<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________.
Commission File Number: 001-13533
NovaStar Financial, Inc.
------------------------
(Exact name of registrant as specified in its charter)
Maryland 74-2830661
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1901 W. 47th Place, Suite 105, Westwood, KS 66205
-------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(913) 362-1090
--------------
(Registrant's telephone number, including area code)
----------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
The number of shares of the registrant's common stock outstanding as of November
10, 1998 was 8,127,314.
<PAGE>
NOVASTAR FINANCIAL, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 1998
INDEX
<TABLE>
<CAPTION>
Page
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements:
Balance Sheets................................................. 1
Statements of Operations....................................... 2
Statements of Cash Flows....................................... 3
Notes.......................................................... 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 6
PART II OTHER INFORMATION
Item 1. Legal Proceedings............................................... 31
Item 2. Changes in Securities........................................... 31
Item 3. Defaults Upon Senior Securities................................. 31
Item 4. Submission of Matters to a Vote of Security Holders............. 31
Item 5. Other Information............................................... 31
Item 6. Exhibits and Reports on Form 8-K................................ 31
Signatures...................................................... 32
</TABLE>
<PAGE>
NOVASTAR FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share amounts)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
(unaudited)
<S> <C> <C>
Assets
Cash and cash equivalents...................................... $ -- $ --
Restricted cash................................................ 55,383 20,424
Mortgage loans................................................. 944,228 574,984
Available-for-sale securities:
Mortgage securities........................................... 390,276 517,246
Other......................................................... 18,000 --
Accrued interest receivable.................................... 11,046 7,088
Investment in NFI Holding Corporation.......................... (409) 2,188
Due from NFI Holding Corporation............................... 259,312 --
Other assets................................................... 15,489 4,322
---------- ----------
Total assets.............................................. $1,693,325 $1,126,252
========== ==========
Liabilities and Stockholders' Equity
Liabilities:
Collateralized mortgage obligations........................... $ 948,590 $ 408,867
Repurchase agreements......................................... 579,697 556,443
Warehouse line of credit...................................... 46,779 40,250
Accounts payable and accrued expenses......................... 8,411 4,203
---------- ----------
Total liabilities......................................... 1,583,477 1,009,763
Stockholders' equity:
Capital stock, $0.01 par value, 50,000,000
shares authorized:
Common stock, 8,127,314 and 7,828,665
shares issued and outstanding, respectively................ 81 78
Additional paid-in capital.................................... 121,358 117,084
Accumulated deficit........................................... (5,416) (2,859)
Accumulated other comprehensive income (deficit).............. (4,777) 4,353
Forgivable notes receivable from founders..................... (1,398) (2,167)
---------- ----------
Total stockholders' equity............................... 109,848 116,489
---------- ----------
Total liabilities and stockholders' equity.................. $1,693,325 $1,126,252
========== ==========
</TABLE>
See notes to consolidated financial statements.
1
<PAGE>
NOVASTAR FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Nine Months Ended For the Three Months
September 30, Ended September 30,
-------------------------- ---------------------------
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Interest income:
Mortgage loans.............................................. $56,274 $14,749 $22,312 $ 7,670
Mortgage securities......................................... 22,881 6,796 6,485 4,555
------- ------- ------- -------
Total interest income........................................ 79,155 21,545 28,797 12,225
Interest expense............................................. 60,948 16,224 22,088 9,786
------- ------- ------- -------
Net interest income.......................................... 18,207 5,321 6,709 2,439
Provision for credit losses.................................. 3,400 1,444 1,179 726
------- ------- ------- -------
Net interest income after provision for credit losses........ 14,807 3,877 5,530 1,713
Fees from NovaStar Mortgage, Inc............................. 3,766 -- 3,349 --
Other income................................................. 2,012 326 919 259
Equity in earnings (loss) of NFI Holding Corporation......... (2,455) (141) (2,446) 290
General and administrative expenses:
Services provided by NovaStar Mortgage, Inc................. 5,700 2,450 2,100 1,200
Loan servicing.............................................. 3,163 694 1,547 123
Compensation and benefits................................... 1,374 701 478 332
Forgiveness of notes receivable from founders............... 812 -- 270 --
Office administration....................................... 681 201 276 89
Professional and outside services........................... 649 430 296 181
Other....................................................... 184 288 (9) 160
------- ------- ------- -------
Total general and administrative expenses................. 12,563 4,764 4,958 2,085
------- ------- ------- -------
Net income (loss)............................................ $ 5,567 $ (702) $ 2,394 $ 177
======= ======= ======= =======
Basic earnings per share..................................... $ 0.69 $ (0.19) $ 0.29 $ 0.05
======= ======= ======= =======
Diluted earnings per share................................... $ 0.64 $ (0.19) $ 0.29 $ 0.05
======= ======= ======= =======
Dividends declared per share................................. $ 1.00 $ 0.18 $ 0.35 $ 0.08
======= ======= ======= =======
Basic weighted average shares outstanding.................... 8,033 3,767 8,124 3,767
======= ======= ======= =======
Diluted weighted average shares outstanding.................. 8,639 3,767 8,157 3,804
======= ======= ======= =======
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
NOVASTAR FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
-------------------------
1998 1997
<S> <C> <C>
Net cash provided by operating activities $ 4,191 $ 3,281
Cash flow from investing activities:
Mortgage loans purchased from NovaStar Mortgage, Inc............... (510,267) (229,364)
Mortgage loans sold to others...................................... 7,933 --
Mortgage loans purchased from others............................... -- (219,995)
Mortgage loan repayments........................................... 125,818 27,402
Purchases of available-for-sale securities......................... (375,051) (380,820)
Proceeds from sales of available-for-sale securities............... 323,631 99,794
Proceeds from paydowns on and maturities of available-for-sale
securities....................................................... 150,018 22,506
Settlement of amounts payable to brokers........................... -- (12,676)
Net change in amounts due from NFI Holding Corporation............. (259,035) 5,861
Investment in NFI Holding Corporation.............................. -- (1,980)
--------- ---------
Net cash used in investing activities.............................. (536,953) (689,272)
Cash flow from financing activities:
Net change in restricted cash...................................... (34,959) --
Proceeds from issuing collateralized mortgage obligations.......... 665,000 --
Payments on collateralized mortgage obligations.................... (125,277) --
Net borrowings under repurchase agreements and warehouse line...... 29,783 644,195
Exercise of stock options and warrants............................. 4,365 --
Registration costs of stock options and warrants................... (88) --
Additional private placement offering costs........................ -- (48)
Dividends paid..................................................... (6,062) (354)
--------- ---------
Net cash provided by financing activities.......................... 532,762 643,793
--------- ---------
Net increase (decrease) in cash and cash equivalents............... -- (42,198)
Cash and cash equivalents, beginning of period..................... -- 46,434
--------- ---------
Cash and cash equivalents, end of period........................... $ -- $ 4,236
========= =========
Supplemental disclosure of cash flow information:
Cash paid for interest............................................. $ 60,312 $ 15,416
========= =========
Dividends payable.................................................. $ 2,845 $ 284
========= =========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
NOVASTAR FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998 (Unaudited)
- --------------------------------------------------------------------------------
Note 1. Financial Statement Presentation
The consolidated financial statements as of and for the periods ended
September 30, 1998 and 1997 are unaudited. In the opinion of management all
adjustments have been made, which were of a normal and recurring nature,
necessary for a fair presentation of the balance sheets and results of
operations. The consolidated financial statements should be read in conjunction
with Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Consolidated Financial Statements of the Company and the
Notes thereto, included in the Company's Annual Report to Shareholders and
Annual Report on Form 10-K for the fiscal year ended December 31, 1997.
The Company owns 100 percent of the common stock of three special purpose
entities -- NovaStar Assets Corporation, NovaStar Certificates Financing
Corporation and NovaStar Mortgage Funding Corporation. The Company formed these
entities in connection with the issuance of collateralized mortgage obligations.
The consolidated financial statements of the Company include the accounts of
these entities. Significant intercompany accounts and transactions have been
eliminated in consolidation.
The Company owns 100 percent of the preferred stock of NFI Holding Corporation
(Holding) for which it receives 99 percent of any dividends paid by Holding.
The founders of the Company own the voting common stock of Holding. NovaStar
Mortgage, Inc. and NovaStar Capital, Inc. are wholly owned subsidiaries of
Holding. Certain key officers of the Company serve as officers of Holding,
NovaStar Mortgage and NovaStar Capital. The Company accounts for its investment
in Holding using the equity method.
Note 2. Subsequent Events
As a result of significant liquidity constraints imposed upon the Company by
certain key lenders subsequent to September 30, 1998, management took the
following actions in October 1998:
On October 11, 1998, the Board of Directors of the Company agreed to defer
payment of the dividend it declared on September 22, 1998 ($0.35 per share, $2.8
million in total) until January 15, 1999.
On various dates during October 1998, the Company and NovaStar Mortgage
executed contracts for the sale of all securities owned by the Company and
NovaStar Mortgage. All securities sales settled during October at an aggregate
loss of $15.4 million.
On various dates during October 1998, the Company executed contracts for the
termination of interest rate swap agreements with a notional amount of $455
million, representing 42 percent of all interest rate agreements owned by the
Company. The terminations settled in October 1998 at an aggregate loss of $8.0
million. The Company continues to own interest rate cap agreements, but has
significantly reduced liquidity risk exposure relating to its interest rate
agreements.
On October 13, 1998, the Company executed a 90-day financing agreement with
GMAC/Residential Funding Corporation, secured by certain mortgage interests of
the Company. Under the terms of the agreement, the Company borrowed $15 million
to support immediate cash needs. In addition, the Company agreed to pay a $3
million commitment fee at maturity of the note. The resulting $18 million
obligation bears interest at one-month LIBOR plus five percent. Additionally,
GMAC/RFC acquired 812,731 warrants for the purchase of the Company's common
stock at a price of $4.5625, the closing price of the common stock on October
12, 1998. The Company and GMAC/RFC are presently in negotiations regarding
terms to establish a long-term strategic alliance. However, no assurance can be
given that the alliance will be established. If a strategic alliance is
successfully negotiated, GMAC/RFC has the option to waive $2 million of the
commitment fees discussed above in exchange for an additional 811,919 warrants
for the purchase of the Company's stock at a price of $4.5625 per share.
Additional events, as described below, occurred subsequent to September 30,
1998. Although these events were not a direct result of the event discussed
above, they affect the Company's liquidity position.
On various dates during October 1998, NovaStar Mortgage accepted bids from
third parties for the sale of approximately $221 million, or 94 percent of loans
it owned as of September 30, 1998. Final terms of the sales will be determined
after due diligence is performed on subject loans. Closings on these sales are
expected to be prior to December 31, 1998. Management of NovaStar Mortgage
expects to continue marketing its originated loans for sale to third parties.
On October 21, 1998, the Company finalized the second closing on the
securitization of asset-backed bonds, the first closing of which was during the
third quarter. In the second closing, approximately $43 million of loans were
added to the trust assets of NovaStar Home Equity Series 1998-2.
4
<PAGE>
Note 3. Related Party Receivable
Prior to July 1, 1998, the Company acquired all mortgage loans originated
by NovaStar Mortgage, Inc. These acquisitions were financed using warehouse and
repurchase lending arrangements with commercial and investment banks. During
the third quarter of 1998, NovaStar Mortgage discontinued virtually all its
sales of mortgage loans to the Company in order to market and sell these loans
to third parties. However, the Company continues to provide financing for these
loans on behalf NovaStar Mortgage. As a result, the Company has a receivable as
of September 30, 1998 of $259.3 million from NovaStar Mortgage. The receivable
represents its interest in mortgage loans, restricted cash and other assets
related to mortgage loans recorded on the balance sheet of NovaStar Mortgage,
Inc. These advances will be repaid when the loans are sold (see Note 2), and
the Company will, in turn, repay borrowings.
Note 4. Comprehensive Income
Effective January 1, 1998, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income."
Comprehensive income includes net income and revenues, expenses, gains and
losses that are not included in net income. Currently, the only components of
comprehensive income for the Company are the net change in the unrealized gain
(loss) on available-for-sale securities and net income. The adoption of SFAS
No. 130 did not result in an adjustment to assets, liabilities, stockholders'
equity or net income. The consolidated balance sheets of the Company as of and
for the year ended December 31, 1997 are comparable to those as of September 30,
1998. However, the caption for comprehensive income has appropriately been
identified.
Following is a summary of comprehensive income for the three- and nine-
month periods ended September 30, 1998.
<TABLE>
<CAPTION>
For the Nine Months For the Three Months
Ended September 30 Ended September 30
------------------- --------------------
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net income (loss)..................................... $ 5,567 $ (702) $ 2,394 $ 177
Other comprehensive income -- net change in unrealized
gain (loss) on available-for-sale securities......... (9,130) 2,255 (4,828) 872
------- ------ ------- ------
Comprehensive income (loss)........................... $(3,563) $1,553 $(2,434) $1,049
======= ====== ======= ======
</TABLE>
5
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the preceding
Consolidated Financial Statements of the Company and the Notes thereto as well
as the Company's Annual Report to Shareholders and Annual Report on Form 10-K
for the fiscal year ended December 31, 1997.
Safe Harbor Statement
"Safe Harbor" statement under the Private Securities Litigation Reform Act
of 1995: Statements in this discussion regarding NovaStar Financial, Inc. (the
Company) and its business, which are not historical facts, are "forward-looking
statements" that involve risks and uncertainties. Risks and uncertainties, which
could cause results to differ from those discussed in the forward-looking
statements herein, are listed in the Company's Annual Report filed on form 10K.
In addition, there are many important factors that could cause NovaStar's actual
results to differ materially from those indicated in the forward-looking
statements. These factors include, but are not limited to, general economic
conditions, interest rate levels and risk, prepayment speeds, delinquency and
loss rates, changes (legislative and otherwise) in the asset securitization
industry or the REIT provisions of the Internal Revenue Code, demand for
NovaStar's service, the impact of certain covenants in loan agreements of
NovaStar, the degree to which NovaStar is leveraged, its needs for and
availability of financing, its access to capital and other risks identified in
NovaStar's Securities and Exchange Commission filings. In addition, it should be
noted that past financial and operational performance of the Company is not
necessarily indicative of future financial and operational performance.
Basis of Presentation
The Company owns 100 percent of the common stock of NovaStar Assets
Corporation, NovaStar Certificates Financing Corporation and NovaStar Mortgage
Funding Corporation. These entities were established as special purpose
entities used in the Company's issuance of collateralized mortgage obligations.
The consolidated financial statements of the Company include the financial
condition and results of operations of these entities.
The Company owns 100 percent of the non-voting preferred stock of NFI
Holding Corporation (Holding) for which it receives 99 percent of any dividends
paid by Holding. Scott Hartman and Lance Anderson, the Company's founders, own
the voting common stock of Holding. NovaStar Mortgage, Inc. is a wholly owned
subsidiary of Holding. Certain key officers of the Company serve as officers of
Holding and NovaStar Mortgage and the founders are the only members of the Board
of Directors of Holding and NovaStar Mortgage. In June 1998, Holding formed
NovaStar Capital, Inc. to purchase and sell mortgage loans. The Company accounts
for its investment in Holding using the equity method.
Events Subsequent to September 30, 1998
As of September 30, 1998, the Company had an arrangement with an lender
whereby the Company could borrow up to 50 percent of the value of the residual
interests in the Company's collateralized mortgage obligations. Borrowing
capacity under this arrangement was in excess of $30 million. However, the
lender restricted the Company's access to funds under this arrangement to $25
million as of September 30, 1998. In October, the lender withdrew its financing
under this arrangement. This event, combined with declining market prices for
its securities and off-balance-sheet financial instruments, caused management to
take several actions, as discussed in following paragraphs, to restore the
Company's liquidity and to reduce further exposure to liquidity risk. As a
result of these actions, the Company anticipates incurring a significant net
loss during the fourth quarter of 1998.
On October 11, 1998, the Board of Directors of the Company agreed to defer
payment of the third quarter dividend ($0.35 per share) until January 15, 1999.
On various dates during October 1998, the Company and NovaStar Mortgage
executed contracts for the sale of all securities owned by the Company and
NovaStar Mortgage. All securities sales settled during October at an aggregated
loss of $15.4 million.
On various dates during October 1998, the Company terminated interest rate
swap agreements with a notional amount of $455 million, representing 42 percent
of all interest rate agreements owned by the Company. The terminations settled
in October 1998 at an aggregate loss of $8.0 million.
On October 13, 1998, the Company executed a 90-day financing agreement with
GMAC/Residential Funding Corporation, secured by certain mortgage interests of
the Company. Under the terms of the agreement, the Company received a $15
million loan to support immediate cash needs. The loan bears interest at one-
month LIBOR plus five percent. The Company is required to pay a $3 million
commitment fee upon maturity of the note. Additionally, GMAC/RFC acquired
812,731 warrants for the purchase of the Company's common stock at a price of
$4.5625, the closing price of the common stock on October 12, 1998. The Company
and GMAC/RFC are presently in negotiations regarding terms for a long-term
strategic alliance. However, no assurances can be given that an alliance will
in fact be executed. Upon execution of a strategic alliance, GMAC/RFC will
refund $2 million of the commitment fees discussed above and NovaStar will issue
additional 811,919 warrants for the purchase of the Company's stock at a price
of $4.5625 per share.
Additional events, as described below, occurred subsequent to September 30,
1998. Although these events were not a direct result of the above-described
events, they affect the Company's liquidity position.
6
<PAGE>
On various dates during October 1998, NovaStar Mortgage has accepted bids
for the sale of approximately $221 million, or 94 percent of loans it owned as
of September 30, 1998. However, final terms of these sales will be determined
after due diligence is performed on subject loans. Closing on these sales is
expected to take place prior to December 31, 1998.
On October 21, 1998, the Company finalized the second closing on the
securitization of asset-backed bonds, the first closing of which occurred during
the second quarter. In the second closing, approximately $43 million of loans
were added to the trust assets of NovaStar Home Equity Series 1998-2.
After completing the above transactions, the Company's balance sheet will
consist primarily of subprime mortgage loans financed with non-recourse asset-
backed bonds. Table I is a condensed balance sheet as of September 30, 1998
with a comparative pro-forma balance sheet assuming the foregoing transactions
had been executed on that date, excluding the sales of mortgage loans expected
to occur during the fourth quarter.
Table I
Condensed Balance Sheets
September 30, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30, 1998
-------------------------
Actual Pro Forma
<S> <C> <C>
Assets
Cash and cash equivalents........................... $ -- $ 15,638
Restricted cash..................................... 55,383 12,683
Mortgage loans...................................... 944,228 987,781
Available-for-sale securities....................... 408,276 --
Due from NFI Holding Corporation.................... 259,312 215,758
Other assets........................................ 26,126 21,008
---------- ----------
Total assets...................................... $1,693,325 $1,252,868
========== ==========
Liabilities and Stockholders' Equity
Liabilities:
Collateralized mortgage obligations................ $ 948,590 $ 948,590
Repurchase agreements.............................. 579,697 151,521
Warehouse line of credit........................... 46,779 35,079
Short-term note payable............................ -- 18,000
Accounts payable and accrued expenses.............. 8,411 8,346
---------- ----------
Total liabilities................................. 1,583,477 1,161,536
Stockholders' equity................................ 109,848 91,332
---------- ----------
Total liabilities and stockholders' equity........ $1,693,325 $1,252,868
========== ==========
</TABLE>
In the foreseeable future, the Company does not expect to purchase a
significant amount of loans originated by NovaStar Mortgage, and NovaStar
Mortgage is expected to sell a majority of the mortgage loans it originates to
unrelated entities for cash. Net income for the Company will be generated from
the spread on securitized loans, general and administrative expenses and equity
in earnings of NFI Holding Corporation. Earnings of NFI Holding Corporation
will primarily include gains on the sales of mortgage loans originated by
NovaStar Mortgage and general and administrative expenses.
