<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 29, 1997
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES
---------------
NOVASTAR FINANCIAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS GOVERNING INSTRUMENTS)
1900 WEST 47TH PLACE, SUITE 205
WESTWOOD, KS 66205
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
---------------
SCOTT F. HARTMAN
CHAIRMAN OF THE BOARD, SECRETARY AND CHIEF EXECUTIVE OFFICER
NOVASTAR FINANCIAL, INC.
1900 WEST 47TH PLACE, SUITE 205
WESTWOOD, KS 66205
(913) 362-1090
(NAME AND ADDRESS OF AGENT FOR SERVICE)
---------------
COPIES TO:
W. LANCE ANDERSON PHILLIP R. POLLOCK, ESQ. PETER T. HEALY, ESQ.
PRESIDENT AND CHIEF TOBIN & TOBIN O'MELVENY & MYERS LLP
OPERATING OFFICER ONE MONTGOMERY STREET, EMBARCADERO CENTER WEST
NOVASTAR FINANCIAL, INC. 15TH FLOOR 275 BATTERY STREET,
1900 WEST 47TH PLACE, SAN FRANCISCO, CA 94104 26TH FLOOR
SUITE 205 (415) 433-1400 SAN FRANCISCO, CA 94111
WESTWOOD, KS 66205 (415) 984-8833
(913) 362-1090
---------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
At any time and from time to time after the effective date of this
Registration Statement.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
---------------
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
PROPOSED PROPOSED
MAXIMUM MAXIMUM
TITLE OF SECURITIES AMOUNT BEING OFFERING PRICE AGGREGATE AMOUNT OF
BEING REGISTERED REGISTERED(1) PER SHARE(2) OFFERING PRICE(2) REGISTRATION FEE
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $.01 par
value................. 3,450,000 shares $18.00 $62,100,000 $18,818
</TABLE>
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(1) Includes 450,000 shares that the Underwriters have the option to purchase
solely to cover over-allotments.
(2) Estimated solely for the purpose of calculating the registration fee,
pursuant to Rule 457(a).
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION
STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
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<PAGE>
NOVASTAR FINANCIAL, INC.
CROSS-REFERENCE SHEET SHOWING LOCATION IN PROSPECTUS
OR REGISTRATION STATEMENT OF INFORMATION
REQUIRED BY ITEMS 1-29
(PURSUANT TO ITEM 501(B) OF REGULATION S-K)
<TABLE>
<CAPTION>
NO. FORM S-11 CAPTION CAPTION IN PROSPECTUS OR PAGE REFERENCE
--- ----------------- ---------------------------------------
<C> <S> <C>
1 Forepart of Registration
Statement and Outside Front Forepart of Registration Statement;
Cover Page of Prospectus....... Outside Front Cover Page of Prospectus
2 Inside Front and Outside Back
Cover Pages of Prospectus...... Inside Front Cover Page of Prospectus;
Outside Back Cover Page; Available
Information
3 Summary Information, Risk
Factors and Ratio of Earnings Prospectus Summary; The Company; Risk
to Fixed Charges............... Factors; Selected Financial Data
4 Determination of Offering Outside Front Cover Page of
Price.......................... Prospectus; Risk Factors; Underwriting
5 Dilution........................ Dilution
6 Selling Security Holders........ *
7 Plan of Distribution............ Outside Front Cover Page of
Prospectus; Plan of Distribution
8 Use of Proceeds................. Prospectus Summary; Use of Proceeds
9 Selected Financial Data......... Selected Financial Data
10 Management's Discussion and
Analysis of Financial Condition Management's Discussion and Analysis
and Results of Operations...... of Financial Condition and Results of
Operations
11 General Information as to Prospectus Summary; The Company;
Registrant..................... Management
12 Policy with Respect to Certain Business; Description of Capital
Activities..................... Stock; Available Information
13 Investment Policies of Prospectus Summary; The Company;
Registrant..................... Business
14 Description of Real Estate...... *
15 Operating Data.................. *
16 Tax Treatment of Registration
and its Security Holders....... Prospectus Summary; Risk Factors;
Federal Income Tax Considerations
17 Market Price of and Dividends on
the Registrant's Common Equity Risk Factors; Dividend Policy and
and Related Stockholder Distributions; Principal
Matters........................ Securityholders
18 Description of Registrant's Outside Front Cover Page of
Securities..................... Prospectus; Prospectus Summary;
Description of Warrants; Description
of Capital Stock; Federal Income Tax
Considerations
19 Legal Proceedings............... Business; Certain Transactions
</TABLE>
i
<PAGE>
<TABLE>
<CAPTION>
NO. FORM S-11 CAPTION CAPTION IN PROSPECTUS OR PAGE REFERENCE
--- ----------------- ---------------------------------------
<C> <S> <C>
20 Security Ownership of Certain
Beneficial Owners and Outside Front Cover Page of
Management....................... Prospectus; Management; Principal
Securityholders
21 Directors and Executive Officers.. The Company; Management
22 Executive Compensation............ The Company; Management
23 Certain Relationships and Related Risk Factors; Management; Certain
Transactions..................... Transactions
24 Selection, Management and Custody
of Registrant's Investments...... Risk Factors; Business; Management
25 Policies with Respect to Certain Risk Factors; Management
Transactions.....................
26 Limitations of Liability.......... The Company; Management; Description
of Capital Stock
27 Financial Statements and Index to Financial Statements
Information......................
28 Interests of Named Experts and Legal Matters; Experts
Counsel..........................
29 Disclosure of Commission Position
on Indemnification for Securities
Act Liabilities.................. Underwriting
30 Quantitative and Qualitative
Disclosures About Market Risk.... *
</TABLE>
- --------
* Not Applicable
ii
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY, NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED JULY 29, 1997
PROSPECTUS
3,000,000 SHARES
NOVASTAR FINANCIAL, INC.
COMMON STOCK
NovaStar Financial, Inc. ("NovaStar" or "the Company") is a self-advised and
self-managed specialty finance company which: (i) originates, acquires, and
services single family residential subprime mortgage loans; (ii) leverages its
assets using bank warehouse lines and repurchase agreements; (iii) will issue
collateralized debt obligations to finance its subprime mortgage loans in the
long-term; (iv) purchases high quality mortgage securities in the secondary
mortgage market; and (v) manages the resulting combined portfolio of mortgage
assets (the "Mortgage Assets") in a tax-advantaged Real Estate Investment Trust
("REIT") structure.
Prior to this Offering, there has been no market for the Common Stock of the
Company. It is currently anticipated that the initial public offering price
will be between $16.00 and $18.00 per share. See "Underwriting" for a
discussion of the factors considered in determining the public offering price.
Application will be made to have the Common Stock approved for quotation on the
Nasdaq National Market.
-----------------
See "Risk Factors" commencing on page 11 for a discussion of certain factors
that should be considered by prospective purchasers of the common stock offered
hereby. these risk factors include:
. Limited Operating . Risk of Decrease in Net
History of the Company Interest Income Due to
and Net Losses Incurred Interest Rate Fluctuations;
Prepayment Risks of Mortgage Assets
. Dependence on Key
Personnel . Risks of Failing to
Effectively Hedge Against Interest
. Risk of Adverse Effect Rate Changes; Risks of Losses
on Earnings of Associated with Hedging; Counterparty
Forgivable Notes Risks
. Consequences of Failure . Risk of Loss on Single
to Maintain REIT Status; Family Mortgage Assets
Company Subject to Tax
as a Regular Corporation . Ability to Acquire Mortgage Assets at
Yields Which are Favorable Relative
. Changes in Interest Rates to Borrowing Costs, Competition and
Supply
. Competition
. Restrictions on Ownership of Capital
. Availability of Funding Stock; Anti-Takeover Effect
Sources
-----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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<TABLE>
<CAPTION>
Price to Underwriting Proceeds to
Public Discount(1) Company(2)
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<S> <C> <C> <C>
Per Share.................................... $ $ $
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Total........................................ $ $ $
</TABLE>
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(1) The Company has agreed to indemnify the Underwriters against certain
liabilities including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(2) Before deducting expenses payable by the Company, estimated to be $500,000.
(3) The Company has granted the Underwriters an option exercisable within 30
days after the date of this Prospectus to purchase up to 450,000 additional
shares of Common Stock on the same terms and conditions set forth above to
cover over-allotments, if any. If all such shares are purchased, the total
Price to Public, Underwriting Discount and Proceeds to Company will be
$ , $ and , respectively. See "Underwriting".
-----------------
The Securities are offered by the Underwriters subject to receipt and
acceptance by them, prior sale and the Underwriters' right to reject any order
in whole or in part and to withdraw, cancel or modify the offer without notice.
It is expected that delivery for the shares of Common Stock will be made
through the Depository Trust Company on or about , 1997.
Stifel, Nicolaus & Company Montgomery Securities
Incorporated
, 1997
<PAGE>
NOVASTAR OFFICE AND ACCOUNT EXECUTIVE LOCATIONS
MAP OF THE UNITED STATES (LOWER 48), INCLUDING MARKINGS
TABLE OF CONTENTS
<TABLE>
<S> <C>
PROSPECTUS SUMMARY......................................................... 3
The Company............................................................... 3
Management................................................................ 4
Executive Officers........................................................ 4
Other Senior Officers..................................................... 4
Business Strategies and Advantages........................................ 5
Mortgage Lending Strategies............................................... 5
Portfolio Management Strategies........................................... 6
Competitive Advantages.................................................... 6
Structural Benefits....................................................... 6
Dividend Policy, Distributions and Reinvestment........................... 7
Risk Factors.............................................................. 8
The Offering.............................................................. 9
SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA.............................. 10
RISK FACTORS............................................................... 11
Risks Associated with the Company's Overall Enterprise.................... 11
Risks Associated with Subprime Mortgage Lending Operation................. 12
Risks Associated with the Acquisition and Management of a Portfolio of
Mortgage Assets.......................................................... 15
Risks Associated with an Investment in the Common Stock in the Offering... 22
THE COMPANY................................................................ 25
USE OF PROCEEDS............................................................ 25
DIVIDEND POLICY AND DISTRIBUTIONS.......................................... 25
DIVIDEND REINVESTMENT PLAN................................................. 26
DILUTION................................................................... 27
CAPITALIZATION............................................................. 28
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA............................. 29
</TABLE>
<TABLE>
<S> <C>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS............................................................... 30
Overview................................................................. 30
Financial Condition as of June 30, 1997.................................. 31
Results of Operations--Six Months Ended June 30, 1997.................... 32
Liquidity and Capital Resources.......................................... 36
BUSINESS.................................................................. 38
Mortgage Lending Operation............................................... 38
Portfolio Management..................................................... 45
MANAGEMENT................................................................ 54
Directors and Executive Officers......................................... 54
Terms of Directors and Officers.......................................... 56
Committees of the Board.................................................. 56
Compensation of Directors................................................ 57
Compensation Committee Interlocks........................................ 57
Executive Compensation................................................... 57
Stock Option Grants...................................................... 59
PRINCIPAL SECURITYHOLDERS................................................. 63
CERTAIN TRANSACTIONS...................................................... 65
FEDERAL INCOME TAX CONSIDERATIONS......................................... 67
DESCRIPTION OF CAPITAL STOCK.............................................. 76
DESCRIPTION OF WARRANTS................................................... 81
UNDERWRITING.............................................................. 83
LEGAL MATTERS............................................................. 85
EXPERTS................................................................... 85
AVAILABLE INFORMATION..................................................... 85
GLOSSARY.................................................................. 86
CONSOLIDATED FINANCIAL STATEMENTS......................................... F-1
</TABLE>
----------------
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANASACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE SHARES OF
COMMON STOCK. SUCH TRANSACTIONS MAY INCLUDE STABILIZING BIDS AND PURCHASES IN
THE OPEN MARKET, OVERALLOTMENTS, SYNDICATE SHORT COVERING TRANSACTIONS AND
PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information appearing in this Prospectus. Certain capitalized and other terms
used herein shall have the meanings assigned to them in the Glossary. Unless
the context otherwise requires, references to the "Company" herein shall
include REIT-qualifying subsidiaries or taxable subsidiaries through which the
Company may carry on its business. The Company's current taxable subsidiaries
include NFI Holding Corporation ("Holding"), which owns NovaStar Mortgage, Inc.
("NMI"), also considered a taxable subsidiary. NMI serves as a vehicle for loan
origination--a primary source of Mortgage Assets for the Company. "NFI" used
herein shall refer to the REIT as a stand alone entity. NFI manages the
Mortgage Assets of the Company. All information in the Prospectus assumes that
the over-allotment option described in "Underwriting" is not exercised.
THE COMPANY
NovaStar Financial, Inc. is a specialty finance company which:
(i) originates, acquires, and services single family residential
subprime mortgage loans;
(ii) leverages its assets using bank warehouse lines and repurchase
agreements;
(iii) will issue collateralized debt obligations to finance its subprime
mortgage loans in the long-term;
(iv) purchases high quality mortgage securities in the secondary
mortgage market; and
(v) manages the resulting combined portfolio of Mortgage Assets in a
tax-advantaged REIT structure.
The Company was incorporated and initially capitalized on September 13, 1996.
As a result of a private placement offering on December 9, 1996, the Company
received net proceeds of $47 million (the "Private Placement"). The entities
shown below contributed, directly or through clients advised by them, the
majority of the capital raised through the Private Placement.
<TABLE>
<CAPTION>
AMOUNT PERCENT
INVESTED OF TOTAL
----------- --------
<S> <C> <C>
General Electric Capital Corporation.................... $10 million 20%
Wellington Management Company........................... 10 million 20
Lindner Dividend Fund................................... 10 million 20
Wallace R. Weitz & Company.............................. 5 million 10
Affiliate of First Union National Bank.................. 3 million 6
</TABLE>
The Company originates subprime residential mortgage loans through a
nationwide network of unaffiliated wholesale loan brokers and correspondents
and purchases bulk pools of closed loans. For the six months ended June 30,
1997, the Company originated $90 million in subprime mortgage loans, including
$28.5 million in the month of June.
The Company has elected to be taxed as a REIT under the Internal Revenue Code
of 1986, as amended (the "Code"). As a result, the Company is generally not
subject to federal income tax to the extent that it distributes its earnings to
stockholders and maintains its qualification as a REIT. See "Federal Income Tax
Considerations." The Company has elected REIT status primarily for the tax
advantages associated with that structure. Management believes the REIT
structure is the most desirable for owning Mortgage Assets due to the
elimination of corporate-level income taxation. In addition, because the
Company is not structured as a traditional lender which accepts deposits, it is
subject to substantially less regulatory oversight and incurs lower compliance
expenses compared to banks, thrifts and many other originators or holders of
Mortgage Assets. The Company is self-advised and self-managed.
3
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS
Scott F. Hartman, Chairman and Chief Executive Officer, is a former executive
officer of Dynex Capital, Inc., formerly Resource Mortgage Capital, Inc.
("Dynex"), a New York Stock Exchange REIT with assets of over $4 billion. From
February 1995 to May 1996, Mr. Hartman managed Dynex's multi-billion dollar
mortgage investment portfolio and loan securitization program. Mr. Hartman
oversaw the securitization and other financing of Dynex's originated mortgages
and purchased mortgage securities, including CMO securitization, repurchase and
other secured funding and the development and execution of hedging strategies.
W. Lance Anderson, President and Chief Operating Officer, is also a former
executive officer of Dynex. From February 1994 to May 1996, Mr. Anderson served
as president of Dynex's single family mortgage loan affiliate, Saxon Mortgage,
Inc. ("Saxon") which became one of the leading wholesale originators of
subprime residential mortgage loans in the United States. Prior to becoming
President of Saxon, Mr. Anderson served as Executive Vice President in charge
of sales, marketing, underwriting and operations. Mr. Anderson spent over seven
years at Dynex where he was responsible for the start-up of the single family
mortgage operation in 1989, building it from a five-person company to become
the fourth largest conduit in the country with annual fundings in excess of $5
billion in a matter of four years. Mr. Anderson was also responsible for re-
focusing the conduit on the subprime mortgage market in late 1993 and by the
end of 1994 had established it as one of the five largest originators of
subprime mortgage loans in the country with annual originations in excess of $1
billion.
Mark J. Kohlrus, Senior Vice President, Treasurer and Chief Financial
Officer, was previously in the Financial Services practice of KPMG Peat Marwick
LLP.
OTHER SENIOR OFFICERS
James H. Anderson, Senior Vice President and National Sales Manager, was most
recently President of his own marketing consulting firm. Prior to that, he was
Regional Vice President of Marketing for Saxon Mortgage, Inc.
Manuel X. Palazzo, Senior Vice President and Chief Credit Officer, was most
recently Senior Vice President of Credit and Administration for Long Beach
Mortgage Company. Mr. Palazzo has been involved in the consumer finance
industry since 1972.
Christopher S. Miller, Senior Vice President and Servicing Manager,
previously managed the collection operations of Option One Mortgage
Corporation.
See "Management" for further information regarding management of the Company.
4
<PAGE>
BUSINESS STRATEGIES AND ADVANTAGES
There are two general aspects to the business of the Company: (i) mortgage
lending, primarily in the subprime market; and (ii) management of a portfolio
of Mortgage Assets, including Mortgage Assets originated through the lending
operation of the Company and acquired through secondary market purchases.
MORTGAGE LENDING STRATEGIES
In its mortgage lending operation, the Company follows the strategies listed
below.
. The Company uses its sales force to establish a nationwide network of
unaffiliated loan brokers and correspondents and competes for their
origination volume by offering subprime mortgage products at competitive
prices delivered with superior customer service. Management of the
Company believes that this network allows the Company to create
investments at more attractive prices than are available through
secondary market purchases. As of June 30, 1997, the Company's mortgage
lending operation had a staff of 47, including 17 account executives
organized in three regions throughout the United States.
. Focus is placed on originating mortgage loans that have adjustable rates
in order to mitigate interest rate risk. For the six months ended June
30, 1997, 90 percent of the Company's wholesale mortgage loan
originations had adjustable rates. As of June 30, 1997, 81 percent of its
mortgage loan portfolio had adjustable rates.
. Prepayment penalties, generally through a loan's first two years, are
emphasized in the Company's mortgage loan originations to protect the
Company from the impact of early prepayments on loans purchased at a
premium. For the six months ended June 30, 1997, 82 percent of wholesale
mortgage loan originations had prepayment penalties. As of June 30, 1997,
63 percent of its mortgage loan portfolio had prepayment penalties.
. Centralized loan underwriting, appraisal evaluation, loan funding and
loan pricing are used to maintain tight control over risks and expenses.
. Emphasis is placed on the use of early intervention, aggressive
collection and loss mitigation techniques in the servicing process
designed to manage and reduce delinquencies and minimize losses in its
mortgage loans portfolio. The Company has put in place an experienced
management team and staff to service its mortgage loans.
Since inception, the Company has concentrated on obtaining high quality
professionals and developing the infrastructure for its wholesale loan
origination operation. The Company originated its first loan in February 1997
and has increased its loan production during 1997 as shown below.
<TABLE>
<CAPTION>
WHOLESALE LOAN ORIGINATIONS
-------------------------------
NUMBER PRINCIPAL
OF LOANS AMOUNT
-------------------------------
<S> <C> <C>
(IN THOUSANDS)
February.................................... 17 $ 2,941
March....................................... 51 9,747
April....................................... 132 19,219
May......................................... 173 29,964
June........................................ 204 28,509
-------- -------------------
1997 year-to-date........................... 577 $ 90,380
======== ===================
</TABLE>
During the six months ended June 30, 1997, the Company also acquired Mortgage
Assets through the acquisition of bulk pools of mortgage loans and agency-
issued Mortgage Securities with aggregate principal amounts of $207.2 million
and $370.6 million, respectively.
5
<PAGE>
PORTFOLIO MANAGEMENT STRATEGIES
In its portfolio management, the Company:
. acquires mortgage securities and mortgage loans which satisfy the
Company's requirements for its overall asset/liability strategy;
. borrows funds under repurchase agreements and its warehouse line of
credit to finance subprime mortgage originations and acquisitions and
mortgage securities acquisitions;
. will issue debt obligations securitized by mortgage loans to provide
long-term non-recourse financing;
. monitors interest rate sensitivity through progressive analytical
techniques and mitigates interest rate risk by using various hedging
techniques to match the cost and terms of funding sources with that of
the yield and terms of Mortgage Assets; and
. adheres to its Capital Allocation Guidelines ("CAG") in the application
of equity and debt financing to acquire Mortgage Assets.
The Company uses a combination of equity and borrowings to finance its
acquisition of Mortgage Assets. All investments are evaluated in the context of
the CAG and investment policy, both of which have been approved by the Board of
Directors. The Company will use leverage to enhance the return to stockholders.
The CAG detail the borrowing limits to be used given the composition of
Mortgage Assets. Management focuses on the CAG to determine the appropriate
amount of equity and borrowings to balance the risks and returns associated
with potential investments and the existing portfolio. Until the Company is
fully leveraged, the Company will not reach its full earnings potential. During
the six month period ended June 30, 1997, the Company has operated with a
substantial amount of excess or available capital, according to its CAG.
COMPETITIVE ADVANTAGES
The Company's principal competition in the business of originating, acquiring
and servicing subprime mortgage loans are financial institutions such as banks,
thrifts and other independent wholesale mortgage lenders, and certain other
mortgage acquisition companies structured as REITs. The Company's principal
competition in the business of holding mortgage loans and Mortgage Securities
are life insurance companies, institutional investors such as mutual funds and
pension funds, other well-capitalized publicly-owned mortgage lenders and
certain other mortgage acquisition companies structured as REITs. The Company
anticipates that it will be able to effectively compete due to its:
(i) experienced management team;
(ii) tax advantaged status as a REIT;
(iii) vertical integration as originator, servicer and investor;
(iv) freedom from certain regulatory-related administrative and oversight
costs;
(v) direct access to capital markets to securitize its assets; and
(vi) cost-efficient operations.
STRUCTURAL BENEFITS
The REIT tax status is a primary distinction between the Company and many
other subprime mortgage originators. The Company will attempt to maximize its
after-tax return advantage over non-REIT financial companies by holding
Mortgage Assets and earning REIT-qualifying income over time through the
Company.
Generally, the Company does not intend to sell its mortgage loan production
in order to realize gain on sale for financial accounting or tax reporting
purposes. Rather, the Company intends to finance its mortgages through
structured debt vehicles where the emphasis is on earning net interest income
and not taking gain on the sale of
6
<PAGE>
assets. The Company's strategy is to build and hold a portfolio of Mortgage
Assets for investment that generates a net interest margin over time and allows
the Company to take full advantage of its REIT status. While selling mortgage
loans presents greater earnings and taxable income during the period of
production (assuming constant portfolio assumptions) due to the current income
recognition of the present value of future cash flows, management believes that
over the long term the Company will produce a tax-advantaged stream of income
and a more stable dividend flow to stockholders because its earnings will be
dependent on the size of the Company's portfolio of Mortgage Assets, rather
than on its quarterly mortgage loan production level. The accounting for gain
on sale presents, as current income, the present value of expected future cash
flows from the mortgage loans sold. Future performance expectations are subject
to revision should actual losses, interest rates and prepayment experience
differ from the assumed levels. Holding the mortgage loans as investments
allows the Company to record income as interest is earned. While management
intends to aggressively manage costs in all production cycles, holding the
mortgage loans and recording income as interest is earned provides management
the flexibility to reduce its mortgage loan production rate during periods in
which management believes the market conditions for subprime mortgage loans are
unattractive without necessarily experiencing an immediate decline in net
income. Companies utilizing gain on sale accounting will typically experience a
decline in net income during periods of declining mortgage loan origination
volume.
The Company believes it has an advantage over other mortgage REITs through
its infrastructure that allows the Company to originate mortgage loans to its
specifications at a total cost lower than purchasing those mortgage loans in
the secondary market. Moreover, because the Company and its subsidiaries are a
vertically integrated and consolidated organization, which is self-advised and
self-managed, there is no potential conflicts between the interests of the
mortgage lending operation and the portfolio management operation. Such
conflicts can arise in REITs where the incentives and interest of management
are dependent on asset size rather than return on equity or stockholder
returns. Conflict may arise in entities which have external management
contracts or situations where management's compensation is not directly related
with the company's performance or return to stockholders. The Company's primary
management incentive programs are dependent on return on equity (the annual
bonus plan, of which half is paid in stock) and stock price appreciation
(forgivable loans to founders and stock option plan). See "Management--
Executive Compensation."
DIVIDEND POLICY, DISTRIBUTIONS AND REINVESTMENT
The Company generally intends to distribute to stockholders each year
substantially all of its net taxable income (which does not ordinarily equal
net income as determined in accordance with generally accepted accounting
principles) to qualify for the tax benefits accorded to REITs under the Code.
The Company has declared dividends of $0.05 per share for each of the first and
second quarters of 1997. Both of these dividends were declared on Preferred
Stock. It is expected that the 1997 third quarter dividend will be declared on
Preferred Stock. Subsequent to the closing of this Offering, the Company
intends to declare quarterly dividends on its Common Stock.
The Company intends to distribute any taxable income remaining after the
distribution of the regular quarterly dividends annually in a special dividend
on or prior to the date of the first regular quarterly dividend payment date of
the following taxable year. The dividend policy is subject to revision at the
discretion of the Board of Directors. All distributions will be made by the
Company at the discretion of the Board of Directors and will depend on the
taxable income and financial condition of the Company, maintenance of REIT
status and such other factors as the Board of Directors deems relevant.
The Company expects to adopt a dividend reinvestment plan ("DRP") for
stockholders who wish to reinvest their distributions in additional shares of
Common Stock. Generally, under a DRP, dividends paid with respect to shares of
Capital Stock are automatically invested in additional shares of Common Stock
at a discount to the then current market price. The DRP will also allow each
stockholder to make additional investments in Common Stock by contributing cash
to the DRP administrator (up to a specified maximum). Stockholders are not
automatically enrolled in the DRP.
7
<PAGE>
SUMMARY RISK FACTORS
Prior to making an investment decision, prospective investors should
carefully consider all of the information set forth in this prospectus and, in
particular, should evaluate the factors set forth in "Risk Factors." These risk
factors include:
. Limited Operating History of the Company and Net Losses Incurred. The
Company has not yet developed an extensive earnings history or
experienced a wide variety of interest rate or market conditions.
Historical operating performance may be of limited relevance in
predicting future performance. For the period since inception to December
31, 1996 and for the six months ended June 30, 1997, the Company has
incurred net losses.
. Dependence on Key Personnel. The Company's operations depend heavily upon
the contributions of Scott Hartman and Lance Anderson, both of whom would
be difficult to replace. The loss of either of these individuals could
have a material adverse effect upon the Company's business and results of
operations.
. Risk of Adverse Effect on Earnings of Forgivable Notes. In the Company's
Private Placement, Messrs. Hartman and Anderson each acquired Units paid
for by delivering to the Company promissory notes. Principal due on the
notes will be forgiven by the Company if the return to Private Placement
investors meets certain benchmarks. The charge against earnings resulting
from forgiveness of the notes could have a material adverse effect on the
Company's earnings for the related accounting period and on the amount of
dividends available to be paid to shareholders of the Company including
investors in this Offering.
. Consequence of Failure to Maintain REIT Status; Company Subject to Tax as
a Regular Corporation. If the Company fails to maintain its qualification
as a REIT, the Company will be subject to federal income tax as a regular
corporation. The Company intends to conduct its business at all times in
a manner consistent with the REIT provisions of the Code.
. Changes in Interest Rates. The profitability of the Company's subprime
mortgage lending operation is likely to be adversely affected during any
period of unexpected or rapid changes in interest rates. For example, a
substantial or sustained increase in interest rates could adversely
affect the ability of the Company to originate and purchase loans in
expected volumes necessary to support fixed overhead expense levels.
. Competition. As an originator and purchaser of subprime mortgage loans,
the Company will face intense competition, primarily from commercial
banks, savings and loans, other independent mortgage lenders, and certain
other mortgage REITs. The increasing level of capital resources being
devoted to subprime mortgage lending may increase the competition among
lenders to originate or purchase subprime loans and result in either
reduced interest margin on such mortgage loans compared to present levels
or revised underwriting standards permitting higher loan-to-value ratios
on properties securing subprime mortgage loans.
. Availability of Funding Sources. The Company is currently dependent upon
a few lenders to provide the primary credit facilities for its funding of
mortgage loan originations and acquisitions. Any failure to renew or
obtain adequate funding under these financing arrangements could have a
material adverse effect on the Company's lending operations.
. Risk of Decrease in Net Interest Income Due to Interest Rate
Fluctuations; Prepayment Risks of Mortgage Assets. Interest rate
fluctuations may affect the Company's earnings as a result of potential
changes in the spread between the interest rates on its borrowings and
the interest rates on its Mortgage Assets. In addition, mortgage
prepayment rates vary depending on such factors as mortgage interest
rates and market conditions. Changes in anticipated prepayment rates may
adversely affect the Company's earnings.
8
<PAGE>
. Risks of Failing to Effectively Hedge Against Interest Rate Changes;
Risks of Losses Associated with Hedging; Counterparty
Risks. Asset/liability management hedging strategies involve risk and may
not be effective in reducing the Company's exposure to interest rate
changes. Moreover, compliance with the REIT provisions of the Code may
prevent the Company from effectively implementing the strategies that the
Company determines, absent such compliance, would best insulate the
Company from the risks associated with changing interest rates.
. Risk of Loss on Single Family Mortgage Assets. A substantial portion of
the Mortgage Assets of the Company consists of single family mortgage
loans or Mortgage Securities evidencing interests in single family
mortgage loans. The Company will be subject to the risk of loss on such
Mortgage Assets arising from borrower defaults to the extent not covered
by third-party credit enhancement.
. Ability to Acquire Mortgage Assets at Yields Which are Favorable Relative
to Borrowing Costs, Competition and Supply. Despite management's
experience in the acquisition of Mortgage Assets and its relationships
with various mortgage suppliers, there can be no assurance that the
Company will be able to acquire sufficient Mortgage Assets from mortgage
suppliers at spreads above the Company's cost of funds.
. Restrictions on Ownership of Capital Stock; Anti-takeover Effect. In
order for the Company to meet the requirements for qualification as a
REIT, the Charter generally prohibits any person from acquiring or
holding, directly or indirectly, shares of Common Stock in excess of 9.8
percent of the outstanding shares. This restriction, among others, may
inhibit market activity and the resulting opportunity for the holders of
the Company's Common Stock to receive a premium for their stock that
might otherwise exist in the absence of such restrictions.
THE OFFERING
Common Stock Offered by the Company(1).... 3,000,000 Shares
Common Stock to be outstanding after the
Offering(2).............................. 6,766,665 Shares
Use of Proceeds........................... The Company will use a portion of
the proceeds to repay certain
short-term borrowings. The
remaining proceeds will be used to
fund the Company's origination of
and investment in Mortgage Assets,
and for working capital.
Proposed Nasdaq National Market symbol....
- --------
(1)Assumes the Underwriters' over-allotment option is not exercised. See
"Underwriting".
(2) Includes the conversion of 3,549,999 shares of preferred stock in
connection with the Offering. Does not reflect the exercise of the
3,649,999 warrants and the 334,332 common stock options which are
outstanding as of June 30, 1997. Dividend equivalent rights were granted
with 45,000 of the common stock options. See "Description of Warrants" and
"Management--Executive Compensation".
9
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED FOR THE PERIOD ENDED
JUNE 30, 1997 DECEMBER 31, 1996(1)
------------------------ --------------------------
<S> <C> <C>
STATEMENT OF OPERATIONS
DATA
Interest income........... $ 9,320 $ 155
Interest expense.......... 6,438 --
Net interest income....... 2,882 155
Provision for credit
losses................... 718 --
Net interest income after
provision for credit
losses................... 2,164 155
Other income.............. 213 --
General and administrative
expenses................. 3,256 457
Net loss.................. (879) (302)
Pro forma net loss per
share(2)................. (0.21) (0.07)
<CAPTION>
AS OF JUNE 30, 1997 AS OF DECEMBER 31, 1996
------------------------ --------------------------
<S> <C> <C>
BALANCE SHEET DATA
Mortgage assets:
Mortgage securities....... $284,348 $13,239
Mortgage loans............ 303,732 --
Total assets.............. 601,741 59,796
Borrowings................ 553,640 --
Stockholders' equity...... 46,337 46,365
<CAPTION>
AS OF OR FOR THE SIX
MONTHS AS OF OR FOR THE PERIOD
ENDED JUNE 30, 1997 ENDED DECEMBER 31, 1996(1)
------------------------ --------------------------
<S> <C> <C>
OTHER DATA
Wholesale loans
originations:
Production................ $ 90,380 --
Average principal balance
per loan................. $ 157 --
Weighted average interest
rate:
Adjustable rate mortgage
loans................... 10.0% --
Fixed rate mortgage
loans................... 10.6% --
Loans with prepayment
penalties................ 82% --
Weighted average
prepayment penalty period
(in years)............... 2.7 --
Loans purchased in bulk:
Principal at purchase..... $207,240 --
Average principal balance
per loan................. $ 106 --
Weighted average interest
rate:
Adjustable rate mortgage
loans................... 9.6% --
Fixed rate mortgage
loans................... 10.5% --
Loans with prepayment
penalties................ 54% --
Weighted average
prepayment penalty period
(in years)............... 3.0 --
Net interest spread....... 1.77% --
Net yield................. 2.51% --
Return on assets.......... (0.15)% (0.50)%
Return on equity.......... (1.90)% (0.65)%
Taxable income (loss)--
NovaStar Financial,
Inc...................... $ 365 $ (173)
Pro forma taxable income
(loss) per preferred
share--NovaStar
Financial, Inc........... $ 0.10 $ (0.05)
Dividends per preferred
share(3)................. $ 0.10 --
Number of account
executives............... 17 --
</TABLE>
- --------
(1) The Company was formed on September 13, 1996. Operations began in substance
after the Private Placement which closed on December 9, 1996.
(2) Pro forma loss per share is based on the weighted average shares of Common
Stock and preferred stock outstanding, and includes the effect of warrants
and options using the treasury stock method, assuming a repurchase price
per share of $17.00.
(3) No dividends have been declared on the Common Stock. The level of quarterly
dividends is determined by the Board of Directors based upon its
consideration of a number of factors and should not be deemed indicative of
taxable income for the quarter in which declared or future quarters, or of
income calculated in accordance with GAAP. See "Dividend Policy and
Distributions."
10
<PAGE>
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following risk factors should be carefully considered in evaluating the
Company and its business before purchasing any of the shares of Common Stock
offered hereby. This Prospectus contains forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. Discussions containing such forward-looking statements may be found in
the material set forth under "Prospectus Summary," "Use of Proceeds,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business," as well as within this Prospectus generally.
Actual results could differ materially from those described in the forward-
looking statements as a result of the risks and uncertainties set forth below
and within this Prospectus generally. The Company cautions the reader,
however, that this discussion of risk factors may not be exhaustive.
RISKS ASSOCIATED WITH THE COMPANY'S OVERALL ENTERPRISE
Limited Operating History of the Company and Net Losses Incurred
The Company began operations in December 1996 following the closing of the
Private Placement. The mortgage lending operation began in late January 1997.
Accordingly, the Company has not yet developed an extensive earnings history
or experienced a wide variety of interest rate or market conditions and, as
such, historical operating performance may be of limited relevance in
predicting future performance. Although the Company has grown its assets
dramatically since the beginning of operations, there can be no assurances
that it will be able to continue to successfully operate its business as
described in this Prospectus. In addition, management of the Company does not
have extensive experience working together as a management team. The Company
has incurred net losses for the period since inception to December 31, 1996
and for the six months ended June 30, 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Dependence on Key Personnel
The Company's operations depend heavily upon the contributions of Scott
Hartman and Lance Anderson, both of whom would be difficult to replace.
Although Mr. Hartman and Mr. Anderson have both signed employment agreements,
there can be no assurance that these individuals will remain employees of the
Company. The loss of either of these individuals could have a material adverse
effect upon the Company's business and results of operations.
Risk of Adverse Effect on Earnings of Forgivable Notes
In the Company's Private Placement, Messrs. Hartman and Anderson each
acquired 108,333 Units at the price of $15.00 per Unit. Payment for the Units
was made by delivering to the Company promissory notes, each in the amount of
$1,624,995, bearing interest at eight percent per annum and secured by the
Units acquired. The principal amount of the notes was divided into three equal
tranches. Principal due will be forgiven by the Company if the return to
Private Placement investors meets certain benchmarks as follows: one tranche
will be forgiven if the Company generates a total return to the Private
Placement investors equal to or greater than 15 percent in any one fiscal year
and all tranches will be forgiven if the total cumulative return to Private
Placement investors reaches 100 percent prior to December 31, 2001. Return to
investors includes dividends paid as well as any appreciation in the average
price per share of the Common Stock and the related Warrant during the period.
If one tranche is forgiven, the Company will recognize a non-cash charge
against earnings of $1,083,330 for the related accounting period. If the
entire amount of the notes is forgiven, the Company will recognize a non-cash
charge against earnings of $3,249,990. Such charges resulting from forgiveness
of the notes could have a material effect on the Company's earnings for the
related accounting period and on the amount of dividends available to be paid
to shareholders of the Company including investors in this Offering. See
"Management--Executive Compensation."
Need for Additional Equity Financing
To implement fully the Company's strategy to continue rapid growth in its
portfolio of Mortgage Assets, the Company will be required to raise capital in
addition to that raised by the Offering. Accordingly, the Company expects to
undertake future equity offerings, in addition to long-term securitized debt
offerings. There can be no assurance that the Company will successfully and
economically raise the capital it will require through such offerings. See
"Risk Factors--Risk of Potential Futures Offerings."
11
<PAGE>
Consequences of Failure to Maintain REIT Status; Company Subject to Tax as a
Regular Corporation
The Company intends, at all times, to operate so as to qualify as a REIT for
federal income tax purposes. In order to maintain its qualification as a REIT
for federal income tax purposes, the Company must satisfy certain tests with
respect to the sources of its income, the nature and diversification of its
assets, the amount of its distributions to stockholders and the ownership of
its stock. If the Company fails to qualify as a REIT in any taxable year and
certain relief provisions of the Code do not apply, the Company would be
subject to federal income tax as a regular, domestic corporation, and its
stockholders would be subject to tax in the same manner as stockholders of
such corporation. Distributions to stockholders in any year in which the
Company fails to qualify as a REIT would not be deductible by the Company in
computing its taxable income. As a result, the Company could be subject to
income tax liability, thereby significantly reducing or eliminating the amount
of cash available for distribution to its stockholders. Further, the Company
could also be disqualified from re-electing REIT status for the four taxable
years following the year during which it became disqualified.
No assurance can be given that future legislation, regulations,
administrative interpretations or court decisions will not significantly
change the tax laws with respect to the Company's qualification as a REIT or
the federal income tax consequences of such qualification, which changes may
reduce or eliminate the Company's competitive advantage over non-REIT
competitors. See "Federal Income Tax Considerations--Qualification as a REIT"
and "--Taxation of the Company."
Investment Company Act Risk
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act.
Accordingly, the Company does not expect to be subject to the restrictive
provisions of the Investment Company Act. If the Company fails to qualify for
exemption from registration as an investment company, its ability to use
leverage would be substantially reduced and it would be unable to conduct its
business as described herein. Any such failure to qualify for such exemption
could have a material adverse effect on the Company.
Risk of Future Revisions in Policies and Strategies by Board of Directors
Management has established the operating policies and strategies set forth
in this Prospectus as the operating policies and strategies of the Company.
However, these policies and strategies may be modified or waived by the Board
of Directors, subject in certain cases to approval by a majority of the
Independent Directors, without stockholder approval. The ultimate effect of
these changes may be positive or negative.
RISKS ASSOCIATED WITH SUBPRIME MORTGAGE LENDING OPERATION
Changes in Interest Rates
The profitability of the Company is likely to be adversely affected during
any period of unexpected or rapid changes in interest rates. For example, a
substantial or sustained increase in interest rates could adversely affect the
ability of the Company to originate and purchase loans in expected volumes
necessary to support fixed overhead expense levels.
Competition
As an originator and purchaser of subprime mortgage loans, the Company will
face intense competition, primarily from commercial banks, savings and loans,
other independent mortgage lenders, and certain other mortgage REITs. As the
Company expands into the national market and particular geographic markets, it
will face competition from lenders with established positions in these
locations. Competition can take place on various levels, including convenience
in obtaining a loan, service, marketing, origination channels and pricing.
The subprime market is currently undergoing substantial changes. There are
new entrants into the market creating a changing competitive environment.
Furthermore, certain large national finance companies and prime mortgage
originators have begun to implement plans to adapt their prime mortgage
origination programs and
12
<PAGE>
allocate resources to the origination of subprime mortgage loans. Certain of
these larger mortgage companies and commercial banks have begun to offer
products similar to those which are offered by the Company and to target
customers similar to those targeted by the Company. For example, the Federal
Home Loan Mortgage Corporation has recently issued securities collateralized
by subprime mortgage loans originated by a financial institution.
The entrance of these competitors into the Company's market could have a
material adverse effect upon the Company's results of operations and financial
condition. In particular, the increasing level of capital resources being
devoted to subprime mortgage lending may increase the competition among
lenders to originate or purchase subprime loans and result in either reduced
interest margin on such mortgage loans compared to present levels or revised
underwriting standards permitting higher loan-to-value ratios on properties
securing subprime mortgage loans. There can be no assurance that the Company
will be able to compete successfully in this market environment and any
failure in this regard could have a material adverse effect on the Company's
results of operations and financial condition.
Availability of Funding Sources
The Company finances substantially all of the mortgage loans which it
originates or acquires through interim financing facilities including its bank
warehouse credit line and repurchase agreements, and with equity. These
borrowings have been, and will going forward be, repaid with the proceeds
received by the Company from financing mortgage loans through securitization.
The Company is currently dependent upon a few lenders to provide the primary
credit facilities for its mortgage loan originations and acquisitions. Any
failure to renew or obtain adequate funding under these financing arrangements
could have a material adverse effect on the Company's lending operations.
Dependence Upon Independent Brokers and Correspondents
The Company depends upon independent mortgage loan brokers and mortgage
lenders for its originations and purchases of new mortgage loans. The
Company's competitors also seek to establish relationships with brokers and
correspondents. The Company's future results may become more exposed to
fluctuations in the volume and cost of acquiring its mortgage loans resulting
from competition from other prospective purchasers of such mortgage loans.
Legislative and Regulatory Risk
Members of Congress and government officials from time to time have
suggested the elimination of the mortgage interest deduction for federal
income tax purposes, either entirely or in part, based on borrower income,
type of mortgage loan or principal amount. Because many of the Company's
mortgage loans will be made to borrowers for the purpose of consolidating
consumer debt or financing other consumer needs, the competitive advantages of
tax deductible interest, when compared with alternative sources of financing,
could be eliminated or seriously impaired by such government action.
Accordingly, the reduction or elimination of these tax benefits could have a
material adverse effect on the demand for mortgage loans offered by the
Company.
The Company's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and will be
subject to various laws and judicial and administrative decisions imposing
requirements and restrictions on part or all of its operations. Regulated
matters include, without limitation, mortgage loan origination marketing
efforts, credit application and underwriting activities, maximum finance and
other charges, disclosure to customers, certain rights of rescission on
mortgage loans, closing and servicing mortgage loans, collection and
foreclosure procedures, qualification and licensing requirements for doing
business in various jurisdictions and other trade practices. Mortgage loan
origination activities are subject to the laws and regulations in each of the
states in which those activities are conducted. Activities as a lender are
13
<PAGE>
also subject to various federal laws. The Truth in Lending Act ("TILA") and
Regulation Z promulgated thereunder, as both are amended from time to time,
contain disclosure requirements designed to provide consumers with uniform,
understandable information with respect to the terms and conditions of loans
and credit transactions in order to give them ability to compare credit terms.
TILA also guarantees consumers a three-day right to cancel certain credit
transactions. TILA also imposes disclosure, underwriting and documentation
requirements on mortgage loans, known as "Section 32 loans," with (i) total
points and fees upon origination in excess of eight percent of the mortgage
loan amount or (ii) an annual percentage rate of more than ten percentage
points higher than comparably maturing U.S. treasury securities. The Company
is also required to comply with the Equal Credit Opportunity Act of 1974, as
amended ("ECOA"), which prohibits creditors from discriminating against
applicants on the basis of race, color, sex, age or marital status. Regulation
B promulgated under ECOA restricts creditors from obtaining certain types of
information from loan applicants. It also requires certain disclosures by the
lender regarding consumer rights and requires lenders to advise applicants of
the reasons for any credit denial. In instances where the applicant is denied
credit or the rate or charge for a loan increases as a result of information
obtained from a consumer credit agency, the Fair Credit Reporting Act of 1970,
as amended, requires the lender to supply the applicant with a name and
address of the reporting agency. The Company will also be subject to the Real
Estate Settlement Procedures Act ("RESPA") and the Debt Collection Practices
Act and will be required to file an annual report with the Department of
Housing and Urban Development pursuant to the Home Mortgage Disclosure Act
("HMDA"). The Company will also be subject to the rules and regulations of,
and examinations by, GNMA, the Department of Housing and Urban Development
("HUD") and state regulatory authorities with respect to originating,
processing, underwriting, selling and servicing loans. There can be no
assurance that the Company will maintain compliance with these requirements in
the future without additional expenses, or that more restrictive local, state
or federal laws, rules and regulations will not be adopted or that existing
laws and regulations will not be interpreted in a more restrictive manner,
which would make compliance more difficult for the Company. Failure to comply
with these requirements can lead to loss of approved status, termination or
suspension of servicing contracts without compensation to the servicer,
demands for indemnifications or mortgage loan repurchases, certain rights of
rescission for mortgage loans, class action lawsuits and administrative
enforcement actions, any of which could cause a material adverse effect on the
Company's profitability.
The laws and regulations described above are subject to legislative,
administrative and judicial interpretation, and certain of these laws and
regulations have been infrequently interpreted or only recently enacted.
Infrequent interpretations of these laws and regulations or an insignificant
number of interpretations of recently enacted regulations can result in
ambiguity with respect to permitted conduct under these laws and regulations.
Any ambiguity under the regulations to which the Company is subject may lead
to regulatory investigations or enforcement actions and private causes of
action, such as class action lawsuits, with respect to the Company's
compliance with the applicable laws and regulations. As a mortgage lender, the
Company will be subject to regulatory enforcement actions and private causes
of action from time to time with respect to its compliance with applicable
laws and regulations.
Elimination of Lender Payments to Brokers
Class-action lawsuits have been filed against a number of mortgage lenders
alleging that such lenders have violated RESPA by making certain payments to
independent mortgage brokers. These lawsuits have generally been filed on
behalf of a purported nationwide class of borrowers and allege that payments
made by a lender to a broker in addition to payments made by the borrower to a
broker are prohibited by RESPA, and are therefore illegal. If these cases are
resolved against the lenders, it may cause an industry-wide change in the way
independent mortgage brokers are compensated. The Company's broker
compensation programs permit such payments. Future regulatory interpretations
or judicial decisions may require the Company to change its broker
compensation programs or subject it to material monetary judgments or other
penalties. Any such changes or penalties may have a material adverse effect on
the Company's results of operations, financial condition and business
prospects. See "Risk Factors--Legislative and Regulatory Risk."
14
<PAGE>
Environmental Liabilities
Certain properties securing mortgage loans may be contaminated by hazardous
substances. As a result, the value of the real property may be diminished. In
the event that the Company is forced to foreclose on a defaulted mortgage loan
on that property, the Company may be subject to environmental liabilities
regardless of whether the Company was responsible for the contamination. While
the Company intends to exercise due diligence to discover potential
environmental liabilities prior to the acquisition of any property through
foreclosure, hazardous substances or wastes, contaminants, pollutants or
sources thereof (as defined by state and federal laws and regulations) may be
discovered on properties during the Company's ownership or after a sale
thereof to a third party. If such hazardous substances are discovered on a
property, the Company may be required to remove those substances or sources
and clean up the property. The Company may also be liable to tenants and other
users of neighboring properties. Such clean-up costs and liabilities may be
extensive and may materially and adversely affect the Company's profitability.
In addition, the Company may find it difficult or impossible to sell the
property prior to or following any such clean up.
RISKS ASSOCIATED WITH THE ACQUISITION AND MANAGEMENT OF A PORTFOLIO OF
MORTGAGE ASSETS
Operations Risk
Although the Company hedges its interest rate risk, the results of the
Company's Mortgage Assets portfolio operation are affected by various factors,
many of which are beyond the control of the Company. The performance of the
Company's Mortgage Assets portfolio depends on, among other things, the level
of net interest income generated by the Company's Mortgage Assets, the market
value of such Mortgage Assets and the supply of and demand for such Mortgage
Assets. The Company's net interest income varies primarily as a result of
changes in short-term interest rates, borrowing costs and prepayment rates,
the behavior of which involve various risks and uncertainties as set forth
below. Prepayment rates, interest rates, borrowing costs and credit losses
depend upon the nature and terms of the Mortgage Assets, the geographic
location of the properties securing the mortgage loans included in or
underlying the Mortgage Assets, conditions in financial markets, the fiscal
and monetary policies of the United States government and the Board of
Governors of the Federal Reserve System, international economic and financial
conditions, competition and other factors, none of which can be predicted with
any certainty. Because changes in interest rates may significantly affect the
Company's activities, the operating results of the Company depend, in large
part, upon the ability of the Company effectively to manage its interest rate
and prepayment risks while maintaining its status as a REIT. Prolonged failure
to manage such risks would adversely affect the Company's profitability. See
"Risk Factors--Risks of Failing to Hedge Effectively Against Interest Rate
Changes; Risk of Losses Associated with Hedging; Counterparty Risks."
Risk of Decrease in Net Interest Income Due to Interest Rate Fluctuations;
Prepayment Risks of Mortgage Assets
General. The Company's adjustable rate Mortgage Assets bear adjustable
interest or pass-through rates based on short-term interest rates, and
substantially all of the Company's borrowings bear interest at short-term
rates and have maturities of less than one year. Consequently, changes in
short-term interest rates may significantly influence the Company's net
interest income. While rising short-term interest rates generally increase the
yields on the Company's adjustable-rate Mortgage Assets, rising short-term
rates also increase the costs of borrowings by the Company which are utilized
to fund the Mortgage Assets and, to the extent such costs escalate more
rapidly than the yields, the Company's net interest income may be reduced or a
net loss may result. Conversely, falling short-term interest rates may
decrease the interest cost on the Company's borrowings more rapidly than the
yields on the Mortgage Assets and hence may increase the Company's net
interest income. No assurance can be given as to the amount or timing of
changes in interest rates or their effect on the Company's Mortgage Assets or
net interest income.
Risks Associated with Differences Between Mortgage Asset and Borrowing
Characteristics. A substantial portion of all mortgage loans owned by Company
have adjustable terms today or are fixed today, but will adjust at some point
in the future. For instance, the Company's most popular product to date has
been a mortgage with
15
<PAGE>
a rate fixed for two years, at which time it becomes an adjustable rate
mortgage. As of June 30, 1997, all of the Company's Mortgage Securities were
backed by ARMs. Interest rates on the Company's borrowings are and generally
will be based on short-term indices. To the extent any of the Company's
Mortgage Assets are financed with borrowings bearing interest based on or
varying with an index different from that used for the related Mortgage
Assets, so-called "basis" interest rate risk will arise. In such event, if the
index used for the Mortgage Assets is a "lagging" index (such as the 11th
District Cost of Funds) that reflects market interest rate changes on a
delayed basis, and the rate borne by the related borrowings reflects market
rate changes more rapidly, the Company's net interest income will be adversely
affected in periods of increasing market interest rates. Additionally, the
Company's adjustable-rate Mortgage Assets will be subject to periodic rate
adjustments which may be more or less frequent than the increases or decreases
in rates borne by the borrowings or financings utilized by the Company.
Accordingly, in a period of increasing interest rates, the Company could
experience a decrease in net interest income or a net loss because the
interest rates on borrowings could adjust faster than the interest rates on
the Company's ARMs or Mortgage Assets backed by ARMs. Moreover, ARMs are
typically subject to periodic and lifetime interest rate caps that limit the
amount an ARM interest rate can change during any given period. The Company's
borrowings will not be subject to similar restrictions. Hence, in a period of
rapidly increasing interest rates, the Company could also experience a
decrease in net interest income or a net loss in the absence of effective
hedging because the interest rates on borrowings could increase without
limitation while the interest rates on the Company's ARMs and Mortgage Assets
backed by ARMs would be limited by caps. Further, some ARMs may be subject to
periodic payment caps that result in some portion of the interest accruing on
the ARM being deferred and added to the principal outstanding. This could
result in receipt by the Company of less cash income on its ARMs than is
required to pay interest on the related borrowings, which will not have such
payment caps. The Company expects that the net effect of these factors, all
other factors being equal, could be to lower the Company's net interest income
or cause a net loss during periods of rapidly rising market interest rates,
which could negatively impact the level of dividend distributions and the
market price of the Company's securities. However, in such periods the
Company's business strategy is designed to produce increased income and levels
of dividend distributions following a lag period the length of which will
depend on the extent and timing of the market interest rate increases.
Conversely, in periods of declining market interest rates, the Company's net
interest income may be initially increased, but following a lag period the
Company's income and levels of dividend distributions may be reduced.
Prepayment Risks. Prepayment rates vary from time to time and may cause
changes in the amount of the Company's net interest income. Prepayments of
ARMs and Mortgage Assets backed by ARMs usually can be expected to increase
when mortgage interest rates fall below the then-current interest rates on
such ARMs and decrease when mortgage interest rates exceed the then-current
interest rate on the ARMs, although such effects are not predictable.
Prepayment experience also may be affected by the geographic location of the
property securing the mortgage loans, the assumability of the mortgage loans,
conditions in the housing and financial markets and general economic
conditions. In addition, prepayments on ARMs are affected by the ability of
the borrower to convert an ARM to a fixed-rate loan and by conditions in the
fixed-rate mortgage market. If the interest rates on ARMs increase at a rate
greater than the interest rates on fixed-rate mortgage loans, prepayments on
ARMs may tend to increase. In periods of fluctuating interest rates, interest
rates on ARMs may exceed interest rates on fixed-rate mortgage loans, which
may tend to cause prepayments on ARMs to increase at a rate greater than
anticipated. Mortgage Securities backed by single family mortgage loans are
often structured so that certain classes are provided protection from
prepayments for a period of time. However, in a period of extremely rapid
prepayments, during which earlier-paying classes may be retired faster than
expected, the protected classes may receive unscheduled payments of principal
earlier than expected and would have average lives that, while longer than the
average lives of the earlier-paying classes, would be shorter than originally
expected. The Company will seek to minimize prepayment risk through a variety
of means, which may include (to the extent capable of being implemented at
reasonable cost at various points in time) structuring a diversified portfolio
with a variety of prepayment characteristics, investing in Mortgage Assets
with prepayment prohibitions and penalties, investing in certain Mortgage
Security structures which have prepayment protection, and balancing assets
purchased at a premium with assets purchased at a discount. In addition, the
Company may in the future
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purchase interest-only strips to a limited extent. However, no strategy can
completely insulate the Company from prepayment risks arising from the effects
of interest rate changes. There is also probably more uncertainty about
prepayment rates on subprime mortgage loans since there is less information
and historical data than exists for prime mortgage loans. Certain Mortgage
Assets may consist of mortgage loans that are, and Mortgage Securities
evidencing interests in, ARMs convertible to fixed-rate loans. Because
converted mortgage loans are required to be repurchased by the applicable
Agency or servicer, the conversion of a mortgage loan results, in effect, in
the prepayment of such mortgage loan.
Changes in anticipated prepayment rates of Mortgage Assets could affect the
Company in several adverse ways. Faster than anticipated prepayment of any
Mortgage Asset that had been purchased at a premium by the Company would
generally result in a faster than anticipated write-off of any remaining
capitalized premium amount and consequent reduction of the Company's net
interest income by such amount. A portion of the adjustable-rate single family
mortgage loans which may be acquired by the Company (either directly as
mortgage loans or through Mortgage Securities backed by ARMs) will have been
recently originated and will still bear initial interest rates which are lower
than their "fully-indexed" rates (the applicable index plus margin). In the
event that such an ARM is prepaid faster than anticipated prior to or soon
after the time of adjustment to a fully-indexed rate, the Company will have
experienced an adverse effect on its net interest income during the time it
held such ARM compared with holding a fully-indexed ARM and will have lost the
opportunity to receive interest at the fully-indexed rate over the expected
life of the ARM. These effects may be mitigated to the extent such ARMs were
acquired at a discount.
Risk of Failing to Hedge Effectively Against Interest Rate Changes; Risk of
Losses Associated with Hedging; Counterparty Risk
The Company's operating strategy subjects it to interest rate risks as
described under "--Risk of Decrease in Net Interest Income Due to Interest
Rate Fluctuations; Prepayment Risks of Mortgage Assets" above. The Company
follows an asset/liability management program intended to protect against
interest rate changes and prepayments. See "Business--Portfolio of Mortgage
Assets--Interest Rate Risk Management." Nevertheless, developing an effective
asset/liability management strategy is complex and no strategy can completely
insulate the Company from risks associated with interest rate changes and
prepayments. In addition, there can be no assurance that the Company's hedging
activities will have the desired beneficial impact on the Company's results of
operations or financial condition. Hedging typically involves costs, including
transaction costs, which increase dramatically as the period covered by the
hedge increases and which also increase during periods of rising and volatile
interest rates. The Company may increase its hedging activity, and thus
increase its hedging costs, during such periods when interest rates are
volatile or rising and hedging costs have increased. Moreover, federal tax
laws applicable to REITs may substantially limit the Company's ability to
engage in asset/liability management transactions. Such federal tax laws may
prevent the Company from effectively implementing hedging strategies that the
Company determines, absent such restrictions, would best insulate the Company
from the risks associated with changing interest rates and prepayments. See
"Federal Income Tax Considerations--Qualification as a REIT--Sources of
Income."
The Company has purchased interest rate caps and interest rate swaps to
attempt to mitigate the risk of variable rate liabilities increasing at a
faster rate than the earnings on its assets during a period of rising interest
rates. In this way, the Company intends generally to hedge as much of the
interest rate risk as management determines is in the best interests of the
Company given the cost of such hedging transactions and the need to maintain
the Company's status as a REIT. In this regard, the amount of income the
Company may earn from its interest rate swaps and caps is subject to
substantial limitations under the REIT provisions of the Code. The Company may
hedge the risk of its borrowing costs on its variable rate liabilities
increasing faster than its income, due to the effect of the periodic and
lifetime caps on its Mortgage Assets, through the acquisition of (a) Qualified
REIT Assets, such as interest-only REMIC regular interests, that function in a
manner similar to
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hedging instruments, (b) Qualified Hedges, the income from which qualifies for
the 95 percent income test, but not the 75 percent income test for REIT
qualification purposes, and (c) other hedging instruments, whose income
qualifies for neither the 95 percent income test nor the 75 percent income
test. See "Federal Income Tax Considerations--Qualification as a REIT--Sources
of Income." The latter form of hedging may be accomplished through a taxable
affiliate of the Company. See "Business--Interest Rate Risk Management" and
"Federal Income Tax Considerations--Qualification as a REIT--Sources of
Income." This determination may result in management electing to have the
Company bear a level of interest rate risk that could otherwise be hedged when
management believes, based on all relevant facts, that bearing such risk is
advisable.
In the event that the Company purchases interest rate caps or other interest
rate agreements to hedge against lifetime and periodic rate or payment caps,
and the provider of interest rate agreements becomes financially unsound or
insolvent, the Company may be forced to unwind its interest rate agreements
with such provider and may take a loss on such interest rate agreements.
Although the Company intends to purchase interest rate agreements only from
financially sound institutions and to monitor the financial strength of such
institutions on a periodic basis, no assurance can be given that the Company
can avoid such third party risks.
Risk of Loss on Single Family Mortgage Assets
A substantial portion of the investment portfolio of the Company consists of
single family mortgage loans or Mortgage Assets evidencing interests in single
family mortgage loans. The Company will bear the risk of loss on any such
Mortgage Assets it purchases in the secondary mortgage market or through its
mortgage lending business. In particular, the Mortgage Securities that the
Company retains from its securitizations are subordinated Mortgage Securities,
are not supported by credit enhancements, are not rated and have limited
liquidity. With respect to the Mortgage Securities the Company acquires in the
secondary market, if such securities are either Agency Certificates or are
generally structured with one or more types of credit enhancement, the credit
risk to the Company will be reduced or eliminated. To the extent third parties
have been contracted to provide the credit enhancement, the Company is
dependent in part upon the creditworthiness and claims-paying ability of the
insurer and the timeliness of reimbursement in the event of a default on the
underlying obligations. Further, the insurance coverage for various types of
losses is limited in amount and losses in excess of the limitation would be
borne by the Company.
Prior to securitization, the Company generally does not intend to obtain
credit enhancements such as mortgage pool or special hazard insurance for its
single family mortgage loans, other than FHA insurance, VA guarantees and
private mortgage insurance, in each case relating only to individual mortgage
loans. Accordingly, during the time it holds such mortgage loans for which
third party insurance is not obtained, the Company will be subject to risks of
borrower defaults and bankruptcies and special hazard losses that are not
covered by standard hazard insurance (such as those occurring from earthquakes
or floods). In the event of a default on any single family mortgage loan held
by the Company, including, without limitation, resulting from higher default
levels as a result of declining property values and worsening economic
conditions, among other factors, the Company would bear the risk of loss of
principal to the extent of any deficiency between the value of the related
real property, plus any payments from an insurer or guarantor, and the amount
owing on the mortgage loan. Defaulted mortgage loans would also cease to be
eligible collateral for borrowings and would have to be financed by the
Company out of other funds until ultimately liquidated, resulting in increased
financing costs and reduced net income or a net loss.
The Company may pool and finance or sell through securitizations a
substantial portion of the single family mortgage loans it acquires. In
securitizations, the Company continues to bear risk of loss on the underlying
mortgage loans.
Credit risks associated with non-conforming mortgage loans, especially
subprime mortgage loans, may be greater than those associated with prime
mortgage loans that conform to FNMA and FHLMC guidelines. The principal
difference between non-conforming subprime mortgage loans and conforming
mortgage loans include
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the applicable loan-to-value ratios, the credit and income histories of the
mortgagors, the documentation required for approval of the mortgagors, the
types of properties securing the mortgage loans, loan sizes and the mortgagors
occupancy status with respect to the mortgaged property. As a result of these
and other factors, the interest rates charged on non-conforming mortgage loans
are often higher than those charged for conforming mortgage loans. The
combination of different underwriting criteria and higher rates of interest
may lead to higher delinquency rates and/or credit losses for non-conforming
as compared to conforming mortgage loans and could have an adverse effect on
the Company to the extent that the Company invests in such mortgage loans or
securities secured by such mortgage loans.
Many of the risks of holding subprime mortgage loans and retaining, after
securitization, credit risk derived therefrom reflect the risks of investing
directly in the real estate securing the underlying mortgage loans. This may
be especially true in the case of a relatively small or less diverse pool of
subprime mortgage loans. In the event of a default on the underlying mortgage
loan, the ultimate extent of the loss, if any, may only be determined after a
foreclosure of the mortgage encumbering the property and, if the mortgagee
takes title to the property, upon liquidation of the property. Factors such as
the title to the property or its physical condition (including environmental
considerations) may make a third party unwilling to purchase the property at a
foreclosure sale or for a price sufficient to satisfy the obligations with
respect to the related Mortgage Securities. Foreclosure laws in various states
may protract the foreclosure process. In addition, the condition of a property
may deteriorate during the pendency of foreclosure proceedings. Certain
obligors on underlying mortgages may become subject to bankruptcy proceedings,
in which case the amount and timing of amounts due may be materially adversely
affected.
Ability to Acquire Mortgage Assets at Yields Which Are Favorable Relative to
Borrowing Costs, Competition and Supply
The Company's net income depends, in large part, on the Company's ability to
acquire Mortgage Assets at favorable spreads over the Company's borrowing
costs. In acquiring Mortgage Assets, the Company competes with other REITs,
securities dealers, savings and loan associations, banks, mortgage bankers,
insurance companies, mutual funds, other lenders, GNMA, FNMA, FHLMC and other
entities purchasing Mortgage Assets. In addition, there are several mortgage
REITs similar to the Company, and others may be organized in the future. The
effect of the existence of additional REITs may be to increase competition for
the available supply of Mortgage Assets suitable for purchase by the Company.
In addition, in fluctuating interest rate environments, the spread between
ARM interest rates and interest rates on fixed-rate mortgage loans may
decrease, and may cease to exist or become negative. Under such conditions,
mortgagors tend to favor fixed-rate mortgage loans, thereby decreasing the
supply of ARMs available to the Company for purchase. The relative
availability of ARMs may also be diminished by a number of other market and
regulatory considerations.
Despite management's experience in the acquisition of Mortgage Assets and
its relationships with various mortgage suppliers, there can be no assurance
that the Company will be able to acquire sufficient Mortgage Assets from
mortgage suppliers at spreads above the Company's cost of funds. The Company
will also face competition for financing sources, and the effect of the
existence of additional mortgage REITs may be to deny the Company access to
sufficient funds to carry out its business strategy and/or to increase the
cost of funds to the Company.
Risks of Substantial Leverage and Potential Net Interest and Operating Losses
in Connection with Borrowings
General. The Company employs a financing strategy to increase the size of
its Mortgage Assets portfolio by borrowing a substantial portion (which may
vary depending upon the mix of the Mortgage Assets in the
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Company's portfolio and the application of the Company's policies with respect
to such mix of Mortgage Assets) of the market value of its Mortgage Assets. If
the returns on the Mortgage Assets purchased with borrowed funds fail to cover
the cost of the borrowings, the Company will experience net interest losses
and may experience net losses. In addition, due to increases in haircuts
(i.e., the discount from face value applied by a lender or purchaser with
respect to the Company's Mortgage Securities), decreases in the market value
of the Company's Mortgage Assets, increases in interest rate volatility,
availability of financing in the market, circumstances then applicable in the
lending market and other factors, the Company may not be able to achieve the
degree of leverage it believes to be optimal, which may cause the Company to
be less profitable than it might be otherwise.
Risk of Failure to Refinance Outstanding Borrowings. Additionally, the
ability of the Company to achieve its investment objectives depends not only
on its ability to borrow money in sufficient amounts and on favorable terms
but also on the Company's ability to renew or replace on a continuous basis
its maturing short-term borrowings. The Company's business strategy relies on
short-term reverse repurchase agreements to fund Mortgage Asset originations
and purchases. The Company has not at the present time entered into any
commitment agreements under which a lender would be required to enter into new
borrowing agreements during a specified period of time; however, the Company
may enter into one or more of such commitment agreements in the future if
deemed favorable to the Company. In the event the Company is not able to renew
or replace maturing borrowings, the Company could be required to sell Mortgage
Assets under adverse market conditions and could incur losses as a result. In
addition, in such event, the Company may be required to terminate hedge
positions, which could result in further costs to the Company. An event or
development such as a sharp rise in interest rates or increasing market
concern about the value or liquidity of a type or types of Mortgage Assets in
which the Company's portfolio is concentrated will reduce the market value of
the Mortgage Assets, which would likely cause lenders to require additional
collateral. At the same time, the market value of the assets in which the
Company's liquidity capital is invested may have decreased. A number of such
factors in combination may cause difficulties for the Company, including a
possible liquidation of a major portion of the Company's Mortgage Assets
portfolio at disadvantageous prices with consequent losses, which could have a
materially adverse effect on the Company's profitability and its solvency.
A majority of the Company's borrowings are collateralized borrowings,
primarily in the form of reverse repurchase agreements and similar borrowings,
the availability of which are based on the market value of the Mortgage Assets
pledged to secure the specific borrowings, availability of financing in the
market, circumstances then applicable in the lending market and other factors.
The cost of borrowings under reverse repurchase agreements generally
corresponds to LIBOR or the Federal Funds rate plus or minus a spread,
although most of such agreements do not expressly incorporate an index. The
cost of borrowings under other sources of funding which the Company may use
may refer or corresponds to other short-term indices, plus or minus a margin.
The margins on such borrowings over or under LIBOR, the Federal Funds rate or
such other short-term indices vary depending upon the lender, the nature and
liquidity of the underlying collateral, the movement of interest rates, the
availability of financing in the market and other factors. If the actual cash
flow characteristics are other than as expected, the Company may experience
reduced net interest income.
Risk of Decline in Market Value of Mortgage Assets; Margin Calls. A decline
in the market value of the Company's portfolio of Mortgage Assets may limit
the Company's ability to borrow or result in lenders initiating margin calls
(i.e., requiring a pledge of cash or additional Mortgage Assets to re-
establish the ratio of the amount of the borrowing to the value of the
collateral). This remains true despite effective hedging against such
fluctuations as the hedging instruments may not be part of the collateral
securing the collateralized borrowings. Additionally, it may be difficult to
realize the full value of the hedging instrument when desired for liquidity
purposes due to the applicable REIT provisions of the Code. The Company could
be required to sell Mortgage Assets under adverse market conditions in order
to maintain liquidity. Such sales may be effected by management when deemed by
it to be necessary in order to preserve the capital base of the Company. If
these sales were made at prices lower than the amortized cost of the Mortgage
Assets, the Company would experience losses. A default by the Company under
its collateralized borrowings could also result in a liquidation of the
collateral, including any cross-collateralized assets, and a resulting loss of
the difference between the value of
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the collateral and the amount borrowed. Additionally, in the event of a
bankruptcy of the Company, certain reverse repurchase agreements may qualify
for special treatment under the Bankruptcy Code, the effect of which is, among
other things, to allow the creditors under such agreements to avoid the
automatic stay provisions of the Bankruptcy Code and to liquidate the
collateral under such agreements without delay. Conversely, in the event of
the bankruptcy of a party with whom the Company had a reverse repurchase
agreement, the Company might experience difficulty recovering the collateral
subject to such agreement if the agreement were to be repudiated and the
Company's claim against the bankrupt lender for damages resulting therefrom
were to be treated simply as one of an unsecured creditor. Should this occur,
the Company's claims would be subject to significant delay and recoveries, if
and when received, may be substantially less than the damages actually
suffered by the Company. Although the Company has entered, and intends to
continue to enter, into reverse repurchase agreements with several different
parties and has developed policies to reduce its exposure to such risks, no
assurance can be given that the Company will be able to avoid such third-party
risks.
To the extent the Company is compelled to liquidate Mortgage Assets that are
Qualified REIT Assets to repay borrowings, the Company may be unable to comply
with the REIT provisions of the Code regarding assets and sources of income
requirements, ultimately jeopardizing the Company's status as a REIT. The Code
does not provide for any mitigating provisions with respect to the 30 percent
of income limit. Accordingly, if the Company failed to meet the 30 percent of
income limit, its status as a REIT would terminate automatically. Failure to
maintain REIT status would eliminate the Company's competitive advantage over
non-REIT competitors and subject the Company to federal taxation. See "Risk
Factors--Failure to Maintain REIT Status" and "Federal Income Tax
Considerations--Qualification as a REIT--The 30 percent Limit."
Dependence on Securitization Market
Adverse changes in the securitization market could impair the Company's
ability to originate, acquire and finance mortgage loans through
securitizations on a favorable or timely basis. Any such impairment could have
a material adverse effect upon the Company's results of operations and
financial condition. In addition, in order to gain access to the
securitization market, the Company generally expects to rely upon credit
enhancements provided by one or more monoline insurance carriers. Any
substantial reductions in the size or availability of the securitization
market for the Company's loans, or the unwillingness of insurance companies to
provide credit enhancement for the Company's Mortgage Securities could have a
material adverse effect upon the Company's results of operations and financial
condition.
Lack of Loan Performance Data
The loans originated and purchased by the Company have been outstanding for
a relatively short period of time. Consequently, the delinquency and loss
experience of these loans to date may not be indicative of future results. It
is unlikely that the Company will be able to sustain delinquency and loan loss
ratios at their present levels as the portfolio becomes more seasoned.
Illiquidity of Investments
A substantial portion of the Company's portfolio may be invested in Mortgage
Securities for which the secondary trading market is not as well developed as
the market for certain other Mortgage Securities (or which are otherwise
considered less marketable or illiquid). In addition, the Company may invest
in Mortgage Securities which have been sold in private placements and have not
been registered under the Securities Act. Unregistered Mortgage Securities may
be subject to restrictions on resale which may limit the ability of the
Company to sell them when it might be most desirable to do so. Although the
Company expects that most of the Company's investments will be in Mortgage
Securities for which a resale market exists, certain of the Company's
investments may lack a regular trading market and may be illiquid. In
addition, during turbulent market conditions, the liquidity of all of the
Company's Mortgage Assets may be adversely impacted. There is no limit in the
percentage of the Company's investments that may be invested in illiquid
Mortgage Assets.
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Risk of Lack of Geographic and Industry Diversification
The Company seeks geographic diversification of the properties underlying
its Mortgage Assets and has established a diversification policy. See
"Business--Mortgage Lending Operation--Underwriting and Quality Control
Strategy." Nevertheless, properties underlying such Mortgage Assets may be
located in the same or a limited number of geographical regions. To the extent
that properties underlying such Mortgage Assets are located in the same
geographical region, such Mortgage Assets may be subject to a greater risk of
default than other comparable Mortgage Assets in the event of adverse
economic, political or business developments and natural hazard risks that may
affect such region and, ultimately, the ability of property owners to make
payments of principal and interest on the underlying mortgages.
RISKS ASSOCIATED WITH AN INVESTMENT IN THE COMMON STOCK IN THE OFFERING
Restrictions on Ownership of Capital Stock; Anti-takeover Effect
Subject to the limitations set forth in the Articles Supplementary creating
the Preferred Stock, the Charter authorizes the Board of Directors to
reclassify any of the unissued shares of authorized capital stock into a class
or classes of preferred stock. The issuance of additional preferred stock
could have the effect of making an attempt to gain control of the Company more
difficult by means of a merger, tender offer, proxy contest or otherwise. The
additional preferred stock, if issued, could have a preference on dividend
payments over the Common Stock which could affect the ability of the Company
to make dividend distributions to the holders of Common Stock.
In order that the Company may meet the requirements for qualification as a
REIT at all times, the Charter prohibits any person from acquiring or holding,
directly or indirectly, shares of Capital Stock in excess of 9.8 percent in
value of the aggregate of the outstanding shares of Capital Stock or in excess
of 9.8 percent (in value or in number of shares, whichever is more
restrictive) of the aggregate of the outstanding shares of Common Stock of the
Company. For this purpose, the term "ownership" is defined in accordance with
REIT provisions of the Code and the constructive ownership provisions of
Section 544 of the Code, as modified by Section 856(h)(1)(B) of the Code.
Under such rules, for example, certain types of entities such as widely-held
corporations may hold in excess of the 9.8 percent limit because shares held
by such entities are attributed to such entities' stockholders. Conversely,
shares of Capital Stock owned or deemed to be owned by a person who
individually owns less than 9.8 percent of the shares outstanding may
nevertheless be in violation of the ownership limitations set forth in the
Charter if, under certain circumstances, shares owned by others (such as
family members or partners) are attributed to such individual. See "Federal
Income Tax Considerations--Qualification as a REIT--Ownership of Stock." The
Charter further prohibits (1) any person from beneficially or constructively
owning shares of Capital Stock that would result in the Company being "closely
held" under Section 856(h) of the Code or otherwise cause the Company to fail
to qualify as a REIT, and (2) any person from transferring shares of Capital
Stock if such transfer would result in shares of Capital Stock being owned by
fewer than 100 persons. If any transfer of shares of Capital Stock occurs
which, if effective, would result in any person beneficially or constructively
owning shares of Capital Stock in excess or in violation of the above transfer
or ownership limitations, then that number of shares of Capital Stock the
beneficial or constructive ownership of which otherwise would cause such
person to violate such limitations (rounded to the nearest whole shares) shall
be automatically transferred to a trustee (the "Trustee") as trustee of a
trust (the "Trust") for the exclusive benefit of one or more charitable
beneficiaries (the "Charitable Beneficiary"), and the intended transferee
shall not acquire any rights in such shares. See "Description of Capital
Stock--Repurchase of Shares and Restriction on Transfer."
Every owner of more than 5 percent (or such lower percentage as required by
the Code or the regulations promulgated thereunder) of all classes or series
of the Company's stock, within 30 days after the end of each taxable year, is
required to give written notice to the Company stating the name and address of
such owner, the number of shares of each class and series of stock of the
Company beneficially owned and a description of the manner in which such
shares are held. Each such owner shall provide to the Company such additional
information as the Company may request in order to determine the effect, if
any, of such beneficial ownership on the Company's status as a REIT and to
ensure compliance with the ownership limitations.
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Subject to certain limitations, the Board of Directors may increase or
decrease the ownership limitations. In addition, to the extent consistent with
the REIT provisions of the Code, the Board of Directors may waive the
ownership limitations for and at the request of individual investors.
The provisions described above may inhibit market activity and the resulting
opportunity for the holders of the Company's Capital Stock and Warrants to
receive a premium for their Securities that might otherwise exist in the
absence of such provisions. Such provisions also may make the Company an
unsuitable investment vehicle for any person seeking to obtain ownership of
more than 9.8 percent of the outstanding shares of Capital Stock.
In addition, certain provisions of the Maryland General Corporation Law
relating to "business combinations" and a "control share acquisition" and of
the Charter and Bylaws may also have the effect of delaying, deterring or
preventing a takeover attempt or other change in control of the Company which
would be beneficial to shareholders and might otherwise result in a premium
over then prevailing market prices. See "Management" and "Description of
Capital Stock."
Risk of Potential Future Offerings
The Company expects in the future to increase its capital resources by
making additional offerings of equity and debt securities, including classes
of preferred stock, Common Stock, commercial paper, medium-term notes,
mortgage-backed obligations and senior or subordinated debt. All debt
securities and classes of preferred stock will be senior to the Common Stock
in the event of a liquidation of the Company. Additional equity offerings may
dilute the equity of stockholders of the Company or reduce the price of shares
of the Company's Common Stock, or both. The Company is unable to estimate the
amount, timing or nature of additional offerings as they will depend upon
market conditions and other factors.
Absence of Active Public Trading Market
There is currently no trading market for the Common Stock and there can be
no assurance that an active trading market for the Common Stock will develop.
Although the Common Stock is expected to be approved for quotation on the
Nasdaq National Market, there can be no assurance that an active public
trading market for the Common Stock will develop after this Offering or that,
if developed, it will be sustained. The initial public offering price of the
Common Stock offered hereby was determined by negotiations among the Company
and representatives of the Underwriters and may not be indicative of the price
at which the Common Stock will trade after the Offering. See "Underwriting."
Consequently, there can be no assurance that the market price for the Common
Stock will not fall below the initial public offering price.
Possible Volatility of Stock Price
In the event an active trading market for the Common Stock does develop, the
market price of the Common Stock may experience fluctuations unrelated to the
operating performance of the Company. In particular, the price of the Common
Stock may be affected by general market price movements as well as
developments specifically related to the specialty finance industry such as
interest rate movements and credit quality trends.
In the event that an active trading market for the Common Stock does
develop, it is likely that the market price of the Common Stock will be
influenced by any variation between the net yield on the Company's Mortgage
Assets and prevailing market interest rates and by the markets perception of
the Company's ability to achieve earnings growth. The Company's earnings will
be derived primarily from any positive spread between the yield on the
Company's Mortgage Assets and the cost of the Company's borrowings. During the
period immediately following the receipt by the Company of new proceeds from
an offering or other source, prior to the time the Company has fully
implemented its financing strategy to employ those proceeds, the Company's
earnings and levels of dividend distributions may be lower than if the
financing strategy were fully implemented, which may affect the market value
of the Common Stock. In addition, the positive spread between the yield on the
Company's Mortgage Assets and the cost of borrowings will not necessarily be
larger in high interest rate environments than in low interest rate
environments regardless of the Company's business strategy to achieve
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such result. Accordingly, in periods of high interest rates, the net income of
the Company and, therefore, the dividend yield on the Common Stock may be less
attractive compared with alternative investments, which could negatively
impact the price of the Common Stock. If the anticipated or actual net yield
on the Company's Mortgage Assets declines or if prevailing market interest
rates rise, thereby decreasing the positive spread between the net yield on
the Mortgage Assets and the cost of the Company's borrowings, the market price
of the Common Stock may be materially adversely affected. In addition, if the
market price of other REIT stocks decline for any reason, or there is a broad-
based decline in real estate values or in the value of the Company's portfolio
of Mortgage Assets, the market price of the Common Stock may be adversely
affected. During any period when the market price of the Common Stock has been
adversely affected due to any of the foregoing reasons, the liquidity of the
Common Stock may be negatively impacted and stockholders who may desire or be
required to sell their Common Stock may experience losses.
Securities Eligible for Future Sale
Following the closing of this Offering (and assuming that the Underwriters'
over-allotment option is not exercised), there will be outstanding 6,766,665
shares of Common Stock and 3,649,999 Warrants, of which (i) 3,000,000 shares
of Common Stock are being offered hereby (ii) 3,549,999 shares of Common
Stock, together with 3,649,999 Warrants and a like number of shares of Common
Stock issuable upon exercise of those Warrants, will be covered by the Shelf
Registration Statement and (iii) 216,666 shares of Common Stock are not being
offered in this Offering or under the Shelf Registration Statement. The
3,549,999 shares of Common Stock, 3,649,999 Warrants, together with the Common
Stock issuable pursuant to the exercise of the 3,649,999 outstanding Warrants
set forth in (ii) above, may be sold without restriction upon effectiveness of
the Shelf Registration Statement (subject to a 90-day "lock-up" period
following the closing of this Offering), subject to certain restrictions. The
216,666 shares of Common Stock not being offered in this Offering or under the
Shelf Registration Statement, are "restricted securities" within the meaning
of Rule 144 ("Rule 144") under the Securities Act. Such restricted securities
will be available for resale pursuant to Rule 144 following a holding period
ending one year from the date of issuance, subject to the volume limitations
imposed by Rule 144 and, unless held by affiliates of the Company, will become
unrestricted two years from the date of issuance. Future sales of restricted
securities could have an adverse effect on the market price of the Common
Stock. The holders of the currently restricted shares of Common Stock have
certain registration rights with respect to such shares. See "Description of
Capital Stock--Registration Rights."
As of June 30, 1997, options to purchase 334,332 shares of Common Stock were
outstanding under the Company's Stock Option Plan, which will vest on various
dates extending through September 1, 2000. The Company will file a Form S-8
registration statement approximately 90 days following the effective date of
this Offering to permit shares issued pursuant to the exercise of options to
be sold.
Immediate Dilution
The initial public offering price is higher than the net tangible book value
per share of Common Stock in this Offering. Investors purchasing shares of
Common Stock in the Offering will be subject to immediate dilution of $3.22
per share in net tangible book value. See "Dilution."
24
<PAGE>
THE COMPANY
NovaStar Financial, Inc. (on a non-consolidated basis, "NFI") was
incorporated by Scott Hartman and Lance Anderson, the founders, in the State
of Maryland on September 13, 1996 and has elected to be a REIT for federal
income tax purposes. As a result of its REIT status, NFI will be permitted to
deduct dividend distributions to stockholders, thereby effectively eliminating
the "double taxation" that generally results when a corporation earns income
and distributes that income to stockholders in the form of dividends. See
"Federal Income Tax Considerations--Taxation of the Company."
NFI Holding Corporation, Inc. ("Holding") was incorporated in the State of
Delaware on February 6, 1997. One hundred percent of the voting common stock
of Holding is owned equally by the Company's founders. See "Management." NFI
owns one hundred percent of the preferred stock of Holding, for which it
receives 99 percent of dividends paid by Holding. As currently structured,
Holding exists solely for the purpose of owning NovaStar Mortgage, Inc.
("NMI"). NMI was incorporated in the State of Virginia on May 16, 1996 and is
a wholly-owned subsidiary of Holding. Although NMI was formed in 1996,
substantial operations did not commence until January 1997. This Prospectus
refers to these three entities collectively as "NovaStar" or "the Company."
The basic function of NFI is to manage the Mortgage Assets of the Company.
NMI serves as a vehicle for loan origination--a primary source of Mortgage
Assets for the Company. In addition, NMI will sub-service loans owned by the
Company. Through June 30, 1997, all loans originated by NMI were sold to NFI.
See "Certain Transactions."
The Company is self-advised and self-managed. Management oversees the day-
to-day operations of the Company, subject to supervision by the Company's
Board of Directors. The management team of the Company has considerable
expertise in the origination, acquisition and management of mortgage loans and
Mortgage Assets and asset/liability management. See "Management." The
principal executive offices of the Company are at 1900 W. 47th Place, Suite
205, Westwood, Kansas 66205, telephone (913) 362-1090. Principal offices for
the Company's mortgage lending operations are in Irvine, California.
USE OF PROCEEDS
The net proceeds of this Offering are estimated to be $46,930,000, assuming
a public offering price of $17.00 per share and that the Underwriters' over-
allotment option is not exercised. A portion of the proceeds from the Offering
will be used to repay certain short-term borrowings. The remaining proceeds
will be used to fund the Company's origination of and investment in Mortgage
Assets and for working capital.
DIVIDEND POLICY AND DISTRIBUTIONS
The Company generally intends to distribute substantially all of its taxable
income each year (which does not ordinarily equal net income as calculated in
accordance with GAAP) to its stockholders so as to comply with the REIT
provisions of the Code. The Company intends to make dividend distributions
quarterly. The Company intends to distribute any taxable income remaining
after the distribution of the final regular quarterly dividend each year
together with the first regular quarterly dividend payment of the following
taxable year or in a special dividend distributed prior thereto. The dividend
policy is subject to revision at the discretion of the Board of Directors. All
distributions will be made by the Company at the discretion of the Board of
Directors and will depend on the taxable income of the Company, the financial
condition of the Company, maintenance of REIT status and such other factors as
the Board of Directors deems relevant. See "Federal Income Tax
Considerations--Qualification as a REIT--Distributions."
Distributions to stockholders will generally be subject to tax as ordinary
income, although a portion of such distributions may be designated by the
Company as capital gain or may constitute a tax-free return of capital.
25
<PAGE>
The Company generally does not intend to declare dividends that would result
in a return of capital. The Company will annually furnish to each of its
stockholders a statement setting forth distributions paid during the preceding
year and their characterization as ordinary income, capital gains, or return
of capital. For a discussion of the Federal income tax treatment of
distributions by the Company, see "Federal Income Tax Considerations--Taxation
of the Company's Stockholders."
DIVIDEND REINVESTMENT PLAN
The Company expects to adopt a dividend reinvestment plan ("DRP") for
stockholders who wish to reinvest their distributions in additional shares of
Common Stock. Generally, under a DRP dividends paid with respect to shares of
Capital Stock are automatically invested in additional shares of Common Stock
at a discount to the then current market price. The DRP will also allow each
stockholder to make additional investments in Common Stock by contributing
cash to the DRP administrator (up to a specified maximum). Stockholders will
not be automatically enrolled in the DRP.
26
<PAGE>
DILUTION
The net tangible book value of the Company as of June 30, 1997 was $46.3
million, or $12.29 per share of Common and Preferred Stock. Net tangible book
value per share represents the total tangible assets of the Company, reduced
by the amount of its total liabilities, and divided by the number of shares of
Common and Preferred Stock outstanding as of that date. The following
calculations include 216,666 Units issued to the founders acquired with
forgivable debt, assumed to be for no consideration.
After giving effect to the net proceeds from the sale of Common Stock
offered hereby at an assumed initial public offering price of $17.00 per
share, and assuming full conversion of the Preferred Stock and no exercise of
Warrants or options to acquire Common Stock, the pro forma net tangible book
value of the Company as of June 30, 1997 would have been $93,222,000 or $13.78
per share of Common Stock. This represents an immediate dilution of $3.22 per
share to new investors purchasing Common Stock at $17.00 per share.
The following table illustrates the per share dilution in net tangible book
value to new investors as of June 30, 1997.
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............... $17.00
Net tangible book value per share before this Offering........ $12.29
Increase attributable to purchase of Common Stock by new
investors in this Offering................................... 1.49
------
Pro forma net tangible book value per share of Common Stock
after giving effect to the consummation of this Offering..... $13.78 13.78
====== ------
Dilution of net tangible book value per share to investors in
this Offering................................................ $ 3.22
======
</TABLE>
The above calculations assume no exercise of the Warrants or any outstanding
options to acquire Common Stock. As of June 30, 1997, options to acquire
10,000 shares of Common Stock were outstanding at an exercise price of $0.01
per share and options to acquire 35,000 shares of Common Stock were
outstanding at an exercise price of $1.06 per share, which options vest 25
percent on September 1, 1997 and 25 percent on each anniversary of such date
thereafter. Options to purchase an additional 289,332 shares of Common Stock
granted to founders at an exercise price of $15.00 per share vest upon closing
of this Offering. If all of the Warrants and options are exercised upon
vesting, dilution to investors in this Offering would be $2.83.
The following table summarizes on a pro forma basis as of June 30, 1997 the
differences between the total consideration paid and the average price per
share of Common Stock paid by the existing stockholders prior to the Private
Placement, by the investors in the Private Placement and by the new investors
in this Offering (assuming an initial public offering price of $17.00 per
share), assuming full conversion of the Preferred Stock and no exercise of the
Warrants or options to acquire Common Stock:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
----------------- -------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
<S> <C> <C> <C> <C> <C>
Existing Common
Stockholders........... 216,666 3.2 $ 2,167 -- $ 0.01
Private Placement
investors.............. 3,549,999 52.5 49,999,995 49.5 14.08
New investors in this
Offering............... 3,000,000 44.3 51,000,000 50.5 17.00
--------- ----- ------------ -----
Total............... 6,766,665 100.0 $101,002,162 100.0 $14.93
========= ===== ============ ===== ======
</TABLE>
27
<PAGE>
CAPITALIZATION
The table below sets forth the capitalization of the Company as of June 30,
1997 and as adjusted to give effect to the sale by the Company of 3,000,000
shares of Common Stock offered hereby and the conversion of all outstanding
Preferred Stock into Common Stock.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
-----------------------------
ACTUAL AS ADJUSTED(1)(2)(3)
(IN THOUSANDS)
<S> <C> <C>
STOCKHOLDERS' EQUITY:
Capital stock, $0.01 par value, 50,000,000
shares authorized:
Convertible preferred stock; 3,549,999
(actual) and 0 (as adjusted) shares issued
and outstanding........................... $ 36 $ --
Common Stock; 216,666 (actual) and
6,766,665 (as adjusted) shares issued and
outstanding............................... 2 68
Additional paid-in capital(4)............... 49,862 96,762
Accumulated deficit......................... (1,535) (1,535)
Net unrealized gain on available-for-sale
securities................................. 1,367 1,367
Forgivable notes receivable from founders... (3,395) (3,395)
------- -------
Total.................................... $46,337 $93,267
======= =======
</TABLE>
- --------
(1) Does not include 334,332 shares of Common Stock options granted under
Company's Stock Option Plan, of which 309,332 have been granted to
executive officers and directors of the Company. See "Management--
Executive Compensation."
(2) Assumes that no Warrants are exercised, that the Underwriters over-
allotment options is not exercised and that the underwriting discounts and
other offering expenses total $4,070,000.
(3) Assumes conversion of all Preferred Stock into Common Stock. Conversion is
automatic upon closing of the Offering.
(4) Based on an assumed initial public offering price of $17.00.
28
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following selected financial data are derived from the audited
consolidated financial statements of the Company for the periods presented and
should be read in conjunction with the more detailed information therein and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Prospectus. Operating results for the
six months ended June 30, 1997 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1997.
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED FOR THE PERIOD ENDED
JUNE 30, 1997 DECEMBER 31, 1996(1)
------------------------ --------------------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA
Interest income................. $ 9,320 $ 155
Interest expense................ 6,438 --
Net interest income............. 2,882 155
Provision for credit losses..... 718 --
Net interest income after
provision for credit losses.... 2,164 155
Other income.................... 213 --
General and administrative
expenses....................... 3,256 457
Net loss........................ (879) (302)
Pro forma net loss per
share(2)....................... (0.21) (0.07)
<CAPTION>
AS OF AS OF
JUNE 30, 1997 DECEMBER 31,1996
------------------------ --------------------
<S> <C> <C>
BALANCE SHEET DATA
Mortgage assets:
Mortgage securities............. $284,348 $13,239
Mortgage loans.................. 303,732 --
Total assets.................... 601,741 59,796
Borrowings...................... 553,640 --
Stockholders' equity............ 46,337 46,365
<CAPTION>
AS OF OR FOR AS OF OR FOR
THE SIX MONTHS ENDED THE PERIOD ENDED
JUNE 30, 1997 DECEMBER 31, 1996(1)
------------------------ --------------------
<S> <C> <C>
OTHER DATA
Wholesale loan originations:
Production...................... $ 90,380 --
Average principal balance per
loan........................... $ 157 --
Weighted average interest rate:
Adjustable rate mortgage
loans......................... 10.0% --
Fixed rate mortgage loans...... 10.6% --
Loans with prepayment
penalties...................... 82% --
Weighted average prepayment
penalty period (in years)...... 2.7 --
Loans purchased in bulk:
Principal at purchase........... $207,240 --
Average principal balance per
loan........................... $ 106 --
Weighted average interest rate:
Adjustable rate mortgage
loans......................... 9.6% --
Fixed rate mortgage loans...... 10.5% --
Loans with prepayment
penalties...................... 54% --
Weighted average prepayment
penalty period (in years)...... 3.0 --
Net interest spread............. 1.77% --
Net yield....................... 2.51% --
Return on assets................ (0.15)% (0.50)%
Return on equity................ (1.90)% (0.65)%
Taxable income (loss)--NovaStar
Financial, Inc................. $ 365 $ (173)
Pro forma taxable income (loss)
per preferred share--NovaStar
Financial, Inc................. $ 0.10 $ (0.05)
Dividends per preferred
share(3)....................... $ 0.10 --
Number of account executives.... 17 --
</TABLE>
- --------
(1) The Company was formed on September 13, 1996. Operations began in
substance after the Private Placement, which closed on December 9, 1996.
(2) Pro forma loss per share is based on the weighted average shares of
Common Stock and Preferred Stock outstanding, and includes the effect of
warrants and options using the treasury stock method, assuming a
repurchase price per share of $17.00.
(3) No dividends have been declared on the Common Stock. The level of
quarterly dividends is determined by the Board of Directors based upon
its consideration of a number of factors and should not be deemed
indicative of taxable income for the quarter in which declared or future
quarters, or of income calculated in accordance with GAAP. See "Dividend
Policy and Distributions."
29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the preceding
Selected Consolidated Financial and Other Data and the Company's Consolidated
Financial Statements and the Notes thereto, included elsewhere in this
Prospectus.
OVERVIEW
The Company was incorporated on September 13, 1996 by the founders. Through
a Private Placement, the Company raised $47 million in December 1996, allowing
the Company to commence operations. Those operations consisted of developing
the infrastructure to begin the loan origination operation and of investing
proceeds from the Private Placement in short-term liquid assets. Investments
earned $155,000, while general and administrative costs were $457,000,
resulting in a net loss of $302,000 during the period from inception to
December 31, 1996. Those operating results are not meaningful to the on-going
operations of the Company. The asset size of the Company has grown since the
initial capitalization to a total of $602 million as of June 30, 1997. The
1997 operating results and financial condition of the Company reflect this
growth and should be interpreted accordingly.
The Company generates income principally from the earnings on its Mortgage
Assets. The Company uses a combination of equity and borrowings to finance the
acquisition of its Mortgage Assets. The Board of Directors has established
Capital Allocation Guidelines ("CAG") which assist management in assessing the
appropriate combination of equity and debt financings. The CAG are intended to
keep the Company properly leveraged by (i) matching the amount of leverage
allowed to the riskiness (return and liquidity) of an asset and (ii)
monitoring the credit and prepayment performance of each investment to adjust
the required capital. Until the Company is fully leveraged, the Company will
not reach its full earnings potential. Since inception, the Company has used
less debt financing than the maximum allowed under the CAG as it has reserved
the use of equity funding for future loan originations. The Company's short-
term borrowings are provided through a $50 million warehouse line of credit
with First Union National Bank and through repurchase agreements with various
securities dealers.
A significant portion of the Company's Mortgage Assets earn adjustable
interest rates based on short-term interest rates. All of the Company's
borrowings bear short-term rates of interest. As a result, net interest income
depends on prevailing market rates, as well as the volume of interest-earning
assets and interest-bearing liabilities. Increases in short-term interest
rates will generally increase the yields on Mortgage Assets and the costs of
borrowings. However, to the extent that borrowing costs adjust at different
times or amounts relative to the yield on the Mortgage Assets, the Company is
subject to interest rate risk. When the costs of borrowings increase more
rapidly than yields on assets, net interest income may be reduced. Conversely,
decreases in short-term rates may decrease the interest cost on the Company's
borrowings more rapidly than the yields on assets causing an increase in net
interest income. Management monitors and aggressively manages interest rate
risk. However, the Company's portfolio cannot be completely hedged against
changing interest rates. See "Business--Portfolio Management--Interest Rate
Risk Management."
Many costs of the Company are directly related to the infrastructure
necessary to support current period wholesale loan production, which has grown
from a monthly total of $2.9 million in February 1997 to a monthly total of
$28.5 million in June 1997. Revenue, on the other hand, is dependent on the
size and composition of the Company's Mortgage Asset portfolio. As a result,
during the first six months of 1997, the Company's operating results reflect
the substantial costs related to building the mortgage lending and servicing
infrastructure and have exceeded the income from the Company's portfolio of
Mortgage Assets. Management believes the established infrastructure allows for
the addition of Mortgage Assets that will provide a higher return on equity
than could otherwise be acquired in the secondary market. Management also
believes that, over time, earnings will reflect the value of the
infrastructure.
Through its mortgage lending operation, the Company will continue adding
interest-earning assets to its balance sheet. Management projects that, at or
near the completion of this Offering, the Company will have reached the
maximum level of interest-earning assets for the debt/equity mix allowed under
its CAG. Securing
30
<PAGE>
additional capital allows the Company to further develop and grow its balance
sheet. The Company is seeking to increase its capital base by issuing shares
of Common Stock in this Offering. Capital will, in the short term, be used to
retire certain borrowings. In the long term, the proceeds from the Offering
will be used primarily to originate and acquire additional Mortgage Assets.
Upon completion of the Offering, the Company expects to be able to continue
adding interest-earning assets to more effectively utilize the Company's human
and other resources.
FORGIVABLE NOTES RECEIVABLE FROM FOUNDERS
The Company's founders, Messrs. Hartman and Anderson, received 216,666 Units
upon closing of the Private Placement. Payment for these Units was made by the
founders delivering to the Company forgivable promissory notes. Payment of the
original principal on these notes will be forgiven if certain incentive
performance targets are achieved. One tranche will be forgiven for each fiscal
period that the Company generates a total return to investors in the Private
Placement of 15 percent. All tranches will be forgiven when the Company has
generated a 100 percent return. As of June 30, 1997, the aggregate amount
receivable from founders was $3,395,000, of which $145,000 is accrued
interest. See Note 7 to the consolidated financial statements. The incentive
tests relate to the total return generated to investors in the Private
Placement. Total return includes the appreciation of the Company's stock price
and dividends paid. In the event the incentive tests are reached during 1997,
one or more of the tranches of the forgivable notes could be forgiven,
resulting in compensation expense during the 1997 fourth quarter. Management
estimates that if one or more of the tranches are forgiven in 1997, the
resulting recognition of compensation expense could have a material effect on
the Company's results of operations for that period, including resulting in a
net loss for the quarter, and possibly for the 1997 fiscal year. See
"Management--Executive Compensation."
FINANCIAL CONDITION AS OF JUNE 30, 1997
During the first half of 1997, the Company added over $200 million in
mortgage loans to the balance sheet through the purchase of bulk pools of
loans originated by other mortgage lenders. During February 1997, the Company
originated its first wholesale production loans. From that time until June 30,
1997 the Company has originated 577 wholesale production loans with an
aggregate principal amount of $90 million. Table I summarizes the Company's
loan originations and bulk acquisitions by month.
TABLE I
WHOLESALE LOAN ORIGINATIONS AND ACQUISITIONS
SIX MONTHS ENDED JUNE 30, 1997 (DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
WHOLESALE ORIGINATIONS BULK ACQUISITIONS TOTAL
-------------------------- ------------------ ------------------
NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL
OF LOANS AMOUNT OF LOANS AMOUNT OF LOANS AMOUNT
<S> <C> <C> <C> <C> <C> <C>
January.... -- $ -- 851 $ 94,710 851 $ 94,710
February... 17 2,941 376 41,784 393 44,725
March...... 51 9,747 195 20,938 246 30,685
April...... 132 19,219 427 39,753 559 58,972
May........ 173 29,964 103 10,055 276 40,019
June....... 204 28,509 -- -- 204 28,509
--------- ------------- ----- -------- ----- --------
Total.... 577 $ 90,380 1,952 $207,240 2,529 $297,620
========= ============= ===== ======== ===== ========
</TABLE>
Further details regarding mortgage loans outstanding as of June 30, 1997 are
given in various sections of "Business" and in Note 3 to the consolidated
financial statements.
31
<PAGE>
As an alternative investment while its wholesale production has been
growing, the Company has been an active investor in Mortgage Securities issued
by Government-sponsored entities. During the six months ended June 30, 1997,
the Company acquired securities with an aggregate cost of $378.5 million and
sold securities with an aggregate carrying value, at the time of sale, of
$99.8 million. Proceeds from these sales were reinvested in other Mortgage
Securities issued by Government-Sponsored entities, deemed by the Company to
be preferable under its asset liability management strategy. As of June 30,
1997, mortgage securities totaled $284.3 million. Details of mortgage
securities are provided in Note 2 to the consolidated financial statements.
Wholesale loans and smaller pools of bulk loans originated through the
lending operations of the Company have typically been funded through a $50
million mortgage loan warehouse agreement with First Union National Bank. As
advances under the line approach the maximum available borrowing under the
warehouse line, mortgage loan collateral is transferred to a $300 million
master repurchase agreement with Merrill Lynch Mortgage Capital, Inc. and
Merrill Lynch Credit Corporation. During the first half of 1997, funds
borrowed under this agreement have been used to acquire some of the largest
pools of mortgage loans acquired by the Company. Funds borrowed against the
master repurchase agreement are used to pay off amounts borrowed against the
warehouse line of credit to free its use for further wholesale production.
Management expects to continue using this method for the short-term financing
of its mortgage lending operations.
Acquisitions of agency-issued Mortgage Securities have been financed by
using individual assets as collateral for repurchase agreements. These
agreements have been executed with a number of reputable securities dealers.
Management expects to continue to finance the acquisition of Mortgage
Securities using this method.
Under the terms of all financing arrangements, lending institutions require
"over-collateralization" from the Company. The value of the collateral
generally must exceed the allowable borrowing by two to five percent. As a
result, the Company must have resources available to cover this "haircut."
Proceeds from the Private Placement have been used for such purpose. Proceeds
from future capital issuances, including this Offering, will also be used in
this manner.
Amounts outstanding under borrowing arrangements aggregated $553.6 million
as of June 30, 1997. Details of these borrowings are included in Note 4 to the
consolidated financial statements.
The Company expects to aggregate substantially all of its outstanding
mortgage loans to serve as collateral for the issuance of its own
collateralized mortgage obligations ("CMO"). Expected proceeds from these
issuances will be used to pay off amounts borrowed under its master repurchase
agreement and its warehouse line of credit. Management intends to make a
regular practice of issuing collateralized debt as part of its normal
asset/liability management. The Company expects to benefit from this practice
by lowering its overall financing costs.
RESULTS OF OPERATIONS--SIX MONTHS ENDED JUNE 30, 1997
Net Interest Income
Table II presents a summary of the average interest-earning assets, average
interest-bearing liabilities, and the related yields and rates thereon for the
six months ended June 30, 1997.
Interest Income. The Company had average interest-earning assets of $229.7
million during the six months ended June 30, 1997. Of these, $63.0 million
were mortgage securities, and $166.6 million were mortgage loans. During the
period, mortgage securities earned $2.2 million, or a yield of 7.1 percent,
while mortgage loans earned $7.1 million, or a yield of 8.5 percent. In total,
assets of the Company earned $9.3 million, or a yield of 8.1 percent.
A substantial portion of the mortgage loans owned by the Company have
interest rates that fluctuate with short-term market interest rates. However,
many of these mortgage loans have initial coupons lower than market rates
("teaser" rates). As a result, during the first six months of 1997, the
assets, collectively, have not adjusted upward to their full potential coupon
rate. The effect of this is a temporary lower rate and lower interest yield to
the Company. As these assets "season," they should increase to their higher
rates and result in higher yields.
32
<PAGE>
The Company originates and acquires substantially all of its mortgage loans
at a premium. Such premiums are amortized as a reduction of interest income
over the estimated lives of the assets. If mortgage principal repayment rates
accelerate, the Company will recognize more premium amortization, thereby
reducing the effective yield on the assets. Decelerating repayment rates will
have the opposite effect on asset yields. To mitigate the effect of
prepayments, the Company generally strives to originate and acquire mortgage
loans that have some form of prepayment penalty. Of all the loans originated
during the six months ended June 30, 1997, 82 percent had prepayment penalties
for at least the first two years of the loan. Fifty-four percent of the loans
acquired through bulk purchases by the Company had prepayment penalties. For
loans with prepayment penalties the weighted average prepayment penalty period
is 2.7 years for mortgage loans originated by the Company and 3.0 years for
those acquired through bulk purchases.
As noted above, interest income is a function of volume and rates.
Management expects the asset portfolio to continue to increase through its
wholesale loan origination operation. Management will continue to monitor the
markets for Mortgage Securities and whole loan mortgage pools and will acquire
Mortgage Assets that are appropriate for its overall asset/liability strategy.
Increasing volume of assets will cause future increases in interest income,
while declining balances will reduce interest income. Market interest rates
will also affect future interest income.
Interest Expense. The cost of borrowed funds for the Company was $6.4
million during the six months ended June 30, 1997. Advances under the master
repurchase agreement and the warehouse facility bear interest at rates based
on short-term interest rate indexes, such as the Federal Funds rate and LIBOR,
plus a spread. During the six months ended June 30, 1997, the Federal Funds
rate averaged 5.4 percent and one month LIBOR averaged 5.6 percent. As with
interest income, the Company's cost of funds in the future will largely depend
on market conditions, most notably levels of short-term interest rates.
TABLE II
INTEREST ANALYSIS
SIX MONTHS ENDED JUNE 30, 1997 (DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
INTEREST ANNUAL
AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE
<S> <C> <C> <C>
ASSETS
Mortgage securities............................... $ 63,025 $2,241 7.11%
Mortgage loans.................................... 166,644 7,079 8.50
-------- ------
Total interest-earning assets................... $229,669 9,320 8.12
========
LIABILITIES
Master repurchase agreement....................... $132,937 4,359 6.56
Warehouse line of credit.......................... 13,711 442 6.44
Other repurchase agreements....................... 56,226 1,637 5.82
-------- ------
Total borrowings................................ $202,874 6,438 6.35
======== ------
Net interest income............................... $2,882
======
Net interest spread............................... 1.77%
====
Net yield......................................... 2.51%
====
</TABLE>
Net Interest Income and Spread. Net interest income during the first six
months of 1997 was $2.9 million, or 2.51 percent of average interest-earning
assets. Net interest spread for the Company was 1.77 percent during the six
months ended June 30, 1997. Net interest income and the spread are functions
of the yield of the Company's assets relative to its costs of funds. During
the first half of 1997, the cost of funds was relatively low and stable. The
low cost of funds offset, to some degree, the lower yield on the assets due to
their teaser rates, as discussed above. In addition, the Company has entered
into interest rate agreements to mitigate the exposure to
33
<PAGE>
variations in interest rates on interest-earning assets that are different
from the variations in interest incurred on borrowings. The volume of assets
and liabilities and how well the Company manages the spread between earnings
on assets and the cost of funds will dictate future net interest income.
Impact of Interest Rate Agreements. During the six months ended June 30,
1997, the Company entered into interest rate agreements designed to mitigate
exposure to interest rate risk. See "Business--Portfolio Management." Two of
these agreements are interest rate cap agreements, with a combined notional
amount of $75 million, which require the Company to pay a monthly fixed
premium while allowing the Company to receive a rate that adjusts with LIBOR,
when rates rise above a certain agreed-upon rate. The other agreements are
simple fixed to floating interest rate swaps with an aggregate notional amount
of $191 million. These agreements are used to, in effect, alter the interest
rates on funding costs to more closely match the yield on interest-earning
assets. During the six months ended June 30, 1997, the Company incurred net
interest expense on these agreements of $346,000. Net income earned from or
expense incurred on these agreements is accounted for on the accrual method
and is recorded as an adjustment to interest expense. Further details
regarding these agreements are provided in Note 5 to the consolidated
financial statements.
Gains and Losses on Sales
The Company classifies its Mortgage Securities as available-for-sale.
Management may deem it appropriate to sell securities, from time to time, to
reallocate the Company's capital. Since inception, the Company has not sold
mortgage loans and, as a general rule the Company does not intend to sell
mortgage loans in the future. The strategy of the Company is to hold and
service mortgage loans in order to earn the spread over the life of the loans,
rather than sell the loans and recognize the gain or loss in the current
period.
Provisions for Credit Losses
In 1997, the Company started providing regular allowances for credit losses
in connection with its initial bulk purchases of loans and wholesale
originations. The Company has not experienced any credit losses to date, but
management expects that losses will be incurred in the future. The Company
regularly evaluates the potential for credit losses for mortgage loans held in
its portfolio. Since the Company has limited actual performance history for
its loan portfolio, losses have been provided for primarily based on general
industry trends and on the judgement of the Company's management.
The Company believes that loan defaults occur throughout the life of a loan
or group of loans. As a result, the Company believes it is appropriate to
record provisions for credit losses against income over the estimated life of
the loans, rather than immediately upon acquisition of the loan. Currently,
the Company provides for credit losses depending on the type and credit grade
of loans comprising the portfolio. The amount of the provision as a percent of
the loans will vary. During the six months ended June 30, 1997, the Company
provided $718,000 for credit losses.
Table III presents a summary of delinquent loans as of June 30, 1997. The
low level of delinquencies is reflective of the short amount of time loans
originated or acquired by the Company have been outstanding. Management
expects to experience higher rates of delinquency in the future and has
established the appropriate staff and policies to monitor delinquencies.
TABLE III
LOAN DELINQUENCIES
AS OF JUNE 30, 1997
<TABLE>
<CAPTION>
PERCENT OF
TOTAL
MORTGAGE LOANS
<S> <C>
Loans delinquent 60 to 90 days.............................. 0.91%
Loans delinquent greater than 90 days....................... 0.82
</TABLE>
34
<PAGE>
General and Administrative Expenses
Table IV displays a summary of general and administrative expenses for the
six months ended June 30, 1997.
TABLE IV
GENERAL AND ADMINISTRATIVE EXPENSES
SIX MONTHS ENDED JUNE 30, 1997 (IN THOUSANDS)
<TABLE>
<S> <C>
Compensation and benefits.......................................... $1,234
Professional and outside services.................................. 596
Loan servicing..................................................... 571
Office administration.............................................. 334
Travel and public relations........................................ 248
Occupancy.......................................................... 162
Other.............................................................. 111
------
Total............................................................ $3,256
======
</TABLE>
During the first six months of 1997, the Company recognized income on
average interest-earning assets of $230 million, while realizing expenses on
the origination of $90 million in mortgage loans. The Company's general and
administrative expenses are typically impacted by current production and the
Company's net interest income is the result of the size of the Company's
portfolio. As the Company's portfolio grows, management expects the income
from the portfolio to exceed general and administrative expenses.
Compensation and benefits include employee base salaries, benefit costs and
incentive bonus awards. The number of employees and the related compensation
costs have increased throughout the first six months of 1997 as the Company
has continued to hire staff. Certain personnel costs directly related to the
origination of mortgage loans are deferred and recognized as a yield
adjustment on such mortgage loans, using the interest method.
Professional and outside services includes the cost of contract labor, as
well as fees for legal and accounting services. Management has used contract
labor services extensively during the development of its operations during the
six months ended June 30, 1997, particularly in the areas of loan underwriting
and systems development. As permanent employees are hired, management
anticipates using contract labor to a lesser extent during the remainder of
1997. Legal fees during the six months ended June 30, 1997 relate to the
execution of numerous agreements with market counterparties and the Company's
ongoing compliance with state and local licensing efforts. The Company has
also incurred expenses for professional services relating to staff
recruitment.
Loan servicing consists of direct costs associated with the mortgage loan
servicing operation, which the Company outsourced until July 15, 1997.
Effective July 15, 1997, the Company assumed the servicing for all of its
mortgage loans. Management believes that by servicing its own mortgage loans,
the Company will be able to more readily monitor and control delinquencies and
defaults. Management believes this is particularly important in the subprime
sector of the mortgage industry. In addition, management believes cost
efficiencies can be gained from servicing the Company's loans in house.
Office administration includes such items as telephone, office supplies,
postage, delivery, maintenance and repairs. Certain of these items have been
necessarily high during the start up phase of the Company. Management expects
many of these expenses to increase relative to production in future periods.
Travel and public relations includes costs of account executives in
developing customer relationships. In addition, the Company operates from
offices in Kansas and California. Management and staff incur travel related
costs in managing those operations. This category also includes travel
incurred by sales managers in recruiting account executives. Management
expects these costs to continue to be incurred.
35
<PAGE>
Occupancy expense includes the rent on office space for the Company's two
main offices in Kansas and California. In addition, office space and equipment
is leased for certain members of its sales force.
Net Loss
During the six months ended June 30, 1997, the Company recorded a net loss
of $879,000, primarily as a result of the significant costs associated with
the development of its operations. From the date of the closing of the Private
Placement in December 1996 through June 30, 1997, the Company's focus was on
the hiring of key employees and the development of policies and procedures.
The Company did not generate significant income during 1996. In addition, the
results for the six months ended June 30, 1997 reflect the significant cost of
developing operations. During the Company's rapid expansion during 1997, the
Company's operating expenses have increased more rapidly than its revenues.
Taxable Income (Loss)
Income reported for financial reporting purposes as calculated in accordance
with generally accepted accounting principles (GAAP) differs from income
computed for income tax purposes. This distinction is important as dividends
paid to the Company's stockholders are based on taxable income. For tax
purposes, the provision for credit losses is not deductible. In addition,
income reported for consolidated financial reporting purposes includes the
accounts of its taxable affiliates. Such entities are excluded in the
preparation of the Company's income tax returns. Table V is a summary of the
differences between the net loss reported for GAAP, as reported herein, and
taxable income of NFI.
TABLE V
TAXABLE INCOME--NFI
SIX MONTHS ENDED JUNE 30, 1997 (IN THOUSANDS)
<TABLE>
<S> <C>
Net loss.......................................................... $(879)
Results of NFI Holding Corporation and subsidiary, net of
intercompany transactions........................................ 536
-----
NFI loss.......................................................... (343)
Provision for credit losses....................................... 718
Other, net........................................................ (10)
-----
Taxable income--NFI............................................... $ 365
=====
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Liquidity, as used herein, means the need for, access to and uses of cash.
The Company's primary needs for cash include the acquisition and origination
of Mortgage Assets, principal repayment and interest on borrowings, operating
expenses and dividend payments. The Company has a certain amount of cash on
hand to fund operations. The Company requires access to short term warehouse
and credit facilities to fund its wholesale loan originations. Also,
principal, interest and fees received on Mortgage Assets will serve to support
the cash needs of the Company. Major cash requirements are typically satisfied
by drawing upon various borrowing arrangements.
The Company has a $50 million warehouse line of credit to fund current loan
funding and operations. The Company also has available a $300 million master
repurchase agreement. In addition, the Company has been approved as a borrower
from other reputable securities dealers for repurchase agreements to fund the
acquisition of Mortgage Assets. On a long term basis, the Company will pool
its mortgage loans to serve as collateral for its CMOs. By doing so, the loans
will be cleared as collateral for the master repurchase agreement and the
warehouse line of credit, freeing those arrangements to fund further loan
originations. Although it generally does not intend to do so, all Mortgage
Securities are classified as available-for-sale and could be sold in the open
market in order to provide additional cash for liquidity needs.
36
<PAGE>
The Company's business requires substantial cash to support its operating
activities and growth plans. Management believes that net proceeds from the
Offering, together with existing funds and amounts available under credit
facilities, will be sufficient to fund its operations for the next twelve
months, if future operations are consistent with management's expectations. If
the Company's wholesale loan originations exceed expectations, the timing of
liquidity and capital needs would accelerate. In the event the Offering is not
consummated, the Company would have to arrange alternative financial, or
possibly, sell Mortgage Securities or its wholesale loans.
Cash used by operating activities during the six months ended June 30, 1997
was $5.9 million, consisting primarily of the net loss adjusted for accrued
interest receivable which increased $6.2 million during the period. Cash used
by investing activities was $593.1 million, consisting primarily of purchases
and originations of mortgage assets, net of sales and repayments. Cash
provided by financing activities aggregated $553.4 million, consisting
primarily of net borrowings and advances under the lines of credit and the
repurchase agreements.
The Company uses a combination of equity and borrowings to finance the
acquisition of its Mortgage Assets. The Board of Directors has established
Capital Allocation Guidelines ("CAG") which assist management in assessing the
appropriate combination of equity and debt financings. The mix of debt and
equity is dependent upon the level of risk associated with individual assets,
which determines the amount of over-collateralization required by the lender.
See "Business--Portfolio Management--Capital and Leverage Policies."
INFLATION
Virtually all of the Company's assets and liabilities are financial in
nature. As a result, interest rates and other factors drive the company's
performance far more than does inflation. Changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates. The
Company's consolidated financial statements are prepared in accordance with
generally accepted accounting principles and the Company's dividends are
determined by the Company's net income as calculated for tax purposes. In each
case, the Company's activities and balance sheet are measured with reference
to historical cost or fair market value without considering inflation.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Note 1 to the consolidated financial statements describes certain recently
issued accounting pronouncements. Management believes the implementation of
these pronouncements will not have a material impact on the consolidated
financial statements.
37
<PAGE>
BUSINESS
There are two general aspects to the business of the Company: (i) mortgage
lending, targeting primarily the subprime market, and (ii) management of a
portfolio of Mortgage Assets, both those originated and acquired.
MORTGAGE LENDING OPERATION
Market Overview
Over the last three years, the residential mortgage market generated annual
volume in excess of $600 billion per year. The majority of these originations
(approximately 80 to 90 percent) were classified as "prime" mortgages which
generally means they have credit quality and documentation sufficient to
qualify for guarantee by GNMA, FNMA or FHLMC. The remaining 10 to 20 percent
(approximately $85 to $150 billion) of the originations were classified as
"subprime."
The Company believes there is strong national demand by borrowers for
subprime mortgage loans. Across the country, many borrowers have suffered
dislocation and temporary unemployment, resulting in negative entries on their
credit reports. Erratic market and economic conditions and other factors have
resulted in high ratios of debts to assets and high levels of credit card and
other installment debt for these individuals. In addition, more borrowers are
choosing to become self-employed. These are some of the circumstances which
create the market for subprime mortgage loans.
One of the significant differences between the prime and subprime mortgage
loan markets has been the comparative dependence upon the overall level of
interest rates. Generally, the subprime mortgage loan market's historical
performance has been more consistent without regard to interest rates. This is
evident by the growth in subprime originations from 1993 through 1995. While
the prime market experienced a decline in originations of more than 40 percent
due primarily to an increase in interest rates, loan originations in the
subprime market continued to grow at an annual rate of 10 to 15 percent over
the same three-year period. Many traditional prime mortgage lenders, with
excess capacity after the end of the 1993 refinance boom, expanded into
subprime mortgage lending. At this time the subprime mortgage loan market
represents one of the fastest growing and most profitable segments of the
mortgage industry. Historically, the subprime mortgage loan market has been a
highly fragmented niche market dominated by local brokers with direct ties to
investors who owned and serviced this relatively higher margin, riskier
product. Although there have recently been several new entrants into the
subprime mortgage business, the Company believes the subprime mortgage market
is still highly fragmented, with no single competitor having more than a 5
percent market share.
Based on industry sources, the estimated size of the subprime mortgage loan
market in 1997 is approximately $85 to $150 billion in annual originations and
the market is highly fragmented. The growth and profitability of the subprime
mortgage loan market, the demise of numerous financial institutions in the
late 1980s which had served this market, and reduced profits and loan volume
at traditional financial institutions have together drawn new participants and
capital to the subprime mortgage loan market. Management believes the subprime
mortgage loan market requires more business judgement from underwriters in
evaluating borrowers with previous credit problems. Subprime lending is also
generally a lower volume/higher profit margin business rather than the
generally higher volume/lower profit margin prime mortgage business to which
traditional mortgage bankers have become accustomed. Subprime mortgage lending
is also more capital intensive than the prime mortgage market due to the fact
that the securitization function requires a higher level of credit enhancement
which must be provided by the issuer in the form of over-collateralization or
subordination.
The Company believes that the subprime mortgage market will continue to grow
and to generate relatively attractive risk-adjusted returns over the long term
due in part to the following reasons: (i) growth in the number of existing
homeowners with negative entries on their credit reports due to the number of
corporate downsizings which have occurred over the last several years; (ii)
growth in the number of immigrants with limited credit
38
<PAGE>
histories who are in the prime home buying ages of 25 to 34; (iii) growth in
the number of self-employed individuals who have sources of income which are
inconsistent and difficult to document; (iv) growth in consumer debt levels
which are causing many borrowers to have higher debt/income ratios; and (v)
growth in consumer bankruptcy filings which cause borrowers to be classified
as subprime.
Due to the relative growth and potential returns on equity of the subprime
mortgage market, the Company believes that more competitors may attempt to
enter the market. While this may cause profit margins to narrow, the Company
believes that the subprime mortgage market will be able to sustain attractive
profit margins due to certain barriers to entry which include (i) the capital
intensive nature of the business as issuers of securities backed by subprime
mortgage loans are required to retain the credit and prepayment risks; (ii)
the higher level of expertise required to underwrite the mortgage loans; (iii)
the higher cost to service the mortgage loans due to the additional emphasis
required on collections and loss mitigation; and (iv) the highly fragmented
nature of business due to the difficulty of sourcing the mortgage loans.
One of the Company's two principal businesses will be originating, acquiring
and servicing primarily subprime mortgage loans, generally secured by first
liens on single family residential properties. Subprime mortgage lending
involves lending to individuals whose borrowing needs are generally not being
served by traditional financial institutions due to poor credit history and/or
other factors which make it difficult for them to meet prime mortgage loan
underwriting criteria. The Company will target as potential customers
individuals with relatively significant equity value in their homes, but who
(i) have impaired credit profiles, (ii) are self-employed, tend to experience
some volatility in their income or have difficult-to-document sources of
income, or (iii) are otherwise unable to qualify for traditional prime
mortgage loans. Loan proceeds are used by borrowers for a variety of purposes
such as to consolidate consumer credit card and other installment debt, to
finance home improvements and to pay educational expenses. These borrowers are
often seeking to lower their monthly payments by reducing the rate of interest
they would otherwise pay or extending their debt amortization period or doing
both. Customer service is emphasized by providing prompt responses and
flexible terms to broker-initiated customer borrowing requests. Through this
approach, the Company expects to originate new loans and purchase closed loans
with relatively higher interest rates than are typically charged by lenders
for prime mortgage loans while having comparable or lower loan-to-value
ratios.
Subprime mortgage loans generally tend to be "cash out" refinance loans for
the purpose of debt consolidation. The majority of the Company's originations
have been made for debt consolidation purposes, with the remainder of its
originations either rate/term refinances or purchase money loans. Given the
borrowers needs, subprime mortgage lending tends to be less interest rate
sensitive than the prime mortgage purchase market or rate/term refinance
market, since borrowings secured by real estate are generally less expensive
than credit card or installment debt. The pricing differential between typical
prime non-conforming mortgage loans and subprime mortgage loans is often as
much as 300 basis points. With proper management of the credit risk, this
additional spread may become additional profit for the owner of these loans.
Subprime borrowers are also generally more willing to accept a prepayment
penalty since they have fewer options for obtaining financing then the typical
prime mortgage loan borrower. To date, 82 percent of the mortgage loans
originated by the Company have included a prepayment penalty.
Marketing and Production Strategy
General. The Company's competitive strategy is to build efficient channels
of production for originating subprime mortgage loans. The Company has
generated mortgage product through two distinct production channels: (i)
direct origination through a wholesale broker network; and (ii) bulk
acquisitions from originators. The Company's long-term strategy is to
emphasize production through the wholesale broker network. Management believes
that production channels that allow the Company to get closer to the customer
and eliminate as many intermediaries as possible will generally be the most
efficient over the long-term and that, by developing the direct origination
channel through a mortgage broker network, the Company will be able to
differentiate itself from other end investors who purchase their production in
bulk from other originators. From time to time, the Company may participate in
the bulk acquisition market depending on market conditions and the
availability of capital.
39
<PAGE>
The Company believes that subprime mortgage loans provide a relatively
attractive net earnings profile, producing higher yields without
commensurately higher credit risks when compared to prime mortgage loans. With
the proper focus on underwriting, appraisal, management and servicing of
subprime mortgage loans, the Company believes it can be successful in
developing a profitable business in this segment of the market. While many new
competitors have recently entered the subprime mortgage loan market, the
Company believes that the experience of its management in this industry and
the infrastructure which has been established allows it to effectively compete
in this segment. Moreover, there are few public companies competing in the
subprime market that are operated as REITs, which the Company believes to be
the most efficient structure for competing in this segment of the market.
Mortgage Products. The Company's mortgage lending operation offers a broad
menu of products in order to serve its customers. These products are comprised
of both fixed rate and adjustable rate mortgages. Since inception, the
percentage of fixed rate and adjustable rate loans originated by the Company
is 10 percent and 90 percent, respectively. The Company categorizes the loans
that it originates into one of five different credit risk classifications.
Loan are assigned a credit classification based on several factors consisting
of such things as loan to value (LTV) ratios, the credit history of the
borrower, debt ratios of the borrower and other characteristics. The Company
provides loans up to a maximum LTV ratio of 90 percent based on the credit
risk classification and the loan amount. For loans originated since inception
the average LTV ratio is 76.6 percent and the average loan amount is $157,000.
Wholesale Channel. The Company's wholesale origination consists of a network
of brokers and correspondents that offer its line of mortgage products.
Management believes that its wholesale channel allows the Company to originate
loans at a lower cost, including the cost to originate the loan, than it could
purchase the loan in the market. For example, assume the price to purchase a
loan in bulk is 106 percent of the face amount. If the Company can originate
the same loan at 102 percent of face amount and incurs origination costs of
two percent of par, the wholesale loan would be two percent less expensive
than the loan purchased in bulk.
The wholesale origination infrastructure consists of a sales force to call
on mortgage loan brokers, an underwriting and processing center to underwrite,
close and fund mortgage loans and systems to process data. As of June 30,
1997, the Company had a staff of 17 account executives, located in offices
nationwide, whose job is to call on brokers. Supporting the sales force is a
staff of 30 in Irvine, California. Management believes it can originate loans
through the wholesale channel at a price 1.5 to 2.0 percent lower than the
cost of acquiring mortgage loans in bulk.
Management believes it has been, and will continue to be, successful in
competing in the wholesale business for several reasons. First, the Company is
a vertically integrated wholesale originator and investor. Management believes
this approach will provide a competitive advantage over many competitors who
either only originate loans or only act as end investors because of the
elimination of redundancy in separating the two functions. Second, the Company
believes its REIT status gives it a pricing advantage over non-REIT mortgage
investors. Third, the Company believes it has assembled a high quality staff
with extensive experience and contacts in the subprime mortgage loan market.
Management believes that important factors influencing success or failure in
the wholesale channel are offering competitive prices, consistent application
of underwriting guidelines, and superior service.
Bulk Acquisitions. The bulk acquisition channel was the first channel
developed by the Company as it requires the least infrastructure to operate
and it allowed the Company to acquire Mortgage Assets very quickly. Although
it generally carries a lower margin than the wholesale channel, from time to
time the Company may still acquire mortgage loans through this channel. In
bulk acquisitions, pools of mortgage loans ranging in size from $2 million to
in excess of $25 million are acquired from large originators of mortgage
loans.
Due diligence is often performed by contract underwriters under the guidance
of the Company's Senior Credit Officer. Personnel for this channel are
centralized in the mortgage operations headquarters with the only field
personnel consisting of the sales force strategically located in select
markets. Through this production channel, the Company is able to quickly
invest its capital in pools of subprime mortgage loans.
40
<PAGE>
Retail Channel. The Company has not yet established a retail or direct
origination channel to the consumer. This is the typical finance company model
with a local office in a strip center and commissioned loan originators.
Retail origination is the most expensive and potentially the most profitable
origination channel. The overhead cost to originate retail mortgage loans can
be as high as four to six percent of the face amount of the loan. However, the
gross profit on such a mortgage loan can be as high as 10 percent of the face
amount of the mortgage loan and the prepayment risk is mitigated due to the
loan being funded at a discount to par. Success in retail origination often
times depends on the branch's ability to generate leads, access to an outlet
to sell mortgage loan products which are attractive to borrowers, and
flexible, common sense underwriting. This segment of the mortgage industry
remains highly fragmented and dominated by local brokers. While the Company
does not have plans to implement a retail production channel initially, it may
test a variety of direct consumer marketing strategies in the future.
Profitability and Capital Allocation by Production Channel. In general, the
Company believes that the closer it gets to the consumer in the mortgage
process chain, the more profitable the production channel will be due to the
elimination of unnecessary intermediaries. While over the long term the
Company believes this to be true, there may be times when market conditions
are such that the bulk acquisition channel (the furthest from the customer) is
the most profitable. In order to properly manage the allocation of capital,
the Company will measure the profitability of each channel on a stand-alone
basis. Direct expenses will be tracked by channel and measured against
mortgage loans originated via each channel.
By measuring each channel independently, the Company intends to avoid
supporting a channel which has been unprofitable over time. This is an
important exercise to go through especially since the Company does not intend
to enter transactions which would result in gains on sales. In addition, by
knowing the profitability of each channel at any given point in time, as well
as on average over a specified time period, the Company can make the proper
decisions in deciding where to invest its capital to obtain the best return
for stockholders.
Underwriting and Quality Control Strategy
Underwriting Guidelines. The Company originates or purchases loans in
accordance with its underwriting guidelines (the "Underwriting Guidelines")
described herein. These Underwriting Guidelines were developed by the
Company's President and Chief Credit Officer utilizing their experience in the
industry. The Underwriting Guidelines are intended to evaluate the credit
history of the potential borrower, the capacity and willingness of the
borrower to repay the loan and the adequacy of the collateral securing the
loan.
The Company underwrites all mortgage loans it originates or purchases
through its wholesale channel. The Company has hired experienced underwriters
who work under the supervision of the Chief Credit Officer. The underwriters
hired by the Company all have substantial experience in the underwriting of
subprime mortgage loans and generally have a minimum of ten years experience.
As of June 30, 1997, the Company employed nine underwriters with an average of
ten years experience in subprime mortgage lending.
