Drive Shack (DSHK) 10-Q 2010 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2010

or

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

For the transition period from            to            

Commission File Number: 001-31458

Newcastle Investment Corp.

(Exact name of registrant as specified in its charter)

Maryland	81-0559116
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

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

(212) 798-6100

(Registrant’s telephone number, including area code)

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

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

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

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

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

Smaller reporting company  ¨

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

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

Common stock, $0.01 par value per share: 62,024,945 shares outstanding as of November 2, 2010.

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

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

• our ability to take advantage of opportunities in additional asset classes at attractive risk-adjusted prices;

• our ability to deploy capital accretively;

• the risks that default and recovery rates on our loan portfolios exceed our underwriting estimates;

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

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

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

• adverse changes in the financing markets we access affecting our ability to finance our investments or our ability to maintain 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 or requirements with respect to asset-backed securities that we may issue;

• reductions in cash flows received from our investments, particularly our CDOs;

• completion of pending investments;

• the availability and cost of capital for future investments;

• competition within the finance and real estate industries; and

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

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

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

SPECIAL NOTE REGARDING EXHIBITS

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

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

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

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

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

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

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

NEWCASTLE INVESTMENT CORP.

FORM 10-Q

INDEX

		PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of September 30, 2010 (unaudited) and December 31, 2009		1
	Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2010 and 2009		2
	Consolidated Statements of Stockholders’ Equity (Deficit) (unaudited) for the nine months ended September 30, 2010		3
	Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2010 and 2009		4
	Notes to Consolidated Financial Statements (unaudited)		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		53
Item 4.	Controls and Procedures		56
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings		57
Item 1A.	Risk Factors		57
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		75
Item 3.	Defaults upon Senior Securities		75
Item 4.	Reserved		75
Item 5.	Other Information		75
Item 6.	Exhibits		76
SIGNATURES			77

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

	September 30, 2010 (Unaudited)			December 31, 2009
Assets
Non-Recourse VIE Financing Structures
Real estate securities, available for sale	$	1,941,162		$	1,784,487
Real estate related loans, held for sale, net		736,386			554,367
Residential mortgage loans, held for investment, net		127,830			—
Residential mortgage loans, held for sale, net		255,452			380,123
Subprime mortgage loans subject to call option		403,584			403,006
Restricted cash		156,825			200,251
Derivative assets		4,403			—
Receivables and other assets		32,571			36,643
		3,658,213			3,358,877
Recourse Financing Structures and Unlevered Assets
Real estate securities, available for sale		1,117			46,308
Real estate related loans, held for sale, net		32,821			19,495
Residential mortgage loans, held for sale, net		343			3,524
Operating real estate, held for sale		9,066			9,966
Cash and cash equivalents		58,336			68,300
Receivables and other assets		170			8,158
		101,853			155,751
	$	3,760,066		$	3,514,628
Liabilities and Stockholders’ Equity (Deficit)
Liabilities
Non-Recourse VIE Financing Structures
CDO bonds payable	$	3,393,139		$	4,058,928
Other bonds payable		266,243			303,697
Notes payable		4,516			—
Financing of subprime mortgage loans subject to call option		403,584			403,006
Derivative liabilities		220,447			203,054
Accrued expenses and other liabilities		7,076			2,992
		4,295,005			4,971,677
Recourse Financing Structures and Other Liabilities
Repurchase agreements		—			71,309
Junior subordinated notes payable		51,255			103,264
Derivative liabilities		—			4,100
Due to affiliates		1,419			1,497
Accrued expenses and other liabilities		3,571			3,433
		56,245			183,603
		4,351,250			5,155,280
Stockholders’ Equity (Deficit)
Preferred stock, $0.01 par value, 100,000,000 shares authorized, 1,347,321 and 2,500,000 shares of 9.75% Series B Cumulative Redeemable Preferred Stock, 496,000 and 1,600,000 shares of 8.05% Series C Cumulative Redeemable Preferred Stock, and 620,000 and 2,000,000 shares of 8.375% Series D Cumulative Redeemable Preferred Stock, liquidation preference $25.00 per share, issued and outstanding as of September 30, 2010 and December 31, 2009, respectively		61,583			152,500
Common stock, $0.01 par value, 500,000,000 shares authorized, 62,024,945 and 52,912,513 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively		620			529
Additional paid-in capital		1,065,362			1,033,520
Accumulated deficit		(1,527,368	)		(2,193,383	)
Accumulated other comprehensive income (loss)		(191,381	)		(633,818	)
		(591,184	)		(1,640,652	)
	$	3,760,066		$	3,514,628

1

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(dollars in thousands, except share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Interest income	$	81,040		$	75,222		$	225,315		$	287,033
Interest expense		42,547			52,438			131,277			167,154
Net interest income		38,493			22,784			94,038			119,879
Impairment
Valuation allowance (reversal) on loans		(105,360	)		(6,926	)		(292,668	)		83,093
Other-than-temporary impairment on securities		3,616			130,555			102,397			526,691
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)		6,425			(32,827	)		(15,575	)		(88,105	)
		(95,319	)		90,802			(205,846	)		521,679
Net interest income (loss) after impairment		133,812			(68,018	)		299,884			(401,800	)
Other Income (Loss)
Gain (loss) on settlement of investments, net		(1,134	)		(1,709	)		17,497			7,788
Gain on extinguishment of debt		46,624			132,534			141,698			186,209
Other income (loss), net		(8,828	)		(1,956	)		(12,606	)		2,474
		36,662			128,869			146,589			196,471
Expenses
Loan and security servicing expense		1,116			1,097			3,473			3,869
General and administrative expense		1,775			2,230			6,751			6,821
Management fee to affiliate		4,258			4,492			12,993			13,475
Depreciation and amortization		36			73			161			218
		7,185			7,892			23,378			24,383
Income (loss) from continuing operations		163,289			52,959			423,095			(229,712	)
Income (loss) from discontinued operations		213			79			186			(96	)
Net Income (Loss)		163,502			53,038			423,281			(229,808	)
Preferred dividends		(1,395	)		(3,375	)		(6,058	)		(10,126	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid - Note 9		—			—			43,043			—
Income (Loss) Applicable to Common Stockholders	$	162,107		$	49,663		$	460,266		$	(239,934	)
Income (Loss) Per Share of Common Stock
Basic	$	2.61		$	0.94		$	7.77		$	(4.54	)
Diluted	$	2.61		$	0.94		$	7.77		$	(4.54	)
Income (loss) from continuing operations per share of common stock, after preferred dividends and excess of carrying amount of exchanged preferred stock over fair value of consideration paid
Basic	$	2.61		$	0.94		$	7.77		$	(4.54	)
Diluted	$	2.61		$	0.94		$	7.77		$	(4.54	)
Income (loss) from discontinued operations per share of common stock
Basic	$	—		$	—		$	—		$	—
Diluted	$	—		$	—		$	—		$	—
Weighted Average Number of Shares of Common Stock Outstanding
Basic		62,024,945			52,905,335			59,249,175			52,850,034
Diluted		62,024,945			52,905,335			59,249,175			52,850,034
Dividends Declared per Share of Common Stock	$	—		$	—		$	—		$	—

See notes to consolidated financial statements

2

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

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

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010

(dollars in thousands)

	Preferred Stock						Common Stock				Additional Paid-in Capital		Accumulated Deficit			Accum. Other Comp. Income (Loss)			Total Stock-holders’ Equity (Deficit)
	Shares			Amount			Shares		Amount
Stockholders’ equity (deficit) - December 31, 2009		6,100,000		$	152,500			52,912,513	$	529	$	1,033,520	$	(2,193,383	)	$	(633,818	)	$	(1,640,652	)
Preferred dividends declared		—			—			—		—		—		(19,484	)		—			(19,484	)
Exchange of preferred stock for common stock and cash		(3,636,679	)		(90,917	)		9,091,668		91		31,782		43,043			—			(16,001	)
Issuance of common stock to directors		—			—			20,764		—		60		—			—			60
Deconsolidation of CDO VII:
Cumulative net loss		—			—			—		—		—		219,175			—			219,175
Deconsolidation of unrealized loss on securities		—			—			—		—		—		—			40,715			40,715
Deconsolidation of unrealized loss on derivatives designated as cash flow hedges		—			—			—		—		—		—			28,514			28,514
Comprehensive income:
Net income (loss)		—			—			—		—		—		423,281			—			423,281
Net unrealized gain on securities		—			—			—		—		—		—			341,566			341,566
Reclassification of net realized loss on securities into earnings		—			—			—		—		—		—			66,047			66,047
Net unrealized (loss) on derivatives designated as cash flow hedges		—			—			—		—		—		—			(48,758	)		(48,758	)
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		—			—			—		—		—		—			14,353			14,353
Total comprehensive income (loss)																				796,489
Stockholders’ equity (deficit) - September 30, 2010		2,463,321		$	61,583			62,024,945	$	620	$	1,065,362	$	(1,527,368	)	$	(191,381	)	$	(591,184	)

See notes to consolidated financial statements

3

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

	Nine Months Ended September 30,
	2010			2009
Cash Flows From Operating Activities
Net income (loss)	$	423,281		$	(229,808	)
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		161			223
Accretion of discount and other amortization		(19,806	)		(23,657	)
Interest income in CDOs redirected for reinvestment or CDO bonds paydown		(4,609	)		(7,496	)
Valuation allowance on loans		(292,668	)		83,093
Non-cash directors’ compensation		60			91
(Gain) loss on sale of investments		(17,497	)		(7,788	)
Unrealized (gain) loss on non-hedge derivatives and hedge ineffectiveness		13,356			(1,946	)
Other-than-temporary impairment on securities		86,822			438,586
Impairment on real estate held for sale		60			400
(Gain) loss on extinguishment of debt		(141,698	)		(186,208	)
Change in:
Restricted cash		1,025			897
Receivables and other assets		3,781			6,174
Due to affiliates		(78	)		(35	)
Accrued expenses and other liabilities		(1,182	)		(982	)
Net cash provided by (used in) operating activities		51,008			71,544
Cash Flows From Investing Activities
Purchase of real estate securities		(2,291	)		(1,800	)
Proceeds from sale of real estate securities		49,117			135,999
Purchase of and advances on loans		(6,024	)		(14,723	)
Repayments of loan and security principal		150,164			72,544
Margin received on derivative instruments		5,073			3,550
Return of margin deposits on total rate of return swaps (treated as derivative instruments)		—			37
Payments on settlement of derivative instruments		(11,394	)		(11,610	)
Proceeds from sale of real estate held for sale		840			1,350
Distributions of capital from equity method investees		161			109
Net cash provided by (used in) investing activities		185,646			185,456
Cash Flows From Financing Activities
Repayments of CDO bonds payable		(130,527	)		(30,943	)
Repurchase of CDO bonds payable		(11,400	)		(19,753	)
Issuance of other bonds payable		97,650			—
Repayments of other bonds payable		(134,027	)		(65,058	)
Repayments of repurchase agreements		(71,309	)		(198,488	)
Margin deposits under repurchase agreements		—			(7,303	)
Return of margin deposits under repurchase agreements		—			7,586
Cash consideration paid in exchange for junior subordinated notes		(9,715	)		—
Cash consideration paid to redeem preferred stock		(16,001	)		—
Dividends paid		(19,484	)		—
Payment of deferred financing costs		(1,677	)		(1,900	)
Restricted cash returned from refinancing activities		49,872			82,362
Net cash provided by (used in) financing activities		(246,618	)		(233,497	)
Net Increase (Decrease) in Cash and Cash Equivalents		(9,964	)		23,503
Cash and Cash Equivalents, Beginning of Period		68,300			49,746
Cash and Cash Equivalents, End of Period	$	58,336		$	73,249
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense	$	97,948		$	124,787
Supplemental Schedule of Non-Cash Investing and Financing Activities
Common stock issued to redeem preferred stock	$	28,457		$	—
Face amount of CDO bonds issued in exchange for previously issued junior subordinated notes of $52,094	$	37,625		$	—

See notes to consolidated financial statements

4

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

1. GENERAL

Newcastle Investment Corp. (and its subsidiaries, “Newcastle”) is a Maryland corporation that was formed in 2002. Newcastle conducts its business through four primary segments: (i) investments financed with non-recourse collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments financed with recourse debt, and (iv) unlevered investments. With respect to the first two nonrecourse segments, Newcastle is generally entitled to receive the net cash flows from these structures on a periodic basis.

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

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

Approximately 3.8 million shares of Newcastle’s common stock were held by Fortress, through its affiliates, and its principals at September 30, 2010. In addition, Fortress, through its affiliates, held options to purchase approximately 1.7 million shares of Newcastle’s common stock at September 30, 2010.

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, financial statement presentation, revenue recognition, leases, financial instruments, hedging and fair value. Some of the proposed changes are significant and could have a material impact on Newcastle’s reporting. Newcastle has not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.

The accompanying consolidated financial statements and related notes of Newcastle have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under U.S. generally accepted accounting principles have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of Newcastle’s financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with Newcastle’s consolidated financial statements for the year ended December 31, 2009 and notes thereto included in Newcastle’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. Capitalized terms used herein, and not otherwise defined, are defined in Newcastle’s consolidated financial statements for the year ended December 31, 2009.

Change in Presentation

Newcastle has changed the format of its consolidated balance sheets for all periods presented to reflect the requirements of new guidance which became effective January 1, 2010. This change in format did not have any effect on any of the reported line items within the balance sheets, other than breaking them out by financing type, or on the statement of consolidated equity (deficit).

2. INFORMATION REGARDING BUSINESS SEGMENTS

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

5

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

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

	Non-Recourse									Corporate
	CDOs (A)			Other (A)			Recourse			Unlevered			Other			Total
Nine Months Ended September 30, 2010
Interest income	$	168,150		$	54,952		$	976		$	1,189		$	48		$	225,315
Interest expense		83,209			44,462			645			356			2,605			131,277
Net interest income (expense)		84,941			10,490			331			833			(2,557	)		94,038
Impairment		(146,833	)		(35,323	)		(60	)		(23,630	)		—			(205,846	)
Other income (loss)		153,919			(5,417	)		(663	)		(905	)		(345	)		146,589
Depreciation and amortization		—			—			—			—			161			161
Other operating expenses		1,134			2,394			4			17			19,668			23,217
Income (loss) from continuing operations		384,559			38,002			(276	)		23,541			(22,731	)		423,095
Income (loss) from discontinued operations		—			—			—			186			—			186
Net income (loss)		384,559			38,002			(276	)		23,727			(22,731	)		423,281
Preferred dividends		—			—			—			—			(6,058	)		(6,058	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid - Note 9		—			—			—			—			43,043			43,043
Income (loss) applicable to common stockholders	$	384,559		$	38,002		$	(276	)	$	23,727		$	14,254		$	460,266
Three Months Ended September 30, 2010
Interest income	$	62,429		$	18,146		$	—		$	447		$	18		$	81,040
Interest expense		27,035			14,561			—			—			951			42,547
Net interest income (expense)		35,394			3,585			—			447			(933	)		38,493
Impairment		(86,525	)		(1,094	)		—			(7,700	)		—			(95,319	)
Other income (loss)		38,189			(1,636	)		—			109			—			36,662
Depreciation and amortization		—			—			—			—			36			36
Other operating expenses		345			768			—			7			6,029			7,149
Income (loss) from continuing operations		159,763			2,275			—			8,249			(6,998	)		163,289
Income (loss) from discontinued operations		—			—			—			213			—			213
Net income (loss)		159,763			2,275			—			8,462			(6,998	)		163,502
Preferred dividends		—			—			—			—			(1,395	)		(1,395	)
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid - Note 9		—			—			—			—			—			—
Income (loss) applicable to common stockholders	$	159,763		$	2,275		$	—		$	8,462		$	(6,998	)	$	162,107
September 30, 2010
Investments (B) (C)	$	2,727,017		$	737,397		$	—		$	43,347		$	—		$	3,507,761
Cash and restricted cash		156,825			—			—			232			58,104			215,161
Other assets		36,974			—			—			160			10			37,144
Total assets		2,920,816			737,397			—			43,739			58,114			3,760,066
Debt (C)		(3,397,655	)		(669,827	)		—			—			(51,255	)		(4,118,737	)
Derivative liabilities		(200,386	)		(20,061	)		—			—			—			(220,447	)
Other liabilities		(6,349	)		(727	)		—			(542	)		(4,448	)		(12,066	)
Total liabilities		(3,604,390	)		(690,615	)		—			(542	)		(55,703	)		(4,351,250	)
Preferred stock		—			—			—			—			(61,583	)		(61,583	)
GAAP book value (D)	$	(683,574	)	$	46,782		$	—		$	43,197		$	(59,172	)	$	(652,767	)

6

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

	Non-Recourse									Corporate
	CDOs (A)			Other (A)			Recourse			Unlevered			Other			Total
Nine Months Ended September 30, 2009
Interest income	$	221,385		$	58,043		$	6,200		$	1,333		$	72		$	287,033
Interest expense		107,475			50,440			3,021			—			6,218			167,154
Net interest income (expense)		113,910			7,603			3,179			1,333			(6,146	)		119,879
Impairment		478,631			(7,876	)		41,365			9,559			—			521,679
Other income (loss)		189,588			2,435			4,270			177			1			196,471
Depreciation and amortization		—			—			—			—			218			218
Other operating expenses		1,318			2,527			30			1			20,289			24,165
Income (loss) from continuing operations		(176,451	)		15,387			(33,946	)		(8,050	)		(26,652	)		(229,712	)
Income (loss) from discontinued operations		—			—			—			(96	)		—			(96	)
Net income (loss)		(176,451	)		15,387			(33,946	)		(8,146	)		(26,652	)		(229,808	)
Preferred dividends		—			—			—			—			(10,126	)		(10,126	)
Income (loss) applicable to common stockholders	$	(176,451	)	$	15,387		$	(33,946	)	$	(8,146	)	$	(36,778	)	$	(239,934	)
Three Months Ended September 30, 2009
Interest income	$	54,446		$	19,184		$	1,398		$	165		$	29		$	75,222
Interest expense		33,908			15,523			833			—			2,174			52,438
Net interest income (expense)		20,538			3,661			565			165			(2,145	)		22,784
Impairment		79,455			(1,319	)		8,894			3,772			—			90,802
Other income (loss)		130,715			(2,080	)		(41	)		275			—			128,869
Depreciation and amortization		—			—			—			—			73			73
Other operating expenses		436			657			5			—			6,721			7,819
Income (loss) from continuing operations		71,362			2,243			(8,375	)		(3,332	)		(8,939	)		52,959
Income (loss) from discontinued operations		—			—			—			79			—			79
Net income (loss)		71,362			2,243			(8,375	)		(3,253	)		(8,939	)		53,038
Preferred dividends		—			—			—			—			(3,375	)		(3,375	)
Income (loss) applicable to common stockholders	$	71,362		$	2,243		$	(8,375	)	$	(3,253	)	$	(12,314	)	$	49,663

(A) Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the extent Newcastle receives net cash flow distributions from such structures. Furthermore, economic losses from such structures cannot exceed Newcastle’s invested equity in them. Therefore, economically their book value cannot be less than zero.

(B) The following table summarizes the investments in the unlevered segment as of September 30, 2010:

	Outstanding Face Amount		Carrying Value
Real estate securities	$	156,613	$	1,117
Real estate related loans		226,956		32,821
Residential mortgage loans		1,268		343
Operating real estate		N/A		9,066
	$	384,837	$	43,347

(C) Included in the other non-recourse segment were $403.6 million of Investments and Debt at September 30, 2010, representing the loans subject to call option of the two subprime securitizations and the corresponding financing.

(D) 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 and will eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or termination of such non-recourse financing structure. For non-recourse financing structures with negative GAAP book value, the aggregate negative GAAP book value which will eventually be recorded as an increase to GAAP book value is $497.0 million as of September 30, 2010.

7

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

Comprehensive Income

The following table summarizes our comprehensive income for the interim periods presented:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Net income (loss)	$	163,502		$	53,038		$	423,281		$	(229,808	)
Net unrealized gain on securities		79,534			179,546			341,566			229,077
Reclassification of net realized loss on securities into earnings		11,117			99,437			66,047			431,328
Net unrealized gain (loss) on derivatives designated as cash flow hedges		(16,078	)		(20,303	)		(48,758	)		88,514
Reclassification of net realized loss on derivatives designated as cash flow hedges into earnings		8,207			3,484			14,353			6,001
	$	246,282		$	315,202		$	796,489		$	525,112

Variable Interest Entities (“VIEs”)

In June 2009, the FASB issued new guidance which changes the definition of a VIE and changes the methodology to determine who is the primary beneficiary of, or in other words who consolidates, a VIE. Furthermore, it eliminates the scope exception for qualified special purpose entities (QSPEs), which are now subject to the VIE consolidation rules. This guidance is effective for fiscal years beginning after November 15, 2009.

Under the new guidance, a primary beneficiary is defined as the party who has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and will absorb a significant portion of the VIE’s expected losses or receive a significant portion of the expected residual returns as a result of holding variable interests.

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

In addition, Newcastle’s investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. Newcastle is not obligated to provide, nor has it provided, any financial support to these VIEs. Newcastle monitors these investments and, to the extent Newcastle determines that it potentially owns a majority of the currently controlling class, it analyzes them for potential consolidation. As of September 30, 2010, Newcastle has not consolidated these potential VIEs due to the determination that, based on the nature of Newcastle’s investments and the provisions governing these structures, Newcastle does not have the power to direct the activities that most significantly impact their economic performance. Newcastle will continue to analyze future investments, as well as reconsideration events in existing entities, pursuant to the VIE requirements. These analyses require considerable judgment in determining the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power and economics. The result could be the consolidation of an entity that would otherwise not have been consolidated or the de-consolidation of an entity that would otherwise have been consolidated.

8

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

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. As a result of this new guidance, Newcastle has interests in the following unconsolidated VIE at September 30, 2010, in which it has a significant interest, in addition to the subprime securitizations which are described in Note 4:

					Carrying Value of Newcastle’s
Entity	Gross Assets (A)		Debt (B)		Investment (C)
CDO VII	$	485,441	$	470,565	$	—

(A) Face amount.

(B) Includes $61.1 million face amount of debt owned by Newcastle with a carrying value of zero at September 30, 2010.

(C) Represent’s Newcastle’s maximum exposure to loss from these entities.

Gain (Loss) on Settlement of Investments, Net and Other Income (Loss), Net

These items are comprised of the following:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Gain (loss) on settlement of investments, net
Gain on settlement of real estate securities	$	638		$	304		$	28,744		$	25,774
Loss on settlement of real estate securities		(1,772	)		(1,910	)		(7,968	)		(18,413	)
Loss on repayment of real estate securities		—			(103	)		—			(103	)
Gain on disposition of loans held for sale		—			—			—			526
Realized gain (loss) on termination of derivative instruments		—			—			(3,279	)		4
	$	(1,134	)	$	(1,709	)	$	17,497		$	7,788
Other income (loss), net
Gain (loss) on non-hedge derivative instruments	$	(1,861	)	$	(2,080	)	$	(5,992	)	$	11,232
Unrealized (loss) recognized at de-designation of hedges		(7,279	)		—			(7,279	)		(8,797	)
Hedge ineffectiveness		83			(171	)		(85	)		(489	)
Other income (loss)		229			295			750			528
	$	(8,828	)	$	(1,956	)	$	(12,606	)	$	2,474

9

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

3. REAL ESTATE SECURITIES

The following is a summary of Newcastle’s real estate securities at September 30, 2010, all of which are classified as available for sale and are, therefore, reported at fair value with changes in fair value recorded in other comprehensive income, except for securities that are other-than-temporarily impaired.

			Amortized Cost Basis																Weighted Average
	Outstanding Face Amount		Before Impairment		Other-Than- Temporary Impairment (A)			After Impairment		Gross Unrealized					Carrying Value (B)		Number of Securities		Rating (C)		Coupon			Yield			Maturity (Years) (D)		Principal Subordination (E)
Asset Type										Gains		Losses
CMBS-Conduit	$	1,528,976	$	1,299,535	$	(455,597	)	$	843,938	$	118,386	$	(96,442	)	$	865,882		199		BB+		5.75	%		11.54	%		3.4		10.2	%
CMBS- Single Borrower		495,133		480,603		(32,494	)		448,109		25,433		(66,199	)		407,343		65		B+		3.99	%		6.73	%		2.2		8.8	%
CMBS-Large Loan		45,734		45,729		—			45,729		—		(16,672	)		29,057		7		BB		1.96	%		2.02	%		0.9		14.8	%
REIT Debt		376,055		375,286		—			375,286		21,517		(11,748	)		385,055		44		BB+		6.13	%		5.90	%		3.4		N/A
ABS-Subprime (F)		378,819		364,026		(190,904	)		173,122		24,482		(6,682	)		190,922		89		B-		1.57	%		15.88	%		4.4		21.9	%
ABS-Manufactured Housing		48,275		46,935		—			46,935		1,410		(782	)		47,563		9		BBB		6.67	%		7.26	%		5.7		37.6	%
ABS-Franchise		30,709		30,972		(22,047	)		8,925		262		(1,207	)		7,980		13		CCC+		3.74	%		7.66	%		2.1		15.4	%
FNMA/FHLMC (G)		3,415		3,718		—			3,718		64		—			3,782		1		AAA		5.70	%		3.84	%		3.3		N/A
CDO (H)		80,462		14,734		(14,734	)		—		—		—			—		4		C		4.18	%		0.00	%		—		N/A
Debt Security Total /Average (I)		2,987,578		2,661,538		(715,776	)		1,945,762		191,554		(199,732	)		1,937,584		431		BB		4.87	%		9.37	%		3.2
Equity Securities				1,388		(276	)		1,112		3,583		—			4,695		2
Total			$	2,662,926	$	(716,052	)	$	1,946,874	$	195,137	$	(199,732	)	$	1,942,279	$	433

(A) Represents the cumulative impairment against amortized cost basis recorded through earnings, net of the effect of the cumulative adjustment as a result of the adoption of new accounting guidance on impairment in 2009.

