated as cash flow hedges
Reclassification of net realized loss on derivatives designated as
cash flow hedges into earnings
Other comprehensive income (loss)
Total comprehensive income
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7
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009
(dollars in thousands)
Cash Flows From Operating Activities
Net income (loss)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities (inclusive of amounts related to discontinued operations):
Depreciation and amortization
Accretion of discount and other amortization
Interest income in CDOs redirected for reinvestment or CDO bond paydown
Interest income on investments accrued to principal balance
Interest expense on debt accrued to principal balance
Deferred interest received
Non-cash directors' compensation
Valuation allowance (reversal) on loans
Other-than-temporary impairment on securities
Impairment on real estate held-for-sale
Change in fair value of investments in excess mortgage servicing rights
Gain on settlement of investments (net) and real estate held-for-sale
Unrealized loss on non-hedge derivatives and hedge ineffectiveness
Gain on extinguishment of debt
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
Principal repayments from repurchased CDO debt
Principal repayments from CDO securities
Return of investments in excess mortgage servicing rights
Principal repayments from loans and non-CDO securities
Purchase of real estate securities
Proceeds from sale of real estate securities
Acquisition of investments in excess mortgage servicing rights
Acquisition of servicing rights
Purchase of and advances on loans
M argin received on derivative instruments
Return of margin deposits on total rate of return swaps (treated as derivative instruments)
Proceeds (payments) on settlement of derivative instruments
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,
2010
2011
2009
$
259,447
$
621,662
$
(209,904)
312
(44,786)
(10,279)
(19,507)
728
1,027
149
(15,163)
15,840
433
(367)
(77,310)
11,572
(66,110)
1,161
(1,342)
240
986
57,031
65,912
10,728
760
82,907
(333,895)
3,885
(40,492)
(2,268)
-
-
-
(14,322)
650
-
(226,135)
262
(18,982)
(25,975)
(12,535)
2,964
44
75
(339,887)
99,029
260
-
(52,307)
36,564
(265,656)
151
4,577
(78)
(1,278)
48,890
1,211
-
-
64,681
(4,059)
26,022
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(6,024)
5,073
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(11,394)
840
193
76,443
295
(28,066)
(20,984)
-
2,402
-
105
15,007
533,533
550
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(11,438)
55
(215,279)
4,142
4,370
(35)
(584)
74,169
-
-
-
63,934
(1,800)
131,120
-
-
(14,588)
3,550
37
(11,610)
1,350
91
172,084
See notes to consolidated financial statements.
80
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009
(dollars in thousands)
Cash Flows From Financing Activities
Repurchases of CDO bonds payable
Issuance of other bonds payable
Repayments of other bonds payable
Borrowings under repurchase agreements
Repayments of repurchase agreements
M argin deposits under repurchase agreements
Return of margin deposits under repurchase agreements
Issuance of common stock
Costs related to issuance of common stock
Cash consideration paid in exchange for junior subordinated notes
Cash consideration paid to redeem preferred stock
Common stock dividends paid
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
Year Ended December 31,
2010
2009
2011
$
(101,954)
142,736
(204,151)
321,020
(100,012)
-
-
211,567
(905)
-
-
(23,706)
(8,371)
(1,581)
58,293
292,936
$
(72,718)
97,650
(143,678)
18,914
(71,491)
-
-
-
-
(9,715)
(16,001)
-
(19,484)
(1,677)
58,091
(160,109)
$
(27,422)
-
(77,360)
-
(205,163)
(7,303)
7,586
-
-
-
-
-
-
(200)
82,163
(227,699)
123,832
33,524
(34,776)
68,300
18,554
49,746
Cash and Cash Equivalents, End of Period
$
157,356
$
33,524
$
68,300
S upplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense
$
99,096
$
125,582
$
161,254
S upplemental S chedule of Non-Cash Investing and Financing Activities
Common stock dividends declared but not paid
Preferred stock dividends declared but not paid
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
$
$
15,777
930
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
28,457
$
100,000
$
-
$
-
$
-
$
$
37,625
24,907
-
$
$
-
81
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(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 (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered
CDOs”), (iii) unlevered investments in excess mortgage servicing rights (“unlevered excess MSRs”), (iv) investments
financed with other non-recourse debt (“non-recourse other”), (v) investments and debt repurchases financed with recourse
debt (“recourse”), (vi) other unlevered investments (“unlevered other”) and (vii) corporate. With respect to the non-recourse
CDOs and non-recourse other segments, subject to the passing of certain periodic coverage tests, Newcastle is generally
entitled to receive the net cash flows from these structures on a periodic basis.
In the fourth quarter of 2011, Newcastle changed the composition of its reportable segments such that the unlevered
segment is further broken down into (i) unlevered CDOs, (ii) unlevered excess MSRs and (iii) unlevered other.
Management believes the additional segments better reflect its investments in deconsolidated CDOs and its new
investment in excess MSRs. Segment information for previously reported periods in the accompanying financial
statements has been restated to reflect this change to the composition of its segments.
The 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 - 2006
2007
2008
2009
2010
2011
December 31, 2011
45,713,817
7,065,362
9,871
123,463
9,114,671
43,153,825
105,181,009
$27.75-$31.30
N/A
N/A
$3.13
$4.55 - $6.00
$201.3
$0.1
$0.1
$28.5
$210.8
(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”) for U.S. federal
income tax purposes. As such, Newcastle will generally not be subject to U.S. federal corporate income tax on that portion
of its net income that is distributed to stockholders if it distributes at least 90% of its REIT taxable income to its
stockholders by prescribed dates and complies with various other requirements.
Newcastle is party to a management agreement (the “Management Agreement”) with FIG LLC (the “Manager”), a
subsidiary of Fortress Investment Group LLC (“Fortress”), under which the Manager advises Newcastle on various aspects
of its business and manages its day-to-day operations, subject to the supervision of Newcastle’s board of directors. For its
services, the Manager receives an annual management fee and incentive compensation, both as defined in, and in
accordance with the terms of, the Management Agreement. For a further discussion of the Management Agreement, see
Note 10.
In March 2011, Newcastle issued 17,250,000 shares of its common stock in a public offering at a price to the public of
$6.00 per share for net proceeds of approximately $98.4 million. For the purpose of compensating the Manager for its
successful efforts in raising capital for Newcastle, in connection with this offering, Newcastle granted options to the
Manager to purchase 1,725,000 shares of Newcastle’s common stock at the public offering price, which were valued at
approximately $7.0 million as of the grant date.
In September 2011, Newcastle issued 25,875,000 shares of its common stock in a public offering at a price to the public of
$4.55 per share for net proceeds of approximately $112.3 million. Certain principals of Fortress and officers of Newcastle
participated in this offering and purchased an aggregate of 1,314,780 shares at the offering price. For the purpose of
compensating the Manager for its successful efforts in raising capital for Newcastle, in connection with this offering,
Newcastle granted options to the Manager to purchase 2,587,500 shares of Newcastle’s common stock at the public
offering price, which were valued at approximately $5.6 million as of the grant date.
Approximately 4.8 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its
principals at December 31, 2011. In addition, Fortress, through its affiliates, held options to purchase approximately 6.0
million shares of Newcastle’s common stock at December 31, 2011.
82
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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.
Newcastle’s investments in equity method investees were not significant at December 31, 2011, 2010 or 2009. 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.
Certain prior period amounts have been reclassified to conform to the current period’s presentation.
Risks and Uncertainties (cid:127) 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 (cid:127) 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 (cid:127) 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,
2011
2010
Net unrealized gains (losses) on securities
Net unrealized gains (losses) on derivatives designated as cash flow hedges
Accumulated other comprehensive income (loss)
83
$
(2,585)
(70,501)
(73,086)
$
$
70,730
(116,908)
(46,178)
$
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
REVENUE RECOGNITION
Real Estate Securities and Loans Receivable (cid:127) 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 and $8.2 million in 2010 and 2009, respectively. No
prepayments penalties were received in 2011.
Investments in Excess Mortgage Servicing Rights (“Excess MSRs”) (cid:127) Excess MSRs are aggregated into pools as
applicable; each pool of excess MSRs investments is accounted for in the aggregate. Excess MSRs investments are
accreted into interest income on an effective yield or “interest” method, based upon the expected excess servicing income
through the expected life of the underlying mortgages. Changes to expected cash flows result in a cumulative retrospective
adjustment, which will be recorded in the period in which the change in expected cash flows occurs. Under the
retrospective method, the interest income recognized for a reporting period would be measured as the difference between
the amortized cost basis at the end of the period and the amortized cost basis at the beginning of the period, plus any cash
received during the period. The amortized cost basis is calculated as the present value of estimated future cash flows using
an effective yield, which is the yield that equates all past actual and current estimated future cash flows to the initial
investment. In addition, Newcastle’s policy is to recognize interest income only on excess MSRs in existing eligible
underlying mortgages. The difference between the fair value of excess MSRs investments and their amortized cost basis is
recorded as “Other Income” or “Other Losses”, as applicable. Fair value is generally determined by discounting the
expected future cash flows using discount rates that incorporate the market risks and liquidity premium specific to the
excess MSRs investments, and therefore may differ from their effective yields.
Impairment of Securities and Loans (cid:127) 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
84
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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.
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 repayment/disposition of loans held for sale
Loss on repayment/disposition of loans held for sale
Realized gain (loss) of termination of derivative instruments
Other income (loss), net
Gain (loss) on non-hedge derivative instruments
Unrealized gain (loss) recognized upon de-designation of hedges
Year-Ended December 31,
2011
2010
2009
$
81,434
(5,091)
1,838
-
-
$
64,778
(9,192)
-
-
(3,279)
$
29,663
(18,644)
526
(111)
4
$
78,181
$
52,307
$
11,438
$
3,284
(13,939)
$
(1,240)
(35,905)
$
15,446
(15,223)
Increase in fair value of investments in excess mortgage servicing rights
Hedge ineffectiveness
Equity in earnings of equity method investees
Collateral management fee income, net
Other income (loss)
367
(917)
272
2,432
-
-
580
94
475
320
-
(278)
420
-
317
$
(8,501)
$
(35,676)
$
682
EXPENSE RECOGNITION
Interest Expense (cid:127)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 effective yield or “interest” method, based upon a comparison of actual and expected
cash flows, through the expected maturity date of the financing.
Deferred Costs and Interest Rate Cap Premiums (cid:127) 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 (cid:127) 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.
85
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Description of the risks being hedged
1)
2)
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.
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 for the
derivative financial instruments within its CDO financing structures. Newcastle’s major derivative counterparties include
Bank of America, Credit Suisse and Wells Fargo.
86
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Management Fees to Affiliate (cid:127)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 (cid:127) 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
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 (cid:127) 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.
Investments in Excess Mortgage Servicing Rights (Excess MSRs) – Upon acquisition, Newcastle has elected to record
each of such investments at fair value. Newcastle elected to record its investments in excess MSRs at fair value in order to
provide users of the financial statements with better information regarding the effects of prepayment risk and other market
factors on the excess MSRs. Under this election, Newcastle records a valuation adjustment on its excess MSRs investments
on a quarterly basis to recognize the changes in fair value in net income as described in Revenue Recognition –Investments
in Excess Mortgage Servicing Rights above. As of December 31, 2011, all excess MSRs investments are classified as held-
for-investment as Newcastle has the intent and ability to hold the investments for the foreseeable future.
Investment in Operating Real Estate (cid:127) 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 (cid:127) 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
Derivative margin accounts
December 31,
2011
$
94,781
1,897
1,812
6,550
$
2010
150,185
2,939
3,881
-
$
105,040
$
157,005
87
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Supplemental non-cash investing and financing activities relating to CDOs are disclosed below:
Year Ended December 31,
2010
2009
2011
Restricted cash generated from sale of securities
Restricted cash generated from sale of real estate related loans
$
$
336,911
125,141
$
$
249,549
53,020
$
$
132,578
26,961
Restricted cash generated from paydowns on securities and loans
$
546,752
$
511,276
$
433,918
Restricted cash generated from margin collateral received
Restricted cash used for purchases of real estate securities
$
$
6,550
427,826
$
-
$
368,893
$
-
$
297,632
Restricted cash used for purchases of real estate related loans
$
384,850
$
107,708
$
-
Restricted cash used for repayments of CDO bonds payable
Restricted cash used for repurchases of CDO bonds payable
and other bonds payable
Restricted cash used for purchases of derivative instruments
$
101,687
$
202,037
$
59,741
$
3,213
$
-
$
$
143,046
5,187
$
2,525
$
-
CDO V deconsolidation:
Real estate securities
Restricted cash
Derivative liabilities
CDO bonds payable
$
$
$
$
262,617
37,988
20,257
336,046
$
-
$
-
$
-
$
-
-
$
$
-
-
$
$
-
Stock Options (cid:127) 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 (cid:127) Newcastle’s accounting policy for its preferred stock is described in Note 9.