Underwriters are given approval authority only after their work has been
reviewed by the Chief Credit Officer for a period of at least two weeks.
Thereafter, the Chief Credit Officer re-evaluates the authority levels of all
underwriting personnel on an ongoing basis. All loans in excess of $350,000
currently require the approval of the Chief Credit Officer. In addition, the
President approves all loans in excess of $750,000.
On a case-by-case basis, exceptions to the Underwriting Guidelines are made
where compensating factors exist. Compensating factors may consist of factors
like length of time in residence, lowering of the borrower's monthly debt
service payments, the loan to value ratio on the loan or other criteria that
in the judgment of the underwriter warrants an exception.
Each loan applicant completes an application that includes information with
respect to the applicants income, assets, liabilities and employment history.
A credit report is also submitted by the broker along with the loan
application which provides detailed information concerning the payment history
of the borrower on all of
41
<PAGE>
their debts. Prior to issuing an approval on the loan, the underwriter runs an
independent credit report to verify that the information submitted by the
broker is still accurate and up-to-date. An appraisal is also required on all
loans and in many cases a review appraisal or second appraisal may be required
depending on the value of the property and the underwriters comfort with the
original valuation. All appraisals are required to conform to the Uniform
Standards of Professional Appraisal Practice adopted by the Appraisal
Standards Board of the Appraisal Foundation and are generally on forms
acceptable to FNMA and FHLMC.
The Underwriting Guidelines include three levels of applicant documentation
requirements, referred to as "Full Documentation", "Limited Documentation",
and "Stated Income". Under the Full Documentation program applicants generally
are required to submit two written forms of verification of stable income for
at least 12 months. Under the Limited Documentation program, one such form of
verification of income is required. Under the Stated Income Documentation
program, an applicant may be qualified based on monthly income as stated in
the loan application.
The Company's categories and criteria for grading the credit history of
potential and the maximum loan to value ratios allowed for each category are
shown below.
<TABLE>
<CAPTION>
A RISK A- RISK B RISK C RISK D RISK
------------- ------------- ------------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
Mortgage
History..... Maximum one Maximum two Maximum three Maximum five Maximum six 30
30-day late 30-day lates 30 day lates 30 day lates day lates,
and no 60-day and no 60-day and one 60 and two 60 three 60 day
lates within lates within day late day lates lates and two
last 12 last 12 within the within the 90 day lates
months months last 12 last 12 within the last
months months 12 months. Must
be current at
time of
origination
Other
Credit...... Limited 30 Limited 60 Limited 60 Limited 90 Discretionary--
day lates day lates day lates day lates credit is
within the within the within the within the generally
last 12 last 12 last 12 last 12 expected to be
months. months months months late pay
Generally
paid as
agreed
Bankruptcy
Filings..... Chapter 13 Chapter 13 Chapter 13 Chapter 13 no Chapter 13 no
must be must be must be seasoning seasoning
discharged discharged discharged required on required on
minimum of 1 minimum of 1 minimum of 1 discharge discharge with
year with year with year with with evidence evidence of
reestablished reestablished reestablished of satisfactory
credit; credit; credit; satisfactory discharge;
Chapter 7 Chapter 7 Chapter 7 discharge; Chapter 7
must be must be must be Chapter 7 minimum
discharged discharged discharged minimum discharge of 1
minimum of 2 minimum of 2 minimum of 2 discharge of year
years with years with years with 2 years
reestablished reestablished reestablished
credit credit credit
Debt to
Service
Ratio....... 45% 45% 50% 55% 60%
Maximum Loan-
to-Value
Ratio:
Full
documentation.. 90% 90% 85% 75% 65%
Limited
documentation.. 85% 80% 75% 70% 60%
Stated
income...... 80% 75% 70% 65% 60%
</TABLE>
42
<PAGE>
Loan Portfolio by Credit Risk Category. The following table sets forth the
Company's mortgage loan portfolio by credit grade as of June 30, 1997, all of
which are non-conforming.
<TABLE>
<CAPTION>
PRINCIPAL PERCENT OF LOAN TO
BALANCE TOTAL VALUE RATIO
(IN
THOUSANDS)
<S> <C> <C> <C>
A........................................ $125,198 43.1% 74.0%
A-....................................... 75,292 25.9 74.5
B........................................ 54,847 18.9 73.3
C........................................ 23,980 8.3 69.1
D........................................ 10,976 3.8 63.5
-------- -----
Total.................................. $290,293 100.0% 73.2%
======== =====
</TABLE>
Geographic Diversification. Close attention is paid to geographic
diversification in managing the Company's credit risk. The Company believes
one of the best tools for managing credit risk is to diversify the markets in
which it originates and purchases mortgage loans. The Company has established
a diversification policy to be followed in managing this credit risk which
states that no one market can represent a percentage of total mortgage loans
owned by the Company higher than twice that market's percentage of the total
national market share. While there generally is some geographic concentration
in mortgage loans originated through the bulk acquisition channel, over time
the Company's mortgage lending operation plans to diversify its credit risk by
selecting target markets through the wholesale channel. Presented below is a
breakdown of the Company's current geographic diversification for both its
wholesale and bulk channels combined as of June 30, 1997.
<TABLE>
<CAPTION>
PRINCIPAL PERCENT
AMOUNT OF TOTAL
(IN
THOUSANDS)
<S> <C> <C>
California............................................. $103,747 35.7%
Illinois............................................... 24,401 8.4
Washington............................................. 20,618 7.1
Utah................................................... 17,954 6.2
Texas.................................................. 17,592 6.1
Others................................................. 105,981 36.5
-------- -----
Total................................................ $290,293 100.0%
======== =====
</TABLE>
Collateral Valuation. Collateral valuation also receives close attention in
the Company's underwriting of its mortgage loans. Given that the Company
primarily lends to subprime borrowers, it places great emphasis on the ability
of collateral to protect against losses in the event of default by borrowers.
The Company has established an appraisal policy as part of its underwriting
guidelines. This policy includes requiring second and/or review appraisals on
certain properties in order to verify the value of the property.
Quality Control. Quality control reviews are conducted to ensure that all
mortgage loans, whether originated or purchased, meet quality standards. The
type and extent of the reviews depend on the production channel through which
the mortgage loan was obtained and the characteristics of the mortgage loan.
The Company reviews a high percentage of mortgage loans with (i) principal
balances in excess of $450,000, (ii) higher loan to value ratios (in excess of
75%), (iii) limited documentation, or (iv) made for "cash out" refinance
purposes. The Company also performs appraisal reviews and compliance reviews
as part of the quality control process to ensure adherence to Company
appraisal policies and state and federal regulations.
43
<PAGE>
Mortgage Loan Servicing Strategy
Overview. The Company plans to acquire the large majority of mortgage loans
it originates and purchases on a servicing released basis and thereby acquire
the servicing rights. Through July 14, 1997, Advanta Mortgage Corp. USA was
acting as sub-servicer for the mortgage loans originated and acquired by the
Company. Effective, July 15, 1997, the Company began servicing its own
mortgage loans. The servicing operation is located in the Westwood, Kansas
office and is currently staffed with 11 employees. Servicing includes
collecting and remitting loan payments, making required advances, accounting
for principal and interest, holding escrow or impound funds for payment of
taxes and insurance, making required inspections of the property, contacting
delinquent borrowers and supervising foreclosures and property disposition in
the event of unremedied defaults in accordance with the Company's guidelines.
The Company's focus as a servicer of subprime mortgage loans is on effective
credit risk. The Company intends to employ the proper resources to mitigate
losses on the mortgage loans being serviced. The Company also believes it can
better manage prepayment risk by servicing its own mortgage loans. Through its
servicing function, the Company intends to pre-select borrowers that have an
incentive to refinance and re-capture those mortgage loans by soliciting the
borrowers directly rather than losing them to another mortgage lender.
Although it is not a primary focus, management estimates that the Company will
be able to effectively service its loans at a cost less than the cost to
outsource this function.
Procedures. In servicing subprime mortgage loans, the Company uses
collection procedures that are generally more stringent than those typically
employed by a servicer of prime mortgage loans consistent with applicable
laws. Management believes one of the first steps in effectively servicing
subprime mortgage loans is to establish contact with the borrower prior to any
delinquency problems. To achieve this objective, each borrower is telephoned
ten days prior to the first payment due date on the mortgage loan. This
initial telephone call serves several purposes: (i) the Company ensures it has
the proper telephone number for the borrower, (ii) the borrower will be aware
of who is servicing the loan, where payment is to be made, and has a contact
to call in the event of any questions, and (iii) the Company is able to stress
to the borrower the importance of making payments in a complete and timely
manner.
The first 30 days of a delinquency are, in the Company's view, the crucial
period for resolving the delinquency. At a minimum, all borrowers who have not
made their mortgage payment by the 10th day of the month in which it is due
receive a call from a collector. Borrowers whose payment history exhibits
signs that the borrower may be having financial difficulty receive more
attention. For example, any borrowers who made their previous months payment
after the late charge date (generally the 15th of the month) receive a call
from a collector no later than the second business day of the current month if
their payment has not yet been received. This allows the Company to be more
aggressive with those borrowers who need the most attention and also focuses
the efforts of the Company's collection staff on the higher risk borrowers.
For accounts that have become 60 days or more delinquent, the collection
follow-up is increased and a full financial analysis of the borrower is
performed, a Notice of Intent to Foreclose is filed, and efforts to establish
a work out plan with the borrower are instituted.
The Company uses reasonable discretion to extend appropriate relief to
borrowers who encounter hardship and who are cooperative and demonstrate
proper regard for their obligation. As servicer, the Company is available to
offer some guidance and make personal contact with delinquent borrowers as
often as possible to seek to achieve a solution that will bring the mortgage
loan current. However, no relief will be granted unless there is reasonable
expectation that the borrower can bring the mortgage loan current within 180
days following the initial default.
If properly managed from both an underwriting and a servicing standpoint,
the Company believes it will be able to keep the level of delinquencies and
losses in its mortgage loans in line with industry standards.
44
<PAGE>
PORTFOLIO MANAGEMENT
The Company builds its Mortgage Asset portfolio from two sources--loans
originated in its mortgage lending operation and purchases in the secondary
mortgage and securities markets. Initially, the portfolio was comprised of
purchased Mortgage Assets. As the Company has developed its infrastructure for
subprime mortgage lending, the Company has relied less on purchasing mortgage
loans in bulk and more on its wholesale origination function. Ultimately, the
Company expects a substantial portion of its portfolio to consist of retained
interests in originated loans collateralizing the Company's structured debt
instruments.
Types of Mortgage Assets
The Mortgage Assets purchased by the Company in the secondary mortgage
market are principally single family mortgage loans and Mortgage Securities
backed by single family mortgage loans, as well as from time to time
multifamily mortgage loans and Mortgage Securities backed by multifamily
mortgage loans and commercial mortgage loans and Mortgage Securities backed by
commercial mortgage loans. Single family mortgage loans are mortgage loans
secured solely by first mortgages or deeds of trust on single family (one-to-
four unit) residences. Multifamily mortgage loans are mortgage loans secured
solely by first mortgages or deeds of trust on multifamily (more than four
units) residential properties. Commercial mortgage loans are secured by
commercial properties. Substantially all of its Mortgage Assets of the Company
bear adjustable interest rates or have a fixed-rate coupon that has been
paired with an interest rate swap, so that the Company has the proper matching
of assets and liabilities.
The Company has not and generally will not acquire residuals, first loss
subordinated bonds rated below BBB, or mortgage securities rated below B. The
Company could retain the subordinate class from mortgage loans securitized
through its taxable affiliate. The Company may acquire interest-only or
principal-only mortgage strips to assist in the hedging of prepayment or other
risks. In addition, as discussed above the Company may create a variety of
different types of assets, including the types mentioned in this paragraph,
through the normal process of securitization of the Company's own Mortgage
Assets. In no event will the Company (exclusive of its taxable affiliates)
acquire or retain any REMIC residual interest that may give rise to excess
inclusion income as defined under Section 860E of the Code. Excess inclusion
income realized by a taxable affiliate is not passed through to stockholders
of the Company. See "Federal Income Tax Considerations--Taxation of Tax--
Exempt Entities."
Single Family Mortgage Loans. In future periods, the Company may acquire or
originate conforming mortgage loans--those that comply with the requirements
for inclusion in a loan guarantee program sponsored by either FHLMC or FNMA.
To date, the Company has acquired or originated nonconforming mortgage loans.
The Company also may acquire FHA Loans or VA Loans, which qualify for
inclusion in a pool of mortgage loans guaranteed by GNMA. Under current
regulations, the maximum principal balance allowed on conforming mortgage
loans ranges from $214,600 ($321,900 for mortgage loans secured by properties
located in either Alaska or Hawaii) for one-unit to $412,450 ($618,675 for
mortgage loans secured by properties located in either Alaska or Hawaii) for
four-unit residential loans. Nonconforming single family mortgage loans are
single family mortgage loans that do not qualify in one or more respects for
purchase by FNMA or FHLMC. The Company expects that a majority of the
nonconforming mortgage loans it purchases will be nonconforming because they
have original principal balances which exceed the requirements for FHLMC or
FNMA programs or generally because they vary in certain other respects from
the requirements of such programs including the requirements relating to
creditworthiness of the mortgagors. A substantial portion of the Company's
nonconforming mortgage loans meet the requirements for sale to national
private mortgage conduit programs in the secondary mortgage market which focus
upon the subprime mortgage lending market.
Multifamily Mortgage Loans. The Company has not, to date, acquired or
originated multifamily mortgage loans. However, these types of loans may be
acquired or originated in future periods. Multifamily mortgage loans generally
involve larger principal amounts per loan than single family mortgage loans
and require more complex credit and property evaluation analysis. Multifamily
mortgage loans share many of the characteristics and risks associated with
commercial mortgage loans and are often categorized as commercial loans rather
than residential
45
<PAGE>
loans. For example, the credit quality of a multifamily mortgage loan
typically depends upon the existence and terms of underlying leases, tenant
credit quality and the historical and anticipated level of vacancies and rents
on the mortgaged property and on the competitive market condition of the
mortgaged property relative to other competitive properties in the same
region, among other factors. Multifamily mortgage loans, however, constitute
"qualified mortgages" for purposes of the REMIC regulations and the favorable
tax treatment associated therewith and, when securitized, certain of the
resulting rated classes of multifamily Mortgage Securities qualify as
"mortgage-related securities" and for the favorable treatment accorded such
securities under the Secondary Mortgage Market Enhancement Act of 1984
("SMMEA").
Mortgage Securities. Mortgage Securities owned by the Company as of and
during the period since inception and through June 30, 1997, have consisted of
mortgage securities issued by corporations sponsored by the United States
government, including FNMA, GNMA and FHLMC. Mortgage Securities owned by the
Company as of June 30, 1997 are detailed in Note 2 to the consolidated
financial statements.
Mortgage Assets purchased by the Company in the future may include Mortgage
Securities as follows:
(1) Single Family and Multifamily Privately Issued Certificates. Single
family and multifamily Privately Issued Certificates are issued by
originators of, investors in, and other owners of mortgage loans, including
savings and loan associations, savings banks, commercial banks, mortgage
banks, investment banks and special purpose "conduit" subsidiaries of such
institutions. Single family and multifamily Privately Issued Certificates
are generally covered by one or more forms of private (i.e., non-
governmental) credit enhancements. Forms of credit enhancements include,
but are not limited to, surety bonds, limited issuer guarantees, reserve
funds, private mortgage guaranty pool insurance, over-collateralization and
subordination.
(2) Agency Certificates. At present, all GNMA Certificates are backed by
single family mortgage loans. FNMA Certificates and FHLMC Certificates may
be backed by pools of single family or multifamily mortgage loans. The
interest rate paid on Agency Certificates may be fixed rate or adjustable
rate.
(3) Commercial Mortgage Securities. To the extent the Company will seek
to acquire any Mortgage Assets either backed by or secured by commercial
property, the Company intends to favor the acquisition of Mortgage
Securities backed by commercial mortgage loans rather than direct
acquisition of commercial mortgage loans. These Mortgage Securities
generally have been structured as Pass-Through Certificates with private
(i.e., non-governmental) credit enhancements or as CMOs. Because of the
great diversity in characteristics of the commercial mortgage loans that
secure or underlie these Mortgage Securities, such securities will also
have diverse characteristics. Although many are backed by large pools of
commercial mortgage loans with relatively small individual principal
balances, these Mortgage Securities may be backed by commercial mortgage
loans collateralized by only a few commercial properties or a single
commercial property. Because the risk involved in single commercial
property financings is highly concentrated, single commercial property
Mortgage Securities to date have tended to be limited to extremely
desirable commercial properties with excellent values and/or lease
agreements with extremely creditworthy and reliable tenants, such as major
corporations.
Commercial Mortgage Loans. The Company will only acquire commercial mortgage
loans when it believes it has the necessary expertise to evaluate and manage
them and only if they are consistent with the company's CAG. Commercial
mortgage loans are secured by commercial properties, such as industrial and
warehouse properties, office buildings, retail space and shopping malls,
hotels and motels, hospitals, nursing homes and senior living centers.
Commercial mortgage loans have certain distinct risk characteristics:
commercial mortgage loans generally lack standardized terms, which may
complicate their structure (although certain of the new conduits are
introducing standard form documents for use in their programs); commercial
mortgage loans tend to have shorter maturities than single family mortgage
loans; they may not be fully amortizing, meaning that they may have a
significant principal balance or "balloon" due on maturity; and commercial
properties, particularly industrial and warehouse properties, are generally
subject to relatively greater environmental risks than non-commercial
properties and the corresponding burdens and costs of compliance with
environmental laws and regulations. To date, the Company has not acquired
commercial mortgage loans.
46
<PAGE>
Asset Acquisition Policies
The Company acquires only those Mortgage Assets in the secondary mortgage
market that it believes it has the necessary expertise to evaluate and manage
and which are consistent with the Company's risk management objectives. The
Company's strategy is to focus primarily on the acquisition of single family
mortgage loans, Single Family mortgage securities, multifamily mortgage loans
and multifamily Mortgage Securities. The Company focuses primarily on the
acquisition of floating-rate and adjustable-rate assets, so that assets and
liabilities remain matched. The Company's asset acquisition strategy will
change over time as market conditions change and as the Company evolves.
The Company may also purchase the stock of other mortgage REITs or similar
companies when the Company believes that such purchases will yield attractive
returns on capital employed. The Company does not, however, presently intend
to invest in the securities of other issuers for the purpose of exercising
control or to underwrite securities of other issuers.
The Company generally intends to hold Mortgage Assets to maturity. In
addition, the REIT provisions of the Code limit in certain respects the
ability of the Company to sell Mortgage Assets. See "Federal Income Tax
Considerations." Management may decide to sell assets from time to time,
however, for a number of reasons, including, without limitation, to dispose of
an asset as to which credit risk concerns have arisen, to reduce interest rate
risk, to substitute one type of Mortgage Asset for another to improve yield or
to maintain compliance with the 55 percent requirement under the Investment
Company Act, and generally to restructure the balance sheet when management
deems such action advisable. Management will select any Mortgage Assets to be
sold according to the particular purpose such sale will serve. The Board of
Directors has not adopted a policy that would restrict management's authority
to determine the timing of sales or the selection of Mortgage Assets to be
sold.
Financing for Mortgage Lending Operations and Mortgage Security Acquisitions
The Company finances its mortgage loan originations and purchases through
interim financing facilities such as bank warehouse credit lines and reverse
repurchase agreements. A reverse repurchase agreement is a borrowing device
evidenced by an agreement to sell securities or other assets to a third-party
and a simultaneous agreement to repurchase them at a specified future date and
price, the price differential constituting interest on the borrowing.
The Company's subprime mortgage lending operation is a capital intensive
business. Depending on the type of product originated and the production
channel, the amount of capital required as a percentage of the balance of
mortgage loans originated may range from 6 percent to 12 percent. For
illustration purposes only, based on a hypothetical monthly volume of $25
million, this will equate to a capital requirement of $1.5 to $3 million per
month, and on a hypothetical volume of $50 million, this requirement doubles
to $3 to $6 million per month. The Company's subprime mortgage lending
operation is managed through a taxable affiliate, which provides the Company
the flexibility to sell its mortgage loan production as whole loans or in the
form of pass-through securities in the event it encounters restrictions in
accessing the capital markets.
To mitigate the interest rate risk in its mortgage lending operation, the
Company enters into transactions designed to hedge interest rate risk, which
may include mandatory and optional forward selling of mortgage loans or
Mortgage Assets, interest rate caps, floors and swaps, buying and selling of
futures and options on futures, and acquisition of interest-only REMIC regular
interests. The nature and quantity of these hedging transactions will be
determined by the Company based on various factors, including market
conditions and the expected volume of mortgage loan purchases. The Company
believes its strategy of issuing long-term structured debt securities will
also assist it in managing interest rate risk. See "Business--Portfolio
Management--Interest Rate Risk Management."
Acquisitions of Mortgage Securities are generally financed using repurchase
agreements. A summary of amounts outstanding under all borrowing arrangements
as of June 30, 1997 is included in Note 4 to the consolidated financial
statements.
47
<PAGE>
Mortgage Loans Held as Collateral for Structured Debt
The Company intends to securitize the subprime mortgage loans produced by
its mortgage lending operation as part of its overall asset/liability
strategy. Securitization is the process of pooling mortgage loans and issuing
equity securities, such as mortgage pass throughs, or debt securities, such as
Collateralized Mortgage Obligations ("CMOs"). The Company intends to
securitize by issuing structured debt. Under this approach, for accounting
purposes the mortgage loans so securitized remain on the balance sheet as
assets and the debt obligations (i.e., the CMOs) appear as liabilities. A
securitization, as executed by the Company, results only in rearranging the
Company's borrowings, as proceeds from the structured debt issuance are
applied against preexisting borrowings (i.e., advances under the warehouse
line of credit or borrowings under repurchase agreements). Issuing structured
debt in this matter serves to lock in less expensive, non-recourse long-term
financing that better matches the terms of the loans serving as collateral for
the debt.
Proceeds from such securitizations will be available to support new mortgage
loan originations. Securitizations are long-term financing and are not subject
to a margin call if a rapid increase in rates would reduce the value of the
underlying mortgages.
The Company's investment in retained interests under securitizations, as
discussed above, reflects the excess of the mortgage loan collateral over the
related liabilities on the balance sheet. The resulting stream of expected
"spread" income will be recognized over time through the tax-advantaged REIT
structure. Other forms of securitizations may also be employed from time to
time under which a "sale" of interests in the mortgage loans occurs and a
resulting gain or loss is reflected for accounting purposes at the time of
sale. Under this form, only the net retained interest in the securitized
mortgage loans remains on the balance sheet. The Company anticipates such
sales will generally be made through one or more of its taxable affiliates.
See "Interest Rate Risk Management" below. The Company may conduct certain of
its securitization activities through one or more taxable affiliates or
Qualified REIT Subsidiaries formed for such purpose.
The Company expects that its retained interests in its securitizations,
regardless of the form used, will be subordinated to the classes of securities
issued to investors in such securitizations with respect to losses of
principal and interest on the underlying mortgage loans. Accordingly, any such
losses incurred on the underlying mortgage loans will be applied first to
reduce the remaining amount of the Company's retained interest, until reduced
to zero. Thereafter, any further losses would be borne by the investors or, if
used, the monoline insurers in such securitizations rather than the Company.
The Company will structure its securitizations so as to avoid the
attribution of any excess inclusion income to the Company's stockholders. See
"Federal Income Tax Considerations--Taxation of the Company's Stockholders."
The Company's management is experienced in the securitization of subprime and
other single family residential mortgage loans.
The Company plans to finance the retained interests in its securitizations
through a combination of equity and secured debt financings.
Credit Risk Management Policies
Mortgage Loans. With respect to its mortgage loan portfolio, the Company
attempts to control and mitigate credit risk through:
(i) the underwriting of each loan to ensure it meets the guidelines
established;
(ii) geographic diversification of its loan originations and purchases;
(iii) the use of early intervention, aggressive collection and loss
mitigation techniques in the servicing process;
(iv) the use of insurance and the securitization process to limit the
amount of credit risk that it is exposed to on its retained interests
in securitizations; and
(v) maintenance of appropriate capital reserve levels.
48
<PAGE>
A summary of the credit quality and diversification of the Company's loan
portfolio as of June 30, 1997 is presented in "Business--Mortgage Lending
Operations."
Secondary Market Acquisitions. With respect to its Mortgage Assets purchased
in the secondary market, the Company reviews the credit risk associated with
each investment and determines the appropriate allocation of capital to apply
to such investment under its CAG. Because the risks presented by single
family, multifamily and commercial Mortgage Assets are different, the Company
analyzes the risk of loss associated with such Mortgage Assets separately. In
addition, the Company attempts to diversify its portfolio to avoid undue
geographic, issuer, industry and certain other types of concentrations. The
Company attempts to obtain protection against some risks from sellers and
servicers through representations and warranties and other appropriate
documentation. The Board of Directors will monitor the overall portfolio risk
and determine appropriate levels of provision for losses.
With respect to its purchased Mortgage Assets, the Company is exposed to
various levels of credit and special hazard risk, depending on the nature of
the underlying Mortgage Assets and the nature and level of credit enhancements
supporting such securities. Each of the Mortgage Assets acquired by the
Company will have some degree of protection from normal credit losses. Credit
loss protection for Privately Issued Certificates is achieved through the
subordination of other interests in the pool to the interest held by the
Company, through pool insurance or through other means. The degree of credit
protection varies substantially among the Privately Issued Certificates held
by the Company. While Privately Issued Certificates held by the Company will
have some degree of credit enhancement, the majority of such assets are, in
turn, subordinated to other interests. Thus, should such a Privately Issued
Certificate experience credit losses, such losses could be greater than the
Company's pro rata share of the remaining mortgage pool, but in no event could
exceed the Company's investment in such Privately Issued Certificate.
With respect to purchases of Mortgage Assets in the form of mortgage loans,
the Company has developed a quality control program to monitor the quality of
loan underwriting at the time of acquisition and on an ongoing basis. The
Company will conduct, or cause to be conducted, a legal document review of
each mortgage loan acquired to verify the accuracy and completeness of the
information contained in the mortgage notes, security instruments and other
pertinent documents in the file. As a condition of purchase, the Company will
select a sample of mortgage loans targeted to be acquired, focusing on those
mortgage loans with higher risk characteristics, and submit them to a third
party, nationally recognized underwriting review firm for a compliance check
of underwriting and review of income, asset and appraisal information. In
addition, the Company or its agents will underwrite all multifamily and
commercial mortgage loans. During the time it holds mortgage loans, the
Company will be subject to risks of borrower defaults and bankruptcies and
special hazard losses (such as those occurring from earthquakes or floods)
that are not covered by standard hazard insurance. The Company will not
generally obtain credit enhancements such as mortgage pool or special hazard
insurance for its mortgage loans, although individual loans may be covered by
FHA insurance, VA guarantees or private mortgage insurance and, to the extent
securitized into Agency Certificates, by such government sponsored entity
obligations or guarantees.
49
<PAGE>
Capital and Leverage Policies
Capital Allocation Guidelines (CAG). The Company's goal is to strike a
balance between the under-utilization of leverage, which reduces potential
returns to stockholders, and the over-utilization of leverage, which could
reduce the Company's ability to meet its obligations during adverse market
conditions. The Company's CAG have been approved by the Board of Directors.
The CAG are intended to keep the Company properly leveraged by (i) matching
the amount of leverage allowed to the riskiness (return and liquidity) of an
asset and (ii) monitoring the credit and prepayment performance of each
investment to adjust the required capital. This analysis takes into account
the Company's various hedges and other risk programs discussed below. In this
way, the use of balance sheet leverage will be controlled. The following table
presents the Company's CAG for the following levels of capital for the types
of assets it owns.
<TABLE>
<CAPTION>
(A) (B) (C) (D) (E) (F) (G)
(C + D) (B X E) (A + F)
MINIMUM ESTIMATED DURATION LIQUIDITY TOTAL EQUITY CAG
ASSET CATEGORY LENDER PRICE SPREAD SPREAD SPREAD CUSHION EQUITY
- -------------- HAIRCUT DURATION CUSHION CUSHION CUSHION (% OF MV) REQUIRED
<S> <C> <C> <C> <C> <C> <C> <C>
Agency-issued:
Conventional ARMs...... 3.00% 3.50% 50 -- 50 1.75% 4.75%
GNMA ARMs.............. 3.00 4.50 50 -- 50 2.25 5.25
Mortgage loans.......... 3.00 3.00 100 50 150 4.50 7.50
Hedging instruments..... 100.00 -- -- -- -- -- 100.00
</TABLE>
- --------
(a) Indicates the minimum amount of equity a typical lender would require with
an asset from the applicable asset category. There is some variation in
haircut levels among lenders, from time to time. From the lenders
perspective, this is a "cushion" to protect capital in case the borrower
is unable to meet a margin call. The size of the haircut depends on the
liquidity and price volatility of the asset. Agency securities are very
liquid, with price volatility in line with the fixed income markets which
means a lender requires a smaller haircuts. On the other extreme, "B"
rated securities and securities not registered with the Commission are
substantially less liquid, and have more price volatility than Agency
securities, which results in a lender requiring a larger haircut.
Particular securities that are performing below expectations would also
typically require a larger haircut.
(b) Duration is the price-weighted average term to maturity of financial
instruments' cash flows.
(c) Estimated cushion need to protect against investors requiring a higher
return compared to Treasury securities, assuming constant interest rates.
(d) Estimated cushion required due to a potential imbalance of supply and
demand resulting in a wider bid/ask spread.
(e) Sum of duration (c) and liquidity (d) spread cushions.
(f) Product of estimated price duration (b) and total spread cushion. The
additional equity, as determined by management, to reasonably protect the
Company from lender margin calls. The size of each cushion is based on
managements experience with the price volatility and liquidity in the
various asset categories. Individual assets that have exposure to
substantial credit risk will be measured individually and the leverage
adjusted as actual delinquencies, defaults and losses differ with
management's expectations.
(g) The sum of the minimum lender haircut (a) and the Company's equity cushion
(f).
Implementation of the CAG--Mark to Market. Each quarter, the Company marks
its assets to market. This process consists of two steps: (i) valuing the
Company's Mortgage Assets acquired in the secondary market and (ii) valuing
the Company's non-security investments, such as its mortgage loans. For the
purchased Mortgage Assets portfolio, the Company obtains market quotes for its
Mortgage Assets from traders that make markets in securities similar to those
in the Companys portfolio. Market values for the Company's mortgage loan
portfolio is calculated internally using assumptions for losses, prepayments
and discount rates.
The face amount of all financing used for securities and mortgage loans is
subtracted from the current market value of the Company's assets (and hedges).
This is the current market value of the Company's equity. This number is
compared to the required capital as determined by the CAG. If the actual
equity of the Company falls below the capital required by the CAG, the Company
must prepare a plan to bring the actual capital above the level required by
the CAG.
Each quarter, management presents to the Board of Directors the results of
the CAG compared to actual equity. Management may propose changing the capital
required for a class of investments or for an individual investment based on
its prepayment and credit performance relative to the market and the ability
of the Company to predict or hedge the risk of the asset.
50
<PAGE>
Interest Rate Risk Management
The Company addresses the interest rate risk to which its mortgage portfolio
is subject in part through its securitization strategy, which is designed to
provide long-term financing for its mortgage loan production while maintaining
a consistent spread in a variety of interest rate environments. In order to
address any remaining mismatch of assets and liabilities, the Company follows
the hedging section of its investment policy, as approved by the Board.
Specifically, the Company's interest rate risk management program will be
formulated with the intent to offset the potential adverse effects resulting
from rate adjustment limitations on its mortgage loans and Mortgage Assets and
the differences between interest rate adjustment indices and interest rate
adjustment periods of its adjustable-rate mortgage loans and related
borrowings.
The Company uses interest rate caps and interest rate swaps and may, from
time to time, purchase interest-only REMIC regular interests and similar
instruments to attempt to mitigate the risk of the cost of its variable rate
liabilities increasing at a faster rate than the earnings on its assets during
a period of rising rates. In this way, the Company intends generally to hedge
as much of the interest rate risk as management determines is in the best
interests of the stockholders of the Company, given the cost of such hedging
transactions and the need to maintain the Company's status as a REIT. See
"Federal Income Tax Considerations-Qualification as a REIT--Sources of
Income." This determination may result in management electing to have the
Company bear a level of interest rate risk that could otherwise be hedged when
management believes, based on all relevant facts, that bearing such risk is
advisable. The Company may also, to the extent consistent with its compliance
with the REIT gross income tests and applicable law, utilize financial futures
contracts, options and forward contracts as a hedge against future interest
rate changes.
The Company seeks to build a balance sheet and undertake an interest rate
risk management program which is likely, in management's view, to enable the
Company to generate positive earnings and maintain an equity liquidation value
sufficient to maintain operations given a variety of potentially adverse
circumstances. Accordingly, the hedging program addresses both income
preservation, as discussed in the first part of this section, and capital
preservation concerns.
Interest rate cap agreement are legal contracts between the Company and a
third party firm (the "counter-party"). The counter-party agrees to make
payments to the Company in the future should the one or three month LIBOR
interest rate rise above the "strike" rate specified in the contract. The
Company makes monthly premium payments to the counterparty under the contract.
Each contract has a fixed "notional face" amount, on which the interest is
computed, and a set term to maturity. Should the reference LIBOR interest rate
rise above the contractual strike rate, the Company will earn cap income.
Payments on an annualized basis equal the contractual notional face amount
times the difference between actual LIBOR and the strike rate.
Interest rate swap agreements entered into by the Company through June 30,
1997 stipulate that the Company will pay a fixed rate of interest to the
counterparty. In return, the counterparty pays the Company a variable rate of
interest based on the notional amount. The agreements have fixed notional
amounts, on which the interest is computed, and set terms to maturity.
In all of its interest rate risk management transactions, the Company
follows certain procedures designed to limit credit exposure to
counterparties, including dealing only with counterparties whose financial
strength meets the Company's requirements. See "Risk Factors-Operations Risks
and Risks of Failing to Effectively Hedge Against Interest Rate Changes; Risks
of Losses Associated with Hedging; Counterparty Risks."
In its assessment of the interest sensitivity and as an indication of the
Company's exposure to interest rate risk, management relies on models of
financial information in a variety of interest rate scenarios. Using these
models, the fair value and interest rate sensitivity of each financial
instrument (or groups of similar instruments) is estimated, and then
aggregated to form a comprehensive picture of the risk characteristics of the
balance sheet. Table X depicts the interest sensitivity of the Company's
financial instruments as of June 30, 1997. These amounts contain estimates and
assumptions regarding prepayments and future interest rates. Actual economic
conditions may produce results significantly different from the results
depicted below. However, management believes the interest sensitivity model
used is a valuable tool to manage the Company's exposure to interest rate
risk.
51
<PAGE>
INTEREST RATE SENSITIVITY
JUNE 30, 1997
<TABLE>
<CAPTION>
BASIS POINT INCREASE (DECREASE)
IN INTEREST RATE(A)
-------------------------------------------
(100) BASE(B) 100 ELASTICITY(E)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Market value of:
Assets........................... $616,216 $608,410 $597,554 1.53%
Liabilities...................... 572,576 570,004 567,466 0.46%
Interest rate agreements......... (2,692) 1,180 5,657 1.57%
-------- -------- --------
Cumulative change in value(B)..... $ 1,362 -- $ (3,841)
======== ======== ========
Percent change from base
assets(C)........................ 0.22% -- (0.63%) 0.43%
======== ======== ======== ====
Percent change of capital(D)...... 2.94% -- (8.29%) 5.61%
======== ======== ======== ====
</TABLE>
- --------
(A)Value of asset, liability or interest rate agreement in a parallel shift in
the yield curve, up and down one percent.
(B)Total change in estimated market value, in dollars, from "base." "Base" is
the estimated market value at June 30, 1997.
(C)Total change in estimated market value, as a percent, from base.
(D)Total change in estimated market value as a percent of total stockholders'
equity at June 30, 1997.
(E)Elasticity is the average percentage change in estimated market value from
base over a range of up and down interest rate scenarios.
The Company's investment policy sets the following general goals:
(1) Maintain the net interest margin between assets and liabilities, and
(2) Diminish the effect of changes in general interest rate levels on the
market value of the Company's assets.
The above interest sensitivity analysis displays an estimate of the market
value of the Company's assets, liabilities and interest rate agreements as of
June 30, 1997. The analysis also shows the estimated changes in the fair value
of financial instruments should interest rates increase or decrease one
percent (100 basis points). Management uses this information to determine the
impact on stockholders' equity of changing interest rates and to monitor the
effectiveness of the interest rate risk management techniques discussed above.
Although management evaluates the portfolio using interest rate increases and
decreases greater than one percent, management focuses on the one percent
increase as any further increase in interest rates would require action to
adjust the portfolio to adapt to changing rates. The Company's investment
policy allows for no more than a ten percent change in the net fair value of
assets when interest rates rise or fall by one percent.
Another measure of interest risk is elasticity, a refinement of duration.
Duration is the price-weighted average term to maturity of financial
instruments' cash flows. Elasticity is the change, expressed as a percent, in
market value of a financial instrument, given a 100 basis point change in
interest rates. Financial companies with relatively long duration assets
financed by shorter duration liabilities generally experience market value
losses when rates increase and market value gains when rates decrease. This
pattern is complicated because many mortgages have prepayment options which
result in shorter mortgage durations as these prepayment option are exercised
in falling rate environment. Management's dynamic hedging strategies allow the
Company to match the elasticity of its assets with the elasticity of its
liabilities.
Prepayment Risk Management
The Company seeks to minimize the effects of faster or slower than
anticipated prepayment rates in its Mortgage Assets portfolio by originating
mortgage loans with prepayment penalties, utilizing various financial
instruments and the production of new mortgage loans as a hedge against
prepayment risk, and capturing through
52
<PAGE>
its servicing of the mortgage loans a large portion of those loans which are
refinanced. Prepayment risk is monitored by management and through periodic
review of the impact of a variety of prepayment scenarios on the Company's
revenues, net earnings, dividends, cash flow and net balance sheet market
value.
Although the Company believes it has developed a cost-effective
asset/liability management program to provide a level of protection against
interest rate and prepayment risks, no strategy can completely insulate the
Company from the effects of interest rate changes, prepayments and defaults by
counterparties. Further, certain of the federal income tax requirements that
the Company must satisfy to qualify as a REIT limit the Company's ability to
fully hedge its interest rate and prepayment risks. See "Federal Income Tax
Considerations--Qualification as a REIT--Sources of Income."
Taxable Affiliates
The Company has implemented, and will continue to implement, portions of its
business strategy from time to time through one of its taxable affiliates.
Other taxable affiliates may be used to implement future business strategies.
For a REIT, a taxable affiliate refers to a corporation that is a consolidated
subsidiary for purposes of financial reporting under GAAP because the REIT is
entitled to up to 99 percent of dividends distributed by such corporation. The
voting common stock of such corporation, however, is owned by persons other
than the REIT due to the provisions of the Code limiting ownership by REITs of
the voting stock of non-REIT qualifying entities. See "Federal Income Tax
Considerations--Qualification as a REIT--Nature of Assets." In the Company's
case, the voting common stock of Holding, its taxable affiliate holding
company, is held by Messrs. Hartman and Anderson. See "Certain Transactions."
Such common stock will at all times have at least one percent of the dividends
and liquidation rights of Holding. It is contemplated that the Company would
hold a class of preferred stock of the taxable affiliate holding company,
which preferred stock is entitled to substantially all (up to 99 percent) of
the dividends and liquidation proceeds distributable from Holding.
Taxable affiliates are not Qualified REIT Subsidiaries and would be subject
to federal and state income taxes. In order to comply with the nature of asset
tests applicable to the Company as a REIT, as of the last day of each calendar
quarter, the value of the securities of any such affiliate held by the Company
must be limited to less than five percent of the value of the Company's total
assets and no more than ten percent of the voting securities of any such
affiliate may be owned by the Company. See "Federal Income Tax
Considerations--Qualification as a REIT--Nature of Assets." Taxable affiliates
have not elected REIT status and distribute any net profit after taxes to the
Company and its other stockholders. Any dividend income received by the
Company from any such taxable affiliate (combined with all other income
generated from the Company's assets, other than Qualified REIT Assets) must
not exceed 25 percent of the gross income of the Company. See "Federal Income
Tax Considerations--Qualification as a REIT--Sources of Income." Before the
Company forms any additional taxable affiliate corporations, the Company will
obtain an opinion of counsel to the effect that the formation and contemplated
method of operation of such corporation will not cause the Company to fail to
satisfy the nature of assets and sources of income tests applicable to it as a
REIT.
Properties
The Company's executive and administrative offices are located in Westwood,
Kansas, and consist of approximately 7,000 square feet. The lease on the
premises expires February 2000. The current annual rent for these offices is
approximately $101,000.
The Company also leases space for its mortgage lending operations in Irvine,
California. As of June 30, 1997, these offices consisted of approximately
5,000 square feet. The lease on the premises expires November 2001 and the
current annual rent is approximatley $84,000.
Legal Proceedings
The Company occasionally becomes involved in litigation arising in the
normal course of business. Management believes that any liability with respect
to such legal actions, individually or in the aggregate, will not have a
material adverse effect on the Company's financial position or results of
operations.
53
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company and their positions are
as follows:
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Scott F. Hartman(1)..... Chairman of the Board, Secretary and Chief Executive Officer
W. Lance Anderson(1).... Director, President and Chief Operating Officer
Mark J. Kohlrus......... Senior Vice President, Treasurer and Chief Financial Officer
Edward W.
Mehrer(2)(3)(4)........ Director
Gregory T.
Barmore(2)(4).......... Director
Jenne K. Britell(2)(3).. Director
</TABLE>
- --------
(1)Founder of the Company.
(2)Independent Director.
(3)Member of the Audit Committee.
(4)Member of the Compensation Committee.
Information regarding the business background and experience of the
Company's directors and officers follows:
Directors and Executive Officers
SCOTT F. HARTMAN, age 38, is Chairman of the Board of Directors and Chief
Executive Officer. His main responsibilities are to manage the Company's
portfolio of investments, interact with the capital markets and oversee the
securitization of the Company's mortgage loan production. Mr. Hartman most
recently served as Executive Vice President of Dynex Capital, Inc., (Dynex)
formerly Resource Mortgage Capital, Inc., a New York Stock Exchange listed
Real Estate Investment Trust. His responsibilities while at Dynex included
managing a $4 billion investment portfolio, overseeing the securitization of
mortgage loans originated through Dynex's mortgage operation and the
administration of the securities issued by Dynex. Mr. Hartman left Dynex in
June 1996 to pursue this opportunity. Prior to joining Dynex in February 1995,
Mr. Hartman served as a consultant to Dynex for three years during which time
he was involved in designing and overseeing the development of the Dynex's
analytical and securities structuring system.
W. LANCE ANDERSON, age 37, is President and Chief Operating Officer of the
Company and is a member of the Board of Directors. His main responsibility is
to manage the Company's mortgage origination and servicing operations. Mr.
Anderson most recently served as Executive Vice President of Dynex. In
addition, Mr. Anderson was President and Chief Executive Officer of Dynex's
Single Family mortgage operation, Saxon Mortgage. In this role he was
responsible for the origination, underwriting, servicing, quality control and
pricing functions for Saxon. He served in this capacity for two years prior to
which he was Executive Vice President in charge of production for the Single
Family operation. Mr. Anderson served from October 1989 at Dynex where he was
responsible for the start up of the Single Family operation, building it from
a five-person company to become the fourth largest conduit in the country with
annual fundings in excess of $5 billion in a matter of two years. Mr. Anderson
was also responsible for re-focusing the conduit on the subprime mortgage
market in late 1993 and by the end of 1994 had established it as one of the
five largest originators of subprime mortgage loans in the country with annual
originations in excess of $1 billion.
MARK J. KOHLRUS, age 38, is Senior Vice President, Treasurer and Chief
Financial Officer. In that role, Mr. Kohlrus is responsible for all accounting
and finance functions, including external reporting and compliance with REIT
regulations. Prior to his joining the Company, Mr. Kohlrus was employed by the
public accounting firm of KPMG Peat Marwick LLP (KPMG) in Kansas City,
Missouri for nearly 15 years. During his tenure with KPMG, Mr. Kohlrus worked
extensively in the firm's Financial Services practice and was involved in
several public stock and debt offerings.
54
<PAGE>
EDWARD W. MEHRER, age 58, is Chief Financial Officer of Cydex, a
pharmaceutical company based in Overland Park, Kansas. Mr. Mehrer was
previously associated with Hoechst Marion Roussel (Marion), formerly Marion
Merrell Dow, Inc., an international pharmaceutical company, for approximately
ten years until his retirement in December 1995. From December 1991, he served
as Executive Vice President, Chief Financial Officer and a Director of Marion.
Prior to that position, he served in a number of financial and administrative
positions. Prior to joining Marion, Mr. Mehrer was a partner with the public
accounting firm of Peat Marwick Mitchell & Co. in Kansas City, Missouri.
GREGORY T. BARMORE, age 54, was most recently Chairman of the Board of GE
Capital Mortgage Corporation (GECMC) headquartered in Raleigh, North Carolina.
He was responsible for overseeing the strategic development of GECMC's
residential real estate-affiliated financial businesses, including mortgage
insurance, mortgage services and mortgage funding. Prior to joining GECMC in
1986, Mr. Barmore was Chief Financial Officer of Employers Reinsurance
Corporation (ERC), one of the nation's largest property and casualty
reinsurance companies and also a subsidiary of GE Capital. Prior to his
appointment at ERC, he held a number of financial and general management
positions within GE. Mr. Barmore was selected to serve on the Company's Board
as an Independent Director without regard to the GE Capital investment and
accordingly there are no arrangements with GE Capital or its affiliates
regarding his term of office or other aspects of his service on the Board.
JENNE K. BRITELL, age 55, has been President and General Manager of G.E.
Capital Mortgage Services, Inc. (GECMS) since July 1996. Before joining GECMS,
she was Executive Vice President and Chief Lending Officer of Dime Savings
Bank of New York, FSB, the nation's fifth largest thrift, for three years.
Prior to these positions she was Chairman and Chief Executive Officer of
HomePower, Inc, an international consulting firm, from March 1990 to April
1993. She also served as President of the Polish American Mortgage Bank,
Warsaw, Poland, the first private residential construction and mortgage
lending institution based on Western models, in Eastern Europe.
Other Senior Officers
JAMES H. ANDERSON, age 34, is Senior Vice President and National Sales
Manager. His primary responsibilities include overseeing the Company's overall
marketing efforts, including managing the sales force of account executives.
Prior to joining NovaStar in November 1996, Mr. Anderson was President of his
own marketing consulting business. From August 1992 through September 1996,
Mr. Anderson was employed by Saxon, where he served as Vice President of
Marketing, in charge of the Western Region of the United States. In addition,
Mr. Anderson was in charge of Saxon's national sales force for correspondent
lending.
MANUAL X. PALAZZO, age 47, is Senior Vice President and Chief Credit
Officer. His primary responsibility is to manage the Company's underwriting
and funding departments. Prior to joining NovaStar in December 1996, Mr.
Palazzo was Senior Vice President of Credit and Administration of Long Beach
Mortgage Company since October 1995. From May 1994 Mr. Palazzo was with
Household Financial as Director of Underwriting. Prior to his tenure at
Household Mr. Palazzo spent eight years as manager of the wholesale lending
business for Novus Financial. Mr. Palazzo has been involved in the consumer
finance industry since 1972.
CHRISTOPHER S. MILLER, age 32, is Senior Vice President and Servicing
Manager. Mr. Miller is a former Vice President of Option One Mortgage
Corporation, a subsidiary of Fleet Mortgage Corporation. From July 1995 to
March 1997 Mr. Miller's responsibilities included managing the Collections
Department, Customer Service Department, Escrow Analysis, Payoff Department,
and Reconveyance. Prior to his tenure at Option One Mortgage in 1995, Mr.
Miller spent over seven years at Novus Financial Corporation, a subsidiary of
Dean Witter Financial Services, where he managed multiple servicing
departments. Mr. Miller brings to NovaStar a diverse servicing background with
an emphasis on default management.
55
<PAGE>
TERMS OF DIRECTORS AND OFFICERS
The Company's Board of Directors consists of such number of persons as shall
be fixed by the Board of Directors from time to time by resolution to be
divided into three classes, designated Class I, Class II and Class III, with
each class to be as nearly equal in number of directors as possible. Currently
there are five directors. Mr. Mehrer is a Class I director, Mr. Anderson and
Mr. Barmore are Class II directors and Mr. Hartman and Ms. Britell are Class
III directors. Class I, Class II and Class III directors will stand for
reelection at the annual meetings of stockholders held in 1997, 1998 and 1999,
respectively. At each annual meeting, the successors to the class of directors
whose term expires at that time are to be elected to hold office for a term of
three years, and until their respective successors are elected and qualified,
so that the term of one class of directors expires at each such annual
meeting. The Company intends to maintain the composition of the Board so that
there will be no more than six directors, with a majority of Independent
Directors at all times after the issuance of the Units, each of whom shall
serve on the Audit and/or Compensation Committees. Ms. Britell joined the
Board as the GE Capital nominee. Such nominee will serve as a Class III
director with a term running until the 1999 annual meeting of stockholders. In
the case of any vacancy on the Board of Directors, including a vacancy created
by an increase in the number of directors, the vacancy may be filled by
election of the Board of Directors or the stockholders, with the director so
elected to serve until the next annual meeting of stockholders (if elected by
the Board of Directors) or for the remainder of the term of the director being
replaced (if elected by the stockholders); any newly-created directorships or
decreases in directorships are to be assigned by the Board of Directors so as
to make all classes as nearly equal in number as possible. Directors may be
removed only for cause and then only by vote of a majority of the combined
voting power of stockholders entitled to vote in the election for directors.
Subject to the voting rights of the holders of the Preferred Stock, the
Charter may be amended by the vote of a majority of the combined voting power
of stockholders, provided that amendments to the Article dealing with
directors may only be amended if it is advised by at least two-thirds of the
Board of Directors and approved by vote of at least two-thirds of the combined
voting power of stockholders. The effect of the foregoing as well as other
provisions of the Company's Charter and Bylaws may discourage takeover
attempts and make more difficult attempts by stockholders to change
management. Prospective investors are encouraged to review the Charter and
Bylaws in their entirety.
The Bylaws of the Company provide that, except in the case of a vacancy, a
majority of the members of the Board of Directors will at all times be
Independent Directors. Independent Directors are defined as directors who are
not officers or employees of the Company or any affiliate or subsidiary of the
Company. GE Capital and its affiliates are expressly deemed not to be
affiliates of the Company for this purpose. Vacancies occurring on the Board
of Directors among the Independent Directors may be filled by a vote of a
majority of the remaining directors, including a majority of the remaining
Independent Directors. Officers are elected annually and serve at the
discretion of the Board of Directors. There are no family relationships
between the executive officers or directors.
COMMITTEES OF THE BOARD
Audit Committee. The Company has established an Audit Committee composed of
two Independent Directors. The Audit Committee makes recommendations
concerning the engagement of independent public accountants, review with the
independent public accountants the plans and results of any audits, review
other professional services provided by the independent public accountants,
review the independence of the independent public accountants, consider the
range of audit and non-audit fees and review the adequacy of the Company's
internal accounting controls.
Compensation Committee. The Company has established a Compensation Committee
composed of two Independent Directors. The Compensation Committee determines
the compensation of the Company's executive officers.
Other Committees. The Board of Directors may establish other committees as
deemed necessary or appropriate from time to time, including, but not limited
to, an Executive Committee of the Board of Directors.
56
<PAGE>
COMPENSATION OF DIRECTORS
The Company pays Independent Directors $10,000 per year plus $500 for each
meeting attended in person. Independent Directors also receive automatic stock
options pursuant to the Company's Stock Option Plan. However, as the GE
Capital nominee, Ms. Britell does not receive any compensation (including fees
and stock options) for her services on the Board of Directors. See "--
Executive Compensation--Stock Option Plan--Automatic Grants to Non-Employee
Directors." None of the directors of the Company has received any separate
compensation for service on the Board of Directors or on any committee
thereof. In addition, each Independent Director has been granted options to
purchase 5,000 shares of Common Stock at the fair market value of the Common
Stock upon becoming a director and options to purchase 2,500 shares at the
fair market value of the Common Stock on the day after each annual meeting of
stockholders. All directors receive reimbursement of reasonable out-of-pocket
expenses incurred in connection with meetings of the Board of Directors. No
director who is an employee of the Company will receive separate compensation
for services rendered as a director.
COMPENSATION COMMITTEE INTERLOCKS
No interlocking relationship exists between the Company's Board of Directors
or officers responsible for compensation decisions and the board of directors
or compensation committee of any other company, nor has any such interlocking
relationship existed in the past.
EXECUTIVE COMPENSATION
The objective of senior management in constructing its own compensation
packages as well as those of all the managers of the Company is to align the
interests of management as closely as possible with those of the stockholders.
This is accomplished by basing a large percentage of key managers'
compensation on the profitability of the Company (measured by return on
stockholders' equity) and the stock price.
EXECUTIVE OFFICER SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
-------------------
SECURITIES
NAME AND POSITION OTHER ANNUAL UNDERLYING ALL OTHER
- ----------------- YEAR SALARY BONUS COMPENSATION OPTIONS(#) DER'S(3) COMPENSATION
<S> <C> <C> <C> <C> <C> <C> <C>
Scott F. Hartman(1)..... 1996 $70,000 -- -- 144,666 -- --
Chairman of the Board,
Secretary and Chief
Executive Officer
W. Lance Anderson(1).... 1996 70,000 -- -- 144,666 -- --
President and Chief
Operating Officer
Mark J. Kohlrus(2)...... 1996 4,000 -- -- 10,000 -- --
Senior Vice President,
Treasurer and Chief
Financial Officer
</TABLE>
- --------
(1) Mr. Hartman and Mr. Anderson were reimbursed by the Company for services
provided by them that were necessary and prudent in connection with the
formation of the Company and its Private Placement in 1996, including
payments in lieu of salary and for expenses directly attributable to the
formation of the Company. Mr. Hartman and Mr. Anderson are employed by the
Company at a base salary of $120,000 per annum which will increase upon
the closing of the Offering to $185,000.
(2) Mr. Kohlrus' employment with the Company began on December 16, 1996 at an
annual base salary of $96,000 which will increase upon the closing of
this Offering to $120,000 per annum. Mr. Kohlrus is eligible to receive
an annual bonus of up to 75 percent of his annual salary in 1997.
(3) Options granted to Mr. Hartman and Mr. Anderson which vest on the closing
of this Offering were granted without Dividend Equivalent Rights
("DERs"). Options granted to Mr. Kohlrus which begin to vest September 1,
1997, were granted with DER's. See "Management--Stock Option Grants."
57
<PAGE>
Bonus Incentive Compensation Plan. A bonus incentive compensation plan will
be established for certain executive and key officers of the Company and its
subsidiaries, to be effective commencing with the first full fiscal year after
this Offering. The annual bonus pursuant to the bonus incentive compensation
plan will be paid one-half in cash and one-half in shares of Common Stock of
the Company, annually, following receipt of the audit for the related fiscal
year. This program will award bonuses annually to those officers out of a
total pool determined by stockholder return on equity ("ROE") as follows:
<TABLE>
<CAPTION>
ROE(1) IN EXCESS OF BASE RATE(2) BY: BONUS AS PERCENT OF AVERAGE NET WORTH(3) OUTSTANDING
------------------------------------ ----------------------------------------------------
<C> <S>
zero or less 0%
greater than 0% but less than 6% 10% X (actual ROE - Base Rate)
Greater than 6% (10% X 6%) + 15% X (Actual
ROE - (Base Rate + 6%))
</TABLE>
Of the amount so determined, one-half will be deemed contributed to the
total pool in cash and the other half deemed contributed to the total pool in
the form of shares of Common Stock, with the number of shares to be calculated
based on the average price per share during the preceding year. The total pool
may not exceed $1 million for fiscal years ending December 31, 1998 and
December 31, 1999.
- --------
(1) "ROE" is determined for the fiscal year by averaging the monthly ratios
calculated each month by dividing the Company's monthly Net Income
(adjusted to an annual rate) by its Average Net Worth for such month. For
such calculations, the "Net Income" of the Company means the net income or
net loss of the Company determined according to GAAP, but after deducting
any dividends paid or payable on preferred stock issued after the Offering
and before giving effect to the bonus incentive compensation or any
valuation allowance adjustment to stockholders' equity. The definition
"ROE" is used only for purposes of calculating the bonus incentive
compensation payable pursuant to the bonus incentive compensation plan,
and is not related to the actual distributions received by stockholders.
The bonus payments will be an operating expense of the Company.
(2) "Base Rate" is the average for each month of the Ten-Year U.S. Treasury
Rate, plus four percent.
(3) "Average Net Worth" for any month means the arithmetic average of the sum
of (i) the net proceeds from all offerings of equity securities by the
Company since formation including exercise of Warrants and stock options
and pursuant to the proposed DRP (but excluding any offerings of preferred
stock subsequent to the Offering), after deducting any underwriting
discounts and commissions and other expenses and costs relating to the
offerings, plus (ii) the Company's retained earnings (without taking into
account any losses incurred in prior fiscal years, after deducting any
amounts reflecting taxable income to be distributed as dividends and
without giving effect to any valuation allowance adjustment to
stockholders' equity) computed by taking the daily average of such values
during such period.
58
<PAGE>
STOCK OPTION GRANTS
Options to acquire 334,332 shares were granted under the Company's 1996
Stock Option Plan. Of these options, 10,000 have been granted to two non-
employee directors and an additional 35,000 were granted to current employees
(excluding the founders) and will vest 25 percent on September 1, 1997 and 25
percent on each anniversary of such date thereafter. Options granted to non-
employee directors are exercisable at $0.01 per share. The 35,000 options
granted to employees are exercisable at $1.06 per share. All such options were
granted with related DERs. The remaining options were granted to the founders,
exercisable at $15 per share, and shall vest only upon closing this Offering.
These options were granted without DERs. The Purchase Terms Agreement in the
Company's Private Placement restricted further grants of stock options (or
other Awards) prior to this Offering. See "Description of Capital Stock--
Purchase Terms Agreement."
The following table sets forth information concerning stock options granted
during 1996 to each of the Board of Director members and Executive Officers.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT
---------------------------------------------------- ASSUMED ANNUAL
PERCENT OF RATES OF
TOTAL OPTIONS STOCK PRICE
GRANTED TO APPRECIATION FOR
EMPLOYEES EXERCISE PRICE OPTION TERM
NAME DURING THE OR BASE PRICE EXPIRATION ---------------------
---- GRANTED(#) YEAR ($/SHARE) DATE 5% ($) 10% ($)
<S> <C> <C> <C> <C> <C> <C>
Scott F. Hartman........ 144,666(1) 43.27 $15.00 12/6/06 $3,534,685 $5,628,395
W. Lance Anderson....... 144,666(1) 43.27 15.00 12/6/06 3,534,685 5,628,395
Gregory T. Barmore...... 5,000(2) 1.50 0.01 9/27/06 81 130
Edward W. Mehrer........ 5,000(2) 1.50 0.01 9/27/06 81 130
Mark J. Kohlrus......... 10,000(2) 2.99 1.06 12/10/06 40,722 64,844
------- -----
Total shares granted
under SOP to Directors
and Executive
Officers............... 309,332 92.53
======= =====
</TABLE>
- --------
(1) Options granted vest upon closing of this Offering.
(2) 25 percent of the options granted will vest on September 1, 1997 and 25
percent on each anniversary of such date thereafter.
The following table sets forth certain information with respect to the value
of the options as of December 31, 1996 held by the named directors and
executive officers.
FISCAL YEAR END OPTION VALUE
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AS OF OPTIONS AS OF
DECEMBER 31, 1996 DECEMBER 31, 1996(1)
------------------------- -------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
NAME <S> <C> <C> <C>
Scott F. Hartman........ -- 144,666 -- --
W. Lance Anderson....... -- 144,666 -- --
Gregory T. Barmore...... -- 5,000 -- $12,450
Edward W. Mehrer........ -- 5,000 -- 12,450
Mark J. Kohlrus......... -- 10,000 -- 14,400
</TABLE>
- --------
(1) The amounts set forth represents the difference between the estimated fair
market value of $2.50 per share as of December 31, 1996 and the exercise
price of the options, multiplied by the applicable number of shares
underlying the options.
Units Acquired with Forgivable Debt. Messrs. Hartman and Anderson each
received 108,333 Units which were acquired at the price of $15 per Unit.
Payment for such Units was made by delivering to the Company promissory notes,
bearing interest at eight percent per annum compounded annually and secured by
the Units being acquired. Interest accrues during the first year and is added
to principal due under the note. Thereafter, interest is payable quarterly and
upon forgiveness or at maturity of the notes, which is at the end of the fifth
fiscal period (as defined below).
The principal amount of the notes is divided into three equal tranches.
Payment of principal on each tranche will be forgiven by the Company, if the
following incentive performance tests are achieved:
. During the first five fiscal periods after issuance of the notes:
--One tranche will be forgiven for each fiscal period as to which the
Company generates a total return to investors in Units equal to or
greater than 15 percent.
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--At the end of each of the five fiscal periods, all remaining tranches
will be forgiven if the Company has generated a total cumulative return
to investors in Units (from date of initial issuance of the notes) equal
to or greater than 100 percent.
. For purposes of calculating the returns to such investors:
--The term "fiscal period" will refer to each of five periods, the first
period commenced with the closing of the Offering of Units on December
9, 1996, and ends on December 31, 1997, and each succeeding fiscal
period extending for twelve months and ending on each December 31.
. The term "return" for each fiscal period will mean the sum of (on a per
Unit basis) (a) all cash dividends paid during (or declared with respect
to) such fiscal period per share of Preferred Stock (or per share of
Common Stock following conversion of the Preferred Stock upon completion
of a the Offering), (b) any increase or decrease in the price per share
of Preferred Stock (or resulting Common Stock) during such fiscal period,
measured by using the price per Unit to investors in this Offering as the
starting price ($15.00), and using the average public trading price
during the last 90 days of each succeeding fiscal period for such
succeeding periods (except such shorter period as the Common Stock is
traded in 1997), and (c) any increase or decrease in the price per
Warrant during such fiscal period, determined in the same manner as in
(b). For purposes of the fiscal period 15 percent return test, the total
return for a given period will be equal to the sum of (a), (b), and (c)
during the period, and for purposes of the cumulative 100 percent return
test, the amounts in (a), (b) and (c) will all be measured from the
beginning of the first fiscal period. The amount of that "return" will
then be measured as a percentage of the investors investment in the Units
(on a per Unit basis) without regard to timing of receipt of dividends or
timing of increases in per share or per Warrant prices.
. If one of the incentive tests is met, the amount of loan forgiveness for
each tranche will be the principal amount of such tranche of the note. In
addition, a loan will be made by the Company to Messrs. Hartman and
Anderson in the amount of (i) personal tax liability resulting from the
forgiveness of debt, and (ii) interest accrued during the first year of
the forgiven tranches. The note will bear interest at a floating market
rate, will be secured by that proportionate number of Units that had
secured the forgiven tranche of the note and will mature upon the earlier
of the sale of those Units (or the underlying securities) or the
termination of the officers employment with the Company.
Employment Agreements. The Company has entered into employment agreements
with the Founders, Mr. Hartman and Mr. Anderson. Each employment agreement
provides for a term through December 31, 2001 and will be automatically
extended for an additional year at the end of each year of the agreement,
unless either party provides a prescribed prior written notice to the
contrary. Each employment agreement provides for the annual base salary set
forth in the compensation table above and for participation by the subject
officer in the Bonus Incentive Compensation Plan. Each employment agreement
provides for the subject officer to receive his annual base salary and bonus
compensation to the date of the termination of employment by reason of death,
disability or resignation and to receive base compensation to the date of the
termination of employment by reason of a termination of employment for cause
as defined in the agreement. Each employment agreement also provides for the
subject officer to receive, if the subject officer resigns for "good reason"
or is terminated without cause after a "Change in Control" of the Company as
those terms are defined in the agreement, an amount, 50 percent payable
immediately and 50 percent payable in monthly installments over the succeeding
twelve months, equal to three times such officer's combined maximum base
salary and actual bonus compensation for the preceding year, subject in each
case to a maximum amount of one percent of the Company's book equity value
(exclusive of valuation adjustments) and a minimum of $360,000. In that
instance, the subject officer is prohibited from competing with the Company
for a period of one year. In addition, all outstanding options granted to the
subject officer under the 1996 Stock Option Plan shall immediately vest.
Section 280G of the Code may limit the deductibility of the payments to such
loan officer by the Company for federal income tax purposes. "Change of
Control" for purposes of the agreements would include a merger or
consolidation of the Company, a sale of all or substantially all of the assets
of the Company, changes in the identity of a majority of the members of the
Board of Directors of the Company (other than due to the death, disability or
age of a director) or acquisitions of more than 25 percent of the combined
voting power of the Company's capital stock, subject to certain limitations.
Absent a "Change in Control," if the Company terminates the officers
employment without cause, or if the officer resigns for "good reason," the
officer receives an amount, payable immediately, equal to such officers
combined maximum base salary and actual bonus compensation for the preceding
year, subject in each case to a maximum amount of one percent of the Company's
book value (exclusive of valuation adjustments) and a minimum of $120,000. If
the officer resigns for any other reason, there is no severance payment and
the officer is prohibited from competing with the Company for a period of one
year following the resignation.
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Stock Option Plan
General. The Company's 1996 Executive and Non-Employee Director Stock Option
Plan (the "1996 Stock Option Plan") provides for the grant of qualified
incentive stock options ("ISOs") which meet the requirements of Section 422 of
the Internal Revenue Code, stock options not so qualified ("NQSOs"), deferred
stock, restricted stock, performance shares, stock appreciation and limited
stock awards ("Awards") and dividend equivalent rights ("DERs").
Purpose. The 1996 Stock Option Plan is intended to provide a means of
performance-based compensation in order to attract and retain qualified
personnel and to afford additional incentive to others to increase their
efforts in providing significant services to the Company.
Administration. The 1996 Stock Option Plan is administered by the
Compensation Committee of the Board of Directors (the "Committee"), which
shall at all times be composed solely of non-employee directors as required by
Rule 16b-3 under the Exchange Act. Members of the Committee are eligible to
receive only NQSOs pursuant to automatic grants of stock options discussed
below.
Options and Awards. Options granted under the 1996 Stock Option Plan will
become exercisable in accordance with the terms of grant made by the
Committee. Awards will be subject to the terms and restrictions of the Awards
made by the Committee. Option and Award recipients shall enter into a written
stock option agreement with the Company. The Committee has discretionary
authority to select participants from among eligible persons and to determine
at the time an option or Award is granted when and in what increments shares
covered by the option or Award may be purchased or will vest and, in the case
of options, whether it is intended to be an ISO or a NQSO provided, however,
that certain restrictions applicable to ISOs are mandatory, including a
requirement that ISOs not be issued for less than 100 percent of the then fair
market value of the Common Stock (110 percent in the case of a grantee who
holds more than ten percent of the outstanding Common Stock) and a maximum
term of ten years (five years in the case of a grantee who holds more than ten
percent of the outstanding Common Stock). Fair market value means as of any
given date, with respect to any option or Award granted, at the discretion of
the Board of Directors or the Committee, (i) the closing sale price of the
Common Stock on such date as reported in the Western Edition of the Wall
Street Journal or (ii) the average of the closing price of the Common Stock on
each day of which it was traded over a period of up to twenty trading days
immediately prior to such date, or (iii) if the Common Stock is not publicly
traded (e.g., prior to this Offering), the fair market value of the Common
Stock as otherwise determined by the Board of Directors or the Committee in
the good faith exercise of its discretion.
Eligible Persons. Officers and directors and employees of the Company and
other persons expected to provide significant services to the Company are
eligible to participate in the 1996 Stock Option Plan. ISOs may be granted to
the officers and key employees of the Company. NQSOs and Awards may be granted
to the directors, officers, key employees, agents and consultants of the
Company or any of its subsidiaries.
Under current law, ISOs may not be granted to any director of the Company
who is not also an employee, or to directors, officers and other employees of
entities unrelated to the Company. No options or Awards may be granted under
the Stock Option Plan to any person who, assuming exercise of all options held
by such person, would own or be deemed to own more than 25 percent of the
outstanding shares of equity stock of the Company.
Shares Subject to the Plan. The 1996 Stock Option Plan authorizes the grant
of options to purchase, and Awards of, an aggregate of up to ten percent of
the Company's total outstanding shares at any time, provided that no more than
320,000 shares of Common Stock shall be cumulatively available for grant as
Incentive Stock Options. If an option granted under the 1996 Stock Option Plan
expires or terminates, or an Award is forfeited, the shares subject to any
unexercised portion of such option or Award will again become available for
the issuance of further options or Awards under the 1996 Stock Option Plan. In
connection with any reorganization, merger, consolidation, recapitalization,
stock split or similar transaction, the Compensation Committee shall
appropriately adjust the number of shares of Common Stock subject to
outstanding options, Awards and DERs and the total number of shares for which
options, Awards or DERs may be granted under the Plan.
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<PAGE>
Term of the Plan. Unless previously terminated by the Board of Directors,
the 1996 Stock Option Plan will terminate on September 1, 2006, and no options
or Awards may be granted under the 1996 Stock Option Plan thereafter, but
existing options or Awards remain in effect until the options are exercised or
the options or Awards are terminated by their terms.
Term of Options. Each option must terminate no more than ten years from the
date it is granted (or five years in the case of ISOs granted to an employee
who is deemed to own an excess of 10 percent of the combined voting power of
the Company's outstanding equity stock). Options may be granted on terms
providing for exercise either in whole or in part at any time or times during
their restrictive terms, or only in specified percentages at stated time
periods or intervals during the term of the option.
DERs. The Plan provides for granting of DERs in tandem with any options
granted under the Plan. Such DERs accrue for the account of the optionee
shares of Common Stock upon the payment of dividends on outstanding shares of
Common Stock. The number of shares accrued is determined by a formula and such
shares may be made transferable to the optionee either upon exercise of the
related option or on a "current-pay" basis so that payments would be made to
the optionee at the same time as dividends are paid to holders of outstanding
Common Stock. Holders of DERs may be made eligible to participate not only in
cash distributions but also in distributions of stock or other property made
to holders of outstanding Common Stock. Shares of Common Stock accrued for the
account of the optionee are eligible to receive dividends and distributions.
DERs may also be made "performance based" by conditioning the right of the
holder of the DER to receive any dividend equivalent payment or accrual upon
the satisfaction of specified performance objectives.
Option Exercise. The exercise price of any option granted under the 1996
Stock Option Plan is payable in full in cash, or its equivalent as determined
by the Committee. The Company may make loans available to options holders to
exercise options evidenced by a promissory note executed by the option holder
and secured by a pledge of Common Stock with fair value at least equal to the
principal of the promissory note unless otherwise determined by the Committee.
Automatic Grants to Non-Employee Directors. Each non-employee director of
the Company is automatically granted NQSOs to purchase 5,000 shares of Common
Stock with DERs upon becoming a director of the Company, and is also
automatically granted NQSOs to purchase 2,500 shares of Common Stock (with
DERs) the day after each annual meeting of stockholders upon re-election to or
continuation on the Board. Such automatic grants of stock options vest 25
percent on the anniversary date in the year following the date of the grant
and 25 percent on each anniversary date thereafter. The exercise price for
such automatic grants of stock options is the fair market value of the Common
Stock on the date of grant, and is required to be paid in cash.
Amendment and Termination of Stock Option Plan. The Board of Directors may,
without affecting any outstanding options or Awards, from time to time revise
or amend the 1996 Stock Option Plan, and may suspend or discontinue it at any
time. However, no such revision or amendment may, without stockholder
approval, increase the number of shares subject to the 1996 Stock Option Plan,
modify the class of participants eligible to receive options or Awards granted
under the 1996 Stock Option Plan or extend the maximum option term under the
1996 Stock Option Plan.
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<PAGE>
PRINCIPAL SECURITYHOLDERS
BENEFICIAL OWNERSHIP OF COMMON STOCK BY LARGE SECURITYHOLDERS
The following table sets forth certain information known to the Company with
respect to beneficial ownership of the Company's Common Stock as of June 30,
1997, after giving effect to the conversion of the Preferred Stock into Common
Stock and as adjusted to reflect the sale of Common Stock being offered
hereby, by each person other than members of management known to the Company
to beneficially own more than five percent (5%) of the Company's Common Stock.
Unless otherwise indicated in the footnotes to the table, the beneficial
owners named have, to the knowledge of the Company, sole voting and investment
power with respect to the shares beneficially owned, subject to community
property laws where applicable.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
OF COMMON STOCK OF COMMON STOCK
BEFORE OFFERING(1) AFTER OFFERING(2)
----------------------- -----------------------
NAME AND ADDRESS OF BENEFICIAL
OWNER SHARES PERCENT SHARES PERCENT
- ------------------------------ ------------ ---------- ------------ ----------
<S> <C> <C> <C> <C>
Wellington Management
Company(3).................... 1,333,400 31.62% 1,333,400 18.48%
75 State Street
Boston, MA 02109
Lindner Dividend Fund(4)...... 1,333,334 31.62 1,333,334 18.48
7711 Carondolet Avenue, Suite
700
St. Louis, MO 63104
General Electric Capital
Corporation(5)................ 1,333,332 31.62 1,333,332 18.48
260 Long Ridge Road
Stamford, CT 06927
First Financial Fund,
Inc.(6)....................... 933,400 23.24 933,400 13.30
c/o Wellington Management
Company
75 State Street
Boston, MA 02109
Wallace R. Weitz &
Company(7).................... 666,666 17.17 666,666 9.69
1125 South 103rd Street
Suite 600
Omaha, NE 68124-6008
Weitz Series Fund, Inc.(8).... 410,000 10.92 410,000 6.07
c/o Wallace R. Weitz & Company
1125 South 103rd Street,
Suite 600
Omaha, NE 68124-6008
Bay Pond Partners, L.P.(9).... 400,000 10.67 400,000 5.93
c/o Wellington Management
Company
75 State Street
Boston, MA 02109
First Fidelity, Inc.(10)...... 373,334 9.99 373,334 5.54
c/o First Union National Bank
One First Union Center
301 South College Street
Charlotte, NC 28288
</TABLE>
- --------
(1) Assuming conversion of all of the Securityholders' Preferred Stock into
Common Stock and the exercise of the listed Securityholder's Warrants.
(2) Assuming no exercise of Underwriter's over-allotment option, no exercise
of Warrants (except by the Securityholder named, separately) and no
purchases by any of the listed Securityholders in this Offering.
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<PAGE>
(3) Consists of 466,700 shares of Common Stock currently outstanding, and
466,700 shares of Common Stock issuable upon the exercise of Warrants, in
each case beneficially owned by First Financial Fund, Inc., for whom
Wellington Management Company ("Wellington") acts as investment advisor
and over which Wellington has shared investment power; 200,000 shares of
Common Stock currently outstanding, and 200,000 shares of Common Stock
issuable upon the exercise of Warrants, in each case beneficially owned
by Bay Pond Partners, L.P., for whom Wellington acts as investment
advisor and over which Wellington has shared voting and investment power.
(4) Includes 666,667 shares of Common Stock issuable upon the exercise of
Warrants.
(5) Includes 666,666 shares of Common Stock issuable upon the exercise of
Warrants.
(6) Includes 466,700 shares of Common Stock issuable upon the exercise of
Warrants. Wellington acts as investment advisor and shares investment
power with First Financial Fund, Inc. See footnote 3.
(7) Consists of 205,000 shares of Common Stock currently outstanding, and
205,000 shares of Common Stock issuable upon the exercise of Warrants, in
each case beneficially owned by Weitz Series Fund, Inc. (see footnote
10); 65,000 shares of Common Stock currently outstanding, and 65,000
shares of Common Stock issuable upon the exercise of Warrants, in each
case beneficially owned by Weitz Partners, Inc,; and 63,333 shares of
Common Stock issuable upon the exercise of Warrants, in each case
beneficially owned by Weitz Partners III Limited Partnership.
(8) Includes 185,000 shares of Common Stock beneficially owned by Weitz
Series Fund, Inc. --Value Portfolio and 20,000 shares of Common Stock
beneficially owned by Weitz Series Fund, Inc.--Hickory Portfolio and the
related 205,000 shares of Common Stock issuable upon the exercise of
Warrants. Wallace R. Weitz & Company has sole voting and investment power
with respect to these shares.
(9) Includes 200,000 shares of Common Stock issuable upon the exercise of
Warrants. Wellington also acts as investment advisor and shares
investment power with Bay Pond Partners, L.P. See footnote 3.
(10) Includes 186,667 shares of Common Stock issuable upon the exercise of
Warrants. Wallace R. Weitz, as President of Weitz Series Fund, Inc. and
Weitz Partners, Inc. and as general partner of Weitz Parters III Limited
Partnership, may be deemed to beneficially own such shares of Common
Stock.
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<PAGE>
BENEFICIAL OWNERSHIP OF COMMON STOCK BY DIRECTORS AND MANAGEMENT
The following table sets forth certain information known to the Company with
respect to beneficial ownership of the Company's Common Stock as of June 30,
1997, after giving effect to the conversion of the Preferred Stock into Common
Stock and as adjusted to reflect the sale of Common Stock being offered
hereby, by (i) each director and nominee for director, (ii) the Company's
Named Executive Officers, and (iii) all directors and executive officers as a
group. Unless otherwise indicated in the footnotes to the table, the
beneficial owners named have, to the knowledge of the Company, sole voting and
investment power with respect to the shares beneficially owned, subject to
community property laws where applicable.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP OF BENEFICIAL OWNERSHIP OF
COMMON STOCK COMMON STOCK
NAME AND ADDRESS OF BEFORE OFFERING (1) AFTER OFFERING (2)
BENEFICIAL OWNER ---------------------------------------------------
- ------------------- NUMBER PERCENT NUMBER PERCENT
<S> <C> <C> <C> <C>
Scott F. Hartman (3)........ 401,332 10.91 401,332 6.01
W. Lance Anderson (3)....... 411,732 11.18 411,732 6.16
Edward W. Mehrer (4)........ 29,000 * 29,000 *
Gregory T. Barmore (5)...... 5,000 * 5,000 *
Jenne K. Britell............ -- -- -- --
Mark J. Kohlrus (6)......... 13,000 * 13,000 *
All Directors and Executive
Officers as a Group
(6 persons) ............... 860,064 -- 860,064 --
</TABLE>
- --------
*Less than one percent.
(1)Assuming conversion of all of the Securityholders' Preferred Stock into
Common Stock and the exercise of the listed Securityholder's Warrants and
currently exercisable options.
(2)Assuming no exercise of Underwriter's over-allotment option, no exercise of
Warrants (except by Securityholder named, separately), no purchases by any
of the listed Securityholders in this table and that all shares eligible to
be sold hereunder are sold.
(3)Messrs. Hartman and Anderson acquired (i) Units with promissory notes (see
"Management--Executive Compensation"), (ii) Common Stock as Founders (see
"Capitalization"), (iii) Units as purchasers in the Private Placement, and
(iv) Stock Options (see "Management--Executive Compensation").
(4)Consists of 12,000 Units purchased in the Private Placement, including
2,000 owned by his wife, and 5,000 shares of Common Stock issuable upon the
exercise of options.
(5)Includes 5,000 shares of Common Stock issuable upon the exercise of
options.
(6)Includes 1,500 Units purchased in the Private Placement and 10,000 shares
of Common Stock issuable upon the exercise of options.
CERTAIN TRANSACTIONS
TRANSACTIONS WITH MANAGEMENT
In May 1996, Messrs. Hartman and Anderson formed NovaStar Mortgage Inc.
("NMI") for the purpose of engaging in the subprime lending business. During
the remainder of 1996, NMI obtained required licenses and permits, developed
guidelines for the origination of mortgage loans through its wholesale lending
channel and, following the Company's Private Placement, began to hire critical
senior personnel to put in place the infrastructure for its mortgage lending
and servicing operations.
Following the close of the Private Placement of Units in December 1996,
NovaStar Financial, Inc. (in its non-consolidated, parent only capacity,
"NFI") moved to implement the portion of its business strategy to be conducted
through taxable subsidiaries. In February 1997, NFI Holding Corporation
("Holding") was formed to serve as a holding company for such taxable
subsidiaries. In March 1997, Messrs. Hartman and Anderson acquired all of the
outstanding voting Common Stock of Holding for a total price of $20,000 and
NFI acquired all of the outstanding preferred stock of Holding for a total
price of $1,980,000. The Common Stock is entitled to 1 percent of the dividend
distributions of Holding and the preferred stock is entitled to 99 percent of
such distributions. At the time of acquisition of the common stock, Messrs.
Hartman and Anderson entered into an agreement of shareholders, to which NFI
is a party, which contains certain management and control provisions and
restrictions on transfer of the common stock. The obligations of Messrs.
Hartman and Anderson under the agreement of shareholders are secured by the
pledge of their common stock in Holding.
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<PAGE>
In March 1997, Holding acquired all of the outstanding common stock of NMI
from Messrs. Hartman and Anderson for a total price of $250,000, the amount of
cash previously invested by them in NMI. NMI thereby became a wholly-owned
subsidiary of Holding. Through Holding, NFI thus owns a beneficial interest in
99 percent of the future dividend distributions attributable to NMI.
During the three months ended June 30, 1997, NFI entered into a loan
purchase agreement with NMI pursuant to which NFI agrees to buy from time to
time and NMI agrees to sell to NFI mortgage loans originated or acquired by
NMI. The loan purchase agreement is non-exclusive as to both parties and
provides for an arm's-length, fair market value transfer of mortgage loans,
generally on a servicing-released basis. NFI and NMI also entered into a flow
subservicing agreement under which NMI agrees to service mortgage loans for
NFI initially for a fixed dollar fee per loan based on the fee in comparable,
arm's-length subservicing arrangements. The subservicing agreement became
effective with the commencement of NMI's servicing operation in July 1997. NFI
and NMI further entered into an Administrative Services Outsourcing Agreement
dated as of June 30, 1997 pursuant to which NMI will provide NFI on a fee
basis certain administrative services, including consulting with respect to
the development of mortgage loan products, loan underwriting and loan funding.
INDEBTEDNESS OF MANAGEMENT
Messrs. Hartman and Anderson are indebted to NFI pursuant to forgivable
promissory notes as described under "Management--Executive Compensation--Units
Acquired with Forgivable Debt."
CERTAIN BUSINESS RELATIONSHIPS
In connection with a commitment from General Electric Capital Corporation
("GE Capital") to purchase Units in the Company's Private Placement of Units
in 1996, the Company agreed that so long as GE Capital owns at least ten
percent of the outstanding Common Stock, assuming full conversion of the
Preferred Stock and full exercise of all Warrants, GE Capital will have the
right to appoint one director (of up to six authorized directors) or,
alternatively, to have board observation rights so long as it maintains more
than 20 percent of its initial investment in the Company. The current director
serving pursuant to these provisions is Jenne K. Britell, who was elected to
serve as an Independent Director with a term running until the 1999 annual
meeting of stockholders.
The Company also agreed, unless GE Capital waives its compliance, (i) to
give GE Capital's insurance affiliate FGIC three years' right of first offer
to issue credit enhancements on the Company's securitizations, (ii) to permit
GE Capital's mortgage company affiliate GE Capital Mortgage Corporation to
sell subprime mortgage loans, conforming to underwriting guidelines, to the
Company on an arm's-length basis, and (iii) to pay, subject to closing of the
Private Placement, GE Capital's reasonable legal and consulting fees up to
$40,000 incurred in the Private Placement.
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<PAGE>
FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes the material federal income tax
considerations that may be relevant to a prospective purchaser of units. This
discussion is based on current law. The following discussion is not exhaustive
of all possible tax considerations. It does not give a detailed discussion of
any state, local or foreign tax considerations, nor does it discuss all of the
aspects of federal income taxation that may be relevant to a prospective
investor in light of such investors' particular circumstances or to certain
types of investors (including insurance companies, certain tax-exempt
entities, financial institutions, broker/dealers, foreign corporations and
persons who are not citizens or residents of the United States) subject to
special treatment under federal income tax laws.
EACH PROSPECTIVE PURCHASER OF THE COMMON STOCK IS URGED TO CONSULT WITH HIS
OR HER OWN TAX ADVISOR REGARDING THE SPECIFIC CONSEQUENCES TO HIM OR HER OF
THE PURCHASE, OWNERSHIP AND SALE OF THE COMMON STOCK, INCLUDING THE FEDERAL,
STATE, LOCAL, FOREIGN AND OTHER TAX CONSIDERATIONS OF SUCH PURCHASE, OWNERSHIP
AND SALE AND THE POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
GENERAL
The Code provides special tax treatment for organizations that qualify and
elect to be taxed as REITs. The discussion below summarizes the material
provisions applicable to the Company as a REIT for federal income tax purposes
and to its stockholders in connection with their ownership of shares of stock
of the Company. However, it is impractical to set forth in this Prospectus all
aspects of federal, state, local and foreign tax law that may have tax
consequences with respect to an investor's purchase of the Common Stock. The
discussion of various aspects of federal taxation contained herein is based on
the Code, administrative regulations, judicial decisions, administrative
rulings and practice, all of which are subject to change. In brief, if certain
detailed conditions imposed by the Code are met, entities that invest
primarily in real estate assets, including mortgage loans, and that otherwise
would be taxed as corporations are, with certain limited exceptions, not taxed
at the corporate level on their taxable income that is currently distributed
to their stockholders. This treatment eliminates most of the "double taxation"
(at the corporate level and then again at the stockholder level when the
income is distributed) that typically results from the use of corporate
investment vehicles. A qualifying REIT, however, may be subject to certain
excise and other taxes, as well as normal corporate tax, on Taxable Income
that is not currently distributed to its stockholders. See "Federal Income Tax
Considerations--Taxation of the Company."
The Company elected to be taxed as a REIT under the Code commencing with its
taxable year ended December 31, 1996.
OPINION OF SPECIAL TAX COUNSEL
Jeffers, Wilson, Shaff & Falk, LLP ("Special Tax Counsel"), special tax and
ERISA counsel to the Company, has advised the Company in connection with the
formation of the Company, the Private Placement, this Offering and the
Company's election to be taxed as a REIT. Based on existing law and certain
representations made to Special Tax Counsel by the Company, Special Tax
Counsel is of the opinion that the Company (exclusive of any taxable
affiliates) operated in a manner consistent with its qualifying as a REIT
under the Code since the beginning of its taxable year ended December 31, 1996
through June 30, 1997, the date of the Company's unaudited balance sheet and
income statement made available to Counsel, and the organization and
contemplated method of operation of the Company are such as to enable it to
continue to so qualify throughout the balance of 1997 and in subsequent years.
However, whether the Company will in fact so qualify will depend on actual
operating results and compliance with the various tests for qualification as a
REIT relating to its income, assets, distributions, ownership and certain
administrative matters, the results of which may not be reviewed by Special
Tax Counsel. Moreover, certain aspects of the Company's method of operations
have not
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<PAGE>
been considered by the courts or the Service. There can be no assurance that
the courts or the Service will agree with this opinion. In addition,
qualification as a REIT depends on future transactions and events that cannot
be known at this time. Accordingly, Special Tax Counsel is unable to opine
whether the Company will in fact qualify as a REIT under the Code in all
events. In the opinion of Special Tax Counsel, the section of the Prospectus
entitled "Federal Income Tax Considerations" identifies and fairly summarizes
the federal income tax considerations that are likely to be material to a
holder of the Common Stock and to the extent such summaries involve matters of
law, such statements of law are correct under the Code. Special Tax Counsel's
opinions are based on various assumptions and on the factual representations
of the Company concerning its business and assets. Accordingly, no assurance
can be given that the actual results of the Company's operation for any one
taxable year will satisfy such requirements. See "Termination or Revocation of
REIT Status" below.
The opinions of Special Tax Counsel are based upon existing law including
the Internal Revenue Code of 1986, as amended, existing Treasury Regulations,
Revenue Rulings, Revenue Procedures, proposed regulations and case law, all of
which is subject to change either prospectively or retroactively. Moreover,
relevant laws or other legal authorities may change in a manner that could
adversely affect the Company or its stockholders. Special Tax Counsel's
opinions also are based in part on the opinion of special Maryland counsel,
Piper & Marbury, L.L.P., Baltimore, Maryland, that the Company is duly
organized and existing under Maryland law.
In the event the Company does not qualify as a REIT in any year, it will be
subject to federal income tax as a domestic corporation and its stockholders
will be taxed in the same manner as stockholders of ordinary corporations. To
the extent the Company would, as a consequence, be subject to potentially
significant tax liabilities, the amount of earnings and cash available for
distribution to its stockholders would be reduced. See "Termination or
Revocation of REIT Status" below.
QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, the Company must meet
certain tests which are described immediately below.
Ownership of Stock. For all taxable years after the first taxable year for
which a REIT election is made, the Company's shares of stock must be
transferable and must be held by a minimum of 100 persons for at least 335
days of a 12 month year (or a proportionate part of a short tax year). Since
the closing of its Private Placement, the Company has had more than 100
shareholders of record. The Company must also use the calendar year as its
taxable year. In addition, at all times during the second half of each taxable
year, no more than 50 percent in value of the shares of any class of the stock
of the Company may be owned directly or indirectly by five or fewer
individuals. In determining whether the Company's shares are held by five or
fewer individuals, the attribution rules of Section 544 of the Code apply. For
a description of these attribution rules, see "Description of Capital Stock."
The Company's Charter imposes certain repurchase provisions and transfer
restrictions to avoid more than 50 percent by value of any class of the
Company's stock being held by five or fewer individuals (directly or
constructively) at any time during the last half of any taxable year. Such
repurchase and transfer restrictions will not cause the stock not to be
treated as "transferable" for purposes of qualification as a REIT. The Company
has satisfied and intends to continue satisfying both the 100 stockholder and
50 percent/5 stockholder individual ownership limitations described above for
as long as it seeks qualification as a REIT. See "Description of Capital
Stock." The Company uses the calendar year as its taxable year for income tax
purposes.
Nature of Assets. On the last day of each calendar quarter at least 75
percent of the value of the Company's assets must consist of Qualified REIT
Assets, government securities, cash and cash items (the "75 percent of assets
test"). The Company expects that substantially all of its assets, other than
the preferred stock of the Company's taxable affiliate, will be "Qualified
REIT Assets." Qualified REIT Assets include interests in real property,
interests in mortgage loans secured by real property and interests in REMICs.
The Company has complied with the 75 percent of assets test for each quarter
since inception of its REIT election.
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On the last day of each calendar quarter, of the investments in securities
not included in the 75 percent of assets test, the value of any one issuer's
securities may not exceed 5 percent by value of the Company's total assets and
the Company may not own more than ten percent of any one issuer's outstanding
voting securities. Pursuant to its compliance guidelines, the Company intends
to monitor closely (on not less than a quarterly basis) the purchase and
holding of the Company's assets in order to comply with the above assets
tests. In particular, as of the end of each calendar quarter the Company
intends to limit and diversify its ownership of securities of any taxable
affiliate of the Company, hedging contracts and other mortgage securities that
do not constitute Qualified REIT Assets to less than 25 percent, in the
aggregate, by value of its portfolio, to less than 5 percent by value as to
any single issuer, including the stock of any taxable affiliate of the
Company, and to less than 10 percent of the voting stock of any single issuer
(collectively the "25 percent of assets limits"). If such limits are ever
exceeded, the Company intends to take appropriate remedial action to dispose
of such excess assets within the 30 day period after the end of the calendar
quarter, as permitted under the Code. As of June 30, 1997, the Company
complied with the tests described in this paragraph.
When purchasing mortgage-related securities, the Company may rely on
opinions of counsel for the issuer or sponsor of such securities given in
connection with the offering of such securities, or statements made in related
offering documents, for purposes of determining whether and to what extent
those securities (and the income therefrom) constitute Qualified REIT Assets
(and income) for purposes of the 75 percent of assets test (and the source of
income tests discussed below). If the Company invests in a partnership, the
Company will be treated as receiving its share of the income and loss of the
partnership and owning a proportionate share of the assets of the partnership
and any income from the partnership will retain the character that it had in
the hands of the partnership.
Sources of Income. The Company must meet three separate income-based tests
each year in order to qualify as a REIT.
1. The 75 percent Test. At least 75 percent of the Company's gross income
(the "75 percent of income test") for the taxable year must be derived from
the following sources among others: (i) interest (other than interest based in
whole or in part on the income or profits of any person) on obligations
secured by mortgages on real property or on interests in real property; (ii)
gains from the sale or other disposition of interests in real property and
real estate mortgages, other than gain from property held primarily for sale
to customers in the ordinary course of the Company's business ("dealer
property"); (iii) income from the operation, and gain from the sale, of
property acquired at or in lieu of a foreclosure of the mortgage secured by
such property or as a result of a default under a lease of such property
("foreclosure property"); (iv) income received as consideration for entering
into agreements to make loans secured by real property or to purchase or lease
real property (including interests in real property and interests in mortgages
on real property) (for example, commitment fees); (v) rents from real
property; and (vi) income attributable to stock or debt instruments acquired
with the proceeds from the sale of stock or certain debt obligations ("new
capital") of the Company received during the one-year period beginning on the
day such proceeds were received ("qualified temporary investment income"). The
investments that the Company intends to make (as described under "Business--
Portfolio of Mortgage Assets") will give rise primarily to mortgage interest
qualifying under the 75 percent of income test. As of June 30, 1997, the
Company complied with the 75 percent income test on an annualized basis.
2. The 95 percent Test. In addition to deriving 75 percent of its gross
income from the sources listed above, at least an additional 20 percent of the
Company's gross income for the taxable year must be derived from those
sources, or from dividends, interest or gains from the sale or disposition of
stock or other securities that are not dealer property (the "95 percent of
income test"). Income attributable to assets other than Qualified REIT Assets,
such as income from or gain on the disposition of Qualified Hedges, that the
Company holds, dividends on stock (including any dividends from a taxable
affiliate), interest on any other obligations not secured by real property,
and gains from the sale or disposition of stock or other securities that are
not Qualified REIT Assets will constitute qualified income for purposes of the
95 percent of income test only, and will not be qualified income for purposes
of the 75 percent of income test. Income from mortgage servicing, loan
guarantee fees (or other contracts under which the Company would earn fees for
performing services) and hedging (other
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than from Qualified REIT Assets) will not qualify for either the 95 percent or
75 percent of income tests. The Company intends to severely limit its
acquisition of any assets or investments the income from which does not
qualify for purposes of the 95 percent of income test. Moreover, in order to
help ensure compliance with the 95 percent of income test and the 75 percent
of income test, the Company intends to limit substantially all of the assets
that it acquires (other than the shares of the preferred stock of any taxable
affiliate and Qualified Hedges) to Qualified REIT Assets. The policy of the
Company to maintain REIT status may limit the type of assets, including
hedging contracts, that the Company otherwise might acquire. As of June 30,
1997, the Company complied with the 95 percent income test on an annualized
basis.
For purposes of determining whether the Company complies with the 75 percent
of income test and the 95 percent of income test detailed above, gross income
does not include gross income from "prohibited transactions." A "prohibited
transaction" is one involving a sale of dealer property, other than
foreclosure property. Net income from "prohibited transactions" is subject to
a 100 percent tax. See "--Taxation of the Company."
3. The 30 percent Limit. The Company must also derive less than 30 percent
of its gross income from the sale or other disposition of (i) Qualified REIT
Assets held for less than four years, other than foreclosure property or
property involuntarily or compulsorily converted through destruction,
condemnation or similar events, (ii) stock or securities held for less than
one year (including Qualified Hedges) and (iii) property in a prohibited
transaction (together the "30 percent of income limit"). As a result of the
Company's having to closely monitor such gains, the Company may have to hold
mortgage loans and Mortgage Assets for four or more years and securities
(other than securities that are Qualified REIT Assets) and hedges for one year
or more at times when the Company might otherwise have opted for the
disposition of such assets for short term gains, in order to ensure that it
maintains compliance with the 30 percent of income limit.
The Company intends to maintain its REIT status by carefully monitoring its
income, including income from hedging transactions, futures contracts and
sales of Mortgage Assets to comply with the 75 percent of income test, the 95
percent of income test and the 30 percent of income limit. See "--Taxation of
the Company" for a discussion of the potential tax cost of the Company's
selling certain Mortgage Assets on a regular basis. In order to help insure
its compliance with the REIT requirements of the Code, the Company has adopted
guidelines the effect of which will be to limit the Company's ability to earn
certain types of income, including income from hedging, other than hedging
income from Qualified REIT Assets and from Qualified Hedges. See "Business--
Portfolio of Mortgage Assets--Interest Rate Risk Management."
If the Company fails to satisfy one or both of the 75 percent or 95 percent
of income tests for any year, it may face either (a) assuming such failure was
for reasonable cause and not willful neglect, a 100 percent tax on the greater
of the amounts of income by which it failed to comply with the 75 percent test
of income or the 95 percent of income test, reduced by estimated related
expenses or (b) loss of REIT status. There can be no assurance that the
Company will always be able to maintain compliance with the gross income tests
for REIT qualification despite the Company's periodic monitoring procedures.
Moreover, there is no assurance that the relief provisions for a failure to
satisfy either the 95 percent or the 75 percent of income tests will be
available in any particular circumstance. There are no comparable relief
provisions which could mitigate the consequences of a failure to satisfy the
30 percent of income limit.
Distributions. The Company must distribute to its stockholders on a pro rata
basis each year an amount equal to (i) 95 percent of its Taxable Income before
deduction of dividends paid and excluding net capital gain, plus (ii) 95
percent of the excess of the net income from foreclosure property over the tax
imposed on such income by the Code, less (iii) any "excess noncash income"
(the "95 percent distribution test"). See "Dividend Policy and Distributions."
The Company intends to make distributions to its stockholders in amounts
sufficient to meet this 95 percent distribution requirement. Such
distributions must be made in the taxable year to which they relate or, if
declared before the timely filing of the Company's tax return for such year
and paid not later than the first regular dividend payment after such
declaration, in the following taxable year. A nondeductible excise tax, equal
to 4 percent of the excess of such required distributions over the amounts
actually distributed
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will be imposed on the Company for each calendar year to the extent that
dividends paid during the year (or declared during the last quarter of the
year and paid during January of the succeeding year) are less than the sum of
(i) 85 percent of the Company's "ordinary income," (ii) 95 percent of the
Company's capital gain net income, and (iii) income not distributed in earlier
years.
If the Company fails to meet the 95 percent distribution test as a result of
an adjustment to the Company's tax returns by the Service, the Company by
following certain requirements set forth in the Code, may pay a deficiency
dividend within a specified period which will be permitted as a deduction in
the taxable year to which the adjustment is made. The Company would be liable
for interest based on the amount of the deficiency dividend. A deficiency
dividend is not permitted if the deficiency is due to fraud with intent to
evade tax or to a willful failure to file timely tax return.
TAXATION OF THE COMPANY
In any year in which the Company qualifies as a REIT, it generally will not
be subject to federal income tax on that portion of its taxable income or net
capital gain which is distributed to its stockholders. The Company will,
however, be subject to tax at normal corporate rates upon any net income or
net capital gain not distributed. The Company intends to distribute
substantially all of its taxable income to its stockholders on a pro rata
basis in each year. See "Dividend Policy and Distributions."
In addition, the Company will also be subject to a tax of 100 percent of net
income from any prohibited transaction and will be subject to a 100 percent
tax on the greater of the amount by which it fails either the 75 percent or 95
percent of income tests, reduced by approximated expenses, if the failure to
satisfy such tests is due to reasonable cause and not willful neglect and if
certain other requirements are met. The Company may be subject to the
alternative minimum tax on certain items of tax preference.
If the Company acquires any real property as a result of foreclosure, or by
a deed in lieu of foreclosure, the Company may elect to treat such real
property as "foreclosure property." Net income from the sale of foreclosure
property is taxable at the maximum federal corporate rate, currently 35
percent. Income from foreclosure property will not be subject to the 100
percent tax on prohibited transactions and will not be included in income
subject to the 30 percent of income limit. The Company will determine whether
to treat such real property as foreclosure property on the tax return for the
fiscal year in which such property is acquired. The Company expects to so
elect.
The Company will securitize mortgage loans and sell such mortgage loans
through one or more taxable affiliates. However, if the Company itself were to
sell such Mortgage Assets on a regular basis, there is a substantial risk that
they would be deemed "dealer property" and that all of the profits from such
sales would be subject to tax at the rate of 100 percent as income from
prohibited transactions. Such taxable affiliate will not be subject to this
100 percent tax on income from prohibited transactions, which is only
applicable to REITs.
The Company will also be subject to the nondeductible 4 percent excise tax
discussed above if it fails to make timely dividend distributions for each
calendar year. See "--Qualification as a REIT-Distributions." The Company
intends to declare its fourth regular annual dividend during the final quarter
of the year and to make such dividend distribution no later than thirty-one
(31) days after the end of the year in order to avoid imposition of the excise
tax. Such a distribution would be taxed to the stockholders in the year that
the distribution was declared, not in the year paid. Imposition of the excise
tax on the Company would reduce the amount of cash available for distribution
to the Company's stockholders.
As a publicly held corporation, the Company will not be allowed a deduction
for applicable employee remuneration with respect to any covered employee in
excess of $1 million per year (the "Million Dollar Limit"). The Million Dollar
Limit on deductibility is subject to certain exceptions, including the
exception for "performance based compensation" meeting each of the following
criteria: (i) the agreement must have been approved by the corporation's
stockholders, (ii) the agreement must have been approved by a compensation
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committee consisting solely of two or more non-employee directors of the
corporation and (iii) under the agreement compensation payable to the employee
must be based on objective performance criteria and the meeting of this
criteria is certified by the compensation committee. Based on certain
representations of the Company, Counsel is of the opinion that it is more
likely than not that the deduction for compensation to the officers under the
agreements would not be disallowed under the Million Dollar Limit.
TAXATION OF TAXABLE AFFILIATES
The Company has caused, and will continue to cause, the creation and sale of
Mortgage Assets or conduct certain hedging activities through one or more
taxable affiliates. To date, the Company has caused the formation of NFI
Holding Corporation, Inc. (Holding) and NovaStar Mortgage, Inc. (NMI), the
wholly owned subsidiary of Holding. The Company owns all of the preferred
stock issued by Holding, which is entitled to 99 percent of the dividends to
be distributed by Holding. Scott Harman and Lance Anderson each own 50 percent
of the common stock of Holding. The common stock of Holding is entitled to one
percent of the dividends and liquidating distributions to be distributed by
Holding. The common stock is the sole class of voting stock of Holding,
although the Company would be entitled to vote on any matter that could
adversely affect the rights of its preferred stock. The assets of Holding
consist of the issued capital stock of NMI and a nominal amount of cash.
In order to ensure that the Company will not violate the prohibition on
ownership of more than 10 percent of the voting stock of a single issuer and
the prohibition on investing more than 5 percent of the value of its assets in
the stock or securities of a single issuer, the Company will primarily own
only shares of nonvoting preferred stock of the taxable affiliate and will not
own any of the taxable affiliates' common stock. The Company will monitor the
value of its investment in the taxable affiliate on a quarterly basis to limit
the risk of violating any of the tests that comprise the 25 percent of assets
limits. In addition, the dividends that the taxable affiliate pays to the
Company will not qualify as income from Qualified REIT Assets for purposes of
the 75 percent of income test, and in all events would have to be limited,
along with the Company's other interest, dividends, gains on the sale of
securities, hedging income, and other income not derived from Qualified REIT
Assets to less than 25 percent of the Company's gross revenues in each year.
See "Qualification as a REIT--Nature of Assets" and "--Sources of Income." The
taxable affiliate will not elect REIT status, will be subject to income
taxation on its net earnings and will generally be able to distribute only its
net after-tax earnings to its stockholders, including the Company, as dividend
distributions. If the taxable affiliate creates a taxable mortgage pool, such
pool itself will constitute a separate taxable subsidiary of the taxable
affiliate. The taxable affiliate would be unable to offset the income derived
from such a taxable mortgage pool with losses derived from any other
activities.
TAXATION OF THE COMPANY'S STOCKHOLDERS
General. For any taxable year in which the Company is treated as a REIT for
federal income purposes, amounts distributed by the Company to its
stockholders out of current or accumulated earnings and profits will be
includible by the stockholders as ordinary income for federal income tax
purposes unless properly designated by the Company as capital gain dividends.
In the latter case, the distributions will be taxable to the stockholders as
long-term capital gains.
Distributions of the Company will not be eligible for the dividends received
deduction for corporations. Stockholders may not deduct any net operating
losses or capital losses of the Company.
Any loss on the sale or exchange of shares of the stock of the Company held
by a stockholder for six months or less will be treated as a long-term capital
loss to the extent of any capital gain dividend received on the stock held by
such stockholders.
If the Company makes distributions to its stockholders in excess of its
current and accumulated earnings and profits, those distributions will be
considered first a tax-free return of capital, reducing the tax basis of a
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stockholder's shares until the tax basis is zero. Such distributions in excess
of the tax basis will be taxable as gain realized from the sale of the
Company's shares.
The Company (exclusive of its taxable affiliates) does not expect to acquire
or retain residual interests issued by REMICs. Such residual interests, if
acquired by a REIT, would generate excess inclusion income to shareholders of
the REIT. Excess inclusion income cannot be offset by net operating losses of
a stockholder. If the stockholder is a Tax-Exempt Entity, the excess inclusion
income is fully taxable as UBTI. If allocated to a foreign stockholder, the
excess inclusion income is subject to Federal income tax withholding without
reduction pursuant to any otherwise applicable tax treaty. Excess inclusion
income realized by a taxable affiliate is not passed through to stockholders
of the Company. Potential investors, and in particular Tax Exempt Entities,
are urged to consult with their tax advisors concerning this issue.
The Company intends to finance the acquisition of Mortgage Assets by
entering into reverse repurchase agreements, which are essentially loans
secured by the Company's Mortgage Assets. The Company expects to enter into
master repurchase agreements with secured lenders known as "counterparties."
Typically, such master repurchase agreements have cross-collateralization
provisions that afford the counterparty the right to foreclose on the Mortgage
Assets pledged as collateral. If the Service were to successfully take the
position that the cross-collateralization provisions of the master repurchase
agreements result in the Company having issued debt instruments (the reverse
repurchase agreements) with differing maturity dates secured by a pool of
mortgage loans, a portion of the Company's income could be characterized as
"excess inclusion income." Special Tax Counsel has advised the Company that it
is more likely than not that the cross-collateralization provisions of the
master repurchase agreements will not cause the Company to realize excess
inclusion income. Nevertheless, in the absence of any definitive authority on
this issue, Special Tax Counsel cannot give complete assurance.
The Company will notify stockholders after the close of the Company's
taxable year as to the portions of the distributions which constitute ordinary
income, return of capital and capital gain. Dividends and distributions
declared in the last quarter of any year payable to stockholders of record on
a specified date in such month will be deemed to have been received by the
stockholders and paid by the Company on December 31 of the record year,
provided that such dividends are paid before February 1 of the following year.
TAXATION OF TAX-EXEMPT ENTITIES
In general, a Tax-Exempt Entity that is a stockholder of the Company is not
subject to tax on distributions. The Service has ruled that amounts
distributed by a REIT to an exempt employees' pension trust do not constitute
UBTI and thus should be nontaxable to such a Tax-Exempt Entity. Based on that
ruling, but subject to the discussion of excess inclusion income set forth
under the heading "Taxation of the Company's Stockholders," Special Tax
Counsel is of the opinion that indebtedness incurred by the Company in
connection with the acquisition of real estate assets such as mortgage loans
will not cause dividends of the Company paid to a stockholder that is a Tax-
Exempt Entity to be UBTI, provided that the Tax-Exempt Entity has not financed
the acquisition of its stock with "acquisition indebtedness" within the
meaning of the Code. Under certain conditions, if a tax-exempt employee
pension or profit sharing trust were to acquire more than 10 percent of the
Company's stock, a portion of the dividends on such stock could be treated as
UBTI.
For social clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts, and qualified group legal services plans exempt
from federal income taxation under Code Sections 501(c)(7), (c)(9), (c)(17)
and (c)(20), respectively, income from an investment in the Company will
constitute UBTI unless the organization is able to properly deduct amounts set
aside or placed in reserve for certain purposes so as to offset the UBTI
generated by its investment in the Company. Such entities should review Code
Section 512(a)(3) and should consult their own tax advisors concerning these
"set aside" and reserve requirements.
FOREIGN INVESTORS
The preceding discussion does not address the federal income tax
consequences to foreign investors (non-resident aliens and foreign
corporations as defined in the Code) of an investment in the Company. In
general,
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foreign investors will be subject to special withholding tax requirements on
income and capital gains distributions attributable to their ownership of the
Company's stock. Foreign investors in the Company should consult their own tax
advisors concerning the federal income tax consequences to them of a purchase
of shares of the Company's stock including the federal income tax treatment of
dispositions of interests in, and the receipt of distributions from, REITs by
foreign investors. In addition, federal income taxes must be withheld on
certain distributions by a REIT to foreign investors unless reduced or
eliminated by an income tax treaty between the United States and the foreign
investor's country. A foreign investor eligible for reduction or elimination
of withholding must file an appropriate form with the Company in order to
claim such treatment.
RECORDKEEPING REQUIREMENT
A REIT is required to maintain records regarding the actual and constructive
ownership of its shares, and other information, and within 30 days after the
end of its taxable year, to demand statements from persons owning above a
specified level of the REIT's shares (e.g., if the Company has over 200 but
fewer than 2,000 stockholders of record, from persons holding 1 percent or
more of the Company's outstanding shares of stock and if the Company has 200
or fewer stockholders of record, from persons holding 1/2 percent or more of
the stock) regarding their ownership of shares. The Company must maintain, as
part of the Company's records, a list of those persons failing or refusing to
comply with this demand. Stockholders who fail or refuse to comply with the
demand must submit a statement with their tax returns setting forth the actual
stock ownership and other information. The Company intends to maintain the
records and demand statements as required by these regulations.
TERMINATION OR REVOCATION OF REIT STATUS
The Company's election to be treated as a REIT will be terminated
automatically if the Company fails to meet the requirements described above.
In that event, the Company will not be eligible again to elect REIT status
until the fifth taxable year which begins after the year for which the
Company's election was terminated unless all of the following relief
provisions apply: (i) the Company did not willfully fail to file a timely
return with respect to the termination taxable year, (ii) inclusion of
incorrect information in such return was not due to fraud with intent to evade
tax, and (iii) the Company establishes that failure to meet requirements was
due to reasonable cause and not willful neglect. The Company may also
voluntarily revoke its election, although it has no intention of doing so, in
which event the Company will be prohibited, without exception, from electing
REIT status for the year to which the revocation relates and the following
four taxable years.
If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Company would be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to stockholders of the Company with
respect to any year in which the Company fails to qualify as a REIT would not
be deductible by the Company nor would they be required to be made. Failure to
qualify as a REIT would result in the Company's reduction of its distributions
to stockholders in order to pay the resulting taxes. If, after forfeiting REIT
status, the Company later qualifies and elects to be taxed as a REIT again,
the Company could face significant adverse tax consequences.
BACKUP WITHHOLDING
The Code imposes a modified form of "backup withholding" for payments of
interest and dividends. This withholding applies only if a stockholder, among
other things, (i) fails to furnish the Company with a properly certified
taxpayer identification number, (ii) furnishes the Company with an incorrect
taxpayer identification number, (iii) fails properly to report interest or
dividends from any source, or (iv) under certain circumstances fails to
provide the Company or the stockholder's securities broker with a certified
statements, under penalty of perjury, that he or she is not subject to backup
withholding.
The backup withholding rate is 31 percent of "reportable payments", which
include the Company's dividends. Stockholders should consult their tax
advisors as to the procedure for insuring that Company distributions to them
will not be subject to backup withholding.
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The Company will report to its stockholders and the Service the amount of
dividends paid during each calendar year and the amount of tax withheld, if
any.
STATE AND LOCAL TAXES
State and local tax laws may not correspond to the federal income tax
principles discussed in this section. Accordingly, prospective stockholders
should consult their tax advisers concerning the state and local tax
consequences of an investment in the Company's stock.
ERISA INVESTORS
A fiduciary of a pension, profit-sharing, stock bonus plan or individual
retirement account, including a plan for self-employed individuals and their
employees or any other employee benefit plan subject to the prohibited
transaction provisions of the Code or the fiduciary responsibility provisions
of the Employee Retirement Income Security Act of 1974 ("ERISA")
(collectively, a "Plan"), should consider (i) whether the ownership of the
Company's stock is in accordance with the documents and instruments governing
the Plan, (ii) whether the ownership of the Company's stock is consistent with
the fiduciary's responsibilities and satisfies the requirements of Part 4 of
Subtitle A of Title I of ERISA (if applicable) and, in particular, the
diversification, prudence and liquidity requirements of Section 404 of ERISA,
(iii) the prohibitions under ERISA on improper delegation of control over, or
responsibility for "plan assets" and ERISA's imposition of co-fiduciary
liability on a fiduciary who participates in, or permits (by action or
inaction) the occurrence of, or fails to remedy a known breach of duty by
another fiduciary with respect to plan assets, and (iv) the need to value the
assets of the Plan annually.
As to the "plan assets" issue noted in clause (iii) above, based on certain
representations of the Company, Special Tax Counsel is of the opinion that the
Company's Common Stock will qualify as "publicly offered securities" within
the meaning of the regulations defining "plan assets" and therefore, in most
circumstances, the Common Stock, and not the underlying assets of the Company,
will be considered the assets of a Plan investing in the Common Stock.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
Upon the closing of this Offering, the authorized capital stock of the
Company will consist of 46,450,000 shares of Common Stock, of which 6,766,665
shares of Common Stock will be outstanding, and 3,550,000 shares of the
Company's unclassified capital stock, none of which will be outstanding.
HISTORICAL CAPITAL STRUCTURE
The authorized capital stock of the Company consists of 50,000,000 shares of
Capital Stock, $0.01 par value ("Capital Stock"). All such shares of Capital
Stock were initially classified as Common Stock. The Company's Charter
authorizes the Board of Directors to reclassify any of the unissued shares of
authorized Capital Stock into other classes or series of Capital Stock,
including classes or series of preferred stock. On December 6, 1996, the
Company supplemented its Charter to divide and classify 3,550,000 shares of
the Capital Stock of the Company into a series of preferred stock designated
as the Company's Class A Convertible Preferred Stock (the "Preferred Stock").
The Preferred Stock has the rights and privileges and is subject to the
conditions set forth in the Articles Supplementary establishing the terms of
the Preferred Stock. On December 9, 1996, the Company issued (i) 3,333,333
shares of Preferred Stock as part of the Units, each Unit consisted of one
share of Preferred Stock and one Warrant, in the Company's Private Placement
of Units; and (ii) 216,666 shares of Preferred Stock as part of the Units
acquired by the founders with forgivable debt. Effective on the closing of
this Offering, such shares of outstanding Preferred Stock will automatically
convert to Common Stock. Shares of the Preferred Stock received by the Company
upon the conversion will be restored to the status of authorized but unissued
shares of Capital Stock, without designation as to class, and the Company
intends to so reclassify all remaining authorized shares of Preferred Stock.
The following summary of the respective rights of the Common Stock and the
Preferred Stock is qualified in its entirety by reference to the Company's
Charter and Articles Supplementary, copies of which have been filed with the
Commission as exhibits to the Registration Statement of which this Prospectus
is a part.
COMMON STOCK
Voting. Each holder of Common Stock is entitled to one vote for each share
of record on each matter submitted to a vote of holders of Capital Stock of
the Company. The Company's Charter does not provide for cumulative voting and,
accordingly, the holders of a majority of the outstanding shares of Capital
Stock have the power to elect all directors to be elected each year.
Annual meetings of the stockholders of the Company will be held, and special
meetings may be called by any member of the Board of Directors, by the
President or generally by stockholders holding at least 20 percent of the
outstanding shares of Capital Stock entitled to be voted at the meeting. The
Charter of the Company may be amended in accordance with Maryland law, subject
to certain limitations set forth in the Charter.
Dividends; Liquidation; Other Rights. So long as the Class A Convertible
Preferred Stock remains outstanding, the holders of Common Stock shall not be
entitled to dividends or distributions. Following conversion of all
outstanding shares of Preferred Stock upon the closing of this Offering, the
holders of shares of Common Stock are entitled to receive dividends when, as,
and if declared by the Board of Directors out of funds legally available
therefor. In the event of liquidation, dissolution or winding up of the
Company, the holders of Common Stock will share ratably in all assets of the
Company remaining after the payment of liabilities and after payment of the
liquidation preference of any shares or series of preferred stock that may be
issued and outstanding. There are no preemptive or other subscription rights,
conversion rights or redemption or sinking fund provisions with respect to
shares of Common Stock.
PREFERRED STOCK
Additional preferred stock may be issued from time to time in one or more
classes or series, with such distinctive designations, rights and preferences
as shall be determined by the Board of Directors. Additional
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series of preferred stock would be available for possible future financing of,
or acquisitions by, the Company and for general corporate purposes without any
legal requirement that further stockholder authorization for issuance be
obtained. The issuance of additional series of preferred stock could have the
effect of making an attempt to gain control of the Company more difficult by
means of a merger, tender offer, proxy contest or otherwise. Additional series
of preferred stock, if issued, would have a preference on dividend payments
(as does the Preferred Stock) which would affect the ability of the Company to
make dividend distributions to the holders of Common Stock.
REGISTRATION RIGHTS
Purchasers of Units in the Company's Private Placement are entitled to
certain rights with respect to registration under the Securities Act. Pursuant
to a Registration Rights Agreement between the Company and the Placement
Agent, the Company has agreed to (i) file with the Commission, within six
months after the closing of this Offering, and use its best efforts to cause
to become effective as soon as practicable thereafter, a shelf registration
statement (the "Shelf Registration Statement") with respect to the shares of
Common Stock into which the shares of Preferred Stock have been converted, the
Warrants and the shares of Common Stock issuable pursuant to the exercise of
the Warrants and (ii) use its best efforts to have such shares of Common Stock
and the Warrants approved for quotation on the Nasdaq National Market or
listed on a stock exchange upon effectiveness of the Shelf Registration
Statement. The Company will be required to keep the Shelf Registration
Statement effective until the sooner of three years or such time as, in the
written opinion of counsel to the Company, such registration is not required
for the unrestricted resale of shares of Common Stock or Warrants entitled to
registration rights under the Registration Rights Agreement. In addition, with
respect to each investor who purchased 5 percent or more of the Units sold in
the Private Placement (a "5 percent purchaser"), the Company has agreed to
include with each registration statement it files relating to a new issuance
of Common Stock during the term of the Registration Rights Agreement shares of
Common Stock of such 5 percent purchaser resulting from the conversion of the
Preferred Stock or the exercise of Warrants, subject to certain conditions.
Such conditions provide, among other things, that the managing underwriter in
any offering being so registered may determine that all of such shares of
Common Stock proposed to be included in the offering cannot be sold, in which
case the number of such shares included will be reduced pro rata among such 5
percent purchasers proposing to participate according to the number of such
shares proposed to be sold, provided, however, that with respect to the
Company's first two public offerings of Common Stock, such purchasers will be
entitled to participate pro rata in any amount that can be sold in excess of
$50 million per offering. In addition, following the end of the effectiveness
of the Shelf Registration Statement, each 5 percent purchaser shall have two
demand registration rights, unless, in the written opinion of counsel to the
Company (which opinion is reasonably acceptable to such purchaser), such
registration is not necessary for such 5 percent purchaser to sell its shares
in the manner contemplated in compliance with applicable securities laws. If
requested by any participating 5 percent purchaser, the Company's management
will conduct road shows to assist such 5 percent purchaser in selling its
shares under either the Shelf Registration Statement or the demand
registrations.
PRIVATE PLACEMENT PURCHASE TERMS AGREEMENT
Pursuant to a Purchase Terms Agreement between the Company and the placement
agent in the Company's Private Placement, the Company agreed to a number of
provisions for the benefit of the purchasers of Units. The Purchase Terms
Agreement included, among other covenants, the following: (i) financial
reporting and information requirements prior to this Offering; (ii) approval
by a majority of Independent Directors of material increases in management
compensation; (iii) restrictions on affiliated transactions (excluding
transactions with GE Capital and its affiliates); (iv) prohibitions on
entering unrealted lines of business (including, but not limited to,
investments in commercial and multifamily mortgage and mortgage-backed
securities or other REITs); (v) maintenance of Key Man life insurance on
Messrs. Hartman and Anderson for five years; (vi) maintenance of the Company's
status as a REIT; (vii) changes in the capital allocation guidelines and hedge
policies; (viii) undertaking to carry out a liquidation of the Company upon
the vote of a majority of the stockholders recommending such action; and (ix)
prohibition on grants of stock options (or other Awards) under the Company's
1996 Stock Option Plan prior to this Offering other than those stock options
described in "Management--Executive Compensation."
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Following this Offering or, in the case of clauses (iv) and (v) above, one
year following this Offering, the provisions of clauses (ii) through (vii)
above may be modified or waived by a majority of Independent Directors. During
such one-year period, clause (iv) and (v) may be waived by a unanimous vote of
the Board of Directors. Clauses (viii) and (ix) will terminate upon the
closing of this offering.
REPURCHASE OF SHARES AND RESTRICTION ON TRANSFER
Two of the requirements of qualification for the tax benefits accorded by
the REIT provisions of the Code are that (1) during the last half of each
taxable year not more than 50 percent in value of the outstanding shares may
be owned directly or indirectly by five or fewer individuals (the "50
percent/5 stockholder test") and (2) there must be at least 100 stockholders
on 335 days of each taxable year of 12 months.
In order that the Company may meet these requirements at all times, the
Charter prohibits any person from acquiring or holding, directly or
indirectly, shares of Capital Stock in excess of 9.8 percent in value of the
aggregate of the outstanding shares of Capital Stock or in excess of 9.8
percent (in value or in number of shares, whichever is more restrictive) of
the aggregate of the outstanding shares of Common Stock of the Company. For
this purpose, the term "ownership" is defined in accordance with the REIT
provisions of the Code and the constructive ownership provisions of Section
544 of the Code, as modified by Section 856(h)(1)(B) of the Code.
For purposes of the 50 percent/5 stockholder test, the constructive
ownership provisions applicable under Section 544 of the Code attribute
ownership of securities owned by a corporation, partnership, estate or trust
proportionately to its stockholders, partners or beneficiaries, attribute
ownership of securities owned by family members and partners to other members
of the same family, treat securities with respect to which a person has an
option to purchase as actually owned by that person, and set forth rules as to
when securities constructively owned by a person are considered to be actually
owned for the application of such attribution provisions (i.e.,
"reattribution"). Thus, for purposes of determining whether a person holds
shares of Capital Stock in violation of the ownership limitations set forth in
the Charter, many types of entities may own directly more than the 9.8 percent
limit because such entities shares are attributed to its individual
stockholders. For example, it is contemplated that GE Capital and perhaps
other corporate investors will own in excess of 9.8 percent of the Capital
Stock outstanding immediately after the Offering. On the other hand, a person
will be treated as owning not only shares of Capital Stock actually or
beneficially owned, but also any shares of Capital Stock attributed to such
person under the attribution rules described above. Accordingly, under certain
circumstances, shares of Capital Stock owned by a person who individually owns
less than 9.8 percent of the shares outstanding may nevertheless be in
violation of the ownership limitations set forth in the Charter. Ownership of
shares of the Company's Capital Stock through such attribution is generally
referred to as constructive ownership. The 100 stockholder test is determined
by actual, and not constructive, ownership. The Company has greater than 100
shareholders of record.
Under the constructive ownership provisions of Section 544 of the Code, a
holder of a Warrant will be treated as owning the number of shares of Capital
Stock into which such Warrant may be converted.
The Charter further provides that if any transfer of shares of Capital Stock
occurs which, if effective, would result in any person beneficially or
constructively owning shares of Capital Stock in excess or in violation of the
above transfer or ownership limitations, then that number of shares of Capital
Stock the beneficial or constructive ownership of which otherwise would cause
such person to violate such limitations (rounded to the nearest whole shares)
shall be automatically transferred to a trustee (the "Trustee") as trustee of
a trust (the "Trust") for the exclusive benefit of one or more charitable
beneficiaries (the "Charitable Beneficiary"), and the intended transferee
shall not acquire any rights in such shares. Shares held by the Trustee shall
be issued and outstanding shares of Capital Stock. The intended transferee
shall not benefit economically from ownership of any shares held in the Trust,
shall have no rights to dividends, and shall not possess any rights to vote or
other rights attributable to the shares held in the Trust. The Trustee shall
have all voting rights and rights to dividends or other distributions with
respect to shares held in the Trust, which rights shall be exercised for the
exclusive
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benefit of the Charitable Beneficiary. Any dividend or other distribution paid
to the intended transferee prior to the discovery by the Company that shares
of Common Stock have been transferred to the Trustee shall be paid with
respect to such shares to the Trustee by the intended transferee upon demand
and any dividend or other distribution authorized but unpaid shall be paid
when due to the Trustee. The Board of Directors of the Company may, in their
discretion, waive these requirements on owning shares in excess of the
ownership limitations.
Within 20 days of receiving notice from the Company that shares of Capital
Stock have been transferred to the Trust, the Trustee shall sell the shares
held in the Trust to a person, designated by the Trustee, whose ownership of
the shares will not violate the ownership limitations set forth in the
Charter. Upon such sale, the interest of the Charitable Beneficiary in the
shares sold shall terminate and the Trustee shall distribute the net proceeds
of the sale to the intended transferee and to the Charitable Beneficiary as
follows. The intended transferee shall receive the lesser of (1) the price
paid by the intended transferee for the shares or, if the intended transferee
did not give value for the shares in connection with the event causing the
shares to be held in the Trust (e.g., in the case of a gift, devise or other
such transaction), the Market Price (as defined below) of the shares on the
day of the event causing the shares to be held in the Trust and (2) the price
per share received by the Trustee from the sale or other disposition of the
shares held in the Trust. Any net sales proceeds in excess of the amount
payable to the intended transferee shall be immediately paid to the Charitable
Beneficiary. In addition, shares of Capital Stock transferred to the Trustee
shall be deemed to have been offered for sale to the Company, or its designee,
at a price per share equal to the lesser of (i) the price per share in the
transaction that resulted in such transfer to the Trust (or, in the case of a
devise or gift, the Market Price at the time of such devise or gift) and (ii)
the Market Price on the date the Company, or its designee, accepts such offer.
The Company shall have the right to accept such offer until the Trustee has
sold shares held in the Trust. Upon such a sale to the Company, the interest
of the Charitable Beneficiary in the shares sold shall terminate and the
Trustee shall distribute the net proceeds of the sale to the intended
transferee.
The term "Market Price" on any date shall mean, with respect to any class or
series of outstanding shares of the Company's stock, the Closing Price (as
defined below) for such shares on such date. The "Closing Price" on any date
shall mean the last sale price for such shares, regular way, or, in case no
such sale takes place on such day, the average of the closing bid and asked
prices, regular way, for such shares, in either case as reported in the
principal consolidated transaction reporting system with respect to securities
listed or admitted to trading on the NYSE or, if such shares are not listed or
admitted to trading on the NYSE, as reported on the principal consolidated
transaction reporting system with respect to securities listed on the
principal national securities exchange on which such shares are listed or
admitted to trading or, if such shares are not listed or admitted to trading
on any national securities exchange, the last quoted price, or, if not so
quoted, the average of the high bid and low asked prices in the over-the-
counter market, as reported by the National Association of Securities Dealers,
Inc. Automated Quotation System of, if such system is no longer in use, the
principal other automated quotation system that may then be in use or, if such
shares are not quoted by any such organization, the average of the closing bid
and asked prices as furnished by a professional market maker making a market
in such shares selected by the Board of Directors or, in the event that no
trading price is available for such shares, the fair market value of the
shares, as determined in good faith by the Board of Directors.
Every owner of more than five percent (or such lower percentage as required
by the Code or the regulations promulgated thereunder) of all classes or
series of the Company's stock, within 30 days after the end of each taxable
year, is required to give written notice to the Company stating the name and
address of such owner, the number of shares of each class and series of stock
of the Company beneficially owned and a description of the manner in which
such shares are held. Each such owner shall provide to the Company such
additional information as the Company may request in order to determine the
effect, if any, of such beneficial ownership on the Company's status as a REIT
and to ensure compliance with the ownership limitations.
Subject to certain limitations, the Board of Directors may increase or
decrease the ownership limitations. In addition, to the extent consistent with
the REIT provisions of the Code, the Board of Directors may waive the
ownership limitations for and at the request of certain purchasers in this
Offering or subsequent purchasers.
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The provisions described above may inhibit market activity and the resulting
opportunity for the holders of the Company's Capital Stock and Warrants to
receive a premium for their shares or warrants that might otherwise exist in
the absence of such provisions. Such provisions also may make the Company an
unsuitable investment vehicle for any person seeking to obtain ownership of
more than 9.8 percent of the outstanding shares of Capital Stock.
INDEMNIFICATION
The Company's Charter obligates the Company to indemnify its directors and
officers and to pay or reimburse expenses for such individuals in advance of
the final disposition of a proceeding to the maximum extent permitted from
time to time by Maryland law. The Maryland General Corporation Law (the
"Maryland GCL") permits a corporation to indemnify its present and former
directors and officers, among others, against judgments, penalties, fines,
settlements and reasonable expenses actually incurred by them in connection
with any proceeding to which they may be made a party by reason of their
service in those or other capacities, unless it is established that (a) the
act or omission of the director or officer was material to the matter giving
rise to the proceeding and (i) was committed in bad faith, or (ii) was a
result of active and deliberate dishonesty, (b) the director or officer
actually received an improper personal benefit in money, property or services,
or (c) in the case of any criminal proceeding, the director or officer had
reasonable cause to believe that the act or omission was unlawful.
LIMITATION OF LIABILITY
The Maryland GCL permits the charter of a Maryland corporation to include a
provision limiting the liability of its directors and officers to the
corporation and its stockholder for money damages, except to the extent that
(i) it is proved that the person actually received an improper benefit or
profit in money, property or services, or (ii) a judgment or other final
adjudication adverse to the person is entered in a proceeding based on a
finding that the person's action, or failure to act, was the result of active
and deliberate dishonesty and was material to the cause of action adjudicated
in the proceeding. The Company's Charter contains a provision providing for
elimination of the liability of its directors and officers to the Company or
its stockholders for money damages to the maximum extent permitted by Maryland
law as amended or interpreted.
BUSINESS ACQUISITIONS STATUTES
Under the Maryland GCL, certain "business combinations" (including a merger,
consolidation, share exchange, or, in certain circumstances, an asset transfer
or issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns ten percent or more of the
voting power of the corporations shares or an affiliate of the corporation
which, at any time within the two-year period prior to the date in question,
was the beneficial owner of 10 percent or more of the voting power of the
then-outstanding voting stock of the corporation (an "Interested Stockholder")
or an affiliate thereof are prohibited for five years after the most recent
date on which the Interested Stockholder became an Interested Stockholder.