(B) See Note 6 regarding the estimation of fair value, which is equal to carrying value for all securities.

(C) Represents the weighted average of the ratings of all securities in each asset type, expressed as an S&P equivalent rating. For each security rated by multiple rating agencies, the lowest rating is used. FNMA/FHLMC securities have an implied AAA rating. Ratings provided were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including a “negative watch” assignment) at any time.

(D) The weighted average maturity is based on the timing of expected principal reduction on the assets.

(E) Percentage of the outstanding face amount of securities that is subordinate to Newcastle’s investments.

(F) Includes the retained bonds with face amount of $30.3 million and carrying value of $1.8 million from Securitization Trust 2006 and Securitization Trust 2007 (Note 4). The residual interests were fully written off in the first quarter of 2010.

(G) Amortized cost basis and carrying value include principal receivable of $0.1 million.

(H) Includes one CDO bond issued by a third party and three CDO bonds issued by CDO VII, which has been deconsolidated, and held as investments by Newcastle.

(I) The total outstanding face amount of fixed rate securities was $2.2 billion, and of floating rate securities was $0.8 billion.

10

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

Unrealized losses that are considered other-than-temporary are recognized currently in income. During the nine months ended September 30, 2010, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of $102.4 million (gross of $15.6 million of the portion of other-than-temporary impairment recognized in other comprehensive income) with respect to real estate securities. Based on management’s analysis of these securities, the performance of the underlying loans and changes in market factors, Newcastle noted adverse changes in the expected cash flows on certain of these securities and concluded that they were other-than-temporarily impaired. Any remaining unrealized losses on Newcastle’s securities were primarily the result of changes in market factors, rather than issue-specific credit impairment. The following table summarizes Newcastle’s securities in an unrealized loss position as of September 30, 2010.

			Amortized Cost Basis							Gross Unrealized									Weighted Average
Securities in an Unrealized Loss Position	Outstanding Face Amount		Before Impairment		Other-than- Temporary Impairment			After Impairment		Gains		Losses			Carrying Value		Number of Securities		Rating		Coupon			Yield			Maturity (Years)
Less Than Twelve Months	$	114,447	$	94,170	$	(10,828	)	$	83,342	$	—	$	(3,216	)		80,126		18		BB+		5.66	%		12.48	%		4.7
Twelve or More Months		955,004		950,461		(62,718	)		887,743		—		(196,516	)		691,227		153		BB-		4.75	%		5.36	%		3.1
Total	$	1,069,451	$	1,044,631	$	(73,546	)	$	971,085	$	—	$	(199,732	)	$	771,353		171		BB-		4.85	%		5.97	%		3.3

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:

	September 30, 2010
	Fair Value		Amortized Cost Basis		Unrealized Losses
					Credit (B)			Non-Credit (C)
Securities Newcastle intends to sell	$	—	$	—	$	—			N/A
Securities Newcastle is more likely than not to be required to sell (A)		—		—		—			N/A
Securities Newcastle has no intent to sell and is not more likely than not to be required to sell:
Credit impaired securities		62,514		82,979		(68,157	)		(20,465	)
Non credit impaired securities		708,839		888,106		—			(179,267	)
Total debt securities in an unrealized loss position	$	771,353	$	971,085	$	(68,157	)	$	(199,732	)

(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.

11

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

The following table summarizes the activity related to credit losses on debt securities for the nine months ended September 30, 2010:

Beginning balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(408,782	)
Additions for credit losses on securities for which an OTTI was not previously recognized		(14,697	)
Increases to credit losses on securities for which an OTTI was previously recognized and a portion of an OTTI was recognized in other comprehensive income		(10,450	)
Additions for credit losses on securities for which an OTTI was previously recognized without any portion of OTTI recognized in other comprehensive income		(10,797	)
Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive income at September 30, 2010		211,643
Reduction for securities sold during the period		48,965
Reduction for securities deconsolidated during the period		112,408
Reduction for increases in cash flows expected to be collected that are recognized over the remaining life of the security		3,553
Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in other comprehensive income	$	(68,157	)

The table below summarizes the geographic distribution of the collateral securing our CMBS and ABS at September 30, 2010 (in thousands):

	CMBS					ABS
Geographic Location	Outstanding Face Amount		Percentage			Outstanding Face Amount		Percentage
Western U.S.	$	553,217		26.7	%	$	127,841		27.9	%
Northeastern U.S.		487,545		23.6	%		84,065		18.4	%
Southeastern U.S.		414,549		20.0	%		106,559		23.3	%
Midwestern U.S.		305,601		14.8	%		61,574		13.4	%
Southwestern U.S.		229,490		11.1	%		48,302		10.6	%
Other		56,272		2.7	%		29,453		6.4	%
Foreign		23,169		1.1	%		9		0.0	%
	$	2,069,843		100.0	%	$	457,803		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.

12

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

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

All of Newcastle’s loan investments, other than the manufactured housing loans Portfolio I as described below, were classified as held for sale as of September 30, 2010 and December 31, 2009 and marked to the lower of carrying value or fair value. A portfolio of manufactured housing loans, which was refinanced in April 2010 through a securitization transaction (see Note 5), was reclassified from held for sale to held for investment during the nine months ended September 30, 2010.

The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans at September 30, 2010. The loans contain various terms, including fixed and floating rates, self-amortizing and interest only. They are generally subject to prepayment.

Loan Type	Outstanding Face Amount		Carrying Value (A)		Loan Count		Wtd. Avg. Yield			Weighted Average Coupon			Weighted Average Maturity (Years) (B)		Floating Rate Loans as a % of Face Amount			Delinquent Face Amount (C)
Mezzanine Loans	$	658,103	$	368,267		19		15.70	%		3.98	%		2.0		83.9	%	$	87,382
Corporate Bank Loans		301,102		195,800		9		16.60	%		8.60	%		3.6		62.7	%		—
B-Notes		283,132		149,167		10		15.88	%		4.37	%		1.6		78.7	%		95,092
Whole Loans		102,228		55,973		4		7.45	%		2.85	%		11.5		98.1	%		71,162
Total Real Estate Related Loans Held for Sale, Net	$	1,344,565	$	769,207		42		15.36	%		5.01	%		3.0		79.1	%	$	253,636
Manufactured Housing Loans Portfolio I	$	155,005	$	127,830		4,022		9.62	%		8.74	%		7.8		1.2	%	$	1,318
Residential Mortgage Loans, Held for Investment, Net	$	155,005	$	127,830		4,022		9.62	%		8.74	%		7.8		1.2	%	$	1,318
Residential Loans	$	65,246	$	49,469		228		6.00	%		2.49	%		6.8		100.0	%	$	5,837
Manufactured Housing Loans		1,268		343		31		46.99	%		8.30	%		0.7		0.0	%		562
Manufactured Housing Loans Portfolio II		220,027		205,983		7,325		8.58	%		9.72	%		5.9		17.4	%		3,755
Total Residential Mortgage Loans Held for Sale, Net	$	286,541	$	255,795		7,584		8.13	%		8.07	%		6.1		36.1	%	$	10,154
Subprime Mortgage Loans Subject to Call Option	$	406,217	$	403,584

(A) Carrying value includes interest receivable of $0.1 million for the residential housing loans and principal and interest receivable of $7.0 million for the manufactured housing loans.

(B) The weighted average maturity is based on the timing of expected principal reduction on the assets.

(C) Includes loans that are non-performing, in foreclosure, under bankruptcy, or considered real estate owned.

The following is a summary of real estate related loans by maturities at September 30, 2010:

Year of Maturity(1)	Outstanding Face Amount		Carrying Value		Number of Loans
Delinquent(2)	$	253,636	$	24,907		7
Period from October 1, 2010 to December 31, 2010		51,614		46,193		1
2011		494,824		374,078		15
2012		158,310		87,149		6
2013		17,018		14,753		2
2014		125,672		54,846		3
2015		200,923		152,020		6
Thereafter		42,568		15,261		2
Total	$	1,344,565		769,207		42

(1) Based on the final extended maturity date of each loan investment as of September 30, 2010.

(2) Includes loans that are non-performing, in foreclosure, or under bankruptcy.

13

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

The following is a rollforward of the related loss allowance.

	Held For Sale						Held For Investment
	Real Estate Related Loans			Residential Mortgage Loans			Residential Mortgage Loans
Balance at December 31, 2009	$	(822,409	)	$	(96,409	)	$	—
Charge-offs (A)		55,681			6,478			813
Deconsolidation of CDO VII		5,263			—			—
Transfer to held for investment		—			21,884			(21,884	)
Valuation (allowance) reversal on loans		257,877			35,662			(871	)
Balance at September 30, 2010	$	(503,588	)	$	(32,385	)	$	(21,942	)

(A) The charge-offs of $55.7 million in real estate related loans for the nine months ended September 30, 2010 represent five loans which were either sold, restructured or paid off at a discounted price during the period.

Securitization of Subprime Mortgage Loans

The following table presents information on the retained interests in Newcastle’s securitizations of subprime mortgage loans at September 30, 2010:

	Subprime Portfolio
	I		II
Total securitized loans (unpaid principal balance) (A)	$	540,192	$	714,113
Loans subject to call option (carrying value)	$	299,176	$	104,408
Retained interests (fair value) (B)	$	1,677	$	84

(A) Average loan seasoning of 62 months and 44 months for Subprime Portfolios I and II, respectively, at September 30, 2010.

(B) The retained interests include retained bonds of the securitizations. Newcastle’s residual interests were written off in the first quarter of 2010. Fair value is estimated based on pricing models.

Newcastle has no obligation to repurchase any loans from either of its subprime securitizations. Therefore, it is expected that its exposure to loss is limited to the carrying amount of its retained interests in the securitization entities, as described above. A subsidiary of Newcastle gave limited representations and warranties with respect to Subprime Portfolio II; however, it has no assets and does not have recourse to the general credit of Newcastle.

The following table summarizes certain characteristics of the underlying subprime mortgage loans, and related financing, in the securitizations as of September 30, 2010:

	Subprime Portfolio
	I			II
Loan unpaid principal balance (UPB)	$	540,192		$	714,113
Weighted average coupon rate of loans		6.20	%		5.88	%
Delinquencies of 60 or more days (UPB) (A)	$	114,386		$	222,056
Net credit losses for the nine months ended September 30, 2010	$	29,189		$	50,741
Cumulative net credit losses	$	154,716		$	153,987
Cumulative net credit losses as a % of original UPB		10.30	%		14.15	%
Percentage of ARM loans (B)		53.0	%		65.8	%
Percentage of loans with original loan-to-value ratio >90%		10.60	%		17.10	%
Percentage of interest-only loans		22.9	%		4.1	%
Face amount of debt (C)	$	528,402		$	695,587
Weighted average funding cost of debt (D)		1.47	%		1.58	%

(A) Delinquencies include loans 60 or more days past due, in foreclosure, under bankruptcy filing or real estate owned.

(B) ARM loans are adjustable-rate mortgage loans. An option ARM is an adjustable-rate mortgage that provides the borrower with an option to choose from several payment amounts each month for a specified period of the loan term. None of the loans in the subprime portfolios are an option ARM.

(C) Excludes face amount of $11.8 million and $18.5 million of retained notes for Subprime Portfolios I and II, respectively, at September 30, 2010.

(D) Includes the effect of applicable hedges.

14

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

Newcastle received net cash inflows of $0.3 million and $0.5 million from the retained interests of Subprime Portfolios I and II, respectively, during the nine months ended September 30, 2010 and $0.7 million and $1.1 million from I and II, respectively, during the nine months ended September 30, 2009.

The weighted average yield of the retained notes of Subprime Portfolios I and II was 23.1%, as of September 30, 2010. The loans subject to call option and the corresponding financing recognize interest income and expense based on the expected weighted average coupons of the loans subject to call option at the call date of 9.24% and 8.68% for Subprime Portfolio’s I and II, respectively.

15

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

5. DEBT OBLIGATIONS

The following table presents certain information regarding Newcastle’s debt obligations and related hedges at September 30, 2010:

																			Collateral
Debt Obligation/Collateral	Month Issued			Outstanding Face Amount		Carrying Value		Unhedged Weighted Average Funding Cost (A)		Final Stated Maturity		Weighted Average Funding Cost (B)			Weighted Average Maturity (Years)		Face Amount of Floating Rate Debt		Outstanding Face Amount (C)		Amortized Cost Basis (C)		Carrying Value (C)		Weighted Average Maturity (Years)		Floating Rate Face Amount (C)		Aggregat Notional Amount of Hedges (D)
CDO Bonds Payable
CDO IV (E)		Mar 2004		$	336,084	$	335,170		1.23%		Mar 2039		2.92	%		2.5	$	312,286	$	398,584	$	325,780	$	292,298		2.8	$	163,224	$	153,600
CDO V		Sep 2004			371,751		370,477		1.03%		Sep 2039		3.10	%		2.5		359,751		423,609		305,556		268,830		3.3		154,572		188,228
CDO VI (E)		Apr 2005			362,921		361,668		0.68%		Apr 2040		3.40	%		3.5		360,259		439,754		212,410		214,365		2.6		127,170		214,486
CDO VIII		Nov 2006			618,313		617,838		0.89%		Nov 2052		2.14	%		3.1		610,713		819,334		545,203		568,363		3.5		524,374		161,655
CDO IX		May 2007			530,125		534,299		0.67%		May 2052		1.49	%		4.2		530,125		760,547		523,026		535,939		3.6		545,495		91,606
CDO X		Jul 2007			1,175,000		1,173,687		0.64%		Jul 2052		4.33	%		4.7		1,175,000		1,314,003		976,431		1,003,552		3.6		240,632		1,049,629
					3,394,194		3,393,139						3.11	%		3.7		3,348,134		4,155,831		2,888,406		2,883,347		3.4		1,755,467		1,859,204
Other Bonds Payable
MH loans Portfolio I (F)		Apr 2010			90,071		88,673		4.75%		Jul 2035		5.37	%		3.6		—		155,005		127,830		127,830		7.8		1,821		—
MH loans Portfolio II		Aug 2006			177,904		177,570		LIBOR+ 0.88%		Aug 2011		6.11	%		0.8		177,904		220,027		205,983		205,983		5.9		38,181		134,426
					267,975		266,243						5.86	%		1.7		177,904		375,032		333,813		333,813		6.7		40,002		134,426
Notes Payable
Residential Mortgage Loans (G)		Aug 2004			4,516		4,516		LIBOR+ 0.90%		Dec 2034		1.25	%		7.1		4,516		4,516		4,516		4,516		7.1		4,516		—
					4,516		4,516						1.25	%		7.1		4,516		4,516		4,516		4,516		7.1		4,516		—
Corporate
Junior subordinatednotes payable		Mar 2006			51,004		51,255		7.57% (I)		Apr 2035		7.42	%		24.6		—		—		—		—		—		—		—
					51,004		51,255						7.42	%		24.6		—		—		—		—		—		—		—
Subtotal debt obligations					3,717,689		3,715,153						3.36	%		3.9	$	3,530,554	$	4,535,379	$	3,226,735	$	3,221,676		3.7	$	1,799,985	$	1,993,630
Financing on subprime mortgage loans subject to call option		(H	)		406,217		403,584
Total debt obligations				$	4,123,906	$	4,118,737

(A) Weighted average, including floating and fixed rate classes and including the amortization of deferred financing costs.

(B) Including the effect of applicable hedges.

(C) Including restricted cash held for reinvestment in CDOs.

(D) Including a $36.4 million notional amount of interest rate cap agreements in CDO X and a $134.4 million notional amount of interest rate swap agreements in MH loans portfolio II, which were not designated as hedges for accounting purposes.

(E) CDOs IV and VI were not in compliance with their applicable over collateralization tests as of September 30, 2010. Newcastle is not receiving cash flows from these CDOs (other than senior management fees) and expects these CDOs to remain out of compliance for the foreseeable future.

(F) Excluding $36.9 million of debt sold to certain Newcastle CDOs, which was eliminated in consolidation. See further description below.

(G) Notes payable issued to CDO VII, which was eliminated in consolidation through December 31, 2009.

(H) Issued in April 2006 and July 2007. See Note 4 regarding the securitizations of Subprime Portfolios I and II.

(I) LIBOR + 2.25% after April 2016.

16

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

See Note 2 regarding the deconsolidation of CDO VII.

In the first nine months of 2010, Newcastle repurchased $168.0 million face amount of CDO bonds for $25.6 million. As a result, Newcastle extinguished $168.0 million face amount of CDO debt and recorded a gain on extinguishment of debt of $141.7 million.

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 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:

				Consideration
	Repurchased junior subordinated notes			Cash		Reissued CDO bonds			Total
Outstanding face amount	$	52,094		$	9,715	$	37,625		$	47,340
Weighted average coupon		7.574	% (A)		N/ A		LIBOR + 0.66	% (B)
Maturity		April 2035					June 2052
Collateral		General credit of Newcastle					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.

In March 2010, Newcastle sold $22.8 million face amount of FHLMC securities and repaid the corresponding repurchase agreements in the amount of $22.6 million. Concurrent with the sales, Newcastle terminated the related interest rate swap agreements. As a result, the gain on sale recorded from these assets was offset by the loss on the termination of the derivatives.

On April 15, 2010, Newcastle completed a securitization transaction to refinance its Manufactured Housing Loans Portfolio I (the “Portfolio”). Newcastle sold approximately $164.1 million outstanding principal balance of manufactured housing loans to Newcastle MH I LLC (the “Issuer”). The Issuer issued approximately $134.5 million aggregate principal amount of asset-backed notes (the “Notes”), of which $97.6 million was sold to third parties and $36.9 million was sold to certain CDOs managed and consolidated by Newcastle. At the closing of the securitization transaction, Newcastle used the gross proceeds received from the issuance of the Notes to repay the previously existing financing on this portfolio in full, terminate the related interest rate swap contracts, pay the related transaction costs and increase its unrestricted cash by approximately $14 million. Under the applicable accounting guidance, the securitization transaction is accounted for as a secured borrowing. As a result, no gain or loss is recorded for the transaction. Newcastle continues to recognize the portfolio of manufactured housing loans as pledged assets, which have been classified as loans held for investment at securitization, and records the notes issued to third parties as a secured borrowing. The associated assets, liabilities, revenues and expenses are presented in the non-recourse financing structure sections of the consolidated financial statements.

In April 2010, Newcastle repaid in full all of its outstanding repurchase agreements.

In July 2010, Newcastle repaid in full the remaining $1.4 million of recourse debt on its Manufactured Housing Loan Portfolio II.

17

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair Value Summary Table

Newcastle held the following financial instruments at September 30, 2010:

	Principal Balance or Notional Amount		Carrying Value		Fair Value		Fair Value Method (A)	Weighted Average Yield/Funding Cost			Weighted Average Maturity (Years)
Assets
Non-Recourse VIE Financing Structures (F)
Financial instruments:
Real estate securities, available for sale*	$	2,830,965	$	1,941,162	$	1,941,162	Broker quotations, counterparty quotations, pricing services, pricing models		9.33	%		3.39
Real estate related loans, held for sale, net		1,117,609		736,386		736,708	Broker quotations, counterparty quotations, pricing services, pricing models		15.29	%		3.26
Residential mortgage loans, held for investment, net		155,005		127,830		128,034	Pricing models		9.62	%		7.8
Residential mortgage loans, held for sale, net		285,273		255,452		255,452	Pricing models		8.08	%		6.09
Subprime mortgage loans subject to call option (B)		406,217		403,584		403,584	(B)		9.09	%		(B	)
Restricted cash*		156,825		156,825		156,825
Derivative assets, treated as hedges (C)(E)*		104,205		2,782		2,782	Counterparty quotations		N/A			(C	)
Non-hedge derivative assets (D)(E)*		36,428		1,621		1,621	Counterparty quotations		N/A			(D	)
Receivables and other assets				32,571		32,571
			$	3,658,213	$	3,658,739
Recourse Financing Structures and Unlevered Assets
Financial instruments:
Real estate securities, available for sale*	$	156,613	$	1,117	$	1,117	Broker quotations, counterparty quotations, pricing services, pricing models		138.55	%		0.3
Real estate related loans, held for sale, net		226,956		32,821		32,821	Broker quotations, counterparty quotations, pricing services, pricing models		17.05	%		1.72
Residential mortgage loans, held for sale, net		1,268		343		343	Pricing models		46.99	%		0.7
Cash and cash equivalents*		58,336		58,336		58,336
Operating real estate, held for sale				9,066		9,066
Receivables and other assets				170		170
			$	101,853	$	101,853
Liabilities
Non-Recourse VIE Financing Structures (F)(G)
Financial instruments:
CDO bonds payable	$	3,394,194	$	3,393,139	$	2,104,822	Pricing models		3.12	%		3.7
Other bonds payable		267,975		266,243		247,127	Pricing models		5.86	%		1.7
Notes payable		4,516		4,516		3,672	Broker quotation		1.25	%		7.1
Financing of subprime mortgage loans subject to call option (B)		406,217		403,584		403,584	(B)		9.09	%		(B	)
Interest rate swaps, treated as hedges (C)(E)*		1,718,571		200,386		200,386	Counterparty quotations		N/A			(C	)
Non-hedge derivatives (D)(E)*		134,426		20,061		20,061	Counterparty quotations		N/A			(D	)
Accrued expenses and other liabilities				7,076		7,076
			$	4,295,005	$	2,986,728
Recourse Financing Structures and Other Liabilities (G)
Financial instruments:
Junior subordinated notes payable	$	51,004	$	51,255	$	21,603	Pricing models		7.42	%		24.6
Due to affiliates				1,419		1,419
Accrued expenses and other liabilities				3,571		3,571
			$	56,245	$	26,593

* Measured at fair value on a recurring basis.

18

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

(A) Methods are listed in order of priority. In the case of real estate securities and real estate related loans, broker quotations are obtained if available and practicable, otherwise counterparty quotations or pricing service valuations are obtained or, finally, internal pricing models are used. Internal pricing models are only used for (i) securities and loans that are not traded in an active market, and, therefore, have little or no price transparency, and for which significant unobservable inputs must be used in estimating fair value, or (ii) loans or debt obligations which are private and untraded.

(B) These two items result from an option, not an obligation, to repurchase loans from Newcastle’s subprime mortgage loan securitizations (Note 4), are noneconomic until such option is exercised, and are equal and offsetting.

(C) Represents derivative agreements as follows:

Year of Maturity	Weighted Average Month  of Maturity		Aggregate Notional Amount		Weighted Average Fixed Pay Rate / Cap Rate			Aggregate Fair Value Asset / (Liability)
Interest rate cap agreements which receive 1-Month LIBOR:
2015		Sep	$	21,000		2.26	%	$	441
2016		Jul		77,905		2.66	%		2,128
2017		Jan		5,300		1.86	%		213
			$	104,205				$	2,782
Interest rate swap agreements which receive 1-Month LIBOR:
2011		Dec	$	91,606		5.00	%	$	(4,965	)
2014		Oct		15,914		5.09	%		(2,414	)
2015		Sep		915,034		5.31	%		(93,678	)
2016		May		180,155		5.04	%		(27,212	)
2017		Aug		174,034		5.24	%		(37,669	)
Interest rate swap agreements which receive 3-Month LIBOR:
2014		Jul		341,828		4.20	%		(34,448	)
			$	1,718,571				$	(200,386	)

(D) This represents an interest rate swap with a notional balance of $134.4 million, maturing in June 2016 and three interest rate cap agreements with a total notional balance of $36.4 million, maturing in August 2017 and January 2019, respectively. Newcastle entered into these hedge agreements to reduce its exposure to interest rate changes on the floating rate financings of its manufactured housing loan portfolio II and on the floating rate financings of CDO X. These derivative agreements were not designated as hedges for accounting purposes.

(E) Newcastle’s derivatives fall into two categories. Derivatives held within Newcastle’s nonrecourse debt structures (primarily CDOs), all of which were liabilities at period end, are not subject to Newcastle’s credit risk as they are senior to all the debt obligations of the related CDO. As a result, no adjustments have been made to the fair value quotations received related to credit risk. Newcastle’s significant derivative counterparties include Bank of America, Deutsche Bank, Wells Fargo and Credit Suisse.

