x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
_____
Maryland | ||
Incorporation or | Identification No.) |
2114 Central Street, Suite | ||
(Address of Principal Executive Office) | 64108 (Zip Code) |
| ||
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities
Act. Yes x¨ Nox
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes ¨ Nox
Large accelerated filer ¨ | Non-accelerated filer ¨ | Non-accelerated filer ¨ | Small business filer x |
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes ¨ Nox
9,368,053.
2008
Item 1. | 2 | |||
Item 1A. | ||||
Item 1B. | ||||
Item 2. | Properties | |||
Item 3. | ||||
Item 4. | ||||
Part II | ||||
Item 5. | ||||
Item 6. | ||||
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||
Item 7A. | ||||
Item 8. | ||||
Item 9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure | |||
Item 9A. | ||||
Item 9B. | ||||
Part III | ||||
Item 10. | ||||
Item 11. | ||||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | |||
Item 13. | Certain Relationships and Related Transactions, and Director Independence | |||
Item 14. | 89 | |||
Item 15. |
This Annual Report on Form 10-K contains forward-looking statements
We are
Wewe have added new lending customers during 2008 and into 2009. While StreetLinks does not currently provide positive cash flow to us, we believe it is uniquely positioned to produce positive earnings and cash flow for us in the future. Subsequent to 2008, we committed to acquire a majority interest in Advent Financial Services LLC, a start up operation which will provide access to tailored banking accounts, small dollar banking products and related services to meet the needs of low and moderate income level individuals.
Restrict investmentsterminated retroactive to certain real estate related assets;
Avoid certain investment trading and hedging activities; and
Distribute virtually all REIT taxable income to our shareholders.
As long as we maintainJanuary 1, 2006. This retroactive revocation of our REIT status distributions to our shareholders will generally be deductible byresulted in us for income tax purposes. This deduction effectively eliminates REIT level income taxes. Management believes that we have met the requirements to maintain our REIT statusbecoming taxable as a C corporation for 2006 and priorsubsequent years. We are, however, currently evaluating whether it is in shareholders’ best interests to retain our REIT status.
We operate three core businesses:
Mortgage portfolio management;
Mortgage lending; and
Loan servicing.
Segment information regarding these businesses for the three years ended December 31, 2006 is included in Note 16 to ourOur consolidated financial statements.
Mortgage Portfolio Management
We operatestatements have been prepared on a going concern basis of accounting which contemplates continuity of operations, realization of assets, liabilities and commitments in the normal course of business. There are substantial doubts that we will be able to continue as a long-term mortgage securitiesgoing concern and, mortgage loan portfolio investor. therefore, may be unable to realize our assets and discharge our liabilities in the normal course of business. The financial statements do not reflect any adjustments relating to the recoverability and classification of recorded asset amounts or to the amounts and classification of liabilities that may be necessary should we be unable to continue as a going concern.
In 2005 we began retaining various subordinate securities from our securitization transactions. In 2006, we began purchasing subordinated ABS of other ABS issuers. Weobligations for the near term, but their cash flow will continueneed to acquire, retain, and aggregate ABS with the intention of securing non-recourse long-term financing through collateralized debt obligation (“CDO”) securitizations. In the future, we may enter into derivative transactions referencing third party ABS, commonly referred to as “synthetic” assets. We also intend to retain the risk of the underlying securities by investingbe replaced in the equity and subordinated debt of CDO securitizations. CDO equity securities bear the first-loss and second-loss credit risk with respect to the securities owned by the securitization entity. Our goal is to leverage our extensive portfolio management experience by purchasing securities that are higher in the capital structure than our residual securities and executing CDOsorder for long-term non-recourse financing, thereby generating good risk-adjusted returns. We closed our first CDO securitization which was structured as a financing transaction on February 8, 2007, and we expectus to continue to purchase securities that are higher in the capital structure and finance them with CDOs.
The long-term mortgage loan portfolio on our balance sheet consists of mortgage loans classified as held-in-portfolio resulting from securitization transactions treated as financings completed in the second and third quarters of 2006 (NHES Series 2006-1 and NHES Series 2006-MTA1). We have financed our investment in these loans by issuing ABB.
operating.
Mortgage Lending
The mortgage lending operation is significant to our financial results as it produces loans that ultimately collateralize
Our mortgage lending operations generate earnings primarily from securitizing and selling loans for a premium. We also earn revenue from fees from loan originations and interest income on mortgage loans held-for-sale. The timing, size and structure of our securitization transactions have a significant impact on the gain on sale recognized and ultimately the profitability of this segment. In addition the market prices for whole loans and short-term interest rates have a significant impact on this segment’s profitability.
Our mortgage lending segment originates and purchases primarily nonconforming, single-family residential mortgage loans. Our mortgage lending operation continues to innovate in loan origination. Our lending decisions are driven by three primary objectives:
Originating loans that perform in line with expectations,
Maintaining economically sound pricing (profitable coupons), and
Controlling costs of origination.
In our nonconforming lending operations, we lend to individuals who generally do not qualify for agency/conventional lending programs because of a lack of available documentation, previous credit difficulties or higher loan-to-value (“LTV”) ratios. These types of borrowers are generally willing to pay higher mortgage loan origination fees and interest rates than those charged by conventional lenders. Because these borrowers typically use the proceeds of the mortgage loans to consolidate debt and to finance home improvements, education and other consumer needs, loan volume is generally less dependent on general levels of interest rates or home sales and therefore less cyclical than conventional mortgage lending.
Our nationwide loan origination network includes wholesale loan brokers, mortgage lenders, and correspondent institutions, all of which are independent of any of the NovaStar Financial entities, as well as our own direct to consumer operations. Our sales force, which includes account executives in 38 states, develops and maintains relationships with this network of independent retail brokers. Our correspondent origination channel consists of a network of institutions from which we purchase nonconforming mortgage loans on a bulk or flow basis. Our direct to consumer operations channel consists of call centers where we contact potential borrowers as well as a network of branch operations which we acquired in the fourth quarter of 2006 in order to expand this origination channel.
We underwrite, process, fund and service the nonconforming mortgage loans sourced through our network of wholesale loan brokers and mortgage lenders and our direct to consumer operations in centralized facilities.
Loan Servicing
Management believes loan servicing remains a critical part of our business operation because maintaining contact with our borrowers is critical in managing credit risk and for borrower retention. Nonconforming borrowers are more prone to late payments and are more likely to default on their obligations than conventional borrowers. By servicing our loans, we strive to identify problems with borrowers early and take quick action to address problems. In addition, borrowers may be motivated to refinance their mortgage loans either by improving their personal credit or due to a decrease in interest rates. By keeping in close touch with borrowers, we can provide them with information about NovaStar Financial products to encourage them to refinance with us.
We retain the servicing rights with respect to the loans we securitize. Mortgage servicing yields fee income for us in the form of contractual fees approximating 0.50% of the outstanding balance of loans we service that have been securitized. In addition we receive fees paid by borrowers for normal customer service and processing fees. We also earn interest income on funds we hold as custodian as part of the servicing process.
Market in Which NovaStar Operates and Competes
Over the last ten years, the nonconforming lending market has grown from less than $50 billion annually to approximately $640 billion in 2006 as estimated by Inside Mortgage Finance Publications. A significant portion of nonconforming loans are made to borrowers who are using equity in their primary residence to consolidate installment or consumer debt, or take cash out for personal reasons. The nonconforming market has grown through a variety of interest rate environments. Management estimates that in 2006 we had a 1-2% share of the nonconforming loan market.
We face intense competition in the business of originating, purchasing, selling and securitizing mortgage loans. The number of market participants is believed to be well in excess of 100 companies who originate and purchase nonconforming loans. No single participant holds a dominant share of the lending market. We compete for borrowers with consumer finance companies, conventional mortgage bankers, commercial banks, credit unions, thrift institutions and other independent wholesale mortgage lenders. Competition among industry participants can take many forms, including convenience in obtaining a loan, amount and term of the loan, customer service, marketing/distribution channels, loan origination fees and interest rates. To the extent any competitor significantly expands their activities in the nonconforming and subprime market, we could be adversely affected.
Our principal competition in the business of holding mortgage loans and mortgage securities are life insurance companies, institutional investors such as mutual funds and pension funds, other well-capitalized, publicly-owned mortgage lenders and certain other mortgage acquisition companies structured as REITs. Many of these competitors are substantially larger than we are and have considerably greater financial resources than we do.
One of our key competitive strengths is our employees and the level of service they are able to provide our borrowers. We service our nonconforming loans and, in doing so,event we are able to stay in close contact withsignificantly increase our borrowers and identify potential problems early.
We also believeliquidity position (as to which no assurance can be given), we compete successfully due to our:
experienced management team;
may use of technology to enhance customer service and reduce operating costs;
freedom from depository institution regulation;
vertical integration – we broker and/or originate, purchase, fund, service and manage mortgage loans;
access to capital markets to securitize our assets.
Risk Management
Management recognizes the following primary risks associated with the business and industry in which it operates.
Interest Rate/Market
Liquidity/Funding
Credit
Prepayment
Regulatory
Interest Rate/Market Risk. Our investment policy goals are to maintain the net interest margin between our assets and liabilities and to diminish the effect of changes in interest rate levels on the market value of our assets.
Interest Rate Risk. When interest rates on our assets do not adjust at the same time or in the same amounts as the interest rates on our liabilities or when the assets have fixed rates and the liabilities have adjustable rates, future earnings potential is affected. We express this interest rate risk as the risk that the market value of our assets will increase or decrease at different rates than that of our liabilities. Expressed another way, this is the risk that our net asset value will experience an adverse change when interest rates change. We assess the risk based on the change in market values given increases and decreases in interest rates.
The interest rates under our primary financing sources reset frequently. As of December 31, 2006, rates on a majority of our borrowings adjust daily or monthly off London Inter-Bank Offered Rate (“LIBOR”). On the other hand, very few of the mortgage assets we own adjust on a monthly or daily basis. Most of the mortgage loans have rates that are fixed for some period of time ranging from 2 to 30 years. For example, one of our loan products is the “2/28” loan. This loan is fixed for its first two years and then adjusts every six months thereafter.
While short-term borrowing rates are low and long-term asset rates are high, this portfolio structure produces good results. However, if short-term interest rates rise rapidly, earning potential would be significantly affected and impairments may be incurred, as the asset rate resets would lag the borrowing rate resets.
We transfer interest rate agreements at the time of securitization into the securitization trusts to protect the third-party bondholders from interest rate risk and to decrease the volatility of futureexcess cash flows related to the securitized mortgage loans. We enter into these interest rate agreements as we originate and purchase mortgage loans in our mortgage lending segment. At the time of a securitization structured as a sale, we transfer interest rate agreements into the securitization trusts and they are removed from our balance sheet. The trust assumes the obligation to make payments and obtains the rightcertain investments if we determine that such investments could provide attractive risk-adjusted returns to receive payments under these agreements. Generally, net settlement obligations paid by the trust for these interest rate agreements reduce the excess interest cash flows to our residual securities. Net settlement receipts from these interest rate agreements are either used to cover interest shortfalls on the third-party primary bondsshareholders, including, potentially investing in new or to provide credit enhancement with any remaining funds then flowing to our residual securities. For securitizations structured as financings the derivatives will remainexisting operating companies.
Interest Rate Sensitivity Analysis.We model financial information in a variety of interest rate scenarios to assess interest rate sensitivity as an indication of exposure to interest rate risk. 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 picturesheets of the risk characteristicstrusts. The trusts have financed these assets by issuing asset backed bonds (“ABB”). At the time of these securitizations, we owned significant beneficial interests in the balance sheet. The risks are analyzed on a market value basis.
The following table summarizes management’s estimates oftrusts and we serviced the changesmortgage loans. During 2007, we sold all servicing rights. Currently, our ownership interests in market value of our mortgage assets and interest rate agreements assuming interest rates were 100 and 200 basis points, or one and two percent higher or lower. The cumulative change in market value represents the change in market value of mortgage assets, net of the change in market value of interest rate agreements. The change in market value of the liabilities on our balance sheet due to a change in interest rates is insignificant since a majority of our short-term borrowings and ABB are adjustable rate; however, as noted above, rapid increases in short-term interest rates would negatively impact the interest-rate spread between our liabilities and assets and, consequently, our earnings.
Interest Rate Sensitivity - Market Value
(dollars in thousands)
Basis Point Increase (Decrease) in Interest Rates (A) | ||||||||||||||||
(200) | (100) | 100 | 200 | |||||||||||||
As of December 31, 2006: | ||||||||||||||||
Change in market values of: | ||||||||||||||||
Assets – non trading (B) | $ | 226,262 | $ | 105,038 | $ | (78,698 | ) | $ | (150,481 | ) | ||||||
Assets – trading (C) | 9,999 | 7,080 | (14,120 | ) | (30,707 | ) | ||||||||||
Interest rate agreements | (40,018 | ) | (20,946 | ) | 23,998 | 49,264 | ||||||||||
Cumulative change in market value | $ | 196,243 | $ | 91,172 | $ | (68,820 | ) | $ | (131,924 | ) | ||||||
Percent change of market value portfolio equity (D) | 34.0 | % | 15.8 | % | (11.9 | %) | (22.9 | %) | ||||||||
As of December 31, 2005: | ||||||||||||||||
Change in market values of: | ||||||||||||||||
Assets – non trading (B) | $ | 95,322 | $ | 41,344 | $ | (41,417 | ) | $ | (84,971 | ) | ||||||
Assets – trading (C) | 1,134 | 983 | (2,837 | ) | (7,512 | ) | ||||||||||
Interest rate agreements | (33,502 | ) | (17,365 | ) | 20,072 | 41,616 | ||||||||||
Cumulative change in market value | $ | 62,954 | $ | 24,962 | $ | (24,182 | ) | $ | (50,867 | ) | ||||||
Percent change of market value portfolio equity (D) | 11.0 | % | 4.4 | % | (4.2 | %) | (8.9 | %) | ||||||||
Hedging.We use derivative instruments to mitigate the risk of our cost of funding increasing at a faster rate than the interest on the loans. We adherebonds issued by these trusts have declined to an interest rate risk management program that is approved by our Board. This program is formulated with the intent to offset the potential adverse effects resulting from rate adjustment limitations on mortgage assets and the differences between interest rate adjustment indices and interest rate adjustment periods of adjustable-rate mortgage loans and related borrowings.
We use interest rate cap and swap contracts to mitigate the risk of the financing expense of variable rate liabilities increasing at a faster rate than the income produced on assets during a period of rising rates. Management intends generally to hedge as much of the interest rate risk as determined to be in our best interest, given the cost and risk of hedging transactions and the limitations on our ability to hedge imposed on us by REIT tax requirements.
We seek to build a balance sheet and undertake an interest rate risk management program that is likely, in management’s view, to enable us to maintain an equity liquidation value sufficient to maintain operations given a variety of potentially adverse circumstances. Accordingly, the hedging program addresses both income preservation, as discussed in the first part of this section, and capital preservation concerns.
Interest rate cap and swap agreements are legal contracts between us and a third-party firm or “counterparty”. Under an interest rate cap agreement the counterparty agrees to make payments to us in the future should the one-month LIBOR interest rate rise above the strike rate specified in the contract. We make either quarterly or monthly premium payments or have chosen to pay the premiums at the beginning to the counterparties under contract. Each contract has either a fixed or amortizing notional face amount on which the interest is computed, and a set term to maturity. When the referenced LIBOR interest rate rises above the contractual strike rate, we earn cap income. Under interest rate swap agreements we pay a fixed rate of interest while receiving a rate that adjusts with one-month LIBOR.
The following table summarizes the key contractual terms associated with interest rate risk management contracts on our balance sheet as of December 31, 2006. All of our pay-fixed swap contracts and interest rate cap contracts are indexed to one-month LIBOR.
immaterial amount. We have determined the following estimated net fair value amounts by using available market information and valuation methodologies we deem appropriate as of December 31, 2006.
Interest Rate Risk Management Contracts
(dollarsprovided financial statements for these trusts in thousands)
Net Fair Value | Total Notional Amount | Maturity Range | |||||||||||||||||||||||||
2007 | 2008 | 2009 | 2010 | 2011 | |||||||||||||||||||||||
Pay-fixed swaps: | |||||||||||||||||||||||||||
Contractual maturity | $ | 6,527 | $ | 1,575,000 | $ | 490,000 | $ | 720,000 | $ | 365,000 | $ | — | $ | — | |||||||||||||
Weighted average pay rate | 4.9 | % | 4.7 | % | 5.0 | % | 4.9 | % | — | — | |||||||||||||||||
Weighted average receive rate | 5.4 | % | (A | ) | (A | ) | (A | ) | — | — | |||||||||||||||||
Interest rate caps: | |||||||||||||||||||||||||||
Contractual maturity | $ | 4,634 | $ | 610,000 | $ | 80,000 | $ | 285,000 | $ | 195,000 | $ | 40,000 | $ | 10,000 | |||||||||||||
Weighted average strike rate | 5.0 | % | 4.9 | % | 4.9 | % | 5.0 | % | 5.2 | % | 5.4 | % |
We had no interest rate agreements with contractual maturities beyond 2011 as of December 31, 2006.
Liquidity/Funding Risk.A significant risk to our mortgage lending operations is the risk that we will not have financing facilities and cash available to fund and hold loans prior to their sale or securitization, to fund required repurchase requests and margin calls or that we may not be able to securitize our loans or securities upon favorable terms. On a short-term basis, we finance mortgage loans using warehouse repurchase agreements that we maintain with large banking and investment institutions. In addition, we have access to facilities secured by our mortgage securities and servicing advance receivables. For long-term financing, we depend on securitizations and CDOs. Other matters also impact our liquidity and funding risk. See the “Liquidity and Capital Resources” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion of liquidity risks and resources available to us.
Credit Risk. Credit risk is the risk that we will not fully collect the principal we have invested in mortgage loans or the amount we have invested in securities. Nonconforming mortgage loans comprise substantially our entire mortgage loan portfolio and serve as collateral for our mortgage securities. Nonconforming borrowers include individuals who do not qualify for agency/conventional lending programs because of a lack of conventional documentation or previous credit difficulties but have considerable 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 reduce the amount of money it takes to service their monthly debt obligations. Our underwriting guidelines are intended to evaluate the credit history of the potential borrower, the capacity and willingness of the borrower to repay the loan, and the adequacy of the collateral securing the loan.
Our underwriting staff worksthis report under the credit policies established by our Credit Committee. Underwriters are given approval authority only after their work has been reviewed for a periodheading Assets and Liabilities of time. Thereafter, the Chief Credit Officer re-evaluates the authority levels of all underwriting personnel on an ongoing basis. All loans in excess of $350,000 currently require the approval of an underwriting supervisor. Our Chief Credit Officer or our President must approve loans in excess of $1,000,000.
Our underwriting guidelines take into consideration the number of times the potential borrower has recently been late on a mortgage payment and whether that payment was 30, 60 or 90 days past due. Factors such as FICO score, bankruptcy and foreclosure filings, debt-to-income ratio, and loan-to-value ratio are also considered. The credit grade that is assigned to the borrower is a reflection of the borrower’s historical credit. Maximum loan-to-value ratios for each credit grade depend on the level of income documentation provided by the potential borrower. In some instances, when the borrower exhibits strong compensating factors, exceptions to the underwriting guidelines may be approved.
In 2006, we saw the performance of our 2006 vintage production drop to unacceptable levels. We believe this performance is related to a few key fundamentals such as:
Downturn in the housing market
Underwriting guidelines that worked in a stronger housing market were no longer effective in the weaker 2006 market
Tolerance levels previously allowed for appraisals were no longer effective in the weaker 2006 market
Going forward, the key area of focus for our credit management function is to ensure that the 2007 vintage performs better than 2006 and in line with our expectations. In this regard, we have taken several steps which include:
Tightening of underwriting guidelines
Enhancing our appraisal review process
Identifying loans with unacceptable levels of risk.
Other strategies we use for managing credit risk are to diversify the markets in which we originate, purchase and own mortgage loans and the purchase of mortgage insurance. We have purchased mortgage insurance on a majority of the loans that are held in our portfolio – on the balance sheet and those that serve as collateral for our mortgage securities. The use of mortgage insurance is discussed under “Premiums for Mortgage Loan Insurance” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. Details regarding loans charged off are disclosed in Note 2 to our consolidated financial statements.
Prepayment Risk.Generally speaking, when market interest rates decline, borrowers are more likely to refinance their mortgages. The higher the interest rate a borrower currently has on his or her mortgage the more incentive he or she has to refinance the mortgage when rates decline. In addition, the incentive to refinance increases when credit ratings improve. When home values rise, loan-to-value ratios drop, making it more likely that a borrower will do a “cash-out” refinance. Each of these factors increases the chance for higher prepayment speeds.