Additional information regarding the Company's liquidity position and
events subsequent to September 30, 1998 are included in "Liquidity and Capital
Resources."
Liquidity and Capital Resources
Subsequent to September 30, 1998, access to a key financing source was
withdrawn, as discussed in "Events Subsequent to September 30, 1998." The
events and actions discussed therein are important to the discussion below
regarding the liquidity and capital resources of the Company.
Liquidity, as used herein, means the need for, access to and uses of cash.
The Company's primary needs for cash include the acquisition of mortgage loans,
principal repayment and interest on borrowings, operating expenses and dividend
payments. The Company's business requires substantial cash to support its
operating activities. The Company has a certain amount of cash on hand to fund
operations. Principal, interest and fees received on mortgage assets will
serve to support the cash needs of the Company. Drawing upon various borrowing
arrangements typically satisfies major cash requirements. Historically, the
Company demonstrated the ability to access public markets as a source of long-
term cash resources. The events in early October
7
<PAGE>
1998 changed the liquidity position of the Company. Options available to the
Company for financing sources have been restricted.
Actions of the Company, during unfavorable market conditions as discussed
in "Events Subsequent to September 30, 1998" were taken to restore liquidity and
mitigate additional margin call risk. Although these actions will result in a
significant net loss for the fourth quarter of 1998, management believes they
were necessary under the circumstances.
In addition to the mortgage loans that have been securitized and are
reflected on the Company's balance sheet, NovaStar Mortgage continues to
originate subprime mortgage loans expected to be sold to third parties. As of
September 30, 1998, NovaStar Mortgage had $238 million of subprime mortgage
loans. The Company provides financing for these loans through its own warehouse
and repurchase credit facilities. Sales commitments have been accepted for $221
million of these loans. Management expects to continue selling loans originated
by NovaStar Mortgage during the fourth quarter of 1998 and into 1999. Loans
financed with warehouse and repurchase credit facilities are subject to changing
market valuation and margin calls.
Table II is a summary of financing arrangements and available borrowing
capacity under those arrangements as of November 9, 1998.
<TABLE>
<CAPTION>
Table II
Liquidity Resources
November 9, 1998 (dollars in thousands)
- ------------------------------------------------------------------------------------------------------
Maximum
Borrowing Value of
Resource Limit Collateral Borrowings Availability
<S> <C> <C> <C> <C>
First Union National Bank:
Committed warehouse line of credit................. $ 75,000 $ 34,895 $ 16,913 $17,982
Committed secured whole loan repurchase agreement.. 100,000 85,816 85,816
Merrill Lynch Mortgage Capital, Inc. ................ 150,100 150,100 --
Residual financing available under CMOs.............. 18,000 (A) 18,000 --
-------- -------
Total............................................ $270,829 $17,982
======== =======
Total availability as percent of:
Total assets....................................... 1.06%
=====
Total stockholders' equity......................... 16.37%
=====
</TABLE>
- --------------
(A) The Company's estimates of the value of the residuals range from $50 to $70
million.
During the nine months ended September 30, 1998, the Company's operating
and financing activities generated cash of $4 million and $533 million, while
investing activities used cash of $537 million.
Forgivable Notes Receivable from Founders
The Company's founders purchased 216,666 units in the 1996 private
placement in exchange for forgivable promissory notes. A unit consisted of one
share of convertible preferred stock and one common stock warrant. Principal on
these notes will be forgiven if certain incentive performance targets are
achieved. The incentive tests relate to the return generated to investors in the
private placement, including the appreciation in the Company's stock price, the
value of the warrants, and dividends paid. One tranche will be forgiven for each
fiscal year the Company generates a return of 15 percent to investors in the
private placement. All three tranches will be forgiven if the Company generates
a 100 percent return within five years. For the period from the closing of the
private placement through December 31, 1997, the Company generated a return
exceeding 15 percent to the private placement investors and the first tranche of
these notes was forgiven resulting in a non-cash charge of $1,083,000 during the
fourth quarter of 1997.
Based on the Company's performance and stock price during the first three
quarters of the year, the Company's management anticipated forgiveness of the
second tranche of these notes. As a result, non-cash charges to earnings have
been recorded during the first three quarters of 1998 in the amount of $812,000.
Based on actions taken by management as described in "Events Subsequent to
September 30, 1998" and the current value of Company's stock, it appears
unlikely that the second tranche of the notes receivable from founders will be
forgiven. Final determination regarding forgiveness will be made during the
fourth quarter of 1998. If the second tranche is not forgiven, all amounts that
have been charged off during 1998 will be reinstated.
8
<PAGE>
Financial Condition
During the nine months ended September 30, 1998, NovaStar Mortgage
originated approximately 8,000 subprime residential mortgage loans with an
aggregate principal amount of $735 million, of which $498 million was acquired
by the Company. However, unlike previous periods, the Company discontinued
virtually all its purchase of NovaStar Mortgage's loan originations during the
third quarter of 1998 as NovaStar Mortgage intends to sell the majority of its
third quarter production to independent third parties. The Company's balance
sheet continues to become more heavily weighted toward subprime mortgage loans.
As of September 30, 1998, subprime mortgage loans comprise 71 percent of the
mortgage assets owned by the Company compared with 51 percent at December 31,
1997.
During the nine months ended September 30, 1998, the Company sold $7.5
million of loans purchased from NovaStar Mortgage to unrelated third parties for
cash, recognizing gains on these transactions of $315,000. The Company also
completed two securitizations during the nine months ended September 30, 1998,
pooling $618 million of mortgage loans as collateral of which $43 million was
added during the fourth quarter of 1998.
Table III is a summary of wholesale loan originations and bulk acquisitions
for 1998 and 1997. Table IV presents a more detailed analysis of wholesale loan
originations.
<TABLE>
<CAPTION>
Table III
Wholesale Loan Originations (A) and Bulk Acquisitions (B)
Nine Months Ended September 30, 1998 and Year Ended December 31, 1997
(dollars in thousands)
- ----------------------------------------------------------------------------------------------
Wholesale Originations (A) Bulk Acquisitions (B) Total
--------------------------------------------------------------------------
Number Principal Number Principal Number Principal
of Loans Amount of Loans Amount of Loans Amount
<S> <C> <C> <C> <C> <C> <C>
1998:
Third quarter... 2,576 $232,333 79 $ 8,165 2,655 $240,498
Second quarter.. 3,133 294,303 -- -- 3,133 294,303
First quarter... 2,033 207,976 -- -- 2,033 207,976
----- -------- ----- ----------- ----- --------
1998 total...... 7,742 $734,612 79 $ 8,165 7,821 $742,777
===== ======== ===== ======== ===== ========
1997:
Fourth quarter.. 1,552 $183,012 -- $ -- 1,552 $183,012
Third quarter... 1,025 136,582 -- -- 1,025 136,582
Second quarter.. 509 77,692 530 49,808 1,039 127,500
First quarter... 68 12,688 1,422 157,432 1,490 170,120
----- -------- ----- -------- ----- --------
1997 total...... 3,154 $409,974 1,952 $207,240 5,106 $617,214
===== ======== ===== ======== ===== ========
</TABLE>
- ----------------
(A) Loans originated by NovaStar Mortgage
(B) First two quarters of 1997 represent bulk acquisitions by NFI; third
quarter of 1998 represents bulk acquisitions by NovaStar Capital, Inc.
9
<PAGE>
<TABLE>
<CAPTION>
Table IV
1998 and 1997 Quarterly Wholesale Loan Originations (A)
(dollars in thousands)
- --------------------------------------------------------------------------------------------------------------
Weighted Average
-----------------------------
Average Loan-to- Credit Percent with
Number Loan Price Paid to Value Rating (B) Coupon Prepayment
of Loans Principal Balance Broker Penalty
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998:
Third quarter... 2,576 $232,333 $ 90 101.4 81% 4.37 10.11% 79%
Second quarter.. 3,133 294,303 94 101.3 81 4.43 9.93 71
First quarter... 2,033 207,976 102 101.4 81 4.45 9.93 65
----- --------
1998 total........ 7,742 $734,612 95 101.4 81 4.42 9.99 72
===== ========
1997:
Fourth quarter.. 1,552 $183,012 118 101.6 81 4.32 10.09 71
Third quarter... 1,025 136,582 133 101.6 79 4.21 10.12 66
Second quarter.. 509 77,692 153 102.1 77 4.23 10.17 84
First quarter... 68 12,688 187 102.3 75 4.22 9.64 78
----- --------
1997 total........ 3,154 $409,974 130 101.7 79 4.26 10.10 73
===== ========
</TABLE>
- -----------------
(A) Loans originated by NovaStar Mortgage
(B) AAA=7, AA=6, A=5, A-=4, B=3, C=2, D=1
The Company's subprime borrowers generally include individuals that do not
qualify for agency/conventional lending programs because of a lack of available
documentation or previous credit difficulties, but have equity in their homes.
Often, they are individuals or families who have built up high-rate consumer
debt and are attempting to use the equity in their home to consolidate debt and
lower their monthly payments. The credit grade assigned is a function of the
relative strength or weakness of the borrower's credit and/or the nature and
extent of documents that can be provided to support income. NovaStar Mortgage
underwrites the loans acquired by the Company using guidelines that have been
approved by the Company.
Table V is a presentation of loans as of September 30, 1998 and their
credit grades.
<TABLE>
<CAPTION>
Table V
Mortgage Loans by Credit Grade
September 30, 1998 (dollars in thousands)
- ----------------------------------------------------------------------------------------
Maximum Weighted Weighted
Allowed Loan-to- Current Average Average
Credit Rating Mortgage Lates value Principal Coupon Loan-to-value
<S> <C> <C> <C> <C> <C>
AA........... 0 x 30 95 $115,975 9.48 83.3%
A............ 1 x 30 90 367,921 9.82 79.6
A-........... 2 x 30 90 222,011 10.25 80.7
B............ 3 x 30, 1 x 60 85 141,165 10.52 77.5
5 x 30, 2 x 60,
C............ 1 x 90 80 62,965 11.09 72.3
D............ 6 x 30, 3 x 60,
2 x 90 65 14,398 11.97 62.2
--------
Total...... $924,435 10.11 79.2
========
</TABLE>
Table VI is a summary of loans originated by NovaStar Mortgage by state.
Table VII is a summary of all mortgage loans owned by the Company as of
September 30, 1998 by state.
10
<PAGE>
Table VI
Mortgage Loan Originations by State (A)
Nine Months Ended September 30, 1998 and Year Ended December 31, 1997
- ---------------------------------------------------------------------
<TABLE>
<CAPTION>
Percent of Total Originations during Quarter
(based on original principal balance)
-----------------------------------------------------------------------------------
1998 1997
------------------------------- ----------------------------------------
Collateral Location Third Second First Fourth Third Second First
<S> <C> <C> <C> <C> <C> <C> <C>
Florida.................. 17% 16% 12% 9% 10% 8% 1%
California............... 6 9 15 19 24 26 40
Washington............... 5 6 7 8 11 16 15
Michigan................. 5 5 5 5 3 -- --
Texas.................... 5 3 3 3 4 7 2
North Carolina........... 5 3 2 1 1 -- 1
Ohio..................... 4 5 2 2 2 2 --
Nevada................... 4 3 6 5 4 2 --
Oregon................... 3 4 5 6 6 9 7
Maryland................. 2 3 4 5 6 5 13
Utah..................... 2 3 3 6 6 9 13
Virginia................. 2 2 2 5 6 2 --
Oklahoma................. -- 1 1 1 1 2 5
All other states......... 40 40 35 26 17 12 4
</TABLE>
- -------------------------
(A) Loans originated by NovaStar Mortgage, Inc.
Table VII
Mortgage Loans by State
As of September 30, 1998
- ------------------------
<TABLE>
<CAPTION>
Percent of Portfolio (based on
original principal balance)
Collateral Location
Percent
<S> <C>
California............... 19%
Florida.................. 12
Washington............... 8
Oregon................... 5
All other states......... 56
</TABLE>
As of September 30, 1998, the carrying value of mortgage securities totaled
$390.3 million compared with $517.2 million as of December 31, 1997. As more of
the Company's capital is allocated to subprime mortgage loans, less is available
for mortgage securities. As a result, during the nine months ended September 30,
1998, the Company sold mortgage securities with an amortized cost of $323.3
million compared with $100.6 million for the period ended September 30, 1997.
The Company acquired mortgage securities with an aggregate cost of $354.9
million for the period ended September 30, 1998 compared with $376.0 million for
the same period of 1997. Tables VIII and XI are summaries of the securities
acquired during 1998 and 1997 by quarter and the portfolio as of September 30,
1998.
11
<PAGE>
Table VIII
Mortgage Security Acquisitions
Nine Months Ended September 30, 1998 and Year Ended December 31, 1997 (dollars
in thousands)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Weighted
Price to Average
Principal Premium Discount Par Coupon
<S> <C> <C> <C> <C> <C>
1998:
Third quarter $ -- $ -- $ -- -- -- %
Second quarter - Federal National Mortgage..... 80,237 823 -- 101.0 6.40
Association.................................
First quarter:
Federal National Mortgage Association....... 40,929 444 -- 101.1 6.12
Government National Mortgage Association.... 229,130 3,726 (364) 101.5 6.39
1997:
Fourth quarter:
Federal National Mortgage Association....... 46,779 1,856 -- 104.0 8.00
Government National Mortgage Association.... 233,546 2,649 (1,457) 100.5 5.74
Third quarter - Federal Home Loan Mortgage..... 2,202 87 -- 104.0 7.40
Corporation....................................
Second quarter:
Federal National Mortgage Association....... 247,219 5,174 -- 102.1 7.48
Federal Home Loan Mortgage Corporation...... 102,083 2,450 -- 102.4 6.90
First quarter:
Federal National Mortgage Association....... 7,491 231 -- 103.1 7.57
Government National Mortgage Association.... 8,931 174 -- 101.9 7.13
</TABLE>
Table IX
Mortgage Security Portfolio
As of September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Gross
--------------------------- Weighted
Unamortized Unaccreted Carrying Average
Principal Premium Discount Value Coupon
<S> <C> <C> <C> <C> <C>
Federal National Mortgage Association.......... $259,860 $5,565 $ -- $265,424 7.04%
Government National Mortgage Association....... 123,211 282 (225) 123,268 5.40
Federal Home Loan Mortgage Corporation......... 4,160 136 -- 4,296 7.54
-------- ------ ----- --------
$387,231 $5,983 $(225) 392,989 6.52%
======== ====== =====
Net unrealized loss (2,713)
--------
Carrying value $390,276
========
</TABLE>
As described under the section labeled "Events Subsequent to September 30,
1998", all of the securities portfolio at September 30, 1998 was sold in October
1998 at losses aggregating $15.4 million.
Mortgage loan originations are funded with various warehouse facilities
prior to securitization. Loans originated through the lending operations of
NovaStar Mortgage have typically been funded initially through a $75 million
warehouse line with First Union National Bank under which the Company and
NovaStar Mortgage are co-borrowers. The Company also uses repurchase agreements
to finance mortgage loan purchases. Funds borrowed against master repurchase
agreements are also used to acquire loans from NovaStar Mortgage. Residual
financing is another short-term borrowing instrument currently available to the
Company.
Using individual assets as collateral for repurchase agreements, the
Company has financed acquisitions of agency-issued mortgage securities. These
agreements have been executed with a number of reputable securities dealers.
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 capital available to cover this "haircut."
Table X displays the amounts outstanding under borrowing arrangements as of
September 30, 1998.
12
<PAGE>
Table X
Borrowings
September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
As of September 30, 1998
----------------------------------
Weighted Average Daily
Weighted Days to Balance During the
Average Reset or Nine Months Ended
Rate Maturity Balance September 30, 1998
<S> <C> <C> <C> <C>
Repurchase agreements secured by mortgage securities.......... 5.44% 4 $397,176 $511,460
Master repurchase agreement secured by mortgage loans......... 6.38 31 182,521 156,854
--------
Total repurchase agreements................................. 579,697
Warehouse line of credit...................................... Demand 46,779 20,043
--------
Total borrowings............................................ $626,476
========
</TABLE>
On a long-term basis, the Company finances its mortgage loans using
collateralized mortgage obligations (CMOs). Investors in CMOs are repaid based
on the performance of the mortgage loans collateralizing the CMOs. CMOs are
outstanding as long as the mortgage loans are outstanding. However, under the
CMOs issued by NovaStar, the Company has the right to reacquire the mortgage
loans collateralizing the CMO when certain events occur. These non-recourse
financing arrangements match the loans with the financing arrangement for long
periods of time, as compared to repurchase agreements that mature frequently
with interest rates that reset frequently and have liquidity risk in the form of
margin calls. Table XI displays the amounts outstanding under collateralized
mortgage obligations as of September 30, 1998.
Table XI
Collateralized Mortgage Obligations
September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Collateralized
Mortgage Obligation Underlying Mortgage Loans
--------------------------- ----------------------------------------------
Estimated
Weighted Weighted
Remaining Interest Carrying Average Average Months
Principal Rate Value Coupon to Maturity
<S> <C> <C> <C> <C> <C>
NovaStar Home Equity Series:
Issue 1997-1................... $181,770 5.97% $192,084 10.43% 24
Issue 1997-2................... 179,371 5.84 184,013 10.45 26
Issue 1998-1................... 283,020 5.70 290,240 10.14 24
Issue 1998-2................... 308,986 5.70 273,308 (A) 9.99 37
Debt issuance costs, net....... (4,557) --
-------- --------
$948,590 $939,645
======== ========
</TABLE>
------------------------------
(A) Does not include $43 million of loans added as collateral during October
1998.
In periods of decreasing interest rates, borrowers are more likely to
refinance their mortgages to obtain a lower interest rate and monthly payment.
Even in rising rate environments, borrowers tend to collectively repay their
mortgage principal balances earlier than is required by the terms of their
mortgages. This is particularly true for subprime borrowers who are seeking to
upgrade their credit rating to obtain a lower interest rate. Table XII
displays the historical prepayment speeds for mortgage loans collateralizing the
Company's CMOs. Table XVI provides an analysis of prepayment characteristics of
the Company's mortgage loan portfolio.
13
<PAGE>
<TABLE>
<CAPTION>
Table XII
Prepayment Speed
- --------------------------------------------------------------------------------
Constant Prepayment Rate (Annual Percent)
------------------------------------------
One-month Three-month Twelve-month Life
<S> <C> <C> <C> <C>
As of September 30, 1998
NovaStar Home Equity Series:
1997-1....................... 35.5 34.9 -- 29.8
1997-2....................... 28.3 26.0 -- 17.7
1998-1....................... 13.3 12.8 -- 9.6
1998-2....................... 9.4 -- -- 7.8
As of December 31, 1997
NovaStar Home Equity Series:
1997-1....................... 18.6 15.7 -- 15.7
1997-2....................... 10.5 -- -- 10.5
</TABLE>
To mitigate the Company's exposure to prepayment risk and in order for the
Company to retain those borrowers whose credit is considered desirable, the
Company created a portfolio retention department in the latter part of 1997 that
encourages borrowers who have satisfactorily met their obligations to refinance
or rate modify their loans with NovaStar. Of the loans that prepaid during the
first nine months of 1998, $11.5 million, or ten percent of the loans were
successfully refinanced and $1.9 million, or two percent of the loans, were
rate-modified. For the third quarter of 1998, $5.1 million, or eleven percent of
the loans were successfully refinanced and $1.2 million or three percent of the
loans were rate-modified. Although these loans are considered prepayments for
the purposes of the information in Table XII, they remain in the NovaStar loan
portfolio.
Table XIII summarizes quarterly mortgage asset activity during 1998 and
1997 and Table XIV details the amount of premium as a percent of principal at
quarter end for 1998 and 1997.