(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, our economic losses from such structures cannot exceed Newcastle’s invested equity in them. Therefore, economically, their net book value cannot be less than zero and 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.

19

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

Valuation Hierarchy

The methodologies used for valuing such instruments have been categorized into three broad levels which form a hierarchy. Newcastle follows this hierarchy for its financial instruments measured at fair value on a recurring basis. The classifications are based on the lowest level of input that is significant to the fair value measurement.

The following table summarizes such financial assets and liabilities measured at fair value on a recurring basis at September 30, 2010:

	Principal Balance or Notional Amount				Fair Value
			Carrying Value		Level 2		Level 3A (1)		Level 3B (2)		Total
Assets:
Real estate securities, available for sale:
CMBS	$	2,069,843	$	1,302,282	$	—	$	1,120,862	$	181,420	$	1,302,282
REIT debt		376,055		385,055		385,055		—		—		385,055
ABS - subprime		378,819		190,922		—		95,457		95,465		190,922
ABS - other real estate		78,984		55,543		—		48,589		6,954		55,543
FNMA / FHLMC		3,415		3,782		3,782		—		—		3,782
CDO		80,462		—		—		—		—		—
Debt security total	$	2,987,578		1,937,584		388,837		1,264,908		283,839		1,937,584
Equity securities				4,695		—		—		4,695		4,695
Real estate securities total			$	1,942,279	$	388,837	$	1,264,908	$	288,534	$	1,942,279
Derivative assets:
Interest rate caps, treated as hedges	$	104,205	$	2,782	$	2,782	$	—	$	—	$	2,782
Interest rate caps, not treated as hedges		36,428		1,621		1,621		—		—		1,621
Derivative assets total	$	140,633	$	4,403	$	4,403	$	—	$	—	$	4,403
Liabilities:
Derivative Liabilities:
Interest rate swaps, treated as hedges	$	1,718,571	$	200,386	$	200,386	$	—	$	—	$	200,386
Interest rate swaps, not treated as hedges		134,426		20,061		20,061		—		—		20,061
Derivative liabilities total	$	1,852,997	$	220,447	$	220,447	$	—	$	—	$	220,447

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

(2) Internal models with significant unobservable inputs.

20

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

Newcastle’s investments in instruments measured at fair value on a recurring basis using Level 3 inputs changed during the nine months ended September 30, 2010 as follows:

	Level 3A
	CMBS						ABS						Equity/Other Securities			Total
	Conduit			Other			Subprime			Other
Balance at December 31, 2009	$	536,092		$	397,407		$	87,883		$	46,059		$	—		$	1,067,441
Transfers (C)
Transfers from Level 3B		761			1,637			—			—			—			2,398
Transfers into Level 3B		(44,512	)		(22,177	)		(10,538	)		—			—			(77,227	)
CDO VII Deconsolidation		(32,858	)		(3,379	)		(10,685	)		—			—			(46,922	)
Total gains (losses) (A)
Included in net income (loss) (B)		5,614			300			59			—			—			5,973
Included in other comprehensive income (loss)		144,712			63,774			2,174			6,837			—			217,497
Amortization included in interest income		11,055			6,081			6,335			131			—			23,602
Purchases, sales and settlements
Purchases		201,262			21,478			44,894			—			—			267,634
Proceeds from sales		(25,679	)		(6,934	)		(6,478	)		—			—			(39,091	)
Proceeds from repayments		(20,281	)		(113,491	)		(18,187	)		(4,438	)		—			(156,397	)
Balance at September 30, 2010	$	776,166		$	344,696		$	95,457		$	48,589		$	—		$	1,264,908
	Level 3B
	CMBS						ABS						Equity/Other Securities
	Conduit			Other			Subprime			Other						Total
Balance at December 31, 2009	$	95,376		$	32,744		$	85,377		$	10,719		$	2,620		$	226,836
Transfers (C)
Transfers from Level 3A		44,512			22,177			10,538			—			—			77,227
Transfers into Level 3A		(761	)		(1,637	)		—			—			—			(2,398	)
CDO VII Deconsolidation		(48,665	)		—			(17,890	)		(457	)		—			(67,012	)
Total gains (losses) (A)
Included in net income (loss) (B)		(77,220	)		9,459			(5,417	)		(3,488	)		(279	)		(76,945	)
Included in other comprehensive income (loss)		87,301			73,982			32,009			1,662			2,351			197,305
Amortization included in interest income		12,371			76			8,576			394			—			21,417
Purchases, sales and settlements
Purchases		—			14,414			—			—			3			14,417
Proceeds from sales		(1,751	)		(21,646	)		(1,063	)		—			—			(24,460	)
Proceeds from repayments		(21,447	)		(37,865	)		(16,665	)		(1,876	)		—			(77,853	)
Balance at September 30, 2010	$	89,716		$	91,704		$	95,465		$	6,954		$	4,695		$	288,534

(A) None of the gains (losses) recorded in earnings during the period is attributable to the change in unrealized gains (losses) relating to Level 3 assets still held at the reporting dates.

(B)

	Nine Months Ended September 30, 2010
	Level 3A			Level 3B
Gain (loss) on settlement of investments, net	$	6,705		$	9,145
Other income (loss), net		—			—
OTTI		(732	)		(86,090	)
Total	$	5,973		$	(76,945	)
Gain (loss) on settlement of investments, net, from investments transferred into Level 3 during the period	$	—		$	—

(C) Transfers are assumed to occur at the beginning of the quarter.

21

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

Securities Valuation

As of September 30, 2010, Newcastle’s securities valuation methodology and results are further detailed as follows:

	Outstanding Face Amount (A)		Amortized Cost Basis (B)		Fair Value
Asset Type					Multiple Quotes (C)		Single Quote (D)		Internal Pricing Models (E)		Total
CMBS	$	2,069,843	$	1,337,776	$	878,880	$	241,982	$	181,420	$	1,302,282
REIT debt		376,055		375,286		320,856		64,199		—		385,055
ABS – subprime		378,819		173,122		53,611		41,846		95,465		190,922
ABS – other real estate		78,984		55,860		1,026		47,563		6,954		55,543
FNMA / FHLMC		3,415		3,718		—		3,782		—		3,782
CDO		80,462		—		—		—		—		—
Debt security total	$	2,987,578		1,945,762		1,254,373		399,372		283,839		1,937,584
Equity securities				1,112		—		—		4,695		4,695
Total			$	1,946,874	$	1,254,373	$	399,372	$	288,534		1,942,279

(A) Net of incurred losses.

(B) Net of discounts (or gross of premiums) and after OTTI, including impairment taken during the period ended September 30, 2010.

(C) Management generally obtained pricing service quotations or broker quotations from two sources, one of which was generally the seller (the party that sold us the security). Management selected one of the quotes received as being most representative of fair value and did not use an average of the quotes. Newcastle’s methodology is to not use quotes from selling brokers, unless those quotes are the only marks available, or unless the quotes provided by other (non-selling) brokers are, in management’s judgment, not representative of fair value. Even if Newcastle receives two or more quotes on a particular security that come from non-selling brokers, it does not use an average because management believes using an actual quote more closely represents a transactable price for the security than an average level. Furthermore, in some cases there is a wide disparity between the quotes Newcastle receives. Management believes using an average of the quotes in these cases would generally not represent the fair value of the asset. Based on Newcastle’s own fair value analysis using internal models, management selects one of the quotes which is believed to more accurately reflect fair value. Newcastle never adjusts quotes received.

(D) Management was unable to obtain quotations from more than one source on these securities. The one source was generally the seller (the party that sold us the security) or a pricing service.

(E) Securities whose fair value was estimated based on internal pricing models are further detailed as follows:

	Amortized Cost Basis		Fair Value		Impairment Recorded In Current Year		Unrealized Gains (Losses) in Accumulated OCI			Assumption Ranges
										Discount Rate		Prepayment Speed (F)	Cumulative Default Rate		Loss Severity
CMBS – Conduit	$	84,595	$	89,716	$	74,165	$	5,121			15%	N/A		0% -73%		0% - 49%
CMBS – Large loan / Single borrower		79,379		91,704		—		12,325			2% -15%	N/A		0% -100%		0% - 100%
ABS – subprime		82,115		95,465		5,827		13,350			10%	1% - 8%		27% -89%		60% -100%
ABS – other RE		7,215		6,954		3,487		(261	)		10%	0% - 4%		44% -75%		56% - 90%
CDO		—		—		3		—			N/A	N/A		100%		100%
Debt security total	$	253,304	$	283,839	$	83,482	$	30,535
Equity securities		1,112		4,695		276		3,583
Total	$	254,416	$	288,534	$	83,758	$	34,118

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 (e.g., 2007 vintage origination) 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.

22

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

Default rates are determined from the current “pipeline” of loans that are more than 90 days delinquent, in foreclosure, or are real estate owned (REO). These significantly delinquent loans determine the first 24 months of the default vector. Beyond month 24, the default vector transitions to a steady-state value that is generally equal to or greater than that given by the widely published investment bank model.

The discount rates Newcastle uses are derived from a range of observable pricing on securities backed by similar collateral and offered in a live market. As the markets in which Newcastle transacts have become less liquid, Newcastle has had to rely on fewer data points in this analysis.

(F) Projected annualized average prepayment rate.

Loan Valuation

Loans which Newcastle does not have the ability to hold into the foreseeable future are classified as held-for-sale. As a result, these held-for-sale loans are carried at the lower of amortized cost or fair value and are therefore recorded at fair value on a non-recurring basis. During the nine months ended September 30, 2010, Newcastle recorded ($257.9) million and ($35.7) million of valuation allowance (reversal) on real estate related loans and residential mortgage loans (Note 4), respectively. These loans were written down to fair value at the time of the impairment, based on broker quotations, pricing service quotations or internal pricing models. All the loans were within Level 3 of the fair value hierarchy. For real estate related loans, the most significant inputs used in the valuations are the amount and timing of expected future cash flows, market yields and the estimated collateral value of such loan investments. For residential mortgage loans, significant inputs include management’s expectations of prepayment speeds, default rates, loss severities and discount rates that market participants would use in determining the fair values of similar pools of residential mortgage loans.

The following tables summarize the fair value information of real estate related loans and residential mortgage loans:

	Outstanding Face Amount		Carrying Value		Fair Value		Valuation Allowance/ (Reversal) In Current Year			Significant Input Ranges
Loan Type										Discount Rate	Loss Severity
Mezzanine	$	658,103	$	368,267	$	368,267	$	(164,500	)	9.0% - 36.4%	0.0% - 100.0%
Bank Loan		301,102		195,800		196,095		(10,744	)	8.5% - 24.9%	0.0% - 38.0%
B-Note		283,132		149,167		149,167		(90,941	)	15.0% - 20.0%	0.0% - 100.0%
Whole Loan		102,228		55,973		56,000		8,308		4.6% - 10.8%	0.0% - 15.0%
Total Real Estate Related Loans Held for Sale, Net	$	1,344,565	$	769,207	$	769,529	$	(257,877	)
	Outstanding Face Amount		Carrying Value		Fair Value		Valuation Allowance/ (Reversal) In Current Year			Significant Input Ranges
Loan Type										Discount Rate	Prepayment Speed	Cumulative Default Rate	Loss Severity
Residential Loans	$	65,246	$	49,469	$	49,469	$	527		5.7% - 7.3%	5% - 30%	0.3% - 4.0%		30% - 40%
Manufactured Housing Loans I		1,268		343		343		5		46.99%	3.00%	4.00%		75.00%
Manufactured Housing Loans II		220,027		205,983		205,983		(36,194	)	8.58%	6.00%	3.50%		75.00%
Total Residential Mortgage Loans Held for Sale, Net	$	286,541	$	255,795	$	255,795	$	(35,662	)

Derivatives

Newcastle is exposed to certain risks relating to its ongoing business operations. The primary risk managed by Newcastle using derivative instruments is interest rate risk. Newcastle enters into interest rate swap and interest rate cap agreements to reduce the impact of fluctuating interest rates on its earnings. Newcastle designates certain interest rate swap and interest rate cap agreements as cash flow hedges of its floating rate financings. 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 is recognized in current earnings during the period of change.

23

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

Newcastle’s derivative instruments are valued using counterparty quotations. These quotations are generally based on valuation models with model inputs that can generally be verified and which do not involve significant judgment. The significant observable inputs used in determining the fair value of our Level 2 derivative contracts are contractual cash flows and market based interest rate curves. Newcastle’s derivatives are recorded on its balance sheet as follows:

			Fair Value
	Balance sheet location		September 30, 2010		December 31, 2009
Derivative Assets
Interest rate caps, designated as hedges		Derivative Assets	$	2,782	$	—
Interest rate caps, not designated as hedges		Derivative Assets		1,621		—
			$	4,403	$	—
Derivative Liabilities
Interest rate swaps, designated as hedges		Derivative Liabilities	$	200,386	$	178,037
Interest rate swaps, not designated as hedges		Derivative Liabilities		20,061		29,117
			$	220,447	$	207,154

The following table summarizes information related to derivatives:

	September 30, 2010			December 31, 2009
Cash flow hedges
Notional amount of interest rate swap agreements	$	1,718,571		$	2,099,435
Notional amount of interest rate cap agreements		104,205			—
Amount of (loss) recognized in OCI on effective portion		(183,283	)		(173,683	)
Deferred hedge gain (loss) related to anticipated financings, which have subsequently occurred, net of amortization		371			832
Deferred hedge gain (loss) related to dedesignation, net of amortization		(3,873	)		(8,045	)
Expected reclassification of deferred hedges from AOCI into earnings over the next 12 months		(41	)		(4,234	)
Expected reclassification of current hedges from AOCI into earnings over the next 12 months		(75,136	)		(90,666	)
Non-hedge Derivatives
Notional amount of interest rate swap agreements		134,426			296,243
Notional amount of interest rate cap agreements		36,428			—

The following table summarizes gains (losses) recorded in relation to derivatives:

		Nine Months Ended September 30,
	Income statement location	2010			2009
Cash flow hedges
Gain (loss) on the ineffective portion	Other income (loss)	$	(85	)	$	(489	)
Gain (loss) immediately recognized at dedesignation	Gain (loss) on sale of investments; Other income (loss)		(10,558	)		(8,793	)
Amount of gain (loss) reclassified from AOCI into income, related to effective portion	Interest expense		(63,426	)		(74,180	)
Deferred hedge gain reclassified from AOCI into income, related to anticipated financings	Interest expense		461			75
Deferred hedge gain (loss) reclassified from AOCI into income, related to effective portion of dedesignated hedges	Interest expense		(4,172	)		(8,021	)
Non-hedge derivatives gain (loss)	Other income (loss)		(5,992	)		11,232

24

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

7. EARNINGS PER SHARE

Newcastle is required to present both basic and diluted earnings per share (“EPS”). Basic EPS is calculated by dividing net income (loss) applicable to common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted EPS is calculated by dividing net income available for common stockholders by the weighted average number of shares of common stock outstanding plus the additional dilutive effect of common stock equivalents during each period. Newcastle’s common stock equivalents are its outstanding stock options. During the nine months ended September 30, 2010 and 2009, Newcastle had no dilutive common stock equivalents. Net income (loss) applicable to common stockholders is equal to net income (loss) less preferred dividends plus excess of carrying amount of exchanged preferred stock over fair value of consideration paid.

As of September 30, 2010, Newcastle’s outstanding options were summarized as follows:

Held by the Manager	1,686,447
Issued to the Manager and subsequently transferred to certain of the Manager’s employees	798,162
Held by the independent directors	14,000
Total	2,498,609

8. COMMITMENTS AND CONTINGENCIES

Litigation —Newcastle is, from time to time, a defendant in legal actions from transactions conducted in the ordinary course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such actions which existed at September 30, 2010, if any, will not materially affect Newcastle’s consolidated results of operations or financial position.

Preferred Dividends in Arrears – As of September 30, 2010, $2.3 million of dividends of Newcastle’s cumulative preferred stock were unpaid and in arrears.

Contingent Gain in CDOs —Newcastle cannot economically lose more than its investment amount in any given non-recourse financing structure. Therefore, impairment recorded in excess of such investment, which results in negative GAAP book value for a given non-recourse financing structure, cannot economically be incurred. For non-recourse financing structures with negative GAAP book value, the aggregate negative GAAP book value will eventually be recorded as an increase to GAAP book value. As of September 30, 2010, Newcastle has recorded $497.0 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.

9. RECENT ACTIVITIES

These financial statements include a discussion of material events which have occurred subsequent to September 30, 2010 (referred to as “subsequent events”) through the issuance of these consolidated financial statements. Events subsequent to that date have not been considered in these financial statements.

On March 23, 2010, Newcastle announced the final results of its offer to exchange (the “Exchange Offer”) shares of its common stock and cash for up to (i) 1,725,000 shares of its outstanding 9.75% Series B Cumulative Redeemable Preferred Stock (“Series B Preferred Stock”), (ii) 1,104,000 shares of its outstanding 8.05% Series C Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”), and (iii) 1,380,000 shares of its outstanding 8.375% Series D Cumulative Redeemable Preferred Stock (“Series D Preferred Stock,” and, together with Series B Preferred Stock and Series C Preferred Stock, the “Preferred Stock”).

On March 25, 2010, Newcastle settled the Exchange Offer. 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.

25

NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2010

(dollars in tables in thousands, except share data)

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.

In connection with the Exchange Offer, all of Newcastle’s preferred stock dividends in arrears were paid, and all cumulative preferred stock dividends accrued through April 30, 2010 have been paid. 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.

See Note 5 regarding certain recent financing-related transactions.

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.

26

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following should be read in conjunction with the unaudited consolidated financial statements and notes included herein, and with Part II, Item 1A, “Risk Factors.”

GENERAL

Newcastle Investment Corp. is a real estate investment and finance company. We invest in, and actively manage, a portfolio of real estate securities, loans 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.

We currently own a diversified portfolio of credit sensitive real estate debt investments, including securities and loans. Our portfolio of real estate securities includes commercial mortgage backed securities (CMBS), senior unsecured debt issued by REITs, real estate related asset backed securities (ABS), and FNMA/FHLMC securities. Mortgage backed securities are interests in or obligations secured by pools of mortgage loans. We generally target investments rated A through BB, except for our FNMA/FHLMC securities, which have an implied AAA rating. We also own, directly and indirectly, interests in loans and pools of loans, including real estate related loans, commercial mortgage loans, residential mortgage loans, manufactured housing loans, and subprime mortgage loans.

We employ leverage as part of our investment strategy. We do not have a predetermined target debt to equity ratio as we believe the appropriate leverage for the particular assets we are financing depends on the credit quality of those assets. As a result of our negative GAAP equity, our GAAP debt to equity ratio is not a meaningful measure as of September 30, 2010. As of September 30, 2010, we have complied with the general investment guidelines adopted by our board of directors that limit total leverage. We utilize leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.

We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential fluctuations in the availability of capital. We seek to utilize multiple forms of financing including collateralized debt obligations (CDOs), other securitizations, term loans, and trust preferred securities, as well as short term financing in the form of loans and repurchase agreements. As we discuss in more detail under “–Market Considerations” below, the continued challenging credit and liquidity conditions 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. However, credit and liquidity conditions have continued to improve during 2010, and, as a result, 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 four primary segments: (i) investments financed with non-recourse collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments financed with recourse debt, and (iv) unlevered investments. With respect to the first two nonrecourse segments, Newcastle is generally entitled to receive the net cash flows from these structures on a periodic basis. Revenues attributable to each segment are disclosed below (in thousands).

	Non-recourse				Recourse		Corporate				Total
For the Nine Months Ended September 30,	CDOs		Other Non-Recourse				Unlevered		Other
2010	$	168,150	$	54,952	$	976	$	1,189	$	48	$	225,315
2009	$	221,385	$	58,043	$	6,200	$	1,333	$	72	$	287,033

27

Market Considerations

Financial Markets in which We Operate

Our ability to generate income is dependent on our ability to invest our capital on a timely basis at attractive levels. The two primary market factors that affect this ability are (1) credit spreads and (2) the availability of financing on favorable terms.

Generally speaking, widening credit spreads reduce any unrealized gains on our current investments (or cause or increase unrealized losses) and increase our costs for new financings, but increase the yields available on potential new investments, while tightening credit spreads increase the unrealized gains (or reduce unrealized losses) on our current investments and reduce our costs for new financings, but reduce the yields available on potential new investments. By reducing unrealized gains (or causing unrealized losses), widening credit spreads also impact our ability to realize gains on existing investments if we were to sell such assets.

During the first nine months of 2010, credit spreads tightened. This tightening of credit spreads caused the net unrealized losses on our securities to decrease.

Despite signs of improvement, market conditions remain significantly challenging, and we do not know how recent changes in market conditions will affect our business over the long-term.

Liquidity

Credit and liquidity conditions have continued to improve in 2010, but such conditions are still less favorable than those we experienced prior to 2007. The continued challenging credit and liquidity conditions have adversely affected us and the markets in which we operate in a number of other ways. For example, they 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:

• decreasing our net book value;

• contributing to our decision to record significant impairment charges;

• prompting us to negotiate the removal of certain financial covenants from our non-CDO financings;

• reducing the amount, which we refer to as cushion, by which we satisfy the over collateralization and interest coverage tests of our CDOs (sometimes referred to as CDO “triggers”) or contributing to several of our CDOs failing their over collateralization tests (see “– Liquidity and Capital Resources” and “– Debt Obligations” below); and

• requiring us to pay additional amounts under certain financing arrangements.

In some cases, we have sold, and may continue to sell, assets at prices below what we believed to be their value in order to meet liquidity requirements under certain financing arrangements. Failed CDO triggers, impairments resulting from incurred losses, and asset sales made at prices significantly below face amount while the related debt is being repaid at its full face amount, as well as the retention of cash, further contribute to reductions in future earnings, cash flow and liquidity. As a result, we expect that our future cash flow from operations will be significantly reduced relative to periods prior to the onset of challenging market conditions.

In order to maintain liquidity, we have elected not to declare any common dividends since the third quarter of 2008 or any preferred dividends since the second quarter of 2010. 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.

In addition, we note that the recent reduction in the number of financial institutions has impacted our liquidity options and sources of capital. The consolidation or elimination of Lehman Brothers, Bear Stearns and several other counterparties has increased our concentration of counterparty risk, decreased the universe of potential counterparties and reduced our ability to obtain competitive financing rates and terms. For a more detailed discussion of our counterparty default and concentration risk, see Part II, Item 1A, “Risk Factors – Risks Related to the Financial Services Industry and Financial Markets – We are subject to counterparty default and concentration risk.”

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Extent of Market Disruption

While market conditions have generally improved over the last several quarters, it is not clear whether a sustained recovery will occur or, if so, for how long it will last. We do not currently know the full extent to which the continuing challenging market conditions will affect us or the markets in which we operate. If such conditions continue, 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 financing on attractive terms. Moreover, we will likely need to continue to place a high priority on managing our liquidity. If we raised capital or issued unsecured debt in the current market, it could be significantly dilutive to our current shareholders. Certain aspects of these effects are more fully described in Part I, Item 2, “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 I, Item 3, “Quantitative and Qualitative Disclosures About Market Risk.”

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Actual results could differ from these estimates. Management believes that the estimates and assumptions utilized in the preparation of the consolidated financial statements are prudent and reasonable. Actual results have been in line with management’s estimates and judgments used in applying each of the accounting policies described below, as modified periodically to reflect current market conditions. The following is a summary of our accounting policies that are most effected by judgments, estimates and assumptions.

Variable Interest Entities

Variable interest entities (“VIEs”) are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The guidance for consolidating a VIE was changed effective January 1, 2010. A VIE is now 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 we do not have the power to direct the relevant activities of CDO VII, as a result of the event of default which allows us to be removed as collateral manager of CDO VII and prevents us from purchasing or selling collateral within CDO VII, and therefore we have deconsolidated CDO VII as of January 1, 2010. Similar events of default in the future, if they occur, could cause us to deconsolidate additional financing structures. Our manufactured housing loan financing structures were consolidated under prior guidance and continue to be consolidated under the new guidance. However, as discussed in “- Liquidity and Capital Resources – Debt Obligations”, we completed a securitization transaction to refinance our Manufactured Housing Loans Portfolio I. We analyzed the securitization under the applicable accounting guidance and concluded that the securitization transaction should be accounted for as a secured borrowing. As a result, we continue to recognize the portfolio of manufactured housing loans as pledged assets, which have been classified as loans held for investment at securitization, and recorded the notes issued to third parties as a secured borrowing.

Our subprime securitizations are also considered VIEs, but we do not control their activities and no longer receive a significant portion of their returns. These subprime securitizations were not consolidated under the current or prior guidance.