Accretion of Discount and Other Amortization (cid:127) As reflected on the Consolidated Statements of Cash Flows, this item is
comprised of the following:
2011
2010
2009
Accretion of net discount on securities and loans
$
(45,387)
$
(26,934)
$
(52,925)
Amortization of net discount on debt obligations
(822)
Amortization of deferred financing costs and interest rate cap premiums
3,740
Amortization of net deferred hedge (gains) and losses - debt
(2,317)
337
3,432
4,183
7,004
8,409
9,446
$
(44,786)
$
(18,982)
$
(28,066)
Securitization of Subprime Mortgage Loans (cid:127) Newcastle’s accounting policy for its securitization of subprime mortgage
loans is disclosed in Note 5.
Recent Accounting Pronouncements (cid:127) 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, 2011, 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
88
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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 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.
In May 2011, the FASB issued new guidance regarding the measurement and disclosure of fair value, which will become
effective for Newcastle on January 1, 2012. Newcastle has not yet completed its assessment of the potential impact of this
guidance.
In June 2011, the FASB issued a new accounting standard that eliminates the current option to report other comprehensive
income and its components in the statement of stockholders’ equity. Instead, an entity will be required to present items of
net income and other comprehensive income in one continuous statement or in two separate, but consecutive,
statements. Newcastle has early-adpoted this accounting standard and has opted to present two separate statements.
The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, the definition
of an investment company, financial statement presentation, revenue recognition, leases, financial instruments, hedging,
and contingencies. Some of the proposed changes are significant and could have a material impact on Newcastle’s
reporting. Newcastle has not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as
the standards are finalized.
3. SEGMENT REPORTING AND VARIABLE INTEREST ENTITIES
Newcastle conducts its business through the following segments: (i) investments financed with non-recourse collateralized
debt obligations (“non-recourse CDOs”), (ii) unlevered investments in deconsolidated Newcastle CDO debt (“unlevered
CDOs”), (iii) unlevered investments in excess mortgage servicing rights (“unlevered excess MSRs”), (iv) investments
financed with other non-recourse debt (“non-recourse other”), (v) investments and debt repurchases financed with recourse
debt (“recourse”), (vi) other unlevered investments (“unlevered other”) and (vii) corporate. With respect to the non-recourse
CDOs and non-recourse other segments, subject to the passing of certain periodic coverage tests, Newcastle is generally
entitled to receive the net cash flows from these structures on a periodic basis.
In the fourth quarter of 2011, Newcastle changed the composition of its reportable segments such that the unlevered
segment is further broken down into (i) unlevered CDOs, (ii) unlevered excess MSRs and (iii) unlevered other.
Management believes the additional segments better reflect its investments in deconsolidated CDOs and its new
investment in excess MSRs. Segment information for previously reported periods in the accompanying financial
statements has been restated to reflect this change to the composition of its segments.
The corporate segment consists primarily of interest income on short term investments, general and administrative
expenses, interest expense on the junior subordinated notes payable (Note 8) and management fees pursuant to the
Management Agreement (Note 10).
89
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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
(E) The following table summarizes the investments in the unlevered other segment:
Real estate securities
Real estate related loans
Residential mortgage loans
Other investments
December 31, 2011
Carrying
Value
Outstanding
Face Amount
183,507
$
24,543
5,227
N/A
213,277
$
$
7,614
6,366
2,687
6,024
22,691
$
Number of
Investments
25
1
170
1
197
Outstanding
Face Amount
186,081
$
97,106
1,169
N/A
284,356
$
December 31, 2010
Carrying
Value
Number of
Investments
25
5
27
1
58
*
$
600
32,475
298
6,024
39,397
$
*A mezzanine loan with a $28.0 million of face amount and carrying value was repaid in full in February 2011.
(F) Represents the elimination of investments and financings and their related income and expenses between the CDO segment and other non-
recourse segment as the corresponding inter-segment investments and financings are presented on a gross basis within each of these segments.
Variable Interest Entities (“VIEs”)
The VIEs in which Newcastle has a significant interest include (i) Newcastle’s CDOs, in which Newcastle has been
determined to be the primary beneficiary and therefore consolidates them (with the exception of CDOs V and 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 VIEs,
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, 2011, Newcastle has not
consolidated these potential VIEs due to the determination that, based on the nature of Newcastle’s investments and the
provisions governing these structures, Newcastle does not have the power to direct the activities that most significantly
impact their economic performance.
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.
In April 2011, Newcastle sold its retained interests in Newcastle CDO VII, a non-consolidated VIE of Newcastle. As a
result of the sale of Newcastle’s retained interests in CDO VII and the subsequent liquidation of the VIE, CDO VII has
been removed from Newcastle’s non-consolidated VIE disclosure.
On June 17, 2011, Newcastle deconsolidated a non-recourse financing structure, CDO V. Newcastle determined that it does
not currently have the power to direct the relevant activities of CDO V as an event of default had occurred and Newcastle
may be removed as the collateral manager by a single party. The deconsolidation has reduced Newcastle’s gross assets by
$301.6 million, reduced liabilities by $357.0 million and increased equity by $55.4 million. The deconsolidation also
reduced revenues and expenses from June 17, 2011 onwards, but its impact was not material to net income applicable to
common stockholders.
Newcastle has interests in the following unconsolidated VIE at December 31, 2011, in addition to the subprime
securitizations which are described in Note 4:
Entity
Gross Assets (A)
Debt (B)
Carrying Value of Newcastle's
Investment (C)
CDO V
$
303,392
$
304,068
$
3,940
(A) Face amount.
(B)
(C) This amount represents Newcastle’s maximum exposure to loss from this entity, which was its fair value at December 31, 2011, related to $5.5
Includes $41.6 million face amount of debt owned by Newcastle with a carrying value of $3.9 million at December 31, 2011.
million face amount of CDO V Class I notes.
93
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e
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the years ended
December 31, 2011, 2010 and 2009, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $12.9
million, $101.4 million and $603.8 million, respectively, with respect to real estate securities (gross of ($2.9) million, $2.4
million and $70.2 million of other-than-temporary impartment recognized (reversed) in Other Comprehensive Income in
2011, 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, 2011.
Securities in
an Unrealized
Loss Position
Outstanding
Face
Amount
Amortized Cost Basis
Other-than-
T emporary
Impairment
After
Impairment
Before
Impairment
Gross Unrealized
Weighted Average
Gains
Losses
Carrying
Value
Number
of
Securities
Rating
Coupon Yield
Maturity
(Years)
Less T han
T welve Months
T welve or
More Months
T otal
$
679,084
$
581,333
$
(18,809)
$
562,524
-$
$
(57,312)
$
505,212
67
BBB-
4.55% 8.54%
464,717
1,143,801
$
456,156
1,037,489
$
(2,258)
(21,067)
$
453,898
1,016,422
$
-
-$
(63,363)
(120,675)
$
390,535
895,747
$
83
150
BB+
BB+
4.94% 5.54%
4.71% 7.20%
4.5
3.3
4.0
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
T otal debt securities in an unrealized loss position
December 31, 2011
Amortized Cost Basis
Unrealized Losses
Fair Value
6,332
$
-
After Impairment
6,332
$
-
Credit (B)
$
(773)
-
Non-Credit (C)
N/A
N/A
24,039
871,708
902,079
$
27,341
989,081
1,022,754
$
(20,207)
-
(20,980)
$
(3,302)
(117,373)
(120,675)
$
(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.
95
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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 an 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:
Beginning balance of credit losses on debt securities for which a portion of an OT T I was recognized
in other comprehensive income
$
(60,688)
$
(408,782)
Additions for credit losses on securities for which an OT T I was not previously recognized
-
(12,156)
Increases to credit losses on securities for which an OT T I was previously recognized and a
portion of an OT T I was recognized in other comprehensive income
(574)
(8,175)
Additions for credit losses on securities for which an OT T I was previously recognized without
any portion of OT T I recognized in other comprehensive income
(16,269)
(25,520)
2011
2010
Reduction for credit losses on securities for which no OT T I was recognized in other comprehensive
income at the current measurement date
Reduction for securities sold during the period
Reduction for securities deconsolidated during the period
12,998
37,833
6,254
228,871
48,965
112,408
Reduction for increases in cash flows expected to be collected that are recognized over the remaining
life of the security
239
3,701
Ending balance of credit losses on debt securities for which a portion of an OT T I was recognized in
other comprehensive income
$
(20,207)
$
(60,688)
The securities are encumbered by various debt obligations, as described in Note 8, at December 31, 2011.
As of December 31, 2011 and 2010, Newcastle had $94.8 million and $150.2 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,
2011:
Geographic Location
Western U.S.
Northeastern U.S.
Southeastern U.S.
Midwestern U.S.
Southwestern U.S.
Other
Foreign
CMBS
ABS
Outstanding Face Amount
$
609,732
260,057
298,564
172,510
132,484
16,621
55,909
1,545,877
$
Percentage
39.4%
16.8%
19.3%
11.2%
8.6%
1.1%
3.6%
100.0%
Outstanding Face Amount
$
78,655
56,063
75,733
47,203
31,425
10,282
-
299,361
$
Percentage
26.3%
18.7%
25.3%
15.8%
10.5%
3.4%
0.0%
100.0%
Geographic concentrations of investments expose Newcastle to the risk of economic downturns within the relevant regions,
particularly given the current unfavorable market conditions. These market conditions may make regions more vulnerable
to downturns in certain market factors. Any such downturn in a region where Newcastle holds significant investments could
have a material, negative impact on Newcastle.
96
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NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
(D) Loans which are more than 3% of the total current carrying value (or $24.4 million) at December 31, 2011 are as follows:
December 31, 2011
Loan T ype
Outstanding
Face Amount
Carrying
Value
Prior Liens
(1)
Loan
Count
Individual Bank Loan
(3)
$
136,156
$
106,156
Individual Mezzanine Loan (4)
Individual Mezzanine Loan (4)
Individual Mezzanine Loan (4)
Individual B-Note Loan
(4)
Individual Mezzanine Loan (4)
Individual B-Note Loan
(5)
Individual Mezzanine Loan (4)
Individual Mezzanine Loan (4)
Individual Mezzanine Loan (4)
Individual Whole Loan
Individual B-Note
(6)
(4)
Individual Mezzanine Loan (4)
Individual Mezzanine Loan (4)
Individual Mezzanine Loan (7)
70,000
70,000
53,510
50,000
45,000
54,298
40,000
39,958
38,510
29,117
36,423
26,119
25,000
55,574
70,000
70,000
52,382
50,000
45,000
701,931
425,000
735,000
815,728
225,000
317,000
44,524
2,087,317
40,000
38,160
37,290
29,117
29,077
26,119
25,000
24,801
324,940
672,942
815,728
-
53,116
621,654
369,940
199,420
Others
(8)
326,949
125,954
$
1,096,614
$
813,580
Yield (2) Coupon (2)
24.85%
15.55%
8.52%
8.69%
8.00%
8.65%
12.50%
10.53%
6.32%
9.25%
15.89%
8.24%
8.45%
5.93%
9.25%
2.91%
8.00%
6.50%
15.00%
12.26%
5.23%
15.00%
7.72%
10.51%
15.00%
14.49%
12.78%
3.76%
6.23%
2.42%
10.15%
9.75%
3.49%
7.39%
Weighted Average
Maturity (Years)
3.36
1.58
4.42
2.50
4.25
1.92
1.69
2.17
4.25
2.50
1.92
3.06
0.08
2.17
3.33
2.11
2.60
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
16
31
Interest accrued to principal balance over life to maturity with a discounted payoff option prior to maturity.
Interest only payments over life to maturity and balloon principal payment upon maturity.
(1) Represents face amount of third party liens that are senior to Newcastle’s position.
(2) For Others, represents weighted average yield and weighted average coupon.
(3)
(4)
(5) Defaulted.
(6)
(7)
(8) Various terms of payment. This represents $146.6 million, $145.5 million, $33.4 million and $1.4 million face amounts of bank loans,
mezzanine loans, B-notes and whole loans, respectively. Each of the sixteen loans had a carrying value of less than $24.4 million at December
31, 2011.
Interest only payment over life to maturity with a discounted payoff option prior to loan maturity.
Interest accrued to principal balance over life to maturity.
(E)
Includes securitized and non-securitized Manufactured Housing Loan Portfolio II at December 31, 2010.