Thereafter, any such business combination must be recommended by the board of
directors of such corporation and approved by the affirmative vote of at least
(a) 80 percent of the votes entitled to be cast by holders of outstanding
voting shares of the corporation and (b) two-thirds of the votes entitled to
be cast by holders of outstanding voting shares of the corporation other than
shares held by the Interested Stockholder with whom the business combination
is to be effected, unless, among other things, the corporation's stockholders
receive a minimum price (as defined in the Maryland GCL) for their shares and
the consideration is received in cash or in the same form as previously paid
by the Interested Stockholder for its shares. These provisions of Maryland law
do not apply, however, to business combinations that are approved or exempted
by the board of directors of the corporation prior to the time that the
Interested Stockholder becomes an Interested Stockholder. The Board of
Directors of the Company has adopted a resolution to the effect that the
foregoing provisions of Maryland law shall not apply to any future business
combination with any purchaser of Units in the Offering (or an affiliate
thereof) or to any other future business combination with the Company. No
assurance can be given that such provision will not be amended or eliminated
at any point in the future with respect to business combinations not involving
a purchaser of Units.
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CONTROL SHARE ACQUISITIONS
The Maryland GCL provides that "control shares" of a Maryland corporation
acquired in a "control share acquisition" have no voting rights except to the
extent approved by a vote of two-thirds of the votes entitled to be cast on
the matter, excluding shares of stock owned by the acquiror or by officers or
directors who are employees of the corporation. "Control shares" are voting
shares of stock which, if aggregated with all other shares of stock owned by
such a person, would entitle the acquiror to exercise voting power in electing
directors within one of the following ranges of voting power: (i) one-fifth or
more but less than one third, (ii) one-third or more but less than a majority,
or (iii) a majority or more of all voting power. "Control shares" do not
include shares of stock the acquiring person is then entitled to vote as a
result of having owned stockholder approval. A "control share acquisition"
means, subject to certain exceptions, the acquisition of, ownership of, or the
power to direct the exercise of voting power with respect to, control shares.
A person who has made or proposes to make a "control share acquisition,"
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the Board of Directors to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the corporation may itself
present the question at any stockholders' meeting. If voting rights are not
approved at the meeting or if the acquiring person does not deliver an
acquiring person statement as permitted by the statute, then, subject to
certain conditions and limitations, the corporation may redeem any or all of
the "control shares" (except those for which voting rights have previously
been approved) for fair value determined, without regard to absence of voting
rights, as of the date of the last control share acquisition or of any meeting
of stockholders at which the voting rights of such shares are considered and
not approved. If voting rights for "control shares" are approved at a
stockholders meeting and the acquiror becomes entitled to vote a majority of
the shares entitled to vote, all other stockholders may exercise appraisal
rights. The fair value of the stock, as determined for purposes of such
appraisal rights may not be less than the highest price per share paid in the
control share acquisition, and certain limitations and restrictions otherwise
applicable to the exercise of dissenters rights do not apply in the context of
"control share acquisitions."
The "control share acquisition" statute does not apply to stock acquired in
a merger, consolidation or share exchange if the corporation is a party to the
transaction, or to acquisitions approved or exempted by a provision of the
articles of incorporation or bylaws of the corporation adopted prior to the
acquisition of the shares. The Company has adopted a provision in its Bylaws
that exempts the Company's shares of Capital Stock from application of the
control share acquisition statute. No assurance can be given, however, that
such Bylaw provision may not be removed at any time by amendment of the
Bylaws.
TRANSFER AGENT AND REGISTRAR
The Company expects to appoint an outside transfer agent and registrar with
respect to the Common Stock and the Warrants.
DESCRIPTION OF WARRANTS
The Warrants were issued pursuant to a warrant agreement (the "Warrant
Agreement") dated as of December 9, 1996 between the Company and the warrant
agent (the "Warrant Agent"). The Company is initially acting as Warrant Agent.
The following summary of certain provisions of the Warrant Agreement does not
purport to be complete and is qualified in its entirety by reference to the
Warrant Agreement including the definitions therein of certain terms used
below. A copy of the Warrant Agreement is filed with the Commission along with
the Registration Statement of which this Prospectus is a part.
The Warrants were originally issued as part of the Units, each Unit
consisting of one share of Preferred Stock and one Warrant. The Warrants were
represented by the Preferred Stock, which have an endorsement representing
beneficial ownership of the related Warrants on deposit with the Warrant Agent
as custodian for the registered holders of the Warrant. Prior to conversion,
transfer of a share of Preferred Stock to which the related Warrant has not
been exercised constituted transfer of a holder's beneficial interest in the
related Warrant. Upon
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closing of this Offering, each share of Preferred Stock will automatically
convert into one share of Common Stock and the registered holder of the
Preferred Stock will receive a stock certificate representing the Common
Stock, a certificate from the Warrant Agent evidencing a separately
transferable Warrant (the "Warrant Certificate"). Certain Warrants issued to
the placement agent are evidenced by Warrant Certificates issued at that time.
The Warrants and the Warrant Shares have not been registered under the
Securities Act and are subject to certain transfer restrictions. Holders of
the Warrants have certain registration rights with respect to the Common Stock
issued upon conversion of the Warrant Shares. The Warrants are exercisable
beginning on the earlier of the date of effectiveness of a Shelf Registration
Statement (see "Description of Capital Stock--Registration Rights") or six
months following the closing of the Offering and will remain exercisable until
the third anniversary of the exercise date at an exercise price of $15.00 per
share of Common Stock and will be subject to anti-dilution protection.
Each Warrant, when exercised, will entitle the holder thereof to receive one
share of Common Stock at an exercise price of $15.00 per share (the "Exercise
Price.") The exercise price per Warrant was established at the time of the
Company's initial Private Placement of Units, prior to its commencement of
operations, and was fixed by management at the per Unit offering price.
The Warrants may be exercised by surrendering to the Warrant Agent the
definitive Warrant Certificates evidencing such Warrants, with the
accompanying form of election to purchase properly completed and executed,
together with payment of the Exercise Price. Payment of the Exercise Price may
be made (a) in the form of cash or by certified or official bank check payable
to the order of the Company or (b) by surrendering additional Warrants or
shares of Common Stock for cancellation to the extent the Company may lawfully
accept shares of Common Stock, with the value of such shares of Common Stock
for such purpose to equal the average trading price of the Common Stock during
the ten trading days preceding the date surrendered and the value of the
Warrants to equal the difference between the value of a share of Common Stock
and the Exercise Price. Upon surrender of the Warrant Certificate and payment
of the Exercise Price and any other applicable amounts, the Warrant Agent will
deliver or cause to be delivered, to or upon the written order of such holder,
stock certificates representing the number of whole shares of Common Stock or
other securities or property to which such holder is entitled. If less than
all of the Warrants evidenced by a Warrant Certificate are to be exercised, a
new Warrant Certificate will be issued for the remaining number of Warrants.
No fractional shares of Common Stock will be issued upon exercise of the
Warrants. The holders of the Warrants have no right to vote on matters
submitted to the stockholders of the Company and have no right to receive
dividends. The holders of the Warrants not yet exercised are not entitled to
share in the assets of the Company in the event of liquidation, dissolution or
the winding up of the affairs of the Company.
The Exercise Price of the Warrants will be appropriately adjusted if the
Company (i) pays a dividend or makes a distribution on its Common Stock in
shares of its Common Stock, (ii) subdivides its outstanding shares of Common
Stock into a greater number of shares, (iii) combines its outstanding shares
of Common Stock into a smaller number of shares, (iv) issues by
reclassification of its Common Stock any shares of its capital stock, or (v)
issues shares of Capital Stock at a price below the greater of (a) $15 or (b)
fair market value, provided that this clause (v) shall not apply to this
Offering.
In case of certain consolidations or mergers of the Company, or the
liquidation of the Company or the sale of all or substantially all of the
assets of the Company to another corporation, each Warrant will thereafter be
deemed exercised for the right to receive the kind and amount of shares of
stock or other securities or property to which such holder would have been
entitled as a result of such consolidation, merger or sale had the Warrants
been exercised immediately prior thereto (for shares of Preferred Stock if
prior to the conversion of the Preferred Stock and shares of Common Stock if
after the conversion), less the Exercise Price.
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UNDERWRITING
The underwriters named below (the "Underwriters"), represented by Stifel,
Nicolaus & Company, Incorporated and Montgomery Securities (the
"Representatives"), have severally agreed to purchase, and the Company has
agreed to sell, subject to the terms and conditions set forth in an
underwriting agreement (the "Underwriting Agreement"), the respective number
of shares of Common Stock set forth opposite their names below. The
Underwriting Agreement provides that the obligations of the Underwriters are
subject to certain conditions precedent and that the Underwriters will be
obligated to purchase all of the shares if any are purchased.
<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERWRITER TO BE PURCHASED
----------- ----------------
<S> <C>
Stifel, Nicolaus & Company, Incorporated....................
Montgomery Securities.......................................
---------
Total............................................... 3,000,000
=========
</TABLE>
The Underwriters, through the Representatives, have advised the Company that
they propose to offer the shares to the public at the Price to Public set
forth on the cover page of this Prospectus. The Underwriters may allow to
selected dealers a concession of not more than $ per share, and the
Underwriters may allow, and such dealers may reallow, a concession of not more
than $ per share to certain other dealers. After the initial public
offering, the public offering price, concession and reallowance may be changed
by the representatives. The Common Stock is offered subject to receipt and
acceptance by the Underwriters, and to certain other conditions, including the
right to reject orders in whole or in part.
The Company has granted the Underwriters an option exercisable for 30 days
after the date hereof to purchase up to 450,000 additional shares to cover
over-allotments, if any, at the initial public offering price less the
underwriting discount. If the Underwriters exercise this option, each of the
Underwriters will have a firm commitment, subject to certain conditions, to
purchase approximately the same percentage of such additional shares as the
number of shares to be purchased by it shown in the foregoing table bears to
the shares initially offered hereby. The Underwriters may purchase such shares
only to cover over-allotments in connection with this Offering.
Prior to this Offering, there has been no public market for the Common
Stock. Consequently, the public offering price will be determined by
negotiation between the Company and the Representatives and may not bear any
relation to the book value or assets of the Company or any other recognized
criteria of value. Among the factors considered in such negotiations were the
nature of the Company's business, its prospects and management, and the
general conditions of the securities markets at the time of the offering.
There can be no assurance, however, that the prices at which the shares will
sell to the public market after the public offering will not be lower than the
price at which they are sold by the Underwriters.
The Company has agreed to indemnify the several Underwriters against certain
civil liabilities, including liabilities under the Securities Act of 1933, as
amended or to contribute to payments which the Underwriters may be required to
make in respect thereof. The Company has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and therefore unenforceable.
The Representatives have informed the Company that they do not expect to
make sales to accounts over which they exercise discretionary authority in
excess of five percent of the number of shares of Common Stock offered hereby.
The Company and the officers and directors of the Company have agreed that,
for a period of 180 days from the date of this Prospectus, they will not,
without the prior written consent of Stifel, Nicolaus & Company, Incorporated,
directly or indirectly, sell, offer to sell, grant any option for the sale of,
or otherwise dispose of
83
<PAGE>
any shares of Common Stock or any security convertible into Common Stock,
except for options granted pursuant to the Company's stock option plan.
Certain of the Underwriters have in the past performed, and may continue to
perform, investment banking, broker-dealer and financial advisory services for
the Company and have received customary compensation therefor.
Out of the 3,000,000 shares to be sold by the Company pursuant to this
Offering (not including the Underwriters' over-allotment option), the
Underwriters have accepted the Company's request to sell up to 5 percent of
such shares at the price to public set forth on the cover page of this
Prospectus to employees and other persons designated by the Company.
Current Stifel, Nicolaus & Company, Incorporated personnel purchased 83,450
Units in the Company's Private Placement of Units and, accordingly, hold that
number of shares of Preferred Stock (approximately two percent of the
Preferred Stock outstanding) and of Warrants. In addition, Stifel, Nicolaus &
Company Incorporated received Warrants to purchase 100,000 shares of Common
Stock at a price of $15.00 per share in connection with the Private Placement.
Application will be made to have the Common Stock approved for quotation on
the Nasdaq National Market.
The Company has been advised by the Representatives that each of the
Representatives presently intends to make a market in the Common Stock offered
hereby; however, the Representatives are not obligated to do so, and any
market making activity may be discontinued at any time. Until the
Representatives' participations in the distribution of the Common Stock is
complete, any such passive market making activities will be conducted in
accordance with Rule 103 of Regulation M under the Securities Exchange Act of
1934. There can be no assurance that an active public market for the Common
Stock will develop and continue after this Offering.
Until the distribution of the Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters
and certain selling group members to bid for and purchase the Units, Warrants
and Common Stock. As an exception to these rules, the Representatives are
permitted to engage in certain transactions that stabilize the price of the
Common Stock. Such transactions consist of bids or purchases for the purpose
of pegging, fixing or maintaining the price of such securities. If the
Representatives over-allot, i.e., if they sell more shares of Common Stock
than is set forth on the cover page of this Prospectus and thereby create a
short position in the Common Stock in connection with this Offering, then the
Representatives may reduce that short position by purchasing Common Stock in
the open market. The Representatives may also elect to reduce any short
position by exercising all or part of the over-allotment option described
herein. The Representatives may also impose a penalty bid on certain
Underwriters and selling group members. This means that if the Representatives
purchase shares of Common Stock in the open market to reduce the Underwriters
short position or to stabilize the price of the Common Stock, they may reclaim
the amount of the selling concession from the Underwriters and selling group
members who sold those securities as part of the Offering. In general,
purchases of securities for the purpose of stabilization or to reduce a short
position could cause the price of the security to be higher than it might be
in the absence of such purchases. The imposition of a penalty bid might also
have an effect on the price of a security to the extent that it were to
discourage resales of the security. These transactions may be effected on the
Nasdaq National Market or otherwise. Neither the Company nor any of the
Underwriters makes any representation or prediction as to the direction or
magnitude of any effect that the transactions described above may have on the
price of the Common Stock. In addition, neither the Company nor any of the
Underwriters makes any representation that the Representatives will engage in
such transactions or that such transactions, once commenced, will not be
discontinued without notice.
84
<PAGE>
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed on for the
Company by Tobin & Tobin, a professional corporation, San Francisco,
California. Certain tax matters will be passed on by Jeffers, Wilson, Shaff &
Falk, LLP, Irvine, California. Certain legal matters will be passed upon for
the Underwriters by O'Melveny & Myers LLP, San Francisco, California.
Attorneys at such firm own 5,333 shares of Preferred Stock and Warrants in the
Company. Tobin & Tobin, a professional corporation, Jeffers, Wilson, Shaff &
Falk, LLP and O'Melveny & Myers LLP will rely as to all matters of Maryland
law upon the opinion of special Maryland counsel to the Company, Piper &
Marbury, L.L.P., Baltimore, Maryland.
EXPERTS
The consolidated financial statements of NovaStar Financial, Inc. and
subsidiary as of June 30, 1997 and December 31, 1996 and for the six-months
ended June 30, 1997 and for the period from September 13, 1996 (inception) to
December 31, 1996, have been included herein and in the registration statement
in reliance upon the report of KPMG Peat Marwick LLP, independent certified
public accountants, appearing elsewhere herein, and upon the authority of said
firm as experts in accounting and auditing.
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"), in Washington, D.C., a Registration Statement on Form S-11
under the Securities Act with respect to the Common Stock offered hereby. This
Prospectus does not contain all of the information set forth in the
Registration Statement and the exhibits thereto. Certain items are omitted in
accordance with the rules and regulations of the Commission. For further
information with respect to the Company and the Common Stock offered hereby,
reference is made to the Registration Statement and the exhibits filed as a
part thereof. Statements contained in this Prospectus as to the contents of
any contract or any other document referred to are not necessarily complete
and, in each instance, if such contract or document is filed as an exhibit,
reference is made to the copy of such contract or document filed as an exhibit
to the Registration Statement, each such statement being qualified in all
respects by such reference to such exhibit. Upon completion of the Offering
the Company will subject to the informational requirements of the Securities
and Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith will file reports and other information with the Commission.
Reports, proxy statements and other information filed by the Company may be
inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
Commission's regional offices located at Seven World Trade Center, 13th Floor,
New York, New York 10048, and at 500 West Madison Street, Chicago, Illinois
60661. Copies of such materials can also be obtained at prescribed rates from
the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549. Electronic filings made through the Electronic Data
Gathering Analysis and Retrieval System are publicly available through the
Commission's Web Site (http://www.sec.gov). The Common Stock of the Company is
expected to be approved for quotation on the Nasdaq National Market. Holders
of the Common Stock will receive annual reports containing audited financial
statements with a report thereon by the Company's independent certified public
accountants, and quarterly reports containing unaudited financial information
for each of the first three quarters of each fiscal year.
85
<PAGE>
GLOSSARY
As used in this Prospectus, the capitalized and other terms listed below
have the meanings indicated.
"Agency" means FNMA, FHLMC or GNMA.
"Agency Certificates" means Pass-Through Certificates guaranteed by FNMA,
FHLMC or GNMA.
"ARM" or "Adjustable Rate Mortgage" means a mortgage loan (including any
mortgage loan underlying a Mortgage Security) that features adjustments of the
underlying interest rate at predetermined times based on an agreed margin to
an established index. An ARM is usually subject to periodic interest rate
and/or payment caps and a lifetime interest rate cap.
"Capital Stock" means the shares of capital stock issuable by the Company
under its Charter, and includes Common Stock and Preferred Stock.
"CMO" or "Collateralized Mortgage Obligations" means adjustable or short-
term fixed-rate debt obligations (bonds) that are collateralized by mortgage
loans or Pass-Through Certificates and issued by private institutions or
issued or guaranteed by GNMA, FNMA or FHLMC.
"Code" means the Internal Revenue Code of 1986, as amended.
"Company" means NovaStar Financial, Inc., a Maryland corporation, and
includes any subsidiaries thereof except when the context otherwise requires.
"conforming mortgage loans" means mortgage loans that either comply with
requirements for inclusion in credit support programs sponsored by FHLMC or
FNMA or are FHA or VA Loans, all of which are secured by first mortgages or
deeds of trust on single family (one to four units) residences.
"ERISA" means the Employee Retirement Income Security Act of 1974.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"FHA" means the United States Federal Housing Administration.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"founders" means Scott F. Hartman and W. Lance Anderson.
"FNMA" means the Federal National Mortgage Association.
"GAAP" means generally accepted accounting principles.
"GNMA" means the Government National Mortgage Association.
"Independent Directors" means a director of the Company who is not an
officer or employee of the Company or any affiliate (excluding GE Capital and
its affiliates) or subsidiary of the Company.
"ISOs" means qualified incentive stock options granted under the Stock
Option Plan which meet the requirements of Section 422 of the Code.
"LTV" means loan-to-value ratio which is the percentage obtained by dividing
the principal amount of a loan by the lower of the sales price or appraised
value of the mortgaged property when the loan is originated.
"Mortgage Assets" means (i) mortgage loans, and (ii) Mortgage Securities,
and (iii) other Qualified REIT Assets.
"Mortgage Securities" means (i) Pass-Through Certificates and (ii) CMOs.
86
<PAGE>
"Pass-Through Certificates" means securities (or interests therein) which
are Qualified REIT Assets evidencing undivided ownership interests in a pool
of mortgage loans, the holders of which receive a "pass-through" of the
principal and interest paid in connection with the underlying mortgage loans
in accordance with the holders' respective undivided interests in the pool.
"Private Placement" means the Company's private placement of Units which
closed December 9, 1996. Each Unit consists of one share of Convertible
Preferred Stock and one Warrant to purchase one share of Common Stock.
"Qualified Hedge" means a hedging contract that has each of the following
attributes: (a) the hedging contract must be a swap or cap agreement, as
contemplated by Section 1.446-3 of the Treasury Regulations; (b) the swap or
cap agreement must be a bona fide interest rate swap or cap agreement entered
into by the Company to hedge any variable rate indebtedness of the Company
incurred or to be incurred to acquire or carry real estate assets; (c) the
Company will not treat as a Qualified Hedge any hedging instrument acquired to
hedge an asset of the Company; and (d) the Company will only treat as a
Qualified Hedge a hedging instrument acquired to hedge a variable rate
indebtedness secured by a variable rate asset that itself is subject to
periodic or lifetime interest rate caps, or a variable rate indebtedness that
is subject to a different interest rate index from that of the Company's asset
securing such variable rate indebtedness.
"Qualified REIT Assets" means Pass-Through Certificates, mortgage loans,
Agency Certificates and other assets of the type described in Code Section
856(c)(6)(B).
"Real Estate Asset" means interests in real property, interests in mortgages
on real property, and regular or residual interests in REMICs.
"REIT" means Real Estate Investment Trust as defined under Section 856 of
the Code.
"REMIC" means Real Estate Mortgage Investment Conduit as defined under
Section 860D of the Code.
"Reverse Repurchase Agreement" means a secured borrowing device evidenced by
an agreement to sell securities or other assets to a third party and a
simultaneous agreement to repurchase them at a specified future date and
price, the price difference constituting the interest on the borrowing.
"Securities Act" means the Securities Act of 1933, as amended.
"single family" means, with respect to mortgage loans, loans secured by one-
to four-unit residential property.
"Special Tax Counsel" means the law firm of Jeffers, Wilson, Shaff & Falk,
LLP.
"Tax-Exempt Entity" means a qualified pension, profit-sharing or other
employee retirement benefit plan, Keogh Plans, bank commingled trust funds for
such plans, IRAs and other similar entities intended to be exempt from Federal
income taxation.
"taxable income" means for any year the taxable income of the Company for
such year (excluding any net income derived either from property held
primarily for sale to customers or from foreclosure property) subject to
certain adjustments provided in Section 857 of the Code.
"UBTI" means "unrelated trade or business income" as defined in Section 512
of the Code.
"Underwriters" shall have the meaning under the heading "Underwriting."
"VA" means the United States Department of Veterans Affairs.
87
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report............................................... F-2
Consolidated Financial Statements:
Balance Sheets........................................................... F-3
Statements of Operations................................................. F-4
Statements of Stockholders' Equity....................................... F-5
Statements of Cash Flows................................................. F-6
Notes to Consolidated Financial Statements................................. F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
NovaStar Financial, Inc.:
We have audited the accompanying consolidated balance sheets of NovaStar
Financial, Inc. and subsidiary as of June 30, 1997 and December 31, 1996 and
the related consolidated statements of operations, stockholders' equity and
cash flows for the six months ended June 30, 1997 and the period from
September 13, 1996 (inception) to December 31, 1996. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of NovaStar Financial, Inc. and subsidiary as of June 30, 1997 and December
31, 1996 and the consolidated results of their operations and their cash flows
for the six months ended June 30, 1997 and the period from September 13, 1996
(inception) to December 31, 1996, in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
Kansas City, Missouri
July 25, 1997
F-2
<PAGE>
NOVASTAR FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
<S> <C> <C>
ASSETS
Cash and cash equivalents............................. $ 874 $46,434
Mortgage securities available-for-sale................ 284,348 13,239
Mortgage loans........................................ 303,732 --
Accrued interest receivable........................... 6,244 14
Other assets.......................................... 6,543 109
-------- -------
Total assets...................................... $601,741 $59,796
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Borrowings.......................................... $553,640 $ --
Amounts due to brokers and dealers for unsettled
mortgage securities purchases...................... -- 13,255
Accounts payable and accrued expenses............... 1,764 176
-------- -------
Total liabilities................................. 555,404 13,431
Commitments and contingencies
Stockholders' equity:
Capital stock, $0.01 par value, 50,000,000 shares
authorized:
Convertible preferred stock, 3,549,999 issued and
outstanding....................................... 36 36
Common stock, 216,666 shares issued and
outstanding....................................... 2 2
Additional paid-in capital.......................... 49,862 49,910
Accumulated deficit................................. (1,535) (302)
Net unrealized gain (loss) on available-for-sale
securities......................................... 1,367 (16)
Forgivable notes receivable from founders........... (3,395) (3,265)
-------- -------
Total stockholders' equity........................ 46,337 46,365
-------- -------
Total liabilities and stockholders' equity........ $601,741 $59,796
======== =======
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
NOVASTAR FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
FOR THE SIX SEPTEMBER 13, 1996
MONTHS ENDED (INCEPTION) TO
JUNE 30, 1997 DECEMBER 31, 1996
<S> <C> <C>
Interest income:
Mortgage securities....................... $2,241 $ 155
Mortgage loans............................ 7,079 --
------ -----
Total interest income....................... 9,320 155
Interest expense............................ 6,438 --
------ -----
Net interest income......................... 2,882 155
Provision for credit losses................. 718 --
------ -----
Net interest income after provision for
credit losses.............................. 2,164 155
Other income................................ 213 --
General and administrative expenses:
Compensation and benefits................. 1,234 199
Professional and outside services......... 596 --
Loan servicing............................ 571 200
Office administration..................... 334 --
Travel and public relations............... 248 --
Occupancy................................. 162 27
Other..................................... 111 31
------ -----
Total general and administrative
expenses................................. 3,256 457
------ -----
Net loss.................................... $ (879) $(302)
====== =====
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
NOVASTAR FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
FORGIVABLE
NET UNREALIZED NOTES
CONVERTIBLE ADDITIONAL GAIN (LOSS) ON RECEIVABLE TOTAL
PREFERRED COMMON PAID-IN ACCUMULATED AVAILABLE-FOR-SALE FROM STOCKHOLDERS'
STOCK STOCK CAPITAL DEFICIT SECURITIES FOUNDERS EQUITY
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, September 13,
1996................... $ -- $ -- $ -- $ -- $ -- $ -- $ --
Issuance of 216,666
shares of common stock
for cash............... -- 2 -- -- -- -- 2
Net proceeds from
private placement of
3,333,333 units........ 34 -- 46,662 -- -- -- 46,696
Units (216,666) acquired
with forgivable debt... 2 -- 3,248 -- -- (3,250) --
Net loss................ -- -- -- (302) -- -- (302)
Net change in unrealized
gain (loss) on
available-for-sale
securities............. -- -- -- -- (16) -- (16)
Interest on forgivable
notes receivable from
founders............... -- -- -- -- -- (15) (15)
----- ----- ------- ------- ------ ------- -------
Balance, December 31,
1996................... 36 2 49,910 (302) (16) (3,265) 46,365
Private placement
issuance costs......... -- -- (48) -- -- -- (48)
Net loss................ -- -- -- (879) -- -- (879)
Net change in unrealized
gain (loss) on
available-for-sale
securities............. -- -- -- -- 1,383 -- 1,383
Dividends on convertible
preferred stock ($0.10
per share)............. -- -- -- (354) -- -- (354)
Interest on forgivable
notes receivable from
founders............... -- -- -- -- -- (130) (130)
----- ----- ------- ------- ------ ------- -------
Balance, June 30, 1997.. $ 36 $ 2 $49,862 $(1,535) $1,367 $(3,395) $46,337
===== ===== ======= ======= ====== ======= =======
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
NOVASTAR FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
FOR THE SIX SEPTEMBER 13, 1996
MONTHS ENDED (INCEPTION) TO
JUNE 30, 1997 DECEMBER 31, 1996
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES:
Net loss..................................... $ (879) $ (302)
Adjustments to reconcile net loss to cash
used in operating activities:
Amortization of premiums................... 700 --
Interest on forgivable notes receivable
from founders............................. (130) (15)
Provision for credit losses................ 718 --
Gains on sales of mortgage securities...... (42) --
Change in:
Accrued interest receivable.............. (6,230) (14)
Other assets............................. (826) (109)
Other liabilities........................ 832 176
--------- -------
Net cash used in operating activities.. (5,857) (264)
CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of available-for-sale securities.. (378,526) --
Settlement of amounts due to brokers........ (12,676) --
Proceeds from sales of available-for-sale
securities................................. 99,794 --
Proceeds from paydowns on and maturities of
available-for-sale securities.............. 3,211 --
Mortgage loans acquired..................... (219,995) --
Mortgage loans originated, net of
repayments................................. (84,926) --
--------- -------
Net cash used in investing activities.. (593,118) --
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from private placement, net of
offering costs............................. (48) 46,696
Proceeds from issuance of common stock...... -- 2
Net borrowings under repurchase agreements.. 540,040 --
Net advances under warehouse line of
credit..................................... 13,600 --
Dividends paid on convertible preferred
stock...................................... (177) --
--------- -------
Net cash provided by financing
activities............................ 553,415 46,698
--------- -------
Net increase (decrease) in cash and cash
equivalents................................. (45,560) 46,434
Cash and cash equivalents, beginning of
period...................................... 46,434 --
--------- -------
Cash and cash equivalents, end of period..... $ 874 $46,434
========= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest...................... $ 5,631 $ --
========= =======
Issuance of units acquired with forgivable
debt....................................... $ -- $ 3,250
========= =======
Dividends payable........................... $ 177 $ --
========= =======
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
NOVASTAR FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
NovaStar Financial, Inc. (NovaStar, or, collectively with its consolidated
affiliates, the Company) is a Maryland corporation formed on September 13,
1996. The Company completed a private placement offering of units, consisting
of convertible preferred stock and warrants in December 1996 (see Note 7). The
Company originates and acquires subprime mortgage loans, acquires mortgage
securities and manages the resulting portfolio of mortgage assets.
Financial Statement Presentation
The Company's consolidated financial statements include the accounts of
NovaStar, NFI Holding Corporation (Holding) and NovaStar Mortgage, Inc. (NMI).
NovaStar owns 100 percent of the nonvoting preferred stock of Holding, for
which it receives 99 percent of the dividends paid by Holding. The common
stock of Holding is owned by the founders of NovaStar. Holding owns 100
percent of the outstanding stock of NMI. NMI serves as the Company's principal
source of subprime mortgage loans. NovaStar manages the assets and liabilities
of the Company.
The Company's consolidated financial statements have been prepared in
conformity with generally accepted accounting principles and prevailing
practices within the financial services industry. The preparation of financial
statements requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of income and expense during the period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers investments with maturities of three months or less at
the date of purchase to be cash equivalents. As of December 31, 1996, cash
equivalents include $35 million in commercial paper.
Mortgage Securities
Although the Company generally intends to hold its mortgage securities to
maturity, it may on occasion deem it necessary to sell securities.
Accordingly, the Company classifies all of its mortgage securities as
available-for-sale and, therefore, reports them at their estimated fair value
with unrealized gains and losses reported as a separate component of
stockholders' equity. Premiums are amortized as a yield adjustment over the
estimated lives of the securities using the interest method. Gains or losses
on sales of securities are recognized using the specific identification
method.
Mortgage Loans
Mortgage loans include loans originated through the Company's wholesale
production operation and those acquired in bulk pools from other originators
and securities dealers. Loans are generally purchased at a premium over the
outstanding principal balance. Mortgage loans are stated at amortized cost.
For originated loans, cost includes deferred fees received and direct costs
incurred, which, along with premiums paid, are amortized as a yield adjustment
over the estimated lives of the loans using the interest method.
Interest is recognized as revenue when earned according to the terms of the
mortgage loans and when, in the opinion of management, it is collectible.
Accrual of interest on non-performing loans is suspended when, in
F-7
<PAGE>
NOVASTAR FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the opinion of management, the collection of interest or the related principal
is less than probable. Any interest received on non-accrual loans is credited
to principal.
Credit Risk
NovaStar maintains an allowance for credit losses at a level it deems
appropriate for both known losses and unidentified potential losses in its
mortgage loan portfolio. The allowance for credit losses is based upon the
assessment by management of various factors affecting its mortgage loan
portfolio, including current and projected economic conditions, the makeup of
the portfolio based on credit grade, delinquency status and other factors
deemed to warrant consideration. The allowance is maintained through ongoing
provisions charged to operating income, reduced by net charge-offs.
Interest Rate Agreements
The Company has entered into interest rate swap and cap agreements designed
to, in effect, alter the interest rates on its funding costs to more closely
match the yield on interest-earning assets. Net income earned from or expense
incurred on these agreements is accounted for on the accrual method and is
recorded as an adjustment to interest expense.
Income Taxes
NovaStar intends to operate and qualify as a real estate investment trust
(REIT) under the requirements of the Internal Revenue Code. Requirements for
qualification as a REIT include various restrictions on ownership of the stock
of NovaStar and certain restrictions on the nature of assets and sources of
income. In addition, a REIT must distribute at least 95 percent of its annual
taxable income to its stockholders. If in any tax year NovaStar does not
qualify as a REIT, it will be taxed as a corporation and distributions to
stockholders will not be deductible in computing taxable income. If the
Company fails to qualify as a REIT in any tax year, it will not be permitted
to qualify for the succeeding four years. For tax purposes, the REITs
deduction for credit losses is limited to actual net charge-offs.
Holding and NMI are not operated as REITs, will file Federal and state
income tax returns separately and will record income taxes using the asset and
liability method.
New Accounting Pronouncements
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities," as amended by SFAS No. 127, is effective
for all transfers and servicing of financial assets and extinguishments of
liabilities occurring after December 31, 1996, except for secured borrowings
and collateral, repurchase agreements, dollar rolls, securities lending and
similar transactions, which transfers will be effective for transactions
occurring after December 31, 1997. This statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on consistent application of financial-
components approach that focuses on control. It distinguishes transfers of
financial assets that are sales from transfers that are secured borrowings.
Under the financial-components approach, after a transfer of financial assets,
an entity recognizes all financial and servicing assets it controls and
liabilities it has incurred and derecognizes financial assets it no longer
controls and liabilities that have been extinguished. Many of these assets and
liabilities are components of financial assets that existed prior to the
transfer. If a transfer does not meet the criteria for a sale, the transfer is
accounted for as a secured borrowing with a pledge of collateral. Management
believes adoption of SFAS No. 125, as amended by SFAS No. 127, will not have a
material effect on the financial position or results of operations, nor will
adoption require any significant additional capital resources.
F-8
<PAGE>
NOVASTAR FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
SFAS No. 128, "Earnings Per Share" is effective for the fiscal year ending
December 31, 1997, with earlier adoption prohibited. SFAS No. 128 supersedes
APB Opinion No. 15 (APB No. 15) and specifies the computation, presentation,
and disclosure requirements for earnings per share (EPS) for entities with
publicly held common stock or potential common stock. SFAS No. 128 was issued
to simplify the computation of EPS and to make the U.S. standard more
compatible with the EPS standards of other countries and the International
Accounting Standards Committee (IASC). It replaces the presentation of primary
EPS with a presentation of basic EPS and fully diluted EPS with diluted EPS.
Basic EPS, unlike primary EPS, excludes dilution and is computed by dividing
income available to common stockholders by the weighted-average number of
common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity.
Diluted EPS is computed similarly to fully diluted EPS under APB No. 15.
Retroactive application will be required.
NOTE 2. MORTGAGE SECURITIES
Mortgage securities, all classified as available-for-sale, consist of the
following as of June 30, 1997 (dollars in thousands):
<TABLE>
<CAPTION>
WEIGHTED UNREALIZED
AVERAGE AMORTIZED ------------- CARRYING
RATE COST GAINS LOSSES VALUE
<S> <C> <C> <C> <C> <C>
Mortgage securities issued by:
Federal National Mortgage
Association................... 8.02% $270,821 $1,355 $20 $272,156
Government National Mortgage
Association................... 7.88 8,334 29 -- 8,363
Federal Home Loan Mortgage
Corporation................... 8.44 3,826 8 5 3,829
-------- ------ --- --------
$282,981 $1,392 $25 $284,348
======== ====== === ========
</TABLE>
As of December 31, 1996, mortgage securities consisted of obligations of the
Federal National Mortgage Association with a weighted average rate of 7.77
percent. These securities had gross unrealized losses of $16,233.
The contractual maturities of mortgage securities were approximately 25.7
years as of June 30, 1997. The expected maturities of mortgage securities may
differ from contractual maturities since borrowers have the right to prepay
the obligations.
Proceeds from the sales of two mortgage securities during the six months
ended June 30, 1997 were $99.8 million. Gross gains of $42,112 were realized
on these sales.
All mortgage securities are pledged as collateral under various borrowing
arrangements as described in Note 4.
NOTE 3. MORTGAGE LOANS
Mortgage loans, all of which are secured by residential properties, consist
of the following as of June 30, 1997 (in thousands):
<TABLE>
<S> <C>
Outstanding principal.............................................. $290,293
Unamortized premium................................................ 14,157
--------
Amortized cost..................................................... 304,450
Reserve for credit losses.......................................... (718)
--------
$303,732
========
</TABLE>
F-9
<PAGE>
NOVASTAR FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Mortgage loans serve as collateral for various borrowing arrangements as
discussed in Note 4.
Collateral for approximately 36 percent of mortgage loans outstanding as of
June 30, 1997 was located in California. The Company has no other significant
concentration of credit risk. The Company expects the portfolio to become more
diversified as a national sales force is fully developed. As of June 30, 1997,
the Company's mortgage loans consisted primarily of single family mortgage
residential loans, with interest rates ranging from 7.5 to 18.0 percent, none
of which individually exceeded one percent of the outstanding aggregate
balance of mortgage loans.
NOTE 4. BORROWINGS
NovaStar has financed its mortgage assets through various arrangements,
including a warehouse line of credit and repurchase agreements with brokerage
firms. Mortgage loan originations have been financed in the short-term through
a $50 million warehouse facility with First Union National Bank. In addition,
the Company has a $300 million repurchase agreement with Merrill Lynch
Mortgage Capital, Inc. and Merrill Lynch Credit Corporation as another source
of short-term financing. Borrowings under the warehouse facility generally
bear interest at a spread over the Federal Funds rate. The warehouse facility
matures in February 1998 and includes financial and non-financial covenants.
Borrowings under the master repurchase agreement bear interest at various
rates priced in connection with respective purchases of mortgage assets. The
master repurchase agreement matures in January 1998 and also includes
customary covenants. As of June 30, 1997, the Company was in compliance with
all covenants under both agreements.
Repurchase agreements used to finance mortgage securities bear interest at
prevailing market rates and mature in 30 days to one year.
The following table presents a summary of the Company's borrowings (dollars
in thousands):
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
--------------------------
WEIGHTED AVERAGE DAILY
WEIGHTED DAYS TO BALANCE DURING THE
AVERAGE RESET OR SIX MONTHS ENDED
RATE MATURITY BALANCE JUNE 30, 1997
<S> <C> <C> <C> <C>
Repurchase agreements secured by
mortgage securities............ 6.00% 85 $275,790 $ 56,226
Master repurchase agreement
secured by mortgage loans...... 6.44 30 264,250 132,937
Warehouse line of credit secured
by mortgage loans.............. 8.12 1 13,600 13,711
--------
Total borrowings.............. $553,640
========
</TABLE>
No amounts were outstanding under borrowing arrangements as of December 31,
1996.
NOTE 5. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
INTEREST RATE SWAP AND CAP AGREEMENTS NovaStar engages in various
transactions which result in off-balance sheet risk. Interest rate swap and
cap agreements are used in conjunction with on balance sheet liabilities to
mitigate the exposure to variations in interest rates on interest-earning
assets that are different from the variations in interest incurred on
borrowings. These instruments involve, to varying degrees, elements of credit
and market risk in addition to the amount recognized in the financial
statements.
Credit Risk NovaStar is exposed to credit risk on derivatives, limited to
the cost of replacing contracts should the counterparty fail. The contract or
notional value is not at risk in derivative contracts. NovaStar seeks to
minimize credit risk through the use of credit approval and review processes,
the selection of only the most creditworthy counterparties, continuing review
and monitoring of all counterparties, exposure reduction techniques and
through legal scrutiny of agreements. Prior to engaging in negotiated
derivative transactions with
F-10
<PAGE>
NOVASTAR FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
any counterparty, NovaStar has in place fully executed written agreements.
Agreements with counterparties also call for full two-way netting of payments.
Under such an agreement, on each payment exchange date all gains and losses of
a counterparty are netted into a single amount, limiting exposure to the
counterparty to any net positive value.
Market Risk The potential for financial loss due to adverse changes in
market interest rates is a function of the sensitivity of each position to
changes in interest rates, the degree to which each position can affect future
earnings under adverse market conditions, the source and nature of funding for
the position, and the net effect due to offsetting positions. The synthetic
products created through these transactions are "matched" transactions for
NovaStar. In these transactions, NovaStar generally does not take a market
position, which could either positively or negatively affect its market risk
exposure. The combination of off-balance sheet instruments with on-balance
sheet liabilities leaves NovaStar in a market risk position that is designed
to be a better position than if the derivative had not be used in interest
rate risk management. Derivatives instruments used in matched transactions as
described above are classified as derivatives held for purposes other than
trading. No derivatives were held for trading purposes during the periods
ended December 31, 1996 and June 30, 1997.
Other Risk Considerations NovaStar is cognizant of the risks involved with
financial derivatives. The Company's policies and procedures seek to mitigate
risk associated with the use of financial derivatives in ways appropriate to
its business activities, considering its risk profile as a limited end-user.
The Company did not enter into any interest rate agreements during the
period ended December 31, 1996. Derivatives held for purposes other than
trading consisted of the following as of June 30, 1997 (dollars in thousands):
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
UNREALIZED WEIGHTED INTEREST RATE ACCRUED INTEREST
NOTIONAL ------------ DAYS TO ------------------ ------------------
VALUE GAINS LOSSES MATURITY RECEIVABLE PAYABLE RECEIVABLE PAYABLE
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest rate swap
agreements--
Fixed rate pay........ $191,000 $17 $282 681 5.80% 6.33% $2,180 $2,206
</TABLE>
As of June 30, 1997, the Company had also entered into interest rate cap
agreements with a notional amount of $75 million. Under the terms of these
agreements, the Company receives a variable rate of interest when three-month
LIBOR rises above a contractual rate for which it pays a monthly premium. The
agreements have a weighted cap rate of 6.30 percent and have weighted average
maturity of 542 days. The Company had no amounts receivable under these
agreements as of June 30, 1997.
NOTE 6. STOCK OPTION PLAN
The Company's 1996 Stock Option Plan (the Plan) provides for the grant of
qualified incentive stock options (ISOs), stock options not so qualified
(NQSOs), deferred stock, restricted stock, performance shares, stock
appreciation and limited stock awards, and dividend equivalent rights (DERs).
ISOs may be granted to the officers and key employees of the Company. NQSOs
and awards may be granted to the directors, officers, key employees, agents
and consultants of the Company or any subsidiaries. Unless previously
terminated by the Board of Directors, the Plan will terminate on September 1,
2006.
In September 1996, options to acquire 10,000 shares of common stock were
granted to non-officer directors for $.01 per share, an amount believed to be
the fair value of such shares at that time. In December 1996, options to
acquire 289,332 shares of common stock were granted to the founders (see note
7) for $15 per share, an amount believed to be greater than the fair value of
such shares at that time. Also in December 1996, options to acquire 35,000
shares of common stock were granted to certain officers for $1.06 per share.
In accordance with the provisions of APB Opinion No. 25, the Company will
recognize compensation expense for the difference between such exercise price
and the estimated fair value of the underlying shares, aggregating
approximately
F-11
<PAGE>
NOVASTAR FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
$50,000 over their vesting period. Such options, along with the options
granted to non-officer directors, vest over 4 years, have ten year terms and
were granted with DERs. Compensation recognized during the six months ended
June 30, 1997 aggregated $18,000. The options granted to the founders vest
only after a qualified initial public offering (IPO) of common stock at a
price of at least $15 per share, and were granted without DERs.
No additional options were granted after December 1996; as of June 30, 1997,
no options have been exercised or are eligible to be exercised.
If the Company had recorded expense based on the fair value of the stock
options at the grant date under SFAS No. 123, the Company's net loss would not
have been materially different than as presented herein. The weighted average
minimum fair value of stock options granted during 1996 was estimated to be
$0.18 per share on the date of the grant. This value was determined using the
Black-Scholes option pricing model assuming an expected life of five years, an
annual risk-free interest rate of 7.0 percent and no annual expected dividend
yield, as holders of common stock receive no dividend as long as preferred
stock is outstanding.
Pro forma net losses reflect only options granted and vested in fiscal 1996.
Therefore, the full impact of calculating compensation expense for stock
options under SFAS No. 123 is not reflected in the pro forma net loss amount
described above because compensation expense is reflected over the options'
vesting period.
NOTE 7. STOCKHOLDERS' EQUITY
The Company was initially capitalized by its founders in September 1996. In
December 1996, the Company successfully completed its private placement
offering of 3,549,999 units. Each unit consists of one share of convertible
preferred stock and one warrant which entitles the holder thereof to purchase
one share of common stock for $15.00 per share. The underwriter received
100,000 warrants in addition to underwriting discounts. The preferred stock
automatically converts to one share of common stock upon the closing of a
qualified IPO of at least $20 million and a price per share of at least
$15.00. Alternatively, the preferred stock may convert at a lesser amount of
proceeds or a lower price, if approved by two-thirds of the preferred
shareholders, or at any time after December 1999 at the option of the holder.
As long as the preferred stock is outstanding, holders thereof will receive
100 percent of dividends paid. The warrants become exercisable within six
months following the closing of a qualified IPO and will remain exercisable
until the third anniversary at an exercise price of $15.00 per share. The
Company raised $47 million in the offering, net of $3 million of offering
expenses.
In addition, 216,666 units were issued in equal amounts to the two founders
at a price of $15.00 per unit upon the closing of the private placement
offering. Payment for such units was made by the founders delivering to the
Company forgivable promissory notes, bearing interest at eight percent per
annum and secured by the units acquired. Interest accrues during the first
year and is added to principal due under the note. Thereafter, interest is
payable quarterly, upon forgiveness or at maturity of the notes on December
31, 2001. The principal amount of the notes will be divided into three equal
tranches. Payment of principal on each tranche will be forgiven if certain
incentive performance tests are achieved. These notes have been reflected as a
reduction of stockholders' equity in the accompanying consolidated balance
sheets. The forgiveness of the notes will result in compensation expense
during the periods of forgiveness.
NOTE 8. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made using amounts that have been determined using available
market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts that could be realized in a current
market exchange. The use of different market assumptions or estimation
methodologies could have a material impact on the estimated fair value
amounts.
F-12
<PAGE>
NOVASTAR FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The estimated fair values of the Company's financial instruments as of June
30, 1997 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
CARRYING VALUE FAIR VALUE
<S> <C> <C>
Financial assets:
Mortgage securities............................ $284,348 $284,348
Mortgage loans................................. 303,732 308,945
Financial liabilities:
Warehouse lines of credit...................... 13,600 13,600
Repurchase agreements.......................... 540,040 541,038
Off-balance sheet items--interest rate
agreements...................................... -- 1,180
</TABLE>
Market quotations are received for estimating the fair value of mortgage
securities. The fair value of all other financial instruments is estimated by
discounting projected future cash flows, including projected prepayments for
mortgage loans, at prevailing market rates. The fair value of cash and cash
equivalents and accrued interest receivable and payable approximates its
carrying value.
As of December 31, 1996, fair values of financial instruments approximated
carrying values.
NOTE 9. COMMITMENTS AND CONTINGENCIES
The Company leases facilities and equipment under operating leases. Rent
expense and future obligations under these leases are not material to the
consolidated financial statements.
In the normal course of its business, the Company is subject to various
legal proceedings and claims, the resolution of which, in the opinion of
management, will not have a material adverse effect on the Company's financial
condition or results of operations.
NOTE 10. INCOME TAXES
NovaStar has elected to be taxed as a REIT and accordingly will deduct, for
income tax purposes, dividends paid on its common and preferred stock. Because
NovaStar intends to pay dividends in amounts approximating its taxable income
for the year ended December 31, 1997, no provision for income tax on the
earnings of NovaStar have been provided in the accompanying consolidated
financial statements. NMI and Holding are subject to Federal and state income
taxes. However, during the periods ended December 31, 1996 and June 30, 1997,
those entities experienced net operating losses. Because of uncertainties
about these entities' ability to achieve profitable operations, no tax benefit
has been recorded in the accompanying consolidated financial statements.
F-13
<PAGE>
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 11
The Company.............................................................. 25
Use of Proceeds.......................................................... 25
Dividend Policy and Distributions........................................ 25
Dividend Reinvestment Plan............................................... 26
Dilution................................................................. 27
Capitalization........................................................... 28
Selected Consolidated Financial and Other Data........................... 29
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 30
Business................................................................. 38
Management............................................................... 54
Principal Securityholders................................................ 63
Certain Transactions..................................................... 65
Federal Income Tax Considerations........................................ 67
Description of Capital Stock............................................. 76
Description of Warrants.................................................. 81
Underwriting............................................................. 83
Legal Matters............................................................ 85
Experts.................................................................. 85
Available Information.................................................... 85
Glossary................................................................. 86
Consolidated Financial Statements........................................ F-1
</TABLE>
---------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION AND
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY OR ANY OTHER PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT
THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR
THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO
ITS DATE. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY SECURITIES OTHER THAN THE SECURITIES TO WHICH
IT RELATES. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH
SUCH OFFER OR SOLICITATION IS UNLAWFUL.
UNTIL (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING
TRANSACTIONS IN THE SECURITIES OFFERED HEREBY, WHETHER OR NOT PARTICIPATING IN
THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION
TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
3,000,000 SHARES
NOVASTAR FINANCIAL, INC.
COMMON STOCK
---------------
Prospectus
, 1997
---------------
STIFEL, NICOLAUS & COMPANY
INCORPORATED
MONTGOMERY SECURITIES
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The expenses expected to be incurred in connection with the issuance and
distribution of the securities being registered are as set forth below. All
such expenses, except for the SEC registration and filing fees, are estimated:
<TABLE>
<S> <C>
SEC Registration.................................................. $18,818
NASD Filing Fee................................................... 6,710
Nasdaq National Market Listing Fee................................ *
Legal Fees and Expenses........................................... *
Accounting Fees and Expenses...................................... *
Printing Fees..................................................... *
Transfer Agent and Registrar Fees................................. *
-------
Total........................................................... $ *
=======
</TABLE>
- --------
* To be provided by amendment.
ITEM 32. SALES TO SPECIAL PARTIES.
None.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.
In September and December 1996 the Registrant sold 216,666 shares of Common
Stock to the two founders of the Registrant for $2,167 cash. Such shares were
sold without registration under the Securities Act of 1933, as amended (the
"Act"), in reliance on the exemption provided by Section 4(2) thereof.
In December 1996 the Registrant sold an aggregate of 3,333,333 Units, each
Unit consisting of one share of Class A Convertible Preferred Stock and one
Stock Purchase Warrant, to approximately 180 "accredited investors" (as such
term is defined under Rule 501(a) promulgated under the Act) for $49,999,995
cash and an additional 216,666 Units to the two founders of the Registrant for
$3,249,999 in forgivable notes. Stifel, Nicolaus & Company, Incorporated acted
as placement agent (the "Placement Agent") in connection with such issuance
and received commissions and reimbursement of expenses totaling approximately
$3,000,000 along with 100,000 Stock Purchase Warrants. Such shares were sold
without registration under the Securities Act of 1933, as amended, in reliance
on the exemption provided by Section 4(2) thereof and on Regulation D
promulgated thereunder.
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 2-418 of the Corporations and Associations Article of the Annotated
Code of Maryland provides that a Maryland corporation may indemnify any
director of the corporation and any person who, while a director of the
corporation, is or was serving at the request of the corporation as a
director, officer, partner, trustee, employee, or agent of another foreign or
domestic corporation, partnership, joint venture, trust, or other enterprise
or employee benefit plan, is made a party to any proceeding by reason of
service in that capacity unless it is established that the act or omission of
the director was material to the matter giving rise to the proceeding and was
committed in bad faith or was the result of active and deliberate dishonesty;
or the director actually received an improper personal benefit in money,
property or services; or, in the case of any criminal proceeding, the director
had reasonable cause to believe that the act or omission was unlawful.
Indemnification may be against judgments, penalties, fines, settlements, and
reasonable expenses actually incurred by the director in connection with the
proceeding, but if the proceeding was one by or in the right of the
corporation, indemnification may not be made in respect of any proceeding in
which the director shall have been adjudged to
II-1
<PAGE>
be liable to the corporation. Such indemnification may not be made unless
authorized for a specific proceeding after a determination has been made, in
the manner prescribed by the law, that indemnification is permissible in the
circumstances because the director has met the applicable standard of conduct.
On the other hand, the director must be indemnified for expenses if he has
been successful in the defense of the proceeding or as otherwise ordered by a
court. The law also prescribes the circumstances under which the corporation
may advance expenses to, or obtain insurance or similar protection for,
directors.
The law also provides for comparable indemnification for corporate officers
and agents.
The Registrant's Articles of Incorporation provide that its directors and
officers shall, and its agents in the discretion of the Board of Directors
may, be indemnified to the fullest extent required or permitted from time to
time by the laws of Maryland.
The Maryland GCL permits the charter of a Maryland corporation to include a
provision limiting the liability of its directors and officers to the
corporation and its stockholders for money damages except to the extent that
(i) it is proved that the person actually received an improper benefit or
profit in money, property or services for the amount of the benefit or profit
in money, property or services actually received, or (ii) a judgment or other
final adjudication is entered in a proceeding based on a finding that the
person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. The Company's Articles of Incorporation contain a provision
providing for elimination of the liability of its directors and officers to
the Company or its stockholders for money damages to the maximum extent
permitted by Maryland law from time to time.
The Underwriting Agreement, the Purchase Terms Agreement, Registration
Rights Agreement and Founders Registration Rights Agreement, included as
Exhibits 1.1, 10.1, 10.2 and 10.4, respectively, to the Registration
Statement, provide for indemnification of the Registrant, its directors and
certain of its officers against certain liabilities, including liabilities
under the Securities Act.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Consolidated Financial Statements (each included in the Prospectus):
Balance Sheets
Statements of Operations
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Consolidated Financial Statements
(b) Exhibits:
<TABLE>
<C> <S>
1.1* Form of Underwriting Agreement
3.1 Articles of Amendment and Restatement of the Registrant
3.2 Articles Supplementary of the Registrant
3.3 Bylaws of the Registrant
4.1* Specimen Common Stock Certificate
5.1* Opinion of Tobin & Tobin, a professional corporation, as to
legality (including consent of such firm)
5.2* Opinion of Piper & Marbury L.L.P., as to legality (including
consent of such firm)
</TABLE>
II-2
<PAGE>
<TABLE>
<C> <S>
8.1* Opinion of Jeffers, Wilson, Shaff & Falk, LLP, as to certain tax
matters (including consent of such firm)
10.1 Purchase Terms Agreement, dated December 6, 1996, between the
Registrant and the Placement Agent.
10.2 Registration Rights Agreement, dated December 9, 1996, between the
Registrant and the Placement Agent.
10.3 Warrant Agreement, dated December 9, 1996, between the Registrant
and the Holders of the Warrants Acting Through the Registrant as
the Initial Warrant Agent.
10.4 Founders Registration Rights Agreement, dated December 9, 1996,
between the Registrant and the original holders of Common Stock
of the Registrant.
10.5 Commitment Letter dated October 3, 1996 from General Electric
Capital Group accepted by the Registrant.
10.6 Master Repurchase Agreement dated as of January 31, 1997 among
Merrill Lynch Mortgage Capital Inc., Merrill Lynch Credit
Corporation and the Registrant.
10.7 Mortgage Loan Warehousing Agreement dated as of February 20, 1997
between First Union National Bank of North Carolina and the
Registrant.
10.8 Employment Agreement, dated September 30, 1996, between the
Registrant and Scott F. Hartman.
10.9 Employment Agreement, dated September 30, 1996, between the
Registrant and W. Lance Anderson.
10.10 Promissory Note by Scott F. Hartman to the Registrant, dated
December 9, 1996.
10.11 Promissory Note by W. Lance Anderson to the Registrant, dated
December 9, 1996.
10.12 Stock Pledge Agreement between Scott F. Hartman and the
Registrant, dated December 9, 1996.
10.13 Stock Pledge Agreement between W. Lance Anderson and the
Registrant, dated December 9, 1996.
10.14 1996 Executive and Non-Employee Director Stock Option Plan, as
last amended December 6, 1996.
10.15 Administrative Services Outsourcing Agreement, dated June 30,
1997, between the Registrant and NovaStar Mortgage, Inc.
10.16 Mortgage Loan Sale and Purchase Agreement, dated as of June 30,
1997, between the Registrant and NovaStar Mortgage, Inc.
10.17 Flow Loan Subservicing Agreement, dated as of June 30, 1997,
between the Registrant and NovaStar Mortgage, Inc.
21.1 Subsidiaries of the Registrant (set forth in "The Company" in the
Prospectus)
23.1* Consent of Tobin & Tobin, a professional corporation (included in
Exhibit 5.1)
23.2* Consent of Piper & Marbury L.L.P. (included in Exhibit 5.2)
23.3* Consent of Jeffers, Wilson, Shaff & Falk, LLP (included in Exhibit
8.1)
23.4 Consent of KPMG Peat Marwick LLP.
</TABLE>
II-3
<PAGE>
<TABLE>
<C> <S>
24.1 Power of Attorney (set forth on signature page)
27.1 Financial Data Schedule
</TABLE>
- --------
* To be filed by amendment.
ITEM 39. UNDERTAKINGS.
The Registrant hereby undertakes to provide to the Underwriters at the
closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant, pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange
Commission, such indemnification is against public policy as expressed in the
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities begin registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that: (1) for purposes of
determining any liability under the Securities Act of 1933, the information
omitted from the form of Prospectus filed as part of this Registration
Statement in reliance upon Rule 430A and contained in a form of Prospectus
filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act of 1933 shall be deemed to be part of this Registration
Statement as of the time it was declared effective; and (2) for the purpose of
determining any liability under the Securities Act of 1933, each post-
effective amendment that contains a form of Prospectus shall be deemed to be a
new Registration Statement relating to the securities offered therein and the
offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS ALL OF THE
REQUIREMENTS FOR FILING ON FORM S-11 AND HAS DULY CAUSED THIS REGISTRATION
STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY
AUTHORIZED, IN THE CITY OF WESTWOOD, STATE OF KANSAS, ON JULY 28, 1997.
NovaStar Financial, Inc.
By: /s/ Scott F. Hartman
---------------------------------
Scott F. Hartman
Chairman of the Board and
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Scott F. Hartman, W. Lance Anderson, Mark J.
Kohlrus and Rodney E. Schwatken, and each of them, his or her true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for him or her and in his or her name, place and stead, in any
and all capacities including his or her capacity as a director and/or officer
of NovaStar Financial, Inc., to sign any and all amendments (including post-
effective amendments) to this Registration Statement, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with
the Securities and Exchange Commission, granting unto said attorneys-in-fact
and agents, and each of them, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he or she might or could do
in person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or any of them, or their or his or her substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED:
<TABLE>
<CAPTION>
SIGNATURE POSITION DATE
--------- -------- ----
<S> <C> <C>
/s/ Scott F. Hartman Chairman of the Board, July 28,
- ------------------------------- Secretary, Chief Executive 1997
Scott F. Hartman Officer and Director
(Principal Executive Officer)
/s/ W. Lance Anderson President, Chief Operating July 28,
- ------------------------------- Officer and Director 1997
W. Lance Anderson
/s/ Mark J. Kohlrus Senior Vice President, July 28,
- ------------------------------- Treasurer, Chief Financial 1997
Mark J. Kohlrus Officer (Principal Financial
Officer)
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE POSITION DATE
--------- -------- ----
<S> <C> <C>
/s/ Rodney E. Schwatken Vice President, Controller, July 28,
- ------------------------------- Assistant Treasurer, 1997
Rodney E. Schwatken (Principal Accounting
Officer)
/s/ Edward W. Mehrer Director July 28,
- ------------------------------- 1997
Edward W. Mehrer
/s/ Gregory T. Barmore Director July 28,
- ------------------------------- 1997
Gregory T. Barmore
/s/ Jenne K. Britell Director July 29,
- ------------------------------- 1997
Jenne K. Britell
</TABLE>
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT PAGE
NO. DESCRIPTION OF DOCUMENT NUMBER
------- ----------------------- ------
<C> <S> <C>
1.1* Form of Underwriting Agreement
3.1 Articles of Amendment and Restatement of the Registrant
3.2 Articles Supplementary of the Registrant
3.3 Bylaws of the Registrant
4.1* Specimen Common Stock Certificate
5.1* Opinion of Tobin & Tobin, a professional corporation, as to
legality (including consent of such firm)
5.2* Opinion of Piper & Marbury L.L.P., as to legality (including
consent of such firm)
8.1* Opinion of Jeffers, Wilson, Shaff & Falk, LLP, as to certain
tax matters (including consent of such firm)
10.1 Purchase Terms Agreement, dated December 6, 1996, between
the Registrant and the Placement Agent.
10.2 Registration Rights Agreement, dated December 9, 1996,
between the Registrant and the Placement Agent.
10.3 Warrant Agreement, dated December 9, 1996, between the
Registrant and the Holders of the Warrants Acting Through
the Registrant as the Initial Warrant Agent.
10.4 Founders Registration Rights Agreement, dated December 9,
1996, between the Registrant and the original holders of
Common Stock of the Registrant.
10.5 Commitment Letter dated October 3, 1996 from General
Electric Capital Group accepted by the Registrant.
10.6 Master Repurchase Agreement dated as of January 31, 1997
among Merrill Lynch Mortgage Capital Inc., Merrill Lynch
Credit Corporation and the Registrant.
10.7 Mortgage Loan Warehousing Agreement dated as of February 20,
1997 between First Union National Bank of North Carolina
and the Registrant.
10.8 Employment Agreement, dated September 30, 1996, between the
Registrant and Scott F. Hartman.
10.9 Employment Agreement, dated September 30, 1996, between the
Registrant and W. Lance Anderson.
10.10 Promissory Note by Scott F. Hartman to the Registrant, dated
December 9, 1996.
10.11 Promissory Note by W. Lance Anderson to the Registrant,
dated December 9, 1996.
10.12 Stock Pledge Agreement between Scott F. Hartman and the
Registrant, dated December 9, 1996.
10.13 Stock Pledge Agreement between W. Lance Anderson and the
Registrant, dated December 9, 1996.
10.14 1996 Executive and Non-Employee Director Stock Option Plan,
as last amended December 6, 1996.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT PAGE
NO. DESCRIPTION OF DOCUMENT NUMBER
------- ----------------------- ------
<C> <S> <C>
10.15 Administrative Services Outsourcing Agreement, dated June
30, 1997 between the Registrant and NovaStar Mortgage, Inc.
10.16 Mortgage Loan Sale and Purchase Agreement, dated as of June
30, 1997 between the Registrant and NovaStar Mortgage, Inc.
10.17 Flow Loan Subservicing Agreement, dated as of June 30, 1997
between the Registrant and NovaStar Mortgage, Inc.
21.1 Subsidiaries of the Registrant (set forth in "The Company"
in the Prospectus)
23.1* Consent of Tobin & Tobin, a professional corporation
(included in Exhibit 5.1)
23.2* Consent of Piper & Marbury L.L.P. (included in Exhibit 5.2)
23.3* Consent of Jeffers, Wilson, Shaff & Falk, LLP (included in
Exhibit 8.1)
23.4 Consent of KPMG Peat Marwick LLP.
24.1 Power of Attorney (set forth on signature page)
27.1 Financial Data Schedule
</TABLE>
- --------
* To be filed by amendment.
<PAGE>
EXHIBIT 3.1
ARTICLES OF AMENDMENT AND RESTATEMENT
OF
CAPSTAR FINANCIAL, INC.
CAPSTAR FINANCIAL, INC., a Maryland corporation, having its principal
office in Baltimore City, Maryland (hereinafter referred to as the
"Corporation"), hereby certifies to the State Department of Assessments and
Taxation of Maryland that:
FIRST: The Corporation desires to amend and restate its charter as
-----
currently in effect and as hereinafter amended:
ARTICLE I
INCORPORATOR
------------
The undersigned, Eugene C. Payne III, whose address is One Montgomery
Street, 15th Floor, San Francisco, California 94104, being at least 18 years of
age, does hereby act as an incorporator, under and by virtue of the General Laws
of the State of Maryland authorizing the formation of corporations and with the
intention of forming a corporation.
ARTICLE II
NAME
----
The name of the corporation (which is hereinafter called the
"Corporation") is:
NovaStar Financial, Inc.
ARTICLE III
PURPOSES
--------
The purpose for which the Corporation is formed is to transact any or
all lawful business, not required to be specifically stated in the Charter, for
which corporations may be incorporated under the MGCL.
ARTICLE IV
PRINCIPAL OFFICE
----------------
The present address of the principal office of the Corporation in this
State is:
The Corporation Trust Incorporated
32 South Street
Baltimore, Maryland 21202
<PAGE>
ARTICLE V
RESIDENT AGENT
--------------
The name and address of the resident agent of the Corporation are:
The Corporation Trust Incorporated
32 South Street
Baltimore, Maryland 21202
Said resident agent is a Maryland corporation.
ARTICLE VI
CAPITAL STOCK
-------------
A. The total number of shares of Capital Stock of all classes which
the Corporation has authority to issue is fifty million (50,000,000) shares of
Capital Stock, par value one cent ($0.01) per share, amounting in aggregate par
value to Five Hundred Thousand Dollars ($500,000.00). All of such shares are
initially classified as "Common Stock." The Board of Directors may classify and
reclassify any unissued shares of Capital Stock, whether now or hereafter
authorized, by setting or changing in any one or more respects the preferences,
conversion or other rights, voting powers, restrictions, limitations as to
dividends, qualifications or terms or conditions of redemption of such shares of
Capital Stock. All persons who acquire shares of Capital Stock or securities
exercisable for or convertible into shares of Capital Stock shall acquire such
shares subject to the provisions of the Charter (including Article XI) and
Bylaws of the Corporation.
B. The following is a description of the preferences, conversion
and other rights, voting powers, restrictions, limitations as to dividends,
qualifications and terms and conditions of redemption of the Common Stock of the
Corporation:
(1) Each share of Common Stock shall have one vote, and, except as
otherwise provided in respect of any class of Capital Stock hereafter classified
or reclassified, the exclusive voting power for all purposes shall be vested in
the holders of the Common Stock.
(2) Subject to the provisions of law and any preferences of any class
of Capital Stock hereafter classified or reclassified, dividends, including
dividends payable in shares of the Corporation's Capital Stock, may be paid on
the Common Stock of the Corporation at such time and in such amounts as the
Board of Directors may deem advisable.
(3) In the event of any liquidation, dissolution or winding up of the
Corporation, whether voluntary or involuntary, the holders of the Common Stock
shall be entitled, after payment or provision for payment of the debts and other
liabilities of the
2
<PAGE>
Corporation and the amount to which the holders of any class of Capital Stock
hereafter classified or reclassified having a preference on distributions in
the liquidation, dissolution or winding up of the Corporation shall be
entitled, together with the holders of any other class of Capital Stock
hereafter classified or reclassified not having a preference on distributions
in the liquidation, dissolution or winding up of the Corporation, to share
ratably in the remaining net assets of the Corporation.
C. Subject to the foregoing, the power of the Board of Directors to
classify and reclassify any of the shares of Capital Stock shall include,
without limitation, subject to the provisions of the Charter, authority to
classify or reclassify any unissued shares of such Capital Stock into a class or
classes of preferred stock, preference stock, special stock, or other stock, and
to divide and classify shares of any class into one or more series of such
class, by determining, fixing or altering one or more of the following:
(1) The distinctive designation of such class or series and the number
of shares to constitute such class or series; provided that, unless otherwise
prohibited by the terms of such or any other class or series, the number of
shares of any class or series may be decreased by the Board of Directors in
connection with any classification or reclassification of unissued shares and
the number of shares of such class or series may be increased by the Board of
Directors in connection with any such classification or reclassification, and
any shares of any class or series which have been redeemed, purchased, otherwise
acquired or converted into shares of Common Stock or any other class or series
shall become part of the authorized Capital Stock and be subject to
classification and reclassification as provided in this subparagraph.
(2) Whether or not and, if so, the rates, amounts and times at which,
and the conditions under which, dividends shall be payable on shares of such
class or series, whether any such dividends shall rank senior or junior to or on
a parity with the dividends payable on any other class or series of Capital
Stock, and the status of any such dividends as cumulative, cumulative to a
limited extent or noncumulative and as participating or nonparticipating.
(3) Whether or not shares of such class or series shall have voting
rights in addition to any voting rights provided by law and, if so, the terms of
such voting rights.
(4) Whether or not shares of such class or series shall have
conversion or exchange privileges and, if so, the terms and conditions thereof,
including provision for adjustment of the conversion or exchange rate in such
events or at such times as the Board of Directors shall determine.
(5) Whether or not shares of such class or series shall be subject to
redemption and, if so, the terms and conditions of such redemption, including
the date or dates upon or after which they shall be redeemable and the amount
per share payable in case of redemption, which amount may vary under different
conditions and at different redemption dates; and whether or not there shall be
any sinking fund or purchase account in respect thereof, and if so, the terms
thereof.
3
<PAGE>
(6) The rights of the holders of shares of such class or series upon
the liquidation, dissolution or winding up of the affairs of, or upon any
distribution of the assets of, the Corporation, which rights may vary depending
upon whether such liquidation, dissolution or winding up is voluntary or
involuntary and, if voluntary, may vary at different dates, and whether such
rights shall rank senior or junior to or on a parity with such rights of any
other class or series of Capital Stock.
(7) Whether or not there shall be any limitations applicable, while
shares of such class or series are outstanding, upon the payment of dividends or
making of distributions on, or the acquisition of, or the use of moneys for
purchase or redemption of, any Capital Stock of the Corporation, or upon any
other action of the Corporation, including action under this subparagraph, and,
if so, the terms and conditions thereof.
(8) Any other preferences, rights, restrictions, including
restrictions on transferability, and qualifications of shares of such class or
series, not inconsistent with law and the Charter.
D. For the purposes hereof and of any Articles Supplementary hereto
providing for the classification or reclassification of any shares of Capital
Stock or of any other Charter document of the Corporation (unless otherwise
provided in any such Articles or document), any class or series of Capital Stock
of the Corporation shall be deemed to rank:
(1) prior to another class or series either as to dividends or upon
liquidation, if the holders of such class or series shall be entitled to the
receipt of dividends or of amounts distributable on liquidation, dissolution or
winding up, as the case may be, in preference or priority to holders of such
other class or series;
(2) on a parity with another class or series either as to dividends or
upon liquidation, whether or not the dividend rates, dividend payment dates or
redemption or liquidation price per share thereof be different from those of
such others, if the holders of such class or series of stock shall be entitled
to receipt of dividends or amounts distributable upon liquidation, dissolution
or winding up, as the case may be, in proportion to their respective dividend
rates or redemption or liquidation prices, without preference or priority over
the holders of such other class or series; and
(3) junior to another class or series either as to dividends or upon
liquidation, if the rights of the holders of such class or series shall be
subject or subordinate to the rights of the holders of such other class or
series in respect of the receipt of dividends or the amounts distributable upon
liquidation, dissolution or winding up, as the case may be.
4
<PAGE>
ARTICLE VII
DIRECTORS
---------
A. The number of directors of the Corporation shall be three (3),
which number may be increased or decreased pursuant to the Bylaws of the
Corporation, but shall never be less than the minimum number permitted by the
General Laws of the State of Maryland now or hereafter in force.
B. The names of the directors who will serve until the first annual
meeting of stockholders and until their successors are elected and qualify are
as follows:
Scott F. Hartman
W. Lance Anderson
Edward F. Mehrer
C. At the 1996 annual meeting of stockholders and thereafter the
directors shall be divided into three classes as follows: (1) the term of
office of Class I shall be until the 1997 annual meeting of stockholders and
until their successors shall be elected and have qualified and thereafter shall
be for three years and until their successors shall be elected and have
qualified; (2) the term of office of Class II shall be until the 1998 annual
meeting of stockholders and until their successors shall be elected and have
qualified and thereafter shall be for three years and until their successors
shall be elected and have qualified; and (3) the term of office of Class III
shall be until the 1999 annual meeting of stockholders and until their
successors shall be elected and have qualified and thereafter shall be for three
years and until their successors shall be elected and have qualified. If the
number of directors is changed, any increase or decrease shall be apportioned
among the classes so as to maintain the number of directors in each class as
nearly equal as possible. A director elected by stockholders shall hold office
until the annual meeting for the year in which his or her term expires and until
his or her successor shall be elected and shall qualify, subject, however, to
prior death, resignation, retirement, disqualification or removal from office.
D. Subject to the rights of the holders of any class of preferred
stock then outstanding, newly created directorships resulting from any increase
in the authorized number of directors or any vacancies on the Board of Directors
resulting from death, resignation, retirement, disqualification, removal from
office, or other cause shall be filled by the required vote of the stockholders
or the directors then in office. A director so chosen by the stockholders shall
hold office for the balance of the term then remaining. A director so chosen by
the remaining directors shall hold office until the next annual meeting of
stockholders, at which time the stockholders shall elect a director to hold
office for the balance of the term then remaining. No decrease in the number of
directors constituting the Board of Directors shall affect the tenure of office
of any director.
5
<PAGE>
E. Whenever the holders of any one or more series of preferred stock
of the Corporation shall have the right, voting separately as a class, to elect
one or more directors of the Corporation, the Board of Directors shall consist
of such directors so elected in addition to the number of directors fixed as
provided in paragraph A of this Article VII or in the Bylaws. Notwithstanding
the foregoing, and except as otherwise may be required by law, whenever the
holders of any one or more series of preferred stock of the Corporation shall
have the right, voting separately as a class, to elect one or more directors of
the Corporation, the terms of the director or directors elected by such holders
shall expire at the next succeeding annual meeting of stockholders.
F. Subject to the rights of the holders of any class separately
entitled to elect one or more directors, any director, or the entire Board of
Directors, may be removed from office at any time, but only for cause and then
only by the affirmative vote of the holders of at least a majority of the
combined voting power of all classes of shares of capital stock entitled to vote
in the election for directors voting together as a single class.
ARTICLE VIII
PREEMPTIVE RIGHTS
-----------------
No holder of any Capital Stock or any other securities of the
Corporation, whether now or hereafter authorized, shall have a preemptive right
to subscribe for or purchase any Capital Stock or any other securities of the
Corporation other than such, if any, as the Board of Directors, in its sole
discretion, may determine and at such price or prices and upon such other terms
as the Board of Directors, in its sole discretion, may determine and at such
price or prices and upon such other terms as the Board of Directors, in its sole
discretion, may fix; and any Capital Stock or other securities which the Board
of Directors may determine to offer for subscription may, as the Board of
Directors in its sole discretion shall determine, be offered to the holders of
any class, series or type of Capital Stock or other securities at the time
outstanding to the exclusion of the holders of any or all other classes, series
or types of Capital Stock or other securities at the time outstanding.
ARTICLE IX
INDEMNIFICATION
---------------
The Corporation shall indemnify (A) its directors and officers,
whether serving the Corporation or at its request any other entity, to the full
extent required or permitted by the General Laws of the State of Maryland now or
hereafter in force, including the advance of expenses under the procedures and
to the full extent permitted by law and (B) other employees and agents to such
extent as shall be authorized by the Board of Directors or the Corporation's
Bylaws and be permitted by law. The foregoing rights of indemnification shall
not be exclusive of any other rights to which those seeking indemnification may
be entitled. The Board of Directors may take such action as is necessary to
carry out these indemnification provisions and
6
<PAGE>
is expressly empowered to adopt, approve and amend from time to time such
Bylaws, resolutions or contracts implementing such provisions or such further
indemnification arrangements as may be permitted by law. No amendment of the
Charter of the Corporation or repeal of any of its provisions shall limit or
eliminate the right to indemnification provided hereunder with respect to acts
or omissions occurring prior to such amendment or repeal.
ARTICLE X
PERSONAL LIABILITY
------------------
To the fullest extent permitted by Maryland statutory or decisional
law, as amended or interpreted, no director or officer of this Corporation shall
be personally liable to the Corporation or its stockholders for money damages.
No amendment of the Charter of the Corporation or repeal of any of its
provisions shall limit or eliminate the benefits provided to directors and
officers under this provision with respect to any act or omission which occurred
prior to such amendment or repeal.
ARTICLE XI
RESTRICTION ON TRANSFER, ACQUISITION AND REDEMPTION OF SHARES
-------------------------------------------------------------
Section 11.1 Definitions. For the purpose of this Article XI, the
-----------
following terms shall have the following meanings:
Aggregate Stock Ownership Limit. The term "Aggregate Stock Ownership
-------------------------------
Limit" shall mean not more than 9.8 percent in value of the aggregate of the
outstanding shares of Capital Stock. The value of the outstanding shares of
Capital Stock shall be determined by the Board of Directors of the Corporation
in good faith, which determination shall be conclusive for all purposes hereof.
Beneficial Ownership. The term "Beneficial Ownership" shall mean
--------------------
ownership of Capital Stock by a Person, whether the interest in the shares of
Capital Stock is held directly or indirectly (including by a nominee), and shall
include interests that would be treated as owned through the application of
Section 544 of the Code, as modified by Section 856(h)(1)(B) of the Code. The
terms "Beneficial Owner," Beneficially Owns" and "Beneficially Owned" shall have
the correlative meanings.
Business Day. The term "Business Day" shall mean any day, other than
------------
a Saturday or Sunday, that is neither a legal holiday nor a day on which banking
institutions in New York City are authorized or required by law, regulation or
executive order to close.
Charitable Beneficiary. The term "Charitable Beneficiary" shall mean
----------------------
one or more beneficiaries of the Trust as determined pursuant to Section 11.3.6,
provided that each such organization must be described in Section 501(c)(3) of
the Code and contributions to each such
7
<PAGE>
organization must be eligible for deduction under each Sections 170(b)(1)(A)
(without regard to clauses (vii) or (viii) thereof), 2055 and 2522 of the Code,
provided selecting such beneficiary or beneficiaries would not violate Section
11.2.1(a) hereof.
Code. The term "Code" shall mean the Internal Revenue Code of 1986,
----
as amended from time to time.
Common Stock Ownership Limit. The term "Common Stock Ownership Limit"
----------------------------
shall mean not more than 9.8 percent (in value or in number of shares, whichever
is more restrictive) of the aggregate of the outstanding shares of Common Stock
of the Corporation. The number and value of outstanding shares of Common Stock
of the Corporation shall be determined by the Board of Directors of the
Corporation in good faith, which determination shall be conclusive for all
purposes hereof.
Constructive Ownership. The term "Constructive Ownership" shall mean
----------------------
ownership of Capital Stock by a Person, whether the interest in the shares of
Capital Stock is held directly or indirectly (including by a nominee), and shall
include interests that would be treated as owned through the application of
Section 318(a) of the Code, as modified by Section 856(d)(5) of the Code. The
terms "Constructive Owner," "Constructively Owns" and "Constructively Owned"
shall have the correlative meanings.
Excepted Holder. The term "Excepted Holder" shall mean a stockholder
---------------
of the Corporation for whom an Excepted Holder Limit is created by the Charter
or by the Board of Directors pursuant to Section 11.2.7.
Excepted Holder Limit. The term "Excepted Holder Limit" shall mean,
---------------------
provided that the affected Excepted Holder agrees to comply with the
requirements established by the Board of Directors pursuant to Section 11.2.7,
and subject to adjustment pursuant to Section 11.2.8, the percentage limit
established by the Board of Directors pursuant to Section 11.2.7.
Initial Date. The term "Initial Date" shall mean the date upon which
------------
the Corporation shall close its initial issuance of shares of Capital Stock to
investors for an aggregate amount of gross proceeds of at least $15 million.
Market Price. The term "Market Price" on any date shall mean, with
------------
respect to any class or series of outstanding shares of Capital Stock, the
Closing Price for such Capital Stock on such date. The "Closing Price" on any
date shall mean the last sale price for such Capital Stock, regular way, or, in
case no such sale takes place on such day, the average of the closing bid and
asked prices, regular way, for such Capital Stock, in either case as reported in
the principal consolidated transaction reporting system with respect to
securities listed or admitted to trading on the NYSE or, if such Capital Stock
is not listed or admitted to trading on the NYSE, as reported on the principal
consolidated transaction reporting system with respect to securities listed on
the principal national securities exchange on which such Capital Stock is listed
or admitted to trading or, if such Capital Stock is not listed or admitted to
trading on any national
8
<PAGE>
securities exchange, the last quoted price, or, if not so quoted, the average of
the high bid and low asked prices in the over-the-counter market, as reported by
the National Association of Securities Dealers, Inc. Automated Quotation System,
or, if such system is no longer in use, the principal other automated quotation
system that may then be in use or, if such Capital Stock is not quoted by any
such organization, the average of the closing bid and asked prices as furnished
by a professional market maker making a market in such Capital Stock selected by
the Board of Directors of the Corporation or, in the event that no trading price
is available for such Capital Stock, the fair market value of the Capital Stock,
as determined in good faith by the Board of Directors of the Corporation.
NYSE. The term "NYSE" shall mean the New York Stock Exchange.
----
Person. The term "Person" shall mean an individual, corporation,
------
joint venture, limited liability company, unincorporated organization,
partnership, estate, state or political subdivision thereof, government agency,
trust (including a trust qualified under Sections 401(a) or 501(c)(17) of the
Code), a portion of a trust permanently set aside for or to be used exclusively
for the purposes described in Section 642(c) of the Code, association, private
foundation within the meaning of Section 509(a) of the Code, joint stock company
or other entity, but does not include an Underwriter participating in an
offering of Common Stock, Preferred Stock, and/or convertible securities of the
Corporation, provided that the ownership of such Common Stock, Preferred Stock
and/or convertible securities by such Underwriter would not result in the
Corporation being "closely held" within the meaning of Section 856(h) of the
Code and would not otherwise result in the Corporation's failure to qualify as a
REIT.
Prohibited Owner. The term "Prohibited Owner" shall mean, with
----------------
respect to any purported Transfer, any Person who, but for the provisions of
Section 11.2.1, would Beneficially Own or Constructively Own shares of Capital
Stock, and if appropriate in the context, shall also mean any Person who would
have been the record owner of the shares that the Prohibited Owner would have so
owned.
REIT. The term "REIT" shall mean a real estate investment trust
----
within the meaning of Section 856 of the Code.
Restriction Termination Date. The term "Restriction Termination Date"
----------------------------
shall mean the first day after the Initial Date on which the Corporation
determines that it is no longer in the best interests of the Corporation to
attempt to, or continue to, qualify as a REIT or that compliance with the
restrictions and limitations on Beneficial Ownership, Constructive Ownership and
Transfers of shares of Capital Stock set forth herein is no longer required in
order for the Corporation to qualify as a REIT.
Transfer. The term "Transfer" shall mean any issuance, sale,
--------
transfer, gift, assignment, devise or other disposition, as well as any other
event that causes any Person to acquire Beneficial Ownership or Constructive
Ownership, or any agreement to take any such actions or cause any such events,
of Capital Stock or the right to vote or receive dividends on
9
<PAGE>
Capital Stock, including (a) the granting or exercise of any option or warrant
(or any disposition of any option or warrant), (b) any disposition of any
securities or rights convertible into or exchangeable for Capital Stock or any
interest in Capital Stock or any exercise of any such conversion or exchange
right and (c) Transfers of interests in other entities that result in changes in
Beneficial or Constructive Ownership of Capital Stock; in each case, whether
voluntary or involuntary, whether owned of record, Constructively Owned or
Beneficially Owned and whether by operation of law or otherwise. The terms
"Transferring" and "Transferred" shall have the correlative meanings.
Trust. The term "Trust" shall mean any trust provided for in Section
-----
11.3.1.
Trustee. The term "Trustee" shall mean the Person unaffiliated with
-------
the Corporation, a Prohibited Owner and any Charitable Beneficiary, that is
appointed by the Corporation to serve as trustee of the Trust, and any successor
or trustee appointed by the Trustee.
Underwriter. The term "Underwriter" shall mean a securities firm or
-----------
other similar entity only in its capacity as a party of an underwriting
agreement with the Corporation entered into with the intent of such firm or
other entity acquiring securities of the Corporation for resale.
Section 11.2 Capital Stock.
-------------
Section 11.2.1 Ownership Limitations. Subject to Section 11.2.10,
---------------------
during the period commencing on the Initial Date and prior to the Restriction
Termination Date:
(a) Basic Restrictions.
------------------
(i) (1) No Person, other than an Excepted Holder, shall Beneficially
Own or Constructively Own shares of Capital Stock in excess of the Aggregate
Stock Ownership Limit, (2) no Person, other than an Excepted Holder, shall
Beneficially Own or Constructively Own shares of Common Stock in excess of the
Common Stock Ownership Limit and (3) no Excepted Holder shall Beneficially Own
or Constructively Own shares of Capital Stock in excess of the Excepted Holder
Limit for such Excepted Holder.
(ii) No Person shall Beneficially Own or Constructively Own shares of
Capital Stock to the extent that such Beneficial or Constructive Ownership of
Capital Stock would result in the Corporation being "closely held" within the
meaning of Section 856(h) of the Code (without regard to whether the ownership
interest is held during the last half of a taxable year), or otherwise failing
to qualify as a REIT (including, but not limited to, Beneficial Ownership or
Constructive Ownership that would result in the Corporation owning (actually or
Constructively) an interest in a tenant that is described in Section
856(d)(2)(B) of the Code if the income derived by the Corporation from such
tenant would cause the Corporation to fail to satisfy any of the gross income
requirements of Section 856(c) of the Code).
10
<PAGE>
(iii) Any Transfer of shares of Capital Stock that, if effective,
would result in any person Beneficially Owning or Constructively Owning any
shares of Capital Stock in violation of Section 11.2.1(a) or Section
11.2.1(a)(ii) shall be null and void ab initio, and the purported transferee or
-- ------
purported owner shall acquire no rights to, or economic interest in, any Capital
Stock held in violation of these restrictions.
(iv) Notwithstanding any other provisions contained herein, any
Transfer of shares of Capital Stock (whether or not such Transfer is the result
of a transaction entered into through the facilities of the NYSE or any other
national securities exchange or automated inter-dealer quotation system) that,
if effective, would result in the Capital Stock being beneficially owned by less
than 100 Persons (determined under the principles of Section 856(a)(5) of the
Code) shall be null and void ab initio, and the intended transferee shall
-- ------
acquire no rights in such shares of Capital Stock.
(b) Transfer in Trust. If, notwithstanding the other provisions
-----------------
contained in this Article XI, there is a purported Transfer, change in capital
structure or other event such that any person would Beneficially Own or
Constructively Own Shares of Capital Stock in violation of Section 11.2.1(a)(i)
or Section 11.2.1(a)(ii), or if effective, any Transfer of shares of Capital
Stock occurs which, if effective, would result in any Person Beneficially Owning
or Constructively Owning shares of Capital Stock in violation of Section
11.2.1(a)(i) or (ii),
(i) then that number of shares of the Capital Stock to
Beneficial or Constructive Ownership of which
otherwise would cause such Person to violate
Section 11.2.1(a)(i) or (ii) (rounded to the
nearest whole shares) shall be automatically
transferred to a Trust for the benefit of a
Charitable Beneficiary, as described in Section
11.3, effective on the close of business on the
Business Day prior to the date of such Transfer
or other event, and such Person shall acquire
no rights in such shares; and
(ii) upon the transfer of a share of Capital Stock to
the Trust described in clause (i) of this
subsection 11.2.1(b), such share shall have
such voting, dividend, liquidation and other
rights, and shall be subject to such terms and
limitations, as set forth in Section 11.3 of
this Article XI.
Section 11.2.2 Remedies for Breach. If the Board of Directors of the
-------------------
Corporation or any duly authorized committee thereof shall at any time determine
in good faith that a Transfer or other event has taken place that results in a
violation of Section 11.2.1 or that a Person intends to acquire or has attempted
to acquire Beneficial or Constructive Ownership of any shares of Capital Stock
in violation of Section 11.2.1 (whether or not such violation is intended), the
Board of Directors or a committee thereof shall take such action as it deems
advisable to refuse to give effect to or to prevent such Transfer or other
event, including, without limitation, causing the Corporation to redeem shares,
refusing to give effect to such Transfer on
11
<PAGE>
the books of the Corporation or instituting proceedings to enjoin such Transfer
or other event; provided, however, that any Transfers or attempted
-------- -------
Transfers or other events in violation of Section 11.2.1 shall be null and
void and shall automatically result in the transfer to the Trust described
above, and, where applicable, such Transfer (or other event) shall be void ab
--
initio as provided above irrespective of any action (or non-action) by the Board
- ------
of Directors or a committee thereof.
Section 11.2.3 Notice of Restricted Transfer. Any Person who
-----------------------------
acquires or attempts or intends to acquire Beneficial Ownership or Constructive
Ownership of shares of Capital Stock that will or may violate Section 11.2.1(a),
or any Person who would have owned shares of Capital Stock that resulted in a
transfer to the Trust pursuant to the provisions of Section 11.2.1(b) shall
immediately give written notice to the Corporation of such event, or in the case
of such proposed or attempted transaction, give at least 15 days prior written
notice, and shall provide to the Corporation such other information as the
Corporation may request in order to determine the effect, if any, of such
Transfer on the Corporation's status as a REIT.
Section 11.2.4 Owners Required to Provide Information. From the
--------------------------------------
Initial Date and prior to the Restriction Termination Date:
(a) every owner of more than five percent (or such lower percentage as
required by the Code or the Treasury Regulations promulgated thereunder) of the
outstanding shares of Capital Stock, within 30 days after the end of each
taxable year, shall give written notice to the Corporation stating the name and
address of such owner, the number of shares of Capital Stock Beneficially Owned
and a description of the manner in which such shares are held. Each such owner
shall provide to the Corporation such additional information as the Corporation
may request in order to determine the effect, if any, of such Beneficial
Ownership on the Corporation's status as a REIT and ensure compliance with the
Aggregate Stock Ownership Limit.
(b) each Person who is a Beneficial or Constructive Owner of Capital
Stock and each Person (including the stockholder of record) who is holding
Capital Stock for a Beneficial or Constructive Owner shall provide to the
Corporation such information as the Corporation may request, in good faith, in
order to determine the Corporation's status as a REIT and to comply with
requirements of any taxing authority or governmental authority or to determine
such compliance.
Section 11.2.5 Remedies Not Limited. Nothing contained in this
--------------------
Section 11.2 shall limit the authority of the Board of Directors of the
Corporation to take such other action as it deems necessary or advisable to
protect the Corporation and the interests of its stockholders in preserving the
Corporation's status as a REIT and to ensure compliance with Section 11.2.1(a)..
Section 11.2.6 Ambiguity. In the case of an ambiguity in the
---------
application of any of the provisions of this Section 11.2, Section 11.3, or any
definition contained in Section 11.1, the Board of Directors of the Corporation
shall have the power to determine the application of the
12
<PAGE>
provisions of this Section 11.2 or Section 11.3 with respect to any situation
based on the facts known to it. In the event Section 11.2 or 11.3 requires an
action by the Board of Directors and the Charter fails to provide specific
guidance with respect to such action, the Board of Directors shall have the
power to determine the action to be taken so long as such action is not contrary
to the provisions of Sections 11.1, 11.2 or 11.3.
Section 11.2.7 Exceptions.
----------
(a) Subject to Section 11.2.1(a)(ii), the Board of Directors of
the Corporation, in its sole discretion, may exempt a Person from the Aggregate
Stock Ownership Limit and the Common Stock Ownership Limit, as the case may be,
and may establish or increase an Excepted Holder Limit for such Person, if:
(i) the Board of Directors obtains such representations
and undertakings from such Person as are reasonably
necessary to ascertain that no individual's
Beneficial or Constructive Ownership of such
shares of Capital Stock will violate Section
11.2.1(a)(ii);
(ii) such Person does not and represents that it will
not own, actually or Constructively, an interest
in a tenant of the Corporation (or a tenant of any
entity owned or controlled by the Corporation) that
would cause the Corporation to own, actually or
Constructively, more than a 9.9% interest (as set
forth in Section 856(d)(2)(B) of the Code) in such
tenant and the Board of Directors obtains such
representations and undertakings from such Persons
are reasonably necessary to ascertain this fact
(for this purpose, a tenant from whom the
Corporation (or an entity owned or controlled by
the Corporation) derives (and is expected to
continue to derive) a sufficiently small amount of
such that, in the opinion of the Board of
Directors of the Corporation, rent from such tenant
would not adversely affect the Corporation's
ability to qualify as a REIT, shall not be
treated as a tenant of the Corporation); and
(iii) such Person agrees that any violation or
attempted violation of such representations or
undertakings (or other action which is contrary to
the restrictions contained in Sections 11.2.1
through 11.2.6) will result in such shares of
Capital Stock being automatically transferred to a
Trust in accordance with Sections 11.2.1(b) and
11.3.
(b) Prior to granting any exception pursuant to
Section 11.2.7(a), the Board of Directors of the Corporation may require a
ruling from the Internal Revenue Service, or an opinion of counsel, in either
case in form and substance satisfactory to the Board of Directors in its sole
discretion, as it may deem necessary or advisable in order to determine or
ensure the Corporation's status as a REIT. Notwithstanding the receipt of any
ruling or opinion, the Board
13
<PAGE>
of Directors may impose such conditions or restrictions as it deems appropriate
in connection with granting such exception.
(c) The Board of Directors may only reduce the Excepted Holder Limit
for an Excepted Holder: (1) with the written consent of such Excepted Holder at
any time, or (2) pursuant to the terms and conditions of the agreements and
understandings entered into with such Excepted Holder in connection with the
establishment of the Excepted Holder Limit for that Excepted Holder. No
Excepted Holder Limit shall be reduced to a percentage that is less than the
Common Stock Ownership Limit.
Section 11.2.8 Increase in Aggregate Stock Ownership and Common Stock
------------------------------------------------------
Ownership Limits. The Board of Directors may from time to time increase or
- ----------------
decrease the Common Stock Ownership Limit and the Aggregate Stock Ownership
Limit; provided, however, that:
-------- -------
(a) Any decrease may be made only prospectively as to subsequent
holders (other than a decrease as a result of a retroactive change in existing
law, in which case such decrease shall be effective immediately);
(b) Neither ownership limitation may be increased if, after giving
effect to such increase, five Persons could Beneficially Own or Constructively
Own, in the aggregate, more than 50.0% in value of the shares of Capital Stock
then outstanding; and
(c) Prior to the modification of either of the ownership limitations,
the Board of Directors of the Corporation may require such opinions of counsel,
affidavits, undertakings or agreements as it may deem necessary or advisable in
order to determine or ensure the Corporation's status as a REIT.
Section 11.2.9 Legend. Each certificate for shares of Capital Stock
------
or securities exercisable or exchangeable for or convertible into shares of
Capital Stock shall bear the following legend:
The securities represented by this certificate are subject to
restrictions on Beneficial and Constructive Ownership and Transfer
for the purpose of the Corporation's maintenance of its status as a
Real Estate Investment Trust under the Internal Revenue Code of
1986, as amended (the "Code"). Subject to certain further
restrictions and except as expressly provided in the Corporation's
Charter, (i) no Person may Beneficially or Constructively Own shares
of the Corporation's Common Stock in excess of 9.8 percent (in value
or number of shares) of the outstanding shares of Common Stock of
the Corporation unless such Person is an Excepted Holder (in which
case the Excepted Holder Limit shall be
14
<PAGE>
applicable); (ii) no Person may Beneficially or Constructively Own
shares of Capital Stock of the Corporation in excess of 9.8 percent
of the value of the total outstanding shares of Capital Stock of the
Corporation, unless such Person is an Excepted Holder (in which case
the Excepted Holder Limit shall be applicable); (iii) no Person may
Beneficially or Constructively Own Capital Stock that would result
in the Corporation being "closely held" under Section 856(h) of the
Code or otherwise cause the Corporation to fail to qualify as a
REIT; and (iv) no Person may Transfer shares of Capital Stock if
such Transfer would result in the Capital Stock of the Corporation
being owned by fewer than 100 Persons. Any Person who Beneficially
or Constructively Owns or attempts to Beneficially or Constructively
Own shares of Capital Stock which causes or will cause a Person to
Beneficially or Constructively Own shares of Capital Stock in excess
or in violation of the above limitations must immediately notify the
Corporation. Attempted transfers of ownership in violation of these
restrictions shall be null and void ab initio. In addition, if
-- ------
any of the restrictions on transfer or ownership are violated, the
shares of Capital Stock represented hereby may be automatically
transferred to a Trustee of a Trust for the benefit of one or more
Charitable Beneficiaries. In addition, upon the occurrence of
certain events, attempted Transfers in violation of the restrictions
described above may be void ab--initio. All capitalized terms in
this legend have the meanings defined in the Charter of the
Corporation, as the same may be amended from time to time, a copy of
which, including the restrictions on transfer and ownership, will be
furnished to each holder of Capital Stock of the Corporation on
request and without charge .
Section 11.2.10 Settlements Permitted. Nothing contained in this
---------------------
Article XI or in any provision hereof shall preclude the settlement of any
transaction entered into through the facilities of the NYSE or any other
national securities exchange or automated inter-dealer quotation system.
Although settlement of any transaction is permitted, any transferee in such
transaction shall be subject to all the provisions and limitations set forth in
this Article XI.
Section 11.3 Transfer of Capital Stock in Trust.
----------------------------------
Section 11.3.1 Ownership in Trust. Upon any purported Transfer or
------------------
other event described in Section 11.2.1(b) that would result in a transfer of
shares of Capital Stock to a Trust, such shares of Capital Stock shall be deemed
to have been transferred to the Trustee as trustee of a Trust for the exclusive
benefit of one or more Charitable Beneficiaries. Such transfer to the Trustee
shall be deemed to be effective as of the close of business on the Business Day
prior to the purported Transfer or other event that results in the transfer to
the Trust pursuant to Section 11.2.1(b). The Trustee shall be appointed by the
Corporation and shall be a Person
15
<PAGE>
unaffiliated with the Corporation, any Prohibited Owner and any Charitable
Beneficiary. Each Charitable Beneficiary shall be designated by the Trustee as
provided in Section 11.3.6.
Section 11.3.2 Status of Shares Held by the Trustee. Shares of
------------------------------------
Capital Stock held by the Trustee shall be issued and outstanding shares of
Capital Stock of the Company. The Prohibited Owner shall have no rights in the
shares held by the Trustee. The Prohibited Owner shall not benefit economically
from ownership of any shares held in trust by the Trustee, shall have no rights
to dividends and shall not possess any rights to vote or other rights
attributable to the shares held in the Trust.
Section 11.3.3 Dividend and Voting Rights. The Trustee shall have
--------------------------
all voting rights and rights to dividends or other distributions with respect to
shares of Capital Stock held in the Trust, which rights shall be exercised for
the exclusive benefit of the Charitable Beneficiary. Any dividend or other
distribution paid prior to the discovery by the Corporation that the shares of
Capital Stock have been transferred to the Trustee shall be paid with respect to
such shares of Capital Stock to the Trustee upon demand and any dividend or
other distribution authorized but unpaid shall be paid when due to the Trustee.
Any dividends or distributions so paid over to the Trustee shall be held in
trust for the Charitable Beneficiary. The Prohibited Owner shall have no voting
rights with respect to shares held in the Trust and, subject to Maryland law,
effective as of the date that the shares of Capital Stock have been transferred
to the Trustee, the Trustee shall have the authority (at the Trustee's sole
discretion) (i) to rescind as void any vote cast by a Prohibited Owner prior to
the discovery by the Corporation that the shares of Capital Stock have been
transferred to the Trustee and (ii) to recast such vote in accordance with the
desires of the Trustee acting for the benefit of the Charitable Beneficiary.
Notwithstanding the provisions of this Article XI, until the Corporation has
received notification that shares of Capital Stock have been transferred into a
Trust, the Corporation shall be entitled to rely on its share transfer and other
stockholder records for purposes of preparing lists of stockholders entitled to
vote at meetings, determining the validity and authority of proxies and
otherwise conducting votes of stockholders.
Section 11.3.4 Sale of Shares by Trustee. Within 20 days of
-------------------------
receiving notice from the Corporation that shares of Capital Stock have been
transferred to the Trust, the Trustee of the Trust shall sell the shares held in
the Trust to a person, designated by the Trustee, whose ownership of the shares
will not violate the ownership limitations set forth in Section 11.2.1(a). Upon
such sale, the interest of the Charitable Beneficiary in the shares sold shall
terminate and the Trustee shall distribute the net proceeds of the sale to the
Prohibited Owner and to the Charitable Beneficiary as provided in this Section
11.3.4. The Prohibited Owner shall receive the lesser of (1) the price paid by
the Prohibited Owner for the shares or, if the Prohibited Owner did not give
value for the shares in connection with the event causing the shares to be held
in the Trust (e.g., in the case of a gift, devise or other such transaction),
----
the Market Price of the shares on the day of the event causing the shares to be
held in the Trust and (2) the price per share received by the Trustee from the
sale or other disposition of the shares held in the Trust. Any net sales
proceeds in excess of the amount payable to the Prohibited Owner shall be
immediately paid to the Charitable Beneficiary. If, prior to the discovery by
the Corporation that shares of
16
<PAGE>
Capital Stock have been transferred to the Trustee, such shares are sold by a
Prohibited Owner, then (i) such shares shall be deemed to have been sold on
behalf of the Trust and (ii) to the extent that the Prohibited Owner received an
amount for such shares that exceeds the amount that such Prohibited Owner was
entitled to receive pursuant to this Section 11.3.4, such excess shall be paid
to the Trustee upon demand.
Section 11.3.5 Purchase Right in Stock Transferred to the Trustee.
--------------------------------------------------
Shares of Capital Stock transferred to the Trustee shall be deemed to have been
offered for sale to the Corporation, or its designee, at a price per share equal
to the lesser of (i) the price per share in the transaction that resulted in
such transfer to the Trust (or, in the case of a devise or gift, the Market
Price at the time of such devise or gift) and (ii) the Market Price on the date
the Corporation, or its designee, accepts such offer. The Corporation shall
have the right to accept such offer until the Trustee has sold the shares held
in the Trust pursuant to Section 11.3.4. Upon such sale to the Corporation, the
interest of the Charitable Beneficiary in the shares sold shall terminate and
the Trustee shall distribute the net proceeds of the sale to the Prohibited
Owner.
Section 11.3.6 Designation of Charitable Beneficiaries. The Trustee
---------------------------------------
shall designate one or more nonprofit organizations to be the Charitable
Beneficiary of the interest in the Trust such that (i) the shares of Capital
Stock held in the Trust would not violate the restrictions set forth in Section
11.2.1(a) in the hands of such Charitable Beneficiary and (ii) each such
organization must be described in Section 501(c)(3) of the Code and
contributions to each such organization must be eligible for deduction under
each of Sections 170(b)(1)(A) (without regard to clauses (vii) or (viii)
thereof), 2055 and 2522 of the Code.
ARTICLE XII
DIRECTOR DISCRETION
-------------------
With respect to any proposed merger, acquisition, business combination
or other similar transaction or proposal, a director of the Corporation, in
determining what is in the best interests of the Corporation, shall consider the
interest of the stockholders of the Corporation and, in his or her discretion,
may consider (i) the interests of the Corporation's employees, suppliers,
creditors and customers, (ii) the economy of the nation, (iii) community and
societal interests and (iv) the long-term as well as short-term interests of the
Corporation and its stockholders, including the possibility that these interests
may be best served by the continued independence of the Corporation. Pursuant
to this provision, the Board of Directors may consider numerous judgmental or
subjective factors affecting a proposal, including certain nonfinancial matters,
and on the basis of these considerations may oppose a business combination or
other transaction which, as an exclusively financial matter, might be attractive
to some, or a majority, of the Corporation's stockholders.
17
<PAGE>
ARTICLE XIII
MAJORITY VOTE
-------------
Notwithstanding any provision of law requiring the authorization of
any action by a greater proportion than a majority of the total number of shares
of all classes of Capital Stock or of the total number of shares of any class of
Capital Stock, such action shall be valid and effective if authorized by the
affirmative vote of the holders of a majority of the total number of shares of
all classes outstanding and entitled to vote thereon, except as otherwise
provided in the Charter.
ARTICLE XIV
SHARE ISSUANCE
--------------
The Board of Directors is hereby empowered to authorize the issuance
from time to time of shares of its Capital Stock of any class, whether now or
hereafter authorized, or securities exercisable or exchangeable for or
convertible into shares of its Capital Stock of any class or classes, whether
now or hereafter authorized, for such consideration as may be deemed advisable
by the Board of Directors and without any action by the stockholders.
ARTICLE XV
CHARTER AMENDMENTS
------------------
The Corporation reserves the right to amend, alter, change or repeal
any provision contained in the Charter, including any amendments changing the
terms or contract rights, as expressly set forth in the Charter, of any of its
outstanding stock by classification, reclassification or otherwise, by a
majority of the directors' adopting a resolution setting forth the proposed
change, declaring its advisability, and either calling a special meeting of the
stockholders entitled to vote on the proposed change, or directing the proposed
change to be considered at the next annual stockholders meeting. Unless
otherwise provided herein, the proposed change will be effective only if it is
adopted upon the affirmative vote of the holders of not less than a majority of
the aggregate votes entitled to be cast thereon (considered for this purpose as
a single class); provided, however, that any amendment to, repeal of or adoption
of any provision inconsistent with Article VII or this Article XV will be
effective only if it is also advised by at least two-thirds of the Board of
Directors and adopted upon the affirmative vote of the holders of not less than
two-thirds of the aggregate votes entitled to be cast thereon (considered for
this purpose as a single class).
18
<PAGE>
ARTICLE XVI
DIRECTORS' POWERS
-----------------
The enumeration and definition of particular powers of the Board of
Directors included in the foregoing Articles shall in no way be limited or
restricted by reference to or inference from the terms of any other Article of
the Charter of the Corporation, or construed as or deemed by inference or
otherwise in any manner to exclude or limit any powers conferred upon the Board
of Directors under the General Laws of the State of Maryland now or hereafter in
force.
The Board of Directors of the Corporation shall, consistent with
applicable law, have power in its sole discretion to determine from time to time
in accordance with sound accounting practice or other reasonable valuation
methods what constitutes annual or other net profits, earnings, surplus, or net
assets in excess of capital; to fix and vary from time to time the amount to be
reserved as working capital, or determine that retained earnings or surplus
shall remain in the hands of the Corporation; to set apart out of funds of the
Corporation such reserve or reserves in such amount or amounts and for such
proper purpose or purposes as it shall determine and to abolish any such reserve
or any part thereof; to distribute and pay distributions or dividends in Capital
Stock, cash or other securities or property, out of surplus or any other funds
or amounts legally available therefor, at such times and to the stockholders of
record on such dates as it may, from time to time, determine; and to determine
whether and to what extent and at what times and places and under what
conditions and regulations the books, accounts and documents of the Corporation,
or any of them, shall be open to the inspection of stockholders, except as
otherwise provided by statute or by the Bylaws, and, except as so provided, no
stockholder shall have any right to inspect any book, account or document of the
Corporation unless authorized to do so by resolution of the Board of Directors.
For any stockholder proposal to be presented in connection with an
annual meeting of stockholders of the Corporation, including any proposal
relating to the nomination of a director to be elected to the Board of Directors
of the Corporation, the stockholders must have given timely written notice
thereof in writing to the Secretary of the Corporation in the manner and
containing the information required by the Bylaws. Stockholder proposals to be
presented in connection with a special meeting of stockholders will be presented
by the Corporation only to the extent required by Section 2-502 of the MGCL and
the Bylaws.
ARTICLE XVII
DURATION
--------
The duration of the Corporation shall be perpetual.
19
<PAGE>
ARTICLE XVIII
DEFINITIONS
-----------
The following terms shall have the meanings provided below when used
in the Charter:
Board of Directors. The term "Board of Directors" shall mean the
------------------
board of directors of the Corporation, as it may be constituted from time to
time.
Bylaws. The term "Bylaws" shall mean the Corporation's bylaws adopted
------
by the Board of Directors, as they may be amended from time to time.
Capital Stock. The term "Capital Stock" shall mean all classes or
-------------
series of stock of the Corporation, including, without limitation, Common Stock
and Preferred Stock.
Charter. The term "Charter" shall mean the charter of the
-------
Corporation, as that term is defined in the MGCL.
Corporation. The term "Corporation" shall mean the corporation formed
-----------
by these Articles of Incorporation, as they may be amended from time to time.
MGCL. The term "MGCL" shall mean the Maryland General Corporation
----
Law, as amended from time to time.
THIRD: The amendment to and restatement of the Charter of the
-----
Corporation as hereinabove set forth has been duly advised by the Board of
Directors and approved by the stockholders of the Corporation as required by
law.
FOURTH: The amendment and restatement of the Charter of the
------
Corporation does not increase the authorized stock of the Corporation.
FIFTH: The undersigned President acknowledges these Articles of
-----
Amendment and Restatement to be the corporate act of the Corporation and as to
all matters or facts required to be verified under oath, the undersigned
President acknowledges that to the best of his knowledge, information and
belief, these matters and facts are true in all material respects and that this
statement is made under the penalties for perjury.
20
<PAGE>
IN WITNESS WHEREOF, the Corporation has caused these Articles to be
signed in its name and on its behalf by its President and attested by its
Secretary on this _____ day of October, 1996.
CAPSTAR FINANCIAL, INC.
_________________________________ By_________________________________
Scott F. Hartman, Secretary W. Lance Anderson, President
21
<PAGE>
EXHIBIT 3.2
ARTICLES SUPPLEMENTARY
NOVASTAR FINANCIAL, INC.
CLASS A CONVERTIBLE PREFERRED STOCK
(PAR VALUE $.01 PER SHARE)
NovaStar Financial, Inc., a Maryland corporation (hereinafter called
the "Corporation"), having its principal office in Baltimore City, Maryland,
hereby certifies to the Department of Assessments and Taxation of the State of
Maryland that:
FIRST: Pursuant to authority expressly vested in the Board of
Directors of the Corporation by Article VI of the Charter of the Corporation,
the Board of Directors has duly divided and classified 3,550,000 shares of the
capital stock of the Corporation into a series designated Class A Convertible
Preferred Stock and has provided for the issuance of such series.
SECOND: The terms of the Class A Convertible Preferred Stock as set
by the Board of Directors are as follows:
Section 1. Designation and Amount; Fractional Shares; Par Value.
There shall be a class of Preferred Stock of the Corporation designated as
"Class A Convertible Preferred Stock" and the number of shares constituting such
series shall be 3,550,000. The Class A Convertible Preferred Stock is issuable
solely in whole shares that shall entitle the holder thereof to exercise the
voting rights, to participate in the distributions and to have the benefit of
all other rights of holders of Class A Convertible Preferred Stock as set forth
herein and in the Charter. The par value of each share of Class A Convertible
Preferred Stock shall be $0.01. Certain shares of Class A Convertible Preferred
Stock together with Stock Purchase Warrants are being offered for sale as Units
in a private placement through Stifel, Nicolaus & Company, Incorporated (the
"Placement").
Section 2. Dividends. The holders of Class A Convertible Preferred
Stock shall be entitled to receive, when and as declared by the Board of
Directors out of funds legally available for such purpose, cash dividends in
such amounts as the Board of Directors may from time to time determine in order
to satisfy the dividend distribution requirements applicable to "real estate
investment trusts" under the provisions of the Internal Revenue Code of 1986, as
it may be amended, or for such other purpose as the Board of Directors may deem
appropriate.
In no event, so long as any Class A Convertible Preferred Stock shall
remain outstanding, shall any dividend whatsoever be declared or paid upon, nor
shall any distribution be made upon, any Common Stock or any other class or
series of capital stock that ranks junior to the Class A Convertible Preferred
Stock as to dividends, nor (without the written consent of the holders of 66
2/3% of the outstanding Class A Convertible Preferred Stock) shall any shares of
Common Stock or such other class or series of capital stock be purchased or
redeemed by the Corporation, nor shall any moneys be paid to or made available
for a sinking fund for the
1
<PAGE>
purchase or redemption of any shares of Common Stock or such other class or
series of capital stock, unless in each instance the price paid for such
purchase or redemption does not exceed $0.01 per share (adjusted for any
subsequent dividends or distributions payable in Common Stock or such other
class or series of capital stock or any subdivision or combination or
reclassification of Common Stock or such other class or series of capital
stock).
Section 3. Liquidation Preference. Subject to the prior payment in
full of the preferential amounts to which shares of any other series or class of
stock of the Corporation ranking, as to distributions upon any liquidation,
dissolution or winding up of the Corporation, whether voluntary or involuntary
(any such event, a "Liquidation"), senior to the Class A Convertible Preferred
Stock, are entitled in the event of any Liquidation, each holder of a Class A
Convertible Preferred Stock shall be entitled to receive, and be paid out of the
assets of the Corporation available for distribution to its stockholders, a
liquidation preference in the amount of $15.00 per share, plus all declared and
unpaid dividends on such share (the "Liquidation Preference"). If upon any
Liquidation the amounts payable with respect to the Liquidation Preference of
the Class A Convertible Preferred Stock and any shares of a class or series of
the Corporation's stock ranking on a parity with the Class A Convertible
Preferred Stock as to distributions upon such Liquidation ("Parity Stock") are
not paid in full, the holders of Class A Convertible Preferred Stock and of such
shares of Parity Stock will share pro rata in the amounts payable and other
property distributable with respect to such Liquidation so that the per share
amounts to which the holders of Class A Convertible Preferred Stock and the
holders of such shares of Parity Stock are entitled will in all cases bear to
each other the same ratio that the liquidation preferences of the Class A
Convertible Preferred Stock and such shares of Parity Stock bear to each other.
Following the payment of all of the Liquidation Preference, to the extent of any
remaining assets, the holders of the Class A Convertible Preferred Stock and the
holders of the Common Stock of the Corporation will share the remaining amounts
payable and other property distributable with respect to such Liquidation
equally per share, with each share of Class A Convertible Preferred Stock being
treated for such purposes as if it had been converted on the day immediately
prior to the commencement of the Liquidation into the number of shares of Common
Stock that would be issuable at such time pursuant to Section 4(a)(i). Neither
a consolidation or merger of the Corporation with or into another corporation,
nor a merger of any other corporation with or into the Corporation, nor the sale
of all or substantially all of the Corporation's property or business (other
than in connection with a winding up of its business) will be considered a
Liquidation for purposes of this Section.
Section 4. Conversion Provisions.
(a) Conversion Events.
(i) Automatic Conversion. Notwithstanding anything to the
contrary contained in this Section, each share of Class A Convertible Preferred
Stock shall automatically be converted into that number of fully paid and
nonassessable shares of Common Stock, or such other securities and property as
hereinafter provided (calculated as to each conversion to the nearest 1/100th of
a share with .5/100 rounded upwards), equal to one times the ratio (the
"Conversion Ratio") of (A) $15.00 (the issue price per share of Class A
Convertible Preferred
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Stock), divided by (B) the Conversion Price. The conversion shall occur at the
effective time of closing on the date of the closing of a firm commitment
underwritten public offering pursuant to an effective registration statement
under the Securities Act of 1933, as amended, covering the offer and sale of
Common Stock for the account of the Corporation to the public resulting in gross
proceeds to the Corporation of at least $20 million and at a price per share of
at least $15.00 or such lesser amount of proceeds and/or lower price per share
as may be approved by two-thirds of the voting power of the Preferred Stock (a
"Qualified IPO"). For purposes of the Class A Convertible Preferred Stock,
"Conversion Price" shall initially mean $15.00 until such Conversion Price is
adjusted in accordance with the provisions of Section 4(d) hereof and thereafter
shall mean the Conversion Price in effect from time to time as adjusted. Except
as specifically provided in Section 4(d) hereof, there shall be no adjustment of
the Conversion Price in case of the issuance of any securities of the
Corporation. All adjustments in the Conversion Price shall be rounded to the
nearest whole cent, with one-half cent rounded upwards.
(ii) Optional Conversion. Each holder of shares of Class A
Convertible Preferred Stock shall have the right, at such holder's option, to
convert all or a portion of the shares held, at any time or from time to time
following the date occurring three years after the last closing under the
Placement into that number of fully paid and nonassessable shares of Common
Stock, or such other securities and property as hereinafter provided (calculated
as to each conversion to the nearest 1/100th of a share, with .5/100 rounded
upwards), determined by multiplying the aggregate number of shares of Class A
Convertible Preferred Stock being converted at such time by such holder, by the
Conversion Ratio.
(b) Conversion Procedures. Any holder of shares of Class A
Convertible Preferred Stock desiring to convert shares pursuant hereto shall
surrender the certificate or certificates evidencing such shares to the
Corporation at its principal office (or such other office or agency of the
Corporation as the Corporation may designate by notice in writing to the holder
or holders of the Class A Convertible Preferred Stock) at any time during its
usual business hours which certificate or certificates, if the Corporation shall
so require, shall be duly endorsed to the Corporation or in blank, or
accompanied by proper instruments of transfer to the Corporation or in blank,
accompanied by (i) an irrevocable written notice to the Corporation that the
holder elects to convert such shares and specifying the name or names (with
address or addresses) in which a certificate or certificates evidencing shares
of Common Stock are to be issued and (ii) if required pursuant to Section 4(f),
an amount sufficient to pay any transfer or similar tax (or evidence reasonably
satisfactory to the Corporation demonstrating that such taxes have been paid).
The Corporation shall, as soon as practicable after effectiveness of
conversion of shares of Class A Convertible Preferred Stock and compliance with
the other conditions herein contained, deliver to the holder whose shares of
Class A Convertible Preferred Stock are so converted, or to the nominee or
nominees of such person, certificates evidencing the number of full shares of
Common Stock to which such person shall be entitled, together with a cash
payment in respect of any fraction of a share of Common Stock as hereinafter
provided. The conversion pursuant to Section 4(a)(i) shall be deemed to have
been effected at the time and on the date therein specified. Subject to the
following provisions of this paragraph, each conversion
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pursuant to Section 4(a)(ii) shall be deemed to have been effected immediately
prior to the close of business on the date on which the certificates for shares
of Class A Convertible Preferred Stock to be converted shall have been
surrendered together with the irrevocable written notice and the payment of
taxes (if applicable), all as provided in this Section 4(b), and the person or
persons entitled to receive the Common Stock deliverable upon conversion of such
Class A Convertible Preferred Stock shall be treated for all purposes as the
record holder or holders of such Common Stock at such time on such date, unless
the stock transfer books of the Corporation shall be closed on such date, in
which event such person or persons shall be deemed to have become such holder or
holders of record at the close of business on the next succeeding day on which
such stock transfer books are open, but such conversion shall be at the
Conversion Ratio in effect on the date on which such shares shall have been
surrendered and the other conditions specified above have been satisfied.
Notwithstanding the preceding sentence, in the event that at the time of
surrender of shares of Class A Convertible Preferred Stock for conversion
pursuant to Section 4(a)(ii) the Corporation has an effective registration
statement covering such conversion to Common Stock, the holder so surrendering
shares for conversion shall have the right to rescind such election to convert
(by delivering a written notice to that effect to the Corporation at the office
at which such shares were surrendered) for a period ending at the close of
business on the fifth business day after the Corporation shall have mailed (for
overnight delivery if possible) to such holder at its last address as it shall
appear upon the stock transfer books of the Corporation a copy of the Prospectus
covering such conversion. No holder of Class A Convertible Preferred Stock shall
have any rights as a holder of Common Stock (or any other securities into which
the Class A Convertible Preferred Stock may become convertible) unless and until
such conversion has been effected.
The holder of a share of Class A Convertible Preferred Stock at the
close of business on a record date shall be entitled to receive the dividend
payable thereon on the corresponding dividend payment date notwithstanding the
conversion thereof during the period between the record date with respect to
such dividend and the corresponding dividend payment date or the Corporation's
default in the payment of the dividend due on such dividend payment date.
Except as provided in the preceding sentence, no payments or adjustments in
respect of dividends on shares of Class A Convertible Preferred Stock converted
or on account of any dividend on the Common Stock issued upon conversion shall
be made upon the conversion of any shares of Class A Convertible Preferred
Stock.
(c) No Fractional Shares. No fractional shares or scrip representing
fractional shares of Common Stock shall be issued upon conversion of Class A
Convertible Preferred Stock. If a certificate or certificates representing more
than one share of Class A Convertible Preferred Stock shall be surrendered for
conversion at one time by the same record holder, the number of full shares of
Common Stock issuable upon conversion thereof shall be computed on the basis of
the aggregate number of shares of Class A Convertible Preferred Stock so
surrendered by such record holder as provided in Section 4(b). In lieu of any
fractional share of Common Stock that would otherwise be issuable upon
conversion of any shares of Class A Convertible Preferred Stock, the Corporation
shall pay a cash adjustment in respect of such fractional share in an amount
equal to the same fraction of the current fair market value of the
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Common Stock on the day immediately preceding the date of conversion, as
determined by the Board of Directors.
(d) Adjustments to Conversion Price; Fundamental Change.
(i) Changes in Capital Stock. If, after the issuance of any shares
of Class A Convertible Preferred Stock, the Corporation:
(A) subdivides its outstanding shares of Common Stock into
a greater number of shares; or
(B) combines its outstanding shares of Common Stock into a
smaller number of shares; or
(C) issues, by any dividend or distribution to the holders
of Common Stock, shares of Common Stock; or
(D) issues, by reclassification of its Common Stock, any
shares of its capital stock;
then the conversion rights and the Conversion Price in effect immediately prior
to such action shall be adjusted so that the holder of shares of Class A
Convertible Preferred Stock thereafter converted may receive the number of
shares of capital stock of the Corporation which such holder would have owned
immediately following such action if such holder had converted the shares of
Class A Convertible Preferred Stock immediately prior to such action. The
adjustment shall become effective immediately after the effective date of the
subdivision, combination, issuance or reclassification.
If after an adjustment a holder of shares of Class A Convertible
Preferred Stock upon conversion of such shares may receive shares of two or more
classes of capital stock of the Corporation, the Conversion Price shall
thereafter be subject to adjustment upon the occurrence of an action taken with
respect to any such class of capital stock as is contemplated by this Section
4(d) with respect to Common Stock, on terms comparable to those applicable to
Common Stock in this Section 4(d).
(ii) Anti-dilution Provision. If the Corporation shall issue any
class or series of capital stock of the Corporation that ranks junior to the
Class A Convertible Preferred Stock at a price per share less than the greater
of (A) $15 and (B) the Fair Market Value per share of such capital stock (such
greater amount being hereinafter referred to as the "Base Price"), then the
Conversion Price in effect at the opening of business on the day next following
such issuance shall be adjusted to equal the price determined by multiplying (I)
the Conversion Price in effect immediately prior to the opening of business on
the day next following such issuance by (II) a fraction, the numerator of which
shall be the sum of (x) the number of shares of all classes and series of
capital stock outstanding on the close of business on the day next preceding the
day of such issuance and (y) the number of shares that could be purchased at the
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Base Price from the aggregate proceeds to the Corporation from the issuance of
such new shares of capital stock, and the denominator of which shall be the sum
of (xx) the number of shares of all classes and series of capital stock
outstanding on the close of business on the day next preceding the day of such
issuance and (yy) the number of additional shares of capital stock being issued;
provided, however, that no adjustment to the Conversion Price shall be made as a
- -------- -------
result of a Qualified IPO. For purposes of this subsection, "Fair Market Value"
shall mean, as to any class or series of capital stock that is not publicly
traded, the fair value of the shares of such class or series as determined
reasonably and in good faith by a majority of the Board of Directors of the
Corporation including a majority of the Independent Directors (as defined in the
Corporation's Bylaws) and, as to publicly traded securities, shall mean the
average of the daily Current Market Prices of a share of such capital stock
during five (5) consecutive trading days selected by the Corporation commencing
not more than twenty (20) trading days before, and ending not later than the
effective day of the Conversion Price adjustment pursuant to this subsection.
"Current Market Price" of publicly traded securities for any day shall mean the
closing price, regular way on such day, or, if no sale takes place on such day,
the average of the reported closing bid and asked prices regular way on such
day, in either case as reported on the Nasdaq National Market or the principal
national securities exchange on which such securities are listed or admitted for
trading, or if not so quoted, listed or admitted, the average of the closing bid
and asked prices on such day in the over-the-counter market as reported by
Nasdaq.
(iii) De Minimis Adjustments. If the amount of any adjustment of
the Conversion Price required pursuant to this Section 4(d) would be less than
one percent (1%) of the Conversion Price in effect at the time such adjustment
is otherwise so required to be made, no adjustment to the Conversion Price shall
be made and such amount shall be carried forward and an adjustment with respect
thereto made at the time of and together with any subsequent adjustment which,
together with such amount and any other amounts so carried forward, shall
aggregate at least one percent (1%) of such Conversion Price.
(iv) Fundamental Change. If a Change of Control shall occur with
respect to the Corporation or if the Corporation is a party to a consolidation
or a merger or other combination, or transfers all or substantially all of its
assets as an entirety (any such Change of Control, consolidation, merger,
combination or transfer being hereinafter referred to as a "Fundamental
Change"), each holder of Class A Convertible Preferred Stock shall be given the
option to elect to receive either (A) the kind and amount of securities, cash or
other assets which such holder would have received immediately after the
Fundamental Change if such holder had converted such shares of Class A
Convertible Preferred Stock immediately before the effective date of the
Fundamental Change or (B) the Liquidation Preference of such shares of Class A
Convertible Preferred Stock. No later than the twentieth day after the day the
Corporation mails notice of a proposed Fundamental Change or the occurrence of a
Fundamental Change, as required under Section 4(g), each holder of Class A
Convertible Preferred Stock electing to receive such payment shall mail to the
Corporation its election to receive the amounts specified under either (A) or
(B) above. If an election is so timely mailed by a holder, but the holder fails
to elect either clause (A) or (B) above, the Corporation shall determine in its
sole discretion whether such holder receives the amounts under (A) or (B). For
purposes of this subsection (d)(iv), a "Change of Control" shall be deemed to
occur if, and only if, either (I) during any
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period of two consecutive years (not including any period prior to the initial
closing of the Placement), individuals who at the beginning of such period
constitute the Board of Directors and any new director, (x) whose election by
the Board of Directors or nomination for election by the Company's stockholders
was approved by a vote of at least two-thirds (2/3) of the directors then still
in office who either were directors at the beginning of the period or whose
election or nomination for election was previously so approved or (y) whose
election is to replace a person who ceases to be a director due to heath,
disability or age, cease for any reason to constitute a majority of the Board of
Directors, or (II) any person (as defined in Section 13(d) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), including any group as
therein provided) becomes the beneficial owner as defined in Rule 13d-3
promulgated under the Exchange Act, directly or indirectly, of more than fifty
percent (50%) of the outstanding voting stock of the Corporation.
(e) Adjustment Reports. Whenever any adjustment is required in the
shares into which any share of Class A Convertible Preferred Stock is
convertible, the Corporation shall cause a notice of such adjustment, setting
forth the adjusted Conversion Price and the calculation thereof to be mailed to
the holders of record of shares of Class A Convertible Preferred Stock at their
address as shown on the stock transfer books of the Corporation.
(f) Reservation of Shares; Transfer Taxes; Etc. The Corporation shall
at all times reserve and keep available, out of its authorized and unissued
stock, solely for the purpose of effecting the conversion of the Class A
Convertible Preferred Stock, such number of shares of its Common Stock free of
preemptive rights as shall from time to time be sufficient to effect the
conversion of all shares of Class A Convertible Preferred Stock from time to
time outstanding. The Corporation shall from time to time, in accordance with
the laws of the State of Maryland, increase the authorized number of shares of
Common Stock if at any time the number of shares of authorized and unissued
Common Stock shall not be sufficient to permit the conversion of all the then
outstanding shares of Class A Convertible Preferred Stock.
The Corporation shall pay any and all issue or other taxes that may be
payable in respect of any issue or delivery of Common Stock upon conversion of
the Class A Convertible Preferred Stock. The Corporation shall not, however, be
required to pay any tax which may be payable in respect of any transfer involved
in the issue or delivery of Common Stock (or other securities or assets) in a
name other than that in which the shares of Class A Convertible Preferred Stock
so converted were registered, and no such issue or delivery shall be made unless
and until the person requesting such issue has paid to the Corporation the
amount of such tax or has established, to the satisfaction of the Corporation,
that such tax has been paid.
(g) Prior Notice of Certain Events. In case:
(i) the Corporation proposes to take any action that would
require an adjustment pursuant to Section 4(d) hereof; or
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(ii) the Corporation proposes to take any action that would
require any person to make provisions in a certificate or articles of
incorporation or other constituent document as contemplated by Section
4(d) hereof; or
(iii) of a proposed Liquidation or a Fundamental Change;
then the Corporation shall cause to be mailed to the holders of record of the
Class A Convertible Preferred Stock at their last addresses as they appear upon
the stock transfer books of the Corporation, at least twenty days prior to the
proposed effective date of the event being reported, or, if such event takes
place without prior notice to or knowledge of the Corporation, within five days
after the actual effective date, a notice summarizing the material terms of such
event and stating the proposed or actual effective date (but no failure to mail
such notice or any defect therein or in the mailing thereof shall effect the
validity of the corporate action required to be specified in such notice).
Section 5. Voting Rights. The holders of Class A Convertible
Preferred Stock and Common Stock shall vote together as a class for the election
of all the directors of the Corporation and, except as otherwise provided by
law, the Charter or the terms of the Class A Convertible Preferred Stock, on all
other matters to be voted on by the stockholders of the Corporation on the
following basis: (1) each holder of Class A Convertible Preferred Stock shall
be entitled to one vote for each share of Common Stock which would be issuable
to such holder upon the conversion of all the shares of Class A Convertible
Preferred Stock so held on the record date for the determination of stockholders
entitled to vote, and (2) each holder of Common Stock shall be entitled to one
vote per share; provided, however, that:
(i) the holders of Class A Convertible Preferred Stock and the
holders of Common Stock will be entitled to vote as separate classes
for any proposed merger, consolidation or sale of the assets of the
Company as an entirety, but only if at the time of such proposal, one
person or group of persons is the "beneficial owner" (as determined
under the rules of Regulation 13D-G under the Securities Exchange Act
of 1934, as amended) of more than 66 2/3% of the Preferred Stock;
(ii) the holders of Class A Convertible Preferred Stock and the
holders of Common Stock will be entitled to vote as separate classes
for any stock splits, reverse stock splits, or other amendments to the
Charter which in any way adversely affects the respective preferences,
qualifications, special or relative rights or privileges of the Common
Stock.
Section 6. Restrictions. At any time when shares of Class A
Convertible Preferred Stock are outstanding, except where the vote or written
consent of the holders of a greater number of shares of the Corporation is
required by law or by the Charter or the terms of the Class A Convertible
Preferred Stock, and in addition to any other vote required by law, without the
prior consent of the holders of sixty-six and two-thirds percent (66 2/3%) of
the outstanding Class A Convertible Preferred Stock, given in person or by
proxy, either in writing
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or at a special meeting called for that propose, at which meeting the holders of
the shares of such Class A Convertible Preferred Stock shall vote together as a
class:
(a) The Corporation will not create or issue any additional class or
series of capital stock or any securities convertible into any additional class
or series of capital stock unless such additional class or series of capital
stock ranks junior to the Class A Convertible Preferred Stock both as to
dividends and as to the distribution of the assets on Liquidation or increase
the authorized amount of the Class A Convertible Preferred Stock or increase the
authorized amount of any additional class or series of capital stock unless the
same ranks junior to the Class A Convertible Preferred Stock both as to
dividends and as to the distribution of assets on Liquidation, whether any such
creation or authorization or increase shall be by means of amendment of the
Charter or the terms of the Class A Convertible Preferred Stock, merger,
consolidation or otherwise.