In addition, our investments in CMBS, CDO securities and loans may be deemed to be variable interests in VIEs, depending on their structure. We are not obligated to provide, nor have we provided, any financial support to these VIEs. We monitor these investments and, to the extent we determine that we potentially own a majority of the currently controlling class, analyze them for potential consolidation. As of September 30, 2010, we have not consolidated these potential VIEs due to the determination that, based on the nature of Newcastle’s investments and the provisions governing these structures, we do not have the power to direct the activities that most significantly impact their economic performance.

We will continue to analyze future investments, as well as reconsideration events in existing entities, pursuant to the VIE requirements. These analyses require considerable judgment in determining the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power and economics. The result could be the consolidation of an entity that would otherwise not have been consolidated or the de-consolidation of an entity that would otherwise have been consolidated.

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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 the sources described above, 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 6 to our consolidated financial statements in Part I, Item 1, “Financial Statements and Supplementary Data” for information regarding the fair value of our investments, and its estimation methodology, as of September 30, 2010.

Our estimation of the fair value of level 3B assets (as described below) involves significant judgment. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in our book equity. 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 slight improvement in liquidity currently in the markets. In the first nine months of 2010, we have generally used lower discount rates as inputs to our models 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 year-end, other than certain modifications we have made to the assumptions to reflect conditions relevant to specific assets.

For debt securities valued with internal models, which have an aggregate fair value of $283.8 million as of September 30, 2010, a 10% unfavorable change in our assumptions would result in the following decreases in such aggregate fair value:

	CMBS			ABS
Outstanding face amount	$	699,635		$	298,108
Fair value	$	181,420		$	102,419
Effect on fair value with 10% unfavorable change in:
Discount rate	$	(3,448	)	$	(3,499	)
Prepayment rate		N/A		$	(1,015	)
Default rate	$	(21,028	)	$	(7,557	)
Loss severity	$	(13,331	)	$	(11,195	)

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.

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.

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These quotations are generally based on models prepared by the brokers and we have little visibility into the inputs they use. Based on procedures we have performed with respect to prior quotations received from these brokers in 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. In addition, management performs its own quarterly analysis of fair value, based on internal pricing models, to confirm that each of the quotations received represented a reasonable estimate of fair value as defined under GAAP. For the $1.7 billion carrying value of securities valued using quotations, a 100 basis point change in credit spreads would impact estimated fair value at period and by approximately $49.8 million.

We must also assess whether unrealized losses on securities, if any, reflect a decline in value which is other-than-temporary and, if so, write the impaired security down to its fair value through earnings. A decline in value is deemed to be other-than-temporary if (i) it is probable that we will be unable to collect all amounts due according to the contractual terms of a security which was not impaired at acquisition (there is an expected credit loss), or (ii) if we have the intent to sell a security in an unrealized loss position or it is more likely than not we will be required to sell a security in an unrealized loss position prior to its anticipated recovery (if any). For the purposes of performing this analysis, we assume the anticipated recovery period is until the respective security’s expected maturity. Also, for certain securities which represent “beneficial interests in securitized financial assets,” whenever there is a probable adverse change in the timing or amounts of estimated cash flows of a security from the cash flows previously projected, an other-than-temporary impairment is considered to have occurred. These securities are also analyzed for other-than-temporary impairment under the guidelines applicable to all securities as described herein. We note that primarily all of our securities, except our FNMA/FHLMC securities, fall within the definition of beneficial interests in securitized financial assets.

Temporary declines in value generally result from changes in market factors, such as market interest rates and credit spreads, or from certain macroeconomic events, including market disruptions and supply changes, which do not directly impact our ability to collect amounts contractually due. We continually evaluate the credit status of each of our securities and the collateral supporting our securities. This evaluation includes a review of the credit of the issuer of the security (if applicable), the credit rating of the security, the key terms of the security (including credit support), debt service coverage and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the collateral supporting such loans, including the effect of local, industry and broader economic trends and factors. These factors include loan default expectations and loss severities, which are analyzed in connection with a particular security’s credit support, as well as prepayment rates. These factors are also analyzed in relation to the amount of the unrealized loss and the period elapsed since it was incurred. The result of this evaluation is considered when determining management’s estimate of cash flows, particularly with respect to developing the necessary inputs and assumptions. Each security is impacted by different factors and in different ways; generally the more negative factors which are identified with respect to a given security, the more likely we are to determine that we do not expect to receive all contractual payments when due with respect to that security. Significant judgment is required in this analysis.

As of September 30, 2010, we had 138 securities, with a carrying amount of $417.9 million, that had been downgraded during the nine months ended September 30, 1010 and recorded a net other-than-temporary impairment charge of $55.5 million on these securities in 2010. However, we do not depend on credit ratings in underwriting our securities, either at acquisition or on an ongoing basis. As mentioned above, a credit rating downgrade is one factor that we monitor and consider in our analysis regarding other-than-temporary impairment, however 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 be 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, the net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income, offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Provision for Credit Losses on Loan Pools. The provision is determined based on an evaluation of the credit status of securities, as described in connection with the analysis of impairment above.

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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 by 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, they are reported currently in income. To the extent they qualify as fair value hedges, net unrealized gains or losses on both the derivative and the related portion of the hedged item are reported currently in income. Fair values of such derivatives are subject to significant variability based on many of the same factors as the securities discussed above, including counterparty credit risk. The results of such variability could be 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 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 fair 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 loan pools acquired at a discount for credit losses, the net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income, offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Provision for Credit Losses. The provision is determined based on an evaluation of the loans as described under “Impairment of Loans” above.

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 rates to the extent management believes it is collectible. Purchase discounts are not amortized as interest income during the period the loans are held for sale. A change in the market value of the loans, to the extent that the value is not above the cost basis, is recorded in Valuation Allowance.

Recent Accounting Pronouncements

In June 2009, the FASB issued new guidance on transfers of financial assets which eliminates the concept of qualified special purpose entities (QSPEs), changes the requirements for reporting a transfer of a portion of financial assets as a sale, clarifies other sale accounting criteria and changes the initial measurement of a transferor’s interest in transferred financial assets. Furthermore, it requires additional disclosures. This guidance is effective for fiscal years beginning after November 15, 2009. The adoption of this guidance did not have a material impact on our financial position, liquidity or results of operations.

In June 2009, the FASB issued new guidance which changes the definition of a variable interest entity (“VIE”) and changes the methodology to determine who is the primary beneficiary of, or in other words who consolidates, a VIE. Furthermore, it eliminates the scope exception for qualified special purpose entities (QSPEs), which are now subject to the VIE

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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 our gross assets, liabilities, equity, revenues and expenses but are not material to the net income applicable to our common stockholders.

RESULTS OF OPERATIONS

The following table summarizes the changes in our results of operations for the three and nine months ended September 30, 2009 to the three and nine months ended September 30, 2010 (dollars in thousands):

Comparison of Results of Operations for the three months ended September 30, 2010 and 2009

	Three Months Ended
	September 30,						Increase (Decrease)
	2010			2009			Amount			%
Interest income	$	81,040		$	75,222		$	5,818			7.7	%
Interest expense		42,547			52,438			(9,891	)		(18.9	%)
Net interest income		38,493			22,784			15,709			68.9	%
Impairment
Valuation allowance (reversal) on loans		(105,360	)		(6,926	)		(98,434	)		(1421.2	%)
Other-than-temporary impairment on securities, net		10,041			97,728			(87,687	)		(89.7	%)
		(95,319	)		90,802			(186,121	)		(205.0	%)
Net interest income (loss) after impairment		133,812			(68,018	)		201,830			296.7	%
Other Income (Loss)
Gain (loss) on settlement of investments, net		(1,134	)		(1,709	)		575			33.6	%
Gain on extinguishment of debt		46,624			132,534			(85,910	)		(64.8	%)
Other income (loss), net		(8,828	)		(1,956	)		(6,872	)		(351.3	%)
		36,662			128,869			(92,207	)		(71.6	%)
Expenses
Loan and security servicing expense		1,116			1,097			19			1.7	%
General and administrative expense		1,775			2,230			(455	)		(20.4	%)
Management fee to affiliate		4,258			4,492			(234	)		(5.2	%)
Depreciation and amortization		36			73			(37	)		(50.7	%)
		7,185			7,892			(707	)		(9.0	%)
Income (loss) from continuing operations	$	163,289		$	52,959		$	110,330			208.3	%

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Comparison of Results of Operations for the nine months ended September 30, 2010 and 2009

	Nine Months Ended
	September 30,						Increase (Decrease)
	2010			2009			Amount			%
Interest income	$	225,315		$	287,033		$	(61,718	)		(21.5	%)
Interest expense		131,277			167,154			(35,877	)		(21.5	%)
Net interest income		94,038			119,879			(25,841	)		(21.6	%)
Impairment
Valuation allowance (reversal) on loans		(292,668	)		83,093			(375,761	)		(452.2	%)
Other-than-temporary impairment on securities, net		86,822			438,586			(351,764	)		(80.2	%)
		(205,846	)		521,679			(727,525	)		(139.5	%)
Net interest income (loss) after impairment		299,884			(401,800	)		701,684			174.6	%
Other Income (Loss)
Gain (loss) on settlement of investments, net		17,497			7,788			9,709			124.7	%
Gain on extinguishment of debt		141,698			186,209			(44,511	)		(23.9	%)
Other income (loss), net		(12,606	)		2,474			(15,080	)		(609.5	%)
		146,589			196,471			(49,882	)		(25.4	%)
Expenses
Loan and security servicing expense		3,473			3,869			(396	)		(10.2	%)
General and administrative expense		6,751			6,821			(70	)		(1.0	%)
Management fee to affiliate		12,993			13,475			(482	)		(3.6	%)
Depreciation and amortization		161			218			(57	)		(26.1	%)
		23,378			24,383			(1,005	)		(4.1	%)
Income (loss) from continuing operations	$	423,095		$	(229,712	)	$	652,807			284.2	%

Interest Income

Three months ended September 30, 2010 compared to the three months ended September 30, 2009

Interest income increased by $5.8 million primarily due to (i) a $3.3 million increase in the amount of prepayment penalties we received as a result of the prepayment of securities and (ii) an $8.8 million net increase in interest income in our CDOs as a result of new investments made, partially offset by changes in interest rates. The increases described in items (i) and (ii) above were partially offset by a $4.1 million decrease as a result of the deconsolidation of CDO VII, a $0.6 million decrease as a result of the disposition of certain securities and loans and a $1.6 million decrease due to paydowns of existing securities and loans.

Nine months ended September 30, 2010 compared to the nine months ended September 30, 2009

Interest income decreased by $61.7 million primarily due to (i) a $15.3 million decrease as a result of the deconsolidation of CDO VII, (ii) a $1.7 million decrease as a result of the disposition of securities and loans, (iii) a $5.0 million decrease due to paydowns of existing securities and loans, (iv) a $2.9 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 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 $4.1 million net increase as a result of new investments made offset by interest rate changes.

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Interest Expense

Three Months ended September 30, 2010 compared to the three months ended September 30, 2009

Interest expense decreased by $9.9 million primarily due to (i) a $0.8 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 $0.8 million decrease in connection with the purchase of CDO debt obligations, (ii) a $4.5 million decrease as a result of the deconsolidation of CDO VII, (iii) a $0.7 million decrease due to the repayment of debt resulting from paydowns of existing securities and loans, (iv) a $1.2 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, respectively, and (v) a $1.9 million net decrease, which was primarily due to changes in interest rates.

Nine months ended September 30, 2010 compared to the nine months ended September 30, 2009

Interest expense decreased by $35.9 million primarily due to (i) a $2.4 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 $2.2 million decrease in connection with the repurchase of CDO debt obligations, (ii) a $14.0 million decrease as a result of the deconsolidation of CDO VII, (iii) a $2.3 million decrease due to the repayment of debt resulting from paydowns of existing securities and loans, (iv) a $3.6 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, respectively, (v) a $3.9 million decrease due to changes in the amortization of a deferred hedge loss and (vi) a $7.5 million net decrease, which was primarily due to changes in interest rates.

Valuation Allowance on Loans

Three Months ended September 30, 2010 compared to the three months ended September 30, 2009

The valuation allowance on loans decreased by $98.4 million primarily due to improved market conditions, certain successful loan restructurings and the sale of a loan at a price substantially above its carrying value, resulting in a larger net reversal of valuation allowances on loans during the three months ended September 30, 2010.

Nine months ended September 30, 2009 compared to the nine months ended September 30, 2009

The valuation allowance on loans decreased by $375.8 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 net reversal of valuation allowances on loans during the nine months ended September 30, 2010, compared to a net allowance recorded during the nine months ended September 30, 2009.

Other-than-temporary Impairment on Securities, Net

Three months ended September 30, 2010 compared to the three months ended September 30, 2009

The other-than-temporary impairment on securities decreased by $87.7 million primarily due to improved market conditions.

Nine months ended September 30, 2010 compared to the nine months ended September 30, 2009

The other-than-temporary impairment on securities decreased by $351.8 million primarily due to improved market conditions.

Gain (Loss) on Settlement of Investments, Net

Three months ended September 30, 2010 compared to the three months ended September 30, 2009

The net loss on settlement of investments has remained relatively unchanged during the three months ended September 30, 2010 and September 30, 2009.

Nine months ended September 30, 2010 compared to the nine months ended September 30, 2009

The net gain on settlement of investments increased by $9.7 million 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 nine months ended September 30, 2010 compared to the nine months ended September 30, 2009.

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Gain (Loss) on Extinguishment of Debt

Three months ended September 30, 2010 compared to the three months ended September 30, 2009

The gain on extinguishment of debt decreased by $85.9 million primarily due to the significantly lower amounts of debt repurchased (but at higher discounts to our basis, such discounts are based on the market conditions as well as the level within the capital structure we are repurchasing) in the three months ended September 30, 2010 compared to the three months ended September 30, 2009.

Nine months ended September 30, 2010 compared to the nine months ended September 30, 2009

The net gain on extinguishment of debt decreased by $44.5 million primarily due to the significantly lower amounts of debt repurchased (and at lower discounts to our basis, such discounts are based on the market conditions as well as the level within the capital structure we are repurchasing) in the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009.

Other Income (Loss), Net

Three Months ended September 30, 2010 compared to the three months ended September 30, 2009

Other income decreased by $6.9 million primarily due to the recognition of unrealized losses on certain interest rate swap agreements. These interest rate swap agreements were de-designated as accounting hedges during the quarter ended September 30, 2010 as the hedged items were considered not probable of occurring.

Nine months ended September 30, 2010 compared to the nine months ended September 30, 2009

Other income decreased by $15.1 million primarily due to the decrease in fair value of certain non-hedge derivative instruments during the nine months ended September 30, 2010.

Loan and Security Servicing Expense

Loan and security servicing expense has remained relatively stable during the three and nine months ended September 30, 2010 compared to the three and nine months ended September 30, 2009.

General and Administrative Expense

General and administrative expense has remained relatively stable during the three and nine months ended September 30, 2010 compared to the three and nine months ended September 30, 2009.

Management Fee to Affiliate

Three Months ended September 30, 2010 compared to the three months ended September 30, 2009

Management fees decreased by $0.2 million primarily due to a reduction in gross equity as a result of the exchange of preferred stock in the first quarter of 2010.

Nine months ended September 30, 2010 compared to the nine months ended September 30, 2009

Management fees decreased by $0.5 million primarily due to a reduction in gross equity as a result of the exchange of preferred stock in the first quarter of 2010.

Depreciation and Amortization

Depreciation and amortization expense has remained relatively stable during the three and nine months ended September 30, 2010 compared to the three and nine months ended September 30, 2009, as we did not acquire or dispose of any material long-lived assets during these periods.

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

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REIT under the Code, we must distribute annually at least 90% of our REIT taxable income. We note that up to 90% of this requirement may be met in future years through stock dividends, rather than cash, subject to limitations based on the value of our stock. Our primary sources of funds for liquidity consist of net cash provided by operating activities, sales or repayments of investments, potential refinancing of existing debt and the issuance of equity securities, when feasible. Our debt obligations are generally secured directly by our investment assets, except for the junior subordinated notes payable.

Sources of Liquidity and Uses of Capital

As of the date of this filing, we currently have no recourse liabilities other than our junior subordinated notes payable, which are long-term obligations. With respect to the next twelve months, we expect that our cash on hand combined with our cash flow provided by operations will be sufficient to satisfy our anticipated liquidity needs with respect to both our current investment portfolio, including related financings, hedging activity, potential margin calls and operating expenses, and making new investments. While it is inherently more difficult to forecast beyond the next twelve months, we currently expect to meet our long term liquidity requirements, specifically the repayment of our recourse debt obligations, through our cash on hand and, if needed, additional borrowings, proceeds received from repurchase agreements and similar financings, and the liquidation or refinancing of our assets.

These short-term and long-term expectations are forward-looking and subject to a number of uncertainties and assumptions, which are described below under “–Factors That Could Impact Our Liquidity” as well as Part II, 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 provision for credit losses and valuation allowance recorded in connection with our loan assets, as well as other-than-temporary impairment on our securities, (iv) unrealized gains or losses on our non-hedge derivatives, (v) the non-cash charges associated with our early extinguishment of debt, and (vi) net income (loss) generated within CDOs that have failed their over collateralization or interest coverage tests. Proceeds from the sale of assets that 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 November 5, 2010 are set forth below:

• Cash– We had a total of $239.2 million of cash to invest, comprised of unrestricted cash of $63.5 million and $175.7 million of restricted cash for reinvestments in our CDOs;

• Margin Exposure – We had no financings or derivatives subject to margin calls; and

• Recourse Financings– We currently do not have any short-term recourse debt.

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

The following factors could affect our liquidity, access to capital resources and our capital obligations. As such, if their outcomes do not fall within our expectations, changes in these factors could negatively affect our liquidity.

• Access to Financing from Counterparties– Decisions by investors, counterparties and lenders to enter into transactions with us will depend upon a number of factors, such as our historical and projected financial performance, compliance with the terms of our current credit and derivative arrangements, industry and market trends, the availability of capital and our investors’, counterparties’ and lenders’ policies and rates applicable

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thereto, and the relative attractiveness of alternative investment or lending opportunities. As we discuss in more detail under “–Market Considerations” above, the continued challenging credit and liquidity conditions have limited the array of capital resources available to us and made the terms of capital resources we are able to obtain generally less favorable to us relative to the terms we were able to obtain prior to the onset of challenging conditions. Our core business strategy is dependent upon our ability to finance our real estate securities, loans and other real estate related assets with match funded debt at rates that provide a positive net spread. Currently, spreads for such liabilities have widened relative to historical levels and demand for such liabilities has been limited, thereby restricting our ability to execute future financings.

• 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.

With regard to our two subprime securitizations, we have no obligation to repurchase any loans. Therefore, it is expected that our exposure to loss is limited to the carrying amount of our retained interests in the securitization entities, valued at $1.8 million as of September 30, 2010. A subsidiary of Newcastle gave limited representations and warranties with respect to Subprime Portfolio II; however, it has no assets and does not have recourse to the general credit of Newcastle.

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Investment Portfolio

The following summarizes our investment portfolio at September 30, 2010 (dollars in millions).

	Outstanding Face Amount		Amortized Cost Basis  (1)			Percentage of Total Amortized Cost Basis			Number of Investments		Credit (2)		Weighted Average Life (years) (3)		Weighted Average Carrying Value (4)
Investment (7)
Commercial (5)
CMBS	$	2,070	$	1,338			43.3	%		271		BB		3.1		62.9	%
Mezzanine Loans		658		368			11.9	%		19		65%		2.0		56.0	%
B-Notes		283		149			4.8	%		10		59%		2.2		52.7	%
Whole Loans		102		56			1.8	%		4		80%		11.5		54.8	%
Total Commercial Assets		3,113		1,911			61.8	%						3.0		60.2	%
Residential
Manufactured Housing and Residential Mortgage Loans		442		377			12.2	%		11,606		704		6.7		85.3	%
Subprime Securities		379		173			5.6	%		89		B-		4.4		50.4	%
Real Estate ABS		79		56			1.8	%		22		BB		4.3		70.3	%
		900		606			19.6	%						5.5		69.3	%
FNMA/FHLMC securities		3		3			0.1	%		1		AAA		3.3		107.3	%
Total Residential Assets		903		609			19.7	%						5.5		69.4	%
Corporate
REIT Debt		376		375			12.1	%		44		BB+		3.4		38.0	%
Corporate Bank Loans		301		196			6.4	%		9		C		3.6		102.4	%
Total Corporate Assets		677		571			18.5	%						3.5		73.8	%
TOTAL / WA	$	4,693	$	3,091			100.0	%						3.6		64.0	%
Reconciliation to GAAP total assets:
Net unrealized loss recorded in accumulated other comprehensive income				(5	)
Other assets
Subprime mortgage loans subject to call option (6)				404
Real estate held for sale				9
Cash and restricted cash				215
Other				46
GAAP total assets			$	3,760

WA – Weighted average, in all tables.

(1) Net of impairment.

(2) Credit represents weighted average of minimum rating for rated assets, loan-to-value ratio (based on the appraised value at the time of purchase or refinancing) for non-rated commercial assets, or the FICO score for non-rated residential assets and an implied AAA rating for FNMA/FHLMC securities. Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including a “negative watch” assignment) at any time.

(3) Weighted average life is based on the timing of expected principal reduction on the asset.

(4) Weighted average carrying value as a percentage of outstanding face amount.

(5) Excludes four CDO securities with an aggregate face amount of $80.5 million and a zero basis. One CDO bond was issued by a third party and three CDO bonds were issued by CDO VII, which was deconsolidated, and held as investments by Newcastle.

(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):

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CMBS

Deal Vintage (A)	Average Minimum Rating (B)	Number	Outstanding Face  Amount		Amortized Cost Basis		Percentage of Total Amortized Cost Basis			Delinquency 60+/FC/REO (C)			Principal Subordination (D)			Weighted Average Life (years) (E)
Pre 2004	BBB-	84	$	417,718	$	379,932		28.4	%		5.8	%		10.5	%		2.5
2004	BB	60		427,435		261,147		19.5	%		3.9	%		5.5	%		2.7
2005	BB	38		375,044		168,926		12.6	%		5.9	%		8.2	%		3.1
2006	BBB-	56		505,578		346,212		25.9	%		4.3	%		12.6	%		3.8
2007 and later	BB-	33		344,068		181,559		13.6	%		6.3	%		13.1	%		3.2
Total / WA	BB	271	$	2,069,843	$	1,337,776		100.0	%		5.1	%		10.0	%		3.1

(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 (including a “negative watch” assignment) at any time. We had approximately $372 million of CMBS assets that were on negative watch for possible downgrade by at least one rating agency as of September 30, 2010.

(C) The percentage of underlying loans that are 60+ days delinquent, in foreclosure or considered real estate owned (REO).

(D) The percentage of the outstanding face amount of securities that is subordinate to our investments.

(E) Weighted average life is based on the timing of expected principal reduction on the asset.

Mezzanine Loans, B-Notes and Whole Loans

	Number		Outstanding Face Amount		Amortized Cost Basis		Percentage of Total Amortized Cost Basis			Weighted Average First Dollar Loan to Value (A)			Weighted Average Last Dollar to Loan Value (A)			Delinquency (B)
Mezzanine Loans		19	$	658,103	$	368,267		64.2	%		53.7	%		64.5	%		13.3	%
B-Notes		10		283,132		149,167		26.0	%		46.7	%		59.0	%		33.6	%
Whole Loans		4		102,228		55,973		9.8	%		0.0	%		79.9	%		69.6	%
Total/WA		33	$	1,043,463	$	573,407		100.0	%		46.5	%		64.5	%		24.3	%

(A) Loan to value is based on the appraised value at the time of purchase or refinancing.

(B) The percentage of underlying loans that are non-performing, in foreclosure, under bankruptcy filing or considered real estate owned.

Manufactured Housing and Residential Loans

Deal	Average FICO Score (A)		Outstanding Face Amount		Amortized Cost Basis		Percentage of Total Amortized Cost Basis			Average Loan Age (months)		Original Balance		Delinquency 90+/FC/REO (B)			Cumulative Loss to Date
Manufactured Housing Loans Portfolio I		704	$	156,273	$	126,107		33.5	%		108	$	327,855		1.0	%		6.5	%
Manufactured Housing Loans Portfolio II		700		220,027		201,276		53.4	%		138		434,743		1.4	%		4.5	%
Residential Loans Portfolio I		714		61,451		45,900		12.2	%		88		646,357		7.1	%		0.3	%
Residential Loans Portfolio II		737		3,795		3,439		0.9	%		68		83,950		0.0	%		0.0	%
Total / WA		704	$	441,546	$	376,722		100.0	%		120	$	1,492,905		2.0	%		4.6	%

(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.

(B) The percentage of loans that are 90+ days delinquent, or in foreclosure or considered real estate owned (REO).