The majority of our mortgage securities available-for-sale portfolio consists of securities which are “interest-only” in nature. These securities represent the net cash flow – interest income – on the underlying loans in excess of the cost to finance the loans. When borrowers repay the principal on their mortgage loans early, the effect is to shorten the period over which interest is earned, and therefore, reduce the cash flow and yield on our securities.
We mitigate prepayment risk by originating and purchasing loans that include a penalty if the borrower repays the loan in the early months of the loan’s life. A majority of our loans have a prepayment penalty up to but no greater than 80% of six months interest on the principal balance that is being repaid. As of December 31, 2006, 60% of the loans which serve as collateral for our mortgage securities had a prepayment penalty. As of December 31, 2006, 60% of our mortgage loans on our balance sheet had a prepayment penalty. During 2006, 62% of the loans we originated and purchased had prepayment penalties.
Regulatory Risk.As a mortgage lender, we are subject to many laws and regulations. Any failure to comply with these rules and their interpretations or with any future interpretations or judicial decisions could harm our profitability or cause a change in the way we do business. For example, several lawsuits have been filed challenging types of payments made by mortgage lenders to mortgage brokers.
State and local governing bodies are focused on the nonconforming lending business and are concerned about borrowers paying “excessive fees” in obtaining a mortgage loan – generally termed “predatory lending”. In several instances, states or local governing bodies have imposed strict laws on lenders to curb predatory lending. To date, these laws have not had a significant impact on our business. We have capped fee structures consistent with those adopted by federal mortgage agencies and have implemented rigid processes to ensure that our lending practices are not predatory in nature.
We regularly monitor the laws, rules and regulations that apply to our business and analyze any changes to them. We integrate many legal and regulatory requirements into our automated loan origination system to reduce inadvertent non-compliance due to human error. We also maintain policies and procedures, summaries and checklists to help our origination personnel comply with these laws. Our training programs are designed to teach our personnel about the significant laws, rules and regulations that affect their job responsibilities.
U.S. Federal Income Tax Consequences
The following general discussion summarizes the material U.S. federal income tax considerations regarding our qualification and taxation as a REIT. This discussion is based on interpretations of the Code, regulations issued thereunder, and rulings and decisions currently in effect (or in some cases proposed), all of which are subject to change. Any such change may be applied retroactively and may adversely affect the federal income tax consequences described herein. This summary does not discuss all of the tax consequences that may be relevant to particular shareholders or shareholders subject to special treatment under the federal income tax laws. Accordingly, you should consult your own tax advisor regarding the federal, state, local, foreign, and other tax consequences of your ownership of our common stock and our REIT status and any termination of our REIT status, and regarding potential changes in applicable tax laws.
General.Since inception, we have elected to be taxed as a REIT under Sections 856 through 859 of the Code. We believe we have complied, and intend to comply in the future for so long as we remain a REIT, with the requirements for qualification as a REIT under the Code. To the extent that we qualify as a REIT for federal income tax purposes, we generally will not be subject to federal income tax on the amount of income or gain that is distributed to shareholders. However, origination and broker operations are conducted through NovaStar Mortgage, which is owned by NFI Holding Corporation, Inc. – a taxable REIT subsidiary (“TRS”). Consequently, all of the taxable income of NFI Holding Corporation, Inc. is subject to federal and state corporate income taxes. In general, a TRS may hold assets that a REIT cannot hold directly and generally may engage in any real estate or non-real estate related business. However, special rules do apply to certain activities between a REIT and its TRS. For example, a TRS will be subject to earnings stripping limitations on the deductibility of interest paid to its REIT. In addition, a REIT will be subject to a 100% excise tax on certain excess amounts to ensure that (i) amounts paid to a TRS for services are based on amounts that would be charged in an arm’s-length transaction, (ii) fees paid to a REIT by its TRS are reflected at fair market value and (iii) interest paid by a TRS to its REIT is commercially reasonable.
The REIT rules generally require that a REIT invest primarily in real estate related assets, that its activities be passive rather than active and that it distribute annually to its shareholders substantially all of its taxable income. We could be subject to a number of taxes if we failed to satisfy those rules or if we acquired certain types of income-producing real property through foreclosure. Although no complete assurance can be given, we do not expect that we will be subject to material amounts of such taxes.
Failure to satisfy certain Code requirements could cause loss of REIT status. If we fail to qualify, or elect to terminate our status, as a REIT for any taxable year, we would be subject to federal income tax (including any applicable minimum tax) at regular corporate rates and would not receive deductions for dividends paid to shareholders. As a result, the amount of after-tax earnings available for distribution to shareholders would decrease substantially.
Qualification as a REIT. Qualification as a REIT requires that we satisfy a variety of tests relating to income, assets, distributions and ownership so long as we remain a REIT. The significant tests are summarized below.
Sources of Income.To qualify as a REIT, we must satisfy two gross income requirements, each of which is applied on an annual basis. First, at least 75% of our gross income, excluding gross income from prohibited transactions, for each taxable year generally must be derived directly or indirectly from:
rents from real property;
interest on debt secured by mortgages on real property or on interests in real property;
dividends or other distributions on, and gain from the sale of, stock in other REITs;
gain from the sale of real property or mortgage loans;
amounts, such as commitment fees, received in consideration for entering into an agreement to make a loan secured by real property, unless such amounts are determined by income and profits;
income derived from a Real Estate Mortgage Investment Conduit (“REMIC”) in proportion to the real estate assets held by the REMIC, unless at least 95% of the REMIC’s assets are real estate assets, in which case all of the income derived from the REMIC; and
interest or dividend income from investments in stock or debt instruments attributable to the temporary investment of new capital during the one-year period following our receipt of new capital that we raise through equity offerings or public offerings of debt obligations with at least a five-year term.
Second, at least 95% of our gross income, excluding gross income from prohibited transactions, for each taxable year must be derived from sources that qualify for purposes of the 75% gross income test, and from (i) dividends, (ii) interest, (iii) certain qualifying hedges entered into prior to January 1, 2005 and (iv) gain from the sale or other disposition of stock, securities, or, certain qualifying hedges entered into prior to January 1, 2005.
Management believes that we were in compliance with both of the income tests for the 2006 and 2005 calendar years.
Nature and Diversification of Assets. As of the last day of each calendar quarter, we must meet six requirements under the two asset tests. Under the 75% of assets test, at least 75% of the value of our total assets must represent cash or cash items (including receivables), government securities or real estate assets. Under the 25% of assets test, no more than 25% of the value of our total assets can be represented by securities, other than (A) government securities, (B) stock of a qualified REIT subsidiary and (C) securities that qualify as real estate assets under the 75% assets test ((A), (B) and (C) are collectively the “75% Securities”). Additionally, under the 25% assets test, no more than 20% of the value of our total assets can be represented by securities of one or more taxable REIT subsidiaries and no more than 5% of the value of our total assets can be represented by the securities of a single issuer, excluding 75% Securities. Furthermore, we may not own more than 10% of the total voting power or the total value of the outstanding securities of any one issuer, excluding 75% Securities.
If we inadvertently fail to satisfy one or more of the asset tests at the end of a calendar quarter, such failure would not cause us to lose our REIT status. We could still avoid disqualification by eliminating any discrepancy within 30 days after the close of the calendar quarter in which the discrepancy arose. Management believes that we were in compliance with all of the requirements of both asset tests for all quarters during 2006 and 2005.
Ownership of Common Stock. Our capital stock must be held by a minimum of 100 persons for at least 335 days of each year. In addition, at all times during the second half of each taxable year, no more than 50% in value of our capital stock may be owned directly or indirectly by 5 or fewer individuals. We use the calendar year as our taxable year for income tax purposes. The Code requires us to send annual information questionnaires to specified shareholders in order to assure compliance with the ownership tests. Management believes that we have complied with these stock ownership tests for 2006 and 2005.
Distributions.To maintain REIT status, we must distribute at least 90% of our taxable income and any after-tax net income from certain types of foreclosure property less any non-cash income. No distributions are required in periods in which there is no taxable income. Management believes that we have complied with these distribution requirements for 2005 and intends to comply with these requirements with respect to 2006 taxable income.
Taxable Income. We use the calendar year for both tax and financial reporting purposes. However, taxable income may, and in our case does, differ from income computed in accordance with GAAP. These differences primarily arise from timing and character differences in the recognition of revenue and expense and gains and losses for tax and GAAP purposes. Additionally, taxable income that is subject to the distribution requirement does not include the taxable income of our TRS, although the subsidiary’s operating results are included in our GAAP results.
Personnel
As of December 31, 2006,2008, we employed 2,048 people. Management believes that relations with its employees are good.60 people in total between NFI and StreetLinks. Because of subsequent hiring at StreetLinks to staff for additional business needs as of May 27, 2009 we employ approximately 363 people in total between NFI, StreetLinks, and Advent. None of our employees are represented by a union or covered by a collective bargaining agreement.
600 64108 Activities ability to continue as a going concern. going concern. The value of residual negatively affected. control. going concern. current shareholders.www.novastarmortgage.comwww.novastarfinancial.com) as soon as reasonably practicable after filing with the SEC. References to our website do not incorporate by reference the information on such website into this Annual Report on Form 10-K and we disclaim any such incorporation by reference. Copies of our board committee charters, our board’s Corporate Governance Guidelines, Code of Conduct, and other corporate governance information are available at the Corporate Governance section of our Internet site (www.novastarmortgage.com), or by contacting us directly. Our investor relations contact information follows.8140 Ward Parkway, 30064114technological obsolescence, labor relations, general economic conditions and geopolitical events. Additional risks not currently known to us or that we currently believe are immaterial also may impair our business, operations and our liquidity.Securitization, Loan Sale,Recent Changes in Our BusinessBorrowing ActivitiesOur growth is dependent on leverage, which may create other risks.Our success is dependent, in part, uponhas adversely affected our ability to growcontinue as a going concern.throughto generate cash to repay indebtedness and to reduce cash requirements. We also have terminated all but a core group of our workforce. Our historical operations are now limited to managing our existing portfolio of mortgage securities.usenature and extent of leverage. Leverage creates an opportunity for increased net income, butthe disruption subprime mortgage loan markets, there can be no assurances that these markets will improve or return to past levels. Further, in light of our current financial condition, massive reductions in our workforce, regulatory requirements, capital and financing requirements, and other uncertainties, there can be no assurances that we would be able to recommence mortgage lending, servicing or securitization activities if and when the relevant markets improve, or that any such activities would be at the same time creates risks. For example, whileor near our historical levels. Unless we are able to reestablish profitable operations, either within our historical or new business areas, at levels necessary to meet our existing and future expenses, we will incur leveragenot be able to continue as a going concern.when theresignificant source of cash flows and will continue to decrease in the next several months to a level that is an expectation that itnot sufficient to fund our existing expenses and continue as a going concern.enhance returns, leveraging magnifies both positivecontinue to decrease in the next several months as the underlying mortgage loans are repaid, and negative changescould be significantly less than our current projections if losses on the underlying mortgage loans exceed our current assumptions or if prepayment speeds continue to decline. In addition, we have significant operating expenses associated with office leases, and other obligations relating to our discontinued operations, as well as periodic interest payment obligations with respect to junior subordinated debentures relating to the trust preferred securities of NovaStar Capital Trust I and NovaStar Capital Trust II. Our cash flows from mortgage securities are likely to be insufficient to cover our existing expenses in the near future. If, as the cash flows from mortgage securities decrease, we are unable to recommence or invest in profitable operations, and restructure our net worth. In addition,unsecured debt, capital structure and contractual obligations, there can be no assurance that we will be able to meet our debt service obligationscontinue as a going concern and toavoid seeking the protection of applicable bankruptcy laws.cannot,generally retain the “first loss” risk associated with the underlying pool of mortgage loans. As a result, losses on the underlying mortgage loans directly affect our returns on, and cash flows from, these mortgage securities. In addition, if delinquencies and/or losses on the underlying mortgage loans exceed specified levels, the level of over-collateralization required for higher rated securities held by third parties may be increased, further decreasing cash flows presently payable to us. Further, slower prepayment speeds reduce our prepayment penalty cash flows.meet minimum REIT dividend requirementsrestructure existing obligations, establish new business operations, and continue as a going concern, will be materiallyadversely affected.adversely affected. Furthermore, if we wereestablish or acquire, and profitably manage, operate and grow, new operations is critical to liquidate, our debt holders and lenders will receive a distribution of our available assets before any distributions are made to our common shareholders.An interruption or reduction in the securitization market or our ability to access thiscontinue as a going concern and is subject to significant uncertainties and limitations. If we attempt to make any acquisitions, we will incur a variety of costs and may never realize the anticipated benefits.would harmand declining cash flows from our financial position.We are dependent on the securitization market for long-term financing of our origination and purchase of mortgage loans and mortgage securities, which we initially finance with our short-term financing. In addition, many of the buyers of our whole loans purchase the loans with the intention of securitizing them. A disruption in the securitization market could prevent us from being ableability to sell loans or mortgage securities at a favorable price or at all. Factors that could disrupt the securitization market include an international liquidity crisis such as occurred in the fall of 1998, sudden changes in interest rates, changes in the non-conforming loan market, a terrorist attack, an outbreak of war or other significant event risk, and market specific events suchcontinue as a default under a comparable type of securitization. Further, poor performance ofgoing concern is dependent upon our previously securitized loans could harmability to identify and establish or acquire new operations that contribute sufficient additional cash flow to enable us to meet our accesscurrent and future expenses. Our ability to the securitization market.In addition, a court recently found a lenderstart or acquire new businesses is significantly constrained by our limited liquidity and securitization underwriter liable for consumer fraud committed by a companyour likely inability to whom they providedobtain debt financing and underwriting services. In the event other courts or regulators adopted the same liability theory, lenders and underwriters could be named as defendants in more litigation andto issue equity securities as a result they may exitof our current financial condition, including a shareholders’ deficit, as well as other uncertainties and risks. There can be no assurances that we will be able to establish or acquire new business operations.charge more for their services, allnegotiating the acquisition and integrating an acquired business may result in operating difficulties and expenditures and may require significant management attention. Moreover, we may never realize the anticipated benefits of whichany new business or acquisition. We may not have, and may not be able to acquire or retain, personnel with experience in any new business we may establish or acquire. In addition, future acquisitions could have a negative impact on our abilityresult in contingent liabilities and/or amortization expenses related to securitize our mortgage loansgoodwill and mortgage securities and the securitization market in general.A decline in our ability to obtain long-term funding for our mortgage loans or mortgage securities in the securitization market in general or on attractive terms or a decline in the market’s demand for our mortgage loans or mortgage securitiesother intangible assets, which could harm our results of operations, financial condition and business prospects and ability to continue as a going concern.defaults under our short term financing arrangements for these assets.We may not be able to continue to sell our mortgage loans on terms and conditions that are profitable to us.A portion of our revenues comes from the gains on sale generated by sales of pools of our mortgage loans as whole loans. We make whole loan sales to a limited number of institutional purchasers, some of which may be frequent, repeat purchasers, and others of which may make only one or a few purchases from us. We cannot assure you that we will continue to have purchasers for our loans on terms and conditions that will be profitable to us. Also, even though our mortgage loans are generally marketable to multiple purchasers, certain loans may be marketable to only one or a few purchasers, thereby increasing the risk that we may be unable to sell such loans at a profit.Failure to renew or obtain adequate funding under warehouse repurchase agreements may harm our business.We are dependent upon several warehouse repurchase agreements to provide short term financing for our origination and purchase of mortgage loans pending their sale or securitization. In addition, we utilize warehouse repurchase agreements for short and medium term financing for our purchase and retention of mortgage securities. Under a warehouse repurchase agreement, we sell an asset and agree to repurchase the same asset at some point in time in the future. Generally, the repurchase agreements we enter into require monthly roll-over repurchase transactions, with a six- to nine-month maximum financing period for mortgage loans and a three-year maximum financing period for securities retained from our mortgage loan securitizations. For financial accounting purposes, these arrangements are treated as secured financings. We retain the assets on our balance sheet and record an obligation to repurchase the assets. The amount we may borrow under these arrangements is generally 95% to 100% of the asset market value with respect to performing mortgage loans and 70% to 80% of the asset market value with respect to nonperforming mortgage loans. Additionally, the amount we may borrow under these arrangements is generally 40% to 95% of the asset market value with respect to mortgage securities depending on the investment rating.These warehouse repurchase agreements contain numerous representations, warranties and covenants, including requirements to maintain a certain minimum net worth, to maintain minimum equity ratios, to maintain our REIT status, and other customary debt covenants. Events of default under these facilities include material breaches of representations and warranties, failure to comply with covenants, material adverse effects upon or changes in our business, assets, or financial condition, and other customary matters. Events of default under certain of our facilities also include termination of our status as servicer with respect to certain securitized loan pools and failure to maintain profitability over consecutive quarters. If we were unable to make the necessary representations and warranties at the time we need financing, we would not be able to obtain needed funds. In addition, if we default under any warehouse repurchase agreement under which borrowings are then outstanding, the lenders under substantially all of our existing warehouse repurchase agreements could demand immediate payment of all outstanding amounts pursuant to cross-default provisions. Any failure to renew or obtain adequate funding under these financing arrangements for any reason, or any demand by warehouse lenders for immediate payment of outstanding balances, could harm our lending and loan purchase operations and have a material adverse effectimpact on our results of operations, liquidity, financial condition and business prospects.ability to continue as a going concern.an increasewe have received requests or subpoenas for information relating to our operations from various federal and state regulators and law enforcement, including, without limitation, the United States Department of Justice, the Federal Bureau of Investigation, the New York Attorney General and the Department of Labor. While we have provided, or are in the costprocess of warehouse financing in excess of any change inproviding, the income derived from our mortgage assets could also harm our earnings and reduce the cash available for distribution to our shareholders. In October 1998, the subprime mortgage loan market faced a liquidity crisis with respectrequested information to the availability of short-term borrowingsapplicable officials, we may be subject to further information requests from, major lendersor action by, these or other regulators or law enforcement officials. To the extent we are subject to any actions, our financial condition, liquidity, and long-term borrowings through securitization. At that time, we faced significant liquidity constraints which harmed our business and our profitability. ability to continue a going concern could be materially adversely affected.iscan be no assurance that our common stock or Series C Preferred Stock will continue to be traded in an active market.comparable situationresult of failure to meet applicable standards for continued listing on the NYSE. Our common stock and Series C Preferred Stock are currently quoted on the OTC Bulletin Board and on the Pink Sheets. However, there can be no assurance that an active trading market will not occur inbe maintained. Trading of securities on the future.A decline inOTC and Pink Sheets is generally limited and is effected on a less regular basis than on exchanges, such as the NYSE, and accordingly investors who own or purchase our stock will find that the liquidity or transferability of the stock may be limited.mortgage assets financed under our warehouse finance arrangementsstock. If an active public trading market cannot be sustained, the trading price of our common and preferred stock could be adversely affected and your ability to transfer your shares of our common and preferred stock may resultbe limited.margin calls or similar obligations, which may require thatthe foreseeable future.liquidate assets at a disadvantageous time.When, in a lender’s opinion, the market value of assetsare no longer subject to a warehouse repurchase agreement decreases for any reason, including a rise in interest rates or general concern aboutREIT distribution requirement. Instead, payment of dividends is at the value ordiscretion of our board of directors. To preserve liquidity, our board of the assets, we are required to repay the margin or difference in market value, or post additional collateral. If cash or additional collateral is unavailable to meet margin calls, we may defaultdirectors has suspended dividend payments on our obligations underSeries C Preferred Stock and Series D1 Preferred Stock. Dividends on our Series C Preferred Stock and D1 Preferred Stock continue to accrue and the applicable repurchase agreement, which would cross-default substantiallydividend rate on our Series D1 Preferred Stock increased from 9.0% to 13.0%, compounded quarterly, effective January 16, 2008 with respect to all unpaid dividends and subsequently accruing dividends. No dividends can be paid on any of our warehouse repurchase agreements. In that event,common stock until all accrued and unpaid dividends on our lenders would haveSeries C Preferred Stock and Series D1 Preferred Stock