(F) The following is an aging analysis of past due residential loans held-for-investment as of December 31, 2011:
Securitized Manufactured
Housing Loan Portoflio I
Securitized Manufactured
Housing Loan Portoflio II
30-59 Days
Past Due
60-89 Days
Past Due
Over 90 Days
Past Due
REO
T otal Past
Due
Current
T otal
Outstanding
Face Amount
$
1,398
$
148
$
828
$
1,067
$
3,441
$
131,768
$
135,209
$
1,644
$
344
$
1,545
$
826
$
4,359
$
174,244
$
178,603
Residential Loans
$
1,080
$
-
$
6,700
$
-
$
7,780
$
52,376
$
60,156
Newcastle’s management monitors the credit quality of the Manufactured Housing Loan Portfolios I and II primarily by using the aging analaysis,
current trends in delinquencies and the actual loss incurrence rate.
(G) Loans acquired at a discount for credit quality.
Newcastle’s investments in real estate related loans and non-securitized manufactured housing loans were classified as
held-for-sale as of December 31, 2011 and December 31, 2010. Loans held-for-sale are marked to the lower of carrying
value or fair value.
Newcastle’s investment in the securitized manufactured housing loan portfolio I was classified as held-for-investment as of
December 31, 2011 and December 31, 2010. Newcastle’s investment in the manufactured housing loan portfolio II was
classified as held-for-sale as of December 31, 2010. However, subsequent to the refinancing of a portion of the
manufactured housing loan portfolio II in May 2011, Newcastle reclassified the securitized portion of the related pool of
loans from held-for-sale to held-for-investment since the longer term financing provided Newcastle with the ability to hold
these loans for the foreseeable future. In connection with the securitizations of the manufactured housing loan portfolios,
98
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Newcastle gave representations and warranties with respect to the manufactured housing loans sold to the securitization
trusts. To the extent a breach of any such representations and warranties materially and adversely affects the value or
enforceability of the related loans, Newcastle will be required to repurchase such loans from the respective securitization
trusts.
Newcastle’s investment in the residential loans was classified as held-for-investment as of December 31, 2011 and
classified as held-for-sale as of December 31, 2010. In the third quarter of 2011, in light of its current capital and liquidity
positions, Newcastle re-evaluated its intent and ability to hold its investment in residential loans and determined that it has
the intent and ability to hold this investment to maturity and reclassified this investment as held-for-investment.
The following is a summary of real estate related loans by maturity at December 31, 2011:
Year of Maturity (1)
Delinquent (2)
2012
2013
2014
2015
2016
Thereafter
Total
Outstanding
$
Face Amount Carrying Value
44,524
$
47,697
19,907
227,902
179,053
279,526
14,971
813,580
66,297
113,273
29,340
350,847
220,395
299,501
16,961
1,096,614
$
$
Number of
Loans
2
4
3
9
6
6
1
31
(1) Based on the final extended maturity date of each loan investment as of December 31, 2011.
(2)
Includes loans that are non-performing, in foreclosure, or under bankruptcy.
Activities relating to the carrying value of our real estate loans and residential mortgage loans are as follows:
Held for Sale
Real Estate Related
Loans
$
Residential Mortgage
Loans
$
$
$
De ce mbe r 31, 2008
Additional fundings
Principal paydowns (A)
Sales
Valuation (allowance) reversal on loans
Other
De ce mbe r 31, 2009
Purchases / additional fundings
Interest accrued to principal balance
Principal paydowns
Sales
T ransfer to held for investment
T ransfer to other investments
Valuation (allowance) reversal on loans
Accretion of loan discount and other amortization
Deconsolidation of CDO VII
Other
De ce mbe r 31, 2010
Purchases / additional fundings
Interest accrued to principal balance
Principal paydowns
Sales
T ransfer to held-for-investment
Valuation (allowance) reversal on loans
Accretion of loan discount and other amortization
Other
De ce mbe r 31, 2011
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
384,850
19,507
(270,767)
(125,141)
-
21,629
(7)
904
813,580
$
$
Held for Investment
Residential Mortgage
Loans
$
-
-
-
-
-
-
-
$
-
-
(10,916)
-
135,942
-
(960)
1,035
-
(127)
124,974
-
-
(30,514)
-
238,721
(3,602)
2,371
(714)
331,236
$
$
409,632
-
(54,177)
-
29,557
(1,365)
383,647
-
-
(34,781)
-
(135,942)
-
41,227
-
-
(938)
253,213
-
-
(8,818)
-
(238,721)
(2,864)
-
(123)
2,687
$
$
(A) Includes $1.4 million carrying value of two bank loans converted to equity securities during the year ended December 31, 2009.
99
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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 (C)
Balance at De ce mbe r 31, 2009
$
(822,409)
$
(96,409)
$
-
Charge-offs (A)
Deconsolidation of CDO VII
T ransfer 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 De ce mbe r 31, 2010
$
(321,591)
$
(25,193)
$
(21,350)
Charge-offs (A)
Reclassified as accretable discount (B)
T ransfer to held-for-investment
Valuation (allowance) reversal on loans
71,945
-
-
21,629
4,232
-
21,364
(2,864)
5,802
14,439
(21,364)
(3,602)
Balance at De ce mbe r 31, 2011
$
(228,017)
$
(2,461)
$
(26,075)
(A) The charge-offs for real estate related loans represent six and nine loans which were written off, sold, restructured, or paid off at a discounted
price during 2011 and 2010, respectively.
(B) Represents the accretable discount of the residential loans upon the reclassification from held-for-sale to held-for-investment, which will be
recognized prospectively as an adjustment of the loans’ yield over the expected life of the loans.
(C) 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 $795.3 million, $670.7 million and
$668.4 million during 2011, 2010 and 2009, respectively, on which Newcastle earned approximately $65.7 million, $53.3
million and $53.8 million of gross interest revenues, respectively.
The average carrying amount of Newcastle’s residential mortgage loans was approximately $354.9 million, $388.1 million
and $380.2 million during 2011, 2010 and 2009, respectively, on which Newcastle earned approximately $34.1 million,
$37.8 million and $42.6 million of gross interest revenues, respectively.
The loans are encumbered by various debt obligations as described in Note 8.
CDO Servicing Rights
In February 2011, Newcastle, through one of its subsidiaries, purchased the management rights with respect to certain
CBASS Investment Management LLC (“C-BASS”) CDOs pursuant to a bankruptcy proceeding for $2.2 million. 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 was $1.3 billion at
acquisition. Newcastle initially recorded the cost of acquiring the collateral management rights as a servicing asset and
subsequently amortizes this asset in proportion to, and over the period of, estimated net servicing income. Servicing assets
are assessed for impairment on a quarterly basis, with impairment recognized as a valuation allowance. Key economic
assumptions used in measuring any potential impairment of the servicing assets include the prepayment speeds of the
underlying loans, default rates, loss severities and discount rates. During the year ended December 31, 2011, Newcastle
recorded $0.3 million of servicing rights amortization and no servicing rights impairment. As of December 31, 2011,
Newcastle’s servicing asset had a carrying value of $2.0 million recorded in Receivables and Other Assets.
Investments in Excess Mortgage Servicing Rights
On December 8, 2011, Newcastle entered into an agreement (the “MSR Agreement”) with Nationstar Mortgage LLC
(“Nationstar”), an affiliate of Newcastle’s manager, to purchase excess MSRs from Nationstar. Nationstar acquired the
mortgage servicing rights on a pool of agency residential mortgage loans with an outstanding principal balance of
approximately $9.9 billion (the “Portfolio”) on September 30, 2011. Nationstar is entitled to receive an initial weighted
average total mortgage servicing fee of 35 basis points (bps) on the performing unpaid principal balance, as well as any
ancillary income from the Portfolio. Pursuant to the MSR Agreement, Nationstar performs all servicing functions and
advancing functions related to the Portfolio for a base mortgage servicing fee of 6 bps. Therefore, the remainder, or excess
mortgage servicing fees are initially equal to a weighted average of 29 bps. Newcastle acquired the right to receive 65% of
the excess mortgage servicing fees on the Portfolio and, subject to certain limitations and pursuant to a loan replacement
agreement (the “Recapture Agreement”), 65% of the excess mortgage servicing fees on any future mortgage loans
originated by Nationstar, which represent refinancings of loans in the Portfolio (which loans then become part of the
100
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Portfolio) for $43.7 million. Nationstar has invested, pari passu with Newcastle, in 35% of the excess mortgage servicing
fees. Nationstar, as servicer, also retains the ancillary income, the servicing obligations and liabilities as the servicer. If
Nationstar is terminated as the servicer, Newcastle’s right to receive its portion of the excess mortgage servicing fee is also
terminated. To the extent that Nationstar is terminated as the servicer and receives a termination payment, Newcastle is
entitled to a pro rata share, or 65%, of such termination payment.
The following is a summary of Newcastle’s excess MSRs investments at December 31, 2011:
December 31, 2011
Year Ended
December 31, 2011
Amortized Cost
Basis
$
37,469
$
6,135
43,604
Carrying
Value (A)
$
37,637
6,334
43,971
$
Weighted
Average
Yield
20.0%
20.0%
20.0%
Weighted
Average
Maturity
(Years) (B)
4.5
10.3
6.0
Changes in Fair Value
Recorded in Other
Income (Loss)
$
168
$
199
367
Portfolio I
Portfolio I - Recapture Agreement
(A) Fair value.
(B) The weighted average maturity is based on the timing of expected return of investments.
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 and is
required to pay the difference, if any, between the repurchase price of any loan in such portfolio and the price required to be
paid by a third party originator for such loan. Such subsidiary, however, has no assets and does not have recourse to the
general credit of Newcastle.
101
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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.
Subprime Portfolio
I
March 2006
11,300
2005
$1.5 billion
II
March 2007
7,300
2006
$1.3 billion
($4.1 million)
$5.5 million
Less than $0.1 million
($5.8 million)
$5.8 million
$0.1 million
April 2006
$1.5 billion
$1.4 billion
March 2036
$37.6 million
$62.4 million (A)
July 2007
$1.1 billion
$1.0 billion
April 2037
$38.8 million
$46.7 million (A)
3.1
5.3%
28.0%
18.8%
3.8
8.0%
30.1%
22.5%
The following table presents information on the retained interests in the securitizations of Subprime Portfolios I and II at
December 31, 2011:
Subprime Portfolio
I
II
T otal
T otal securitized loans (unpaid principal balance) (A)
$
476,525
$
619,793
$
1,096,318
Loans subject to call option (carrying value)
$
299,176
$
105,547
$
404,723
Retained interests (fair value) (B)
$
1,195
$
-
$
1,195
(A) Average loan seasoning of 77 months and 59 months for Subprime Portfolios I and II, respectively, at December 31, 2011.
(B) The retained interests include retained bonds of the securitizations. Their fair value is estimated based on pricing models. Newcastle’s residual
interests were written off in 2010. The weighted average yield of the retained notes was 9.09% as of December 31, 2011.
The following table summarizes certain characteristics of the underlying subprime mortgage loans, and related financing, in
the securitizations as of December 31, 2011 (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, 2011
December 31, 2010
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)
$
$
$
$
$
$
$
$
$
$
476,525
5.35%
118,818
29,460
37,881
192,869
12.8%
52.4%
10.7%
22.3%
472,525
0.66%
$
$
619,793
4.74%
186,261
54,217
64,389
221,853
20.4%
65.0%
17.2%
4.3%
619,793
1.36%
(A) Audited.
(B) Delinquencies include loans 60 or more days past due, in foreclosure, under bankruptcy filing or real estate owned.
102
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
(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 $4.0 million of retained notes for Subprime Portfolio I at December 31, 2011.
(E)
Includes the effect of applicable hedges.
Cash flows related to the two securitizations were as follows:
Suprime Portfolio
I
II
Net cash inflows from retained interests
Year Ended December 31, 2011
$
29
$
77
Year Ended December 31, 2010
Year Ended December 31, 2009
$
315
$
629
$
878
$
1,461
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, 2011 and 2010 and marked to the lower of cost or market value
based on a discounted cash flow analysis. 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:
Year Ended December 31,
2010
2011
2009
Rental income
Expenses
Impairment
Net gain on sale
Other income
Net income (loss)
$
$
$
2,035
2,035
1,357
678
(433)
61
-
306
2,135
2,135
1,910
225
(260)
-
27
(8)
2,106
2,106
1,916
190
(550)
-
42
(318)
$
$
$
No income tax related to discontinued operations was recorded for the years ended December 31, 2011, 2010 or 2009.
The following table sets forth certain information regarding the operating real estate portfolio as of December 31, 2011:
Net
Rentable
Sq. Ft. (A)
Acquisition
Date
Year Built/
Renovated
(A)
Initial Cost
Costs
Capitalized
Subsequent to
Acquisition
Occupancy
(A)
Carrying
Value
56,797
29,916
45,500
132,213
Mar 06
Mar 06
Mar 06
1986
1986
1986
$
2,673
2,727
2,624
$
390
132
383
84.0%
100.0%
100.0%
$
2,662
2,527
2,552
$
8,024
$
905
93.2%
$
7,741
T ype of Property
Location
Ohio Portfolio
Office Building
Office Building
Office Building
Beavercreek, OH
Beavercreek, OH
Beavercreek, OH
(A) Unaudited.