Subprime Securities (A)

	Security Characteristics
Vintage (B)	Average Minimum Rating (C)	Number of Securities	Outstanding Face  Amount		Amortized Cost Basis		Percentage of Total Amortized Cost Basis			Principal Subordination (D)			Excess Spread (E)
2003	B	15	$	19,957	$	11,641		6.7	%		22.3	%		4.1	%
2004	B	28		85,651		31,163		18.0	%		16.9	%		4.0	%
2005	CCC+	26		96,682		30,728		17.7	%		28.2	%		4.7	%
2006	CCC	10		90,837		48,184		27.8	%		22.4	%		4.9	%
2007 and later	B	10		85,692		51,406		29.8	%		19.3	%		3.3	%
Total / WA	B-	89	$	378,819	$	173,122		100.0	%		21.9	%		4.2	%

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	Collateral Characteristics
Vintage (B)	Average Loan  Age (months)		Collateral Factor (F)		3 month CPR (G)			Delinquency (H)			Cumulative Losses to  Date
2003		91		0.10		7.0	%		18.2	%		3.1	%
2004		77		0.14		8.9	%		19.9	%		3.5	%
2005		65		0.20		9.3	%		32.4	%		8.3	%
2006		53		0.41		9.4	%		32.8	%		15.3	%
2007 and later		39		0.48		8.8	%		20.8	%		12.5	%
Total / WA		60		0.29		9.0	%		26.3	%		9.6	%

Real Estate ABS

	Security Characteristics
Asset Type	Average Minimum Rating (C)	Number		Outstanding Face Amount		Amortized Cost Basis Amount		Percentage of Total Amortized Basis			Principal Subordination (D)			Excess Spread  (E)
Manufactured Housing	BBB		9	$	48,275	$	46,935		84.0	%		37.6	%		1.6	%
Small Business Loans	CCC+		13		30,709		8,925		16.0	%		15.4	%		2.9	%
Total / WA	BB		22	$	78,984	$	55,860		100.0	%		29.0	%		2.1	%

	Collateral Characteristics
Asset Type	Average Loan Age (months)		Collateral Factor (F)		3 Month CPR (G)			Delinquency (H)			Cumulative Loss to Date
Manufactured Housing		118		0.35		7.4	%		3.2	%		10.7	%
Small Business Loans		72		0.55		7.6	%		29.4	%		6.4	%
Total / WA		100		0.43		7.5	%		13.4	%		9.0	%

(A) Includes subprime retained securities in the securitizations of Subprime Portfolios I and II. For further information on these securitizations, see Note 4 to our consolidated financial statements included herein.

(B) The year in which the securities were issued.

(C) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including a “negative watch” assignment) at any time. We had approximately $97 million of ABS assets that were on negative watch for possible downgrade by at least one rating agency as of September 30, 2010.

(D) The percentage of the outstanding face amount of securities and residual interests that is subordinate to our investments.

(E) The annualized amount of interest received on the underlying loans in excess of the interest paid on the securities, as a percentage of the outstanding collateral balance.

(F) The ratio of original unpaid principal balance of loans still outstanding.

(G) Three month average constant prepayment rate.

(H) The percentage of underlying loans that are 90+ days delinquent, or in foreclosure or considered real estate owned (REO).

REIT Debt

Industry	Average Minimum Rating (A)	Number		Outstanding Face Amount		Amortized Cost Basis		Percentage of Total Amortized Cost Basis
Retail	BBB+		10	$	75,665	$	71,877		19.2	%
Diversified	CCC+		10		94,336		95,088		25.3	%
Office	BBB		11		115,469		117,041		31.2	%
Multifamily	BBB		3		12,765		12,824		3.4	%
Hotel	BBB		3		29,220		29,641		7.9	%
Healthcare	BBB-		5		41,600		41,689		11.1	%
Storage	A-		1		5,000		5,057		1.3	%
Industrial	BB-		1		2,000		2,069		0.6	%
Total / WA	BB+		44	$	376,055	$	375,286		100.0	%

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Corporate Bank Loans

Industry	Average Minimum Rating	Number		Outstanding Face Amount		Amortized Cost Basis		Percentage of Total Amortized Cost
Real Estate	CC		3	$	31,996	$	30,102		15.3	%
Media	CC		2		111,764		42,051		21.5	%
Resorts	NR		1		112,191		82,191		42.0	%
Restaurant	B		2		18,159		15,813		8.1	%
Transportation	NR		1		26,992		25,643		13.1	%
Total / WA	C		9	$	301,102	$	195,800		100.0	%

(A) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including a “negative watch” assignment) at any time. We had approximately $2 million of REIT assets or bank loans that were on negative watch for possible downgrade by at least one rating agency as of September 30, 2010.

Debt Obligations

Our debt obligations, as summarized in Note 5 to our consolidated financial statements included herein, existing at September 30, 2010 (gross of $5.2 million of discounts) had contractual maturities as follows (in thousands):

	Nonrecourse		Recourse		Total
Period from October 1, 2010 through December 31, 2010	$	—	$	—	$	—
2011		177,904		—		177,904
2012		—		—		—
2013		—		—		—
2014		—		—		—
2015		—		—		—
Thereafter		3,894,998		51,004		3,946,002
Total	$	4,072,902	$	51,004	$	4,123,906

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 debt obligations contain various customary loan covenants. We were in compliance with all of the covenants in our non-CDO financings as of September 30, 2010.

The following table provides additional information regarding short-term borrowings. These short-term borrowings were used to finance certain of our investments in real estate securities and loans, including FNMA/FHLMC securities, and our investments in manufactured housing loans. During the nine months ended September 30, 2010, we did not incur any short-term borrowings.

			Three Months Ended September 30, 2010							Nine Months Ended September 30, 2010
	Outstanding Balance at September 30, 2010		Average Daily Amount Outstanding		Maximum Amount Outstanding		Weighted Average Interest Rate			Average Daily Amount Outstanding		Maximum Amount Outstanding		Weighted Average Interest Rate
Repurchase agreements	$	—	$	—	$	—		N/A		$	21,050	$	71,309		LIBOR+1.12	%
Short-term other bonds payable	$	—	$	124	$	1,423		LIBOR+2.75	%	$	4,133	$	10,206		LIBOR+2.75	%

In the first nine months of 2010, we repurchased $168.0 million face amount of CDO bonds for $25.6 million. As a result, we extinguished $168.0 million face amount of CDO debt and recorded a gain on extinguishment of debt of $141.7 million.

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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 the partial repayments 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:

				Consideration
	Repurchased junior subordinated notes			Cash		Reissued CDO bonds			Total
Outstanding face amount	$	52,094		$	9,715	$	37,625		$	47,340
Weighted average coupon		7.574	%(A)		N/A		LIBOR+ 0.66	%(B)
Maturity		April 2035					June 2052
Collateral		General credit of Newcastle					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.

On April 15, 2010, Newcastle completed a securitization transaction to refinance its Manufactured Housing Loans Portfolio I (the “Portfolio”). Newcastle sold approximately $164.1 million outstanding principal balance of manufactured housing loans to Newcastle MH I LLC (the “Issuer”). The Issuer issued approximately $134.5 million aggregate principal amount of asset-backed notes (the “Notes”), of which $97.6 million was sold to third parties and $36.9 million was sold to certain CDOs managed and consolidated by Newcastle. At the closing of the securitization transaction, Newcastle used the gross proceeds received from the issuance of the Notes to repay the previously existing financing on this portfolio in full, terminate the related interest rate swap contracts, pay the related transaction costs and increase its unrestricted cash by approximately $14 million. Under the applicable accounting guidance, the securitization transaction is accounted for as a secured borrowing. As a result, no gain or loss is recorded for the transaction. Newcastle continues to recognize the portfolio of manufactured housing loans as pledged assets, which have been classified as loans held for investment at securitization, and records the notes issued to third parties as a secured borrowing. The associated assets, liabilities, revenues and expenses are presented in the non-recourse financing structure sections of the consolidated financial statements.

In April 2010, Newcastle repaid in full all of its outstanding repurchase agreements.

In July 2010, Newcastle repaid in full the remaining $1.4 million of recourse debt on its Manufactured Housing Loan Portfolio II.

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 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 September 30, 2010 unless otherwise noted (dollars in thousands). For those CDOs that have failed their applicable over collateralization tests, the impact of failing is already reflected in the cash flow set forth in the table. For those CDOs that have satisfied their applicable over collateralization tests, we could potentially lose substantially all of the cash flows from those CDOs in future quarters if we fail to satisfy the tests in the future. The amounts in the table reflect data at the CDO level and thus are different from the GAAP balance sheet due to intercompany amounts eliminated in Newcastle’s consolidated balance sheet.

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	CDO IV						CDO V						CDO VI						CDO VIII						CDO IX						CDO X
Balance Sheet:
Assets Face Amount			$	398,584					$	423,609					$	439,754					$	928,270					$	835,747					$	1,365,959
Assets Fair Value				290,861						267,696						214,365						605,322						560,777						1,004,199
Issued Debt Face Amount (1)				356,616						392,251						362,921						678,313						580,125						1,224,250
Issued Debt Basis (1)				355,701						390,977						361,668						677,464						584,299						1,222,900
Quarterly net cash receipts (2)			$	193					$	1,656					$	116					$	4,506					$	6,443					$	3,702
Collateral Composition (3):	Face		Fair Value				Face		Fair Value				Face		Fair Value				Face		Fair Value				Face		Fair Value				Face		Fair Value
CMBS	$	246,963	$	155,398		BB-	$	275,861	$	153,792		BB-	$	290,721	$	106,217		B+	$	234,089	$	144,487		BB	$	79,899	$	66,552		BB	$	925,277	$	675,838		BBB-
REIT Debt		91,590		97,125		BBB-		74,404		78,272		BBB-		59,200		60,530		BB+		—		—		—		—		—		—		150,861		149,127		BB-
ABS		46,322		26,631		B+		69,929		31,850		B-		80,480		38,692		B		88,996		68,768		B+		3,232		2,871		BBB+		201,919		144,890		BB+
FNMA/FHLMC		—		—		—		3,415		3,782		AAA		—		—		—		—		—		—		—		—		—		—		—		—
Bank Loans		3,977		3,755		CCC-		—		—		—		9,353		8,926		CCC+		122,938		76,417		CC		135,646		96,013		D		29,188		10,982		CC
Mezzanine Loans / B-Notes / Whole Loans		9,732		7,952		BB+		—		—		—		—		—		—		333,225		233,475		CCC+		477,344		302,625		CCC+		—		—		—
CDO		—		—		—		—		—		—		—		—		—		90,503		23,656		B-		74,250		22,645		CCC+		35,529		177		C
Equity Securities		—		—		—		—		—		—		—		—		—		—		—		—		—		4,695		—		—		—		—
Restricted Cash for Reinvestment		—		—		—		—		—		—		—		—		—		58,519		58,519		—		65,376		65,376		—		23,185		23,185		—
Total	$	398,584	$	290,861		BB-	$	423,609	$	267,696		BB-	$	439,754	$	214,365		B+	$	928,270	$	605,322		B	$	835,747	$	560,777		CCC+	$	1,365,959	$	1,004,199		BB+
Collateral on Negative Watch (4)	$	34,478					$	45,053					$	51,140					$	113,602					$	29,795					$	340,132
CDO Cash Flow Triggers (5):
Over Collateralization (6):
As of September 2010 remittance Cushion (Deficit) ($)			$	(54,513	)				$	1,991					$	(167,624	)				$	104,652					$	106,526					$	39,543
As of October 2010 remittance Cushion (Deficit) ($)				—						—					$	(148,696	)				$	102,843					$	111,436					$	43,951
Interest Coverage (6):
As of September 2010 remittance Cushion (Deficit) (%)				104.4	%					162.1	%					199.1	%					246.2	%					167.5	%					174.5	%
As of October 2010 remittance Cushion (Deficit) (%)				—						—						21.6	%					278.6	%					221.3	%					293.7	%
CDO Overview:
Effective				Sep-04						Feb-05						Aug-05						Mar-07						Jul-07						Dec-07
Reinvestment Period End (7)				Passed						Passed						Passed						Nov-11						May-12						Jul-12
Optional Call (8)				Jun-07						Dec-07						May-08						Dec-09						Jun-10						Aug-10
Auction Call (9)				Mar-14						Sep-14						Apr-15						Nov-16						May-17						Jul-17
WA Debt Spread (bps) (10)				71						57						34						44						57						34
Asset Average Life				2.8						3.3						2.6						3.9						3.8						3.9
Debt Average Life				2.6						2.6						3.5						3.3						4.4						4.9

(1) Includes only CDO bonds issued to third parties and other Newcastle CDOs.

(2) Represents net cash received from each CDO based on all of our interests in such CDO (including senior management fees) for the nine months ended September 30, 2010. Cash receipts for this period included $3.8 million of non-recurring interest, prepayment penalty, extension fees and yield maintenance fees, and $1.8 million of senior collateral management fees, and may not be indicative of cash receipts for subsequent periods. See “Cautionary Note Regarding Forward Looking Statements” for risks and uncertainties that could cause our receipts for subsequent periods to differ materially from these amounts.

Notes continued on next page.

44

(3) Collateral composition is calculated as a percentage of the face amount of collateral and includes CDOs bonds of $200.3 million and other bonds of $92.2 million issued by Newcastle, which are eliminated in consolidation. The fair value of these CDO bonds and other bonds was $46.5 million and $68.4 million at September 30, 2010, respectively. Also reflected are weighted average credit ratings, which were determined by third party rating agencies as of a particular date, may not be current and are subject to change (including a “negative watch” assignment) at any time.

(4) Represents the face amount of collateral on negative watch for possible downgrade by at least one rating agency (Moody’s, S&P or Fitch) as of the determination date of September 17, 2010 for CDOs IV and V, as these deals only report actual over collateralization excess percentages on a quarterly basis, and as of the determination date of October 18, 2010 for all other CDOs. The amounts include bonds of $55.3 million issued by Newcastle, which are eliminated in consolidation and not reflected in our investment portfolio segments.

(5) Each of our CDO financings contains tests that measure the amount of over collateralization and excess interest in the transaction. Failure to satisfy these tests would cause the principal and/or interest cashflow that would otherwise be distributed to more junior classes of securities (including those held by Newcastle) to be redirected to pay down the most senior class of securities outstanding until the tests are satisfied. As a result, our cash flow and liquidity are negatively impacted upon such a failure, and the impact could be material. Each CDO contains tests at various over collateralization and interest coverage percentage levels. The trigger percentages used above represent the first threshold at which cashflows would be redirected as described in this footnote. The data presented is as of the most recent remittance date on or before September 30, 2010 or October 31, 2010, as applicable, and may change or have changed subsequent to that date. CDO IV and V only report on a quarterly basis and, therefore, no updated October 2010 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 distributed to us. As of the September 2010 remittance date for CDO IV and as of the October 2010 remittance date for CDO VI, these CDOs were not in compliance with their applicable over collateralization tests and, consequently, we are not receiving cash flows from these CDOs (other than senior management fees). 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 II, Item 1A, “Risk Factors – The use of CDO financings with coverage tests may have a negative impact on our operating results and cash flows.”

(6) Represents excess or deficiency under the applicable over collateralization or interest coverage tests to the first threshold at which cash flow would be redirected. We generally do not receive material cash flow from the CDO until a deficiency is corrected. Ratings downgrades of assets in our CDOs can negatively impact compliance with the over collateralization tests. Generally, the over collateralization test measures the principal balance of the specified pool of assets in a CDO against the corresponding liabilities issued by the CDO. However, based on ratings downgrades, the principal balance of an asset or of a specified percentage of assets in a CDO may be deemed reduced below their current balance to levels set forth in the related CDO documents for purposes of calculating the over collateralization test. As a result, ratings downgrades can reduce the principal balance of the assets used in the over collateralization test relative to the corresponding liabilities in the test, thereby reducing the over collateralization percentage. In addition, actual defaults of an asset would also negatively impact compliance with the over collateralization tests. Failure to satisfy an over collateralization test could result in the redirection of cashflows as described in footnote 5 above or, in certain instances, in our removal as manager of the applicable portfolio.

(7) Our CDO financings typically have a 5 year reinvestment period. Generally, after such period ends, principal payments on the collateral are used to paydown the most senior debt outstanding. Prior to the end of the reinvestment period, principal payments received on the collateral are reinvested.

(8) At the option call date, Newcastle, as the equity holder, has the right to payoff the CDO bonds at their related redemption price.

(9) At the auction call date, there is a mandatory auction of the assets. If the prices are sufficient to pay off the outstanding CDO bonds, the assets will be sold and the CDO bonds will be redeemed.

(10) Debt spread represents the spread above the benchmark interest rate (LIBOR or U.S. Treasuries) that Newcastle pays on its debt.

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The following table sets forth further information with respect to the bonds of our consolidated CDO financings as of September 30, 2010 (dollars in thousands):

			Current Face Amount (1)
			Held By						Total
Class	Original Face Amount		Third Parties		Newcastle CDOs (2)		Newcastle Outside of its CDOs (3)				Stated Interest Rate
CDO IV
Class I	$	353,250	$	295,895	$	—	$	1,685	$	297,580		LIBOR +	0.40	%
Class II-FL		13,000		3,030		—		10,101		13,131		LIBOR +	0.65	%
Class II-FX		7,250		2,096		5,503		—		7,599			4.73	%
Class III-FL		7,500		5,089		—		2,545		7,634		LIBOR +	1.00	%
Class III-FX		15,000		11,966		—		911		12,877			5.11	%
Class IV-FL		9,000		8,272		—		—		8,272		LIBOR +	2.25	%
Class IV-FX		9,000		9,736		—		—		9,736			6.34	%
Class V		13,500		—		15,029		—		15,029			8.67	%
Preferred		22,500		—		—		22,500		22,500			N/A
	$	450,000	$	336,084	$	20,532	$	37,742	$	394,358
CDO V
Class I	$	388,000	$	309,251	$	—	$	—	$	309,251		LIBOR +	0.34	%
Class II-FL		23,500		23,500		—		—		23,500		LIBOR +	0.55	%
Class III-FL		23,000		23,000		—		—		23,000		LIBOR +	0.90	%
Class IV-FL		8,000		4,000		—		4,000		8,000		LIBOR +	1.90	%
Class IV-FX		12,000		12,000		—		—		12,000			6.26	%
Class V		20,500		—		20,500		—		20,500			6.94	%
Preferred		25,000		—		—		25,000		25,000			N/A
	$	500,000	$	371,751	$	20,500	$	29,000	$	421,251
CDO VI
Class I-MM LT	$	323,000	$	272,309	$	—	$	—	$	272,309		LIBOR +	0.25	%
Class I-B		59,000		59,000		—		—		59,000		LIBOR +	0.40	%
Class II		33,000		23,243		—		10,105		33,348		LIBOR +	0.50	%
Class III-FL		15,000		5,089		—		10,179		15,268		LIBOR +	0.80	%
Class III-FX		5,000		—		—		5,469		5,469			5.67	%
Class IV-FL		9,600		619		—		9,294		9,913		LIBOR +	1.70	%
Class IV-FX		2,400		2,661		—		—		2,661			6.55	%
Class V		21,000		—		—		23,755		23,755			7.81	%
Preferred		32,000		—		—		32,000		32,000			N/A
	$	500,000	$	362,921	$	—	$	90,802	$	453,723
CDO VIII (4)
Class I-A	$	462,500	$	462,500	$	—	$	—	$	462,500		LIBOR +	0.28	%
Class I-AR		60,000		60,000		—		—		60,000		LIBOR +	0.34	%
Class I-B		38,000		4,000		—		34,000		38,000		LIBOR +	0.36	%
Class II		42,750		—		29,000		13,750		42,750		LIBOR +	0.42	%
Class III		42,750		20,000		22,750		—		42,750		LIBOR +	0.50	%
Class IV		28,500		—		—		—		—		LIBOR +	0.60	%
Class V		28,500		28,500		—		—		28,500		LIBOR +	0.75	%
Class VI		27,313		—		—		—		—		LIBOR +	0.80	%
Class VII		21,375		—		—		—		—		LIBOR +	0.90	%
Class VIII		22,562		11,063		8,250		3,250		22,563		LIBOR +	1.45	%
Class IX-FL		6,000		6,000		—		—		6,000		LIBOR +	1.80	%
Class IX-FX		7,600		7,600		—		—		7,600			6.80	%
Class X		19,650		18,650		—		—		18,650		LIBOR +	2.25	%
Class XI		26,125		—		—		24,125		24,125		LIBOR +	2.50	%
Class XII		28,500		—		—		28,500		28,500			7.50	%
Preferred		87,875		—		—		87,875		87,875			N/A
	$	950,000	$	618,313	$	60,000	$	191,500	$	869,813

Continued on next page.

46

			Current Face Amount (1)
			Held By						Total
Class	Original Face Amount		Third Parties		Newcastle CDOs (2)		Newcastle Outside of its CDOs (3)				Stated Interest Rate
CDO IX (4)
Class A-1	$	379,500	$	379,500	$	—	$	—	$	379,500		LIBOR +	0.26	%
Class A-2		115,500		115,500		—		—		115,500		LIBOR +	0.47	%
Class B		37,125		35,125		—		2,000		37,125		LIBOR +	0.65	%
Class C		33,000		—		—		—		—		LIBOR +	0.93	%
Class D		20,625		—		—		—		—		LIBOR +	1.00	%
Class E		24,750		—		—		24,750		24,750		LIBOR +	1.10	%
Class F		18,562		—		—		18,562		18,562		LIBOR +	1.30	%
Class G		18,562		—		—		11,262		11,262		LIBOR +	1.50	%
Class H		21,656		—		8,751		9,305		18,056		LIBOR +	2.50	%
Class J		21,656		—		21,656		—		21,656		LIBOR +	3.00	%
Class K		19,593		—		19,593		—		19,593		LIBOR +	3.50	%
Class L		23,718		—		—		23,718		23,718			7.50	%
Class M		39,187		—		—		39,187		39,187			8.00	%
Preferred		51,566		—		—		51,566		51,566			N/A
	$	825,000	$	530,125	$	50,000	$	180,350	$	760,475
CDO X (4)
Class A-1	$	980,000	$	980,000	$	—	$	—	$	980,000		LIBOR +	0.26	%
Class A-2		140,000		140,000		—		—		140,000		LIBOR +	0.35	%
Class A-3		99,750		55,000		10,000		—		65,000		LIBOR +	0.60	%
Class B		28,000		—		—		—		—		LIBOR +	1.25	%
Class C		40,250		—		39,250		—		39,250		LIBOR +	1.75	%
Class D		22,000		—		—		22,000		22,000		LIBOR +	2.50	%
Class E		13,500		—		—		13,500		13,500		LIBOR +	3.00	%
Class F		14,000		—		—		14,000		14,000			9.04	%
Preferred		62,500		—		—		62,500		62,500			N/A
	$	1,400,000	$	1,175,000	$	49,250	$	112,000	$	1,336,250

(1) The amounts presented in these columns exclude the face amount of any cancelled bonds within an applicable class.

(2) Amounts in this column represent the amount of bonds of the applicable class held by Newcastle’s consolidated CDOs. These bonds are eliminated in Newcastle’s consolidated balance sheet.

(3) Amounts in this column represent the amount of bonds of the applicable class held as investments by Newcastle outside of its non-recourse financing structures.

(4) These CDOs issued the following interest only fixed-rate notes with a 5-year maturity from inception:

• CDO VIII Class S with a notional amount of $33.9 million at 5.41%

• CDO IX Class S with a notional amount of $33.5 million at 5.45%

• CDO X Class S with a notional amount of $24.2 million at 5.78%

Stockholders’ Equity

Common Stock

The following table presents information on shares of our common stock issued during the nine months ended September 30, 2010:

Shares Issued	Range of Issue Prices (1)		Net Proceeds (millions)		Options Granted to Manager
9,112,432	$	3.13	$	28.5	N/A

(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.

At September 30, 2010, we had 62,024,945 shares of common stock outstanding. See “Preferred Stock” below for a discussion of common stock issued in exchange for preferred stock.

47

As of September 30, 2010, our outstanding options had a weighted average strike price of $26.64 and were summarized as follows:

Held by the Manager	1,686,447
Issued to the Manager and subsequently transferred to certain of the Manager’s employees	798,162
Held by the independent directors	14,000
Total	2,498,609

As of September 30, 2010, approximately 3.8 million shares of our common stock were held by Fortress, through its affiliates, and its principals.

No dividends were declared with respect to our common stock related to the nine months ended September 30, 2010.

Preferred Stock

On March 23, 2010, Newcastle announced the final results of its offer to exchange (the “Exchange Offer”) shares of its common stock and cash for up to (i) 1,725,000 shares of its outstanding 9.75% Series B Cumulative Redeemable Preferred Stock (“Series B Preferred Stock”), (ii) 1,104,000 shares of its outstanding 8.05% Series C Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”), and (iii) 1,380,000 shares of its outstanding 8.375% Series D Cumulative Redeemable Preferred Stock (“Series D Preferred Stock,” and, together with Series B Preferred Stock and Series C Preferred Stock, the “Preferred Stock”).