are paid in full. Accumulating dividends with respect to our preferred stock will negatively affect the rightability of our common stockholders to liquidate the collateral we provided themreceive any distribution or other value upon liquidation.settle the amount due from usMortgage Asset Financing, Sale, and in general, the right to recover any deficiency from us.In addition, we utilize warehouse financing arrangements for the accumulation of third-party mortgage-backed securities and related credit default derivatives for purposes of CDO offerings. Under these arrangements, the financing party has the right to liquidate any assets that decline in credit quality or fail to continue to meet eligibility requirements, and the right to liquidate the entire pool of financed assets if the related CDO offering does not occur by a specified date. If a liquidation results in a net loss, we are required to pay to the financing party the amount of the net loss.In order to obtain cash to satisfy a margin call or a net loss payment obligation, we may be required to liquidate assets at a disadvantageous time, which could cause us to incur further losses and adversely affect our results of operations and financial condition. In addition, an unplanned liquidation of assets could change our mix of investments, which in turn could jeopardize our REIT status or our ability to rely on certain exemptions under the Investment Company Act of 1940, as amended (the “Investment Company Act”).results of operations and financial condition.sellsold mortgage loans, whether as whole loans or pursuant to a securitization, we are required to makemade customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our whole loan sale agreements require us to repurchase or substitute mortgage loans in the event we breach any of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower, fraudbroker, or in the event of early payment default on a mortgage loan.employee fraud. Likewise, we are required to repurchase or substitute mortgage loans if we breach a representation or warranty in connection with our securitizations. The remedies available to us against the originating broker or correspondent may not beWe have received various repurchase demands as broad as the remedies available to a purchaserperformance of subprime mortgage loans has deteriorated. A majority of repurchase requests have been denied, otherwise a negotiated purchase price adjustment was agreed upon with the purchaser. Enforcement of repurchase obligations against us and we face thewould further risk that the originating broker or correspondent may not have the financial capacity to perform remedies that otherwise may be available to us. Therefore, if a purchaser enforces its remedies against us, we may not be able to recover losses from the originating broker or correspondent. Repurchased loans are typically sold at a significant discount to the unpaid principal balance and, prior to sale, can be financed by us, if at all, only at a steep discount to our cost. As a result, significant repurchase activity could harm our liquidity cash flow, results of operations, financial condition and business prospects.Recently, we have received an increased number of repurchase and indemnity demands from purchasers of whole loansability to continue as a result of borrower fraud and early borrower payment defaults, which has had a negative impact on our results of operations. While we have taken steps to enhance our underwriting policies and procedures, there can be no assurance that these steps will be effective. To the extent that repurchase and indemnity demands continue at this rate or increase, our results of operations and financial condition will be adversely affected.Our investments in mortgage securities and loans are subject to changes in credit spreads which could adversely affect our ability to realize gains on the sale of such investments and may subject us to margin calls or similar liquidity requirements.The value of mortgage securities is dependent on the yield demanded on these securities by the market based on their credit relative LIBOR. Excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher, or “wider,” spread over the benchmark rate (usually the applicable LIBOR security yield) to value such securities. Under such conditions, the value of our mortgage securities portfolio would tend to decline. Conversely, if the spread used to value such securities were to decrease, or “tighten,” the value of our mortgage securities portfolio would tend to increase.Our loan portfolio is also subject to changes in credit spreads. The value of these loans is dependent on the yield demanded by the market based on their credit relative to LIBOR. The value of our loans would tend to decline should the market require a higher yield on such loans, resulting in the use of a higher spread over the benchmark rate (usually the applicable LIBOR yield). Conversely, if the spread used to value such loans were to decrease, or “tighten,” the value of our loan portfolio would tend to increase.A decrease in the value of our loans or mortgage securities would reduce our ability to realize gains upon the sale or securitization of these assets and, with respect to mortgage securities (which are marked to market quarterly), could result in impairments for securities classified as available-for-sale or mark-to-market losses for securities classified as trading.. In addition, a decrease in the value of our mortgage loans or securities reduces the funds available to us in respect of these assets under our warehouse repurchase agreements and may result in margin calls. Further, a decrease in the value of third party mortgage securities that we have accumulated for the purpose of a CDO offering may reduce the availability or attractiveness of the CDO offering, in which case we may be required to seek other forms of potentially less attractive longer-term financing or to liquidate the assets on unfavorable terms.We retain and assume credit risk under a variety of mortgage securities and similar assets in connection with and as a result of our securitization activities. Significant losses on these assets reduce our earnings, negatively affect our liquidity, and otherwise negatively affect our business.We retain certain residual securities resulting from our securitizations of mortgage loans, which typically consist of interest-only, prepayment penalty, and overcollateralization bonds. We also retain from our securitizations, as well as purchase from 3rd party ABS issuers, certain investment grade and non-investment grade rated subordinated mortgage securities. The residual securities are typically unrated or rated below investment grade and, as such, involve significant investment risk that exceeds the aggregate risk of the full pool of securitized loans. By holding the residual securities, we retain the “first loss” risk associated with the underlying pool of mortgage loans. As a result, the credit performance and prepayment rates of the sub-prime loans underlying these mortgage securities directly affect our returns on these mortgage securities. Significant realized losses from our residual and subordinated mortgage securities could harm our results of operations and financial condition. In addition, because we finance these securities under medium-term warehouse repurchase agreements, decreases in the value of these retained securities may result in margin calls and adversely affect our liquidity.We invest in or assume financial risk associated with mortgage securities issued by third party residential real estate loan securitization entities, most of which are backed by sub-prime loans. In addition, following a CDO offering, we retain equity or unsecured debt securities of the CDO issuer. We expect to increase our investment in third party mortgage securities and CDO issuer equity and debt securities and, consequently, to increase our credit and prepayment exposure to the assets that underlie these securities. A significant portion of these third party mortgage securities consists of securities that are subordinate to other securities secured by the same pool of assets and, as such, have significant investment risk. Generally, we do not control or influence the underwriting, servicing, management, or loss mitigation efforts with respect to the assets underlying securities issued by securitizations we do not sponsor. If the asset pools underlying any of these securities were to experience poor credit results, the market value of the third party securities that we hold directly and of our equity interest in or unsecured debt of a CDO issuer could decrease. Significant realized losses from third party mortgage securities, directly or indirectly through our interest in a CDO issuer, could harm our results from operations, liquidity, and financial condition.Further, we may enter into or assume financial risk associated with ABS credit default swaps or similar derivatives, referred to a “synthetic securities,” in contemplation of the transfer of such synthetic securities to a CDO issuer in connection with our CDO offerings. Under these synthetic securities, we may assume, in exchange for a premium, payment and credit risk associated with third party mortgage securities. In addition to the risks associated with the third party securities to which the synthetic security relates, synthetic securities are unsecured and would expose us to the risk of payment default by the swap counterparty and to risks associated with the determination of settlement payments upon a credit event relating to the referenced mortgage securities or other settlement event. In addition, the market for synthetic securities of this type is not highly liquid and, as such, we may not be able to realize the full value of a synthetic security in the event we need to liquidate or dispose of the synthetic security, which could negatively impact our results of operations and financial condition.Credit results with respect to mortgage assets underlying our securitizations may negatively affect our access to the securitization market on favorable terms, which in turn would harm our financial condition and prospects.If the non-conforming loan industry continues to experience credit difficulties, our ability to access the securitization market on favorable terms may be negatively affected. In addition if the pools of mortgage loans underlying our securitizations of mortgage loans or indirectly underlying our securitizations of mortgage securities were to experience poor credit results, the securities issued in these securitizations could have their credit ratings down-graded, could suffer losses in market value, and could experience principal losses. In addition to reducing the long-term returns and near-term cash flows from the securities we have retained or acquired in these transactions, any of the foregoing may reduce our ability to sponsor securitization transactions, including CDO offerings, in the future.Competition in the securitization market may erode our securitization margins, which in turn may adversely affect or harm our financial condition and prospects.Competition in the business of sponsoring securitizations of the type we focus on is increasing as Wall Street broker-dealers, hedge funds, mortgage REITs, investment management companies, and other financial institutions expand their activities or enter this field. Increased competition could reduce our securitization margins. To the extent that our securitization margins erode, our results of operations, financial condition and business prospects will be negatively impacted.arewere structured as sales for financial reporting purposes resultresulted in gain recognition at closing as well as the recording of the residual mortgage securities we retainretained at fair value. As of December 31, 2006 we had retained residual mortgage securities from our securitizations of mortgage loans with a fair value of $349.3 million on our balance sheet.Delinquency, loss, prepayment and discount rate assumptions have a material impact on the amount of gain recognized and on the carrying value of our residual mortgage securities. It is extremely difficult to validate the assumptions we use in determining the amount of gain on sale and the value of our residual mortgage securities. If our actual experience differs materially from the assumptions that we use to determine our gain on sale or the value of these mortgage securities, our future cash flows, our financial condition and our results of operations could be negatively affected.interestssecurities represents the present value of future cash flows expected to be received by us from the excess cash flows created in the securitization transaction. In general, future cash flows are estimated by taking the coupon rate of the loans underlying the transaction less the interest rate paid to the investors, less contractually specified servicing and trustee fees, and after giving effect to estimated prepayments and credit losses. We estimate future cash flows from these securities and value them utilizing assumptions based in part on projected discount rates, delinquency, mortgage loan prepayment speeds and credit losses. It is extremely difficult to validate the assumptions we use in valuing our residual interests. Even if the general accuracy of the valuation model is validated, valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships which drive the results of the model. SuchDue to deteriorating market conditions, our actual experience has differed significantly from our assumptions, are complex as we must make judgments aboutresulting in a reduction in the effectfair value of matters that are inherently uncertain.these securities and impairments on these securities. If our actual experience differscontinues to differ materially from ourthe assumptions that we would be requiredused to reducedetermine the fair value of these securities.Furthermore, ifsecurities, our actual experience differs materially from these assumptions, our cash flow, financial condition, results of operations, liquidity and business prospects may be harmed, including an adverse affect on the amount of dividend payments that are made on our common stock.Changes in accounting standards might cause us to alter the way we structure or account for securitizations.Changes could be made to current accounting standards, which could affect the way we structure or account for securitizations. For example, if changes were made in the types of transactions eligible for gain on sale treatment, we may have to change the way we account for securitizations, which may harm our results of operations or financial condition.The rate at which we are able to acquire eligible mortgage loans or mortgage securities and changes in market conditions during asset accumulation may adversely affect our anticipated returns from the securitization of these assets.We use short term warehouse financing arrangements to finance the acquisition of mortgage loans and mortgage securities until a sufficient quantity of assets is accumulated, at which time we may refinance these lines through a securitization or other long term financing. As a result, we are subject to the risk that we will not be able to acquire, during the period in which the relevant warehouse facility is available for the funding of such assets, a sufficient amount of eligible securities to maximize the efficiency of a securitization. In addition, changes in conditions in the capital markets may make a securitization less attractive to us by the time we do have a sufficient pool of collateral. If we are unable to securitize these assets, we may be required to seek other forms of potentially less attractive financing or otherwise to liquidate the assets on unfavorable terms.Market factors may limit our ability to originate and acquire mortgage assets at yields that are favorable relativecontinue as a going concern will continue to costs.Despite our experience in the origination and acquisition of mortgage assets and our relationships with brokers and sellers of mortgage assets, we face the risk that we might not be able to originate or acquire mortgage assets that earn interest rates greater than our cost of funds under our short-term borrowings and securitizations, or that we might not be able to originate or acquire a sufficient number of such mortgage assets to maintain our profitability. An inability to originate or purchase sufficient volumes of loans and mortgage securities at a cost lower than the net cash proceeds realized from their sale or securitization would materially harm our results of operations, financial condition and business prospects.We have recently imposed stricter mortgage loan and borrower requirements, which may result in a decrease in our mortgage loan origination and purchase volumes and, consequently, our loan sale and securitization volumes.As a result of less favorable economic conditions and an increase in the number of fraudulently obtained loans and borrower defaults, we have tightened our mortgage loan lending and purchase requirements and the processes we undergo to document loans. There may be fewer borrowers and loans that qualify under these revised standards, and we may face increased competition from lenders and loan purchasers with less rigorous standards. As a result, our loan origination and purchase volumes may decline. A decline in our loan origination or purchase volumes would decrease the volume of assets available to us for sale or securitization, which could adversely affect our results of operations and financial condition.liquidityability to continue as a going concern in the following ways:a substantial or sustained increase in interest rates could harm our ability to originate or acquire mortgage loans and mortgage securities in expected volumes, which could result in a decrease in our cash flow and in our ability to support our fixed overhead expenses;interest rate fluctuations may harm our earnings and access to capital as the spread between the interest rates we pay on our borrowings and hedges and the interest rates we receive on our mortgage assets narrows;· interest rate fluctuations may harm our cash flow as the spread between the interest rates we pay on our borrowings and hedges and the interest rates we receive on our mortgage assets narrows; if prevailing interest rates increase after we fund a loan, the value that we receive upon the sale or securitization of the loan decreases;· the value of our residual and subordinated securities and the income we receive from them are based primarily on LIBOR, and an increase in LIBOR increases funding costs which reduces the cash flow we receive from, and the value of, these securities; when we securitize loans, the value of the residual and subordinated securities we retain and the income we receive from them are based primarily on LIBOR, and an increase in LIBOR increases our funding costs which reduces the net income we receive from, and the value of, these securities;· existing borrowers with adjustable-rate mortgages or higher risk loan products may incur higher monthly payments as the interest rate increases, and consequently may experience higher delinquency and default rates, resulting in decreased cash flows from, and decreased value of, our mortgage securities; and existing borrowers with adjustable-rate mortgages or higher risk loan products may incur higher monthly payments as the interest rate increases, and consequently may experience higher delinquency and default rates, resulting in decreased earnings and decreased value of our mortgage securities;· mortgage prepayment rates vary depending on such factors as mortgage interest rates and market conditions, and changes in prepayment rates may harm our earnings and the value of our mortgage securities. mortgage prepayment rates vary depending on such factors as mortgage interest rates and market conditions, and changes in anticipated prepayment rates may harm our earnings and the value of our mortgage securities.Our mortgage loans and debt obligations are not marked to market. Generally, as interest rates increase, the value of our mortgage securities decreasedecreases which decreases the book value of our equity. We intend to increase our investment in mortgage securities, which may amplify the impact of interest rate changes on our book value.operations.Hedging against interest rate exposureour ability to continue as a going concern.adversely affectfurther decline due to factors beyond our earnings, which could adversely affect cash available for operations and for distribution to our shareholders.limits onmany factors that affect the abilityvalue of, and cash flows from, our hedging strategy to protect us completely against interest rate risks. When interest rates change, we expect the gain or loss on derivatives to be offset by a related but inverse change inmortgage securities, many of which are beyond our control. For example, the value of the hedged items,homes collateralizing residential loans may decline due to a variety of reasons beyond our control, such as weak economic conditions or natural disasters. Over the past year, residential property values in most states have declined, in some areas severely, which has increased delinquencies and losses on residential mortgage loans generally, especially where the aggregate loan amounts (including any subordinate loans) are close to or greater than the related property value. A borrower’s ability to repay a loan also may be adversely affected by factors beyond our liabilities. We cannot assure you, however, that our use of derivatives will offset the risks related to changes in interest rates. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses. We may enter into interest rate cap or swap agreements or pursue other interest rate hedging strategies. Our hedging activity will vary in scope based on interest rates, the type of mortgage assets held, other changing market conditions and, so longcontrol, such as we remain a REIT, compliance with REIT requirements. Interest rate hedging may fail to protect or could adversely affect us because, among other things:interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;hedging instruments involve risk because they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities; consequently, there are no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions, and the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory, commodity and other regulatory requirements;available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;the durationsubsequent over-leveraging of the hedgeborrower, reductions in personal incomes, and increases in unemployment.not match the duration of the related liability or asset;the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction;the party owing moneyinvolve higher than expected delinquencies and defaults. For instance, any increase in the hedging transaction may default on its obligation to pay, which may result in the loss of unrealized profits; andwe may not be able to dispose of or close out a hedging position without the consent of the hedging counterparty, and we may not be able to enter into an offsetting contract in order to cover our risks.Any hedging activity we engage in may adversely affect our earnings, which could adversely affect cash available for operations and for distribution to our shareholders. Unanticipated changes inprevailing market interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions.Complying with REIT requirements may limit our ability to hedge effectively.We attempt to minimize exposure to interest rate fluctuations by hedging. The REIT provisions of the Code limit our ability to hedge mortgage assets and related borrowings by requiring us to limit our income in each year from any qualified hedges, together with any other income not generated from qualified real estate assets, to no more than 25% of our gross income. The interest rate hedges that we generally enter into will not be counted as a qualified assetincreased payments for the purposes of satisfying this requirement. In addition, under the Code, we must limit our aggregate income from non-qualified hedging transactions and from other non-qualifying sources to no more than 5% of our annual gross income. As a result, we may have to limit our use of advantageous hedging techniques. This could result in greater risks associated with changes in interest rates than we would otherwise want to incur. In addition, if it is ultimately determined that some of our interest rate hedging transactions are non-qualified under the Code; we may have more than 5% of our annual gross income from non-qualified sources. If we violate the 5% or 25% limitations, we may have to pay a penalty tax equal to the amount of income in excess of those limitations, multiplied by a fraction intended to reflect our profitability. In addition, if we fail to observe these limitations, we could lose our REIT status unless our failure was due to reasonable cause and not due to willful neglect.Risks Related to Credit Losses and Prepayment RatesLoans made to nonconforming mortgage borrowers entail relatively higher delinquency and default rates which will result in higher loan losses.Lenders in the nonconforming mortgage banking industry make loans to borrowers who have impaired or limited credit histories, limited documentationadjustable rate mortgage loans. Moreover, borrowers with option ARM mortgage loans with a negative amortization feature may experience a substantial increase in their monthly payment, even without an increase in prevailing market interest rates, when the loan reaches its negative amortization cap. The current lack of incomeappreciation in residential property values and higher debt-to-income ratios than traditional mortgage lenders allow. Mortgage loans made to nonconformingthe adoption of tighter underwriting standards throughout the mortgage loan industry may adversely affect the ability of borrowers generally entail a relatively higher riskto refinance these loans and avoid default.delinquencythese factors may be exacerbated by general economic slowdowns and foreclosure thanby changes in consumer behavior, bankruptcy laws, and other laws.madeheld in our portfolio will be further reduced, which will adversely affect our operating results, liquidity, cash flows, financial condition and ability to borrowerscontinue as a going concern.better creditrespect to residential mortgage loans, particularly in the sub-prime sector, may cause us to recognize additional losses, which would further adversely affect our operating results, liquidity, financial condition, business prospects and therefore, will result in higher levels of realized losses than conventional loans. ability to continue as a going concern.LoansAlso, loans that becomeare delinquent prior to sale or securitizationin default may become unsaleablebe unmarketable or saleable only at a discount,discount.the longer we holddefaults, which has adversely affected our liquidity, cash flows, results of operations and financial condition. Nearly all of our remaining loans prior toheld for sale or securitization, the greater the chance we will bear all costs associated