The aggregate United States federal income tax basis for Newcastle’s operating real estate at December 31, 2011 was
approximately $7.2 million. The operating real estate portfolio was pledged as collateral in one of Newcastle’s non-
recourse financing structures at December 31, 2011.
103
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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,
2011 and do not take into consideration the effects of subsequent changes in market or other factors.
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,
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(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:
Sep
Jul
Jan
2015
2016
2017
$
21,000
77,905
5,300
104,205
Interest rate swap agreements which receive 1-Month LIBOR:
2014
2015
2016
2017
Nov
May
May
Aug
$
15,172
484,932
174,296
174,034
2.26%
2.66%
1.86%
5.08%
5.43%
5.04%
5.24%
$
149
858
85
1,092
(1,849)
(29,404)
(21,102)
(37,670)
$
$
$
848,434
$
(90,025)
(D) This represents two interest rate swap agreements with a notional balance of $127.7 million and $188.9 million, maturing in March 2014 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
CDO IV, CDO VI and CDO X. These derivative agreements were not designated as hedges for accounting purposes as of December 31, 2011.
(E) Newcastle’s derivatives fall into two categories. As of December 31, 2011, all derivatives were held within Newcastle’s nonrecourse CDO
structures. An aggregate notional balance of $1.2 billion, which were liabilities at period end, are only subject to the credit risks of the respective
CDO structures. As they are senior to all the debt obligations of the respective CDOs and the fair value of each of the CDOs’ total investments
exceeded the fair value of each of the CDOs’ derivative liabilities, no credit valuation adjustments were recorded. An aggregate notional balance
of $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, and Wells Fargo.
(F) Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the extent
Newcastle receives net cash flow distributions from such structures. Furthermore, creditors or beneficial interest holders of these structures have
no recourse to the general credit of Newcastle. Therefore, Newcastle’s exposure to the economic losses from such structures is limited to its
invested equity in them and economically their book value cannot be less than zero. As a result, the fair value of Newcastle’s net investments in
these non-recourse financing structures is equal to the present value of their expected future net cash flows.
(G) Newcastle notes that the unrealized gain on the liabilities within such structures cannot be fully realized.
(H) The notional amount represents the total unpaid principal balance of the mortgage loans on which Newcastle is entitled to receive 65% of the
excess MSRs on performing loans.
Valuation Hierarchy
The methodologies used for valuing such instruments have been categorized into three broad levels, which form a
hierarchy.
Level 1 - Quoted prices in active markets for identical instruments.
Level 2 - Valuations based principally on other observable market parameters, including
(cid:120) Quoted prices in active markets for similar instruments,
(cid:120) Quoted prices in less active or inactive markets for identical or similar instruments,
(cid:120) Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities,
credit risks and default rates), and
(cid:120) Market corroborated inputs (derived principally from or corroborated by observable market data).
Level 3 - Valuations based significantly on unobservable inputs.
(cid:120) 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.
(cid:120) Level 3B - Valuations based on internal models with significant unobservable inputs.
Newcastle follows this hierarchy for its financial instruments measured at fair value on a recurring basis. The classifications
are based on the lowest level of input that is significant to the fair value measurement.
107
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(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,
2011:
Principal Balance or
Notional Amount
Carrying Value
Level 2
Level 3A (1)
Level 3B (2)
T otal
Fair Value
Assets:
Real estate securities, available for sale:
CMBS
REIT debt
ABS - subprime
ABS - other real estate
FNMA / FHLMC
CDO
Real estate securities total
$
$
1,545,877
137,393
246,014
53,347
232,355
206,150
2,421,136
$
1,128,818
135,296
128,622
38,107
244,915
55,986
1,731,744
$
-
135,296
-
-
244,915
-
380,211
$
948,718
-
66,141
31,188
-
52,047
1,098,094
$
180,100
-
62,481
6,919
-
3,939
253,439
$
1,128,818
135,296
128,622
38,107
244,915
55,986
1,731,744
Investments in excess MSRs (3)
$
9,705,512
$
43,971
$
-
$
-
$
43,971
$
43,971
Derivative assets:
Interest rate caps, treated as hedges
Interest rate caps, not treated as hedges
Derivative assets total
Liabilitie s:
Derivative Liabilities:
Interest rate swaps, treated as hedges
Interest rate swaps, not treated as hedges
Derivative liabilities total
$
$
$
104,205
36,428
140,633
1,092
862
1,954
1,092
862
1,954
$
$
$
$
$
$
848,434
316,600
1,165,034
90,025
29,295
119,320
90,025
29,295
119,320
$
$
$
$
-
-
$
-
$
-
-
$
-
-
$
-
$
-
-
$
-
$
-
$
$
1,092
862
1,954
$
90,025
29,295
119,320
$
(1) Third party pricing sources with significant unobservable inputs.
(2)
(3) The notional amount represents the total unpaid principal balance of the mortgage loans on which Newcastle is entitled to receive 65% of the
Internal models with significant unobservable inputs.
excess MSRs on performing loans.
108
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Newcastle’s investments in instruments (excluding the excess MSRs investments, see below) measured at fair value on a
recurring basis using Level 3 inputs changed as follows:
Balance at January 1, 2010
T ransfers (A)
T ransfers from Level 3B
T ransfers into Level 3B
CDO VII Deconsolidation
T otal gains (losses) (B)
Included in net income (loss) (C)
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
T ransfers (A)
T ransfers from Level 3A
T ransfers into Level 3A
CDO VII Deconsolidation
T otal gains (losses) (B)
Included in net income (loss) (C)
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
$
-
T otal
1,067,441
$
5,528
(54,816)
(32,858)
20,511
(22,177)
(3,379)
-
(16,015)
(10,685)
-
-
-
17,645
198,146
16,663
3,508
79,436
7,131
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
T otal
$
95,376
$
32,744
$
85,377
$
10,719
$
2,620
$
226,836
54,816
(5,528)
(48,665)
22,177
(20,511)
-
16,015
-
(17,890)
-
-
(457)
-
-
-
(83,128)
107,272
17,204
26,959
55,781
1,207
(9,374)
31,469
11,843
(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
$
109
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Balance at January 1, 2011
T ransfers (A)
T ransfers from Level 3B
T ransfers into Level 3B
CDO V Deconsolidation
T otal gains (losses) (B)
Included in net income (loss) (C)
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, 2011
Balance at January 1, 2011
T ransfers (A)
T ransfers from Level 3A
T ransfers into Level 3A
CDO V Deconsolidation
T otal gains (losses) (B)
Included in net income (loss) (C)
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, 2011
CMBS
Level 3A Assets
ABS
Conduit
$
840,227
Other
331,904
$
Subprime
$
83,582
Other
36,193
$
Equity/Other
Securities
$
-
T otal
1,291,906
$
41,158
(88,464)
(59,970)
25,000
(24,826)
(55,838)
19,950
(15,031)
(5,107)
718
(7,548)
-
2,641
(2,475)
-
89,467
(138,344)
(120,915)
42,597
(106,500)
23,878
579
38,583
5,883
(23)
(9,158)
5,210
(113)
(716)
338
-
(11,461)
3,376
43,040
(89,252)
38,685
313,857
(139,387)
(51,113)
816,283
$
27,262
(54,885)
(161,227)
$
132,435
29,359
(6,573)
(36,068)
66,141
$
7,548
-
(5,232)
31,188
$
69,308
-
(9,342)
52,047
$
447,334
(200,845)
(262,982)
1,098,094
$
CMBS
Level 3B Assets
ABS
Conduit
Other
Subprime
Other
Equity/Other
Securities
T otal
$
107,457
$
21,146
$
94,424
$
8,985
$
4,282
$
236,294
88,464
(41,158)
(32,289)
24,826
(25,000)
(1,908)
15,031
(19,950)
(14,568)
7,972
32,374
17,055
722
1,743
163
(1,332)
3,766
8,796
7,548
(718)
(3,833)
(287)
(3,200)
911
2,475
(2,641)
-
2,273
(3,346)
617
138,344
(89,467)
(52,598)
9,348
31,337
27,542
13,634
(27,400)
(25,487)
140,622
$
25,000
(721)
(6,493)
39,478
$
25
(8,624)
(15,087)
62,481
$
-
(348)
(2,139)
6,919
$
10,192
(3,884)
(6,029)
3,939
$
48,851
(40,977)
(55,235)
253,439
$
(A) Transfers are assumed to occur at the beginning of the quarter. CDO V was deconsolidated on June 17, 2011 and CDO VII was deconsolidated
on January 1, 2010.
(B) 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.
(C) These gains (losses) are recorded in the following line items in the consolidated statements of operations:
Year Ended December 31,
2011
2010
Level 3A
Level 3B
Level 3A
Level 3B
Gain (loss) on settlement of investments, net
Other income (loss), net
OT T I
T otal
Gain (loss) on sale of investments, net, from
investments transferred into Level 3 during
the period
$
$
$
$
44,560
-
(1,520)
43,040
22,895
-
(13,547)
9,348
23,775
-
(2,908)
20,867
26,668
-
(96,121)
(69,453)
$
$
$
$
$
-
$
-
$
-
$
-
110
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Securities Valuation
As of December 31, 2011, Newcastle’s securities valuation methodology and results are further detailed as follows:
Outstanding
Face
Amount (A)
Amortized
Cost
Basis (B)
Multiple
Quotes (C)
Single
Quote (D)
Internal
Pricing
Models (E)
T otal
Fair Value
$
$
$
$
$
$
$
1,545,877
137,393
246,014
53,347
232,355
206,150
2,421,136
1,124,447
135,931
123,022
39,919
243,385
67,625
1,734,329
745,189
34,029
46,715
30,553
153,062
2,750
1,012,298
203,529
101,267
19,426
635
91,853
49,297
466,007
180,100
-
62,481
6,919
-
3,939
253,439
1,128,818
135,296
128,622
38,107
244,915
55,986
1,731,744
$
$
$
$
$
Asset T ype
CMBS
REIT debt
ABS - subprime
ABS - other real estate
FNMA / FHLMC
CDO
T otal
(A) Net of incurred losses.
(B) Net of discounts (or gross premiums) and after OTTI, including impairment taken during the period ended December 31, 2011.
(C) Management generally obtained pricing service quotations or broker quotations from two sources, one of which was generally the seller (the party
that sold us the security). Management selected one of the quotes received as being most representative of fair value and did not use an average of
the quotes. Even if Newcastle receives two or more quotes on a particular security that come from non-selling brokers or pricing services, it does
not use an average because management believes using an actual quote more closely represents a transactable price for the security than an
average level. Furthermore, in some cases there is a wide disparity between the quotes Newcastle receives. Management believes using an average
of the quotes in these cases would generally not represent the fair value of the asset. Based on Newcastle’s own fair value analysis using internal
models, management selects one of the quotes which is believed to more accurately reflect fair value. Newcastle never adjusts quotes received.
These quotations are generally received via email and contain disclaimers which state that they are “indicative” and not “actionable” – meaning
that the party giving the quotation is not bound to actually purchase the security at the quoted price.
(D) Management was unable to obtain quotations from more than one source on these securities. The one source was generally the seller (the party
that sold us the security) or a pricing service.
(E) Securities whose fair value was estimated based on internal pricing models are further detailed as follows:
Amortized
Cost
Basis (B)
Fair
Value
Impairment Gains (Losses)
in Accumulated
Recorded in
OCI
Current Year
Discount
Rate
Assumption Ranges
Prepayment Cumulative
Speed (F) Default Rate
Loss
Severity
Unrealized
$
114,493
$
140,622
$
5,709
$
26,129
12.0%
N/A 0% - 100% 0% - 100%
40,246
49,859
8,709
4,224
39,478
62,481
6,919
3,939
-
2,624
275
-
(768)
12,622
(1,790)
(285)
3% - 9%
8.0%
8.0%
14.0%
N/A 0% - 100% 0% - 100%
0% - 8% 25% - 87% 60% - 100%
1% - 5% 33% - 63% 85% - 95%
83%
18%
4%
Asset T ype
CMBS - conduit
CMBS - Large loan
/ single borrower
ABS - subprime
ABS - other real estate
CDO
T otal
$
217,531
$
253,439
$
8,608
$
35,908
All of the assumptions listed have some degree of market observability, based on Newcastle’s knowledge of the market, relationships with market
participants, and use of common market data sources. Collateral prepayment, default and loss severity projections are in the form of “curves” or
“vectors” that vary for each monthly collateral cash flow projection. Methods used to develop these projections vary by asset class (e.g., CMBS
projections are developed differently than Home Equity ABS projections) but conform to industry conventions. Newcastle uses assumptions that
generate its best estimate of future cash flows of each respective security.