<TABLE>
<CAPTION>
Table XIII
Mortgage Assets Activity (thousands)
- ---------------------------------------------------------------------------------------------------------------
Mortgage Loans Mortgage Securities Total
------------------- ------------------- --------------------
Principal Premium Principal Premium Principal Premium
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997................ $ -- $ -- $ 12,821 $ 434 $ 12,821 $ 434
Acquisitions............................ 170,120 10,530 16,422 405 186,542 10,935
Principal repayments and amortization... (338) (53) (977) (28) (1,315) (81)
--------- ------- --------- ------- ---------- -------
Balance, March 31, 1997................. 169,782 10,477 28,266 811 198,048 11,288
Acquisitions............................ 127,500 4,100 349,302 7,624 476,802 11,724
Principal repayments and amortization... (6,989) (420) (2,332) (133) (9,321) (553)
Dispositions............................ -- -- (98,267) (2,309) (98,267) (2,309)
--------- ------- --------- ------- ---------- -------
Balance, June 30, 1997.................. 290,293 14,157 276,969 5,993 567,262 20,150
Acquisitions............................ 136,582 2,449 2,202 87 138,784 2,536
Principal repayments and amortization... (22,227) (913) (19,291) (383) (41,518) (1,296)
--------- ------- --------- ------- ---------- -------
Balance, September 30, 1997............. 404,648 15,693 259,880 5,697 664,528 21,390
Acquisitions............................ 183,012 3,314 280,325 3,048 463,337 6,362
Principal repayments and amortization... (28,224) (1,146) (26,095) (363) (54,319) (1,509)
Dispositions............................ -- -- (9,263) (177) (9,263) (177)
--------- ------- --------- ------- ---------- -------
Balance, December 31, 1997.............. 559,436 17,861 504,847 8,205 1,064,283 26,066
Acquisitions............................ 207,976 3,758 270,059 3,806 478,035 7,564
Principal repayments and amortization... (27,224) (1,160) (63,892) (731) (91,116) (1,891)
Dispositions............................ -- -- (310,113) (5,294) (310,113) (5,294)
--------- ------- --------- ------- ---------- -------
Balance, March 31, 1998................. 740,188 20,459 400,901 5,986 1,141,089 26,445
Acquisitions............................ 290,350 5,148 80,237 823 370,587 5,971
Principal repayments and amortization... (43,849) (1,506) (47,201) (451) (91,050) (1,957)
Dispositions............................ (2,843) (53) -- -- (2,843) (53)
--------- ------- --------- ------- ---------- -------
Balance, June 30, 1998.................. 983,846 24,048 433,937 6,358 1,417,783 30,406
Acquisitions............................ -- -- -- -- -- --
Principal repayments and amortization... (54,745) (1,442) (38,925) (493) (93,670) (1,935)
Dispositions............................ (4,666) (56) (7,781) (107) (12,447) (163)
--------- ------- --------- ------- ---------- -------
Balance, September 30, 1998............. $ 924,435 $22,550 $ 387,231 $ 5,758 $1,311,666 $28,308
========= ======= ========= ======= ========== =======
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
Table XIV
Premium as a Percent of Principal
- --------------------------------------------------------------------------------
Total
Mortgage Mortgage Mortgage
Loans Securities Assets
<S> <C> <C> <C>
As of:
September 30, 1998....... 2.44% 1.49% 2.16%
June 30, 1998............ 2.44 1.47 2.14
March 31, 1998........... 2.76 1.49 2.32
December 31, 1997........ 3.19 1.63 2.45
September 30, 1997....... 3.88 2.19 3.22
June 30, 1997............ 4.88 2.16 3.55
March 31, 1997........... 6.17 2.87 5.70
</TABLE>
Results of Operations -- Nine Months Ended September 30, 1998 Compared to Nine
Months Ended September 30, 1997
Net Loss
During the nine months ended September 30, 1998, the Company recorded net
income of $5,567,000, a diluted $0.64 per share, compared with a net loss of
$702,000, a diluted $0.19 per share, for the nine months ended September 30,
1997.
Net Interest Income
Interest Income. The Company had average interest-earning assets of $1.3
billion during the nine months ended September 30, 1998, including $781.8
million of mortgage loans and $478.1 million of mortgage securities compared
with average interest-earning assets of $351.6 million during the nine months
ended September 30, 1997. During the nine months ended September 30, 1998,
mortgage loans earned $56.3 million, or a yield of 9.6 percent, compared with
$14.7 million, or a yield of 9.1 percent for the nine months ended September 30,
1997. Mortgage securities earned $22.9 million for the nine months ended
September 30, 1998, or a yield of 6.4 percent, compared with $6.8 million, or a
yield of 6.7 percent for the nine months ended September 30, 1997. In total,
assets earned $79.2 million, or a 8.4 percent yield for the nine months ended
September 30, 1998. During the nine months ended September 30, 1997, assets
earned $21.5 million or an 8.2 percent yield.
A substantial portion of the mortgage assets owned by the Company have
interest rates that fluctuate with short-term market interest rates. However,
many of these assets have initial coupons that are lower than current market
rates ("teaser" rates). Rates on the Company's assets are expected to increase
to their full potential as the assets "season". Table XV is a summary of the
Company's mortgage assets by type, presenting their current and fully indexed
weighted-average coupons.
<TABLE>
<CAPTION>
Table XV
Mortgage Assets by Product/Type and Weighted Average Coupon
September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------
Weighted Average
Coupon
----------------
Outstanding Fully
Product/Type Principal Current Indexed
<S> <C> <C> <C>
Mortgage loans:
Two and three year fixed/adjustable thereafter.. $ 521,535 10.15% 10.90%
Fixed rate (30 Yr, 15 Yr, 30/15)................ 301,087 10.02 --
Other (1 year CMT, 6 month LIBOR)............... 101,813 10.19 10.81
----------
Total mortgage loans........................ 924,435
Mortgage securities issued by:
Federal National Mortgage Association........... 259,860 7.04 6.64
Government National Mortgage Association........ 123,211 5.40 6.87
Federal Home Loan Mortgage Corporation.......... 4,160 7.54 6.81
----------
Total mortgage securities................... 387,231
----------
Total............................................. $1,311,666
==========
</TABLE>
15
<PAGE>
The Company acquires substantially all of its mortgage assets at a premium.
Premiums are amortized as a reduction of interest income over the estimated
lives of the assets. See Tables XII, XIII and XIV for the dollar impact of
principal payments on amortization. To mitigate the effect of prepayments on
interest income from mortgage loans, the Company generally strives to acquire
mortgage loans that have some form of prepayment penalty. During the nine
months ended September 30, 1998 and the third quarter of 1998, the Company
collected $1.3 million and $625,000, respectively, in prepayment penalties from
borrowers. Table XVI is an analysis of mortgage loans and prepayment penalties.
Prepayments on mortgage loans of the Company have been consistent with
management's expectations.
Table XVI
Mortgage Loan Prepayment Penalties
September 30, 1998 (dollars in thousands)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
Weighted Average
------------------------------------
Remaining
Percent with Prepayment Penalty
Current Prepayment Loan-to- Period (in years)
Principal Premium Penalty Coupon value Loans with Penalty
<S> <C> <C> <C> <C> <C> <C>
Loans collateralizing NovaStar
Home Equity Series (CMO):
1997-1....................... $183,760 $ 9,375 70.6% 10.45% 75.02% 1.44
1997-2....................... 181,329 3,049 70.8 10.31 78.14 1.77
1998-1....................... 286,746 4,306 68.7 9.99 81.04 2.43
1998-2....................... 268,312 5,266 69.6 9.90 80.88 3.13
All other loans................. 4,288 554 70.1 9.39 81.96 3.41
-------- -------
Total........................... $924,435 $22,550 69.8 10.11 79.24 2.31
======== =======
</TABLE>
As noted above, interest income is a function of volume and rates.
Management will continue to monitor the market for mortgage securities and whole
loan mortgage pools and will acquire mortgage assets that are appropriate for
its overall asset/liability strategy. Increasing the 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 $60.9
million during the nine months ended September 30, 1998, or 6.2 percent of
average borrowings, compared with $16.2 million for the nine months ended
September 30, 1997, or 6.4 percent of average borrowings. Advances under the
warehouse line of credit bear interest based on the Federal Funds rate, plus a
spread. The Company receives credits to warehouse line interest based on
restricted cash balances maintained with First Union. Advances under the master
repurchase agreement bear interest at rates based on LIBOR, plus a spread.
During the nine months ended September 30, 1998 and 1997, the 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. Rates on other borrowings generally fluctuate with
short-term market interest rates, such as LIBOR or the Federal Funds rate.
Table XVII presents a summary of the average interest-earning assets,
average interest-bearing liabilities and the related yields and rates thereon
for the nine months ended September 30, 1998.
Table XVII
Interest Analysis
Nine Months Ended September 30, 1998 (dollars in thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Mortgage Loans Mortgage Securities Total
-------------------------- --------------------------- ----------------------------
Interest Annual Interest Annual Interest Annual
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage Assets......................... $781,786 $56,274 9.60% $478,125 $22,881 6.38% $1,259,911 $79,l55 8.38%
======== ======== ==========
Liabilities.............................
Repurchase agreements.................. $156,854 7,643 6.50% $511,460 20,785 5.42% $ 668,314 28,428 5.67%
Collateralized mortgage obligations.... 626,960 29,659 6.31 626,960 29,659 6.31
Other borrowings....................... 20,043 647 4.30 21,492 647 4.01
-------- ----------
Cost of derivative financial 577
Instruments hedging liabilities....... 1,637 ------- 2,214
------- -------
Total borrowings.................... $803,857 39,586 6.57 $511,460 21,362 5.57 $1,316,766 60,948 6.18
======== ------- ======== ------- ========== -------
Net interest income.................... $16,688 $ 1,519 $18,207
======= ======= =======
Net interest spread.................... 3.03% 0.81% 2.20%
==== ==== ====
Net yield.............................. 2.85% 0.42% 1.93%
==== ==== ====
</TABLE>
16
<PAGE>
Net Interest Income and Spread. Net interest income during the nine months
ended September 30, 1998 was $18.2 million or 1.93 percent of average interest-
earning assets, compared with 5.3 million, or 2.02 percent of average interest-
earning assets during the nine months ended September 30, 1997. Net interest
spread for the Company was 2.20 percent during the nine months ended September
30, 1998 compared with 1.73 percent during the nine months ended September 30,
1997. Net interest income and the spread are functions of the yield of the
Company's assets relative to its costs of funds. The Company's cost of funds
has remained relatively low and stable during 1998. This lower cost of funds
offsets, to some degree, the lower yield on "teased" assets discussed above. 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. The Company has entered into certain
interest rate agreements and financial futures contracts designed to mitigate
exposure to interest rate risk. Interest rate cap agreements require the
Company to pay a monthly fixed premium while allowing it to receive a rate that
adjusts with LIBOR, when rates rise above a certain agreed-upon rate. Other
agreements executed by the Company include simple fixed to floating interest
rate swaps. These agreements are used to alter, in effect, the interest rates
on funding costs to more closely match the yield on interest-earning assets.
During the nine months ended September 30, 1998, the Company incurred net
interest expense on these agreements of $2.2 million, which is included as a
component of interest expense. The net interest expense for the same period
ending September 30, 1997 was $808,000. Table XVIII details the Company's
interest rate agreements as of September 30, 1998 (dollars in thousands):
Table XVIII
Interest Rate Agreements
As of September 30, 1998 (dollars in thousands)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Weighted Average
Unrealized Weighted Interest Rate Accrued Interest
Notional -------------- Days to Cap ------------------- -------------------
Value Gains Losses Maturity Rate Receivable Payable Receivable Payable
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest rate swap agreements
-- fixed rate pay............ $ 455,000 $ -- $ 7,845 674 NA 5.64% 6.11% $2,671 $2,736
Interest rate cap agreements.. 625,000 -- 3,645 710 6.27% NA NA -- --
---------- ----- -------
$1,080,000 $ -- $11,490
========== ===== =======
</TABLE>
As discussed in the section, "Events Subsequent to September 30, 1998", the
Company terminated all swap agreements and paid off the liabilities pertaining
to these hedging instruments in October 1998, recognizing losses aggregating
$8.0 million.
Fees from NovaStar Mortgage, Inc.
The Company and NovaStar Mortgage are party to a Mortgage Loan Sale and
Purchase Agreement whereby the Company has committed to acquire the wholesale
loan originations of NovaStar Mortgage. Under the terms of the agreement, if
NovaStar Mortgage chooses to sell its loan originations to other parties, it
pays a fee to the Company for not delivering its production under the purchase
commitment. During the first two quarters of 1998, the Company acquired
virtually all of the mortgage loans originated by NovaStar Mortgage. As a
result, there were no significant fees paid to the Company during the first half
of 1998. During the 1998 third quarter, NovaStar Mortgage retained
substantially all of its production with the intent of selling loans to third
parties. Under the terms of the Mortgage Loan Sale and Purchase Agreement,
NovaStar Mortgage remitted fees aggregating $3.8 million to the Company during
the nine months ended September 30, 1998.
Other Income
The Company may deem it appropriate to sell securities and loans, from time
to time, to reallocate the Company's capital. During the nine months ended
September 30, 1998, the Company recognized $108,000 in net gains on sales of
mortgage securities with a principal balance of $318 million. Also, during this
same period, the company sold two separate pools of loans (principal of $7.5
million) recognizing gains of $315,000.
Additional components of other income during the nine months ended
September 30, 1998 are prepayment penalties of $1.3 million and interest earned
on notes receivable from founders of $300,000.
As discussed in "Events Subsequent to September 30, 1998" the Company and
NovaStar Mortgage sold all mortgage securities at an aggregate loss of $15.4
million during October 1998.
17
<PAGE>
Provisions for Credit Losses
The Company provides regular reserves for credit losses, including
principal and interest, on its mortgage loans. Management continuously 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 management. The Company believes that loan defaults occur
throughout the life of a loan or group of loans. As a result, provisions for
credit losses are recorded against income over the estimated life of the loans,
rather than immediately upon acquisition of the loan. During the nine months
ended September 30, 1998, the Company provided $3.4 million for credit losses,
compared with $1.4 million during the nine months ended September 30, 1997.
During the third quarter of 1998, the Company and NovaStar Mortgage
executed an agreement with Commonwealth Mortgage Acceptance Corporation (CMAC)
whereby CMAC will provide insurance coverage on certain mortgage loans owned by
the Company and NovaStar Mortgage. As of September 30, 1998, approximately 29
percent of the loans owned by the Company and substantially all of the loans
owned by NovaStar Mortgage are covered under this agreement. During the third
quarter of 1998, total premiums paid to CMAC totaled $291,000, which are
included as a component of loan servicing expenses on the Company's financial
statements. Management believes that its exposure to credit loss on loans
insured by CMAC is minimal and, therefore, has not included these loans in
determining its loan loss provision. Management expects that a substantial
portion of loans originated in future periods will be covered under similar
insurance arrangements.
The Company charges off a loan when in management's best judgment the loan
is uncollectable. In addition, the Company will charge off a loan to the lower
of cost or market when it takes title of the property collateralizing the loan.
As of September 30, 1998, the Company had 86 loans in real estate owned with a
principal balance of $9.6 million and a carrying value of $7.3 million.
Charge-offs during the nine months ended September 30, 1998 were $3.0 million.
The Company had no charge-offs during the same period of 1997. As the portfolio
continues to season, management expects that the actual loss rate may continue
to increase. Table XIX is a rollforward of the reserve for credit losses during
1998 and 1997.
<TABLE>
<CAPTION>
Table XIX
Rollforward of Reserve for Credit Losses
Nine Months Ended September 30, 1998 and Year Ended December 31, 1997
- -----------------------------------------------------------------------------------------------------------------------
1998 1997
--------------------------------- -----------------------------------------------
September 30 June 30 March 31 December 31 September 30 June 30 March 31
<S> <C> <C> <C> <C> <C> <C> <C>
Beginning balance................ $ 3,341 $2,871 $2,313 $1,444 $ 718 $170 $ --
Provision for credit losses.... 1,179 1,145 1,076 1,009 726 548 170
Amounts charged off, net of
recoveries.................... (1,763) (675) (518) (140) -- -- --
------- ------ ------ ------ ------ ---- ----
Ending Balance................... $ 2,757 $3,341 $2,871 $2,313 $1,444 $718 $170
======= ====== ====== ====== ====== ==== ====
</TABLE>
Table XX is a summary of delinquent loans as of September 30, 1998 and 1997
by quarter. Table XXI provides summaries of the Company's delinquencies,
defaults, and loss statistics as of September 30, 1998 and 1997 by quarter.
Other information regarding the credit quality of the Company's mortgage loans
are provided in Tables V, VI and VII.
<TABLE>
<CAPTION>
Table XX
Loan Delinquencies (90 days and greater)
Nine Months Ended September 30, 1998 and Year Ended December 31, 1997 (A)
- --------------------------------------------------------------------------------------------------------------------------
1998 1997
--------------------------------- -----------------------------------------------
September 30 June 30 March 31 December 31 September 30 June 30 March 31
<S> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans collateralizing
NovaStar Home Equity series (CMO):
1997-1 (Issued October 1, 1997)... 5.97% 5.86% 4.39% 2.71% -- -- --
1997-2 (Issued December 11, 1997). 4.97 4.72 2.23 -- -- -- --
1998-1 (Issued April 30, 1998).... 2.06 -- -- -- -- -- --
1998-2 (Issued April 30, 1998).... 0.40 -- -- -- -- -- --
All mortgage loans.................. 2.45 2.53 2.28 1.80 1.47% -- --
</TABLE>
- --------------------
(A) Includes loans in foreclosure or bankruptcy.
18
<PAGE>
<TABLE>
<CAPTION>
Table XXI
Delinquencies, Defaults and Losses
September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------------------------------------------
NovaStar Home Equity Series
------------------------------------------
1997-1 1997-2 1998-1 1998-2 Other (A) All Loans
<S> <C> <C> <C> <C> <C> <C>
Loan servicing portfolio................... $187,838 $185,093 $286,891 $267,744 $251,295 $1,178,861
======== ======== ======== ======== ======== ==========
Reserve for Credit Losses:
Balance, July 1, 1998.................... $ 1,446 $ 1,118 $ 585 $ -- $ 192 $ 3,341
Provision for credit losses.............. 179 204 460 270 65 1,179
Amounts charged off, net of recoveries... (575) (957) (233) -- 3 (1,763)
-------- -------- -------- -------- -------- ----------
Balance, September 30, 1998............ $ 1,050 $ 365 $ 812 $ 270 $ 260 $ 2,757
======== ======== ======== ======== ======== ==========
Defaults as a percent of loan servicing
Portfolio, September 30, 1998:
Delinquent loans......................... 3.99% 5.19% 3.05% 2.84% 0.55% 2.95%
======== ======== ======== ======== ======== ==========
Loans in foreclosure..................... 4.87 3.57 1.94 0.82 0.14 2.02
======== ======== ======== ======== ======== ==========
Real estate owned........................ 2.24 1.99 0.15 -- 0.50 0.81
======== ======== ======== ======== ======== ==========
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
1998 1997
--------------------------------- -----------------------------------------------
September 30 June 30 March 31 December 31 September 30 June 30 March 31
<S> <C> <C> <C> <C> <C> <C> <C>
Total defaults:
Delinquent loans............... 2.95% 1.95% 1.92 1.76% 4.44% 3.09% --
==== ==== ==== ==== ==== ==== ===
Loans in foreclosure........... 2.02 2.28 2.29 2.05 0.47 0.01 --
==== ==== ==== ==== ==== ==== ===
Real estate owned (%).......... 0.81 0.52 0.24 0.05 -- -- --
==== ==== ==== ==== ==== ==== ===
</TABLE>
- ---------------
(A) Primarily loans owned by NovaStar Mortgage, Inc.