(b) The Corporation will not amend, alter or repeal the terms of the
Class A Convertible Preferred Stock in any way or amend the Charter in any way
which adversely affects the respective preferences, qualifications, special or
relative rights or privileges of the Class A Convertible Preferred Stock.
Section 7. Ranking Upon Liquidation. Any class or series of capital
stock of the Corporation shall be deemed to rank:
(i) senior to the Class A Convertible Preferred Stock, as to
dividends or upon Liquidation, if the holders of such class or series
shall be entitled to the receipt of dividends or of amounts
distributable upon Liquidation, as the case may be, in preference or
priority to the holders of Class A Convertible Preferred Stock;
(ii) on a parity with the Class A Convertible Preferred Stock, as
to dividends or upon Liquidation, whether or not the dividend rates,
dividend payment dates or redemption or Liquidation prices per share
thereof are different from those of the Class A Convertible Preferred
Stock, if the holders of such class or series of stock and the Class A
Convertible Preferred Stock shall be entitled to the receipt of
dividends or of amounts distributable upon Liquidation, as the case
may be, in proportion to their respective amounts of accumulated and
unpaid dividends per share or Liquidation prices, as the case may be,
without preferences or priority one over the other; and
(iii) junior to the Class A Convertible Preferred Stock, as to
dividends or upon Liquidation, if such stock shall be Common Stock or
any other class or series of capital stock of the Corporation if the
holders of Class A Convertible Preferred Stock shall be entitled to
receipt of dividends or of amounts distributable upon Liquidation, as
the case may be, in preference or priority to the holders of shares of
such other stock.
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Section 8. Outstanding Shares. For purposes of the Class A
Convertible Preferred Stock, all shares of Class A Convertible Preferred Stock
issued by the Corporation shall be deemed outstanding except (i) from the date
specified herein upon the conversion of the shares of Class A Convertible
Preferred Stock into Common Stock and (ii) from the date of registration of
transfer to the Corporation or any direct or indirect majority-owned subsidiary
of the Corporation, all shares of Class A Convertible Preferred Stock held of
record by the Corporation or any such direct or indirect majority-owned
subsidiary of the Corporation.
Section 9. Status of Acquired Shares. Shares of Class A Convertible
Preferred Stock received by the Corporation upon conversion pursuant to Section
4 or otherwise acquired by the Corporation will be restored to the status of
authorized but unissued shares of capital stock, without designation as to
class, and may thereafter be issued, but not as shares of Class A Convertible
Preferred Stock except as otherwise permitted herein.
Section 10. No Redemption. The shares of Class A Convertible
Preferred Stock shall not be subject to redemption, either mandatorily or at the
option of the Corporation or the holder thereof, except as provided in Section
4(d)(iv) hereof or the Charter.
Section 11. Severability of Provisions. Whenever possible, each
provision hereof shall be interpreted in a manner as to be effective and valid
under applicable law, but if any provision hereof is held to be prohibited by or
invalid under applicable law, such provision shall be ineffective only to the
extent of such prohibition or invalidity, without invalidating or otherwise
adversely affecting the remaining provisions hereof.
Section 12. Time and Business Days. Wherever there are references
herein to "at the close of business" such references shall mean 5:00 p.m.
Pacific Standard or Daylight Time, as the case may be, on a business day.
References to "business day" shall mean days other than (i) Saturday or Sunday,
(ii) a legal holiday in the State of California, or (iii) a day on which banking
institutions in the City and County of San Francisco are authorized or obligated
by law or executive order to be closed.
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IN WITNESS WHEREOF, the Corporation has caused these presents to be
signed in its name and on its behalf by its President and witnessed by its
Secretary on December 6, 1996.
WITNESS: NOVASTAR FINANCIAL, INC.
_______________________________ ______________________________
Scott F. Hartman W. Lance Anderson
Secretary President
THE UNDERSIGNED, President of NovaStar Financial, Inc., who executed
on behalf of the Corporation Articles Supplementary of which this Certificate is
made a part, hereby acknowledges in the name and on behalf of said Corporation
the foregoing Articles Supplementary to be the corporate act of said Corporation
and hereby certifies that the matters and facts set forth herein with respect to
the authorization and approval thereof are true in all material respects under
the penalties of perjury.
______________________________
W. Lance Anderson
President
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EXHIBIT 3.3
BYLAWS
OF
NOVASTAR FINANCIAL, INC.
DECEMBER 6, 1996
ARTICLE I
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STOCKHOLDERS
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SECTION 1. Annual Meeting. The Corporation shall hold an annual
--------------
meeting of its stockholders to elect directors and transact any other business
within its power, either at 10:00 a.m. on the fourth Tuesday of May in each year
if not a legal holiday, or at such other time on such other day falling on or
before the 30th day thereafter as shall be set by the Board of Directors;
provided, however, that the 1996 annual meeting shall be held at 10:00 a.m. on
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October 1, 1996, or at such other time on such other day falling on or before
the 30th day thereafter as shall be set by the Board of Directors. Except as
the Charter or statute provides otherwise, any business may be considered at an
annual meeting without the purpose of the meeting having been specified in the
notice. Failure to hold an annual meeting does not invalidate the Corporation's
existence or affect any otherwise valid corporate acts. Meetings of
stockholders shall be held at the principal office of the Corporation or at such
place in the United States as is set forth from time to time by the Board of
Directors.
SECTION 2. Special Meetings. Special meetings of the stockholders
----------------
for any purpose or purposes may be called at any time by the President, any
member of the Board of Directors, or by stockholders entitled to cast at least
twenty percent (20%) of the votes which all stockholders are entitled to cast at
the particular meeting, addressed to the Secretary and then only as may be
required by law.
SECTION 3. Notices. Notice of the annual meeting and of any special
-------
meeting of stockholders shall, at least ten days but not more than ninety days
prior to the date thereof, be given to each stockholder entitled to vote thereat
and each other stockholder entitled to notice of the meeting. Notice is given
to a stockholder when it is personally delivered to it, left at its residence or
usual place of business, or mailed to it at its address as it appears on the
records of the Corporation. Notwithstanding the foregoing provisions, each
person who is entitled to notice waives notice if, before or after the meeting,
such stockholder signs a waiver of notice which is filed with the records of the
stockholders' meeting, or is present at the meeting in person or by proxy.
Every notice of an annual meeting or a special meeting shall state the time and
place of the meeting. If the meeting is a special meeting or notice of the
purpose or purposes is required by
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statute, the notice shall also briefly state the purpose or purposes thereof,
and no business, other than that specified in such notice and matters germane
thereto, shall be transacted at the meeting without further notice to
stockholders not present in person or by proxy.
SECTION 4. Quorum; Manner of Acting and Adjournment. Unless statute
----------------------------------------
or the Charter provides otherwise, at a meeting of stockholders the presence in
person or by proxy of stockholders entitled to cast a majority of all the votes
entitled to be cast at the meeting constitutes a quorum, and a majority of all
the votes cast at a meeting at which a quorum is present is sufficient to
approve any matter which properly comes before the meeting, except that a
plurality of all the votes cast at a meeting at which a quorum is present is
sufficient to elect a director.
Whether or not a quorum is present, a meeting of stockholders convened
on the date for which it was called may be adjourned from time to time without
further notice by a majority vote of the stockholders present in person or by
proxy to a date not more than 120 days after the original record date. Any
business which might have been transacted at the meeting as originally notified
may be deferred and transacted at any such adjourned meeting at which a quorum
shall be present.
SECTION 5. Organization. At every meeting of the stockholders, the
------------
Chairman of the Board, if there be one, shall conduct the meeting or, in the
case of vacancy in office or absence of the Chairman of the Board, one of the
following officers present shall conduct the meeting in the order stated: the
Vice Chairman of the Board, if there be one, the President, the Vice Presidents
in their order of rank and seniority, or a Chairman chosen by the stockholders
entitled to cast a majority of the votes which all stockholders present in
person or by proxy are entitled to cast, shall act as Chairman, and the
Secretary or, in his or her absence, an assistant secretary, or in the absence
of both Secretary and assistant secretaries, a person appointed by the Chairman,
shall act as Secretary.
SECTION 6. Voting. Unless the Charter provides for a greater or
------
lesser number of votes per share or limits or denies voting rights, each
outstanding share of stock, regardless of class, is entitled to one vote on each
matter submitted to a vote at a meeting of stockholders. In all elections for
directors, each share of stock may be voted for as many individuals as there are
directors to be elected and for whose election the share is entitled to be
voted, but cumulative voting is not permitted.
SECTION 7. Proxies. A stockholder may vote the stock the stockholder
-------
owns of record either in person or by proxy. A stockholder may sign a writing
authorizing another person to act as proxy. Signing may be accomplished by the
stockholder or the stockholder's authorized agent signing the writing or causing
the stockholder's signature to be affixed to the writing by any reasonable
means, including facsimile signature. A stockholder may authorize another
person to act as proxy by transmitting, or authorizing the transmission of, a
telegram, cablegram, datagram, or other means of electronic transmission to the
person authorized to act as proxy or to a proxy solicitation firm, proxy support
service organization, or other person authorized by the person who will act as
proxy to receive the transmission. Unless a proxy provides otherwise, it is not
valid more than 11 months after its date. A proxy is revocable by a stockholder
at any time without
2
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condition or qualification unless the proxy states that it is irrevocable and
the proxy is coupled with an interest. A proxy may be made irrevocable for so
long as it is coupled with an interest. The interest with which a proxy may be
coupled includes an interest in the stock to be voted under the proxy or another
general interest in the Corporation or its assets or liabilities.
SECTION 8. Voting Lists. At each meeting of stockholders, a full,
------------
true and complete list of all stockholders entitled to vote at such meeting,
showing the number and class of shares held by each and certified by the
transfer agent for such class or by the Secretary, shall be furnished by the
Secretary.
SECTION 9. Informal Action by Stockholders. Unless otherwise
-------------------------------
provided by law, any action required to be taken at a meeting of the
stockholders, or any other action which may be taken at a meeting of the
stockholders, may be taken without a meeting if a consent in writing, setting
forth the action so taken, shall be signed by all of the stockholders entitled
to vote with respect to the subject matter thereof.
SECTION 10. Meeting by Conference Telephone. Stockholders may
-------------------------------
participate in a meeting by means of a conference telephone or similar
communications equipment if all persons participating in the meeting can hear
each other at the same time. Participation in a meeting by these means
constitutes presence in person at a meeting.
SECTION 11. Stockholder Proposals. For any stockholder proposal to
---------------------
be presented in connection with an annual meeting of stockholders of the
Corporation, including any proposal relating to the nomination of a director to
be elected to the Board of Directors of the Corporation, the stockholder putting
forth such proposal must have given timely notice thereof in writing to the
Secretary of the Corporation. To be timely, a stockholder's notice shall be
delivered to the Secretary at the principal executive offices of the Corporation
not less than 60 days nor more than 90 days prior to the first anniversary of
the preceding year's annual meeting; provided, however, that in the event that
the date of the annual meeting is advanced by more than 30 days or delayed by
more than 60 days from such anniversary date, notice by the stockholder to be
timely must be so delivered not earlier than the 90th day prior to such annual
meeting and not later than the close of business on the later of the 60th day
prior to such annual meeting or the tenth day following the day on which public
announcement of the date of such meeting is first made. Such stockholder's
notice shall set forth (a) as to each person whom the stockholder proposes to
nominate for election or reelection as a director all information relating to
such person that is required to be disclosed in solicitations of proxies for
election of directors pursuant to Regulation 14A under the Securities Exchange
Act of 1934, as amended (the "Exchange Act") (including such person's written
consent to being named in the proxy statement as a nominee and to serving as a
director if elected); (b) as to any other business that the stockholder proposes
to bring before the meeting, a brief description of the business desired to be
brought before the meeting, the reasons for conducting such business at the
meeting and any material interest in such business of such stockholder and of
the beneficial owner, if any, on whose behalf the proposal is made; and (c) as
to the stockholder giving the notice and the beneficial owner, if any, on whose
behalf the nomination or proposal is made, (i) the name and address of such
stockholder, as they appear on the Corporation's books, and of such beneficial
3
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owner and (ii) the class and number of shares of stock of the Corporation which
are owned beneficially and of record by such stockholder and such beneficial
owner. This Section shall not apply to the 1996 annual meeting. For the 1997
annual meeting the previous year's meeting shall be deemed to have taken place
on May 29, 1996; provided that this sentence shall cease to be a part of the
Bylaws after holding the 1997 annual meeting and any adjournments thereof.
ARTICLE II
----------
DIRECTORS
---------
SECTION 1. Number, Classification, Election and Term. The affairs of
-----------------------------------------
the Corporation shall be under the direction and control of a Board of Directors
which shall be initially composed of three (3) members who shall hold office
until its successors are duly chosen and qualified. The directors shall be
divided into three Classes, designated Class I, Class II and Class III. Each
class shall consist, as nearly as may be possible, of one-third of the total
number of directors constituting the entire Board of Directors. The term of the
initial Class I directors shall terminate on the date of the annual meeting of
stockholders held in 1997; the term of the initial Class II directors shall
terminate on the date of the annual meeting of stockholders held in 1998; and
the term of the initial Class III directors shall terminate on the date of the
annual meeting of stockholders held in 1999. At each annual meeting of
stockholders beginning in 1997, successors to the class of directors whose term
expires at that annual meeting shall be elected for a three-year term. The
number of directors shall be increased or decreased from time to time by vote of
a majority of the entire Board of Directors; provided, however, that the number
of directors may not exceed fifteen (15) nor be less than three (3) except as
permitted by law. If the number of directors is changed, any increase or
decrease shall be apportioned among the classes so as to maintain the number of
directors in each class as nearly equal as possible. A director elected by
stockholders shall hold office until the annual meeting for the year in which
his or her term expires and until his or her successor shall be elected and
shall qualify, subject, however, to prior death, resignation, retirement,
disqualification or removal from office.
At all times subsequent to the first closing in the Corporation's
initial private placement of its Capital Stock (the "Private Placement"), except
in the case of a vacancy, a majority of the Board of Directors shall be
Independent Directors (as hereinafter defined). For the purposes of these
Bylaws, "Independent Director" shall mean a director of the Corporation who is
not an officer or employee of the Corporation or any subsidiary or affiliate of
the Corporation. General Electric Capital Corporation and its affiliates,
including GE Capital Mortgage Corporation, shall not be deemed to be affiliates
of the Corporation for purposes of this definition. Directors need not be
stockholders in the Corporation.
Whenever the holders of any one or more series of preferred stock of
the Corporation shall have the right, voting separately as a class, to elect one
or more directors of the Corporation, the Board of Directors shall consist of
said directors so elected in addition to the number of directors fixed as
provided above in the first paragraph of this Section 1. Notwithstanding the
foregoing, and except as otherwise may be required by law, whenever the holders
of any one or more series of
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preferred stock of the Corporation shall have the right, voting separately as a
class, to elect one or more directors of the Corporation, the terms of the
director or directors elected by such holders shall expire at the next
succeeding annual meeting of stockholders.
SECTION 2. Function of Directors. The business and affairs of the
---------------------
Corporation shall be managed under the direction of the Board of Directors. All
the powers of the Corporation are vested in and shall be exercised by or under
the authority of the Board of Directors except as otherwise prescribed by
statute, by the Charter or by these Bylaws.
SECTION 3. Vacancies. Subject to the rights of the holders of any
---------
class of stock separately entitled to one or more directors, any vacancy
occurring on the Board of Directors for any cause other than by reason of an
increase in the number of directors may, subject to the provisions of Section 5,
be filled by a majority of the remaining members of the Board of Directors,
regardless of whether such majority of the remaining members of the Board of
Directors is less than a quorum; provided, however, that if the Corporation has
completed its Private Placement and, in accordance with Section 1, a majority of
the Board of Directors are required to be Independent Directors, then
Independent Directors shall nominate replacements for vacancies among the
Independent Directors, which replacements must be elected by a majority of the
directors, including a majority of the Independent Directors. Subject to the
rights of the holders of any class of stock separately entitled to elect one or
more directors, any vacancy occurring by reason of an increase in the number of
directors may be filled by action of a majority of the entire Board of Directors
including, following the Private Placement, a majority of the Independent
Directors. The stockholders may fill any vacancy occurring on the Board of
Directors for any reason, subject to the requirement for Independent Directors,
if applicable. If the stockholders of any class or series are entitled
separately to elect one or more directors, a majority of the remaining directors
elected by that class or series or the sole remaining director elected by that
class or series may fill any vacancy among the number of directors elected by
that class or series. A director elected by the Board of Directors to fill a
vacancy shall be elected to hold office until the next annual meeting of
stockholders or until his successor is elected and qualified.
SECTION 4. Resignations. Any director or member of a committee may
------------
resign at any time. Such resignation shall be made in writing and shall take
effect at the time specified therein, or if no time be specified, at the time of
the receipt by the Chairman of the Board, the President or the Secretary.
Acceptance of a resignation shall not be necessary to make it effective.
SECTION 5. Removal. Any director or the entire Board of Directors
-------
may be removed only in accordance with the Charter.
SECTION 6. Committees of the Board of Directors. The Board of
------------------------------------
Directors may appoint from among its members an Executive Committee, an Audit
Committee, a Compensation Committee and other committees composed of one or more
directors and delegate to these committees any of the powers of the Board of
Directors, except the power to authorize dividends of stock, elect directors,
issue stock other than as provided in the next sentence, recommend to the
stockholders any action which requires stockholder approval, amend these Bylaws,
or approve any
5
<PAGE>
merger or share exchange which does not require stockholder approval. At least a
majority of all committees of the Board shall be comprised of Independent
Directors. If the Board of Directors has given general authorization for the
issuance of stock providing for or establishing a method or procedure for
determining the maximum number of shares to be issued, a committee of the Board,
in accordance with that general authorization or any stock option or other plan
or program adopted by the Board of Directors, may authorize or fix the terms of
stock subject to classification or reclassification and the terms on which any
stock may be issued, including all terms and conditions required or permitted to
be established or authorized by the Board of Directors.
Each committee may fix rules of procedure for its business. One-third
of the members of a committee shall constitute a quorum for the transaction of
business and the act of a majority of those present at a meeting at which a
quorum is present shall be the act of the committee. The members of a committee
present at any meeting, whether or not they constitute a quorum, may appoint a
director to act in the place of an absent member; provided, however, that in the
-------- -------
event of the absence or disqualification of any Independent Director, such
appointee shall be an Independent Director. Any action required or permitted to
be taken at a meeting of a committee may be taken without a meeting, if an
unanimous written consent which sets forth the action is signed by each member
of the committee and filed with the minutes of the committee. The members of a
committee may conduct any meeting thereof by conference telephone in accordance
with the provisions of Section 8 of this Article.
Subject to the provisions hereof, the Board of Directors shall have
the power at any time to change the membership of any committee, to fill all
vacancies, to designate alternative members to replace any absent or
disqualified member, or to dissolve any such committee.
SECTION 7. Meetings of the Board of Directors. Meetings of the Board
----------------------------------
of Directors, regular or special, may be held at any place in or out of the
State of Maryland as the Board of Directors may from time to time determine or
as shall be specified in the notice of such meeting.
Members of the Board of Directors may participate in a meeting by
means of a conference telephone or similar communications equipment if all
persons participating in the meeting can hear each other at the same time.
Participation in a meeting by such means constitutes presence in person at a
meeting.
The first meeting of each newly elected Board of Directors shall be
held as soon as practicable after the annual meeting of the stockholders at
which the directors were elected. The meeting may be held at such time and
place as shall be specified in a notice given as hereinafter provided for
special meetings of the Board of Directors, or as shall be specified in a
written waiver signed by all of the directors as provided in this Section 7,
except that no notice shall be necessary if such meeting is held immediately
after the adjournment, and at the site, of the annual meeting of stockholders.
Regular meetings of the Board of Directors may be held without notice
at such time and place as shall from time to time be determined by the Board of
Directors. Special meetings of the
6
<PAGE>
Board of Directors may be called at any time by two (2) or more directors or by
a majority of the members of the executive committee, if one be constituted, in
writing with or without a meeting of such committee, or by the Chairman of the
Board of Directors or the President.
Special meetings may be held at such place or places in or out of the
State of Maryland as may be designated from time to time by the Board of
Directors; in the absence of such designation, such meetings shall be held at
such places as may be designated in the notice of meeting.
Notice of the place and time of every special meeting of the Board of
Directors shall be delivered by the Secretary to each director either personally
or by telephone, telegraph, overnight courier or facsimile, or by leaving the
same at his residence or usual place of business at least twenty-four (24) hours
before the time at which such meeting is to be held or, if by first-class mail,
at least 72 hours before the time of such meeting. If mailed, such notice shall
be deemed to be given when deposited in the United States Mail addressed to the
director at his post office address as it appears on the records of the
Corporation, with postage thereon paid. Unless the Bylaws or a resolution of
the Board of Directors provides otherwise, the notice need not state the
business to be transacted at, or the purposes of, any special meeting of the
Board of Directors. No notice of any special meeting of the Board of Directors
need be given to any director who attends except where a director attends a
meeting for the express purpose of objecting to the transaction of any business
because the special meeting is not lawfully called or convened, or to any
director who, in writing executed and filed with the records of the meeting
either before or after the holding thereof, waives such notice.
Any meeting of the Board of Directors, regular or special, may adjourn
from time to time to reconvene at the same or some other place, and no notice
need be given of any such adjourned meeting other than by announcement.
SECTION 8. Informal Action by Directors. Unless otherwise provided
----------------------------
by law, any action required to be taken at a meeting of the directors or any
other action which may be taken at a meeting of the directors may be taken
without a meeting if a consent in writing, setting forth the action so taken,
shall be signed by all of the directors.
SECTION 9. Quorum and Voting. At all meetings of the Board of
-----------------
Directors, a majority of the entire Board of Directors shall constitute a quorum
for the transaction of business, and the action of a majority of the directors
present at any meeting at which a quorum is present shall be the action of the
Board of Directors unless the concurrence of a greater proportion is required
for such action by law, the Charter or these Bylaws. If a quorum shall not be
present at any meeting of directors, the directors present thereat may, by a
majority vote, adjourn the meeting from time to time, without notice other than
announcement at the meeting, until a quorum shall be present.
SECTION 10. Organization. The Chairman of the Board shall preside at
------------
each meeting of the Board of Directors. In the absence or inability of the
Chairman of the Board to preside at a meeting, the President or, in his absence
or inability to act, another director chosen by a majority of the directors
present, shall act as chairman of the meeting and preside thereat. The
Secretary (or, in
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<PAGE>
his absence or inability to act, any person appointed by the chairman of the
meeting) shall act as Secretary of the meeting and keep the minutes thereof.
SECTION 11. Compensation of Directors. Independent Directors shall
-------------------------
receive compensation for their services, and expenses of attendance for
attendance at each regular or special meeting of the Board of Directors, or of
any committee thereof or both, as may be determined from time to time by the
Board of Directors. Nothing herein contained shall be construed to preclude any
director from serving the Corporation in any other capacity and receiving
compensation therefor.
SECTION 12. Investment Policies and Restrictions. The Board of
------------------------------------
Directors, including a majority of the Independent Directors, shall approve the
investment policies of the Corporation. The investment policies and compliance
therewith shall be reviewed by the Independent Directors at least annually to
determine that the policies then being followed by the Corporation are in the
best interest of the stockholders of the Corporation. Each such determination
and the basis therefor shall be set forth in the minutes of the meeting of the
Board of Directors.
It shall be the duty of the Board of Directors to ensure that the
purchase, sale, retention and disposal of the Corporation's assets, and the
investment policies of the Corporation and the limitations thereon or amendment
thereof are at all times in compliance with the restrictions applicable to real
estate investment trusts pursuant to the Internal Revenue Code of 1986, as
amended.
SECTION 13. Presumption of Assent. A director of the Corporation who
---------------------
is present at a meeting of the Board of Directors at which action on any
corporate matter is taken shall be presumed to have assented to the action taken
unless his or her dissent or abstention shall be entered in the minutes of the
meeting or unless he or she shall file his or her written dissent to such action
with the person acting as the secretary of the meeting before the adjournment
thereof or shall forward such dissent by registered mail to the Secretary of the
Corporation immediately after the adjournment of the meeting. Such right to
dissent shall not apply to any director who votes in favor of such action.
SECTION 14. Advisory Directors. The Board of Directors may by
------------------
resolution appoint advisory directors to the Board, who may also serve as
directors emeriti, and shall have such authority and receive such compensation
and reimbursement as the Board of Directors shall provide. Advisory directors
or directors emeriti shall not have the authority to participate by vote in the
transaction of business.
ARTICLE III
-----------
OFFICERS
--------
SECTION 1. Officers. The officers of the Corporation shall be a
--------
Chairman of the Board, a President, a Treasurer and a Secretary, who shall be
elected by the Board of Directors to serve
8
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during the pleasure of the Board and until their respective successors are
elected and qualified, except as otherwise provided in any employment agreement
between the Corporation and any officer. The Board of Directors may also appoint
one or more Vice Presidents. The same person may hold any two or more offices
except those of President and Vice President.
SECTION 2. Subordinate Officers, Committees and Agents. The Board of
-------------------------------------------
Directors may from time to time elect such other officers and appoint such
committees, employees or other agents as the business of the Corporation may
require, including one or more assistant secretaries, and one or more assistant
treasurers, each of whom shall hold office for such period, have such authority,
and perform such duties as are provided in these Bylaws, or as the Board of
Directors may from time to time determine. The Board of Directors may delegate
to any officer or committee the power to elect subordinate officers and to
retain or appoint employees or other agents.
SECTION 3. Chairman of the Board. The Chairman of the Board shall
---------------------
preside at all meetings of the stockholders and the Board of Directors at which
he or she is present. Unless otherwise specified by the Board of Directors, the
Chairman of the Board shall also be the Chief Executive Officer of the
Corporation and perform the duties customarily performed by chief executive
officers, and shall perform such other duties as may from time to time be
requested of him or her by the Board of Directors.
SECTION 4. President. Unless otherwise provided by resolution of the
---------
Board of Directors, the President, in the absence of the Chairman of the Board,
shall preside at all meetings of the Board of Directors and of the stockholders
at which he shall be present. The President shall, subject to the control of
the Board of Directors, in general supervise and control all of the business and
affairs of the Corporation. The President may sign, with the Secretary or any
other proper officer of the Corporation thereunto authorized by the Board of
Directors, certificates for shares of the Corporation, any deeds, mortgages,
bonds, contracts, or other instruments which the Board of Directors have
authorized to be executed, except in cases where the signing and execution
thereof shall be expressly delegated by the Board of Directors or by these
Bylaws to some other officer or agent of the Corporation, or shall be required
by law to be otherwise signed or executed; and in general shall perform all
duties incident to the office of president and such other duties as may be
prescribed by the Board of Directors from time to time.
SECTION 5. Vice Presidents. In the absence of the President or in
---------------
event of his or her death, inability or refusal to act, or at the request of the
Chief Executive Officer or President, the Vice President or Vice Presidents
shall perform the duties and exercise all the powers of the President and be
subject to all the restrictions upon the President. The Vice President or Vice
Presidents shall perform such other duties as from time to time may be assigned
to him or her or them by the President or by the Board of Directors.
SECTION 6. Secretary. The Secretary shall keep the minutes of the
---------
stockholders' and of the Board of Directors' meetings in one or more books
provided for that purpose, see that all notices are duly given in accordance
with the provisions of these Bylaws or as required by law,
9
<PAGE>
be custodian of the corporate records and of the seal of the Corporation and
keep a register of the post office address of each stockholder which shall be
furnished to the Secretary by such stockholder, have general charge of the stock
transfer books of the Corporation and, in general, perform all duties incident
to the office of Secretary and such other duties as from time to time may be
assigned to him or her by the President, the Chief Executive Officer or the
Board of Directors.
SECTION 7. Treasurer. The Treasurer shall have charge and custody of
---------
and be responsible for all funds and securities of the Corporation, receive and
give receipts for moneys due and payable to the Corporation from any source
whatsoever, and deposit all such moneys in the name of the Corporation in such
banks, trust companies or other depositories as shall be selected in accordance
with these Bylaws and in general perform all of the duties incident to the
office of Treasurer and such other duties as from time to time may be assigned
to him or her by the President, the Chief Executive Officer, the Chief Financial
Officer or by the Board of Directors.
SECTION 8. Other Officers. The other officers of the Corporation
--------------
shall perform such duties as the President may from time to time assign to them.
SECTION 9. Removal. Any officer elected by the Board of Directors
-------
may be removed, either for or without cause, at any time upon the vote of a
majority of the Board of Directors. Any other employee of the Corporation may
be removed or dismissed at any time by the President. The removal of an officer
does not prejudice any of his or her contract rights.
SECTION 10. Resignation. Any officer or agent may resign at any time
-----------
by giving written notice to the Board of Directors, or to the President or to
the Secretary of the Corporation. Any such resignation shall take effect at the
date of the receipt of such notice or at any later time specified therein and,
unless otherwise specified therein, the acceptance of such resignation shall not
be necessary to make it effective.
SECTION 11. Vacancies. A vacancy in any office because of death,
---------
resignation, removal, disqualification, or any other cause, shall be filled by
the Board of Directors or by the officer or remaining members of the committee
to which the power to fill such office has been delegated pursuant to Section 2
of this Article, as the case may be, and if the office is one for which these
Bylaws prescribe a term, shall be filled for the unexpired portion of the term.
SECTION 12. Salaries. The salaries, if any, of the officers elected
--------
by the Board of Directors shall be fixed from time to time by the Board of
Directors or by such officer as may be designated by resolution of the Board of
Directors. The salaries or other compensation of any other officers, employees
and other agents shall be fixed from time to time by the officer or committee to
which the power to elect such officers or to retain or appoint such employees or
other agents has been delegated pursuant to Section 2 of this Article. No
officer shall be prevented from receiving such salary or other compensation by
reason of the fact that he is also a director of the Corporation.
10
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ARTICLE IV
----------
STOCK
-----
SECTION 1. Certificates. Each stockholder shall be entitled to a
------------
certificate or certificates which shall represent and certify the number and
kind and class of shares owned by it in the Corporation. Each certificate shall
be signed by the Chairman of the Board or the President or a Vice President and
countersigned by the Secretary or an assistant secretary or the Treasurer or an
assistant treasurer.
The signatures may be either manual or facsimile signatures. In case
any officer who has signed any certificate ceases to be an officer of the
Corporation before the certificate is issued, the certificate may nevertheless
be issued by the Corporation with the same effect as if the officer had not
ceased to be such officer as of the date of its issue. Each stock certificate
shall include on its face the name of the Corporation, the name of the
stockholder and the class of stock and number of shares represented by the
certificate. If the Corporation has authority to issue stock of more than one
class, the stock certificate shall contain on its face or back a full statement
or summary of the designations and any preferences, conversion and other rights,
voting powers, restrictions, limitations as to dividends, qualifications and
terms and conditions of redemption of the stock of each class which the
Corporation is authorized to issue and if the Corporation is authorized to issue
any preferred or special class in series, the differences in the relative rights
and preferences between the shares of each series to the extent they have been
set, and the authority of the Board of Directors to set the relative rights and
preferences of subsequent series. In lieu of such full statement or summary,
there may be set forth upon the face or back of the certificate a statement that
the Corporation will furnish to any stockholder upon request and without charge,
a full statement of such information. Such request may be made to the Secretary
or to the Corporation's transfer agent. Every stock certificate representing
shares of stock which are restricted as to transferability by the Corporation
shall contain a full statement of the restriction or state that the Corporation
will furnish information about the restriction to the stockholder on request and
without charge. A stock certificate may not be issued until the stock
represented by it is fully paid, except in the case of stock purchased under an
option plan as permitted by law.
SECTION 2. Lost Certificates. The Board of Directors may order a new
-----------------
certificate or certificates of stock to be issued in place of any certificates
shown to have been lost or destroyed under such terms and conditions as to it
may seem reasonable. When authorizing such issue of a new certificate or
certificates, the Board of Directors may, in its discretion and as a condition
precedent to the issuance thereof, require the owner of such stolen, lost or
destroyed certificate or certificates, or his legal representative, to advertise
the same in such manner as it shall require and/or to give the Corporation a
bond, with sufficient surety to the Corporation to indemnify it against any loss
or claim which may arise by reason of the issuance of a new certificate.
SECTION 3. Transfer Agents and Registrars. At such time as the
------------------------------
Corporation lists its securities on a national securities exchange or the Nasdaq
National Market, or such earlier time as
11
<PAGE>
the Board of Directors may elect, the Board of Directors shall appoint one or
more banks or trust companies in such city or cities as the Board of Directors
may deem advisable, from time to time, to act as transfer agents and/or
registrars of the shares of stock of the Corporation; and, upon such
appointments being made, no certificate representing shares shall be valid until
countersigned by one of such transfer agents and registered by one of such
registrars.
SECTION 4. Transfer of Stock. No transfers of shares of stock of the
-----------------
Corporation shall be made if (i) void ab initio pursuant to the Charter, or (ii)
-- ------
the Board of Directors, pursuant to the Charter, shall have refused to transfer
such shares; provided, however, that nothing contained in these Bylaws shall
impair the settlement of transactions entered into on the facilities of the New
York Stock Exchange or any other national securities exchange or automated
inter-dealer quotation system. Permitted transfers of shares of stock of the
Corporation shall be made on the stock records of the Corporation only upon the
instruction of the registered holder thereof, or by his attorney thereunto
authorized by power of attorney duly executed and filed with the Secretary or
with a transfer agent or transfer clerk, and upon surrender of the certificate
or certificates, if issued, for such shares properly endorsed or accompanied by
a duly executed stock transfer power and the payment of all taxes thereon. Upon
surrender to the Corporation or the transfer agent of the Corporation of a
certificate for shares duly endorsed or accompanied by proper evidence of
succession, assignment or authority to transfer, as to any transfers not
prohibited by the Charter or by action of the Board of Directors thereunder, it
shall be the duty of the Corporation to issue a new certificate to the person
entitled thereto, cancel the old certificate and record the transaction upon its
books.
SECTION 5. Fixing of Record Dates. The Board of Directors may fix,
----------------------
in advance, a date as the record date for the purpose of determining
stockholders entitled to notice of, or to vote at, any meeting of stockholders,
or stockholders entitled to receive payment of any dividend or the allotment of
any rights, or in order to make a determination of stockholders for any other
proper purpose. Such date, in any case, may not be prior to the close of
business on the day the record date is fixed nor, subject to Section 4 of
Article I, more than ninety (90) days, or in case of a meeting of stockholders,
less than ten (10) days, prior to the date on which the particular action
requiring such determination of stockholders is to be taken.
SECTION 6. Registered Stockholders. The Corporation shall be
-----------------------
entitled to recognize the exclusive right of a person registered on its books as
the owner of shares to receive dividends, and to vote as such owner, and to hold
liable for calls and assessments, if any, a person registered on its books as
the owner of shares, and shall not be bound to recognize any equitable or other
claim to or interest in such share or shares on the part of any other person,
whether or not it shall have express or other notice thereof, except as
otherwise provided by law or the Charter.
SECTION 7. Regulations. The Board of Directors may make such
-----------
additional rules and regulations, not inconsistent with the Bylaws or the
Charter, as it may deem expedient concerning the issue, transfer and
registration of certificates for shares of stock of the Corporation.
ARTICLE V
---------
12
<PAGE>
SEAL
----
The Board of Directors may provide a suitable seal for the
Corporation, which may be either facsimile or any other form of seal and shall
remain in the custody of the Secretary. If the Board of Directors so provides,
it shall be affixed to all certificates of the Corporation's stock and to other
instruments requiring a seal. If the Corporation is required to place its
corporate seal to a document, it is sufficient to meet the requirement of any
law, rule, or regulation relating to a corporate seal to place the word "Seal"
adjacent to the signature of the person authorized to sign the document on
behalf of the Corporation.
ARTICLE VI
----------
SIGNATURES
----------
SECTION 1. Checks, Drafts, Etc. All checks, drafts and orders for
-------------------
the payment of money, notes and other evidences of indebtedness, issued in the
name of the Corporation, shall, unless otherwise provided by resolution of the
Board of Directors, be signed by the President, a Vice President or an Assistant
Vice President and countersigned by the Treasurer, an Assistant Treasurer, the
Secretary or an Assistant Secretary.
SECTION 2. Stock Transfer. All endorsements, assignments, stock
--------------
powers or other instruments of transfer of securities standing in the name of
the Corporation shall be executed for and in the name of the Corporation by the
President or Vice President or by such officer as the Board of Directors may
designate.
13
<PAGE>
ARTICLE VII
-----------
FISCAL YEAR
-----------
The fiscal year of the Corporation shall be the twelve calendar months
period ending December 31 in each year, unless otherwise provided by the Board
of Directors.
SECTION VIII
------------
INDEMNIFICATION
---------------
SECTION 1. Procedure. Any indemnification, or payment of expenses in
---------
advance of the final disposition of any proceeding, shall be made promptly, and
in any event within 60 days, upon the written request of the director or officer
entitled to seek indemnification (the "Indemnified Party"). The right to
indemnification and advances hereunder shall be enforceable by the Indemnified
Party in any court of competent jurisdiction, if (i) the Corporation denies such
request, in whole or in part, or (ii) no disposition thereof is made within 60
days. The Indemnified Party's costs and expenses incurred in connection with
successfully establishing his or her right to indemnification, in whole or in
part, in any such action shall also be reimbursed by the Corporation. It shall
be a defense to any action for advance for expenses that (a) a determination has
been made that the facts then known to those making the determination would
preclude indemnification or (b) the Corporation has not received either (i) an
undertaking as required by law to repay such advances in the event it shall
ultimately be determined that the standard of conduct has not been met or (ii) a
written affirmation by the Indemnified Party of such Indemnified Party's good
faith belief that the standard of conduct necessary for indemnification by the
Corporation has been met.
SECTION 2. Exclusivity, Etc. The indemnification and advance of
----------------
expenses provided by the Charter and these Bylaws shall not be deemed exclusive
of any other rights to which a person seeking indemnification or advance of
expenses may be entitled under any law (common or statutory), or any agreement,
vote of stockholders or disinterested directors or other provision that is
consistent with law, both as to action in his or her official capacity and as to
action in another capacity while holding office or while employed by or acting
as agent for the Corporation, shall continue in respect of all events occurring
while a person was a director or officer after such person has ceased to be a
director or officer, and shall inure to the benefit of the estate, heirs,
executors and administrators of such person. All rights to indemnification and
advance of expenses under the Charter of the Corporation and hereunder shall be
deemed to be a contract between the Corporation and each director or officer of
the Corporation who serves or served in such capacity at any time while this
Bylaw is in effect. Nothing herein shall prevent the amendment of this Bylaw,
provided that no such amendment shall diminish the rights of any person
hereunder with respect to events occurring or claims made before its adoption or
as to claims made after its adoption in respect of events occurring before its
adoption. Any repeal or modification of this Bylaw shall not in any way
diminish any rights to indemnification or advance of expenses of such director
or officer or the obligations of the Corporation arising
14
<PAGE>
hereunder with respect to events occurring, or claims made, while this Bylaw or
any provision hereof is in force.
SECTION 3. Severability; Definitions. The invalidity or
-------------------------
unenforceability of any provision of this Article VIII shall not affect the
validity or enforceability of any other provision hereof. The phrase "this
Bylaw" in this Article VIII means this Article VIII in its entirety.
SECTION IX
----------
SUNDRY PROVISIONS
-----------------
SECTION 1. Books and Records. The Corporation shall keep correct and
-----------------
complete books and records of its accounts and transactions and minutes of the
proceedings of its stockholders and Board of Directors and of any executive or
other committee when exercising any of the powers of the Board of Directors.
The books and records of the Corporation may be in written form or in any other
form which can be converted within a reasonable time into written form for
visual inspection. Minutes shall be recorded in written form but may be
maintained in the form of a reproduction. The original or a certified copy of
the Bylaws shall be kept at the principal office of the Corporation.
SECTION 2. Voting Upon Shares in Other Corporations. Stock of other
----------------------------------------
corporations or associations, registered in the name of the Corporation, may be
voted by the President, a Vice President, or a proxy appointed by either of
them. The Board of Directors, however, may by resolution appoint some other
person to vote such shares, in which case such person shall be entitled to vote
such shares upon the production of a certified copy of such resolution.
SECTION 3. Exemption from Control Share Acquisition Statute. The
------------------------------------------------
provisions of Sections 3-701 to 3-709 of the Corporations and Associations
Article of the Annotated Code of Maryland shall not apply to any share of
capital stock of the Corporation now or hereafter outstanding. Such shares of
capital stock are exempted from such Sections to the fullest extent permitted by
Maryland law.
SECTION 4. Annual Statement of Affairs. The President or chief
---------------------------
accounting officer shall prepare annually a full and correct statement of the
affairs of the Corporation, to include a balance sheet and a financial statement
of operations for the preceding fiscal year. The statement of affairs shall be
submitted at the annual meeting of the stockholders and, within 20 days after
the meeting, placed on file at the Corporation's principal office.
SECTION 5. Mail. Except as herein expressly provided, any notice or
----
other document which is required by these Bylaws to be mailed shall be deposited
in the United States mails, postage prepaid.
SECTION 6 Reliance. Each director, officer, employee and agent of
--------
the Corporation shall, in the performance of his or her duties with respect to
the Corporation, be fully justified
15
<PAGE>
and protected with regard to any act or failure to act in reliance in good faith
upon the books of account or other records of the Corporation, upon the opinion
of counsel or upon reports made to the Corporation by any of its officers or
employees or by the adviser, accountants, appraisers or other experts or
consultants selected by the Board of Directors or officers of the Corporation,
regardless of whether such counsel or expert may also be a director.
SECTION 7. Certain Rights of Directors, Officers, Employees and
----------------------------------------------------
Agents. The directors shall have no responsibility to devote their full time to
- ------
the affairs of the Corporation. Any director or officer, employee or agent of
the Corporation, in his or her personal capacity or in a capacity as an
affiliate, employee or agent of any other person, or otherwise, may have
business interests and engage in business activities similar to or in addition
to those of or relating to the Corporation.
SECTION X
---------
AMENDMENTS
----------
These Bylaws may be amended or replaced, or new Bylaws may be adopted,
either (1) by the vote of the stockholders entitled to cast at least a majority
of the votes which all stockholders are entitled to cast thereon at any duly
organized annual or special meeting of stockholders, or (2), with respect to
those matters which are not by statute reserved exclusively to the stockholders,
by vote of a majority of the Board of Directors, including a majority of the
Independent Directors of the Corporation, in office at any regular or special
meeting of the Board of Directors; provided, however, that Section 2 of Article
-------- -------
I and Sections 1 through 14 of Article II of these Bylaws may only be amended or
modified by the vote of at least 66 2/3% of the votes which all stockholders are
entitled to cast thereon. It shall not be necessary to set forth such proposed
amendment, repeal or new Bylaws, or a summary thereof, in any notice of such
meeting, whether annual, regular or special.
16
<PAGE>
________________________________________________________________________________
EXHIBIT 10.1
PURCHASE TERMS AGREEMENT
NOVASTAR FINANCIAL, INC.
3,333,333 UNITS, EACH UNIT TO CONSIST OF ONE SHARE
OF CLASS A CONVERTIBLE PREFERRED STOCK, $0.01 PAR VALUE
AND ONE STOCK PURCHASE WARRANT
Dated December 6, 1996
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
-----------------
<S> <C>
SECTION 1. ISSUANCE OF UNITS............................................ 1
1.1 Introduction................................................. 1
1.2 Rights of Purchasers......................................... 2
1.3 Legends...................................................... 2
SECTION 2. PLACEMENT AND SALE OF UNITS.................................. 2
2.1 Exclusive Rights; Purchase Price............................. 2
2.2 Purchasers' Duties........................................... 2
2.3 Solicitation of Potential Purchasers......................... 3
2.4 Closing and Delivery of Payment.............................. 3
2.5 Placement Agent's Fees and Reliance.......................... 4
2.6 Failure to Close............................................. 5
SECTION 3. CLOSING CONDITIONS........................................... 5
3.1 Opinion of Counsel........................................... 5
3.2 Officers' Certificate........................................ 6
3.3 Purchase Permitted by Applicable Laws;
Legal Investment............................................. 7
3.4 The Registration Rights Agreement............................ 7
3.5 The Warrant Agreement........................................ 8
3.6 Consents and Permits......................................... 8
3.7 Information.................................................. 8
3.8 Acceptance of All Units...................................... 8
SECTION 4. CONDITIONS TO THE COMPANY'S OBLIGATIONS...................... 8
4.1 Executed Agreement........................................... 8
4.2 Approved States.............................................. 9
4.3 Fulfillment of Other Obligations............................. 9
SECTION 5. PURCHASER'S SPECIAL RIGHTS................................... 9
5.1 Delivery Expenses............................................ 9
5.2 Taxes........................................................ 9
5.3 Mutilated, Lost and Stolen Certificates...................... 9
SECTION 6. REPRESENTATIONS AND WARRANTIES OF THE COMPANY................ 10
6.1 Organization, Standing and Qualifications.................... 10
6.2 Authorization and Legality of Operative
Documents and Units.......................................... 10
6.3 Capitalization............................................... 11
6.4 Full Disclosure.............................................. 11
6.5 No Violation................................................. 11
6.6 Projections.................................................. 12
6.7 No Default................................................... 12
6.8 Litigation; Labor Relations.................................. 12
6.9 Title to Properties.......................................... 13
</TABLE>
i
<PAGE>
<TABLE>
<S> <C>
6.10 Material Agreements.......................................... 13
6.11 No Material Adverse Change................................... 13
6.12 Compliance With Laws......................................... 14
6.13 Governmental Regulations..................................... 15
6.14 Taxes........................................................ 15
6.15 Insurance.................................................... 15
6.16 Private Placement............................................ 15
6.17 ERISA........................................................ 16
6.18 No Violation of Regulations of Board of
Governors of Federal Reserve System.......................... 16
6.19 Brokers...................................................... 16
6.20 Commodities.................................................. 16
6.21 Accounting................................................... 17
6.22 Intellectual Property........................................ 17
6.23 Policies..................................................... 17
SECTION 7. COVENANTS OF THE COMPANY..................................... 17
7.1 Compliance with Representations and Warranties............... 17
7.2 Sale of Other Securities..................................... 17
7.3 144A Information............................................. 18
7.4 Registration Rights Agreement................................ 18
7.5 Commodities.................................................. 18
7.6 Use of Proceeds.............................................. 18
7.7 Retention of Accountants..................................... 18
7.8 Investment Company........................................... 18
7.9 Material Increases in Management Compensation................ 18
7.10 Affiliated Transactions...................................... 18
7.11 Unrelated Lines of Business.................................. 19
7.12 Key Man Insurance............................................ 19
7.13 REIT Status.................................................. 19
7.14 Capital Allocation Guidelines and Hedge Policies............. 19
7.15 Liquidation upon Approval of the Stockholders ............... 19
7.16 Restrictions on Grants of Stockoptions ...................... 19
7.17 First Exception.............................................. 20
7.18 Second Exception............................................. 20
7.19 Third Exception.............................................. 20
SECTION 8. INDEMNIFICATION.............................................. 20
8.1 Company's Indemnification.................................... 20
8.2 Conduct of Indemnification Proceedings....................... 21
8.3 Contribution................................................. 22
8.4 Additional Remedies.......................................... 23
SECTION 9. RIGHTS AND RESPONSIBILITIES OF PLACEMENT AGENT............... 23
9.1 Responsibilities For Memorandum............................... 23
9.2 Reliance..................................................... 23
</TABLE>
ii
<PAGE>
<TABLE>
<S> <C>
9.3 Rights of Placement Agent.................................... 23
9.4 PORTAL....................................................... 24
SECTION 10. DEFINITIONS.................................................. 24
SECTION 11. MISCELLANEOUS................................................ 26
11.1 Notices...................................................... 26
11.2 Parties in Interest, Successors and Assigns.................. 27
11.3 Amendment and Waiver......................................... 27
11.4 Counterparts................................................. 28
11.5 Headings..................................................... 28
11.6 Governing Law................................................ 28
11.7 Waiver of Trial by Jury...................................... 28
11.8 Entire Agreement............................................. 28
11.9 Severability................................................. 28
11.10 Public Disclosure............................................ 28
11.11 Survival..................................................... 29
</TABLE>
EXHIBITS
EXHIBIT A - Purchasers
- ---------
EXHIBIT B - Subscription Agreement
- ---------
EXHIBIT C - Company Counsel's Opinion
- ---------
EXHIBIT D - Registration Rights Agreement
- ---------
EXHIBIT E - Warrant Agreement
- ---------
EXHIBIT F - Subsidiaries
- ---------
EXHIBIT G - Licenses
- ---------
EXHIBIT H - Legal Proceedings
- ---------
iii
<PAGE>
NOVASTAR FINANCIAL, INC.
__________________
PURCHASE TERMS AGREEMENT
3,333,333 Units
__________________
December 6, 1996
STIFEL, NICOLAUS & COMPANY, INCORPORATED
500 N. Broadway
St. Louis, Missouri 63102
Ladies and Gentlemen:
NovaStar Financial, Inc., a Maryland corporation (the "Company"),
hereby confirms its agreement (this "Agreement") with you as the placement agent
(the "Placement Agent") as follows:
SECTION 1. ISSUANCE OF UNITS
1.1 Introduction. The Company proposes to issue and sell at the closing
------------
(the "Placement") an aggregate of up to 3,333,333 units (the "Units"),
consisting of one share of Class A Convertible Preferred Stock, par value $0.01
per share of the Company ("Preferred Stock") and one Stock Purchase Warrant of
the Company ("Warrant"), to the purchasers listed on Exhibit A attached hereto,
---------
as it may be updated from time to time (collectively, the "Purchasers") pursuant
to the terms of a Subscription and Purchase Agreement entered between the
Company and each such Purchaser (collectively, the "Subscription Agreements"),
an exemplar of which is attached hereto as Exhibit B. Unless otherwise defined
---------
in Section 10 or elsewhere in this Agreement, capitalized terms shall have the
meanings ascribed thereto in the Memorandum.
The shares of Preferred Stock which in part comprise the Units are
herein called the "Preferred Shares." The Units, the Preferred Shares, the
Warrants and the Common Stock issuable upon conversion of the Preferred Shares
or the exercise of the Warrants are herein called the "Securities."
The Preferred Shares pursuant to the terms of the Articles
Supplementary will convert on a one-for-one basis (subject to certain
anti-dilution provisions) to shares of the Company's Common Stock, par value
$0.01 per share (the "Common Stock"), upon the earlier to occur of (i) the
closing of a firm commitment underwritten initial public
<PAGE>
offering of the Common Stock resulting in aggregate gross proceeds to the
Company of at least Twenty Million Dollars ($20,000,000), at an offering price
of not less than Fifteen Dollars ($15) per share, provided such gross proceeds
and/or the price per share may be reduced upon the consent of the holders of at
least two-thirds of the Preferred Stock, or (ii) at any time after three (3)
years from the last closing of Units in the Placement, at the option of the
holder.
Each Warrant entitles the holders thereof for Fifteen Dollars ($15) to
purchase one (1) share (subject to certain anti-dilution provisions) of the
Company's Common Stock (a "Warrant Share"). The Warrants will become exercisable
upon the earlier to occur of (i) the effectiveness of a Shelf Registration
Statement registering the Securities together with the Common Stock issuable
upon the conversion of the Preferred Stock and the Warrant Shares under the
Securities Act, or (ii) six (6) months following the closing of a Qualified IPO.
The Warrants will remain exercisable until 5:00 p.m. San Francisco time on the
third anniversary of the date on which they become exercisable at the price
provided for in the Warrant and the Warrant Agreement.
1.2 Rights of Purchasers. The Units will be offered and sold by the
--------------------
Company directly to the Purchasers pursuant to an exemption from the
registration requirements under the Securities Act of 1933, as amended (the
"Securities Act"). The Company agrees that the Placement Agent and the
Purchasers are entitled to the benefit of and to rely upon the provisions of
this Agreement which is incorporated by reference into the Subscription
Agreements. As a condition to the Subscription Agreements, the Company and the
Placement Agent are entering this Agreement to set forth their understanding as
to their relationship and their respective rights, duties and obligations.
1.3 Legends. Upon original issuance thereof, and until such time as the
-------
same is no longer required under the applicable requirements of the Securities
Act, each Transfer Restricted Security shall contain a legend substantially
similar to the legend set forth under the caption "Notice to Investors -
Representations and Acknowledgements of Investors" in the Memorandum or as
otherwise required pursuant to any of the Operative Documents.
SECTION 2. PLACEMENT AND SALE OF UNITS
2.1 Exclusive Rights: Purchase Price. From the date hereof until December
--------------------------------
31, 1996 (which date may be extended by mutual agreement of the Company and the
Placement Agent), the Company hereby grants to the Placement Agent the exclusive
right to solicit prospective purchasers of the Units. As set forth in the
Memorandum and the Subscription Agreements, the purchase price for each Unit
shall be $15.00.
2.2 Purchasers' Duties. Each Purchaser intending to acquire Units will be
------------------
required to complete and execute a copy of the Subscription Agreement, together
with a representation certificate required in connection with the Subscription
Agreement. Each Subscription Agreement shall be independent of any other
Subscription Agreement, and
<PAGE>
the obligation of one Purchaser to purchase Units under a Subscription Agreement
shall be independent of, and not conditioned upon, the fulfillment of the
obligations of any other Purchaser under its Subscription Agreement; provided,
--------
however, that at the Closing subscriptions for a minimum of 1,000,000 Units must
- -------
be accepted and carried out. The Company shall have the right to reject
subscriptions for any reason and shall evidence its acceptance of a subscription
by countersigning a copy of the Subscription Agreement and returning the same to
the Placement Agent.
2.3 Solicitation of Potential Purchasers. The Placement Agent agrees to
------------------------------------
solicit potential purchasers of the Units only from parties whom it has a
reasonable basis to believe are either QIBs or institutional Accredited
Investors or individual Accredited Investors and a limited number of
non-Accredited Investors meeting the standards set forth in Rule 506(b)(2)(ii)
of Regulation D of the Securities Act of 1933, as amended, residing in
jurisdictions designated by the Company. The Placement Agent will only solicit
potential purchasers in compliance with applicable federal and state securities
laws. The Placement Agent agrees not to make any representation with respect to
the Company other than as contained in the Memorandum. The Placement Agent
agrees to furnish a certificate at Closing to the effect that they have complied
with this Section 2.3. The Placement Agent may arrange for the solicitation of
prospective purchasers by other Persons; provided, however, that (i) any
compensation shall be received by such Person pursuant to Section 2.5, and (ii)
each such Person shall comply with the representations set forth in this Section
2.3 and shall furnish a certificate at the Closing to the effect that it has
complied with this Section 2.3. The Placement Agent agrees to promptly deliver
or cause Persons acting on their behalf to deliver, a copy of the Memorandum to
each Purchaser and prior to the Closing to deliver any subsequent supplements
and exhibits thereto, if any.
2.4 Closing and Delivery of Payment.
--------------------------------
2.4.1 Closing: Closing Date. The sale and purchase of the Units by
---------------------
the Company to the Purchasers shall take place at a closing (a "Closing") at
the offices of Tobin & Tobin, One Montgomery Street, 15th Floor, San Francisco,
California 94104, at 8 a.m. (San Francisco Time) on December ___, 1996, or such
other business day as may be agreed upon by the Company and the Placement Agent
(the "Initial Closing Date"); and in subsequent Closing as agreed upon by the
Company and the Placement Agent (each of the Initial Closing Date and all other
closing dates being referred to herein as a "Closing Date"); provided, however,
-------- -------
that in no event will the Closing Date occur later than 11:59 p.m. (San
Francisco Time) on December 31, 1996 unless consented to by the Purchasers.
Payments by the Purchaser shall be payable in the manner set forth in the
Subscription Agreements and shall be made prior to or on the Closing Date. If
payments by the Purchasers are in the Company's name, the Company shall deposit
the payment of such funds directly into the account set forth in this Section
2.4.
2.4.2 Account. The Company will establish an account with its counsel
-------
entitled "Tobin & Tobin Re: Private Placement Closing" (the "Account"), The
Company
3
<PAGE>
will deposit into the Account such funds received by it promptly upon receipt
thereof prior to or on the Closing Date for the purchase of the Units.
2.4.3 DTC. If a Purchaser is a QIB, on the Closing Date, and on the
---
payment of the purchase price, the Purchaser will become either, at the
Purchaser's election: (A)(i) the registered owner of the Units on the records of
The Depository Trust Company ("DTC"), a limited purpose trust company arranged
under the laws of the state of New York, and (ii) the owner of a beneficial
interest in the Units issued in global book entry form and registered in the
name of Cede & Co., as nominee for DTC, corresponding to the number of purchased
Units acquired by the Purchaser, or (B) the holder of physical certificate(s)
representing the Units.
2.4.4 Physical Delivery. If a Purchaser is not a QIB, on the Closing
-----------------
Date and on the payment of the purchase price, the Purchaser will receive a
physical certificate(s) representing the Units.
2.4.5 Transfer Agent. The Company will deposit the certificates
--------------
representing the Units with the Transfer Agent prior to the Closing Date. The
funds in the Account, except for an amount equal to the Placement Agent
Commission (as defined in Section 2.5.1), will be immediately available to the
Company upon the Closing on the Closing Date.
2.5 Placement Agent's Fees and Reliance.
------------------------------------
2.5.1 Placement Agent's Cash Commission.
---------------------------------
(a) In connection with each transfer of Units to the
Purchasers, other than those Purchasers described in Section 2.5.1(b) and
2.5.1(c), the Placement Agent shall have a right to payment from the Account of
an amount equal to a commission of seven percent (7.0%) of the gross proceeds
from the sale of the Units to such Purchasers, such commission to be the sole
cash amount paid by the Company with respect to commissions or other
compensation on such sales.
(b) In connection with each transfer of Units to the Purchasers
who are General Electric Capital Corporation or Bank One Corporation or their
affiliates, the Placement Agent shall have a right to payment from the Account
of an amount equal to a commission of four percent (4.0%) of the gross proceeds
from the sale of the Units to such Purchasers, such commission to be the sole
cash amount paid by the Company with respect to commissions or other
compensation on such sales.
(c) In connection with each transfer of Units to Purchasers
consisting of Messrs. Scott F. Hartman, W. Lance Anderson, or their direct
family members, the Placement Agent shall not be entitled to a commission from
the transfer of the Units to such Purchasers; provided, however, the value of
such Units transferred shall not exceed One Million Five Hundred Thousand
Dollars ($1,500,000) in the aggregate.
4
<PAGE>
2.5.2 In addition to the Placement Agent's commission described in
Section 2.5.1, the Placement Agent shall have the right to receive Warrants in
an amount equal to three percent (3%) of the Units sold to Purchasers described
in Sections 2.5.1(a) and 2.5.1(b).
2.5.3 Costs and Expenses. The Company agrees that, whether or not the
------------------
Units are sold, it will pay all legal and other costs associated with the
preparation of the offering materials, including, without limitation, the costs
of preparing and reproducing the Memorandum and the Operative Documents and the
legal fees and expenses of qualifying the offering under the Blue Sky laws.
2.5.4 Allocation Between Placement Agent and other Persons. All
----------------------------------------------------
Persons arranging sales of Units in accordance with the terms of this Agreement
shall receive commissions or fees as the Placement Agent shall determine from
the proceeds payable to the Placement Agent pursuant to Section 2.5.1 above.
2.6 Failure to Close. If at the Closing any of the conditions of the
----------------
Closing specified in this Agreement shall not have been fulfilled to the
Placement Agent's satisfaction or if a Closing fails to occur on or before
11:59 p.m. (San Francisco Time) on December 31, 1996, the Placement Agent,
notwithstanding anything to the contrary in this Agreement, shall be relieved
of all further obligations under this Agreement without thereby waiving any
rights it may have by reason of such nonfulfillment or failure. Nothing in this
Section 2.6 shall operate to relieve the Company from any of its obligations
under this Agreement.
SECTION 3. CLOSING CONDITIONS
The obligations of each Purchaser and the Placement Agent on the
Closing Date shall be subject to the accuracy at and as of the Closing Date of
the representations and warranties of the Company contained in this Agreement,
to the accuracy at and as of the Closing Date of the statements of the Company
made in any certificates pursuant to this Agreement, to the performance by the
Company of its obligations under this Agreement, to compliance at and as of the
Closing Date by the Company with agreements herein contained and to the
following further conditions:
3.1 Opinion of Counsel.
------------------
3.1.1. On the Closing Date, the Purchasers shall have received a
favorable opinion, dated as of the Closing Date and addressed to the Purchasers,
the Placement Agent and counsel to the Placement Agent from Tobin & Tobin,
counsel for the Company, in the form and as to the matters set forth on Exhibit
-------
C attached hereto ("Company Counsel's Opinion"). In rendering Company Counsel's
- -
Opinion, counsel to the Company may rely as to factual matters upon certificates
or other documents furnished by officers and directors of the Company (copies of
which shall be delivered to the Placement Agent and counsel to the Placement
Agent on behalf of the Purchasers)
5
<PAGE>
and by government officials, and upon such other documents as counsel to the
Company deems appropriate as a basis for Company Counsel's Opinion. Counsel to
the Company may specify the jurisdictions in which they are admitted to practice
and that they are not admitted to practice in any other jurisdiction and are not
experts in the law of any other jurisdiction. To the extent Company Counsel's
Opinion concerns the laws of any other such jurisdiction counsel to the Company
may rely upon the opinion of other counsel (reasonably satisfactory to counsel
to the Placement Agent on behalf of the Purchasers) admitted to practice in such
jurisdiction. Any such other opinion relied upon by counsel to the Company as
aforesaid shall be addressed to the Purchasers, the Placement Agent and counsel
to the Placement Agent.
3.1.2 On the Closing Date, the Purchasers shall also have received a
favorable opinion, dated as of the Closing Date and addressed to the Purchasers,
the Placement Agent and counsel to the Placement Agent from Jeffers, Wilson &
Shaff, LLP special tax counsel for the Company that the Company (exclusive of
any taxable affiliates but taking into account the ownership and operation
thereof) will be organized in confirmity with the requirements for qualification
as a REIT pursuant to Sections 856-860 of the Internal Revenue Code of 1986, as
amended, and the Company's proposed method of operation described in the Private
Placement Memorandum will enable the Company (exclusive of any taxable
affiliates but taking into account the ownership and operation thereof) to
qualify and be in compliance with the REIT provisions of the Internal Revenue
Code of 1996, as amended (the "Company's Tax Counsel's Opinion"). In rendering
Company's Tax Counsel's Opinion, tax counsel to the Company may rely as to
factual matters upon certificates or other documents furnished by officers and
directors of the Company (copies of which shall be delivered to the Placement
Agent and counsel to the Placement Agent on behalf of the Purchasers) and by
government officials, and upon such other documents as counsel to the Company
deems appropriate as a basis for Company's Tax Counsel's Opinion. Tax counsel to
the Company may specify the jurisdictions in which they are admitted to practice
and that they are not admitted to practice in any other jurisdiction and are not
experts in the law of any other jurisdiction. To the extent Company's Tax
Counsel's Opinion concerns the laws of any other such jurisdiction counsel to
the Company may rely upon the opinion of other counsel (reasonably satisfactory
to counsel to the Placement Agent on behalf of the Purchasers) admitted to
practice in such jurisdiction. Any such other opinion relied upon by counsel to
the Company as aforesaid shall be addressed to the Purchasers, the Placement
Agent and counsel to the Placement Agent.
3.2 Officers' Certificate. On the Closing Date, the Placement Agent shall
---------------------
have received a certificate addressed to the Purchasers, the Placement Agent and
counsel to the Placement Agent, dated as of the Closing Date, of authorized
representatives of the Company stating that to the best of their knowledge:
3.2.1 The representations and warranties of the Company in this
Agreement and the Subscription Agreements are true and correct on and as of the
Closing Date with the same force and effect as if made on the Closing Date and
the
6
<PAGE>
Company has complied with all of the agreements and satisfied all the conditions
on its part to be performed or satisfied at or prior to the Closing Date as set
forth therein.
3.2.2 Such authorized representatives have carefully examined the
Memorandum at the time of the execution of this Agreement and as of the Closing
Date, and the Memorandum did not and does not contain any untrue statement of a
material fact or omit to state a material fact required to be stated therein or
necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading.
3.2.3 Subsequent to the respective dates as of which the information
is given in the Memorandum (except as contemplated in the Memorandum), there has
been no material adverse change, or development involving a prospective material
adverse change, in the condition (financial or otherwise), business, liquidity,
properties, results of operations or prospects of the Company and the
Subsidiaries, taken as a whole, whether or not arising from transactions in the
ordinary course of business; nor has there been any material change in the
long-term debt of the Company or any of the Subsidiaries other than in the
ordinary course of business; nor has the net liability or obligations (direct,
contingent or otherwise) of the Company or any Subsidiary for borrowed money
materially increased other than in the ordinary course of business; nor have
there been any other material transactions entered into by the Company or any
Subsidiary other than in the ordinary course of business, it being understood
that the financing strategy of the Company and the Subsidiaries as described in
the Memorandum is in the ordinary course of business; nor has any legal or
government action, suit or proceeding been filed or threatened against the
Company or any Subsidiary which could result in a material adverse change in the
condition (financial or otherwise), business, liquidity, properties, results of
operations or prospects of the Company and the Subsidiaries, taken as a whole.
3.3 Purchase Permitted by Applicable Laws: Legal Investment. With
-------------------------------------------------------
respect to each Purchaser, the purchase of and payment for the Units (a) shall
not be prohibited by any applicable law or governmental regulation, (b) shall
not subject such Purchaser to any penalty or, in such Purchaser's reasonable
judgment, other onerous condition under or pursuant to any applicable law or
governmental regulation, and (c) shall be permitted by the laws and regulations
of the jurisdictions to which such Purchaser is subject. The failure by one
Purchaser to comply with this Section 3.3 shall only prevent the purchase by
such Purchaser, and shall not have any effect on the other Purchasers in the
Placement, except to the extent that it results in fewer than 1,000,000 Units
being accepted by the Company in the Placement.
3.4 The Registration Rights Agreement. The Company shall have
---------------------------------
entered into the registration rights agreement (the "Registration Rights
Agreement") for the benefit of the Purchasers, dated the Closing Date and each
Purchaser shall have received an original of the Registration Rights Agreement,
duly executed by the Company, and counterparts, conformed as executed, of the
Registration Rights Agreement and of this
7
<PAGE>
Agreement. An exemplar of the Registration Rights Agreement is attached hereto
as Exhibit D.
---------
3.5 The Warrant Agreement. The Company shall have entered into the warrant
---------------------
agreement (the "Warrant Agreement") for the benefit of the Purchasers and the
Placement Agent, dated the Closing Date, and each Purchaser and the Placement
Agent shall have received an original, duly executed by the Company, and
counterparts, conformed as executed, of the Warrant Agreement. An exemplar of
the Warrant Agreement is attached hereto as Exhibit E.
---------
3.6 Consents and Permits. The Company and each Subsidiary shall have
--------------------
received all consents, permits and other authorizations, and made all such
filings and declarations, as may be required from any Person pursuant to any
law, statute, regulation or rule (federal, state, local and foreign), or
pursuant to any agreement, order or decree to which the Company is a party or to
which it is subject, in connection with the transactions contemplated by this
Agreement.
3.7 Information. Prior to or on the Closing Date, the Company shall have
-----------
furnished to the Placement Agent such further information, certificates,
opinions and documents addressed to the Purchasers, the Placement Agent and
counsel to the Placement Agent, which the Placement Agent or counsel to the
Placement Agent may reasonably request, including, without limitation, a
complete set of the Operative Documents or any other documents or certificates
required by this Section 3; and all proceedings taken by the Company in
connection with the issuance, offer and sale of the Units as herein contemplated
shall be satisfactory in form and substance to the Placement Agent and counsel
to the Placement Agent. If any condition specified in this Section 3 shall not
have been fulfilled when and as required in this Agreement, or if any of the
opinions or certificates mentioned above or elsewhere in this Agreement shall
not be satisfactory in form and substance to the Placement Agent or counsel to
the Placement Agent, this Agreement may be cancelled by the Placement Agent by
notice to the Company at any time at or prior to the Closing Date. Notice of
such cancellation shall be given to the Company in writing or by telephone or
telegraph confirmed in writing.
3.8 Acceptance of All Units. Prior to or on the Closing Date, the Company
-----------------------
shall have accepted offers to purchase not fewer than 1,000,000 Units, and the
Company shall have a minimum of 100 persons holding Preferred Stock in order to
qualify for tax treatment as a REIT under the Internal Revenue Code, as amended.
SECTION 4. CONDITIONS TO THE COMPANY'S OBLIGATIONS
The obligations of the Company to sell the Units to the Purchasers and
consummate the transactions contemplated by this Agreement shall be subject to
the following conditions:
8
<PAGE>
4.1 Executed Agreement. The Company shall have received from the Placement
------------------
Agent an executed copy of this Agreement.
4.2 Approved States. The Placement Agent shall not have offered the Units
---------------
to any individual Accredited Investors in any State other than States approved
by the Company and States in which Blue Sky exemption clearance has been
obtained according to counsel to the Company.
4.3 Fulfillment of Other Obligations. The Placement Agent shall have
--------------------------------
fulfilled all of its other obligations and duties required to be fulfilled under
this Agreement prior to the Closing.
SECTION 5. PURCHASER'S SPECIAL RIGHTS
The provisions of this Section 5 shall apply only to Transfer
Restricted Securities; provided, however, that in the event Transfer Restricted
--------- --------
Securities shall cease to be Transfer Restricted Securities, any obligation
existing and not satisfied under this Section 5 with respect to such Transfer
Restricted Securities shall survive until such time as such obligation shall
have been satisfied in full.
5.1 Delivery Expenses. If a Purchaser shall surrender any certificate
-----------------
representing any of the Transfer Restricted Securities to the Company for any
reason, the Company will pay the cost of delivering to or from such Purchaser or
such Purchaser's designee, insured to the Purchaser's satisfaction, each
surrendered certificate and each certificate issued in substitution or
replacement for such surrendered certificate.
5.2 Taxes. The Company will pay all stamp and transfer taxes in connection
-----
with the issuance, sale, delivery or transfer by the Company to the Purchasers
of the Transfer Restricted Securities and the execution and delivery of the
Operative Documents and any other agreements and instruments contemplated
thereby and any modification of any of such Transfer Restricted Securities,
Operative Documents or such other agreements and instruments and will hold the
Purchaser harmless against any and all liabilities with respect to all such
taxes. Notwithstanding anything to the contrary contained in this Agreement, the
obligations of the Company under this Section 5.2 shall survive the termination
of this Agreement.
5.3 Mutilated, Lost and Stolen Certificates. If any Transfer Restricted
---------------------------------------
Securities are mutilated, destroyed, lost or stolen, then the affidavit of an
authorized representative of the respective Purchaser or holder reasonably
satisfactory to the Company, setting forth the circumstances with respect to
such mutilation, destruction, loss or theft, shall be accepted as satisfactory
evidence thereof, and no indemnity, security or payment of charges or expenses
shall be required as a condition to the execution and delivery by the Company or
its transfer agent of a new certificate in substitution therefor, other than
such Purchaser's or holder's unsecured written
9
<PAGE>
agreement, in form reasonably satisfactory to the Company, indemnifying the
Company or its transfer agent with respect to such mutilated, destroyed, lost or
stolen Transfer Restricted Securities.
SECTION 6. REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company represents, warrants and covenants to the Purchasers, the
Placement Agent and counsel to the Placement Agent, as of the date of this
Agreement and pursuant to Section 3.2.1 as of the time of the Closing Date, as
follows:
6.1 Organization, Standing and Qualifications.
-----------------------------------------
6.1.1 The Company does not own or control, directly or indirectly, any
corporation, association or other entity except as described in the Memorandum
and listed on Exhibit F attached hereto (each, a "Subsidiary" and collectively,
---------
the "Subsidiaries"). The Company and each Subsidiary have been duly organized
and are validly existing as a corporation in good standing under the respective
laws of the state of their formation, with full power and authority (corporate
and other) to own and lease their respective properties and conduct their
businesses as currently conducted; the Company and each Subsidiary are operating
in compliance with all authorizations, licenses, permits, consents, certificates
and orders material to the conduct of their respective current business, all of
which are valid and in full force and effect except as set forth in the
Memorandum; the Company and each Subsidiary are duly qualified to do business
and in good standing as a foreign corporation in each jurisdiction in which the
ownership or leasing of properties or the conduct of their business requires
such qualification, except for jurisdictions in which the failure to so qualify
would not have a material adverse effect upon the condition (financial or
otherwise), business, liquidity, properties, results of operations or prospects
of Company and the Subsidiaries, taken as a whole; and no proceeding has been
instituted in any such jurisdiction, revoking, limiting or curtailing, or
seeking to revoke, limit or curtail, such power and authority or qualification.
A true, correct and complete list of all licenses and pending applications for
licenses of the Company and each Subsidiary is set forth on Exhibit G attached
---------
hereto (the "Licenses").
6.12 The Company has all requisite power and authority to enter into
and perform all its obligations under this Agreement and the other Operative
Documents, to issue and sell the Units and to carry out the transactions
contemplated hereby and thereby.
6.2 Authorization and Legality of Operative Documents and Units.
-----------------------------------------------------------
6.2.1 This Agreement and the other Operative Documents have been duly
authorized, executed and delivered by the Company and constitute valid and
binding obligations of the Company in accordance with their terms.
10
<PAGE>
6.2.2 The Units, the Preferred Stock and the Common Stock have
been duly and validly authorized by the Company and, when issued and delivered
against payment of the purchase price therefor as provided in this Agreement and
the Warrant Agreement, as applicable, will be duly and validly issued, fully
paid and nonassessable and will conform to the descriptions thereof in the
Memorandum. Additionally, the Company has reserved a sufficient number of
shares of Common Stock to permit (i) the conversion of the Preferred Stock on a
one-for-one basis (subject to certain anti-dilution provisions) to shares of
Common Stock in accordance with the terms of this Agreement and the Preferred
Stock, and (ii) the issuance of shares of Common Stock upon exercise of the
Warrants in accordance with the terms thereof.
6.3 Capitalization. The Company has an authorized and outstanding
--------------
capital stock as set forth under the heading "Capitalization" in the Memorandum;
the issued and outstanding shares of the capital stock of the Company and each
Subsidiary have been duly authorized and validly issued, are fully paid and
nonassessable, have been issued in compliance with all federal and state
securities laws, were not issued in violation of or subject to any preemptive
rights or other rights to subscribe for or purchase securities, and conform to
the description thereof contained in the Memorandum. Except as disclosed in or
contemplated by the Memorandum, the Company does not have outstanding any
options to purchase, or any preemptive rights or other rights to subscribe for
or to purchase, any securities or obligations convertible into, or any contracts
or commitments to issue or sell, shares of its capital stock or any such
options, rights, convertible securities or obligations. The description of the
Company's stock option, stock bonus and other stock plans or arrangements, and
the options or other rights granted and exercised thereunder, set forth in the
Memorandum accurately and fairly presents the information required to be shown
with respect to such plans, arrangements, options and rights.
6.4 Full Disclosure. The Memorandum is accurate in all material
---------------
respects and does not contain any untrue statement of a material fact or omit to
state any material fact necessary in order to make the statements therein, in
the light of the circumstances under which they were made, not misleading, and
the Memorandum will be at the Closing Date accurate in all material respects and
will not contain any untrue statement of a material fact or omit to state a
material fact necessary in order to make the statements therein, in the light of
the circumstances under which they were made, not misleading.
6.5 No Violation. The making and performance of this Agreement, the
------------
Subscription Agreements, the Registration Rights Agreement, the Warrant
Agreement, and the other Operative Documents by the Company and the consummation
of the transactions herein and therein contemplated will not violate any
provisions of the articles of incorporation or bylaws of the Company or any
Subsidiary and will not conflict with, result in the breach or violation of, or
constitute, either by itself or upon notice or the passage of time or both, a
default under any agreement, mortgage, deed of trust, lease, franchise, license,
indenture, permit or other instrument to which the Company or any Subsidiary is
a party or by which the Company or any Subsidiary or any of their
11
<PAGE>
respective properties may be bound or affected, any statute or any
authorization, judgment, decree, order, rule or regulation of any court or any
regulatory body, administrative agency or other governmental body having
jurisdiction over the Company or any Subsidiary or any of their respective
properties (except for such conflicts, breaches, defaults or failures to comply
which would not have a material adverse effect on the condition (financial or
otherwise), business, liquidity, properties, results of operations or prospects
of the Company and the Subsidiaries, taken as a whole). No consent, approval,
authorization or other order of any court, regulatory body, administrative
agency or other governmental body is required for the execution and delivery of
this Agreement, the Subscription Agreements, the Registration Rights Agreement,
the Warrant Agreement or any other Operative Document or the consummation of the
transactions contemplated by this Agreement, the Subscription Agreements, the
Registration Rights Agreement, the Warrant Agreement or any other Operative
Document, except for compliance with applicable Blue Sky laws applicable to the
distribution of the Units to the Purchasers and, with respect to consummation of
the transactions contemplated by the Registration Rights Agreement, compliance
with the registration requirements under the Securities Act and applicable Blue
Sky laws.
6.6 Projections. The Company believes that the assumptions set forth in
-----------
Appendix A of the Memorandum and under the heading "Financial Projections,
- ----------
Related Assumptions and Discussion" are reasonable, given current market
conditions.
6.7 No Default. Except as disclosed in the Memorandum and except as to
----------
defaults which individually or in the aggregate would not be material to the
Company and Subsidiaries, taken as a whole, neither the Company nor any
Subsidiary is in violation or default of any provision of their respective
certificate or articles of incorporation or bylaws, or is in breach of or
default with respect to any provision of any agreement, judgment, decree, order,
mortgage, deed of trust, lease, franchise, license, indenture, permit or other
instrument to which it is a party or by which it or any of its respective
properties is bound; and there does not exist any state of facts which
constitutes an event of default on the part of the Company or any Subsidiary as
defined in such documents or which, with notice or lapse of time or both, would
constitute such an event of default.
6.8 Litigation; Labour Relations. Except as disclosed in the
----------------------------
Memorandum, there are no legal or governmental actions, suits or proceedings
pending or, to the best of the Company's knowledge, threatened to which the
Company or any Subsidiary is or may be a party or of which property owned or
leased by the Company or any Subsidiary is or may be the subject, or related to
environmental or discrimination matters, which actions, suits or proceedings
might, individually or in the aggregate, prevent or adversely affect the
transactions contemplated by this Agreement or result in a material adverse
change in the condition (financial or otherwise), business, liquidity,
properties, results of operations or prospects of the Company and the
Subsidiaries, taken as a whole; and no labor disturbance by the employees of the
Company or any Subsidiary exists or is imminent which might be expected to
affect adversely such condition, business, liquidity, properties, results of
operations or prospects. Neither the Company nor any Subsidiary
12
<PAGE>
is a party or subject to the provisions of any material injunction, judgment,
decree or order of any court, regulatory body, administrative agency or other
governmental body. A list of all legal or governmental actions, suits or
proceedings pending or, to the best of the Company's knowledge threatened, to
which the Company or any Subsidiary or any officer thereof is a party is set
forth on Exhibit H attached hereto (the "Legal Proceedings").
---------
6.9 Title to Properties. Neither the Company nor any Subsidiary owns
-------------------
any real property, except such property as may be held by the Company from time
to time as the result of a defaulted loan and subsequent foreclosure. The
Company and each Subsidiary have good and marketable title to all the properties
and assets owned by it, subject to no lien, mortgage, pledge, charge or
encumbrance of any kind except (i) those, if any, reflected in the Memorandum or
(ii) those which are not material in amount and do not adversely affect the use
made and proposed to be made of such property by the Company or any Subsidiary.
The Company and each Subsidiary hold their respective leased properties under
valid and binding leases, with such exceptions as are not materially significant
in relation to the business of the Company and the Subsidiaries, taken as a
whole. Except as disclosed in the Memorandum, the Company and each Subsidiary
own or lease all such properties as are necessary to their respective operations
as now conducted.
6.10 Material Agreements. There are no contracts or other documents
-------------------
required to be described in the Memorandum which have not been described. Each
of the agreements referred to herein or described in the Memorandum in
connection with the formation of the company (collectively, the "Formation
Agreements"), including this Agreement, the employment agreement between the
Company and Scott F. Hartman, and the employment agreement between the Company
and W. Lance Anderson has been, or prior to the Closing Date will be, duly
authorized, executed and delivered by the Company, Mr. Hartman and Mr. Anderson
(including obtaining all necessary consents) and constitutes a valid and binding
agreement; and none of the Company, Mr. Hartman and Mr. Anderson, any of the
Subsidiaries, nor to the best of the Company's knowledge, any other party is, or
upon the Closing Date will be, in breach of or in default under any Formation
Agreement. The Company and each of the Subsidiaries, Mr. Hartman and Mr.
Anderson has full legal right, power and authority to enter into each Formation
Agreement as to which such person is a party and to consummate the transactions
contemplated therein.
6.11 No Material Adverse Change. Since the respective dates as of which
--------------------------
information is given in the Memorandum, and except as described in or
specifically contemplated by the Memorandum: (i) neither the Company nor any
Subsidiary has incurred any material liabilities or obligations, indirect,
direct or contingent, or entered into any material verbal or written agreement
or other transaction which is not in the ordinary course of business or which
could result in a material reduction in the future earnings of the Company
and the Subsidiaries, taken as a whole; (ii) neither the Company nor any
Subsidiary has sustained any material loss or interference with their respective
business or properties from fire, flood, windstorm, accident or other
13
<PAGE>
calimity, whether or not covered by insurance; (iii) neither the Company nor any
Subsidiary has paid or declared any dividends or other distributions with
respect to its capital stock and neither the Company nor any Subsidiary is in
default in the payment of principal or interest on any outstanding debt
obligations; (iv) there has not been any change in the capital stock (other than
the sale of the Units) or indebtedness material to the Company and the
Subsidiaries (other than in the ordinary course of business); and (v) there has
not been any material adverse change in the condition (financial or otherwise),
business, liquidity, properties, results of operations or prospects of
the Company and the Subsidiaries, taken as a whole.
6.12 Compliance With Laws.
--------------------
6.12.1 Neither the Company nor any Subsidiary has been advised, or
has reason to believe, that it is not conducting business in compliance with all
applicable laws, rules and regulations of the respective jurisdicitons in which
it is conducting business, including without limitation, all applicable local,
state and federal enviornmental laws and regulations; except where failure to b
eso in compliance would not materially adversely affect the condition (financial
or otherwise), business, liquidity, properties, results of operations or
prospects of the Company and the Subsidiaries, taken as a whole.
6.12.2 Each of the Company and the Subsidiaries (i) is or will be,
as of the Closing Date, in compliance with any and all applicable foreign,
federal, state and local laws and regulations relating to the protection of
human health and safety, the
<PAGE>
costs, natural resources damages, property damages, personal injuries or
penalties of any of the Company or any Subsidiary arising out of, based on or
resulting from (a) the presence or release into the environment of any Hazardous
Material at any location, whether or not owned by the Company or any Subsidiary
or (b) any violation or alleged violation of any Environmental Law, which
liability, alleged liability or potential liability is required to be disclosed
in the Memorandum other than as disclosed therein, or which liability, alleged
liability or potential liability, singly or in the aggregate, would have a
material and adverse effect on the condition (financial or otherwise), business,
liquidity, properties, results of operations or prospects of the Company and the
Subsidiaries, taken as a whole.
6.13 Governmental Regulations. Neither the Company nor any Subsidiary is
------------------------
an "investment company" within the meaning of the Investment Company Act.
6.14 Taxes. The Company and each Subsidiary have filed all necessary
-----
federal, state and foreign income and franchise tax returns and have paid all
taxes shown as due thereon; and neither Company nor any Subsidiary has knowledge
of any tax deficiency which has been or might be asserted or threatened against
the Company or any Subsidiary which could materially adversely affect the
condition (financial or otherwise), business, liquidity, properties, results of
operations or prospects of the Company and the Subsidiaries, taken as a whole.
6.15 Insurance. The Company and each Subsidiary maintain insurance of the
---------
types and in the amounts generally deemed adequate for their respective
business, including, but not limited to, insurance covering real and personal
property owned or leased by the Company and Subsidiaries against theft, damage
destruction, acts of vandalism and all other risks customarily insured against,
all of which insurance is in full force and effect.
6.16 Private Placement.
-----------------
6.16.1 Exemption. The sale of the Units under the Subscription
---------
Agreements is exempt from the registration and prospectus delivery requirements
of the Securities Act. In the case of each offer or sale of the Units, no form
of general solicitation or general advertising was used by the Company or its
representatives, including, but not limited to, advertisements, articles,
notices or other communications published in any newspaper, magazine or similar
medium or broadcast over television or radio or any seminar or meeting whose
attendees have been invited by any general solicitation or general advertising.
6.16.2 Sole Purchasers. Except for the Units being purchased by
---------------
Messrs. Anderson and Hartman with promissory notes, the Purchasers are the sole
purchasers of the Units. Except as set forth in the Memorandum, no securities of
the same class as the Units have been issued and sold by the Company within the
six (6)-month period immediately prior to the date of this Agreement. The
Company agrees that neither it, nor anyone acting on its behalf, will offer the
Units so as to bring the issuance and sale
15
<PAGE>
of the Units within the provisions of Section 5 of the Securities Act nor offer
any similar securities for issuance or sale to, or solicit any offer to acquire
any of the same from, or otherwise approach or negotiate with respect thereto
with, anyone if the sale of the Units would be integrated as a single offering
for the purposes of the Securities Act, including, without limitation,
Regulation D thereunder.
6.16.3 Personal. The Company has made such reasonable inquiry as is
--------
necessary to a determination that each Purchaser is acquiring the Units for
itself.
6.17 ERISA.
-----
6.17.1 Section 4975. The execution and delivery of this Agreement,
------------
the other Operative Documents and the sale of the Units to be purchased by the
Purchasers will not involve any non-exempt prohibited transaction within the
meaning of ERISA or Section 4975 of the Code. The representation made by the
Company in the preceding sentence is made in reliance upon and subject to the
accuracy of the Purchasers' representations in the Subscription Agreements as to
the source of the funds to be used by the Purchasers to purchase the Units.
6.17.2 Benefit Plans. The Company and each Subsidiary do not, and
-------------
have never maintained any employee pension benefit plans or any employee welfare
benefit plans. Neither the Company nor any Subsidiary has any obligation to make
any payment to or with respect to any former employee of the Company or any
Subsidiary pursuant to any retiree medical benefit or other welfare plan. As
used in this Section 6.18, the terms "employee pension benefit plan" and
"employee welfare benefit plan" shall have the meanings assigned to such terms
in ERISA.
6.18 No Violation of Regulations of Board of Governors of Federal Reserve
--------------------------------------------------------------------
System. None of the transactions contemplated by this Agreement (including,
- ------
without limitation, the use of the proceeds from the sale of the Units) will
violate or result in a violation of Section 7 of the Exchange Act or any
regulation issued pursuant thereto. The services provided by the Placement Agent
in connection with the offer and sale of the Units by the Company have been
provided as part of the placement agent services rendered to the Company by the
Placement Agent.
6.19 Brokers. Except as set forth in the Memorandum, the Company has dealt
-------
with no broker, finder, commission agent or other Person in connection with the
sale of the Units and the transactions contemplated by this Agreement, other
than the Placement Agent, and the Company is under no obligation to pay any
broker's fee or commission in connection with such transactions, other than a
fee payable to the Placement Agent for placement agent services rendered in
connection with such transactions, which fees are the sole obligations of the
Company.
16
<PAGE>
6.20 Commodities. Neither the Company nor any Subsidiary has invested in
-----------
futures contracts, options on futures contracts or options on commodities
except to the extent that the Company or such Subsidiary was exempt from the
registration requirements of the Commodity Exchange Act, as amended (the
"Commodity Act").
6.21 Accounting. Each of the Company and the Subsidiaries currently
----------
maintain, and upon the Closing Date, each will maintain, a system of internal
accounting controls sufficient to provide reasonable assurances that (i)
transactions are executed in accordance with management's general or specific
authorization; (ii) transactions are recorded as necessary to permit preparation
of financial statements in conformity with generally accepted accounting
principles and to maintain accountability for assets; (iii) access to financial
and corporate books and records is permitted only in accordance with
management's general or specific authorization; and (iv) the recorded
accountability for assets is compared with existing assets at reasonable
intervals and appropriate action is taken with respect to any differences.
6.22 Intellectual Property. The Company and each Subsidiary have to the
---------------------
best of their respective knowledge, sufficient, or has sufficient rights in,
trademarks, trade names, patent rights, copyrights, licenses, approval and
governmental authorizations to conduct its business; the expiration of any
trademarks, trade names, patent rights, copyrights, licenses, approvals or
governmental authorizations or rights therein would not have a material adverse
effect on the condition (financial or otherwise), business, liquidity,
properties, results of operation or prospects of the Company and the
Subsidiaries, taken as a whole; and neither the Company nor any Subsidiary has
knowledge of any material infringement by any entity of trademarks, trade name
rights, patent rights, copyrights, licenses, trade secrets or other similar
rights of others, and there is no claim being made against any entity regarding
any trademark, trade name, patent, copyright, license, trade secret or other
infringement which could have a material adverse effect on the condition
(financial or otherwise), business, liquidity, properties, results of operations
or prospects of the Company and the Subsidiaries, taken as whole.
6.23 Policies. The Company has prepared written policies for each policy
--------
referenced in the Memorandum (with the exception of the capital allocation
guidelines referenced in Section 7.14 hereof) and the Board of Directors of the
Company has approved each such policy. A copy of each such policy has been
delivered by the Company to counsel to the Company, the Placement Agent and
counsel to the Placement Agent.
SECTION 7. COVENANTS OF THE COMPANY
The Company covenants and agrees that:
7.1 Compliance with Representations and Warranties. During the period from
----------------------------------------------
the date of this Agreement to the Closing Date, the Company shall use its best
efforts and take all action necessary or appropriate to cause its
representations and warranties
17
<PAGE>
contained in Section 6 hereof to be true as of Closing Date, after giving effect
to the transactions contemplated by this Agreement, as if made on and as of the
Closing Date.
7.2 Sale of Other Securities. The Company agrees not to sell, offer for
------------------------
sale or solicit offers to buy or otherwise negotiate in respect of any security
(as defined in the Securities Act) that would be integrated with the sale of
the Units in a manner that would require the registration under the Securities
Act of the sale to the Purchasers of the Units.
7.3 144A Information and Financial Information. For so long as any of the
------------------------------------------
Securities remain outstanding and during any period in which the Company
is not subject to Section 13 or 15(d) of the Exchange Act, the Company agrees to
make available to any beneficial owner of the Securities and any prospective
purchaser of such Securities, the information required by Rule 144A(d)(4)
under the Securities Act. In addition, the Company will furnish to all
stockholders within the time periods required for comparable reports required by
the Securities and Exchange Commission, annual reports containing financial
statements audited by the Company's independent auditors and quarterly reports
for the first three quarters of each fiscal year containing unaudited financial
information.
7.4 Registration Rights Agreement: Warrant Agreement. The Company agrees
------------------------------------------------
to comply with its agreements as set forth in the Registration Rights Agreement
and the Warrant Agreement.
7.5 Commodities. The Company will not invest in futures contracts, options
-----------
on futures contracts or options on commodities except to the extent that the
Company is exempt from the registration requirements of the Commodity Act or has
received a no action letter from the CFTC authorizing such investment.
7.6 Use of Proceeds. The net proceeds from the sale of the Units will be
---------------
used solely for the purposes set forth in the Memorandum.
7.7 Retention of Accountants. The Company will retain a "Big 6" Accounting
------------------------
Firm as qualified accountants for a period of not less than two years beginning
on the Closing Date, to assist the Company in developing procedures and to
annually conduct compliance reviews which relate to each quarterly period;
provided, however, that, the first review shall occur at the time of the
- -------- -------
Company's audit for the year ending December 31, 1996 and each additional
review shall be provided in connection with the Company's fiscal year-end audit.
The review shall be designed to determine the Company's exempt status under the
Investment Company Act and compliance with the provisions of the Internal
Revenue Code of 1986, as amended, applicable to real estate investment trusts
("REIT").
7.8 Investment Company. The Company will not engage, or permit any
------------------
Subsidiary to engage, in any activity which would cause it or any Subsidiary to
be an "investment company" under the provisions of the Investment Company Act.
18
<PAGE>
7.9 Material Increases in Management Compensation. The Company shall not
---------------------------------------------
authorize, approve or permit any material increase in the compensation of any
individual employed by the Company or any affiliate of the Company without the
prior written consent of a majority of the Independent Directors.
7.10 Affiliated Transactions. The Company may not engage in transactions
-----------------------
with affiliates of the Company or with affiliates of any entities owned or
controlled by any employee, officer or director of the Company except to the
extent that such transactions meet the following criteria: are in the ordinary
course of business, the compensation therefor is fair and reasonable, and the
overall terms and conditions thereof are not less favorable to the Company than
the probable overall market-rate terms and conditions of a similar transaction
with an unaffiliated person. Prior to entering into such transaction, such
transaction shall be approved by a majority of the Independent Directors.
Notwithstanding the foregoing, the Company shall have the right to engage in
transactions with a wholly-owned subsidiary of the Company (including, without
limitation, any so-called non-taxable subsidiary) and transactions with a so-
called taxable subsidiary (to the extent that either or both of Mr. Hartman and
Mr. Anderson own only a de minimis number of the total number of outstanding
shares thereof), and transactions with General Electric Capital Corporation and
its affiliates.
7.11 Unrelated Lines of Business. The Company shall not engage in any
---------------------------
lines of business beyond the scope of subprime lending and portfolio investing,
and to the extent not a significant part of its business, prime lending, in each
case limited to single-family residential and mortgage-backed securities. Such
prohibition shall extend to, without limitation, investments in commercial and
multi-family mortgages and mortgage-backed securities and other real estate
investment trusts.
7.12 Key Man Insurance. The Company shall maintain, for a period of not
-----------------
less than five (5) years from the Initial Closing Date, Key Man Life Insurance
insuring each of Messrs. Hartman and Anderson, with a company with a Best's
Rating of not less than B+, VII, in the amount of not less than Five Million
Dollars ($5,000,000) with the Company named as beneficiary thereunder.
7.13 REIT Status. The Company shall operate so as to qualify as a REIT in
-----------
accordance with the requirements of Section 856-860 of the Internal Revenue Code
of 1986, as amended, and shall elect to be taxed as a REIT beginning with its
taxable year ending December 31, 1996. The Company shall thereafter not revoke
its REIT election nor conduct its business and operations so as to fail to
qualify as a REIT.
7.14 Capital Allocation Guidelines and Hedge Policies. The Company has
------------------------------------------------
adopted hedging policies to address the risk of interest rate fluctuations.
Within forty-five (45) days after the Initial Closing Date management of the
Company shall submit to the Company's Board of Directors capital allocation
guidelines for its review and approval. The Company shall not amend the
Company's hedging policy, or following adoption of the capital allocation
guidelines, such capital allocation guidelines, without the prior written
approval of a majority of the Independent Directors.
19
<PAGE>
7.15 Liquidation upon Approval of the Stockholders. Prior to a Qualified
---------------------------------------------
IPO, the Company shall, upon the majority vote of the holders of the Common
Stock and the Preferred Shares (voting together), undertake to liquidate the
Company or sell the Company, as applicable.
7.16 Restrictions on Grants of Stock Options. The Company shall not
----------------------------------------
grant any awards prior to a Qualified IPO other than those awards described in
or specifically contemplated by the Memorandum under the heading
"Management-Executive Compensation-Stock Option Plan."
7.17 First Exception. Following a Qualified IPO, the covenants of the
---------------
Company set forth in Sections 7.9, 7.10, 7.13 and 7.14 hereof may be waived or
modified upon the majority vote of the Independent Directors.
7.18 Second Exception. The covenants of the Company set forth in Sections
----------------
7.11 and 7.12 may be waived or modified (i) following a Qualified IPO upon the
unanimous vote of the Company's Board of Directors, and (ii) one (1) year
following a Qualified IPO upon the majority vote of the Independent Directors.
7.19 Third Exception. In addition, any of the covenants contained in
---------------
Sections 7.9 through 7.16 may be waived upon the vote of holders of two-thirds
of the voting power of the Preferred Stock.
SECTION 8. INDEMNIFICATION
8.1 Company's Indemnification. The Company agrees to indemnify and hold
-------------------------
harmless each Purchaser (each such Purchaser shall be an "Indemnified
Purchaser") and the Placement Agent and each person that controls each
Indemnified Purchaser and each Placement Agent within the meaning of Section 15
of the Securities Act or Section 20 of the Exchange Act, and agents, employees,
officers and directors or any such controlling person of any Indemnified
Purchaser and Placement Agent (each such indemnified party, an "Indemnified
Party") from and against any and all losses, claims, damages, judgments,
liabilities or expenses, joint or several, to which such Indemnified Party may
become subject under the Securities Act, the Exchange Act or other federal or
state statutory law or regulation, or at common law or otherwise (including in
settlement of any litigation, if such settlement is effected with the written
consent of the Company), insofar as such losses, claims, damages, liabilities or
expenses (or actions in respect thereof as contemplated below) arise out of or
are based upon any untrue statement or alleged untrue statement of any material
fact contained in the Memorandum, arise out of or are based upon the omission or
alleged omission to state in the Memorandum a material fact required to be
stated therein or necessary to make the statements in the Memorandum not
misleading, or arise out of or are based in whole or in part on any failure of
the Company to perform its obligations hereunder or under the Subscription
Agreements or under law; and will reimburse each Indemnified Party for any legal
and other expenses as such expenses are reasonably incurred by such Indemnified
Party in
20
<PAGE>
connection with investigating, defending, settling, compromising or paying any
such loss, claim, damage, liability, expense or action; provided, however, that
-------- -------
the Company will not be liable in any such case to the extent that any such
loss, claim, damage, liability or expense arises out of or is based upon an
untrue statement or alleged untrue statement or omission or alleged omission
made in the Memorandum about an Indemnified Party in reliance upon and in
conformity with the information furnished to the Company in writing by such
Indemnified Party expressly for use therein. In addition to its other
obligations under this Section 8.1, the Company agrees that, as an interim
measure during the pendency of any claim, action, investigation, inquiry or
other proceeding arising out of or based upon any statement or omission, or any
alleged statement or omission, or failure to perform its obligations hereunder,
all as described in this Section 8.1, it will reimburse each Indemnified Party
on a quarterly basis for all reasonable legal or other expenses incurred in
connection with investigating or defending any such claim, action,
investigation, inquiry or other proceeding, notwithstanding the absence of a
judicial determination as to the propriety and enforceability of the Company's
obligation to reimburse each Indemnified Party for such expenses and the
possibility that such payments might later be held to have been improper by a
court of competent jurisdiction. To the extent that any such interim
reimbursement payment is so held to have been improper, each Indemnified Party
shall promptly return it to the Company together with interest, determined on
the basis of the prime rate (or other commercial lending rate for borrowers of
the highest credit standing) announced from time to time by Bank of America
NT&SA, San Francisco, California (the "Prime Rate"). Any such interim
reimbursement payments which are not made to an Indemnified Party within 30 days
of a request for reimbursement, shall bear interest at the Prime Rate from the
date of such request.
8.2 Conduct of Indemnification Proceedings. Promptly after receipt by an
--------------------------------------
indemnified party under this Section 8 of notice of the commencement of any
action, such indemnified party will, if a claim in respect thereof is to be made
against an indemnifying party under this Section 8, notify the indemnifying
party in writing of the commencement thereof, but the omission so to notify the
indemnifying party will not relieve it from any liability which it may have to
any indemnified party for contribution or otherwise than under the indemnity
agreement contained in this Section 8 or to the extent it is not prejudiced as a
proximate result of such failure. In case any such action is brought against any
indemnified party and such indemnified party seeks or intends to seek indemnity
from an indemnifying party, the indemnifying party will be entitled to
participate in, and, to the extent that it may wish, jointly with all other
indemnifying parties similarly notified, to assume the defense thereof with
counsel reasonably satisfactory to such indemnified party; provided, however, if
-------- -------
the defendants in any such action include both the indemnified party and the
indemnifying party and the indemnified party shall have reasonably concluded
that there may be a conflict between the positions of the indemnifying party and
the indemnified party in conducting the defense of any such action or that there
may be legal defenses available to it and/or other indemnified parties which are
different from or additional to those available to the indemnifying party, the
indemnified party or parties shall have the right to select separate counsel to
assume such legal defenses and to otherwise participate in the
21
<PAGE>
defense of such action on behalf of such indemnified party or parties. Upon
receipt of notice from the indemnifying party to such indemnified party of its
election so to assume the defense of such action and approval by the indemnified
party of counsel, the indemnifying party will not be liable to such indemnified
party under this Section 8 for any legal or other expenses subsequently incurred
by such indemnified party in connection with the defense thereof unless (i) the
indemnified party shall have employed such counsel in connection with the
assumption of legal defenses in accordance with the proviso to the next
preceding sentence (it being understood, however, that the indemnifying party
shall not be liable for the expenses of more than one separate counsel
representing the indemnified parties who are parties to such action) or (ii) the
indemnifying party shall not have employed counsel reasonably satisfactory to
the indemnified party to represent the indemnified party within a reasonable
time after notice of commencement of the action, in each of which cases the fees
and expenses of counsel shall be at the expense of the indemnifying party.
8.3 Contribution. If the indemnification provided for in this Section 8 is
------------
required by its terms, but is for any reason held to be unavailable to or
otherwise insufficient to hold harmless an indemnified party under Sections 8.1
or 8.2 in respect of any losses, claims, damages, liabilities or expenses
referred to herein, then each applicable indemnifying party shall contribute to
the amount paid or payable by such indemnified party as a result of any losses,
claims, damages, liabilities or expenses referred to herein (i) in such
proportion as is appropriate to reflect the relative benefits received by the
Company and the Placement Agent from the Placement, or (ii) if the allocation
provided by clause (i) above is not permitted by applicable law, in such
proportion as is appropriate to reflect not only the relative benefits referred
to in clause (i) above but also the relative fault of the Company and the
Placement Agent in connection with the statements or omissions or inaccuracies
in the representations and warranties herein which resulted in such losses,
claims, damages, liabilities or expenses, as well as any other relevant
equitable considerations. The respective relative benefits received by the
Company and the Placement Agent shall be deemed to be in the same proportion, in
the case of the Company, as the total price paid to the Company for the Units
sold by the Company to the Purchasers (net of the Placement Agent commission set
forth in Section 2.5, but before deducting expenses), and in the case of the
Placement Agent as the Placement Agent commission received by it bears to the
total of such amounts paid to the Company and received by the Placement Agent as
a commission. The relative fault of the Company and the Placement Agent shall be
determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission or alleged untrue statement
of a material fact or the inaccurate or the alleged inaccurate representation
and/or warranty relates to information supplied by the Company or the Placement
Agent and the parties' relative intent, knowledge, access to information and
opportunity to correct or prevent such statement or omission. The amount paid or
payable by a party as a result of the losses, claims, damages liabilities and
expenses referred to above shall be deemed to include, subject to the
limitations set forth in Section 8.2, any legal or other fees or expenses
reasonably incurred by such party in connection with investigating or defending
any action or claim. The provisions set forth in Section 8.2 with respect to
notice of
22
<PAGE>
commencement of any action shall apply if a claim for contribution is made under
this Section 8.3; provided, however, that no additional notice shall be required
with respect to any action for which notice has been given under Section 8.2 for
purposes of indemnification. The Company and the Placement Agent agree that it
would not be just and equitable if contribution pursuant to this Section 8.3
were determined by pro rata allocation or by any other method of allocation that
does not take account of the equitable considerations referred to in this
Section 8.3. The amount paid or payable by an indemnified party as a result of
the losses, claims, damages, liabilities or expenses referred to in this Section
8.3 shall be deemed to include, subject to the limitations set forth above, any
legal or other expenses reasonably incurred by such indemnified party in
connection with investigating or defending any such action or claim. In no event
shall the liability of the Placement Agent hereunder be greater in amount than
the dollar amount of the proceeds (net of payment of all expenses) received by
the Placement Agent upon the sale of the Units giving rise to such
indemnification obligation. No person found guilty of fraudulent
misrepresentation (within the meaning of Section 11(f) of the Securities Act)
shall be entitled to contribution from any person who was not found guilty of
such fraudulent misrepresentation.
8.4 Additional Remedies. The indemnity and contribution agreements
-------------------
contained in this Section 8 are in addition to any liability that any
indemnifying party may otherwise have to any indemnified party.
SECTION 9. RIGHTS AND RESPONSIBILITIES OF PLACEMENT AGENT
9.1 Responsibilities For Memorandum. The Company has prepared the
-------------------------------
Memorandum and the Placement Agent is not responsible for any information
contained therein. The Placement Agent undertakes no responsibility of any kind,
including fiduciary responsibility, on behalf of any Purchaser and the Placement
Agent is not acting on any Purchaser's behalf.
9.2 Reliance. In performing their duties under this Agreement, the
--------
Placement Agent will be entitled to rely upon any notice, signature or writing
which they shall in good faith believe to be genuine and to be signed or
presented by a proper party or parties. In particular, the Placement Agent will
be entitled to rely on any instruction regarding disposition of funds or Units
in the Account which they shall in good faith believe to be genuine and to be
signed by any officer of the Company listed in the Memorandum. The Placement
Agent may consult with Placement Agent's counsel or counsel of any of the other
parties hereto and will not be held liable for any action taken or omitted to be
taken in good faith on advice of such counsel. The Placement Agent may rely on
any opinions or certificates delivered to the Purchasers and may rely upon such
other certificates or documents delivered to either the Purchasers or the
Placement Agent.
9.3 Rights of Placement Agent. In connection with the performance of
-------------------------
their duties under this Agreement, the Placement Agent shall not be liable for
any error of
23
<PAGE>
judgment or any action taken or omitted to be taken unless the Placement Agent
was grossly negligent or engaged in willful misconduct in connection with such
performance or non-performance. No provision of this Agreement will require the
Placement Agent to expend or risk its own funds or otherwise incur any financial
liability on behalf of the Purchasers in connection with the performance of any
of their duties hereunder. The Placement Agent will not be under any obligation
to exercise any of the rights or powers vested in it by this Agreement.
9.4 PORTAL. The Placement Agent shall use its commercially reasonable
------
efforts to have the Units designed as PORTAL securities.
SECTION 10. DEFINITIONS
As used in this Agreement, the following terms shall have the
following meanings:
Account: See Section 2.4.2
-------
Accredited Investors: "Accredited investors" as defined in Regulation
--------------------
D under the Securities Act.
Agreement: This Agreement between the Company and the Placement
---------
Agent.
Awards: The grant by the Company of qualified incentive stock
------
options, stock options not so qualified, deferred stock, restricted stock,
performance shares, stock appreciation and limited stock awards and dividend
equivalent rights.
Closing: See Section 2.4.1.
-------
Closing Date: See Section 2.4.1.
------------
Company: See the preamble hereto.
-------
Company Counsel's Opinion: See Section 3.1.1.
-------------------------
Company's Tax Counsel's Opinion: See Section 3.1.2.
-------------------------------
Common Stock: See Section 1.1.
------------
ERISA: The Employee Retirement Income Security Act of 1974, as
-----
amended.
Exchange Act: The Securities Act of 1934, as amended.
------------
24
<PAGE>
Independent Director: A director of the Company who is not an officer
--------------------
or employee of the Company or any affiliate (excluding General Electric Capital
Corporation and its affiliates) or subsidiary of the Company.
Initial Closing Date: See Section 2.4.1.
--------------------
Investment Company Act: The Investment Company Act of 1940, as
----------------------
amended.
Memorandum: The Private Placement Memorandum, dated October 15, 1996,
----------
as supplemented, relating to the Company and the Units and all supplements and
amendments thereto and all agreements, exhibits, schedules or other attachments
thereto as such agreements, exhibits, schedules or attachments may have been
amended.
Operative Documents: This Agreement, the Subscription Agreements, the
-------------------
Warrant Agreement and the Registration Rights Agreement collectively, together
with any exhibits, schedules or other attachments thereto.
Person: An individual, partnership, corporation, trust or
------
unincorporated organization or a government or agency or political subdivision
thereof.
Placement: See Section 1.1.
---------
Placement Agent: Stifel, Nicolaus & Company, Incorporated.
---------------
Preferred Shares: See Section 1.1.
----------------
Preferred Stock: See Section 1.1.
---------------
OIB's: "Qualified institutional buyers" as defined in Rule 144A under
-----
the Securities Act.
Qualified IPO: A firm commitment underwritten initial public offering
-------------
of Common Stock resulting in aggregate gross proceeds to the Company of at least
Twenty Million Dollars ($20,000,000) and a price of at least Fifteen Dollars
($15) or such lesser amount of proceeds and/or lower price per share as may be
approved by the holders of two-thirds of the Preferred Stock.
Registration Rights Agreement: See Section 3.4.
-----------------------------
Rule 144: Rule 144 as promulgated by the Securities and Exchange
--------
Commission under the Securities Act, and any successor rule or regulation
thereto.
Rule 144A: Rule 144A as promulgated by the Securities and Exchange
---------
Commission under the Securities Act, and any successor rule or regulation
thereto.
25
<PAGE>
Securities: See Section 1.1.
----------
Securities Act: The Securities Act of 1933, as amended.
--------------
Subsidiaries: See Section 6.1.
------------
Transfer Agent: The Company, or its designee, as transfer agent and
--------------
registrar of the Units.
Transfer Restricted Securities: The Securities, shares of Common
--------------------------------
Stock issuable upon the conversion of the Preferred Shares and the Warrant
Shares acquired by the holder thereof than pursuant to an effective registration
under Section 5 of the Securities Act or pursuant to Rule 144; provided that,
Securities, shares of Common Stock issuable upon the conversion of the Preferred
Shares and the Warrants Shares which may be issuable upon the exercise of the
Warrants that have ceased to be a Transfer Restricted Security cannot thereafter
become a Transfer Restricted Security.
Units: See Section 1.1.
-----
Warrant: See Section 1.1.
-------
Warrant Agreement: See Section 3.5.
-----------------
Warrant Share: See Section 1.1.
-------------
SECTION 11. MISCELLANEOUS
11.1 Notices. Prior to the Closing, and thereafter with respect to matters
-------
pertaining to this Agreement only, all notices and other communications provided
for or permitted hereunder shall be made in writing by hand-delivery, first-
class mail, telex, telecopier or overnight air courier guaranteeing next day
delivery:
(a) if to the Placement Agent, to:
Stifel, Nicolaus & Company, Incorporated
500 North Broadway, Suite 1500
St. Louis, Missouri 63102
Telecopier: (314) 342-2775
Telephone: (314) 342-2000
Attn: Mr Rick E. Maples
with a copy to
O'Melveny & Myers LLP
275 Battery Street, 26th Floor
26
<PAGE>
San Francisco, California 94111
Telecopier: (415) 984-8701
Telephone: (415) 984-8833
Attn: Peter T. Healy, Esq.
(b) if to the Company, to:
NovaStar Financial, Inc.
1900 W. 47th Place, Suite 205
Westwood, Kansas 66205
Telecopier: (913) 362-1011
Telephone; (913) 362-1090
Attn: Mr. Scott F. Hartman
with a copy to:
Tobin & Tobin
One Montgomery Street, 15th Floor
San Francisco, California 94104
Telecopier: (415) 433-3883
Telephone: (415) 772-9679
Attn: Phillip R. Pollock, Esq.
All such notices and communications shall be deemed to have been duly given: at
the time delivered by hand, if personally delivered; five business days after
being deposited in the mail, postage prepaid, if mailed; when answered back, if
telexed; the next business day after being telecopied; or the next business day
after timely delivery to a courier, if sent by overnight air courier
guaranteeing next day delivery. From and after the Closing, the foregoing
notice provisions shall be superseded by any notice provisions of the Operative
Document under which notice is given. The Placement Agent, the Company, and
their respective counsel, may change their respective notice addresses from time
to time by written notice to all of the foregoing persons.
11.2 Parties in Interest, Successors and Assigns. This Agreement is made
-------------------------------------------
solely for the benefit of the Placement Agent, counsel to the Placement Agent,
the Purchasers and the Company and any person controlling the Placement Agent,
the Purchasers or the Company and their respective executors, administrators,
successors and assigns; and no other person shall acquire or have any right
under or by virtue of this Agreement. This Agreement shall inure to the benefit
of and be binding upon the successors and assigns of each of the parties,
including without limitation and without the need for an express assignment,
subsequent holders of Transfer Restricted Securities.
11.3 Amendment and Waiver. Prior to the Closing Date, this Agreement and
--------------------
the other Operative Documents may be amended, modified or supplemented, and
waivers or consents to departures from the provisions hereof may be given,
provided that
27
<PAGE>
the same are in writing, signed by the Placement Agent and the Company, and
delivered to each Purchaser for their review and approval. Thereafter, this
Agreement and the other Operative Documents, respectively, may only be so
amended, and such waivers be given by a vote of the holders of two-thirds of the
Preferred Shares, or as provided in the applicable Operative Document,
respectively.
11.4 Counterparts. This Agreement may be executed in any number of
------------
counterparts and by the parties hereto in separate counterparts, each of which
when so executed shall be deemed to be an original and all of which taken
together shall constitute one and the same agreement.
11.5 Headings. The headings in this Agreement are for convenience of
--------
reference only and shall not limit or otherwise affect the meaning hereof.
11.6 Governing Law. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN
-------------
ACCORDANCE WITH THE INTERNAL LAWS (AND NOT THE LAWS PERTAINING TO CONFLICTS OF
LAWS) OF THE STATE OF NEW YORK.
11.7 Waiver of Trial by Jury. The Company, the Placement Agent, and each
-----------------------
of the Purchasers hereby irrevocably waive any right they may have to a trial by
jury in any action, suit or proceeding brought to enforce or defend any rights
or remedies arising under or in connection with this Agreement, any of the other
Operative Documents, or the transactions contemplated hereby, whether grounded
in tort, contract or otherwise.
11.8 Entire Agreement. This Agreement, together with the other Operative
----------------
Documents and the Engagement Letter by and between the Company and the Placement
Agent, dated July 23, 1996 (the "Engagement Letter"), is intended by the parties
as a final expression of their agreement and intended to be a complete and
exclusive statement of the agreement and understanding of the parties hereto in
respect of the subject matter contained herein and therein. There are no
restrictions, promises, warranties or undertakings, other than those set forth
or referred to herein and therein. This Agreement, together with the other
Operative Documents, supersedes all prior agreements and understandings between
the parties with respect to such subject matter; provided, however, that this
Agreement does not supersede the terms of the Engagement Letter and the terms
hereof are supplementary to the terms of the Engagement Letter.
11.9 Severability. In the event that any one or more of the provisions
-----------
contained herein, or the application thereof in any circumstances, is held
invalid, illegal or unenforceable in any respect for any reason, the validity,
legality and enforceability of any such provision in every other respect and of
the remaining provisions hereof shall not be in any way impaired or affected, it
being intended that all of the Placement Agent's and the Purchasers' rights and
privileges shall be enforceable to the fullest extent permitted by law.
28
<PAGE>
11.10 Public Disclosure. The Company covenants that it will take all
-----------------
reasonable actions necessary to keep the Placement Agent's and each Purchaser's
identity confidential, and will not disclose the Purchaser's identity as an
investor in the Company in any public announcement, governmental filing or
otherwise without the Purchaser's prior written consent unless such disclosure
is (a) required under the Securities Act in connection with the registration of
the Units as contemplated by the Registration Rights Agreement, or (b) compelled
by law or by order of a court of competent jurisdiction, in which case prior to
making such disclosure the Company will give written notice to the Placement
Agent and the Purchaser describing in all reasonable detail the proposed content
of such disclosure and will afford the Placement Agent and the Purchaser in good
faith an opportunity to suggest modifications in the form and substance of such
proposed disclosure.
11.11 Survival. The Placement Agent and the Company, respectively, agree
--------
that the representations, warranties and agreements made by each of them in this
Agreement and in any certificate or other instrument delivered pursuant hereto
shall remain in full force and effect and shall survive the delivery and payment
for the Units.
If this Agreement is satisfactory to you, please so indicate by
signing the acceptance of this Agreement and deliver such counterpart to the
Company whereupon this Agreement will become binding between us in accordance
with its terms.
Very truly yours,
NOVASTAR FINANCIAL, INC.
By: /s/ Scott F.Hartman
------------------------
Its: Secretary
-----------------------
STIFEL, NICOLAUS & COMPANY, INCORPORATED,
as Placement Agent
By: /s/ Patrick ???
----------------------
Its: VP
---------------------
29
<PAGE>
________________________________________________________________________________
EXHIBIT 10.2
REGISTRATION RIGHTS AGREEMENT
NOVASTAR FINANCIAL, INC.
Dated December 9, 1996
<PAGE>
REGISTRATION RIGHTS AGREEMENT
-----------------------------
(NovaStar Financial, Inc.)
THIS REGISTRATION RIGHTS AGREEMENT (this "Agreement") is made and
entered into as of December 9, 1996, by and between NOVASTAR FINANCIAL, INC.,
a Maryland corporation (the "Company"), and STIFEL, NICOLAUS & COMPANY,
INCORPORATED (the "Placement Agent"), as a matter of convenience for the Holders
of the Registrable Securities (each as defined herein).
In consideration of the mutual agreements contained herein and for
other good and valuable consideration, the receipt and sufficiency of which is
hereby acknowledged, the parties hereto, intending to be legally bound hereby,
agree as follows:
SECTION 1
DEFINITIONS
1.1 As used in this Agreement, the following capitalized terms shall
have the following meanings:
"Affiliate" of a specified Person shall mean any other Person directly
or indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control"
when used with respect to any Person, means the power to direct the management
and policies of such Person, directly or indirectly, whether through the
ownership of voting securities, by contract or otherwise; and the terms
"controlling" and "controlled" have meanings correlative to the foregoing.
"Business Model" shall mean the financial projections and related
assumptions contained in a memorandum furnished upon request to prospective
purchasers in the placement.
"Common Stock" shall mean the Company's Common Stock, par value $0.01
per share.
"Company" shall mean NovaStar Financial, Inc., a Maryland
corporation, and any successor thereto.
"Document Supplement" shall mean the package furnished to each
purchaser of Units in the Placement containing the Articles of Incorporation of
the Company, including the Articles Supplementary for the Preferred Stock, the
form of Warrant Agreement between the Company, as issuer, and the Warrant Agent,
dated as of the date of this Agreement, the form of Warrant, the form of
Purchase Terms Agreement and the form of this Agreement.
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"Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended, and the rules and regulations of the SEC promulgated thereunder.
"Five Percent Purchaser" shall mean a Purchaser of 5% or more of the
Units sold by the Company in the Placement.
"Founders" shall mean W. Lance Anderson and Scott F. Hartman.
"Holders" shall have the meaning provided in Section 2.2 hereof.
"Initial Purchaser" shall mean a purchaser of Units directly from the
Company including the Founders.
"NASD" means National Association of Securities Dealers, Inc.
"NASDAQ/NMS" shall mean the Nasdaq National Market.
"Person" shall mean an individual, trustee, corporation, partnership,
limited liability company, joint stock company, trust, unincorporated
association, union, business association, firm or other entity.
"Piggyback Notice" shall have the meaning provided in Section 4
hereof.
"Piggyback Underwritten Offering" shall have the meaning provided in
Section 4 hereof.
"Placement" shall mean the placement of the Units pursuant to the
Private Placement Memorandum and the Purchase Terms Agreement.
"Placement Agent" shall mean Stifel, Nicolaus & Company, Incorporated.
"Preferred Stock" shall mean the Company's Class A Convertible
Preferred Stock, par value $0.01 per share.
"Private Placement Memorandum" shall mean the Private Placement
Memorandum, dated October 15, 1996, the Business Model, the Document Supplement
and all other amendments and supplements thereto, pursuant to which the Company
is offering for sale up to 3,333,333 Units.
"Proceeding" shall mean an action, claim, suit or proceeding
(including, without limitation, an investigation or partial proceeding, such
as a deposition), whether commenced or threatened.
"Prospectus" shall mean the Prospectus included in any Registration
Statement (including, without limitation, a prospectus that discloses
information
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previously omitted from a prospectus filed as part of an effective Registration
Statement in reliance upon Rule 430A promulgated under the Securities Act), as
amended or supplemented by any prospectus supplement, with respect to the terms
of the offering of any portion of the Registrable Securities covered by such
Registration Statement, and all other amendments and supplements to the
Prospectus, including post-effective amendments, and all material incorporated
by reference or deemed to be incorporated by reference in such Prospectus.
"Purchase Terms Agreement" means the Purchase Terms Agreement, dated
as of December 6, 1996, by and between the Company and the Placement Agent.
"Qualified Public Offering" shall mean the initial sale to the public
of the Company's Common Stock pursuant to a registration statement on Form S-11
or any similar form which raises in the aggregate at least $20 million of gross
proceeds for the Company at a minimum price of $15 per share or such lesser
amount of proceeds and/or price per share as may be approved by the holders of
two-thirds of the voting power of the Preferred Stock.
"Registrable Common Stock" shall mean Common Stock constituting
Registrable Securities or Common Stock issued upon exercise or conversion of
Registrable Securities.
"Registrable Securities" shall mean (i) the Preferred Stock purchased
by the Initial Purchasers as the components of the Units, (ii) the Warrants and
the Common Stock issuable pursuant to the exercise of the Warrants, and (iii)
the Common Stock issuable upon conversion of shares of the Preferred Stock
purchased as part of the Units; provided, however, that following a Qualified
Public Offering the term "Registrable Securities" shall apply only to the
securities described in subparagraphs (ii) and (iii).
"Registration Statement" shall mean any registration statement of the
Company that covers any of the Registrable Securities pursuant to the provisions
of this Agreement, including the Prospectus, amendments and supplements to such
Registration Statement, including post-effective amendments, all exhibits and
all material incorporated by reference or deemed to be incorporated by reference
in such Registration Statement.
"Rule 144" shall mean Rule 144 under the Securities Act, as such rule
may be amended from time to time, or any similar rule or regulation hereafter
adopted by the SEC.
"SEC" shall mean the Securities and Exchange Commission.
"Securities Act" shall mean the Securities Act of 1933, as amended,
and the rules and regulations promulgated by the SEC thereunder.
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"Shelf Registration Statement" shall have the meaning provided in
Section 3.1 hereof.
"Supplemental Shelf Registration Statement" shall have the meaning
provided in Section 3.3 hereof.
"Underwriter" shall mean any underwriter, placement agent, selling
broker, dealer manager, qualified independent underwriter or similar securities
industry professional.
"Underwritten Registration or Underwritten Offering" shall mean a
registration in which securities of the Company are sold to one or more
Underwriters for reoffering to the public.
"Units" shall mean the 3,333,333 units consisting of one share of
Preferred Stock and one Warrant to be sold in the Placement and the Units being
purchased by the Founders in exchange for promissory notes as described in the
Private Placement Memorandum.
"Warrants" shall mean the warrants issued pursuant to the Warrant
Agreement dated as of the date of this Agreement between the Company as issuer,
and the Holders of the Warrants acting through the Company, as the initial
warrant agent.
SECTION 2
SECURITIES SUBJECT TO THIS AGREEMENT
2.1 The securities entitled to the benefits of this Agreement are the
Registrable Securities.
2.2 A Person is deemed to be a Holder of Registrable Securities
(each, a "Holder") whenever such Person owns Registrable Securities, whether or
not such Person was an Initial Purchaser.
SECTION 3
SHELF REGISTRATION; DEMAND REGISTRATION
3.1 The Company shall cause to be filed with the SEC within six (6)
months following the Qualified Public Offering (or the end of the twentieth
(20th) month after the last sale of Units in the Offering, if the Qualified
Public Offering has not occurred within such 20-month period), a shelf
Registration Statement pursuant to Rule 415 under the Securities Act (the "Shelf
Registration Statement") on Form S-11 (or other appropriate form, e.g., Form S-3
-----
after having established eligibility therefor) to cover sales of the Registrable
Securities. In connection with the Shelf Registration Statement, the Company
shall also register the offer and sale of the Common Stock issuable upon
exercise of the Warrants as a primary registration. The Company shall use its
best
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efforts to cause such Shelf Registration Statement to be declared effective by
the SEC as soon as practicable thereafter. The Company shall use its best
efforts to keep such Shelf Registration Statement continuously effective until
the earlier to occur of three (3) years following the last sale of Units in the
Offering or such time as, in the written opinion of counsel to the Company, such
registration is not required for the unrestricted resale of Registrable
Securities entitled to registration rights under this Agreement. Notwithstanding
the foregoing, with respect to the Common Stock issuable upon exercise of the
Warrants, the Company shall use its best efforts to keep such Registration
Statement continuously effective until the earlier to occur of three (3) years
following the date the Warrants may first be exercised or such time as, in the
written opinion of counsel to the Company, such registration is not required for
the unrestricted resale of such securities. The Company further agrees to use
its best efforts to prevent the happening of any event that would cause the
Shelf Registration Statement to contain a material misstatement or omission or
to be not effective and usable for resale of the Registrable Securities during
the period that such Shelf Registration Statement is required to be effective
and usable.
Upon the occurrence of any event that would cause the Shelf
Registration Statement (i) to contain a material misstatement or omission,
or (ii) to be not effective and usable for resale of Registrable Securities
during the period that such Shelf Registration Statement is required to be
effective and usable, the Company shall as promptly as reasonably practicable
file an amendment to the Shelf Registration Statement, in the case of clause (i)
immediately above, correcting any such misstatement or omission, and in the case
of either clause (i) or (ii) immediately above, use its best efforts to cause
such amendment to be declared effective and such Shelf Registration Statement to
become usable as soon as reasonably practicable thereafter.
3.2 If the Holders of a majority of the Registrable Securities to be
registered for resale in the Shelf Registration Statement, or any Five Percent
Purchasers so elect, an offering of Registrable Securities pursuant to the Shelf
Registration Statement may be effected in the form of an Underwritten Offering.
Upon the receipt of a notice of election by a majority of the Registrable
Securities or any Five Percent Holder to effect an Underwritten Offering, the
Company will notify in writing all Holders whose names are not included in such
notice and such non-electing Holders may, within five (5) business days of
receipt of such notice, elect to be included with, and treated as, an electing
Holder. If the managing Underwriter advises the Company and the Holders of such
Registrable Securities and additional securities in writing that in their
opinion the amount of Registrable Securities and additional securities proposed
to be sold in such offering exceeds the amount of Registrable Securities and
additional securities which can be sold in such offering, there shall be
included in such Underwritten Offering the amount of such Registrable Securities
which in the opinion of such Underwriters can be sold with such additional
securities, and such amount or number of shares of such Registrable Securities
and additional securities shall be allocated pro rata among the Holders
electing to participate in such Underwritten Offering. The Holders of the
Registrable Securities to be registered shall pay all
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underwriting discounts and commissions of such Underwriters with respect to the
sales of such Registrable Securities. If requested by any Five Percent Purchaser
selling its shares pursuant to an Underwritten Offering as provided in this
Section 3.2, the Company's management shall cooperate in a commercially
reasonable manner in roadshow presentations to assist such Five Percent
Purchaser in selling its shares.
3.3 In addition to the registration rights provided in Section 3.1,
each Five Percent Purchaser shall also have two (2) demand registration rights
following the expiration of the Shelf Registration Statement to cause all or a
portion of the Registrable Securities held by such Five Percent Purchaser to be
registered under the Securities Act (the "Supplemental Shelf Registration
Statement") on Form S-11 (or other appropriate form) to cover sales of
Registrable Securities held by such Five Percent Purchaser, unless, in the
written opinion of counsel to the Company (which opinion is reasonably
acceptable to such Five Percent Purchaser), such registration is not necessary
for such Five Percent Purchaser to sell its shares in the manner contemplated in
compliance with applicable securities laws. The Supplemental Shelf Registration
Statement shall be governed by the provisions of Section 3.1.
3.4 No Holder of Registrable Securities may include any of its
Registrable Securities in any Shelf Registration Statement or Underwritten
Offering pursuant to this Agreement unless such Holder furnishes to the Company
in writing, within ten (10) business days after receipt of a written request
therefor, such information as the Company may reasonably request for use in
connection with any Shelf Registration Statement or Prospectus or preliminary
Prospectus included therein.
SECTION 4
PIGGYBACK REGISTRATION
4.1 Subject to Section 4.2, if the Company proposes to file a
Registration Statement under the Securities Act with respect to a public
offering of Common Stock during the period in which a Holder of Registrable
Securities has registration rights granted pursuant to this Agreement, including
the Qualified Public Offering (other than a Registration Statement (i) on Form
S-4, Form S-8 or any successor forms thereto or (ii) filed solely in connection
with an exchange offer or any employee benefit or dividend reinvestment plan),
whether or not for its own account, then the Company shall give written notice
of such proposed filing to the Five Percent Purchasers who still own Registrable
Securities at least fifteen (15) business days before the anticipated filing
date (the "Piggyback Notice"). The Piggyback Notice shall offer such Five
Percent Purchasers the opportunity to include in such Offering such amount of
Registrable Securities as each such Five Percent Purchaser may request (a
"Piggyback Offering"). Subject to Sections 4.2 and 6.2 hereof, the Company shall
include in each such Piggyback Offering all Registrable Securities held by such
Five Percent Purchasers with respect to which the Company has received written
requests for inclusion therein within ten (10) days after written notice has
been given to the Five Percent Purchasers (which written request shall specify
the intended method of distribution). The Five
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Percent Purchases shall be permitted to withdraw all or part of the Registrable
Securities from a Piggyback Offering at any time prior to the effective date of
such Piggyback Offering. The Five Percent Purchasers shall pay all underwriting
discounts and commissions of such Underwriters with respect to the sales of any
of their Registrable Securities.
4.2 If, in connection with an Underwritten Offering, the managing
Underwriter or Underwriters of an Underwritten Offering have informed the
Company in writing that it is their opinion that the total amount of Common
Stock that such Five Percent Purchasers, the Company and any other Persons
having rights to participate in such Underwritten Offering, intend to include in
such Underwritten Offering is such as to materially and adversely affect the
success of such Underwritten Offering, then the amount of Common Stock to be
offered in the Underwritten Offering shall be the amount recommended by such
managing Underwriter or Underwriters and the Common Stock to be included in such
Underwritten Offering shall be included in the following order of priority: (i)
for the account of the Company; provided however, for the first two Underwritten
Offerings of the Company any amounts in excess of Fifty Million Dollars
($50,000,000) in gross proceeds shall be allocated between the Five Percent
Purchasers electing to participate in such Piggyback Offering pro rata according
to the number of securities proposed to be sold, (ii) for the account of the
Five Percent Purchasers, allocated pro rata among the Five Percent Purchasers
electing to participate in such Piggyback Offering, pro rata according to the
number of securities proposed to be sold, and (iii) for the account of the
remaining Holders, allocated pro rata among such Holders electing to participate
in such Piggyback Offering pro rata according to the number of securities
proposed to be sold.