On March 25, 2010, Newcastle settled the Exchange Offer. In the aggregate, Newcastle issued 9,091,668 shares of its common stock (approximately 17.2% of Newcastle’s outstanding shares of common stock prior to the issuance of shares in the Exchange Offer). A total of 2,881,694 shares of common stock were issued in exchange for 1,152,679 shares of Series B Preferred Stock, a total of 2,759,989 shares of common stock were issued in exchange for 1,104,000 shares of Series C Preferred Stock, and a total of 3,449,985 shares of common stock were issued in exchange for 1,380,000 shares of Series D Preferred Stock. The shares of Preferred Stock acquired by Newcastle in the Exchange Offer were retired upon receipt. After settlement of the Exchange Offer, 1,347,321 shares of Series B Preferred Stock, 496,000 shares of Series C Preferred Stock and 620,000 shares of Series D Preferred Stock remain outstanding for trading on the New York Stock Exchange.

The shares of common stock were issued in the Exchange Offer in reliance on the exemption set forth in Section 3(a)(9) of the Securities Act of 1933, as amended, for securities exchanged by an issuer with its existing security holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange.

In connection with the Exchange Offer, all of Newcastle’s preferred stock dividends in arrears were paid, and all cumulative preferred stock dividends accrued through April 30, 2010 have been paid. 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 September 30, 2010, $2.3 million of dividends on Newcastle’s cumulative preferred stock were unpaid and in arrears.

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Accumulated Other Comprehensive Income (Loss)

During the nine months ended September 30, 2010, our accumulated other comprehensive income (loss) changed due to the following factors (in thousands):

	Gains (Losses) on Cash Flow Hedges			Gains (Losses) on Securities			Total Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss), December, 31, 2009	$	(180,895	)	$	(452,923	)	$	(633,818	)
Deconsolidation of unrealized loss on securities in CDO VII		—			40,715			40,715
Deconsolidation of unrealized loss on derivatives designated as cash hedges in CDO VII		28,514			—			28,514
Net unrealized gain (loss) on securities		—			341,566			341,566
Reclassification of net realized (gain) loss on securities into earnings		—			66,047			66,047
Net unrealized gain (loss) on derivatives		(48,758	)		—			(48,758	)
Reclassification of net realized (gain) loss on derivatives designated as cash flow hedges into earnings		14,353			—			14,353
Accumulated other comprehensive income (loss), September 30, 2010	$	(186,786	)	$	(4,595	)	$	(191,381	)

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 nine months ended September 30, 2010, a net tightening of credit spreads has caused a net decrease in unrealized losses recorded in accumulative other comprehensive income on our real estate securities. Net unrealized losses on derivatives designated as cash flow hedges increased for the nine months ended September 30, 2010 primarily as a result of decreases in long-term interest rates. In addition, accumulated other comprehensive loss decreased as a result of the deconsolidation of the unrealized losses on securities and derivatives for CDO VII.

See “- Market Considerations” above for a further discussion of recent trends and events affecting our unrealized gains and losses as well as our liquidity.

Cash Flow

Operating Activities

Net cash flow provided by (used in) operating activities decreased to $51.0 million for the nine months ended September 30, 2010 from $71.5 million for the nine months ended September 30, 2009. This change primarily resulted from the acquisition and settlement of our investments as described above, and the performance thereof.

Operating Activities – Direct Method Comparison

Cash interest received for investments in securities and loans decreased approximately $45.1 million as a result of a lower average balance of interest earning securities and loans of $4.4 billion in the first nine months of 2010 compared to $5.5 billion in the first nine months of 2009, a decrease in the weighted average interest rate to 5.04% in the first nine months of 2010 from 5.09% in the first nine months of 2009 and the redirection of defaulted interests in certain CDOs. The lower interest earning asset balance is primarily a result of paydowns and delinquencies. Prepayment penalty income decreased by $2.9 million for the nine months ended September 30, 2010 due to a higher volume of asset prepayment in the first nine months of 2009.

Cash interest paid decreased approximately $26.8 million due to a lower average debt balance of $3.7 billion in the first nine months of 2010 compared to $4.9 billion in the first nine months of 2009 and a decrease in the weighted average funding cost, including the effect of hedges to 3.37% from 3.49 % for the nine months ended September 30, 2010 and September 30, 2009, respectively.

49

Investing Activities

Investing activities provided (used) $185.6 million and $185.5 million during the nine months ended September 30, 2010 and 2009, respectively. Investing activities consisted primarily of investments made in certain real estate securities, loans and other real estate related assets, offset by proceeds from the sale or settlement of investments.

Financing Activities

Financing activities provided (used) ($246.6) million and ($233.5) million during the nine months ended September 30, 2010 and 2009, respectively. The return of restricted cash from refinancing activities, the refinancing of our manufactured housing loan portfolio I and return of margin deposits served as the primary sources of cash flow from financing activities. Offsetting uses included the repayment of debt as described above, the payment of related deferred financing costs, the payment of preferred dividends, the payment related to the exchange of the junior subordinated notes, as well as the payment related to the preferred stock exchange described under “ – Preferred Stock” above.

See the consolidated statements of cash flows included in our consolidated financial statements for a reconciliation of our cash position for the periods described.

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 “Quantitative and Qualitative Disclosures About Market Risk.”

OFF-BALANCE SHEET ARRANGEMENTS

As of September 30, 2010, we had the following material off-balance sheet arrangements.

• In April 2006, we securitized our 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 our Subprime Portfolio II. The loans were sold to a securitization trust, of which 90% were treated as a sale, which is an off-balance sheet financing.

• On January 1, 2010, pursuant to new accounting guidance, we deconsolidated CDO VII which is now effectively an off-balance sheet financing.

We have no obligation to repurchase any loans from either of our subprime securitizations. Therefore, it is expected that our exposure to loss is limited to the carrying amount of our retained interests in the securitization entities, as described above. A subsidiary of ours gave limited representations and warranties with respect to the second securitization; however, it has no assets and does not have recourse to the general credit of Newcastle.

We also had the following arrangements which do not meet the definition of off-balance sheet arrangements, but do have some of the characteristics of off-balance sheet arrangements.

• We have made investments in three equity method investees, two of which are dormant at September 30, 2010 and the other of which is immaterial to our financial condition, liquidity and operations.

In each case, our exposure to loss is limited to the carrying (fair) value of our investment.

CONTRACTUAL OBLIGATIONS

During the first nine months of 2010, we had all of the material contractual obligations referred to in our annual report on Form 10-K for the year ended December 31, 2009, excluding the debt which was repaid or repurchased, as described in “– Liquidity and Capital Resources,” as well as the following:

Contract Category	Change
CDO bonds payable	We re-issued $37.6 million face amount of CDO bonds payable in exchange for junior subordinated notes payable, and we also deconsolidated CDO VII, both as described in “ – Liquidity and Capital Resources.”
Other bonds payable	We refinanced a portfolio of manufactured housing loans.

The terms of these contracts are described under “Quantitative and Qualitative Disclosures About Market Risk” below.

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INFLATION

We believe that our risk of increases in the market interest rates on our floating rate debt as a result of inflation is largely offset by our use of match funding and hedging instruments as described above. See “Quantitative and Qualitative Disclosure About Market Risk — Interest Rate Exposure” below.

ADJUSTED FUNDS FROM OPERATIONS

We believe Adjusted Funds From Operations (“AFFO”) is one appropriate measure of the operating performance of real estate companies. We also believe that AFFO is an appropriate supplemental disclosure of operating performance for a REIT. Furthermore, AFFO is used to compute our incentive compensation to the Manager. AFFO, for our purposes, represents net income available for common stockholders (computed in accordance with GAAP), excluding extraordinary items, plus depreciation of operating real estate, and after adjustments for equity method investees, if any. We consider gains and losses on resolution of our investments to be a normal part of our recurring operations and therefore do not exclude such gains and losses when arriving at AFFO. This is the one difference between our definition of AFFO and the National Association of Real Estate Investment Trusts (“NAREIT”) definition of FFO, which excludes gains and losses. Adjustments for equity method investees, if any, are calculated to reflect AFFO on the same basis. AFFO does not represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indicator of our operating performance or as an alternative to cash flow as a measure of liquidity and is not necessarily indicative of cash available to fund cash needs. Our calculation of AFFO may be different from the calculation used by other companies and, therefore, comparability may be limited.

AFFO is calculated as follows (in thousands):

	For the Nine Months Ended September 30,
	2010		2009
Income (loss) applicable to common stockholders	$	460,266	$	(239,934	)
Operating real estate depreciation		—		(124	)
Adjusted Funds from Operations (AFFO)		$460,266		$(240,058)

Adjusted Funds from Operations was derived from our segments as follows (in thousands):

	Book Equity at September 30, 2010			AFFO for the nine Months Ended September 30, 2010
CDOs		(496,962	)		384,559
Other nonrecourse		52,387			38,002
Recourse		—			(276	)
Corporate - unlevered	$	42,732		$	23,727
Corporate - other (1)		(59,543	)		14,254
Total (2)		(461,386	)		460,266
Preferred stock		61,583
Accumulated depreciation		—
Accumulated other comprehensive income (loss)		(191,381	)
Net GAAP equity	$	(591,184	)

(1) Corporate – other AFFO represents $43,043 of the excess of carrying amount of exchanged preferred stock over fair value of consideration paid (described in “ – Preferred Stock” above), ($6,058) of preferred dividends, ($2,605) of interest expense on our junior subordinated notes payable and interest rate swaps, and ($20,126) of corporate general and administrative expenses and management fees for the nine months ended September 30, 2010.

(2) Invested common equity is equal to GAAP equity excluding preferred stock, accumulated depreciation and accumulated other comprehensive income (loss).

As a result of the effect of the other-than-temporary impairment on our AFFO, we expect that there will be no incentive compensation payable to the Manager for an indeterminate amount of time.

NET INTEREST INCOME LESS EXPENSES (NET OF PREFERRED DIVIDENDS)

Newcastle has five primary variables that impact its operating performance: (i) the current yield earned on its investments that are not included in non-recourse financing structures (i.e., unlevered investments and investments subject to recourse debt), (ii) the net yield it earns from its non-recourse financing structures, (iii) the interest expense and dividends incurred under its recourse debt and preferred stock, (iv) its operating expenses, and (v) its realized and unrealized gains on its investments and its debt obligations, including impairment. Net Interest Income Less Expenses (Net of Preferred Dividends) is a measure of the operating performance of the Company that excludes the fifth variable listed above. It is

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used by management to gauge the current performance of the Company without taking into account gains and losses, which, although they represent a part of our recurring operations, are subject to significant variability and are only a potential indicator of future economic performance. Management views Net Interest Income Less Expenses (Net of Preferred Dividends) as Newcastle’s “core” current earnings, while gains and losses (including impairment) are simply a potential indicator of future earnings. Management believes that Net Interest Income Less Expenses (Net of Preferred Dividends) provides investors with useful information regarding the Company’s “core” current earnings, and it enables investors to evaluate the Company’s current performance using the same measure that management uses to operate the business.

Net interest income less expenses (net of preferred dividends) does not represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indicator of our operating performance or as an alternative to cash flow as a measure of our liquidity and is not necessarily indicative of cash available to fund cash needs. For a further description of the differences between cash flow provided by operations and net income see “ – Liquidity and Capital Resource) above. Our calculation of net interest income less expenses (net of preferred dividends) may be different from the calculation used by other companies and, therefore, comparability may be limited.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Income (loss) applicable to common stockholders	$	162,107		$	49,663		$	460,266		$	(239,934	)
Add (Deduct):
Impairment (including the reversal of prior valuation allowance on loans)		(95,319	)		90,802			(205,846	)		521,679
Other (income) loss		(36,662	)		(128,869	)		(146,589	)		(196,471	)
(Income) loss from discontinued operations		(213	)		(79	)		(186	)		96
Excess of carrying amount of exchanged preferred stock over fair value of consideration paid - Note 9		—			—			(43,043	)		—
	$	29,913		$	11,517		$	64,602		$	85,370

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ITEM 3. 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 related derivative positions are for non-trading purposes only. For a further understanding of how market risk may affect our financial position or results of operations, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Application of Critical Accounting Policies.”

Interest Rate Exposure

Changes in interest rates, including changes in expected interest rates or “yield curves,” affect our investments in two distinct ways, each of which is discussed below.

First, changes in interest rates affect our net interest income, which is the difference between the interest income earned on assets and the interest expense incurred in connection with our debt obligations and hedges.

Our general financing strategy focuses on the use of match funded structures, when appropriate and available. This means that we seek to match the maturities of our debt obligations with the maturities of our assets to minimize the risk that we have to refinance our liabilities prior to the maturities of our assets, and to reduce the impact of changing interest rates on our earnings. In addition, we generally match fund interest rates on our assets with like-kind debt (i.e., fixed rate assets are financed with fixed rate debt and floating rate assets are financed with floating rate debt), directly or through the use of interest rate swaps, caps or other financial instruments (see below), or through a combination of these strategies, which 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 September 30, 2010, a 100 basis point increase in short term interest rates would increase our earnings by approximately $1.6 million per annum, assuming a static portfolio of current investments and financings.

Second, changes in the level of interest rates also affect the yields required by the marketplace on debt. Increasing interest rates would decrease the value of the fixed rate assets we hold at the time because higher required yields result in lower prices on existing fixed rate assets in order to adjust their yield upward to meet the market.

Changes in unrealized gains or losses resulting from changes in market interest rates do not directly affect our cash flows, or our ability to pay a dividend, to the extent the related assets are expected to be held, as their fair value is not 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. As of September 30, 2010, a 100 basis point change in short term interest rates would impact our net book value by approximately $10.8 million, assuming a static portfolio of current investments and financings.

Interest rate swaps are agreements in which a series of interest rate flows are exchanged with a third party (counterparty) over a prescribed period. The notional amount on which swaps are based is not exchanged. In general, our swaps are “pay fixed” swaps involving the exchange of floating rate interest payments from the counterparty for fixed interest payments from us. This can effectively convert a floating rate debt obligation into a fixed rate debt obligation. Interest rate swaps may be subject to margin calls.

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.

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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 September 30, 2010, a 25 basis point movement in credit spreads would impact our net book value by approximately $22.0 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 the liabilities we issue, our net spread will be reduced.

Credit Risk

In addition to the above described market risks, Newcastle is subject to credit risk.

Credit risk refers to the ability of each individual borrower under our loans and securities to make required interest and principal payments on the scheduled due dates. The commercial mortgage and asset backed securities we invest in are generally junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of one or more subordinate classes of securities or other form of credit support (which absorbs losses before the securities in which we invest) within a securitization transaction. The senior unsecured REIT debt securities we invest in reflect comparable credit risk. As a result of the current challenging credit and liquidity conditions, the value of the subordinated securities has generally been reduced or, in some cases, eliminated, which could leave our securities economically in a first loss position. We also invest in loans and securities which represent “first loss” pieces; in other words, they do not benefit from credit support although we believe they predominantly benefit from underlying collateral value in excess of their carrying amounts.

We seek to reduce credit risk by actively monitoring our asset portfolio and the underlying credit quality of our holdings and, where appropriate and achievable, repositioning our investments to upgrade their credit quality. In the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults may increase and result in credit losses that would adversely affect our liquidity and operating results. As described above in “- Market Considerations” and elsewhere in this quarterly report, adverse market and credit conditions have resulted in our recording of other-than-temporary impairment in certain securities and loans.

Margin

We may, from time to time, be a party to derivatives 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 6 to our consolidated financial statements included herein. For information regarding the impact of prepayment,

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reinvestment, and expected loss factors on the timing of realization of our investments, please refer to the consolidated financial statements included herein and in our Annual Report on Form 10-K for the year ended December 31, 2009. For information regarding the impact of changes in these factors on the value of securities valued with internal models, see Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies.”

We note that the values of our investments in real estate securities, loans and derivative instruments are sensitive to changes in market interest rates, credit spreads and other market factors. The value of these investments can vary, and has varied, materially from period to period.

Trends

See “- Market Considerations” above for a further discussion of recent trends and events affecting our liquidity, unrealized gains and losses.

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ITEM 4. 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 Act) occurred during the 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.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we are or may be involved in various disputes and litigation matters that arise in the ordinary course of business. The Company is not party to any material legal proceedings as of the date on which this report is filed.

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. Importantly, many key aspects of the changes imposed by the Act will be established by various regulatory bodies and other groups over the next several years. As a result, we do not know how significantly the Act will affect us. It is possible that the Act could, among other things, increase our costs of operating as a public company, impose restrictions on our ability to securitize assets and reduce our investment returns on securitized assets.

We do not know what impact the U.S. government’s programs to attempt to stabilize the economy and the financial markets will have on our business. The government’s current efforts to modify terms of outstanding loans negatively affects our business, financial condition and results of operations.

Over the past two years, the U.S. government has taken a number of steps to attempt to stabilize the global financial markets and U.S. economy, including direct government investments in, and guarantees of, troubled financial institutions as well as government-sponsored programs such as the Term Asset-Backed Securities Loan Facility program (TALF) and the Public Private Investment Partnership Program (PPIP). The U.S. government is also currently evaluating or implementing an array of other measures and programs that purport to help improve U.S. financial and market conditions. While conditions appear to have improved relative to the depths of the global financial crisis, it is not clear whether this improvement is real or will last for a significant period of time. Moreover, it is not clear what impact the government’s future plans to improve the global economy and financial markets will have on our business. To date, we have not benefited in a direct, material way from any government programs, and we may not derive any meaningful benefit from these programs in the future. Moreover, if any of our competitors are able to benefit from one or more of these initiatives, they may gain a significant competitive advantage over us.

In addition, the U.S. government has enacted legislation that enables government agencies to modify the terms of a significant number of residential and other loans to provide relief to borrowers without the applicable investor’s consent. These modifications allow for outstanding principal to be deferred, interest rates to be reduced, the length of the loan to be extended or other terms to be changed in ways that can permanently eliminate the cash flow (principal and interest) associated with a portion of the loan. These modifications are currently reducing, or in the future may reduce, the value of a number of our mortgage-backed securities and other investments. As a result, such loan modifications are negatively affecting our business, results of operations and financial condition. In addition, certain market participants propose reducing the amount of paperwork required by a borrower to modify their loan, which could increase the likelihood of fraudulent modifications and materially harm the U.S. mortgage market and investors that have exposure to this market.

Risks Relating to Our Management

We are dependent on our manager and may not find a suitable replacement if our manager terminates the management agreement.

We have no employees. Our officers and other individuals who perform services for us are employees of our manager. We are completely reliant on our manager, which has significant discretion as to the implementation of our operating policies and strategies, to conduct our business. We are subject to the risk that our manager will terminate the management agreement and that we will not be able to find a suitable replacement for our manager in a timely manner, at a reasonable cost or at all. Furthermore, we are dependent on the services of certain key employees of our manager whose compensation is partially or entirely dependent upon the amount of incentive or management compensation earned by our manager and whose continued service is not guaranteed and the loss of such services could adversely affect our operations.

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There are conflicts of interest in our relationship with our manager.

Our chairman serves as an officer of our manager. Our management agreement with our manager was not negotiated at arm’s-length and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party.

There are conflicts of interest inherent in our relationship with our manager insofar as our manager and its affiliates — including investment funds, private investment funds, or businesses managed by our manager — invest in real estate securities, real estate related loans and operating real estate and whose investment objectives overlap with our investment objectives. Certain investments appropriate for Newcastle may also be appropriate for one or more of these other investment vehicles. Members of our board of directors and employees of our manager who are our officers may serve as officers and/or directors of these other entities. In addition, our manager or its affiliates may have investments in and/or earn fees from such other investment vehicles which are larger than their economic interests in Newcastle and which may therefore create an incentive to allocate investments to such other investment vehicles. Our manager or its affiliates may determine, in their discretion, to make a particular investment through another investment vehicle rather than through Newcastle and have no obligation to offer to Newcastle the opportunity to participate in any particular investment opportunity. Accordingly, it is possible that we may not be given the opportunity to participate at all in certain investments made by our affiliates that meet our investment objectives.

Our management agreement with our manager generally does not limit or restrict our manager or its affiliates from engaging in any business or managing other pooled investment vehicles that invest in investments that meet our investment objectives, except that under our management agreement neither our manager nor any entity controlled by or under common control with our manager is permitted to raise or sponsor any new pooled investment vehicle whose investment policies, guidelines or plan targets as its primary investment category investment in United States dollar-denominated credit sensitive real estate related securities reflecting primarily United States loans or assets. Our manager intends to engage in additional real estate related management and investment opportunities in the future which may compete with us for investments.

The ability of our manager and its officers and employees to engage in other business activities, subject to the terms of our management agreement with our manager, may reduce the time our manager, its officers or other employees spend managing Newcastle. In addition, we may engage in material transactions with our manager or another entity managed by our manager or one of its affiliates, including certain financing arrangements and co-investments which present an actual, potential or perceived conflict of interest, subject to our investment guidelines. It is possible that actual, potential or perceived conflicts could give rise to investor dissatisfaction, litigation or regulatory enforcement actions. Appropriately dealing with conflicts of interest is complex and difficult, and our reputation could be damaged if we fail, or appear to fail, to deal appropriately with one or more potential, actual or perceived conflicts of interest. Regulatory scrutiny of, or litigation in connection with, conflicts of interest could have a material adverse effect on our reputation which could materially adversely affect our business in a number of ways, including causing an inability to raise additional funds, a reluctance of counterparties to do business with us, a decrease in the prices of our common and preferred securities and a resulting increased risk of litigation and regulatory enforcement actions.

The management compensation structure that we have agreed to with our manager may incentivize our manager to invest in high risk investments. In addition to its management fee, our manager is entitled to receive incentive compensation based in part upon our achievement of targeted levels of funds from operations. In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on funds from operations may lead our manager to place undue emphasis on the maximization of funds from operations at the expense of other criteria, such as preservation of capital, in order to achieve higher incentive compensation, particularly in light of the fact that our manager has not received any incentive compensation and likely will not receive any incentive compensation in the future unless it meaningfully increases Newcastle’s investment returns. Investments with higher yield potential are generally riskier or more speculative than lower-yielding investments. Moreover, because our manager receives compensation in the form of options in connection with the completion of our common equity offerings, our manager may be incentivized to cause us to issue additional common stock, which could be dilutive to existing shareholders.

It would be difficult and costly to terminate our management agreement with our manager.

Termination of the management agreement with our manager would be difficult and costly. The management agreement may only be terminated annually upon the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of a majority of the outstanding shares of our common stock, based upon (1) unsatisfactory performance by our manager that is materially detrimental to us or (2) a determination that the management fee payable to our manager is

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not fair, subject to our manager’s right to prevent such a compensation termination by accepting a mutually acceptable reduction of fees. Our manager will be provided 60 days’ prior notice of any termination and will be paid a termination fee equal to the amount of the management fee earned by the manager during the twelve-month period preceding such termination. In addition, following any termination of the management agreement, the manager may require us to purchase its right to receive incentive compensation at a price determined as if our assets were sold for their fair market value (as determined by an appraisal, taking into account, among other things, the expected future value of the underlying investments) or otherwise we may continue to pay the incentive compensation to our manager. These provisions may increase the effective cost to us of terminating the management agreement, thereby adversely affecting our ability to terminate our manager without cause.

Our directors have approved very broad investment guidelines for our manager and do not approve each investment decision made by our manager.

Our manager is authorized to follow very broad investment guidelines. Consequently, our manager has great latitude in determining the types of assets it may decide are proper investments for us. Our directors periodically review our investment guidelines and our investment portfolio. However, our board does not review or pre-approve each proposed investment or our related financing arrangements. In addition, in conducting periodic reviews, the directors rely primarily on information provided to them by our manager. Furthermore, transactions entered into by our manager may be difficult or impossible to unwind by the time they are reviewed by the directors even if the transactions contravene the terms of the management agreement.

We may change our investment strategy without stockholder consent, which may result in our making investments that entail more risk than our current investments.

Our investment strategy may evolve, in light of existing market conditions and investment opportunities, and this evolution may involve additional risks depending upon the nature of such assets and our ability to finance such assets on a short or long term basis. Investment opportunities that present unattractive risk-return profiles relative to other available investment opportunities under particular market conditions may become relatively attractive under changed market conditions and changes in market conditions may therefore result in changes in the investments we target. Decisions to make investments in new asset categories present risks that may be difficult for us to adequately assess and could therefore reduce the stability of our dividends or have adverse effects on our financial condition. A change in our investment strategy may also increase our exposure to interest rate, foreign currency, real estate market or credit market fluctuations. Our failure to accurately assess the risks inherent in new asset categories or the financing risks associated with such assets could adversely affect our results of operations and our financial condition.

Risks Relating to Our Business

Challenging market conditions will likely continue to negatively impact our business, results of operations and financial condition.

The market in which we operate is affected by a number of factors that are largely beyond our control but can nonetheless have a potentially significant, negative impact on us. These factors include, among other things:

• Interest rates and credit spreads;

• The availability of credit, including the price, terms and conditions under which it can be obtained;

• The quality, pricing and availability of suitable investments and credit losses with respect to our investments;

• The ability to obtain accurate market-based valuations;

• Loan values relative to the value of the underlying real estate assets;

• Default rates on both commercial and residential mortgages and the amount of the related losses;

• The actual and perceived state of the real estate markets, market for dividend-paying stocks and public capital markets generally;

• Unemployment rates; and

• The attractiveness of other types of investments relative to investments in real estate or REITs generally.