General and Administrative Expenses
General and administrative expenses for the nine months ended September 30,
1998 and September 30, 1997 are provided in table XXII. Table XXIII displays the
relationship of portfolio expenses to net interest income during the nine months
ended September 30, 1998 and 1997 by quarter.
19
<PAGE>
Table XXII
General and Administrative Expenses
Nine Months Ended September 30, 1998 and September 30, 1997 (dollars in
thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
------------------------ -----------------------
Percent of Percent of
Net Interest Net Interest
Income Income
<S> <C> <C> <C> <C>
Loan servicing........................................... $3,163 27.5% $ 701 13.2%
Compensation and benefits................................ 1,374 11.9 694 13.0
Professional and outside services........................ 649 5.6 430 8.1
Office administration.................................... 681 5.9 201 3.8
Other.................................................... 184 1.6 288 5.4
------- ---- ------ ----
Total portfolio-related expenses......................... 6,051 52.6% 2,314 43.5%
==== ====
Forgiveness of notes receivable from founders............ 812
Administrative services provided by NovaStar Mortgage.... 5,700 2,450
------- ------
Total................................................... $12,563 $4,764
======= ======
</TABLE>
Table XXIII
Portfolio Related Expenses as a
Percent of Net Interest Income
Nine Months Ended September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Percent of Net
Interest Income
1998:
<S> <C>
Third quarter................................ 38.6%
Second quarter............................... 33.6
First quarter................................ 26.3
1997:
Fourth quarter............................... 65.9
Third quarter................................ 36.3
Second quarter............................... 62.1
First quarter................................ 42.0
</TABLE>
The monthly administrative service fee paid by the Company to NovaStar
Mortgage represents compensation for certain services, including the development
of loan products, underwriting, funding, and quality control. The increase in
this fee for the nine months ended September 30, 1998 compared with September
30, 1997 is primarily a result of an increase in the extent of services
required.
Compensation and benefits include employee base salaries, benefit costs and
incentive bonus awards. The increase in compensation and benefits for the nine
months ended September 30, 1998 compared with the nine months ended September
30, 1997 is due to adding portfolio, accounting and finance management staff
throughout 1997 and 1998. In addition, during the first nine months of 1998 the
Company recognized $812,000 of expense for the anticipated forgiveness of a
second tranche of founders' debt, as mentioned earlier in the Forgivable Notes
Receivable from Founders section of this document. No debt forgiveness was
recognized during the same period of 1997.
Loan servicing consists of direct costs associated with the mortgage loan
servicing operation. The fee the Company pays for servicing its mortgage loan
portfolio is based on volume as well as number of delinquencies and
foreclosures. During the first six months of 1997, the Company contracted the
servicing of its mortgage portfolio with an independent third party. Beginning
July 15, 1997, NovaStar Mortgage began servicing the Company's mortgage loan
portfolio. The increase in loan servicing during the nine months ended September
30, 1998 compared with September 30, 1997 is primarily due to the significant
growth in the Company's mortgage loan portfolio during the period ended
September 30, 1998 compared with September 30, 1997.
20
<PAGE>
Professional and outside services include fees for legal and accounting
services. In the normal course of business, the Company incurs fees for
professional services related to general corporate matters and specific
transactions. Office administration includes items such as rent, depreciation,
telephone, office supplies, postage, delivery, maintenance and repairs. The
increases in both these financial statement captions can be attributable to
additional personnel and the general growth of the Company.
Equity in Earnings (Loss) of NFI Holding Corporation
For the nine months ended September 30, 1998, NFI Holding Corporation
(Holding) recorded a net loss of $2.48 million compared with a net loss of
$143,000 for the nine months ended September 30, 1997. The Company records its
portion of these losses as equity in net loss of Holding in its income
statement, which includes the net loss of its affiliates--NovaStar Mortgage and
NovaStar Capital, Inc. Net income generated by Holding is primarily a function
of the fees earned by NovaStar Mortgage relating to the origination and
servicing of loans for the Company and the costs of these activities. As the
Company did not purchase any of NovaStar Mortgage's production during the third
quarter of 1998, NovaStar Mortgage incurred significant losses during this
period. These losses were offset to a degree by net gains on sales of $1.0
million on $25 million of mortgage loan production. General and administrative
expenses consist largely of compensation and benefits for the marketing,
underwriting, funding and servicing staffs. NovaStar Mortgage incurs significant
general and administrative expenses in generating loan production and servicing
loans and will vary, as a general rule, with loan production. Net losses
incurred by NovaStar Capital, Inc. were $162,000 during the nine months ended
September 30, 1998 as this company started operations during the third quarter
of 1998.
Tables XXIV and XXV are summary financial statements for NFI Holding
Corporation as of and for the nine months ended September 30, 1998. Table XXVI
is a summary of loan costs for NovaStar Mortgage relative to its wholesale loan
originations.
Table XXIV
NFI Holding Corporation--Balance Sheet
September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Assets
<S> <C>
Restricted cash............................... $ 18,997
Mortgage loans................................ 238,207
Mortgage securities........................... 8,686
Other assets.................................. 5,186
--------
Total assets................................ $271,076
========
Liabilities and stockholders' equity
Securities under repurchase agreements........ $ 8,559
Due to NovaStar Financial, Inc................ 259,312
Other liabilities............................. 3,614
--------
Total liabilities............................. 271,485
Stockholders' equity.......................... (409)
Total liabilities and stockholders' equity.. $271,076
========
</TABLE>
21
<PAGE>
Table XXV
NFI Holding Corporation -- Statement of Operations
Nine Months Ended September 30, 1998 (dollars in thousands)
- -----------------------------------------------------------
<TABLE>
<S> <C>
Net interest income............................. $ 1,730
Services provided to NovaStar Financial, Inc.... 6,031
Fees from third parties......................... 879
Gains on sale of mortgage assets................ 1,209
Expenses:
Production.................................... 6,189
Servicing..................................... 2,170
Other......................................... 3,970
-------
Net loss........................................ $(2,480)
=======
</TABLE>
Table XXVI
Cost of Loan Production -- NovaStar Mortgage, Inc.
Nine Months Ended September 30, 1998 and Year Ended December 31, 1997 (dollars
in thousands)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
----------------------------------------------------------------------------------------
Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C> <C> <C> <C>
Total costs of loan production (A)..... $ 4,975 $ 3,837 $ 3,079 $ 2,096 $ 1,938 $ 1,401 $ 410
Wholesale loan origination -- principal 232,333 294,303 207,974 183,012 136,582 77,692 12,688
Premium paid to broker................. 3,322 3,679 2,935 2,896 2,119 1,618 295
-------- -------- -------- -------- -------- ------- -------
Total acquisition cost (B)............. $240,630 $301,819 $213,988 $188,004 $140,639 $80,711 $13,393
======== ======== ======== ======== ======== ======= =======
Costs as a percent of principal:
Loan production...................... 2.1% 1.3% 1.5% 1.1% 1.4% 1.8% 3.2%
=== === === === === === ===
Premium paid to broker............... 1.4% 1.3% 1.4% 1.6% 1.6% 2.1% 2.3%
=== === === === === === ===
Total acquisition cost............... 3.6% 2.6% 2.9% 2.7% 3.0% 3.9% 5.6%
=== === === === === === ===
</TABLE>
- ----------------
(A) Loan production general and administrative as reported for GAAP, plus net
deferred loan costs.
(B) Principal, premium and general administrative expenses associated with loan
production.
Value of Mortgages Added through Wholesale Operations
By establishing a wholesale lending operation to originate subprime
residential mortgage loans, NovaStar has developed a process to add mortgage
assets to its balance sheet at amounts management believes are below what it
would generally cost, in most market environments, to acquire the same assets in
bulk through open market purchases. In effect, the value created by generating
assets at this lower cost is creating future economic benefit, or value, for our
stockholders. This added value is demonstrated in the estimated fair value of
our loan portfolio. The values presented in tables XXVII and XXVIII are
management's estimates based on market conditions as of September 30, 1998. As
discussed in "Events Subsequent to September 30, 1998," market conditions
changed during October 1998. The change in market conditions has, among other
things, caused supply of to be greater than demand for subprime mortgage loans.
As a result, the prices reflected below may not be indicative of market prices
subsequent to September 30, 1998.
Table XXVII provides management's estimates of the value of the mortgage
loans in its portfolio, given the assumptions presented. Because any estimated
value assigned can vary dramatically based upon the assumptions used, the
Company has presented a range of assumptions to allow readers to apply their own
judgment in determining an estimated value. The Company estimates the weighted-
average value of its mortgage loan portfolio as of September 30, 1998 to be
between 103 and 104 (in terms of price to par).
As presented in Table XXVI, during 1998, NovaStar originated mortgage loans
at an all-in cost of 103.6 percent of principal, including direct costs of
acquisition, such as broker premiums, and general overhead expenses. This cost
is higher than in recent quarters. However, NovaStar Mortgages operated during
the third quarter at less than full capacity. If NovaStar Mortgage had operated
at or near full capacity, the all-in cost would be similar to prior quarters.
Direct costs of acquisition are capitalized as premium and amortized as an
adjustment of yield over the life of the loan.
22
<PAGE>
The weighted-average premium on mortgage loans outstanding at September 30,
1998 represented 2.44 percent of principal. Using the estimated market values
from above, this implies an estimated unrealized gain (or additional value) in
the Company's mortgage loan portfolio at September 30, 1998 of between 1.0 and
2.0 percent. Applying this percent to the balance of mortgage loans outstanding
of $1.2 billion results in an estimated unrealized gain of between $12 and $24
million. This additional value results in an estimated mark-to-market equity of
between $122 and $134 million, or $15 per outstanding share.
<TABLE>
<CAPTION>
Table XXVII
Estimated Market Price on Entire Loan Portfolio
As of September 30, 1998
- ---------------------------------------------------------------------------------------------------------------------------
Estimated Market Price Estimated Market Price
------------------------- ------------------------
Two- and Three-year Six-month LIBOR Loan
Fixed Loan Products Products
------------------------- ------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Bond Equivalent Yield............ 8.25% 8.50% 8.75% Bond Equivalent Yield............ 9.00% 9.25% 9.50%
Spread to Index.................. 3.00% 3.25% 3.50% Spread to Index.................. 3.75% 4.00% 4.25%
Assumed Prepayment Speed (CPR)... Assumed Prepayment Speed (CPR)...
30............................... 105.6% 105.0% 104.4% 35............................... 104.6% 104.1% 103.6%
35............................... 104.7% 104.2% 103.7% 40............................... 104.4% 103.5% 103.1%
40............................... 104.0% 103.6% 103.2% 45............................... 103.4% 102.9% 102.5%
<CAPTION>
30/15-year Fixed and
One-year CMT Loan Balloon Loan Products
Products (Three-year Treasury)
------------------------- ------------------------
Bond Equivalent Yield............ 7.64% 7.89% 8.14% Bond Equivalent Yield............ 7.75% 8.00% 8.25%
Spread to Index.................. 3.25% 3.50% 3.75% Spread to Index.................. 3.50% 3.75% 4.00%
Assumed Prepayment Speed (CPR)... Assumed Prepayment Speed (CPR)...
30............................... 104.9% 104.3% 103.7% 25............................... 106.3% 105.6% 104.9%
35............................... 104.1% 103.6% 103.2% 30............................... 105.4% 104.9% 104.3%
40............................... 103.6% 103.2% 102.7% 35............................... 104.7% 104.2% 103.7%
<CAPTION>
Table XXVIII
Estimated Market Price of Loans Originated in Third Quarter of 1998
Third Quarter 1998
- ---------------------------------------------------------------------------------------------------------------------------
Estimated Market Price Estimated Market Price
------------------------- ------------------------
Two- and Three-year Six-month LIBOR Loan
Fixed Loan Products Products
------------------------- ------------------------
Bond Equivalent Yield............ 8.25% 8.50% 8.75% Bond Equivalent Yield............ 7.50% 7.75% 8.00%
Spread to Index.................. 3.00% 3.25% 3.50% Spread to Index.................. 2.25% 2.50% 2.75%
Assumed Prepayment Speed (CPR)... Assumed Prepayment Speed (CPR)...
30............................... 105.4% 104.9% 104.3% 30............................... 104.2% 103.6% 103.0%
35............................... 104.6% 104.1% 103.6% 35............................... 103.6% 103.1% 102.6%
40............................... 103.9% 103.5% 103.1% 40............................... 103.1% 102.7% 102.3%
<CAPTION>
One-year CMT Loan 30/15-year Fixed and
Products Balloon Loan Products
------------------------- ------------------------
Bond Equivalent Yield............ 7.64% 7.89% 8.14% Bond Equivalent Yield............ 7.75% 8.00% 8.25%
Spread to Index.................. 3.25% 3.50% 3.75% Spread to Index.................. 3.50% 3.75% 4.00%
Assumed Prepayment Speed (CPR)... Assumed Prepayment Speed (CPR)...
30............................... 104.3% 103.7% 103.1% 25............................... 106.4% 105.7% 105.1%
35............................... 103.7% 103.2% 102.7% 30............................... 105.5% 105.0% 104.4%
40............................... 103.2% 102.8% 102.3% 35............................... 104.8% 104.3% 103.8%
</TABLE>
23
<PAGE>
Table XXIX
Carrying Value of Loans by Product/Type
As of September 30, 1998 (in thousands)
- -----------------------------------------------------------------
<TABLE>
<CAPTION>
Product/Type Amount
<S> <C>
Two- and three-year fixed.................... $521,535
Six-month LIBOR.............................. 61,342
One-year CMT................................. 40,471
30/15-year fixed and balloon................. 301,087
--------
Outstanding principal.................... 924,435
Premium...................................... 22,550
Reserve for credit losses.................... (2,757)
--------
Carrying Value........................... $944,228
========
Carrying value as a percent of principal..... 102.4%
========
</TABLE>
Results of Operations -- Three Months Ended September 30, 1998 Compared to Three
Months Ended September 30, 1997
Net Income
During the three months ended September 30, 1998, the Company realized net
income of $2.4 million compared with net income of $177,000 for the same period
of 1997. The components of net income are discussed in the following
paragraphs.
Net Interest Income
Table XXX presents a summary of the average interest-earning assets,
average interest-bearing liabilities and the related yields and rates thereon
for the three months ended September 30, 1998.
Table XXX
Interest Analysis
Three Months Ended September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Mortgage Loans Mortgage Securities Total
---------------------------- --------------------------- ------------------------------
Interest Annual Interest Annual Interest Annual
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage Assets......................... $927,132 $22,312 9.63% $412,335 $6,485 6.29% $1,339,467 $28,797 8.60%
======== ======== ==========
Liabilities.............................
Repurchase agreements................. $144,041 2,303 6.40% $419,901 6,121 5.83% $ 563,942 8,424 5.98%
Collateralized mortgage obligations... 821,739 12,734 6.20 821,739 12,734 6.20
Other borrowings...................... 10,446 111 4.25 10,446 111 4.25
-------- ---------
Cost of derivative financial
Instruments hedging liabilities....... 638 181 819
------- ------ -------
Total borrowings.................... $976,226 15,786 6.47 $419,901 6,302 6.00 $1,396,127 $22,088 6.33
======== ------- ======== ------ ========== =======
Net interest income................... $ 6,526 $ 183 $ 6,709
======= ====== =======
Net interest spread................... 3.16% 0.29% 2.27%
==== ==== ====
Net yield............................. 2.82% 0.18% 2.00%
==== ==== ====
</TABLE>
The Company had average interest-earning assets of $1.34 billion during the
three months ended September 30, 1998, compared with $629.0 million for the
three months ended September 30, 1997. During the three month period ended
September 30, 1998, mortgage securities earned $6.5 million, or a yield of 6.3
percent, while mortgage loans earned $22.3 million, or a yield of 9.6 percent.
For the same period of 1997, mortgage securities earned $4.6 million, or a
yield of 6.6 percent, while mortgage loans earned $7.7 million, or a yield of
8.7 percent. In total, assets earned $28.8 million -- a yield of 8.6 percent
for the period ending September 30, 1998 compared with $12.2 million, or a yield
of 7.8 percent for the period ending September 30, 1997.
During the three months ended September 30, 1998, borrowed funds for the
Company averaged $1.4 billion on which interest was incurred of $22.1 million,
or 6.3 percent. In comparison, for the three months ended September 30, 1997,
borrowed
24
<PAGE>
funds for the Company averaged $593.2 million on which interest was incurred of
$9.8 million, or 6.6 percent. Rates on other borrowings generally fluctuate with
short-term market interest rates, such as LIBOR or the Federal Funds rate.
Net interest income during the three months ended September 30, 1998 was
$6.7 million, or 2.00 percent of average interest-earning assets compared with
$2.4 million, or 1.53 percent of average interest-earning assets for the three
month period ending September 30, 1997. Net interest spread for the Company was
2.27 percent versus 1.18 percent during the three months ended September 30,
1998 and September 30, 1997, respectively.
Provisions for Credit Losses
During the three months ended September 30, 1998, the Company provided $1.2
million for credit losses compared with $726,000 for the three months ended
September 30, 1997. Credit losses recognized during the three-month period
ended September 30, 1998 were $1.8 million. The Company recognized no losses on
its mortgage loan portfolio during the three-month period ended September 30,
1997. As mentioned earlier, reserves are maintained for losses management
expects to incur on loans in the portfolio.
Fees provided by NovaStar Mortgage, Inc. and Other Income
Fees paid by NovaStar Mortgage to the Company in accordance with the
Mortgage Loan Sale and Purchase Agreement aggregated $3.3 million during the
third quarter 1998.
During the three months ended, September 30, 1998, the Company recognized a
$200,000 gain on sale of mortgage loans, pooling $4.7 million of mortgage loans
in the transaction. Also, included in other income during the third quarter of
1998, are prepayment penalties of $625,000 and interest on founders' notes
receivable of $129,000.
General and Administrative Expenses
General and administrative expenses during the three months ended September
30, 1998 and September 30, 1997, respectively, were $5.0 million and $2.1
million. Consistent with prior periods, the single largest component of general
and administrative expenses is the administrative outsourcing fee paid to
NovaStar Mortgage, which was $2.1 million for the three month period ending
September 30, 1998 compared with $1.2 million for the three month period ended
September 30, 1997. Compensation and benefits totaled $478,000 during the third
quarter of 1998 compared with $332,000 for the third quarter of 1997.
Professional and outside services include legal fees and contract labor for
the development of information systems. These expenses were $296,000 and
$181,000 for the third quarter of 1998 and 1997, respectively.
Loan servicing costs were $1.5 million compared with $123,000 for the three
month period ending September 30, 1998 and 1997, respectively. Loan servicing
costs include direct costs of managing the loan portfolio which are not
reimbursable by the borrower. In addition, loan servicing costs include fees
associated with the service provider who services the Company's loans. These
fees were paid to NovaStar Mortgage in 1998 and to an outside party during the
same period of 1997 as the Company outsourced this service until July 15, 1997.
Equity in Earnings (Loss) of NFI Holding Corporation
For the three months ended September 30, 1998, Holding recognized a net
loss of $2.5 million of which the Company recorded its portion. For the same
period of 1997, Holding realized a net income of 293,000. As mentioned earlier,
the increase in the net loss is largely due to the fee from NovaStar Mortgage to
the Company as NFI did not acquire any of NovaStar Mortgage's production during
the third quarter of 1998. This loss was partly offset by realized gains of
$798,000 on the sale of mortgage securities and loans.
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 are based on taxable income. Table XXXI is a summary of the
differences between the Company's net income or loss reported for GAAP the three
month period ended September 30, 1998 and 1997 by quarter and its taxable
income.