4.3 In addition to the Piggyback Registration Rights of the Holders
of Registrable Securities, the Founders receiving Common Stock in the Company
shall have similar registration rights pursuant to a separate agreement as
provided in this Section 4, as well as the right to include all or portion of
their Common Stock in any demand registration of any Holder of Registrable
Securities as provided in Section 3.3; provided, however, (i) any reduction in
the number of securities being sold pursuant to the recommendation of any
managing Underwriter as provided in Section 3.2 or 4.2 shall first be applied to
the Founders, and (ii) the rights and obligations of the Holders of Registrable
Securities shall otherwise apply to the Founders, including, without limitation,
the hold-back provisions of Section 5.
SECTION 5
HOLD-BACK AGREEMENTS
5.1 Each Holder of Registrable Securities agrees, in connection with
the Company's Qualified Public Offering and any other underwritten public
offering during the period in which such Holder of Registrable Securities has
registration rights granted pursuant to this Agreement, if requested (pursuant
to a timely written notice) by the Company or the managing Underwriter or
Underwriters in an Underwritten Offering,
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not to effect any public sale or distribution of any of its Registrable
Securities, including a sale pursuant to Rule 144 (expect as part of such
Underwritten Offering), during the period beginning five (5) days prior to, and
ending ninety (90) days after, the closing date of such underwritten Public
Offering made by the Company, unless a shorter time period is agreed to by the
managing Underwriter or Underwriters. The foregoing provisions shall not apply
to any Holder of Registrable Securities if such Holder is prevented by
applicable statute or regulation from entering into any such agreement;
provided, however, that any such Holder shall undertake upon written request to
participate in any such Underwritten Offering not to effect any public sale or
distribution of the class of securities covered by such Registration Statement
(except as part of such Underwritten Offering) during such period unless it has
provided forty-five (45) days' prior written notice of such sale or distribution
to the managing Underwriter or Underwriters.
5.2 The Company agrees that without the written consent of the
managing Underwriter or Underwriters in an Underwritten Offering of
Registrable Securities as described in Sections 3 or 4 hereof, it will not
effect any public or private sale or distribution of its equity securities,
including a sale pursuant to Regulation D under the Securities Act, during the
five (5) day period prior to, and the ninety (90) day period beginning on, the
closing date of each such Underwritten Offering, unless a shorter time period is
agreed upon by the managing Underwriter or Underwriters (except (i) as part of
such Underwritten Offering, (ii) pursuant to registrations on Form S-4 or Form
S-8 or any successor form to such forms, pursuant to any dividend reinvestment
and optional purchase plan of the Company or pursuant to any unregistered
offering to the Company's employees or directors, or to employees of its
subsidiaries, pursuant to any employee benefit plan (as defined in Rule 405
under the Securities Act), (iii) in connection with an exchange offer, or (iv)
in connection with the acquisition of assets by the Company or its
subsidiaries).
SECTION 6
REGISTRATION PROCEDURES
6.1 In connection with the Company's registration obligations
pursuant to Sections 3 or 4 of this Agreement, the Company shall effect such
registration(s) to permit the sale of such Registrable Securities in accordance
with the intended method or methods of disposition thereof, and pursuant thereto
the Company shall as expeditiously as possible:
(a) Prepare and file with the SEC, as soon as practicable, a
Registration Statement or Registration Statements on such form which shall be
available for the sale of the Registrable Securities by the Holders thereof in
accordance with the intended method or methods of distribution thereof, and use
its best efforts to cause such Registration Statement to become effective and to
remain effective as provided herein; provided, however, that before filing a
Registration Statement or Prospectus or any amendments or supplements thereto
(including documents that would be
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incorporated or deemed to be incorporated therein by reference), the Company
shall notify the Holders of the Registrable Securities covered by such
Registration Statement, their counsel and the managing Underwriters, if any, of
its intention to file such documents, and upon written request shall furnish to
such parties so requesting copies of all such documents proposed to be filed,
which documents will be subject to the review of such Holders, their counsel and
such Underwriters, if any; provided, further, that the Company shall not be
required to deliver to such Holders a copy of any such document that has not
been materially changed from a copy of such document that was previously
delivered to such Holders.
(b) Prepare and file with the SEC such amendments and
post-effective amendments to each Registration Statement as may be necessary to
keep such Registration Statement continuously effective during the period
provided in this Agreement with respect to the disposition of all securities
covered by such Registration Statement, and cause the related Prospectus to be
supplemented by any required Prospectus supplement, and as so supplemented to be
filed pursuant to Rule 424 (or any similar provisions then in force) under the
Securities Act.
(c) Notify the selling Holders of the Registrable Securities,
their counsel and the managing Underwriters, if any, promptly, and (if requested
in writing by any such Person), confirm such notice in writing: (i) when a
Registration Statement or any amendment thereto has been filed, and, with
respect to a Registration Statement or any post-effective amendment, when the
same has become effective, (ii) of any request by the SEC or any other Federal
or state governmental authority for amendments or supplements to a Registration
Statement or related Prospectus or for additional information (provided, that
the Company shall not be required to notify the Holders or their counsel of all
"comment letters" received by the Company from the SEC or to deliver copies of
such comment letters or the Company's responses thereto to the Holders or their
counsel unless such letters request information from or about the Holders),
(iii) of the issuance by the SEC of any stop order suspending the effectiveness
of a Registration Statement or the initiation of any proceedings for that
purpose, (iv) if at any time the representations and warranties of the Company
contained in any agreement (including any underwriting agreement) contemplated
by Section 6.1(n) below cease to be true and correct, (v) of the receipt by the
Company of any modification with respect to the suspension of the qualification
or exemption from qualification of any of the Registrable Securities for sale in
any jurisdiction, or the initiation or threatening of any proceeding for such
purpose, and (vi) of the happening of any event that makes any statement made in
such Registration Statement or related Prospectus or any document incorporated
or deemed to be incorporated therein by reference untrue in any material respect
or that requires the making of any changes to such Registration Statement,
Prospectus or documents so that, in the case of the Registration Statement, it
will not contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or necessary to make the statements
therein, not misleading, and that in the case of the Prospectus, it will not
contain any untrue statement of a material fact or omit to state any material
fact necessary in order to make
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the statements therein, in light of the circumstances under which they were
made, not misleading.
(d) Use its best efforts to obtain the withdrawal of any order
suspending the effectiveness of a Registration Statement, or the lifting of any
suspension of the qualification (or exemption from qualification) of any of the
Registrable Securities for sale in any jurisdiction.
(e) If requested by the managing Underwriters, if any, or the
Holders of a majority of the then outstanding Registrable Securities being sold
in connection with an Underwritten Offering, promptly include in a Prospectus
supplement or post-effective amendment such information as the managing
Underwriters, if any, and such Holders may reasonably request in order to permit
the intended method of distribution of such securities and make all required
filings of such Prospectus supplement or such post-effective amendment as soon
as practicable after the Company has received such request; provided, however,
that the Company shall not be required to take any actions under this Section
6.1(e) that are not, in the opinion of counsel for the Company, in compliance
with applicable law.
(f) Furnish to a selling Holder of Registrable Securities, their
counsel and each managing Underwriter, if any, without charge, at least one
conformed copy of the Registration Statement and each post-effective amendment
thereto, including financial statements (but excluding schedules, all documents
incorporated or deemed to be incorporated therein by reference, and all
exhibits, unless requested in writing by such Holder, counsel or Underwriter).
(g) Deliver to each selling Holder, their counsel, and the
Underwriters, if any, without charge, as many copies of the Prospectus or
Prospectuses (including each form of prospectus) and each amendment or
supplement thereto as such Persons may reasonably request in connection with the
distribution of the Registrable Securities; and the Company hereby consents to
the use of such Prospectus and each amendment or supplement thereto by each of
the selling Holders of Registrable Securities and the Underwriters, if any, in
connection with the offering and sale of the Registrable Securities covered by
such Prospectus and any such amendment or supplement thereto.
(h) Use its best efforts to register or qualify, or obtain an
exemption therefrom (or cooperate with selling Holders of Registrable
Securities, the Underwriters, if any, and their respective counsel in connection
with the registration or qualification (or exemption from such registration or
qualification)) of such Registrable Securities for offer and sale under the
securities or "Blue Sky" laws of such jurisdictions within the United States as
any seller (or Underwriter) reasonably requests in writing and to keep each such
registration or qualification (or exemption therefrom) effective during the
period such Registration Statement is required to be kept effective; provided,
however, that the Company will not be required to (1) qualify generally to do
business in
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any jurisdiction where it is not then so qualified, or (2) take any action that
would subject it to general service of process or to taxation in any
jurisdiction where it is not then so subject.
(i) Cooperate with the selling Holders of Registrable Securities
and the managing Underwriters, if any, to facilitate the timely preparation and
delivery of certificates representing Registrable Securities to be sold, which
certificates shall be in a form eligible for deposit with The Depository Trust
Company; and enable such Registrable Securities to be in such denominations and
registered in such names as the managing Underwriters, if any, or Holders may
request in writing at least two (2) business days prior to any sale of
Registrable Securities in a firm commitment public offering, or in any other
such sale within ten (10) business days.
(j) Use its best efforts to cause the Registrable Securities
covered by such Registration Statement to be registered with or approved by such
other governmental agencies or authorities within the United States, except as
may be required solely as a consequence of the nature of such selling Holder's
business, in which case the Company will cooperate with the filing of such
Registration Statement and the granting of such approvals as may be necessary to
enable the seller or sellers thereof or the Underwriters, if any, to consummate
the deposition of such Registrable Securities.
(k) Upon the occurrence of any event contemplated by Section
6.1(c)(vi) above, prepare a supplement or post-effective amendment to the
Registration Statement or a supplement to the related Prospectus or any document
incorporated or deemed to be incorporated therein by reference, or file any
other required document so that, as thereafter delivered to the purchasers of
the Registrable Securities being sold thereunder, such Prospectus will not
contain an untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein, in
light of the circumstances under which they were made, not misleading.
(l) Prior to the effective date of the Registration Statement
relating to the Registrable Securities, provide a CUSIP number for the
Registrable Securities.
(m) Use its best efforts to cause all Registrable Securities
covered by such Registration Statement to be authorized to be quoted on the
NASDAQ/NMS or listed on a national securities exchange.
(n) Enter into such agreements (including an underwriting
agreement in form, scope and substance as is customary in Underwritten
Offerings) and take all such other actions reasonably requested by the Holders
of a majority of the Registrable Securities being sold in connection
therewith (including those reasonably requested by the managing Underwriters, if
any) in order to expedite or facilitate the disposition of such Registrable
Securities, and in such connection, whether or not an
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underwriting agreement is entered into and whether or not the registration is an
Underwritten Offering, (i) make such representations and warranties to the
Holders of such Registrable Securities and the Underwriters, if any, with
respect to the business of the Company and its subsidiaries, and the
Registration Statement, Prospectus and documents, if any, incorporated or
deemed to be incorporated by reference therein, in each case, in form, substance
and scope as are customarily made by issuers to Underwriters in Underwritten
Offerings, and, if true, confirm the same if and when requested in writing to do
so, (ii) use its reasonable efforts to obtain opinions of counsel to the Company
and updates thereof (wich counsel and opinions [in form, scope and substance]
shall be reasonably satisfactory to the managing Underwriters, if any, and
counsel to the Holders of Registrable Securities being sold), addressed to each
selling Holder and each of the Underwriters, if any, covering the matters
customarily covered in opinions requested in Underwritten Offerings and such
other matters as may be reasonably requested in writing by such counsel and
Underwriters, (iii) use its reasonable efforts to obtain "cold comfort" letters
and updates thereof from the independent certified public accountants of the
Company (and, if necessary, any other independent certified public accountants
of any subsidiary of the Company or of any business acquired by the Company for
which financial statements and financial data are, or are required to be,
included in the Registration Statement), addressed to each selling Holder
(unless such accountants shall be prohibited from so addressing such letters by
applicable standards of the accounting profession) and each of the Underwriters,
if any, such letters to be in customary form and covering matters of the type
customarily covered in "cold comfort" letters in connection with Underwritten
Offerings, (iv) if an underwriting agreement is entered into, the same shall
contain indemnification provisions and procedures substantially to the effect
set forth in Section 8 hereof with respect to all parties to be indemnified
pursuant to Section 8 and (v) deliver such additional documents and certificates
as may be reasonably requested by the Holders of a majority of the Registrable
Securities being sold, their counsel and the managing Underwriters, if any, to
evidence the continued validity of the representations and warranties made
pursuant to Section 6.1(n)(i) above and to evidence compliance with any
customary conditions contained in the underwriting agreement or other agreement
entered into by the Company. The above shall be done at each closing under such
underwriting or similar agreement, or as and to the extent required thereunder.
(o) Make available for inspection by a representative of the
Holders of registrable Securities being sold, any Underwriter participating in
any such disposition of Registrable Securities, if any, and any attorney or
accountant retained by such selling Holder or Underwriter, at the offices where
normally kept, during reasonable business hours, all financial and other
records, pertinent corporate documents and properties of the Company and its
subsidiaries, and cause the officers, directors and employees of the Company and
its subsidiaries to supply all information reasonably requested by any such
representative, Underwriter, attorney or accountant in connection with such
Registration Statement; provided, however, that any information that is
designated by the Company in writing as confidential at the time of delivery of
such information shall be kept confidential by such Persons unless (i)
disclosure of such
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information is required by court or administrative order, (ii) disclosure of
such information, in the opinion of counsel to such Person, is required by law,
or (iii) such information becomes generally available to the public other than
as a result of a disclosure or failure to safeguard by such Person. Without
limiting the foregoing, no such information shall be used by such Person as the
basis for any market transactions in securities of the Company or its
subsidiaries in violation of law.
(p) Comply with all applicable rules and regulations of the SEC
and make generally available to its security Holders earning statements
satisfying the provisions of Section 11(a) of the Securities Act and Rule 158
thereunder, or any similar rule promulgated under the Securities Act, no later
than forty-five (45) days after the end of any twelve (12) month period (or
ninety (90) days after the end of any twelve (12) month period if such period is
a fiscal year) (i) commencing at the end of any fiscal quarter in which
Registrable Securities are sold to Underwriters in a firm commitment or best
efforts Underwritten Offering, and (ii) if not sold Underwriters in such an
offering, commencing on the first day of the first fiscal quarter of the Company
after the effective date of a Registration Statement, which statements shall
cover such twelve (12) month periods.
(q) Make every reasonable effort to obtain the withdrawal of any
order suspending the effectiveness of the Shelf Registration Statement at the
earliest possible moment.
(r) Cooperate and assist in any filings required to be made with
the NASD and in the performance of any due diligence investigation by any
Underwriter (including and "qualified independent Underwriter" that is required
to be retained in accordance with the rules and regulations of the NASD).
6.2 The Company may require each seller of Registrable Securities as
to which any registration is being effected to furnish to the Company such
information regarding such seller and the distribution of such Registrable
Securities as the Company may, from time to time, reasonably request in writing
and the Company may exclude from such registration the Registrable Securities of
any seller who unreasonably fails to furnish such information within a
reasonable time after receiving such request.
6.3 Each Holder agrees by acquisition of such Registrable Securities
that, upon receipt of any notice from the Company of the happening of any event
of the kind described in any of Sections 6.1(c)(ii), 6.1(c)(iii), 6.1(c)(v) or
6.1(c)(vi) hereof, such Holder will forthwith discontinue disposition of such
Registrable Securities covered by such Registration Statement or Prospectus
until such Holder's receipt of the copies of the supplemental or amended
Prospectus contemplated by Section 6.1(k) hereof, or until such Holder is
advised in writing by the Company that the use of the applicable Prospectus may
be resumed and such Holder has received copies of any additional or supplemental
filings that are incorporated or deemed to be incorporated by reference in such
Prospectus.
<PAGE>
SECTION 7
REGISTRATION EXPENSES
7.1 All expenses incident to the Company's performance of or
compliance with this Agreement will be borne by the Company, regardless to
whether a Registration Statement filed pursuant to Sections 3 or 4 hereof
becomes effective, including without limitation:
(a) all registration and filing fees and expenses associated
therewith;
(b) fees and expenses of compliance with federal securities or
state Blue Sky laws (including fees and disbursements of counsel for the
Underwriters or selling Holders in connection with Blue Sky qualifications of
the Registrable Securities pursuant to Section 6.1(h) hereof);
(c) expenses of printing (including, without limitation,
expenses of printing or engraving certificates for the Registrable Securities in
a form eligible for deposit with The Depositary Trust Company and of printing
Prospectuses), messenger and delivery services and telephone;
(d) reasonable fees and disbursements of counsel for the Company
and for the Holders of Registrable Securities (subject to the provisions of
Section 7.2 hereof);
(e) fees and disbursements of all independent certified public
accountants of the Company (including the expenses of any special audit and
"cold comfort" letters required by or incident to such performance);
(f) fees and expenses associated with any NASD filing required
to be made in connection with a Registration Statement, including, if
applicable, the fees and expenses of any "qualified independent Underwriter"
(and its counsel) that is required to be retained in accordance with the rules
and regulations of the NASD; and
(g) fees and expenses of listing the Registrable Securities on
any securities exchange or quotation system in accordance with Section 6.1(m)
hereof. All such expenses being herein called "Registration Expenses."
The Company will, in any event, bear its internal expenses (including,
without limitation, all salaries and expenses of its officers and employees
performing legal or accounting duties), the expense of any annual audit, rating
agency fees and the fees and expenses of any Person, including special experts,
retained by the Company. The Holders of Registrable Securities shall bear the
expense of any broker's commission or Underwriters' discount or commission.
4
<PAGE>
7.2 In connection with the Registration Statement, the Company will
reimburse the Holders of Registrable Securities being registered pursuant to
such Registration Statement for the fees and disbursements of not more than one
counsel chosen by a majority of the Holders of the Registrable Securities to be
included in the Registration Statement; provided, however, that in the case of
an Underwritten Offering which includes shares of Common Stock, such counsel
shall be chosen by the Holders of a majority of the shares of Commons Stock to
be included in such Underwritten Offering. Notwithstanding the provisions of
this Section 7, each Holder shall pay all registration expenses to the extent
required by applicable law.
SECTION 8
INDEMNIFICATION
8.1 The Company agrees to indemnify and hold harmless each Holder
(each such Holder an "Indemnified Holder") and in the case of an Underwritten
Offering, each Underwriter participating in the distribution (each such
Underwriter an "Indemnified Underwriter") and each person that controls each
Indemnification Holder or Indemnified Underwriter within the meaning of Section
15 of the Securities Act or Section 20 of the Exchange Act, and agents,
employees, officers and directors of such Indemnified Holder or Indemnified
Underwriter or of any such controlling person of any Indemnified Holder or
Indemnified Underwriter from and against any and all losses, claims, damages,
judgments, liabilities and expenses (including the reasonable fees and expenses
of counsel and other expenses in connection with investigating, defending or
settling any such action or claim) as they are incurred arising out of or based
upon any untrue statement or alleged untrue statement of a material fact
contained in any Registration Statement or the Prospectus (as amended or
supplemented if the Company shall have furnished any amendments or supplements
thereto) or any preliminary Prospectus or arising out of or based upon any
omission or alleged omission to state therein a material fact required to be
stated therein or necessary to make the statements therein not misleading,
except (i) the Company shall not be liable to any Indemnified Holder or
Indemnified Underwriter in any such case insofar as such losses, claims,
damages, judgments, liabilities or expenses arise out of, or are based upon, any
such untrue statement or omission or alleged untrue statement or omission based
upon information relating to such Indemnified Holder or Indemnified Underwriter
furnished in writing by such Indemnified Holder or Indemnified Underwriter to
the Company expressly for use therein, and (ii) the Company shall not be liable
to any Indemnified Holder or Indemnifed Underwriter in this Section 8.1 with
respect to any preliminary Prospectus to the extent that any such loss, claim,
damage, judgment, liability or expense results sole from the fact that any
Indemnified Holder or Indemnified Underwriter sold Registrable Securities to a
person to whom there was not sent or given, at or prior to the written
confirmation of such sale, a copy of the Prospectus as then amended or
supplemented provided the Company previously furnished sufficient copies thereof
to the Indemnified Holder or Indemnified Underwriter.
15
<PAGE>
8.2 If any action or proceeding (including any governmental or
regulatory investigation or proceeding) shall be brought or asserted against any
Indemnified Holder or Indemnified Underwriter with respect to which indemnity
may be sought against the Company pursuant to Section 8.1, such Indemnified
Holder or Indemnified Underwriter shall promptly notify the Company in writing,
and the Company shall have the right to assume the defense thereof, including
the employment of counsel reasonably satisfactory to such Indemnified Holder or
Indemnified Underwriter and the Company shall be responsible for the payment of
all fees and expenses; provided, however, that the omission so to notify the
Company shall not relieve the Company from any liability that it may have to any
Indemnified Holder or Indemnified Underwriter (except to the extent that the
Company is materially prejudiced or otherwise forfeits substantive rights or
defenses by reason of such failure). An Indemnified Holder or Indemnified
Underwriter shall have the right to employ separate counsel in any such action
or proceeding and to participate in the defense thereof, but the fees and
expenses of such counsel shall be at the expense of such Indemnified Holder or
Indemnified Underwriter unless (i) the Company agrees in writing to pay such
fees and expenses, (ii) the Company has failed promptly to assume the defense
and employ counsel satisfactory to the Indemnified Holder or Indemnified
Underwriter or (iii) the named parties to any such action or proceeding
(including any impleaded parties) include both the Indemnified Holder or
Indemnified Underwriter and the Company and such Indemnified Holder or
Indemnified Underwriter shall have been advised in writing by its counsel that
representation of them and the Company by the same counsel would be
inappropriate under applicable standards of professional conduct (whether or not
such representation has been proposed) due to actual or potential differing
interests between them (in which case the Company shall not have the right to
assume the defense of such action on behalf of such Indemnified Holder or
Indemnified Underwriter). It is understood that the Company shall not, in
connection with any one such action or separate but substantially similar or
related actions in the same jurisdiction arising out of the same general
allegations or circumstances, be liable for the fees and expenses of more than
one separate firm of attorneys (in addition to any local counsel) at any time
for such Indemnified Holders or Indemnified Underwriters, which firm shall be
designated in writing by the majority of the Holders of the Registrable
Securities on behalf of the Holders of all of the Registrable Securities, and
that all such fees and expenses shall be reimbursed as they are incurred. The
Company shall not be liable for any settlement of any such action effected
without the written consent of the Company (which shall not be unreasonably
withheld), but if settled with the written consent of the Company, or if there
is a final judgment with respect thereto, the Company agrees to indemnify and
hold harmless each Indemnified Holder or Indemnified Underwriter from and
against any loss or liability by reason of such settlement or judgment. The
Company shall not, without the prior written consent of each Indemnified Holder
or Indemnified Underwriter affected thereby, effect any settlement of any
pending or threatened proceeding in which such Indemnified Holder or Indemnified
Underwriter has sought indemnity hereunder, unless such settlement includes an
unconditional release of such Indemnified Holder or Indemnified Underwriter from
all liability arising out of such action, claim , litigation or proceeding.
16
<PAGE>
8.3 Each Holder and Underwriter agrees to indemnify and hold harmless
the Company, its directors, its officers who sign the Registration Statement
and any person controlling the Company within the meaning of Section 15 of the
Securities Act or Section 20 of the Exchange Act (collectively, the "Company
Indemnified Parties") to the same extent as the foregoing indemnity from the
Company to any Indemnified Holder or Indemnified Underwriter, but only with
respect to information relating to such Holder or Underwriter furnished to the
Company in writing by each Holder or Underwriter, respectively, expressly for
use in the Registration Statement, Prospectus (or any amendment of supplement
thereto), or any preliminary Prospectus, and only to the extent of the net
proceeds received by the Holder and Underwriter, respectively. In case any
action shall be brought against any Company Indemnified Party based on the
Registration Statement, Prospectus (or any amendment of supplement thereto), or
any preliminary Prospectus and in respect of which indemnification may be
sought against each Holder and Underwriter pursuant to this Section 8.3, each
Holder and Underwriter shall have the rights and duties given to the Company by
Section 8.1 (except that if the Company shall have assumed the defense thereof,
each Holder and Underwriter may, but shall not be required to, employ separate
counsel therein and participate in the defense thereof and the fees and expenses
of such counsel shall be at the expense of the Holder or Underwriter) and the
Company Indemnified Parties shall have the rights and duties given to the
Indemnified Holders or Indemnified Underwriters by Section 8.2.
8.4 If the indemnification provided for in this Section 8 is
unavailable to any party entitled to indemnification pursuant to Section 8.1 or
8.3, then each indemnifying party, in lieu of indemnifying such indemnified
party, shall contribute to the amount paid or payable by such indemnified party
as a result of such losses, claims, damages, judgments, liabilities and expenses
(i) in such proportion as is appropriate to reflect the relative benefits
received by the Company on the one hand and each Indemnified Holder or
Indemnified Underwriter on the other from the offering of the Registrable
Securities or (ii) if the allocation provided by clause (i) above is not
permitted by applicable law, in such proportion as is appropriate to reflect not
only the relative benefits referred to in clause (i) above but also the relative
fault of the Company on the one hand and each Indemnified Holder or Indemnified
Underwriter on the other in connection with the statements or omissions which
resulted in such losses, claims, damages, judgments, liabilities or expenses, as
well as any other relevant equitable considerations, but with respect to the
Holders and the Underwriter, only to the extent of the net proceeds received by
each, respectively. The relative benefits received by the Company on the one
hand and each Indemnified Holder or Indemnified Underwriter on the other shall
be deemed to be in the same proportions as the total net proceeds from the
offering (before deducting expenses) received by the Company and each
Indemnified Holder bear to each other and to the total net discounts and
commissions received by the Indemnified Underwriter, in each case as set forth
in the table on the cover page of the Prospectus. The relative fault of the
Company on the one hand and each Indemnified Holder and Indemnified Underwriter
on the other shall be determined by reference to, among other things, whether
the untrue or alleged untrue statement of a material fact or the omission or
alleged omission to state a material fact relates to
17
<PAGE>
information supplied by the Company on the one hand or by each Indemnified
Holder and Indemnified Underwriter on the other and the parties' relative
intent, knowledge, access to information and opportunity to correct or prevent
such statement or omission.
8.5 The Company and each Indemnified Holder and Indemnified
Underwriter agree that it would not be just and equitable if contribution
pursuant to Section 8.4 were determined by pro rata allocation or by any other
method of allocation that does not take account of the equitable considerations
referred to in Section 8.4. The amount paid or payable by an indemnified party
as a result of the losses, claims, damages, liabilities or expenses referred to
in the immediately preceding paragraph shall be deemed to include, subject to
the limitations set forth above, any legal or other expenses reasonably incurred
by such indemnified party in connection with investigating or defending any such
action or claim. No person found guilty of fraudulent misrepresentation (within
the meaning of Section 11(f) of the Securities Act) shall be entitled to
contribution from any person who was not found guilty of such fraudulent
misrepresentation.
8.6 The indemnity and contribution agreements contained in this
Section 8 are in addition to any liability that any indemnifying party may
otherwise have to any indemnified party.
SECTION 9
RULE 144A
The Company hereby agrees with each Holder, for so long as any
Registrable Securities remain outstanding and during any period in which the
Company is not subject to Section 13 or 15(d) of the Exchange Act, to make
available to the Initial Purchasers or any beneficial owner of such Registrable
Securities in connection with any sale thereof and any prospective purchaser of
such Registrable Securities from such Initial Purchaser or beneficial owner, the
information required by Rule 144A(d)(4) under the Act in order to permit
resales of such Registrable Securities pursuant to Rule 144A.
SECTION 10
PARTICIPATION IN UNDERWRITTEN REGISTRATIONS
No Holder may participate in any Underwritten Offering hereunder
unless such Holder (a) agrees to sell such Holder's Registrable Securities on
the basis provided in any underwriting arrangements approved by the Persons
entitled hereunder to approve such arrangements, (b) completes and executes all
questionnaires, powers of attorney, indemnities, underwriting agreements,
hold-back agreements and other documents required under the terms of such
underwriting arrangements and (c) furnishes the Company in writing information
in accordance with Section 3.4 and agrees to indemnify and hold harmless the
Company, its directors, its officers who sign the Registration Statement and
any person controlling the Company within the meaning of Section 15 of the
Securities Act or Section 20 of the Exchange Act as contemplated by Section 8.3.
18
<PAGE>
SECTION 11
SELECTION OF UNDERWRITERS
The Holders of Registrable Securities covered by a Registration
Statement filed pursuant to Section 3 herein, who desire to do so, may sell such
Registrable Securities in an Underwritten Offering. In any such Underwritten
Offering, the Underwriter(s) that will administer the offering will be selected
by the Holders of Registrable Securities included in such offering holding a
majority in interest of the Registrable Securities included in such offering;
provided, however, that such Underwriters must be reasonably satisfactory to the
Company.
SECTION 12
MISCELLANEOUS
12.1 Remedies. Each Holder, in addition to being entitled to exercise
--------
all rights provided herein, and as provided in the Purchase Terms Agreement and
granted by law, including recovery of damages, will be entitled to specific
performance of such Holder's rights under this Agreement. The Company agrees
that monetary damages would not be adequate compensation for any loss incurred
by reason of a breach by it of the provisions of this Agreement and hereby
agrees to waive the defense in any action for specific performance that a remedy
at law would be adequate.
12.2 No Inconsistent Agreements. The Company will not on or after the
--------------------------
date of this Agreement enter into any agreement with respect to its securities
that is inconsistent with the rights granted to the Holders of Registrable
Securities in this Agreement or otherwise conflicts with the provisions hereof.
The rights granted to the Holders of Registrable Securities hereunder do not in
any way conflict with and are not inconsistent with the rights granted to the
Holders of the Company's securities under any other agreements.
12.3 Amendments and Waivers. The provisions of this Agreement,
----------------------
including the provisions of this sentence, may not be amended, modified or
supplemented, and waivers or consents to departures from the provisions hereof
may not be given unless the Company has obtained the written consent of Holders
of at least 66-2/3% of the Registrable Securities affected by such amendment,
modification, supplement, waiver or departure. Notwithstanding the foregoing, a
waiver or consent to departure from the provisions hereof that relates
exclusively to the rights of Holders of Registrable Securities whose securities
are being sold pursuant to a Registration Statement and that does not directly
or indirectly affect the rights of other Holders of Registrable Securities shall
be valid only with the written consent of Holders of at least 66-2/3% of the
Registrable Securities being sold, in each case calculated in accordance with
the provisions of Section 3.2.
12.4 Notices. All notices and other communications provided for or
-------
permitted hereunder shall be made in writing by hand-delivery, first-class mail
19
<PAGE>
(registered or certified, return receipt requested), telex, telecopier, or air
courier guaranteeing overnight delivery:
(a) if to a Holder, at the most current address given by such
Holder to the Company;
(b) if to the Placement Agent, to Stifel, Nicolaus & Company,
Incorporated, 500 North Broadway, Suite 1500, St. Louis, Missouri 63102,
attention: Rick E. Maples, with a copy to O'Melveny & Myers LLP, 275 Battery
Street, San Francisco, California 94111, attention: Peter T. Healy, Esq. and
(c) if to the Company, to NovaStar Financial, Inc., 1900 W.
47th Place, Westwood, Kansas 66205, attention: Mr. Scott F. Hartman, with a copy
to Tobin & Tobin, One Montgomery Street, Fifteenth Floor, San Francisco,
California 94104, attention: Phillip R. Pollock, Esq.
All such notices and communications shall be deemed to have been duly
given: at the time delivered by hand, if personally delivered; five business
days after being deposited in the mail, postage prepaid, if mailed; when
answered back, if telexed; when receipt acknowledged, if telecopied; and on the
next business day, if timely delivered to an air courier guaranteeing overnight
delivery. The Placement Agent, the Company, any Holder and their respective
counsel may change their respective notice addresses from time to time by
written notice to all of the foregoing persons.
12.5 Successors and Assigns. This Agreement shall inure to the
----------------------
benefit of and be binding upon the successors and assigns of each of the
parties, including without limitation and without the need for an express
assignment, Initial Purchasers and subsequent Holders of Registrable Securities;
provided, however, that this Agreement shall not inure to the benefit of or be
binding upon a successor or assign of a Holder unless and to the extent such
successor or assign acquired Registrable Securities from such Holder; and
provided further that nothing herein shall be deemed to permit any assignment,
transfer or any disposition of Registrable Securities in violation of the terms
of the Private Placement Memorandum or applicable law. If any transferee of any
Holder shall acquire Registrable Securities, in any manner, whether by operation
of law or otherwise, such Registrable Securities shall be held subject to all of
the terms of this Agreement and by taking and holding such Registrable
Securities such person shall be conclusively seemed to have agreed to be bound
by and to perform all of the terms and provisions of this Agreement and such
Person shall be entitled to receive the benefits hereof.
12.6 Counterparts. This Agreement may be executed in any number of
------------
counterparts and by the parties hereto in separate counterparts, each of which
when so executed shall be deemed to be an original and all of which taken
together shall constitute one and the same agreement.
20
<PAGE>
12.7 Headings. The headings in this Agreement are for
--------
convenience of reference only and shall not limit or otherwise affect the
meaning hereof.
12.8 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND
-------------
CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REGARD TO
THE CONFLICT OF LAW RULES THEREOF.
12.9 Waiver of Trial by Jury. The Company, the Placement Agent,
-----------------------
and each of the Holders hereby irrevocably waive any right they may have to a
trial by jury in any action, suit or proceeding brought to enforce or defend any
rights or remedies arising under or in connection with this Agreement, or the
transactions contemplated hereby, whether grounded in tort, contract or
otherwise.
12.10 Severability. In the event that any one or more of the
------------
provisions contained herein, or the application thereof in any circumstance, is
held invalid, illegal or unenforceable, the validity, legality and
enforceability of any such provision in every other respect and of the remaining
provisions contained herein shall not be affected or impaired thereby.
12.11 Entire Agreement. This Agreement together with the other
----------------
Operative Documents (as defined in the Purchase Terms Agreement) is intended by
the parties as a final expression of their agreement and intended to be a
complete and exclusive statement of the agreement and understanding of the
parties hereto in respect of the subject matter contained herein. There are no
restrictions, promises, warranties or undertakings, other than those set forth
in the Private Placement Memorandum or referred to herein with respect to the
registration rights granted by the Company with respect to the securities sold
pursuant to the Private Placement Memorandum. This Agreement supersedes all
prior agreements and understandings between the parties with respect to such
subject matter.
12.12 Benefit, Obligations and Duties. The Placement Agent has
-------------------------------
entered into this Agreement as a matter of convenience only pursuant to Section
1.4 of the Subscription Agreement and shall have no obligations or duties under
this Agreement to either the Company or any Holder. The Placement Agent
undertakes no responsibility of any kind, including any fiduciary
responsibility, on behalf of any Holder and is not acting on any Holder's
behalf. The Placement Agent does not intend to exercise any rights on behalf of
any Holder. This Agreement shall not give any Holder or the Company any rights
with regard to or claims against the Placement Agent. All of the
21
<PAGE>
rights, duties and obligations of any Holder shall inure directly to the benefit
or detriment of such Holder.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first written above.
NOVASTAR FINANCIAL, INC.,
a Maryland corporation
By:/s/ Scott F. Hartman
--------------------------
Its: Secretary
---------------------
STIFEL, NICOLAUS & COMPANY,
INCORPORATED
By:[SIGNATURE ILLEGIBLE]
--------------------------
Its: VP
---------------------
The undersigned sign this Agreement in their
individual capacity for the purpose of being
bound by Section 4.3 hereof.
/s/ Scott F. Hartman
- -------------------------------
Scott F. Hartman
_______________________________
W. Lance Anderson
22
<PAGE>
EXHIBIT 10.3
NOVASTAR FINANCIAL, INC.
WARRANT AGREEMENT
This WARRANT AGREEMENT (the "Agreement"), dated as of December 9,
1996, is made by and between NovaStar Financial, Inc., a Maryland corporation
(the "Company"), as issuer of the Warrants, and the Holders of the Warrants
acting through the Company as the initial warrant agent (together with successor
warrant agents, if any, the "Warrant Agent").
WHEREAS, the Company and the Warrant Agent desire to set forth certain
terms and instructions regarding the issuance, division, transfer and exercise
of the Company's Stock Purchase Warrants (the "Warrants"), to be issued to (i)
each Initial Purchaser of the Units in the Offering (as hereinafter defined) and
(ii) the Placement Agent, as partial payment of its sales fee;
NOW, THEREFORE, in consideration of the mutual agreements contained
herein, and for other good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, the parties hereto, intending to be
legally bound hereby, agree as follows:
SECTION 1. CERTAIN DEFINITIONS
Unless the context otherwise requires, the terms set forth below shall
have the meanings herein specified:
"Affiliate" of any specified Person means any other Person, which,
---------
directly or indirectly, controls, is controlled by or is under direct or
indirect common control with, such specified Person. For the purposes of this
definition, "control" when used with respect to any Person means the power to
direct or cause the direction of the management or policies of such Person,
directly or indirectly, whether through the ownership of voting securities, by
contract or otherwise, and the terms "controlling" and "controlled" have
meanings correlative to the foregoing.
"Common Stock" shall mean the Common Stock, par value $.01 per share,
------------
of the Company.
"Conversion Event" means, with respect to each share of Preferred
----------------
Stock, the conversion thereof into Common Stock upon the first to occur of (i)
the closing of a firm commitment underwritten initial public offering of Common
Stock resulting in aggregate gross proceeds to the Company of at least $20
million and at a price per share of at least $15 or such lesser amount of
proceeds and/or lower price per share as may be approved by two-thirds of the
voting power of the Preferred Stock, or (ii) at any time after three years from
the last closing of the Offering, upon the election of the holder.
"Conversion Exercise Price" shall initially mean $15 per share of
-------------------------
Common Stock, and shall be adjusted and readjusted from time to time in
accordance with the provisions of Section 9.1 of this Agreement.
1
<PAGE>
"Current Price" with respect to any security on any day shall mean the
-------------
closing sale price, regular way, on such day or, in case no such sale takes
place on such day, the average of the reported closing bid and asked prices,
regular way, in each case on the Nasdaq National Market or if such security is
not quoted on the Nasdaq National Market, on the principal national securities
exchange or quotation system on which such security is quoted or listed or
admitted to trading or, if not quoted or listed or admitted to trading on any
national securities exchange or quotation system, the average of the closing bid
and asked prices of such security on the over-the-counter market on the day in
question as reported by the National Quotation Bureau Incorporated, or a similar
generally accepted reporting service, or, if the security is not publicly
traded, a price determined reasonably and in good faith by the Board of
Directors including a majority of the Independent Directors (such determination
to be conclusive and evidenced in a resolution adopted by the Board of
Directors).
"Detachment Date" shall have the meaning set forth in Section 3.2
---------------
hereof.
"Document Supplement" shall mean the package furnished to each
-------------------
purchaser of Units in the Offering containing the Amended and Restated Articles
of Incorporation of the Company, the Articles Supplementary for the Preferred
Stock, the form of this Agreement, the form of Warrant, the form of Purchase
Terms Agreement and the form of Registration Rights Agreement.
"Exercise Price" shall mean $15 per Warrant, provided, however, that
-------------- -------- -------
the Company reserves the right to reduce such price at any time following a
Qualified IPO, in its sole discretion and for such limited periods as it may
from time to time determine, upon no less than 10 days nor more than 60 days
prior written notice to the Holders, provided, however, that no such reduction
may be effected without the approval of a majority of the Independent Directors.
"Expiration Date" shall mean 5:00 p.m. Eastern Standard Time on the
---------------
third anniversary of the date the Warrants become exercisable.
"Founders" means W. Lance Anderson and Scott F. Hartman.
--------
"Fundamental Change" means, with respect to the Company, the
------------------
occurrence of any transaction to which the Company is a party pursuant to which
a majority of the Preferred Stock or Common Stock is converted into the right to
receive other securities, cash or other property (including without limitation
any consolidation of the Company with, or merger of the Company into, any other
Person, any merger of another Person into the Company (other than a merger which
does not result in a reclassification, conversion, exchange or cancellation of
outstanding shares of Preferred Stock or Common Stock of the Company), a
Liquidation of the Company or any sale or transfer of all or substantially all
of the assets of the Company or any compulsory share exchange), or any
reclassification of the Company's Common Stock pursuant to which stockholders
receive any cash or property other than shares of its capital stock, but
excluding the conversion of the Preferred Stock into Common Stock pursuant to a
Conversion Event.
"Holder" shall mean a registered owner of the Warrants.
------
"Independent Directors" shall have the meaning set forth in the
---------------------
Company's Bylaws.
2
<PAGE>
"Initial Purchaser" shall mean a purchaser of Units directly from the
-----------------
Company in the Offering and the Founders.
"Liquidation" shall mean the voluntary or involuntary liquidation,
-----------
dissolution or winding up of the affairs of the Company.
"Nasdaq National Market" shall mean the National Market System of the
----------------------
National Association of Securities Dealers, Inc.
"Offering" shall mean the offering of the Units by the Company
--------
pursuant to the Private Placement Memorandum and the Purchase Terms Agreement.
"Person" means any individual, corporation, limited liability company,
------
partnership, joint venture, association, business trust, joint-stock company,
trust, unincorporated organization or government or agency or political
subdivision thereof.
"Placement Agent" shall mean Stifel, Nicolaus & Company, Incorporated.
---------------
"Preferred Stock" means the Company's Class A Convertible Preferred
---------------
Stock, par value $.01 per share.
"Private Placement Memorandum" means the Private Placement Memorandum,
----------------------------
dated October 15, 1996, as supplemented on November ___, 1996, the Document
Supplement and all other amendments and supplements thereto, pursuant to which
the Company is offering for sale up to 3,333,333 Units.
"Purchase Terms Agreement" shall mean the Purchase Terms Agreement,
------------------------
dated ___________, 1996, by and between the Company and the Placement Agent.
"Purchase Warrant" shall mean the Warrants being acquired by the
----------------
Initial Purchasers as part of the Units.
"Qualified IPO" shall mean a firm commitment underwritten initial
-------------
public offering of Common Stock resulting in aggregate gross proceeds to the
Company of at least $20 million and at a price per share of at least $15 or such
lesser amount of proceeds and/or lower price per share as may be approved by
two-thirds of the voting power of the Preferred Stock.
"Registration Rights Agreement" shall mean the Registration Rights
-----------------------------
Agreement, dated December 9, 1996, by and between the Company and the Placement
Agent.
"SEC" shall mean the Securities and Exchange Commission.
---
"Securities Act" shall mean the Securities Act of 1933, as amended,
--------------
and the rules and regulations of the SEC promulgated thereunder.
"Shelf Registration Statement" shall mean the shelf registration
----------------------------
statement to be filed with the SEC pursuant to Rule 415 under the Securities Act
as required by the Registration Rights Agreement.
3
<PAGE>
"Start Date" shall have the meaning set forth in Section 4.1 hereof.
----------
"Trading Day" shall mean (x) if the applicable security is quoted on
-----------
the Nasdaq National Market, a day on which a trade may be made on the Nasdaq
National Market, (y) if the applicable security is listed or admitted for
trading on the national securities exchange, a day on which such national
securities exchange is open for business or (z) if the applicable security is
not otherwise listed, admitted for trading or quoted, any day other than a
Saturday or Sunday or a day on which banking institutions in the State of New
York are authorized or obligated by law or executive order to close.
"Unit" shall mean a unit consisting of one share of Preferred Stock
----
and one Warrant.
"Warrant" shall mean each Stock Purchase Warrant issued hereunder.
-------
"Warrant Certificate" shall having the meaning set forth in Section
-------------------
2.1 hereof.
"Warrant Shares" shall mean the shares of Common Stock and other
--------------
consideration, if any, issuable upon exercise of the Warrants, as determined in
accordance with the terms hereof.
SECTION 2. WARRANT CERTIFICATES
2.1 Form of Certificates. Prior to the Detachment Date, beneficial
--------------------
ownership of each Purchased Warrant shall be evidenced by the Preferred Stock
certificate to which such Warrant relates bearing the legend set forth in
Section 2.3(a) hereof. Following the Detachment Date, upon tender of the
Preferred Stock certificate bearing the legend set forth in Section 2.3(a)
hereof, a certificate evidencing the related Warrants (the "Warrant
Certificate") shall be issued to the record owner of the Preferred Stock
certificate substantially in the form set forth as Exhibit A hereto, which
Warrant Certificate for the related Warrants shall be marked with the legend set
forth in Section 2.3(b) hereof. The Warrants being acquired by the Placement
Agent shall be evidenced by Warrant Certificates issued on the closing date or
dates for issuance of Units. The Warrant Certificate may have such letters,
numbers or other marks of identification or designation and such legends,
summaries or endorsements printed, lithographed or engraved thereon as the
Company may deem appropriate and as are not inconsistent with the provisions of
this Agreement, or as may be required to comply with any law, or with any rule
or regulation made pursuant thereto, or with any rule or regulation of any stock
exchange on which the Preferred Stock, the Common Stock or the Warrants may be
listed, or any inter-dealer quotation system upon which the Preferred Stock, the
Common Stock or the Warrants may be quoted.
2.2 Execution. Warrant Certificates shall be executed on behalf of
---------
the Company by its Chairman of the Board, President, Executive or Senior Vice
President, and attested by its Secretary or an Assistant Secretary. The
signature of any of such officers may be manual or facsimile. Warrant
Certificates bearing the manual or facsimile signatures of individuals who were
at any time the proper officers of the Company shall bind the Company,
notwithstanding that any of such individuals shall have ceased to hold such
offices prior to the delivery of such Warrant Certificates or did not hold such
offices on the date of this Agreement.
2.3 Legend.
------
4
<PAGE>
(a) Prior to the Warrants becoming detached from the Preferred
Stock pursuant to Section 3.2, each Preferred Stock certificate to which a
Warrant is deemed to be attached shall carry a legend as follows:
THE SECURITIES REPRESENTED BY THIS CERTIFICATE INCLUDE THE BENEFICIAL OWNERSHIP
IN A STOCK PURCHASE WARRANT FOR THE LIKE NUMBER OF WARRANT SHARES AS THE NUMBER
OF SHARES OF PREFERRED STOCK SET FORTH ON THE FACE HEREOF, SUBJECT TO
ADJUSTMENTS AS SET FORTH IN THE WARRANT AGREEMENT GOVERNING THE WARRANTS, WHICH
STOCK PURCHASE WARRANT IS HELD BY THE WARRANT AGENT AND IS DEEMED TO BE ATTACHED
HERETO AND IS NOT DETACHABLE HEREFROM NOR EXERCISABLE EXCEPT AS SET FORTH IN THE
WARRANT AGREEMENT. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT
TO THE PROVISIONS AND ENTITLED TO THE BENEFITS OF SUCH WARRANT AGREEMENT, A COPY
OF WHICH IS ON FILE AT THE OFFICES OF THE COMPANY AND WILL BE MADE AVAILABLE TO
ANY STOCKHOLDER UPON REQUEST WITHOUT CHARGE. UPON DETACHMENT OF THE WARRANT
FOLLOWING THE DETACHMENT DATE, A SEPARATE PREFERRED STOCK CERTIFICATE AND A
WARRANT CERTIFICATE REPRESENTING OWNERSHIP OF THE PREFERRED STOCK AND STOCK
PURCHASE WARRANTS, RESPECTIVELY, EVIDENCED BY THIS PREFERRED STOCK CERTIFICATE
WILL BE ISSUED TO THE REGISTERED HOLDER OF THIS PREFERRED STOCK AGAINST TENDER
TO THE COMPANY OF THIS PREFERRED STOCK CERTIFICATE.
(b) A copy of this Agreement shall be filed with the Secretary of
the Company and shall be kept at its principal executive office. Each Warrant
Certificate shall carry a legend as follows:
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO THE PROVISIONS AND
ENTITLED TO THE BENEFITS OF A WARRANT AGREEMENT, DATED AS OF DECEMBER 9, 1996.
A COPY OF SUCH AGREEMENT IS ON FILE AT THE OFFICES OF THE COMPANY AND WILL BE
MADE AVAILABLE TO ANY WARRANTHOLDER UPON REQUEST WITHOUT CHARGE.
(c) So long as required thereunder, each Warrant Certificate
(including each Warrant Certificate issued upon the transfer or partial exercise
of any Warrant), each certificate for Common Stock issued upon the exercise of
any Warrant, and each certificate for Preferred Stock or Common Stock issued
upon the transfer of any such Preferred Stock or Common Stock shall be stamped
or otherwise imprinted with the legend required pursuant to Section 1.3 of the
Purchase Terms Agreement.
SECTION 3. OWNERSHIP, DETACHABILITY, TRANSFER AND EXCHANGE
3.1 Ownership. The Warrant Certificates following issuance shall be
---------
numbered and shall be registered in the books of the Company (the "Warrant
Register") maintained at the principal office of the Company at the address
specified in Section 14 hereof. The Company shall be entitled to treat the
Holder of any Warrant whose name appears in the Warrant Register (or Preferred
Stock register if beneficial ownership of the Warrants is represented by a
Preferred
5
<PAGE>
Stock certificate) as the owner in fact thereof for all purposes
(notwithstanding any notation of ownership or other writing thereon made by
anyone or any notice to the contrary).
3.2 Detachability. Each Warrant will become detachable from the
-------------
share of Preferred Stock offered together with such Warrant as a Unit in the
Offering upon the occurrence of a Conversion Event with respect to such share of
Preferred Stock (the "Detachment Date"). Accordingly, the Detachment Date may
be different for different Warrants, depending upon the date of the Conversion
Event for the related Preferred Stock. As used herein, the term "Detachment
Date" includes all such dates of detachment. In addition, the Detachment Date
for the Warrants being issued to the Placement Agent shall be deemed to be their
date of issuance.
3.3 Transfer. The Warrants shall be transferable only on the Warrant
--------
Register, upon delivery thereof, accompanied by a written instrument or
instruments of transfer in form reasonably acceptable to the Company, duly
executed by the registered Holder or Holders thereof or by the duly appointed
legal representative thereof or by a duly authorized attorney. Prior to the
Detachment Date, the Warrants shall be transferable only upon transfer of the
Preferred Stock to which they relate, upon delivery of the Preferred Stock
Certificate, accompanied by a written instrument or instruments of transfer in
form reasonably acceptable to the Company, duly executed by the registered
Holder or Holders thereof or by the duly appointed legal representative thereof
or by a duly authorized attorney. Upon any registration of transfer of
Warrants, the Company shall (i) issue and deliver a new Warrant Certificate (or
new Preferred Stock certificate if prior to the Detachment Date) evidencing the
Warrant or Warrants to the Person entitled thereto and (ii) cancel the
surrendered Warrant Certificate (or surrendered Preferred Stock certificate if
prior to the Detachment Date). If a Holder desires to transfer a Warrant
bearing legends required pursuant to Section 2.3(c) hereof (other than pursuant
to an effective registration statement under the Securities Act) such Holder may
be required to deliver to the Company a written opinion of counsel, reasonably
satisfactory in form and substance to the Company, that an exemption from the
registration requirements of the Securities Act is available.
3.4 Exchange.
--------
(a) Prior to the Detachment Date, each Preferred Stock
certificate evidencing a Warrant or Warrants may be exchanged at the option of
the Holder thereof for another Preferred Stock certificate or certificates of
like tenor and representing in the aggregate a like number of shares of
Preferred Stock and Warrants. Any Holder desiring to exchange such a Preferred
Stock certificate shall make such request in writing delivered to the Company,
and shall surrender the Preferred Stock certificate to be so exchanged at the
principal office of the Company. Thereupon, the Company shall (i) issue and
deliver to the Person entitled thereto a new Preferred Stock certificate or
certificates as so requested and (ii) cancel the Preferred Stock certificate
surrendered for exchange.
(b) On and after the Detachment Date, each Preferred Stock
certificate evidencing a Warrant or Warrants may be exchanged at the option of
the Holder thereof for (i) a Preferred Stock certificate or certificates not
evidencing a Warrant or Warrants and (ii) a Warrant Certificate or Certificates
representing in the aggregate a like number of Warrants evidenced by
6
<PAGE>
such surrendered Preferred Stock certificate. Any Holder desiring to exchange
such a Preferred Stock certificate shall make such request in writing delivered
to the Company, and shall surrender the Preferred Stock certificate to be so
exchanged at the principal office of the Company. Thereupon, the Company shall
(i) issue and deliver to the Person entitled thereto a new Preferred Stock
certificate or certificates and a new Warrant Certificate or Certificates as so
requested and (ii) cancel the Preferred Stock certificate surrendered for
exchange.
(c) Each Warrant Certificate may be exchanged at the option of
the Holder thereof for another Warrant Certificate or Certificates of like tenor
and representing in the aggregate a like number of Warrants. Any Holder desiring
to exchange a Warrant Certificate shall make such request in writing delivered
to the Company, and shall surrender the Warrant Certificate to be so exchanged
at the principal office of the Company. Thereupon, the Company shall (i) issue
and deliver to the Person entitled thereto a new Warrant Certificate or
Certificates as so requested and (ii) cancel the Warrant Certificate surrendered
for exchange.
SECTION 4. TERM OF WARRANTS; EXERCISE OF WARRANTS
4.1 Term of Warrants. Subject to the terms of this Agreement, each
----------------
Warrant may be exercised at any time beginning on the date (the "Start Date") of
the earlier to occur of (i) the effectiveness of the Shelf Registration
Statement, or (ii) six (6) months after the closing of a Qualified IPO, in whole
or in part, from time to time, at the option of the Holder thereof, until the
Expiration Date. Each Warrant, when exercised, will entitle the Holder thereof
to receive the number of Warrant Shares set forth on such Warrant upon payment
of the Exercise Price, provided, however, that the number of Warrant Shares
-------- -------
actually issued upon payment of the $15 exercise price shall be subject to
adjustment as set forth in Section 9.1.
4.2 Exercise of Warrants. Each Holder of a Warrant Certificate may
--------------------
exercise such related Warrants upon (i) surrender of the Warrant Certificate at
the principal office of the Company as identified in Section 14 hereof, with the
form of election to purchase on the reverse thereof duly completed and signed,
(ii) payment of the Exercise Price with respect to the Warrant Shares being
purchased, and (iii) if required pursuant to Section 5, an amount sufficient to
pay any transfer or similar tax (or evidence reasonably satisfactory to the
Company demonstrating that such taxes have been paid). Payment of the Exercise
Price may be made (a) in the form of cash or by certified or official bank check
payable to the order of the Company or (b) by surrendering additional Warrants
or shares of Common Stock for cancellation to the extent the Company may
lawfully accept shares of Common Stock, with the value of such shares of Common
Stock for such purpose to equal the average Current Market Price of the Common
Stock during the 10 Trading Days preceding the date surrendered and the value of
the Warrants to equal the difference between the value of a share of Common
Stock and the Exercise Price.
The Company shall, as soon as practicable after such surrender for
exercise of Warrant Certificates and compliance with the other conditions herein
contained, deliver at such offices of such transfer agent to the Person for whom
such Warrant Certificates are so surrendered, or to the nominee or nominees of
such Person, in its sole discretion, certificates evidencing the number of full
shares of Warrant Shares to which such Person shall be entitled, together with a
cash payment in respect of any fraction of a share of such Warrant Shares as
hereinafter provided.
7
<PAGE>
Subject to the following provisions of this paragraph, each exercise shall be
deemed to have been effected immediately prior to the close of business on the
date on which the Warrant Certificates to be exercised shall have been
surrendered together with the payment of the aggregate exercise price and taxes
(if applicable), all as provided in this Section 4.2, and the Person or Persons
entitled to receive the Warrant Shares deliverable upon exercise of such
Warrants shall be treated for all purposes as the record holder or holders of
such Warrant Shares at such time on such date, unless the stock transfer books
of the Company shall be closed on such date, in which event such Person or
Persons shall be deemed to have become such holder or holders of record at the
close of business on the next succeeding day on which such stock transfer books
are open, but such exercise shall be effected based on the Conversion Exercise
Price in effect on the date on which such Warrant Certificates shall have been
surrendered and the other conditions specified above have been satisfied. No
holder of Warrants shall have any rights as a holder of Warrant Shares (or any
other securities into which the Warrants may become exercisable) unless and
until such exercise has been effected.
If a Warrant Certificate is exercised in respect of less than all of
the Warrant Shares purchasable on such exercise at any time prior to the date of
expiration of the Warrants, a new Warrant Certificate evidencing the remaining
Warrant or Warrants will be issued to the Holder, or its nominee(s), without
charge therefor, and the Company shall issue and deliver the required new
Warrant Certificate or Certificates pursuant to the provisions of this Section
4 and of Section 3 hereof. All Warrant Certificates surrendered in the exercise
of the rights thereby evidenced shall be canceled.
Each Holder of a Warrant represented by a Preferred Stock certificate
may exercise such Warrant in the manner substantially similar as set forth above
by surrendering the Preferred Stock certificate in exchange for a Preferred
Stock certificate representing a like number of shares of Preferred Stock and
otherwise following the procedures set forth above.
4.3 No Fractional Shares. No fractional shares or scrip representing
--------------------
fractional shares of Common Stock shall be issued upon exercise of Warrants. If
more than one Warrant shall be surrendered for conversion at any one time by the
same Holder, the number of full shares of Warrant Shares issuable upon exercise
thereof shall be computed on the basis of the aggregate number of Warrants so
surrendered by such Holder as provided in Section 4.2. In lieu of any
fractional share of Warrant Shares that would otherwise be issuable upon
exercise of any Warrants, the Company shall pay a cash adjustment in respect of
such fractional share in an amount equal to the same fraction of the Current
Market Price of the Warrant Shares on the Trading Day immediately preceding the
date of exercise, calculated to the nearest cent, with one-half cent rounded
upward.
SECTION 5. PAYMENT OF TAXES
The Company shall pay any and all issue or other taxes that may be
payable in respect of any issue or delivery of Warrant Shares upon exercise of
the Warrants. The Company shall not, however, be required to pay any tax which
may be payable in respect of any transfer involved in the issue or delivery of
Warrants or Warrant Shares (or other securities or assets) in a name other than
that in which the Warrants so exercised were registered, and no such issue or
delivery shall
8
<PAGE>
be made unless and until the person requesting such issue has paid to the
Company the amount of such tax or has established, to the satisfaction of the
Company, that such tax has been paid.
SECTION 6. MUTILATED OR MISSING WARRANTS
If any Warrant Certificate (or Preferred Stock certificate
representing Warrants) shall be mutilated, lost, stolen or destroyed, the
Company shall issue and deliver in exchange and substitution for and upon
cancellation of the mutilated Warrant Certificate (or Preferred Stock
certificate representing Warrants), or in lieu of and substitution for the
Warrant Certificate (or Preferred Stock certificate representing Warrants) lost,
stolen or destroyed, and upon receipt of evidence to their reasonable
satisfaction of the destruction, loss or theft of any Warrant Certificate (or
Preferred Stock certificate representing Warrants) and such security or
indemnity as may reasonably be required by them to save each of them and any of
their agents harmless, to issue a new Warrant Certificate (or Preferred Stock
certificate representing Warrants) of like tenor and representing an equivalent
right or interest.
SECTION 7. RESERVATION OF WARRANT SHARES
The Company shall at all times reserve and keep available out of its
authorized and unissued stock, solely for the purpose of effecting the exercise
of the Warrants, such number of shares of its Common Stock free of preemptive
rights as shall from time to time be sufficient to effect the exercise of all
Warrants from time to time outstanding. The Company shall from time to time, in
accordance with the laws of the State of Maryland, increase the authorized
number of shares of Common Stock if at any time the number of shares of
authorized and unissued Common Stock shall not be sufficient to permit the
exercise of all the then outstanding Warrants.
The transfer agent for the Common Stock and every subsequent transfer
agent for any shares of the Company's capital stock issuable upon the exercise
of the Warrants shall be irrevocably authorized and directed at all times to
reserve the maximum number of authorized shares as shall be required for such
purpose. The Company shall keep a copy of this Agreement on file with the
transfer agent for the Common Stock and with every subsequent transfer agent for
any shares of the Company's capital stock issuable upon the exercise of the
Warrants.
Before taking any action that would cause an adjustment pursuant to
Section 9.1, the Company will take all corporate action that, in the opinion of
its counsel (which may be counsel employed by the Company), may be necessary in
order that the Company may validly and legally issue fully paid and
nonassessable Warrant Shares at the then applicable exercise price. The Company
covenants that all Warrant Shares issued upon exercise of the Warrants will,
upon issuance in accordance with the terms of this Agreement, be fully paid and
nonassessable and free from all taxes, liens, charges and security interests
with respect to the issuance thereof that may be created by virtue of any act or
omission of the Company.
SECTION 8. CANCELLATION OF WARRANTS
If the Company purchases or otherwise acquires Warrants, the same
shall thereupon be canceled. The Company shall cancel any Warrant surrendered
for exchange, substitution,
9
<PAGE>
transfer or exercise in whole or in part. Canceled Warrant Certificates shall
thereafter be disposed of in a manner satisfactory to the Company.
SECTION 9. ADJUSTMENTS
The number of Warrant Shares that the Holder of a Warrant shall be
entitled to receive upon each exercise thereof shall be determined by
multiplying the number of Warrant Shares that would otherwise (but for the
provisions of this Section 9) be issuable upon such exercise, as designated by
the Holder pursuant to Section 4.2 of this Agreement, by the fraction of which
(a) the numerator is $15 per share with respect to the Warrants and (b) the
denominator is the Conversion Exercise Price in effect on the date of such
exercise.
9.1 Adjustments to the Conversion Exercise Price.
--------------------------------------------
(a) Dividend of Common Stock. In the event that the Company shall
------------------------
pay or make a dividend or other distribution on its Common Stock exclusively in
Common Stock or shall pay or make a dividend or other distribution on any other
class or series of capital stock of the Company which includes Common Stock, the
Conversion Exercise Price, as in effect on the close of business on the date
fixed for the determination of stockholders entitled to receive such dividend or
other distribution, shall be reduced by multiplying such Conversion Exercise
Price by a fraction of which the numerator shall be the number of shares of
Common Stock outstanding at the close of business on the date fixed for such
determination and the denominator shall be the sum of such number of shares and
the total number of shares of Common Stock included in such dividend or other
distribution, such reduction to become effective immediately prior to the
opening of business on the day following the date fixed for such determination.
For the purpose of this subparagraph (b), the number of shares of Common Stock
at any time outstanding shall not include shares held in the treasury of the
Company and the number of shares of Common Stock included in such dividend or
other distribution shall be deemed not to include any shares issued or
distributed in respect of shares held in the treasury of the Company.
(b) Common Stock-Splits, etc. In case outstanding shares of
------------------------
Common Stock shall be subdivided into a greater number of shares of Common
Stock, the Conversion Exercise Price in effect at the close of business on the
day upon which such subdivision becomes effective shall be proportionately
reduced, and conversely, in case outstanding shares of Common Stock shall each
be combined into a smaller number of shares of Common Stock, the Conversion
Exercise Price in effect at the close of business on the day upon which such
combination becomes effective shall be proportionately increased, such reduction
or increase, as the case may be, to become effective immediately prior to the
opening of business on the day following the day upon which such subdivision or
combination becomes effective.
(c) Reclassification. If the Company issues by way of
----------------
reclassification of the Common Stock any shares of its capital stock, then, as a
condition of such reclassification, lawful and adequate provisions shall be made
whereby each Holder of a Warrant shall have the right to receive, upon the basis
and upon the terms and conditions specified herein, in lieu of the shares of
Common Stock of the Company immediately theretofore receivable upon exercise of
such Warrant, such shares of capital stock as may be issued or payable with
respect to or in exchange for such number of shares of Common Stock issuable
upon exercise of the Warrant
10
<PAGE>
immediately prior to the occurrence of the reclassification. In the case of any
reclassification, appropriate provision shall be made with respect to the rights
and interests of the Holders to the effect that the provisions hereof (including
without limitation provisions for adjustment of the Conversion Exercise Price)
shall thereafter be applicable, as nearly as may be, in relation to any shares
of capital stock thereafter deliverable upon the exercise of any Warrant
hereunder.
(d) Anti-Dilution Provision. If the Company shall issue any class
-----------------------
or series of capital stock of the Corporation that ranks junior to the Preferred
Stock at a price per share less than the greater of (i) $15 and (ii) the Fair
Market Value per share of such capital stock (such greater amount being
hereinafter referred to as the "Base Rate"), then the Conversion Exercise Price
in effect at the opening of business on the day next following such issuance
shall be adjusted to equal the price determined by multiplying (A) the
Conversion Exercise Price in effect immediately prior to the opening of business
on the day next following such issuance by (B) a fraction, the numerator of
which shall be the sum of (x) the number of shares of all classes and series of
capital stock outstanding on the close of business on the day next preceding the
day of such issuance and (y) the number of shares that could be purchased at the
Base Rate from the aggregate proceeds to the Company from the issuance of such
new shares of capital stock, and the denominator of which shall be the sum of
(xx) the number of shares of all classes and series of capital stock outstanding
on the close of business on the day next preceding the day of such issuance and
(yy) the number of additional shares of capital stock being issued; provided ,
--------
however, that no adjustment to the Conversion Exercise Price shall be made as a
- -------
result of a Qualified IPO. For purposes of this subsection, "Fair Market Value"
shall mean, as to any class or series of capital stock that is not publicly
traded, the fair value of the shares of such class or series as determined
reasonably and in good faith by a majority of the Board of Directors of the
Company including a majority of the Independent Directors and, as to publicly-
traded securities, shall mean the average of the daily Current Market Prices of
a share of such capital stock during five (5) consecutive trading days selected
by the Company commencing not more than twenty (20) Trading Days before, and
ending not later than the effective day of the Conversion Exercise Price
adjustment pursuant to this subsection.
(e) Rounding of Calculations. All calculations under this Section
------------------------
9.1 shall be made to the nearest one-hundredth of a share.
(f) Minimum Adjustment of Conversion Exercise Price. If the
-----------------------------------------------
amount of any adjustment of the Conversion Exercise Price required pursuant to
this Section 9.1 would be less than one percent (1%) of the Conversion Exercise
Price in effect at the time such adjustment is otherwise so required to be made,
no such adjustment shall be made and such amount shall be carried forward and
adjustment with respect thereto made at the time of and together with any
subsequent adjustment which, together with such amount and any other amount or
amounts so carried forward, shall aggregate at least one percent (1%) of such
Conversion Exercise Price.
(g) Timing of Issuance. In any case in which this Section 9.1
------------------
shall require that an adjustment be made effective immediately after a
determination date for a specified event, the Company may defer until the
occurrence of such event (i) the issuing to the Holder of any Warrant the
Warrant Shares issuable upon such exercise over and above the Warrant Shares
issuable upon such exercise after such determination date prior to such
adjustment and (ii) paying
11
<PAGE>
to such Holder any cash pursuant to Section 4.2 hereof; provided, however, that
the Company shall deliver to such Holder a due bill or other appropriate
instrument evidencing such Holder's right to receive such additional shares, and
such cash, upon the occurrence of the event requiring such adjustment.
9.2 Notice of Adjustment. On or prior to each day on which the
--------------------
Conversion Exercise Price is adjusted as herein provided, the Company shall send
to each Holder notice of such adjustment(s) and a certificate setting forth the
Warrant Shares purchasable upon the exercise of each Warrant and the Conversion
Exercise Price after such adjustment(s), a brief statement of the facts
requiring such adjustment(s), and the computation by which such adjustment(s)
were made. Such certificate shall, in the absence of manifest error, be
conclusive evidence of the correctness of such adjustment.
9.3 No Adjustment of Dividends. Except as provided in this Section
--------------------------
9, no adjustment in respect of any dividends shall be made during the term of a
Warrant or upon the exercise of a Warrant.
9.4 Statement on Warrants. Irrespective of any adjustments in the
---------------------
Conversion Exercise Price or the number or kind of Warrant Shares purchasable
upon the exercise of the Warrants, Warrant Certificates theretofore or
thereafter issued may continue to express the same price and number and kind of
shares as are stated in the Warrant Certificates initially issuable pursuant to
this Agreement.
SECTION 10. FUNDAMENTAL CHANGE
In the event of a Fundamental Change, each Warrant will be deemed
exercised at the opening of business on the effective date thereof for the right
to receive the kind and amount of shares of stock or other securities or
property to which such holder would have been entitled as a result of such
transaction had the Warrants been exercised immediately prior to the
consummation of such transaction (i) for a number of shares of Preferred Stock
equal to the number of shares of Common Stock receivable upon such exercise, if
prior to the conversion of the related Preferred Stock and (ii) for the number
of shares of Common Stock receivable upon such exercise, if after the conversion
of the related Preferred Stock, less in each case the amount of the Exercise
Price as of such date of consummation of the transaction.
SECTION 11. NOTICES TO HOLDERS
In case:
(a) the Company shall (i) declare any dividend or any other
distribution payable in shares of Common Stock, (ii) declare or authorize a
subdivision or combination of shares of Common Stock, (iii) authorize the
granting to all holders of Common Stock of rights or warrants to subscribe for
or purchase any shares of stock of any class or of any other rights or warrants,
or (iv) any reclassification of Common Stock; or
(b) the Company shall propose to take any action that would
require an adjustment pursuant to Section 9.1; or
12
<PAGE>
(c) of any Fundamental Change;
then the Company shall cause to be mailed to the Holders of Warrants, at least
fifteen (15) days prior to the applicable date hereinafter specified, a notice
stating (x) the date on which a record (if any) is to be taken for the purpose
of such dividend, distribution or granting of rights or warrants or (y) the date
on which such subdivision, combination, reclassification, adjustment or
Fundamental Change is expected to become effective. No failure to mail such
notice or any defect therein or in the mailing thereof shall affect the validity
of the corporate action required to be specified in such notice.
SECTION 12. NO RIGHTS AS STOCKHOLDERS
Nothing contained in this Agreement or in the Warrants shall be
construed as conferring upon the Holders thereof or their transferees (a) the
right to vote or to receive dividends, (b) the right to consent or receive
notice as stockholders in respect of any meeting of stockholders for the
election of directors of the Company or any other matter, or (c) any rights
whatsoever as stockholders of the Company.
SECTION 13. INSPECTION OF WARRANT AGREEMENT
The Company shall keep copies of this Agreement and any notices given
or received hereunder available for inspection by the Holders during normal
business hours at its office as set forth in Section 15.
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<PAGE>
SECTION 14. IDENTITY OF TRANSFER AGENT
The initial transfer agent is the Company. Promptly upon the
appointment of any subsequent transfer agent of the Preferred Stock or Common
Stock, or any other shares of the Company's capital stock issuable upon the
exercise of the Warrants, the Company will cause to be mailed to the Holders of
Warrants a statement setting forth the name and address of such subsequent
transfer agent.
SECTION 15. NOTICES
All notices and other communications provided for or permitted
hereunder shall be in writing and shall be deemed given (i) when made, if made
by hand delivery, (ii) upon mailing, if by first class mail, postage prepaid,
(iii) upon confirmation, if made by telecopier or (iv) one (1) business day
after being deposited with a reputable next-day courier, postage prepaid, to the
parties as follows:
if to the Company: NovaStar Financial, Inc.
1900 West 47th Place
Suite 205
Westwood, KS 66205
Attn: Scott F. Hartman
Phone No.: (913) 362-1090
Fax No.: (913) 362-1011
with a copy to: Tobin & Tobin
One Montgomery Street, 15th Floor
San Francisco, CA 94104
Attn: Phillip R. Pollock
Phone No.: (415) 433-1400
Fax No: (415) 433-3883
The Company will initially act as Warrant Agent; however, the Company
reserves the right at any time to designate a new acting Warrant Agent. Upon
appointment of a successor Warrant Agent to the Company, the Company or the
Warrant Agent will cause to be mailed to the Holders of Warrants a statement
setting forth the name and address of such subsequent Warrant Agent.
Any notice or communication sent or required to be sent to a Holder of
a Warrant shall be mailed to him or her by first class mail, postage prepaid, at
such Holder's address as it appears in the Warrant Register and shall be
sufficiently given to him or her if so mailed within the time prescribed.
SECTION 16. AMENDMENT AND WAIVER
The Company may from time to time supplement, modify or amend this
Agreement, and waivers or consents to departures from the provisions hereof may
be given, without the approval of any Holder, in order to cure any ambiguity or
to correct or supplement any provisions
14
<PAGE>
contained herein which provisions may be defective or inconsistent with any
other provisions herein, or to make any other provisions in regard to matters or
questions arising hereunder which the Company may deem necessary or desirable
and which shall not be inconsistent with the provisions of the Warrants and
which shall not adversely affect the interest of the Holders. Except as provided
above, this Agreement may not be amended, modified or supplemented, and waivers
or consents to departures from the provisions hereof may not be given, without
the written consent of Holders of at least 66 2/3% in interest of the Warrants.
SECTION 17. SUCCESSORS
All the covenants and provisions of this Agreement and the Warrants by
or for the benefit of the Company or the Holders of the Warrants shall be
binding upon and shall inure to the benefit of their respective successors and
assigns hereunder.
SECTION 18. GOVERNING LAW
THE VALIDITY, INTERPRETATION AND PERFORMANCE OF THIS AGREEMENT SHALL
BE GOVERNED BY THE LAWS OF THE STATE OF NEW YORK, AS APPLIED TO CONTRACTS MADE
AND PERFORMED WITHIN THE STATE OF NEW YORK, WITHOUT REGARD TO PRINCIPLES OF
CONFLICTS OF LAW, EXCEPT TO THE EXTENT THAT THE MARYLAND GENERAL CORPORATION LAW
MAY GOVERN THIS AGREEMENT SOLELY BY VIRTUE OF THE FACT THAT THE COMPANY IS
INCORPORATED UNDER THE LAWS OF THE STATE OF MARYLAND. EACH OF THE COMPANY AND
THE WARRANT AGENT, ACTING ON BEHALF OF THE HOLDERS, HEREBY IRREVOCABLY SUBMITS
TO THE JURISDICTION OF ANY NEW YORK STATE COURT OR ANY FEDERAL COURT IN RESPECT
OF ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT,
AND IRREVOCABLY AGREES THAT ALL CLAIMS IN RESPECT OF ANY SUCH SUIT, ACTION OR
PROCEEDING MAY BE HEARD AND DETERMINED IN ANY SUCH COURT. EACH OF THE COMPANY,
AND THE WARRANT AGENT, ACTING ON BEHALF OF THE HOLDERS, IRREVOCABLY WAIVES ANY
OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF THE VENUE OF ANY
SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT AND ANY CLAIM THAT ANY
SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT IN AN
INCONVENIENT FORUM.
SECTION 19. THIRD-PARTY BENEFICIARY
The provisions hereof have been and are made solely for the benefit of
the Company, the Warrant Agent and each of the Holders of Warrants, and their
respective successors and assigns, and no other person shall acquire or have any
right hereunder or by virtue hereof.
15
<PAGE>
SECTION 20. COUNTERPARTS
This Agreement may be executed in any number of counterparts and by
the parties hereto in separate counterparts, each of which when so executed
shall be deemed to be an original and all of which taken together shall
constitute one and the same instrument.
SECTION 21. HEADINGS
The headings in this Agreement are for convenience only and shall not
limit or otherwise affect the meaning hereof.
SECTION 22. SEVERABILITY
If any term, provision, covenant or restriction of this Agreement is
held by a court of competent jurisdiction to be invalid, illegal, void or
unenforceable, the remainder of the terms, provisions, covenants and
restrictions set forth herein shall remain in full force and effect and shall in
no way be affected, impaired or invalidated, and the parties hereto shall use
their best efforts to find and employ an alternative means to achieve the same
or substantially the same result as that contemplated by such term, provision,
covenant or restriction. It is hereby stipulated and declared to be the
intention of the parties that they would have executed the remaining terms,
provisions, covenants and restrictions without including any of such which may
be hereafter invalid, illegal, void or unenforceable.
SECTION 23. ENTIRE AGREEMENT
This Agreement, together with the Purchase Terms Agreement, the
Registration Rights Agreement, the Subscription and Purchase Agreements executed
by the Initial Purchasers and accepted by the Company, and the Warrants
(collectively, the "Operative Agreements"), are intended by the parties to be a
final expression of their agreement and intended to be a complete and exclusive
statement of the agreement and understanding of the parties hereto in respect of
the subject matter contained herein and therein. There are no restrictions,
promises, warranties and undertakings, other than those set forth or referred to
herein and therein. The Operative Agreements supersede all prior agreements and
understandings between the parties with respect to such subject matter.
SECTION 24. ATTORNEYS' FEES
In any action or proceeding brought to enforce any provision of the
Operative Agreements, or where any provision hereof or thereof is validly
asserted as a defense, the prevailing party, as determined by the court, shall
be entitled to recover reasonable attorneys' fees in addition to any other
available remedy.
SECTION 25. FURTHER ASSURANCES
Each party hereto agrees to use all reasonable efforts to obtain all
consents and approvals, and to do all other things, necessary for the
transactions contemplated by this Agreement on or prior to the Expiration Date.
The parties agree to take such further action and to deliver or cause
16
<PAGE>
to be delivered to each other after the date hereof such additional agreements
or instruments as any of them may reasonably request for the purpose of carrying
out the agreements and transactions contemplated hereby and thereby.
SECTION 26. EQUITABLE REMEDIES
Each party hereto acknowledges and agrees that irreparable harm, for
which there may be no adequate remedy at law and for which the ascertainment of
damages would be difficult, would occur in the event any of the provisions of
this Agreement were not performed in accordance with its specific terms or were
otherwise breached. Each party hereto accordingly agrees that each other party
hereto shall be entitled to an injunction or injunctions to prevent breaches of
the provisions of this Agreement, or any agreement contemplated hereunder and to
enforce specifically the terms and provisions hereof or thereof in any court of
the United States or any state thereof having jurisdiction, in each instance
without being required to post bond or other security and in addition to, and
without having to prove the inadequacy of, other remedies of law.
17
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to
be duly executed, all as of the day and year first above written.
NOVASTAR FINANCIAL, INC.
(as issuer of the Warrants)
By_________________________________
W. Lance Anderson, President
(SEAL)
Attest:
____________________________________
Scott F. Hartman, Secretary
NOVASTAR FINANCIAL, INC.
(as initial Warrant Agent)
By_________________________________
W. Lance Anderson, President
(SEAL)
Attest:
_____________________________________
Scott F. Hartman, Secretary
18
<PAGE>
EXHIBIT A
[Form of Warrant Certificate]
THE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF
1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAWS. NEITHER
THIS SECURITY NOR ANY INTEREST OR PARTICIPATION HEREIN MAY BE REOFFERED, SOLD,
ASSIGNED, TRANSFERRED, PLEDGED, ENCUMBERED OR OTHERWISE DISPOSED OF IN THE
ABSENCE OF SUCH REGISTRATION OR UNLESS SUCH TRANSACTION IS EXEMPT FROM, OR NOT
SUBJECT TO, REGISTRATION.
THE HOLDER OF THIS SECURITY BY ITS ACCEPTANCE HEREOF AGREES TO OFFER,
SELL OR OTHERWISE TRANSFER SUCH SECURITY, PRIOR TO THE DATE (THE "RESALE
RESTRICTION TERMINATION DATE") WHICH IS THREE YEARS AFTER THE LATER OF THE
ORIGINAL ISSUE DATE HEREOF AND THE LAST DATE ON WHICH THE COMPANY OR ANY
AFFILIATED PERSON OF THE COMPANY WAS THE OWNER OF THIS SECURITY (OR ANY
PREDECESSOR OF SUCH SECURITY) ONLY (A) TO THE COMPANY, (B) PURSUANT TO A
REGISTRATION STATEMENT WHICH HAS BEEN DECLARED EFFECTIVE UNDER THE SECURITIES
ACT, (C) FOR SO LONG AS THE SECURITIES ARE ELIGIBLE FOR RESALE PURSUANT TO RULE
144A, TO A PERSON IT REASONABLY BELIEVES IS A "QUALIFIED INSTITUTIONAL BUYER" AS
DEFINED IN RULE 144A UNDER THE SECURITIES ACT, THAT PURCHASES FOR ITS OWN
ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS
GIVEN THAT THE TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A, (D) TO AN
INSTITUTIONAL "ACCREDITED INVESTOR" WITHIN THE MEANING OF SUBPARAGRAPH (A)(1),
(A)(2), (A)(3) OR (A)(7) OF RULE 501 UNDER THE SECURITIES ACT THAT IS ACQUIRING
THE SECURITY FOR ITS OWN ACCOUNT, OR FOR THE ACCOUNT OF SUCH AN INSTITUTIONAL
"ACCREDITED INVESTOR" FOR INVESTMENT PURPOSES AND NOT WITH A VIEW TO, OR FOR
OFFER OR SALE IN CONNECTION WITH, ANY DISTRIBUTION IN VIOLATION OF THE
SECURITIES ACT, (E) TO AN INDIVIDUAL "ACCREDITED INVESTOR" AS DEFINED IN
SUBPARAGRAPH (A)(4), (A)(5) OR (A)(6) OF RULE 501 UNDER THE SECURITIES ACT THAT
IS RESIDING IN ONE OF THE JURISDICTIONS AUTHORIZED BY THE COMPANY AND WHO IS
ACQUIRING THE SECURITY FOR ITS OWN ACCOUNT FOR INVESTMENT PURPOSES AND NOT WITH
A VIEW TO, OR FOR OFFER OR SALE IN CONNECTION WITH, ANY DISTRIBUTION IN
VIOLATION OF THE SECURITIES ACT OR (F) PURSUANT TO ANOTHER AVAILABLE EXEMPTION
FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT, SUBJECT TO (I) IN EACH
OF THE FOREGOING CASES, ANY REQUIREMENT OF LAW THAT THE DISPOSITION OF ITS
PROPERTY OR THE PROPERTY OF SUCH ACCOUNTS BE AT ALL TIMES WITHIN ITS OR THEIR
CONTROL AND IN COMPLIANCE WITH ANY APPLICABLE STATE SECURITIES LAWS, AND (II)
THE COMPANY'S OR WARRANT AGENT'S RIGHT, AS THE CASE
A-1
<PAGE>
MAY BE, PRIOR TO ANY SUCH OFFER, SALE OR TRANSFER PURSUANT TO CLAUSES (D), (E)
OF (F) TO REQUIRE THE DELIVERY OF AN OPINION OF COUNSEL, CERTIFICATION AND/OR
OTHER INFORMATION REASONABLY SATISFACTORY TO EACH OF THEM, AND IN EACH OF THE
FOREGOING CASES, A CERTIFICATE OF TRANSFER IN THE FORM APPEARING ON THE OTHER
SIDE OF THIS SECURITY COMPLETED AND DELIVERED BY THE TRANSFEROR TO THE COMPANY
OR THE WARRANT AGENT, AS THE CASE MAY BE. IN ADDITION, PRIOR TO THE TIME THE
CLASS OF STOCK ISSUABLE UPON EXERCISE OF THIS SECURITY IS LISTED ON A NATIONAL
SECURITIES EXCHANGE OR THE NASDAQ NATIONAL MARKET, THIS SECURITY MAY NOT BE
TRANSFERRED TO ANY "BENEFIT PLAN INVESTOR" AS SUCH TERM IS DEFINED IN 29 C.F.R.
(S)2510.3-101 UNLESS THE PROPOSED TRANSFEREE PROVIDES A DISCLOSURE AND
ACKNOWLEDGMENT FORM AND THE AGGREGATE PERCENTAGE OF THE CLASS OF STOCK ISSUABLE
UPON EXERCISE OF THE SECURITY PROPOSED TO BE TRANSFERRED, TAKEN TOGETHER WITH
ALL OTHER SHARES OF SUCH CLASS OWNED BY BENEFIT PLAN INVESTORS, WOULD NOT EQUAL
OR EXCEED 25% OF SUCH CLASS OUTSTANDING.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO THE
PROVISIONS AND ENTITLED TO THE BENEFITS OF A WARRANT AGREEMENT, DATED AS OF
DECEMBER 9, 1996. A COPY OF SUCH AGREEMENT IS ON FILE AT THE OFFICES OF THE
COMPANY AND WILL BE MADE AVAILABLE TO ANY WARRANTHOLDER UPON REQUEST WITHOUT
CHARGE.
CUSIP NO. [ ] Warrant No.: [ ]
Certificate for __________ Warrants
EXERCISABLE IN WHOLE OR IN PART
FROM TIME TO TIME AT ANY TIME AFTER THE START DATE
UNTIL THE EXPIRATION DATE
NOVASTAR FINANCIAL, INC.
STOCK PURCHASE WARRANT CERTIFICATE
THIS CERTIFIES that _______________________________ or registered
assigns is the registered holder (the "Holder") of the number of Stock Purchase
Warrants set forth above (the "Warrants"), each of which represents the right to
purchase one (1) share of Common Stock, par value $.01 per share ("Common
Stock") of NovaStar Financial, Inc., a Maryland corporation (the "Company"), on
the terms set forth in the Warrant Agreement, dated as of December 9, 1996 (the
"Warrant Agreement), between the Company, as issuer of the Warrants, and the
Holders of the Warrants initially acting through the Company as the initial
warrant agent (together with successor warrant agents, if any, the "Warrant
Agent"), at any time on or after the
A-2
<PAGE>
Start Date (as defined below) and on or before the Expiration Date (as defined
below), by surrendering this Warrant Certificate, with the form of election to
purchase set forth hereon duly executed, at the office maintained for that
purpose by the Company or its successors as Warrant Agent, and by paying in full
a price per share equal to the Exercise Price under the Warrant Agreement (the
"Exercise Price"). The Warrants are subject to certain anti-dilution provisions
and, accordingly, the number of shares of Common Stock actually purchased upon
payment of the Exercise Price may be adjusted in accordance with the terms of
the Warrant Agreement. Capitalized terms used in this Warrant Certificate and
not otherwise defined herein shall have the meanings set forth in the Warrant
Agreement.
Payment of the Exercise Price may be made (a) in the form of cash or
by certified or official bank check payable to the order of the Company or (b)
by surrendering additional Warrants or shares of Common Stock for cancellation
to the extent the Company may lawfully accept shares of Common Stock, with the
value of such shares of Common Stock for such purpose to equal the average
trading price of the Common Stock during the 10 trading days preceding the date
surrendered and the value of the Warrants to equal the difference between the
value of a share of Common Stock and the Exercise Price.
Subject to the terms contained in the Warrant Agreement, this Warrant
may be exercised at any time beginning on the date (the "Start Date") of the
earlier to occur of (i) the effectiveness of the Shelf Registration Statement or
(ii) six (6) months after the closing of a Qualified IPO and ending at 5:00
p.m., Eastern Standard Time, on the third anniversary of the date the Warrants
become exercisable (the "Expiration Date"). No Warrant may be exercised after
the Expiration Date and all Warrants evidenced hereby shall thereafter become
void.
Upon the exercise of less than all of the Warrants evidenced by this
Warrant Certificate, there shall be issued to the Holder a new Warrant
Certificate representing the Warrants not exercised.
Prior to the Expiration Date, subject to any applicable laws, rules or
regulations restricting transferability and to any restriction on
transferability that may appear on this Warrant Certificate, or in the Warrant
Agreement or the Purchase Terms Agreement, the Holder shall only be entitled to
transfer this Warrant Certificate on the Warrant Register maintained at the
principal office of the Company, upon delivery thereof, duly endorsed by the
Holder or by his or her duly authorized attorney or representative, or
accompanied by proper evidence of succession, assignment or authority to
transfer deemed acceptable by the Company, with the form of assignment set forth
hereon duly executed. Upon any such transfer, a new Warrant Certificate or
Warrant Certificates representing the same aggregate number of Warrants will be
issued in accordance with instructions in the form of assignment.
Prior to the Expiration Date, the Holder shall be entitled to exchange
this Warrant Certificate, with or without other Warrant Certificates, for
another Warrant Certificate or Warrant Certificates for the same aggregate
number of Warrants, upon surrender of this Warrant Certificate at the principal
office maintained for this purpose by the Company.
No fractional shares will be issued upon the exercise of Warrants. As
to any final fraction of a share that the Holder of one or more Warrant
Certificates, the rights under which are
A-3
<PAGE>
exercised in the same transaction, would otherwise be entitled to purchase upon
such exercise, the Company shall pay the cash value thereof determined as
provided in the Warrant Agreement.
This Warrant Certificate is issued under and in accordance with the
Warrant Agreement and is subject to the terms and provisions contained in said
Warrant Agreement, to all of which terms and provisions the Holder consents by
acceptance hereof.
This Warrant Certificate shall not entitle the Holder to any of the
rights of a stockholder of the Company, including, without limitation, the right
to vote, to receive dividends and other distributions, or to attend or receive
any notice of meetings of stockholders or any other proceedings of the Company.
THE VALIDITY, INTERPRETATION AND PERFORMANCE OF THIS WARRANT
CERTIFICATE SHALL BE GOVERNED BY THE LAWS OF THE STATE OF NEW YORK, AS APPLIED
TO CONTRACTS MADE AND PERFORMED WITHIN THE STATE OF NEW YORK, WITHOUT REGARD TO
PRINCIPLES OF CONFLICTS OF LAWS, EXCEPT TO THE EXTENT THAT THE GENERAL
CORPORATION LAW OF THE STATE OF MARYLAND MAY GOVERN THIS AGREEMENT SOLELY BY
VIRTUE OF THE FACT THAT THE COMPANY IS INCORPORATED UNDER THE LAWS OF THE STATE
OF MARYLAND.
IN WITNESS WHEREOF, the Company has caused this Warrant Certificate to
be duly executed.
NOVASTAR FINANCIAL, INC.
By_______________________________________
W. Lance Anderson, President
Attest:
_________________________________________
Scott F. Hartman, Secretary
(SEAL)
A-4
<PAGE>
ELECTION TO PURCHASE
The undersigned hereby irrevocably elects to exercise __________
Warrants represented by this Warrant Certificate and to purchase the shares of
Common Stock issuable upon the exercise of said Warrants, and requests that
certificates for such shares be issued and delivered as follows:
ISSUE TO: _______________________________________________
(Name)
_______________________________________________
(Address, Including Zip Code)
_______________________________________________
(Social Security or Tax Identification Number)
DELIVER TO: _______________________________________________
(Name)
_______________________________________________
(Address, Including Zip Code)
In payment of the purchase price with respect to the Warrants
exercised, the undersigned hereby tenders payment in accordance with Section 4.2
of the Warrant Agreement. If the number of Warrants hereby exercised is fewer
than all the Warrants represented by this Warrant Certificate, the undersigned
requests that a new Warrant Certificate representing the number of full Warrants
not exercised be issued and delivered as set forth below:
Name of Warrantholder or Assignee:
______________________________________________
(Please Print)
Address: ______________________________________________________________________
______________________________________________________________________________
Signature: __________________________________ Dated:___________________________
(Signature must conform in all respects to name of holder as specified on the
face of the Warrant Certificate.)
Signature Guaranteed:___________________________________________________________
A-5
<PAGE>
ASSIGNMENT
FOR VALUE RECEIVED, the undersigned hereby sells, assigns and
transfers unto the Assignee named below all of the rights of the undersigned
represented by the within Warrant Certificate, with respect to the number of
Warrants set forth below:
<TABLE>
<CAPTION>
Taxpayer
Number of Identification
Name of Assignee Address Warrants Number
- ---------------- ------- -------- ------
<S> <C> <C> <C>
- -------------------- ----------------- -------- ----------
- -------------------- ----------------- -------- ----------
</TABLE>
and does hereby irrevocably constitute and appoint ___________________________,
Attorney, to make such transfer on the Warrant Register maintained at the
principal office of the Company with full power of substitution in the premises.
Dated: _________________, 199__ ____________________________________
(Signature)
(Signature must conform in all respects to
name of holder as specified on the face of
the Warrant Certificate.)
Signature Guaranteed:
____________________________________
A-6
<PAGE>
EXHIBIT 10.4
NOVASTAR FINANCIAL, INC.
FOUNDERS REGISTRATION RIGHTS AGREEMENT
This REGISTRATION RIGHTS AGREEMENT (the "Agreement) is made and
entered into as of December 9, 1996, by and among NovaStar Financial, Inc., a
Maryland corporation (the "Company"), and the undersigned stockholders of the
Company.
In consideration of the mutual agreements contained herein and for
other good and valuable consideration, the receipt and sufficiency of which is
hereby acknowledged, the parties hereto, intending to be legally bound, hereby
agree as follows:
SECTION 1. DEFINITIONS
-----------
As used in this Agreement, the following capitalized terms shall have
the following meanings:
"Affiliate" of a specified person shall mean any other person directly
or indirectly controlling or controlled by or under direct or indirect common
control with such specified person. For purposes of this definition, "control,"
when used with respect to any person means the power to direct the management
and policies of such person, directly or indirectly, whether through the
ownership of voting securities, by contract or otherwise; and the terms
"controlling" and "controlled have meanings correlative to the foregoing.
"Common Stock" shall mean the Company's Common Stock, par value $0.1
per share.
"Company" shall mean NovaStar Financial, Inc., a Maryland corporation,
until a successor replaces it and thereafter means such successor.
"Company Allotment" shall be as defined in Section 3(b).
"Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended, and the rules and regulations of the SEC promulgated thereunder.
"Holders" shall be as defined in Section 2(b) hereof.
"Holders Allotment" shall be as defined in 4(b).
"NASD" means National Association of Securities Dealers, Inc.
"NASDAQ/NMS shall mean Nasdaq National Market.
"Other Holders Allotment" shall be as defined in Section 4(b).
1
<PAGE>
"Person" shall mean an individual, trustee, corporation, partnership,
limited liability company, joint stock company, trust, unincorporated
association, union, business association, firm or other entity.
"Piggyback Notice" shall have the meaning as set forth in Section 3(a)
hereof.
"Piggyback Underwritten Offering" shall have the meaning as set forth
in Section 3(a) hereof.
"Preferred Stock" shall mean the Company's Class A Convertible
Preferred Stock, par value $0.01 per share.
"Proceeding" shall mean an action, claim, suit or proceeding
(including, without limitation, an investigation or partial proceeding, such as
a deposition), where commenced or threatened.
"Prospectus" shall mean the prospectus included in any Registration
Statement (including, without limitation, a prospectus that discloses
information previously omitted from a prospectus filed as part of an effective
Registration Statement in reliance upon Rule 430A promulgated under the
Securities Act), as amended or supplemented by any prospectus supplement, with
respect to the terms of the offering of any portion of the Registrable
Securities covered by such Registration Statement, and all other amendments and
supplements to Prospectus, including post-effective amendments, and all material
incorporated by reference or deemed to be incorporated by reference in this
Prospectus.
"Registrable Securities" shall mean the shares of Common Stock held by
such Holder on the date of this Agreement until such time as such shares of
Common Stock shall have been effectively registered under the Securities Act and
disposed of in accordance with the Registration Statement covering such shares,
or are otherwise freely transferable by the holder without requirement of
registration under the Securities Act.
"Registration Statement" shall mean any registration statement of the
Company that covers any of the Registrable Securities pursuant to the provisions
of this Agreement, including the Prospectus, amendments and supplements of such
Registration Statement and all exhibits and all material incorporated by
reference or deemed to be incorporated by reference in such Registration
Statement.
"Rule 144" shall mean Rule 144 under the Securities Act, as such Rule
may be amended from time to time, or any similar rule or regulation hereafter
adopted by the SEC.
"SEC" shall mean the Securities and Exchange Commission.
"Shelf Registration Statement" shall mean the registration statement
covering sales of securities of the Company by or to purchasers of Units
consisting of the Preferred Stock and Stock Purchase Warrants in the Company's
1996 private placement.
2
<PAGE>
"Underwriter" shall mean any Underwriter, placement agent, selling
broker, dealer manager, qualified independent Underwriter or similar securities
industry professional.
"Underwritten Registration or Underwritten Offering" shall mean a
registration in which securities of the Company are sold to an Underwriter for
re-offering to the public.
SECTION 2. SECURITIES SUBJECT TO THIS AGREEMENT
(a) Registrable Securities. The securities entitled to the benefits
----------------------
of this Agreement are the Registrable Securities.
(b) Holders of Registrable Securities. A Person is deemed to be a
---------------------------------
Holder of Registrable Securities (each, a "Holder") whenever such Person owns
Registrable Securities.
SECTION 3. PIGGYBACK REGISTRATION
(a) Right to Piggyback. Following the effective date of the Shelf
------------------
Registration Statement, if the Company proposes to file a Registration Statement
under the Securities Act with respect to a firm commitment underwritten public
offering of Common Stock (other than a Registration Statement (i) on Form S-4,
Form S-8 or any successor forms thereto or (ii) filed solely in connection with
an exchange offer or any employee benefit or dividend reinvestment plan),
whether or not for its own account, then the Company shall give written notice
of such proposed filing to the Holders of Registrable Securities at least
fifteen (15) days before the anticipated filing date (the "Piggyback Notice").
The Piggyback Notice shall offer such Holders the opportunity to include in such
Underwritten Offering such amount of Registrable Securities as each such Holder
may request (a "Piggyback Underwritten Offering. Subject to Section 3(b)
hereof, the Company shall include in each such Piggyback Underwritten Offering
all Registrable Securities with respect to which the Company has received
written requests for inclusion therein within ten (10) days after notice has
been given to the applicable Holder (which request shall specify the intended
method of distribution). The Holders of Registrable Securities shall be
permitted to withdraw all or part of the Registrable Securities from a Piggyback
Underwritten Offering at any time prior to the effective date of such Piggyback
Underwritten Offering.
(b) Priority on Piggyback Underwritten Offerings. The Company shall
--------------------------------------------
cause the managing Underwriter or Underwriters of a proposed Underwritten
Offering to permit Holders of Registrable Securities to include all such
Registrable Securities requested to be included in the Piggyback Underwritten
Offering on the same terms and conditions as any other shares of Common Stock,
if any, of the Company included therein. Notwithstanding the foregoing, if the
managing Underwriter or Underwriters of such Piggyback Underwritten Offering
have informed the Company in writing that it is their opinion that the total
amount of securities that such Holders, the Company and any other Persons having
rights to participate in such offering, intended to include in such offering is
such as to materially and adversely affect the success of such offering, then
the Common Stock to be offered in the Piggyback Underwritten Offering shall be
the amount recommended by such managing Underwriter or
3
<PAGE>
Underwriters and the Common Stock to be included in such Piggyback Underwritten
Offering shall be included in the following order of priority: (i) for the
account of the Company, as many shares as the Company may desire or be permitted
to sell at such time (the "Company Allotment"); (ii) for the account of all such
other Persons (other than the Company), as many shares as such Persons may
desire to sell at such time, (the "Other Holders Allotment"); and (iii) the
remaining capacity, if any, for the account of the Holders (the "Holders
Allotment"), to be divided among such Holders pro rata in proportion to the
respective dollar amounts of such securities requested to be registered
SECTION 4. HOLD-BACK AGREEMENTS
(a) Restrictions on Public Sale by Holders of Registrable
-----------------------------------------------------
Securities. Each Holder of Registrable Securities agrees, in connection with any
- ----------
sale of securities by the Company and in connection with any Registration
Statement filed pursuant to Section 3 hereof in which all or a portion of the
Company Allotment is being sold, until such time as there are no remaining
Registrable Securities, if requested (pursuant to a timely written notice) by
the Company or the managing Underwriter or Underwriters in an Underwritten
Offering, not to effect any public sale or distribution of any of its
Registrable Securities, including a sale pursuant to Rule 144 (except as part of
such Underwritten Offering), during the sale pursuant to Rule 144 (except as
part of such Underwritten Offering), during the period beginning ten (10) days
prior to, and ending ninety (90) days after, the closing date of such
Underwritten Offering made by the Company or pursuant to such Registration
Statement, unless a shorter time period is agreed to be the managing Underwriter
or Underwriters.
(b) Restrictions on Public Sale by the Company. The Company agrees
------------------------------------------
that without the written consent of the managing Underwriter or Underwriters in
an Underwritten Offering of Registrable Securities as described in Section 3
hereof in which all or a portion of the Holders Allotment is being sold, it will
not affect any public or private sale or distribution of its equity securities,
including a sale pursuant to Regulation D under the Securities Act, during the
ten (10) day period prior to, and the ninety (90) day period beginning on, the
closing date of each such Underwritten Offering, unless a shorter time period is
agreed to by the managing Underwriter or Underwriters (except (v) as part of
such Underwritten Registration, (w) pursuant to registrations on Form S-4 or
Form S-8 or any successor form to such forms or pursuant to any unregistered
offering to the Company's employees or directors, or to employees of its
subsidiaries, pursuant to any employee benefit plan (as defined in Rule 405
under the Securities Act) or dividend reinvestment plan, (x) pursuant to the
conversion of preferred stock or exercise of warrants, (y) in connection with an
exchange offer or (z) in connection with the acquisition of assets by the
Company or its subsidiaries).
SECTION 5. REGISTRATION PROCEDURES
In connection with the Company's registration obligations pursuant to
Section 3 hereof, the Company shall effect such registration(s) to permit the
sale of such Registrable Securities in accordance with the intended method or
methods of disposition thereof, as follows:
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(a) Prepare and file with the SEC a Registration Statement or
Registration Statements on such form which shall be available for the sale of
Registrable Securities in accordance with the intended method or methods of
distribution thereof, and use its best efforts to cause such Registration
Statement to become effective and to remain effective as provided herein;
provided, however, that before filing a Registration Statement or Prospectus or
any amendments or supplements thereof (including documents that would be
incorporated or deemed to be incorporated therein by reference), the Company
shall notify the Holders of the Registrable Securities covered by such
Registration Statement, their counsel and managing Underwriters, if any, of its
intention to file such documents, and upon request shall furnish to such parties
so requesting copies of all such documents, and upon request shall furnish to
such parties so requesting copies of all such documents proposed to be filed,
which documents will be subject to the review of such Holders, their counsel and
such Underwriters, if any, provided, however, that the Company shall not be
required to deliver to such Holders a copy of any such document that has not
been materially changed from a copy of such document that was previously
delivered to such Holders.
(b) Prepare and file with the SEC such amendments to each
Registration Statement as may be necessary to cause such Registration Statement
to become effective with respect to the disposition of all securities covered by
such Registration Statement; and cause the related Prospectus to be supplemented
by any required Prospectus supplement, and as so supplemented to be filed
pursuant to Rule 424 (or any similar provisions then in force) under the
Securities Act.
(c) Notify the selling Holders of Registrable Securities, their
counsel and the managing Underwriters, if any, promptly, and (if requested by
any such Person), confirm such notice in writing, (i) when a Registration
Statement or any amendment thereto has been filed, and, with respect to a
Registration Statement, when the same has become effective, (ii) of any request
by the SEC or any other Federal or state governmental authority for amendments
or supplements to a Registration Statement or related Prospectus or for
additional information (provided, that the Company shall not be required to
notify the Holders or their counsel of all "comment" letters received by the
Company from the SEC or to deliver copies of such comment letters of the
Company's responses thereto to the Holders or their counsel unless such letters
request information from or about the Holders), (iii) of the issuance by the SEC
of any stop order suspending the effectiveness of a Registration Statement or
the initiation of any proceedings for that purpose, (iv) if at any time the
representations and warranties of the Company contained in any agreement
(including any underwriting agreement) contemplated by Section 5(n) below cases
to be true and correct, (v) of the receipt by the Company of any notification
with respect to the suspension of the qualification or exemption from
qualification of any of the Registrable Securities for sale in any jurisdiction,
or the initiation or threatening of any proceeding for such purpose, and (vi) of
the happening of any event that makes any statement made in such Registration
Statement or related Prospectus or any document incorporated or deemed to be
incorporated therein by reference untrue in any material respect or that
requires the making of any changes in such Registration Statement, Prospectus or
documents so that, in the case of the Registration Statement, it will not
contain any untrue statement of a material fact or omit to state
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<PAGE>
any material fact necessary in order to make the statements therein, in light of
the circumstances under which they were made, not misleading.
(d) Use its best efforts to obtain the withdrawal of any order
suspending the effectiveness of a Registration Statement, or the lifting of any
suspension of the qualification (or exemption from qualification) of any of the
Registrable Securities for sale in any jurisdiction.
(e) If requested by managing Underwriters, if any, or the Holders of
a majority of the then outstanding Registrable Securities being sold in
connection with an Underwritten Offering, promptly include in a Prospectus
supplement or post-effective amendment such information as the managing
Underwriters, if any, and such Holders may reasonably request in order to permit
the intended method of distribution of such securities and make all required
filings of such Prospectus supplement or such post-effective amendment as soon
as practicable after the Company has received such request; provided however,
that the Company shall not be required to take any actions under this Section
5(e) that are not, in the opinion of counsel for the Company, in compliance with
applicable law.
(f) Furnish to a selling Holder of Registrable Securities, their
counsel and each managing Underwriter, if any, without charge, at lease one
conformed copy o f the Registration Statement and each post-effective amendment
thereto, including financial statements (but excluding schedules, all documents
incorporated or deemed to be incorporated therein by reference, and all
exhibits, unless requested in writing by such holder, counsel or Underwriter).
(g) Deliver to each selling Holder of Registrable Securities, their
counsel, and the Underwriters, if any, without charge, as many copies of the
Prospectus or Prospectuses (including each form of prospectus) and each
amendment or supplement thereto as such Persons may reasonably request in
connection with the distribution of the Registrable Securities; and the Company
hereby consents to the use of such Prospectus and each amendment or supplement
thereto by each of the selling Holders of Registrable Securities and the
Underwriters, if any, in connection with the offering and sale of the
Registrable Securities covered by such Prospectus and any such amendment or
supplement thereto.
(h) Use its best efforts to register or qualify, or obtain an
exemption therefrom (or cooperate with the selling Holders of Registrable
Securities, the Underwriters, if any, and their respective counsel in connection
with the registration or qualification (or exemption from such registration or
qualification)) of such Registrable Securities for offer and sale under the
securities or "Blue Sky" laws of such jurisdictions within the United States as
any seller (or Underwriter) reasonably requests in writing and to keep such
registration or qualification (or exemption therefrom) effective during the
period such Registration Statement is required to be kept effective; provided,
however, that the Company will not be required to (A) qualify generally to do
business in any jurisdiction where it is not then so qualified or (B) take any
action that would subject it to general service of process or to taxation in any
such jurisdiction where it is not then so subject.
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(i) Cooperate with the selling Holders of Registrable Securities and
the managing Underwriters, if any, to facilitate the timely preparation and
delivery of certificates representing Registrable Securities to be sold, which
certificates shall be in a form eligible for deposit with The Depository Trust
Company; and enable such Registrable Securities to be in such denominations and
registered in such names as the managing Underwriters, if any, or Holders may
request at least two (2) business days prior to any sale of Registrable
Securities in a firm commitment public offering, or in any other such sale
within ten (10) business days.
(j) Use its best efforts to cause the Registrable Securities covered
by the Registration Statement to be registered with or approved by such other
governmental agencies or authorities within the United States, except as may be
required solely as a consequence of the nature of such selling Holder's
business, in which case the Company will cooperate in all best respects with the
filing of such Registration Statement and the granting of such approvals as may
be necessary to enable the seller or sellers thereof or the Underwriters, if
any, to consummate the disposition of such Registrable Securities.
(k) Upon the occurrence of any event contemplated by Section
5(c)(vi) above, prepare a supplement or post-effective amendment to the
Registration Statement or a supplement to the related Prospectus or any document
incorporated or deemed to be incorporated therein by reference, or file any
other required document so that, as thereafter delivered to the purchasers of
the Registrable Securities being sold thereunder, such Prospectus will not
contain an untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein, in
light of the circumstances under which they were made, not misleading.
(l) Prior to the effective date of the Registration Statement
relating to the Registrable Securities, provide a CUSIP number for the
Registrable Securities.
(m) Use its best efforts to cause all Registrable Securities covered
by such Registration Statement to be authorized to be quoted on the NASDAQ/NMS
or listed on a national securities exchange.
(n) Enter into such agreements (including an underwriting agreement
in form, scope and substance as is customary in Underwritten Offerings) and take
all such other actions reasonably requested by the Holders of a majority of the
Registrable Securities being sold in connection therewith (including those
reasonably requested by the managing Underwriters, if any) in order to expedite
or facilitate the disposition of such Registrable Securities, and in such
connection, whether or not an underwriting agreement is entered into and whether
or not the registration is an Underwritten Registration, (i) make such
representations and warranties to the Holders of such Registrable Securities and
the Underwriters, if any, with respect to the business of the Company and its
subsidiaries, and the Registration Statement, Prospectus and documents, if any,
incorporated or deemed to be incorporated by reference therein, in each case, in
form, substance and scope as are customarily made by users to Underwriters in
Underwritten Offerings, and if true, confirm the same if and when requested,
(ii) use its reasonable efforts to obtain opinions of counsel to the Company and
updates thereof (which counsel and opinions (in
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<PAGE>
form, scope and substance) shall be reasonably satisfactory to the managing
Underwriters, if any, and counsel to the Holders of the Registrable Securities
being sold), addressed to each selling Holder of Registrable Securities and each
of the Underwriters, if any, covering the matters customarily covered in
opinions requested in Underwritten Offerings and such other matters as may be
reasonably requested by such counsel and Underwriters, (iii) use its reasonable
efforts to obtain "cold comfort" letters and updates thereof from the
independent certified public accountants of the Company (and, if necessary, any
other independent certified public accountants of any subsidiary of the Company
or of any business acquired by the Company for which financial statements and
financial data are, or are required to be, included in the Registration
Statement), addressed to each selling Holder of Registrable Securities (unless
such accountants shall be prohibited from so addressing such letters by
applicable standards of the accounting profession) and each of the Underwriters,
if any, such letters to be in customary form and covering matters of the type
customarily covered in "cold comfort" letters in connection with Underwritten
Offerings, (iv) if an underwriting agreement is entered into, the same shall
contain indemnification provisions and procedures substantially to the effect
set forth in Section 7 hereof with respect to all parties to be indemnified
pursuant to said Section and (v) deliver such documents and certificates as may
be reasonably requested by the Holders of a majority of the Registrable
Securities being sold, their counsel and the managing Underwriters, if any, to
evidence the continued validity of the representations and warranties made
pursuant to Section 5(n)(i) above and to evidence compliance with any customary
conditions contained in the underwriting agreement or other agreement entered
into by the Company. The above shall be done at each closing under such
underwriting or similar agreement, or as and to the extent required thereunder.
(o) Make available for inspection by a representative of the Holders
of Registrable Securities being sold, any Underwriter participating in any such
disposition of Registrable Securities, if any, and any attorney or accountant
retained by such selling Holders or Underwriter, at the offices where normally
kept, during reasonable business hours, all financial and other records,
pertinent corporate documents and properties of the Company and its
subsidiaries, and cause the officers, directors and employees of the Company and
its subsidiaries to supply all information in each case reasonably requested by
any such representative, Underwriter, attorney or accountant in connection with
such Registration Statement; provided, however, that any information that is
designated by the Company in writing as confidential at the time of delivery of
such information shall be kept confidential by such Persons unless (i)
disclosure of such information is required by court or administrative order,
(ii) disclosure of such information, in the opinion of counsel to such Person,
is required by law, or (iii) such information becomes generally available to the
public other than as a result of a disclosure or failure to safeguard by such
Person. Without limiting the foregoing, no such information shall be used by
such Person as the basis for any market transactions in securities by the
Company or its subsidiaries in violation of law.
(p) Comply with all applicable rules and regulations of the SEC and
make generally available to its securities Holders earning statements satisfying
the provisions of Section 11(a) of the Securities Act and Rule 158 thereunder,
or any similar rule promulgated under the Securities Act, no later than forty-
five (45) days after the end of any twelve (12) month
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period (or ninety (90) days after the end of any twelve (12) month period if
such period is a fiscal year) (i) commencing at the end of any fiscal quarter in
which Registrable Securities are sold to Underwriters in a firm commitment or
best efforts Underwritten Offering and (ii) if not sold to Underwriters in such
an offering, commencing on the first day of the first fiscal quarter of the
Company after the effective date of the Registration Statement, which statements
shall cover said twelve (12) month periods.
(q) Make every reasonable effort to obtain the withdrawal of any
order suspending the effectiveness of the Registration Statement at the earliest
possible moment.
(r) Cooperate and assist in any filings required to be made with the
NASD and in the performance of any due diligence investigation by any
Underwriter (including any "qualified independent Underwriter" that is required
to be retained in accordance with the rules and regulations of the NASD).
The Company may require each seller of Registrable Securities as to
which any registration is being effected to furnish to the Company such
information regarding such seller and the distribution of such Registrable
Securities as the Company may, from time to time, reasonably request in writing
and the Company may exclude from such registration the Registrable Securities of
any seller who unreasonably fails to furnish such information within a
reasonable time after receiving such request.
Each Holder of Registrable Securities agrees by acquisition of such
Registrable Securities that, upon receipt of any notice from the Company of the
happening of any event of the kind described in Section 5(c)(ii), (iii), (v) or
(vi) hereof, such Holder will forthwith discontinue disposition of such
Registrable Securities covered by such Registration Statement or Prospectus
until such Holder's receipt of the copies of the supplemented or amended
Prospectus contemplated by Section 5(k) hereof, or until it is advised in
writing by the Company that the use of applicable Prospectus may be resumed, and
has received copies of any additional or supplemental filings that are
incorporated or deemed to be incorporated by reference in such Prospectus.
SECTION 6. REGISTRATION EXPENSES
(a) All expenses incident to the Company's performance of or
compliance with this Agreement will be borne by the Company, regardless whether
a Registration Statement filed pursuant to Section 3 herein becomes effective,
including without limitation:
(i) all registration and filing fees and expenses associated
with any SEC filing;
(ii) fees and expenses of compliance with federal securities or
state blue sky laws (including fees and disbursements of counsel for the
Underwriters or selling Holders in connection with the Blue Sky qualifications
of the Registrable Securities pursuant to 5(h) herein);
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<PAGE>
(iii) expenses of printing (including, without limitation,
expenses of printing or engraving certificates for the Registrable Securities in
a form eligible for deposit with The Depository Trust Company and of printing
Prospectuses), messenger and delivery services and telephone.
(iv) reasonable fees and disbursements of counsel for the
Company and for the Holders of the Registrable Securities (subject to the
provisions of Section 4(b) hereof);
(v) fees and disbursements of all independent certified public
accountants of the Company (including the expenses of any special audit and
"cold comfort" letters required by or incident to such performance);
(vi) fees and expenses associated with any NASD filing required
to be made in connection with a Registration Statement, including, if
applicable, the fees and expenses of any "qualified independent Underwriter"
(and its counsel) that is required to be retained in accordance with the rules
and regulations of the NASD; and
(vii) fees and expenses of listing the Registrable Securities on
any securities exchange or quotation system in accordance with Section 5(m)
hereof. All such expenses being herein called "Registration Expenses."
The Company will, in any event, bear its internal expenses (including,
without limitation, all salaries and expenses of its officers and employees
performing legal or accounting duties), the expense of any annual audit, rating
agency fees and the fees and expenses of any Person, including special experts,
retained by the Company. The Holders of the Registrable Securities shall bear
the expense of any broker's commission or Underwriters' discount or commission.
(b) In connection with the Registration Statement, the Company will
reimburse the Holders of Registrable Securities being registered pursuant to
such Registration Statement for the fees and disbursements of not more than one
counsel chosen by a majority of the Holders of the for the fees and
disbursements of not more than one counsel chosen by a majority of the Holders
of the Registrable Securities to be included in the Registration Statement;
provided, however, that in the case of an Underwritten Offering which includes
shares of Common Stock, such counsel shall be chosen by the Holders of a
majority of the shares of Common Stock to be included in such Underwritten
Offering. Notwithstanding the provisions of this Section 6, each Holder of
Registrable Securities shall pay all registration expenses to the extent
required by applicable law.
SECTION 7. INDEMNIFICATION
(a) The Company agrees to indemnify and hold harmless each Holder
(each such Holder an "Indemnified Holder") and each Underwriter participated in
the distribution (each such Underwriter as "Indemnified Underwriter") and each
person that controls each
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Indemnified Holder or Indemnified Underwriter within the meaning of Section 15
of the Securities Act or Section 20 of the Exchange Act, and agents, employees,
officers and directors or any such controlling person of any Indemnified Holder
or Indemnified Underwriter from and against any and all losses, claims, damages,
judgments, liabilities and expenses (including the reasonable fees and expenses
of counsel and other expenses in connection with investigating, defending or
setting any such action or claim) as they are incurred arising out of or based
upon an untrue statement or alleged untrue statement of a material fact
contained in any Registration Statement or the Prospectus (as amended or
supplemented if the Company shall have furnished any amendments or supplements
thereto) or any preliminary Prospectus or arising out of or based upon any
omission or alleged omission to state therein a material fact required to be
stated therein or necessary to make the statements therein not misleading,
except (i) the Company shall not be liable to any Indemnified Holder or
Indemnified Underwriter in any such case insofar as such losses, claims,
damages, judgments, liabilities or expenses arise out of, or are based upon, any
such untrue statement or omission or alleged untrue statement or omission based
upon information relating to such Indemnified Holder or Indemnified Underwriter
furnished in writing by such Indemnified Holder or Indemnified Underwriter to
the Company expressly for use therein, and (ii) the Company shall not be liable
to any Indemnified Holder or Indemnified Underwriter under the indemnity
agreement in this Section 7(a) with respect to any preliminary Prospectus to the
extent that any such loss, claim, damage, judgment, liability or expense results
solely from the fact that any Indemnified Holder or Indemnified Underwriter sold
Registrable Securities to a person to whom there was not sent or give, at or
prior to the written confirmation of such sale, a copy of the Prospectus as then
amended or supplemented, if the Company has previously furnished sufficient
copies thereof to the Indemnified Holder or Indemnified Underwriter.
(b) If any action or proceeding (including any governmental or
regularly investigation or proceeding) shall be brought or asserted against any
Indemnified Holder or Indemnified Underwriter with respect to which indemnity
may be sought against the Company pursuant to Section 7(a) such Indemnified
Holder or Indemnified Underwriter shall promptly notify the Company in writing,
and the Company shall have the right to assume the defense thereof, including
the employment of counsel reasonable satisfactory of such Indemnified Holder or
Indemnified Underwriter and payment of all fees and expenses; provided, however,
that the omission so to notify the Company shall not relieve the Company from
any liability that they may have to any Indemnified Holder or Indemnified
Underwriter (except to the extent that the Company is materially prejudiced or
otherwise forfeits substantive rights or defenses by reason of such failure).
An Indemnified Holder or Indemnified Underwriter shall have the right to employ
separate counsel in any such action or proceeding and to participate in the
defense thereof, but the fees and expenses of such counsel shall be at the
expense of such Indemnified Holder or Indemnified Underwriter unless (i) the
Company agrees in writing to pay such fees and expenses, (ii) the Company has
failed to assume the defense and employ counsel satisfactory to the Indemnified
Holder or Indemnified Underwriter or (iii) the named parties to any such action
or proceeding (including any impleaded parties) include both the Indemnified
Holder or Indemnified Underwriter and the Company and such Indemnified Holder or
Indemnified Underwriter shall have been advised in writing by its counsel that
representation of them and the Company by the same counsel would be
inappropriate under applicable standards of professional
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conduct (whether or not such representation has been proposed) due to actual or
potential differing interests between them (in which case the Company shall not
have the right to assume the defense of such action on behalf of such
Indemnified Holder or Indemnified Underwriter). It is understood that the
Company shall not, in connection with any one such action or separate but
substantially similar or related actions in the same jurisdiction arising out of
the same general allegations or circumstances, be liable for the fees and
expenses of more than one separate firm of attorneys (in addition to any local
counsel) at any time for such Indemnified Holders or Indemnified Underwriters,
which firm shall be designated in writing by the majority of Holders of the
Registrable Securities on behalf of the Holders of all of the Registrable
Securities, and that all such fees and expenses shall be reimbursed as they are
incurred. The Company shall not be liable for any settlement of any such action
effected without the written consent of the Company, but if settled with the
written consent of the Company, or if there is a final judgment with respect
thereto, the Company agrees to indemnify and hold harmless each Indemnified
Holder or Indemnified Underwriter from and against any loss or liability by
reason of such settlement or judgment. The Company shall not, without the prior
written consent of each Indemnified Holder or Indemnified Underwriter affected
thereby, effect any settlement of any pending or threatened proceeding in which
such Indemnified Holder or Indemnified Underwriter has sought indemnity
hereunder, unless such settlement includes an unconditional release of such
Indemnified Holder or Indemnified Underwriter from all liability arising out of
such action, claim, litigation or proceeding.
(c) Each Holder and Underwriter agrees to indemnify and hold
harmless the Company, its directors, its officers who sign the Registration
Statement and any person controlling the Company within the meaning of Section
15 of the Securities Act or Section 20 of the Exchange Act (collectively, the
"Company Indemnified Parties") to the extent as the foregoing indemnity from the
Company to any Indemnified Holder or Indemnified Underwriter, but only with
respect to information relating to each Holder or Underwriter furnished to the
Company in writing by each Holder or Underwriter, respectively, expressly for
use in the Registration Statement, Prospectus (or any amendment of supplement
thereto), or any preliminary Prospectus. In case any action shall be brought
against any Company Indemnified Party based on the Registration Statement,
Prospectus (or any amendment or supplement thereto), or any preliminary
Prospectus and in respect of which indemnification may be sought against each
Holder and Underwriter pursuant to this Section 7(c), each Holder and
Underwriter shall have the rights and duties given to the Company by Section
7(a) (except that if the Company shall have assumed the defense thereof, each
Holder and Underwriter may, but shall not be required to, employ separate
counsel therein and participate in the defense thereof and the fees and expenses
of such counsel shall be at the expense of the Holder or Underwriter) and the
Company Indemnified Parties shall have the rights and duties given to the
Indemnified Holders or Indemnified Underwriters by Section 7(b).
(d) If the indemnification provided for in this Section 7 is
unavailable to any party entitled to indemnification pursuant to Section 7(a) or
(c), then each indemnifying party, in lieu of indemnifying such indemnified
party, shall contribute to the amount paid or payable by such indemnified party
as a result of such losses, claims, damages, judgments, liabilities and expenses
(i) in such proportion as is appropriate to reflect the relative benefits
received by the
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Company on the one hand, and each Indemnified Holder or Indemnified Underwriter
on the other, from the offering of the Registrable Securities or (ii) if the
allocation provided by clause (i) above is not permitted by applicable law, in
such proportion as is appropriate to reflect not only the relative benefits
referred to in clause (i) above but also the relative fault of the Company on
the one hand and each Indemnified Holder or Indemnified Underwriter on the other
in connection with the statement or omissions which resulted in such losses,
claims, damages, judgments, liabilities or expenses, as well as any other
relevant equitable considerations. The relative benefits received by the Company
on the one hand and each Indemnified Holder or Indemnified Underwriter on the
other shall be deemed to be in the same proportions as the total net proceeds
from the offering (before deducting expenses) received by the Company bear to
the total net discounts and commissions received by each Indemnified Holder or
Indemnified Underwriter, in each case as set forth in the table on the cover
page of the Prospectus. The relative fault of the Company on the one hand each
Indemnified Holder or Indemnified Underwriter on the other shall be determined
by reference to, among other things, whether the untrue or alleged untrue
statement of a material fact or the omission or alleged omission to state a
material fact relates to information supplied by the Company on the one hand or
by each Indemnified Holder or Indemnified Underwriter on the other and the
parties' relative intent, knowledge, access to information and opportunity to
correct or prevent such statement or omission.
(e) The Company and each Indemnified Holder or Indemnified
Underwriter agree that it would not be just and equitable if contribution
pursuant to Section 7(d) were determined by pro rata allocation or by any other
method of allocation that does not take account of the equitable considerations
referred to in Section 7(d). The amount paid or payable by an indemnified party
as a result of the losses, claims, damages, liabilities or expenses referred to
in the immediately preceding paragraph shall be deemed to include, subject to
the limitations set forth above, any legal or other expenses reasonably incurred
by such indemnified party in connection with investigating or defending any such
action or claim. No person found guilty of fraudulent misrepresentation (within
the meaning of Section 11(f) of the Securities Act) shall be entitled to
contribution from any person who was not found guilty of such fraudulent
misrepresentation.
(f) The indemnity and contribution agreements contained in this
Section 7 are in addition to any liability that any indemnifying party may
otherwise have to any indemnified party.
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SECTION 8. PARTICIPATION IN UNDERWRITTEN REGISTRATIONS
No Holder may participate in any Underwritten Offering hereunder
unless such Holder (a) agrees to sell such Holder's Registrable Securities on
the basis provided in any underwriting arrangements approved by the Persons
entitled hereunder to approve such arrangements, (b) completes and executes all
questionnaires, powers of attorney, indemnities, underwriting agreements, hold-
back agreements and other documents required under the terms of such
underwriting arrangements, and (c) furnishes the Company in writing information
in accordance with the second to the last paragraph of Section 5 and agrees to
indemnify and hold harmless the Company, its directors, its officers who sign
the Registration Statement and any person controlling the Company within the
meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act as
contemplated by Section 7(c).
SECTION 9. MISCELLANEOUS
(a) Remedies. Each Holder of Registrable Securities, in addition to
--------
being entitled to exercise all rights provided herein and granted by law,
including recovery of damages, will be entitled to specific performance of such
Holder's rights under this Agreement. The Company agrees that monetary damages
would not be adequate compensation for any loss incurred by reason of a breach
by it of the provisions of this Agreement and hereby agrees to waive the defense
in any action for specific performance that a remedy at law would be adequate.
(b) No Inconsistent Agreements. The Company will not on or after the
--------------------------
date of this Agreement enter into any agreement with respect to its securities
that is inconsistent with the rights granted to the Holders of Registrable
Securities in this Agreement or otherwise conflicts with the provisions hereof.
The rights granted to the Holders of Registrable Securities hereunder do not in
any way conflict with and are not inconsistent with the rights granted to the
Holders of the Company's securities under any other agreements.
(c) Amendments and Waivers. The provisions of this Agreement,
----------------------
including the provisions of this sentence, may not be amended, modified or
supplemented, and waivers or consents to departures with the provisions hereof
may not be given unless the Company has obtained the written consent of a
majority of the Holders of the Registrable Securities affected by such
amendment, modification, supplement, waiver or departure. Notwithstanding the
foregoing, a waiver or consent to departure from the provisions hereof that
relates exclusively to the rights of Holders of Registrable Securities whose
securities are being sold pursuant to a Registration Statement and that does not
directly or indirectly affect the rights of other Holders of Registrable
Securities shall be valid only with the written consent of Holders of at least
66-2/3% of the Registrable Securities being sold.
(d) Notices. All notices and other communications provided for or
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permitted hereunder shall be made in writing by hand-delivery, first-class mail
(registered or certified, return receipt requested), telex, telecopier, or air
courtier guaranteeing overnight delivery:
(i) if to a Holder of Registrable Securities, at the most
current address given by such Holder to the Company; and
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(ii) if to the Company, to
NovaStar Financial, Inc.
1900 West 47th Place
Suite 205
Westwood, KS 66205
Attn: President
with a copy to:
Tobin & Tobin
One Montgomery Street, 15th Floor
San Francisco, CA 94104
Attn: Phillip R. Pollock
All such notices and communications shall be deemed to have been duly
given: at the time delivered by hand, if personally delivered; five (5)
business days after being deposited in the mail, postage prepaid, if mailed;
when answered back, if telexed; when receipt acknowledged, if telecopied; and on
the next business day, if timely delivered to an air courier guaranteeing
overnight delivery.
(e) Successors and Assigns. This Agreement shall inure to the
----------------------
benefit of and be binding upon the successors and assigns of each of the
parties, including without limitation and without the need for an express
assignment, and subsequent Holders of Registrable Securities; provided, however,
that this Agreement shall not inure to the benefit of or be binding upon a
successor or assign of a Holder of Registrable Securities unless and to the
extent such successor or assign acquired Registrable Securities from such
Holder. If any transferee of any Holder shall acquire Registrable Securities, in
any manner, whether by operation of law or otherwise, such Registrable
Securities shall be held subject to all of the terms of this Agreement and by
taking and holding such Registrable Securities such person shall be conclusively
seemed to have agreed to be bound by and to perform all of the terms and
provisions of this Agreement and such Person shall be entitled to receive the
benefits hereof.
(f) Counterparts. This Agreement may be executed in any number of
------------
counterparts and by the parties hereto in separate counterparts, each of which
when so executed shall be deemed to be an original and all of which taken
together shall constitute one and the same agreement.
(g) Headings. The headings of this Agreement are for convenience of
--------
reference only and shall not limit or otherwise affect the meaning hereof.
(h) GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED
-------------
IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK, WITHOUT REGARD TO THE
CONFLICT OF LAW RULES THEREOF.
15
<PAGE>
(i) Severability. In the event that any one or more of the
------------
provisions contained herein, or the application thereof in any circumstance, is
held invalid, illegal or unenforceable, the validity, legality and
enforceability of any such provision in every other respect and of the remaining
provisions contained herein shall not be affected or impaired thereby.
(j) Entire Agreement. This Agreement is intended by the parties
----------------
as a final expression of their agreement and intended to be a complete and
exclusive statement of the agreement and understanding of the parties hereto in
respect of the subject matter contained herein. There are no restrictions,
promises, warranties or undertakings, other than referred to herein with respect
to the registration rights granted by the Company with respect to Registrable
Securities. This Agreement supersedes all prior agreements and understandings
between the parties with respect to such subject matter.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first above written.
COMPANY: NOVASTAR FINANCIAL, INC.
By____________________________________
STOCKHOLDERS: _______________________________________
W. Lance Anderson
_______________________________________
Scott F. Hartman
16
<PAGE>
EXHIBIT 10.5
GE Capital
- -------------------------------------------------------------------------------
Equity Capital Group
General Electric Capital Corporation
260 Long Ridge Road, Stamford, CT 05927
203-357-3100
October 3, 1996
NovaStar Financial, Inc.
1900 W. 47th Place
Westwood, Kansas 66205
Stifel, Nicolaus & Company, Incorporated
500 North Broadway
St. Louis, Missouri 63102
Gentlemen:
You have advised General Electric Capital Corporation ("GE Capital")
that NovaStar Financial, Inc. (the "Company") is seeking to consummate a
transaction to raise $15 million to $45 million of equity capital. We have
reviewed the information provided by you in connection with this proposed
investment. Based on the information that you have provided to date, and our
understanding of the transaction, GE Capital is pleased to issue its commitment
to invest $10 million in the Company, subject to the terms and conditions
contained in the term sheet attached hereto as Annex A (the "Term Sheet") and
included herein by reference and the following additional terms and conditions:
(i) The Company will provide evidence satisfactory to GE Capital as to
its legal, capital and tax structure and ownership, and copies of all documents,
as GE Capital may reasonably request;
(ii) The Company will be in compliance with all applicable federal,
state and local laws and regulations;
(iii) All governmental consents and regulatory approvals and third party
consents, if any, necessary to consummate the proposed transaction shall have
been obtained in form satisfactory to GE Capital; and
(iv) There will exist no litigation which could reasonably be expected
to have a material adverse effect on the financial condition, business, assets,
operations or prospects of the Company, or that challenges the transaction
contemplated hereby.