with the loans’ delinquency. Also, our cost of financing and servicing aare delinquent or defaulted loan is generally higher than for a performing loan.We bear the risk of delinquencyare in default. In addition, our economic investment in and default oncash flows from loans beginning when we originate them. In whole loan sales, our risk of delinquency and default typically only extends until the borrower makes the first payment but can extend up to the third payment. When we securitize any of our loans, wehave securitized continue to be exposed to delinquencies and losses, either through our residual interests forsecurities that we retain in securitizations structured as sales, or through the loans that remain on our balance sheet forin securitizations structured as financings. We also re-acquire the risks of delinquency and default for loans that we are obligated to repurchase.We attempt to manage these risks with risk based mortgage loan pricing and appropriate underwriting criteria and policies and loan collection methods. However, as with the broader nonconforming mortgage loan industry, we have recently experienced an increase in borrower delinquencies and defaults, which has adversely affected our cash flows, results of operations and financial condition. While we have taken steps to tighten our underwriting guidelines and procedures, there can be no assurance that these steps will be effective. To the extent that we cannot successfully address these issues, or the increase inloan delinquencies and defaults becomescontinue at their current rates or become more severe, our results of operations, andcash flows, liquidity, financial condition and ability to continue as a going concern may be further adversely affected.We face loss exposure due fraudulent and negligent acts on the part of loan applicants, employees, mortgage brokers and other third parties.When we originate or purchase mortgage loans, we rely heavily upon information provided to us by third parties, including information relating to the loan application, property appraisal, title information and employment and income documentation. If any of this information is fraudulently or negligently misrepresented to us and such misrepresentation is not detected by us prior to loan funding, the value of the loan may be significantly lower than we expected. Whether a misrepresentation is made by the loan applicant, the loan broker, one of our employees, or any other third party, we generally bear the risk of loss associated with it. A loan subject to misrepresentation typically cannot be sold and, if sold prior to our detection of the misrepresentation, generally must be repurchased by us. We may not be able to recover losses incurred as a result of the misrepresentation.As with the broader nonconforming mortgage loan industry, we have recently experienced an increase in exposure due to fraud, which has resulted in an increase in our repurchaseborrowers entail relatively higher delinquency and indemnity obligations and has adversely affected our cash flow, results of operations and financial condition. To the extent that we cannot successfully address these issues or the increase in fraud becomes more severe, our results of operations and financial condition may be further adversely affected.Our reliance on cash-out refinancings as a significant source of our origination volume increases the risk that our earnings will be harmed if the demand for this type of refinancing declines.Approximately 65% of our loan production volume during the year ended December 31, 2006 consisted of cash-out refinancings. Our reliance on cash-out refinancings as a significant source of our origination volume increases the risk that our earnings will be reduced if interestdefault rates rise and the prices of homes decline, which would reduce the demand and production volume for this type of refinancing. To the extent interest rates continue to rise, the number of borrowers who would qualify or elect to pursue a cash-out refinancing could be reduced significantly, which will result in a decline in that origination source. Similarly, a decrease in home prices would reduce the amount of equity availablehigher loan losses, which are likely to be borrowed against in cash-out refinancingsexacerbated during economic slowdowns.result in a decrease in our loan production volume from that origination source. Therefore, our reliance on cash-out refinancings as a significant source of our origination volume could harm our results of operations, financial condition and business prospects.Our effortshigher debt-to-income ratios than traditional mortgage lenders allow. Mortgage loans made to manage credit risk may not be successful in limiting delinquencies and defaults in underlying loans and, as a result, our results of operations may be affected.There are many aspects of credit that we cannot control and our quality control and loss mitigation operations may not be successful in limiting future delinquencies, defaults and losses. For example, the value of the homes collateralizing residential loans may decline due to a variety of reasons beyond our control, such as weak economic conditions, natural disasters, over-leveraging of the borrower, and reduction in personal incomes. Interest-only loans, negative amortization loans, adjustable-rate loans, reduced documentation loans, sub-prime loans, home equity lines of credit and second lien loans may involve higher than expected delinquencies and defaults. Changes in consumer behavior, bankruptcy laws, and other laws may exacerbate loan losses.Our comprehensive underwriting process may not be effective in mitigating these risks and our risk of loss on the underlying loans. Further, expanded loss mitigation efforts in the event that defaults increase could increase our operating costs. In response to increasing default rates recently experienced by us and the nonconforming mortgage loan industryborrowers generally we have enhanced our underwriting policies and procedures, which may decrease our ability to originate and purchase loans. To the extent that these efforts are ineffective to reduce the current level of loan delinquencies and defaults or adversely affect our origination and purchase volumes, our results of operations may be adversely affected.Mortgage insurers may in the future change their pricing or underwriting guidelines or may not pay claims resulting in increased credit losses.We use mortgage insurance to mitigate our risk of credit losses. Our decision to obtain mortgage insurance coverage is dependent, in part, on pricing trends. Mortgage insurance coverage on our new mortgage loan production may not be available at rates that we believe are economically viable for us or at all. We also face the risk that our mortgage insurers might not have the financial ability to pay all claims presented by us or may deny a claim if the loan is not properly serviced, has been improperly originated, is the subject of fraud, or for other reasons. Any of those events could increase our credit losses and thus adversely affect our results of operations and financial condition.Investments in diverse types of assets and businesses could expose us to new, different, or increased risks.We have invested in and intend to invest in a variety of assets that are related to our current core business, including loans, securities, and related derivatives. We may make investments in debt and equity securities issued by our own and third party CDOs that own various types of assets. These CDOs may invest in manufactured housing loans, sub-prime residential mortgage loans, and other residential mortgage loans backed by lower-quality borrowers, in other loans and receivables, in securities backed by the foregoing, and in credit default derivatives referencing these or other securities. The higher credit and/or prepayment risks associated with these types of investments may increase our exposure to losses. In addition, certain of these assets may be relatively new or unique products, which may increase contractual and liquidity risks.The federal banking agencies’ final guidance on nontraditional mortgage products may impact our ability to originate, buy, or sell certain nontraditional mortgage loans.On October 4, 2006, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the National Credit Union Administration issued their final “Interagency Guidance on Nontraditional Mortgage Product Risks” (the “Guidance”). Nontraditional mortgage products are those which allow borrowers to defer payment of principal and sometimes interest. They include what are commonly referred to as “option ARM” loans and interest-only loans.The Guidance addresses the portfolio risks and consumer protection issues that the federal agencies believe investors and lenders face when making or investing in nontraditional mortgage loans. As a matter of portfolio risk management, the Guidance warns applicable financial institutions that loan terms should be analyzed to ensure a manageable risk level, utilizing sound underwriting standards including an evaluation of factors that may compound the risk, such as reduced documentation programs and the use of second lien mortgages. The analysis of repayment ability “should avoid over-reliance on credit scores as a substitute for income verification in the underwriting process” and should include an analysis of the borrower’s ability to make the payment when it increases to include amortization of the loan.As a matter of consumer protection, financial institutions subject to the Guidance, when promoting or describing nontraditional mortgage products, are directed to ensure that they provide consumers with marketing materials and at application with information that is designed to help them make informed decisions when selecting and using these products. Lenders subject to the Guidance are instructed that the information they are to provide should apprise consumers of the risk that the monthly payment amounts could increase in the future, and explain the possibility of negative amortization.While not directly applicable to us, the Guidance may affect our ability to make, buy or sell the nontraditional loans covered by the Guidance. Further, the Guidance is instructive of the regulatory climate concerning those loans and may be adopted in whole or part by other agencies that regulate us. The Guidance reports that the Conference of State Bank Supervisors (“CSBS”) and the State Financial Regulators Roundtable (“SFRR”) are committed to preparing a model guidance document for state regulators of non-depository institutions such as us, which would be “similar in nature and scope” to the Guidance. It is also possible that the Guidance, or certain provisions within it, may be adopted as laws or used as guidance by federal, state or local agencies and that those laws or guidance may be applied to us.If we are required (either by a regulatory agency or by third-party originators or investors) to make changes to our business practices to comply with the Guidance, it might affect the business activities in which we may engage and the profitability of those activities. Our business could be adversely affected if, as a result of the Guidance, investors from which we purchase loans, or to whom we sell loans, change their business practices and policies relative to nontraditional mortgage products. For example, if entities from which we purchase loans are required to change their origination guidelines thereby affecting the volume, diversity, and quality of loans available for purchase by us, or if purchasers of mortgage loans are required to make changes to the purchasing policies, then our loan volume, ability to sell mortgage loans and profitability, could be adversely affected.Our interest-only loans may haveentail a higher risk of defaultdelinquency and foreclosure than our fully-amortizing loans.For the year ended December 31, 2006, originations of interest-only loans totaled $1.4 billion, or 13%, of our total originations. These interest-only loans require the borrowers to make monthly payments only of accrued interest for the first 24, 36 or 120 months following origination. After such interest-only period, the borrower’s monthly payment is recalculated to cover both interest and principal so that the mortgage loan will amortize fully prior to its final payment date. The interest-only feature may reduce the likelihood of prepayment during the interest-only period due to the smaller monthly payments relative to a fully-amortizing mortgage loan. If the monthly payment increases, the related borrower may not be able to pay the increased amount and may default or may refinance the related mortgage loan to avoid the higher payment. Because no principal payments may be made on such mortgage loans for an extended period following origination, ifmade to borrowers with better credit and, therefore, will result in higher levels of realized losses than conventional loans. General economic slowdowns, such as that currently affecting the borrower ultimately defaults, the unpaid principal balance of the related loans would be greater than otherwise would be the case for a fully-amortizing loan. As a result, the likelihood that we would incur a loss on these loans will increase, especially in a declining real estate market.Current loan performance data may not be indicative of future results.When making capital budgeting and other decisions, we use projections, estimates and assumptions based on our experience with mortgage loans. Actual results and the timing of certain events could differ materially in adverse ways from those projected, due to factors including changes in general economic conditions, interest rates, mortgage loan prepayment rates and in losses due to defaults on mortgage loans. These differences and fluctuations could rise to levels that may adversely affect our profitability and financial condition.Changes in prepayment rates of mortgage loans could adversely affect the return that we are able to achieve on our assets.The value of our assets may be affected by prepayment rates on our residential mortgage loans and other floating rate assets. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. In periods of declining mortgage interest rates, prepayments on loans generally increase. If general interest rates decline as well, the proceeds of such prepayments received during such periodsUnited States, are likely to be reinvested by us in assets yielding less than the yields on the assets that were prepaid. In addition, the market value of floating rate assets may, because of the risk of prepayment, benefit less than fixed rate assets from declining interest rates. Conversely, in periods of rising interest rates, prepayments on loans generally decrease, in which case we would not have the prepayment proceeds available to invest in assets with higher yields. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain investments. As a result of all of these factors, changes in prepayment rates could adversely affect our return on our assets.Geographic concentration of mortgage loans we originate or purchase increases our exposure to risks in those areas.Over-concentration of loans we originate or purchase in any one geographic area increases our exposure to the economic and natural hazard risks associated with that area. Declines in the residential real estate markets in which we are concentrated may reduce the values of the properties collateralizing our mortgages which in turn may increase the risk of delinquency, foreclosure, bankruptcy, or losses from those loans. To the extent that borrowers in a geographic area in which we have made a significant number of loans become delinquent or otherwise default on such loans, our financial condition and results of operations may be adversely affected.To the extent that we have a large number of loans in an area hit by a natural disaster, we may suffer losses.Standard homeowner insurance policies generally do not provide coverage for natural disasters, such as hurricanes and floods. Furthermore, nonconforming borrowers to a greater extent than conforming borrowers and, consequently, are not likely to have special hazard insurance. To the extent that borrowers do not have insurance coverage for natural disasters, they may not be ablea greater negative impact on delinquency and loss rates with respect to repair the property or may stop paying their mortgages if the property is damaged. A natural disaster that results in a significant number of delinquencies could cause increased foreclosures and decrease our ability to recover losses on properties affected by such disasters, and that in turn could harm our financial condition and results of operations.A prolonged economic slowdown or a decline in the real estate market could harm our results of operations.A substantial portion of our mortgage assets consist of single-family mortgage loans or mortgage securities evidencing interests in single-family mortgagenonconforming loans. Because we make a substantial number of loans to credit-impaired borrowers, the actual rates of delinquencies, foreclosures and losses on these loans tend to be higher during economic slowdowns. Recently, we have experienced an increase in delinquencies and foreclosures. Any sustained period of increased delinquencies or defaults or any sharp increase in the number of delinquencies and defaults could harm our ability to sell loans, the prices we receive for our loans, the values of our mortgage loans held for sale, our ability to finance loan originations and our residual interests in securitizations, which could harm our financial condition and results of operations. In addition, any material decline in real estate values would weaken our collateral loan-to-value ratios and increase the possibility of loss if a borrower defaults. In such event, we will be subject to the risk of loss on such mortgage asset arising from borrower defaults to the extent not covered by third-party credit enhancement.Various legal proceedings could adversely affect our financial condition or results of operations.In the course of our business, we are subject to various legal proceedings and claims. See “Item 3 – Legal Proceedings.” The resolution of these legal matters or other legal matters could result in a material adverse impact on our results of operations, financial condition and business prospects.We are subject to the risk that provisions of our loan agreements may be unenforceable.Our rights and obligations with respect to our loans are governed by written loan agreements and related documentation. It is possible that a court could determine that one or more provisions of a loan agreement are unenforceable, such as a loan prepayment prohibition or the provisions governing our security interest in the underlying collateral. If this were to happen with respect to a material asset or group of assets, we could be required to repurchase these loans and may not be able to sell or liquidate the loans, which could negatively affect our liquidity and financial condition.We are exposed to the risk of environmental liabilities with respect to properties to which we take title.In the course of our business, we occasionally foreclose and take title to residential properties and as a result could become subject to environmental liabilities associated with these properties. We may be held liable for property damage, personal injury, investigation, and cleanup costs incurred in connection with environmental contamination. These costs could be substantial. If we ever become subject to significant environmental liabilities, our financial condition and results of operations could be adversely affected.Regulation as an investment company could harm our business; efforts to avoid regulation as an investment company could limit our operations.If we were required to comply with the Investment Company Act, we would be prevented from conducting our business as described in this document by, among other things, substantially limiting our ability to use leverage. The Investment Company Act does not regulate entities that are primarily engaged, directly or indirectly, in a business “other than that of investing, reinvesting, owning, holding or trading in securities,” or that are primarily engaged in the business of “purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” Under the Commission’s current interpretation, in order to qualify for the latter exemption we must maintain at least 55% of our assets directly in “qualifying real estate interests” and at least an additional 25% of our assets in other real estate-related assets or additional qualifying real estate interests. Mortgage-backed securities that do not represent all the certificates issued with respect to an underlying pool of mortgages may be treated as securities separate from the underlying mortgage loans and thus may not qualify as a qualifying real estate interest for the purposes of the 55% requirement. Therefore, to insure that we continue to qualify for the exemption, we may be required to adopt less efficient methods of financing certain of our mortgage assets, we may be required to sell certain mortgage securities at disadvantageous terms, and we may be precluded from acquiring certain types of higher yielding mortgage assets. If we fail to qualify for an applicable exemption from the Investment Company Act, we could not operate our business efficiently under the regulatory scheme imposed by the Investment Company Act. Accordingly, we could be required to restructure our activities which could materially adversely affect our financial condition and results of operations.Our failuremortgage lending, loan servicing, broker compensation programs, or other aspects of our businessdiscontinued businesses could harm our financial condition and ability to recommence mortgage banking operations.and profitability.As a mortgage lender, loan servicer and broker, we arewere subject to an extensive body of both state and federal law. The volume of new or modified laws and regulations has increased in recent years and, in addition, some individual municipalities and cities have begun to enact laws that restrict loan origination and servicing activities. As a result, it may be more difficult to comprehensively identify and accurately interpret all of these laws and regulations, to properly program our technology systems and to effectively train our personnel with respect to all of these laws and regulations, thereby potentially increasing our exposure to the risks of noncompliance with these laws and regulations. Our failure to comply with these laws and regulations can lead to civil and criminal liability; loss of licensure; damage to our reputation in the industry; inability to sell or securitize our loans; demands for indemnification or loan repurchases from purchasers of our loans; fines and penalties and litigation, including class action lawsuits; or administrative enforcement actions. Any of these results could harm our results of operations, financial condition and business prospects.New legislation could restrict our ability to make, finance and sell mortgage loans, could increase our compliance and origination costs, and could expose us to lawsuits and compliance actions, any of which could harm our earnings and business prospects.The regulatory environments in which we operate have an impact on the activities in which we may engage, how these activities may be carried out, and the profitability of these activities. Therefore, changes to laws, regulations or regulatory policies can affect whether and to what extent we are able to operate profitably.Several states, cities or other government entities are considering or have passed laws, regulations or ordinances aimed at curbing lending practices perceived as predatory. The federal government is also considering legislative and regulatory proposals in this regard. In general, these proposals involve lowering the existing thresholds for defining a “high-cost” loan and establish enhanced protections and remedies for borrowers who receive such loans. For example, certain of these new or proposed laws and regulations prohibit inclusion of some provisions in mortgage loans that have mortgage rates or origination costs in excess of prescribed levels, and require that borrowers be given certain disclosures or obtain advice, at the expense of the lender, prior to the consummation of such mortgage loans. Passage of these laws and rules could reduce our loan origination and purchase volumes and could increase our costs. The institutions that provide short-term financing to us generally refuse to finance any loan labeled as a “high cost” loan under any local, state or federal law or regulation. In addition, many whole loan buyers may elect not to purchase these loans, and rating agencies likewise may refuse to rate securities backed by such loans. Accordingly, these laws and rules could severely restrict short-term financing and the secondary market for a significant portion of our loan production. This would effectively preclude us from continuing to originate loans either in jurisdictions unacceptable to our lenders or the rating agencies or that exceed the newly defined thresholds, which in either case could harm our results of operations and business prospects.We cannot provide any assurance that these proposed laws, rules and regulations, or other similar laws, rules or regulations, will not be adopted in the future. Adoption of these laws and regulations could have a material adverse impact on our business by substantially increasing the costs of compliance with a variety of inconsistent federal, state and local rules, or by restricting our ability to charge rates and fees adequate to compensate us for the risk associated with certain loans. Compliance with some of these restrictions requires lenders to make subjective judgments, such as whether a loan will provide a “net tangible benefit” to the borrower. These restrictions impact the way in which a loan is underwritten and expose a lender to risks of litigation and regulatory sanction regardless of the care with which a loan is underwritten. Our failure to comply with these laws could subject us to monetary penalties and could result in the borrowers rescinding the loans, whether held by us or subsequent holders. The remedies for violations of these laws are not based solely on actual harm to the consumer and can result in damages and penalties that could extend not only to us, but to our secured warehouse lenders, institutional loan purchasers, securitization trusts that hold our loans and other assignees, regardless of whether such assignee knew of or participated in the violation, which, in turn, could have an adverse affect on the availability of financing to us and our access to securitization and other secondary markets.Similarly, recently enacted and proposed local, state and federal privacy laws and laws prohibiting or limiting marketing by telephone, facsimile, email and the Internet may limit our ability to market and our ability to access potential loan applicants.We are subject to significant legal and reputational risks and expenses under federal and state laws concerning privacy, use, and security