25
<PAGE>
<TABLE>
<CAPTION>
Table XXXI
Taxable Income (Loss)
Nine months Ended September 30, 1998 (in thousands)
- ---------------------------------------------------------------------------------------------------------
1998 1997
--------------------------------------------------------------------
Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C> <C> <C> <C>
Net income (loss).................. $ 2,394 $1,894 $1,279 $ (433) $ 177 $(1,073) $194
Results of Holding and subsidiary.. 2,447 -- 273 (169) (393) 126 408
Provision for credit losses........ 1,179 1,145 1,076 1,009 726 547 171
Loans charged-off.................. (1,762) (675) (518) (140)
Other, net......................... 95 208 (4) 296 (4) (8) --
------- ------ ------ ------ ----- ------- ----
Taxable income (loss).............. $ 4,353 $2,572 $2,106 $ 563 $ 506 $ (408) $773
======= ====== ====== ====== ===== ======= ====
</TABLE>
As discussed under "Events Subsequent to September 30, 1998," the Company
executed several transactions during October 1998 that included the sale of
assets and termination of hedging arrangements. Management anticipates the
significant losses resulting from these transactions will eliminate taxable
income for 1998.
Interest rate sensitivity. 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. 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. Table XXXII details the
Company's Interest Rate Sensitivity as of September 30, 1998.
<TABLE>
<CAPTION>
Table XXXII
Interest Rate Sensitivity (A) (B)
September 30, 1998
- ------------------------------------------------------------------------------------------------
Basis Point Increase (Decrease) in Interest Rate (C)
----------------------------------------------------
(100) Base (D) 100
---------- ---------- ----------
<S> <C> <C> <C>
Market value of:
Assets............................. $1,715,188 $1,703,308 $1,687,861
Liabilities........................ 1,594,020 1,593,078 1,592,136
Interest rate agreements........... 69 571 2,977
---------- ---------- ----------
Net market value..................... $ 121,237 $ 110,801 $ 98,702
========== ========== ==========
Cumulative change in value(D)........ $ 10,436 -- $ (12,099)
========== ========== ==========
Percent change from base assets(E)... 0.83% -- (0.95)%
========== ========== ==========
Percent change of capital(F)......... 9.50% -- (11.01)%
========== ========== ==========
</TABLE>
- ---------------
(A) Management analyzes the interest sensitivity of the Company and NovaStar
Mortgage on a combined basis. The assets and liabilities of NovaStar
Mortgage consist primarily of mortgage loans with a carrying value of
$238,207 and securities with a current face of $8.5 million and their
related repurchase agreement financing.
(B) Reflects the sale of all securities and all swap terminations made in
October 1998.
(C) Value of asset, liability or interest rate agreement in a parallel shift in
the yield curve, up and down 1%.
(D) Total change in estimated market value, in dollars, from "base." "Base" is
the estimated market value at October 15, 1998.
(E) Total change in estimated market value, as a percent, from base.
(F) Total change in estimated market value as a percent of total stockholders'
equity at September 30, 1998.
Interest Rate Sensitivity Analysis. The values under the heading "Base" are
management's estimates of market values of the Company's assets, liabilities and
interest rate agreements on September 30, 1998. The values under the headings
"100" and "(100)" are management's estimates of the market value of those same
assets, liabilities and interest rate agreements assuming that interest rates
were 100 basis points (1%) higher and lower. The cumulative change in value
represents the change in value of assets from base, net of the change in value
of liabilities and interest rate agreements from base.
The interest sensitivity analysis is prepared regularly (at least monthly).
If the analysis demonstrates that a 100 basis point shift (up or down) in
interest rates would result in 10% or more cumulative change in value from base,
management will modify the Company's portfolio by adding or removing interest
rate cap or swap agreements.
26
<PAGE>
Sensitivity as of September 30, 1998. As shown in the table above, if
interest rates were to decrease one percent (-100 basis points), the value of
the Company's capital would increase by an estimated 9.50 percent. If interest
rates rise by one percent (+100 basis points), the value of the Company's
capital would decrease by an estimated 11.01 percent.
Capital Allocation Guidelines (CAG). The Company's goal is to strike a
balance between the under-utilization of leverage, which reduces 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. Following presents a summary of the
Company's CAG for the following levels of capital for the types of assets it
owns.
Table XXXIII
Capital Allocation Guidelines
September 30, 1998
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
(A) (B) (C) (D) (E) (F) (F)
Minimum Duration Liquidity (c+d) (bxe) (a + f)
Lender Estimated Price Spread Spread Total Spread Equity Cushion CAG Equity
Asset Category 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
GNMA Fixed Rates........ 3.00 5.00 50 -- 50 2.50 5.50
Corporate Bonds......... 10.00 3.50 225 25 250 8.75 18.75
Mortgage loans:
Collateral for
warehouse financing.... 2.00 3.00 100 50 150 4.50 7.50
Collateral for CMO...... 5.80 -- -- -- -- -- 5.80
Delinquent.............. 100.00 -- -- -- -- -- 100.00
Hedging.................. -- -- -- -- -- -- 5.80
Other.................... 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 the lender 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
haircut. On the other extreme, "B" rated securities and securities not
registered with the Securities and Exchange Commission (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
management's 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.
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.
Table XXXIV is a summary of the capital allocation for NovaStar as they
apply to the Company's mortgage assets and hedging instruments during 1998 and
1997.
27
<PAGE>
<TABLE>
<CAPTION>
Table XXXIV
Required Equity
- ----------------------------------------------------------------------------------------------------------------------
1998 1997
---------------------------------- -----------------------------------------------
Category September 30 June 30 March 31 December 31 September 30 June 30 March 31
<S> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Current........................ $ 14,567 $ 21,566 $ 23,628 $ 6,675 $ 33,832 $22,780 $15,958
Delinquent..................... 452 601 1,200 1,600 2,376 -- --
Securitized loans.............. 55,822 37,766 23,478 22,500 -- -- --
Mortgage securities.............. 19,514 24,904 27,426 36,170 12,763 13,549 1,646
Other assets..................... 20,682 13,782 10,733 -- -- -- --
Hedging instruments.............. (688) (232) (203) 5,500 427 1,787 2,804
-------- -------- -------- -------- --------- ------- -------
Required equity.................. 110,349 98,387 86,262 72,445 49,398 38,116 20,408
Stockholders' equity............. 109,848 114,875 115,798 116,489 47,036 46,337 46,202
Market value in excess of the
carrying value of assets and
hedges (A)...................... 2,331 31,999 20,685 -- -- -- --
-------- -------- -------- -------- --------- ------- -------
Excess equity.................... $ 1,830 $ 48,487 $ 50,221 $ 44,044 ($ 2,362) $ 8,221 $25,794
======== ======== ======== ======== ========= ======= =======
</TABLE>
- -----------------
(A) The Company revised its CAG model during the first quarter of 1998 to
include the market value in excess of the carrying value of assets and
hedges as the Company has the ability to borrow against this residual.
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 financial statements are prepared in accordance with generally
accepted accounting principles and the Company's dividends are based upon the
Company's taxable income. 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 of the Annual Report to
Shareholders and Annual Report on Form 10-K for the year ended December 31, 1997
describes certain recently issued accounting pronouncements. Management believes
the implementation of these pronouncements and others that have gone into effect
since the date of these reports, will not have a material impact on the
consolidated financial statements.
During June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS No. 133). SFAS No. 133 requires that
entities recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
Derivatives meeting certain conditions may be designated as hedging instruments,
for which SFAS No. 133 prescribes accounting treatment, depending on the type of
hedge. For those derivatives not designated as a hedging instrument, the gain or
loss is recognized in earnings in the period of change. For the Company, SFAS
No. 133 must be applied not later than for the fiscal year beginning January 1,
2000. Management is currently evaluating the impact of SFAS No. 133 to the
company's financial statements.
Statement of Financial Accounting Standards No. 134, Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise was issued by the FASB during
October 1998. SFAS No. 134 amends SFAS No. 65 and 115, and requires entities to
classify retained mortgage-backed securities after the securitization of
mortgage loans held for sale in accordance with SFAS No. 115. However, a
mortgage banking enterprise must classify as trading retained mortgage-backed
securities that it commits to sell before or during the securitization process.
This statement is effective for the first fiscal quarter beginning after
December 15, 1998. Management does not expect the adoption of this standard to
have a material impact on the Company's financial position and results of
operations.
28
<PAGE>
The Year 2000
The Company is highly dependent on purchased and leased computer software
to conduct business. In addition, the Company is highly dependent on computer
software used by market counterparties and vendors, including banks, in
conducting business. The Company recognizes that some computer software may not
have the ability to correctly identify dates beyond December 31, 1999. The
Company's successful modification of computer software, or the vendors'
successful modification of their programs, to be year 2000 compliant is critical
to the Company's viability.
NovaStar uses three major, and a number of smaller, internal automation
solutions to conduct its business operations. The three computer systems
considered the most significant to the Company's operations are as follows:
. The internally developed loan origination and database system
. The externally provided loan servicing system
. The purchased accounting system
In addition, the Company integrates with a number of outside entities in
our normal business transactions. Interfaces with other businesses and third
party solution providers are used to conduct some of our business processes.
Certain other processes are supported by systems created internally.
NovaStar is using the Federal Financial Institutions Examination Council's
(FFIEC) "Year 2000 Project Management Awareness" document to guide our year 2000
readiness effort. Each program/system interface used by the Company is being
reviewed and tested for year 2000 compliance. The FFIEC guide calls for a
three-phase approach to assess year 2000 compliance.
In the Assessment Phase, the Company has determined which business
processes/interfaces rely on dates and date arithmetic. Most of the Company's
business processes/interfaces rely on dates and date arithmetic. These business
processes/interfaces are being tested internally for compliance. The Company
has asked its market counterparties and vendors to document that they have
assessed software for year 2000 compliance.
Solution updates to non-compliant Year 2000 software should be made in the
Correction Phase. Corrections on Company developed software will be made
internally and are expected to be insignificant. The Company is requiring all
market counterparties and vendors to document they have made all corrections.
The Company will conduct "mock" business as if it is in the year 2000
during the Validation Phase. During this phase, the Company will test all
internally developed software as well as vendor software.
NovaStar has contacted all of its significant outside market counterparties
and vendors to obtain documentation regarding their process and status for
assuring year 2000 compliance. The Company has asked that each party adhere to
the same FFIEC guidelines and to provide documents of progress during each
phase. Recent status reports have been received from Alltel Residential Lending
Solutions (vendor of the Company's servicing system) and Baan/CODA (vendor of
the Company's accounting system) and are as follows:
. Alltel, vendor of the servicing platform expects to complete testing by
December 31, 1998 and maintains they will be fully year 2000 compliant
by the first quarter of 1999.
. Baan/CODA, vendor of the accounting system has provided the Company
written confirmation that the version the Company currently uses is
fully year 2000 compliant.
All internally developed software was designed to be year 2000 compliant.
In addition, the Company has contacted its significant financial counterparty,
First Union National Bank, who is completing their internal review of year 2000
compliance.
The Company believes that its greatest risk in regards to year 2000
compliance is the software and systems used to service its subprime mortgage
loans. NovaStar Mortgage, Inc., an affiliate of the Company, services the
Company's loans. NovaStar Mortgage uses systems developed by Alltel for loan
servicing. If these systems fail, NovaStar Mortgage will not be able to continue
on a manual basis. In this worst case scenario, loans would not be serviced
until the failed system could be remedied. If the loans go "unserviced" for an
extended period of time -- several weeks -- the result could have a material
adverse impact on the Company.
The Company is also at significant risk in the event the systems of
financial institutions, on which the Company is relying for financing and cash
management, fail. In a worst case scenario, the Company and NovaStar Mortgage
may not be able to meet financial obligations during the period of failure -- an
unknown timeframe. The result could have a material adverse impact on the
Company.
The Company is exposed to smaller risks in the event other systems,
including those developed internally, fail to perform beyond December 31, 1999.
However, management believes functions, other than servicing, can be maintained
on a manual basis should systems fail. Although processing and performance
would be slow, risk of material adverse impact to the Company for these systems
failures is expected to be minimal.
Management expects, through the completion of its year 2000 plan, the
likelihood of a material business disruption is not significant. The major
risks presented above involve year 2000 remediation efforts of third party
vendors used by the Company.
29
<PAGE>
Based on the information provided, the Company believes these vendors will meet
their obligation for resolution of year 2000 issues.
The Company estimates it has incurred less than $75,000 in costs to date in
carrying out its year 2000 compliance plan and estimates it will spend less than
$100,000 in completing the plan. However, the costs could increase dramatically
if the Company determines that any market counterparty will not be year 2000
compliant.
The Company has not developed formal contingency plans to be used in the
event any of its hardware, software or other computerized systems, or those of a
vendor, are not ready for the year 2000. A full contingency plan will be
developed prior to March 31, 1999.
30
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As of September 30, 1998, there were no material legal proceedings
pending to which the Company was a party or of which any of its
property was subject.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults upon Senior Securities
Not applicable
Item 4. Submission of Matters of Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits filed with this report are as follows:
10.1 Master repurchase agreement with First Union National Bank
10.2 Primary mortgage insurance agreement with Commonwealth Mortgage
Assurance Company
11.1 Schedule regarding computation of per share earnings
21.1 Subsidiaries of the Registrant
27.1 Financial data schedule
99.1 Press release dated October 29, 1998
(b) The Company has filed the following Form 8-K's:
. Regarding certain amendments made to its charter filed on July 6,
1998.
. Regarding announcement of current market conditions and postponement
of the third quarter dividend filed on October 12, 1998.
. Regarding announcement of $15 million 90-day committed secured
financing agreement to address immediate liquidity needs filed on
October 13, 1998.
. Regarding announcement of steps taken to address immediate liquidity
needs filed on October 15, 1998.
31
<PAGE>
NOVASTAR FINANCIAL, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NOVASTAR FINANCIAL, INC.
DATE: November 12, 1998 /s/ Scott F. Hartman
--------------------
Scott F. Hartman
Chairman of the Board, Secretary and
Chief Executive Officer
(Principal Executive Officer)
DATE: November 12, 1998 /s/ Rodney E. Schwatken
-----------------------
Rodney E. Schwatken
Vice President, Controller and
Assistant Treasurer
(Principal Accounting Officer)
32
<PAGE>
EXHIBIT 10.1
[EXECUTION COPY]
MASTER REPURCHASE AGREEMENT
Dated as of August 21, 1998
Between:
NOVASTAR FINANCIAL, INC.,
as Seller
and
FIRST UNION NATIONAL BANK,
as Buyer
1. Applicability
From time to time the parties hereto may enter into transactions in which the
Seller agrees to transfer to the Buyer mortgage loans or other assets (the
"Collateral") against the transfer of funds by the Buyer, with a simultaneous
agreement by the Buyer to transfer to the Seller such Collateral at a date
certain, against the transfer of funds by the Seller. Each such transaction
shall be referred to herein as a "Transaction" and, unless otherwise agreed in
writing, shall be governed by this Agreement.
2. Definitions
As used in this Agreement, and unless the context requires a different meaning,
the following terms shall have the meanings assigned to them below:
(a) "1934 Act" shall mean the Securities Exchange Act of 1934.
(b) "Act of Insolvency" shall mean, 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 or
election, or the filing against a party of an application for a
protective decree under the provisions of SIPA, 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, the 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.
(c) "Additional Collateral" shall mean Mortgage Loans and/or cash provided
by the Seller to the Buyer pursuant to Paragraph 5(b) hereof.
(d) "Additional Required Documents" shall mean the following documents
with respect to any Mortgage Loan:
(i) original disclosure statements complying with Regulation Z
("Truth in Lending") of the Board of Governors of the Federal
Reserve System and all agreements relating thereto, if
applicable;
(ii) original Equal Credit Opportunity Act notice and additional
disclosure statements or agreements relating thereto, if
applicable;
<PAGE>
(iii) survey of the property covered by the Mortgage Loan, including
a determination of whether or not such property falls into a
flood zone as identified by a HUD identified flood map;
(iv) an attorney's opinion of title and abstract of title or an
ALTA mortgage title insurance policy or such other policy in
form acceptable to FNMA or FHLMC, issued by and constituting
the valid and binding obligation of a title insurer generally
acceptable to prudent mortgage lenders that regularly
originate or purchase mortgage loans comparable to the
Purchased Loans for sale to prudent investors in the secondary
market that invest in mortgage loans such as the Purchased
Loans and qualified to do business in the jurisdiction where
the related property is located, insuring the Seller, its
successors and assigns, as to the first priority lien of the
related Mortgage in the case of a Mortgage Loan secured by a
first priority lien and the second priority lien of the
Mortgage Loan in the case of a Purchased Loan secured by a
second lien on the related property, in the original principal
amount of the Purchased Loan; provided that the Seller shall
be the sole named insured of any such mortgage title insurance
policy, the assignment to the Buyer or the Custodian as
assignee of the Buyer of the Seller's interest in such
mortgage title insurance policy shall not require the consent
of or notification to the insurer or the same has been
obtained, and such mortgage title insurance policy shall be in
full force and effect and will be in full force and effect and
inure to the benefit of the Buyer upon the consummation of the
transactions contemplated by this Agreement; and, provided
further, that no claims shall have been made under such
mortgage title insurance policy and no prior holder of the
related Mortgage Loan, including the Seller, shall have done,
by act or omission, anything that would impair the coverage of
such mortgage title insurance policy;
(v) written statement signed by the attorney, title company or
closing agent responsible for supervising the closing of the
Mortgage Loan that such Person closed the Mortgage Loan in
accordance with any closing instructions received by such
Person;
(vi) a property and casualty insurance policy on the property
securing the Mortgage Loan covering fire, hazard and extended
coverage, and if applicable, flood and earthquake insurance,
all in amounts not less than the principal amount of the
promissory note relating to the Mortgage Loan (or the maximum
amount issuable for flood insurance) which insurance has been
endorsed to provide for payment thereof to the Seller, as
mortgagee, together with written notice to the mortgagor of
the fact, if true, that mortgagor's property lies within a
flood zone;
(vii) original or copy of executed application by the obligor on
such Mortgage Loan for such Mortgage Loan;
(viii) original or copy of credit bureau report on the obligor on
such Mortgage Loan;
(ix) original HUD-1 settlement statement duly executed by the
obligor on such Mortgage Loan;
(x) original complete appraisal obtained with respect to the
applicable property obtained in connection with the Mortgage
Loan; and
(xi) such other documents as the Buyer may reasonably request from
time to time, including but not limited to verification of
employment of the obligor on such Mortgage Loan, verification
of deposit by such obligor (if applicable), and any inspection
reports performed with respect to such obligor or the property
covered by such Mortgage Loan.
(e) "Agreement" shall mean this Master Repurchase Agreement, together with
all exhibits, schedules or amendments hereto and all Confirmations
hereunder.
(f) "Aggregate Commitment" shall have the meaning assigned to such term in
Paragraph 6.
(g) "Bankruptcy Code" shall mean Title 11 of the United States Code, as
amended.
<PAGE>
(h) "Business Day" shall mean any day except Saturday, Sunday and any day
which is a legal holiday or a day on which banking institutions are
authorized or required by law to close in Charlotte, North Carolina.
(i) "Buyer" shall mean First Union National Bank, a national banking
association, with its principal place of business in Charlotte, North
Carolina.
(j) [reserved]
(k) "Collateral" shall have the meaning assigned to such term in Paragraph
1.
(l) "Confirmation" shall mean a confirmation for a Transaction as required
by Paragraph 4(a) hereof, substantially in the form of Exhibit A
hereto.
(m) "Current Margin" shall mean, with respect to any date, the difference
between (i) the aggregate Market Value of all Purchased Loans held by
the Buyer on such date and (ii) the aggregate Purchase Price paid by
the Buyer for all Purchased Loans held by the Buyer on such date.
(n) "Custodial Agreement" shall mean the Repurchase Facility Custodial
Agreement, dated as of August 21, 1998, among the Buyer, the Seller
and the Custodian.
(o) "Custodian" shall mean First Union National Bank, a national bank.
(p) "Default Rate" shall mean, for any day, the Pricing Rate for such day
plus 4.00%.