The prepayment vector specifies the percentage of the collateral balance that is expected to voluntarily pay off at each point in the future. The
prepayment vector is based on projections from a widely published investment bank model, which considers factors such as collateral FICO score,
loan-to-value ratio, debt-to-income ratio, and vintage on a loan level basis. This vector is scaled up or down to match recent collateral-specific
prepayment experience, as obtained from remittance reports and market data services.
Loss severities are based on recent collateral-specific experience with additional consideration given to collateral characteristics. Collateral age is
taken into consideration because severities tend to initially increase with collateral age before eventually stabilizing. Newcastle typically uses
projected severities that are higher than the historic experience for collateral that is relatively new to account for this effect. Collateral
characteristics such as loan size, lien position, and location (state) also effect loss severity. Newcastle considers whether a collateral pool has
experienced a significant change in its composition with respect to these factors when assigning severity projections.
Default 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.
111
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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 or intent to hold into the foreseeable future are classified as held-for-sale.
As a result, these held-for-sale loans are carried at the lower of amortized cost or fair value and are therefore recorded at
fair value on a non-recurring basis. During the year ended December 31, 2011, Newcastle recorded ($19.1) million and $6.5
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 certain information for real estate related loans and residential mortgage loans held-for-
sale as of December 31, 2011:
Loan T ype
Mezzanine
Bank Loan
B-Note
Whole Loan
T otal Real Estate Related
Loans Held for Sale, Net
Loan T ype
Non-securitized
Manufactured Housing
Loans I
Non-securitized
Manufactured Housing
Loans II
T otal Residential Mortgage
Loans Held for Sale, Net
Outstanding
Face
Amount
$
609,117
282,778
174,153
30,566
$
Carrying
Value
469,326
161,153
152,535
30,566
$
Fair
Value
474,980
161,153
152,535
30,581
Valuation
Allowance/
(Reversal) In
Current Year
(31,236)
$
21,276
(11,669)
-
Significant Input Ranges
Discount
Rate
Loss
Severity
7.7% - 20.0% 0.0% - 100.0%
14.4% - 24.9% 0.0% - 74.0%
6.3% - 15.9%
5.2% - 7.1% 0.0% - 15.0%
0.0%
$
1,096,614
$
813,580
$
819,249
$
(21,629)
Outstanding
Face
Amount
Carrying
Value
Fair
Value
Valuation
Allowance/
(Reversal) In
Current Year
Discount
Rate
Significant Input Ranges
Prepayment
Speed
Cumulative
Default Rate
Loss
Severity
$
768
$
199
$
199
$
74
39.8%
0.0%
52.9%
75.0%
4,459
2,488
2,488
(958)
15.5%
5.0%
10.2%
80.0%
$
5,227
$
2,687
$
2,687
$
(884)
Loans which Newcastle has the intent and ability to hold into the foreseeable future are classified as held-for-investment.
Loans held-for-investment are carried at the aggregate unpaid principal balance adjusted for any unamortized premium or
discount, deferred fees or expenses, an allowance for loan losses, charge-offs and write-downs for impaired loans.
112
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
The following table summarizes certain information for residential mortgage loans held-for-investment as of December 31,
2011:
Significant Input Ranges
Outstanding
Face Amount
Carrying
Value
Fair Value
Valuation
Allowance/
(Reversal) In
Current Year
Discount
Rate
Prepayment
Speed
Constant
Default Rate Loss Severity
$
135,209
$
112,316
$
113,929
$
700
9.5%
178,603
60,156
175,120
43,800
172,561
43,787
3,132
3,518
$
373,968
$
331,236
$
330,277
$
7,350
3.0%
5.0%
4.0%
3.5%
75.0%
80.0%
7.6%
4.7% - 8.2% 0.0% - 5.0% 0.0% - 3.0% 0.0% - 50.0%
Loan T ype
Securitized Manufactured Housing
Loans I
Securitized Manufactured Housing
Loans II
Residential Loans
T otal Residential Mortgage Loans,
Held-for-Investment, Net
Excess MSRs Valuation
Fair value estimates of Newcastle’s excess MSRs investments were based on internal pricing models. Significant inputs
used in the valuations included expectations of prepayment speeds, delinquencies, default rates and recapture rates of the
underlying mortgage loans, and discount rates that market participants would use in determining the fair values of servicing
assets on similar pools of residential mortgage loans. In addition, in valuing the excess MSRs investments, management
considered the likelihood of Nationstar being removed as servicer, which likelihood is considered to be remote.
The following table summarizes certain information regarding the inputs used in valuing the excess MSRs investments as
of December 31, 2011:
Prepayment
Speed (A)
Delinquency
(B)
Constant Default
Rate (C)
Recapture
Rate (D)
Significant Input Ranges
Portfolio I
Portfolio I - Recapture Agreement
20.0%
8.0%
10.0%
10.0%
5.0%
5.0%
35.0%
35.0%
Excess Mortgage
Servicing Fee (E)
29 bps
21 bps
Discount
Rate
20.0%
20.0%
(A)
(B)
(C)
(D)
(E)
Projected annualized weighted average lifetime prepayment rate using a prepayment vector.
Percentage of mortgage loans in the pool that were 30 or more days past due at period end.
Projected annualized average default rate.
Percentage of voluntarily prepaid loans that are expected to be refinanced by Nationstar.
Weighted average mortgage servicing fees in excess of the base mortgage servicing fee.
All of the assumptions listed have some degree of market observability, based on Newcastle’s knowledge of the market,
relationships with market participants, and use of common market data sources. Prepayment and default projections are in
the form of “curves” or “vectors” that vary over the expected life of the pool. Newcastle uses assumptions that generate its
best estimate of future cash flows for each excess MSRs investment.
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 that consider factors such as the underlying borrower’s FICO
score, loan-to-value ratio, debt-to-income ratio, vintage on a loan level basis, as well as the potential effect on loans eligible
for the Home Affordable Refinance Program 2.0 (“HARP 2.0”). This vector is scaled up or down to match recent collateral-
specific prepayment experience, as obtained from remittance reports, market data services and other market factors.
Delinquency rates and default rates are based on recent pool-specific experience with additional consideration given to the
current “pipeline” of loans that are more than 90 days delinquent, in foreclosure, or are real estate owned (REO).
Recapture projections are based on recent actual average recapture rates experienced by Nationstar on similar GSE
mortgage loan pools.
For existing mortgage pools, excess mortgage servicing fee projections are based on actual mortgage servicing fees. For
loans that are yet to be refinanced by Nationstar, Newcastle considers the excess mortgage servicing fees on loans recently
originated by Nationstar and generally assumes lower excess servicing fees than the historic experience.
113
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
The discount rates Newcastle uses are derived from a range of observable pricing on mortgage servicing assets backed by
similar collateral.
Newcastle’s MSRs investments measured at fair value on a recurring basis using Level 3B inputs changed during the period
ended December 31, 2011 as follows:
Balance at December 31, 2010
Transfers (A)
Transfers from Level 3
Transfers into Level 3
Total gains (losses)
Included in net income (B)
Amortization included in interest income
Purchases, sales and settlements
Purchases
Proceeds from sales
Proceeds from repayments
Balance at December 31, 2011
Level 3B
Portfolio I -
Recapture
Agreement
$
-
-
-
199
-
Portfolio I
$
-
-
-
168
1,260
Total
$
-
-
-
367
1,260
37,607
-
(1,398)
37,637
$
6,135
-
-
6,334
$
43,742
-
(1,398)
43,971
$
(A) Transfers are assumed to occur at the beginning of the quarter.
(B) The gains (losses) recorded in earnings during the period are attributable to the change in unrealized gains (losses) relating to Level 3 assets
still held at the reporting dates. These gains(losses) are recorded in “Other Income (Loss)” in the consolidated statement of income.
Derivatives
Newcastle’s derivative instruments are valued using counterparty quotations. These quotations are generally based on
valuation models with model inputs that can generally be verified and which do not involve significant judgment. The
significant observable inputs used in determining the fair value of our Level 2 derivative contracts are contractual cash
flows and market based interest rate curves.
Newcastle’s derivatives are recorded on its balance sheet as follows:
Balance sheet location
2011
2010
Fair Value
December 31,
Derivative Assets
Interest rate caps, designated as hedges
Interest rate caps, not designated as hedges
Derivative Assets
Derivative Assets
Derivative Liabilities
Interest rate swaps, designated as hedges
Derivative Liabilities
Interest rate swaps, not designated as hedges Derivative Liabilities
$
1,092
862
$
4,537
2,530
$
1,954
$
7,067
$
90,025
29,295
$
136,575
40,286
$
119,320
$
176,861
114
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
The following table summarizes information related to derivatives:
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
$
848,434
104,205
(69,908)
$
1,473,669
104,205
(118,608)
December 31,
2011
2010
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
Non-hedge Derivatives
Notional amount of interest rate swap agreements
Notional amount of interest rate cap agreements
299
(893)
1,688
357
1,343
2,289
(35,348)
(63,541)
316,600
36,428
343,570
36,428
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,
2010
2011
2009
$
(917)
$
580
$
(278)
(13,939)
(39,184)
(15,223)
Interest Expense
(63,350)
(83,869)
(100,046)
Interest Expense
58
475
101
Interest Expense
Other Income (Loss)
2,259
3,284
(5,471)
(1,240)
(9,547)
15,446
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)
115
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0
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(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
Each CDO financing is subject to tests that measure the amount of over collateralization and excess interest in the
transaction. Failure to satisfy these tests would cause the principal and/or interest cashflow that would otherwise be
distributed to more junior classes of securities (including those held by Newcastle) to be redirected to pay down the most
senior class of securities outstanding until the tests are satisfied. As a result, our cash flow and liquidity are negatively
impacted upon such a failure. As of December 31, 2011, CDOs IV and VI were not in compliance with their applicable
over collateralization tests.
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. During 2011, Newcastle repurchased $167.5 million face amount of CDO bonds for $102.0 million and
recorded a gain of $65.0 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 matures in June 2012 and bears interest at a rate of LIBOR + 1.75%. In accordance with GAAP,
Newcastle recorded an $82 million gain on the extinguishment of debt and $24 million of mark-to-market loss on the
related interest rate swap agreement. As of December 31, 2011, the repurchase agreement had an outstanding balance of
$8.7 million, which was secured by $29.1 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 $2.2 million as of December 31, 2011.
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. As a result of this failure and upon the adoption of the new accounting guidance on consolidation, CDO VII was
deconsolidated effective January 1, 2010.
In April 2011, Newcastle entered into an agreement to sell its retained interests in Newcastle CDO VII. Pursuant to the
agreement, the buyer of the retained interests liquidated CDO VII in June 2011 and paid Newcastle total consideration of
approximately $3.9 million. As a result, Newcastle recorded a gain of approximately $3.4 million in the second quarter of
2011, representing the excess of the sales proceeds over the carrying value of Newcastle’s retained interests.
In June 2011, Newcastle deconsolidated a non-recourse financing structure, CDO V. Newcastle determined that it does not
currently have the power to direct the relevant activities of CDO V as an event of default had occurred and Newcastle may
be removed as the collateral manager by a single party. So long as the event of default continues, Newcastle will not be
permitted to purchase or sell any collateral in CDO V. If Newcastle is removed as the collateral manager of CDO V, it
would no longer receive the senior management fees from such CDO. As of February 29, 2012, 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 of February 17, 2012, CDOs IV 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 two 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.
117
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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 “2010 Issuer”). The 2010 Issuer 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. 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.
On May 4, 2011, Newcastle completed a securitization transaction to refinance its Manufactured Housing Loans Portfolio
II. Newcastle sold approximately $197.0 million outstanding principal balance of manufactured housing loans to Newcastle
Investment Trust 2011-MH 1 (the “2011 Issuer”), an indirect wholly-owned subsidiary of Newcastle. The 2011 Issuer
issued approximately $159.8 million aggregate principal amount of investment grade notes, of which $142.8 million was
sold to third parties and $17.0 million was sold to one of the CDOs managed and consolidated by Newcastle. In addition,
Newcastle retained the below investment grade notes and residual interest. As a result, Newcastle invested approximately
$20.0 million of its unrestricted cash in the new securitization structure. The notes issued to third parties have an average
expected maturity of 3.8 years and bear interest at an average rate of 3.23% per annum. At the closing of the securitization
transaction, Newcastle used the gross proceeds received from the issuance of the notes to repay the previously existing debt
in full, terminate the related interest rate swap contracts and pay the related transaction costs. 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 residential mortgage 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.
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 accrued interest at a rate of 1.0% per year, beginning on February 1, 2009, and the rate reverted to
7.574% on February 1, 2010 in connection with the preferred stock exchange (Note 9). 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.