of customer information.The scope of business activity affected by “privacy” concerns is likely to expand and will affect our non-prime mortgage loan origination business. The federal Gramm-Leach-Bliley financial reform legislation imposes significant privacy obligations on us in connection with the collection, use and security of financial and other non-public information provided to us by applicants and borrowers. We adopted a privacy policy and adopted controls and procedures to comply with the law after it took effect on July 1, 2001. Privacy rules also require us to protect the security and integrity of the customer information we use and hold.licensing requirements. Although we haveutilized systems and procedures designed to help us withfacilitate compliance, these privacy requirements we cannot assure you that more restrictive lawswere voluminous and, regulations will not be adopted in the future, or that governmental bodies will not interpret existing laws or regulations in a more restrictive manner, making compliance more difficult or expensive. These requirements also increase the risk that we may besome cases, complex and subject to liability for non-compliance.A number of states are considering privacy amendments that may be more demanding than federal law,interpretation, and California recently has enacted two statutes — the California Financial Information Privacy Act (also know as SB-1) and the California Online Privacy Protection Act, both of which took effect on July 1, 2004. Under SB-1, a financial company must allow its customers to opt out of the sharing of their information with affiliates in separately regulated lines of business and must receive a customer opt-in before confidential customer data may be shared with unaffiliated companies (subject to certain exceptions). A federal court rejected the effort of three financial trade associations to prevent SB-1 from taking effect, and as of July 1, 2004, the California Department of Financial Institutions announced that it would require immediate compliance with SB-1. Under the new California Online Privacy Act, all operators of commercial websites and online services that allow interaction with California consumers (even if no transactions may be effected online) must post privacy policies meeting statutory requirements. The FTC, which administers the federal privacy rules for mortgage lenders, has determined that privacy laws in several states are not preempted by Gramm-Leach-Bliley, most recently new privacy laws enacted by Vermont and Illinois. In view of the public concern with privacy, we cannot assure you that additional rules that restrict or make more costly our activities and the activities of our vendors will not be adopted and will not restrict the marketing of our products and services to new customers.Because laws and rules concerning the use and protection of customer information are continuing to develop at the federal and state levels, we expect to incur increased costs in our effort to be and remain in full compliance with these requirements. Nevertheless, despite our efforts, we will be subject to legal and reputational risks in connection with our collection and userequirements depended on the actions of customer information, and we cannot assure you that we will not be subject to lawsuits or compliance actions under such state or federal privacy requirements. Furthermore, to the extent that a variety of inconsistent state privacy rules or requirements are enacted, our compliance costs could substantially increase.New regulatory actions affecting the mortgage industry may increase our costs and decrease our mortgage acquisition.In addition to changes to legal requirements contained in statutes, regulations, case law, and other sources of law, changes in the investigation or enforcement policies of federal and state regulatory agencies could impact the activities in which we may engage, how the activities may be carried out, and the profitability of those activities. Several state and federal agencies have initiated regulatory enforcement proceedings against mortgage companies for engaging in business practices that were not specifically or clearly proscribed by law, but which in the judgment of the regulatory agencies were unfair or deceptive to consumers. For example, state attorneys general and other state officials representing various states entered into a settlement agreement with a large subprime mortgage company.The subject company agreednumber of employees. Investigations, enforcement actions, litigation, fines, penalties and liability with respect to pay a substantial amount in restitution to consumers and reimbursement to the states and also agreed to make changes to certain business practices, including the company’s underwriting criteria and pricing policies. Many of the practices and policies are not specifically prohibited by any federal or state laws but were alleged to be deceptive or unfair to consumers. The terms of this settlement agreement do not apply directly to us; however, federal and state regulatory agencies and private parties might nevertheless expect mortgage companies, including us, to make our business practices consistent with the provisions of the settlement agreement. If this happens, it could impact the activities in which we may engage, how we carry out those activities, our acquisition practices and our profitability. We might also be required to pay fines, make reimbursements, and make other payments to third parties for our business practices. Additionally, if an administrative enforcement proceeding were to result in us having to discontinue or alter certain business practices, then we might be placed at a competitive disadvantage vis-à-vis competitors who are not required to make comparable changes to their business practices.Changes in Internal Revenue Service regulations regarding the timing of income recognition and/or deductions could materially adversely affect the amount of our dividends.On September 30, 2004, the IRS released Announcement 2004-75, which describes rules that may be included in proposed IRS regulations regarding the timing of recognizing income and/or deductions attributable to interest-only securities. We believe the effect of these regulations, if adopted, may narrow the spread between book income and taxable income on the interest-only securities we hold and would thus reduce our taxable income during the initial periods that we hold such securities. A significant portion of our mortgage securities—available-for-sale consists of interest-only securities. If regulations are adopted by the IRS that reduces our taxable income in a particular year during which we are a REIT, our dividend paid to common shareholders may be reduced for that year because, so long as we remain a REIT, the amount of our dividend on common stock is entirely dependent upon our taxable income.If we do not maintain our REIT status, we would be subject to tax as a regular corporation and would otherwise operate as a regular corporation. We conduct a substantial portion of our business through our taxable REIT subsidiaries, which creates additional compliance requirements.We must comply with numerous complex tests to continue to qualify as a REIT for federal income tax purposes, including the requirement that we distribute 90% of taxable income to our shareholders and the requirement that no more than 5% of our annual gross income come from non-qualifying sources. So long as we remain a REIT, failure to complynon-compliance with these requirements may subject us to penalty taxes andconsume attention of key personnel, may put our REIT status at risk. In the event that we fail to maintain or elect to terminate our REIT status, we would be taxed at the corporate level and would not be required to pay out our taxable income in the form of dividends. For any year that we do not generate taxable income, we are not required to declare and maintain dividends to maintain our REIT status.We conduct a substantial portion of our business through taxable REIT subsidiaries, such as NovaStar Mortgage. Despite our qualification as a REIT, our taxable REIT subsidiaries must pay federal income tax on their taxable income. Our income from, and investments in, our taxable REIT subsidiaries do not constitute permissible income or investments for some of the REIT qualification tests. We may be subject to a 100% penalty tax, or our taxable REIT subsidiaries may be denied deductions, to the extent that our dealings with our taxable REIT subsidiaries are deemed not to be arm’s length in nature.Our cash balances and cash flows may become limited relative to our cash needs, which may ultimatelyadversely affect our REIT status or solvency.We use cash for originating mortgage loans, to meet minimum REIT dividend distribution requirements, and for other operating needs. Cash is also required to pay interest on our outstanding indebtedness and may be required to pay down indebtedness in the event that the market values of the assets collateralizing our debt decline, the terms of short-term debt become less attractive or for other reasons. If our income as calculated for tax purposes significantly exceeds our cash flows from operations, our minimum REIT dividend distribution requirements could exceed the amount of our available cash. In the event that our liquidity needs exceed our access to liquidity, we may need to sell assets at an inopportune time, thus adversely affecting our financial condition and results of operations. Furthermore, in an adverse cash flow situation, our REIT status or our solvency could be threatened.The tax imposed on REITs engaging in “prohibited transactions” will limit ourfuture ability to engage in transactions, including certain methods of securitizing loans, which would be treated as sales for federal income tax purposes.A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property but including any mortgage loans held in inventory primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to sell a loan or securitize the loans in a manner that was treated as a sale of such inventory for federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans other than through our taxable REIT subsidiariesregulated activities, and may limit the structures we utilize for our securitization transactions even though such sales or structures might otherwise be beneficial for us. In addition, this prohibition may limit our ability to restructure our portfolio of mortgage loans from time to time even if we believe it would be in our best interest to do so.Even if we qualify as a REIT, the income earned by our taxable REIT subsidiaries will be subject to federal income taxmaterially and we could be subject to an excise tax on non-arm’s-length transactions with our taxable REIT subsidiaries.Our taxable REIT subsidiaries, including NovaStar Mortgage, expect to earn income from activities that are prohibited for REITs, and will owe income taxes on the taxable income from these activities. For example, we expect that NovaStar Mortgage will earn income from our loan origination and sales activities, as well as from other origination and servicing functions, which would generally not be qualifying income for purposes of the gross income tests applicable to REITs or might otherwise be subject to adverse tax liability if the income were generated by a REIT. Our taxable REIT subsidiaries are taxable as C corporations and are subject to federal, state and local income tax at the applicable corporate rates on their taxable income, notwithstanding our qualification as a REIT.In the event that any transactions between us and any of our taxable REIT subsidiaries are not conducted on an arm’s-length basis, we could be subject to a 100% excise tax on certain amounts from such transactions. Any such tax couldadversely affect our overall profitability and the amounts of cash available for operations or to make distributions.We may, at some point in the future, borrow funds from one or more of our corporate subsidiaries. The IRS may recharacterize the indebtedness as a dividend distribution to us by our subsidiary. Any such recharacterization may cause us to fail one or more of the REIT requirements.We may be harmed by changes in tax laws applicable to REITs or the reduced 15% tax rate on certain corporate dividends may harm us.Changes to the laws and regulations affecting us, including changes to securities laws and changes to the Code applicable to the taxation of REITs may harm our business. New legislation may be enacted into law or new interpretations, rulings or regulations could be adopted, any of which could harm us and our shareholders, potentially with retroactive effect.Generally, dividends paid by REITs are not eligible for the 15% U.S. federal income tax rate on certain corporate dividends, with certain exceptions. The more favorable treatment of regular corporate dividends could cause domestic non-corporate investors to consider stocks of other corporations that pay dividends as more attractive relative to stocks of REITs.We may be unable to comply with the requirements applicable to REITs or compliance with such requirements could harm our financial condition.The requirements to qualify as a REIT under the Code are highly technical and complex. We routinely rely on legal opinions to support our tax positions. A technical or inadvertent failure to comply with the Code as a result of an incorrect interpretation of the Code or otherwise could jeopardize our REIT status. The determination that we qualify as a REIT requires an analysis of various factual matters and circumstances that may not be totally within our control. For example, to qualify as a REIT, at least 75% of our gross income must come from real estate sources and 95% of our gross income must come from real estate sources and certain other sources that are itemized in the REIT tax laws, mainly interest and dividends. We are subject to various limitations on our ownership of securities, including a limitation that the value of our investment in taxable REIT subsidiaries, including NovaStar Mortgage, cannot exceed 20% of our total assets at the end of any calendar quarter. In addition, at the end of each calendar quarter, at least 75% of our assets must be qualifying real estate assets, government securities and cash and cash items. The need to comply with these asset ownership requirements may cause us to acquire other assets that are qualifying real estate assets for purposes of the REIT requirements (for example, interests in other mortgage loan portfolios or mortgage-related assets) but are not part of our overall business strategy and might not otherwise be the best investment alternative for us. Moreover, we may be unable to acquire sufficient qualifying REIT assets, due to our inability to obtain adequate financing or otherwise, in which case we may fail to qualify as a REIT or may incur a penalty tax at the REIT level.Also, to qualify as a REIT, we must distribute to our shareholders with respect to each year at least 90% of our REIT taxable income (determined without regard to the dividends paid deduction and by excluding any net capital gain). After-tax earnings generated by our taxable REIT subsidiaries and not distributed to us are not subject to these distribution requirements and may be retained by such subsidiaries to provide for future growth, subject to the limitations imposed by REIT tax rules. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay out to our shareholders in a calendar year is less than a minimum amount specified under federal tax laws. We expect in some years that we will be subject to the 4% excise tax. We could be required to borrow funds on a short-term basis even if conditions are not favorable for borrowing, or to sell loans from our portfolio potentially at disadvantageous prices, to meet the REIT distribution requirements and to avoid corporate income taxes. These alternatives could harm our financial condition, results of operations, liquidity and could reduce amounts availableability to originate mortgage loans.If we fail to qualify or remain qualifiedcontinue as a REIT, our distributions will not be deductible by us, and we will be subject to federal income tax on our taxable income. This would substantially reduce our earnings and our cash available to make distributions. The resulting tax liability, in the event of our failure to qualify as a REIT, might cause us to borrow funds, liquidate some of our investments or take other steps that could negatively affect our operating results. Moreover, if our REIT status is terminated because of our failure to meet a technical REIT requirement or if we voluntarily revoke our election, we generally would be disqualified from electing treatment as a REIT for the four taxable years following the year in which REIT status is lost.We could lose our REIT status if more than 20% of the value of our total assets are represented by the securities of one or more taxable REIT subsidiaries at the close of any calendar quarter.To qualify as a REIT, not more than 20% of the value of our total assets may be represented by the securities of one or more taxable REIT subsidiaries at the close of any calendar quarter, subject to a 30-day “cure” period following the close of the quarter and, for taxable years beginning on or after January 1, 2005, subject to certain relief provisions even after the 30-day cure period. Our taxable REIT subsidiaries, including NovaStar Mortgage, conduct a substantial portion of our business activities, including a majority of our loan origination and servicing activities. If the IRS determines that the value of our investment in our taxable REIT subsidiaries was more than 20% of the value of our total assets at the close of any calendar quarter, we could lose our REIT status. In certain cases, we may need to borrow from third parties to acquire additional qualifying REIT assets or increase the amount and frequency of dividends from our taxable REIT subsidiaries in order to comply with the 20% of assets test.Investors in our common stock may experience losses, volatilitypoor liquidity, and we may reduce or delay payment of our dividends in a variety of circumstances.Our earnings, cash flow, taxable income, GAAP income, book value and dividends can be volatile and difficult to predict. Investors should not rely on past performance, predictions or management beliefs. Although we historically paid a regular common stock dividend, we may reduce or eliminate our dividend payments in the future for a variety of reasons. For example, to the extent that the historic difference between our taxable income and GAAP income is reduced or reversed due to changes in the tax laws, our operating results or otherwise, our dividend could be reduced or eliminated. Furthermore, if we failed, or chose not to satisfy the complex requirements necessary to maintain our REIT status, our dividend may be reduced or eliminated because we would not be required to pay out our taxable income in the form of dividends. We may not provide public warnings of such dividend reductions or eliminations prior to their occurrence. Fluctuations in our current and prospective earnings, cash flow and dividends, as well as many other factors such as perceptions, economic conditions, stock market conditions, and the like, can affect the pricetrading volume of our common stock. Investors may experience volatile returns and material losses. In addition, liquidity in the trading of our commonpreferred stock may be insufficient to allow investors to sell their stock in a timely manner or at a reasonable price.We may not pay common stock dividends to stockholders.So long as we maintain our status as a REIT, REIT provisions of the Code generally require that we annually distribute to our stockholders at least 90% of all of our taxable income, exclusive of the application of any tax loss carry forwards that may be used to offset current period taxable income. These provisions restrict our ability to retain earnings and thereby generate capital from our operating activities. If in any year, however, we do not generate taxable income, we are not required to declare and pay common stock dividends to maintain our REIT status. In addition, we are currently evaluating and may decide at a future date to terminate our REIT status, which would cause us to be taxed at corporate levels and to significantly reduce or eliminate regular dividends.Restrictions on ownership of capital stock may inhibit market activity and the resulting opportunity for holders of our capital stock to receive a premium for their securities.In order for us to meet the requirements for qualification as a REIT, our charter generally prohibits, so long as we remain a REIT, any person from acquiring or holding, directly or indirectly, (i) shares of our common stock in excess of 9.8% (in value or number of shares, whichever is more restrictive) of the aggregate outstanding shares of our common stock or (ii) shares of our capital stock in excess of 9.8% in value of the aggregate outstanding shares of our capital stock. These restrictions may inhibit market activity and the resulting opportunity for the holders of our capital stock to receive a premium for their stock that might otherwise exist in the absence of such restrictions.The market price of our common stock and trading volume may be volatile, which could result in substantial losses for our shareholders.commoncapital stock can be highly volatile and subject to wide fluctuations. In addition, the trading volume in our commoncapital stock may fluctuate and cause significant price variations to occur. Investors may experience volatile returns and material losses. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our commoncapital stock include:general market and economic conditions;actual or anticipated changes in residential real estate value;· actual or perceived changes in our ability to continue as a going concern; actual or anticipated changes in the delinquency and default rates on mortgage loans, in general, and specifically on the loans we originate or invest in through our mortgage securities-available for-sale;· actual or anticipated changes in the delinquency and default rates on mortgage loans, in general, and specifically on the loans we invest in through our mortgage securities; actual or anticipated changes in our future financial performance;· actual or anticipated changes in residential real estate values; actual or anticipated changes in market interest rates;· actual or anticipated changes in market interest rates; actual or anticipated changes in our access· actual or anticipated changes in our earnings and cash flow; · general market and economic conditions, including the operations and stock performance of other industry participants; · developments in the subprime mortgage lending industry or the financial services sector generally; · the impact of new state or federal legislation or adverse court decisions; · the activities of investors who engage in short sales of our common stock; · actual or anticipated changes in financial estimates by securities analysts; · sales, or the perception that sales could occur, of a substantial number of shares of our common stock by insiders; · additions or departures of senior management and key personnel; and · actions by institutional shareholders. capital;actual or anticipated changes in the amount of our dividend or any delay in the payment of a dividend;competitive developments, including announcements by us or our competitors of new products or services;the operations and stock performance of our competitors;developments in the mortgage lending industry or the financial services sector generally;the impact of new state or federal legislation or adverse court decisions;fluctuations in our quarterly operating results;the activities of investors who engage in short sales of our common stock;actual or anticipated changes in financial estimates by securities analysts;sales, or the perception that sales could occur, of a substantial number of shares of our common stock by insiders;additions or departures of senior management and key personnel; andactions by institutional shareholders.Our common stock may become illiquid if an active public trading market cannot be sustained,issue additional equity without shareholder approval, which could materially adversely affect the trading price and your ability to transfer our common stock.Our common stock’s trading volume is relatively low compared to the securities of many other companies listed on the New York Stock Exchange. If an active public trading market cannot be sustained, the trading price of our common stock could be adversely affected and your ability to transfer your shares of our common stock may be limited.We may issue additional shares that may cause dilution and may depress the price of our common stock.· authorize the issuance of additional shares of common stock or preferred stock without shareholder approval, including the issuance of shares of preferred stock that have preference rights over the common stock with respect to dividends, liquidation, voting and other matters or shares of common stock that have preference rights over our outstanding common stock with respect to voting; · classify or reclassify any unissued shares of common stock or preferred stock and to set the preferences, rights and other terms of the classified or reclassified shares; and · issue additional shares of common stock or preferred stock in exchange for outstanding securities, with the consent of the holders of those securities. shares of common stockcapital, we may issue, reclassify or preferred stock without shareholder approval, including the issuance of shares of preferred stock that have preference rights over the common stock with respect to dividends, liquidation, voting and other matters or shares of common stock that have preference rights over our outstanding common stock with respect to voting; andclassify or reclassify any unissued shares of common stock or preferred stock and to set the preferences, rights and other terms of the classified or reclassified shares.
In the future, we expect to access the capital markets from time to time by making additional offerings ofexchange securities, including debt instruments, preferred stock or common stock. Additional equity offeringsAny of these or similar actions by us may dilute your interest in us or reduce the market price of our commoncapital stock, or both. Our outstanding shares of preferred stock have, and any additional series of preferred stock may also have, a preference on distribution payments that could limit our ability to make a distribution to common shareholders. Because our decision to issue, reclassify or exchange securities in any future offering will depend on negotiations with third parties, market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings.issuances, if any. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future. Thus, our common shareholders will bear the risk ofthat our future offerings reducingissuances, reclassifications and exchanges will reduce the market price of our common stock and dilutingand/or dilute their interest in us.