<PAGE>
This Commitment Letter is being delivered to you on the understanding
and on the condition that neither this Commitment Letter nor its substance shall
be disclosed publicly or privately by either Stifel, Nicolaus & Company,
Incorporated or the Company, except that this Commitment Letter may be disclosed
to those individuals who are, or upon consummation of the transaction
contemplated hereby will be, officers, employees or advisors of the Company who
have a need to know of it as a result of their being specifically involved in
the transaction contemplated hereby and then only on the condition that such
matters may not, except as required by law, be further disclosed. Except as
specifically permitted by the foregoing sentence, none of such persons shall,
except as required by law, use the name of or refer to GE Capital or any of its
affiliates, in any disclosure made in connection with the transaction
contemplated hereby without the prior written consent of GE Capital. Following
your acceptance of this Commitment Letter, reference may be made to this
Commitment Letter in the Private Placement Memorandum for the transactions
contemplated hereby provided that GE Capital reasonably approves of such
disclosure of this letter.
The Company agrees to indemnify and hold harmless GE Capital, its
affiliates and their respective officers, directors, employees, attorneys and
agents, and all persons controlling any of them or any of their affiliates
within the meaning of the Securities Act of 1933 or the Securities Exchange Act
of 1934 (all such persons being hereinafter referred to as "Indemnified
Persons"), whether or not the transaction contemplated hereby is consummated,
from and against all claims, losses, damages, liabilities or expenses of any
kind or nature whatsoever that may be incurred by or asserted against or involve
any Indemnified Person in any and all actions, suits, proceedings (including any
investigations or inquiries) or claims with respect to this Commitment Letter or
the transaction contemplated hereby (whether or not consummated), or the
preparation, execution and delivery of this Commitment Letter and the
documentation contemplated hereby, subject to the limitation on the
reimbursement of legal fees in connection with such documentation as provided in
the Term Sheet and exclusive of any loss resulting solely from a decline in
value of the Units purchased by GE Capital; and, upon demand by GE Capital, to
pay or reimburse any such Indemnified Person for any reasonable legal or other
expenses incurred in connection with investigating, defending or preparing to
defend or participating in any such action, suit, proceeding (including any
inquiry or investigation) or claim, whether commenced or threatened, it being
understood that GE Capital shall have the right to select its own counsel in
connection with such matters; provided, that the Company shall not be
responsible to any such Indemnified Person to the extent that any such losses,
damages, liabilities or expenses are determined by a final judgment of a court
of competent jurisdiction to be attributable solely to the gross negligence or
willful misconduct of such Indemnified Person. Under no circumstances shall GE
Capital or any other Indemnified Person be responsible for or liable to any
other party hereto or to any other person for consequential, indirect, punitive
or exemplary damages which may be alleged as a result of or in connection with
this Commitment
2
<PAGE>
Letter or the transaction contemplated hereby. The indemnification provisions
set forth herein shall apply whether or not any Indemnified Person is a party to
any such action, suit, proceeding or claim, and are expressly intended to cover,
but not be limited to, reimbursement of legal and other expenses, including
expenses incurred in depositions or other discovery proceedings. The indemnity
obligations hereunder shall be in addition to, and not in limitation of, any
other liability or obligations that the Company or any other person or entity
may have to any indemnified Person, at common law or otherwise, including but
not limited to any obligation of contribution.
GE Capital's offer of this commitment shall expire at the close of
business on October 7, 1996 unless accepted by you on or prior to such date. To
accept this offer, we ask that you return to GE Capital an executed copy of this
letter. Once accepted by you, GE Capital's commitment set forth herein shall
expire at 5:00 p.m. on November 11, 1996, unless the transaction contemplated
hereby shall have been consummated. Notwithstanding the expiration of GE
Capital's commitment hereunder, the obligations set forth herein with respect to
confidentiality and indemnification shall survive such expiration.
This letter: (i) may be executed in counterparts, each of which shall be
deemed an original and all of which counterparts shall constitute one and the
same document; (ii) shall be governed by, and construed and enforced in
accordance with, the laws of the State of New York without regard to the
principles thereof regarding conflict of laws; (iii) supersedes any and all
discussions, negotiations, understandings or agreements, written or oral,
expressed or implied, between us regarding the transaction contemplated hereby;
and (iv) may not be contradicted by evidence of any actual or alleged prior,
contemporaneous or subsequent understandings or agreements of the parties
written or oral, expressed or implied, other than a writing which expressly
amends or supersedes this letter. There are no unwritten understandings or
agreements between the parties. THE PARTIES HAVING DETERMINED IT TO BE IN THEIR
BEST INTERESTS TO SECURE FOR THEMSELVES THE ADVANTAGES OF THE BEST ASPECTS OF
EACH OF ARBITRATION AND THE JUDICIAL SYSTEM, BY PRESERVING FOR THEMSELVES THE
RIGHT OF TRIAL BY JUDGE ALONE, EACH PARTY HEREBY EXPRESSLY WAIVES ANY RIGHT TO
TRIAL BY JURY OF ANY CLAIM, DEMAND, ACTION OR CAUSE OF ACTION ARISING UNDER THIS
COMMITMENT LETTER, ANY TRANSACTION RELATING HERETO, OR ANY OTHER INSTRUMENT,
DOCUMENT OR AGREEMENT EXECUTED OR DELIVERED IN CONNECTION HEREWITH WHETHER
SOUNDING IN CONTRACT, TORT OR OTHERWISE.
3
<PAGE>
We look forward to working with you to bring the proposed transaction to
completion.
Very truly yours,
GENERAL ELECTRIC CAPITAL
CORPORATION
By: /s/ JEROME C. MARCUS
--------------------------------------
Name: Jerome C. Marcus
Title: Department Operations Manager
Accepted this day of October, 1996:
NOVASTAR FINANCIAL, INC.
By:
------------------------------
Name:
Title:
STIFEL, NICOLAUS & COMPANY, INCORPORATED
By:
-------------------------------
Name:
Title:
4
<PAGE>
Annex A
NovaStar Financial, Inc.
Summary of Proposed Principal Terms
Class A Convertible Preferred Stock
-----------------------------------
Issuer: NovaStar Financial, Inc.(the "Company")
Purchaser: General Electric Capital Corporation ("GE Capital") or an
affiliate of GE Capital.
Amount: $10 million for 666,666 Units at $15 per Unit, provided that the
GE Capital minimum condition is satisfied.
Issue: All of the units (the Units") are being offered by the Company.
The closing of this offering (the "Offering" is expected to occur
on or about [November 8, 1996] and will involve at least
1,000,000. Units ($15 million, the Minimum Offering") excluding
Units purchased by Purchaser, and not exceed between 3,000,000
Units and 3,333,333 Units (between $45 million and $50 million;
the "Maximum Offering"). If the maximum amount of the offering ha
not been attained at the time of such closing, one or more
additional closings ("Additional Closings') may be affected, but
in no event will the last closing occur later than December 31,
1996. It is understood that it is a condition to the purchase
hereunder that at least, 1,666,666 Units ($25 million), including
the Units purchased by Purchaser, be sold.
Each Unit consists of one share of Class A Convertible Preferred
Stock. ("the Preferred Stock") and one Stock Purchase Warrant
("Warrant").
Issue Capit- The Company's Common Stock outstanding shall be equal to 100,000
alization share plus 5% of the total amount of Units issued in excess of
Common Stock 1,000,000 Units ("Founders' Stock"), and purchased by the
and Founders Founders for $.01 per share. The Founders intend to also purchase
Units: an amount closely approximately 40.000 Units issued in this
Offering which shall be paid for which cash by the Founders shall
purchase 100,000 Units plus outlined in "Issue" above, the
Founder shall purchase
<PAGE>
NovaStar Financial, Inc.
Page 2
October 3, 1996
through a full recourse Company forgivable loan,
carrying an 8% fixed interest rate with one year
pay-in-kind interest and current interest
payments thereafter, to be secured by the Units.
Further, to assist the Founders with the tax
consequences related to possible debt
forgiveness, the Company shall make a full
recourse loan to the Founders with a floating
interest rate, with interest paid currently at
Prime plus 2.5%. Such loan shall be
collateralized by the Units and be payable upon
the earlier of (i) the Founders selling the
related Units or shares thereof, or (ii) upon
the Founders leaving employment of the Company.
Issuer Capitalization-
Options: The Company shall reserve shares of Common Stock
for issuance upon the exercise of Options
granted to employees, officers and directors,
the number of which shall not exceed (a) 10% of
the Units issued in this Offering plus the
number of Founders' Forgivable Loan Units at any
time prior to a Qualified IPO, and (b) 10% of
the Company's outstanding Common Shares at any
time after a Qualified IPO. The number of such
options granted to the Founders in conjunction
with the closing of this Offering shall not
exceed 133,000 plus 6.7% of the Units issued in
this Offering in excess of 1,000,000 Units. Up
to 50,000 additional options shall be issued to
current and future employees of the Company, not
to include the Founders, and shall be issued at
exercise prices which range from approximately
$1 to $3 per share, with Dividend Equivalent
Rights ("DERs"). The options issued to Messrs.
Anderson and Hartman upon closing of the
Offering shall have an exercise price of $15 per
share. Such options issued to Messrs. Anderson
and Hartman shall vest upon a Qualified IPO and
remain restricted stock (i.e., not publicly
transferable) for a minimum of two years
following the Qualified IPO. Other than the
50,000 DERs mentioned above, the Company shall
not issue any other DERs. In addition, no stock
awards shall be issued by the Company.
Placement Agent
Warrants: Warrants may be granted to Stifel, Nicolaus &
Company, Incorporated in an amount equal to 3%
of the total Units issued in the Offering. The
exercise price for such Warrants shall be
<PAGE>
NovaStar Financial, Inc.
Page 3
October 3, 1996
$15/warrant share. In addition, Stifel, Nicolaus
& Company. Incorporated shall be paid a cash fee
at closing in an amount not to exceed 7% of the
total gross proceeds from the sale of Units in
the Offering.
Use of Proceeds: To fund, along with proceeds from short-term and
other collateralized borrowings, the Company's
origination of and investment in residential
sub-prime mortgage loans and residential
mortgage-backed securities. Pending completion
of the purchase of such assets, the proceeds of
the Offering may be invested in short-term
investments.
Dividends: The Company intends to distribute to
stockholders each year substantially all of its
net taxable income so as to qualify for the tax
benefits accorded to REITs under the Code. The
Company intends to make dividend distributions
at least quarterly. It is anticipated that the
first dividend distribution to stockholders
will be made promptly after the first full
fiscal quarter following completion of this
offering.
Until such time that a Conversion event has
taken place, all net income/dividends will be
paid to the Preferred Stock.
Warrants: Each Warrant entitles the holder thereof to
purchase one share (a "Warrant Share") of the
Company's Common Stock. The Warrants will be
exercisable within six months of a Qualified IPO
at an exercise price of $15 per share ("Warrant
Exercise Price") and remain exercisable for
three years following the initial exercise date.
The Warrants will be deemed exercised upon a
sale or liquidation of the Company which yields
a common stock distribution in excess of $15 per
share.
Warrants may be exercised by (i) paying the
Warrant Exercise Price in cash or (ii)
surrendering the appropriate number of common
shares or Warrants, where the value of such
common shares shall be the then market value of
the Company's common stock and the value of such
Warrants shall be the then market value of the
Company's common stock less the Warrant Exercise
Price.
<PAGE>
NovaStar Financial, Inc.
Page 4
October 3, 1996
Governance Provisions:
Voting Rights: Preferred Stockholders shall have the right to
vote with the common shareholders on all matters
submitted to a vote of shareholders of the
Issuer.
The affirmative vote of two-thirds of the
Preferred Stock outstanding is necessary for the
issuance of securities senior to or on a parity
with the Preferred Stock, the authorization or
issuance of securities convertible into such
senior or parity securities, the amendment of
the Certificate of Incorporation so as to
adversely affect the Preferred Stock, the
amendment of any of the terms of the Preferred
Stock, or the waiver of any other covenants and
other deal-specific class voting provisions.
This does not pertain to the initial public
offering. Shares of Class A Convertible
Preferred stock may be issued through permitted
Additional Closings.
Board
Representation: Purchaser shall have the right to appoint 1
director out of a total of no more than 6
authorized directors so long as it owns at least
10% of the outstanding common shares, assuming a
conversion of the Preferred Stock and full
exercise of all Warrants. Such director shall be
reasonably acceptable to the Company; it being
further understood that GE Capital will put
forth Jenne Britell as its nominee to represent
GE Capital on the Company's Board. A majority of
the Board members will be independent, non-
management directors. Moreover, such GE Capital
director shall be considered an independent
director.
In the event Purchaser does not appoint a
director, Purchaser shall have board observation
rights which will include the right to receive
all information provided to board members
(including all committees of the board) and
reimbursement of related expenses. The
Purchaser's board observation rights shall
terminate when the Purchaser has sold 80% of its
investment assuming full exercise of all
Warrants.
The reasonably acceptable GE Capital designee
shall be elected to the Board for a three-year
term prior to or simultaneously with the closing
of the Offering. The Founders shall agree that
so long as GE Capital is entitled to a director,
the Founders will vote as
<PAGE>
NovaStar Financial, Inc.
Page 5
October 3, 1996
directors and stockholders to nominate and to
elect such reasonably acceptable GE Capital
designee to the Board.
Special Meetings: A Special Meeting of the shareholders may be
called at the request of shareholders holding a
minimum of 20% of the Company's outstanding
shares or by a director. The Board of Directors
agrees that it will implement any resolution
adopted by a majority vote of the Company's
shareholders to sell or liquidate the Company.
Redemption Provisions:
Holder's Option to Redeem: In the event of a change of control, a merger,
consolidation or other combination by the
Company, or transfer of all or substantially all
of the Company's assets, the Purchaser shall
have the option to receive the greater of: (i)
what the common stock would have received if
conversion had occurred prior to the record
date, or (ii) 100% of the Liquidation Preference
of the Preferred Stock as provided under the
"Liquidation Preference" clause below.
Conversion Terms:
Automatic Conversion: Shares of Preferred Stock will convert to the
Company's Common Stock, par value $.01 per share
("Common Stock"), upon the closing of a firm
commitment underwriting by Stifel, Nicolaus &
Company, Incorporated or another nationally
recognized investment banking firm for an
initial public offering of the Common Stock
resulting in aggregate gross proceeds to the
Company of at least $20 million at a minimum
price of $15 per share ("a Qualified IPO"). The
size and minimum price of the Offering can only
be reduced and still be deemed a Qualified IPO
by an affirmative vote of the holders of two-
thirds of the Preferred Stock. Any such vote to
reduce the minimum price shall constitute a
waiver of anti-dilution protection with respect
to the Preferred Stock and Warrants resulting
from such issuance at a price below $15 per
share.
<PAGE>
NovaStar Financial, Inc.
Page 6
October 3, 1996
Optional Conversion: Three years following the last closing of the
Offering at the option of the holder.
Conversion Price: Each share of Preferred will convert into common
on a one-for-one basis provided that such
conversion price shall be appropriately adjusted
for any stock splits or similar transactions and
is subject to Anti-Dilution Provisions included
herein.
Covenants/Restrictions on Issuer:
Covenants: The Purchase Agreement and/or the Certificate of
Incorporation will contain usual and customary
covenants for this type of investment including,
but not limited to: (i) prohibitions on Common
Stock dividends until a Conversion event; (ii)
information requirements until a Qualified IPO;
(iii) approval by a majority of independent
directors of material increases in management
compensation; (iv) restrictions on affiliated
transactions; (v) prohibitions on entering
unrelated lines of business (including, but not
limited to, investments in commercial and multi-
family mortgages and mortgage backed securities
or other REITs); (vi) maintenance of Key Man
life insurance (as required under Conditions of
Purchase and Sale) for five years; (vii)
maintenance of the Company's status as a REIT;
and (viii) approval by a majority of the
independent directors for any changes in the
capital allocation guidelines and hedge
policies.
Following a Qualified IPO or, in the case of
clauses (v) and (vi) above, one year following
Qualified IPO, the provisions of clauses (iii)
through (vii) above may be modified or waived by
a majority of independent directors. During such
one-year period, clauses (v) and (vi) may be
waived by a unanimous vote of the Board of
Directors.
<PAGE>
NovaStar Financial, Inc.
Page 7
October 3, 1996
Other:
Indemnities: The Company shall indemnify Purchaser and its
directors, officers and employees against all
losses and damages resulting from the
transaction other than such losses and damages
which arise out of Purchaser's gross negligence
or willful misconduct.
Representations and
Warranties: Customary representations relating to
organization and qualification, authorization,
execution and delivery, validity and
enforceability of agreements, issuance of the
Preferred Stock, actions pending, compliance
with laws and environmental regulations,
governmental consent, insurance adequacy, no
conflict with agreements and charter provisions,
capitalization, taxes ERISA, and no material
adverse change.
Anti-Dilution Provisions: Conversion rights and the Warrant Exercise Price
will be adjusted to provide standard anti-
dilution protection, including adjustments for
extraordinary dividends, recapitalization, or
subdivisions, combinations or reclassifications
of common stock, issuance of shares at prices
below the higher of (a) $15 per share, and (b)
fair market value subject, however, to the
provisions relating to a Qualified IPO.
Registration Rights: GE Capital and each other purchaser of at least
5% of the Units in this Offering shall be
entitled to unlimited piggyback registration
rights provided that to the extent that the
underwriters require a "cut-back," GE Capital's
and such purchasers' shares shall be cut back
before the Company's, except that to the extent
the Company has or would be issuing more than
$50 million of securities in either of its first
two offerings the Company shall be cut back
first as to any securities in excess of $50
million. Such registrations and the ones
referred to below will be at the expense of the
Company, except that underwriting commissions
will be borne pro rata by the holders.
The Company will file a shelf registration at
the earlier of (i) six months after the
Qualified IPO, and (ii) twenty months following
the closing date provided that if a Qualified
IPO occurs within such 20-month period, the
shelf registration will be filed six months
thereafter. Such shelf registration shall remain
open for three years
<PAGE>
NovaStar Financial, Inc.
Page 8
October 3, 1996
from the closing date of this Offering. Each of
GE Capital and each other purchaser of at least
5% of the Units in this Offering shall further
have two demand registration rights following
the end of the shelf registration period to the
extent necessary for it to sell its shares in
compliance with applicable securities laws. GE
Capital shall not have such demand registration
rights if in the written opinion of the
Company's counsel, which opinion must be
reasonably acceptable to GE Capital and its
counsel, such registration is not necessary for
GE Capital to sell its shares in the manner
contemplated so as to comply with applicable
securities laws. The shelf registration
applicable to the shares issuable upon exercise
of the Warrants shall also be a primary
registration and shall remain effective so long
as the Warrants are outstanding. If requested by
GE Capital, the Company's management will
conduct roadshows to assist GE Capital in
selling its shares under the shelf offering or
demand offering.
Other Provisions:
Conditions of Purchase and
Sale: The purchase and sale of the Preferred Stock
would be subject to certain conditions,
including execution and delivery of all
necessary documentation in form and substance
satisfactory to GE Capital, satisfaction with
the Certificate of Incorporation and bylaws of
the Company, the satisfactory completion of all
business, financial and legal due diligence, the
receipt of opinions of the Company's counsel
satisfactory to the Purchaser (including as to
REIT status), the absence of the occurrence of
any material adverse event, receipt of all
agreements with management (including non-
competition agreements), all stock incentive
plans and other employee benefit plans in form
and substance satisfactory to GE Capital, the
obtaining of Key Man life insurance policies on
both Lance Anderson and Scott Hartman in the
amount of $5 million per individual, the
election of GE Capital's designee to the Board
for a three-year term, and receipt of a
satisfactory waiver or opinion of counsel so
that the restrictions on maximum ownership of
shares and the "Control Shares Provision" of
Maryland law shall not apply to GE Capital. It
is understood that no investor in this Offering
shall be offered any investment terms other than
as previously disclosed to GE Capital and set
forth in the written information previously
provided to GE Capital.
<PAGE>
[LETTERHEAD OF GE CAPITAL APPEARS HERE]
November 8, 1996
NovaStar Financial, Inc.
1900 W. 47th Place
Westwood, Kansas 62205
Stifel, Nicolaus & Company, Incorporated
500 North Broadway
St. Louis, Missouri 63102
Gentlemen:
Reference is made to the letter between us dated October 3, 1996,
pursuant to which General Electric Capital Corporation ("GE Capital"), issued
its commitment to invest $10 million (the "Commitment") in NovaStar Financial,
Inc. (the "Company"), subject to the terms and conditions contained therein (the
"Commitment Letter").
The Commitment Letter is hereby amended by changing the November 11,
1996 expiration date set forth in the first paragraph of page 2 thereof to
December 11, 1996. Further, the Company hereby confirms that if GE Capital
subscribes for $10,000,000 of the Units of the Company as contemplated by the
Commitment Letter, the Company will accept such subscription in full in
accordance with the terms of the Commitment Letter. Except as amended hereby,
the terms of the Commitment Letter shall remain in full force and effect.
This letter: (i) shall become effective only if accepted by you by
signing and returning a copy thereof to GE Capital by the close of business on
November 12, 1996, (ii) may be executed in counterparts, each of which shall be
deemed an original and all of which counterparts shall constitute one and the
same document, and (iii) shall be governed by, and construed and enforced in
accordance with, the laws of the State of New York without regard to the
principles thereof regarding conflict of laws.
Very truly yours,
GENERAL ELECTRIC CAPITAL
CORPORATION
By: /s/ JEROME C. MARCUS
---------------------------------
Name: Jerome C. Marcus
Title: Department Operations Manager
Accepted this 12th day of November, 1996:
NOVASTAR FINANCIAL, INC.
By: /s/ W. LANCE ANDERSON
-------------------------------------
Name: W. Lance Anderson
Title: President
STIFEL, NICOLAUS & COMPANY, INCORPORATED
By: /s/ PATRICK KOSTER
--------------------------------------
Name: Patrick Koster
Title: Vice President
<PAGE>
Exhibit 10.6
- --------------------------------------------------------------------------------
PSA THE BOND MARKET
TRADE ASSOCIATION
MASTER
REPURCHASE AGREEMENT
SEPTEMBER 1996 VERSION
Dated as of January 31, 1997
Between:
MERRILL LYNCH MORTGAGE CAPITAL INC.
and
MERRILL LYNCH CREDIT CORPORATION
and
NOVASTAR FINANCIAL, INC.
1. Applicability
From time to time the parties hereto may enter into transactions in which one
party ("Seller") agrees to transfer to the other ("Buyer") securities or
other assets ("Securities") against the transfer of funds by Buyer, with a
simultaneous agreement by Buyer to transfer to Seller such Securities at a
date certain or on demand, against the transfer of funds by Seller. Each such
transaction shall be referred to herein as a "Transaction" and, unless
otherwise agreed in writing, shall be governed by this Agreement, including
any supplemental terms or conditions contained in Annex I hereto and in any
other annexes identified herein or therein as applicable hereunder.
2. Definitions
(a) "Act of Insolvency", with respect to any party, (i) the commencement by
such party as debtor of any case or proceeding under any bankruptcy,
insolvency, reorganization, liquidation, moratorium, dissolution,
delinquency or similar law, or such party seeking the appointment or
election of a receiver, conservator, trustee, custodian or similar
official for such party or any substantial part of its property, or the
convening of any meeting of creditors for purposes of commencing any such
case or proceeding or seeking such an appointment or election, (ii) the
commencement of any such case or proceeding against such party, or
another seeking such an appointment of election, or the filing against a
party of an application for a protective decree under the provisions of
the Securities Investor Protection Act of 1970, which (A) is consented to
or not timely contested by such party, (B) results in the entry of an
order for relief, such an appointment or election, issuance of such a
protective decree or the entry of an order having a similar effect, or
(C) is not dismissed within 15 days, (iii) the making by such party of a
general assignment for the benefit of creditors, or (iv) the admission in
writing by such party of such party's inability to pay such party's debts
as they become due;
(b) "Additional Purchased Securities", Securities provided by Seller to Buyer
pursuant to Paragraph 4(a) hereof;
(c) "Buyer's Margin Amount", with respect to any Transaction as of any date,
the amount obtained by application of the Buyer's Margin Percentage to
the Repurchase Price for such Transaction as of such date;
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(d) "Buyer's Margin Percentage", with respect to any Transaction as of any
date, a percentage (which may be equal to the Seller's Margin Percentage)
agreed to by Buyer and Seller or, in the absence of any such agreement, the
percentage obtained by dividing the Market Value of the Purchased
Securities on the Purchase Date by the Purchase Price on the Purchase Date
for such Transaction;
(e) "Confirmation", the meaning specified in Paragraph 3(b) hereof;
(f) "Income", with respect to any Security at any time, any principal thereof
and all interest, dividends or other distributions thereon;
(g) "Margin Deficit", the meaning specified in Paragraph 4(a) hereof;
(h) "Margin Excess", the meaning specified in Paragraph 4(b) hereof;
(i) "Margin Notice Deadline", the time agreed to by the parties in the relevant
Confirmation, Annex I hereto or otherwise as the deadline for giving notice
requiring same-day satisfaction of margin maintenance obligations as
provided in Paragraph 4 hereof (or, in the absence of any such
agreement, the deadline for such purposes established in accordance with
market practice);
(j) "Market Value", with respect to any Securities as of any date, the price
for such Securities on such date obtained from a generally recognized
source agreed to by the parties or the most recent closing bid quotation
from such a source, plus accrued Income to the extent not included therein
(other than any Income credited or transferred to, or applied to the
obligations of, Seller pursuant to Paragraph 5 hereof) as of such date
(unless contrary to market practice for such Securities);
(k) "Price Differential", with respect to any Transaction as of any date, the
aggregate amount obtained by daily application of the Pricing Rate for such
Transaction to the Purchase Price for such Transaction on a 360-day-per-
year basis for the actual number of days during the period commencing on
(and including) the Purchase Date for such Transaction and ending on (but
excluding) the date of determination (reduced by the amount of such Price
Differential previously paid by Seller to Buyer with respect to such
Transaction);
(l) "Pricing Rate", the per annum percentage rate for determination of the
Price differential;
(m) "Prime Rate", the prime rate of U.S. commercial banks as published in
The Wall Street Journal (or, if more than one such rate is published, the
average of such rates);
(n) "Purchase Date", the date on which Purchased Securities are to be
transferred by Seller to Buyer;
(o) "Purchase Price", (i) on the Purchase Date, the price at which Purchased
Securities are transferred by Seller to Buyer, and (ii) thereafter except
where Buyer and Seller agree otherwise, such price increased by the amount
of any such cash transferred by Buyer to Seller pursuant to Paragraph 4(b)
hereof and decreased by the amount of any cash transferred by Seller to
Buyer pursuant to Paragraph 4(a) hereof or applied to reduce Seller's
obligations under clause (ii) of Paragraph 5 hereof;
(p) "Purchased Securities", the Securities transferred by Seller to Buyer
in a Transaction hereunder, and any Securities substituted therefor in
accordance with Paragraph 9 hereof. The term "Purchased Securities" with
respect to any Transaction at any time also shall include Additional
Purchased Securities delivered pursuant to Paragraph 4(a) hereof and shall
exclude Securities returned pursuant to Paragraph 4(b) hereof;
(q) "Repurchase Date", the date on which Seller is to repurchase the Purchased
Securities from Buyer, including any date determined by application of the
provisions of Paragraph 3(c) or 11 hereof;
(r) "Repurchase Price", the price at which Purchased Securities are to be
transferred from Buyer to Seller upon termination of a Transaction,
which will be determined in each case (including Transactions terminable
upon demand) as the sum of the Purchase Price and the Price Differential
as of the date of such determination;
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(s) "Seller's Margin Amount", with respect to any Transaction as of any
date, the amount obtained by application of the Seller's Margin
Percentage to the Repurchase Price for such Transaction as of such
date;
(t) "Seller's Margin Percentage", with respect to any Transaction as of
any date, a percentage (which may be equal to the Buyer's Margin
Percentage) agreed to by Buyer and Seller or, in the absence of any
such agreement, the percentage obtained by dividing the Market Value
of the Purchased Securities on the Purchase Date by the Purchase Price
on the Purchase Date for such Transaction.
3. Initiation; Confirmation; Termination
(a) An agreement to enter into a Transaction may be made orally or in
writing at the initiation of either Buyer or Seller. On the Purchase
Date for the Transaction, the Purchased Securities shall be
transferred to Buyer or its agent against the transfer of the Purchase
Price to an account of Seller.
(b) Upon agreeing to enter into a Transaction hereunder, Buyer or Seller
(or both), as shall be agreed, shall promptly deliver to another party
a written confirmation of each Transaction (a "Confirmation"). The
Confirmation shall describe the Purchased Securities (including CUSIP
number, if any), identify Buyer and Seller and set forth (i) the
Purchase Date, (ii) the Purchase Price, (iii) the Repurchase Date,
unless the Transaction is to be terminable on demand, (iv) the Pricing
Rate or Repurchase Price applicable to the Transaction, and (v) any
additional terms or conditions of the Transaction not inconsistent
with this Agreement. The Confirmation, together with this Agreement,
shall constitute conclusive evidence of the terms agreed between Buyer
and Seller with respect to the Transaction to which the Confirmation
relates, unless with respect to the Confirmation specific objection is
made promptly after receipt thereof. In the event of any conflict
between the terms of such Confirmation and this Agreement, this
Agreement shall prevail.
(c) In the case of Transactions terminable upon demand, such demand shall
be made by Buyer or Seller, no later than such time as is customary in
accordance with market practice, by telephone or otherwise on or prior
to the business day on which such termination will be effective. On
the date specified in such demand, or on the date fixed for
termination in the case of Transactions having a fixed term,
termination of the Transaction will be effected by transfer to Seller
or its agent of the Purchased Securities and any income in respect
thereof received by Buyer (and not previously credited or transferred
to, or applied to the obligations of, Seller pursuant to Paragraph 5
hereof) against the transfer of the Repurchase Price to an account of
Buyer.
4. Margin Maintenance
(a) If at any time the aggregate Market Value of all Purchased Securities
subject to all Transactions in which a particular party is acting as
Buyer is less than the aggregate Buyer's Margin Amount for all such
Transactions (a "Margin Deficit"), then Buyer may by notice to Seller
require Seller in such Transactions, at Seller's option, to transfer
to Buyer cash or additional Securities reasonably acceptable to Buyer
("Additional Purchased Securities"), so that the cash and aggregate
Market Value of the Purchased Securities, including any such
Additional Purchased Securities, will thereupon equal or exceed such
aggregate Buyer's Margin Amount (decreased by the amount of any Margin
Deficit as of such date arising from any Transactions in which such
Buyer is acting as Seller).
(b) If at any time the aggregate Market Value of all Purchased Securities
subject to all Transactions in which a particular party hereto is
acting as Seller exceeds the aggregate Seller's Margin Amount for all
such Transactions at such time (a "Margin Excess"), then Seller may by
notice to Buyer require Buyer in such Transactions, at Buyer's
option, to transfer cash or Purchased Securities to Seller, so that
the aggregate Market Value of the Purchased Securities, after
deduction of any such
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cash or any Purchased Securities so transferred, will thereupon not
exceed such aggregate Seller's Margin Amount (increased by the amount
of any Margin Excess as of such date arising from any Transactions in
which such Seller is acting as Buyer.
(c) If any notice is given by Buyer or Seller under subparagraph (a) or
(b) of this Paragraph at or before the Margin Notice Deadline on any
business day, the party receiving such notice shall transfer cash or
Additional Purchased Securities as provided in such subparagraph no
later than the close of business in the relevant market on such day.
If any such notice is given after the Margin Notice Deadline, the
party receiving such notice shall transfer such cash or Securities no
later than the close of business in the relevant market on the next
business day following such notice.
(d) Any cash transferred pursuant to this Paragraph shall be attributed to
such Transactions as shall be agreed upon by Buyer and Seller.
(e) Seller and Buyer may agree, with respect to any or all Transactions
hereunder, that the respective rights of Buyer or Seller (or both)
under subparagraphs (a) and (b) of this Paragraph may be exercised
only where a Margin Deficit or a Margin Excess, as the case may be,
exceeds a specified dollar amount or a specified percentage of the
Repurchase Prices for such Transactions (which amount or percentage
shall be agreed to by Buyer and Seller prior to entering into any such
Transactions).
(f) Seller and Buyer may agree, with respect to any or all Transactions
hereunder, that the respective rights of Buyer and Seller under
subparagraphs (a) and (b) of this Paragraph to require the elimination
of a Margin Deficit or a Margin Excess, as the case may be, may be
exercised whenever such a Margin Deficit or a Margin Excess exists
with respect to any single Transaction hereunder (calculated without
regard to any other Transaction outstanding under this Agreement).
5. Income Payments
Seller shall be entitled to receive an amount equal to all Income paid or
distributed on or in respect of the Securities that is not otherwise
received by Seller, to the full extent it would be so entitled if the
Securities had not been sold to Buyer. Buyer shall, as the parties may
agree with respect to any Transaction (or, in the absence of any such
agreement, as Buyer shall reasonably determine in its discretion), on the
date such Income is paid or distributed either (i) transfer to or credit to
the account of Seller such Income with respect to any Purchased Securities
subject to such Transaction or (ii) with respect to Income paid in cash,
apply the Income payment or payments to reduce the amount, if any, to be
transferred to Buyer by Seller upon termination of such Transaction. Buyer
shall not be obligated to take any action pursuant to the preceding
sentence (A) to the extent that such action would result in the creation of
a Margin Deficit, unless prior thereto or simultaneously therewith Seller
transfers to Buyer cash or Additional Purchased Securities sufficient to
eliminate such Margin Deficit, or (B) if an Event of Default with respect
to Seller has occurred and is then continuing at the time such Income is
paid or distributed.
6. Security Interest
Although the parties intend that all Transactions hereunder be sales and
purchases and not loans, in the event any such Transactions are deemed to
be loans, Seller shall be deemed to have pledged to Buyer as security for
the performance by Seller of its obligations under each such Transaction,
and shall be deemed to have granted to Buyer a security interest in all of
the Purchased Securities with respect to all Transactions hereunder and all
Income thereon and other proceeds thereof.
7. Payment and Transfer
Unless otherwise mutually agreed, all transfers of funds shall be in
immediately available funds. All Securities transferred by one party hereto
to the other party (i) shall be in suitable form for transfer or shall be
accompanied by duly executed instruments of transfer or assignments in
blank and
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such other documentation as the party receiving possession may reasonably
request, (ii) shall be transferred on the book-entry system of a Federal
Reserve Bank, or (iii) shall be transferred by any other method mutually
acceptable to Seller and Buyer.
8. Segregation of Purchased Securities
To the extend required by applicable law, all Purchased Securities in the
possession of Seller shall be segregated from other securities in its
possession and shall be identified as subject to this Agreement.
Segregation may be accomplished by appropriate identification on the books
and records of the holder, including a financial or securities intermediary
or a clearing corporation. All of Seller's interest in the Purchased
Securities shall pass to Buyer on the Purchase Date and, unless otherwise
agreed by Buyer and Seller, nothing in this Agreement shall preclude Buyer
from engaging in repurchase transactions with the Purchased Securities or
otherwise selling, transferring, pledging or hypothecating the Purchased
Securities, but no such transaction shall relieve Buyer of its obligations
to transfer Purchased Securities to Seller pursuant to Paragraph 3, 4 and
11 hereof, or of Buyer's obligation to credit or pay Income to, or apply
Income to the obligations of, Seller pursuant to Paragraph 5 hereof.
------------------------------------------------------------------------
Required Disclosure for Transactions in Which the Seller Retains
Custody of the Purchased Securities
Seller is not permitted to substitute other securities for those
subject to this Agreement and therefore must keep Buyer's securities
segregated at all times, unless in this Agreement Buyer grants
Seller the right to substitute other securities. If Buyer grants
the right to substitute, this means that Buyer's securities will
likely be commingled with Seller's own securities during the trading
day. Buyer is advised that, during any trading day that Buyer's
securities are commingled with Seller's securities, they [will]*
[may]** be subject to liens granted by Seller to [its clearing
bank]* [third parties]** and may be used by Seller for deliveries
on other securities transactions. Whenever the securities are
commingled, Seller's ability to resegregate substitute securities
for Buyer will be subject to Seller's ability to satisfy [the
clearing]* [any]** lien or to obtain substitute securities.
------------------------------------------------------------------------
* Language to be used under 17 C.F.R. (S)403.4(e) if Seller is a government
securities broker or dealer other than a financial institution.
** Language to be used under 17 C.F.R. (S)403.5(d) if Seller is a financial
institution.
9. Substitution
(a) Seller may, subject to agreement with and acceptance by Buyer,
substitute other Securities for any Purchased Securities. Such
substitution shall be made by transfer to buyer of such other
Securities and transfer to Seller of such Purchased Securities.
After substitution, the substituted Securities shall be deemed
to be Purchased Securities.
(b) In Transactions in which Seller retains custody of Purchased
Securities, the parties expressly agree that Buyer shall be deemed,
for purposes of subparagraph (a) of this Paragraph, to have agreed to
and accepted in this Agreement substitution by Seller of other
Securities for Purchased Securities; provided, however, that such
other Securities shall have a Market Value at least equal to the
Market Value of the Purchased Securities for which they are
substituted.
10. Representations
Each of Buyer and Seller represents and warrants to the other that (f) it
is duly authorized to execute and deliver this Agreement, to enter into
Transactions contemplated hereunder and to perform its obligations
hereunder and has taken all necessary action to authorize such execution,
delivery and per-
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formance, (ii) it will engage in such Transactions as principal (or, if
agreed in writing, in the form of an annex hereto or otherwise, in advance
of any Transaction by the other party hereto, as agent for a disclosed
principal), (iii) the person signing this Agreement on its behalf is duly
authorized to do so on its behalf (or on behalf of any such disclosed
principal), (iv) it has obtained all authorizations of any governmental body
required in connection with this Agreement and the Transactions hereunder
and such authorizations are in full force and effect and (v) the execution,
delivery and performance of this Agreement and the Transactions hereunder
will not violate any law, ordinance, charter, by-law or rule applicable to
it or any agreement by which it is bound or by which any of its assets are
affected. On the Purchase Date for any Transaction Buyer and Seller shall
each be deemed to repeat all of the foregoing representations made by it.
11. Events of Default
In the event that (i) Seller fails to transfer or Buyer fails to purchase
Purchased Securities upon the applicable Purchase Date, (ii) Seller fails to
repurchase or Buyer fails to transfer Purchased Securities upon this
applicable Repurchase Date, (iii) Seller or Buyer fails to comply with
Paragraph 4 hereof, (iv) Buyer fails, after one business day's notice, to
comply with Paragraph 5 hereof, (v) an Act of insolvency occurs with
respect to Seller or Buyer, (vi) any representation made by Seller or Buyer
shall have been incorrect or untrue in any material respect when made or
repeated or deemed to have been made or repeated, or (vii) Seller or Buyer
shall admit to the other its inability to, or its intention not to, perform
any of its obligations hereunder (each an "Event of Default"):
(a) The nondefaulting party may, at its option (which option shall be deemed
to have been exercised immediately upon the occurrence of an Act of
Insolvency), declare an Event of Default to have occurred hereunder and,
upon the exercise or deemed exercise of such option, the Repurchase Date
for each Transaction hereunder shall, if it has not already occurred, be
deemed immediately to occur (except that, in the event that the Purchase
Date for any Transaction has not yet occurred as of the date of such
exercise or deemed exercise, such Transaction shall be deemed
immediately canceled). The nondefaulting party shall (except upon the
occurrence of an Act of Insolvency) give notice to the defaulting party
of the exercise of such option as promptly as practicable.
(b) In all Transactions in which the defaulting party is acting as Seller,
if the nondefaulting party exercises or is deemed to have exercised the
option referred to in subparagraph (a) of this Paragraph, (i) the
defaulting party's obligations in such Transactions to repurchase all
Purchased Securities, at the Repurchase Price therefor on the Repurchase
Date determined in accordance with subparagraph (a) of this Paragraph,
shall thereupon become immediately due and payable, (ii) all Income paid
after such exercise or deemed exercise shall be retained by the
nondefaulting party and applied to the aggregate unpaid Repurchase
Prices and any other amounts owing by the defaulting party hereunder,
and (ii) the defaulting party shall immediately deliver to the
nondefaulting party any Purchased Securities subject to such
Transactions then in the defaulting party's possession or control.
(c) In all Transactions in which the defaulting party is acting as Buyer,
upon tender by the nondefaulting party of payment of the aggregate
Repurchase Prices for all such Transactions, all right, title and
interest in and entitlement to all Purchased Securities subject to such
Transactions shall be deemed transferred to the nondefaulting party, and
the defaulting party shall deliver all such Purchased Securities to the
nondefaulting party.
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(d) If the nondefaulting party exercises or is deemed to have exercised
the option referred to in subparagraph (a) of this Paragraph, the
nondefaulting party, without other notice to the defaulting party,
may:
(i) as to Transactions in which the defaulting party is acting as
Seller, (A) immediately sell, in a recognized market (or
otherwise in a commercially reasonable manner) at such price or
prices as the nondefaulting party may reasonably deem
satisfactory, any or all Purchased Securities subject to such
Transactions and apply the proceeds thereof to the aggregate
unpaid Repurchase Prices and any other amounts owing by the
defaulting party hereunder or (B) in its sole discretion elect,
in lieu of selling all or a portion of such Purchased
Securities, to give the defaulting party credit for such
Purchased Securities in an amount equal to the price therefor
on such date, obtained from a generally recognized source or
the most recent closing bid quotation from such a source,
against the aggregate unpaid Repurchase Prices and any other
amounts owing by the defaulting party hereunder; and
(ii) as to Transactions in which the defaulting party is acting as
Buyer, (A) immediately purchase, in a recognized market (or
otherwise in a commercially reasonable manner) at such price or
prices as the nondefaulting party may reasonably deem
satisfactory, securities ("Replacement Securities") of the same
class and amount as any Purchased Securities that are not
delivered by the defaulting party to the nondefaulting party as
required hereunder or (B) in its sole discretion elect, in
lieu of purchasing Replacement Securities, to be deemed to
have purchased Replacement Securities at the price therefor on
such date, obtained from a generally recognized source or the
most recent closing offer quotation from such a source.
Unless otherwise provided in Annex I, the parties acknowledge and
agree that (1) the Securities subject to any Transaction hereunder
are instruments traded in a recognized market, (2) in the absence of
a generally recognized source for prices or bid or offer quotations
for any Security, the nondefaulting party may establish the source
therefor in its sole discretion and (3) all prices, bids and offers
shall be determined together with accrued income (except to the
extent contrary to market practice with respect to the relevant
Securities).
(e) As to Transactions in which the defaulting party is acting as Buyer,
the defaulting party shall be liable to the nondefaulting party for
any excess of the price paid (or deemed paid) by the nondefaulting
party for Replacement Securities over the Repurchase Price for the
Purchased Securities replaced thereby and for any amounts payable by
the defaulting party under Paragraph 5 hereof or otherwise hereunder.
(f) For purposes of this Paragraph 11, the Repurchase Price for each
Transaction hereunder in respect of which the defaulting party is
acting as Buyer shall not increase above the amount of such
Repurchase Price for such Transaction determined, as of the date of
the exercise or deemed exercise by the nondefaulting party of the
option referred to in subparagraph (a) of this Paragraph.
(g) The defaulting party shall be liable to the nondefaulting party for
(i) the amount of all reasonable legal or other expenses incurred by
the nondefaulting party in connection with or as a result of an Event
of Default, (ii) damages in an amount equal to the cost (including
all fees, expenses and commissions) of entering into replacement
transactions and entering into or terminating hedge transactions in
connection with or as a result of an Event of Default, and (iii) any
other loss, damage, cost or expense directly arising or resulting
from the occurrence of an Event of Default in respect of a
Transaction.
(h) To the extent permitted by applicable law, the defaulting party shall
be liable to the nondefaulting party for interest on any amounts
owing by the defaulting party hereunder, from the date the defaulting
party becomes liable for such amounts hereunder until such amounts
are (i) paid in full
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by the defaulting party or (ii) satisfied in full by the exercise of
the nondefaulting party's rights hereunder. Interest on any sum
payable by the defaulting party to the nondefaulting party under this
Paragraph 11(h) shall be at a rate equal to the greater of the
Pricing Rate for the relevant Transaction or the Prime Rate.
(i) The nondefaulting party shall have, in additional to its rights
hereunder, any rights otherwise available to it under any other
agreement or applicable law.
12. Single Agreement
Buyer and Seller acknowledge that, and have entered hereinto and will
enter into each Transaction hereunder in consideration of and in reliance
upon the fact that, all Transactions hereunder constitute a single business
and contractual relationship and have been made in consideration of each
other. Accordingly, each of Buyer and Seller agree (i) to perform all of
its obligations in respect of each Transaction hereunder, and that a
default in the performance of any such obligations shall constitute a
default by it in respect of all Transactions hereunder, (ii) that each of
them shall be entitled to set off claims and apply property held by them in
respect of any Transaction against obligations owing to them in respect of
any other Transactions hereunder and (iii) that payments, deliveries and
other transfers made by either of them in respect to any Transaction shall
be deemed to have been made in consideration of payments, deliveries and
other transfers in respect of any other Transactions hereunder, and the
obligations to make any such payments, deliveries and other transfers may
be applied against each other and netted.
13. Notices and Other Communications
Any and all notices, statements, demands or other communications hereunder
may be given by a party to the other by mail, facsimile, telegraph,
messenger or otherwise to the address specified in Annex II hereto, or so
sent to such party at any other place specified in a notice of change of
address hereafter received by the other. All notices, demands and requests
hereunder may be made orally, to be confirmed promptly in writing, or by
other communication as specified in the preceding sentence.
14. Entire Agreement; Severability
This Agreement shall supersede any existing agreements between the parties
containing general terms and conditions for repurchase transactions. Each
provision and agreement herein shall be treated as separate and independent
from any other provision or agreement herein and shall be enforceable
notwithstanding the unenforceability of any such other provision or
agreement.
15. Non-assignability; Termination
(a) The rights and obligations of the parties under this Agreement and
under any Transaction shall not be assigned by either party without
the prior written consent of the other party, and any such assignment
without the prior written consent of the other party shall be null and
void. Subject to the foregoing, this Agreement and any Transactions
shall be binding upon and shall inure to the benefit of the parties
and their respective successors and assigns. This Agreement may be
terminated by either party upon giving written notice to the other,
except that this Agreement shall, notwithstanding such notice, remain
applicable to any Transactions then outstanding.
(b) Subparagraph (a) of this Paragraph 15 shall not preclude a party from
assigning, charging or otherwise dealing with all or any part of its
interest in any sum payable to it under Paragraph 11 hereof.
16. Governing Law
This Agreement shall be governed by the laws of the State of New York
without giving effect to the conflict of law principles thereof.
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17. No Waivers, Etc.
No express or implied waiver of any Event of Default by either party shall
constitute a waiver of any other Event of Default and no exercise of any
remedy hereunder by any party shall constitute a waiver of its right to
exercise any other remedy hereunder. No modification or waiver of any
provision of this Agreement and no consent by any party to a departure
herefrom shall be effective unless and until such shall be in writing and
duly executed by both of the parties hereto. Without limitation on any of
the foregoing, the failure to give a notice pursuant to Paragraph 4(a) or
4(b) hereof will not constitute a waiver of any right to do so at a later
date.
18. Use of Employee Plan Assets
(a) If assets of an employee benefit plan subject to any provision of the
Employee Retirement Income Security Act of 1974 ("ERISA") are
intended to be used by either party hereto (the "Plan Party") in a
Transaction, the Plan Party shall so notify the other party prior to
the Transaction. The Plan Party shall represent in writing to the
other party that the Transaction does not constitute a prohibited
transaction under ERISA or is otherwise exempt therefrom, and the
other party may proceed in reliance thereon but shall not be required
so to proceed.
(b) Subject to the last sentence of paragraph (a) of this Paragraph, any
such Transaction shall proceed only if Seller furnishes or has
furnished to Buyer its most recent available audited statement of its
financial condition and its most recent subsequent unaudited
statement of its financial condition.
(c) By entering into a Transaction pursuant to this Paragraph, Seller
shall be deemed (i) to represent to Buyer that since the date of
Seller's latest such financial statements, there has been no material
adverse change in Seller's financial condition which Seller has not
disclosed to Buyer, and (ii) to agree to provide Buyer with future
audited and unaudited statements of its financial condition as they
are issued, so long as it is a Seller in any outstanding Transaction
involving a Plan Party.
19. Intent
(a) The parties recognize that each Transaction is a "repurchase
agreement" as that term is defined in Section 101 of Title 11 of the
United States Code, as amended (except insofar as the type of
Securities subject to such Transaction or the term of such
Transaction would render such definition inapplicable), and a
"securities contract" as that term is defined in Section 741 of Title
11 of the United States Code, as amended (except insofar as the type
of assets subject to such Transaction would render such definition
inapplicable).
(b) It is understood that either party's right to liquidate Securities
delivered to it in connection with Transactions hereunder or to
exercise any other remedies pursuant to Paragraph 11 hereof is a
contractual right to liquidate such Transaction as described in
Sections 555 and 559 of Title 11 of this United States Code, as
amended.
(c) The parties agree and acknowledge that if a party hereto is an
"insured depository institution," as such term is defined in the
Federal Deposit Insurance Act, as amended ("FDIA"), then each
Transaction hereunder is a "qualified financial contract," as that
term is defined in FDIA and any rules, orders or policy statements
thereunder (except insofar as the type of assets subject to such
Transaction would render such definition inapplicable).
(d) It is understood that this Agreement constitutes a "netting contract"
as defined in and subject to Title IV of the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA") and each
payment entitlement and payment obligation under any Transaction
hereunder shall constitute a "covered contractual payment
entitlement" or "covered contractual payment obligation",
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respectively, as defined in and subject to FDICIA (except insofar as one
or both of the parties is not a "financial institution" as that term is
defined in FDICIA).
20. Disclosure Relating to Certain Federal Protections
The parties acknowledge that they have been advised that:
(a) in the case of Transactions in which one of the parties is a broker or
dealer registered with the Securities and Exchange Commission ("SEC")
under Section 15 of the Securities Exchange Act of 1934 ("1934 Act");
the Securities Investor Protection Corporation has taken the position
that the provisions of the Securities Investor Protection Act of 1970
("SIPA") do not protect the other party with respect to any Transaction
hereunder;
(b) in the case of Transactions in which one of the parties is a
government securities broker or a government securities dealer
registered with the SEC under Section 15C of the 1934 Act, SIPA will not
provide protection to the other party with respect to any Transaction
hereunder; and
(c) in the case of Transactions in which one of the parties is a financial
institution, funds held by the financial institution pursuant to a
Transaction hereunder are not a deposit and therefore are not insured by
the Federal Deposit Insurance Corporation or the National Credit Union
Share Insurance Fund, as applicable.
MERRILL LYNCH MORTGAGE CAPITAL INC. MERRILL LYNCH CREDIT CORPORATION
By:_______________________________ By:_______________________________
Title:____________________________ Title:____________________________
Date:_____________________________ Date:_____________________________
NOVASTAR FINANCIAL, INC.
/s/ Scott F. Hartman
By:_______________________________
Chairman/CEO
Title:____________________________
Jan. 31, 1997
Date:_____________________________
10
<PAGE>
Amendment No. 1
To
Master Repurchase Agreement
and
Supplemental Terms
Dated as of April 22, 1997
Among:
Merrill Lynch Mortgage Capital Inc.
and
Merrill Lynch Credit Corporation
and
NovaStar Financial Inc.
1. APPLICABILITY. This Amendment No. 1 (the "Amendment") to the Master
-------------
Repurchase Agreement dated as of January 31, 1997 (the "Master Repurchase
Agreement") and the Supplemental Terms thereto set forth in Annex 1 (the
"Supplemental Terms" and collectively with the Master Repurchase Agreement, the
"Agreement") modifies the Agreement and the terms and conditions under which the
parties hereto and thereto, from time to time, enter into transactions.
2. DEFINITIONS.
-----------
(a) Capitalized terms used herein and not otherwise defined shall have the
meaning set forth in the Agreement.
(b) "D Quality Mortgage Loans" shall refer to Mortgage Loans that would be
categorized as D quality under the standards set forth in the Seller's
Origination Guide.
(c) "Seller's Origination Guide" shall refer to the origination guidelines
of Seller for first and second lien residential mortgage loans in the form most
recently accepted in writing by Buyer.
3. REPRESENTATIONS, WARRANTIES AND COVENANTS.
-----------------------------------------
(a) All representations, warranties and covenants made by Buyer and Seller
shall from and after the date hereof be deemed to
<PAGE>
be made with respect to the Agreement as amended by this Amendment and be deemed
to be made on and as of the date hereof and on and as of the Purchase Date of
each Transaction.
(b) Paragraph 15(c) of the Supplemental Terms is hereby amended by adding
subparagraph "(xii)" as follows:
"(xii) The aggregate outstanding Purchase Price for D Quality Mortgage
Loans as of any date of determination shall not exceed 10% of the aggregate
outstanding Purchase Price for all Purchased Securities under the Agreement."
4. MAXIMUM TRANSACTION AMOUNT; TRANSACTIONS OPTIONAL.
-------------------------------------------------
(a) Paragraph 21(a) of the Supplemental Terms is hereby amended by deleting
the dollar amount of $200,000,000 and substituting therefor the dollar amount of
$300,000,000.
(b) Paragraph 21 of the Supplemental Terms is hereby amended by
adding subparagraph "(d)" as follows:
"(d) The aggregate outstanding Repurchase Price for Purchased Securities
that are D Quality Mortgage Loans shall not at any time exceed 10% of the
aggregate outstanding Repurchase Price for all Purchased Securities under the
Agreement."
5. GOVERNING LAW. This Amendment shall be governed by the laws of the State
-------------
of New York without given effect to the conflict of law principles thereof.
6. COUNTERPARTS. This Amendment may be executed in any number of
------------
counterparts, each of which when so executed shall be deemed to be an original,
but all such counterparts shall together constitute but one and the same
instrument.
2
<PAGE>
7. RATIFICATION AND CONFIRMATION. As amended hereby, the Agreement is
-----------------------------
hereby in all respects ratified and confirmed, and the Agreement as amended
hereby shall be read, taken and construed as one and the same instrument.
MERRILL LYNCH MORTGAGE NOVASTAR FINANCIAL, INC.
CAPITAL INC.
By: ______________________________ By: ______________________________
Title: ___________________________ Title: ___________________________
Date: ____________________________ Date: ____________________________
MERRILL LYNCH CREDIT
CORPORATION
By: ______________________________
Title: ___________________________
Date: ____________________________
3
<PAGE>
ANNEX I
SUPPLEMENTAL TERMS AND CONDITIONS TO
MASTER REPURCHASE AGREEMENT,
DATED AS OF JANUARY 31, 1997, AMONG
MERRILL LYNCH MORTGAGE CAPITAL INC. AND
MERRILL LYNCH CREDIT CORPORATION
AND NOVASTAR FINANCIAL, INC.
1. APPLICABILITY. These Supplemental Terms and Conditions (the "Supplemental
-------------
Terms") to Master Repurchase Agreement (the "Master Repurchase Agreement",
and collectively with these Supplemental Terms, the "Agreement") modify the
terms and conditions under which the parties hereto, from time to time,
enter into Transactions. To the extent that these Supplemental Terms
conflict with the terms of the Master Repurchase Agreement, these
Supplemental Terms shall control.
2. ADDITIONAL DEFINITIONS. Capitalized terms used herein and not otherwise
----------------------
defined shall have the meanings set forth in the Master Repurchase
Agreement. Capitalized terms used in the Master Repurchase Agreement whose
definitions are modified in these Supplemental Terms shall, for all
purposes of the Agreement, be deemed to have such modified definitions.
"Acquisition Agreement" shall have the meaning set forth in Paragraph
3(b) of the Master Repurchase Agreement.
"Act of Insolvency" shall have the meaning set forth in Paragraph 2(a)
of the Master Repurchase Agreement except that the number of days
indicated in clause (ii) (C) of such paragraph shall be changed to
forty-five (45).
"Affiliate" means with respect to any Person, a spouse of such Person,
any relative (by blood, adoption or marriage) of such Person within
the third degree, any director, officer, employee or partner of such
Person, and any other Person, directly or indirectly controlling,
controlled by or under common control with such Person, and any
Affiliate of any of the foregoing. The term "control" means the
possession, directly or indirectly, of the power to direct or cause
the direction of the management policies of the Person, whether
through the ownership of securities, by contract or otherwise.
<PAGE>
"Assignment" shall have the meaning set forth in Paragraph 3(b) of the
Master Repurchase Agreement.
"Business Day" shall mean any day excluding Saturday, Sunday and any
day on which banks located in the States of New York or California are
authorized or permitted to close for business. All references to
"business day" in the Master Repurchase Agreement shall be deemed to
be references to Business Day.
"Buyer" shall refer to MLCC, in the case of Eligible Assets secured by
second liens, and MLMCI in all other cases.
"Buyer's Margin Amount" shall have the meaning set forth in the Master
Repurchase Agreement except that the percentage referred to therein
for each Transaction shall be specified in the related
Confirmation/Funding Request.
"Confirmation/Funding Request" shall have the meaning of
"Confirmation" as set forth in the Master Repurchase Agreement but
shall be substantially in the form attached hereto as Exhibit A.
"Custodian" shall refer to First Union National Bank of Maryland, or
any permitted successor thereto pursuant to the Custody Agreement.
"Custody Agreement" shall refer to a custody agreement pursuant to
which the Custodian acts as bailee for Buyer.
"Eligible Assets" shall refer to duly recorded first or second lien
Mortgage Loans acquired pursuant to an Acquisition Agreement.
"GAAP" shall mean generally accepted accounting principles
consistently applied.
"GAAP Net Worth" shall mean net worth determined in accordance with
GAAP.
"CLTV" shall mean the combined loan-to-value ratio calculated as a
fraction, expressed as a percentage, the numerator of which is the
original principal balance of the related Eligible Asset (together, in
the case of an Eligible Asset constituting a second lien Mortgage
Loan, with the related first lien mortgage loan) and the denominator
of which is the lesser of the
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<PAGE>
sales price and the appraised value of the related mortgaged property.
"Market Value" shall mean, with respect to any Securities as of any
date of determination, the value of such Securities on such date as
determined in accordance with Paragraph 12 of these Supplemental
Terms.
"MLCC" shall refer to Merrill Lynch Credit Corporation.
"MLMCI" shall refer to Merrill Lynch Mortgage Capital Inc.
"Mortgage" shall mean a duly recorded first mortgage or first deed of
trust on improved residential real property.
"Mortgage Loan Schedule" shall have the meaning set forth in Paragraph
3(b) of the Master Repurchase Agreement.
"Mortgage Loans" shall mean those first lien or second residential
mortgage loans with respect to which Seller has deposited or caused to
be deposited the Required Loan Documents (or portion thereof) with the
Custodian as bailee under the Custody Agreement.
"Mortgage Loan Income" shall mean income payable with respect to a
Mortgage Loan including all amounts payable on account of such
Mortgage Loan whether principal, interest, partial prepayments,
prepayments in full, penalties, advance payments or expenses and
whether payable by or from the Mortgagor or the servicer for such
Mortgage Loan.
"Person" means a corporation, association, partnership, organization,
business, trust, individual, a government or political subdivision
thereof, any governmental agency or any other entity.
"Related Agreements" shall have the meaning set forth in Paragraph
3(b) of the Master Repurchase Agreement.
"Required Loan Documents" shall refer to the documents required to be
held by the Custodian as bailee under the Custody Agreement.
"Securities" shall, in addition to the definition set forth in the
Master Repurchase Agreement, refer to Mortgage Loans; provided,
--------
however, that such Mortgage
-------
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<PAGE>
Loans shall not be deemed to be securities for the purposes of any
securities or blue sky laws; provided further, however, that
------- -------
"Securities" shall also refer to additional assets as Buyer may
determine at its option and in its sole discretion as evidenced by an
amendment to this Agreement.
"Seller" shall refer to NovaStar Financial, Inc., a Maryland
corporation.
"Seller's Margin Amount" shall have the meaning set forth in the
Master Repurchase Agreement except that the percentage referred to
therein for each Transaction shall be specified in the related
Confirmation/Funding Request.
"Servicer" shall refer to New Century Mortgage Corporation,
discharging its duties through Advanta Mortgage USA as sub-servicer,
or such other FNMA-approved seller/servicer as Buyer may approve in
its sole discretion as the servicer of a Mortgage Loan under a
Servicing Agreement.
"Servicing Agreement" shall have the meaning set forth in Paragraph
3(b) of the Master Repurchase Agreement.
"Third Person" shall refer to any Person to whom Buyer transfers any
portion of its interest in the Eligible Assets.
"Transaction" shall, in addition to the definition set forth in the
Master Repurchase Agreement, refer to substitutions pursuant to
Paragraph 9 of the Master Repurchase Agreement.
"Trust Receipt" shall refer to the Trust Receipt substantially in the
form attached as an exhibit to the Custody Agreement.
3. MODIFICATION OF PARAGRAPH 3(b) OF THE MASTER REPURCHASE AGREEMENT.
-----------------------------------------------------------------
Paragraph 3(b) of the Master Repurchase Agreement is amended by adding at
the end of the first sentence of Paragraph 3(b):
In the case of Transactions involving Securities that are Mortgage
Loans, (a) copies of the documents governing the acquisition of such
Mortgage Loans by Seller (the "Acquisition Agreement"), the servicing
of such Mortgage Loans by Seller or a Servicer (the "Servicing
Agreement"), and the custody of the Required Loan Documents (the
Acquisition Agreement, the
I-4
<PAGE>
Servicing Agreement and the Custody Agreement, collectively, the
"Related Agreements") together with any other documents reasonably
requested by Buyer shall have been delivered to Buyer prior to the
Purchase Date for such Mortgage Loans and such Related Agreements
shall have been specifically approved by Buyer in writing, (b) the
Purchased Securities shall be identified on a detailed listing to be
provided by Seller to Buyer (a "Mortgage Loan Schedule") attached to
an Assignment (as defined below), (c) the Confirmation/Funding Request
shall identify (and shall have as exhibits thereto, if requested by
Buyer) the applicable Related Agreements, (d) Seller shall have, in a
Seller's Warranty Certificate ("Seller's Warranty Certificate") which
shall be substantially in the form of Exhibit B hereto, made, restated
and/or assigned, representations and warranties with respect to the
Mortgage Loans, (e) the Required Loan Documents shall be delivered to
and/or held by the Custodian pursuant to the terms of the Custody
Agreement, pursuant to which Custody Agreement the Custodian shall,
among other things, issue Trust Receipts in a form acceptable to
Buyer, evidencing Custodian's retention of the Required Loan Documents
as custodian for Buyer, (f) the Mortgage Loans shall be serviced for
Buyer by the Servicer pursuant to the Servicing Agreement, and (g) an
assignment agreement (the "Assignment"), substantially in the form of
Exhibit C hereto or in such other form acceptable to Buyer shall have
been executed by Buyer, Seller and the Servicer on the date hereof,
whereby and wherein Seller shall have assigned to Buyer all of its
right, title and interest in the Servicing Agreement to the extent of
all related Purchased Securities hereunder.
4. MODIFICATION OF PARAGRAPH 4 OF THE MASTER REPURCHASE AGREEMENT.
--------------------------------------------------------------
(a) Paragraph 4 of the Master Repurchase Agreement is hereby amended by
adding the following sentence at the end of subparagraph (a):
In case of a Margin Deficit with respect to Mortgage Loans,
Seller shall transfer cash or Mortgage Loans to satisfy its
obligations hereunder; provided, however, Seller may transfer Mortgage
-------- -------
Loans only to the extent that they have been reviewed by the Custodian
pursuant to the Custody Agreement and the Custodian has furnished its
Trust Receipt with respect thereto.
I-5
<PAGE>
(b) Paragraph 4(a) of the Master Repurchase Agreement is hereby further
amended to provide that Seller shall transfer the cash or Mortgage
Loans to Buyer (in the manner contemplated by the Agreement and the
Custody Agreement) in accordance with Paragraph 24 of these
Supplemental Terms.
5. MODIFICATION OF PARAGRAPH 5 OF THE MASTER REPURCHASE AGREEMENT. Paragraph 5
--------------------------------------------------------------
of the Master Repurchase Agreement is hereby amended by adding the
following after the last sentence of such Paragraph:
If an Event of Default shall have occurred and be continuing,
Seller shall collect, or cause to be collected, all Mortgage Loan
Income on behalf of Buyer and, upon request of Buyer, shall forward
such payments to Buyer immediately upon receipt.
6. MODIFICATION OF PARAGRAPH 7 OF THE MASTER REPURCHASE AGREEMENT. Paragraph 7
--------------------------------------------------------------
of the Master Repurchase Agreement is hereby amended by adding the
following after the last sentence of such Paragraph:
Buyer shall disburse funds to an account specified in writing by
Seller. In the case of Mortgage Loans, transfer of such Mortgage Loans
to Buyer shall occur as of the date on which Buyer receives (i) the
Trust Receipt of the Custodian and (ii) a list identifying the
Servicer with respect to each such Mortgage Loan, if not otherwise set
forth in the Trust Receipt.
In the case of Mortgage Loans transferred by Buyer to a Third
Person, Buyer shall send a notice to the Custodian and transfer of
such Mortgage Loans to any Third Person shall occur when such Third
Person receives the acknowledgment of the Custodian identifying such
Mortgage Loans. Any Mortgage Loans repurchased by Seller pursuant to
Paragraph 3(c) or 11(c) of the Master Repurchase Agreement shall be
transferred to Seller or its agent upon the receipt by the Custodian
from Buyer of a notice of transfer which confirms the release of
Buyer's interest in any such Mortgage Loans.
7. MODIFICATION OF PARAGRAPH 8 OF THE MASTER REPURCHASE AGREEMENT. Paragraph 8
--------------------------------------------------------------
of the Master Repurchase Agreement is amended by adding the following at
the end of the last sentence thereof:
In the case of Mortgage Loans, Buyer hereby grants to Seller the
right to perform in Buyer's stead under
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<PAGE>
any repurchase, reverse repurchase or similar transaction in which
Buyer has sold, loaned or otherwise transferred the Mortgage Loans in
the event that Buyer has defaulted on its obligation to repurchase or
accept redelivery of such Mortgage Loans in conformity with the terms
of any such transaction and so long as an Event of Default under the
Agreement on the part of Seller shall not have occurred and be
continuing.
8. MODIFICATIONS OF PARAGRAPH 11 OF THE MASTER REPURCHASE AGREEMENT. Paragraph
----------------------------------------------------------------
11 of the Master Repurchase Agreement is hereby further amended by adding
new subsections (i), (j), (k) and (l) to such Paragraph:
(i) Any sales of Purchased Securities, pursuant to Paragraph
11(d)(i) of the Agreement, which are Mortgage Loans may be effected in
public or private sales as Buyer may reasonably deem appropriate and
at such price or prices as Buyer may reasonably deem satisfactory. In
the event Buyer elects in lieu of so selling such Purchased Securities
to give Seller credit for such Purchased Securities, such credit shall
be in an amount equal to the Market Value thereof as of the date of
such acceleration.
(j) If an Event of Default shall occur and be continuing, Buyer
shall exercise reasonable efforts (the reasonableness of which shall
be determined by Buyer in its discretion in light of the
circumstances) to provide notice to Seller prior to exercising any
remedy in respect of an Event of Default by Seller, provided, however,
-------- -------
that notwithstanding anything in the Agreement to the contrary, Buyer
shall not be required, prior to exercising any remedy in respect of an
Event of Default by Seller, to give any notice otherwise required
hereunder, if Buyer reasonably believes that (i) the Mortgage Loans
then held by Buyer threaten to decline speedily in value or (ii) any
delay occasioned by the giving of such notice will jeopardize Buyer's
ability to recover, by sale of such Securities or otherwise, all or
part of the then-outstanding amount of the Repurchase Price or of any
other amounts owed to Buyer in connection therewith. If no prior
notice is given, Buyer shall give notice to Seller of the remedies
effected by Buyer promptly thereafter. Buyer may forthwith apply the
cash, if any, then held by it as part of the Purchased Securities
relating to any Transaction to the payment of the Repurchase Price,
and, if there shall be no such cash or the cash so applied shall not
be sufficient to pay in full the
I-7
<PAGE>
Repurchase Price, may thereafter collect, receive, appropriate, retain
and realize upon the Purchased Securities, or any part thereof, and
may forthwith sell, assign, contract to sell, or otherwise dispose of
and deliver the Purchased Securities, or any part thereof, in one or
more parcels at such public or private sale or sales, at such place or
places, at such price or prices and upon such other terms and
conditions as Buyer may deem best (provided, however, that Buyer shall
act in a commercially reasonable manner), for cash or on credit or for
future delivery without assumption of any credit risk, with the right
of Buyer upon any such sale or sales to purchase all or any part of
the Purchased Securities so sold. Upon any sale, transfer or other
disposition of the Purchased Securities pursuant hereto Buyer shall
have the right to deliver, assign and transfer to the transferee
thereof the Purchased Securities so sold. Each transferee upon any
such transfer or other disposition shall hold the property thereby
acquired by it absolutely free from any claim or right of any kind,
including any equity or rights of redemption, of Seller, who hereby
specifically waives all rights of redemption, stay or appraisal which
it has or may have under any rule of law or statute whether now
existing or hereafter adopted (in the latter case, to the extent
permitted thereby). Seller agrees that Buyer need give only such
notice of the time and place of any public or private sale (including
any adjourned private sale) or other intended disposition as may be
required by market conditions and standards of commercial
reasonableness and that Buyer need not in any event give more than
five (5) days' notice that such sale or disposition is to take place.
Seller agrees that the notice provided for in the preceding sentence
is reasonable notification of such matters.
Buyer shall not be obligated to make any sale pursuant to any
such notice. Buyer may, without notice or publication, adjourn any
public or private sale or cause the same to be adjourned from time to
time by announcement at the time and place fixed for the sale, and
such sale may be made at any time or place to which the same may be so
adjourned, provided that Buyer shall act in a commercially reasonable
manner. In case of any sale of all or any part of the Purchased
Securities on credit or for future delivery, the Purchased Securities
so sold may be retained by Buyer until the selling price is paid by
the purchaser thereof, but Buyer shall not incur any liability in case
of the failure of such purchaser to take up and pay for the
I-8
<PAGE>
Purchased Securities so sold, and, in case of any such failure, such
Purchased Securities may again be sold upon like notice. Buyer,
however, instead of exercising the power of sale herein conferred upon
it, may proceed by a suit or suits at law or in equity to foreclose
the lien and security interest created hereby and sell the Purchased
Securities, or any portion thereof, under a judgment or decree of a
court or courts of competent jurisdiction.
(k) Buyer shall have no obligation to realize upon any Purchased
Securities, except through proper application of any distributions
with respect to the Purchased Securities made directly to Buyer or its
agent(s). Seller hereby waives the defense of impairment of the
Purchased Securities; provided, however, that Buyer shall act in a
-------- -------
commercially reasonable manner. Buyer may in its sole discretion elect
to realize upon all or a portion of the Purchased Securities by giving
Seller credit for such Purchased Securities, which credit shall be in
an amount equal to the Market Value thereof as of the date of
acceleration.
(l) Any purchases of Replacement Securities, pursuant to
Paragraph 11(d)(ii) of the Agreement, which are Mortgage Loans shall
be of the same or similar type, maturity and amount as the Purchased
Securities that are not delivered by Buyer and may be effected in
purchases in a commercially reasonable manner at such price or prices
as Seller may reasonably deem appropriate. In the event Seller elects
in lieu of so purchasing such Replacement Securities to be deemed to
have purchased Replacement Securities in a commercially reasonable
manner as provided in Paragraph 11(d)(ii), such Replacement Securities
shall be deemed to have been purchased at the Market Value thereof.
9. DISBURSEMENT OF FUNDS. Seller may request that the parties enter into a
---------------------
transaction hereunder by making a written request for the purchase and sale
of Eligible Assets, either by mail or facsimile transmission, to Buyer.
Subject to Paragraph 3(b) of the Master Repurchase Agreement and provided
that Buyer has agreed to enter into a Transaction under the Agreement,
Buyer shall pay the related Purchase Price within one (1) day of receipt of
such notice, so long as the terms and conditions of the Agreement are fully
satisfied and no Event of Default hereunder shall have occurred and be
continuing. The amount of any such Purchase Price of Eligible Assets shall
be in a minimum amount of $1,000,000 and integral multiples of $500,000 in
excess
I-9
<PAGE>
thereof.
10. CONFIRMATIONS.
(a) Each Confirmation shall be binding upon Seller and Buyer unless
written notice of objection is given by the objecting party to the
other party within one (1) business day after the objecting party's
receipt of such Confirmation.
(b) Buyer may, but shall not be required to, deliver Confirmations
confirming periodic adjustments in the Pricing Rate for a particular
Transaction.
(c) Notwithstanding Paragraph 3(b) of the Master Repurchase Agreement, in
the event of any conflict between the terms of a Confirmation and this
Agreement, such Confirmation shall prevail.
11. INCOME PAYMENTS. All payments and distributions, whether in cash or in
------ --------
kind, made on or with respect to the Mortgage Loans shall, unless otherwise
mutually agreed by Buyer and Seller, be paid, delivered or transferred in
the case of Mortgage Loans, so long as an Event of Default on the part of
Seller shall not have occurred and be continuing, directly to the Servicer
from the related mortgagor.
12. MARKET VALUE DETERMINATION. Buyer shall determine the Market Value for the
--------------------------
Purchased Securities in the good faith exercise of its reasonable business
judgment from time to time and at such time as it may elect in its sole
discretion; provided, however, that Buyer shall assign a Market Value of
-------- -------
zero with respect to (i) any Mortgage Loan that has been delinquent for at
least sixty (60) days, (ii) any Mortgage Loan with respect to which there
is a breach of a representation, warranty or covenant made by Seller in
this Agreement or the Custody Agreement that materially adversely affects
Buyer's interest in such Mortgage Loan and which breach has not been cured
prior to the date on which Market Value is being determined, (iii) any
Mortgage Loan that Buyer determines in its sole discretion has not been
originated in accordance with the Acquisition Agreement and (iv) any
Mortgage Loan with respect to which the initial payment of Mortgage Loan
Income is in default or delinquent.
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<PAGE>
13. SECURITY INTEREST.
-----------------
(a) In the event, for any reason, any Transaction is construed by any
court as a secured loan rather than a purchase and sale, the parties
intend that Buyer shall have a perfected first priority security
interest in all of the Purchased Securities.
(b) Seller shall pay all reasonable fees and expenses associated with
perfecting such security interest including, without limitation, the
cost of filing financing statements under the Uniform Commercial Code,
to the extent required by Buyer or its counsel, and any reasonable
fees charged by the Custodian.
14. DELIVERY OF ADDITIONAL DOCUMENTS.
--------------------------------
Seller shall, simultaneously with the funding of each Transaction, deliver
to Buyer through the Custodian a fully executed Trust Receipt.
15. REPRESENTATIONS, WARRANTIES AND COVENANTS.
-----------------------------------------
(a) Each party represents and warrants, and shall on and as of the
Purchase Date of any Transaction be deemed to represent and warrant,
as follows:
(i) The execution, delivery and performance of the Agreement and
the performance of each Transaction do not and will not result
in or require the creation of any lien, security interest or
other charge or encumbrance (other than pursuant hereto) upon
or with respect to any of its properties; and
(ii) The Agreement is, and each Transaction when entered into under
the Agreement will be, a legal, valid and binding obligation of
such party enforceable against it in accordance with the terms
of the Agreement, subject to applicable bankruptcy, insolvency,
and similar laws affecting creditors' rights generally and
subject, as to enforceability, to general principles of equity
(regardless of whether enforcement is sought in a proceeding in
equity or at law).
(b) Seller represents and warrants as of the date of the Agreement and as
of the Purchase Date of each Transaction, as follows:
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<PAGE>
(i) All information provided by Seller to Buyer or the Custodian
concerning the Mortgage Loans is true and correct in all
material respects;
(ii) No Mortgage Loan shall have any scheduled payments of Mortgage
Loan Income in default or delinquent by more than sixty (60)
days unless the Servicer shall have advanced such payment;
(iii) No Mortgage Loan shall have the initial scheduled payment of
Mortgage Loan Income in default or delinquent;
(iv) Seller shall cause each Mortgage Loan to be serviced in
accordance with standards maintained by the servicers of
mortgage loans that are generally accepted in the mortgage
servicing industry as reasonable and prudent;
(v) Seller, immediately prior to the purchase by Buyer under the
Agreement, is the legal and beneficial owner of the Mortgage
Loans free and clear of any lien, security interest, option or
encumbrance;
(vi) Buyer has a perfected first-priority security interest in each
Mortgage Loan (including all proceeds, distributions and other
amounts realized in respect thereof) subject to no prior lien,
charge, encumbrance or rights of others, and no further action,
other than the possession by the Custodian of certain documents
relating thereto pursuant to the Custody Agreement, including
any filing or recordation of any document, is required in order
to establish and perfect the liens on and security interest in
the Mortgage Loans in favor of Buyer against any third party in
any jurisdiction;
(vii) No Mortgage Loan was subject to any lien or encumbrance at the
time of the purchase thereof by Buyer under the Agreement;
(viii) No Mortgage Loan has an CLTV in excess of 95%;
(ix) The weighted average CLTV of all Mortgage
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<PAGE>
Loans subject to the Agreement does not exceed 85%;
(x) Notwithstanding any other provision of the Agreement and except
as otherwise agreed by Buyer in writing with respect to any
particular Eligible Asset or group of Eligible Assets, no
Eligible Asset subject to any Transaction hereunder shall have
been subject to the Agreement or to the Custody Agreement for
more than one hundred and eighty (180) days in aggregate;
(xi) Each Eligible Asset has been originated in compliance with all
applicable laws and the guidelines described in the Acquisition
Agreement or such other origination guidelines as may be agreed
to by Buyer in writing; and
(xii) Since the date of the most recent balance sheet or financial
statement delivered by Seller to Buyer pursuant to Paragraph 19
of these Supplemental Terms, there has been no material adverse
change in its financial condition or results of operations.
(c) Seller covenants with Buyer as follows:
(i) Seller shall be at the time it delivers any Mortgage Loans to
the Custodian or Buyer for any Transaction, and shall continue
to be, through the Purchase Date relating to each such
Transaction, the legal and beneficial owner of such Mortgage
Loans free and clear of any lien, security interest, option or
encumbrance except for the security interest created by the
Agreement;
(ii) All data and other information relating to the Mortgage Loans
provided at any time by or on behalf of Seller to the
Custodian, whether in writing, by electronic transmission or on
computer tape or diskette or otherwise, will be true and
correct;
(iii) Seller or the Servicer will pay and discharge all taxes,
levies, liens and other charges on its assets and on the
Purchased Securities sold by it to Buyer under the Agreement
which, in each case, in any manner would
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<PAGE>
create any lien or charge upon such Purchased Securities and
which would materially adversely affect the interests of Buyer
except those that are being contested by Seller in good faith
and with respect to which payment has been stayed by a court of
competent jurisdiction;
(iv) On an ongoing basis, at Seller's expense without request of
Buyer, Seller shall provide Buyer with Seller's audited year-
end balance sheet and income statement within ninety (90) days
after the end of Seller's fiscal year and Seller's quarterly
balance sheet and income statement within forty-five (45) days
after the end of each of Seller's three other fiscal quarters;
(v) The weighted average CLTV of all Mortgage Loans subject to the
Agreement shall not exceed 85%;
(vi) Seller shall fail to promptly notify Buyer of (i) the
acceleration of any debt obligation or the termination of any
credit facility of Seller; (ii) the amount and maturity of any
such debt assumed after the date hereof; (iii) any adverse
developments with respect to pending or future litigation
involving Seller; and (iv) any other developments which might
materially and adversely affect the financial condition of
Seller;
(vii) The Eligible Assets relating to each Transaction shall satisfy
the origination quality and credit parameters as have been
agreed to by Buyer in writing;
(viii) Seller's GAAP Net Worth shall not at any time be less than
$30,000,000;
(ix) Seller shall not experience losses or changes in its financial
condition that cause its GAAP Net Worth for any two consecutive
calendar quarters to be less than or equal to 80% of its GAAP
Net Worth as of the commencement of such period;
(x) Seller shall promptly notify Buyer when any Mortgage Loan
becomes more than thirty (30) days delinquent; and
I-14
<PAGE>
(xi) The Custodian shall act as an independent third-party bailee
under the Custody Agreement and shall not be in control of or
under common control with Seller.
[INSERT ADDITIONAL CREDIT COVENANTS AS MAY
BE REQUIRED BY MERRILL LYNCH CORPORATE CREDIT]
16. EVENTS OF DEFAULT.
-----------------
(a) The term "Event of Default" shall, in addition to
the definition set forth in the Master Repurchase Agreement, include the
following events:
(i) Any governmental or self-regulatory authority shall take
possession of Seller, or any Affiliate thereof, or all or
substantially all its property or appoint any such trustee,
receiver, conservator or other official, or such party shall
take any action to authorize any of the actions set forth in
this clause (i).
(ii) Buyer or Seller shall have reasonably determined that the
other party is or will be unable to meet its commitments under
this Agreement, shall have notified such other party of such
determination and such other party shall not have responded
with appropriate information to the contrary to the
satisfaction of the notifying party within one (1) Business
Day.
(iii) In the reasonable judgment of Buyer a material adverse change
shall have occurred in the business, operations, properties,
prospects or financial condition of Seller;
(iv) The Agreement shall for any reason cease to create a valid,
perfected, first priority security interest in any of the
Purchased Securities; provided, however, that such
-------- -------
circumstance shall not constitute an Event of Default if,
after determining the Market Value of the Mortgage Loans
without taking into account the Mortgage Loans with respect to
which such circumstance has occurred, no other Event of
Default shall have occurred and be continuing;
I-15
<PAGE>
(v) Seller shall be in default with respect to any normal and
customary covenants under any material contract or agreement
to which it is a party (which covenants include, but are not
limited to, an Act of Insolvency of Seller or the failure of
Seller to make required payments in an aggregate amount in
excess of $100,000) dollars under such contract or agreement
as they become due) which default permits acceleration of the
obligations of Seller under such contract or agreement by any
other party thereto;
(vi) Seller shall merge or consolidate into any entity unless the
surviving or resulting entity shall be acceptable to Buyer, in
its sole discretion, and such entity expressly assumes by
written agreement, executed and delivered to Buyer in form and
substance satisfactory to Buyer, the performance of all
Seller's duties and obligations hereunder and under the
Custody Agreement;
(vii) Buyer shall request assurances as to the financial well-being
of Seller and such assurances shall not have been provided in
writing within twenty-four (24) hours;
(viii) A final judgment by any competent court in the United States
of America for the payment of money in an amount of at least
$100,000 is rendered against the defaulting party, and the
same remains undischarged or unpaid for a period of sixty (60)
days during which execution of such judgment is not
effectively stayed;
(ix) Any representation or warranty made by Seller in the Agreement
or the Custody Agreement shall have been incorrect or untrue
when made or repeated or when deemed to have been made or
repeated and such breach is continuing; provided, however,
-------- -------
that with respect to any representation or warranty made by
Seller with respect to a Mortgage Loan, such circumstance
shall not constitute an Event of Default if after determining
the Market Value of such Mortgage Loan without taking into
account the Mortgage Loan with respect to which such
circumstances have occurred, no other Event of Default shall
have occurred
I-16
<PAGE>
and be continuing;
(x) Seller shall breach any covenant in the Agreement and such
breach is continuing;
(xi) The filing by Seller or an Affiliate of a petition in
bankruptcy, the adjudication of Seller as insolvent or
bankrupt, the application by Seller or an Affiliate for any
receiver or trustee for itself or any substantial part of its
property, the commencement of any proceeding relating to
Seller or an Affiliate under any reorganization, arrangement,
dissolution or liquidation law, or the initiation of any such
proceeding against Seller or an Affiliate if such party
indicates by any act its consent thereto or if such proceeding
is not dismissed or stayed within forty-five (45) days,
notwithstanding Paragraph 2(a)(ii)(C) of the Master Repurchase
Agreement; and
(xii) A firm of independent accountants shall have failed to issue
an opinion or shall have issued an opinion qualified adversely
in any material respect in connection with the most recent
audited financial statements of Seller.
(b) In addition to the other remedies available to Buyer or Seller upon
the occurrence and during the continuance of an Event of Default by a
defaulting party, Buyer shall have the following additional remedies
upon the occurrence and during the continuance of an Event of Default
by Seller:
(i) All rights of Seller to receive payments on the Mortgage Loans
which it would otherwise be authorized to receive pursuant to
Paragraph 5 of the Master Repurchase Agreement as modified by
Paragraph 4 of these Supplemental Terms shall cease, and all
rights to such payments shall thereupon become vested in
Buyer, which shall thereupon have the sole right to receive
such payments and apply them to the amounts owed by Seller
pursuant to the Agreement.
(ii) All payments that are received by Seller contrary to the
provisions of the preceding
I-17
<PAGE>
clause (i) shall be received in trust for the benefit of
Buyer, shall be segregated from other funds of Seller and
shall be promptly paid to Buyer.
(iii) Buyer may unilaterally instruct the Servicer to direct all
payments of Mortgage Loan Income directly to Buyer.
(iv) Buyer may exercise any self-help remedies permitted by
applicable law.
(c) In addition to the other remedies available to Buyer or Seller upon
the occurrence and during the continuance of an Event of Default by a
defaulting party, the non-defaulting party shall be entitled to the
right of set off with respect to any amounts owed by the defaulting
party or any Affiliate of the defaulting party to the non-defaulting
party or any Affiliate of the non-defaulting party under any
contract, margin account or other arrangement.
(d) Any sale of Purchased Securities under Paragraph 11 of the Master
Repurchase Agreement as modified by these Supplemental Terms shall be
conducted in a commercially reasonable manner.
(e) Expenses reasonably incurred in connection with an Event of Default
shall include without limitation those reasonable costs and expenses
incurred by the nondefaulting party as a result of the early
termination of any repurchase agreement or reverse repurchase
agreement entered into by the nondefaulting party in connection with
the Transaction then in default.
(f) Any provision of the Agreement to the contrary notwithstanding, no
breach of a representation, warranty or covenant with respect to any
Mortgage Loan shall be an Event of Default if, after determining the
Market Value of the Mortgage Loans without taking into account the
Mortgage Loan with respect to which such breach has occurred, no
other Event of Default shall have occurred and be continuing.
I-18
<PAGE>
17. UNILATERAL TERMINATION BY BUYER.
-------------------------------
(a) At the option of Buyer, exercised by thirty (30) days prior written
notice to Seller, the Repurchase Date for some or all of the
Transactions under the Agreement shall be deemed to immediately occur
in the event that the senior debt obligations or short-term debt
obligations of Merrill Lynch & Co., Inc. shall be rated below the
four highest generic grades (without regard to any pluses or minuses
reflecting gradations within such generic grades) by any nationally-
recognized statistical rating organization.
(b) The event specified in Paragraph 17(a) of these Supplemental Terms
which may, at the option of Buyer, cause an acceleration of the
Repurchase Date for a Transaction shall be in addition to any other
rights of Buyer to cause such an acceleration under the Agreement.
18. APPLICATION OF PROCEEDS. The proceeds of any sale or other realization of
-----------------------
all or any part of the Purchased Securities, and any other cash at the time
held by Buyer under the Agreement, shall be applied by Buyer in the
following order of priority:
First, to the payment of all reasonable costs and expenses of
-----
such sale incurred by Buyer and its Affiliates and all reasonable
expenses (including the fees and expenses of counsel), liabilities
and advances reasonably made or incurred by Buyer and its affiliates
in connection therewith.
Second, to the payment of the outstanding Repurchase Price
------
owed by Seller jointly and severally under the Agreement.
Third, to the payment of all other amounts owed by Seller
-----
under the Agreement.
Fourth, to the payment of any other amounts owed by Seller to
------
Buyer or any Affiliate thereof under any other instrument or
agreement.
Fifth, to the payment to Seller, or to such other person as a
-----
court of competent jurisdiction may direct, of any surplus then
remaining from such proceeds and other cash.
As used in the Agreement, "proceeds" of the Purchased
Securities shall mean cash and other property
I-19
<PAGE>
received or otherwise realized in respect of the Purchased
Securities.
19. FINANCIAL STATEMENTS.
--------------------
(a) As of the date hereof, Buyer shall provide Seller with its audited
year-end financial statements and its most recently available interim
financial statement. As of the date hereof, Seller shall provide
Buyer with its most recently available interim financial statement
and Seller shall provide Buyer, not later than February 28, 1997,
with its audited year-end financial statements. Buyer and Seller
shall from time to time each provide the other with audited year-end
financial statements and additional publicly available interim
financial statements upon the other party's reasonable request.
(b) Seller shall provide Buyer, at the expense of Seller when requested
by Buyer, with all periodic unaudited balance sheets and income
statements from time to time within forty-five (45) days after the
preparation thereof.
(c) Each delivery of Purchased Securities by Seller to Buyer hereunder
will constitute a representation by Seller that there has been no
material adverse change in Seller's financial condition not disclosed
to Buyer since the date of Seller's most recent unaudited balance
sheet or income statement delivered to Buyer. Seller shall provide
Buyer, from time to time at Seller's expense, with such information
concerning Seller of a financial or operational nature as Buyer may
reasonably request promptly upon receipt of such request.
20. PRICE DIFFERENTIAL; REPURCHASE PRICE; PRICING RATE; BUYER'S MARGIN
------------------------------------------------------------------
PERCENTAGE.
----------
(a) The Price Differential shall be payable in arrears with respect to
each Transaction, together with the Purchase Price therefor, on the
termination date for the related Transaction or as may be otherwise
mutually agreed upon by the parties and as specified in the related
Confirmation.
(b) All calculations of Price Differential shall be made on the basis of
a 360-day year and the actual number of days elapsed.
(c) Payment of the Repurchase Price (including the Price Differential)
shall be made by wire transfer in
I-20
<PAGE>
immediately available funds or in such other manner as may be
mutually agreed upon by Buyer and Seller in writing. Amounts received
by Buyer after 3:00 p.m., New York City time, on any Business Day
shall be deemed to have been paid by Seller and received by Buyer on
the next succeeding Business Day.
(d) Any provision of the Agreement to the contrary notwithstanding, Buyer
has the right, in its sole discretion, to change the Pricing Rate and
the Buyer's Margin Percentage with respect to any Purchased Security
that is a Mortgage Loan more than thirty (30) days delinquent. Any
such adjustment in the Pricing Rate and the Buyer's Margin Percentage
shall be immediately effective even though the Repurchase Date for
the related Transaction shall not have occurred.
21. MAXIMUM TRANSACTION AMOUNT; TRANSACTIONS OPTIONAL.
-------------------------------------------------
(a) The aggregate outstanding Repurchase Price for the Purchased
Securities that are Mortgage Loans shall not at any time exceed
$200,000,000.
(b) The aggregate outstanding Repurchase Price for the Purchased
Securities that are second lien Mortgage Loans shall not at any time
exceed $30,000,000.
(c) Any provision of the Agreement to the contrary notwithstanding, Buyer
is not required to enter into any Transactions under the Agreement,
Buyer may in its sole discretion reject any assets proposed to be
sold to it hereunder and any decision to enter into a Transaction
under the Agreement shall be made by Buyer in its sole discretion.
22. TERMINATION. Notwithstanding any provisions of Paragraph 15 of the
-----------
Master Repurchase Agreement to the contrary, the Agreement and all
Transactions outstanding hereunder shall terminate automatically without
any requirement for notice on the date occurring on the earlier of (i)
eleven months and twenty-nine days after the date of the Agreement and (ii)
the written agreement of Seller and Buyer; provided, however, that
-------- -------
notwithstanding the foregoing, the Agreement shall continue in full force
and effect until any outstanding Repurchase Price has been paid in full.
Upon termination of the Agreement and the payment of the Repurchase Price
with respect to all Transactions, Buyer shall release its lien and security
interest under the Agreement and assign, transfer and deliver, against
receipt, any remaining Purchased Securities and money received in respect
thereof to or on the order of Seller. Upon the
I-21
<PAGE>
request of Seller, Buyer will then execute termination statements and such
other documents as Seller may reasonably request as are necessary to make
clear upon the public record the termination of the lien and security
interests created by the Agreement with respect to the Purchased
Securities.
23. ADDITIONAL INFORMATION; CONFIDENTIALITY.
---------------------------------------
(a) At any reasonable time, Seller shall permit Buyer, its agents or
attorneys, to inspect and copy any and all documents and data in
their possession pertaining to each Mortgage Loan that is the subject
of such Transaction. Such inspection shall occur upon the request of
Buyer at a mutually agreeable location during regular business hours
and on a date not more than two (2) Business Days after the date of
such request.
(b) Seller agrees to provide Buyer from time to time with such
information concerning Seller of a financial or operational nature as
Buyer may reasonably request.
(c) Each of the parties acknowledges that the Agreement and the Custody
Agreement are confidential in nature and each such party agrees that,
unless otherwise directed by a court or regulatory entity of
competent jurisdiction or as may be required by federal or state law
(which determination as to federal or state law shall be based upon
written advice of counsel), it shall limit the distribution of such
document to its officers, employees, attorneys, accountants and
agents as required in order to conduct its business with the other
parties hereto. This subparagraph (c) shall not apply to information
which has entered the public domain through means other than a breach
of the foregoing covenant by the party seeking to distribute such
documents or which the other party has given written permission to
disclose.
24. MARGIN MAINTENANCE. Paragraph 4(a) of the Master Repurchase Agreement is
------------------
hereby modified to provide that if the notice to be given by Buyer to
Seller under such paragraph is given at or prior to 10:00 a.m. New York
City time on a Business Day, Seller transfer the cash or Additional
Purchased Securities to Buyer (in the manner contemplated by the Agreement
and the Custody Agreement) prior to the close of business in New York City
on the date of such notice, and if such notice is given after 10:00 a.m.
New York City time, Seller shall transfer the cash or Additional Purchased
Securities (in the manner as aforesaid) prior to the close
I-22
<PAGE>
of business in New York City on the Business Day following the date of such
notice.
25. OPINIONS OF COUNSEL. Seller shall, on the date of the first Transaction
-------------------
hereunder and, upon the request of Buyer, on the date of any subsequent
Transaction, cause to be delivered to Buyer, with reliance thereon
permitted as to any person or entity that purchases the Eligible Assets
from Buyer in a repurchase transaction, a favorable opinion of Seller's
counsel with respect to the matters set forth in Exhibit D hereto, in form
and substance reasonably acceptable to Buyer.
26. FURTHER ASSURANCES. Seller shall promptly provide such further assurances
------------------
or agreements as Buyer may request in order to effect the purposes of the
Agreement.
27. BUYER AS ATTORNEY-IN-FACT. Upon the occurrence and during the continuation
-------------------------
of an Event of Default, Buyer is hereby appointed the attorney-in-fact of
Seller for the purpose of carrying out the provisions of the Agreement and
taking any action and executing any instruments that Buyer may deem
necessary or advisable to accomplish the purposes hereof, which appointment
as attorney-in-fact is irrevocable and coupled with an interest. Without
limiting the generality of the foregoing, after an Event of Default has
occurred and is continuing, Buyer shall have the right and power to (i)
take any action Buyer deems prudent to direct the receipt of payments on
any Mortgage Loan from the Servicer thereof to Buyer or its designee,
including, without limitation, the sending of any letter which irrevocably
instructs such Servicer to make all payments directly to Buyer or its
designee, and (ii) receive, endorse and collect all checks made payable to
the order of Seller representing any payment on account of the principal of
or interest on any of the Purchased Securities and to give full discharge
for the same.
28. PERMITTED ASSIGNMENT.
--------------------
(a) Seller shall not assign to any Person its duties and obligations
under the Agreement or the Custody Agreement or its liabilities with
respect to the Agreement or the Custody Agreement without the express
written consent of Buyer.
(b) Notwithstanding any assignment of rights as contemplated by Paragraph
28(a) of these Supplemental Terms, Seller shall remain obligated to
Buyer pursuant to the terms of the Agreement as though no such
assignment had occurred.
I-23
<PAGE>
(c) Buyer's rights and remedies with respect to the Mortgage Loans and
otherwise under the Agreement shall not be affected by any such
assignment.
29. APPOINTMENT OF AGENT. MLCC hereby appoints MLMCI as its agent for purposes
--------------------
of reviewing and executing Confirmation/Funding Requests, determining
Market Value, exercising any termination option provided for in the
Agreement, exercising MLCC's rights under any margin maintenance provision
of the Agreement, exercising MLCC's rights under the default provisions of
the Agreement and such other purposes as MLCC may direct. The appointment
of such agent shall not relieve MLCC of its obligations as Buyer hereunder.
30. EXPENSES. Seller shall pay its own expenses incurred in connection with
--------
the transactions contemplated hereby. In addition, Seller shall pay the
reasonable fees and expenses incurred by Buyer in connection with the
transactions contemplated hereby (including without limitation the fees and
expenses of Buyer's counsel) up to an amount equal to $20,000.
31. COUNTERPARTS. The Agreement may be executed in any number of counterparts,
------------
each of which counterparts shall be deemed to be an original, and such
counterparts shall constitute but one and the same instrument.
32. BINDING TERMS. All of the covenants, stipulations, promises and agreements
-------------
in the Agreement shall bind the successors and assigns of the parties
hereto, whether expressed or not.
33. NOTICES AND OTHER COMMUNICATIONS. Any provision of Paragraph 13 of the
--------------------------------
Master Repurchase Agreement to the contrary notwithstanding, any notice
required or permitted by the Agreement shall be in writing (including
telegraphic, facsimile or telex communication) and shall be effective and
deemed delivered only when received by the party to which it is sent;
provided, however, that a facsimile transmission shall be deemed to be
received when transmitted so long as the transmitting machine has provided
an electronic confirmation of such transmission. Any such notice shall be
sent to a party at the address or facsimile transmission number set forth
in Annex II attached hereto.
34. INCORPORATION OF TERMS. The Master Repurchase Agreement as supplemented
----------------------
hereby shall be read, taken and construed as one and the same instrument.
35. CONTROLLING AGREEMENT. The Agreement shall supersede all
---------------------
I-24
<PAGE>
other agreements between the parties relating to the subject matter hereof.
I-25
<PAGE>
EXHIBIT A
CONFIRMATION/FUNDING REQUEST
<TABLE>
<S> <C>
TO: NovaStar Financial, Inc. FROM: Merrill Lynch Mortgage Capital Inc.
------------------------- 101 Hudson Street, 12th Floor
----------------------- Jersey City, NJ 07302
Attention: ] Attention: Michael Jackson
------------------
</TABLE>
Merrill Lynch Mortgage Capital Inc. ("Buyer") is pleased to confirm your sale
and our purchase of the Mortgage Loans listed on Attachment I hereto pursuant to
the Master Repurchase Agreement (including the supplemental terms set forth in
Annex I thereto), dated as of January _, 1997 (the "Master Repurchase
Agreement") among Buyer and NovaStar Financial, Inc. under the following terms
and conditions:
<TABLE>
<S> <C> <C> <C> <C> <C>
ORIG PRIN AMT OF MTG LOANS:
----- ----- ----- ----- ------
REM PRIN AMT OF MTG LOANS:
----- ----- ----- ----- ------
PURCHASE DATE:
----- ----- ----- ----- ------
REPURCHASE DATE:
----- ----- ----- ----- ------
PURCHASE PRICE:
----- ----- ----- ----- ------
PRICING RATE:
----- ----- ----- ----- ------
PRICE DIFFERENTIAL DUE:
----- ----- ----- ----- ------
BUYER'S MARGIN AMOUNT:
----- ----- ----- ----- ------
SELLER'S MARGIN AMOUNT:
----- ----- ----- ----- ------
</TABLE>
The Master Repurchase Agreement is incorporated by reference into this
Confirmation/Funding Request and made a part hereof as if it were fully set
forth herein. All capitalized terms used herein but not otherwise defined shall
have the meanings specified in the Master Repurchase Agreement.
MERRILL LYNCH MORTGAGE CAPITAL INC.
NOVASTAR FINANCIAL, INC.
BY: BY:
------------------------- ---------------------------
A-1
<PAGE>
NAME: NAME:
---------------------- ------------------------
TITLE: TITLE:
---------------------- ------------------------
A-2
<PAGE>
ATTACHMENT I
TO EXHIBIT A
CONFIRMATION/FUNDING REQUEST FOR MORTGAGE LOANS
-----------------------------------------------
Request No. ___
Date: _________
<TABLE>
<CAPTION>
Product Wire Loan Borrower Loan Purchase Market Takeout Note Commitment Takeout Maturity
Investor Type Date Number Last Amount Price Value Date Rate Number* Price Date
-------- ------ ---- ------ ----- ------ ------ ------ ------ ---- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
TOTALS:
NovaStar Financial, Inc.
By:
------------------------------
Title:
------------------------------
Date:
------------------------------ Amount to be
funded by Buyer:
- -----------------
$
------------
</TABLE>
* To be provided within 2 Business Days of funding if not currently available.
** NovaStar Financial, Inc. hereby represents that no warehouse lien or other
lien or encumbrance exists with respect to the above-referenced Mortgage Loans.
A-3
<PAGE>
EXHIBIT B
---------
SELLER'S WARRANTY CERTIFICATE
I, ___________________, hereby certify that I am the duly appointed
_____________ of NovaStar Financial, Inc. ("Seller").
Pursuant to its sale to Merrill Lynch Mortgage Capital Inc. and
Merrill Lynch Credit Corporation, as applicable ("Buyer"), from time to time as
Buyer and Seller may agree, of mortgage loans ("Mortgage Loans") purchased by
Seller from Salomon Brothers Realty Corp. pursuant to an agreement dated as of
January 17, 1997 (the "Acquisition Agreement") in which Salomon Brothers Realty
Corp. assigned to Seller all of its right, title and interest in and to the
Mortgage Loans. New Century Mortgage Corporation will service the Mortgage Loans
pursuant to the Mortgage Loan Purchase and Interim Servicing Agreement, dated as
of December 1, 1996, between Salomon Brothers Realty Corp. and New Century
Mortgage Corporation (the "New Century Servicing Agreement"). New Century
Mortgage Corporation will discharge its servicing duties through Advanta
Mortgage USA, as subservicer, pursuant to a Loan Servicing Agreement, dated as
of March 22, 1996, between New Century Mortgage Corporation and Advanta Mortgage
USA (the "Advanta Servicing Agreement ", and together with the New Century
Servicing Agreement, the "Servicing Agreement"). The documents relating to the
Mortgage Loans will be held by First Union National Bank of Maryland, as
custodian (the "Custodian"), pursuant to a Custody Agreement, dated as of
January 31, 1997 among Buyer, Seller and the Custodian (the "Custody Agreement")
and pursuant to the Master Repurchase Agreement, dated as of January 31, 1997
(the "Master Repurchase Agreement"), between Seller and Buyer. Seller hereby
represents, warrants and covenants as of the date hereof, which representations,
warranties and covenants shall be deemed to be repeated on each Purchase Date
and on each date a Transaction is outstanding with respect to the Mortgage
Loans, as follows:
1. Capitalized terms used herein and not defined shall have the meanings
assigned to such terms in the Master Repurchase Agreement.
2. Seller hereby sells, transfers, assigns, sets over and otherwise
conveys to Buyer all of its right (including the power to assign the same),
title and interest in and to the Acquisition Agreement with respect to each
Mortgage Loan.
3. Seller hereby represents to Buyer as follows with respect to each
Mortgage Loan:
B-1
<PAGE>
(a) Attached as exhibits hereto are true, accurate and complete
copies of the Acquisition Agreement and the Servicing Agreement with
respect to the Mortgage Loan, which agreements are in full force and
effect as of the date hereof, and which have not been waived, amended
or modified in any respect, nor have any notices of termination been
given thereunder.
(b) Seller has good and marketable title to, and is the sole owner
of, the Mortgage Loan, free and clear of any lien, charge or
encumbrance or any ownership or participation interest in favor of any
other person, and the mortgage note has not been assigned, pledged,
hypothecated or otherwise transferred to any person.
4. Seller hereby restates for the benefit of Buyer and hereby makes as of
the date hereof the representations and warranties contained in the Acquisition
Agreement with respect to the Mortgage Loans, which representations and
warranties regardless of whether they were made as, at and to the origination of
the Mortgage Loans by the maker thereunder, shall be deemed to be restated and
made by Seller on each Purchase Date and on each date on which a Transaction is
outstanding with respect to the Mortgage Loans.
5. It is understood and affirmed by Seller that the representations and
warranties set forth herein shall survive the sale of the Mortgage Loans to
Buyer and shall inure to the benefit of Buyer and its successors and assigns,
notwithstanding any restrictive or qualified endorsement on any mortgage note or
assignment or the examination of any Mortgage File and without regard to any
applicable statute of limitations. It is further understood and affirmed that
with respect to the representations and warranties contained in the Acquisition
Agreement which were made to the best of the knowledge of the maker of such
restated representation or warranty thereunder, if it is discovered by Seller or
Buyer that the substance of such representation or warranty is inaccurate and
such inaccuracy materially and adversely affects the value of the related
Mortgage Loan or materially and adversely affects Buyer's interest in such
Mortgage Loan, Buyer shall be entitled to all the remedies to which it would be
entitled for breach of a representation or warranty made herein, including,
without limitation, the indemnification remedy contained herein, notwithstanding
the original maker's or Seller's lack of knowledge with respect to the
inaccuracy at the time the representation or warranty was initially made or
restated by Seller. Upon the discovery by Seller of a breach of any of the
foregoing representations and warranties which materially and adversely affects
the value of the Mortgage Loans or the interest of Buyer in any Mortgage Loan,
Seller shall give prompt written notice to Buyer.
B-2
<PAGE>
Seller shall indemnify Buyer and its successors and assigns and hold
them harmless against any loss, damages, penalties, fines, forfeitures, legal
fees and related costs, judgments, and other costs and expenses resulting from
any claim, demand, defense or assertion based on or grounded upon, or resulting
from a breach of the representations and warranties contained herein, made by
Seller to Buyer. It is understood and agreed that the obligations of Seller set
forth herein to indemnify Buyer as provided herein are in addition to any other
remedies of Buyer respecting a breach of the foregoing representations and
warranties.
IN WITNESS WHEREOF, I have hereunto signed my name as the duly
authorized representative of Seller.
Dated: January 31, 1997 NOVASTAR FINANCIAL, INC.
By:
-----------------------------
Name:
Title:
B-3
<PAGE>
EXHIBIT C
---------
ASSIGNMENT, ASSUMPTION AND RECOGNITION AGREEMENT
This is an Assignment, Assumption and Recognition Agreement ("Agreement")
made this 31st day of January, 1997, among Merrill Lynch Mortgage Capital Inc.
and Merrill Lynch Credit Corporation (collectively, "Buyer"), NovaStar
Financial, Inc. ("Seller") and New Century Mortgage Corporation (the
"Servicer").
Buyer and Seller are contemporaneously herewith entering into a transaction
pursuant to which Buyer shall purchase the mortgage loans identified on the
schedule attached hereto as Schedule I (the "Mortgage Loans"), with a
simultaneous agreement by Seller to repurchase such Mortgage Loans on demand or
at a date certain, in accordance with the terms and conditions of the Master
Repurchase Agreement (the "Master Repurchase Agreement"), dated as of January
31, 1997, between Buyer and Seller, and a written confirmation between Buyer and
Seller.
In consideration of the mutual promises contained herein and for other good
and valuable consideration, the receipt and sufficiency of which are hereby
acknowledged, the parties hereto agree that the Mortgage Loans, which are
serviced by the Servicer for Seller pursuant to the Mortgage Loan Purchase and
Interim Servicing Agreement, dated as of December 1, 1996, between Salomon
Brothers Realty Corp. and New Century Mortgage Corporation (the "New Century
Servicing Agreement"). New Century Mortgage Corporation will discharge its
servicing duties through Advanta Mortgage USA, as subservicer, pursuant to a
Loan Servicing Agreement, dated as of March 22, 1996, between New Century
Mortgage Corporation and Advanta Mortgage USA (the "Advanta Servicing Agreement
", and together with the New Century Servicing Agreement, the "Servicing
Agreement"). The Servicing Agreement, a copy of which is annexed hereto as
Exhibit One, shall be subject to the terms of this Agreement. Capitalized terms
used herein and not defined herein shall have the meanings assigned to those
terms in the Master Repurchase Agreement and the Servicing Agreement.
Warranties
----------
1. The Servicer and Seller warrant and represent that (a) attached
hereto as Exhibit One is a true, accurate and complete copy of the Servicing
Agreement which agreement is in full force and effect as of the date hereof
which has not been waived, amended or modified in any respect nor have any
notices of termination been given thereunder and (b) the Mortgage Loans
constitute all of the mortgage loans serviced by the Servicer under the
Servicing Agreement and that there are no real estate-owned properties managed
or administered by the Servicer under the Servicing Agreement.
C-1
<PAGE>
Assignment and Assumption
-------------------------
2. Seller hereby assigns to Buyer all of its right, title, and interest
in, to, and under the Mortgage Loans and, as permitted by and in accordance with
the Servicing Agreement, the Servicing Agreement. Notwithstanding Seller's
assignment herein of all of its right, title and interest, in, to, and under the
Servicing Agreement, Seller shall not be relieved of its obligations under the
Servicing Agreement and shall be the sole obligor to the Servicer thereunder.
Advanta Mortgage USA shall discharge its duties as subservicer pursuant to the
Advanta Servicing Agreement, which servicing agreement shall be subject to the
terms of this Agreement.
Recognition of Buyer
--------------------
3. From and after the date hereof, the Servicer shall recognize Buyer as
the owner of the Mortgage Loans and assignee of Seller under the Servicing
Agreement and will service the Mortgage Loans for Buyer in accordance with the
terms of the Servicing Agreement as modified herein. It is the intention of
Seller, the Servicer and Buyer that this Agreement will be the entire agreement
between the Servicer and Buyer with respect to the Mortgage Loans and shall be
binding upon and for the benefit of the respective successors and assigns of the
parties hereto.
4. From and after the date hereof, Buyer hereby authorizes and directs
the Servicer to remit all income from, and all proceeds of, the Mortgage Loans
to Seller until otherwise notified by Buyer. Buyer shall so notify the Servicer
in the event that Buyer determines that Seller is in default under the Master
Repurchase Agreement or the Related Agreements, and the Servicer shall
thereafter make all remittances to Buyer or its nominee. The receipt of such
income and proceeds by Seller shall not create nor imply any interest or right
whatsoever of Seller in or to the Mortgage Loans or such income or proceeds.
Seller shall have no right to terminate the Servicer as servicer of the Mortgage
Loans and Seller shall provide Buyer with prior written notice of any and all
actions to be taken by Seller pursuant to its obligations under the Servicing
Agreement with respect to the Mortgage Loans.
Governing Law
-------------
5. This Agreement shall be construed in accordance with the laws of the
State of New York without regard to any conflicts of law provisions, and the
obligations, rights and remedies of the parties hereunder shall be determined in
accordance with the laws of the State of New York.
C-2
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Agreement
the day and year first above written.
MERRILL LYNCH MORTGAGE
CAPITAL INC.
Buyer
By:
----------------------------
Name:
--------------------------
Title:
-------------------------
MERRILL LYNCH CREDIT CORPORATION
Buyer
By:
----------------------------
Name:
--------------------------
Title:
-------------------------
NOVASTAR FINANCIAL, INC.,
Seller
By:
----------------------------
Name:
--------------------------
Title:
-------------------------
NEW CENTURY MORTGAGE CORPORATION
Servicer
By:
----------------------------
Name:
--------------------------
Title:
-------------------------
ADVANTA MORTGAGE USA
Sub-Servicer
By:
----------------------------
Name:
--------------------------
Title:
-------------------------
C-3
<PAGE>
Exhibit One
SERVICING AGREEMENT
C-4
<PAGE>
Schedule 1
MORTGAGE LOAN SCHEDULE
C-5
<PAGE>
EXHIBIT D
OPINION OF COUNSEL TO SELLER
D-1
<PAGE>
ANNEX II
Names and Addresses for Communications Between Parties
MERRILL LYNCH MORTGAGE CAPITAL INC.
James B. Cason
Vice President
Merrill Lynch World Headquarters
World Financial Center
North Tower - 8th Floor
New York, New York 10281
Telephone: (212) 449-1219
Telecopy: (212) 449-6673
MERRILL LYNCH CREDIT CORPORATION
c/o Merrill Lynch Mortgage Capital Inc.
James B. Cason
Vice President
Merrill Lynch World Headquarters
World Financial Center
North Tower - 8th Floor
New York, New York 10281
Telephone: (212) 449-1219
Telecopy: (212) 449-6673
in each case with a copy to
Michael A. Blum
Director
Merrill Lynch World Headquarters
World Financial Center
North Tower - 8th Floor
New York, New York 10281
Telephone: (212) 449-8486
Telecopy: (212) 449-6673
NOVASTAR FINANCIAL, INC.
Scott F. Hartman
1900 West 47th Place
Suite 205
Westwood, Kansas 66205
Telephone: (913) 362-1090
Telecopy: (913) 362-1011
II-1
<PAGE>
MORTGAGE LOAN WAREHOUSING AGREEMENT
-----------------------------------
THIS MORTGAGE LOAN WAREHOUSING AGREEMENT (the "Agreement") is made as
of the _____ day of February, 1997, by and between NOVASTAR MORTGAGE, INC., a
Virginia corporation (the "Company") and FIRST UNION NATIONAL BANK OF NORTH
CAROLINA, a national banking corporation (the "Lender").
STATEMENT OF PURPOSE
--------------------
The Company has requested the Lender to extend to the Company a
mortgage warehousing line of credit to fund the Company's purchase and
accumulation of single-family residential mortgage loans for sale to secondary
market investors or for securitization purposes, and the Lender has agreed to do
so on the terms and subject to the conditions set forth herein. All capitalized
terms not otherwise defined herein are defined in Paragraph 10 hereof.
Now, therefore, for good and valuable consideration, the receipt and
adequacy of which are hereby acknowledged, the parties hereto agree as follows:
AGREEMENT
---------
1. Credit Facility.
---------------
1(a) Lending Limit. Subject to the conditions set forth
-------------
herein, the Lender agrees that it shall from time to time up to and including
the Business Day immediately preceding the Maturity Date, advance loans (the
"Loans" or a "Loan") to the Company in amounts not to exceed, in the aggregate
at any one time outstanding (determined after giving effect to the other
transactions contemplated by the Loan Request pursuant to which said Loan was
requested), the lesser of:
(1) The Credit Limit; and
(2) The Collateral Value of the Borrowing Base.
1(b) Interest Rate. Loans shall bear interest at a rate equal
-------------
to the Applicable Fed-Funds Based Rate unless the Company elects to have a Loan
bear interest at the Applicable LIBOR-Based Rate as permitted herein.
1(c) Payment of Interest. The Company shall pay to the Lender
-------------------
interest on Loans outstanding hereunder from the date disbursed to but not
including the date of payment. Interest on Fed Funds Loans shall be payable
monthly, in arrears, as provided in Paragraph 2(d) below, and interest on
Eurodollar Loans shall be payable at the end of the applicable Interest Period
and, in the event the applicable Interest Period exceeds one month, monthly in
arrears, as provided in Paragraph 2(d) below.
<PAGE>
1(d) Conversion and Continuation.
---------------------------
(1) The Company may elect from time to time to
convert Eurodollar Loans to Fed Funds Loans by giving the Lender at
least one Business Day's prior irrevocable notice of such election. Any
conversion of Eurodollar Loans may only be made on the last day of the
applicable Interest Period. Subject to the limitation set forth in the
last sentence of Paragraph 2(b)(2) hereof, the Company may elect from
time to time to convert Fed Funds Loans to Eurodollar Loans by giving
the Lender at least three Eurodollar Business Days' prior irrevocable
notice of such election. All such elections shall be made by means of a
Loan Request. No Fed Funds Loan shall be converted into a Eurodollar
Loan if an Event of Default or Potential Default has occurred and is
continuing on the day occurring three Eurodollar Business Days prior to
the date of the conversion requested by the Company or on the date of
conversion. All or any part of outstanding Loans may be converted as
provided herein, provided that partial conversions shall be in a
principal amount of $1,000,000.00 or whole multiples of $100,000.00 in
excess thereof.
(2) Any Eurodollar Loan may be continued as such upon
the expiration of the Interest Period with respect thereto by the
Company giving the Lender at least three Eurodollar Business Days'
prior irrevocable notice of such election as set forth in a Loan
Request; provided, however, that no Eurodollar Loan may be continued as
such when any Event of Default or Potential Default has occurred and is
continuing on the day occurring three Eurodollar Business Days prior to
the proposed date of such continuation or on the date of conversion,
but shall be automatically converted to a Fed Funds Rate Loan on the
last day of the then current Interest Period applicable thereto, and
the Lender shall notify the Company promptly that such automatic
conversion will occur. If the Company shall fail to give notice as
provided above, the Company shall be deemed to have elected to convert
the affected Eurodollar Loan to a Fed Funds Loan on the last day of the
relevant Interest Period.
1(e) Inability to Determine Rate. If the Lender determines
---------------------------
(which determination shall be conclusive and binding upon the Company) that by
reason of circumstances affecting the London interbank eurodollar market
adequate and reasonable means do not exist for ascertaining the LIBOR Rate for
any Interest Period, the Lender shall forthwith give facsimile notice of such
determination, confirmed in writing, to the Company. If such notice is given:
(1) no Loan may be funded as a Eurodollar Loan, (2) any Loan that was to have
been converted to a Eurodollar Loan
2
<PAGE>
shall, subject to the provisions hereof, be continued as a Fed Funds Loan and
(3) any outstanding Eurodollar Loan shall be converted on the last day of the
then current Interest Period with respect thereto to a Fed Funds Loan. Until
such notice has been withdrawn by the Lender, the Company shall not have the
right to convert a Loan to a Eurodollar Loan or fund any Loan as a Eurodollar
Loan or to continue a Eurodollar Loan as such. The Lender shall withdraw such
notice in the event that the circumstances giving rise thereto no longer obtain
and that adequate and reasonable means exist for ascertaining the LIBOR Rate for
the Interest Period requested by the Company, and following withdrawal of such
notice by the Lender, the Company shall have the right to fund any Loan as a
Eurodollar Loan or convert a Loan to a Eurodollar Loan or to continue a
Eurodollar Loan in accordance with the terms and conditions of this Agreement.
1(f) Illegality. Notwithstanding any other provisions herein,
----------
if any law, regulation, treaty or directive or any change therein or in the
interpretation or application thereof, shall make it unlawful for the Lender to
make or maintain Eurodollar Loans as contemplated by this Agreement: (1) the
commitment of the Lender hereunder to continue Eurodollar Loans or to convert
Fed Funds Loans to Eurodollar Loans shall forthwith be canceled and (2) all
Loans then outstanding as Eurodollar Loans, if any, shall be converted
automatically to Fed Funds Loans at the end of their respective Interest Periods
or within such earlier period as required by law. In the event of a conversion
of any such Loan prior to the end of its applicable Interest Period the Company
hereby agrees promptly to pay the Lender, upon demand, the amounts required
pursuant to Paragraph 1(i) below, it being agreed and understood that such
conversion shall constitute a prepayment for all purposes hereof. The provisions
hereof shall survive the termination of this Agreement and payment of the
outstanding Loans and all other amounts payable hereunder.
1(g) Requirements of Law; Increased Costs. In the event that
------------------------------------
any change subsequent to the date hereof in any applicable law, order,
regulation, treaty or directive issued by any central bank or other Governmental
Authority, or in the governmental or judicial interpretation or application
thereof, or compliance by the Lender with any request or directive (whether or
not having the force of law) by any central bank or other Governmental
Authority:
(1) subjects the Lender to any tax of any kind whatsoever
with respect to this Agreement or any Loans made hereunder, or change the
basis of taxation of payments to the Lender of principal, fee, interest or
any other amount payable hereunder (except for change in the rate of tax on
the overall net income of the Lender);
3
<PAGE>
(2) imposes, modifies or holds applicable any reserve,
capital requirement, special deposit, compulsory loan or similar
requirements against assets held by, or deposits or other liabilities in or
for the account of, advances or loans by, or other credit extended by, or
any other acquisition of funds by, any office of the Lender which are not
otherwise included in the determination of the Fed Funds Rate or the LIBOR
Rate; or
(3) imposes on the Lender any other condition;
and the result of any of the foregoing is to increase the cost to the Lender of
making, renewing or maintaining any Loan or to reduce any amount receivable in
respect thereof or to reduce the rate of return on the capital of the Lender or
any Person controlling the Lender, then, in any such case, the Company shall
promptly pay to the Lender, upon its written demand, any additional amounts
necessary to compensate the Lender for such additional cost or reduced amounts
receivable or rate of return as determined by the Lender with respect to this
Agreement or Loans made hereunder. If the Lender becomes entitled to claim any
additional amounts pursuant to this Paragraph 1(g), it shall promptly notify the
Company of the event by reason of which it has become so entitled. A certificate
as to any additional amounts payable pursuant to the foregoing sentence
containing the calculation thereof in reasonable detail submitted by the Lender
to the Company shall be conclusive in the absence of manifest error.
The provisions hereof shall survive the termination of this Agreement and
payment of the outstanding Loans and all other amounts payable hereunder.
1(h) Funding. The Lender shall be entitled to fund all or any
-------
portion of the Loans in any manner it may determine in its sole discretion, but
all calculations and transactions hereunder shall be conducted as though the
Lender actually funds all Eurodollar Loans through the purchase in London of
offshore dollar deposits in the amount of the relevant Eurodollar Loan in
maturities corresponding to the applicable Interest Period.
1(i) Funding Indemnification -- Prepayment. In addition to all
-------------------------------------
other payment obligations hereunder, in the event any Loan which is outstanding
as a Eurodollar Loan is prepaid prior to the last day of the applicable Interest
Period, whether following a voluntary prepayment or a mandatory prepayment,
notwithstanding that the Loan may have borne interest at the Eurodollar Rate,
such Loan shall be deemed to have borne interest as though it were a Fed Funds
Loan from the first day of the applicable Interest Period through the date of
such prepayment and the Company shall immediately pay to the Lender interest at
the
4
<PAGE>
Applicable Fed Funds-Based Rate for such period, and shall also immediately
pay to the Lender an additional amount compensating the Lender for losses and
expenses incurred by the Lender in connection with such prepayment, including,
without limitation, such as may arise out of a re-employment of funds obtained
by the Lender and from fees payable to terminate the deposits from which such
funds were obtained, such losses, and expenses and the method of calculation
thereof being set forth in reasonable detail and a statement delivered to the
Company by the Lender. Under no circumstances shall the Lender have any
obligation to remit monies to the Company upon prepayment of any Eurodollar Loan
even under circumstances which do not result in the necessity of the payment by
the Company of any amount hereunder. The provisions hereof shall survive
termination of this Agreement and payment of the outstanding Loans and all
amounts payable hereunder.
1(j) Funding Indemnification -- Default or Failure to Continue
---------------------------------------------------------
or Convert. In addition to all other payment obligations hereunder, in the event
- ----------
the Company shall fail to continue or to make a conversion to a Eurodollar Loan
after the Company has given notice thereof as provided in Paragraph 1(d) above,
or if after giving a notice to have the Lender make a Eurodollar Loan, the
Lender is not obligated to do so due to the existence of an Event of Default or
Potential Default, then the Company shall immediately pay to the Lender an
additional amount compensating the Lender for losses and expenses incurred by
the Lender in connection with such failure to continue or convert a Eurodollar
Loan, or the occurrence of an Event of Default or Potential Default including,
without limitation, such as may arise out of re-employment of funds obtained by
the Lender and from fees payable to terminate the deposits from which such funds
were obtained, such losses and expenses and the method of calcula tion thereof
being set forth in reasonable detail in a statement delivered to the Company by
the Lender. The provisions hereof shall survive termination of this Agreement
and payment of the outstanding Loans and all other amounts payable hereunder.
2. Miscellaneous Lending Provisions.
--------------------------------
2(a) Use of Proceeds. The proceeds of all Loans shall be used
---------------
by the Company solely for the purpose of originating and acquiring Mortgage
Loans or acquiring Mortgage-Backed Securities.
2(b) Request For Loans; Making of Loans.
----------------------------------
(1) If the Company desires to borrow a Fed Funds Loan
hereunder, the Company shall make a Loan Request to the Lender no later
than 2:00 p.m. (Charlotte, North Carolina time) on the proposed funding
date. The Lender shall make available the proposed Loan by crediting
the amount thereof
5
<PAGE>
in immediately available same day funds to the Funding Account no later
than 3:30 p.m. (Charlotte, North Carolina time) on such date.
(2) If the Company desires to borrow or continue a
Eurodollar Loan or to convert a Fed Funds Loan to a Eurodollar Loan as
provided in Paragraph 1(d) above, the Company shall make a Loan Request
to the Lender no later than 2:00 p.m. (Charlotte, North Carolina time)
on the day occurring at least three Eurodollar Business Days prior to
the date of the borrowing, conversion or continuation requested
therein. Notwithstanding any provision hereof to the contrary, the
parties agree that the Company may have only four (4) outstanding
Eurodollar Loans at any time and that each Eurodollar Loan shall be in
a principal amount of $1,000,000.00 or whole multiples of $100,000.00
in excess thereof.
2(c) Notes. The obligation of the Company to repay the Loans
-----
shall be evidenced by a note payable to the order of the Lender in the form
attached hereto as Exhibit A (the "Note").
---------
2(d) Interest and Fee Billing and Payment. The Lender shall
------------------------------------
(1) in the case of Fed Funds Loans and Eurodollar Loans having an Interest
Period in excess of one month, on or before the fifth Business Day of each
month, and (2) in the case of Eurodollar Loans, also on the last day of the
applicable Interest Period, deliver to the Company an interest and fee billing
for the immediately preceding month or Interest Period, as the case may be,
which billing shall set forth interest accrued and payable on Loans and fees
payable hereunder for such period and which billing shall be payable, in the
case of a billing delivered pursuant to subparagraph (1) above, no later than
the second Business Day following receipt thereof by the Company and, in the
case of a billing delivered pursuant to subparagraph (2) above, on the last day
of the applicable Interest Period.
2(e) Repayment of Principal. Subject to the prepayment
----------------------
requirements of Paragraph 2(j) below and the required application of proceeds
from the sale or other disposition of Mortgage Loans as provided in the Security
Agreement, the Company shall pay the principal amount of each Eurodollar Loan on
the last day of the applicable Interest Period relating thereto and shall pay
the principal amount of all other Loans on the Maturity Date.
2(f) Borrowing Base Conformity.
-------------------------
(1) The Company shall cause to be maintained with the Lender a
Borrowing Base such that the Collateral Value of the Borrowing Base is not
less than, at any date, the sum of the aggregate dollar amount of
outstanding Loans.
6
<PAGE>
(2) The Company shall prepay Loans to the Lender, upon
telephonic or facsimile demand by the Lender, on any day in the amount by
which the aggregate principal amount of outstanding Loans exceeds the
Collateral Value of the Borrowing Base, said prepayment to be made on the
date on which demand is made by the Lender if made prior to 4:00 p.m.
(Charlotte, North Carolina time) or, if made later than 4:00 p.m.
(Charlotte, North Carolina time), before 9:00 a.m. (Charlotte, North
Carolina time) on the next Business Day.
(3) If at such time as the Company shall be required to
prepay Loans under this Paragraph 2(f) there shall not have occurred and be
continuing an Event of Default or Potential Default hereunder, in lieu of
prepaying the Loans as required, the Company may deliver to the Lender
additional Eligible Mortgage Loans such that the Collateral Value of the
Borrowing Base, after giving effect to the inclusion of such Eligible
Mortgage Loans in the Borrowing Base, shall be in compliance with the
requirements of subparagraphs (1) and (2) above.
2(g) Nature and Place of Payments. All payments made on
----------------------------
account of the Obligations shall be made to the Lender and the Lender is hereby
irrevocably authorized to debit the Settlement Account on account thereof. All
payments made on account of the Obligations shall be made without set-off or
counterclaim in lawful money of the United States of America in immediately
available same day funds, free and clear of and without deduction for any taxes,
fees or other charges of any nature whatsoever imposed by any taxing authority
and if received by the Lender by 4:00 p.m. (Charlotte, North Carolina time) such
payment will be credited on the Business Day received. If a payment is received
after 4:00 p.m. (Charlotte, North Carolina time) by the Lender, such payment
will be credited on the next succeeding Business Day and interest thereon shall
be payable at the then applicable rate until credited. If any payment required
to be made by the Company hereunder becomes due and payable on a day other than
a Business Day, the due date thereof shall be extended to the next succeeding
Business Day and interest thereon shall be payable at the then applicable rate
during such extension.
2(h) Post-Maturity Interest. Any Obligations not paid when due
----------------------
(whether at stated maturity, upon acceleration or otherwise) shall bear interest
from the date due until paid in full at a per annum rate equal to two percent
(2%) above the interest rate otherwise applicable thereto, or, if such
Obligations do not otherwise bear interest, two percent (2%) above the Corporate
Base Rate.
7
<PAGE>
2(i) Computations. All computations of interest and fees payable
------------
hereunder shall be based upon a year of 360 days for the actual number of days
elapsed.
2(j) Prepayments.
-----------
(1) The Company may voluntarily prepay Loans hereunder
(including a Eurodollar Loan subject to Paragraph 1(i)) in whole or in part
at any time.
(2) Loans hereunder are subject to mandatory prepayment
pursuant to Paragraph 2(f) above and, in addition, by application of
proceeds of the sale or other disposition of Collateral as provided in the
Security Agreement.
(3) The Company shall pay in connection with any prepayment
hereunder all interest accrued but unpaid on Loans to which such prepayment
is applied and any amounts payable pursuant to Paragraph 1(i) above
concurrently with payment to the Lender of any principal amounts.
2(k) Allocation of Payments Received.
-------------------------------
(1) Prior to the occurrence of an Event of Default and
acceleration of all Loans outstanding hereunder or termination of the
commitment of the Lender to advance Loans hereunder, all amounts received
by the Lender shall be applied against the outstanding Obligations.
(2) Following the occurrence of an Event of Default and
acceleration of all Loans outstanding hereunder or termination of the
commitments of the Lender to advance Loans hereunder, all amounts received
by the Lender on account of the Obligations shall be applied by the Lender
as follows:
(i) First, to the payment of reasonable costs and
expenses incurred by the Lender in the enforcement of its rights under the
Credit Documents, including, without limitation, all costs and expenses of
collection, attorneys' fees, court costs and foreclosure expenses;
(ii) Second, to the Lender to be applied against the
Obligations until the Obligations shall have been paid in full; and
(iii) Third, to such Persons as may be legally entitled
thereto.
8
<PAGE>
2(l) Fees. The Company shall pay the following fees to the
----
Lender:
(1) Such closing fees as are agreed to in writing by the
Company and the Lender, said fees to be payable on or before the date of making
the first Loan hereunder.