118
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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)
Cash
$
9,715
N/A
April 2035
Collateral
General credit of Newcastle
Consideration
Reissued CDO
bonds
$
37,625
Total
$
47,340
LIBOR + 0.66% (B)
June 2052
Assets within the
respective CDOs
(A) LIBOR + 2.25% after April 2016
(B) Weighted average effective interest rate of approximately LIBOR+0.35% after the Exchange.
The fair value of the consideration paid approximated the fair value of the repurchased junior subordinated notes of $16.7
million.
Maturity Table
Newcastle’s debt obligations (gross of $4.8 million of discounts at December 31, 2011) have contractual maturities as
follows:
2012
2013
2014
2015
2016
Thereafter
Total
Debt Covenants
Nonrecourse
6,546
$
-
-
-
-
3,013,717
3,020,263
$
Recourse
$
$
233,194
-
-
-
-
51,004
284,198
Total
239,740
-
-
-
-
3,064,721
3,304,461
$
$
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 29, 2012.
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 (loss) applicable to 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 2011, based on the
treasury stock method, Newcastle had 6,324 dilutive common stock equivalents, resulting from its outstanding options.
During 2010 and 2009, 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).
In March 2011, Newcastle filed a shelf registration statement with the SEC covering common stock, preferred stock,
depositary shares, debt securities and warrants.
119
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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 20,000 shares of common stock. The fair value of such options
was not material at the date of grant.
Through December 31, 2011, 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 7,836,227 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.
Newcastle’s outstanding options were summarized as follows:
Held by the Manager
Issued to the Manager and subsequently transferred
to certain of Fortress's employees
Issued to the independent directors
Total
December 31,
2011
2010
5,998,947
1,686,447
798,162
798,162
16,000
6,813,109
14,000
2,498,609
The following table summarizes Newcastle’s outstanding options at December 31, 2011. Note that the last sales price on
the New York Stock Exchange for Newcastle’s common stock in the year ended December 31, 2011 was $4.65 per share.
Recipient
Directors
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Exercised (D)
Outstanding
Date of
Grant/Exercise Number of Options
20,000
700,000
788,227
837,500
330,000
170,000
698,000
1,725,000
2,587,500
(1,043,118)
6,813,109
Various
2002
2003
2004
2005
2006
2007
Mar-11
Sep-11
Prior to 2008
Options Exercisable at
December 31, 2011
16,000
31,500
420,984
834,125
330,000
170,000
698,000
517,500
258,750
N/A
3,276,859
Weighted Average
Exercise Price (A)
$15.78
$12.60
$20.99
$26.66
$29.20
$29.02
$28.58
$6.00
$4.55
$15.70
$13.02
Fair Value At Grant
Date (Millions) (B)
Not Material
$0.4
$1.2
$1.6
$1.1
$0.5
$2.0
$7.0
$5.6
N/A
(E)
(F)
Intrinsic Value at
December 31, 2011
(millions)
-
-
-
-
-
-
-
-
$0.3
N/A
(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. As of December 31, 2011, the weighted average strike price of the
outstanding options issued prior to 2011 was $26.64.
(B) The fair value of the options was estimated using an 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 options issued prior to 2011 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
120
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
expected life of its options and because historical data to date was consistent with the simplified term method. The expected life assumption for
options issued in 2011 was estimated based primarily on the historical expected life of applicable previously issued options.
(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
T otal
T otal Unexercised
Inception to Date
17,500
164,197
226,125
90,750
65,025
234,565
798,162
(D) 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.
(E) The assumptions used in valuing the options were: a 1.7% risk-free rate, 107.8% volatility and a 3.3 year expected term.
(F) The assumptions used in valuing the options were: a 1.13% risk-free rate, 13.2% dividend yield, 151.1% volatility and a 4.6 year expected term.
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
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 January 31, 2012, Newcastle had paid all current and accrued dividends on its preferred stock.
121
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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
number of shares of common stock outstanding.
Management Fee…………………………………..
Expense Reimbursement………………………….
Incentive Compensation………………………….
Amounts Incurred (in millions)
2010
$16.8
0.5
-
2009
$17.5
0.5
-
2011
$17.8
0.5
-
In 2009, principals of Fortress sold an aggregate of 1.1 million common shares of Newcastle to third parties at market
prices.
In September 2011, certain principals of Fortress and officers of Newcastle participated in Newcastle’s public offering
(Note 1) and purchased an aggregate of 1,314,780 common shares at the offering price.
At December 31, 2011, Fortress, through its affiliates, and principals of Fortress, owned 4.8 million shares of Newcastle’s
common stock and Fortress, through its affiliates, had options to purchase an additional 6.0 million shares of Newcastle’s
common stock (Note 9).
At December 31, 2011 and 2010, Due To Affiliates was comprised of $1.7 million and $1.4 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.
122
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
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
$476.5 million and $619.8 million at December 31, 2011, 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.
See Note 5 for a discussion of the MSR Agreement and Recapture Agreement with Nationstar.
As of December 31, 2011, Newcastle held on its balance sheet total investments of $247.0 million face amount of real
estate securities and related loans issued by affiliates of the Manager. Newcastle earned approximately $22.5 million, $22.2
million and $15.1 million of interest on investments issued by affiliates of the Manager for the years ended December 31,
2011, 2010 and 2009, 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 (cid:127) Newcastle has adopted a stockholder rights agreement (the "Rights Agreement'').
Pursuant to the terms of the Rights Agreement, Newcastle will attach to each share of common stock one preferred stock
purchase right (a "Right''). Each Right entitles the registered holder to purchase from Newcastle a unit consisting of one
one-hundredth of a share of Series A Junior Participation Preferred Stock, par value $0.01 per share, at a purchase price of
$70 per unit. Initially, the Rights are not exercisable and are attached to and transfer and trade with the outstanding shares
of common stock. The Rights will separate from the common stock and will become exercisable upon the acquisition or
tender offer to acquire a 15% beneficial ownership interest by an acquiring person, as defined. The effect of the Rights
Agreement will be to dilute the acquiring party's beneficial interest. Until a Right is exercised, the holder thereof, as such,
will have no rights as a stockholder of Newcastle.
Litigation (cid:127) Newcastle is, from time to time, a defendant in legal actions from transactions conducted in the ordinary
course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such
actions, individually and in the aggregate, which existed at December 31, 2011, if any, will not materially affect
Newcastle’s consolidated results of operations or financial position.
Environmental Costs (cid:127) As a commercial real estate owner, Newcastle is subject to potential environmental costs. At
December 31, 2011, 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 (cid:127)Newcastle's debt obligations contain various customary loan covenants. See Note 8.
Subprime Securitizations (cid:127) 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.
123
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
Contingent Gain in CDOs (cid:127) 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, 2011, Newcastle has recorded $166.4 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. A portion 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 2011, 2010 and 2009 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 2011, 2010, and 2009 were taxable as follows:
Dividends Per Share
Book Basis
$0.40
Tax Basis
$0.40
Ordinary/
Qualified Income
100.00%
$0.00
$0.00
$0.00
$0.00
0.00%
0.00%
Capital
Gains
None
None
None
Return of Capital
0.00%
0.00%
0.00%
2011
2010
2009
During 2010 and 2009, Newcastle repurchased an aggregate of $787.8 million face amount of its outstanding CDO debt
and junior subordinated notes at a discount and recorded $521.1 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 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 generally be recognized as ordinary income in the year of such cancellation. During 2011, Newcastle repurchased
$193.2 million face amount of its outstanding CDO debt and notes payable at a discount and recorded $82.2 million of gain
for tax purposes, of which only $66.1 million gain relating to $171.8 million face amount of debt repurchased was
recognized for GAAP purposes. 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, 2011, $32.3 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, 2010, Newcastle had a loss carryforward, inclusive of net operating loss and capital loss, of
approximately $1.05 billion. 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, 2011 are subject to the
finalization of the 2011 tax returns.
13. SUBSEQUENT EVENTS
These financial statements include a discussion of material events which have occurred subsequent to December 31, 2011
(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.
124
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(dollars in tables in thousands, except per share data)
On March 6, 2012, Newcastle entered into definitive agreements to acquire an investment in excess MSRs in connection
with Nationstar’s acquisition of mortgage servicing assets from Aurora Bank FSB, a subsidiary of Lehman Brothers
Bancorp Inc. Newcastle expects to invest approximately $170 million to acquire an approximately 65% interest in the
excess MSRs on a portfolio of residential mortgage loans with an outstanding principal balance of approximately $63
billion, comprised of approximately 75% non-conforming loans in private label securitizations and approximately 25%
conforming loans in GSE pools. Nationstar will invest pari passu with Newcastle in approximately 35% of the excess
MSRs and will be the servicer of the loans performing all servicing and advancing functions, and retaining the ancillary
income, servicing obligations and liabilities as the servicer. Under the terms of this investment, to the extent that any loans
in the portfolio are refinanced by Nationstar, the resulting excess mortgage servicing rights will be shared pro rata by
Newcastle and Nationstar, subject to certain limitations. The investment is expected to close in the second quarter of 2012
and is subject to regulatory and third-party approvals.
In March 2012, Newcastle repurchased $30.0 million face amount of Newcastle CDO bonds for $9.2 million. As a result,
Newcastle extinguished $30.0 million of CDO debt and recorded a gain on extinguishment of debt of $20.7 million in the
first quarter of 2012.
125
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
(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.
2 0 11
Inte re s t inc o m e
Inte re s t e xpe ns e
Ne t inte re s t inc o m e (e xpe ns e )
Im pa irm e nt, ne t o f the re ve rs a l o f prio r va lua tio n a llo wa nc e s o n lo a ns
Othe r inc o m e (lo s s ) (B )
Expe ns e s
Inc o m e (lo s s ) fro m c o ntinuing o pe ra tio ns
Inc o m e (lo s s ) fro m dis c o ntinue d o pe ra tio ns
P re fe rre d divide nds
Inc o m e (lo s s ) a pplic a ble to c o m m o n s to c kho lde rs
Ne t inc o m e (lo s s ) pe r s ha re o f c o m m o n s to c k
M a rc h 31 (A)
J une 30 (A)
$
$
De c e m be r 31
$
72,203
38,165
34,038
(37,206)
45,469
6,850
109,863
(190)
(1,395)
108,278
Qua rte r Ende d
74,143
35,750
38,393
(9,067)
58,889
7,404
98,945
190
(1,395)
97,740
S e pte m be r 30 (A)
72,393
$
32,587
39,806
21,650
18,802
7,166
29,792
151
(1,395)
28,548
$
Ye a r Ende d
De c e m be r 31
292,296
$
138,035
154,261
677
135,790
30,233
259,141
306
(5,580)
253,867
$
73,557
31,533
42,024
25,300
12,630
8,813
20,541
155
(1,395)
19,301
$
$
$
B a s ic
Dilute d
$
1.73
$
1.23
$
0.35
$
0.18
$
3.09
$
1.73
$
1.23
$
0.35
$
0.18
$
3.09
Inc o m e (lo s s ) fro m c o ntinuing o pe ra tio ns pe r s ha re o f c o m m o n
s to c k, a fte r pre fe rre d divide nds a nd re la te d a c c re tio n
B a s ic
Dilute d
Inc o m e (lo s s ) fro m dis c o ntinue d o pe ra tio ns pe r s ha re o f c o m m o n s to c k
$
1.73
$
1.23
$
0.35
$
0.18
$
3.09
$
1.73
$
1.23
$
0.35
$
0.18
$
3.09
B a s ic
Dilute d
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
We ighte d a ve ra ge num be r o f s ha re s o f c o m m o n s to c k o uts ta nding
B a s ic
Dilute d
2 0 10
Inte re s t inc o m e
Inte re s t e xpe ns e
Ne t inte re s t inc o m e (e xpe ns e )
Im pa irm e nt, ne t o f the re ve rs a l o f prio r va lua tio n a llo wa nc e s o n lo a ns
Othe r inc o m e (lo s s ) (B )
Expe ns e s
Inc o m e (lo s s ) fro m c o ntinuing o pe ra tio ns
Inc o m e (lo s s ) fro m dis c o ntinue d o pe ra tio ns
P re fe rre d divide nds
Exc e s s o f c a rrying a m o unt o f e xc ha nge d pre fe rre d s to c k o ve r fa ir va lue
o f c o ns ide ra tio n pa id
Inc o m e (lo s s ) a pplic a ble to c o m m o n s to c kho lde rs
Ne t inc o m e (lo s s ) pe r s ha re o f c o m m o n s to c k
62,602
62,611
79,282
79,282
80,425
80,442
105,175
105,175
81,984
81,990
Qua rte r Ende d
M a rc h 31 (A)
J une 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)
S e pte m be r 30 (A)
81,040
$
42,547
38,493
(95,319)
36,662
7,185
163,289
213
(1,395)
De c e m be r 31
$
74,957
40,942
34,015
(35,012)
135,698
6,150
198,575
(194)
(1,395)
Ye a r Ende d
De c e m be r 31
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
$
B a s ic
Dilute d
$
3.36
$
1.90
$
2.61
$
3.18
$
10.96
$
3.36
$
1.90
$
2.61
$
3.18
$
10.96
Inc o m e (lo s s ) fro m c o ntinuing o pe ra tio ns pe r s ha re o f c o m m o n
s to c k, a fte r pre fe rre d divide nds a nd re la te d a c c re tio n
B a s ic
Dilute d
Inc o m e (lo s s ) fro m dis c o ntinue d o pe ra tio ns pe r s ha re o f c o m m o n s to c k
$
3.36
$
1.90
$
2.61
$
3.18
$
10.96
$
3.36
$
1.90
$
2.61
$
3.18
$
10.96
B a s ic
Dilute d
$
-
$
-
$
-
$
(0.01)
$
-
$
-
$
-
$
-
$
(0.01)
$
-
We ighte d a ve ra ge num be r o f s ha re s o f c o m m o n s to c k o uts ta nding
B a s ic
Dilute d
53,620
53,620
62,011
62,011
62,025
62,025
62,025
62,025
59,949
59,949
(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)
126
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:
(cid:120)
(cid:120)
(cid:120)
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,
2011. 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, 2011, 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.”