statements. preserved). Delaware in Wilmington. .Since April 2004, a number of substantially similar class action lawsuits have been filed and consolidated into a single action in the consolidated financial statements. 2005 First Quarter Second Quarter Third Quarter Fourth Quarter 2006 First Quarter Second Quarter Third Quarter Fourth Quarter Issuer Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Programs Approximate Dollar Value of Shares October 1, 2006 – October 31, 2006 November 1, 2006 – November 30, 2006 December 1, 2006 – December 31, 2006 We are a Maryland corporation formed on September 13, 1996. Prior to significant changes in our business during 2007 and the first quarter of 2008, we originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage backed securities. We retained, through our mortgage securities investment portfolio, significant interests in the nonconforming loans we originated and purchased, and through our servicing platform, serviced all of the loans in which we retained interests. During 2007 and early 2008, we discontinued our mortgage lending operations and sold our mortgage servicing rights which subsequently resulted in the closing of our servicing operations. Consolidated Statement of Operations Data: Interest income Interest expense Net interest income before credit (losses) recoveries Credit (losses) recoveries Gains on sales of mortgage assets Gains (losses) on derivative instruments Impairment on mortgage securities – available for sale General and administrative expenses Income from continuing operations (Loss) gain from discontinued operations, net of income tax Net income available to common shareholders Basic income per share: Income from continuing operations available to common shareholders (Loss) gain from discontinued operations, net of income tax Net income available to common shareholders Diluted income per share: Income from continuing operations available to common shareholders (Loss) gain from discontinued operations, net of income tax Net income available to common shareholders Mortgage Assets: Mortgage loans – held-for-sale Mortgage loans – held-in-portfolio Mortgage securities – available-for-sale Mortgage securities - trading Total assets Borrowings Shareholders’ equity Other Data: Nonconforming loans originated or purchased, principal Loans securitized, principal Nonconforming loans sold, principal Loan servicing portfolio, principal Annualized return on assets Annualized return on equity Taxable net income available to common shareholders (B) Taxable net income per common share (B) (C) Dividends declared per common share (C) Dividends declared per preferred share Management’s discussion and analysis of financial condition and results of operations, along with other portions of this report, are designed to provide information regarding our performance and these key performance measures. discussion. Servicing of Financial Assets and Extinguishments of Liabilities – a replacement of FASB Statement No. 125” (“SFAS 140”) and related authoritative accounting literature. As a result, the assets and liabilities relating to this securitization are included in our consolidated financial statements. Net income available to common shareholders Net income available to common shareholders, per diluted share Estimated taxable net income available to common shareholders (A) Estimated taxable net income available to common shareholders, per share (A) Cash dividends declared per common share Nonconforming originations and purchases Weighted average coupon of nonconforming originations and purchases Nonconforming loans securitized in transactions structured as sales, principal Nonconforming loans securitized in transactions structured as financings, principal Nonconforming loans sold to third parties, principal Gains on sales of mortgage assets Net interest yield on assets (B) Net yield on mortgage securities (C) Weighted average whole loan price used in the initial valuation of residual interests Costs of production, as a percent of principal (D)Intense competitionindustry may harm ourconsolidated financial condition.loan origination business faces intense competition, primarily from consumer finance companies, conventional mortgage bankers, commercial banks, credit unions, thrift institutions,consolidated financial statements have been prepared on a going concern basis of accounting which contemplates continuity of operations, realization of assets, liabilities and other independent wholesale mortgage lenders, including internet-based lending companies and other mortgage REITs. Competitors with lower costs of capital have a competitive advantage over us. In addition, establishing a mortgage lending operation such as ours requires a relatively small commitment of capital and human resources, which permits new competitors to enter our markets quickly and to effectively compete with us. Furthermore, national banks, thrifts and their operating subsidiaries are generally exempt from complying with many of the state and local laws that affect our operations, such as the prohibition on prepayment penalties. Thus, they may be able to provide more competitive pricing and terms than we can offer. Any increasecommitments in the competition among lenders to originate nonconforming mortgage loans may result in either reduced income on mortgage loans compared to present levels, or revised underwriting standards permitting higher loan-to-value ratios on properties securing nonconforming mortgage loans, eithernormal course of which could adversely affect our results of operations,business. The financial condition or business prospects. In addition, the government-sponsored entities, Fannie Mae and Freddie Mac, may also expand their participation in the subprime mortgage industry. To the extent they materially expand their purchase of subprime loans, our ability to profitably originate and purchase mortgage loans may be adversely affected because their size and cost-of-funds advantage allows them to purchase loans with lower rates or fees than we are willing to offer.If we are unable to maintain and expand our network of independent brokers, our loan origination business will decrease.A significant majority of our originations of mortgage loans comes from independent brokers. For the year ended December 31, 2006, 86% of our loan originations were originated through our broker network. Our brokers are not contractually obligated to do business with us. Further, our competitors also have relationships with our brokers and actively compete with us in our efforts to expand our broker networks. Our failure to maintain existing relationships or expand our broker networks could significantly harm our business, financial condition, liquidity and results of operations.Our reported GAAP financial results differ from the taxable income results that drive our common stock dividend distributions, and our consolidated balance sheet, income statement, and statement of cash flows as reported for GAAP purposes may be difficult to interpret.We manage our business based on long-term opportunities to earn cash flows. Our common stock dividend distributions are driven by the REIT tax laws and our taxable income as calculated pursuant to the Code. Our reported results for GAAP purposes differ materially, however, from both our cash flows and our taxable income. We transfer mortgage loans or mortgage securities into securitization trusts to obtain long-term non-recourse funding for these assets. When we surrender control over the transferred mortgage loans or mortgage securities, the transaction is accounted for as a sale. When we retain control over the transferred mortgage loans or mortgage securities, the transaction is accounted for as a secured borrowing. These securitization transactionsstatements do not differ materially in their structure or cash flow generation characteristics, yet under GAAP accounting these transactions are recorded differently. In a securitization transaction accounted for as a sale, we record a gain or loss on the assets transferred in our income statement and we record the retained interests at fair value on our balance sheet. In a securitization transaction accounted for as a secured borrowing, we consolidate all the assets and liabilities of the trust on our financial statements (and thus do not show the retained interest we own as an asset). As areflect any adjustments that might result of this and other accounting issues, shareholders and analysts must undertake a complex analysis to understand our economic cash flows, actual financial leverage, and dividend distribution requirements. This complexity may cause trading in our stock to be relatively illiquid or may lead observers to misinterpret our results.Market values for our mortgage assets and hedges can be volatile. For GAAP purposes, we mark-to-market our non-hedging derivative instruments through our GAAP consolidated income statement and we mark-to-market our mortgage securities—available-for-sale through our GAAP consolidated balance sheet through other comprehensive income unless the mortgage securities are in an unrealized loss position which has been deemed as an other-than-temporary impairment. An other-than-temporary impairment is recorded through the income statement in the period incurred. Additionally, we do not mark-to-market our loans held for sale as they are carried at lower of cost or market, as such, any change in market value would not be recorded through our income statement until the related loans are sold. If we sell an asset that has not been marked-to-market through our income statement at a reduced market price relative to its basis, our reported earnings will be reduced. A decrease in market value of our mortgage assets may or may not result in deterioration in future cash flows. As a result, changes in our GAAP consolidated income statement and balance sheet due to market value adjustments should be interpreted with care.If we attempt to make any acquisitions, we will incur a variety of costs and may never realize the anticipated benefits.In the past we have acquired businesses that we believe are a strategic fit with our business and expect to pursue additional acquisition opportunities in the future. The process of negotiating the acquisition and integrating an acquired business may result in operating difficulties and expenditures and may require significant management attention that would otherwise be available for ongoing development of our business. Moreover, we may never realize the anticipated benefits of any acquisitions. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities and/or amortization expenses related to goodwill and other intangible assets, which could harm our results of operations, financial condition and business prospects.The inability to attract and retain qualified employees could significantly harm our business.We depend on the diligence, skill and experience of our top executives, including our chief executive officer, our president and chief operating officer, and our chief investment officer. To the extent that one or more of our top executives are no longer employed by us, our operations and business prospects may be adversely affected. We also depend on our employees who structure our securitizations and who manage our portfolio of mortgage securities. To the extent that we lose the services of these employees, our ability to manage our portfolio business and our profitability will be adversely affected. Further, we rely on our wholesale account executives and retail loan officers to attract borrowers by, among other things, developing relationships with financial institutions, other mortgage companies and brokers, real estate agents, borrowers and others. The market for skilled account executives and loan officers is highly competitive and historically has experienced a high rate of turnover. Competition for qualified account executives and loan officers may lead to increased hiring and retention costs. If we are unable to attract or retain a sufficient number of skilled account executives at manageable costs, we will be unable to continue to originate quality mortgage loans that we are able to sell for a profit, which would harm our results of operations, financial condition and business prospects.The success and growth of our business will depend upon our ability to adapt to and implement technological changes.Our mortgage loan origination business is currently dependent upon our ability to effectively interface with our brokers, borrowers and other third parties and to efficiently process loan applications and closings. The origination process is becoming more dependent upon technological advancement, such as the ability to process applications over the Internet, accept electronic signatures and provide process status updates instantly and other customer-expected conveniences that are cost-efficient to our process. Becoming proficient with new technology will require significant financial and personnel resources. If we become reliant on any particular technology or technological solution, we may be harmed to the extent that such technology or technological solution (i) becomes non-compliant with existing industry standards, (ii) fails to meet or exceed the capabilities of our competitors’ equivalent technologies or technological solutions, (iii) becomes increasingly expensive to service, retain and update, or (iv) becomes subject to third-party claims of copyright or patent infringement. Any failure to acquire technologies or technological solutions when necessary could limit our ability to remain competitive in our industry and could also limit our ability to increase the cost-efficiencies of our operating model, which would harm our results of operations, financial condition and business prospects.Our business could be adversely affected if we experienced an interruption in or breach of our communication or information systems or if we were unable to safeguardcontinue as a going concern, as to which no assurances can be given. In light of these facts, you should exercise caution in reviewing our financial statements.security and privacyevent of the personal financial information we receive.We rely heavily upon communications and information systems to conduct our business. Any material interruption, or breach in security,certain transfers of our communication or information systems or the third-party systems onvoting securities.rely could cause underwriting or other delays and could result in fewer loan applications being received, slower processing of applications and reduced efficiency in loan servicing. Additionally, in connection with our loan file due diligence reviews,believe that it is more likely than not that we have access to the personal financial information of the borrowers which is highly sensitive and confidential, and subject to significant federal and state regulation. If a third party were to misappropriate this information or if we inadvertently disclosed this information, we potentially could be subject to both private and public legal actions. Our policies and safeguards maywill not be sufficientable to prevent the misappropriation or inadvertent disclosure of confidential information, may become noncompliant with existing federal or state laws or regulations governing privacy, or with those laws or regulations that may be adopted in the future.We may enter into certain transactions at the REITutilize such losses in the future, the net operating loss carryforwards and net unrealized built-in losses could provide significant future tax savings to us if we are able to use such losses. However, our ability to use these tax benefits may be impacted, restricted or eliminated due to a future “ownership change” within the meaning of Section 382 of the Code. We do not have the ability to prevent such an ownership change from occurring. Consequently, an ownership change could occur that incur excess inclusion income that will increasewould severely limit our ability to use the tax liability of our shareholders.When we incur excess inclusion income atbenefits associated with the REIT, it will be allocated among our shareholders. A shareholder’s share of excess inclusion income (i) would not be allowed to be offset by any net operating loss carryforwards and net unrealized built-in losses, otherwise availablewhich may result in higher taxable income for us (and a significantly higher tax cost as compared to the shareholder, (ii) would be subject tosituation where these tax as unrelated business taxable income in the hands of most types of shareholders thatbenefits are otherwise generally exempt from federal income tax, and (iii) would result in the application of U.S. federal income tax withholding at the maximum rate (i.e., 30%), without reduction for any otherwise applicable income tax treaty, to the extent allocable to most types of foreign shareholders. How such income is to be reported to shareholders is not clear under current law. Tax-exempt investors, foreign investors, and taxpayers with net operating losses should carefully consider the tax consequences of having excess inclusion income allocated to them and are urged to consult their tax advisors.Excess inclusion income would be generated if we issue debt obligations with two or more maturities and the terms of the payments on these obligations bear a relationship to the payments that we received on our mortgage loans or mortgage-backed securities securing those debt obligations. The structure of this type of CMO securitization generally gives rise to excess inclusion income. It is reasonably likely that we will structure some future CMO securitizations in this manner. Excess inclusion income could also result if we were to hold a residual interest in a REMIC. The amounts of excess inclusion income in any given year from these transactions could be significant.shareholders by providing them with the opportunity to sell their shares possibly at a premium over the then market price.shareholders. For example, our board of directors is divided into three classes with three year staggered terms of office. This makes it more difficult for a third party to gain control of our board because a majority of directors cannot be elected at a single meeting. Further, under our charter, generally a director may only be removed for cause and only by the affirmative vote of the holders of at least a majority of all classes of shares entitled to vote in the election for directors together as a single class. Our bylaws make it difficult for any person other than management to introduce business at a duly called meeting requiring such other person to follow certain advance notice procedures. Finally, Maryland law provides protection for Maryland corporations against unsolicited takeover situations. These provisions, as well as others, could discourage potential acquisition proposals, or delay or prevent a change inprevent changes inmay significantly affect our management, even if such actions would beresults of operations and financial statements. As current turmoil in the best interestssubprime industry continues to affect the characteristics of our shareholders.Strategies undertakenmortgage assets we may be required to comply with REIT requirements underadjust the Code may create volatility in future reported GAAP earnings.Certain of the residual securities that historically have been held at the REIT generate interest income based on cash flows received from excess interest spread, prepayment penalties and derivatives (i.e., interest rate swap and cap contracts). The cash flows received from the derivatives do not represent qualified income for the REIT income tests requirements of the Code. The Code limits the amount of income from derivative income together with any income not generated from qualified REIT assets to no more than 25%accounting treatment of our gross income. In addition, under the Code, we must limit our aggregate income from derivatives (that are non-qualified tax hedges) and from other non-qualifying sources to no more than 5% of our annual gross income. Because of the magnitude of the derivative income projected for 2006 it was highly likely that we would not satisfy the REIT income tests. In order to resolve this REIT qualification issue, we isolated cash flows received from certain residual securities and created a separate security (the “CT Bonds”). We then contributed the CT Bonds from the REIT to our taxable REIT subsidiary. This transaction may add volatility to future reported GAAP earnings because both the interest only residual bonds (“IO Bonds”) and CT Bonds will be evaluated separately for impairment. Historically, the CT Bonds have acted as an economic hedge for the IO Bonds that are retained at the REIT, thus mitigating the impairment risk to the IO Bonds in a rising interest rate environment.assets. As a result of transferring the CT Bondsthis, stockholders must undertake a complex analysis to the TRS, the IOunderstand our earnings (losses), cash flows and CT Bonds will be valued separately creating the risk of earnings volatility resulting from other-than-temporary impairment charges. For example, in a rising rate environment, the IO bond will generally decrease in value while the CT Bond will increase in value. If the decrease in value of the IO Bond is deemed to be other than temporary in nature, we would record an impairment charge through the income statement for such decrease. At the same time, any increase in value of the CT Bond would be recorded in accumulated other comprehensive income.Ourand loan servicing offices for NFI are located in Kansas City, Missouri, and consist of approximately 200,00012,142 square feet of leased office space. The lease agreements on the premises expire in January 2011.October 2013. The current annual rent for these offices is approximately $4.2 million.We$200,000.for our mortgage lending operations in Lake Forest, California; Independence, Ohio; Richfield, Ohio; Troy, Michigan, Salt Lake City, Utah, Carmel, Indiana and Columbia, Maryland. Currently, these offices consist of approximately 316,444 square feet.Indianapolis, Indiana. The leaseslease agreements on the premises expire in September 2009. The current annual rent for these offices is approximately $100,000.DecemberFebruary 2009 through May 2013,2012, and the current gross annual rent on those premises not terminated as of May 27, 2009 is approximately $5.5$1.4 million, although the majority of this space has been subleased which reduces our costs significantly.mortgage lending operations have mortgage production offices locatedinitial payments made to the Plaintiff following dismissal of the Involuntary Bankruptcy, the Company agreed to pay Plaintiff $5.5 million if, prior to July 1, 2010, (i) NFI’s average common stock market capitalization is at least $94.4 million over a period of five consecutive business days, or (ii) the holders of NFI’s common stock are paid $94.4 million in various states with premises leasenet asset value as a result of any sale of NFI or its assets. If NFI is sold prior to July 1, 2010 for less than $94.4 million and ceases to be a public company, then NFI will obligate the purchaser to pay Plaintiff $5.5 million in the event the value of the company exceeds $94.4 million prior to July 1, 2010 as determined by an independent valuation company. As a result of the settlement, during 2008 the Company reversed a previously recorded liability of $45.2 million that was included in the consolidated financial statements.expiringand restructuring of the Company’s junior subordinated debentures, including the dismissal of the involuntary Chapter 7 bankruptcy filed against NovaStar Mortgage, Inc. (Case No. 08-12125-CSS) by the holders of the trust preferred securities in a rangeU.S. Bankruptcy Court for the District of two months up to 3.5 years.Item 3.Legal ProceedingsOther LitigationUntiedUnited States District Court for the Western District of Missouri. The consolidated complaint names usthe Company and three of ourthe Company’s current and former executive officers as defendants and generally alleges that the defendants made public statements that were misleading for failing to disclose certain regulatory and licensing matters. The plaintiffs purport to have brought this consolidated action on behalf of all persons who purchased ourthe Company’s common stock (and sellers of put options on ourthe Company’s common stock) during the period October 29, 2003 through April 8, 2004. On January 14, 2005, wethe Company filed a motion to dismiss this action, and on May 12, 2005, the court denied such motion. On February 8, 2007, the court certified the case as a class action, and on February 20, 2007, we filedaction. The Company has entered into a motionsettlement agreement to reconsider with the court. We believe thatresolve these claims are without merit and continue to vigorously defend against them.In the wake of the securitiespending class action we have also been named as a nominal defendant in several derivative actions brought against certain of our officers and directors in Missouri and Maryland.lawsuits. The complaints in these actions generally claim that the defendants are liable to us for failing to monitor corporate affairs so as to ensure compliance with applicable state licensing and regulatory requirements.In April 2005, three putative class actions filed against NHMI and certain of its affiliates were consolidated for pre-trial proceedings in the United States District Court for the Southern District of Georgia entitledIn Re NovaStar Home Mortgage, Inc. Mortgage Lending Practices Litigation. These cases contend that NHMI improperly shared settlement service fees with limited liability companies in which NHMI had an interest (the “LLCs”), in violation of the fee splitting and anti-referral provisions of the federal Real Estate Settlement Procedures Act (“RESPA”), and also allege certain violations of state law and civil conspiracy. Plaintiffs seek treble damages with respect to the RESPA claims, disgorgement of fees with respect to the state law claims as well as other damages, injunctive relief, and attorneys’ fees. In addition, two other related class actions have been filed in state courts.Miller v. NovaStar Financial, Inc., et al., was filed in October 2004 in the Circuit Court of Madison County, Illinois andJones et al. v. NovaStar Home Mortgage, Inc., et al., was filed in December 2004 in the Circuit Court for Baltimore City, Maryland. In theMiller case, plaintiffs allege a violation of the Illinois Consumer Fraud and Deceptive Practices Act and civil conspiracy and contend certain LLCs provided settlement services without the borrower’s knowledge. The plaintiffs in the Miller case seek a disgorgement of fees, other damages, injunctive relief and attorney’s fees on behalf of the class of plaintiffs. In theJones case, the plaintiffs allege the LLCs violated the Maryland Mortgage Lender Law by acting as lenders and/or brokers in Maryland without proper licenses and contend this arrangement amounted to a civil conspiracy. The plaintiffs in theJones case seek a disgorgement of fees and attorney’s fees. In January 2007, all of the plaintiffs and NHMI agreed upon a nationwide settlement. Since not all class members will elect to be parttotal amount of the settlement we estimatedis $7.25 million, and it will be paid by the Company’s insurance carriers. The settlement agreement contains no admission of fault or wrongdoing by the Company or other defendants. On April 28, 2009, the Court approved the settlement. obligation related tooutcome of the settlement to be in a range of $3.9 million to $4.7 million. In accordance with SFAS No. 5, “Accounting for Contingencies”, we recorded a charge to earnings of $3.9 million in December of 2006. This amount is included in “Accounts payablefollowing claims and other liabilities” on our consolidated balance sheet and included in “Professional and outside services” on our consolidated statement of income.In December 2005, a putative class action was filed against NMIas such no amounts have been accrued in the United States District Court for the Western District of Washington entitledPierce et al. v. NovaStar Mortgage, Inc. Plaintiffs contend that NMI failed to disclose prior to closing that a broker payment would be made on their loans, which was an unfair and deceptive practice in violation of the Washington Consumer Protection Act. Plaintiffs seek excess interest charged, and treble damages as provided in the Washington Consumer Protection Act and attorney’s fees. On October 31, 2006, the district court granted plaintiffs’ motion to certify a Washington state class. NMI sought to appeal the grant of class certification; however, a panel of the Ninth Circuit Court of Appeals denied the request for interlocutory appeal so review of the class certification order must wait until after a final judgment is entered, if necessary. The case is set for trial on April 23, 2007. NMI believes that it has valid defenses to plaintiffs’ claims and it intends to vigorously defend against them.In December 2005, a putative class action was filed against NHMI in the United States District Court for the Middle District of Louisiana entitledPearson v. NovaStar Home Mortgage, Inc. Plaintiff contends that NHMI violated the federal Fair Credit Reporting Act (“FCRA”) in connection with its use of pre-approved offers of credit. Plaintiff seeks (on his own behalf, as well as for others similarly situated) statutory damages, other nominal damages, punitive damages and attorney’s fees and costs. In January 2007, the named plaintiff and NHMI agreed to settle the lawsuit for a nominal amount.twoa number of substantially similar putative class actions were filed in the United States District Court for the Western District of Missouri. The complaints name usthe Company and three of ourthe Company’s former and current executive officers as defendants and generally allege, among other things, that the defendants made materially false and misleading statements regarding ourthe Company’s business and financial results. The plaintiffs purport to have brought the actions on behalf of all persons who purchased or otherwise acquired ourthe Company’s common stock during the period May 4, 2006 through February 20, 2007. We believeFollowing consolidation of the actions, a consolidated amended complaint was filed on October 19, 2007. On December 29, 2007, the defendants moved to dismiss all of plaintiffs’ claims. On June 4, 2008, the Court dismissed the plaintiffs’ complaints without leave to amend. The plaintiffs have filed an appeal of the Court’s ruling.we arethe Company is currently a party to various other legal proceedings and claims, including, but not limited to, breach of contract claims, class action or individualtort claims, and claims for violations of the RESPA, FLSA, federal and state laws prohibiting employment discrimination, federal and state laws prohibiting discrimination in lending and federal and state licensing and consumer protection laws.While management, Furthermore, the Company has received indemnification and loan repurchase demands with respect to alleged violations of representations and warranties made in loan sale and securitization agreements. These indemnification and repurchase demands have been addressed without significant loss to the Company, but such claims can be significant when multiple loans are involved. Deterioration of the housing market may increase the risk of such claims.internal counsel, currently believes thatwithout limitation the ultimate outcomeFederal Bureau of allInvestigation and the Department of Labor. Management does not expect any significant negative impact to the Company as a result of these proceedingsrequests and claims will not have a material adverse effect on our financial condition or results of operations, litigation is subject to inherent uncertainties. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on our financial condition and results of operations.iswas traded on the NYSE under the symbol “NFI” through December 31, 2007. Our common stock was delisted from the NYSE on January 17, 2008 and is currently quoted on the OTC Bulletin Board and on the Pink Sheets under the symbol “NOVS”. The following table sets forth for the periods indicated, the high and low sales prices per share of common stock on the NYSE and the high and low bid prices as reported by the OTC Bulletin Board and the Pink Sheets, as applicable, for the periods indicated, and the cash dividends paid or payable per share of common stock. The Board of Directors declared a one-for-four reverse stock split of its common stock, providing shareholders of record as of July 27, 2007, with one share of common stock for each four shares owned. The reduction in shares resulting from the split was effective on July 27, 2007 decreasing the number of common shares outstanding to 9.5 million. Dividends High Low Date Declared Date Paid Amount Per
Share $ 48.15 $ 32.40 5/2/05 5/27/05 $ 1.40 39.98 34.50 7/29/05 8/26/05 1.40 42.19 32.20 9/15/05 11/22/05 1.40 33.01 26.20 12/14/05 1/13/06 1.40 $ 33.80 $ 25.70 5/4/06 5/26/06 $ 1.40 37.63 29.08 8/3/06 8/28/06 1.40 35.60 28.25 9/11/06 11/30/06 1.40 32.81 26.32 9/11/06 12/29/06 1.40 Dividends High Low Date Paid 2007 First Quarter $ 105.80 $ 13.72 N/A N/A N/A Second Quarter 40.00 19.56 N/A N/A N/A Third Quarter 34.68 5.10 N/A N/A N/A Fourth Quarter 9.32 1.16 N/A N/A N/A 2008 First Quarter $ 3.44 $ 1.10 N/A N/A N/A Second Quarter 2.03 1.00 N/A N/A N/A Third Quarter 1.99 .28 N/A N/A N/A Fourth Quarter 1.01 .22 N/A N/A N/A February 23, 2007,May 8, 2009, we had approximately 2,2431,010 shareholders of record of our common stock, including holders who are nominees for an undetermined number of beneficial owners based upon a review of the securities position listing provided by our transfer agent.As long as we remain a REIT, we intend to make distributions to shareholders of all or substantially all of taxable income in each year, subject to certain adjustments, so as to qualify for the tax benefits accorded to a REIT under the Code. Allmaintenance of REIT status, cost of equity, investment opportunities and other factors as the Board of Directors may deem relevant. Our estimate of 2006 taxable income already distributed to shareholders in the form ofIn addition, accrued and unpaid dividends is $17 million which includes $1.7 million of preferred dividends paid on January 2, 2007. During 2007, we expect to payout all of our remaining 2006 taxable income, which we currently estimate to be approximately $170 million, in the form of dividends. During the period 2007 through 2011, we expect to recognize little, if any, taxable income as tax losses are realized on our current outstanding securitizations becausepreferred stock must be paid prior to the declaration of the reversal in timing differences between the recognition of GAAP income and taxable income. Further, weany dividends on our common stock. We do not expect that our recent and future securitizations will result in significant taxable income in the early years due to steps we have taken over the last two years to structure our securitizations to minimize the difference between tax and GAAP income. This combination of our older securitizations maturing and the structuring of our recent and future securitizations will result in minimal taxable income over the next several years. This reduction in taxable income will correspondingly result in little, ifdeclare any common stock dividend distributions for those respective years, regardless of whether we remain a REIT.the near future. See “Industry Overview and Known Material Trends and Uncertainties” for further discussion regarding future uncertainties surrounding our taxable income.Recent Sales of Unregistered Securities. NoneIssuer.