(2) A non-refundable non-usage fee, such fee to be
payable in quarterly installments, in arrears, on the last Business Day of each
March, June, September and December during the term of this Agreement, each such
installment to be in an amount equal to the product of: (i) the amount by which
the Credit Limit exceeded the average daily amount of Loans outstanding during
the previous calendar quarter, multiplied by (ii) 0.125%, divided by (iii) 4;
---------- -------
provided, however, that no non-usage fee shall be owed by the Company to the
- -------- -------
Lender under this Paragraph 2(l)(2) for any quarter during which the average
daily amount of Loans outstanding during such calendar quarter equals or exceeds
fifty percent (50%) of the Credit Limit.
(3) An aged loan fee, such fee to be payable monthly in
arrears on the applicable dates specified in Paragraph 2(d) hereof, each such
installment to be in an amount equal to the product of (i) the average daily
aggregate principal balance of all Mortgage Loans included in the Borrowing Base
during said month of the type described in the first proviso to subsection (p)
of the definition of "Eligible Mortgage Loan," multiplied by (ii) 0.125%,
----------
divided by (iii) 12.
(4) A collateral handling fee with respect to each
Mortgage Loan (and related Required Documents) submitted to the Lender for
inclusion in the Borrowing Base, such fee to be payable monthly in arrears
on the applicable date specified in Paragraph 2(d) hereof, and to be in the
amount of (i) for any month during which one hundred (100) or fewer
Mortgage Loans (and related Required Documents) are delivered to the
Lender, $10.00 for each Mortgage Loan delivered in such month, and (ii) for
any month during which more than one hundred (100) Mortgage Loans (and
related Required Documents) are delivered to the Lender, $7.00 for each
Mortgage Loan delivered in such month.
3. Security Agreement; Guaranties; Additional Documents.
----------------------------------------------------
3(a) Security Agreement and Financing Statements. On or before
-------------------------------------------
the date hereof, the Company shall execute and deliver to the Lender: (1) a
security agreement in the form of that attached hereto as Exhibit B (the
---------
"Security Agreement"), pursuant to which the Company shall pledge, assign
and grant to the Lender a perfected, first priority security interest in
and lien upon the Collateral, and (2) such UCC financing statements as the
Lender
9
<PAGE>
may request.
3(b) Guaranties.
----------
(1) On or before the date hereof, the Company shall cause
to be executed and delivered to the Lender by NovaStar Financial a
continuing guaranty in the form of that attached hereto as Exhibit C-1 (the
-----------
"NovaStar Financial Guaranty").
(2) On or before the NFI Holding Delivery Date, the
Company shall cause to be executed and delivered to the Lender by NFI
Holding a continuing guaranty in the form of that attached hereto as
Exhibit C-2 (the "NFI Holding Guaranty" and, together with the NovaStar
-----------
Financial Guaranty, the "Guaranties").
3(c) Further Documents. The Company agrees to execute and
-----------------
deliver and to cause to be executed and delivered to the Lender from time to
time such confirmatory and supplementary security agreements, financing
statements and other documents, instruments and agreements as the Lender may
reasonably request, which are in the Lender's judgment necessary or desirable to
obtain for the Lender the benefit of the Credit Documents and the Collateral.
4. Conditions to Making of Loans.
-----------------------------
4(a) First Loan. As conditions precedent to the Lender's
----------
obligation to make the first Loan hereunder:
(1) The Company shall have delivered to the Lender, in
form and substance satisfactory to the Lender and its counsel, each of
the following:
(i) A duly executed copy of this Agreement;
(ii) A duly executed copy of the Security Agreement
and of the NovaStar Financial Guaranty;
(iii) A duly executed copy of the Note;
(iv) Duly executed copies of all financing
statements and other documents, instruments and agreements, properly
executed, deemed necessary or appropriate by the Lender, in its
reasonable discretion, to obtain for the Lender a perfected, first
priority security interest in and lien upon the Collateral;
(v) Such credit applications, financial
10
<PAGE>
statements, authorizations and such information concerning the Company
and its business, operations and conditions (financial and otherwise)
as the Lender may reasonably request;
(vi) Certified copies of resolutions of the Board
of Directors of each of the Company and NovaStar Financial approving
the execution and delivery of the Credit Documents to which the Company
or NovaStar Financial, as applicable, is a party, the performance of
the Obligations thereunder and the consummation of the transactions
contemplated thereby;
(vii) A certificate of the Secretary or an
Assistant Secretary of each of the Company and NovaStar Financial
certifying the names and true signatures of the officers of the Company
or NovaStar Financial, as applicable, authorized to execute and deliver
the Credit Documents to which the Company or NovaStar Financial, as
applicable, is a party;
(viii) A copy of the Articles of Incorporation of
each of the Company and NovaStar Financial, certified by the respective
Secretary or an Assistant Secretary of the Company or NovaStar
Financial, as applicable, as of the date of this Agreement as being
accurate and complete;
(ix) A copy of the Bylaws of each of the Company
and NovaStar Financial, certified by the respective Secretary or an
Assistant Secretary of the Company or NovaStar Financial, as
applicable, as of the date of this Agreement as being accurate and
complete;
(x) A certificate of the Secretary of State of
the Commonwealth of Virginia, certifying as of a recent date that the
Company is in good standing;
(xi) A certificate of the Secretary of State of
the State of Maryland, certifying as of a recent date that NovaStar
Financial is in good standing;
(xii) An opinion of counsel for the Company and
NovaStar Financial substantially in the form of Exhibit D attached
---------
hereto and covering such other matters as the Lender may reasonably
request;
(xiii) Evidence satisfactory to the Lender that each
of the Funding Account and the Settlement Account has been opened;
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<PAGE>
(xiv) A schedule of the initial Approved Investors
duly approved by the Lender;
(xv) A duly completed Borrowing Base Schedule
dated as of the date of the first Loan hereunder and certified by the
Company to be true in all respects; and
(xvi) A Covenant Compliance Certificate
demonstrating in detail satisfactory to the Lender that the Company is
in compliance with the covenants set forth in Paragraphs 7(h) and 7(i)
below.
(2) All acts and conditions (including, without limitation,
the obtaining of any necessary regulatory approvals and the making of any
required filings, recordings or registrations) required to be done and
performed and to have happened precedent to the execution, delivery and
performance of the Credit Documents and to constitute the same legal, valid
and binding obligations, enforceable in accordance with their respective
terms, shall have been done and performed and shall have happened in due
and strict compliance with all applicable laws.
(3) All documentation, including, without limitation,
documentation for corporate and legal proceedings in connection with the
transactions contemplated by the Credit Documents shall be satisfactory in
form and substance to the Lender and its counsel.
(4) All fees required to be paid on or before the date hereof
pursuant to Paragraph 2(l) above shall have been paid prior to (or will be
paid concurrently with) the making of the first Loan hereunder.
4(b) Ongoing Loans. As conditions precedent to the Lender's
-------------
obligation to make any Loan hereunder, including the first Loan and including
the conversion of any Loan to another type of Loan, at and as of the date of
advance, conversion or continuance thereof;
(1) There shall have been delivered to the Lender a Loan
Request therefor;
(2) The representations and warranties of the Company
contained in the Credit Documents shall be accurate and complete in all
respects as if made on and as of the date of such advance, conversion or
continuance;
12
<PAGE>
(3) There shall not have occurred an Event of Default or
Potential Default;
(4) Following the funding of the requested Loan, the aggregate
principal amount of Loans outstanding will not exceed the lesser of: (i)
the Credit Limit and (ii) the Collateral Value of the Borrowing Base;
(5) There shall not have occurred any material adverse change
in the financial condition, assets, nature of assets, operations or
prospects of the Company from that represented in this Agreement, the other
Credit Documents, or the documents or information furnished to the Lender
in connection herewith or therewith; and
(6) The Required Documents for the Mortgage Loan(s) being
funded therewith shall have been received by the Lender (except as
otherwise provided in subsection (o) of the definition of Eligible Mortgage
Loan).
By making a Loan Request to the Lender hereunder, the Company shall be deemed to
have represented and warranted the accuracy and completeness of the statements
set forth in subparagraphs (b)(2) through (b)(6) above.
4(c) NFI Holding Documents. Within thirty (30) days from the date of
---------------------
this Agreement, the Company shall cause to be delivered to the Lender, in form
and substance satisfactory to the Lender and its counsel, each of the following:
(i) A duly executed copy of the NFI Holding Guaranty;
(ii) Certified copies of resolutions of the Board of
Directors of NFI Holding approving the execution and delivery of the
Credit Documents to which NFI Holding is a party, the performance of
the Obligations thereunder and the communication of the transactions
contemplated thereby;
(iii) A certificate of the Secretary or an Assistant Secretary
of NFI Holding certifying the names and the signatures of the officers
of NFI Holding authorized to execute and deliver the Credit Documents
to which NFI Holding is a party;
(iv) A copy of the Articles of Incorporation of NFI Holding,
certified by the Secretary or an Assistant Secretary of NFI Holding as
of the date of this Agreement as being accurate and complete;
13
<PAGE>
(v) A copy of the Bylaws of NFI Holding, certified by the
Secretary or an Assistant Secretary of NFI Holding as of the date of
this Agreement as being accurate and complete;
(vi) A certificate of the Secretary of State of ____________,
certifying as of a recent date that NFI Holding is in good standing;
and
(vii) An opinion of counsel for the Company and the Guarantors
substantially in the form of Exhibit D attached hereto (as revised to
---------
cover both Guarantors) and covering such other matters as the Lender
may reasonably request.
Upon the NFI Holding Delivery Date, NFI Holding shall become a Guarantor
for all purposes under this Agreement.
5. Representations and Warranties of the Company.
---------------------------------------------
The Company represents and warrants to the Lender that:
5(a) Financial Condition. The financial statements, dated the
-------------------
Interim Date, copies of which have been furnished to the Lender, are complete
and correct and have been prepared to present fairly, in accordance with GAAP
(or with such non-GAAP principles as are disclosed to and approved by Lender
from time to time), the financial condition of the Company at such dates and the
results of its operations and changes in financial position for the fiscal
periods then ended.
5(b) No Change. As of the date hereof, there has been no material
---------
adverse change in the business, operations, assets or financial or other
condition of the Company from that shown on the financial statements dated as of
the Interim Date referred to in Paragraph 5(a) above.
5(c) Corporate Existence; Compliance with Law. The Company: (1) is
----------------------------------------
duly organized, validly existing and in good standing as a corporation under the
laws of the Commonwealth of Virginia and is qualified to do business in each
jurisdiction where its ownership of property or conduct of business requires
such qualification and where failure to qualify could have a material adverse
effect on the Company or its property or business or on the ability of the
Company to pay or perform the Obligations, (2) has the corporate power and
authority and the legal right to own and operate its property and to conduct
business in the manner in which it does and proposes so to do, and (3) is in
compliance with all Requirements of Law and Contractual
14
<PAGE>
Obligations, the failure to comply with which could have a material adverse
effect on the business, operations, assets or financial or other condition of
the Company or on the Collateral or the Collateral Value of the Borrowing Base.
5(d) Corporate Power; Authorization; Enforceable Obligations. The
-------------------------------------------------------
Company has the corporate power and authority and the legal right to execute,
deliver and perform the Credit Documents and has taken all necessary corporate
action to authorize the execution, delivery and performance of the Credit
Documents. The Credit Documents have been duly executed and delivered on behalf
of the Company and constitute legal, valid and binding obligations of the
Company enforceable against the Company in accordance with their respective
terms, subject to the effect of applicable bankruptcy and other similar laws
affecting the rights of creditors generally and the effect of equitable
principles whether applied in an action at law or a suit in equity.
5(e) No Legal Bar. The execution, delivery and performance of the
------------
Credit Documents, the borrowing hereunder and the use of the proceeds thereof,
will not violate any Requirement of Law or any Contractual Obligation of the
Company the violation of which could have a material adverse effect on the
business, operations, assets or financial or other condition of the Company or
on the Collateral or the Collateral Value of the Borrowing Base or create or
result in the creation of any Lien (except the Lien created by the Security
Agreement) on any assets of the Company.
5(f) No Material Litigation. Except as disclosed on Exhibit E
---------------------- ---------
hereto, no litigation, investigation or proceeding of or before any court,
arbitrator or Governmental Authority is pending or, to the knowledge of the
Company, threatened by or against the Company or against any of its properties
or revenues which is likely to be adversely determined and which, if adversely
determined, is likely to have a material adverse effect on the business,
operations, property or financial or other condition of the Company or on the
Collateral or the Collateral Value of the Borrowing Base.
5(g) Taxes. To the best of the Company's knowledge, all tax returns
-----
that are required to be filed by or on behalf of the Company have been filed and
all taxes shown to be due and payable on said returns or on any assessments made
against the Company or any of its property (other than taxes which are being
contested in good faith by appropriate proceedings and as to which the Company
has established adequate reserves in conformity with GAAP) have been paid and
taxes which unknown to the Company were not paid.
15
<PAGE>
5(h) Investment Company Act. The Company is not an "investment
----------------------
company" or a company "controlled" by an "investment company" within the meaning
of the Investment Company Act of 1940, as amended.
5(i) Federal Reserve Board Regulations. The Company is not engaged
---------------------------------
and will not engage, principally or as one of its important activities, in the
business of extending credit for the purpose of "purchasing" or "carrying" any
"margin stock" within the respective meanings of such terms under Regulation U.
No part of the proceeds of any Loan issued hereunder will be used, directly or
indirectly, for "purchasing" or "carrying" "margin stock" as so defined or for
any purpose which violates, or which would be inconsistent with, the provisions
of the Regulations of the Board of Governors of the Federal Reserve System.
5(j) ERISA. The Company and each of its ERISA Affiliates are in
-----
compliance in all respects with the requirements of ERISA and no Reportable
Event has occurred under any Plan maintained by the Company or any of its ERISA
Affiliates which is likely to result in the termination of such Plan for
purposes of Title IV of ERISA.
5(k) Assets. The Company has good and marketable title to all
------
property and assets reflected in the financial statements referred to in
Paragraph 5(a) above, except property and assets sold or otherwise disposed of
in the ordinary course of business subsequent to the respective dates thereof.
The Company has no outstanding Liens on any of its properties or assets and
there are no security agreements to which the Company is a party, nor any title
retention agreements, whether in the form of leases or otherwise, of any
personal property except as permitted under Paragraph 7(a) below.
5(l) Securities Acts. The Company has not issued any unregistered
---------------
securities in violation of the registration requirements of Paragraph 5 of the
Securities Act of 1933, as amended, or any other law, and is not violating any
rule, regulation or requirement under the Securities Act of 1933, as amended, or
the Securities and Exchange Act of 1934, as amended. The Company is not required
to qualify an indenture under the Trust Indenture Act of 1939, as amended, in
connection with its execution and delivery of the Note.
5(m) Consents, etc. No consent, approval, authorization of, or
-------------
registration, declaration or filing with, any Governmental Authority is required
on the part of the Company in connection with the execution and delivery of the
Credit Documents (other than filings to perfect the security interests granted
by it) or the performance of or compliance with the terms, provisions
16
<PAGE>
and conditions hereof or thereof.
5(n) Ownership and Subsidiaries. As of the date hereof, ninety-nine
--------------------------
percent (99%) of the economic interests in the Company are owned by NovaStar
Financial. The Company has no Subsidiaries.
6. Affirmative Covenants. The Company hereby covenants and agrees with
---------------------
the Lender that, as long as any Obligations remain unpaid or the Lender has any
obligation to make Loans hereunder, the Company shall:
6(a) Financial Statements. Furnish or cause to be furnished to the
--------------------
Lender:
(1) Within ninety (90) days after the last day of each fiscal
year of NovaStar Financial, statements of income and cash flows for such
year, and balance sheets as of the end of such year, of each of NovaStar
Financial, NFI Holding and the Company, presented fairly in accordance with
GAAP (or with such non-GAAP principles as are disclosed to and approved by
Lender from time to time) and accompanied by an unqualified report of a
firm of independent certified public accountants acceptable to the Lender
and including therewith a copy of any management letter from such certified
public accountants, together with a consolidating schedule prepared by an
officer of NovaStar Financial in form and substance acceptable to the
Lender which reconciles and consolidates the above-referenced financial
statements;
(2) Within forty-five (45) days after the last day of each
calendar month, statements of income for such month, and balance sheets as
of the end of such month, of each of NovaStar Financial, NFI Holding and
the Company, accompanied in each case by a consolidating schedule prepared
by an officer of NovaStar Financial in form and substance acceptable to the
Lender which reconciles and consolidates the above-referenced financial
statements and by a Covenant Compliance Certificate of the appropriate
officer of NovaStar Financial, stating that all such financial statements
are prepared fairly in accordance with GAAP (or with such non-GAAP
principles as are disclosed to and approved by Lender from time to time)
and demonstrating in detail satisfactory to the Lender compliance with the
financial covenants set forth in Paragraphs 7(h) and 7(i) below as of and
at the end of such month.
6(b) Certificates; Reports; Other Information. Furnish or cause to
----------------------------------------
be furnished to the Lender:
(1) Within forty-five (45) days after the last day of each
calendar month a collateral report, a commitment
17
<PAGE>
report, a Hedging Report and a pipeline management report, all for said
calendar month and each in a form approved by Lender and containing such
other information as may be reasonably requested by Lender;
(2) Promptly, such additional financial and other information,
including, without limitation, financial statements of any of NovaStar
Financial, NFI Holding or the Company or any Approved Investor and
information regarding the Collateral as the Lender may from time to time
reasonably request;
(3) Promptly, and in any event within five (5) business days
after received or sent by the Company, (i) true and complete copies of all
audits, reports, studies and similar documentation prepared by, or on
behalf of FHA, VA or the Department of Housing and Urban Development or
similar agency relating to the Company's operations, servicing or lending
practices or which have been done in connection with a review, extension or
conditioning of any licenses and approvals issued to the Company by FHA or
VA; and (ii) copies of all correspondence between any of the foregoing
departments and agencies and the Company related to any such audits,
reports, studies and similar documents; and
(4) Promptly, copies of any and all forms, reports, supplements
or other documents of any kind filed by the Company with the Securities and
Exchange Commission.
6(c) Payment of Indebtedness. Pay or otherwise satisfy at or before
-----------------------
maturity or before it becomes delinquent or accelerated, as the case may be, all
its Indebtedness (including taxes), except Indebtedness being contested in good
faith by appropriate proceedings and for which provision is made to the
satisfaction of the Lender for the payment thereof in the event the Company is
found to be obligated to pay such Indebtedness and which Indebtedness is
thereupon promptly paid by the Company.
6(d) Maintenance of Existence and Properties. Maintain its
---------------------------------------
corporate existence and obtain and maintain all rights, privileges, licenses,
approvals, franchises, properties and assets necessary or desirable in the
normal conduct of its business, including but not limited to all approvals with
respect to FHA and VA, and comply with all Contractual Obligations and
Requirements of Law (including, without limitation, any Requirements of Law
under or in connection with ERISA), except where the failure to so comply is not
likely to have a material adverse effect on the business, operations, assets or
financial or other condition of the Company or on the Collateral or the
Collateral Value of the Borrowing Base.
18
<PAGE>
6(e) Inspection of Property; Books and Records; Audits.
-------------------------------------------------
(1) Keep proper books of record and account in which full, true
and correct entries in conformity with GAAP (or with such non-GAAP
principles as are disclosed to and approved by Lender from time to time)
and all Requirements of Law shall be made of all dealings and transactions
in relation to its business and activities; and
(2) Permit: (i) representatives of the Lender to (A) visit and
inspect any of its properties and examine and make abstracts from any of
its books and records at any reasonable time and as often as may reasonably
be desired by the Lender (but, prior to the occurrence of an Event of
Default, only upon not less than two Business Days' prior notice), and (B)
discuss the business, operations, properties and financial and other
condition of the Company with officers and employees of the Company, and
with its independent certified public accountants, and (ii) representatives
of the Lender to conduct periodic operational audits of the Company's
business and operations.
6(f) Notices. Promptly give written notice to the Lender of:
-------
(1) The occurrence of any Potential Default or Event of Default
known to responsible management personnel of the Company and the proposed
method of cure thereof;
(2) Any litigation or proceeding affecting the Company or the
Collateral which could have a material adverse effect on the Collateral,
the Collateral Value of the Borrowing Base or the business, operations,
property, or financial or other condition of the Company;
(3) A material adverse change known to responsible management
personnel of the Company in the business, operations, property or financial
or other condition of the Company; and
(4) Any changes in the following senior management positions of
the Company: President, Chief Financial Officer or any Vice President.
6(g) Expenses. Pay all reasonable out-of-pocket costs and expenses
--------
(including fees and disbursements of legal counsel) of the Lender: (1) incident
to the preparation, negotiation and administration of the Credit Documents,
including with respect to or in connection with any waiver or amendment thereof
or thereto, (2) associated with any periodic audits conducted pursuant to
19
<PAGE>
Paragraph 6(e)(2)(ii) above, and (3) incident to the enforcement of payment of
the Obligations, whether by judicial proceedings or otherwise, including,
without limitation, in connection with bankruptcy, insolvency, liquidations
reorganization moratorium or other similar proceedings involving the Company or
a "workout" of the Obligations. The obligations of the Company under this
Paragraph 6(g) shall be effective and enforceable whether or not any Loan is
advanced by the Lender hereunder and shall survive payment of all other
Obligations.
6(h) Credit Documents. Comply with and observe all terms and
----------------
conditions of the Credit Documents.
6(i) Insurance. Obtain and maintain insurance with responsible
---------
companies in such amounts and against such risks as are usually carried by
corporations engaged in similar businesses similarly situated, including,
without limitation, errors and omissions coverage and fidelity coverage in form
and substance acceptable under FNMA, FHLMC or GNMA guidelines, and furnish the
Lender on request full information as to all such insurance, and to provide
within five (5) days after receipt, certificates or other documents evidencing
the renewal of each such policy.
6(j) Wet Funding Mortgage Loan Transmittal Form. Furnish or cause
------------------------------------------
to be furnished to the Lender, with each Eligible Mortgage Loan shipped or
delivered which is of the type described in the proviso contained in subsection
(o) of the definition of Eligible Mortgage Loan, a Wet Funding Mortgage Loan
Transmittal Form substantially in the form attached as Exhibit K hereto.
---------
7. Negative Covenants. The Company hereby agrees that, as long as any
------------------
Obligations remain unpaid or the Lender has any obligation to make Loans
hereunder, the Company shall not at any time, directly or indirectly:
7(a) Liens. Create, incur, assume or suffer to exist, any Lien upon
-----
the Collateral except as contemplated by the Security Agreement, or create,
incur, assume or suffer to exist any Lien upon any of its other property and
assets (including servicing rights) except:
(1) Liens for current taxes, assessments or other governmental
charges which are not delinquent or which remain payable without penalty,
or the validity of which are contested in good faith by appropriate
proceedings upon stay of execution of the enforcement thereof, provided the
Company shall have set aside on its books and shall maintain adequate
reserves for the payment of same in conformity with GAAP;
(2) Liens, deposits or pledges made to secure
20
<PAGE>
statutory obligations, surety or appeal bonds, or bonds for the release of
attachments or for stay of execution, or to secure the performance of bids,
tenders, contracts (other than for the payment of borrowed money), leases
or for purposes of like general nature in the ordinary course of the
Company's business;
(3) Purchase money security interests for property (except
Mortgage Loans) hereafter acquired, conditional sale agreements, or other
title retention agreements, with respect to property hereafter acquired;
provided, however, that no such security interest or agreement shall affect
any servicing rights or extend to any property other than the property
acquired; and
(4) Liens securing Permitted Secured Debt.
7(b) Indebtedness. Create, incur, assume or suffer to exist, or
------------
otherwise become or be liable in respect of any Indebtedness except:
(1) The Obligations;
(2) Indebtedness reflected in the financial statements referred
to in Paragraph 5(a) above;
(3) Trade debt incurred in the ordinary course of business,
paid within thirty (30) days after the same has become due and payable or
which is being contested in good faith, provided provision is made to the
satisfaction of the Lender for the eventual payment thereof in the event it
is found that such contested trade debt is payable by the Company;
(4) Indebtedness secured by Liens permitted under Paragraph
7(a) above;
(5) Liabilities incurred as "seller/repurchaser" under
repurchase agreements covering Mortgage-Backed Securities or Mortgage Loans
in customary form;
(6) Capitalized Lease Obligations in an aggregate amount not to
exceed at any one time outstanding $250,000.00;
(7) Liabilities arising out of collateralized mortgage
obligations created by the Company or entities created by the Company; and
(8) Permitted Other Debt.
21
<PAGE>
7(c) Consolidation and Merger; Change of Business. Liquidate or
--------------------------------------------
dissolve or enter into any consolidation, merger, partnership, joint venture,
syndicate or other combination or make any change in the nature of its business
as a mortgage banker as presently conducted.
7(d) Acquisitions. Purchase or acquire or incur liability for the
------------
purchase or acquisition of any or all of the assets or business of any Person,
other than in the normal course of business as currently conducted (it being
expressly agreed and understood that the acquisition of non-recourse servicing
is a normal course of business activity and that the acquisition of recourse
servicing is not a normal course of business activity).
7(e) Transfer of Stock. Permit the acquisition, purchase,
-----------------
redemption, retirement, transfer or issuance of any shares of its capital stock
now or hereafter outstanding which would result in (i) prior to the NFI Holding
Delivery Date, NovaStar Financial owning less than ninety-nine percent (99%) of
the economic interest in the Company, and (ii) on and after the NFI Holding
Delivery Date, NFI Holding owning less than one hundred percent (100%) of its
outstanding capital stock.
7(f) Investments; Advances; Guaranties. Make or commit to make any
---------------------------------
advance, loan or extension of credit (other than Mortgage Loans made in the
ordinary course of the Company's business) or capital contribution to, or
purchase any stocks, bonds, notes, debentures or other securities of, or make
any other investment in, or guaranty the indebtedness or other obligations of,
any Person.
7(g) Sale of Assets. Sell, lease, assign, transfer or otherwise
--------------
dispose of any of its assets (other than obsolete or worn out property), whether
now owned or hereafter acquired, other than in the ordinary course of business
as currently conducted and at fair market value (it being expressly agreed and
understood that the sale or other disposition of Mortgage-Backed Securities and
Mortgage Loans with or without servicing released and of mortgage servicing
rights is in the ordinary course of business).
7(h) Required Equity Ratio. Permit the ratio at any date of
---------------------
Required Equity to Shareholder Equity to be more than 1.0:1.0.
7(i) Minimum Adjusted Tangible Net Worth. Permit Adjusted Tangible
-----------------------------------
Net Worth as of the last day of any fiscal quarter to be less than the greater
of (i) eighty percent (80%) of the net proceeds from the Equity Issuance, and
(ii) $30,000,000.
8. Events of Default. Upon the occurrence of any of the
-----------------
22
<PAGE>
following events (an "Event of Default"):
8(a) The Company shall fail to pay principal or interest on any Loan
or any fee payable pursuant to Paragraph 2(l) above or any amount payable
pursuant to Paragraph 2(f)(2) above when due; or
8(b) Any representation or warranty made or deemed made by the
Company or either Guarantor in any Credit Document or in connection with any
Credit Document shall be inaccurate or incomplete in any respect on or as of the
date made or deemed made; or
8(c) The Company shall fail to maintain its corporate existence or
shall default in the observance or performance of any covenant or agreement
contained in Paragraph 7 above or in the Security Agreement; or
8(d) The Company shall fail to observe or perform any other term or
provision contained in the Credit Documents and such failure shall continue for
thirty (30) days; or
8(e) The Company shall default in any payment of principal of or
interest on any Indebtedness in the aggregate principal amount of $100,000.00 or
more (and without regard for the dollar amount of the defaulted payment), or any
other event shall occur, the effect of which is to permit such Indebtedness to
be declared or otherwise to become due prior to its stated maturity; or
8(f) (1) The Company or either Guarantor shall commence any case,
proceeding or other action (i) relating to bankruptcy, insolvency,
reorganization or relief of debtors, seeking to have an order for relief entered
with respect to the Company or either Guarantor, or seeking to adjudicate the
Company or either Guarantor a bankrupt or insolvent, or seeking reorganization,
arrangement, adjustment, winding-up, liquidation, dissolution, composition or
other relief with respect to the Company or either Guarantor or the debts of any
of them, or (ii) seeking appointment of a receiver, trustee, custodian or other
similar official for the Company or for all or any substantial part of the
Company's assets, or the Company or either Guarantor shall make a general
assignment for the benefit of its, his or their creditors; or (2) there shall be
commenced against the Company or either Guarantor any case, proceeding or other
action of a nature referred to in clause (1) above which (i) results in the
entry of an order for relief or any such adjudication or appointment, or (ii)
remains undismissed, undischarged or unbonded for a period of sixty (60) days;
or (3) there shall be commenced against the Company or either Guarantor any
case, proceeding or other action seeking
23
<PAGE>
issuance of a warrant of attachment, execution, distraint or similar process
against all or substantially all of the assets of any of them which results in
the entry of an order for any such relief which shall not have been vacated,
discharged, stayed, satisfied or bonded pending appeal within sixty (60) days
from the entry thereof; or (4) the Company or either Guarantor shall take any
action in furtherance of, or indicating its, his or their consent to, approval
of, or acquiescence in (other than in connection with a final settlement), any
of the acts set forth in clauses (1), (2) or (3) above; or (5) the Company or
either Guarantor shall generally not, or shall be unable to, or shall admit in
writing its, his or their inability to pay its, his or their debts as they
become due; or
8(g) (1) The Company or any of its ERISA Affiliates shall engage in
any "prohibited transaction" (as defined in Section 406 of ERISA or Section 4975
of the Code) involving any Plan, (2) any "accumulated funding deficiency" (as
defined in Section 302 of ERISA), whether or not waived, shall exist with
respect to any Plan, (3) a Reportable Event shall occur with respect to, or
proceedings shall commence to have a trustee appointed, or a trustee shall be
appointed, to administer or to terminate, any Single Employer Plan, which
Reportable Event or institution of proceedings is, in the reasonable opinion of
the Lender, likely to result in the termination of such Plan for purposes of
Title IV of ERISA, and, in the case of a Reportable Event, the continuance of
such Reportable Event unremedied for ten days after notice of such Reportable
Event pursuant to Section 4043(a), (c) or (d) of ERISA is given or the
continuance of such proceedings for ten days after commencement thereof, as the
case may be, (4) any Single Employer Plan shall terminate for purposes of Title
IV of ERISA, (5) any withdrawal liability to a Multi-Employer Plan shall be
incurred by the Company or any of its ERISA Affiliates or (6) any other event or
condition shall occur or exist; and in each case in clauses (1) through (6)
above, such event or condition, together with all other such events or
conditions, if any, is likely to subject the Company or any of its respective
ERISA Affiliates to any tax, penalty or other liabilities in the aggregate
material in relation to the business, operations, property or financial or other
condition of the Company or any of its ERISA Affiliates; or
8(h) One or more judgments or decrees in an aggregate amount in
excess of $500,000.00 shall be entered against the Company and all such
judgments or decrees shall not have been vacated, discharged, stayed, satisfied
or bonded pending appeal within sixty (60) days from the entry thereof; or
8(i) Either Guarantor shall fail to observe or perform any term or
provision of the Guaranty to which such Guarantor is a
24
<PAGE>
party or shall attempt to rescind or revoke such Guaranty, with respect to
future transactions or otherwise; or
8(j) Any acquisition, purchase, redemption, retirement,
transfer or issuance of the company's capital stock shall occur in violation of
Paragraph 7(e) above; or
8(k) Either W. Lance Anderson or Scott F. Hartman is removed
from his current position with the Company or his duties in such position are
diminished in any material respect; or
8(l) The NFI Holding Delivery Date shall not occur within
thirty (30) days of the date of this Agreement; or
8(m) The Company shall not have delivered to the Lender
satisfactory evidence from the Secretary of State of California that the Company
is qualified as a foreign corporation in such state within ninety (90) days of
the date of this Agreement.
THEN:
(1) Automatically upon the occurrence of an Event of
Default under Paragraph 8(f) above; and
(2) In all other cases, at the option of the Lender,
the Lender's obligation to make Loans hereunder shall terminate and the
principal balance of outstanding Loans and interest accrued but unpaid thereon
shall become immediately due and payable, without demand upon or presentment to
the Company, which are expressly waived by the Company.
9. Miscellaneous Provisions.
------------------------
9(a) Assignment. The Company may not assign its rights or
----------
obligations under this Agreement without the prior written consent of the
Lender. The Lender shall not assign its rights and obligations under this
Agreement to any other party not a party to this Agreement as of the date
hereof; provided, however, that the Lender may at any time pledge or assign all
-------- -------
or any portion of the Lender's rights under this Agreement and the other Credit
Documents to a Federal Reserve Bank. Subject to the foregoing, all provisions
contained in this Agreement or any document or agreement referred to herein or
relating hereto shall inure to the benefit of the Lender, its successors and
assigns, and shall be binding upon the Company, its successors and assigns.
9(b) Amendment. Neither this Agreement nor any of the other
---------
Credit Documents may be amended or terms or provisions
25
<PAGE>
hereof or thereof waived unless such amendment or waiver is in writing and
signed by the Lender and the Company. It is expressly agreed and understood that
the failure by the Lender to elect to accelerate amounts outstanding hereunder
or to terminate the obligation of the Lender to make Loans hereunder shall not
constitute an amendment or waiver of any term or provision of this Agreement.
9(c) Cumulative Rights; No Waiver. The rights, powers and
----------------------------
remedies of the Lender under the Credit Documents are cumulative and in addition
to all rights, powers and remedies provided under any and all agreements among
the Company and the Lender relating hereto, at law, in equity or otherwise. Any
delay or failure by the Lender to exercise any right, power or remedy shall not
constitute a waiver thereof by the Lender, and no single or partial exercise by
the Lender of any right, power or remedy shall preclude other or further
exercise thereof or any exercise of any other rights, powers or remedies.
9(d) Entire Agreement. This Agreement and the documents
----------------
and agreements referred to herein embody the entire agreement and understanding
between the parties hereto and supersede all prior agreements and understandings
relating to the subject matter hereof and thereof.
9(e) Survival. All representations, warranties, covenants
--------
and agreements on the part of the Company and the Guarantors contained in the
Credit Documents shall survive the termination of this Agreement and shall be
effective until the Obligations are paid and performed in full or longer as
expressly provided herein.
9(f) Notices. All notices given by any party to the others
-------
under the Credit Documents shall be in writing unless otherwise provided for
herein, delivered personally or by depositing the same in the United States
mail, registered, with postage prepaid, addressed to the party at the address
set forth on Schedule I attached hereto. Any party may change the address to
----------
which notices are to be sent by notice of such change to each other party given
as provided herein. Such notices shall be effective on the date received or, if
mailed, on the third Business Day following the date mailed.
9(g) Governing Law. This Agreement shall be governed by and
-------------
construed in accordance with the laws of the State of North Carolina.
9(h) Sub-Participation by Lender. The Lender may at any
---------------------------
time sell to one or more financial institutions (each of such financial
institutions being herein called a "Participant") participating interests in any
of the Obligations held by the Lender and its commitments hereunder; provided,
however, that: (1) no participation contemplated by this Paragraph 9(h) shall
relieve the Lender from its obligations hereunder or under any other Credit
Document; (2) the Lender shall remain solely respon-
26
<PAGE>
sible for the performance of such obligations; and (3) the Company shall
continue to deal solely and directly with the Lender in connection with the
Lender's rights and obligations under the Credit Documents.
9(i) Counterparts. This Agreement and the other Credit
------------
Documents may be executed in any number of counterparts, all of which together
shall constitute one agreement.
9(j) Exculpatory Provisions. Neither the Lender nor any of
----------------------
its officers, directors, employees, agents, counsel, attorneys-in-fact or
Affiliates shall be liable to the Company for any action taken or omitted to be
taken by it or such Person under or in connection with the Credit Documents or
with respect to the Collateral (except for its or such Person's own gross
negligence or willful misconduct).
9(k) Indemnification. The Company agrees to indemnify, defend
---------------
and hold harmless the Lender from and against any and all claims, obligations,
penalties, actions, suits, judgments, costs, disbursements, losses, liabilities
and damages (including, without limitation, reasonable attorneys' fees) of any
kind whatsoever which may at any time be imposed on, assessed against or
incurred by the Lender in any way relating to or arising out of the Credit
Documents or any documents contemplated by or referred to therein or the
transactions contemplated thereby or any action taken or omitted to be taken by
the Lender in connection with the foregoing; provided, the Company shall not be
liable for any portion of any such claims, obligations, etc., arising out of or
resulting from the gross negligence or willful misconduct of the Lender. The
indemnification obligations of the Company under this Paragraph 9(k) shall
survive termination of this Agreement and payment in full of the Obligations.
10. Definitions. For purposes of this Agreement, the terms set
-----------
forth below shall have the following meanings:
"A Paper" shall have the meaning set forth on Exhibit L attached
------- ---------
hereto.
"Additional Required Documents" shall mean for any Mortgage Loan those
-----------------------------
items described on Exhibit F attached hereto.
---------
"Adjusted Tangible Net Worth" shall mean at any date:
---------------------------
(a) Book Net Worth, minus
-----
(b) The sum of (1) all assets which would be classified as
intangible assets under GAAP, including, without limitation, purchased and
capitalized value of servicing rights,
27
<PAGE>
goodwill (whether representing the excess cost over book value of assets
acquired or otherwise), patents, trademarks, trade names, copyrights, franchises
and deferred charges (including, without limitation, unamortized debt discount
and expense, organization costs and research and product development costs) plus
(2) all receivables from directors, officers and shareholders of NovaStar
Financial and its consolidated Subsidiaries, plus
----
(c) The amount of reserves of NovaStar and its consolidated
Subsidiaries for credit losses (as referenced on the financial statements
referred to in Paragraph 6(a) above), minus
-----
(d) The amount of unrealized gains on debt securities
(as defined in FASB 115) of NovaStar Financial and its consolidated
Subsidiaries, plus
----
(e) The amount of unrealized losses on debt securities (as
defined in FASB 115) of NovaStar Financial and its consolidated Subsidiaries.
"Affiliate" shall mean, as to any Person, any other Person directly
---------
or indirectly controlling, controlled by or under direct or indirect common
control with, such Person. "Control" as used herein means the power to direct
the management and policies of such Person.
"Agreement" shall mean this Agreement, as the same may be amended,
---------
extended or replaced from time to time.
"Applicable Fed Funds-Based Rate" shall mean a rate of interest equal
-------------------------------
to the Fed Funds Rate plus one and one-quarter percent (1.25%) per annum.
"Applicable LIBOR-Based Rate" shall mean, with respect to any
---------------------------
Eurodollar Loan for the Interest Period applicable to such Eurodollar Loan, the
rate per annum (rounded upward, if necessary, to the next higher 1/32 of one
percent (.03125%)) calculated in accordance with the following formula:
LR + 1.125
-------
Applicable LIBOR-Based Rate = 1-LRP
where
LR = LIBOR Rate
LRP = LIBOR Reserve Percentage
"Approved Investor" shall mean FNMA, FHLMC or any other Person
-----------------
pre-approved in writing (which pre-approval may be limited in dollar amounts by
type and otherwise) by the Lender (including
28
<PAGE>
those shown on Schedule II) and which approval has not been revoked by the
-----------
Lender in its sole discretion (such revocation to be effective on the tenth
Business Day following notice thereof given to the Company in writing).
"Book Net Worth" shall mean the excess of total assets of NovaStar
--------------
Financial and its consolidated Subsidiaries over Total Liabilities of NovaStar
Financial and its consolidated Subsidiaries determined in accordance with GAAP
(or such non-GAAP principles as may be disclosed to and approved by Lender from
time to time).
"Borrowing Base" shall mean at any date all Eligible Mortgage Loans
--------------
delivered to and held by the Lender or otherwise identified as Collateral under
the Security Agreement as collateral security for the Obligations.
"Borrowing Base Schedule" shall mean a schedule prepared by the Lender
-----------------------
and certified to by the Company in the form of that attached hereto as Exhibit
-------
G.
"Bulk Acquisition" shall mean the acquisition by the Company of a
----------------
seasoned loan pool consisting of Mortgage Loans with an aggregate outstanding
principal balance equal to or greater than $2,000,000.
"Business Day" shall mean any day other than a Saturday, a Sunday or a
------------
day on which banks in Charlotte, North Carolina are authorized or obligated to
close their regular banking business.
"Capitalized Lease Obligations" of any Person shall mean the
-----------------------------
obligations of such Person to pay rent or other amounts under any lease of (or
other arrangement conveying the right to use) real or personal property, or a
combination thereof, which obligations are required to be classified and
accounted for as capital leases on a balance sheet of such Person under GAAP
and, for the purposes of this Agreement, the amount of such obligations at any
time shall be the capitalized amount thereof at such time determined in
accordance with GAAP.
"Code" shall mean the Internal Revenue Code of 1986, as amended.
----
"Collateral" shall have the meaning given such term in the Security
----------
Agreement.
"Collateral Value of the Borrowing Base" shall mean at any date the sum
--------------------------------------
of the Unit Collateral Values of all Eligible Mortgage Loans included in the
Borrowing Base at such date (including Eligible Mortgage Loans shipped into
pools supporting
29
<PAGE>
Warehouse Related MBSs pending sale of such Warehouse Related MBSs and delivery
of the sale proceeds thereof to the Settlement Account).
"Commonly Controlled Entity" of a Person shall mean a Person, whether
--------------------------
or not incorporated, which is under common control with such Person within the
meaning of Section 414(c) of the Internal Revenue Code.
"Company" shall have the meaning given such term in the introductory
-------
paragraph hereof.
"consolidated Subsidiary" shall mean, for the purpose of this
-----------------------
Agreement, either (i) a Subsidiary which is required by GAAP to be consolidated
------
for the purposes of financial statement preparation and reporting, or (ii) any
--
corporation, partnership, or joint venture more than fifty percent (50%) of the
economic interest in which shall, at the time as of which any determination is
made, be owned, either directly or through Subsidiaries.
"Contact Office" shall mean the office of the Lender at One First Union
--------------
Center, 301 South College Street, Charlotte, North Carolina 28288.
"Contractual Obligation" as to any Person shall mean any provision of
----------------------
any security issued by such Person or of any agreement, instrument or
undertaking to which such Person is a party or by which it or any of its
property is bound.
"Corporate Base Rate" shall mean a fluctuating rate per annum announced
-------------------
from time to time by the Lender to be its "Prime Rate" as such "Prime Rate" may
change from time to time, said changes to occur on the first date the "Prime
Rate" changes; it being understood that the "Prime Rate" is the rate announced
by the Lender from time to time as its "Prime Rate" and is not necessarily the
lowest interest rate charged by the Lender to its customers.
"Covenant Compliance Certificate" shall mean a certificate in the form
-------------------------------
of Exhibit H attached hereto.
---------
"Credit Documents" shall mean this Agreement, the Security Agreement,
----------------
the Guaranties, the Note and each other document, instrument and agreement
executed by the Company or either Guarantor in connection herewith, as any of
the same may be amended, extended or replaced from time to time.
"Credit Limit" shall mean $30,000,000.00.
------------
"Eligible Mortgage Loan" shall mean a Mortgage Loan with
----------------------
30
<PAGE>
respect to which each of the following statements shall be accurate and complete
(and the Company by confirming the inclusion of such Mortgage Loan in any
computation of the Collateral Value of the Borrowing Base shall be deemed to so
represent and warrant to the Lender at and as of the date of such computation):
(a) Said Mortgage Loan is a binding and valid obligation
of the Obligor thereon, in full force and effect and enforceable in accordance
with its terms.
(b) Said Mortgage Loan is genuine in all respects as
appearing on its face and as represented in the books and records of the Company
and all information set forth therein is true and correct.
(c) Said Mortgage Loan is free of any default of any
party thereto (including the Company), other than as expressly permitted
pursuant to subparagraph (d) below, counterclaims, offsets and defenses and from
any rescission, cancellation or avoidance, whether by operation of law or
otherwise.
(d) No payment under said Mortgage Loan is more than sixty
(60) days past due the payment due date set forth in the underlying promissory
note and deed of trust (or mortgage); provided, however, that a Mortgage Loan
-------- -------
which is more than sixty (60) days delinquent may be an Eligible Mortgage Loan
so long as (i) said Mortgage Loan is not more than ninety (90) days delinquent,
and (ii) said Mortgage Loan, when added to the Unit Collateral Values of all
other Mortgage Loans which are more than sixty (60) days delinquent, does not
exceed five percent (5%) of the Credit Limit.
(e) Said Mortgage Loan contains the entire agreement of
the parties thereto with respect to the subject matter thereof, has not been
modified or amended in any respect and is free of concessions or understandings
with the Obligor thereon of any kind not expressed in writing therein.
(f) Said Mortgage Loan is in all respects as required by
and in accordance with all applicable laws and regulations governing the same,
including, without limitation, the federal Consumer Credit Protection Act and
the regulations promulgated thereunder and all applicable usury laws and
restrictions, and all notices, disclosures and other statements or information
required by law or regulation to be given, and any other act required by law or
regulation to be performed, in connection with said Mortgage Loan have been
given and performed as required.
(g) All advance payments and other deposits on said
Mortgage Loan have been paid in cash, and no part of said sums has
31
<PAGE>
been loaned, directly or indirectly, by the Company to the Obligor and there
have been no prepayments on account of said Mortgage Loan.
(h) At all times said Mortgage Loan will be free and
clear of all Liens, except in favor of the Lender.
(i) The Property covered by said Mortgage Loan is insured
against loss or damage by fire and all other hazards normally included within
standard extended coverage in accordance with the provisions of said Mortgage
Loan with the Company named as a loss payee thereon.
(j) The Property covered by said Mortgage Loan is free
and clear of all Liens except the Lien securing the Mortgage Loan subject only
to (1) the Lien of current real property taxes and assessments not yet due and
payable; (2) covenants, conditions and restrictions, rights of way, easements
and other matters of the public record, as of the date of recording, as are
acceptable to mortgage lending institutions generally and specifically referred
to in a lender's title insurance policy delivered to the originator of the
Mortgage Loan and (i) referred to or otherwise considered in the appraisal made
for the originator of the Mortgage Loan or (ii) which do not materially
adversely affect the appraised value of the Property as set forth in such
appraisal; (3) other matters to which like properties are commonly subject which
do not materially interfere with the benefits of the security intended to be
provided by the Mortgage Loan or the use, enjoyment, value or marketability of
the related Property; (4) Liens subordinate in priority to the Lien securing the
Mortgage Loan, and (5) if the Lien securing such Mortgage Loan is a second
priority Lien, one Lien securing indebtedness which is prior to the Lien
securing the Mortgage Lien.
(k) If said Mortgage Loan has been withdrawn from the
possession of the Lender and:
(1) If said Mortgage Loan was withdrawn by the
Company for purposes of correcting clerical or other non-substantive
documentation problems pursuant to a trust receipt, as permitted under
Paragraph 6 of the Security Agreement, the Unit Collateral Value of
said Mortgage Loan when added to the Unit Collateral Value of other
Mortgage Loans included in the calculation of the Collateral Value of
the Borrowing Base the promissory notes for which have been similarly
withdrawn by the Company does not exceed one percent (1%) of the Credit
Limit, and the promissory note and other documents relating to said
Mortgage Loan are returned to the Lender within fifteen (15) Business
Days from the date of withdrawal;
32
<PAGE>
(2) If said Mortgage Loan was shipped by the
Lender directly to a permanent investor for purchase, the full
purchase price therefor has been received by the Lender (or said
Mortgage Loan has been returned to the Lender) within forty-five (45)
days from the date of shipment by the Lender; and
(3) If said Mortgage Loan was shipped by the
Lender directly to a custodian for purposes of formation of a pool
supporting a Mortgage-Backed Security, the Mortgage-Backed Security is
issued, sold and the purchase price therefor has been received by the
Lender (or said Mortgage Loan has been returned to the Lender) within
forty-five (45) days from the date of shipment by the Lender.
(l) (i) In the case of a Mortgage Loan which is considered to
be A Paper and which was not acquired as part of a Bulk Acquisition, the date of
the underlying promissory note is no earlier than three hundred and sixty-five
(365) days prior to the date said Mortgage Loan is first included in the
Borrowing Base; and (ii) in the case of a Mortgage Loan which is considered to
be Non-A Paper and which was not acquired as part of a Bulk Acquisition, the
date of the underlying promissory note is no earlier than one hundred and eighty
(180) days prior to the date said Mortgage Loan is first included in the
Borrowing Base (provided, that a Mortgage Loan acquired as part of a Bulk
--------
Acquisition may have an underlying promissory note of any date).
(m) If said Mortgage Loan is FHA insured or VA
guaranteed, such insurance or guaranty (or a binding commitment to issue such
insurance or guaranty) is in full force and effect.
(n) The improvements on the Property consist of a
completed one-to-four unit single family residence, including but not limited to
a condominium, planned unit development or townhouse but excluding in any event
a co-op.
(o) There has been delivered to the Lender the Required
Documents for said Mortgage Loan; provided, however, that the Required Documents
for said Mortgage Loan may be delivered to the Lender within five (5) Business
Days of the inclusion of said Mortgage Loan in the Borrowing Base so long as the
Unit Collateral Value of said Mortgage Loan for which the Required Documents are
delivered within five (5) Business Days after its inclusion in the Borrowing
Base, when added to the Unit Collateral Value of all other such Mortgage Loans
for which the Required Documents are delivered within five (5) Business Days
after its inclusion in the Borrowing Base, does not exceed thirty percent (30%)
of the Credit Limit during the first five (5) Business Days and the last five
33
<PAGE>
(5) Business Days of each month, and (ii) twenty percent (20%) of the Credit
Limit at all other times.
(p) Said Mortgage Loan has not been included in the Borrowing
Base for more than one hundred and eighty (180) days; provided, however that a
-------- -------
Mortgage Loan which is included in the Borrowing Base for more than one hundred
and eighty (180) days may be an Eligible Mortgage Loan so long as (i)(A) said
Mortgage Loan is of a type described in the proviso to subsection (d) of this
definition of "Eligible Mortgage Loan", and (B) said Mortgage Loan is not
included in the Borrowing Base for more than three hundred and sixty (360) days,
or (ii) (A) said Mortgage Loan is not included in the Borrowing Base for more
than three hundred and sixty (360) days, and (B) said Mortgage Loan, when added
to the Unit Collateral Values of all other Mortgage Loans which are included in
the Borrowing Base for more than one hundred and eighty (180) days subject to
this section (B) of this proviso of this subsection (p), does not exceed twenty
percent (20%) of the Credit Limit.
(q) Said Mortgage Loan has not previously been included
in the Borrowing Base, then shipped to an investor or certifying custodian and
returned, for whatever reason, to the Lender.
(r) The Company obtained such appraisal in connection
with the origination of said Mortgage Loan as would satisfy all appraisal
requirements for said Mortgage Loan if such had been originated by a federally
insured depositary institution.
"Equity Issuance" shall mean that certain initial issuance by NovaStar
---------------
Financial of convertible preferred stock which occurred on December 9, 1996.
"ERISA" shall mean the Employee Retirement Income Security Act of 1974,
-----
as the same may from time to time be supplemented or amended.
"ERISA Affiliate" shall mean, with respect to any Person, any trade or
---------------
business (whether or not incorporated) that is a member of the group of which
such Person is a member and which is treated as a single employer under Section
414 of the Internal Revenue Code of 1986, as amended, and the rules and
regulations thereunder in effect from time to time.
"Eurodollar Business Day" shall mean a Business Day upon which
-----------------------
commercial banks in London, England are open for domestic and international
business.
"Eurodollar Loans" shall mean Loans hereunder at such time as they are
----------------
bearing interest at the Applicable LIBOR-Based Rate.
34
<PAGE>
"Event of Default" shall have the meaning set forth in Paragraph 8
----------------
above.
"FHA" shall mean the Federal Housing Administration and any successor
---
agency.
"Fair Market Value" shall mean, with respect to any Mortgage Loan, the
-----------------
market value of such Mortgage Loan as determined by Lender in its sole
discretion from time to time but no less frequently than monthly.
"Fed Funds Loans" shall mean Loans hereunder at such time as they are
---------------
bearing interest at the Applicable Fed Funds-Based Rate.
"Fed Funds Rate" shall mean, for any day, a fluctuating interest rate
--------------
per annum equal to the weekly weighted average of the rates on overnight Federal
funds transactions with members of the Federal Reserve System arranged by
Federal funds brokers for each seven-day period ending on Wednesday of each week
which includes such day, as published in Statistical Release H.15 by the Federal
Reserve System, or, if such rate is not so published for any week, the average
of the quotations for such day on such transactions received by Lender from
three Federal funds brokers of recognized standing selected by Lender.
"Funding Account" shall mean, collectively, Accounts No.
--------------- --------------
and No. maintained in Lender's name alone with the Lender at
-------------------
the Contact Office.
"GAAP" shall mean generally accepted accounting principles in the
----
United States of America in effect from time to time.
"Governmental Authority" shall mean any nation or governments any state
----------------------
or other political subdivision thereof, or any entity exercising executive,
legislative, judicial, regulatory or administrative functions of or pertaining
to government.
"Guaranties" shall mean, collectively, the NovaStar Financial Guaranty
----------
and the NFI Holding Guaranty.
"Guarantors" shall mean, collectively, Novastar Financial and NFI
----------
Holding.
"Hedging Report" shall mean a report prepared by the Company in the
--------------
form of that attached hereto as Exhibit M.
---------
"Indebtedness" of any Person shall mean all items of indebtedness
------------
which, in accordance with GAAP and practices thereof, would be included in
determining liabilities as shown on the liability
35
<PAGE>
side of a statement of condition of such Person as of the date as of which
indebtedness is to be determined, including: without limitation, all obligations
for money borrowed and Capitalized Lease Obligations, all amounts for which such
Person may be obligated under gestation or other repurchase facilities, and
shall also include all indebtedness and liabilities of others assumed or
guaranteed by such Person or in respect of which such Person is secondarily or
contingently liable (other than by endorsement of instruments in the course of
collection) whether by reason of any agreement to acquire such indebtedness or
to supply or advance sums or otherwise.
"Interim Date" shall mean December 31, 1996.
------------
"Interest Period" shall mean with respect to any Loan which is a
---------------
Eurodollar Loan, the period commencing on the date advanced and ending one
month, two months or three months thereafter, as designated in the related Loan
Request; provided, however, that (a) any Interest Period which would otherwise
end on a day which is not a Eurodollar Business Day shall be extended to the
next succeeding Eurodollar Business Day unless by such extension it would fall
in another calendar month, in which case such Interest Period shall end on the
immediately preceding Eurodollar Business Day; (b) any Interest Period
applicable to a Eurodollar Loan which begins on a day for which there is no
numerically corresponding day in the calendar month during which such Interest
Period is to end shall, subject to the provisions of clause (a) hereof, end on
the last day of such calendar month; and (c) no such Interest Period shall
extend beyond the Maturity Date.
"Lender" shall have the meaning given such term in the introductory
------
paragraph hereof.
"LIBOR Rate" shall mean, with respect to any Eurodollar Loan for the
----------
Interest Period applicable to such Eurodollar Loan, the arithmetic average of
the rates at which deposits in immediately available U.S. dollars in an amount
equal to the aggregate amount of Eurodollar Loans proposed to be subject to such
rates having a maturity approximately equal to such Interest Period are offered
to or by reference banks in the London interbank market, as determined by the
Lender in accordance with its standard practices at approximately 11:00 a.m.
(London time) two Eurodollar Business Days prior to the first day of such
Interest Period.
"LIBOR Reserve Percentage" shall mean for any day, that percentage
------------------------
expressed as a decimal, which is in effect on such day, as specified by the
Board of Governors of the Federal Reserve System (or any successor) for
determining the maximum aggregate reserve requirement (including all basis,
supplemental, marginal and other reserves) which is imposed on eurocurrency
liabilities.
36
<PAGE>
"Lien" shall mean any security interest, mortgage, pledge, lien, claim
----
on property, charge or encumbrance (including any conditional sale or other
title retention agreement), any lease in the nature thereof, and the filing of
or agreement to give any financing statement under the Uniform Commercial Code
of any jurisdiction.
"Loan" shall have the meaning given such term in Paragraph 1(a) above.
----
"Loan Request" shall mean a request for a Loan conveyed to the Lender
------------
from a duly authorized officer of the Company, with such request to be confirmed
in writing upon the request of the Lender.
"Maturity Date" shall mean the earlier of: (a) _________, 1998
-------------
[364 DAYS FROM CLOSING] as such date may be extended from time to time in
writing by the Lender, in its sole discretion, and (b) the date the Lender
terminates its obligation to make further Loans pursuant to the provisions
hereof.
"Mortgage-Backed Security" shall mean (a) any security (including,
------------------------
without limitation, a participation certificate) that represents an interest in
a pool of mortgages, deeds of trusts or other instruments creating a Lien on
Property which is improved by a completed single family residence, including but
not limited to a condominium, planned unit development or townhouse.
"Mortgage Loan" shall mean a residential real estate secured loan,
-------------
including, without limitation: (a) a promissory note, any reformation thereof
and related deed of trust (or mortgage) and security agreement; (b) all
guaranties and insurance policies, including, without limitation, all mortgage
and title insurance policies and all fire and extended coverage insurance
policies and rights of the Company to return premiums or payments with respect
thereto; and (c) all right, title and interest of the Company in the Property
covered by said deed of trust (or mortgage).
"Multi-Employer Plan" shall mean, as to the Company or any of its ERISA
-------------------
Affiliates, a Plan of such Person which is a multiemployer plan as defined in
Section 4001(a)(3) of ERISA.
"NFI Holding" shall mean NFI Holding Company, Inc., a _______
-----------
corporation.
"NFI Holding Delivery Date" shall mean the date on which NFI Holding
-------------------------
shall have delivered to the Lender all of the items described in Paragraph 4(c)
above, which date shall be no later than thirty (30) days after the date of this
Agreement.
37
<PAGE>
"NFI Holding Guaranty" shall have the meaning given such term in
--------------------
Paragraph 3(b)(2) above, as such instrument may be amended, extended or replaced
from time to time.
"Non-A Paper" shall have the meaning set forth on Exhibit L attached
----------- ---------
hereto.
"Note" shall mean have the meaning given such term in Paragraph 2(c)
----
hereof.
"NovaStar Financial" shall mean NovaStar Financial, Inc., a Maryland
------------------
corporation.
"NovaStar Financial Guaranty" shall have the meaning given such term in
---------------------------
Paragraph 3(b)(1) above, as such instrument may be amended, extended or replaced
from time to time.
"Obligations" shall mean any and all debts, obligations and liabilities
-----------
of the Company to the Lender (whether now existing or hereafter arising,
voluntary or involuntary, whether or not jointly owed with others, direct or
indirect, absolute or contingent, liquidated or unliquidated, and whether or not
from time to time decreased or extinguished and later increased, created or
incurred), arising out of or related to the Credit Documents.
"Obligor" shall mean the Person or Persons obligated to pay the
-------
Indebtedness which is the subject of a Mortgage Loan.
"Participant" shall have the meaning given such term in Paragraph 9(h)
-----------
above.
"PBGC" shall mean the Pension Benefit Guaranty Corporation established
----
pursuant to Subtitle A of Title IV of ERISA and any successor thereto.
"Permitted Other Debt" shall mean that Indebtedness described as
--------------------
"Permitted Other Debt" on Exhibit I attached hereto.
---------
"Permitted Secured Debt" shall mean that Indebtedness which is the
----------------------
subject of a Lien and described as "Permitted Secured Debt" on Exhibit I
---------
attached hereto.
"Person" shall mean any corporation, natural person, firm, joint
------
venture, partnerships, trust, unincorporated organization or Governmental
Authority.
"Plan" shall mean, as the Company or any of its ERISA Affiliates, any
----
pension plan that is covered by Title IV of ERISA and in respect of which such
Person or a Commonly Controlled
38
<PAGE>
Entity of such Person is an "employer" as defined in Section 3(5) of ERISA.
"Potential Default" shall mean an event which but for the lapse of time
-----------------
or the giving of notice, or both, would constitute an Event of Default.
"Proceeds" shall mean whatever is receivable or received when
--------
Collateral or proceeds are sold, collected, exchanged or otherwise disposed of,
whether such disposition is voluntary or involuntary, and includes, without
limitation, all rights to payment, including return premiums, with respect to
any insurance relating thereto.
"Property" shall mean the real property, including the improvements
--------
thereon, and the personal property (tangible and intangible) which are
encumbered pursuant to a Mortgage Loan.
"Reportable Event" shall mean a reportable event as defined in Title IV
----------------
of ERISA, except actions of general applicability by the Secretary of Labor
under Section 110 of ERISA.
"Required Documents" shall mean for any Mortgage Loan those items
------------------
described on Exhibit J attached hereto.
---------
"Required Equity" shall mean, with respect to NovaStar Financial and
---------------
its consolidated Subsidiaries, the sum of the dollar amounts calculated after
multiplying the amount shown on NovaStar Financial's most recent monthly balance
sheet (as reconciled and consolidated by the schedule referenced to in Paragraph
6(a) above) for each asset class set forth in the table below (or if such asset
class is owned by NovaStar Financial or a consolidated Subsidiary but is not
carried on the balance sheet of NovaStar Financial (as reconciled and
consolidated by the schedules referred to in Paragraph 6(a) above), the fair
market value thereof as calculated by the Company subject, however, to the
approval of the Lender which will not be unreasonably withheld) by the
percentage amounts set forth opposite such asset class in the table below:
<TABLE>
<CAPTION>
Percentage
Asset Class Multiplier
- ----------- ----------
<S> <C>
Cash 0%
Property, Plant and Equipment 50%
Intangible Assets 100%
AAA-Rated Agency Issued Conventional ARM Mortgage-
Backed Securities 4.75%
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
Percentage
Asset Class Multiplier
- ----------- ----------
<S> <C>
AAA-Rated Agency Issued GNMA ARM Mortgage-Backed 5.25%
Securities
AAA-Rated Agency Issued Conventional 30 Year 6.00%
Current Coupon Mortgage-Backed Securities
AAA-Rated Agency Issued Conventional 30 Year 6.50%
Discount Mortgage-Backed Securities
AAA-Rated Agency Issued Conventional 30 Year 4.50%
Premium Mortgage-Backed Securities
AAA-Rated Agency Issued Conventional 15 Year 5.50%
Current Coupon Mortgage-Backed Securities
AAA-Rated Agency Issued Conventional Fixed Balloon 5.00%
Mortgage-Backed Securities
AAA-Rated Private Label Short Term Mortgage-Backed 6.20%
Securities
AAA-Rated Private Label Medium Term Mortgage-Backed 7.60%
Securities
AAA-Rated Private Label Long Term Mortgage-Backed 9.20%
Securities
AA-Rated Private Label Short Term Mortgage-Backed 6.40%
Securities
AA-Rated Private Label Medium Term Mortgage-Backed 8.00%
Securities
AA-Rated Private Label Long Term Mortgage-Backed 9.80%
Securities
A-Rated Mortgage-Backed Securities 25%
BBB-Rated Mortgage-Backed Securities 25%
BB-Rated Mortgage-Backed Securities 50%
B-Rated Mortgage-Backed Securities 50%
Non-Rated Mortgage-Backed Securities 50%
Agency Issued "Principal Only" Mortgage-Backed Securities 25%
Agency Issued "Interest Only" Mortgage-Backed Securities 25%
Excess Cash Flows 50%
Warehouse Mortgage Loans 4%
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
Percentage
Asset Class Multiplier
- ----------- ----------
<S> <C>
Servicing Agreements 45%
Hedging Agreements 100%
Other Receivables 35%
</TABLE>
"Requirements of Law" shall mean, as to any Person, the Articles or
-------------------
Certificate of Incorporation and Bylaws or other organizational or governing
documents of such Person, and any law, treaty, rule or regulation, or a final
and binding determination of an arbitrator or a determination of a court or
other Governmental Authority, in each case applicable to or binding upon such
Person or any of its property or to which such Person or any of its property is
subject.
"Security Agreement" shall have the meaning given such term in
------------------
Paragraph 3(a) above, as the same may be amended, extended or replaced from time
to time.
"Settlement Account" shall mean Account No. _____________ maintained
------------------
in the name of the Lender at the Contact Office.
"Shareholders Equity" shall mean the net worth of NovaStar Financial
-------------------
and its consolidated Subsidiaries as determined in accordance with GAAP (or with
such non-GAAP principles as may be disclosed to and approved by Lender from time
to time).
"Single Employer Plan" shall mean, as to the Company or any of its
--------------------
ERISA Affiliates, any Plan of such Person which is not a Multiemployer Plan.
"Subsidiary" shall mean any corporation, partnership or joint venture
----------
more than fifty percent (50%) of the stock or other ownership interest of which
having by the terms thereof ordinary voting power to elect the board of
directors, managers or trustees of such corporation, partnership or joint
venture (irrespective of whether or not at the time stock of any other class or
classes of such corporation, partnership or joint venture shall have or might
have voting power by reason of the happening of any contingency) shall, at the
time as of which any determination is being made, be owned, either directly or
through Subsidiaries.
"Take-Out Commitment" with respect to any Mortgage Loan shall mean a
-------------------
bona fide current, unused and unexpired whole loan commitment or forward sale
Mortgage Backed Security commitment issued in favor of and held by the Company
made by an Approved Investor, under which said Approved Investor agrees, prior
to the
41
<PAGE>
expiration thereof, upon the satisfaction of certain terms and conditions
therein, to purchase such Mortgage Loan or related Mortgage Backed Security at a
Take-Out Price, which commitment is not subject to any term or condition which
is not customary in commitments of like nature or which, in the reasonably
anticipated course of events, cannot be fully complied with prior to the
expiration thereof.
"Take-Out Price" with respect to any Mortgage Loan shall mean the
--------------
specified price to be paid for such Mortgage Loan under the applicable Take-Out
Commitment covering said Mortgage Loan.
"Total Liabilities" shall mean total liabilities of NovaStar Financial
-----------------
and its consolidated Subsidiaries determined in accordance with GAAP (or with
such non-GAAP principles as may be disclosed to and approved by Lender from time
to time).
"Unit Collateral Value" shall mean, with respect to each Eligible
---------------------
Mortgage Loan contained in the Borrowing Base:
(a) If said Mortgage Loan is of the type described in the proviso to
subsection (d) of the definition of "Eligible Mortgage Loan," eighty percent
(80%) of the lesser of (1) the unpaid principal balance thereof at the time the
Mortgage Loan is included in the Borrowing Base; and (2) the Fair Market Value
thereof.
(b) For all other Mortgage Loans, ninety-eight percent (98%) of the
lesser of (1) the unpaid principal balance thereof at the time the Mortgage Loan
is included in the Borrowing Base; and (2) the Fair Market Value thereof.
"VA" shall mean the Veterans Administration and any successor agency.
--
"Warehouse Related MBS" shall have the meaning given such term in the
---------------------
Security Agreement.
42
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed and sealed as of the day and year first above written.
NOVASTAR MORTGAGE, INC., a
Virginia corporation
By
-------------------------------------
Name
-----------------------------------
Title
----------------------------------
FIRST UNION NATIONAL BANK OF NORTH
CAROLINA, a national banking
association
By
-------------------------------------
Name
-----------------------------------
Title
----------------------------------
352784.5
43
<PAGE>
LIST OF SCHEDULES AND EXHIBITS
------------------------------
<TABLE>
<S> <C>
Schedule I Schedule of Addresses
Schedule II Approved Investors
Exhibit A Form of Promissory Note
Exhibit B Form of Security Agreement
Exhibit C-1 Form of NovaStar Financial Guaranty
Exhibit C-2 Form of NFI Holding Guaranty
Exhibit D Form of Legal Opinion of Counsel for the Company
and NovaStar Financial
Exhibit E Litigation Schedule
Exhibit F Schedule of Additional Required Documents
Exhibit G Form of Borrowing Base Schedule
Exhibit H Form of Covenant Compliance Certificate
Exhibit I Schedule of Permitted Other Debt (Including
Permitted Secured Debt)
Exhibit J Schedule of Required Documents
Exhibit K Form of Wet Funding Mortgage Loan Transmittal Form
Exhibit L Definitions of "A Paper" and "Non-A Paper"
Exhibit M Form of Hedging Report
</TABLE>
<PAGE>
EXHIBIT 10.8
EMPLOYMENT AGREEMENT
--------------------
THIS EMPLOYMENT AGREEMENT ("Agreement"), dated as of the 30th day of
September, 1996, is entered into by and between Scott F. Hartman ("Executive")
and NovaStar Financial, Inc., a Maryland corporation ("Company"), and is
effective as of and conditioned upon the completion of the Company's private
placement of up to 3,333,333 Units, each Unit consisting of one share of Class A
Convertible Preferred Stock and One Stock Purchase Warrant.
The Company desires to establish its right to the continued services of the
Executive, in the capacity described below, on the terms and conditions and
subject to the rights of termination hereinafter set forth, and the Executive is
willing to accept such employment on such terms and conditions.
In consideration of the mutual agreements hereinafter set forth, the
Executive and the Company have agreed and do hereby agree as follows:
1. EMPLOYMENT BY THE COMPANY. The Company does hereby employ, engage and
-------------------------
hire the Executive as Chairman of the Board and Chief Executive Officer of the
Company, and the Executive does hereby accept and agree to such hiring,
engagement and employment. The Executive's duties shall be such executive and
managerial duties as the Board of Directors of the Company or its subsidiaries
shall from time to time prescribe and as provided in the bylaws of the Company.
The terms of this Agreement shall be subject to the personnel policies of the
Company as determined by the Board of Directors from time to time, except to the
extent that any such policy would have a material adverse effect on the rights
of the Executive under the terms of this Agreement. The Executive shall devote
such time, energy and skill to the performance of his duties for the Company and
for the benefit of the Company as may be necessary or required for the effective
conduct and operation of the Company's business. Furthermore, the Executive
shall exercise due diligence and care in the performance of his duties to the
Company under this Agreement.
2. TERM OF AGREEMENT. The term ("Term") of this Agreement shall commence
-----------------
on the date of the closing of the private placement referred to above (the
"Effective Date") and shall continue through December 31, 2001; provided,
however, that on each December 31 commencing December 31, 1997 the Term of the
Agreement shall automatically be extended for one additional year unless, not
later than three months prior to any such December 31, either party shall have
given written notice to the other that it does not wish to extend the Term of
the Agreement.
3. COMPENSATION.
(a) BASE SALARY. The Company shall pay the Executive, and the
-----------
Executive agrees to accept from the Company, in payment for his services to the
Company beginning on the Effective Date, a base salary at the rate per annum to
be determined by the Compensation Committee of the Board of Directors and
provided to the Executive in writing ("Base Salary"), which is subject to change
upon thirty (30) days' notice and shall initially be set
1
<PAGE>
at One Hundred Twenty Thousand Dollars ($120,000.00) until the closing of a firm
commitment underwritten initial public offering of the Common Stock resulting in
aggregate gross proceeds to the Company of at least $20 million and at a price
per share of at least $15.00 or such lesser amount of proceeds and/or lower
price per share as may be approved by two-thirds of the Preferred Stock (a
"Qualified IPO"), when said Base Salary shall be increased to One Hundred
Eighty-Five Thousand Dollars ($185,000.00). Base Salary is payable in equal
biweekly installments or at such other time or times as the Executive and
Company agree.
(b) PERFORMANCE BONUS - BOARD OF DIRECTORS DISCRETION. The Executive
-------------------------------------------------
shall be eligible to receive an incentive performance bonus in accordance with
the Bonus Incentive Compensation Plan established by the Company, which, during
the initial Term of this Agreement, shall substantially reflect the provisions
set forth in Exhibit A. Except as provided in Section 7, any such bonus awarded
to the Executive shall be payable in the amount, in the manner and at the time
determined by the Compensation Committee of the Company's Board of Directors in
its sole and absolute discretion.
(c) ANNUAL REVIEW. The Compensation Committee of the Company's Board
-------------
of Directors shall, at least annually, review the Executive's entire
compensation package to determine whether it continues to meet the Company's
compensation objectives. Such annual review will include a determination of (i)
whether to increase the Base Salary set forth in Section 3(a) and (ii) the
incentive performance bonus to be awarded in accordance with Section 3(b).
(d) UNITS ACQUIRED WITH FORGIVABLE DEBT. Executive will acquire Units
-----------------------------------
in the Company's private placement with a promissory note to the Company which
is forgivable during the initial term of this Agreement in accordance with the
terms of such note which shall substantially reflect the provisions set forth in
Exhibit B.
4. FRINGE BENEFITS. The Executive shall be entitled to participate in
---------------
any benefit programs adopted from time to time by the Company for the benefit of
its executive employees at an appropriate level for the duties of the officer,
and the Executive shall be entitled to receive such other fringe benefits as may
be granted from time to time by the Company's Board of Directors or its
Compensation Committee.
(a) BENEFIT PLANS. The Executive shall be entitled to participate in
-------------
any benefit plans relating to stock options, stock purchases, pension, thrift,
profit sharing, life insurance, medical coverage, education or other retirement
or employee benefits available to other executive employees of the Company at an
appropriate level for the duties of the office, subject to any restrictions
(including waiting periods) specified in such plans. The Company shall make
commercially reasonable efforts to obtain medical and disability insurance, and
such other forms of insurance as the Board of Directors shall determine, for its
employees.
(b) VACATION. The Executive shall be entitled to four (4) weeks of
--------
paid vacation per calendar year, with such vacation to be scheduled and taken in
accordance with the Company's standard vacation policies.
2
<PAGE>
5. BUSINESS EXPENSES. The Company shall reimburse the Executive for any
-----------------
and all necessary, customary and usual expenses, properly receipted in
accordance with Company policies, incurred by the Executive on behalf of the
Company.
6. TERMINATION OF EXECUTIVE'S EMPLOYMENT.
(a) DEATH. If the Executive dies while employed by the Company, his
-----
employment shall immediately terminate. The Company's obligation to pay the
Executive's Base Salary shall cease as of the date of Executive's death.
Thereafter, Executive's beneficiaries or his estate shall receive benefits in
accordance with the Company's retirement, insurance and other applicable
programs and plans then in effect.
(b) DISABILITY.
----------
(i) If, as a result of the Executive's incapacity due to physical or
mental illness ("Disability"), Executive shall have been absent from the full-
time performance of his duties with the Company for six (6) consecutive months,
and, within thirty (30) days after written notice is provided to him by the
Company, he shall not have returned to the full-time performance of his duties,
the Executive's employment under this Agreement may be terminated by the Company
for Disability. During any period prior to such termination during which the
Executive is absent from the full-time performance of his duties with the
Company due to Disability, the Company shall continue to pay the Executive his
Base Salary at the rate in effect at the commencement of such period of
Disability. Subsequent to such termination, the Executive's benefits shall be
determined under the Company's retirement, insurance and other compensation
programs then in effect in accordance with the terms of such programs.
(ii) If, however, as a result of the Executive's partial incapacity
due to physical or mental illness in which Executive shall not have been absent
from his duties for six consecutive months and shall have returned to work on a
full-time basis but is not able to perform at the same level as when hired
and/or is not able to perform the same functions for which originally hired
("Partial Disability"), the Company shall make reasonable efforts to accommodate
the Executive's Partial Disability by modifying his job description
appropriately, together with a commensurate adjustment in compensation;
provided, however, the Company shall be required to so continue the employment
of the Executive in the event of a Partial Disability of the Executive only if
the Company determines, in its sole discretion, that it can create a position
for which the Executive would be suited and that would be economically
advantageous to the Company.
(c) TERMINATION BY THE COMPANY FOR CAUSE. The Company may terminate
------------------------------------
the Executive's employment under this Agreement for "Cause," at any time prior
to expiration of the Term of the Agreement, only in the event of (i) acts or
omissions constituting gross negligence, recklessness or willful misconduct on
the part of the Executive in respect of his fiduciary obligations or otherwise
relating to the business of the Company, (ii) the Executive's material breach of
this Agreement, or (iii) the Executive's conviction or entry of a plea of nolo
contendre for fraud, misappropriation or embezzlement. In such a case, the
Executive's employment under this Agreement may be terminated immediately
without any advance written
3
<PAGE>
notice, and the Company's obligation to pay the Executive's Base Salary, any
bonus and fringe benefits will cease as of the termination date.
(d) TERMINATION BY THE EXECUTIVE FOR GOOD REASON. The Executive shall
--------------------------------------------
have the right to terminate this Agreement for Good Reason. For purposes of
this Agreement, "Good Reason" shall mean the occurrence, without the Executive's
express written consent, of any one or more of the following events:
(i) A reduction in title and/or compensation of the Executive or
the assignment of duties to the Executive not consistent with those of an
executive of the Company, except in connection with the Company's termination of
the Executive's employment for Cause pursuant to Section 6(c) or as otherwise
expressly contemplated herein;
(ii) The Company's material breach of any of the provisions of
this Agreement, including, but not limited to, a reduction by the Company in the
Executive's Base Salary in effect as of the Effective Date; or a change in the
conditions of the Executive's employment (e.g., including, without limitation, a
----
failure by the Company to provide the Executive with incentive compensation and
benefits plans that provide benefits and the opportunity to obtain incentive
compensation, in each case comparable to those available under benefits programs
in effect as of the Effective Date and at an appropriate level for the duties of
the officer, etc.); or
(iii) The relocation of the Company's principal executive offices
to a location more than fifty (50) miles from its location as of the Effective
Date or the Company's requiring the Executive to be based anywhere other than
the Company's principal executive offices, except for requiring travel on the
Company's business to an extent substantially consistent with the Executive's
duties hereunder.
The Executive agrees to provide the Company with thirty (30) days' prior written
notice of any termination for Good Reason.
(e) TERMINATION BY THE EXECUTIVE WITHOUT GOOD REASON. The Executive
------------------------------------------------
may at any time during the Term of this Agreement terminate his employment
hereunder for any reason or no reason by giving the Company notice in writing
not less than one hundred twenty (120) days in advance of such termination.
Except as may be provided in Section 9, the Executive shall have no further
obligations to the Company after the effective date of termination, as set forth
in the notice. Notwithstanding the foregoing, in the event any "person" (as
defined in Section 8 below) begins a tender or exchange offer, circulates a
proxy to shareholders or takes other steps to effect a Change of Control, the
Executive agrees that he will not voluntarily leave the employ of the Company,
and will render services to the Company commensurate with his position, until
such "person" has abandoned or terminated efforts to effect a Change of Control
or until a Change of Control has occurred. In the event of a termination by the
Executive under this paragraph, the Company will pay only the portion of Base
Salary or previously awarded bonus unpaid as of the termination date. Fringe
benefits which have accrued and/or vested on the termination date will continue
in effect according to their terms, but no additional accrual or vesting will
take place.
4
<PAGE>
7.A. COMPENSATION UPON TERMINATION BY THE COMPANY AFTER CHANGE IN CONTROL
--------------------------------------------------------------------
OTHER THAN FOR CAUSE, OR BY THE EXECUTIVE FOR GOOD REASON. If the Executive's
- ---------------------------------------------------------
employment shall be terminated after a Change in Control as defined in Section 8
(i) by the Company other than for Cause, or (ii) by the Executive for Good
Reason, the Executive shall be entitled to the following benefits:
(a) PAYMENT OF UNPAID BASE SALARY. The Company shall immediately pay
-----------------------------
the Executive any portion of the Executive's Base Salary or previously awarded
Bonus not paid prior to the termination date.
(b) SEVERANCE PAYMENT. The Company shall pay the Executive an amount
-----------------
(the "Severance Amount") equal to three times the Executive's combined current
year Base Salary and actual bonus compensation for the preceding fiscal year;
provided, however, the severance amount shall not be less then Three Hundred
Sixty Thousand Dollars ($360,000.00) nor more (once the minimum is reached) than
one percent (1.0%) of the book value of the Company (i.e., the amount reported
----
on the Company's balance sheet prepared in accordance with generally accepted
accounting principles as stockholders' equity). The Severance Amount shall be
payable fifty percent (50%) within five (5) days after the termination date and
the remaining fifty percent (50%) shall be payable in twelve (12) equal
consecutive monthly installments beginning on the first day of the month
following the termination date.
(c) IMMEDIATE VESTING OF STOCK OPTIONS. The Company shall take all
----------------------------------
appropriate action to ensure that all stock options on the Company's stock owned
by the Executive as of the Effective Date and which have not been exercised
prior to the termination date become immediately exercisable by the Executive,
whether or not the right to exercise such stock options would otherwise then be
vested in the Executive. The provisions of this Section 7(c) shall constitute
an amendment to any existing stock option agreements of the Company as of the
Effective Date. All other stock options owned by the Executive as of the
termination date shall be exercisable in accordance with the Company's stock
option plan and the applicable stock option agreements.
(d) CONTINUATION OF FRINGE BENEFITS. From and after termination of
-------------------------------
the Executive's employment, the Company shall continue to provide the Executive
with all life insurance and medical coverage fringe benefits set forth in
Section 4 as if the Executive's employment under the Agreement had not been
terminated until the earlier to occur of (i) such time as the Executive finds
full-time employment or (ii) the expiration of three years. Notwithstanding the
immediately preceding sentence, if, as the result of termination of the
Executive's employment, the Executive and/or his otherwise eligible dependents
or beneficiaries shall become ineligible for benefits under any one of the
Company's benefit plans or the cost of providing such benefits exceeds two
hundred percent (200%) of the cost of providing such benefits to other members
of senior management, the Company, at the Company's option, shall (i) continue
to provide the Executive and his eligible dependents or beneficiaries with
benefits at a level at least equivalent to the level of benefits for which the
Executive and his dependents and beneficiaries were eligible under such plans
immediately prior to the termination date or (ii) for any fringe benefit not so
provided, the Company shall pay the Executive 200% of the cost of providing such
fringe benefit to other members of senior management.
5
<PAGE>
7.B. COMPENSATION UPON TERMINATION BY THE COMPANY OTHER THAN FOR CAUSE, OR
---------------------------------------------------------------------
BY THE EXECUTIVE FOR GOOD REASON. If the Executive's employment shall be
- --------------------------------
terminated either (i) by the Company other than for Cause, or (ii) by the
Executive for Good Reason, the Executive shall be entitled to the following
benefits:
(a) PAYMENT OF UNPAID BASE SALARY. The Company shall immediately pay
-----------------------------
the Executive any portion of the Executive's Base Salary or previously awarded
Bonus not paid prior to the termination date.
(b) SEVERANCE PAYMENT. The Company shall pay the Executive an amount
-----------------
(the "Severance Amount") equal to the Executive's combined current year Base
Salary and actual bonus compensation for the preceding fiscal year; provided,
however, the severance amount shall not be less than One Hundred Twenty Thousand
Dollars ($120,000.00) nor more (once the minimum is reached) than one percent
(1.0%) of the book value of the Company (i.e., the amount reported on the
----
Company's balance sheet prepared in accordance with generally accepted
accounting principles as stockholders' equity). The Severance Amount shall be
payable immediately upon the termination date.
(c) STOCK OPTIONS. Stock options owned by the Executive as of the
-------------
termination date shall be exercisable in accordance with the Company's stock
option plan and the applicable stock option agreements.
(d) CONTINUATION OF FRINGE BENEFITS. From and after termination of
-------------------------------
the Executive's employment, the Company shall continue to provide the Executive
with all life insurance and medical coverage fringe benefits set forth in
Section 4 as if the Executive's employment under the Agreement had not been
terminated until the earlier to occur of (i) such time as the Executive finds
full-time employment or (ii) the expiration of one (1) year. Notwithstanding the
immediately preceding sentence, if, as the result of termination of the
Executive's employment, the Executive and/or his otherwise eligible dependents
or beneficiaries shall become ineligible for benefits under any one of the
Company's benefit plans or the cost of providing such benefits exceeds two
hundred percent (200%) of the cost of providing such benefits to other members
of senior management, the Company, at the Company's option, shall (i) continue
to provide the Executive and his eligible dependents or beneficiaries with
benefits at a level at least equivalent to the level of benefits for which the
Executive and his dependents and beneficiaries were eligible under such plans
immediately prior to the termination date or (ii) for any fringe benefit not so
provided, the Company shall pay the Executive 200% of the cost of providing such
fringe benefit to other members of senior management.
7.C. NO MITIGATION REQUIRED; NO OTHER ENTITLEMENT TO BENEFITS UNDER
--------------------------------------------------------------
AGREEMENT. The Executive shall not be required in any way to mitigate the
- ---------
amount of any payment provided for in this Section 7, including, but not limited
to, by seeking other employment, nor shall the amount of any payment provided
for in this Section 7 be reduced by any compensation earned by the Executive as
a result of employment with another employer after the termination date of
employment, or otherwise. Except as set forth in this Section 7, following a
termination governed by this Section 7, the Executive shall not be entitled to
any other compensation or benefits set forth in this Agreement, except as may be
separately
6
<PAGE>
negotiated by the parties and approved by the Board of Directors of the Company
in writing in conjunction with the termination of Executive's employment under
this Section 7.
8. CHANGE IN CONTROL. A "Change in Control" shall be deemed to have
-----------------
occurred if the conditions set forth in any one of the following paragraphs
shall have been satisfied.
(a) Any "person," as such term is used in Sections 13(d) and 14(d) of
the Securities Exchange Act of 1934 (the "Exchange Act") (other than the
Company; any trustee or other fiduciary holding securities under an Executive
benefit plan of the Company; or any company owned, directly or indirectly, by
the stockholders of the Company in substantially the same proportions as their
ownership of the stock of the Company), is or becomes the "beneficial owner" (as
defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of the
securities of the Company (not including in the securities beneficially owned by
such person, any securities acquired directly from the Company or from a
transferor in a transaction expressly approved or consented to by the Board of
Directors) representing more than 25% of the combined voting power of the
Company's then outstanding securities; or
(b) During any period of two consecutive years (not including any
period prior to the execution of this Agreement), individuals who at the
beginning of such period constitute the Board of Directors and any new director
(other than a director designated by a person who has entered into an agreement
with the Company to effect a transaction described in clause (a), (c) or (d) of
this section), (i) whose election by the Board of Directors or nomination for
election by the Company's stockholders was approved by a vote of at least two-
thirds (2/3) of the directors then still in office who either were directors at
the beginning of the period or whose election or nomination for election was
previously so approved or (ii) whose election is to replace a person who ceases
to be a director due to death, disability or age, cease for any reason to
constitute a majority thereof; or
(c) The shareholders of the Company approve a merger or consolidation
of the Company with other corporation, other than (i) a merger or consolidation
which would result in the voting securities of the Company outstanding
immediately prior thereto continuing to represent (either by remaining
outstanding or by being converted into voting securities of the surviving
entity), in combination with the ownership of any trustee or other fiduciary
holding securities under an Executive benefit plan of the Company, at least 75%
of the combined voting power of the voting securities of the Company or such
surviving entity outstanding immediately after such merger or consolidation, or
(ii) a merger or consolidation effected to implement a recapitalization of the
Company (or similar transaction) in which no person acquires more than 50% of
the combined voting power of the Company's then outstanding securities; or
(d) The shareholders of the Company approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by the
Company of all or substantially all the Company's assets.
7
<PAGE>
9. NONCOMPETITION PROVISIONS.
-------------------------
(a) NONCOMPETITION. The Executive agrees that during the Term of this
--------------
Agreement prior to any termination of his employment hereunder and for a period
of twelve (12) months following either (i) the occurrence of any event entitling
the Executive to Benefit Payments according to the provisions of Section 7.A,
provided the Company makes all such payments when due, or (ii) a resignation by
the Executive other than for Good Reason, he will not directly or indirectly,
without the prior written consent of the Company, manage, operate, join,
control, participate in, or be connected as a stockholder (other than as a
holder of shares publicly traded on a stock exchange or the NASDAQ National
Market System), partner, or other equity holder with, or as an officer, director
or employee of, any other subprime real estate lender or any real estate
investment trust whose business strategy is competitive with that of the
Company, as determined by a majority of the Company's independent directors
("Competing Business"). It is further expressly agreed that the Company will or
would suffer irreparable injury if the Executive were to compete with the
Company or any subsidiary or affiliate of the Company in violation of this
Agreement and that the Company would by reason of such competition be entitled
to injunctive relief in a court of appropriate jurisdiction, and the Executive
further consents and stipulates to the entry of such injunctive relief in such a
court prohibiting the Executive from competing with the Company or any
subsidiary or affiliate of the Company, in the areas of business set forth
above, in violation of this Agreement.
(b) RIGHT TO COMPANY MATERIALS. The Executive agrees that all styles,
--------------------------
designs, lists, materials, books, files, reports, correspondence, records and
other documents ("Company Materials") used, prepared or made available to the
Executive, shall be and shall remain the property of the Company. Upon the
termination of employment or the expiration of this Agreement, all Company
Materials shall be returned immediately to the Company, and the Executive shall
not make or retain any copies thereof.
(c) SOLICITING EXECUTIVES. The Executive promises and agrees that
---------------------
during the noncompetition period defined in paragraph (a) he will not directly
or indirectly solicit any of the Company executives or employees to work for any
Competing Business.
10. NOTICES. All notices and other communications under this Agreement
-------
shall be in writing and shall be given by fax or first class mail, certified or
registered with return receipt requested, and shall be deemed to have been duly
given three (3) days after mailing or twenty-four (24) hours after transmission
of a fax to the respective persons named below:
If to Company: NovaStar Financial, Inc.
Attn: Board of Directors
1900 West 47th Place, Suite 205
Westwood, KS 66205
Phone: (913) 362-1090
Fax: (913) 362-1011
8
<PAGE>
If to Executive: Scott F. Hartman
5315 W. 103rd Place
Overland Park, KS 66207
Phone: (913) 522-1336
Either party may change such party's address for notices by notice duly given
pursuant hereto.
11. ATTORNEYS' FEES. In the event judicial determination is necessary of
---------------
any dispute arising as to the parties' rights and obligations hereunder, each
party shall have the right, in addition to any other relief granted by the
court, to attorneys' fees based on a determination by the court of the extent to
which each party has prevailed as to the material issues raised in determination
of the dispute.
12. TERMINATION OF PRIOR AGREEMENTS. This Agreement terminates and
-------------------------------
supersedes any and all prior agreements and understandings between the parties
with respect to employment or with respect to the compensation of the Executive
by the Company.
13. ASSIGNMENT; SUCCESSORS. This Agreement is personal in its nature and
----------------------
neither of the parties hereto shall, without the consent of the other, assign or
transfer this Agreement or any rights or obligations hereunder; provided that,
in the event of the merger, consolidation, transfer, or sale of all or
substantially all of the assets of the Company with or to any other individual
or entity, this Agreement shall, subject to the provisions hereof, be binding
upon and inure to the benefit of such successor and such successor shall
discharge and perform all the promises, covenants, duties, and obligations of
the Company hereunder.
14. GOVERNING LAW. This Agreement and the legal relations thus created
-------------
between the parties hereto shall be governed by and construed under and in
accordance with the laws of the State of New York.
15. ENTIRE AGREEMENT; HEADINGS. This Agreement embodies the entire
--------------------------
agreement of the parties respecting the matters within its scope and may be
modified only in writing. Section headings in this Agreement are included
herein for convenience of reference only and shall not constitute a part of this
Agreement for any other purpose.
16. WAIVER; MODIFICATION. Failure to insist upon strict compliance with
--------------------
any of the terms, covenants or conditions hereof shall not be deemed a waiver of
such term, covenant or condition, nor shall any waiver or relinquishment of, or
failure to insist upon strict compliance with, any right or power hereunder at
any one or more times be deemed a waiver or relinquishment of such right or
power at any other time or times. This Agreement shall not be modified in any
respect except by a writing executed by each party hereto.
17. SEVERABILITY. In the event that a court of competent jurisdiction
------------
determines that any portion of this Agreement is in violation of any statute or
public policy, only the portions of this Agreement that violate such statute or
public policy shall be stricken. All portions of this Agreement that do not
violate any statute or public policy shall continue in full force and effect.
Further, any court order striking any portion of this Agreement shall modify the
9
<PAGE>
stricken terms as narrowly as possible to give as much effect as possible to the
intentions of the parties under this Agreement.
18. INDEMNIFICATION. The Company shall indemnify and hold Executive
---------------
harmless to the maximum extent permitted by Maryland Law and the Bylaws of the
Company.
19. COUNTERPARTS. This Agreement may be executed in counterparts.
------------
IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by
its duly authorized officer, and the Executive has hereunto signed this
Agreement, as of the date first above written.
NOVASTAR FINANCIAL, INC.,
a Maryland corporation
By
--------------------------------
--------------------------------
SCOTT F. HARTMAN
10
<PAGE>
EXHIBIT A
BONUS INCENTIVE COMPENSATION PLAN
The Bonus Incentive Compensation Plan shall be effective commencing with
the first full fiscal year after the closing of a firm commitment underwritten
initial public offering of the Common Stock resulting in aggregate gross
proceeds to the Company of at least $20 million and at a price of at least $15
or such lessor amount of proceeds and/or lower price per share as may be
approved by two-thirds of the Preferred Stock (a "Qualified IPO").
The annual bonus pursuant to the Bonus Incentive Compensation Plan will be
paid one-half in cash and one-half in shares of Common Stock of the Company,
annually, following receipt of the audit for the related fiscal year. This
program will award bonuses annually to those officers out of a total pool
determined by shareholder return on equity ("ROE") as follows:
<TABLE>
<CAPTION>
ROE/(1)/ in Excess of Base Rate/(2)/ By: Bonus as % of Average Net
---------------------------------------- -------------------------
Worth/(3)/ Outstanding
-------------------------
<S> <C>
zero or less 0%
greater than 0% but less than 6% 10% * (actual ROE - Base Rate)
Greater than 6% (10% * 6%) + 15% * (Actual
ROE - (Base Rate + 6%))
</TABLE>
Of the amount so determined, one-half will be deemed contributed to the
total pool in cash and the other half deemed contributed to the total pool in
the form of shares of Common Stock, with the number of shares to be calculated
based on the average price per share during the preceding year. The total pool
may not exceed $1 million for fiscal years ending December 31, 1998 and December
31, 1999.
_______________________
/(1) /"ROE" is determined for the fiscal year by averaging the monthly ratios
calculated each month by dividing the Company's monthly Net Income
(adjusted to an annual rate) by its Average Net Worth for such month. For
such calculations, the "Net Income" of the Company means the net income or
net loss of the Company determined according to GAAP, but after deducting
any dividends paid or payable on preferred stock issued after the Qualified
IPO and before giving effect to the bonus incentive compensation or any
valuation allowance adjustment to stockholders' equity. The definition
"ROE" is used only for purposes of calculating the bonus incentive
compensation payable pursuant to the Bonus Incentive Compensation Plan, and
is not related to the actual distributions received by stockholders. The
bonus payments will be made before any income distributions are made to
stockholders.
/(2) /"Base Rate" is the average for each month of the Ten-Year U.S. Treasury
Rate, plus 4%.
/(3) /"Average Net Worth" for any month means the arithmetic average of the sum
of (i) the net proceeds from all offerings of equity securities by the
Company since formation (but excluding any offerings of preferred stock
subsequent to the Qualified IPO), after deducting any underwriting
discounts and commissions and other expenses and costs relating to the
offerings, plus (ii) the Company's retained earnings (without taking into
account any losses incurred in prior fiscal years, after deducting any
amounts reflecting taxable income to be distributed as dividends and
without giving effect to any valuation allowance adjustment to
stockholders' equity) computed by taking the daily average of such values
during such period.
<PAGE>
EXHIBIT B
UNITS ACQUIRED WITH FORGIVABLE DEBT
In the Company's private placement, Messrs. Hartman and Anderson will each
acquire Units (in addition to the Units being offered to investors) at the price
of $15 per Unit, in the following amounts:
<TABLE>
<CAPTION>
Aggregate No. of Units Sold at Offering
-----------------------------------------
Minimum (1,000,000) Maximum (3,333,333)
------------------- -------------------
<S> <C> <C>
Mr. Hartman 50,000 108,333
Mr. Anderson 50,000 108,333
</TABLE>
The number of Units to be acquired by each founder using forgivable debt
shall be equal to 50,000 Units plus 2.5% of the number of Units sold in excess
of the minimum number of Units in the Offering.
Payment for such Units will be made by delivering to the Company promissory
notes, bearing interest at 8% per annum compounded annually and secured by the
Units being acquired. Interest will accrue during the first year and will be
added to principal due under the note. Thereafter, interest will be payable
quarterly and upon forgiveness or at maturity of the notes, which is at the end
of the fifth fiscal period (as defined below).
The principal amount of the notes will be divided into three equal
tranches. Payment of principal on each tranche will be forgiven by the Company,
if the following incentive performance tests are achieved:
.During the first five fiscal periods after issuance of the notes:
- One tranche will be forgiven for each fiscal period as to which the
Company generates a total return to investors purchasing Units in the
Company's private placement equal to or greater than 15%.
- At the end of each of the five fiscal periods, all remaining tranches
will be forgiven if the Company has generated a total cumulative return
to investors purchasing Units in the Company's private placement (from
date of initial issuance of the notes) equal to or greater than 100%.
.For purposes of calculating the returns to such investors:
- The term "fiscal period" will refer to each of five periods, the first
commencing with the last closing of the Company's private placement and
ending on December
<PAGE>
31, 1997, and each succeeding fiscal period extending for twelve months
and ending on each December 31.
.The term "return" for each fiscal period will mean the sum of (on a per
Unit basis) (a) all cash dividends paid during (or declared with respect
to) such fiscal period per share of Preferred Stock (or per share of
Common Stock following conversion of the Preferred Stock upon completion
of a Qualified IPO), (b) any increase or decrease in the price per share
of Preferred Stock (or resulting Common Stock) during such fiscal period,
measured by using the price per Unit to investors in the Company's private
placement as the starting price ($15.00), and using the average public
trading price during the last 90 days of each succeeding fiscal period for
such succeeding periods, and (c) any increase or decrease in the price per
Warrant during such fiscal period, determined in the same manner as in
(b). For purposes of the fiscal period 15% return test, the total return
for a given period will be equal to the sum of (a), (b) and (c) during the
period, and for purposes of the cumulative 100% return test, the amounts
in (a), (b) and (c) will all be measured from the beginning of the first
fiscal period. The amount of that "return" will then be measured as a
percentage of the investors' investment in the Units (on a per Unit basis)
without regard to timing of receipt of dividends or timing of increases in
per share or per Warrant prices.
.If one of the incentive tests is met, the amount of loan forgiveness for
each tranche will be the principal amount of such tranche of the note. In
addition, a loan will be made by the Company to Messrs. Hartman and
Anderson in the amount of (i) personal tax liability resulting from the
forgiveness of debt, and (ii) interest accrued during the first year on
the forgiven tranches. The note will bear interest at a floating market
rate, will be secured by that proportionate number of Units that had
secured the forgiven tranche of the note and will mature upon the earlier
of the sale of those Units (or the underlying securities) or the
termination of the officer's employment with the Company.
.At the election of the maker of each promissory note, the Company shall
pay the premium on a term life insurance policy, the proceeds of which
might assist such maker's estate or legal representative to cover the sums
due under the promissory note, and the premium amount so advanced shall be
added to the principal amount due the Company pursuant to the promissory
note.
<PAGE>
EXHIBIT 10.9
EMPLOYMENT AGREEMENT
--------------------
THIS EMPLOYMENT AGREEMENT ("Agreement"), dated as of the 30th day of
September, 1996, is entered into by and between W. Lance Anderson ("Executive")
and NovaStar Financial, Inc., a Maryland corporation ("Company"), and is
effective as of and conditioned upon the completion of the Company's private
placement of up to 3,333,333 Units, each Unit consisting of one share of Class A
Convertible Preferred Stock and One Stock Purchase Warrant.
The Company desires to establish its right to the continued services of the
Executive, in the capacity described below, on the terms and conditions and
subject to the rights of termination hereinafter set forth, and the Executive is
willing to accept such employment on such terms and conditions.
In consideration of the mutual agreements hereinafter set forth, the
Executive and the Company have agreed and do hereby agree as follows:
1. EMPLOYMENT BY THE COMPANY. The Company does hereby employ, engage and
-------------------------
hire the Executive as President of the Company, and the Executive does hereby
accept and agree to such hiring, engagement and employment. The Executive's
duties shall be such executive and managerial duties as the Board of Directors
of the Company or its subsidiaries shall from time to time prescribe and as
provided in the bylaws of the Company. The terms of this Agreement shall be
subject to the personnel policies of the Company as determined by the Board of
Directors from time to time, except to the extent that any such policy would
have a material adverse effect on the rights of the Executive under the terms of
this Agreement. The Executive shall devote such time, energy and skill to the
performance of his duties for the Company and for the benefit of the Company as
may be necessary or required for the effective conduct and operation of the
Company's business. Furthermore, the Executive shall exercise due diligence and
care in the performance of his duties to the Company under this Agreement.
2. TERM OF AGREEMENT. The term ("Term") of this Agreement shall commence
-----------------
on the date of the closing of the private placement referred to above (the
"Effective Date") and shall continue through December 31, 2001; provided,
however, that on each December 31 commencing December 31, 1997 the Term of the
Agreement shall automatically be extended for one additional year unless, not
later than three months prior to any such December 31, either party shall have
given written notice to the other that it does not wish to extend the Term of
the Agreement.
3. COMPENSATION.
(a) BASE SALARY. The Company shall pay the Executive, and the
-----------
Executive agrees to accept from the Company, in payment for his services to the
Company beginning on the Effective Date, a base salary at the rate per annum to
be determined by the Compensation Committee of the Board of Directors and
provided to the Executive in writing
1
<PAGE>
("Base Salary"), which is subject to change upon thirty (30) days' notice and
shall initially be set at One Hundred Twenty Thousand Dollars ($120,000.00)
until closing of a firm commitment underwritten initial public offering of the
Common Stock resulting in aggregate gross proceeds to the Company of at least
$20 million and at a price per share of at least $15.00 or such lessor amount of
proceeds and/or lower price per share as may be approved by two-thirds of the
Preferred Stock (a "Qualified IPO"), when said Base Salary shall be increased to
One Hundred Eighty-Five Thousand Dollars ($185,000.00). Base Salary is payable
in equal biweekly installments or at such other time or times as the Executive
and Company agree.
(b) PERFORMANCE BONUS - BOARD OF DIRECTORS DISCRETION. The Executive
-------------------------------------------------
shall be eligible to receive an incentive performance bonus in accordance with
the Bonus Incentive Compensation Plan established by the Company, which, during
the initial Term of this Agreement, shall substantially reflect the provisions
set forth in Exhibit A. Except as provided in Section 7, any such bonus awarded
to the Executive shall be payable in the amount, in the manner and at the time
determined by the Compensation Committee of the Company's Board of Directors in
its sole and absolute discretion.
(c) ANNUAL REVIEW. The Compensation Committee of the Company's Board
-------------
of Directors shall, at least annually, review the Executive's entire
compensation package to determine whether it continues to meet the Company's
compensation objectives. Such annual review will include a determination of (i)
whether to increase the Base Salary set forth in Section 3(a) and (ii) the
incentive performance bonus to be awarded in accordance with Section 3(b).
(d) UNITS ACQUIRED WITH FORGIVABLE DEBT. Executive will acquire Units
-----------------------------------
in the Company's private placement with a promissory note to the Company which
is forgivable during the initial term of this Agreement in accordance with the
terms of such note which shall substantially reflect the provisions set forth in
Exhibit B.
4. FRINGE BENEFITS. The Executive shall be entitled to participate in
---------------
any benefit programs adopted from time to time by the Company for the benefit of
its executive employees at an appropriate level for the duties of the officer,
and the Executive shall be entitled to receive such other fringe benefits as may
be granted from time to time by the Company's Board of Directors or its
Compensation Committee.
(a) BENEFIT PLANS. The Executive shall be entitled to participate in
-------------
any benefit plans relating to stock options, stock purchases, pension, thrift,
profit sharing, life insurance, medical coverage, education or other retirement
or employee benefits available to other executive employees of the Company at an
appropriate level for the duties of the office, subject to any restrictions
(including waiting periods) specified in such plans. The Company shall make
commercially reasonable efforts to obtain medical and disability insurance, and
such other forms of insurance as the Board of Directors shall determine, for its
employees.
(b) VACATION. The Executive shall be entitled to four (4) weeks of
--------
paid vacation per calendar year, with such vacation to be scheduled and taken in
accordance with the Company's standard vacation policies.
2
<PAGE>
5. BUSINESS EXPENSES. The Company shall reimburse the Executive for any
-----------------
and all necessary, customary and usual expenses, properly receipted in
accordance with Company policies, incurred by the Executive on behalf of the
Company.
6. TERMINATION OF EXECUTIVE'S EMPLOYMENT.
(a) DEATH. If the Executive dies while employed by the Company, his
-----
employment shall immediately terminate. The Company's obligation to pay the
Executive's Base Salary shall cease as of the date of Executive's death.
Thereafter, Executive's beneficiaries or his estate shall receive benefits in
accordance with the Company's retirement, insurance and other applicable
programs and plans then in effect.
(b) DISABILITY.
----------
(i) If, as a result of the Executive's incapacity due to physical or
mental illness ("Disability"), Executive shall have been absent from the full-
time performance of his duties with the Company for six (6) consecutive months,
and, within thirty (30) days after written notice is provided to him by the
Company, he shall not have returned to the full-time performance of his duties,
the Executive's employment under this Agreement may be terminated by the Company
for Disability. During any period prior to such termination during which the
Executive is absent from the full-time performance of his duties with the
Company due to Disability, the Company shall continue to pay the Executive his
Base Salary at the rate in effect at the commencement of such period of
Disability. Subsequent to such termination, the Executive's benefits shall be
determined under the Company's retirement, insurance and other compensation
programs then in effect in accordance with the terms of such programs.
(ii) If, however, as a result of the Executive's partial incapacity
due to physical or mental illness in which Executive shall not have been absent
from his duties for six consecutive months and shall have returned to work on a
full-time basis but is not able to perform at the same level as when hired
and/or is not able to perform the same functions for which originally hired
("Partial Disability"), the Company shall make reasonable efforts to accommodate
the Executive's Partial Disability by modifying his job description
appropriately, together with a commensurate adjustment in compensation;
provided, however, the Company shall be required to so continue the employment
of the Executive in the event of a Partial Disability of the Executive only if
the Company determines, in its sole discretion, that it can create a position
for which the Executive would be suited and that would be economically
advantageous to the Company.
(c) TERMINATION BY THE COMPANY FOR CAUSE. The Company may terminate
------------------------------------
the Executive's employment under this Agreement for "Cause," at any time prior
to expiration of the Term of the Agreement, only in the event of (i) acts or
omissions constituting gross negligence, recklessness or willful misconduct on
the part of the Executive in respect of his fiduciary obligations or otherwise
relating to the business of the Company, (ii) the Executive's material breach of
this Agreement, or (iii) the Executive's conviction or entry of a plea of nolo
contendre for fraud, misappropriation or embezzlement. In such a case, the
Executive's employment under this Agreement may be terminated immediately
without any advance written
3
<PAGE>
notice, and the Company's obligation to pay the Executive's Base Salary, any
bonus and fringe benefits will cease as of the termination date.
(d) TERMINATION BY THE EXECUTIVE FOR GOOD REASON. The Executive shall
--------------------------------------------
have the right to terminate this Agreement for Good Reason. For purposes of
this Agreement, "Good Reason" shall mean the occurrence, without the Executive's
express written consent, of any one or more of the following events:
(i) A reduction in title and/or compensation of the Executive or the
assignment of duties to the Executive not consistent with those of an executive
of the Company, except in connection with the Company's termination of the
Executive's employment for Cause pursuant to Section 6(c) or as otherwise
expressly contemplated herein;
(ii) The Company's material breach of any of the provisions of this
Agreement, including, but not limited to, a reduction by the Company in the
Executive's Base Salary in effect as of the Effective Date; or a change in the
conditions of the Executive's employment (e.g., including, without limitation, a
----
failure by the Company to provide the Executive with incentive compensation and
benefits plans that provide benefits and the opportunity to obtain incentive
compensation, in each case comparable to those available under benefits programs
in effect as of the Effective Date and at an appropriate level for the duties of
the officer, etc.); or
(iii) The relocation of the Company's principal executive offices to
a location more than fifty (50) miles from its location as of the Effective Date
or the Company's requiring the Executive to be based anywhere other than the
Company's principal executive offices, except for requiring travel on the
Company's business to an extent substantially consistent with the Executive's
duties hereunder.
The Executive agrees to provide the Company with thirty (30) days' prior written
notice of any termination for Good Reason.
(e) TERMINATION BY THE EXECUTIVE WITHOUT GOOD REASON. The Executive
------------------------------------------------
may at any time during the Term of this Agreement terminate his employment
hereunder for any reason or no reason by giving the Company notice in writing
not less than one hundred twenty (120) days in advance of such termination.
Except as may be provided in Section 9, the Executive shall have no further
obligations to the Company after the effective date of termination, as set forth
in the notice. Notwithstanding the foregoing, in the event any "person" (as
defined in Section 8 below) begins a tender or exchange offer, circulates a
proxy to shareholders or takes other steps to effect a Change of Control, the
Executive agrees that he will not voluntarily leave the employ of the Company,
and will render services to the Company commensurate with his position, until
such "person" has abandoned or terminated efforts to effect a Change of Control
or until a Change of Control has occurred. In the event of a termination by the
Executive under this paragraph, the Company will pay only the portion of Base
Salary or previously awarded bonus unpaid as of the termination date. Fringe
benefits which have accrued and/or vested on the termination date will continue
in effect according to their terms, but no additional accrual or vesting will
take place.
4
<PAGE>
7.A. COMPENSATION UPON TERMINATION BY THE COMPANY AFTER CHANGE IN CONTROL
--------------------------------------------------------------------
OTHER THAN FOR CAUSE, OR BY THE EXECUTIVE FOR GOOD REASON. If the Executive's
- ---------------------------------------------------------
employment shall be terminated after a Change in Control as defined in Section 8
(i) by the Company other than for Cause, or (ii) by the Executive for Good
Reason, the Executive shall be entitled to the following benefits:
(a) PAYMENT OF UNPAID BASE SALARY. The Company shall immediately pay
-----------------------------
the Executive any portion of the Executive's Base Salary or previously awarded
Bonus not paid prior to the termination date.
(b) SEVERANCE PAYMENT. The Company shall pay the Executive an amount
-----------------
(the "Severance Amount") equal to three times the Executive's combined current
year Base Salary and actual bonus compensation for the preceding fiscal year;
provided, however, the severance amount shall not be less then Three Hundred
Sixty Thousand Dollars ($360,000.00) nor more (once the minimum is reached) than
one percent (1.0%) of the book value of the Company (i.e., the amount reported
----
on the Company's balance sheet prepared in accordance with generally accepted
accounting principles as stockholders' equity). The Severance Amount shall be
payable fifty percent (50%) within five (5) days after the termination date and
the remaining fifty percent (50%) shall be payable in twelve (12) equal
consecutive monthly installments beginning on the first day of the month
following the termination date.
(c) IMMEDIATE VESTING OF STOCK OPTIONS. The Company shall take all
----------------------------------
appropriate action to ensure that all stock options on the Company's stock owned
by the Executive as of the Effective Date and which have not been exercised
prior to the termination date become immediately exercisable by the Executive,
whether or not the right to exercise such stock options would otherwise then be
vested in the Executive. The provisions of this Section 7(c) shall constitute
an amendment to any existing stock option agreements of the Company as of the
Effective Date. All other stock options owned by the Executive as of the
termination date shall be exercisable in accordance with the Company's stock
option plan and the applicable stock option agreements.
(d) CONTINUATION OF FRINGE BENEFITS. From and after termination of
-------------------------------
the Executive's employment, the Company shall continue to provide the Executive
with all life insurance and medical coverage fringe benefits set forth in
Section 4 as if the Executive's employment under the Agreement had not been
terminated until the earlier to occur of (i) such time as the Executive finds
full-time employment or (ii) the expiration of three years. Notwithstanding the
immediately preceding sentence, if, as the result of termination of the
Executive's employment, the Executive and/or his otherwise eligible dependents
or beneficiaries shall become ineligible for benefits under any one of the
Company's benefit plans or the cost of providing such benefits exceeds two
hundred percent (200%) of the cost of providing such benefits to other members
of senior management, the Company, at the Company's option, shall (i) continue
to provide the Executive and his eligible dependents or beneficiaries with
benefits at a level at least equivalent to the level of benefits for which the
Executive and his dependents and beneficiaries were eligible under such plans
immediately prior to the termination date or (ii) for any fringe benefit not so
provided, the Company shall pay the Executive 200% of the cost of providing such
fringe benefit to other members of senior management.
5
<PAGE>
7.B. COMPENSATION UPON TERMINATION BY THE COMPANY OTHER THAN FOR CAUSE, OR
---------------------------------------------------------------------
BY THE EXECUTIVE FOR GOOD REASON. If the Executive's employment shall be
- --------------------------------
terminated either (i) by the Company other than for Cause, or (ii) by the
Executive for Good Reason, the Executive shall be entitled to the following
benefits:
(a) PAYMENT OF UNPAID BASE SALARY. The Company shall immediately pay
-----------------------------
the Executive any portion of the Executive's Base Salary or previously awarded
Bonus not paid prior to the termination date.
(b) SEVERANCE PAYMENT. The Company shall pay the Executive an amount
-----------------
(the "Severance Amount") equal to the Executive's combined current year Base
Salary and actual bonus compensation for the preceding fiscal year; provided,
however, the severance amount shall not be less than One Hundred Twenty Thousand
Dollars ($120,000.00) nor more (once the minimum is reached) than one percent
(1.0%) of the book value of the Company (i.e., the amount reported on the
----
Company's balance sheet prepared in accordance with generally accepted
accounting principles as stockholders' equity). The Severance Amount shall be
payable immediately upon the termination date.
(c) STOCK OPTIONS. Stock options owned by the Executive as of the
-------------
termination date shall be exercisable in accordance with the Company's stock
option plan and the applicable stock option agreements.
(d) CONTINUATION OF FRINGE BENEFITS. From and after termination of
-------------------------------
the Executive's employment, the Company shall continue to provide the Executive
with all life insurance and medical coverage fringe benefits set forth in
Section 4 as if the Executive's employment under the Agreement had not been
terminated until the earlier to occur of (i) such time as the Executive finds
full-time employment or (ii) the expiration of one (1) year. Notwithstanding the
immediately preceding sentence, if, as the result of termination of the
Executive's employment, the Executive and/or his otherwise eligible dependents
or beneficiaries shall become ineligible for benefits under any one of the
Company's benefit plans or the cost of providing such benefits exceeds two
hundred percent (200%) of the cost of providing such benefits to other members
of senior management, the Company, at the Company's option, shall (i) continue
to provide the Executive and his eligible dependents or beneficiaries with
benefits at a level at least equivalent to the level of benefits for which the
Executive and his dependents and beneficiaries were eligible under such plans
immediately prior to the termination date or (ii) for any fringe benefit not so
provided, the Company shall pay the Executive 200% of the cost of providing such
fringe benefit to other members of senior management.
7.C. NO MITIGATION REQUIRED; NO OTHER ENTITLEMENT TO BENEFITS UNDER
--------------------------------------------------------------
AGREEMENT. The Executive shall not be required in any way to mitigate the
- ---------
amount of any payment provided for in this Section 7, including, but not limited
to, by seeking other employment, nor shall the amount of any payment provided
for in this Section 7 be reduced by any compensation earned by the Executive as
a result of employment with another employer after the termination date of
employment, or otherwise. Except as set forth in this Section 7, following a
termination governed by this Section 7, the Executive shall not be entitled to
any
6
<PAGE>
other compensation or benefits set forth in this Agreement, except as may be
separately negotiated by the parties and approved by the Board of Directors of
the Company in writing in conjunction with the termination of Executive's
employment under this Section 7.
8. CHANGE IN CONTROL. A "Change in Control" shall be deemed to have
-----------------
occurred if the conditions set forth in any one of the following paragraphs
shall have been satisfied.
(a) Any "person," as such term is used in Sections 13(d) and 14(d) of
the Securities Exchange Act of 1934 (the "Exchange Act") (other than the
Company; any trustee or other fiduciary holding securities under an Executive
benefit plan of the Company; or any company owned, directly or indirectly, by
the stockholders of the Company in substantially the same proportions as their
ownership of the stock of the Company), is or becomes the "beneficial owner" (as
defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of the
securities of the Company (not including in the securities beneficially owned by
such person, any securities acquired directly from the Company or from a
transferor in a transaction expressly approved or consented to by the Board of
Directors) representing more than 25% of the combined voting power of the
Company's then outstanding securities; or
(b) During any period of two consecutive years (not including any
period prior to the execution of this Agreement), individuals who at the
beginning of such period constitute the Board of Directors and any new director
(other than a director designated by a person who has entered into an agreement
with the Company to effect a transaction described in clause (a), (c) or (d) of
this section), (i) whose election by the Board of Directors or nomination for
election by the Company's stockholders was approved by a vote of at least two-
thirds (2/3) of the directors then still in office who either were directors at
the beginning of the period or whose election or nomination for election was
previously so approved or (ii) whose election is to replace a person who ceases
to be a director due to death, disability or age, cease for any reason to
constitute a majority thereof; or
(c) The shareholders of the Company approve a merger or consolidation
of the Company with other corporation, other than (i) a merger or consolidation
which would result in the voting securities of the Company outstanding
immediately prior thereto continuing to represent (either by remaining
outstanding or by being converted into voting securities of the surviving
entity), in combination with the ownership of any trustee or other fiduciary
holding securities under an Executive benefit plan of the Company, at least 75%
of the combined voting power of the voting securities of the Company or such
surviving entity outstanding immediately after such merger or consolidation, or
(ii) a merger or consolidation effected to implement a recapitalization of the
Company (or similar transaction) in which no person acquires more than 50% of
the combined voting power of the Company's then outstanding securities; or
(d) The shareholders of the Company approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by the
Company of all or substantially all the Company's assets.
9. NONCOMPETITION PROVISIONS.
-------------------------
7
<PAGE>
(a) NONCOMPETITION. The Executive agrees that during the Term of this
--------------
Agreement prior to any termination of his employment hereunder and for a period
of twelve (12) months following either (i) the occurrence of any event entitling
the Executive to Benefit Payments according to the provisions of Section 7.A,
provided the Company makes all such payments when due, or (ii) a resignation by
the Executive other than for Good Reason, he will not directly or indirectly,
without the prior written consent of the Company, manage, operate, join,
control, participate in, or be connected as a stockholder (other than as a
holder of shares publicly traded on a stock exchange or the NASDAQ National
Market System), partner, or other equity holder with, or as an officer, director
or employee of, any other subprime real estate lender or any real estate
investment trust whose business strategy is competitive with that of the
Company, as determined by a majority of the Company's independent directors
("Competing Business"). It is further expressly agreed that the Company will or
would suffer irreparable injury if the Executive were to compete with the
Company or any subsidiary or affiliate of the Company in violation of this
Agreement and that the Company would by reason of such competition be entitled
to injunctive relief in a court of appropriate jurisdiction, and the Executive
further consents and stipulates to the entry of such injunctive relief in such a
court prohibiting the Executive from competing with the Company or any
subsidiary or affiliate of the Company, in the areas of business set forth
above, in violation of this Agreement.
(b) RIGHT TO COMPANY MATERIALS. The Executive agrees that all styles,
--------------------------
designs, lists, materials, books, files, reports, correspondence, records and
other documents ("Company Materials") used, prepared or made available to the
Executive, shall be and shall remain the property of the Company. Upon the
termination of employment or the expiration of this Agreement, all Company
Materials shall be returned immediately to the Company, and the Executive shall
not make or retain any copies thereof.
(c) SOLICITING EXECUTIVES. The Executive promises and agrees that
---------------------
during the noncompetition period defined in paragraph (a) he will not directly
or indirectly solicit any of the Company executives or employees to work for any
Competing Business.
10. NOTICES. All notices and other communications under this Agreement
-------
shall be in writing and shall be given by fax or first class mail, certified or
registered with return receipt requested, and shall be deemed to have been duly
given three (3) days after mailing or twenty-four (24) hours after transmission
of a fax to the respective persons named below:
If to Company: NovaStar Financial, Inc.
Attn: Board of Directors
1900 West 47th Place, Suite 205
Westwood, KS 66205
Phone: (913) 362-1090
Fax: (913) 362-1011
8
<PAGE>
If to Executive: W. Lance Anderson
8699 Butterfield Avenue
Richmond, VA 23229
Phone: (804) 741-6715
Either party may change such party's address for notices by notice duly given
pursuant hereto.
11. ATTORNEYS' FEES. In the event judicial determination is necessary of
---------------
any dispute arising as to the parties' rights and obligations hereunder, each
party shall have the right, in addition to any other relief granted by the
court, to attorneys' fees based on a determination by the court of the extent to
which each party has prevailed as to the material issues raised in determination
of the dispute.
12. TERMINATION OF PRIOR AGREEMENTS. This Agreement terminates and
-------------------------------
supersedes any and all prior agreements and understandings between the parties
with respect to employment or with respect to the compensation of the Executive
by the Company.
13. ASSIGNMENT; SUCCESSORS. This Agreement is personal in its nature and
----------------------
neither of the parties hereto shall, without the consent of the other, assign or
transfer this Agreement or any rights or obligations hereunder; provided that,
in the event of the merger, consolidation, transfer, or sale of all or
substantially all of the assets of the Company with or to any other individual
or entity, this Agreement shall, subject to the provisions hereof, be binding
upon and inure to the benefit of such successor and such successor shall
discharge and perform all the promises, covenants, duties, and obligations of
the Company hereunder.
14. GOVERNING LAW. This Agreement and the legal relations thus created
-------------
between the parties hereto shall be governed by and construed under and in
accordance with the laws of the State of New York.
15. ENTIRE AGREEMENT; HEADINGS. This Agreement embodies the entire
--------------------------
agreement of the parties respecting the matters within its scope and may be
modified only in writing. Section headings in this Agreement are included
herein for convenience of reference only and shall not constitute a part of this
Agreement for any other purpose.
16. WAIVER; MODIFICATION. Failure to insist upon strict compliance with
--------------------
any of the terms, covenants or conditions hereof shall not be deemed a waiver of
such term, covenant or condition, nor shall any waiver or relinquishment of, or
failure to insist upon strict compliance with, any right or power hereunder at
any one or more times be deemed a waiver or relinquishment of such right or
power at any other time or times. This Agreement shall not be modified in any
respect except by a writing executed by each party hereto.
17. SEVERABILITY. In the event that a court of competent jurisdiction
------------
determines that any portion of this Agreement is in violation of any statute or
public policy, only the portions of this Agreement that violate such statute or
public policy shall be stricken. All portions of this Agreement that do not
violate any statute or public policy shall continue in full force and effect.
Further, any court order striking any portion of this Agreement shall modify the
9
<PAGE>
stricken terms as narrowly as possible to give as much effect as possible to the
intentions of the parties under this Agreement.
18. INDEMNIFICATION. The Company shall indemnify and hold Executive
---------------
harmless to the maximum extent permitted by Maryland Law and the Bylaws of the
Company.
19. COUNTERPARTS. This Agreement may be executed in counterparts.
------------
IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by
its duly authorized officer, and the Executive has hereunto signed this
Agreement, as of the date first above written.
NOVASTAR FINANCIAL, INC.,
a Maryland corporation
By____________________________________
_______________________________________
W. LANCE ANDERSON
10
<PAGE>
EXHIBIT A
BONUS INCENTIVE COMPENSATION PLAN
The Bonus Incentive Compensation Plan shall be effective commencing with
the first full fiscal year after the closing of a firm commitment underwritten
initial public offering of the Common Stock resulting in aggregate gross
proceeds to the Company of at least $20 million and at a price of at least $15
or such lessor amount of proceeds and/or lower price per share as may be
approved by two-thirds of the Preferred Stock (a "Qualified IPO").
The annual bonus pursuant to the Bonus Incentive Compensation Plan will be
paid one-half in cash and one-half in shares of Common Stock of the Company,
annually, following receipt of the audit for the related fiscal year. This
program will award bonuses annually to those officers out of a total pool
determined by shareholder return on equity ("ROE") as follows:
<TABLE>
<CAPTION>
ROE/(1)/ in Excess of Base Rate/(2)/ By: Bonus as % of Average Net Worth/(3)/ Outstanding
---------------------------------------- ------------------------------------------------
<S> <C>
zero or less 0%
greater than 0% but less than 6% 10% * (actual ROE - Base Rate)
Greater than 6% (10% * 6%) + 15% * (Actual
ROE - (Base Rate + 6%))
</TABLE>
Of the amount so determined, one-half will be deemed contributed to the
total pool in cash and the other half deemed contributed to the total pool in
the form of shares of Common Stock, with the number of shares to be calculated
based on the average price per share during the preceding year. The total pool
may not exceed $1 million for fiscal years ending December 31, 1998 and December
31, 1999.
- -------------------
/(1)/ "ROE" is determined for the fiscal year by averaging the monthly ratios
calculated each month by dividing the Company's monthly Net Income
(adjusted to an annual rate) by its Average Net Worth for such month. For
such calculations, the "Net Income" of the Company means the net income or
net loss of the Company determined according to GAAP, but after deducting
any dividends paid or payable on preferred stock issued after the
Qualified IPO and before giving effect to the bonus incentive compensation
or any valuation allowance adjustment to stockholders' equity. The
definition "ROE" is used only for purposes of calculating the bonus
incentive compensation payable pursuant to the Bonus Incentive
Compensation Plan, and is not related to the actual distributions received
by stockholders. The bonus payments will be made before any income
distributions are made to stockholders.
/(2)/ "Base Rate" is the average for each month of the Ten-Year U.S. Treasury
Rate, plus 4%.
/(3)/ "Average Net Worth" for any month means the arithmetic average of the sum
of (i) the net proceeds from all offerings of equity securities by the
Company since formation (but excluding any offerings of preferred stock
subsequent to the Qualified IPO), after deducting any underwriting
discounts and commissions and other expenses and costs relating to the
offerings, plus (ii) the Company's retained earnings (without taking into
account any losses incurred in prior fiscal years, after deducting any
amounts reflecting taxable income to be distributed as dividends and
without giving effect to any valuation allowance adjustment to
stockholders' equity) computed by taking the daily average of such values
during such period.
<PAGE>
EXHIBIT B
UNITS ACQUIRED WITH FORGIVABLE DEBT
In the Company's private placement, Messrs. Hartman and Anderson will each
acquire Units (in addition to the Units being offered to investors) at the price
of $15 per Unit, in the following amounts:
<TABLE>
<CAPTION>
Aggregate No. of Units Sold at Offering
-----------------------------------------
Minimum (1,000,000) Maximum (3,333,333)
------------------- -------------------
<S> <C> <C>
Mr. Hartman 50,000 108,333
Mr. Anderson 50,000 108,333
</TABLE>
The number of Units to be acquired by each founder using forgivable debt
shall be equal to 50,000 Units plus 2.5% of the number of Units sold in excess
of the minimum number of Units in the Offering.
Payment for such Units will be made by delivering to the Company promissory
notes, bearing interest at 8% per annum compounded annually and secured by the
Units being acquired. Interest will accrue during the first year and will be
added to principal due under the note. Thereafter, interest will be payable
quarterly and upon forgiveness or at maturity of the notes, which is at the end
of the fifth fiscal period (as defined below).
The principal amount of the notes will be divided into three equal
tranches. Payment of principal on each tranche will be forgiven by the Company,
if the following incentive performance tests are achieved:
. During the first five fiscal periods after issuance of the notes:
. One tranche will be forgiven for each fiscal period as to which
the Company generates a total return to investors purchasing Units
in the Company's private placement equal to or greater than 15%.
. At the end of each of the five fiscal periods, all remaining
tranches will be forgiven if the Company has generated a total
cumulative return to investors purchasing Units in the Company's
private placement (from date of initial issuance of the notes)
equal to or greater than 100%.
. For purposes of calculating the returns to such investors:
. The term "fiscal period" will refer to each of five periods, the
first commencing with the last closing of the Company's private
placement and ending on December
<PAGE>
31, 1997, and each succeeding fiscal period extending for twelve
months and ending on each December 31.
. The term "return" for each fiscal period will mean the sum of (on a
per Unit basis) (a) all cash dividends paid during (or declared with
respect to) such fiscal period per share of Preferred Stock (or per
share of Common Stock following conversion of the Preferred Stock upon
completion of a Qualified IPO), (b) any increase or decrease in the
price per share of Preferred Stock (or resulting Common Stock) during
such fiscal period, measured by using the price per Unit to investors
in the Company's private placement as the starting price ($15.00), and
using the average public trading price during the last 90 days of each
succeeding fiscal period for such succeeding periods, and (c) any
increase or decrease in the price per Warrant during such fiscal
period, determined in the same manner as in (b). For purposes of the
fiscal period 15% return test, the total return for a given period
will be equal to the sum of (a), (b) and (c) during the period, and
for purposes of the cumulative 100% return test, the amounts in (a),
(b) and (c) will all be measured from the beginning of the first
fiscal period. The amount of that "return" will then be measured as a
percentage of the investors' investment in the Units (on a per Unit
basis) without regard to timing of receipt of dividends or timing of
increases in per share or per Warrant prices.
. If one of the incentive tests is met, the amount of loan forgiveness
for each tranche will be the principal amount of such tranche of the
note. In addition, a loan will be made by the Company to Messrs.
Hartman and Anderson in the amount of (i) personal tax liability
resulting from the forgiveness of debt, and (ii) interest accrued
during the first year on the forgiven tranches. The note will bear
interest at a floating market rate, will be secured by that
proportionate number of Units that had secured the forgiven tranche of
the note and will mature upon the earlier of the sale of those Units
(or the underlying securities) or the termination of the officer's
employment with the Company.
. At the election of the maker of each promissory note, the Company
shall pay the premium on a term life insurance policy, the proceeds of
which might assist such maker's estate or legal representative to
cover the sums due under the promissory note, and the premium amount
so advanced shall be added to the principal amount due the Company
pursuant to the promissory note.
<PAGE>
EXHIBIT 10.10
PROMISSORY NOTE
$1,624,995.00 December 9, 1996
FOR VALUE RECEIVED, the undersigned, Scott F. Hartman, promises to pay
to the order of NovaStar Financial, Inc., a Maryland corporation (the
"Company"), the principal amount of One Million Six Hundred Twenty-Four Thousand
Nine Hundred Ninety-Five and 00/100 Dollars ($1,624,995.00) with interest
thereon at Eight Percent (8%) per annum. Certain capitalized and other terms
used herein shall have the meanings described in the Company's Private Placement
Memorandum dated October 15, 1996.
Interest will accrue during the first year and on December 9, 1997
will be added to principal due under the note. Thereafter, interest will be
payable quarterly.
The original principal amount of this Note will be divided into three
equal tranches of Five Hundred Forty-One Thousand Six Hundred Sixty-Five and
00/100 Dollars ($541,665.00). Payment of principal on each tranche will be
forgiven by the Company (and the interest accrued thereon during that quarter
will be immediately due and payable), if the following incentive performance
tests are achieved:
. During the first five fiscal periods after issuance of this Note:
- One tranche will be forgiven for each fiscal period as to
which the Company generates a total return to investors
purchasing Units in the Company's private placement equal to
or greater than 15%.
- At the end of each of the five fiscal periods, all remaining
tranches will be forgiven if the Company has generated a total
cumulative return to investors purchasing Units in the
Company's private placement (from date of initial issuance of
the Note) equal to or greater than 100%.