(q) "Eligible Mortgage Loan" shall mean a Mortgage Loan (i) with respect
to which each of the representations and warranties set out in Exhibit
B hereto is accurate and complete as of the date of the related
Confirmation (and the Seller by including any such Mortgage Loan in
any Transaction shall be deemed to so represent and warrant to the
Buyer at and as of the date of such Transaction) and (ii) that has
been outstanding no more than 180 days since first purchased by the
Buyer in a Transaction.
(r) "ERISA" shall mean the Employee Retirement Income Security Act of
1974.
(s) "Event of Default" shall have the meaning assigned to such term in
Paragraph 12.
(t) "FDIA" shall mean the Federal Deposit Insurance Act, as amended.
(u) "FDICIA" shall mean the Federal Deposit Insurance Corporation
Improvement Act of 1991.
(v) "GAAP" shall mean generally accepted accounting principles.
(w) "Income" shall mean, with respect to any Mortgage Loan at any time,
any payments of principal thereof and all payments of interest and
dividends or other distributions thereon.
(x) "Indemnified Parties" shall have the meaning assigned to such term in
Paragraph 15.
(y) "LIBOR" shall mean the London Interbank Offered Rate obtained on page
3750 of Telerate as being the rate at which deposits in immediately
available U.S. dollars having a maturity of one month are offered to
or by reference banks in the London interbank market, as determined by
the Buyer at the time of each Transaction.
(z) "Margin" shall mean, with respect to any Mortgage Loan or pool of
Mortgage Loans, the difference between the Market Value of such loan
or loans and the Purchase Price for such loan or loans.
(aa) "Margin Call" shall have the meaning assigned to such term in
Paragraph 5(b).
(bb) "Margin Deficit" shall have the meaning assigned to such term in
Paragraph 5(b).
(cc) "Market Value" shall mean, with respect to each Purchased Loan, the
market value of such Purchased Loan as determined by the Buyer in its
sole discretion.
<PAGE>
(dd) "Mortgage Loan" shall mean a residential real estate secured loan to a
sub-prime borrower, including, without limitation: (i) a promissory
note, any reformation thereof and related deed of trust (or mortgage)
and security agreement; (ii) 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 Seller to return premiums or payments with respect
thereto; and (iii) all right, title and interest of the Seller in the
property covered by such deed of trust (or mortgage).
(ee) "Original Margin" shall mean, with respect to any date, the difference
between (i) the aggregate Market Value of all Purchased Loans held by
the Buyer on such date, determined as of the most recent Purchase Date
for each such Purchased Loan, and (ii) the Purchase Price paid by the
Buyer for all such Purchased Loans on such Purchase Date(s); provided
that the Original Margin for any Transaction shall be deemed to be no
greater than the Original Margin set out in the related Confirmation.
(ff) "Person" shall mean a corporation, an association, a partnership, an
organization, a business, a trust, an individual, a government or
political subdivision thereof, any governmental agency or any other
entity.
(gg) "Plan Party" shall have the meaning assigned to such term in Paragraph
29(a).
(hh) "Price Differential" shall mean, with respect to any Transaction as of
any date, the difference between the Purchase Price paid by the Buyer
and the Repurchase Price to be paid by the Seller. The Pricing
Differential will equal 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
Repurchase Date or other date of determination.
(ii) "Pricing Rate" shall mean the per annum rate for determination of the
Price Differential, which rate shall be LIBOR plus [ ] basis points or
such other rate as may be specified in a Confirmation.
(jj) "Purchase Date" shall mean the date on which Purchased Loans are to be
transferred by the Seller to the Buyer.
(kk) "Purchased Loans" shall mean the Mortgage Loans transferred by the
Seller to the Buyer in a Transaction hereunder. The term "Purchased
Loans" with respect to any Transaction at any time also shall include
Additional Collateral delivered pursuant to Paragraph 5(b) hereof.
(ll) "Purchase Price" shall mean the price at which Purchased Loans are
transferred by the Seller to the Buyer.
(mm) "Replacement Mortgage Loans" shall have the meaning assigned to such
term in Paragraph 13(c).
(nn) "Repurchase Date" shall mean the date on which the Seller is required
to repurchase the Purchased Loans from the Buyer, which shall be (i)
the 10th day of the calendar month in which the Purchase Date occurs
or, if such Purchase Date falls on or after the 10th day of such
month, the 10th day of the following calendar month (or, in each case,
if such day is not a Business Day, the next Business Day), (ii) such
earlier date as may be set forth in a Confirmation or (iii) such
earlier date as may be determined by application of the provisions of
Paragraph 13 hereof.
(oo) "Repurchase Price" shall mean the price at which Purchased Loans are
to be transferred from the Buyer to the Seller upon termination of a
Transaction, which will be determined in each case as the sum of the
Purchase Price and the Price Differential as of the date of such
determination.
(pp) "Repurchase Term" shall mean, with respect to any Transaction, the
period beginning on the Purchase Date and continuing through the
Repurchase Date.
(qq) "Required Documents" shall mean the following documents with respect
to any Mortgage Loan:
(i) the original executed and fully completed promissory note
relating to the Mortgage Loan (properly endorsed to the Seller
if purchased by the Seller from another originator), which
<PAGE>
promissory note shall be duly endorsed in blank without recourse
by an authorized officer of the Seller;
(ii) the original executed and fully completed mortgage or deed of
trust relating to the Mortgage Loan in proper form for
recordation in the appropriate jurisdiction and duly recorded in
the appropriate jurisdiction; provided, however, that a
certified copy of the executed mortgage or deed of trust
relating to the Mortgage Loan may be delivered to the Buyer in
lieu of the original recorded deed of trust or mortgage until
such time as the original recorded mortgage or deed of trust is
received from the recording jurisdiction and submitted to the
Buyer; and
(iii) an original executed, fully completed and recordable but
unrecorded assignment of the mortgage or deed of trust relating
to the Mortgage Loan in proper form for recordation in the
appropriate jurisdiction (unless the Buyer determines in its
reasonable judgment that under applicable state law the
assignment should be recorded in order to adequately protect its
interest, in which case the assignment shall be recorded by the
Seller and a certified true copy thereof shall be provided to
the Buyer), together with the original or a duly certified copy
of the fully completed and proper assignment or assignments of
the mortgage or deed of trust from the original holder through
any subsequent transferees to the Seller in proper form for
recordation in the appropriate jurisdiction, duly recorded if
local requirements in the jurisdiction in which the property is
located required the recordation of such assignment or
assignments.
(rr) "SEC" shall mean the Securities and Exchange Commission.
(ss) "Servicer" shall mean NovaStar Mortgage, Inc.
(tt) "Servicing Agreement" shall mean the servicing agreement dated as of
August 21, 1998 between the Seller and the Servicer, as modified by
the First Amendment and Supplement to Servicing Agreement, dated as of
August 21, 1998, between the Buyer, the Seller and the Servicer.
(uu) "SIPA" shall mean the Securities Investor Protection Act of 1970.
(vv) "Transaction" shall mean each transaction between the Seller and the
Buyer that is undertaken pursuant to a Confirmation.
(ww) "Underwriting Standards" shall mean the underwriting policies of the
Seller set forth in Exhibit C hereto.
3. Initiation and Termination of Transactions
(a) An agreement to enter into a Transaction may be made in writing at the
initiation of the Seller and shall be evidenced by a Confirmation
delivered pursuant to Paragraph 4(a). On the Purchase Date for the
Transaction, the Purchased Loans shall be transferred to the Buyer or
its agent against the transfer of the Purchase Price to an account of
the Seller.
(b) The Buyer's obligation to purchase any Mortgage Loan shall be subject
to the following:
(i) The Buyer (or the Custodian, if so directed by the Buyer) shall
have possession of the Required Documents for each Mortgage Loan
to be purchased provided that such possession may have been
released to a prospective purchaser of a Mortgage Loan (or a
custodian acting on its behalf) if the Buyer or the Custodian,
as applicable, has received a bailment letter for the related
required documents.
(ii) The Buyer's determination that the Mortgage Loans to be
purchased in the requested Transaction satisfy the requirements
of this Agreement.
(iii) The Seller's representations and warranties contained in this
Agreement and reaffirmed in the Confirmation shall be true and
correct.
(iv) The Purchase Price for such Transaction shall be at least
$10,000,000.
<PAGE>
(v) No Event of Default shall have occurred under this Agreement.
(c) On the Repurchase Date for each Transaction, termination of the
Transaction will be effected by transfer to the Seller or its agent of
the Purchased Loans and any Income in respect thereof received by the
Buyer (and not previously credited or transferred to, or applied to
the obligations of the Seller hereunder) against the transfer of the
Repurchase Price to an account of the Buyer.
4. Transaction Confirmation
(a) Upon the parties' agreement to enter into a Transaction hereunder, the
Buyer shall prepare and deliver to the Seller, at least one Business
Day prior to the Purchase Date for the Transaction, a Confirmation for
such Transaction.
(b) The Confirmation shall list the Purchased Loans and set forth (i) the
Purchase Date, (ii) the Purchase Price, (iii) the anticipated
Repurchase Date, (iv) the Pricing Rate or Repurchase Price applicable
to the Transaction, and (v) any additional terms or conditions of the
Transaction.
(c) The Confirmation, together with this Agreement, shall constitute
conclusive evidence of the terms agreed between the Buyer and the
Seller, and shall be binding upon the parties unless written notice of
objection is given by the objecting party prior to the closing of the
Transaction.
(d) In the event of any conflict between the terms of a Confirmation and
this Agreement, the Confirmation shall prevail.
5. Margin Maintenance
(a) On Monday of each week during the Repurchase Term (or more often, if
the Buyer in its sole discretion so decides), the Buyer will determine
(i) the aggregate Market Value of all Purchased Loans and other
Collateral held by the Buyer and (ii) the Current Margin for such
date.
(b) If on any date during the term of this Agreement the Current Margin
for such date is less than the Original Margin for such date (such
shortfall, a "Margin Deficit"), the Buyer may by notice to the Seller
(such notice, a "Margin Call") require that the Seller, at the
Seller's option, transfer to the Buyer cash or additional Mortgage
Loans reasonably acceptable to the Buyer (collectively, "Additional
Collateral"), so that the Current Margin for such date will then equal
or exceed the Original Margin for such date; provided, however, that
the Buyer may not make a Margin Call unless the Margin Deficit exceeds
$250,000.
(c) If any notice is given under subparagraph (b) of this Paragraph 5 on
any Business Day, then the Seller shall transfer cash or Mortgage
Loans as provided in such subparagraph no later than the close of
business on the second Business Day following the date on which such
notice is received. Any cash transferred to the Buyer pursuant to this
subparagraph (c) shall be held by the Buyer for so long as any
Transaction remains in effect and shall be applied against the
Repurchase Price for any terminated Transaction on the applicable
Repurchase Date.
6. Aggregate Commitment and Term
(a) The aggregate Purchase Price for all Purchased Loans owned by the
Buyer on any date shall at no time exceed $200,000,000 (the "Aggregate
Commitment").
(b) This Agreement shall continue in effect for a period of 364 days from
the date of its execution by both parties.
7. Payments on Mortgage Loans; Servicing
The parties acknowledge that the Servicer will act as servicer for all Mortgage
Loans, will service all Mortgage Loans in accordance the Servicing Agreement and
will not sell or transfer its rights to service such loans without the Buyer's
consent. Where a particular Transaction's term extends over a payment date on a
Purchased Loan, all Income received with respect to such Purchased Loan shall,
so long as no Event of Default with respect to the Seller shall have occurred
and be continuing, be the property of the Seller, and the Seller shall be
entitled to all Income with respect to Purchased Loans subject to Transactions.
Upon the occurrence and continuance of an Event of Default,
<PAGE>
all Income received by the Servicer with respect to the Purchased Loans shall be
held in a segregated account established by the Servicer and shall be paid to
the Buyer within one Business Day of receipt.
8. Repurchase Prior to Repurchase Date
Notwithstanding any provision hereof to the contrary, the Buyer may require the
Seller to repurchase at the Repurchase Price any of the Purchased Loans subject
to a Transaction as to which a breach of any representation contained in
Paragraph (f) of Exhibit B hereto has occurred upon two Business Days' prior
notice. Notwithstanding the foregoing, the Seller may elect, in lieu of
repurchasing such Purchased Loans, to substitute for such Purchased Loans one or
more Eligible Mortgage Loans having an aggregate Market Value which equals or
exceeds that of the Purchased Loans required to be repurchased under this
Section 8.
9. Delivery of Mortgage Loans
All of the Required Documents for Mortgage Loans that are to be Purchased Loans
for a Transaction shall be delivered to the Buyer (or the Custodian, if so
directed by the Buyer) at least two Business Days prior to the Purchase Date for
such Transaction.
10. Representations and Warranties
(a) Each of the Buyer and the Seller represents and warrants to the other
that (i) 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 performance, (ii) it will engage in such
Transactions as principal, (iii) the individual signing this Agreement
on its behalf is duly authorized to do so on its behalf, (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, bylaw 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
the Buyer and the Seller shall each be deemed to repeat all the
foregoing representations made by it.
(b) In addition to the foregoing, the Seller hereby represents and
warrants that, as of the date of this Agreement and as of the Purchase
Date for each Transaction:
(i) The Seller is servicing or causing to be serviced all Mortgage
Loans in accordance with industry standards for loans held by
third parties.
(ii) No Event of Default has occurred or is continuing under this
Agreement.
(iii) Since the date of the most recent balance sheet or financial
statement delivered by the Seller to the Buyer pursuant to the
Agreement, there has been no material adverse change in its
financial condition or results of operations.
(c) The Seller hereby represents and warrants to the Buyer that, as to
each Mortgage Loan, as of the applicable Purchase Date or such other
date specified herein:
(i) The information set forth in the schedule of Mortgage Loans
attached to each Confirmation is true and correct in all material
respects.
(ii) Such Mortgage Loan is an Eligible Mortgage Loan.
11. Covenants
The Seller hereby covenants and agrees with the Buyer that, as long as the Buyer
has any obligation to enter into Transactions under the Agreement:
(a) The Seller (or the Servicer, at the option of the Seller) shall hold
all Additional Required Documents for the Mortgage Loans that are
Purchased Loans in trust for the benefit of the Buyer.
(b) The Seller shall furnish or cause to be furnished to the Buyer:
<PAGE>
(i) Within 90 days after the last day of each fiscal year of the
Seller, consolidated statements of income (and, in the case of
the consolidated statement, cash flows) for the Seller for such
year and consolidated and consolidating balance sheets for the
Seller as of the end of such year (with the foregoing
consolidating statements to separately display the income and
balance sheet of each of the Seller and its consolidated
subsidiaries in a format reasonably acceptable to the Buyer),
presented fairly in all material respects in accordance with GAAP
and accompanied by an unqualified report of a firm of independent
certified public accountants of nationally recognized standing
and including therewith a copy of any management letter from such
certified public accountants; and
(ii) Within 45 days after the last day of each fiscal quarter, (A)
unaudited consolidated statements of income (and, in the case of
the consolidated statement, cash flows) for the Seller for such
quarter, and unaudited consolidated and consolidating balance
sheets for the Seller as of the end of such quarter (with the
foregoing consolidating statements to separately display the
income and balance sheet of each of the Seller and its
consolidated subsidiaries in a format reasonably acceptable to
the Buyer), and (B) a certificate of an officer of the Seller,
whose position is vice president or higher, stating that such
financial statements are presented fairly in all material
respects and in accordance with GAAP, subject to year-end audit
adjustments, and further certifying that neither the Seller nor
any affiliate thereof is in default under the terms and
conditions of any agreement evidencing or securing any
indebtedness of such entity.
(c) The Seller shall promptly furnish such additional financial and other
information, including, without limitation, financial statements of
the Seller, and information regarding the Purchased Loans, as the
Buyer may from time to time reasonably request.
(d) The Seller shall 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 reasonable satisfaction of the Buyer for the
payment thereof in the event the Seller is found to be obligated to
pay such indebtedness and which indebtedness is thereupon promptly
paid by the Seller.
(e) The Seller shall 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 the SEC or the Securities Commission of the State of Maryland and
comply with all contractual obligations and requirements of law
(including, without limitation, any requirements of law under or in
connection with ERISA, the federal Consumer Credit Protection Act, the
federal Real Estate Settlement Procedures Act, the federal Equal
Credit Opportunity Act, the federal Truth-in-Lending Act, and any
regulations promulgated thereunder), 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
Seller or on the Purchased Loans.
(f) The Seller shall keep proper books of record and account in which
full, true and correct entries in conformity with GAAP and all
requirements of law shall be made of all dealings and transactions in
relation to its business and activities.
(g) The Seller shall permit representatives of the Buyer to (A) visit and
inspect any of its properties and examine and make abstracts from any
of its books and records (including without limitation books and
records relating to the Purchased Loans) at any reasonable time and as
often as may reasonably be desired by the Buyer (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 Seller
with officers and employees of the Seller, and with its independent
certified public accountants; provided, however, that the results of
any such visit, inspection, examination, discussion or audit, to the
extent such results are proprietary and non-public, shall be
maintained by the Buyer in confidentiality except as required by law
or regulation or by any governmental agency or regulatory body having
authority over the Buyer, or to the extent such information may be
communicated to the legal counsel or auditors of the Buyer.
(h) The Seller shall promptly give written notice to the Buyer of:
<PAGE>
(i) the occurrence of any potential default or Event of Default
hereunder known to responsible management personnel of the
Seller and the proposed method of cure thereof;
(ii) any litigation or proceeding affecting the Seller or the
Purchased Loans which could have a material adverse effect on
the Purchased Loans, or the business, operations, property,
or financial or other condition of the Seller;
(iii) a material adverse change known to responsible management
personnel of the Seller in the business, operations, property or
financial or other condition of the Seller;
(iv) any changes in the following senior management positions of the
Seller: President, Chief Executive Officer, Chief Operating
Officer, Chief Financial Officer or any Executive Vice
President;
(v) any default by the Seller or any of the Seller's affiliates
under the terms and conditions of any agreement evidencing or
securing any indebtedness of such entity; and
(vi) any breach of a representation or warranty set out in Exhibit B
hereto.
(i) The Seller shall pay (i) all legal expenses of the Buyer incident to
the preparation and negotiation of this Agreement and related
documents, up to a maximum of $7,500 and (ii) all reasonable out-of-
pocket costs and expenses (including fees and disbursements of legal
counsel) of the Buyer incident to the preparation and negotiation of
documents relating to Transactions, and incident to the enforcement of
the Seller's obligations hereunder or under any Confirmation, whether
by judicial proceedings or otherwise, including, without limitation,
in connection with bankruptcy, insolvency, liquidations,
reorganization, moratorium or other similar proceedings involving the
Seller. The obligations of the Seller under this Paragraph 11(j) shall
be effective and enforceable whether or not any Transaction is
outstanding hereunder and shall survive the termination of this
Agreement.
(j) The Seller shall originate and acquire Mortgage Loans only in
accordance with the Seller's current Underwriting Standards; provided
that the Seller may permit reasonable exceptions to the Underwriting
Standards with compensating factors on a case-by-case basis.
(k) The Seller shall not, directly or indirectly, create, incur, assume or
suffer to exist, any lien or other encumbrance upon the Collateral.
(l) The Seller shall not, without 10 days' prior written notice to the
Buyer, alter its current Underwriting Standards in any material manner
from those disclosed to the Buyer and attached to the Agreement as
Exhibit C.
(m) The Seller shall comply fully with the terms of the Custodial
Agreement.