Announced Plans or
that May Yet Be
Purchased Under
the Plans or
Programs (A) — — — $ 1,020 — — — 1,020 — — — 1,020 October 1, 2008 – October 31, 2008 - - - $ 1,020 November 1, 2008 – November 30, 2008 - - - 1,020 December 1, 2008 – December 31, 2008 - - - 1,020 (A) A current report on Form 8-K was filed on October 2, 2000 announcing that the Board of Directors authorized the Company to repurchase its common shares, bringing the total authorization to $9 million. · maintenance of adequate liquidity to sustain us and allow us to take advantage of investment opportunity, and · generating income for our shareholders. consolidated financial data iskey performance metrics are derived from our audited consolidated financial statements for the periods presented and should be read in conjunction with the more detailed information therein and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”with the disclosure included elsewhere in this annual report. Operating results are not necessarily indicative of future performance.Selected Consolidated Financial and Other Data(dollars in thousands, except per share amounts) For the Year Ended December 31, 2006 2005(A) 2004(A) 2003(A) 2002(A) $ 494,890 $ 320,727 $ 230,845 $ 171,468 $ 108,227 235,331 80,755 52,482 40,364 27,728 259,559 239,972 178,363 131,104 80,499 (30,131 ) (1,038 ) (726 ) 389 432 41,749 65,148 144,950 144,005 53,305 11,998 18,155 (8,905 ) (30,837 ) (36,841 ) (30,690 ) (17,619 ) (15,902 ) — — 201,261 184,630 168,260 143,512 65,754 77,205 150,827 138,942 111,946 48,212 (4,267 ) (11,703 ) (23,553 ) 50 549 66,285 132,471 109,124 111,996 48,761 $ 2.07 $ 4.86 $ 5.24 $ 5.04 $ 2.32 (0.13 ) (0.40 ) (0.93 ) — 0.03 $ 1.94 $ 4.46 $ 4.31 $ 5.04 $ 2.35 $ 2.04 $ 4.81 $ 5.15 $ 4.91 $ 2.23 (0.12 ) (0.39 ) (0.91 ) — 0.02 $ 1.92 $ 4.42 $ 4.24 $ 4.91 $ 2.25 As of December 31, 2006 2005 2004 2003 2002 Consolidated Balance Sheet Data: $ 1,741,819 $ 1,291,556 $ 747,594 $ 697,992 $ 983,633 2,116,535 28,840 59,527 94,717 149,876 349,312 505,645 489,175 382,287 178,879 329,361 43,738 143,153 — — 5,028,263 2,335,734 1,861,311 1,399,957 1,452,497 4,312,258 1,619,812 1,295,422 1,005,516 1,225,228 514,570 564,220 426,344 300,224 183,257 For the Year Ended December 31, 2006 2005 2004 2003 2002 $ 11,224,088 $ 9,283,138 $ 8,424,361 $ 5,250,978 $ 2,492,767 $ 8,625,318 $ 7,621,030 $ 8,329,804 $ 5,319,435 $ 1,560,001 $ 2,248,633 $ 1,138,098 $ — $ 151,210 $ 142,159 $ 16,659,784 $ 14,030,697 $ 12,151,196 $ 7,206,113 $ 3,657,640 1.98 % 6.63 % 7.08 % 7.85 % 4.96 % 13.52 % 28.09 % 31.76 % 46.33 % 31.13 % $ 180,627 $ 270,432 $ 250,555 $ 137,851 $ 49,511 $ 4.85 $ 8.40 $ 9.04 $ 5.64 $ 2.36 $ 5.60 $ 5.60 $ 6.75 $ 5.04 $ 2.15 $ 2.23 $ 2.23 $ 2.11 $ — $ — (A)Reclassified to conform to current year presentation in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets,as described in Note 15 to the consolidated financial statements.(B)Taxable income for years prior to 2006 are actual while 2006 taxable income is an estimate. For a reconciliation of taxable income to GAAP income see “Income Taxes” included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The common shares outstanding as of the end of each period presented are used in calculating the taxable income per common share.(C)On January 29, 2003, a $0.165 special dividend related to 2002 taxable income was declared per common share. On December 22, 2004, a $1.25 special dividend related to 2004 taxable income was declared per common share.Item 7.Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion should be read in conjunction with the consolidated financial statements of NovaStar Financial, Inc. and the notes thereto included elsewhere in this report.General OverviewWe are a specialty finance company that originates, purchases, securitizes, sells, invests in and services residential nonconforming loans and mortgage-backed securities. We operate through three separate operating segments – mortgage portfolio management, mortgage lending and loan servicing.We offer a wide range of mortgage loan products to “nonconforming borrowers,” who generally do not satisfy the credit, collateral, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers, including U.S. government-sponsored entities such as Fannie Mae or Freddie Mac. We retain significant interests in the nonconforming loans we originate and purchase through our mortgage securities investment portfolio. Through our servicing platform, we then service all of the loans in which we retain interests, in order to better manage the credit performance of those loans.We have elected to be taxed as a REIT under the Code. We must meet numerous rules established by the IRS to retain our status as a REIT. As long as we maintain our REIT status, distributions to shareholders will generally be deductible by us for income tax purposes. This deduction effectively eliminates REIT level income taxes. Management believes we have met the requirements to maintain our REIT status. We are, however, currently evaluating whether it is in shareholders’ best interests to retain our REIT status.Our net income is highly dependent upon our mortgage securities portfolio, which is generated primarily from the securitization of nonconforming loans we have originated and purchased but also includes third-party mortgage-backed securities we have purchased. These securities represent the right to receive the net future cash flows from a pool of assets consisting primarily of nonconforming loans. As a result, earnings are related to the volume of nonconforming loans and related performance factors for those loans, including their average coupon, borrower default rate and borrower prepayment rate.The primary function of our mortgage lending operations is to generate nonconforming loans, the majority of which will serve as collateral for our mortgage securities. While our mortgage lending operations generate sizable revenues in the form of gains on sales of mortgage loans and fee income from borrowers and third party investors, the revenue serves largely to offset the related costs.We also service the mortgage loans we originate and purchase and that serve as collateral for the mortgage securities that we issue. The servicing function is critical to the management of credit risk (risk of borrower default and the related economic loss) within our mortgage portfolio. This operation generates significant fee revenue and interest income from investing funds held as custodian, but its revenue serves largely to offset the cost of this function.The key performance measures for executive management are:net income available to common shareholdersdollar volume of nonconforming mortgage loans originated and purchasedrelative cost of the loans originated and purchasedcharacteristics of the loans (coupon, credit quality, etc.), which will indicate their expected yield, andreturn on our mortgage asset investments and the related management of interest rate risk.Executive OverviewThe 2006 fiscal year proved December 31, 2008 2007 Cash and cash equivalents, including restricted cash $ 30,836 $ 34,362 Net loss income available to common shareholders, per diluted share (72.37 ) (78.55 ) berepay outstanding borrowings, pay for costs related to our legacy mortgage lending and servicing operations, pay for current administrative costs and invest in StreetLinks. As of December 31, 2008, we had $30.8 million in cash, cash equivalents and restricted cash, a challenging environmentdecrease of $3.5 million from December 31, 2007. As of May 27, 2009, we have $23.4 million in cash and cash equivalents (including restricted cash). We face substantial liquidity risk and uncertainty, near-term and otherwise, which threatens our ability to continue as a going concern and avoid bankruptcy. See “Liquidity and Capital Resources” for further discussion of our liquidity position and steps we have taken to preserve liquidity levels.industry. loans are repaid and could be significantly less than the current projections if losses on the underlying mortgage loans exceed the current assumptions. We have no outstanding lending facilities available for liquidity purposes. In addition, we have significant outstanding obligations relating to our discontinued operations, as well as payment obligations with respect to unsecured debt. Our liquidity consists solely of cash and cash equivalents.following macroeconomic factors were significant driversdiscussions of our financial condition and results of operation below provide analysis for the changes in our 2006 financial results:Interest rate squeeze – As the Federal Reserve increased interest rates, our cost of funding from 2004 to 2006 increased, while coupons on nonconforming loans did not increasebalance sheet and income statement as presented using Generally Accepted Accounting Principles in the same proportion. This squeeze on net interest margins reducedUnited States of America ("GAAP"). Mortgage loans – held-in-portfolio and certain of our mortgage securities – trading are owned by trusts established when those assets were securitized. The trusts issued asset-backed bonds to finance the profitabilityassets. In accordance with GAAP, we have consolidated these trusts. Due to significant events that have occurred subsequent to the securitization of mortgage banking.Housing price correction – During 2006 housing price appreciation slowed dramatically. Though varying in severity across regions, the housing correction had widespread effects on the economy, mortgage originations and the ability of homeowners to borrow.Credit performance – With repayment risksthese assets, we no longer offset by rapidly rising home values, delinquencieshave a significant economic benefit from these assets. We have provided additional disclosure in Management’s Discussion and Analysis of Financial Condition and Results of Operations under the industry beganheading Assets and Liabilities of Consolidated Securitization Trusts to risedemonstrate the impact of the trusts on our consolidated financial statements.2006. Theseconnection with our former mortgage lending operations. During 2007, the sureties required that we provide letters of credit issues have caused whole loans to lose some value, affectingsupport our reimbursement obligations to the valuesureties. In order to arrange these letters of and income generated by our portfolio of mortgage loans and securities.Competitive pressures – Profitability in nonprime lending continued to suffer in 2006 as a result of lenders focusing on market share at the expense of margins and underwriting standards. Weaker competitors, including some big ones, have begun to exit the industry.In our mortgage portfolio management business, returns were negatively affected by the volatile interest rate environment and credit, related impairments, resulting in full-year returns in 2006 that were more in line with historic returns for this asset class. We generally expect returns to be near the level of 1% to 1.25% over the long-term. While we are optimistic that returns in 2007 will fall in this range, we are staying focused on the disciplines of risk mitigation should it prove to be another challenging year.In our mortgage banking business, gain-on-sale margins continued to be tight in 2006 as coupons on originations increased only slightly and mortgage credit quality declined. In 2006, we were ablerequired to achieve some success despitecollateralize the tough market conditions by increasing our production by over 20% compared to 2005 as many competitors either ceased operations or withdrew from the industry due to the difficult operating conditions. We also made significant strides in our campaign to decrease our cost to originate as it decreased from 2.37% in 2005 to 2.03% in 2006. See Table 25 for a reconciliation of our cost of production to general and administrative expenses. We will continue to focus on further efficiencies and productivity improvements in 2007.As discussed under “Risk Management – Credit Risk” and “Industry Overview and Known Material Trends and Uncertainties”, our 2006 vintage loan originations performed below expectations. We intensified our focus on asset quality as a deteriorationletters of credit performance became apparent in 2006. We underwrite loans with an eye on risk – adjusting guidelines to market changes, keeping a watch on geographic diversity and maintaining loan coupons while competitors decrease their coupons. The credit challenges were greater than expected in 2006, due tocash. During the slowdown in housing prices. In response,first quarter of 2008, we have significantly altered our proprietary modeling and underwriting processes in an attempt to minimize losses and enhance asset quality in loan originations going forward.Overterminated the last several years the REIT’s taxable income has exceeded our GAAP earningssurety bonds when we surrendered state lending licenses as a result of the differencediscontinuation of our mortgage lending operations. The sureties returned a portion of the cash collateral during 2008 ($3.0 million), but continue to hold $6.0 million of the collateral as a hedge against any claims that may be brought during the tail period. The timing of the return of the remaining cash is at the discretion of the sureties and is dependent upon their interpretation of the tail period for filing claims under the various state licensing regulations. No claims have been made against the surety bonds and none are expected to be brought, especially considering the significant amount of time that has elapsed since the bonds were cancelled and since we last originated any mortgage loans. Management expects the cash to be fully returned. However, the timing for return is unknown. For the Year Ended December 31, 2008 2007 Estimated
Fair
Value Discount
Rate Constant
Pre-
payment
Rate Estimated
Fair
Value Discount
Rate Constant
Pre-
payment
Rate Expected
Credit
Losses NMFT Series : 2002-3 $ 2,041 25 % 16 % 0.8 % $ 1,932 25 % 24 % 0.6 % 2003-1 5,108 25 13 2.0 3,260 25 20 1.7 2003-2 2,272 25 12 1.9 2,817 25 18 1.2 2003-3 2,402 25 12 2.7 1,233 25 16 1.2 2003-4 1 25 13 2.7 1,279 25 20 1.6 2004-1 16 25 15 3.4 180 25 24 2.4 2004-2 27 25 14 3.5 180 25 23 2.4 2004-3 73 25 15 4.4 986 25 24 3.0 2004-4 11 25 16 4.3 48 25 26 2.6 2005-1 − 25 17 6.2 512 25 27 3.6 2005-2 − 25 16 7.0 642 25 24 3.3 2005-3 − 25 17 9.3 1,562 25 24 3.6 2005-4 3 25 18 11.5 1,556 25 27 4.5 2006-2 73 25 19 17.0 2,301 25 32 6.8 2006-3 125 25 20 19.8 2,994 25 31 8.4 2006-4 136 25 20 20.0 2,960 25 32 8.2 2006-5 214 25 20 24.0 4,217 25 31 11.0 2006-6 286 25 19 24.4 4,712 25 30 10.0 Total $ 12,788 $ 33,371 S&P Rating Original Face Fair Value Subordinated Securities: Investment Grade (A) $ 12,505 $ 11,891 $ 833 3 6.25 % Non-investment Grade (B) 422,609 406,125 5,547 87 8.08 Total Subordinated Securities 435,114 418,016 6,380 90 7.84 Residual Securities: Unrated 59,500 15,952 705 1 25.00 Total $ 494,614 $ 433,968 $ 7,085 91 9.55 % S&P Rating Original Face Fair Value Subordinated Securities: Investment Grade (A) $ 389,881 $ 367,581 $ 80,004 91 11.46 % Non-investment Grade (B) 45,233 38,514 4,458 17 17.05 Total Subordinated Securities 435,114 406,095 84,462 108 11.76 Residual Securities: Unrated N/A 41,275 24,741 1 21.00 Total $ 435,114 $ 447,370 $ 109,203 109 13.85 % (A) Investment grade includes all securities with S&P ratings above BB+. (B) Non-investment grade includes all securities with S&P ratings below BBB-. December 31, 2008 2007 Interest payable $ 10,177 $ 6,879 Value of derivatives owned by mortgage loan securitization trusts 9,102 6,896 Obligations under office space lease 4,558 1,457 Taxes payable 3,893 11,362 Global facility financing fee − 11,814 Accrued expenses and other liabilities 6,198 14,984 Total $ 33,928 $ 53,392 2008 2007 Interest income: Mortgage securities $ 46,997 $ 102,500 Mortgage loans held-in-portfolio 186,601 258,663 Other interest income 1,411 5,083 Total interest income 235,009 366,246 Interest expense: Short-term borrowings secured by mortgage securities 436 23,649 Asset-backed bonds secured by mortgage loans 95,012 178,937 Asset-backed bonds secured by mortgage securities 13,271 17,635 Junior subordinated debentures 6,261 8,148 Total interest expense 114,980 228,369 Net interest income before provision for credit losses 120,029 137,877 Provision for credit losses (707,364 ) (265,288 ) Net interest (expense) income $ (587,335 ) $ (127,411 ) Payments Due by Period Contractual Obligations Total Less than
1 Year 1-3 Years 3-5 Years After 5 Years Non-recourse - long—term debt (A) $ 3,553,299 $ 696,611 $ 988,857 $ 531,767 $ 1,336,064 Junior subordinated debentures (B) 185,817 8,862 7,695 7,695 161,565 Operating leases (C) 13,694 6,184 6,887 436 187 Total, consolidated obligations 3,752,810 711,657 1,003,439 539,898 1,497,816 Non-recourse obligations (3,553,299 ) (696,611 ) (988,857 ) (531,767 ) (1,336,064 ) Recourse obligations $ 199,511 $ 15,046 $ 14,582 $ 8,131 $ 161,752 (A) The asset-backed bonds will be repaid only to the extent there is sufficient cash receipts on the underlying mortgage loans, which collateralize the debt. The trusts that own these assets and asset-backed obligations have no recourse to us for any shortfall. The timing of the repayment of these mortgage loans is affected by prepayments. These amounts include expected interest payments on the obligations. Interest obligations on our variable-rate long-term debt are based on the prevailing interest rate at December 31, 2008 for each respective obligation. (B) The junior subordinated debentures are assumed to mature in 2035 and 2036 in computing the future payments. These amounts include expected interest payments on the obligations. Interest obligations on our junior subordinated debentures are based on the prevailing interest rate at December 31, 2008 for each respective obligation. On February 18, 2009, the Company, NMI, NovaStar Capital Trust I and NovaStar Capital Trust II (the “Trusts”) and the trust preferred security holders entered into agreements to exchange the existing preferred obligations for new preferred obligations. The new preferred obligations require quarterly distributions of interest to the holders at a rate equal to 1.0% per annum beginning January 1, 2009 through December 31, 2009, subject to reset to a variable rate equal to the three-month LIBOR plus 3.5% upon the occurrence of an “Interest Coverage Trigger.”, see note 21 to the consolidated financial statements for additional details. (C) The operating lease obligations do not include rental income of $1.9 million to be received under sublease contracts. accounting recognitionwhich means all of the assets and the liabilities of the trust are included in our consolidated financial statements. Our results of operations and cash flows include the activity of these trusts. The cash proceeds from the repayment of the loan collateral are owned by the trust and serve to only repay the obligations of the trust. We do not collect the cash and we are not responsible for the obligations of the trust. Principal and interest on the bonds (securities) of the trust can only be paid if there is sufficient cash flow the underlying collateral. We own some of the securities issued by the trust, which are our only source of available cash flow. As a result of the national economic crises, the loans within these trusts have very high rates of default. Therefore, the cash flow on the securities we own has declined significantly within the past two years. For the Year Ended
December 31, 2008 Primary sources: Payments received on mortgage securities $ 59,912 Payments received on mortgage loans – held-for-sale 4,024 Primary uses: Repayment of short-term borrowings (45,488 ) Payment of general, administrative and capital expenditures (37,832 ) For the Years Ended