127
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: 50
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.
128
Kevin J. Finnerty
Director since August 2005
Age: 57
Stuart A. McFarland
Director since October 2002
Age: 65
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 the Lead Independent Director of the
Brandywine Funds and a director of the Brookfield 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.
129
David K. McKown
Director since November 2002
Age: 74
Kenneth M. Riis
Director since February 2007
Age: 52
Alan L. Tyson
Director since November 2011
Age: 55
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. 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.
Mr. Tyson 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 2011. Mr. Tyson is a private investor. He retired as
Managing Director of Credit Suisse in October 2011, where he worked
for 18 years in the Sales and Trading area of the Fixed Income
Department of the Investment Bank. Mr. Tyson began his career at L. F.
Rothschild, Unterberg Towbin and subsequently worked at Smith
Barney and Lehman Brothers before joining Donaldson, Lufkin and
Jenrette in 1994, which was acquired by Credit Suisse in 2000. Mr.
Tyson’s knowledge, skill, expertise and experience as described above
led the board of directors to conclude that Mr. Tyson should be elected
to serve as a director.
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 ....................................
Jonathan Ashley ....................................
Randal A. Nardone ................................
Age
Position
Chairman of the board of directors
Chief Executive Officer and President
Chief Financial Officer and Treasurer
Chief Operating Officer
Secretary
50
52
34
46
56
130
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.
Jonathan Ashley has been our Chief Operating Officer, Principal Accounting Officer and Treasurer 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.
Phillip J. Evanski became our Chief Investment Officer in 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. As of January 2012, Mr. Evanski no longer serves as our Chief Investment
Officer.
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.
To our knowledge, based solely on review of the copies of such reports furnished to us during the year ended December 31,
2011, 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.
131
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 Tyson (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-
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 Tyson, 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
132
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 2011 was computed as the
weighted average gross equity for 2011 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 2011.
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
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
133
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 an affiliate of our manager, who may in turn assign a portion of the options to its employees,
including our named executive 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 2011.
M anagement Fee (1)………………………………………………………………………………….………….
2011
$ 17.8 million
Expense Reimbursements(2)……………………………………………………….……………………………
$ 0.5 million
Incentive Compensation(3)……………………………………………………………………………………… None
Stock Options…………………………………………………………………………………………………..
4,312,500 shares
_________
(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 29, 2012, Fortress through its affiliates, and principals of Fortress, owned 4,848,139 shares of our Common
Stock and Fortress, through its affiliates owned options to purchase an additional 5,998,947 shares of our Common Stock,
which were issued in connection with our equity offerings, representing approximately 9.7% of our Common Stock on a
fully diluted basis.
Grants of Plan-Based Awards in 2011
On March 29, 2011 and September 27, 2011, we granted 1,725,000 options and 2,587,500 options, respectively, to an
affiliate of our manager. The exercise prices were $6.00 and $4.55 per option, respectively, which, pursuant to the policy
explained in more detail below, is equal to the price per share at which we sold shares of our Common Stock on that same
day. The closing price per share of our Common Stock on the grant dates were $5.96 and $4.50, respectively. The table
below sets forth certain information regarding the grants of such options to our named executive officers:
Name
Wesley R. Edens…………………………………
Wesley R. Edens…………………………………
Randal A. Nardone………………………………
Randal A. Nardone………………………………
_________
Grant
Date
3/29/2011
9/27/2011
3/29/2011
9/27/2011
Number of
Options (1)
1,725,000
2,587,500
1,725,000
2,587,500
Exercise
Price
$6.00
$4.55
$6.00
$4.55
Grant Date
Closing Price of
Common S tock
$5.96
$4.50
$5.96
$4.50
Grant Date
Fair Value
of Option
Awards (2)
$7,020,750
$5,594,114
$7,020,750
$5,594,114
(1) As mentioned above, on March 29, 2011 and September 27, 2011, we granted 1,725,000 and 2,587,500 options, respectively, to Fortress Operating
Entity I (“FOE I,” which was formerly known as Fortress Investment Holdings LLC). 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
134
issuable upon 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.
(2) Represents the grant dates fair value of the option awards determined under FASB ASC Topic 718. For information regarding assumptions used in
determining such valuation, please see Note 9 to the Company’s consolidated financial statements included in this Form 10-K.
Name
Wesley R. Edens (1) .…………….
Randal A. Nardone(1)……………
Kenneth M. Riis ………………..
Brian C. Sigman ………………..
Jonathan Ashley ………………..
Phillip Evanski ………………….
_________
Outstanding Option Awards As of December 31, 2011
Numbe r of
Se curitie s
Unde rlying
Une xe rcise d O ptions
Exe rcisable
Numbe r of
Se curitie s
Unde rlying
Une xe rcise d O ption
Une xe rcisable
O ption
Exe rcise Price
14,000
35,880
220,907
239,250
250,125
118,625
239,250
104,975
148,225
315,210
517,500
258,750
14,000
35,880
220,907
239,250
250,125
118,625
239,250
104,975
148,225
315,210
517,500
258,750
17,500
80,500
57,438
57,750
60,375
28,437
57,750
29,750
42,350
58,140
425
605
1,140
19,694
19,800
20,700
9,750
19,800
10,200
14,520
13,680
13,600
19,360
31,920
-
-
-
-
-
-
-
-
-
-
1,207,500
2,328,750
-
-
-
-
-
-
-
-
-
-
1,207,500
2,328,750
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
135
$12.60
$19.95
$22.45
$25.90
$25.35
$31.00
$29.20
$29.02
$30.90
$27.35
$6.00
$4.55
$12.60
$19.95
$22.45
$25.90
$25.35
$31.00
$29.20
$29.02
$30.90
$27.35
$6.00
$4.55
$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
$22.45
$25.90
$25.35
$31.00
$29.20
$29.02
$30.90
$27.35
$29.02
$30.90
$27.35
O ption
Expiration
Date
10/10/2012
7/16/2013
12/1/2013
1/9/2014
5/25/2014
11/22/2014
1/12/2015
11/1/2016
1/23/2017
4/11/2017
3/29/2021
9/27/2021
10/10/2012
7/16/2013
12/1/2013
1/9/2014
5/25/2014
11/22/2014
1/12/2015
11/1/2016
1/23/2017
4/11/2017
3/29/2021
9/27/2021
10/10/2012
7/16/2013
12/1/2013
1/9/2014
5/25/2014
11/22/2014
1/12/2015
11/1/2016
1/23/2017
4/11/2017
11/1/2016
1/23/2017
4/11/2017
12/1/2013
1/9/2014
5/25/2014
11/22/2014
1/12/2015
11/1/2016
1/23/2017
4/11/2017
11/1/2016
1/23/2017
4/11/2017
(1) Represents options held as of December 31, 2011, 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.
Director Compensation Table
Name
Wesley R. Edens ……………………………………………………………..
Kenneth M . Riis ……………………………………………………………..
Kevin J. Finnerty (2) …...…………………………………………………….
Stuart A. M cFarland …………………………………………………………
David K. M cKown …………………………………………………………..
Peter M . M iller(3) ……………………………………………………………
Alan L. Tyson(4) …………………………………………………….………..
_________
Fees Earned
or Paid
in Cash
$ 0
$ 0
$ 0
$ 55,000
$ 45,000
$ 29,470
$ 0
S tock
Awards(1)
$ 0
$ 0
$ 70,000
$ 25,000
$ 25,000
$ 25,000
$ 4,524
Option
Awards
—
—
—
—
—
—
$ 4,964
Total
$ 0
$ 0
$ 70,000
$ 80,000
$ 70,000
$ 54,470
$ 9,488
(1) Pursuant to our Stock Incentive Plan and the additional terms established by resolution of the board of directors, 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
$25,000 based on the per share closing price of our Common Stock on the New York Stock Exchange on the date of such grant. In 2011, such
directors accordingly received 4,780 shares of Common Stock.
In 2011, Mr. Finnerty elected to receive $45,000 of compensation for his services as a director in the form of Common Stock in lieu of cash.
(2)
(3) Mr. Miller resigned from our board of directors effective as of August 26, 2011.
(4) Mr. Tyson was elected to our board of directors on November 25, 2011. Mr. Tyson elected to receive his prorated director’s compensation in 2011
in the amount of $4,524 in the form of Common Stock in lieu of cash and received an initial option grant to purchase 2,000 shares of our Common
Stock pursuant to our Stock Incentive Plan. The options to purchase 2,000 shares of our Common Stock were valued at $4,964 as of the grant date.
The assumptions used in valuing the options were: a 1.2% risk-free rate, 12.0% dividend yield, 149.2% volatility and a 4.7 year expected term.
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.
The following table lists the named executive officers and the estimated fair value of the option awards that would have
been accelerated had a change in control occurred on December 31, 2011.
Name
Estimated Total Value
of Option Awards Accelerated
Upon a Change in Control
Wesley R. Edens…………………………………………………………………………….....
Randal A. Nardone………………………………………………………………….………….
$8,385,225
$8,385,225
Newcastle Investment Corp. Nonqualified Stock Option and Incentive Award Plan
In 2002, we 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. We intend to replace this plan with the 2012 Non-Qualified Stock
Option and Incentive Award Plan, if such plan is approved by our shareholders. 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
136
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.
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 29, 2012, our manager, through an affiliate, had been granted options to purchase 7,836,227 shares, which
were issued in connection with our equity offerings from 2002 through February 29, 2012. 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 29, 2012, Mr. Nardone was an executive officer
of the Company.
The Stock Incentive Plan and the additional terms established by resolution of the board of directors provide for automatic
annual awards of shares of our Common Stock valued at $25,000, 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.
137
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 29, 2012, 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
Wesley R. Edens (3)(6) ……………………………………………….…………………………..
Kevin J. Finnerty (4) ……………………………………………….…………………………….
Stuart A. M cFarland(4) ……………………………………………….…………………………
David K. M cKown(4) ……………………………………………….…………………………..
Alan L. Tyson(4) ……………………………………………….……………………………….
Kenneth M . Riis(4) ……………………………………………….……………………………..
Brian C. Sigman(4) ……………………………………………….………………………………
Jonathan Ashley (4) ……………………………………………….……………………………..
Randal A. Nardone(5)(6) ……………………………………………….………………………..
Amount and Nature
of Beneficial
Ownership
Percent of
Class(2)
5,644,191
297,353
36,560
36,560
2,973
764,990
27,170
256,855
4,704,786
5.2%
* %
* %
* %
* %
* %
* %
* %
4.3%
All directors, nominees and executive officers as a group
7,708,012
7.1%
_________
*
(1)
(2)
(3)
(4)
(5)
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 29, 2012, and no exercise by any other person.
Includes 1,580,765 shares held by Mr. Edens, 1,025,729 shares and 3,037,697 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 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 29, 2012: Riis – 489,990; Sigman – 2,170; Ashley – 128,144; Finnerty – 2,000; McFarland
– 4,000; McKown – 4,000; and Tyson – 2,000.
Includes 641,360 shares held by Mr. Nardone, 1,025,729 shares and 3,037,697 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.
138
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
Nationstar Mortgage LLC (“Nationstar”, formerly known as Centex Home Equity Company, LLC), a subprime home
equity mortgage lender to service this portfolio. In July 2006, private equity funds managed by an affiliate of our manager
completed the acquisition of Nationstar. As compensation under the servicing agreement, Nationstar 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 Nationstar 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 $476.5 million
and $619.8 million at December 31, 2011, 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.