12. Events of Default
The following shall constitute Events of Default hereunder (each, an "Event of
Default"):
(a) the Seller's failure to transfer or the Buyer's failure to purchase
Purchased Loans upon the applicable Purchase Date;
(b) the Seller's failure to repurchase or the Buyer's failure to transfer
Purchased Loans upon the applicable Repurchase Date;
(c) the Seller's or the Buyer's failure to comply with Paragraph 5 hereof;
(d) an Act of Insolvency occurs with respect to the Seller or the Buyer;
(e) any representation or warranty made by the Seller (other than the
representations and warranties of the Seller set out in Paragraph
10(c)) or the Buyer in this Agreement shall have been incorrect or
untrue in any material respect when made or repeated or deemed to have
been made or repeated;
<PAGE>
(f) the Seller or the Buyer shall admit to the other its inability to, or
its intention not to, perform any of its obligations hereunder;
(g) if, for any reason, any Transaction is not deemed to be a purchase and
sale, the Agreement shall for any reason cease to create a valid,
first priority security interest in any of the Purchased Loans
purported to be covered thereby;
(h) the Seller or the Buyer shall breach any covenant, requirement or
obligation contained in this Agreement (other than a covenant made
with respect to a specific Purchased Loan);
(i) a default or event of default shall occur under any credit agreement
or other material agreement for which the Seller is the primary
obligor, which default or event of default would have a material
adverse effect on the business or finances of the Seller (as
reasonably determined by the Buyer);
(j) the Seller shall fail to repurchase any Purchased Loans at the
Repurchase Price when required by Paragraph 8 of this Agreement;
(k) the Buyer or the 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 reasonable satisfaction of the
notifying party within one Business Day;
(l) in the reasonable judgment of the Buyer a material adverse change
shall have occurred in the business, operations, properties, prospects
or financial condition of the Seller; or
(m) the Seller shall merge or consolidate into any entity, unless the
surviving or resulting entity shall be acceptable to the Buyer, in its
reasonable discretion, and such entity expressly assumes by written
agreement, executed and delivered to the Buyer in form and substance
reasonably satisfactory to the Buyer, the performance of all the
Seller's duties and obligations hereunder.
13. Remedies upon Event of Default
Upon the occurrence of any 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) Upon the occurrence of an Event of Default by the Seller, if the Buyer
exercises or is deemed to have exercised the option referred to in
subparagraph (a) of this Paragraph, (i) the Seller's obligation to
repurchase all Purchased Loans, 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 Buyer and applied to the aggregate unpaid Repurchase
Price and any other amounts owing by the Seller hereunder; (iii) the
Seller shall immediately deliver to the Buyer any Purchased Loans that
are subject to a Transaction which are then in the Seller's possession
or control; (iv) the Buyer may, without notice to the Seller, (A)
immediately sell, in a recognized market (or otherwise in a
commercially reasonable manner) at such price or prices as the Buyer
may reasonably deem satisfactory, any or all Purchased Loans subject
to such Transactions and apply the proceeds thereof to the aggregate
unpaid Repurchase Prices and any other amounts owing by the Seller
hereunder or (B) in its sole discretion elect, in lieu of selling all
or a portion of such Purchased Loans, to give the Seller credit for
such Purchased Loans in an amount equal to the price therefor on such
date, obtained from a generally recognized source, against the
aggregate unpaid Repurchase Prices and any other amounts owing by the
Seller hereunder; and (v) the
<PAGE>
Buyer may refuse to enter into any further Transactions with the
Seller under this Agreement and may determine that the Agreement is
terminated.
(c) Upon the occurrence of an Event of Default by the Buyer and tender by
the Seller of payment of the aggregate Repurchase Price for any
Transaction, (i) all right, title and interest in and entitlement to
all Purchased Loans subject to such Transaction shall be deemed
transferred to the Seller; (ii) the Buyer shall deliver all such
Purchased Loans to the Seller; (iii) the Seller may, without notice to
the Buyer, (A) immediately purchase, in a commercially reasonable
manner, at such price or prices as the Seller may reasonably deem
satisfactory, Mortgage Loans ("Replacement Mortgage Loans") of the
same class and amount as any Purchased Loans that are not delivered by
the Buyer to the Seller as required hereunder or (B) in its sole
discretion elect, in lieu of purchasing Replacement Mortgage Loans, to
be deemed to have purchased Replacement Mortgage Loans at the price
therefor on such date, obtained from a generally recognized source;
and (iv) the Buyer shall be liable to the Seller for any excess of the
price paid (or deemed paid) by the Seller for Replacement Mortgage
Loans over the Repurchase Price for the Purchased Loans replaced
thereby.
(d) The parties acknowledge and agree that (i) in the absence of a
generally recognized source for prices or bid or offer quotations for
any Mortgage Loan, the nondefaulting party may establish the source
therefor in its sole discretion; and (ii) 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 Mortgage
Loans).
(e) For purposes of this Paragraph 13, the Repurchase Price for each
Transaction hereunder with respect to which the Buyer is in default
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.
(f) 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
reasonable 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.
(g) To the extent permitted by applicable law, the defaulting party shall
be liable to the nondefaulting party for interest at the Default Rate
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 by the defaulting party or (ii)
satisfied in full by the exercise of the nondefaulting party's rights
hereunder.
(h) The nondefaulting party shall have, in addition to its rights
hereunder, any rights otherwise available to it under any other
agreement or applicable law.
(i) Upon default by the Seller, all rights of the Seller to receive
payments on the Mortgage Loans which it would otherwise be authorized
to receive hereunder shall cease, and all rights to such payments
shall become vested in the Buyer, which shall have the sole right to
receive such payments and apply them to the amounts owed by the Seller
pursuant to this Agreement. All payments that are received by the
Seller contrary to the provisions of this clause (i) shall be received
in trust for the benefit of the Buyer, shall be segregated from other
funds of the Seller and shall be promptly paid to the Buyer.
(j) In addition to the other remedies available to the Buyer upon the
occurrence and during the continuance of an Event of Default by the
Seller, the Buyer shall be entitled to the right of set-off with
respect to any amounts then owed by the Seller to the Buyer under any
contract, margin account or other arrangement. The Seller hereby
waives any right it may have to require that any deposits held by the
Buyer for the Seller be set off by the Buyer against the Seller's
obligations under the Agreement.
<PAGE>
14. Application of Proceeds
The proceeds of any sale of or other realization on any or all of the Collateral
at the time held by the Buyer under the Agreement shall be applied by the Buyer
in the following order of priority:
(a) First, to the payment of all reasonable costs and expenses of such
sale incurred by the Buyer and its affiliates and all reasonable
expenses (including the fees and expenses of counsel), liabilities and
advances reasonably made or incurred by the Buyer and its affiliates
in connection therewith.
(b) Second, to the payment of the outstanding Repurchase Price owed by the
Seller under this Agreement.
(c) Third, to the payment of all other amounts owed by the Seller under
this Agreement.
(d) Fourth, to the payment of any other amounts owed by the Seller to the
Buyer or any affiliate thereof under any other instrument or
agreement.
(e) Fifth, to the payment to the Seller, or to such other Person as 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 Collateral shall mean cash and other
property received or otherwise realized in respect of the Purchased Loans.
15. Indemnification
If the Buyer becomes involved in any capacity in any action, proceeding or
investigation in connection with any matter contemplated by this Agreement, the
primary focus of which action, proceeding or investigation concerns the Seller,
the Seller will reimburse the Buyer for its legal and other expenses (including
the cost of any investigation and preparation) as they are incurred by the
Buyer. The Seller also agrees to indemnify and hold harmless the Buyer and its
affiliates and their respective directors, officers, employees and agents
(collectively, the "Indemnified Parties"), from and against any and all losses,
claims, damages and liabilities, joint or several, related to or arising out of
any matters contemplated by this Agreement. Notwithstanding the foregoing, the
Seller shall have no obligation to reimburse or indemnify the Buyer hereunder if
it shall be finally judicially determined that such expenses, losses, claims,
damages or liabilities resulted primarily from the gross negligence or willful
misconduct of the Buyer.
If the foregoing indemnification is for any reason unavailable to any of the
Indemnified Parties, then the Seller shall contribute to the amount paid or
payable by the Indemnified Parties as a result of such loss, claim, damage or
liability in such proportion as is appropriate to reflect the relative benefits
received by the Seller, on the one hand, and such Indemnified Parties, on the
other, arising out of the matters contemplated by this Agreement.
The reimbursement, indemnity and contribution provided for herein shall be in
addition to any other liability that the Seller may otherwise have under this
Agreement, at law or in equity, and shall survive the termination or expiration
of this Agreement.
16. Payment and Transfer
Unless otherwise mutually agreed, all transfers of funds hereunder shall be in
immediately available funds. All Mortgage Loans transferred by one party hereto
to the other party (a) shall be in suitable form for transfer or shall be
accompanied by duly executed instruments of transfer or assignment in blank and
such other documentation as the party receiving possession may reasonably
request, (b) shall be transferred on the book-entry system of a Federal Reserve
Bank, or (c) shall be transferred by any other method mutually acceptable to the
Seller and the Buyer.
17. Limited Power of Attorney
The Seller hereby appoints the Buyer to act (but only after the occurrence and
during the continuation of an Event of Default) as the attorney-in-fact of the
Seller for the purpose of carrying out the provisions of this Agreement and
taking any action and executing any instruments that the Buyer shall deem
necessary or advisable to accomplish the purposes hereof. This appointment as
attorney-in-fact is irrevocable and is coupled with an interest. Without
limiting the generality of the foregoing, the Buyer and its assigns shall have
the right and power pursuant to this appointment to sell Purchased Loans and to
receive, endorse and collect all checks made payable to the order of the Seller
on account of the principal or interest on any of the Purchased Loans and to
give full discharge of the same.
<PAGE>
18. Effect of Termination
The termination of this Agreement by either party shall not eliminate any
liability for losses incurred by either party during the duration of this
Agreement. To the extent that this Agreement is terminated, the terms of this
Agreement shall continue to apply to any Transactions outstanding after the
termination of this Agreement. The provisions of Paragraph 15 relating to
Indemnification shall survive the termination of this Agreement.
19. Time
All references to time contained in the Agreement shall be deemed to be local
time in Charlotte, North Carolina on the applicable day.
20. Fees and Expenses
Nothing in this Agreement shall act as a bar to the collection of any fees or
expenses of the Buyer that the Seller may agree to pay in any separate agreement
relating to any or all of the Transactions.
21. Payment of Secured Creditors
The Seller may direct the Buyer to pay all or any portion of the Purchase Price
for a Transaction to one or more creditors of the Seller, or any of its
affiliates, if such payment is necessary to release a lien on the Mortgage Loans
that are to be purchased in such Transaction. Such payment and release of an
existing lien may occur simultaneously with the purchase of Mortgage Loans under
this Agreement.
22. Opinions of Counsel
The Seller shall, on the date of the first Transaction hereunder and, upon the
request of the Buyer, on the date of any subsequent Transaction, cause to be
delivered to the Buyer, with reliance thereon permitted as to any Person or
entity that purchases the Purchased Loans from the Buyer, a favorable opinion of
the Seller's counsel with respect to the matters set forth in Exhibit D hereto,
in form and substance reasonably acceptable to the Buyer.
23. Single Agreement
The Buyer and the Seller acknowledge that, and have entered into this Master
Repurchase Agreement 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 the Buyer and the Seller
agrees (a) 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, (b) 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 (c) that payments, deliveries and other
transfers made by either of them in respect of 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.
24. 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 listed below, or such other address as may be specified
in a notice of change of address hereafter received by the other:
SELLER: NovaStar Financial, Inc.
1901 West 47th Place, Suite 105
Westwood, Kansas 66205
Attention: Rodney E. Schwatken
Telephone: (913) 362-1090
Facsimile: (913) 362-1011
<PAGE>
BUYER: First Union National Bank
301 South College Street, DC-06
Charlotte, North Carolina 28288-0166
Attention: Mark Mendenhall, Vice President
Telephone: (704) 383-9518
Facsimile: (704) 383-8121
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.
25. 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.
26. 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 26 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 13 hereof.
27. 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.
28. 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 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 5(b) hereof will not constitute a waiver of any right to do so at a
later date.
29. Use of Employee Plan Assets
(a) If assets of an employee benefit plan subject to any provision of
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 subparagraph (a) of this Paragraph,
any such Transaction shall proceed only if the Seller furnishes or has
furnished to the Buyer its most recent available audited statement of
its financial condition and its most recent subsequent unaudited
statement of its financial condition.
<PAGE>
(c) By entering into a Transaction pursuant to this Paragraph, the Seller
shall be deemed to (i) represent to the Buyer that since the date of
the Seller's latest such financial statements, there has been no
material adverse change in the Seller's financial condition which the
Seller has not disclosed to the Buyer, and (ii) agree to provide the
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.
30. 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
Bankruptcy Code, and a "securities contract" as that term is defined
in Section 741 of the Bankruptcy Code. The parties further intend and
recognize that the Mortgage Loans constitute "securities" as such term
is defined in Section 101(49) of the Bankruptcy Code.
(b) It is understood that either party's right to liquidate Mortgage Loans
delivered to it in connection with Transactions hereunder or to
exercise any other remedies pursuant to Paragraph 13 hereof is a
contractual right to liquidate such Transaction as described in
Sections 555 and 559 of the Bankruptcy Code.
(c) 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, the Seller shall be deemed to have pledged to the
Buyer as security for the performance by the Seller of its obligations
under each such Transaction, and shall be deemed to have granted to
the Buyer a security interest in, all of the Purchased Loans with
respect to all Transactions hereunder and all Income thereon and other
proceeds thereof.
(d) The parties agree and acknowledge that if a party hereto is an
"insured depository institution," as such term is defined in 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).
(e) It is understood that this Agreement constitutes a "netting contract"
as defined in and subject to Title IV of FDICIA and each payment
entitlement and payment obligation under any Transaction hereunder
shall constitute a "covered contractual payment entitlement" or
"covered contractual payment obligation", 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).
31. 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 SEC under Section 15 of the 1934 Act, the
Securities Investor Protection Corporation has taken the position that
the provisions of 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 on deposit and therefore are not insured
by the Federal Deposit Insurance Corporation or the National Credit
Union Share Insurance Fund, as applicable.
<PAGE>
IN WITNESS WHEREOF, the Seller and the Buyer have caused this Master
Repurchase Agreement to be executed by their authorized representatives as of
this ___ day of ________, 1998.
NOVASTAR FINANCIAL, INC.,
as Seller
By:
----------------------------
Name:
--------------------------
Title:
-------------------------
FIRST UNION NATIONAL BANK,
as Buyer
By:
----------------------------
Name:
--------------------------
Title:
-------------------------
<PAGE>
EXHIBIT A
FORM OF CONFIRMATION
[Date]
NovaStar Financial, Inc.
1901 West 47th Place, Suite 105
Westwood, Kansas 66205
Attention: Rodney E. Schwatken
Ladies and Gentlemen:
Pursuant to the master repurchase agreement (the "Master Repurchase
Agreement"), dated as of August 21, 1998 between the undersigned (the "Buyer")
and you (the "Seller"), the Buyer hereby agrees to purchase the Mortgage Loans
identified on Schedule I attached hereto, subject to the terms set forth below:
Purchase Date: ________________
Repurchase Date: ________________
Purchase Price: ________________
Pricing Rate: ________________
Margin: [___]%
Original Margin: 2%
All of the representations and warranties made in the Master Repurchase
Agreement must be true and correct as of the Purchase Date and no Event of
Default shall have occurred. Capitalized terms not defined herein shall have
the meanings assigned to them in the Master Repurchase Agreement.
If you are in agreement with these terms, please execute the
acknowledgement and acceptance set forth below and return one copy of this
Confirmation to the Buyer.
Very truly yours,
FIRST UNION NATIONAL BANK,
as Buyer
By:______________________________
Name:____________________________
Title:___________________________
Accepted and Agreed as of
this ____ day of __________, ____.
NOVASTAR FINANCIAL, INC.,
as Seller
By:______________________________
Name:____________________________
Title:___________________________
<PAGE>
SCHEDULE I TO CONFIRMATION
MORTGAGE LOAN SCHEDULE
<PAGE>
EXHIBIT B
REPRESENTATIONS AND WARRANTIES
RELATING TO ELIGIBLE MORTGAGE LOANS
(a) The Mortgage Loan is a binding and valid obligation of the obligor
thereon, in full force and effect and enforceable in accordance with its terms
except as the same may be limited by bankruptcy, insolvency, reorganization,
moratorium or other similar laws now or hereafter in effect relating to
creditors' rights generally.
(b) The Mortgage Loan is genuine in all respects as appearing on its face
and as represented in the books and records of the Seller and all information
set forth therein is true and correct in all material respects.
(c) The Mortgage Loan is free of any default of any party thereto
(including the Seller), 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 the Mortgage Loan is more than 59 days past due the
payment due date set forth in the underlying promissory note and deed of trust
(or mortgage); provided that no more than five percent of the Mortgage Loans
purchased by the Buyer in any Transaction may be more than 30 days past due the
payment due date set forth in the underlying promissory note and deed of trust
(or mortgage).
(e) The 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) The Mortgage Loan complies in all respects and was originated in
accordance with all applicable laws and regulations governing the same,
including, without limitation, the federal Consumer Credit Protection Act, the
federal Real Estate Settlement Procedures Act, the federal Equal Credit
Opportunity Act, the federal Truth-in-Lending 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 the Mortgage Loan have been given and performed as
required.
(g) All proceeds of the Mortgage Loan have been fully disbursed.
(h) At all times the Mortgage Loan will be free and clear of all liens.
(i) The property covered by the 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 the Mortgage Loan with the Seller
named as a loss payee thereon.
(j) The property covered by the Mortgage Loan is free and clear of all
liens except:
(i) the lien in favor of the Seller;
(ii) the lien of current real property taxes and assessments not yet
due and payable;
(iii) 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 which (A) are referred to or otherwise
considered in the appraisal made for the originator of the Mortgage Loan or
(B) do not materially adversely affect the appraised value of the property
as set forth in such appraisal;
(iv) other matters to which like properties are commonly subject and
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;
(v) liens subordinate in priority to the lien in favor of the Seller;
and
(vi) in the case of second priority Mortgage Loans, one lien superior
in priority to the lien in favor of the Seller.
(k) The property shall be improved, and such improvements shall 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 or mobile home.
<PAGE>
(l) The Mortgage Loan is not subject to any servicing arrangement with any
Person other than the Servicer, nor are any servicing rights relating to the
Mortgage Loan subject to any lien, claim, interest or negative pledge in favor
of any Person other than as permitted hereunder.
(m) The Seller obtained an appraisal in connection with the origination of
the Mortgage Loan as would satisfy all appraisal requirements for the Mortgage
Loan if such had been originated by a federally-insured depositary institution
or in a form otherwise approved by the Buyer.
(n) The Mortgage Loan is secured by a first or second priority mortgage or
deed of trust on the property covered thereby.
(o) The Mortgage Loan is not a revolving credit facility.
(p) No real property taxes or insurance payments due and payable with
respect to the property (or escrow installments therefor) covered by the
Mortgage Loan are past due the payment due date thereof.
(q) The Mortgage Loan complies with the Underwriting Standards provided
that the Seller may permit reasonable exceptions to the Underwriting Standards
with compensating factors on a case-by-case basis.
(r) The Mortgage Loan shall have a cumulative Loan-to-Value Ratio of not
more than 100%.
<PAGE>
EXHIBIT C
SELLER'S UNDERWRITING STANDARDS
<PAGE>
EXHIBIT D
FORM OF OPINION OF COUNSEL
<PAGE>
EXHIBIT 10.2
CMAC(R)
- --------------------------------------------------------------------------------
Commonwealth Mortgage
Assurance Company
1601 Market Street
Philadelphia, PA 19103
(800) 523-1988
(215) 564-6600
(215) 496-0346 (Fax)
August 12, 1998
Mr. Scott Hartman
Chairman
NovaStar Financial, Inc.