Changes in these factors are difficult to predict, and a change in one factor can affect other factors. For example, during 2007, increased default rates in the subprime mortgage market played a role in causing credit spreads to widen, reducing availability of credit on favorable terms, reducing liquidity and price transparency of real estate related assets, resulting in difficulty in obtaining accurate mark-to-market valuations, and causing a negative perception of the state of the real estate markets and of REITs generally. These conditions worsened during 2008, and intensified meaningfully during the fourth quarter of 2008, as a result of the global credit and liquidity crisis, resulting in extraordinarily challenging market conditions. Despite signs of improvement, market conditions during 2010 remain challenging. We do not currently know the full extent to which this market disruption will affect us or the markets in which we operate, and we are unable to predict its length or ultimate severity. If the challenging conditions continue, we may experience additional impairment charges as well as additional challenges in raising capital and obtaining investment or other financing on attractive terms.

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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 are currently experiencing 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 both our net interest income from loans and securities in our portfolio as well as our ability to originate, sell and securitize loans, which would significantly harm our revenues, results of operations, financial condition, liquidity, business prospects and our ability to make distributions to our shareholders. For more information on the impact of the continued challenging credit and liquidity conditions on our business and results of operations see Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Considerations.”

The use of CDO financings with coverage tests may have a negative impact on our operating results and cash flows.

We have retained, and may in the future retain or repurchase, subordinate classes of bonds issued by certain of our subsidiaries in our CDO financings. Each of our CDO financings contains tests that measure the amount of over collateralization and excess interest in the transaction. Failure to satisfy these tests would result in principal and/or interest cash flow that would otherwise be distributed to more junior classes of securities (including those held by Newcastle) to be redirected to pay down the most senior class of securities outstanding until the tests are satisfied. As a result, failure to satisfy the coverage tests could adversely affect our operating results and cash flows by temporarily or permanently directing funds that would otherwise come to us to holders of the senior classes of bonds. In addition, the redirected funds would be used to pay down financing, which currently bears an attractive rate, thereby reducing our future earnings from the affected CDO. The ratings assigned to the assets in each CDO affect the results of the tests governing whether a CDO can distribute cash to the various classes of securities in the CDO. As a result, ratings downgrades of the assets in a CDO can result in a CDO failing its tests and thereby cause us not to receive cash flows from the affected CDO. We note that we have approximately $614.2 million of assets in our consolidated CDOs as of October 31, 2010 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 affect – and possibly materially affect – our future cash flows. As of the September 2010 remittance date for CDO IV and as of the October 2010 remittance date for CDO VI, these CDOs were not in compliance with their applicable over collateralization tests and, consequently, we are not receiving cash flows from these CDOs (other than senior management fees). Based upon our current calculations, we expect these CDOs to remain out of compliance for the foreseeable future. Moreover, given current market conditions, it is possible that all of our CDOs could be out of compliance with their over collateralization tests as of one or more measurement dates within the next twelve months.

Our ability to rebalance will depend upon the availability of suitable securities, market prices, whether the reinvestment period of the applicable CDO has ended, and other factors that are beyond our control. For example, in prior periods, we were able to repurchase notes issued by the CDOs and subsequently cancel those notes in accordance with the terms of the relevant governing documentation. These cancellations assisted the applicable CDO in satisfying its overcollateralization test as of the next testing date and thereby enabled the cash flow from that CDO to be distributed to the junior classes of securities (including those held by Newcastle). The trustee of all of our CDOs has informed us that, if we wish to cancel CDO debt in the future, they will require us to obtain the approval of the noteholders of the applicable CDO. If we are unable to obtain the requisite noteholder consent, we will be unable to use CDO debt cancellations as a tool to help CDOs satisfy their overcollateralization tests and thereby maintain the flow of cash from that CDO to Newcastle. As a result, holders of our common shares and preferred shares should not expect that we will be able to cancel any of our CDO obligations in the future. While there are other permissible methods to rebalance or otherwise correct CDO test failures, such methods may be extremely difficult to employ given current market conditions, and we cannot assure you that we will be successful in our rebalancing efforts. If the liabilities of our CDOs are downgraded by Moody’s to certain predetermined levels, our discretion to rebalance the applicable CDO portfolios may be negatively impacted. Moreover, if we bring these coverage tests into compliance, we cannot assure you that they will not fall out of compliance in the future or that we will be able to correct any noncompliance.

Failure of the over collateralization tests can also cause a “phantom income” issue if cash that constitutes income is diverted to pay down debt instead of distributed to us. For more information regarding noncompliance with the terms of certain of our CDO financings in the near future, please see Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations–Liquidity and Capital Resources” and “–Debt Obligations.”

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We may experience an event of default or the removal of us as collateral manager under one or more of our CDOs, which would negatively affect us in a number of ways.

The documentation governing our CDOs specify certain events of default, which, if they occur, would negatively affect us. Events of default include, among other things, failure to pay interest on senior classes of securities within the CDO, breaches of covenants, representations or warranties, bankruptcy, and failure to satisfy specific over collateralization and interest coverage tests. If an event of default occurs under any of our CDOs, it would negatively affect our cash flows, business, results of operations and financial condition.

In addition, we can be removed as manager of a CDO if certain events occur, including the failure to satisfy specific over collateralization and interest coverage tests, failure to satisfy certain “key man” requirements or an event of default occurring for the failure to pay interest on the related senior classes of securities of the CDO. If we are removed as collateral manager, we would no longer receive management fees from — and no longer be able to manage the assets of — the applicable CDO, which would negatively affect our cash flows, business, results of operations and financial condition. We note that on November 4, 2009, CDO VII failed additional over collateralization tests. The consequences of failing these tests are that an event of default has occurred, and we may be removed as the collateral manager under the documentation governing CDO VII. So long as the event of default continues, we will not be permitted to purchase or sell any collateral in CDO VII. If we are removed as the collateral manager of CDO VII, we would no longer receive the senior management fees from such CDO. As of November 5, 2010, we have not been removed as collateral manager. Based upon our current calculations, we estimate that if we are removed as the collateral manager of CDO VII, the loss of senior management fees would not have a material negative impact on our cash flows, business, results of operations or financial condition. However, given current market conditions, it is possible that events of default may occur in other CDOs, and we could be removed as the collateral manager of those CDOs if certain events of default occur. Moreover, our cash flows, business, results of operations and/or financial condition could be materially and negatively impacted if certain events of default occur.

Our investments have previously been — and in the future may be — subject to significant impairment charges, which adversely affect our results of operations.

We are required to periodically evaluate our investments for impairment indicators. The value of an investment is impaired when our analysis indicates that, with respect to a loan, it is probable that we will not be able to collect the full amount we intended to collect from the loan or, with respect to a security, it is probable that the value of security is other than temporarily impaired. The judgment regarding the existence of impairment indicators is based on a variety of factors depending upon the nature of the investment and the manner in which the income related to such investment calculated for purposes of our financial statements. If we determine that an impairment has occurred, we are required to make an adjustment to the net carrying value of the investment, which could adversely affect our results of operations and funds from operations in the applicable period and thereby adversely affect our ability to pay dividends to our stockholders.

As has been widely publicized, the continued challenging credit and liquidity conditions have resulted in a number of financial institutions recording an unprecedented amount of impairment charges, and we have also been affected by these conditions. These challenging conditions have reduced the market trading activity for many real estate securities, resulting in less liquid markets for those securities. These lower valuations have affected us by, among other things, decreasing our net book value and contributing to our decision to record impairment charges.

The lenders under any repurchase agreements that we may enter into from time to time 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.

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Our counterparties are not required to roll our repurchase agreements upon the expiration of the stated terms, which subjects us to a number of risks. As we have experienced recently and may experience in the future, counterparties electing to roll our repurchase agreements may charge higher spread and impose more onerous terms upon us, including the requirement that we post additional margin as collateral. More significantly, if a repurchase agreement counterparty elects not to extend our financing, we would be required to pay the counterparty the full repurchase price on the maturity date and find an alternate source of financing. Alternate sources of financing may be more expensive, contain more onerous terms or simply may not be available. If we were unable to pay the repurchase price for any security financed with a repurchase agreement, the counterparty has the right to sell the underlying security being held as collateral and require us to compensate them for any shortfall between the value of our obligation to the counterparty and the amount for which the collateral was sold (which may be sold at a significantly discounted price).

Our determination of how much leverage to apply to our investments may adversely affect our return on our investments and may reduce cash available for distribution.

We leverage our portfolio through borrowings, generally through the use of credit facilities, warehouse facilities, repurchase agreements, mortgage loans on real estate, securitizations, including the issuance of CDOs, private or public offerings of debt by subsidiaries, loans to entities in which we hold, directly or indirectly, interests in pools of properties or loans, and other borrowings. Our investment policies do not limit the amount of leverage we may incur with respect to any specific asset or pool of assets, subject to an overall limit on our use of leverage to 90% (as defined in our governing documents) of the value of our assets on an aggregate basis. As a result of the continued challenging credit and liquidity conditions, the return we are able to earn on our investments and cash available for distribution to our stockholders has been significantly reduced due to changes in market conditions causing the cost of our financing to increase relative to the income that can be derived from our assets.

We have limited liquidity. We may become party to agreements that require cash payments at periodic intervals. Failure to make such required payments may adversely affect our business, financial condition and results of operations.

We may become party to 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 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.

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In addition, with respect to our CDOs, certain of our derivative counterparties are required to maintain certain ratings to avoid having to post collateral or transfer the derivative to another counterparty. If the counterparty was downgraded below these levels they may not be able to satisfy their obligations under the derivative, which could have a material negative effect on the applicable CDO.

The counterparty risks that we face have increased in complexity and magnitude as a result of the deterioration of conditions in the financial markets and weakening or insolvency of a number of major financial institutions (such as Bear Stearns, Lehman Brothers, Merrill Lynch, Citigroup and AIG). For example, the consolidation and elimination of counterparties has increased our concentration of counterparty risk and decreased the universe of potential counterparties. In addition, counterparties have generally reacted to the ongoing market volatility by tightening their underwriting standards and increasing their margin requirements for all categories of financing, which has negatively impacted us in several ways, including, decreasing the number of counterparties willing to provide financing to us, decreasing the overall amount of leverage available to us, and increasing the costs of borrowing.

We are not restricted from dealing with any particular counterparty or from concentrating any or all of our transactions with one counterparty. Any loss suffered by us as a result of a counterparty defaulting, refusing to conduct business with us or imposing more onerous terms on us would also negatively affect our business, results of operations and financial condition.

Although we seek to match fund our investments to limit refinance risk and lock in net spreads, we do not currently match fund our investments not held in our CDOs, which increases the risks related to refinancing these investments.

A key to our investment strategy is to finance our investments using match funded financing structures, which match assets and liabilities with respect to maturities and interest rates. This strategy limits our refinance risk, including the risk of being able to refinance an investment on favorable terms or at all. We generally use match funded financing structures, such as CDOs, to finance our investments in real estate securities and loans. However, our manager may elect for us to bear a level of refinancing risk on a short term or longer term basis, such as is the case with investments financed with repurchase agreements, when, based on its analysis, our manager determines that bearing such risk is deemed advisable or unavoidable (this is generally the case with respect to the residential mortgage loans and FNMA/FHLMC in which we invest). In addition, we may be unable, as a result of conditions in the credit markets, to match fund investments. For example, non-recourse term financing not subject to margin requirements was generally not available or economical for the past two years and is currently still challenging to obtain, which impairs our ability to match fund our investments. The decision not, or the inability, to match fund certain investments exposes us to additional refinancing risks that may not apply to our other investments.

Furthermore, we anticipate that, in most cases, for any period during which our floating rate assets are not match funded with respect to maturity, the income from such assets may respond more slowly to interest rate fluctuations than the cost of our borrowings. Because of this dynamic, interest income from such investments may rise more slowly than the related interest expense, with a consequent decrease in our net income. Interest rate fluctuations resulting in our interest expense exceeding interest income would result in operating losses for us from these investments.

Accordingly, if we do not or are unable to match fund our investments with respect to maturities and interest rates, we will be exposed to the risk that we may not be able to finance or refinance our investments on economically favorable terms or may have to liquidate assets at a loss.

We may not be able to finance our investments on a long term basis on attractive terms, including by means of securitization, which may require us to seek more costly financing for our investments or to liquidate assets.

When we acquire securities and loans that we finance on a short term basis with a view to securitization or other long term financing, we bear the risk of being unable to securitize the assets or otherwise finance them on a long term basis at attractive prices or in a timely matter, or at all. If it is not possible or economical for us to securitize or otherwise finance such assets on a long term basis, we may be unable to pay down our short term credit facilities, or be required to liquidate the assets at a loss in order to do so. For example, as a result of the continued deterioration in the credit markets beginning in 2007, financing investments with securitizations or other long-term non-recourse financing not subject to margin requirements was generally not available or economical for the past two years, and is currently still challenging to obtain. 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.

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The loans we invest in and the loans underlying the securities we invest in, are subject to delinquency, foreclosure and loss, which could result in losses to us.

Commercial mortgage loans are secured by multifamily or commercial property and are subject to risks of delinquency and foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other things: tenant mix, success of tenant businesses, property management decisions, property location and condition, competition from comparable types of properties, changes in laws that increase operating expense or limit rents that may be charged, any need to address environmental contamination at the property, the occurrence of any uninsured casualty at the property, changes in national, regional or local economic conditions and/or specific industry segments, declines in regional or local real estate values, declines in regional or local rental or occupancy rates, increases in interest rates, changes in the availability of credit on favorable terms, real estate tax rates and other operating expenses, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest and civil disturbances.

Residential mortgage loans, manufactured housing loans and subprime mortgage loans are secured by single-family residential property and are also subject to risks of delinquency and foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by a residential property is dependent upon the income or assets of the borrower. A number of factors may impair borrowers’ abilities to repay their loans, including, among other things, changes in the borrower’s employment status, changes in national, regional or local economic conditions, changes in interest rates or the availability of credit on favorable terms, changes in regional or local real estate values, changes in regional or local rental rates and changes in real estate taxes.

In the event of any default under a loan held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the outstanding principal and accrued but unpaid interest of the loan, which could adversely affect our cash flow from operations. Foreclosure of a loan, particularly a commercial loan, can be an expensive and lengthy process, which would negatively affect our anticipated return on the foreclosed loan.

Mortgage and asset backed securities are bonds or notes backed by loans and/or other financial assets and include commercial mortgage back securities (CMBS), FNMA/FHLMC securities, and real estate related asset backed securities (ABS). The ability of a borrower to repay these loans or other financial assets is dependent upon the income or assets of these borrowers. If a borrower has insufficient income or assets to repay these loans, it will default on its loan. While we intend to focus on real estate related asset backed securities, there can be no assurance that we will not invest in other types of asset backed securities.

Our investments in mortgage and asset backed securities will be adversely affected by defaults under the loans underlying such securities. To the extent losses are realized on the loans underlying the securities in which we invest, the Company may not recover the amount invested in, or, in extreme cases, any of our investment in, such securities.

We have recently experienced increased default rates on our commercial and residential mortgage loans.

Our investments in debt securities are subject to specific risks relating to the particular issuer of the securities and to the general risks of investing in subordinated real estate securities.

Our investments in debt securities involve special risks. REITs generally are required to invest substantially in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments discussed in this report. Our investments in debt are subject to the risks described above with respect to mortgage loans and MBS and similar risks, including:

• risks of delinquency and foreclosure, and risks of loss in the event thereof;

• the dependence upon the successful operation of and net income from real property;

• risks generally incident to interests in real property; and

• risks that may be presented by the type and use of a particular property.

Debt securities may be unsecured and may also be subordinated to other obligations of the issuer. We may also invest in debt securities that are rated below investment grade. As a result, investments in debt securities are also subject to risks of:

• limited liquidity in the secondary trading market;

• substantial market price volatility resulting from changes in prevailing interest rates or credit spreads;

• subordination to the prior claims of senior lenders to the issuer;

• the possibility that earnings of the debt security issuer may be insufficient to meet its debt service; and

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• the declining creditworthiness and potential for insolvency of the issuer of such debt securities during periods of rising interest rates and economic downturn.

These risks may adversely affect the value of outstanding debt securities and the ability of the issuers thereof to repay principal and interest.

We are subject to significant competition and we may not compete successfully.

We are subject to significant competition in seeking investments. We compete with other companies, including other REITs, insurance companies and other investors, including funds and companies affiliated with our manager. Some of our competitors have greater resources than we possess or have greater access to capital or various types of financing structures than are available to us, and we may not be able to compete successfully for investments or provide attractive investment returns relative to our competitors. Furthermore, competition for investments of the type to be made by us may lead to the returns available from such investments decreasing, which may further limit our ability to generate our desired returns. We cannot assure you that other companies will not be formed that compete with us for investments or otherwise pursue investment strategies similar to ours or that we will be able to complete successfully against any such companies.

Following the closing of a CDO financing when we have locked in the liability costs for a CDO during the reinvestment period, the rate at which we are able to acquire eligible investments and changes in market conditions may adversely affect our anticipated returns.

During the reinvestment period, we must invest the restricted cash available for reinvestments in our CDOs. Until we are able to acquire sufficient assets, our returns will reflect income earned on uninvested cash and, having locked in the cost of liabilities for the particular CDO, the particular CDO’s returns will be at risk of declining to the extent that yields on the assets to be acquired decline. In general, our ability to acquire appropriate investments depends upon the supply in the market of investments we deem suitable, and changes in various economic factors may affect our determination of what constitutes a suitable investment.

Our returns will be adversely affected when investments held in CDOs are prepaid or sold subsequent to the reinvestment period.

Real estate securities and loans are subject to prepayment risk. In addition, we may sell, and realize gains (or losses) on, investments. To the extent such assets were held in CDOs subsequent to the end of the reinvestment period, the proceeds are fully utilized to pay down the related CDOs debt. This causes the leverage on the CDO to decrease, thereby lowering our returns on equity.

Our investments in senior unsecured REIT securities are subject to specific risks relating to the particular REIT issuer and to the general risks of investing in subordinated real estate securities, which may result in losses to us.

Our investments in REIT securities involve special risks relating to the particular REIT issuer of the securities, including the financial condition and business outlook of the issuer. REITs generally are required to substantially invest in operating real estate or real estate related assets and are subject to the inherent risks associated with real estate related investments discussed in this report.

Our investments in REIT securities are also subject to the risks described above with respect to mortgage loans and mortgage backed securities and similar risks, including (i) risks of delinquency and foreclosure, and risks of loss in the event thereof, (ii) the dependence upon the successful operation of and net income from real property, (iii) risks generally incident to interests in real property, and (iv) risks that may be presented by the type and use of a particular commercial property.

REIT securities are generally unsecured and may also be subordinated to other obligations of the issuer. We may also invest in REIT securities that are rated below investment grade. As a result, investments in REIT securities are also subject to risks of: (i) limited liquidity in the secondary trading market, (ii) substantial market price volatility resulting from changes in prevailing interest rates, (iii) subordination to the prior claims of banks and other senior lenders to the issuer, (iv) the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause the issuer to reinvest premature redemption proceeds in lower yielding assets, (v) the possibility that earnings of the REIT issuer may be insufficient to meet its debt service and dividend obligations and (vi) the declining creditworthiness and potential for insolvency of the issuer of such REIT securities during periods of rising interest rates and economic downturn. These risks may adversely affect the value of outstanding REIT securities and the ability of the issuers thereof to repay principal and interest or make dividend payments.

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The real estate related loans and other direct and indirect interests in pools of real estate properties or other loans that we invest in may be subject to additional risks relating to the structure and terms of these transactions, which may result in losses to us.

We invest in real estate related loans and other direct and indirect interests in pools of real estate properties or loans such as mezzanine loans and “B Note” mortgage loans. We invest in mezzanine loans that take the form of subordinated loans secured by second mortgages on the underlying real property or other business assets or revenue streams or loans secured by a pledge of the ownership interests of the entity owning real property or other business assets or revenue streams (or the ownership interest of the parent of such entity). These types of investments involve a higher degree of risk than long term senior lending secured by business assets or income producing real property because the investment may become unsecured as a result of foreclosure by a senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of such entity, or the assets of the entity may not be sufficient to repay our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt is repaid in full. As a result, we may not recover some or all of our investment. In addition, mezzanine loans may have higher loan to value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal.

We also invest in mortgage loans (“B Notes”) that while secured by a first mortgage on a single large commercial property or group of related properties are subordinated to an “A Note” secured by the same first mortgage on the same collateral. As a result, if an issuer defaults, there may not be sufficient funds remaining for B Note holders. B Notes reflect similar credit risks to comparably rated commercial mortgage backed securities. In addition, we invest, directly or indirectly, in pools of real estate properties or loans. However, since each transaction is privately negotiated, these investments can vary in their structural characteristics and risks. For example, the rights of holders of B Notes to control the process following a borrower default may vary from transaction to transaction, while investments in pools of real estate properties or loans may be subject to varying contractual arrangements with third party co-investors in such pools. Further, B Notes typically are secured by a single property, and so reflect the risks associated with significant concentration. These investments also are less liquid than commercial mortgage backed securities.

Investment in non-investment grade loans may involve increased risk of loss.

We acquire and may continue to acquire in the future certain loans that do not conform to conventional loan criteria applied by traditional lenders and are not rated or are rated as non-investment grade (for example, for investments rated by Moody’s Investors Service, ratings lower than Baa3, and for Standard & Poor’s, BBB- or below). The non-investment grade ratings for these loans typically result from the overall leverage of the loans, the lack of a strong operating history for the properties underlying the loans, the borrowers’ credit history, the properties’ underlying cash flow or other factors. As a result, these loans have a higher risk of default and loss than conventional loans. Any loss we incur may reduce distributions to our stockholders. There are no limits on the percentage of unrated or non-investment grade assets we may hold in our portfolio.

Insurance on real estate in which we have interests (including the real estate serving as collateral for our real estate securities and loans) may not cover all losses.

There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war, that may be uninsurable or not economically insurable. Inflation, changes in building codes and ordinances, environmental considerations, and other factors, including terrorism or acts of war, also might make the insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under such circumstances, the insurance proceeds received might not be adequate to restore our economic position with respect to the affected real property. As a result of the events of September 11, 2001, insurance companies are limiting and/or excluding coverage for acts of terrorism in insurance policies. As a result, we may suffer losses from acts of terrorism that are not covered by insurance.

In addition, the mortgage loans that are secured by certain of the properties in which we have interests contain customary covenants, including covenants that require property insurance to be maintained in an amount equal to the replacement cost of the properties. There can be no assurance that the lenders under these mortgage loans will not take the position that exclusions from coverage for losses due to terrorist acts is a breach of a covenant which, if uncured, could allow the lenders to declare an event of default and accelerate repayment of the mortgage loans.

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Many of our investments are illiquid, and this lack of liquidity could significantly impede our ability to vary our portfolio in response to changes in economic and other conditions or to realize the value at which such investments are carried if we are required to dispose of them.

The real estate properties that we own and operate and our other direct and indirect investments in real estate and real estate related assets are generally illiquid. In addition, the real estate securities that we purchase in connection with privately negotiated transactions are not registered under the relevant securities laws, resulting in a prohibition against their transfer, sale, pledge or other disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in accordance with, those laws. In addition, there are no established trading markets for a majority of our investments. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be limited.

Our securities have historically been valued based primarily on third party quotations, which are subject to significant variability based on the liquidity and price transparency created by market trading activity. The ongoing dislocation in the trading markets has continued to reduce the trading for many real estate securities, resulting in less transparent prices for those securities. Consequently, it is currently more difficult for us to sell many of our assets now that it has been historically because, if we were to sell such assets, we will likely not have access to readily ascertainable market prices when establishing valuations of them. Moreover, currently there is a relatively low market demand for the vast majority of the types of assets that we hold, which may make it extremely difficult to sell assets. If we are required to liquidate all or a portion of our illiquid investments quickly, we may realize significantly less than the amount at which we have previously valued these investments.

Interest rate fluctuations and shifts in the yield curve may cause losses.

Our primary interest rate exposures relate to our real estate securities, loans, floating rate debt obligations and interest rate swaps. Changes in interest rates, including changes in expected interest rates or “yield curves,” affect our business in a number of ways. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities and hedges. Changes in the level of interest rates also can affect, among other things, our ability to acquire real estate securities and loans at attractive prices, the value of our real estate securities, loans and derivatives and our ability to realize gains from the sale of such assets.

In the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults may increase and result in credit losses that would adversely affect our liquidity and operating results. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political conditions, and other factors beyond our control.

Our ability to execute our business strategy, particularly the growth of our investment portfolio, depends to a significant degree on our ability to obtain additional capital. Our financing strategy is dependent on our ability to place the match funded debt we use to finance our investments at rates that provide a positive net spread. If spreads for such liabilities widen or if demand for such liabilities ceases to exist, then our ability to execute future financings will be severely restricted.