. For purposes of calculating the returns to such investors:
- The term "fiscal period" will refer to each of five periods,
the first commencing with the last closing of the Company's
private placement and ending on December 31, 1997, and each
succeeding fiscal period extending for twelve months and
ending on each December 31.
. The term "return" for each fiscal period will mean the sum of (on
a per Unit basis) (a) all cash dividends paid during (or declared
with respect to) such fiscal period per share of Preferred Stock
(or per share of Common Stock following conversion of the
Preferred Stock upon completion of a Qualified IPO), (b) any
increase or decrease in the
1
<PAGE>
price per share of Preferred Stock (or resulting Common Stock)
during such fiscal period, measured by using the price per Unit
to investors in the Company's private placement as the starting
price ($15.00), and using the average public trading price during
the last 90 days of each succeeding fiscal period for such
succeeding periods, and (c) any increase or decrease in the price
per Warrant during such fiscal period, determined in the same
manner as in (b). For purposes of the fiscal period 15% return
test, the total return for a given period will be equal to the
sum of (a), (b) and (c) during the period, and for purposes of
the cumulative 100% return test, the amounts in (a), (b) and (c)
will all be measured from the beginning of the first fiscal
period. The amount of that "return" will then be measured as a
percentage of the investors' investment in the Units (on a per
Unit basis) without regard to timing of receipt of dividends or
timing of increases in per share or per Warrant prices.
. If one of the incentive tests is met, the amount of loan
forgiveness for each tranche will be the principal amount of such
tranche of the Note. In addition, a loan will be made by the
Company to the undersigned in the amount of (i) personal tax
liability resulting from the forgiveness of debt, and (ii)
interest accrued during the first year on the forgiven tranches.
The note will bear interest at a floating market rate, will be
secured by that proportionate number of Units that had secured
the forgiven tranche of the Note and will mature upon the earlier
of the sale of those Units (or the underlying securities) or the
termination of the officer's employment with the Company.
. At the election of the undersigned, the Company shall pay the
premium on a term life insurance policy, the proceeds of which
might assist the undersigned's estate or legal representative to
cover the sums due under this Note, and the premium amount so
advanced shall be added to the principal amount due the Company.
Interest and principal shall be payable in full at maturity, which maturity
date is the earlier of (i) the sale of the underlying securities, (ii) the
termination of the undersigned's employment with the Company or (iii) December
31, 2001.
This Note may be prepaid in full or in part at any time. Each payment
hereunder shall be applied by the holder, first, to the payment of interest when
due, and the balance to the repayment of the principal sum.
If default be made in the payment when due of principal and interest, then
the whole sum of principal and interest shall become immediately due and payable
at the option of the holder of this Note, without notice or demand.
Promisor shall pay all costs and expenses, including reasonable attorneys'
fees, incurred by the holder hereof in the collection of this Note.
2
<PAGE>
This Note is secured by the One Hundred Eight Thousand Three Hundred
Thirty-Three (108,333) Units purchased by the undersigned in the NovaStar
Financial, Inc. private placement which is closing on the date hereof.
____________________________________
Scott F. Hartman
3
<PAGE>
EXHIBIT 10.11
PROMISSORY NOTE
$1,624,995.00 December 9, 1996
FOR VALUE RECEIVED, the undersigned, W. Lance Anderson, promises to
pay to the order of NovaStar Financial, Inc., a Maryland corporation (the
"Company"), the principal amount of One Million Six Hundred Twenty-Four Thousand
Nine Hundred Ninety-Five and 00/100 Dollars ($1,624,995.00) with interest
thereon at Eight Percent (8%) per annum. Certain capitalized and other terms
used herein shall have the meanings described in the Company's Private Placement
Memorandum dated October 15, 1996.
Interest will accrue during the first year and on December 9, 1997
will be added to principal due under the note. Thereafter, interest will be
payable quarterly.
The original principal amount of this Note will be divided into three
equal tranches of Five Hundred Forty-One Thousand Six Hundred Sixty-Five and
00/100 Dollars ($541,665.00). Payment of principal on each tranche will be
forgiven by the Company (and the interest accrued thereon during that quarter
will be immediately due and payable), if the following incentive performance
tests are achieved:
. During the first five fiscal periods after issuance of this Note:
- One tranche will be forgiven for each fiscal period as to
which the Company generates a total return to investors
purchasing Units in the Company's private placement equal to or
greater than 15%.
- At the end of each of the five fiscal periods, all remaining
tranches will be forgiven if the Company has generated a total
cumulative return to investors purchasing Units in the Company's
private placement (from date of initial issuance of the Note)
equal to or greater than 100%.
. For purposes of calculating the returns to such investors:
- The term "fiscal period" will refer to each of five periods,
the first commencing with the last closing of the Company's
private placement and ending on December 31, 1997, and each
succeeding fiscal period extending for twelve months and ending
on each December 31.
. The term "return" for each fiscal period will mean the sum of (on a
per Unit basis) (a) all cash dividends paid during (or declared with
respect to) such fiscal period per share of Preferred Stock (or per
share of Common Stock following conversion of the Preferred Stock
upon completion of a Qualified IPO), (b) any increase or decrease in
the
1
<PAGE>
price per share of Preferred Stock (or resulting Common Stock)
during such fiscal period, measured by using the price per Unit to
investors in the Company's private placement as the starting price
($15.00), and using the average public trading price during the last
90 days of each succeeding fiscal period for such succeeding
periods, and (c) any increase or decrease in the price per Warrant
during such fiscal period, determined in the same manner as in (b).
For purposes of the fiscal period 15% return test, the total return
for a given period will be equal to the sum of (a), (b) and (c)
during the period, and for purposes of the cumulative 100% return
test, the amounts in (a), (b) and (c) will all be measured from the
beginning of the first fiscal period. The amount of that "return"
will then be measured as a percentage of the investors' investment
in the Units (on a per Unit basis) without regard to timing of
receipt of dividends or timing of increases in per share or per
Warrant prices.
. If one of the incentive tests is met, the amount of loan forgiveness
for each tranche will be the principal amount of such tranche of the
Note. In addition, a loan will be made by the Company to the
undersigned in the amount of (i) personal tax liability resulting
from the forgiveness of debt, and (ii) interest accrued during the
first year on the forgiven tranches. The note will bear interest at
a floating market rate, will be secured by that proportionate number
of Units that had secured the forgiven tranche of the Note and will
mature upon the earlier of the sale of those Units (or the
underlying securities) or the termination of the officer's
employment with the Company.
. At the election of the undersigned, the Company shall pay the
premium on a term life insurance policy, the proceeds of which might
assist the undersigned's estate or legal representative to cover the
sums due under this Note, and the premium amount so advanced shall
be added to the principal amount due the Company.
Interest and principal shall be payable in full at maturity, which
maturity date is the earlier of (i) the sale of the underlying securities, (ii)
the termination of the undersigned's employment with the Company or (iii)
December 31, 2001.
This Note may be prepaid in full or in part at any time. Each payment
hereunder shall be applied by the holder, first, to the payment of interest when
due, and the balance to the repayment of the principal sum.
If default be made in the payment when due of principal and interest,
then the whole sum of principal and interest shall become immediately due and
payable at the option of the holder of this Note, without notice or demand.
Promisor shall pay all costs and expenses, including reasonable
attorneys' fees, incurred by the holder hereof in the collection of this Note.
2
<PAGE>
This Note is secured by the One Hundred Eight Thousand Three Hundred
Thirty-Three (108,333) Units purchased by the undersigned in the NovaStar
Financial, Inc. private placement which is closing on the date hereof.
____________________________________
W. Lance Anderson
3
<PAGE>
EXHIBIT 10.12
STOCK PLEDGE AGREEMENT
THIS STOCK PLEDGE AGREEMENT, (Pledge Agreement") is made and entered
into this 9th day of December, of 1996 by and between Scott F. Hartman
("Pledgor") and NovaStar Financial, Inc. ("Pledgee").
RECITALS
--------
A. Pledgor is purchasing One Hundred Eight Thousand Three Hundred
Thirty-Three (108,333) Units (the "Shares") in Pledgee's Private Placement which
is closing on the date hereof.
B. In connection with that purchase, Pledgor has executed that
certain Promissory Note (the "Note") in the amount of One Million Six Hundred
Twenty-Four Thousand Nine Hundred Ninety-Five and 00/100 Dollars ($1,624,995) in
favor of Pledgee.
C. Pledgor desires to pledge the Shares as collateral to secure the
payment of Pledgor's obligations under the Note.
AGREEMENT
---------
NOW, THEREFORE, for good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties agree as follows:
Section l. Pledge of the Shares. As collateral security for the
--------------------
obligations of Pledgor under the Note, Pledgor hereby pledges and grants a
security interest to Pledgee in the Shares, together with any securities, issued
or received, in respect of, or in exchange or in substitution for the Shares,
including but not limited to those arising from a stock conversion, stock
dividend, or stock split (collectively referred to as the "Collateral").
Section 2. Delivery of Collateral. Pledgor shall deliver the
----------------------
Collateral to Pledgee with an assignment separate from the certificate duly
endorsed for transfer. Upon the acquisition by Pledgor of any other security
included in the definition of Collateral prior to payment of the obligations in
full, Pledgor shall deliver such security to Escrow Holder with the appropriate
assignment separate from the certificate duly endorsed for transfer.
Section 3. Release of Collateral. So long as there is no event of
---------------------
default under the Note, one-third of the Collateral pledged on the date hereof
shall be released as security upon forgiveness of each tranche of the
indebtedness pursuant to the terms of the Note.
Section 4. Voting and Distributions Prior to Default.
-----------------------------------------
(a) Prior to the occurrence of an event of default as defined
herein, Pledgor shall have the right to vote the shares constituting the
Collateral owned by Pledgor, and
1
<PAGE>
to exercise any other consensual rights pertaining to the Collateral provided,
however, that Pledgor shall not vote such shares in a manner which would cause
or constitute an event of default under the Stock Pledge Agreement.
(b) Prior to the occurrence of an event of default, Pledgor
shall be entitled to receive directly from the Company all dividends (other than
dividends in the form of stock which shall become a part of the Collateral),
property and cash distributions with respect to, or in consequence of the
ownership of, the Collateral.
Section 5. Covenants of Pledgor. Pledgor hereby agrees:
--------------------
(a) To do all acts that may be necessary to maintain, preserve
and protect, to produce, execute and deliver from time to time any endorsements,
assignments, financing statements or other writings deemed necessary or
appropriate by Pledgee to perfect, maintain and protect the security interest
created hereunder and the priority thereof; and
(b) To appear and defend any action or proceeding which may
affect title to or Pledgee's interest in the Collateral.
Section 6. Authorized Action by Pledgee. Pledgor hereby irrevocably
----------------------------
appoints Pledgee as attorney-in-fact to do (but Pledgee shall not be obligated
to do and shall incur no liability to Pledgor or any other party for failure so
to do) any act which Pledgor is obligated by this Pledge Agreement to do, and
exercise such any rights and powers as Pledgor might exercise with respect to
the Collateral, which Pledgee deems necessary or advisable.
Section 7. Event of Default. The occurrence of the following events
----------------
shall constitute an event of default ("Event of Default"):
(a) Failure by Pledgor to perform any of Pledgor's obligations
pursuant to the Note and such failure is not cured within the time, if any, set
forth in the Note; and
(b) Failure of Pledgor to keep or perform any of the terms or
provisions of this Pledge Agreement.
Section 8. Remedies. Upon the occurrence of an Event of Default,
--------
Pledgee shall have the right to exercise of any of the following remedies:
(a) Enforce Pledgee's security interest in any manner permitted
by the applicable Uniform Commercial Code provisions and in any case where
notice is required thereunder and is not otherwise waived, fifteen (15) days
notice shall be deemed reasonable notice; or
(b) Sell or otherwise dispose of the Collateral at one or more
public or private sales, whether or not such Collateral is present at the place
of sale, for cash or credit or future delivery, on such terms and in such manner
as Pledgee may determine.
2
<PAGE>
Section 9. Conduct of Foreclosure Sale. In connection with any sale
---------------------------
or distribution of Collateral, Pledgee is authorized to comply with any
limitations or restrictions as Pledgee may be advised by its counsel that is
necessary or desirable to avoid any violation of applicable law including
federal and state securities laws or obtain any required approval of the
purchaser by any governmental regulatory body or officer. It is hereby agreed
that any such actions taken to comply with such laws or regulations shall be
deemed to be necessary for the sale to be made in a commercially reasonable
manner. Pledgee shall not be liable or accountable by reason of the fact that
the proceeds obtained in any such sale are less than might otherwise have been
obtained without such compliance.
Section 10. Notices. All notices and communications to be given,
-------
delivered or otherwise made to any parties pursuant to this Pledge Agreement
shall be delivered personally by overnight courier or messenger and shall be
deemed to have been made upon actual receipt of the delivery or refusal to
accept delivery by the intended recipient. All notices, requests shall be
addressed as set forth below or at such other address as may be hereinafter
designated in writing by the addressee to each of the other parties.
TO PLEDGOR: Scott F. Hartman
5607 Chadwick
Fairway, KS 66205
TO PLEDGEE: NovaStar Financial, Inc.
1900 West 47th Place
Suite 205
Westwood, KS 66205
Section 11. Binding Upon Successors. All rights of Pledgee under
-----------------------
this Pledge Agreement shall inure to the benefit of its successors and assigns.
All the obligations of Pledgor shall bind Pledgor's heirs, executors,
administrators, successors and assigns.
Section 12. Severability. If any provision of this Pledge Agreement
------------
shall be held invalid or unenforceable, this Pledge Agreement shall be construed
as if not containing the provisions and the rights and obligations of the
parties shall be construed and enforced accordingly.
Section 13. Expenses. If any party institutes legal action to
--------
enforce or interpret this Pledge Agreement, the prevailing party shall be
entitled to recover in addition to any other relief awarded its reasonable
attorneys fees and costs incurred in such legal action.
3
<PAGE>
Section 14. Amendment. This Pledge Agreement may not be modified or
---------
amended except in writing signed by the parties hereto.
IN WITNESS WHEREOF, this Pledge Agreement is executed as of the date
first written above.
PLEDGOR: ____________________________________
Scott F. Hartman
PLEDGEE: NOVASTAR FINANCIAL, INC.
By_________________________________
4
<PAGE>
EXHIBIT 10.13
STOCK PLEDGE AGREEMENT
THIS STOCK PLEDGE AGREEMENT, ("Pledge Agreement") is made and entered
into this 9th day of December, of 1996 by and between W. Lance Anderson
("Pledgor") and NovaStar Financial, Inc. ("Pledgee").
RECITALS
--------
A. Pledgor is purchasing One Hundred Eight Thousand Three Hundred
Thirty-Three (108,333) Units (the "Shares") in Pledgee's Private Placement which
is closing on the date hereof.
B. In connection with that purchase, Pledgor has executed that
certain Promissory Note (the "Note") in the amount of One Million Six Hundred
Twenty-Four Thousand Nine Hundred Ninety-Five and 00/100 Dollars ($1,624,995) in
favor of Pledgee.
C. Pledgor desires to pledge the Shares as collateral to secure the
payment of Pledgor's obligations under the Note.
AGREEMENT
---------
NOW, THEREFORE, for good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties agree as follows:
Section l. Pledge of the Shares. As collateral security for the
--------------------
obligations of Pledgor under the Note, Pledgor hereby pledges and grants a
security interest to Pledgee in the Shares, together with any securities, issued
or received, in respect of, or in exchange or in substitution for the Shares,
including but not limited to those arising from a stock conversion, stock
dividend, or stock split (collectively referred to as the "Collateral").
Section 2. Delivery of Collateral. Pledgor shall deliver the
----------------------
Collateral to Pledgee with an assignment separate from the certificate duly
endorsed for transfer. Upon the acquisition by Pledgor of any other security
included in the definition of Collateral prior to payment of the obligations in
full, Pledgor shall deliver such security to Escrow Holder with the appropriate
assignment separate from the certificate duly endorsed for transfer.
Section 3. Release of Collateral. So long as there is no event of
---------------------
default under the Note, one-third of the Collateral pledged on the date hereof
shall be released as security upon forgiveness of each tranche of the
indebtedness pursuant to the terms of the Note.
Section 4. Voting and Distributions Prior to Default.
-----------------------------------------
(a) Prior to the occurrence of an event of default as defined herein,
Pledgor shall have the right to vote the shares constituting the Collateral
owned by Pledgor, and
1
<PAGE>
to exercise any other consensual rights pertaining to the Collateral provided,
however, that Pledgor shall not vote such shares in a manner which would cause
or constitute an event of default under the Stock Pledge Agreement.
(b) Prior to the occurrence of an event of default, Pledgor shall be
entitled to receive directly from the Company all dividends (other than
dividends in the form of stock which shall become a part of the Collateral),
property and cash distributions with respect to, or in consequence of the
ownership of, the Collateral.
Section 5. Covenants of Pledgor. Pledgor hereby agrees:
--------------------
(a) To do all acts that may be necessary to maintain, preserve and
protect, to produce, execute and deliver from time to time any endorsements,
assignments, financing statements or other writings deemed necessary or
appropriate by Pledgee to perfect, maintain and protect the security interest
created hereunder and the priority thereof; and
(b) To appear and defend any action or proceeding which may affect
title to or Pledgee's interest in the Collateral.
Section 6. Authorized Action by Pledgee. Pledgor hereby irrevocably
----------------------------
appoints Pledgee as attorney-in-fact to do (but Pledgee shall not be obligated
to do and shall incur no liability to Pledgor or any other party for failure so
to do) any act which Pledgor is obligated by this Pledge Agreement to do, and
exercise such any rights and powers as Pledgor might exercise with respect to
the Collateral, which Pledgee deems necessary or advisable.
Section 7. Event of Default. The occurrence of the following events
----------------
shall constitute an event of default ("Event of Default"):
(a) Failure by Pledgor to perform any of Pledgor's obligations
pursuant to the Note and such failure is not cured within the time, if any, set
forth in the Note; and
(b) Failure of Pledgor to keep or perform any of the terms or
provisions of this Pledge Agreement.
Section 8. Remedies. Upon the occurrence of an Event of Default,
--------
Pledgee shall have the right to exercise of any of the following remedies:
(a) Enforce Pledgee's security interest in any manner permitted by
the applicable Uniform Commercial Code provisions and in any case where notice
is required thereunder and is not otherwise waived, fifteen (15) days notice
shall be deemed reasonable notice; or
(b) Sell or otherwise dispose of the Collateral at one or more public
or private sales, whether or not such Collateral is present at the place of
sale, for cash or credit or future delivery, on such terms and in such manner as
Pledgee may determine.
2
<PAGE>
Section 9. Conduct of Foreclosure Sale. In connection with any sale
---------------------------
or distribution of Collateral, Pledgee is authorized to comply with any
limitations or restrictions as Pledgee may be advised by its counsel that is
necessary or desirable to avoid any violation of applicable law including
federal and state securities laws or obtain any required approval of the
purchaser by any governmental regulatory body or officer. It is hereby agreed
that any such actions taken to comply with such laws or regulations shall be
deemed to be necessary for the sale to be made in a commercially reasonable
manner. Pledgee shall not be liable or accountable by reason of the fact that
the proceeds obtained in any such sale are less than might otherwise have been
obtained without such compliance.
Section 10. Notices. All notices and communications to be given,
-------
delivered or otherwise made to any parties pursuant to this Pledge Agreement
shall be delivered personally by overnight courier or messenger and shall be
deemed to have been made upon actual receipt of the delivery or refusal to
accept delivery by the intended recipient. All notices, requests shall be
addressed as set forth below or at such other address as may be hereinafter
designated in writing by the addressee to each of the other parties.
TO PLEDGOR: W. Lance Anderson
8699 Butterfield Avenue
Richmond, VA 23229
TO PLEDGEE: NovaStar Financial, Inc.
1900 West 47th Place
Suite 205
Westwood, KS 66205
Section 11. Binding Upon Successors. All rights of Pledgee under
-----------------------
this Pledge Agreement shall inure to the benefit of its successors and assigns.
All the obligations of Pledgor shall bind Pledgor's heirs, executors,
administrators, successors and assigns.
Section 12. Severability. If any provision of this Pledge Agreement
------------
shall be held invalid or unenforceable, this Pledge Agreement shall be construed
as if not containing the provisions and the rights and obligations of the
parties shall be construed and enforced accordingly.
Section 13. Expenses. If any party institutes legal action to
--------
enforce or interpret this Pledge Agreement, the prevailing party shall be
entitled to recover in addition to any other relief awarded its reasonable
attorneys fees and costs incurred in such legal action.
3
<PAGE>
Section 14. Amendment. This Pledge Agreement may not be modified or
---------
amended except in writing signed by the parties hereto.
IN WITNESS WHEREOF, this Pledge Agreement is executed as of the date
first written above.
PLEDGOR: ____________________________________
W. Lance Anderson
PLEDGEE: NOVASTAR FINANCIAL, INC.
By_________________________________
4
<PAGE>
EXHIBIT 10.14
NOVASTAR FINANCIAL, INC.
AMENDED AND RESTATED
1996 EXECUTIVE AND NON-EMPLOYEE DIRECTOR
STOCK OPTION PLAN
(Last Amended December 6, 1996)
1. GENERAL PURPOSE OF PLAN; DEFINITIONS.
The name of this plan is the NovaStar Financial, Inc. 1996 Executive
and Non-Employee Director Stock Option Plan (the "Plan"). The Plan was adopted
by the Board on September 27, 1996, subject to the approval of the Company
stockholders, which approval was obtained on October 10, 1996. The purpose of
the Plan is to enable the Company and its Subsidiaries to obtain and retain
competent personnel who will contribute to the Company's success by their
ability, ingenuity and industry, to give the Company's non-employee directors a
proprietary interest in the Company and to provide incentives to the
participating directors, officers and other key employees, and agents and
consultants that are linked directly to increases in stockholder value and will
therefore inure to the benefit of all stockholders of the Company.
For purposes of the Plan, the following terms shall be defined as set
forth below:
(1) "Accrued DERs" means dividend equivalent rights with the accrual
------------
rights described in Section 5(11).
(2) "Administrator" means the Board, or if the Board does not
-------------
administer the Plan, the Committee in accordance with Section 2.
(3) "Board" means the Board of Directors of the Company.
-----
(4) "Code" means the Internal Revenue Code of 1986, as amended from
----
time to time, or any successor thereto.
(5) "Committee" means the Compensation Committee of the Board, which
---------
shall be composed entirely of individuals who meet the qualifications to be a
"Non-Employee Director" as defined in Rule 16b-3 ("Rule 16b-3") as promulgated
by the Securities and Exchange Commission (the "Commission") under the
Securities Exchange Act of 1934 (the "Act"), and as such Rule may be amended
from time to time, or any successor definition adopted by the Commission, or any
other Committee the Board may subsequently appoint to administer the Plan. If at
any time the Board shall not administer the Plan, then the functions of the
Board specified in the Plan shall be exercised by the Committee.
1
<PAGE>
(6) "Company" means NovaStar Financial, Inc., a corporation organized
-------
under the laws of the State of Maryland (or any successor corporation).
(7) "Current-pay DERs" means dividend equivalent rights with the
----------------
current-pay rights described in Section 5(11).
(8) "DERs" shall mean Accrued DERs and Current-pay DERs.
----
(9) "Deferred Stock" means an award granted pursuant to Section 7 of
--------------
the right to receive Stock at the end of a specified deferral period.
(10) "Disability" means permanent and total disability as determined
----------
under the Company's disability program or policy.
(11) "Effective Date" shall mean the date provided pursuant to Section
--------------
12.
(12) "Eligible Employee" means an employee of the Company or any
-----------------
Subsidiary eligible to participate in the Plan pursuant to Section 4.
(13) "Eligible Non-Employee Director" means a member of the Board or
------------------------------
the board of directors of any Subsidiary who is not a bona fide employee of the
Company or any Subsidiary and who is eligible to participate in the Plan
pursuant to Section 5A.
(14) "Fair Market Value" means, as of any given date, with respect to
-----------------
any awards granted hereunder, at the discretion of the Administrator and subject
to such limitations as the Administrator may impose, (A) the closing sale price
of the Stock on the next preceding business day as reported in the Western
Edition of the Wall Street Journal Composite Tape, or (B) the average of the
closing price of the Stock on each day on which the Stock was traded over a
period of up to twenty trading days immediately prior to such date, or (C) if
the Stock is not publicly traded, the fair market value of the Stock as
otherwise determined by the Administrator in the good faith exercise of its
discretion.
(15) "Incentive Stock Option" means any Stock Option intended to be
----------------------
designated as an "incentive stock option" within the meaning of Section 422 of
the Code.
(16) "Limited Stock Appreciation Right" means a Stock Appreciation
--------------------------------
Right that can be exercised only in the event of a "Change of Control" (as
defined in Section 10 below).
(17) "Non-Employee Director" shall have the meaning set forth in Rule
---------------------
16b-3.
(18) "Non-Qualified Stock Option" means any Stock Option that is not
--------------------------
an Incentive Stock Option, including any Stock Option that provides (as of the
time such option is granted) that it will not be treated as an Incentive Stock
Option.
2
<PAGE>
(19) "Parent Corporation" means any corporation (other than the
------------------
Company) in an unbroken chain of corporations ending with the Company, if each
of the corporations in the chain (other than the Company) owns stock possessing
50% or more of the combined voting power of all classes of stock in one of the
other corporations in the chain.
(20) "Participant" means any Eligible Employee or any consultant or
-----------
agent of the Company or any Subsidiary selected by the Committee, pursuant to
the Administrator's authority in Section 2, to receive grants of Stock Options,
DERs, Stock Appreciation Rights, Limited Stock Appreciation Rights, Restricted
Stock awards, Deferred Stock awards, Performance Shares or any combination of
the foregoing, or any Eligible Non-Employee Director eligible to receive grants
of Non-Qualified Stock Options and DERs pursuant to Section 5A below.
(21) "Performance Share" means an award of shares of Stock granted
-----------------
pursuant to Section 7 that is subject to restrictions based upon the attainment
of specified performance objectives.
(22) "Restricted Stock" means an award granted pursuant to Section 7
----------------
of shares of Stock subject to restrictions that will lapse with the passage of
time.
(23) "Stock" means the common stock, $0.01 par value, of the Company.
-----
(24) "Stock Appreciation Right" means the right pursuant to an award
------------------------
granted under Section 6 to receive an amount equal to the difference between (A)
the Fair Market Value, as of the date such Stock Appreciation Right or portion
thereof is surrendered, of the shares of Stock covered by such right or such
portion thereof, and (B) the aggregate exercise price of such right or such
portion thereof.
(25) "Stock Option" means an option to purchase shares of Stock
------------
granted pursuant to Section 5 or Section 5A.
(26) "Subsidiary" means any corporation (other than the Company)
----------
either (i) in an unbroken chain of corporations beginning with the Company, if
each of the corporations (other than the last corporation) in the unbroken chain
owns stock possessing 50% or more of the total combined voting power of all
classes of stock in one of the other corporations in the chain or (ii) organized
to act as the mortgage loan conduit for the Company.
2. ADMINISTRATION.
The Plan shall be administered by the Board or by a Committee
appointed by the Board, which shall serve at the pleasure of the Board;
provided, however, that at all times following the commencement of the Company's
- -------- -------
Private Placement on October 15, 1996 the Plan shall be administered by the
Committee appointed by the Board.
3
<PAGE>
The Administrator shall have the power and authority to grant to
Eligible Employees and consultants or agents of the Company or any Subsidiary,
pursuant to the terms of the Plan: (a) Stock Options (with or without DERs), (b)
Stock Appreciation Rights or Limited Stock Appreciation Rights, (c) Restricted
Stock, (d) Deferred Stock, (e) Performance Shares or (f) any combination of the
foregoing.
In particular, the Administrator shall have the authority:
(a) to select those employees of the Company or any Subsidiary who
shall be Eligible Employees;
(b) to determine whether and to what extent Stock Options (with or
without DERs), Stock Appreciation Rights, Limited Stock Appreciation Rights,
Restricted Stock, Deferred Stock, Performance Shares or a combination of the
foregoing, are to be granted to Eligible Employees or any consultant or agent of
the Company or any Subsidiary hereunder;
(c) to determine the number of shares to be covered by each such award
granted hereunder;
(d) to determine the terms and conditions, not inconsistent with the
terms of the Plan, of any award granted hereunder (including, but not limited
to, (x) the restricted period applicable to Restricted or Deferred Stock awards
and the date or dates on which restrictions applicable to such Restricted or
Deferred Stock shall lapse during such period, and (y) the performance goals and
periods applicable to the award of Performance Shares); and
(e) to determine the terms and conditions, not inconsistent with the
terms of the Plan, which shall govern all written instruments evidencing the
Stock Options, DERs, Stock Appreciation Rights, Limited Stock Appreciation
Rights, Restricted Stock, Deferred Stock, Performance Shares or any combination
of the foregoing.
The Administrator shall have the authority, in its discretion, to
adopt, alter and repeal such administrative rules, guidelines and practices
governing the Plan as it shall from time to time deem advisable; to interpret
the terms and provisions of the Plan and any award issued under the Plan (and
any agreements relating thereto); and to otherwise supervise the administration
of the Plan.
All decisions made by the Administrator pursuant to the provisions of
the Plan shall be final and binding on all persons, including the Company, any
Subsidiaries and the Participants.
3. STOCK SUBJECT TO PLAN.
The total number of shares of Stock reserved and available for
issuance under the Plan shall be 339,332; provided, however, that from and after
-------- -------
such time as the number of outstanding shares of Stock as reflected on the
Company's quarterly or year-end balance sheet exceeds
4
<PAGE>
3,393,320 (including treasury shares but not including adjustments in the event
of changes in the corporate structure of the Company as provided below in this
Section 3), the total number of shares of Stock reserved and available for
issuance (inclusive of shares already issued) under the Plan shall automatically
be increased so as to equal ten percent (10%) of the number of then outstanding
shares of Stock, and provided further, that no more than 339,332 shares of Stock
----------------
shall be cumulatively available for Incentive Stock Options. At all times, the
number of shares reserved and available for issuance hereunder as so determined
from time to time shall be decreased by virtue of awards granted and outstanding
or exercised hereunder.
To the extent that (i) a Stock Option or DER expires or is otherwise
terminated without being exercised, or (ii) any shares of Stock subject to any
Restricted Stock, Deferred Stock or Performance Share award granted hereunder
are forfeited, such shares shall again be available for issuance in connection
with future awards under the Plan. If any shares of Stock have been pledged as
collateral for indebtedness incurred by a Participant in connection with the
exercise of a Stock Option and such shares are returned to the Company in
satisfaction of such indebtedness, such shares shall again be available for
issuance in connection with future awards under the Plan.
In the event of any merger, reorganization, consolidation,
recapitalization, Stock dividend, or other change in corporate structure
affecting the Stock, a substitution or adjustment may be made in (i) the
aggregate number of shares reserved for issuance under the Plan, and (ii) the
kind, number and option price of shares subject to outstanding Stock Options and
DERs granted under the Plan as may be determined by the Administrator, in its
sole discretion, provided that the number of shares subject to any award shall
always be a whole number. Such other substitutions or adjustments shall be made
as may be determined by the Administrator, in its sole discretion; provided,
--------
however, that with respect to Incentive Stock Options, such adjustment shall be
- -------
made in accordance with Section 424 of the Code. An adjusted option price shall
also be used to determine the amount payable by the Company upon the exercise of
any Stock Appreciation Right or Limited Stock Appreciation Right associated with
any Stock Option.
The aggregate number of shares of Stock for which Stock Options or
Stock Appreciation Rights may be granted to any individual during any calendar
year may not, subject to adjustment as provided in this Section 3, exceed 75% of
the shares of Stock reserved for the purposes of the Plan in accordance with the
provisions of this Section 3.
4. ELIGIBILITY.
Officers and other key employees of the Company or Subsidiaries who
are responsible for or contribute to the management, growth and/or profitability
of the business of the Company or its Subsidiaries and consultants and agents of
the Company or its Subsidiaries, shall be eligible to be granted Stock Options,
DERs, Stock Appreciation Rights, Limited Stock Appreciation Rights, Restricted
Stock awards, Deferred Stock awards or Performance Shares hereunder. The
Participants under the Plan shall be selected from time to time by the
Administrator, in its sole discretion, from among the Eligible Employees and
consultants and agents recommended by the senior management of the Company, and
the Administrator shall determine, in its sole discretion,
5
<PAGE>
the number of shares covered by each award; provided, however, that Eligible
-----------------
Non-Employee Directors shall only be eligible to receive Stock Options as
provided in Section 5A.
5. STOCK OPTIONS.
Stock Options may be granted alone or in addition to other awards
granted under the Plan, including DERs as described in Section 5(11). Any Stock
Option granted under the Plan shall be in such form as the Administrator may
from time to time approve, and the provisions of Stock Option awards need not be
the same with respect to each optionee. Recipients of Stock Options shall enter
into a stock option agreement with the Company, in such form as the
Administrator shall determine, which agreement shall set forth, among other
things, the exercise price of the option, the term of the option and provisions
regarding exercisability of the option granted thereunder.
The Stock Options granted under the Plan may be of two types: (i)
Incentive Stock Options and (ii) Non-Qualified Stock Options.
The Administrator shall have the authority under this Section 5 to
grant any optionee (except Eligible Non-Employee Directors) Incentive Stock
Options, Non-Qualified Stock Options, or both types of Stock Options (in each
case with or without DERs, Stock Appreciation Rights or Limited Stock
Appreciation Rights), provided, however, that Incentive Stock Options may not be
-------- -------
granted to any individual who is not an employee of the Company or its
Subsidiaries. To the extent that any Stock Option does not qualify as an
Incentive Stock Option, it shall constitute a separate Non-Qualified Stock
Option. More than one option may be granted to the same optionee and be
outstanding concurrently hereunder.
Stock Options granted under the Plan shall be subject to the following
terms and conditions and shall contain such additional terms and conditions, not
inconsistent with the terms of the Plan, as the Administrator shall deem
desirable:
(1) Option Price. The option price per share of Stock purchasable
------------
under a Stock Option shall be determined by the Administrator in its sole
discretion at the time of grant but shall not, in the case of Incentive Stock
Options, be less than 100% of the Fair Market Value of the Stock on such date,
and shall not, in any event, be less than the par value of the Stock. The
option price per share of Stock purchasable under a Non-Qualified Stock Option
may be less than 100% of such Fair Market Value. If an employee owns or is
deemed to own (by reason of the attribution rules applicable under Section
425(d) of the Code) more than 10% of the combined voting power of all classes of
stock of the Company or any Parent Corporation or Subsidiary and an Incentive
Stock Option is granted to such employee, the option price of such Incentive
Stock Option (to the extent required by the Code at the time of grant) shall be
no less than 110% of the Fair Market Value of the Stock on the date such
Incentive Stock Option is granted.
6
<PAGE>
(2) Option Term. The term of each Stock Option shall be fixed by the
-----------
Administrator, but no Stock Option shall be exercisable more than ten years
after the date such Stock Option is granted; provided, however, that if an
-------- -------
employee owns or is deemed to own (by reason of the attribution rules of Section
425(d) of the Code) more than 10% of the combined voting power of all classes of
stock of the Company or any Parent Corporation or Subsidiary and an Incentive
Stock Option is granted to such employee, the term of such Incentive Stock
Option (to the extent required by the Code at the time of grant) shall be no
more than five years from the date of grant.
(3) Exercisability. Stock Options shall be exercisable at such time
--------------
or times and subject to such terms and conditions as shall be determined by the
Administrator at or after grant; provided, however, that, except as provided
-------- -------
herein or unless otherwise determined by the Administrator at or after grant,
Stock Options shall become exercisable as to 25% of the shares subject to such
Stock Option on the first anniversary of the date of grant of the Stock Option,
and as to an additional 25% on each of the next three anniversaries of the date
of grant. To the extent not exercised, installments shall accumulate and be
exercisable in whole or in part at any time after becoming exercisable but not
later than the date the Stock Option expires. The Administrator may provide, in
its discretion, that any Stock Option shall be exercisable only in installments,
and the Administrator may waive such installment exercise provisions at any time
in whole or in part based on such factors as the Administrator may determine, in
its sole discretion.
(4) Method of Exercise. Subject to Section 5(3), Stock Options may be
------------------
exercised in whole or in part at any time during the option period, by giving
written notice of exercise to the Company specifying the number of shares to be
purchased, accompanied by payment in full of the purchase price in cash or its
equivalent as determined by the Administrator. As determined by the
Administrator, in its sole discretion, payment in whole or in part may also be
made in the form of unrestricted Stock already owned by the optionee, or, in the
case of the exercise of a Non-Qualified Stock Option, Restricted Stock or
Performance Shares subject to an award hereunder (based, in each case, on the
Fair Market Value of the Stock on the date the option is exercised); provided,
--------
however, that in the case of an Incentive Stock Option, the right to make
- -------
payment in the form of already owned shares may be authorized only at the time
of grant. Any payment in the form of stock already owned by the optionee may be
effected by use of an attestation form approved by the Administrator. If
payment of the option exercise price of a Non-Qualified Stock Option is made in
whole or in part in the form of Restricted Stock or Performance Shares, the
shares received upon the exercise of such Stock Option (to the extent of the
number of shares of Restricted Stock or Performance Shares surrendered upon
exercise of such Stock Option) shall be restricted in accordance with the
original terms of the Restricted Stock or Performance Share award in question,
except that the Administrator may direct that such restrictions shall apply only
to that number of shares equal to the number of shares surrendered upon the
exercise of such option. An optionee shall generally have the rights to
dividends and other rights of a stockholder with respect to shares subject to
the option only after the optionee has given written notice of exercise, has
paid in full for such shares, and, if requested, has given the representation
described in paragraph (1) of Section 11.
7
<PAGE>
The Administrator may require the voluntary surrender of all or a
portion of any Stock Option granted under the Plan as a condition precedent to a
grant of a new Stock Option. Subject to the provisions of the Plan, such new
Stock Option shall be exercisable at the price, during such period and on such
other terms and conditions as are specified by the Administrator at the time the
new Stock Option is granted; provided, however, that should the Administrator so
-------- -------
require, the number of shares subject to such new Stock Option shall not be
greater than the number of shares subject to the surrendered Stock Option. Upon
their surrender, Stock Options shall be canceled and the shares previously
subject to such canceled Stock Options shall again be available for grants of
Stock Options and other awards hereunder.
(5) Loans. The Company may make loans available to Stock Option
-----
holders in connection with the exercise of outstanding options granted under the
Plan, as the Administrator, in its discretion, may determine. Such loans shall
(i) be evidenced by promissory notes entered into by the Stock Option holders in
favor of the Company, (ii) be subject to the terms and conditions set forth in
this Section 5(5) and such other terms and conditions, not inconsistent with the
Plan, as the Administrator shall determine, and (iii) bear interest, if any, at
such rate as the Administrator shall determine. In no event may the principal
amount of any such loan exceed the sum of (x) the exercise price less the par
value of the shares of Stock covered by the option, or portion thereof,
exercised by the holder, and (y) any federal, state, and local income tax
attributable to such exercise. The initial term of the loan, the schedule of
payments of principal and interest under the loan, the extent to which the loan
is to be with or without recourse against the holder with respect to principal
or interest and the conditions upon which the loan will become payable in the
event of the holder's termination of employment shall be determined by the
Administrator; provided, however, that the term of the loan, including
-------- -------
extensions, shall not exceed seven years. Unless the Administrator determines
otherwise, when a loan is made, shares of Stock having a Fair Market Value at
least equal to the principal amount of the loan shall be pledged by the holder
to the Company as security for payment of the unpaid balance of the loan, and
such pledge shall be evidenced by a pledge agreement, the terms of which shall
be determined by the Administrator, in its discretion; provided, however, that
-------- -------
each loan shall comply with all applicable laws, regulations and rules of the
Board of Governors of the Federal Reserve System and any other governmental
agency having jurisdiction.
(6) Limits on Transferability of Options.
------------------------------------
(a) Subject to Section 5(6)(b), no Stock Option shall be transferable
by the optionee otherwise than by will or by the laws of descent and
distribution or pursuant to a "qualified domestic relations order," as such term
is defined in the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), and all Stock Options shall be exercisable, during the optionee's
lifetime, only by the optionee or in accordance with the terms of a qualified
domestic relations order.
(b) The Administrator may, in its discretion, authorize all or a
portion of the options to be granted to an optionee to be on terms which permit
transfer by such optionee to (i) the spouse, qualified domestic partner,
children or grandchildren of the optionee and any other
8
<PAGE>
persons related to the optionee as may be approved by the Administrator
("Immediate Family Members"), (ii) a trust or trusts for the exclusive benefit
of such Immediate Family Members, (iii) a partnership or partnerships in which
such Immediate Family Members are the only partners, or (iv) any other persons
or entities as may be approved by the Administrator, provided that (x) there may
be no consideration for any transfer unless approved by the Administrator, (y)
the stock option agreement pursuant to which such options are granted must be
approved by the Administrator, and must expressly provide for transferability in
a manner consistent with this Section 5(6)(b), and (z) subsequent transfers of
transferred options shall be prohibited except those in accordance with Section
5(6)(a) or expressly approved by the Administrator. Following transfer, any such
options shall continue to be subject to the same terms and conditions as were
applicable immediately prior to transfer, provided that, except for purposes of
Sections 5(7), (8) and (9) and 11(3) hereof, the terms "optionee," Stock Option
holder" and "Participant" shall be deemed to refer to the transferee. The events
of termination of employment under Sections 5(7), (8) and (9) hereof shall
continue to be applied with respect to the original optionee, following which
the options shall be exercisable by the transferee only to the extent, and for
the periods specified under such sections unless the option agreement governing
such options otherwise provides. Notwithstanding the transfer, the original
optionee will continue to be subject to the provisions of Section 11(3)
regarding payment of taxes, including the provisions entitling the Company to
deduct such taxes from amounts otherwise due to such optionee. Any transfer of a
Stock Option that was originally granted with DERs related thereto shall
automatically include the transfer of such DERs, any attempt to transfer such
Stock Option separately from such DERs shall be void, and such DERs shall
continue in effect according to their terms. "Qualified domestic partner" for
the purpose of this Section 5(6)(b) shall mean a domestic partner living in the
same household as the optionee and registered with, certified by or otherwise
acknowledged by the county or other applicable governmental body as a domestic
partner or otherwise establishing such status in any manner satisfactory to the
Administrator. Stock options granted prior to December 1, 1996 may be amended to
provide for their transferability, subject to the foregoing conditions.
(7) Termination by Death. If an optionee's employment with the Company
--------------------
or any Subsidiary terminates by reason of death, the Stock Option may thereafter
be immediately exercised, to the extent then exercisable (or on such accelerated
basis as the Administrator shall determine at or after grant), by the legal
representative of the estate or by the legatee of the optionee under the will of
the optionee, for a period of twelve months (or such shorter period as the
Administrator shall specify at grant) from the date of such death or until the
expiration of the stated term of such Stock Option, whichever period is shorter.
(8) Termination by Reason of Disability. If an optionee's employment
-----------------------------------
with the Company or any Subsidiary terminates by reason of Disability, any Stock
Option held by such optionee may thereafter be exercised, to the extent it was
exercisable at the time of such termination (or on such accelerated basis as the
Administrator shall determine at the time of grant), for a period of twelve
months (or such shorter period as the Administrator shall specify at grant) from
the date of such termination of employment or until the expiration of the stated
term of such Stock Option, whichever period is shorter; provided, however, that,
-------- -------
if the optionee dies
9
<PAGE>
within such twelve-month period (or such shorter period as the Administrator
shall specify at grant) and prior to the expiration of the stated term of such
Stock Option, any unexercised Stock Option held by such optionee shall
thereafter be exercisable to the extent to which it was exercisable at the time
of termination for a period of twelve months (or such shorter period as the
Administrator shall specify at grant) from the time of death or until the
expiration of the stated term of such Stock Option, whichever period is shorter.
In the event of a termination of employment by reason of Disability, if an
Incentive Stock Option is exercised after the expiration of the applicable
exercise periods under Section 422 of the Code, such Stock Option shall
thereafter be treated as a Non-Qualified Stock Option n.
(9) Other Termination. Except as otherwise determined by the
-----------------
Administrator, if an optionee's employment with the Company or any Subsidiary
terminates for any reason other than death or Disability, the Stock Option may
be exercised for a period of three months from the date of such termination, or
until the expiration of the stated term of such Stock Option, whichever period
is shorter.
(10) Annual Limit on Incentive Stock Options. To the extent that the
---------------------------------------
aggregate Fair Market Value (determined as of the date the Incentive Stock
Option is granted) of shares of Stock with respect to which Incentive Stock
Options granted to an Optionee under this Plan and all other option plans of the
Company, its Parent Corporation or any Subsidiary become exercisable for the
first time by the Optionee during any calendar year exceeds $100,000, such Stock
Options shall be treated as Non-Qualified Stock Options.
(11) DERs. The Administrator shall have the discretion to grant DERs
----
in conjunction with grants of Stock Options pursuant to this Section 5. DERs
may be granted in either of two forms, "Current-pay DERs" and "Accrued DERs" and
the Administrator may condition the payment or accrual of amounts in respect
thereof subject to satisfaction of such performance objectives as the
Administrator may specify at the time of grant. Assuming satisfaction of any
applicable conditions, Current-pay DERs shall be paid concurrently with any
dividends or distributions paid on the Stock during the time the related Stock
Options are outstanding in an amount equal to the cash dividend (or Stock or
other property hereby distributed) per share being paid on the Stock times the
number of shares subject to the related Stock Options. Current-pay DERs are
payable in cash, Stock or such other property in the same manner as may be
distributed to shareholders. Accrued DERs may be accrued in respect of cash
dividends only or cash dividends and the value of any Stock or other property
distributed to shareholders, as the Administrator shall determine at the time of
grant. Assuming satisfaction of any applicable conditions, Accrued DERs shall
be accrued with respect to the related Stock Options outstanding as of the date
dividends are declared on the Company's Stock in accordance with the following
formula:
(A x B) / C
under which "A" equals the number of shares subject to such Stock Options, "B"
equals the cash dividend per share or the value per share of the Stock or other
property being distributed, as the
10
<PAGE>
case may be, and "C" equals the Fair Market Value per share of Stock on the
dividend payment date. The Accrued DERs shall represent shares of Stock which
shall be issuable to the holder of the related Stock Option proportionately as
the holder exercises the Stock Option to which the Accrued DERs relate, rounded
down to the nearest whole number of shares. DERs shall expire upon the
expiration of the Stock Options to which they relate. The Administrator shall
specify at the time of grant whether dividends shall be payable or credited on
Accrued DERs. Notwithstanding anything to the contrary herein, Accrued DERs
granted with respect to Stock Options shall be accrued only to the extent of the
number of shares of stock then reserved and available for issuance under the
Plan in excess of the number of shares subject to issuance pursuant to
outstanding Stock Option, Accrued DER, Stock Appreciation Right, Limited Stock
Appreciation Right, Deferred Stock or Performance Share awards.
5A. STOCK OPTIONS FOR ELIGIBLE NON-EMPLOYEE DIRECTORS.
This Section 5A shall apply only to automatic grants of Stock Options
to Eligible Non-Employee Directors.
(1) Each Eligible Non-Employee Director shall automatically be granted,
upon becoming a director of the Company or any Subsidiary, a Non-
Qualified Stock Option to purchase 5,000 shares of Stock. In addition, on the
day after the annual meeting of stockholders of the Company to be held in the
calendar year 1997, and on the day after each annual stockholders' meeting of
the Company thereafter during the term of the Plan, each Eligible Non-Employee
Director of the Company shall be granted a Non-Qualified Stock Option to
purchase 2,500 shares of Stock, together with accrued DERs with respect to such
Non-Qualified Stock Option. The option price per share of Stock purchasable
under such Stock Option shall be 100% of the Fair Market Value on the date of
grant. Such Stock Option shall become exercisable as to 25% of the shares
subject to such Stock Option on the first anniversary of the date of grant of
the Stock Option, and as to an additional 25% of the shares subject to such
Stock Option on each of the next three anniversaries of the date of grant. To
the extent not exercised, installments shall accumulate and be exercisable in
whole or in part at any time after becoming exercisable but not later than the
date the Stock Option expires. Exercise shall be by payment in full of the
purchase price in cash and no stock option shall be exercisable more than ten
years after the date of grant. The aggregate number of shares of Stock that may
be granted to Eligible Non-Employee Directors pursuant to the Plan may not
exceed 150,000 shares.
(2) Eligible Non-Employee Directors who receive grants of Stock Options
shall enter into a stock option agreement with the Company, which agreement
shall set forth, among other things, the exercise price of the option, the term
of the option and provisions regarding exercisability of the option granted
thereunder. The Stock Options granted under this section shall be Non-Qualified
Stock Options.
(3) Non-Qualified Stock Options granted to Eligible Non-Employee Directors
hereunder shall be transferable only to the extent provided in Sections 5(6)(a)
and (b).
11
<PAGE>
(4) Accrued DERs shall be paid with respect to such Non-Qualified Stock
Options in accordance with the provisions of Section 5(11) above.
(5) The Board may not amend, alter or discontinue the provisions of this
Section 5A more than once every six months other than to comport with changes in
the Code, ERISA and the rules thereunder or the federal securities laws and the
rules thereunder.
6. STOCK APPRECIATION RIGHTS AND LIMITED STOCK APPRECIATION RIGHTS.
(1) Grant and Exercise. Stock Appreciation Rights and Limited Stock
------------------
Appreciation Rights may be granted either alone ("Free Standing Rights") or in
conjunction with all or part of any Stock Option granted under the Plan
("Related Rights"). In the case of a Non-Qualified Stock Option, Related Rights
may be granted either at or after the time of the grant of such Stock Option.
In the case of an Incentive Stock Option, Related Rights may be granted only at
the time of the grant of the Incentive Stock Option.
A Related Right or applicable portion thereof granted in conjunction
with a given Stock Option shall terminate and no longer be exercisable upon the
termination or exercise of the related Stock Option, except that, unless
otherwise provided by the Administrator at the time of grant, a Related Right
granted with respect to less than the full number of shares covered by a related
Stock Option shall only be reduced if and to the extent that the number of
shares covered by the exercise or termination of the related Stock Option
exceeds the number of shares not covered by the Stock Appreciation Right.
A Related Right may be exercised by an optionee, in accordance with
paragraph (2) of this Section 6, by surrendering the applicable portion of the
related Stock Option. Upon such exercise and surrender, the optionee shall be
entitled to receive an amount determined in the manner prescribed in paragraph
(2) of this Section 6. Stock Options which have been so surrendered, in whole
or in part, shall no longer be exercisable to the extent the Related Rights have
been so exercised.
(2) Terms and Conditions. Stock Appreciation Rights shall be subject
--------------------
to such terms and conditions, not inconsistent with the provisions of the Plan,
as shall be determined from time to time by the Administrator, including the
following:
(a) Stock Appreciation Rights that are Related Rights ("Related Stock
Appreciation Rights") shall be exercisable only at such time or times and to the
extent that the Stock Options to which they relate shall be exercisable in
accordance with the provisions of Section 5 and this Section 6; provided,
--------
however, that no Related Stock Appreciation Right shall be exercisable during
- -------
the first six months of its term, except that this additional limitation shall
not apply in the event of death or Disability of the optionee prior to the
expiration of such six-month period.
12
<PAGE>
(b) Upon the exercise of a Related Stock Appreciation Right, an
optionee shall be entitled to receive up to, but not more than, an amount in
cash or that number of shares of Stock (or in some combination of cash and
shares of Stock) equal in value to the excess of the Fair Market Value of one
share of Stock as of the date of exercise over the option price per share
specified in the related Stock Option multiplied by the number of shares of
Stock in respect of which the Related Stock Appreciation Right is being
exercised, with the Administrator having the right to determine the form of
payment.
(c) Related Stock Appreciation Rights shall be transferable or
exercisable only when and to the extent that the underlying Stock Option would
be transferable or exercisable under paragraph (6) of Section 5.
(d) Upon the exercise of a Related Stock Appreciation Right, the Stock
Option or part thereof to which such Related Stock Appreciation Right is related
shall be deemed to have been exercised for the purpose of the limitation set
forth in Section 3 on the number of shares of Stock to be issued under the Plan.
(e) A Related Stock Appreciation Right granted in connection with an
Incentive Stock Option may be exercised only if and when the Fair Market Value
of the Stock subject to the Incentive Stock Option exceeds the exercise price of
such Stock Option.
(f) Stock Appreciation Rights that are Free Standing Rights ("Free
Standing Stock Appreciation Rights") shall be exercisable at such time or times
and subject to such terms and conditions as shall be determined by the
Administrator at or after grant; provided, however, that no Free Standing Stock
-------- -------
Appreciation Right shall be exercisable during the first six months of its term,
except that this limitation shall not apply in the event of death or Disability
of the recipient of the Free Standing Stock Appreciation Right prior to the
expiration of such six-month period.
(g) The term of each Free Standing Stock Appreciation Right shall be
fixed by the Administrator, but no Free Standing Stock Appreciation Right shall
be exercisable more than ten years after the date such right is granted.
(h) Upon the exercise of a Free Standing Stock Appreciation Right, a
recipient shall be entitled to receive up to, but not more than, an amount in
cash or that number of shares of Stock (or any combination of cash or shares of
Stock) equal in value to the excess of the Fair Market Value of one share of
Stock as of the date of exercise over the price per share specified in the Free
Standing Stock Appreciation Right (which price shall be no less than 100% of the
Fair Market Value of the Stock on the date of grant) multiplied by the number of
shares of Stock with respect to which the right is being exercised, with the
Administrator having the right to determine the form of payment.
13
<PAGE>
(i) Free Standing Stock Appreciation Rights shall be transferable or
exercisable subject to the provisions governing the transferability and
exercisability of Stock Options set forth in paragraphs (3) and (6) of Section
5.
(j) In the event of the termination of an employee who has been
granted one or more Free Standing Stock Appreciation Rights, such rights shall
be exercisable to the same extent that a Stock Option would have been
exercisable in the event of the termination of the optionee.
(k) Limited Stock Appreciation Rights may only be exercised within the
30-day period following a "Change of Control" (as defined in Section 10 below),
and, with respect to Limited Stock Appreciation Rights that are Related Rights
("Related Limited Stock Appreciation Rights"), only to the extent that the Stock
Options to which they relate shall be exercisable in accordance with the
provisions of Section 5 and this Section 6; provided, however, that no Related
-------- -------
Limited Stock Appreciation Right shall be exercisable during the first six
months of its term, except that this additional limitation shall not apply in
the event of death or Disability of the optionee prior to the expiration of such
six-month period.
(l) Upon the exercise of a Limited Stock Appreciation Right, the
recipient shall be entitled to receive an amount in cash equal in value to the
excess of the "Change of Control Price" (as defined in Section 10) of one share
of Stock as of the date of exercise over (A) the option price per share
specified in the related Stock Option, or (B) in the case of a Limited Stock
Appreciation Right which is a Free Standing Stock Appreciation Right, the price
per share specified in the Free Standing Stock Appreciation Right, such excess
to be multiplied by the number of shares in respect of which the Limited Stock
Appreciation Right shall have been exercised.
(m) For the purpose of the limitation set forth in Section 3 on the
number of shares to be issued under the Plan, the grant or exercise of Free
Standing Stock Appreciation Rights shall be deemed to constitute the grant or
exercise, respectively, of Stock Options with respect to the number of shares of
Stock with respect to which such Free Standing Stock Appreciation Rights were so
granted or exercised.
7. RESTRICTED STOCK, DEFERRED STOCK AND PERFORMANCE SHARES.
(1) General. Restricted Stock, Deferred Stock or Performance Share
-------
awards may be issued either alone or in addition to other awards granted under
the Plan. The Administrator shall determine the Eligible Employees to whom, and
the time or times at which, grants of Restricted Stock, Deferred Stock or
Performance Share awards shall be made; the number of shares to be awarded; the
price, if any, to be paid by the recipient of Restricted Stock, Deferred Stock
or Performance Share awards; the Restricted Period (as defined in Section 7(3))
applicable to Restricted Stock or Deferred Stock awards; the performance
objectives applicable to Performance Share or Deferred Stock awards; the date or
dates on which restrictions applicable to such Restricted Stock or Deferred
Stock awards shall lapse during such Restricted Period; and
14
<PAGE>
all other conditions of the Restricted Stock, Deferred Stock and Performance
Share awards. The Administrator may also condition the grant of Restricted
Stock, Deferred Stock awards or Performance Shares upon the exercise of Stock
Options, or upon such other criteria as the Administrator may determine, in its
sole discretion. The provisions of Restricted Stock, Deferred Stock or
Performance Share awards need not be the same with respect to each recipient.
(2) Awards and Certificates. The prospective recipient of a Restricted
-----------------------
Stock, Deferred Stock or Performance Share award shall not have any rights with
respect to such award, unless and until such recipient has executed an agreement
evidencing the award (a "Restricted Stock Award Agreement," "Deferred Stock
Award Agreement," or "Performance Share Award Agreement," as appropriate) and
delivered a fully executed copy thereof to the Company, within a period of sixty
days (or such other period as the Administrator may specify) after the award
date. Except as otherwise provided below in this Section 7(2), (i) each
Participant who is awarded Restricted Stock or Performance Shares shall be
issued a stock certificate in respect of such shares of Restricted Stock or
Performance Shares; and (ii) such certificate shall be registered in the name of
the Participant, and shall bear an appropriate legend referring to the terms,
conditions, and restrictions applicable to such award, substantially in the
following form:
"The transferability of this certificate and the shares of stock represented
hereby are subject to the terms and conditions (including forfeiture) of the
NovaStar Financial, Inc. 1996 Executive and Non-Employee Director Stock Option
Plan and a Restricted Stock Award Agreement or Performance Share Award Agreement
entered into between the registered owner and NovaStar Financial, Inc. Copies
of such Plan and Agreement are on file in the offices of NovaStar Financial,
Inc."
The Company shall require that the stock certificates evidencing such
shares be held in the custody of the Company until the restrictions thereon
shall have lapsed, and that, as a condition of any Restricted Stock award or
Performance Share award, the Participant shall have delivered a stock power,
endorsed in blank, relating to the Stock covered by such award.
(3) Restrictions and Conditions. The Restricted Stock, Deferred Stock
---------------------------
and Performance Share awards granted pursuant to this Section 7 shall be subject
to the following restrictions and conditions:
(a) Subject to the provisions of the Plan and the Restricted Stock,
Deferred Stock or Performance Share award agreement, during such period as may
be set by the Administrator commencing on the grant date (the "Restricted
Period"), the Participant shall not be permitted to sell, transfer, pledge or
assign shares of Restricted Stock, Performance Shares or Deferred Stock awarded
under the Plan; provided, however, that the Administrator may, in its sole
-------- -------
discretion, provide for the lapse of such restrictions in installments and may
accelerate or waive such restrictions in whole or in part based on such factors
and such circumstances as the Administrator may determine, in its sole
discretion, including, but not limited to, the attainment
15
<PAGE>
of certain performance related goals, the Participant's termination, death or
Disability or the occurrence of a "Change of Control" as defined in Section 10.
(b) Except as provided in paragraph (3)(a) of this Section 7, the
Participant shall have, with respect to the shares of Restricted Stock or
Performance Shares, all of the rights of a stockholder of the Company, including
the right to vote the shares, and the right to receive any dividends thereon
during the Restricted Period. With respect to Deferred Stock awards, the
Participant shall generally not have the rights of a shareholder of the Company,
including the right to vote the shares during the Restricted Period; provided,
--------
however, that dividends declared during the Restricted Period with respect to
- -------
the number of shares covered by a Deferred Stock award shall be paid to the
Participant. Certificates for shares of unrestricted Stock shall be delivered
to the Participant promptly after, and only after, the Restricted Period shall
expire without forfeiture in respect of such shares covered by the award of
Restricted Stock, Performance Shares or Deferred Stock, except as the
Administrator, in its sole discretion, shall otherwise determine.
(c) Subject to the provisions of the Restricted Stock, Deferred Stock
or Performance Share award agreement and this Section 7, upon termination of
employment for any reason during the Restricted Period, all shares subject to
any restriction as of the date of such termination shall be forfeited by the
Participant, and the Participant shall only receive the amount, if any, paid by
the Participant for such Restricted Stock or Performance Shares, plus simple
interest on such amount at the rate of 8% per year.
8. AMENDMENT AND TERMINATION.
Subject to the provisions of Section 5A(5), the Board may amend, alter
or discontinue the Plan, but no amendment, alteration, or discontinuation shall
be made that would impair the rights of a Participant under any award
theretofore granted without such Participant's consent, or that without the
approval of the stockholders (as described below) would:
(1) except as provided in Section 3, increase the total number of shares
of Stock reserved for the purpose of the Plan;
(2) change the employees or class of employees eligible to participate
in the Plan; or
(3) extend the maximum option period under paragraph (2) of Section 5
of the Plan.
Notwithstanding the foregoing, stockholder approval under this Section
8 shall only be required at such time and under such circumstances as
stockholder approval would be required under (a) Rule 16b-3 of the Act with
respect to any material amendment to any employee benefit plan of the Company or
(b) Sections 162(m), 280G or 422 of the Code.
16
<PAGE>
The Administrator may amend the terms of any award theretofore
granted, prospectively or retroactively, but, subject to Section 3, no such
amendment shall impair the rights of any holder without his or her consent.
9. UNFUNDED STATUS OF PLAN.
The Plan is intended to constitute an "unfunded" plan for incentive
compensation. With respect to any payments not yet made to a Participant or
optionee by the Company, nothing contained herein shall give any such
Participant or optionee any rights that are greater than those of a general
creditor of the Company.
10. CHANGE OF CONTROL.
The following acceleration and valuation provisions shall apply in the
event of a "Change of Control" as defined in paragraph (2) of this Section 10:
(1) In the event of a "Change of Control," unless otherwise determined by
the Administrator or the Board in writing at or after grant (including under any
individual agreement), but prior to the occurrence of such Change of Control:
(a) any Stock Appreciation Rights outstanding for at least six months
and any Stock Options, including Stock Options granted under Section 5A, awarded
under the Plan not previously exercisable and vested shall become fully
exercisable and vested;
(b) the restrictions applicable to any Restricted Stock, Deferred
Stock or Performance Share awards under the Plan shall lapse, and such shares
and awards shall be deemed fully vested; and
(c) the value of all outstanding Stock Options (except Stock Options
granted under Section 5A), DERs (except DERs granted in conjunction with Stock
Options granted under Section 5A), Stock Appreciation Rights, Limited Stock
Appreciation Rights, and Restricted Stock, Deferred Stock and Performance Share
awards shall, to the extent determined by the Administrator at or after grant,
be cashed out by a payment in cash or other property, as the Administrator may
determine, on the basis of the "Change of Control Price" (as defined in
paragraph (3) of this Section 10) as of the date the Change of Control occurs or
such other date as the Administrator may determine prior to the Change of
Control.
(2) For purposes of paragraph (1) of this Section 10, a "Change of
Control" shall be deemed to have occurred if, at any time following an initial
public offering of Common Stock by the Company:
(a) any "person," as such term is used in Sections 13(d) and 14(d) of
the Act (other than the Company; any trustee or other fiduciary holding
securities under an employee benefit plan of the Company; or any company owned,
directly or indirectly, by the stockholders
17
<PAGE>
of the Company in substantially the same proportions as their ownership of Stock
of the Company) is or becomes after the Effective Date the "beneficial owner"
(as defined in Rule 13d-3 under the Act), directly or indirectly, of securities
of the Company (not including in the securities beneficially owned by such
person any securities acquired directly from the Company or its affiliates)
representing 25% or more of the combined voting power of the Company's then
outstanding securities; or
(b) during any period of two consecutive years (not including any
period prior to the Effective Date), individuals who at the beginning of such
period constitute the Board, and any new director (other than a director
designated by a person who has entered into an agreement with the Company to
effect a transaction described in clause (a), (c) or (d) of this Section 10(2))
whose election by the Board or nomination for election by the Company's
stockholders was approved by a vote of at least two-thirds (2/3) of the
directors then still in office who either were directors at the beginning of the
period or whose election or nomination for election was previously so approved,
cease for any reason to constitute at least a majority thereof; or
(c) the stockholders of the Company approve a merger or consolidation
of the Company with any other corporation, other than (A) a merger or
consolidation which would result in the voting securities of the Company
outstanding immediately prior thereto continuing to represent (either by
remaining outstanding or by being converted into voting securities of the
surviving entity), in combination with the ownership of any trustee or other
fiduciary holding securities under an employee benefit plan of the Company, at
least 75% of the combined voting power of the voting securities of the Company
or such surviving entity outstanding immediately after such merger or
consolidation or (B) a merger or consolidation effected to implement a
recapitalization of the Company (or similar transaction) in which no person
acquires more than 50% of the combined voting power of the Company's then
outstanding securities; or
(d) the stockholders of the Company approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by the
Company of all or substantially all of the Company's assets.
(3) For purposes of this Section 10, "Change of Control Price" means the
higher of (i) the highest price per share paid or offered in any transaction
related to a Change of Control of the Company or (ii) the highest price per
share paid in any transaction reported on the exchange or national market system
on which the Stock is listed, at any time during the preceding sixty day period
as determined by the Administrator, except that, in the case of Incentive Stock
Options and Stock Appreciation Rights or Limited Stock Appreciation Rights
relating to Incentive Stock Options, such price shall be based only on
transactions reported for the date on which the Administrator decides to cash
out such options.
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<PAGE>
11. GENERAL PROVISIONS.
(1) The Administrator may require each person purchasing shares pursuant
to a Stock Option to represent to and agree with the Company in writing that
such person is acquiring the shares without a view to distribution thereof. The
certificates for such shares may include any legend which the Administrator
deems appropriate to reflect any restrictions on transfer.
All certificates for shares of Stock delivered under the Plan shall be
subject to such stock-transfer orders and other restrictions as the
Administrator may deem advisable under the rules, regulations, and other
requirements of the Commission, any stock exchange upon which the Stock is then
listed, and any applicable federal or state securities law, and the
Administrator may cause a legend or legends to be placed on any such
certificates to make appropriate reference to such restrictions.
(2) Nothing contained in the Plan shall prevent the Board from adopting
other or additional compensation arrangements, subject to stockholder approval
if such approval is required; and such arrangements may be either generally
applicable or applicable only in specific cases. The adoption of the Plan shall
not confer upon any employee of the Company or any Subsidiary any right to
continued employment with the Company or a Subsidiary, as the case may be, nor
shall it interfere in any way with the right of the Company or a Subsidiary to
terminate the employment of any of its employees at any time.
(3) Each Participant shall, no later than the date as of which the value
of an award first becomes includable in the gross income of the Participant for
federal income tax purposes, pay to the Company, or make arrangements
satisfactory to the Administrator regarding payment of, any federal, state, or
local taxes of any kind required by law to be withheld with respect to the
award. The obligations of the Company under the Plan shall be conditional on the
making of such payments or arrangements, and the Company (and, where applicable,
its Subsidiaries) shall, to the extent permitted by law, have the right to
deduct any such taxes from any payment of any kind otherwise due to the
Participant.
(4) No member of the Board or the Administrator, nor any officer or
employee of the Company acting on behalf of the Board or the Administrator,
shall be personally liable for any action, determination, or interpretation
taken or made in good faith with respect to the Plan, and all members of the
Board or the Administrator and each and any officer or employee of the Company
acting on their behalf shall, to the extent permitted by law, be fully
indemnified and protected by the Company in respect of any such action,
determination or interpretation.
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12. EFFECTIVE DATE OF PLAN.
The Plan became effective (the "Effective Date") on October 10, 1996,
the date the Company's stockholders formally approved the Plan.
13. TERM OF PLAN.
No Stock Option, Stock Appreciation Right, Limited Stock Appreciation
Right, Restricted Stock, Deferred Stock or Performance Share award shall be
granted pursuant to the Plan on or after the tenth anniversary of the Effective
Date, but awards theretofore granted may extend beyond that date.
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EXHIBIT 10.15
INTERCOMPANY ADMINISTRATIVE SERVICES/OUTSOURCING AGREEMENT
THIS INTERCOMPANY ADMINISTRATIVE SERVICES/OUTSOURCING AGREEMENT, dated
as of June 30, 1997 (the "Agreement"), is made by and between NOVASTAR
FINANCIAL, INC., a Maryland corporation ("NovaStar"), and NOVASTAR MORTGAGE,
INC., a Virginia corporation ("Mortgage").
RECITALS
A. Mortgage is an indirect affiliate of Nova Star in that Mortgage is
a wholly owned subsidiary of NFI Holding Corporation (NFI).
NovaStar owns 100% of NFI's Series A (non-voting) Preferred Stock,
for which it receives 99% of NFI's economic benefits. NFI in turn
owns 100% of the outstanding capital stock of Mortgage.
B. NovaStar desires for Mortgage to provide and Mortgage is willing to
provide to NovaStar certain administrative services as described
herein, in each case on the terms and conditions set forth herein.
AGREEMENT
ACCORDINGLY, in consideration of the foregoing premises, the mutual
covenants and agreements set forth herein, and other good and valuable
consideration, the receipt and sufficiency of which is hereby acknowledged, the
parties hereto agree as follows:
1. Provision of Services. NovaStar may engage the services of Mortgage
with respect to, and upon the request of NovaStar, Mortgage will
perform, the Administrative Services described as Schedule 1
attached hereto, as well as other administrative services necessary
or appropriate to enable NovaStar to conduct its business.
2. No Limitations. There are no contractual limitations on Mortgage's
ability to perform any of the activities set forth in Schedule 1 on
its own behalf, nor on NovaStar's ability to utilize the staff and
resources of Mortgage for such activities, provided that NovaStar
pays Mortgage for services as provided herein. NovaStar shall be
responsible for determining those services it requires Mortgage to
perform and for notifying Mortgage of any special requirements with
regard to such services.
3. Compensation for Services. NovaStar shall reimburse Mortgage for
the costs and expenses incurred by Mortgage in furnishing or
obtaining any of the services provided for herein at rates mutually
agreed upon by an officer of each party. Such compensation for the
initial term to be as set forth on Schedule 2 attached hereto.
4. Payment Dates. Invoices for amounts due pursuant to paragraph 3
shall be rendered at least quarterly but not more often than
monthly. Any amounts due shall be paid, or shall be satisfied by
way of offset against any obligation of the parties to each other,
within thirty (30) days after receipt of the invoice.
5. Term. This Agreement shall have an initial term of six months from
the date hereof, terminating on December 31, 1997. After the
initial term it shall automatically renew on each anniversary date
for a one (1) year renewal term until either party gives the other
party at least three (3) months' prior written notice of its intent
to terminate this Agreement at the end of a renewal term.
6. Termination of Employees and Consultants. Mortgage shall have the
right to hire and terminate the employment or engagement of its own
employees and management consultants.
<PAGE>
7. Notices. All notices, requests, consents and other communications
hereunder shall be in writing and shall be deemed to have been duly
given or delivered if delivered personally or mailed by registered
or certified mail return receipt requested with first class postage
prepaid as follows:
If to Mortgage:
NovaStar Mortgage, Inc.
Lance Anderson, President & CEO
1900 W. 47/th/ Place, Suite 205
Westwood, KS 66205
If to NovaStar:
NovaStar Financial, Inc.
Scott Hartman, Chairman & CEO
1900 West 47/th/ Place, Suite 205
Westwood, KS 66205
or such other address as any person may request by notice given.
Notices sent as provided herein shall be deemed to have been
delivered on the fifth business day following the date on which it
is so mailed.
8. Governing Law. This agreement shall be governed by and construed
under the laws of the State of Maryland without regard to such
state's provisions pertaining to choice of law.
9. Amendment. This Agreement, including the Exhibits hereto and all
other agreements and documents executed in connection herewith,
constitutes the entire agreement among the parties hereto with
respect to the subject hereof and no amendment, alteration or
modification of the Agreement shall be valid unless in each
instance such amendment, alteration or modification is expressed in
a written instrument duly executed by each party hereto.
10. No Third Party Beneficiaries. Each of the provisions of this
Agreement is for the sole and exclusive benefit of the parties
hereto, respectively, as their interests shall appear, and shall
not be deemed to be for the benefit of any other person or entity
or group of persons or entities.
11. Successors and Assigns. This Agreement shall bind and inure to the
benefit of each party hereto, and to each party's successors,
assigns, agents and representatives.
12. Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall be deemed to be an original, but
all of which together shall constitute one and the same instrument.
IN WITNESS WHEREOF, the parties have entered into this Agreement as of
the date herein above written.
NOVASTAR FINANCIAL INC.
By:
-------------------------------
Name:
Title:
NOVASTAR MORTGAGE, INC.
----------------------------------
By:
-------------------------------
Name:
Title:
<PAGE>
EXHIBIT 10.16
SALE AND PURCHASE AGREEMENT
THIS Sale and Purchase Agreement (the "Agreement"), is made and entered into as
of _____________, 1997 by and between NovaStar Financial, Inc., ("Purchaser")
and NovaStar Mortgage, Inc. ("Seller").
WITNESSETH
WHEREAS, Seller is engaged in the business of originating and selling mortgage
loans secured by real property; and
WHEREAS, Seller may desire to sell and Purchaser may desire to purchase from
Seller from time to time certain of those mortgage loans; and
WHEREAS, the parties intend hereby to set forth the terms and conditions upon
which the transactions will be effected.
AGREEMENT
NOW, THEREFORE, in consideration of the promises and the mutual agreements
contained herein, the Purchaser and Seller agree as follows:
SECTION 1. Definitions. Whenever used herein, the following words and phrases,
-----------
unless the context otherwise requires, shall have the following meanings:
Acquisition Cost: Amount paid by Seller to acquire mortgage loans from its
customers through its wholesale production operation, either on a flow or bulk
basis.
Agreement: This Purchase and Sale Agreement and all amendments hereof and
supplements hereto.
Assignment of Security Instrument: Assignment of all Seller's rights, title and
interest in and to a Security Instrument for the benefit of Purchaser, in a form
acceptable to Purchaser, to be executed by Seller in connection with each
Mortgage Loan purchased hereunder, as applicable.
Custodian: First Union National Bank, or its successor in interest or assigns,
or any successor to the Custodian.
Document Delivery Procedures: Procedures established by Purchaser for the
delivery of Loan Documents evidencing Loans to be purchased hereunder, attached
hereto as Exhibit "B", as may be amended from time to time by Purchaser in its
sole discretion.
Mortgage Loans: Each Mortgage Loan identified in the Schedule of Loans Delivered
that, from time to time, are subject to this Agreement.
Mortgage Loan Documents: For any Mortgage Loan, at least the documents listed on
Exhibit "B" hereto, as well as any other documents in Seller's possession
relating to the Mortgage Loan.
Mortgaged Premises: The fee simple interest in real property for each Mortgage
Loan purchased which shall consist only of real property improved by one-to-four
family residences, covered by a Security Instrument and securing an Obligor's
indebtedness under the related Note.
Note: Instrument evidencing the indebtedness of the Obligor under a Mortgage
Loan.
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Obligor: The borrower or borrowers under a Note, any other person or entity who
owes payments under a Note, or a subsequent owner of Mortgaged Premises who has
assumed the respective Security Instrument.
Purchase Date: The funding date for the purchase of Mortgage Loans hereunder as
agreed to by the parties in writing on the Schedule of Loans Delivered.
Schedule of Loans Delivered: A listing of Mortgage Loans to be sold to
Purchaser, that at a minimum includes the loan number, borrower name, and loan
amount, and such other pertinent information that Purchaser deems reasonably
necessary in the circumstances, and that is also readily available to Seller.
Security Instrument: All deeds of trust, deeds to secure debt, trust deeds or
mortgages, as applicable securing repayment of the indebtedness evidenced by a
Note executed by an Obligor for a Mortgage Loan purchased hereunder, as
applicable.
Servicing Transfer Date: The date for the transfer of servicing of Mortgage
Loans from Seller to Purchaser as agreed to by the parties in writing on the
Schedule of Loans Delivered. Unless otherwise agreed to in writing, the
Servicing Transfer Date will be the Purchase Date.
SECTION 2. Agreement to Sell and Purchase.
------------------------------
(a) Pursuant to the terms of this Agreement, Seller hereby agrees to sell,
transfer, assign, set over and convey to the Purchaser, subject to the terms
of this Agreement, all rights, title and interest of the Seller in and to
the Mortgage Loans and the Purchaser hereby agrees to purchase the Mortgage
Loans listed on the Schedule of Mortgage Loans Delivered.
(b) The Purchase Price paid by Purchaser to Seller for Mortgage Loans shall be
as follows:
The Acquisition Cost for the Mortgage Loans plus a percentage of the unpaid
principal balance of the Mortgage Loans delivered to the Purchaser under
this Agreement. Such percentage will be agreed to by an officer of both
Seller and Purchaser and may change based on the nature of Mortgage Loans
being purchased. The Purchase Price will be presented to the Board of
Directors of both Seller and Purchaser at their regularly scheduled meetings
for review and approval. Acquisition Cost for Mortgage Loans will be
determined by Seller and communicated at least weekly to Purchaser in
writing via its wholesale rate sheet. An officer of the Purchaser must
approve any variations to the Acquisition Cost as published in writing.
Purchaser hereby agrees to purchase Mortgage Loans, at the agreed upon
Purchase Price, on the date the Seller commits to purchase the loan from its
customer. Purchaser also agrees to pay the Purchase Price in full at the
applicable Purchase Date for such Mortgage Loan, or reimburse the Seller for
interest cost incurred related to such Mortgage Loans.
(c) Unless otherwise agreed to by the parties hereto, the sale of Mortgage Loans
hereof shall be made on a "servicing released" basis and shall constitute a
transfer by Seller to Purchaser of all rights of every kind with respect to
the servicing of each Mortgage Loan. Unless otherwise agreed to by both
parties hereto, this transfer of servicing rights to Purchaser will be
effective as of the Servicing Transfer Date.
(d) Unless otherwise agreed to by the parties hereto, the amount of Mortgage
Loans to be acquired by Purchaser from Seller is limited to $1 billion
annually.
SECTION 2.1. Assignment of Servicing. Seller hereby assigns and releases all
-----------------------
servicing rights and responsibilities including without limitation, all rights
to receive servicing fees and other servicing-related income and benefits, with
respect to each Mortgage Loan purchased under this Agreement to and for the
benefit of Purchaser, as of the Servicing Transfer Date.
SECTION 2.2. Interim Servicing. Notwithstanding anything to the contrary
-----------------
contained in this Agreement, to the extent that the actual servicing of any
Mortgage Loan can not be transferred on the Purchase Date due to the
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<PAGE>
requirements governing the timing of notice of transfer of servicing under the
Real Estate Settlement Procedures Act and Regulation X thereunder, or as
otherwise agreed by the Seller and the Purchaser, Seller shall service such
Mortgage Loans as a subservicer on behalf and for the benefit of Purchaser
pursuant to the terms and conditions of this Section 2.2. Seller shall service
such Mortgage Loans from and after the Purchase Date until the Servicing
Transfer Date in compliance with reasonable and customary servicing practices
and procedures of prudent loan servicers that service Mortgage Loans similar to
the Mortgage Loans. Within three business days after the Servicing Transfer
Date, Seller shall remit to Purchaser, by wire, all amounts received by Seller
prior to and including the Servicing Transfer Date, (including without
limitation monies received or held in reserve for the payment of taxes,
insurance premiums or other charges in connection with the Mortgage Loan, plus
interest thereon) together with the following: (a) a summary of remittances; (b)
a trial balance of Mortgage Loans, (c) a monthly collection report, and (d) as
appropriate, arrears and prepayment reports.
SECTION 2.3. Relationship between Purchaser and Seller. Seller is acting as an
-----------------------------------------
independent contractor and not as an agent of the Company for purposes of
purchasing Mortgage Loans and selling such Mortgage Loans to Purchaser.
Purchaser and Seller are not partners or joint venturers with each other and
nothing herein shall be construed to make them such partners or joint venturers
or impose any liability as such on either of them. In that regard, this
Agreement is not intended to be an exclusive arrangement. Unless otherwise
agreed to by both parties, nothing herein shall prevent Seller from engaging in
other businesses or from rendering other services of any kind to any other
person or entity, including the sale of its Mortgage Loans, or the servicing of
loans. In the event that Purchaser seeks a commitment from Seller to acquire all
of Seller's mortgage loan production for some period of time, Seller must
receive approval from it's Board of Directors and receive appropriate
compensation for such a commitment.
SECTION 2.4. Term of Agreement. This Agreement will automatically terminate on
-----------------
December 31, 1997, unless both Purchaser and Seller agree in writing to extend
the Agreement, after receiving approval by their respective Board of Directors.
SECTION 3. Delivery of Documents and Other Information. Seller will deliver
-------------------------------------------
to the Custodian the Mortgage Loan Documents and upon receipt by Seller of the
Purchase Price, Seller will instruct the Custodian to release the Mortgage Loan
Documents to Purchaser.
SECTION 4. Representations and Warranties of the Seller with Respect to
------------------------------------------------------------
Authority and Other Matters. Seller hereby makes as of the Purchase Date the
- ---------------------------
following representations and warranties:
(a) Seller has not dealt with any broker or agent or other parties who might be
entitled to a fee or commission in connection with this transaction other
than Purchaser or its affiliates;
(b) Seller is a corporation duly organized, validly existing and in good
standing under the laws of the State of Virginia with full corporate power
necessary to carry on its business as now being conducted; Seller has the
full corporate power and authority to execute and deliver this Agreement and
to perform in accordance herewith; the execution, delivery and performance
of this Agreement (including all instruments of transfer to be delivered
pursuant to this Agreement) by the Seller and the consummation of the
transactions contemplated hereby have been duly and validly authorized; this
Agreement evidences the valid, binding and enforceable obligation of the
Seller, and all requisite corporate action has been taken by the Seller to
make this Agreement valid and binding upon the Seller in accordance with its
terms;
(c) The consummation of the transactions contemplated by this Agreement is in
the ordinary course of business of the Seller, and the transfer, assignment
and conveyance of all documents by the Seller pursuant to this Agreement are
not subject to the bulk transfer or any similar statutory provision in
effect in any applicable jurisdiction;
(d) Neither the execution and delivery of this Agreement, the sale of Mortgage
Loans to the Purchaser, or the transactions contemplated hereby, nor the
fulfillment of or compliance with the terms and conditions of this
Agreement, will conflict with or result in a breach of any of the terms,
conditions or provisions of the
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<PAGE>
Seller's charter or by-laws or any legal restriction or any material
agreement or instrument to which the Seller is now a party or by which it is
bound, or constitute a default or result in an acceleration under any of the
foregoing, or result in the violation of any law, rule, regulation, order,
judgment or decree to which the Seller or its property is subject, or impair
the ability of the Purchaser to realize on the Mortgage Loans, or impair the
value of the Mortgage Loans;
(e) There is no action, suit, proceeding or investigation pending, or to the
Seller's knowledge threatened against the Seller that, either in any one
instance or in the aggregate, may result in any material adverse change in
the business, operations, financial condition, properties or assets of the
Seller, or in any material impairment of the right or ability of the Seller
to carry on its business substantially as now conducted, or in any material
liability on the part of the Seller, or that would draw into question the
validity of this Agreement or the Mortgage Loans or of any action taken or
to be taken in connection with the obligations of the Seller contemplated
herein, or that would be likely to impair materially the ability of the
Seller to perform under the terms of this Agreement;
(f) No consent, approval, authorization or order of any court or governmental
agency is required for the execution, delivery and performance by the
Seller, or compliance by the Seller, with this Agreement or the sale of the
Mortgage Loans as evidenced by the consummation of the transactions
contemplated by this Agreement, or if required, such approval has been
obtained prior to the Purchase Date. However, Seller's participation in this
Agreement will be approved by its Board of Directors;
(g) Seller used no adverse selection procedures in selecting the Mortgage Loans
from among the outstanding mortgage loans in its portfolio as to which
representations and warranties in this Section of the Agreement could be
made;
(h) Seller will treat the disposition of the Mortgage Loans as a sale of assets
for financial accounting and reporting purposes;
(i) Seller is the sole owner of, and has the full right to sell to the
Purchaser, all rights with respect to the servicing of the Mortgage Loans
following the Purchase Date;
(j) Seller will not solicit any of the borrowers listed on the Schedule of Loans
Delivered in order to refinance their mortgage loan without prior written
approval from the Purchaser; and
(k) Seller hereby warrants that it is compliance with all applicable licensing
requirements of federal, state, and local governmental authorities,
including, without limitation, any such requirements in the jurisdictions in
which each Mortgaged Premises is located.
SECTION 4.1 Representations and Warranties of the Seller Regarding Individual
-----------------------------------------------------------------
Mortgage Loans. Seller hereby represents and warrants to Purchaser with respect
- --------------
to each Mortgage Loan that, as of the Purchase Date thereof:
(a) The information set forth on the Schedule of Loans Delivered is complete,
true and correct in all material respects.
(b) All policies of title insurance, hazard insurance, and flood insurance
respecting such Mortgage Loan and the related premises and improvements
thereon are in full force and effect, have been fully paid and have been
issued by sound and financially responsible insurance companies, duly
licensed and qualified to transact business, and are in such amounts as are
reasonably required by Purchaser or as required by law. All such policies
insure Seller, among others, as loss payee thereunder, in a form such that
it may be endorsed to Purchaser as loss payee as required hereunder, and
there are no facts or circumstances which could provide a basis for
revocation of any policies or defense to any claims made thereon. If such
Property is located in a flood area identified by the Federal Emergency
Management Agency ("FEMA") pursuant to the National Flood Insurance Act of
1968, as amended, (the "Act") a flood insurance policy issued by
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<PAGE>
FEMA, or one conforming to the requirements of the Federal Housing
Administration, has been obtained and complies with this Subsection (b) and
the Act.
(c) The Mortgage Loan is secured by a valid, existing and enforceable lien on
the Mortgaged Premises, including improvements with respect to the
foregoing. The Security Instrument is subject only to the lien of (a)
current real property taxes and assessments, (b) covenants, conditions and
restrictions, rights of way, easements and other matters of public record as
of the date of recording acceptable to mortgage lending institutions
generally and specifically referred to in the title insurance policy and
which do not adversely affect the appraised value of the Mortgaged Premises
set forth in such appraisal; and (c) other matters to which like properties
are commonly subject which do not materially interfere with the benefits of
the security intended to be provided by the Security Instrument or the use,
enjoyment, value or marketability of the related Mortgaged Premises;
(d) The Note and the Security Instrument are genuine, and each is the legal,
valid and binding obligation of the maker thereof enforceable in accordance
with its terms subject to bankruptcy, reorganization or other similar laws.
All parties to the Note and the Security instrument had legal capacity to
enter into the Mortgage Loan and to execute and deliver the Note and the
Security Instrument, and the Note and the Security Instrument have been duly
and properly executed by such parties;
(e) The terms of the Note and the Security instrument have not been impaired,
waived, altered or modified in any respect, except by a written instrument
which has been recorded, if necessary to protect the interest of the
Purchaser and which has been delivered to the Custodian. The substance of
any such waiver has been approved by the issuer of any related Primary
Mortgage Insurance Policy and the title insurer, to the extent required by
the policy, and its terms are reflected on the Schedule of Loans Delivered.
No borrower has been released, in whole or in part, except in connection
with an assumption agreement approved by the issuer of any related Primary
Mortgage Insurance Policy and the title insurer, to the extent required by
the policy, and which assumption agreement is part of the Mortgage Loan
Documents delivered to the Custodian and the terms of which are reflected in
the Schedule of Loans Delivered.
(f) The Mortgage Loan is not subject to any right of rescission, set-off,
counterclaim or defense, including without limitation the defense of usury,
nor will the operation of any of the terms of the Note or the Security
Instrument, or the exercise of any right thereunder, render either the Note
or the Security instrument unenforceable, in whole or in part, or subject to
any right of rescission, set-off, counterclaim or defense, including without
limitation the defense of usury, and no such right of rescission, set-off,
counterclaim or defense has been asserted with respect thereto;
(g) There are no defaults in complying with the terms of the Security
Instruments, and all taxes, governmental assessments, insurance premiums,
water, sewer and municipal charges, leasehold payments or ground rents which
previously became due and owing have been paid, or an escrow of funds has
been established in an amount sufficient to pay for every such item which
remains unpaid and which has been assessed but is not yet due and payable.
The Seller has not advanced funds, or induced, solicited or knowingly
received any advance of funds by a party other than the borrower, directly
or indirectly, for the payment of any amount required under the Mortgage
Loan, except for interest accruing from the date of the Note or date of
disbursement of the Mortgage Loan proceeds, whichever is later;
(h) Requirements of any federal, state or local law including, without
limitation, usury, truth-in-lending, real estate settlement procedures,
consumer credit protection, equal credit opportunity or disclosure laws
applicable to the Mortgage Loan have been complied with in all material
respects;
(i) The Security Instrument has not been satisfied, canceled, subordinated or
rescinded in whole or in part, and the Mortgaged Premises has not been
released from the lien of the Security Instrument, in whole or in part, nor
has any instrument been executed that would effect any such release,
cancellation, subordination or rescission;
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(j) The proceeds of the Mortgage Loan have been fully disbursed and there is no
requirement for future advances thereunder, and any and all requirements as
to completion of any on-site or off-site improvement and disbursements of
any escrow funds thereof have been complied with. All costs, fees and
expenses incurred in making or closing the Mortgage Loan and the recording
of the Security Instrument were paid, and the Borrower is not entitled to
any refund of any amounts paid or due under the Note or Security Instrument;
(k) Seller is the sole owner of the Mortgage Loan and there has not been any
other sale or assignment thereof. The related Note and Security Instrument
delivered to Purchaser are the only executed copies thereof.
(l) There is no default, breach, violation or event of acceleration existing
under the Security Instrument or the Note and no event which, with the
passage of time or with notice and the expiration of any grace or cure
period, would constitute a default, breach, violation or event of
acceleration, and neither the Seller nor its predecessors have waived any
default, breach, violation or event of acceleration;
(m) There are no mechanics' liens or claims which have been filed for work,
labor or material affecting the Mortgaged Premises which are or may be liens
prior to or equal to the lien of the related Security Instrument;
(n) There is no proceeding pending for total or partial condemnation of the
related Mortgaged Premises or any part thereof and such Mortgaged Premises
are free of material damage. No improvement encumbered by such Mortgage Loan
is in violation of any applicable zoning law or regulation, building code or
any valid restrictive or protective covenant or setback line. No improvement
on such Mortgaged Premises is a mobile home or manufactured home unless
specifically approved by Purchaser in writing prior to purchase;
(o) The Mortgage Loan was underwritten generally in accordance with the
underwriting guidelines of the Seller as presented to the Purchaser;
(p) The related Security Instrument contains customary and enforceable
provisions such as to render the rights and remedies of the holder thereof
adequate for the realization against the related Mortgaged Premises of the
benefits of the security provided thereby, including: (a) in the case of a
Security Instrument designated as a deed of trust, by trustee's sale; and
(b) otherwise by judicial foreclosure. In the event that such Security
Instrument constitutes a deed of trust, a trustee, duly qualified under
applicable law to serve as such, has been properly designated and currently
so serves, and is named in the Security Instrument or has been substituted
in accordance with applicable law and no fees or expenses will become
payable by Purchaser to such trustee under the deed of trust, except in
connection with a trustee's sale after default by the Obligor;
(q) The origination and collection practices used with respect to the Mortgage
Loan have been in all respects legal, proper, prudent and customary in the
mortgage origination and servicing business, and have been in all respects
in compliance with all applicable laws and regulations. With respect to
escrow deposits and escrow payments, all such payments are in the possession
of the Seller and there exist no deficiencies in connection therewith for
which customary arrangement for repayment thereof have not been made. All
escrow payments have been calculated and collected in full compliance with
state and federal law;
(r) Such Mortgage Loan does not fall within the coverage of Section 103(aa) of
the Truth-in-Lending Act, as amended, nor Section 226.32 of Federal Reserve
Board Reg Z, as amended, which govern certain mortgages commonly known as
"high cost mortgages" or "Section 32 loans";
(s) The Mortgage Premises is free from any and all toxic or hazardous
substances, and there exists no violation of any local, state or federal
environmental law, rule or regulation; and
(t) No prepayment penalty, as set forth in the terms of the Note and Security
instrument, has been waived or limited before or after an interest rate
change date.
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SECTION 5. Representations and Warranties of the Purchaser. The Purchaser
-----------------------------------------------
hereby makes as of the Purchase Date the following representations and
warranties:
(a) Purchaser is acquiring Mortgage Loans for its own account only and not for
any other person;
(b) The Purchaser considers itself a substantial, sophisticated institutional
investor having such knowledge and experience in financial and business
matters that it is capable of evaluating the merits and risks of investment
in the Mortgage Loans;
(c) The Purchaser is a corporation duly organized, validly existing and in good
standing under the laws of the State of Maryland with full corporate power
necessary to carry on its business as now being conducted; the Purchaser has
the full corporate power and authority to execute and deliver this Agreement
and to perform in accordance herewith; the execution, delivery and
performance of this Agreement by the Purchaser and the consummation of the
transactions contemplated hereby have been duly and validly authorized; this
Agreement evidences the valid, binding and enforceable obligation of the
Purchaser, and all requisite corporate action has been taken by the
Purchaser to make this Agreement valid and binding upon the Purchaser in
accordance with its terms;
(d) The consummation of the transactions contemplated by this Agreement is in
the ordinary course of business of the Purchaser;
(e) Neither the execution and delivery of this Agreement, the acquisition of the
Mortgage Loans by the Purchaser or the transactions contemplated hereby, nor
the fulfillment of or compliance with the terms and conditions of this
Agreement, will conflict with or result in a breach of any of the terms,
conditions or provisions of the Purchaser's charter or by-laws or any legal
restriction or any material agreement or instrument to which the Purchaser
is now a party or by which it is bound, or constitute a default or result in
an acceleration under any of the foregoing, or result in the violation of
any law, rule, regulation, order, judgment or decree to which the Purchaser
or its property is subject;
(f) There is no action, suit, proceeding or investigation pending, or to the
Purchaser's knowledge threatened against the Purchaser that, either in any
one instance or in the aggregate, may result in any material adverse change
in the business, operations, financial condition, properties or assets of
the Purchaser, or in any material impairment of the right or ability of the
Purchaser to carry on its business substantially as now conducted, or result
in any material liability on the part of the Purchaser, or that would draw
into question the validity of this Agreement or the Mortgage Loans or of any
action taken or to be taken in connection with the obligations of the
Purchaser contemplated herein, or that would be likely to impair materially
the ability of the Purchaser to perform under the terms of this Agreement;
and
(g) No consent, approval, authorization or order of any court or governmental
agency or body is required for the execution, delivery and performance by
the Purchaser of or compliance by the Purchaser with this Agreement, or the
acquisition of the Mortgage Loans as evidenced by the consummation of the
transactions contemplated by this Agreement, or if required, such approval
has been obtained prior to the Purchase Date. However, Purchaser's
participation in this Agreement will be approved by its Board of Directors.
SECTION 6. Remedies. In the event that a party discovers a breach of a
--------
representation and warranty set forth in Section 4, Section 4.1 or Section 5
that materially and adversely affects the value of any of the Mortgage Loans or
the interest of the Purchaser therein, such party shall give prompt notice to
the other parties hereto. The party in breach shall have 60 days, after receipt
of notice of such breach, in which to cure in all material respects such breach.
In the event that the Seller is unable to cure in all material respects a breach
of a representation and warranty set forth in Section 4 or Section 4.1 as to any
Mortgage Loans, then the Seller shall promptly repurchase each affected Mortgage
Loan at a price equal to the unpaid principal balance of such
7
<PAGE>
Mortgage Loan plus accrued and unpaid interest thereon at the gross coupon rate
through the date of repurchase (the Repurchase Date). In the event that the
Seller repurchases a Mortgage Loan such Mortgage Loan will be returned to the
Seller.
As an additional remedy, the Seller shall indemnify the Purchaser and
hold it harmless against any losses, damages, penalties, fines, forfeitures,
reasonable and necessary legal fees and related costs, judgments and other costs
and expenses arising out of or resulting from any claim, demand, defense or
assertion based on or grounded upon, or resulting from, (a) a breach by the
Seller of any of its covenants, representation or warranties contained in this
Agreement or (b) the servicing of any Mortgage Loan prior to the transfer of
servicing.
The Purchaser shall indemnify the Seller and hold it harmless against
any losses, damages, penalties, fines, forfeiture, reasonable and necessary
legal fees and related costs, judgments and other costs and expenses arising out
of or resulting from any claim, demand, defense or assertion based on or
grounded upon, or resulting from, (a) a breach by the Purchaser of any of its
covenants, representations or warranties contained in this Agreement or (b) the
servicing of any Mortgage Loan following the transfer of servicing.
SECTION 7. Successor and Assigns. This Agreement shall bind and inure to the
---------------------
benefit of and be enforceable by the Seller and the Purchaser and the respective
successors and assigns of the Seller and the Purchaser. This Agreement shall not
be assigned, pledged or hypothecated by the Seller to a third party without the
consent of the Purchaser or the successors and assigns of the Purchaser which
shall not be unreasonably withheld or delayed.
SECTION 8. Conditions to Closing. The obligations of the Seller and the
---------------------
Purchaser to consummate the sale and purchase of the Mortgage Loans on the
Purchase Date are subject to the satisfaction of the following conditions:
(a) All representations and warranties of Seller and Purchaser under this
Agreement shall be true and correct as of the Purchase Date, and no event
shall have occurred that, with notice or the passage of time, would
constitute a default under this Agreement;
(b) All Mortgage Loan Documents shall have been delivered to the Custodian; and
(c) All other terms and conditions of this Agreement shall have been complied
with in all material respects.
Subject to the foregoing conditions, Purchaser shall pay the Purchase
Price to Seller on the Purchase Date by wire transfer of immediately available
funds to the account designated by Seller.
SECTION 9. Costs. Seller shall pay any commissions due its salesmen, the
-----
legal fees and expenses of its attorneys, and fees incurred in connection with
the transfer of the Mortgage Loan Documents to the Custodian. Seller shall
prepare the Assignment of Security Instrument and pay all recording fees with
respect to the transfer of each Mortgage Loan to Purchaser or its designee.
8
<PAGE>
SECTION 10. Notices. All demands, notices and communication hereunder shall
-------
be in writing and shall be deemed to have been duly given when mailed by
registered or certified mail, return receipt requested at the address listed
below or at such other address as may hereafter be furnished to the other party
by like notice. Any such demand, notice or communication hereunder shall be
deemed to have been received on the date delivered to or received at the
premises of the addressee as follows: if to Purchaser: NovaStar Financial, Inc.
1900 W. 47th Place, Suite 205, Westwood, KS 66205 Attn: Chairman, and if to
Seller: NovaStar Mortgage, Inc. 15707 Rockfield Blvd., Suite 320, Irvine, CA
92618 Attn: President.
SECTION 11. Severability Clause. Any part, provision, representation or
-------------------
warranty of this Agreement that is prohibited or that is held to be void or
unenforceable shall be ineffective to the extent of such prohibition or
unenforceability without invalidating the remaining provisions.
SECTION 12. Counterparts. This Agreement may be executed simultaneously in
------------
any number of counterparts. Each counterpart shall be deemed to be an original,
and all such counterparts shall constitute one and the same instrument.
SECTION 13. Governing Law. This Agreement shall be governed by, and construed
-------------
in accordance with, the laws of the State of Kansas.
SECTION 14. Waivers. No term or provision of this Agreement may be waived or
-------
modified unless such waiver or modification is in writing and signed by the
party against whom such waiver or modification is sought to be enforced.
SECTION 15. Exhibits. The exhibits to this Agreement are hereby incorporated
--------
and made a part hereof and are an integral part of this Agreement.
SECTION 16. Survival. This Agreement, and the representations and warranties
--------
contained herein, shall survive the Purchase and shall not merge into the
purchase documents.
SECTION 17. Amendment. This Agreement may only be amended with the written
---------
consent of both Seller and Purchaser.
IN WITNESS WHEREOF, the Seller and the Purchaser have caused their names to be
signed hereto by their respective officers thereunto duly authorized as of the
date first above written.
NovaStar Financial, Inc.
By:
------------------
Name:
------------------
Title:
------------------
NovaStar Mortgage, Inc.
By:
------------------
Name:
------------------
Title:
------------------
9
<PAGE>
EXHIBIT "B"
List of Mortgage Loan Documents
and Delivery Procedures
Required Mortgage Loan Documents
- --------------------------------
(1) Original Note bearing all intervening endorsements and (if applicable) the
original recorded assumption agreement, together with the original of any
surety agreement or guaranty agreement relating to the Note or any such
assumption agreement, endorsed in blank.
(2) Buy-down Agreement (if applicable)
(3) Security Instrument (including any required addenda and riders) consisting
of either the recorded original or a certified copy of the original if the
Security Instrument is unavailable because it is in the process of being
recorded or the original in a form suitable for recording;
(4) Originals or certified copies of any intervening Assignment of the Security
Instrument;
(5) Original unrecorded Assignment of the Security Instrument in blank;
(6) An original Title Insurance Policy; if any such policy has not been issued,
a written commitment for such policy (or a copy thereof) issued by the title
insurance company or a binder or Preliminary Title Report if the Mortgaged
Premises is located in California.
(7) Credit file - the same file used by NovaStar during its underwriting of the
Mortgage Loan.
(8) Servicer file - to be delivered with the transfer of servicing.
Delivery Instructions
- ---------------------
Mortgage Loans must be delivered to:
NovaStar Financial, Inc.
15707 Rockfield Blvd
Suite 320
Irvine, CA 92618
10
<PAGE>
EXHIBIT 10.17
FLOW LOAN SUBSERVICING AGREEMENT-MSTR
-------------------------------------
THIS FLOW LOAN SUBSERVICING AGREEMENT (the "Agreement") entered into as of the
_______ day of __________, 1997, by and between NovaStar Financial, Inc. a
Maryland corporation ("NovaStar Financial" or "NovaStar") and NovaStar Mortgage,
Inc., a Virginia corporation ("Servicer").
WITNESSETH
----------
WHEREAS, NovaStar intends to acquire from time to time certain
adjustable-rate mortgage loans having the characteristics described on
Schedule 1 attached hereto (the "Mortgage Loans"); and
WHEREAS, NovaStar shall from time to time securitize the Mortgage Loans
through the issuance of privately issued mortgage-backed securities; and
WHEREAS, NovaStar desires to engage Servicer as an independent contractor
to perform as subservicer all servicing functions related to all of the Mortgage
Loans, and Servicer desires to accept such engagement pursuant to the terms and
conditions hereinafter set forth.
NOW, THEREFORE, for and in consideration of the mutual covenants and
agreements herein and for the other good and valuable consideration, the receipt
and sufficiency of which are hereby acknowledged, NovaStar and Servicer agree as
follows:
SECTION 1. DEFINITIONS.
-----------
For purposes of this Agreement and any amendments hereto:
(a) "Business Day": Any day other than a Saturday, Sunday, or other day
on which banking institutions in either the State of Maryland or Virginia are
required or authorized by law or executive order to be closed.
(b) "Investors": The equitable owners of Mortgage Loans, i.e., either
NovaStar or an affiliate, or the holder of those securities issued by NovaStar
(or an affiliate) that are backed by the Mortgage Loans.
(c) "Guide": The Seller/Servicer Guide of Servicer and any amendments
thereto. A current copy of the Guide is in the possession of each party.
Whereever the Guide refers to "NovaStar Mortgage, Inc." or the "Master
Servicer," such terms will mean "NovaStar" for purposes of this Agreement only.
(d) "Loan Files": All loan documentation, files and records, including
records on microfiche or its equivalent, relating to the Mortgage Loans,
reasonably required by Servicer to document and service each Mortgage Loan,
including but not limited to the documents described in Schedule 1 hereto.
(e) "Mortgage Loans": Those mortgage loans meeting the criteria
described in Section 2.
(f) "Mortgagor": The obligor(s) on a Mortgage Loan.
(g) "Records": Includes, but is not limited to, work files, individual
accounts, books, documents, files, correspondence, related information or data
of any kind relating to the Mortgage Loans.
(h) "Related Escrow Accounts": Mortgage escrow/impound account maintained
in accordance with the Guide in connection with the Mortgage Loans.
<PAGE>
SECTION 2. MORTGAGE LOAN CRITERIA.
----------------------
(a) Unless otherwise agreed to by the parties, each Mortgage Loan
serviced hereunder shall be secured by a valid first lien on existing single-
family (1-4 units) residential properties, shall meet all of the underwriting
and other criteria established by the Guide.
(b) If NovaStar wishes Servicer to service or subservice any mortgage
loan which does not meet all of the above criteria, it shall separately
negotiate the terms of such servicing or subservicing (including appropriate
compensation) with Servicer.
SECTION 3. RELATIONSHIP OF NOVASTAR FINANCIAL AND SERVICER.
-----------------------------------------------
(a) NovaStar Financial and Servicer hereby acknowledge that Servicer is
an affiliate of NovaStar. However, under the terms of this Agreement, both
parties hereby agree that in performing its duties and obligations hereunder,
Servicer is acting as an independent contractor and not as an agent of NovaStar
and nothing herein shall be construed to create a partnership or joint venture
between NovaStar and Servicer.
(b) Nothing herein shall be construed as a warranty or guaranty of
Servicer as to future payments by any Mortgagor.
SECTION 4. COMMENCEMENT OF SERVICER'S SERVICING DUTIES:
--------------------------------------------
OBLIGATION OF NOVASTAR FINANCIAL.
--------------------------------
(a) During the term of the Agreement, NovaStar shall provide Servicer
at least one Business Day notice of its intent to deliver any Mortgage Loans to
Servicer pursuant to this Agreement. Promptly following such notification,
NovaStar shall deliver to Servicer an Initial Loan File relating to such
Mortgage Loan and wire transfer to Servicer's designated depository the amount
of the Related Escrow Accounts. Upon receipt of each Initial Loan File and the
Related Escrow Accounts, Servicer shall begin to service the related Mortgage
Loans.
(b) Servicer shall initially service each Mortgage Loan on behalf of
NovaStar Financial as the owner of such Mortgage Loan. At such time as NovaStar
notifies Servicer that the Mortgage Loan has been securitized and the securities
sold to Investors, this Agreement shall be replaced with, and Servicer shall
subservice the Mortgage Loans on behalf of the Investors as designated by
NovaStar. Except as provided in the Agreement to the contrary, all servicing or
subservicing hereunder shall be in accordance with the Guide.
(c) NovaStar Financial shall deliver the remaining Loan Files to
Servicer pertaining to each Mortgage Loan at such time and in such manner as may
be prescribed by Servicer. NovaStar agrees that it shall cooperate with Servicer
in providing any approvals, authorizations or documents, or any other assistance
reasonably needed by Servicer to effectively service the Mortgage Loans.
(d) On or before April 30 of each year that this Agreement is in
effect, Servicer shall deliver to NovaStar audited financial statements as of
December 31 of the prior calendar year which fairly present the financial
position of Servicer as of such December 31, in conformity with generally
accepted accounting principles applied on a consistent basis, except as
otherwise noted therein.
(e) Whenever the Guide is amended, NovaStar Financial shall promptly
send notice of such amendment to Servicer. In the event that such amendment
requires a material change in the manner that Servicer subservices the Mortgage
Loans hereunder, NovaStar Financial shall allow Servicer sufficient time to make
the changes required by the amendment, and shall compensate Servicer for such
out-of-pocket costs and administrative expenses reasonably incurred by Servicer
to effect such change.
SECTION 5. SERVICING ACTIVITIES.
--------------------
Page 2
<PAGE>
During the term of this Agreement:
(a) Servicer shall observe and perform all material covenants,
undertakings, obligations, representations and warranties required to be
observed or performed pursuant to the Guide including, where permissible and
appropriate, acting on behalf of and in the name of NovaStar Financial, as
appropriate, provided, however, that notwithstanding any provisions in this
Agreement to the contrary, NovaStar and not Servicer shall perform any
responsibilities under the Guide which, by their terms, must be performed by
NovaStar and not Servicer. Servicer shall at all times service the Mortgage
Loans in accordance with applicable federal and state statutes and regulations,
contractual provisions, the Guide and generally accepted prudent mortgage
banking practices. NovaStar agrees that unless it provides Servicer with written
instructions, Servicer shall have complete discretion (subject to the terms of
the Guide) with respect to the manner of servicing the Mortgage Loans, including
but not limited to the exercise of discretion with respect to the assessment or
waiver of late charges, the acceptance or rejection of partial payments, and the
time to sue for foreclosure. However, Servicer shall allow assumptions only upon
the written approval of NovaStar.
(b) Servicer shall on behalf of NovaStar Financial use reasonable
efforts to collect all payments due from the Mortgagors under the Mortgage Loans
as they become due, including but not limited to (i) principal, (ii) interest,
(iii) amounts for hazard insurance premiums, payments with regard to prior
liens, taxes, legal fees, foreclosure costs, and other miscellaneous advances
and monthly escrow and impound payments, as well as repayments of amounts
advanced on behalf of Mortgagors for such items, (iv) late charges, (v)
extension fees, (vi) bad check charges, and (vii) insurance premiums for
mortgage life and disability insurance, such efforts to include but not be
limited to the specific duties set forth herein.
(c) All appropriate deposits into and remittances from escrow/impound
accounts shall be made in accordance with Section 6 hereof.
(d) Servicer shall remit to NovaStar Financial or its designee, in
accordance with the terms and conditions of the Guide, payments of principal and
interest received in connection with each Mortgage Loan no later than (i) the
fifteenth (15th) and (ii) the last day of the month of receipt; and shall make
any necessary deposits to or withdrawals from the Related Escrow Accounts.
(e) Servicer shall keep and maintain a complete and accurate account
reasonably satisfactory to NovaStar Financial of all funds collected and paid
relating to the Mortgage Loans. NovaStar Financial or persons authorized by
NovaStar may, at NovaStar's expense, during or after the term of this Agreement,
reasonably audit all or any part of Servicer's performance hereunder.
(f) Servicer shall not solicit or cause to be solicited any prepayment
of all or any part of the Mortgage Loans, and Servicer shall process all
assumptions and modifications of Mortgage Loans in accordance with applicable
provisions of the Guide and the written consent of NovaStar Financial.
Page 3
<PAGE>
(g) Servicer will give representatives of NovaStar Financial full
access, during normal business hours, to the books, records, agreements and
other documents of Servicer relating to the Mortgage Loans serviced pursuant to
this Agreement or to Servicer's servicing procedures, and will furnish such
representatives with such other information and data concerning the affairs of
Servicer as NovaStar may reasonably request. Servicer also shall facilitate the
furnishing to NovaStar Financial of computer reports containing information
regarding the Mortgage Loans subserviced pursuant to this agreement, which shall
be limited to those reports outlined in Section 5 of this Agreement, unless
otherwise agreed to by the parties.
(h) During the term of this Agreement, Servicer shall prepare and
deliver all reports relating to the Mortgage Loans to NovaStar Financial that
are required pursuant to the Guide. All such reports shall be timely delivered
by Servicer to NovaStar Financial or its designee.
(i) Servicer shall maintain the Records in accordance with the Guide.
(j) Servicer shall be responsible for maintaining adequate hazard
insurance and for safeguarding NovaStar Financial's interest in the real estate
underlying the Mortgage Loans and NovaStar's rights under the Mortgage Loans,
all in accordance with the Guide.
(k) Servicer shall to the extent practicable, secure any premises found
to be vacant or abandoned, and advise NovaStar of the status thereof.
(l) Servicer shall advise NovaStar in writing with respect to requests
for partial releases, easements, divisions, subordinations, alterations, or
waivers of security instrument terms.
(m) Servicer shall advise NovaStar of any change of which it is aware
in the ownership of the security property.
(n) In the event that the record owner of a Mortgage Loan requires that
such Mortgage Loan be repurchased, NovaStar Financial at its own expense shall
promptly repurchase such Mortgage Loan.
SECTION 6. RELATED ESCROW ACCOUNTS.
-----------------------
(a) During the term of this Agreement, with respect to each Mortgage
Loan hereunder, Servicer shall continue to maintain each Related Escrow Account
as required pursuant to the terms of the Guide, and applicable federal and state
laws. Servicer shall prepare an escrow analysis for each Mortgage Loan in
accordance with the Guide and federal and state requirements on an annual basis,
and send such analysis to the Mortgagors.
(b) During the term of this Agreement, the Related Escrow Accounts
shall be held in a depository institution selected by NovaStar Financial,
provided, however, that the Related Escrow Accounts must at all times be on
deposit in an institution that meets the requirements of the Guide. NovaStar
shall be responsible for all costs of maintaining the Related Escrow Accounts,
including the obligation to pay interest thereon.
(c) On each Business Day during the term of this Agreement, Servicer
shall deposit in the appropriate escrow account all collections received by it
with respect to the Mortgage Loans. Servicer shall be responsible (subject to
reimbursement) for all advances required in connection with the various
escrow/impound accounts, and shall be responsible for prompt payment of all
taxes, assessments, and other public charges, hazard insurance premiums, private
mortgage insurance premiums and premiums for fire, windstorm and flood insurance
policies and related fees and charges during the term of this Agreement. If
adequate funds are not held in the Related Escrow Accounts to pay, when due,
assessments, real estate taxes, or insurance premiums, or similar charges on any
property securing a Mortgage Loan, Servicer shall advance sufficient funds to
cover any such deficiency in a manner to ensure payment of such taxes or
insurance premiums before delinquency. Servicer shall make all reasonable
efforts to collect deficiencies from Mortgagors.
Page 4
<PAGE>
(d) On or before the fifth (5th) Business Day of each month, Servicer
shall prepare and submit to NovaStar Financial a report listing all advances,
servicing fees, property inspection costs and third party foreclosure-related
costs and expenses for the preceding month for which Servicer seeks
reimbursement. NovaStar Financial shall reimburse Servicer for such amounts
within five (5) Business Days after receipt of such Servicer report. Upon
request, Servicer shall provide NovaStar Financial with reasonable documentation
in support of its request.
SECTION 7. DELINQUENT OR DEFAULTED MORTGAGE LOANS.
--------------------------------------
(a) Servicer shall inspect properties within 30 days from when the
Mortgagor is 90 days or more delinquent in the payment of any obligation under
the respective Mortgage Loan, and perform such other inspections as required by
the Guide.
(b) Servicer shall promptly notify NovaStar Financial whenever it
receives notice or otherwise becomes aware of any notice of liens, bankruptcies,
condemnations, probate proceedings, tax sales, partitions, local ordinance
violations, seizure of drug dealer property, condemnations or proceedings in
eminent domain that would, in Servicer's judgement, impair NovaStar Financial's
security; and Servicer shall assist NovaStar Financial in undertaking
appropriate action to preserve its security.
(c) Servicer shall promptly take all reasonable actions with regard to
delinquent payments under Mortgage Loans serviced pursuant to this Agreement,
and the collection of any applicable mortgage insurance, as required under the
Guide, by applicable private mortgage insurers, or NovaStar Financial, and,
pending completion of such steps, Servicer shall use all reasonable efforts to
protect such property from waste and vandalism.
(d) Servicer shall perform with respect to the Mortgage Loans all
foreclosure activities, in addition to those specified herein, as may be
required by the Guide or NovaStar Financial, and in accordance with the Guide
and applicable federal and state law.
(e) In the event that foreclosure proceedings are instituted then
Servicer, from the date of commencement of such proceedings until the
termination thereof and the conveyance of title following foreclosure, shall
manage and protect the mortgaged premises under foreclosure in such a manner and
to such an extent as is customary for the proper management and care of such
property in the locality thereof, including without limitation managing and
supervising repairs and maintenance of the premises, and Servicer shall render
to NovaStar Financial customary reports and such other reports as NovaStar
Financial may reasonably request, all in accordance with the Guide and
applicable laws and regulations.
SECTION 8. COMPENSATION.
------------
(a) In consideration of the services provided by Servicer hereunder,
NovaStar Financial shall pay to Servicer a servicing fee and other amounts, as
set forth in this Section 8. Servicer will carry out all of its obligations
hereunder at its own expense, except as otherwise specifically provided herein.
(b) The servicing fee to be paid hereunder shall be Nine Dollars
($9.00) per Mortgage Loan per month (or part thereof), plus all ancillary
income. For purposes of this Agreement, ancillary income shall include all fees
collected from or on behalf of Mortgagors, including but not limited to late
fees and assumption fees; and any administrative fees or other income received
in connection with mortgage life or disability insurance policies.
Page 5
<PAGE>
(c) In addition to the servicing fee set forth in Section 8(b) above,
Servicer shall be entitled to reimbursement of all advances, property inspection
costs and third party foreclosure-related costs and expenses incurred in
connection with this Agreement. Servicer shall also be entitled to receive One
Hundred Fifty Dollars ($150) (payable out of the proceeds of liquidation) for
administering and managing real estate owned property.
(d) If a significant proportion of the Mortgage Loans serviced by
Servicer becomes delinquent, then the parties agree that they shall negotiate in
good faith as to whether Servicer should receive additional compensation to
reflect its increased workload.
SECTION 9. INSURANCE.
---------
At all times while this Agreement is in force, Servicer and NovaStar
Financial each shall maintain at its own expense policies of fidelity, theft,
forgery and errors and omissions insurance in amounts as required to maintain
Servicer and NovaStar Financial, respectively, in good standing under all
applicable laws and requirements of the Guide.
SECTION 10. REPRESENTATIONS OF SERVICER.
---------------------------
Servicer hereby represents and warrants to and covenants with NovaStar
Financial (such representation and warranties to be true and correct throughout
the term of this Agreement) as follows:
(a) Servicer is a Virginia corporation, validly existing and in good
standing under the laws of the Commonwealth of Virginia. Servicer is qualified
or registered to transact business in each jurisdiction in which the ownership
of property or the conduct of its business requires such qualifications or
registration (except where the failure so to qualify or register would not have
a material adverse effect upon the business of Servicer taken as a whole). To
the extent the Servicer is not qualified or registered to transact business in
each jurisdiction in which the property securing the Mortgage Loans is located
and such qualification or registration is required, the Servicer hereby
represents and warrants to NovaStar Financial that the Servicer will file to
become so qualified or registered on a timely basis.
(b) Servicer has the power, authority and legal right to enter into and
perform under this Agreement and to perform the obligations required of it
hereunder, and this Agreement and any document or instrument to be delivered to
NovaStar Financial by Servicer pursuant hereto has been duly authorized,
executed and delivered.
(c) This Agreement and any documents or instruments now or hereafter
executed and delivered to NovaStar Financial by Servicer pursuant to this
Agreement constitute (or shall, when delivered to NovaStar Financial by
Servicer, constitute) valid and legally binding obligations of Servicer
enforceable against Servicer in accordance with their respective terms (except
as may be limited by or subject to (i) any bankruptcy, insolvency,
reorganization, moratorium or other laws affecting creditors' rights generally,
and (ii) general principles of equity (regardless of whether such enforceability
is considered in a proceeding in equity or at law)).
(d) The consummation of the transactions contemplated by this Agreement
will not result, in any material respect (i) in the breach of any term or
provision of, or conflict with or constitute a default under or result in the
acceleration of any obligation under, any agreement, indenture or loan or credit
agreement or other instrument to which Servicer or its property is subject, or
(ii) result in the violation of any law, rule, regulation, order, judgement or
decree to which Servicer or its property is subject.
SECTION 11. REPRESENTATIONS OF NOVASTAR FINANCIAL.
-------------------------------------
NovaStar hereby represents and warrants to and covenants with Servicer (such
representations and warranties to be true and correct throughout the term of
this agreement) as follows:
Page 6
<PAGE>
(a) NovaStar Financial is a Maryland corporation, validly existing and
in good standing under the laws of the State of Maryland. NovaStar Financial is
duly licensed and qualified in each jurisdiction where the property subject to
each Mortgage Loan serviced pursuant to this Agreement is located if the laws of
such state require licensing or qualification in order to service or subservice
such Mortgage Loan.
(b) NovaStar Financial has the power, authority and legal right to
enter into and perform under this Agreement, and this Agreement and any document
or instrument to be delivered by NovaStar to Servicer pursuant hereto has been
duly authorized, executed and delivered.
(c) This Agreement and any documents or instruments now or hereafter
executed or delivered to Servicer by NovaStar Financial pursuant to this
Agreement constitute (or shall, when delivered to Servicer by NovaStar,
constitute) valid and legally binding obligations of NovaStar enforceable
against NovaStar in accordance with their respective terms (except as may be
limited by or subject to (i) any bankruptcy, insolvency, reorganization,
moratorium or other laws affecting creditors, rights generally and (ii) general
principles of equity (regardless of whether such enforceability is considered in
a proceeding in equity or at law)).
(d) The consummation of the transactions contemplated by this Agreement
will not result, in any material respect, (i) in the breach of any term or
provision of, or conflict with or constitute a default under or result in the
acceleration of any obligation under, any agreement, indenture or loan or credit
agreement or other instrument to which NovaStar Financial or its property is
subject, or (ii) result in the violation of any law, rule, regulation, order,
judgement or decree to which NovaStar or its property is subject.
(e) For so long as Servicer subservices any Mortgage Loan hereunder,
NovaStar Financial shall be the owner of the servicing rights to such Mortgage
Loan.
SECTION 12. INDEMNIFICATION.
---------------
(a) Servicer shall indemnify and hold NovaStar Financial harmless from
any and all material losses, costs, damages and expenses (including but not
limited to reasonable attorneys' fees) incurred by NovaStar which result from
material errors or omissions by Servicer in subservicing any Mortgage Loan
subserviced pursuant to this Agreement.
(b) NovaStar Financial shall indemnify and hold Servicer harmless from
any and all losses, costs, damages and expenses (including but not limited to
reasonable attorneys' fees) incurred by Servicer which result from (i) from
subservicing the Mortgage Loans, including but not limited to foreclosure losses
(if not fully reimbursed by a private mortgage insurer), and any penalties and
interest imposed by an Investor or insurer (unless the fault was solely
attributable to Servicer), but not including Servicer's own expenses; (ii) the
material non-fulfillment by NovaStar of any covenant or condition contained in
this Agreement, the Guide or agreements with private mortgage insurers, or in
any schedule, written statement, document or certificate furnished by NovaStar
pursuant to this Agreement; (iii) any materials misrepresentation made by
NovaStar in this Agreement or in any schedule, written statement, document or
certificate furnished to Servicer by NovaStar pursuant to this Agreement, (iv)
any action undertaken by Servicer which if undertaken by NovaStar would result
in indemnification under the guide, and (v) any claim by a Mortgagor which does
not relate to Servicer's servicing of the Mortgage Loans. This indemnity shall
be in addition to (but not exclusive of) any other indemnities set forth in this
Agreement and any other remedies, including without limitation monetary damages
to which Servicer may be entitled by law, the guide or this Agreement. It is
expressly understood and agreed by the parties that, notwithstanding Servicer's
obligations to make advances hereunder, all out-of-pocket losses, foreclosure
losses and repurchase obligations are the sole responsibility of NovaStar
Financial.
(c) The right to indemnification set forth in this Section 12 shall
survive the execution and termination of this Agreement.
SECTION 13. TERMINATION.
-----------
Page 7
<PAGE>
(a) The term of this Agreement shall be two (2) years from the date
hereof, unless terminated sooner (in whole or in part) pursuant to this Section
13, and unless one of the parties provides six (6) months notice of termination
prior to the termination of such term or any subsequent term, this Agreement
shall automatically be renewed on a year-to-year basis.
(b) NovaStar Financial may terminate this Agreement at any time without
cause with respect to one or more of the Mortgage Loans upon providing Servicer
with sixty (60) days prior written notice and paying to Servicer, at the time of
such notice, a termination fee in an amount equal to Twenty Dollars ($20) for
each Mortgage Loan to which such notice applies. In addition, in the event that
NovaStar Financial intends to sell the servicing rights with respect to one or
more Mortgage Loans to a third party servicer, NovaStar Financial shall give
Servicer reasonable prior notice of such intention and Servicer shall be
entitled to bid for the right to purchase such servicing, provided such bid is
given within a reasonable period.
(c) NovaStar Financial may terminate this Agreement with "cause" by
providing Servicer with thirty (30) days prior written notice stating such cause
(unless, within such thirty day notice period, Servicer shall demonstrate to the
satisfaction of NovaStar that there is no "cause" for such termination), and
without payment of any termination fee or compensation for such termination. For
this purpose "cause" shall include only (i) material errors or omissions in
servicing the Mortgage Loans, (ii) the bankruptcy or insolvency of Servicer; or
(iii) material misrepresentations of Servicer hereunder which result in material
damage to NovaStar Financial.
(d) Servicer may terminate this Agreement with respect to one or more
Mortgage Loans at any time by providing NovaStar Financial with one hundred and
eighty (180) days prior written notice. If Servicer terminates this Agreement
with respect to a substantial portion or identifiable segment of the Mortgage
Loans and it gives written notice to NovaStar that such termination is a result
of a material increase in the cost of subservicing such Mortgage Loans (e.g.,
----
because there are excessive delinquencies), then such termination shall be
without payment of any termination fee. In all other cases, Servicer shall
reimburse NovaStar for its out-of-pocket costs of transferring each terminated
Mortgage Loan, up to a maximum reimbursement of Twenty Dollars ($20) per
terminated Mortgage Loan.
(e) Upon termination, subject to obtaining necessary consents of any
Investors, Servicer shall comply immediately with NovaStar Financial's
reasonable instructions to transfer to NovaStar (or its designee) all books,
records and other documents related to servicing the Mortgage Loans for which
the servicing has been terminated pursuant to this Section 13. Upon receipt of a
termination notice hereunder, Servicer shall promptly take such steps and
execute such documents, agreements and powers of attorney as are reasonably
necessary to facilitate such termination of this Agreement and/or the servicing
hereunder has been terminated.
SECTION 14. DISPUTE RESOLUTION.
------------------
In the event that a dispute arises between Servicer and NovaStar Financial with
respect to any matter arising hereunder, Servicer and NovaStar Financial agree
to submit the matter to binding arbitration. Within thirty (30) days of notice
given by either party describing the points at issue and requesting arbitration
(the "Notice"), each party shall appoint an arbitrator by giving written notice
thereof to the other. If one of the parties shall fail to appoint an arbitrator
within such thirty (30) day period, then the arbitrator selected shall arbitrate
the dispute. The determination of the arbitrator(s) shall be final and binding
on the parties. The parties shall within twenty (20) days of the appointment of
a single or the third arbitrator proceed to present their case to the
arbitrator(s) selected, in accordance with the rules of the American Arbitration
Association. The fees of the arbitrator(s) shall be paid by the non-prevailing
party (i.e., as determined by the arbitrator(s), the party whose position at the
----
time of submission to the arbitrator(s) least resembles the award).
SECTION 15. MISCELLANEOUS.
-------------
Page 8
<PAGE>
(a) The parties agree that each shall, at its own expense, at any time
and from time to time after the date hereof, upon the other's request, do,
execute, acknowledge and deliver all such further acts, assignments, transfers
conveyances and assurances as may be required or reasonably advisable for the
transactions provided for or contemplated by this Agreement.
(b) All notices, consents and other communications pertaining to this
Agreement shall be in writing and shall be deemed to be properly given or sent
when received by the addressee or, if mailed, 48 hours after being mailed,
prepaid, registered or certified mail, return receipt requested, addressed as
follows:
If to NovaStar Financial:
NovaStar Financial, Inc.
1900 West 47/th/ Place
Suite 205
Westwood, Kansas 66205
Telephone No. 913-362-1090
Fax No. 913-362-1011
If to Servicer:
NovaStar Mortgage, Inc.
15707 Rockfield Boulevard
Suite 320
Irvine, California 92618
Telephone No. 714-829-8734
Fax No. 714-829-8737
(c) This Agreement shall be binding upon and insure to the benefit of
the parties hereto and their respective successors and assigns.
(d) In the event of a conflict between the terms of this Agreement and
the terms of the Guide, the terms of this Agreement shall prevail.
(e) This Agreement is not assignable by the parties hereto, and no
assignment or other transfer, hypothecation or encumbrance thereof by any party
shall confer any rights in any other person without the prior written approval
of the other party.
(f) This Agreement contains the entire agreement between the parties
hereto and supersedes all prior and contemporaneous agreements, understandings
and discussions, whether written or oral, between the parties relating to the
transactions contemplated herein. This Agreement cannot be modified in any way
except by written agreement signed by the parties.
(g) Except as otherwise provided for herein, neither any failure not
any delay on the part of the parties hereto in exercising any right, power or
privilege hereunder shall operate as a waiver thereof, nor shall a single or
partial exercise thereof preclude any other or further exercise or the exercise
of any other right, power, or privilege.
(h) This Agreement may be executed in any number of counterparts, each
of which shall be deemed an original.
(i) All headings used in this Agreement are for reference purposes only
and shall not be deemed to have any substantive effect.
(j) All words used herein denoting the singular number only shall
include the plural and vice versa.
Page 9
<PAGE>
(k) This Agreement shall be governed, construed and enforced in
accordance with the laws of the State of Maryland.
IN WITNESS WHEREOF, the parties have executed this Flow Loan Subservicing
Agreement as of the date and year written above.
NOVASTAR FINANCIAL, INC.
By:
-------------------------
Name:
-----------------------
Title:
----------------------
"SERVICER"
NOVASTAR MORTGAGE, INC.
By:
-------------------------
Name:
-----------------------
Title:
----------------------
Page 10
<PAGE>
EXHIBIT 23-4
INDEPENDENT AUDITORS' CONSENT
We consent to the use of our report on the consolidated financial statements
of NovaStar Financial, Inc. and subsidiary as of June 30, 1997 and December
31, 1996 and for the six months ended June 30, 1997 and the period from
September 13, 1996 (inception) to December 31, 1996 included herein and to the
reference to our firm under the heading "Experts" in the prospectus.
KPMG Peat Marwick LLP
Kansas City, Missouri
July 29, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF NOVASTAR FINANCIAL, INC. AS OF JUNE
30, 1997 AND DECEMBER 31, 1996, AND FOR THE SIX MONTHS ENDED JUNE 30, 1997
AND THE PERIOD FROM SEPTEMBER 13, 1996 (INCEPTION) TO DECEMBER 31, 1997,
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR 6-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1997
<PERIOD-START> SEP-19-1996 JAN-01-1997
<PERIOD-END> DEC-31-1996 JUN-30-1997
<CASH> 46,434 874
<SECURITIES> 13,239 284,348
<RECEIVABLES> 0 304,450
<ALLOWANCES> 0 718
<INVENTORY> 0 0
<CURRENT-ASSETS> 0 0
<PP&E> 0 0
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 59,796 601,741
<CURRENT-LIABILITIES> 0 0
<BONDS> 0 0
0 0
36 36
<COMMON> 2 2
<OTHER-SE> 46,327 46,299
<TOTAL-LIABILITY-AND-EQUITY> 59,796 601,741
<SALES> 155 9,320
<TOTAL-REVENUES> 155 9,533
<CGS> 0 0
<TOTAL-COSTS> 457 10,412
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 (718)
<INTEREST-EXPENSE> 0 6,438
<INCOME-PRETAX> (302) (879)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (302) (879)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (302) (879)
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0 0
</TABLE>