1901 W. 47th Place
Suite 105
Westwood, KS 66205
Dear Mr. Hartman:
Thank you for giving us the opportunity to offer primary mortgage insurance on
certain groups of residential mortgage loans (each a "Covered Loan") discussed
in detail below (the "Portfolio"). This letter will set forth the terms and
conditions (the "Agreement") under which Commonwealth Mortgage Assurance Company
("CMAC") is willing to provide mortgage guaranty insurance to NovaStar
Financial, Inc., a Maryland corporation ("NFI"), and to its successors and
assigns (collectively, the "Insured").
1. PMI Insurance Coverage
(a) It is understood and agreed that the required coverage will be primary
private mortgage insurance ("PMI") in an amount that reduces the Insured's
exposure on the Covered Loan to - - - of such loan's LTV at origination. The
"Coverage Percentage" for each Covered Loan shall be determined as follows:
- - - - - - - - - - - = "Coverage Percentage"
The Coverage Percentage determined in accordance to the preceding formula
shall be rounded up to the nearest one tenth of one percent. "LTV" means
the loan to value ratio (expressed as a decimal) of the Coverage Loan at
the time of origination, where the value for a new property is the lesser
of the purchase price or the appraisal value and the value for a refinanced
property is the appraisal value.
(b) The effective date for the PMI policy for each Covered Loan (the
"Certificate Effective Date") shall be the first day of the month following
the month in which the Covered Loan is closed; provided, however, that for
the first group of Covered Loans the effective date shall be August 1,
1998.
(c) Each Covered Loan shall be listed on Exhibit A hereto, as supplemented from
time to time. The first Group of Covered Loans shall be identified as
Exhibit A-1. Each subsequent group of Covered Loans shall be consecutively
numbered and a copy of such supplement to Exhibit A shall be dated as of
the Certificate Effective Date for such Covered Loans, signed by both NFI
and CMAC and attached to this Agreement.
(d) NFI shall submit to CMAC by the 15th day of each month via electronic tape
transmission (each an "ETT"), in a format to be agreed upon by the parties,
a list of additional Covered Loans originated during the preceding month,
which shall contain all the information with regard to each such loan that
CMAC may reasonably
<PAGE>
request. CMAC shall prepare and sign the applicable supplement to Exhibit A
hereto listing each additional Covered Loan and shall deliver such
supplement to NFI.
(e) Attached hereto as Exhibit B are NFI's current underwriting guidelines and
procedures (as supplemented and amended as set forth herein; the "NFI
Underwriting Guidelines"). NFI shall have the right to supplement and
amend the NFI Underwriting Guidelines with 30 days prior written notice to
CMAC. In the event of a material adverse change in such guidelines, CMAC
shall have the right in its sole discretion, upon 30 days prior written
notice to NFI, to cease insuring new mortgage loans pursuant to this
Agreement; provided, however, that all PMI policies insuring Covered Loans
previously issued by CMAC shall continue in full force and shall not be
affected thereby.
(f) Attached hereto as Exhibit C are NFI's servicing guidelines and procedures
(the "NFI Servicing Guidelines"). NFI shall have the right to supplement
and amend the NFI Servicing Guidelines with 30 days prior written notice to
CMAC. In the event of a material adverse change in such guidelines, CMAC
shall have the right in its sole discretion, upon 30 days prior written
notice to NFI, to cease insuring new mortgage loans pursuant to this
Agreement; provided, however, that all PMI policies insuring Covered Loans
previously issued by CMAC shall continue in full force and shall not be
affected thereby.
(g) Subject to the terms and conditions set forth in this Agreement, CMAC
hereby agrees to insure Covered Loans closed by NFI and/or its affiliates
on or prior to December 31, 1999 up to an aggregate principal balance at
origination of - - - - - . NFI, however, shall not be obligated to insure
new loans with CMAC and may unilaterally terminate the PMI policy for any
Covered Loans at any time.
2. Commitment to Insure
Subject to the terms and conditions of the Master Policy issued NFI by CMAC
and this letter, and in specific reliance upon the representations and
warranties of NFI set forth in Section 4 below, CMAC agrees to insure each
of the Covered Loans in the Portfolio.
3. Master Policy Interpretation
[Terms of Master Policy and Interpretation]
4. Representations and Warranties of the Insured
In order to induce CMAC to insure the Covered Loans in the Portfolio, NFI
makes the following representations and warranties to CMAC as of the
Certificate Effective Date for such Covered Loan:
(a) The description of each Covered Loan in the Portfolio contained in the
ETT submitted to CMAC by NFI pursuant to Section 1(d) hereof is true
and accurate in all material respects. This information shall be
deemed to be incorporated herein by this reference as if set forth in
full.
(b) The real property identified as the security for each Covered Loan in
the Portfolio consists of a residential one to four family dwelling
located in the United States.
(c) The original appraised value of the real property securing each
Covered Loan as of the origination of each loan is accurately set
forth in the ETT.
(d) The original principal balance of each Covered Loan is accurately set
forth in the ETT.
(e) Each Covered Loan was underwritten at the time it was originated in a
manner generally consistent with NFI's Underwriting Guidelines.
(f) Each Covered Loan is secured by a first mortgage lien on a residential
property.
<PAGE>
(g) Each Covered Loan is current as of the Certificate Effective Date:
provided, however, with respect to the first group of Covered Loans
shown on Exhibit A-1 hereto, each such Covered Loan was current as of
July 1, 1998.
Notwithstanding any investigation by CMAC, the representations and
warranties of NFI set forth above are material inducements to CMAC to
extend PMI coverage on the Covered Loans in the Portfolio. CMAC has relied
upon the accuracy and completeness of each of the representations and
warranties of NFI set forth herein.
5. Certificates of Insurance
(a) At the request of NFI, or of any subsequent Insured, CMAC shall provide to
the Insured a transferable Certificate of Insurance for each Covered Loan
evidencing the PMI policy for such loan; provided, however, that the PMI
policy shall be effective from the Certificate Effective Date for such loan
whether or not an individual Certificate of Insurance for such loan has
been issued by CMAC.
6. PMI Premiums
(a) Each Insured shall remit premiums to CMAC on a monthly basis for each
Covered Loan insured pursuant to the Agreement, at the rates set forth on
Exhibit "E", attached hereto and made a part hereof. Within thirty (30)
days after the date the Insured receives itemized documentation from CMAC,
the Insured shall remit to CMAC the appropriate nonrefundable PMI premium
to CMAC.
(b) CMAC acknowledges and agrees that the PMI policy covering each Covered Loan
is individually transferable, without any transfer charge to any subsequent
transferee of such loan, and that each transferee Insured shall be
responsible for the payment of the PMI premiums, and the performance of
covenants set forth herein and in the Master Policy, solely with respect to
the Covered Loans owned by such Insured.
7. Duty to Cooperate
Whenever requested by CMAC, the Insured shall cooperate with CMAC or shall
use its reasonable efforts to induce the cooperation of its servicer(s) and
shall furnish all reasonable aid, evidence and information in possession of
the Insured or its servicer(s), or to which the Insured or its servicer(s)
has access, with respect to any loan Covered Loan.
8. CMAC Financial Information
CMAC hereby agrees to promptly provide to NFI upon request all publicly
available financial information with respect to CMAC as NFI may reasonably
request, including without limitation copies of its reinsurance policies
with Cap RE and Axa Re that support its "AA" credit rating.
If the foregoing accurately sets forth the understanding between the Insured
and CMAC, please execute both copies of this letter and return an executed copy
to my attention.
Sincerely,
COMMONWEALTH MORTGAGE
ASSURANCE COMPANY
By:/S/ C. Robert Quint
-------------------
Name: C. Robert Quint
Chief Financial Officer
<PAGE>
AGREED TO AND ACCEPTED BY:
NovaStar Financial Inc.
By: /S/ Michael L. Bamburg
------------------------
Title: Sr. VP--CIO
-------------
Date: 8/14/98
---------
<PAGE>
EXHIBIT 11.1
SCHEDULE REGARDING COMPUTATION OF PER SHARE EARNINGS
(000'S EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS THREE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) $5,567 $ (702) $2,395 $ 177
Basic weighted average shares outstanding 8,033 3,767 8,124 3,767
Common equivalent shares:
Dilutive stock options 51 -- 34 37
Dilutive warrants 555 -- -- --
------ ------ ------ ------
Diluted weighted average shares outstanding 8,639 3,767 8,157 3,804
Basic earnings (loss) per share $ 0.69 $(0.19) $ 0.29 $ 0.05
====== ====== ====== ======
Diluted earnings (loss) per share $ 0.64 $(0.19) $ 0.29 $ 0.05
====== ====== ====== ======
</TABLE>
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE REGISTRANT
NovaStar Financial, Inc., a Maryland corporation, and its subsidiaries
. NovaStar Assets Corporation, a Delaware corporation
. NovaStar Mortgage Funding Corporation, a Delaware corporation
. NovaStar Certificates Financing Corporation, a Delaware corporation
. NovaStar Capital Access Corporation, a Delaware corporation
NFI Holding Corporation, a Delaware corporation, and its subsidiaries
. NovaStar Mortgage, Inc., a Virginia corporation
. The Hiresource, Inc., a Delaware corporation
. NovaStar Capital, Inc., a Delaware corporation
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-Q FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH CONSOLIDATED FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 55,383
<SECURITIES> 408,276
<RECEIVABLES> 944,228
<ALLOWANCES> 2,757
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,693,325
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 81
<OTHER-SE> 109,767
<TOTAL-LIABILITY-AND-EQUITY> 1,693,325
<SALES> 79,155
<TOTAL-REVENUES> 84,933
<CGS> 0
<TOTAL-COSTS> 76,911
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 3,400
<INTEREST-EXPENSE> 60,948
<INCOME-PRETAX> 5,567
<INCOME-TAX> 0
<INCOME-CONTINUING> 5,567
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,567
<EPS-PRIMARY> 0.69
<EPS-DILUTED> 0.64
</TABLE>
<PAGE>
Exhibit 99.1
Company contact: Investor information requests:
Mark J. Kohlrus Anna LeCluyse
Chief Financial Officer 913.514.3505
913.514.3534 Fax 913.514.3515
NOVASTAR FINANCIAL, INC. ANNOUNCES
-----------------------------------
INCREASED EARNINGS FOR 1998 THIRD QUARTER;
------------------------------------------
EXPECTS SUBSTANTIAL LOSS IN FOURTH QUARTER
------------------------------------------
(WESTWOOD, Kan. October 27, 1998) NovaStar Financial, Inc. (NYSE: NFI)
announced net earnings of $2.4 million, or $0.29 per share, for the quarter
ended September 30, 1998. The Company also reported that earnings before
founders' debt forgiveness expense for the 1998 third quarter were $2.7 million,
or $0.33 per share. Third quarter operating results represent an increase of
$500,000 (26 percent) over the 1998 second quarter and $2.2 million over the
1997 third quarter. For the nine months ended September 30, 1998, the Company
had net earnings of $5.6 million, or $0.64 per share. However, as discussed
below, events occurring subsequent to September 30, 1998 will result in losses
that exceed earnings for the nine months ended September 30, 1998.
NovaStar Financial ended the third quarter with approximately $1 billion of
subprime residential mortgage loans that secure non-recourse collateralized
mortgage obligations. During the third quarter, the Company and NovaStar
Mortgage executed sales agreements relating to a combined $23 million of
mortgage loans for an aggregate gain of approximately $900,000. The net gain on
the sale of mortgage loans represents a margin of approximately four percent
over the Company's basis, which includes premiums paid to brokers and certain
net deferred origination costs.
Mortgage assets averaged $1.3 billion and earned $28.8 million during the
third quarter, representing a yield of 8.6 percent. Borrowings averaged $1.4
billion, with interest expense, including hedging costs, totaling $22.1 million
- - a rate of 6.3 percent, resulting in net interest income of $6.7 million for
the 1998 third quarter. The Company also provided $1.2 million to its reserve
for credit losses during the quarter, compared with charge-offs of $1.8 million,
resulting in a reserve of $2.8 million at September 30, 1998.
The Company previously announced it had taken a number of measures during
October to restore liquidity after lenders severely restricted access to certain
secured credit facilities. The actions included the sale of its entire $380
million mortgage securities portfolio, the sale of a $20 million corporate bond,
and the termination of certain hedging arrangements. The Company is expecting to
generate losses aggregating in excess of $23 million that will be recognized
during the 1998 fourth quarter as a result of these actions. Also
<PAGE>
in connection with restoring its liquidity position, the Company entered into a
90-day secured financing arrangement with GMAC/RFC that included the issuance of
warrants to purchase up to approximately 800,000 shares of the Company's common
stock at an exercise price of $4.5625 per share. The Company expects to
recognize expenses of over $5 million during the 1998 fourth quarter related to
this financing arrangement. The Company and GMAC/RFC are presently in
negotiations with the intent of entering into a strategic alliance that would
include a number of secured financing arrangements and the issuance of warrants
for the purchase of up to an additional approximate 800,000 shares at the same
exercise price.
"While we were generally pleased with our operating results for the third
quarter, the actions we were forced to take early in the fourth quarter clearly
overshadow those results" said Scott Hartman, Chairman and Chief Executive
Officer. "The financial turmoil that took place during the early fourth quarter
forced us to take measures that have significantly changed the composition of
our balance sheet since September 30. Our assets now consist principally of
cash, mortgage loans securing non-recourse collateralized mortgage obligations
and mortgage loans in warehouse. The transactions we've executed during the
fourth quarter have resulted in a significant decrease in the Company's current
book value. However, we believe NovaStar Mortgage still provides the Company
with the opportunity to rebuild book value by continuing to originate mortgage
loans that can either be sold for cash or securitized. NovaStar Mortgage
increased its sales force to 55 account executives at September 30, 1998 and
currently has the sales and back office infrastructure to service loan
originations at the level we saw during the 1998 second quarter."
Hartman continued, "Market conditions have clearly forced us to alter what was
our normal operating strategy of originating mortgage loans to be securitized
and held in portfolio. In addition, the overall availability of warehouse
financing in the market place has become substantially reduced. We are in the
process of attempting to secure additional committed warehouse facilities. We
expect to continue originating mortgage loans with the intent of selling a
substantial portion of production to third parties through the end of 1998 and
early 1999. We are hopeful that at some point in 1999 we can regain access to
the capital markets and once again securitize our mortgage loan originations."
NovaStar's founders acquired units in the Company's 1996 private placement by
delivering forgivable notes aggregating $3.2 million. The notes are separated
into three equal tranches that are forgiven when certain incentive tests are
met. The first tranche was forgiven in 1997, resulting in a non-cash charge to
earnings of $1.1 million. During the nine months ended September 30, 1998, the
Company has provided quarterly charges to expense aggregating $812,000 as if the
second tranche would be forgiven during 1998. As a result of the current level
of the Company's stock price, it does not appear probable that the second
tranche will be forgiven during 1998.
NovaStar Financial, Inc. is a real estate investment trust (REIT) that invests
in single-family residential subprime mortgage loans originated by its
affiliate, NovaStar Mortgage, Inc. and in high-quality mortgage securities.
Mortgage loans in the portfolio are generally financed on a long-term basis by
issuing collateralized mortgage obligations accounted for as debt instruments.
NovaStar Financial, Inc. is located in Westwood, Kansas, a part of the Kansas
City metropolitan area. NovaStar Mortgage operates wholesale lending operations
in Orange County, California and Boca Raton, Florida.
Certain matters discussed in this news release may constitute forward-looking
statements within the meaning of the federal securities laws that inherently
include certain risks and uncertainties. Actual results and the timing of
certain events could differ materially from those projected in or contemplated
by the forward-looking statements due to a number of factors, including general
economic conditions, fluctuations in interest rates, the availability of
subprime residential mortgage loans, and other risk factors outlined in the
Company's 1997 annual report on Form 10-K.
Financial highlights for NovaStar Financial, Inc. are attached.
* * * * *
<PAGE>
NOVASTAR FINANCIAL, INC.
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Three Months Ended
--------------------------------------------------------------------
09/30/98 06/30/98 03/31/98 12/31/97 09/30/97
<S> <C> <C> <C> <C> <C>
Consolidated Statement of Operations Data
Interest income $ 28,797 $ 26,444 $ 23,914 $ 15,416 $ 12,225
Interest expense 22,088 20,418 18,442 11,961 9,786
Net interest income 6,709 6,026 5,472 3,455 2,439
Provision for credit losses 1,179 1,145 1,076 1,009 726
Net interest income after provision 5,530 4,881 4,396 2,446 1,713
Other income (loss) 4,268 1,146 364 429 259
Equity in earnings of NFI Holding Corporation (2,446) 262 (271) 169 290
General and administrative expenses 4,958 4,395 3,210 3,477 2,085
Forgiveness of founders' notes, included in
general and administrative expenses 270 271 271 1,083 -
Net income (loss) 2,394 1,894 1,279 (433) 177
Diluted earnings (loss) per share 0.29 0.21 0.15 (0.07) 0.05
<CAPTION>
As of
--------------------------------------------------------------------
09/30/98 06/30/98 03/31/98 12/31/97 09/30/97
Consolidated Balance Sheet Data
Mortgage Assets:
Mortgage loans $ 944,227 $1,003,518 $ 757,341 $ 574,984 $418,897
Mortgage securities 390,276 440,322 407,254 517,246 267,835
Reserve for credit losses 1,757 3,341 2,871 2,313 1,444
Total assets 1,693,325 1,519,400 1,233,719 1,126,252 699,133
Borrowings 1,575,066 1,394,830 1,111,620 1,005,560 644,195
Shareholders' equity 109,848 114,875 115,798 116,489 47,036
<CAPTION>
As of or for the Three Months Ended
--------------------------------------------------------------------
09/30/98 06/30/98 03/31/98 12/31/97 09/30/97
Other Data:
Wholesale loan production of NovaStar Mortgage:
Principal at purchase $ 233,333 $ 294,303 $ 207,976 $ 183,012 $136,582
Average principal balance per loan $ 90 $ 94 $ 102 $ 118 $ 133
Weighted-average interest rate:
Adjustable-rate mortgage loans 10.09% 10.00% 9.95% 10.03% 10.03%
Fixed-rate mortgage loans 10.15% 9.89% 9.90% 10.33% 10.57%
Weighted-average loan to value 81% 81% 81% 81% 79%
Weighted-average broker premium 1.39% 1.25% 1.43% 1.61% 1.55%
Loans with prepayment penalties 79% 71% 65% 71% 66%
Weighted-average prepayment period 2.7 2.4 2.0 2.0 2.7
NovaStar Mortgage account executives 55 41 41 36 29
Mortgage Loan Portfolio:
Weighted-average coupon 10.09% 10.12% 10.15% 10.20% 10.17%
Premium as a percent of principal 2.44% 2.34% 2.71% 3.19% 3.88%
Delinquent loans (90 days or greater)
NovaStar Home Equity Series:
1997-1 5.97% 5.86% 4.39% 2.71% -
1997-2 4.97% 4.72% 2.23% - -
1998-1 2.06% - - - -
1998-2 - - - - -
All loans in portfolio 2.45% 2.53% 2.28% 1.80% 1.47%
Charge-offs $ 1,763 $ 675 $ 518 $ 140 -
Net interest rate spread 2.27% 2.10% 1.75% 1.23% 1.18%
Net yield 2.00% 1.91% 1.82% 1.71% 1.53%
Diluted earnings per share before
founders' debt forgiveness $ 0.33 $ 0.24 $ 0.18 $ 0.10 $ 0.05
Return on average assets before debt forgiveness 0.66% 0.63% 0.53% 0.28% 0.10%
Return on average equity before debt forgiveness 9.48% 7.51% 5.34% 3.18% 1.52%
Taxable income (loss) $ 4,353 $ 2,572 $ 2,106 $ 563 $ 506
Taxable income (loss) per share $ 0.54 $ 0.32 $ 0.27 $ 0.07 $ 0.13
Dividends declared per share $ 0.35 $ 0.35 $ 0.30 $ 0.10 $ 0.08
Book value per share $ 13.52 $ 14.14 $ 14.26 $ 14.88 $ 12.49
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