Interest rate changes may also impact our net book value as our real estate securities, real estate related loans and hedge derivatives are marked to market each quarter. Debt obligations are not marked to market. Generally, as interest rates increase, the value of our fixed rate securities decreases, which will decrease the book value of our equity.

Furthermore, shifts in the U.S. Treasury yield curve reflecting an increase in interest rates would also affect the yield required on our real estate securities and therefore their value. For example, increasing interest rates would reduce the value of the fixed rate assets we hold at the time because the higher yields required by increased interest rates result in lower market prices on existing fixed rate assets in order to adjust the yield upward to meet the market, and vice versa. This would have similar effects on our real estate securities portfolio and our financial position and operations to a change in interest rates generally.

Our investments in real estate securities and loans are subject to changes in credit spreads, which could adversely affect our ability to realize gains on the sale of such investments.

Real estate securities and loans are subject to changes in credit spreads. Credit spreads measure the yield demanded on securities and loans by the market based on their credit relative to a specific benchmark.

Fixed rate securities and loans are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. Floating rate securities and loans are valued based on a market credit spread over LIBOR and are affected similarly by changes in LIBOR spreads. Excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities and loans, resulting in the use of a higher, or “wider,” spread over the benchmark rate to value such securities. Under such conditions, the value of our real estate securities and loan portfolios would tend to decline. Conversely, if the spread used to value such securities were to decrease, or “tighten,” the value of our real estate securities portfolio would tend to increase. Such changes in the market

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value of our real estate securities and loan portfolios may affect our net equity, net income or cash flow directly through their impact on unrealized gains or losses on available for sale securities, and therefore our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital. During 2008 through the first quarter of 2009, credit spreads widened substantially. This widening of credit spreads caused the net unrealized gains on our securities, loans and derivatives, recorded in accumulated other comprehensive income or retained earnings, and therefore our book value per share, to decrease and resulted in net losses.

In addition, if the value of our loans subject to financing agreements were to decline, it could affect our ability to refinance such loans upon the maturity of the related repurchase agreements. Any credit or spread related losses incurred with respect to our loans would affect us in the same way as similar losses on our real estate securities portfolio as described above.

Any hedging transactions that we enter into may limit our gains or result in losses.

We use derivatives to hedge a portion of our interest rate exposure, and this approach has certain risks, including the risk that losses on a hedge position will reduce the cash available for distribution to stockholders and that such losses may exceed the amount invested in such instruments. We have adopted a general policy with respect to the use of derivatives, which generally allows us to use derivatives where appropriate, but does not set forth specific policies and procedures or require that we hedge any specific amount of risk. From time to time, we use derivative instruments, including forwards, futures, swaps and options, in our risk management strategy to limit the effects of changes in interest rates on our operations. A hedge may not be effective in eliminating all of the risks inherent in any particular position. Our profitability may be adversely affected during any period as a result of the use of derivatives.

There are limits to the ability of hedging strategy to protect us completely against interest rate risks. When rates change, we expect the gain or loss on derivatives to be offset by a related but inverse change in the value of the items, generally our liabilities, which we hedge. We cannot assure you, however, that our use of derivatives will offset the risks related to changes in interest rates. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses. In addition, our hedging strategy may limit our flexibility by causing us to refrain from taking certain actions that would be potentially profitable but would cause adverse consequences under the terms of our hedging arrangements.

In managing our hedge instruments, we consider the effect of the expected hedging income on the REIT qualification tests that limit the amount of gross income that a REIT may receive from hedging. The REIT provisions of the Internal Revenue Code limit our ability to hedge. We need to carefully monitor, and may have to limit, our hedging strategy to assure that we do not realize hedging income, or hold hedges having a value, in excess of the amounts which would cause us to fail the REIT gross income and asset tests.

Accounting for derivatives under GAAP is extremely complicated. Any failure by us to account for our derivatives properly in accordance with GAAP in our financial statements could adversely affect our earnings.

Under certain conditions, increases in prepayment rates can adversely affect yields on certain investments, including our residential mortgage loans.

The value of our assets may be affected by prepayment rates on our residential mortgage loans and other floating rate assets. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. In periods of declining mortgage interest rates, prepayments on loans generally increase. If general interest rates decline as well, the proceeds of such prepayments received during such periods are likely to be reinvested by us in assets yielding less than the yields on the assets that were prepaid. In addition, the market value of floating rate assets may, because of the risk of prepayment, benefit less than fixed rate assets from declining interest rates. Conversely, in periods of rising interest rates, prepayments on loans generally decrease, in which case we would not have the prepayment proceeds available to invest in assets with higher yields. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain investments.

In addition, when market conditions lead us to increase the portion of our 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.

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Changes in accounting rules could occur at any time and could impact us in significantly negative ways that we are unable to predict or protect against.

As has been widely publicized, the SEC and other regulatory bodies that establish the accounting rules applicable to us have recently proposed or enacted a wide array of changes to current accounting rules. Moreover, these regulators may propose additional changes in the future of which we are not currently aware. Changes to accounting rules that apply to us could significantly impact our business or our reported financial performance in negative ways that we cannot predict or prepare against. We cannot predict whether any changes to current accounting rules will occur or what impact any codified changes will have on our business, results of operation or financial condition.

Environmental compliance costs and liabilities with respect to our real estate in which we have interests may adversely affect our results of operations.

Our operating costs may be affected by our obligation to pay for the cost of complying with existing environmental laws, ordinances and regulations, as well as the cost of complying with future legislation with respect to the assets, or loans secured by assets, with environmental problems that materially impair the value of the assets. Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under, or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of hazardous or toxic substances, or the failure to remediate properly, may adversely affect the owner’s ability to borrow by using such real property as collateral. Certain environmental laws and common law principles could be used to impose liability for releases of hazardous materials, including asbestos-containing materials, into the environment, and third parties may seek recovery from owners or operators of real properties for personal injury associated with exposure to released asbestos-containing materials or other hazardous materials. Environmental laws may also impose restrictions on the manner in which a property may be used or transferred or in which businesses it may be operated, and these restrictions may require expenditures. In connection with the direct or indirect ownership and operation of properties, we may be potentially liable for any such costs. The cost of defending against claims of liability or remediating contaminated property and the cost of complying with environmental laws could adversely affect our results of operations and financial condition.

Risks Relating to Our REIT Status and Other Matters

Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our stockholders.

We operate in a manner intended to qualify as a REIT for federal income tax purposes. Our ability to satisfy the asset tests depends upon our analysis of the fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis. Moreover, the proper classification of an instrument as debt or equity for federal income tax purposes, and the tax treatment of participation interests that we hold in mortgage loans and mezzanine loans, may be uncertain in some circumstances, which could affect the application of the REIT qualification requirements. Accordingly, there can be no assurance that the IRS will not contend that our interests in subsidiaries or other issuers will not cause a violation of the REIT requirements.

If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of, and trading prices for, our stock. Unless entitled to relief under certain Internal Revenue Code provisions, we also would be disqualified from taxation as a REIT for the four taxable years following the year during which we ceased to qualify as a REIT.

Our failure to qualify as a REIT would create issues under a number of our financings and other agreements and would cause our common and preferred stock to be delisted from the NYSE.

Our failure to qualify as a REIT would create issues under a number of our financing and other agreements. In addition, the New York Stock Exchange requires, as a condition to the continued listing of our common and preferred shares, that we maintain our REIT status. Consequently, if we fail to maintain our REIT status, our common and preferred shares would promptly be delisted from the NYSE, which would decrease the trading activity of such shares. This could make it difficult to sell shares and could cause the market volume of the shares trading to decline.

If Newcastle was delisted as a result of losing its REIT status and desired to relist its shares on the NYSE, the Company would have to reapply to the NYSE to be listed as a domestic corporation. As the NYSE’s listing standards for REITs are less onerous than its standards for domestic corporations, it would be more difficult for the Company to become a listed

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company under these heightened standards. Given current conditions, Newcastle may not be able to satisfy the NYSE’s listing standards for a domestic corporation. As a result, if it were delisted from the NYSE, it may not be able to relist as a domestic corporation, and thus the Company’s common and preferred shares could not trade on the NYSE.

Dividends payable by REITs do not qualify for the reduced tax rates.

Tax law changes in 2003 reduced the maximum tax rate for dividends payable to individuals from 35% to 15% (through 2010). Dividends payable by REITs, however, are generally not eligible for the reduced rates. Although this legislation does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock. In addition, the relative attractiveness of real estate in general may be adversely affected by the newly favorable tax treatment given to corporate dividends, which could affect the value of our real estate assets negatively.

REIT distribution requirements could adversely affect our liquidity and our ability to execute our business plan.

We generally must distribute annually at least 90% of our net taxable income, excluding any net capital gain, in order for corporate income tax not to apply to earnings that we distribute. We intend to make distributions to our stockholders to comply with the requirements of the Internal Revenue Code. However, differences in timing between the recognition of taxable income and the actual receipt of cash could require us to sell assets or borrow funds on a short-term or long-term basis to meet the 90% distribution requirement of the Internal Revenue Code. Certain of our assets may generate substantial mismatches between taxable income and available cash. As a result, the requirement to distribute a substantial portion of our net taxable income could cause us to: (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms or (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt, in order to comply with REIT requirements. Further, amounts distributed will not be available to fund investment activities. If we fail to obtain debt or equity capital in the future, it could limit our ability to satisfy our liquidity needs, which could adversely affect the value of our common stock.

As of December 31, 2009, we had a loss carryforward, inclusive of net operating loss and capital loss, of approximately $908 million. The net operating loss carryforward and capital loss carryforward can generally be used to offset future ordinary taxable income and capital gain, respectively. As a result, we do not expect that there will be any REIT distribution requirements for the year ending December 31, 2010.

The IRS tax rules regarding recognizing capital losses and ordinary income for our non-recourse financings, coupled with current REIT distribution requirements, could result in our recognizing significant taxable net income without receiving an equivalent amount of cash proceeds from which to make required distributions. This disconnect could have a serious, negative affect on us.

We may experience issues regarding the characterization of income for tax purposes. For example, we may recognize significant ordinary income, which we would not be able to offset with capital losses, which could, in turn, increase the amount of income we would be required to distribute to shareholders in order to maintain our REIT status. This disconnect could occur in the case of one or more of our non-recourse financing structures, including off balance sheet structures such as our subprime securitizations and non-consolidated CDOs, where we incur capital losses on the related assets, and ordinary income from the cancellation of the related non-recourse financing if the ultimate proceeds from the assets are insufficient to repay such debt. Through September 30, 2010, no such cancellation of CDO debt has been effected as a result of losses incurred. In the case of our subprime securitizations, $1.8 million of such cancellations had been effected through September 30, 2010 and we expect such cancellations will continue as losses are realized. This disconnect could also occur as a result of the repurchase of our outstanding debt at a discount as the gain recorded upon the cancellation of indebtedness is characterized as ordinary income for tax purposes. We have repurchased our debt at a discount in the past, and we intend to attempt to do so in the future. During 2009, we repurchased $246.7 million face amount of our outstanding CDO debt at a discount, and recorded $215.3 million of gain. During the first three quarters of 2010, we purchased $168.0 million face amount of our outstanding CDO debt at a discount, and recorded $141.7 million of gain. In compliance with current tax laws, we have the ability to defer the ordinary income recorded as a result of the cancellation of indebtedness to future years and intend to defer all or a portion of such gain for 2009 and 2010. While such deferral may postpone the effect of the disconnect in the ability to offset taxable income and losses, it does not eliminate it.

If we experienced any of these disconnects, we may not have sufficient cashflow to make the distributions necessary to satisfy our REIT distribution requirements, which would cause us to lose our REIT status and thereby materially negatively impact our business, financial condition and potentially impair our ability to continue operating in the future. Under current market conditions, this type of disconnect between taxable income and cash proceeds would be likely to occur at some point in the future if the current regulations that create the disconnect are not revised, but we cannot predict at this time when such a disconnect may occur.

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We may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay distributions to our stockholders.

As a REIT, we are generally required to distribute at least 90% of our REIT taxable income (determined without regard to the dividends paid deduction and not including net capital losses) each year to our stockholders. To qualify for the tax benefits accorded to REITs, we intend to make distributions to our stockholders in amounts such that we distribute all or substantially all our net taxable income each year, subject to certain adjustments. However, our ability to make distributions may be adversely affected by the risk factors described herein, particularly in light of current market conditions. In the event of a continued downturn in our operating results and financial performance relative to previous periods or continued declines in the value of our asset portfolio, we may be unable to declare or pay quarterly distributions or make distributions to our stockholders, and we may elect to comply with our REIT distribution requirements by, after completing various procedural steps, distributing, under certain circumstances, up to 90% of the required amount in the form of common shares in lieu of cash. The timing and amount of distributions are in the sole discretion of our board of directors, which considers, among other factors, our earnings, financial condition, debt service obligations and applicable debt covenants, REIT qualification requirements and other tax considerations and capital expenditure requirements as our board may deem relevant from time to time.

The stock ownership limit imposed by the Internal Revenue Code for REITs and our charter may inhibit market activity in our stock and restrict our business combination opportunities.

In order for us to maintain our qualification as a REIT under the Internal Revenue Code, not more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) at any time during the last half of each taxable year after our first year. Our charter, with certain exceptions, authorizes our board of directors to take the actions that are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of directors, no person may own more than 8% of the aggregate value of our outstanding capital stock, treating classes and series of our stock in the aggregate, or more than 25% of the outstanding shares of our Series B Preferred Stock, Series C Preferred Stock or our Series D Preferred Stock. Our board may grant an exemption in its sole discretion, subject to such conditions, representations and undertakings as it may determine in its sole discretion. These ownership limits could delay or prevent a transaction or a change in our control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders. Our board has granted limited exemptions to an affiliate of our manager, a third party group of funds managed by Cohen & Steers, and certain affiliates of these entities.

Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.

Even if we remain qualified for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes, such as mortgage recording taxes. Moreover, if a REIT distributes less than 85% of its taxable income to its stockholders during any calendar year (including any distributions declared by the last day of the calendar year but paid in the subsequent year), then it is required to pay an excise tax on 4% of any shortfall between the required 85% and the amount that was actually distributed. Any of these taxes would decrease cash available for distribution to our stockholders. In addition, in order to meet the REIT qualification requirements, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or inventory, we may hold some of our assets through taxable REIT subsidiaries. Such subsidiaries will be subject to corporate level income tax at regular rates.

Complying with REIT requirements may cause us to forego otherwise attractive opportunities.

To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. We also may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our ability to make certain attractive investments.

Complying with REIT requirements may limit our ability to hedge effectively.

The existing REIT provisions of the Internal Revenue Code may substantially limit our ability to hedge our operations because a significant amount of the income from those hedging transactions is likely to be treated as non-qualifying income for purposes of both REIT gross income tests. In addition, we must limit our aggregate income from non-qualified hedging transactions, from our provision of services and from other non-qualifying sources, to less than 5% of our annual gross income (determined without regard to gross income from qualified hedging transactions). As a result, we may have to limit our use of certain hedging techniques or implement those hedges through total return swaps. This could result in greater risks associated with changes in interest rates than we would otherwise want to incur or could increase the cost of our hedging activities. If we fail to comply with these limitations, we could lose our REIT qualification for U.S. federal income tax purposes, unless our failure was due to reasonable cause and not due to willful neglect, and we meet certain other technical requirements. Even if our failure was due to reasonable cause, we might incur a penalty tax.

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The “taxable mortgage pool” rules may increase the taxes that we or our stockholders may incur, and may limit the manner in which we effect future securitizations.

Certain of our securitizations have resulted in the creation of taxable mortgage pools for federal income tax purposes. As a REIT, so long as we own 100% of the equity interests in a taxable mortgage pool, we would generally not be adversely affected by the characterization of the securitization as a taxable mortgage pool. Certain categories of stockholders, however, such as foreign stockholders eligible for treaty or other benefits, stockholders with net operating losses, and certain tax-exempt stockholders that are subject to unrelated business income tax, could be subject to increased taxes on a portion of their dividend income from us that is attributable to the taxable mortgage pool. In addition, to the extent that our stock is owned by tax-exempt “disqualified organizations,” such as certain government-related entities and charitable remainder trusts that are not subject to tax on unrelated business income, we may incur a corporate level tax on a portion of our income from the taxable mortgage pool. In that case, we may reduce the amount of our distributions to any disqualified organization whose stock ownership gave rise to the tax.

Maintenance of our Investment Company Act exemption imposes limits on our operations.

We conduct our operations so as not to become regulated as an investment company under the Investment Company Act of 1940, as amended. We believe that there are a number of exemptions under the Investment Company Act that may be applicable to us. The assets that we may acquire, therefore, are limited by the provisions of the Investment Company Act and the rules and regulations promulgated under the Investment Company Act. In addition, we could, among other things, be required either (a) to change the manner in which we conduct our operations to avoid being required to register as an investment company or (b) to register as an investment company, either of which could adversely affect us and the market price for our stock.

ERISA may restrict investments by plans in our common stock.

A plan fiduciary considering an investment in our common stock should consider, among other things, whether such an investment is consistent with the fiduciary obligations under ERISA, including whether such investment might constitute or give rise to a prohibited transaction under ERISA, the Internal Revenue Code or any substantially similar federal, state or local law and, if so, whether an exemption from such prohibited transaction rules is available.

Maryland takeover statutes may prevent a change of our control. This could depress our stock price.

Under Maryland law, “business combinations” between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include certain mergers, consolidations, share exchanges, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities or a liquidation or dissolution. An interested stockholder is defined as:

• any person who beneficially owns 10% or more of the voting power of the corporation’s outstanding shares; or

• an affiliate or associate of a corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding stock of the corporation.

A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by which he or she otherwise would have become an interested stockholder.

After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:

• 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.

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Our authorized, but unissued common and preferred stock may prevent a change in our control.

Our charter authorizes us to issue additional authorized but unissued shares of our common stock or preferred stock. In addition, our board of directors may classify or reclassify any unissued shares of common stock or preferred stock and may set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board may establish a series of preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.

Our stockholder rights plan could inhibit a change in our control.

We have adopted a stockholder rights agreement. Under the terms of the rights agreement, in general, if a person or group acquires more than 15% of the outstanding shares of our common stock, all of our other common stockholders will have the right to purchase securities from us at a discount to such securities’ fair market value, thus causing substantial dilution to the acquiring person. The rights agreement may have the effect of inhibiting or impeding a change in control not approved by our board of directors and, therefore, could adversely affect our stockholders’ ability to realize a premium over the then-prevailing market price for our common stock in connection with such a transaction. In addition, since our board of directors can prevent the rights agreement from operating, in the event our board approves of an acquiring person, the rights agreement gives our board of directors significant discretion over whether a potential acquirer’s efforts to acquire a large interest in us will be successful. Because the rights agreement contains provisions that are designed to assure that the executive officers, our manager and its affiliates will never, alone, be considered a group that is an acquiring person, the rights agreement provides the executive officers, our manager and its affiliates with certain advantages under the rights agreement that are not available to other stockholders.

Our staggered board and other provisions of our charter and bylaws may prevent a change in our control.

Our board of directors is divided into three classes of directors. Directors of each class are chosen for three-year terms upon the expiration of their current terms, and each year one class of directors is elected by the stockholders. The staggered terms of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interest of our stockholders. In addition, our charter and bylaws also contain other provisions that may delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.

Risks Related to Our Common Shares

Our share price 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 recently been volatile. Moreover, future share price fluctuations could likely be subject to similarly wide price fluctuations in the future in response to various factors, including:

• market conditions in the broader stock market in general, or in the REIT or real estate industry in particular;

• market perception of our current and projected financial condition, potential growth, future earnings and future cash dividends;

• announcements we make regarding dividends;

• actual or anticipated fluctuations in our quarterly financial and operating results;

• market perception or media coverage of our manager or its affiliates;

• actions by rating agencies;

• short sales of our common stock;

• issuance of new or changed securities analysts’ reports or recommendations;

• media coverage of us, other REITs or the outlook of the real estate industry;

• major reductions in trading volumes on the exchanges on which we operate;

• credit deterioration within our portfolio;

• legislative or regulatory developments, including changes in the status of our regulatory approvals or licenses; and

• litigation and governmental investigations.

These and other factors may cause the market price and demand for our common shares to fluctuate substantially, which may negatively affect the price or liquidity of our common shares. Moreover, the recent market conditions have negatively impacted our share price and may do so in the future. When the market price of a stock has been volatile or has decreased significantly in the past, holders of that stock have, at times, instituted securities class action litigation against the company

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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.

We have not paid dividends on our common stock since the third fiscal quarter of 2008. While we are required to make distributions in order to maintain our REIT status (as described above under “–We may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay distributions to our stockholders”), we may elect not to maintain our REIT status, in which case we would no longer be required to make such distributions. Moreover, even if we do elect to maintain our REIT status, we may elect to comply with the applicable requirements by, after completing various procedural steps, distributing, under certain circumstances, up to 90% of the required amount in the form of common shares in lieu of cash. If we elect not to maintain our REIT status or to satisfy any required distributions in common shares in lieu of cash, such action could negatively affect our business and financial condition as well as the price of both our common and preferred shares. No assurance can be given that we will pay any dividends on our common shares in the future.

In addition, our board of directors have elected not to declare any of the specified dividends on our three series of preferred stock in the second quarter of 2010. Until we pay all accrued dividends on our preferred shares, we cannot pay any dividends on our common shares, pay any consideration to repurchase or otherwise acquire shares of our common stock or redeem any shares of any series of our preferred stock without redeeming all of our outstanding preferred shares in accordance with the governing documentation. Consequently, the failure to pay dividends on our preferred shares restricts the actions that we may take with respect to our common shares and preferred shares. Moreover, if we do not pay dividends on any series of preferred stock for six or more periods, then holders of each affected series obtain the right to call a special meeting and elect two members to our board of directors. We cannot predict whether the holders of our preferred stock would take such action or, if taken, how long the process would take or what impact the two new directors on our board of directors would have on our company (other than increasing our director compensation costs). However, the election of additional directors would affect the composition of our board of directors and, thus, could affect the management of our business.

Shares eligible for future sale may adversely affect our common stock price.

Sales of our common stock or other securities in the public or private market, or the perception that these sales may occur, could cause the market price of our common stock to decline. This could also impair our ability to raise additional capital through the sale of our equity securities. Under our certificate of incorporation, we are authorized to issue up to 500,000,000 shares of common stock, of which 62,024,945 shares of common stock were outstanding as of September 30, 2010. We cannot predict the size of future issuances of our common stock or other securities or the effect, if any, that future sales and issuances would have on the market price of our common stock.

An increase in market interest rates may have an adverse effect on the market price of our common stock.

One of the factors that investors may consider in deciding whether to buy or sell shares of our common stock is our distribution rate as a percentage of our share price relative to market interest rates. If the market price of our common stock is based primarily on the earnings and return that we derive from our investments and income with respect to our investments and our related distributions to stockholders, and not from the market value of the investments themselves, then interest rate fluctuations and capital market conditions will likely affect the market price of our common stock. For instance, if market interest rates rise without an increase in our distribution rate, the market price of our common stock could decrease as potential investors may require a higher distribution yield on our common stock or seek other securities paying higher distributions or interest. In addition, rising interest rates would result in increased interest expense on our variable rate debt, thereby adversely affecting cash flow and our ability to service our indebtedness and pay distributions.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Reserved

Item 5. Other Information

None.

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Item 6. Exhibits

3.1	Articles of Amendment and Restatement (incorporated by reference to the Registrant’s Registration Statement on Form S-11 (File No. 333-90578), Exhibit 3.1).
3.2	Articles Supplementary Relating to the Series B Preferred Stock (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2003, Exhibit 3.3).
3.3	Articles Supplementary Relating to the Series C Preferred Stock (incorporated by reference to the Registrant’s Report on Form 8-K, Exhibit 3.3, filed on October 25, 2005).
3.4	Articles Supplementary Relating to the Series D Preferred Stock (incorporated by reference to the Registrant’s Report on Form 8-A, Exhibit 3.1, filed on March 14, 2007).
3.5	Amended and Restated By-laws (incorporated by reference to the Registrant’s Registration Statement on Form 8-K, Exhibit 3.1, filed on May 5, 2006).
4.1	Rights Agreement between the Registrant and American Stock Transfer and Trust Company, as Rights Agent, dated October 16, 2002 (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 2002, Exhibit 4.1).
4.2	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).
4.3	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).
4.4	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 Fortress Investment Group LLC, dated June 23, 2003 (incorporated by reference to the Registrant’s Registration 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, Exchibt 10.1, filed on February 2, 2010).
21.1	Subsidiaries of the Registrant (incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2009, Exhibit 21.1)
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.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:

NEWCASTLE INVESTMENT CORP. November 9, 2010
By:	/s/ Kenneth M. Riis
	Kenneth M. Riis Chief Executive Officer and President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

By:	/s/ Brian C. Sigman
	Brian C. Sigman
	Chief Financial Officer and Chief Accounting Officer
	November 9, 2010

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