In December 2011, we made our first investment in excess mortgage servicing rights. We invested $44 million to acquire a
65% interest in excess mortgage servicing rights of a $9.9 billion residential mortgage portfolio. Nationstar, a leading
residential mortgage servicer that is externally managed by our manager, is the servicer of the loans and invested alongside
Newcastle by acquiring the remaining 35% interest in the excess mortgage servicing rights. To the extent any loans in this
portfolio are refinanced by Nationstar, subject to certain limitations, we are entitled to receive our pro rata share of the
excess mortgage servicing rights. Newcastle will not have any servicing duties, advance obligations or liabilities associated
with the portfolio.
On March 6, 2012, we entered into definitive agreements to acquire an investment in excess MSRs in connection with
Nationstar‘s acquisition of mortgage servicing assets from Aurora Bank FSB, a subsidiary of Lehman Brothers Bancorp
Inc. We expect to invest approximately $170 million to acquire an approximately 65% interest in the excess MSRs on a
portfolio of residential mortgage loans with an outstanding principal balance of approximately $63 billion, comprised of
approximately 75% non-conforming loans in private label securitizations and approximately 25% conforming loans in GSE
pools. Nationstar will invest pari passu with us in approximately 35% of the excess MSRs and will be the servicer of the
loans performing all servicing and advancing functions, and retaining the ancillary income, servicing obligations and
liabilities as the servicer. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by
Nationstar, the resulting excess mortgage servicing rights will be shared pro rata by us and Nationstar, subject to certain
limitations. The investment is expected to close in the second quarter of 2012 and is subject to regulatory and third-party
approvals.
As of December 31, 2011, we held on our balance sheet total face amount investments of $247.0 million in real estate
securities and related loans issued by affiliates of our manager. We earned approximately $22.5 million, $22.2 million, and
$15.1 million of interest on such investments for the years ended December 31, 2011, 2010 and 2009, 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
139
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.
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
(b)
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.
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 Tyson 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.
140
Item 14. Principal Accounting Fees and Services.
During the years ended 2011 and 2010, 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
2011 and 2010 were as follows:
Year
Audit Fees
Audit-Related Fees
Tax-Related Fees
All Other Fees
2011 ..................................................................................... $ 1,858,100
2010 ..................................................................................... $ 1,526,000
— $ 181,162
130,482
— $
—
—
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, 2011 and 2010 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.
141
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
3.2
3.3
3.4
3.5
4.1
4.2
4.3
4.4
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).
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).
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).
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).
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).
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).
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).
10.5 Excess Servicing Spread Sale and Assignment Agreement between NIC MSR I LLC, a wholly owned
subsidiary of Newcastle Investment Corp., and Nationstar Mortgage LLC, dated December 8, 2011.
10.6 Excess Spread Refinanced Loan Replacement Agreement between NIC MSR I LLC, a wholly owned
subsidiary of Newcastle Investment Corp., and Nationstar Mortgage LLC, dated December 8, 2011.
12.1 Statements re: Computation of Ratios.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent registered public accounting firm.
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.
142
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.
101.INS* XBRL Instance Document.
101.SCH* XBRL Taxonomy Extension Schema Document.
101.CAL* XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF* XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB* XBRL Taxonomy Extension Label Linkbase Document.
101.PRE* XBRL Taxonomy Extension Presentation Linkbase Document.
*XBRL (Extensible Business Reporting Language) information is furnished and not filed for purposes of Sections 11 and
12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.
143
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, as amended, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:
NEWCASTLE INVESTMENT CORP.
By: /s/ Wesley R. Edens
Wesley R. Edens
Chairman of the Board
March 15, 2012
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 15, 2012
By: /s/ Brian C. Sigman
Brian C. Sigman
Chief Financial Officer and Principal Accounting Officer
March 15, 2012
By: /s/ Kevin J. Finnerty
Kevin J. Finnerty
Director
March 15, 2012
By: /s/ Stuart A. McFarland
Stuart A. McFarland
Director
March 15, 2012
By: /s/ David K. McKown
David K. McKown
Director
March 15, 2012
By: /s/ Alan L. Tyson
Alan L. Tyson
Director
March 15, 2012
144
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:
(cid:120)
(cid:120)
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;
(cid:120) may apply standards of materiality in a way that is different from what may be viewed as material to you or other
investors; and
(cid:120) 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 “Business – Corporate Governance and Internet Address; 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.
Exhibit Index
3.1
3.2
3.3
3.4
3.5
4.1
4.2
4.3
4.4
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).
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).
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).
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).
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).
Rights Agreement between the Registrant and American Stock Transfer and Trust Company, as Rights
Agent, dated October 16, 2002 (incorporated by reference to the Registrant’s Quarterly Report on Form
10-Q for the period ended September 30, 2002, Exhibit 4.1).
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).
10.5 Excess Servicing Spread Sale and Assignment Agreement between NIC MSR I LLC, a wholly owned
subsidiary of Newcastle Investment Corp., and Nationstar Mortgage LLC, dated December 8, 2011.
10.6 Excess Spread Refinanced Loan Replacement Agreement between NIC MSR I LLC, a wholly owned
subsidiary of Newcastle Investment Corp., and Nationstar Mortgage LLC, dated December 8, 2011.
12.1 Statements re: Computation of Ratios.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent registered public accounting firm.
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.
101.INS* XBRL Instance Document.
101.SCH* XBRL Taxonomy Extension Schema Document.
101.CAL* XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF* XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB* XBRL Taxonomy Extension Label Linkbase Document.
101.PRE* XBRL Taxonomy Extension Presentation Linkbase Document.
*XBRL (Extensible Business Reporting Language) information is furnished and not filed for purposes of Sections 11 and
12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.
Exhibit 12.1
RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED DIVIDENDS AND
RATIO OF EARNINGS TO FIXED CHARGES
The following table sets forth our ratio of earnings to combined fixed charges and preferred dividends and our ratio of
earnings to fixed charges for each of the periods indicated:
Year Ended December 31,
2011
2010
2009 (A)
2008 (B)
2007 (C)
Ratio of Earnings to
Combined Fixed Charges and
Preferred Dividends
2.77
4.42
0.04
(8.32)
0.84
Ratio of Earnings to Fixed Charges
2.88
4.61
0.04
(8.68)
0.86
(A) The 2009 deficiencies in each ratio are $223.1 million and $209.6 million, respectively. The 2009 results included
impairment charges. Excluding such charges, the ratios would have exceeded 1 to 1.
(B) The 2008 deficiencies in each ratio are $2.99 billion and $2.98 billion, respectively. The 2008 results included
impairment charges. Excluding such charges, the ratios would have approximately equaled 1 to 1.
(C) The 2007 deficiencies in each ratio are $77.7 million and $65.1 million, respectively. The 2007 results included
impairment charges. Excluding such charges, the ratios would have exceeded 1 to 1.
For purposes of calculating the above ratios, (i) earnings represent “Income (loss) from continuing operations,” excluding
equity in earnings of unconsolidated subsidiaries, from our consolidated statements of operations, as adjusted for fixed
charges and distributions from unconsolidated subsidiaries, and (ii) fixed charges represent “Interest expense” from our
consolidated statements of operations. The ratios are based solely on historical financial information.
Exhibit 21.1
NEWCASTLE INVESTMENT CORP. SUBSIDIARIES
Subsidiary
1. Dayton Asset Holding LLC
2. DBNC Peach Holdings LLC
3. DBNC Peach I Trust
4. DBNC Peach LLC
5. Fortress Asset Trust
6. Impac CMB Trust 1998-C1
7. Impac Commercial Assets Corporation
8. Impac Commercial Capital Corporation
9. Impac Commercial Holdings, Inc.
10. Karl S.A.
11. LIV Holdings LLC
12. NCT Holdings II LLC
13. NCT Holdings LLC
14. Newcastle 2005-1 Asset Backed Note LLC
15. Newcastle 2006-1 Asset Backed Note LLC
16. Newcastle 2006-1 Depositor LLC
17. Newcastle CDO IV Corp.
18. Newcastle CDO IV Holdings LLC
19. Newcastle CDO IV, Ltd.
20. Newcastle CDO V Corp.
21. Newcastle CDO V Holdings LLC
22. Newcastle CDO V, Ltd.
23. Newcastle CDO VI Corp.
24. Newcastle CDO VI Holdings LLC
25. Newcastle CDO VI, Ltd.
26. Newcastle CDO VII Corp.
27. Newcastle CDO VII Holdings LLC
28. Newcastle CDO VII, Limited
29. Newcastle CDO VIII 1, Limited
30. Newcastle CDO VIII 2, Limited
31. Newcastle CDO VIII Holdings LLC
32. Newcastle CDO VIII LLC
33. Newcastle CDO IX 1, Limited
34. Newcastle CDO IX 2, Limited
35. Newcastle CDO IX Holdings LLC
36. Newcastle CDO IX LLC
37. Newcastle CDO X Holdings LLC
38. Newcastle CDO X Limited
39. Newcastle CDO X LLC
40. Newcastle Foreign TRS Ltd.
Continued on next page.
State/Country of
Incorporation/Formation
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
California
California
Maryland
Belgium
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Cayman Islands
Delaware
Delaware
Cayman Islands
Delaware
Delaware
Cayman Islands
Delaware
Delaware
Cayman Islands
Cayman Islands
Cayman Islands
Delaware
Delaware
Cayman Islands
Cayman Islands
Delaware
Delaware
Delaware
Cayman Islands
Delaware
Cayman Islands
Exhibit 21.1
NEWCASTLE INVESTMENT CORP. SUBSIDIARIES
Subsidiary
41. Newcastle Investment Trust 2010-MH1
42. Newcastle Investment Trust 2011-MH1
43. Newcastle MH I LLC
44. Newcastle Mortgage Securities LLC
45. Newcastle Mortgage Securities Trust 2004-1
46. Newcastle Mortgage Securities Trust 2006-1
47. Newcastle Mortgage Securities Trust 2007-1
48. Newcastle Trust I
49. NIC Airport Corporate Center LLC
50. NIC Apple Valley I LLC
51. NIC Apple Valley II LLC
52. NIC Apple Valley III LLC
53. NIC CRA LLC
54. NIC Dayton Town Center LLC
55. NIC DB LLC
56. NIC DP LLC
57. NIC Management LLC
58. NIC MSR I LLC
59. NIC MSR II LLC
60. NIC MSR LLC
61. NIC OTC LLC
62. NIC SF LLC
63. NIC SN LLC
64. NIC TP LLC
65. NIC TRS Holdings, Inc.
66. NIC TRS LLC
67. NIC WL II LLC
68. NIC WL LLC
69. SP I Term Facility LLC
70. SSL Term Loan LLC
71. Steinhage B.V.
72. Xanadu Asset Holdings LLC
State/Country of
Incorporation/Formation
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
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Delaware
Delaware
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Netherlands
Delaware
EXHIBIT 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 333-172595) of Newcastle
Investment Corp. and Subsidiaries and in the related Prospectus of our reports dated March 15, 2012, with respect to the
consolidated financial statements of Newcastle Investment Corp. and Subsidiaries, and the effectiveness of internal control
over financial reporting of Newcastle Investment Corp. and Subsidiaries, included in this Annual Report (Form 10-K) for
the year ended December 31, 2011.
/s/ Ernst & Young LLP
New York, New York
March 15, 2012
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 15, 2012
(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 15, 2012
(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, 2011 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 15, 2012
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, 2011 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 15, 2012
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 reinvested
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, 2006 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
Total Return Performance
$120
$100
$80
$60
$40
$20
$0
12/31/06
12/31/07
12/31/08
12/31/09
12/31/10
12/31/11
Newcastle Investment Corp.
Russell 2000
S&P 500
NAREIT All REIT
NAREIT Mortgage REIT
3-Newcastle_27121_FN.indd 3
3/21/12 8:33 AM
120
100
80
60
40
20
0
$47.77
$27.50
$20.78
$3.45
$8.59
12/31/06
12/31/07
12/31/08
12/31/09
12/31/10
12/31/11
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
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
Alan L. Tyson (1)
Director
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
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 Information Services
Newcastle Investment Corp.
c/o Fortress Investment Group LLC
1345 Avenue of the Americas, 46th Floor
New York, NY 10105
Tel: (212) 479-3195
Fax: (212) 798-6060
e-mail: investorrelations@newcastleinv.com
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, 2011. These certifications were filed as exhibits 31.1 and 31.2 to such Form 10-K.
Newcastle Investment Corp.
1345 Avenue of the Americas
46th Floor
New York, NY 10105 USA
(212) 798-6100
www.newcastleinv.com