December 31, 2008 2007 Consolidated Statements of Cash Flows: Cash provided by (used in) operating activities $ 29,566 $ (445,788 ) Cash flows provided by investing activities 493,803 1,073,063 Cash flows used in financing activities (523,719 ) (752,433 ) portfolio. However, over the life– available-for-sale during 2008 as compared to 2007 as a result of poor credit performance of the portfolio, GAAPunderlying loans.tax income will generally be equal.a loan securitization both structured as financing transactions for accounting purposes. This was somewhat offset by cash used in financing activities from discontinued operations in 2007. All short term borrowings were also paid off in 2008 and we also experienced a decrease in paydowns of our asset-backed bonds during the year.reversal in timing differencescash flows we receive on our mortgage securities—available-for-sale are highly dependent on the interest rate spread between the recognitionunderlying collateral and the bonds issued by the securitization trusts and default and prepayment experience of GAAP incomethe underlying collateral. The following factors have been the significant drivers in the overall fluctuations in these cash flows:· Higher credit losses have decreased cash available to distribute with respect to our securities, · As short-term interest rates decline, the net spread to us increases and if short-term interest rates increase, the spread we receive will decline, · We have lower average balances of our mortgage securities—available-for-sale portfolio as the securities have paid down and we have not acquired new bonds. taxable incomeavailable for general corporate purposes. We cannot predict the timing of the release.occurringcollected by the securitization trusts from the payment of principal and will accelerate asinterest on securitized loans and securities. The cash is trapped by the trust and is used to repay obligations (primarily to bondholders) of the trust. The cash is not available to us and we are not responsible for the obligations of the trust. For the year ended December 31, 2008 repayments on the mortgage loans held-in-portfolio totaled $288.2 million compared to $824.1 million during 2007.older vintage securitizations mature. We experiencedbusiness. These expenses include staff and management compensation and related benefit payments, professional expenses for audit, tax and related services, legal services, rent and general office operational costs.declinevariable interest rate of taxable income in 2006 of approximately 32 percent from 2005. Furthermore,three-month LIBOR plus 3.5% which resets quarterly. Subsequent to 2008, we restructured our obligations under the junior subordinated debentures, which we expect to recognize littlereduce cash requirements for interest in the near term. See Table 6 for an estimate of our contractual obligations related to these junior subordinated debentures.taxable income at the REIT during the period from 2007 through 2011.longer contribute to our revenue producing operations. See “Industry Overview and Known Material Trends and Uncertainties”“Other Liquidity Factors” for further discussion on taxable income.following selected key performance metrics are derivedloans were transferred to a trust where they serve as collateral for asset-backed bonds, which the trust issued to the public. We often retained our residual and subordinated securities issued by the trust. We also securitized residual and subordinated securities that we retained from our consolidated financial statements forsecuritizations and that we purchased from third parties. Information about the periods presentedrevenues, expenses, liabilities and should be readcash flows we have in conjunctionconnection with our securitization transactions, as well as information about the moresecurities issued and interests retained in our securitizations, are detailed information therein andin “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”Table 1 — SummaryHighlightsAccounting Standards No. 140, “Accounting for Transfers and Key Performance Metrics1. We sold a portion of the beneficial interests we owned, 2. The credit losses on the securitized loans increased to the point where the remaining beneficial interests we own are not significant, 3. We sold the right to service all securitized loans, 4. We executed amendments to the securitization agreements for the 2006 loan pools whereby we relinquished all rights to place certain derivative instruments into the securitization trust and to repurchase a limited number of loans from the trust for any reason and at any time, and 5. For the 2007 securitized loan pool, a significant portion of the derivatives placed into the trust have expired and the remaining derivatives will expire by the end of 2009. December 31, 2008 December 31, 2007 CDO Total CDO Total Assets Mortgage loans – held in portfolio, net of allowance $ − $ 411,146 $ 523,183 $ 847,962 $ 1,782,291 $ $ 670,092 $ 756,912 $ 1,457,054 $ 2,884,058 Trading securities 5,199 − − − 5,199 72,239 − − − 72,239 Real estate owned − 23,289 9,233 37,958 70,480 − 32,126 4,851 39,637 76,614 Accrued interest receivable − 22,566 10,134 44,592 77,292 − 14,239 14,090 33,375 61,704 Other assets 2,043 − − − 2,043 4,473 − − − 4,473 Total assets $ 7,242 $ 457,001 $ 542,550 $ 930,512 $ 1,937,305 $ 76,712 $ 716,457 $ 775,853 $ 1,530,066 $ 3,099,088 Liabilities and net deficiency in assets Liabilities: Asset-backed bonds secured by mortgage loans $ − $ 566,577 $ 700,335 $ 1,398,115 $ 2,665,027 $ − $ 735,235 $ 765,361 $ 1,644,534 $ 3,145,130 Asset-backed bonds secured by mortgage securities 5,384 − − − 5,384 74,542 − − − 74,542 Other liabilities 24,748 47,418 22,401 104,439 199,006 21,945 33,533 22,356 73,231 151,065 Total liabilities 30,132 613,995 722,736 1,502,554 2,869,417 96,487 768,768 787,717 1,717,765 3,370,737 Total net deficiency in assets (22,890 ) (156,994 ) (180,186 ) (572,042 ) (932,112 ) (19,775 ) (52,311 ) (11,864 ) (187,699 ) (271,649 ) Total liabilities and net deficiency in assets $ 7,242 $ 457,001 $ 542,550 $ 930,512 $ 1,937,305 $ 76,712 $ 716,457 $ 775,853 $ 1,530,066 $ 3,099,088 (A) Stand-alone balances do not include impact of intercompany eliminations. (B) The above financial information is considered non-GAAP. For the Year Ended December 31, 2008 For the Year Ended December 31, 2007 CDO Total CDO Total Interest Income $ 26,306 $ 45,160 $ 27,555 $ 109,295 $ 208,316 $ 34,133 $ 68,068 $ 67,936 $ 120,665 $ 290,802 Interest expense 13,124 22,453 25,843 54,874 116,294 19,129 49,298 52,807 86,521 207,755 Provision for credit losses − (127,485 ) (165,063 ) (414,816 ) (707,364 ) − (43,620 ) (23,942 ) (197,726 ) (265,288 ) Servicing fee expense − 3,129 2,736 7,732 13,597 − 3,938 3,210 5,867 13,015 Mortgage insurance − 4,216 292 11,310 15,818 − 5,409 323 10,730 16,462 Other income (15,550 ) 6,393 − (4,844 ) (14,001 ) (25,513 ) (85 ) − (7,509 ) (33,107 ) General and administrative expenses 747 46 42 62 897 5,798 7 5 11 5,821 Net loss before tax expense (3,115 ) (105,776 ) (166,421 ) (384,343 ) (659,655 ) (16,307 ) (34,289 ) (12,351 ) (187,699 ) (250,646 ) Tax expense − − 1,902 − 1,902 3,469 − − − 3,469 Net loss $ (3,115 ) $ (105,776 ) $ (168,323 ) $ (384,343 ) $ (661,557 ) $ (19,776 ) $ (34,289 ) $ (12,351 ) $ (187,699 ) $ (254,115 ) (A) Stand-alone balances do not include impact of intercompany eliminations. (B) The above financial information is considered non-GAAP. thousands; except per share amounts)thousands) For the Year Ended December 31, 2006 2005 2004 $ 66,285 $ 132,471 $ 109,124 $ 1.92 $ 4.42 $ 4.24 $ 180,627 $ 270,432 $ 250,555 $ 4.85 $ 8.40 $ 9.04 $ 5.60 $ 5.60 $ 6.75 $ 11,224,088 $ 9,283,138 $ 8,424,361 8.55 % 7.66 % 7.63 % $ 6,075,405 $ 7,621,030 $ 8,329,804 $ 2,549,913 $ — $ — $ 2,248,633 $ 1,138,098 $ — $ 41,749 $ 65,148 $ 144,950 1.21 % 1.76 % 1.70 % 29.82 % 42.11 % 32.77 % 101.86 102.00 103.28 2.03 % 2.37 % 2.77 % For the Year Ended December 31, 2008 For the Year Ended December 31, 2007 Net cash flow from: CDO Total CDO Total Operating activities $ (7,441 ) $ 27,320 $ (4,415 ) $ 43,622 $ 59,086 $ 25,244 $ 7,295 $ (39,748 ) $ 65,191 $ 57,982 Investing activities 16,135 135,777 70,706 195,954 418,572 (365,097 ) 315,726 321,479 173,813 445,921 Financing activities (8,694 ) (163,097 ) (66,291 ) (239,576 ) (477,658 ) 339,853 (323,021 ) (281,731 ) (239,004 ) (503,903 ) Net cash flow - - - - - - - - - - Cash, beginning of year - - - - - - - - - - Cash, end of year $ − $ - $ - $ - $ - $ - $ - $ - $ - $ - (A) The common shares outstanding at the endStand-alone balances do not include impact of each period presented are used in calculating the taxable income per common share. Taxable income for years prior to 2006 are actual while 2006 taxable income is an estimate.intercompany eliminations.(B) This metricThe above financial information is defined in Table 21.considered non-GAAP.(C)This metric is defined in Table 20.(D)This metric is defined in Table 29.For the year ended December 31, 2006 as compared to the year ended December 31, 2005.Net income available to common shareholders declined by approximately $66.2 million during 2006 as compared to 2005. The following factors contributed to the decline:Gains on sales of mortgage assets decreased by $23.4 million from 2005 to 2006. The reasons for this are:Net gains on sales of loans to third parties declined by $10.1 million even though we doubled the volume of loans sold due to the increase in our reserve for losses related to loan repurchases. Because of the increase in loan repurchase requests which resulted from increased delinquencies in our 2006 production, we increased our reserve for future expected losses resulting from these repurchases by $25.4 million from 2005 to 2006.A shift in securitization strategies in 2006 to add qualified assets to our balance sheet to ensure our compliance with certain REIT tests. This decision ultimately resulted in a decrease in securitization sales transaction volume from $7.6 billion for 2005 to $6.1 billion for 2006. During the second quarter of 2006, we structured the NHES Series 2006-1 securitization as well as the NHES 2006-MTA1 securitization as financing transactions instead of our typical sales transactions. As a result of the decline in the volume of loans securitized in sales transactions, our gains from securitizations of mortgage loans declined to $50.2 million for 2006 from $58.8 million for 2005.As default rates have increased so have the assets we acquired through foreclosure (real estate owned). Our losses on sales of real estate owned increased by $6.3 million in 2006 from 2005 as a result of the deteriorating credit quality of our portfolio.Although the overall balance of our mortgage securities increased in 2006 from 2005 because of the purchase and retention of subordinated securities, our interest income from our securities portfolio as well as the net yield on these securities declined in 2006. Interest income – mortgage securities decreased by $24.0 million from 2005 and the net yield also decreased by 12.29% from 2005. These declines can be attributed to the following main factors:The estimated fair value of our residual securities decreased by $160.2 million from 2005 to 2006. This was caused by erosion of the portfolio being much greater than the initial value of our newly retained residual securities. Because of the higher credit loss expectancies of the 2006 production as well as the tightening of margins, the residual securities we retained from our 2006 securitization deals as a percentage of the collateral balance delivered decreased by 1.2%. Also contributing to this decrease was the $1.5 billion decrease in loans securitized in transactions structured as sales from 2005 to 2006. Significant erosion of the fair value of our portfolio has been driven by higher expected credit losses throughout the entire portfolio as well as normal paydowns.The addition of lower-yielding mortgage securities to our portfolio. The mortgage securities – available-for-sale (residual interests) we retained from our most recent securitizations are accreting income at lower yields than many of our older securities due to margin compression and higher credit loss expectancies. Also, we increased our trading securities portfolio by $285.6 million and the yields on our trading securities are generally lower than the yields on our mortgage securities – available-for-sale.Our portfolio management focus continues to be on managing a portfolio to deliver attractive risk-adjusted returns. The net yield on our mortgage securities portfolio is highly dependent on market conditions and the types of securities in which we invest.Higher expected credit losses contributed to impairments to our mortgage securities available-for-sale portfolio increasing by $13.1 million from 2005 to 2006. As can be seen by our increase in credit loss assumptions as well as our high provision for credit losses, we are beginning to see the effects of a cooling housing market on mortgage credit quality.We increased our provision for credit losses by approximately $29.1 million during 2006 from 2005 due to $2.7 billion of securitizations structured as financing transactions we executed in 2006. Our provision for credit losses significantly offset the positive impact to interest income yielded by these transactions.The rise in short-term interest rates in 2006 was much less than 2005. This resulted in a $6.2 million decrease in the gains we recognized on derivative instruments which did not qualify for hedge accounting during 2006 compared to 2005.Industry Overview and Known Material Trends and UncertaintiesDescribed below are some of the marketplace conditions and known material trends and uncertainties that may impact our future results of operations.Despite the cyclical downturn, we believe the mortgage business will continue to be a pillar of the U.S. economy. The value of homes, even after a correction, represents the largest asset of most American families. Inside Mortgage Finance Publications estimated nonprime originations at more than $600 billion in 2006, roughly one-fifth of total mortgage lending in the United States.The following trends have become evident in the business environment in which we operate and could have a significant impact on our financial condition, results of operations and cash flows:Industry publications have predicted that borrower delinquencies and credit deterioration will continue into 2007 with a positive trend beginning in 2008. In the meantime, the key area of focus for our mortgage banking operation is to ensure that the 2007 vintage performs better than 2006 and in line with our expectations. In this regard, we have significantly altered our proprietary model and underwriting guidelines and processes in an attempt to minimize losses and enhance asset quality in loan originations going forward.
Various industry publications also predict that growth in the nonconforming origination market will be relatively flat in 2007 with some publications predicting a slight decline. Additionally, our origination volume could be negatively impacted by our tightening of underwriting guidelines as fewer borrowers may qualify for loans and as brokers adjust to these tighter guidelines. Our ability to increase the size of our securitized mortgage loan portfolio, which drives our mortgage securities portfolio, could prove difficult under these tighter conditions. We continue to pursue opportunities to increase our market share in the nonconforming market, including the acquisition or new development of businesses. We also believe there are opportunities to increase our market share as the number of competitors decline as a result of the difficult operating conditions. As we explore opportunities for growth, generating good risk-adjusted returns for shareholders remains our focus.
The nonprime market remains very competitive and will likely continue to see pressure on margins as the market normalizes. We see potential for a more rational business environment as some overly aggressive competitors have either ceased operations or withdrawn from the industry. Our ability to generate acceptable risk-adjusted returns is very dependent on the movement in these margins.
Home sales growth and home price appreciation both significantly declined throughout 2006. For 2007, many economists are expecting home-price growth to continue its decline in some markets which had experienced substantial growth. This could have a significant impact on origination growth in our mortgage lending segment, as well as, prepayment speed and credit loss assumptions on the mortgage securities held by our mortgage portfolio management segment.
As a result of the many uncertainties in the subprime mortgage market (i.e. home price appreciation, home sales, credit quality, interest rates), and their impact to the securitization market, we may allocate more capital to mortgage assets which are higher in the capital structure as well as synthetic assets. We also may sell more of our loan production to third parties and we may even sell all or a portion of the residual securities we retain from our securitizations until we begin to see a more rational market.
During 2005 and 2006 we retained various subordinate investment-grade securities from our securitization transactions that were previously held in the form of overcollateralization bonds. We also purchased subordinated securities from other asset-backed securities (“ABS”) issuers. We will continue to retain, acquire and aggregate various types of ABS as well as synthetic assets with the intention of securing non-recourse long-term financing through securitizations while retaining the risk of the underlying securities by investing in the equity and subordinated debt pieces of the collateralized debt obligation (“CDO”). CDO equity securities bear the first-loss and second-loss credit risk with respect to the securities owned by the securitization entity. Our goal is to leverage our extensive portfolio management experience for shareholders by purchasing securities that are higher in the capital structure than our residual securities and executing CDOs for long-term non-recourse financing, thereby generating good risk-adjusted returns for shareholders. As discussed in Note 24 to the consolidated financial statements, we executed our first CDO securitization on February 8, 2007.
As discussed under “Executive Overview of Performance”, over the last several years the REIT’s taxable income has exceeded GAAP earnings as a result of the timing difference between tax and GAAP accounting recognition of income on our mortgage securities portfolio. Generally, this timing difference is created by a variety of factors including the deferred recognition of losses in computing the yield on these securities for tax purposes. However, over the life of the portfolio, GAAP and tax income will generally be equal. The reversal in timing differences between the recognition of GAAP income and taxable income is occurring and will accelerate as our older vintage securitizations mature. We experienced a decline of taxable income in 2006 of approximately 32 percent from 2005. Furthermore, we expect to recognize little or no taxable income at the REIT during the period from 2007 through 2011. Given this outlook, and the operating efficiencies to be gained through operating as a traditional C corporation, we are currently evaluating whether it is in shareholders’ best interest to retain our REIT status. In order to voluntarily revoke REIT status, we must file such revocation with the Internal Revenue Service within 90 days of the beginning of the first tax year for which the revocation is to be effective. We will continue to be subject to the REIT dividend distribution requirements for the year prior to the year in which the revocation is effective. For example, if we elect to revoke our REIT status for 2008, we would still be required to distribute at least 90 percent of our 2007 taxable income by the end of 2008 in order to retain REIT status for 2007.
Critical Accounting Estimates
In order for us to
Have the transferred assets been isolated from the transferor?
Does the transferee have the right to pledge or exchange the transferred assets?
· | Have the transferred assets been isolated from the transferor? |
Is there a “call” agreement that requires the transferor to return specific assets?
· | Does the transferee have the right to pledge or exchange the transferred assets? |
Is there an agreement that both obligates and entitles the transferee to return the transferred assets prior to maturity?
· | Is there a “call” agreement that requires the transferee to return specific assets? |
Have any derivative instruments been transferred?
· | Is there an agreement that both obligates and entitles the transferee to return the transferred assets prior to maturity? |
· | Have any derivative instruments been transferred? |
The weighted average net whole loan market price used in the initial valuation of our retained securities was 101.86 for the year ended December 31, 2006 as compared to 102.00 and 103.28 for the years ended December 31, 2005 and 2004, respectively. The weighted average initial implied discount rate was 15% for the years ended December 31, 2006 and 2005. If the whole loan market price used in the initial valuation of our residual securities for the year ended December 31, 2006 had been increased or decreased by 50 basis points, the initial value of our residual securities and the gain we recognized would have increased or decreased by $30.4 million.
However, we subsequently sold all of these clean up call rights, to the buyer of our mortgage servicing rights. We did retain separate independent rights to require the buyer of our mortgage servicing rights to repurchase loans from the trusts and subsequently sell them to us; we do not expect to exercise any of the call rights that we retained.
The interest spread between the coupon net of servicing fees on the underlying loans, the cost of financing, mortgage insurance, payments or receipts on or from derivative contracts and bond administrative costs.
Prepayment penalties received from borrowers who payoff their loans early in their life.
· | The interest spread between the coupon net of servicing fees on the underlying loans, the cost of financing, mortgage insurance, payments or receipts on or from derivative contracts and bond administrative costs. |
Overcollateralization which is designed to protect the primary bondholder from credit loss on the underlying loans.
· | Prepayment penalties received from borrowers who payoff their loans early in their life. |
· | Overcollateralization which is designed to protect the primary bondholder from credit loss on the underlying loans. |
market prices compared to estimates based on discounting the expected future cash flows of the collateral and bonds.
See Note 3 to the consolidated financial statements for the residual security sensitivity analysis and Note 4 to the consolidated financial statements for the current fair value of our residual securities.
The market discount rates we are using to initially value our residual securities have declined since 2005. As of December 31, 2006, the weighted average discount rate used in valuing our residual securities was 16% as compared to 18% for December 31, 2005. The weighted-average constant prepayment rate used in valuing our residual securities as of December 31, 2006 was 47% versus 49% as of December 31, 2005. If the discount rate used in valuing our residual securities as of December 31, 2006 had been increased by 5%, the value of our mortgage securities- available-for-sale would have decreased by $14.7 million. If we had decreased the discount rate used in valuing our residual securities by 5%, the value of our residual securities would have increased by $15.9 million.
Allowance for Credit Losses. An allowance for credit losses is maintained for mortgage loans held-in-portfolio. The amount of the allowance is based on the assessment by management of probable losses incurred based on various factors affecting our mortgage loan portfolio, including current economic conditions, the makeup of the portfolio based on credit grade, loan-to-value ratios, delinquency status, mortgage insurance we purchase and other relevant factors. The allowance is maintained through ongoing adjustments to operating income. The assumptions used by management regarding key economic indicatorsin estimating the amount of the allowance for credit losses are highly uncertain and involve a great deal of judgment.
statement of operations.
Reserve for Losses – Loans Sold to Third Parties.We maintain a reserve for the representation and warranty liabilities related to loans sold to third parties, and for the contractual obligation to rebate a portion of any premium paid by a purchaser when a borrower prepays a sold loan within an agreed period. The reserve, which is recorded as a liability on the consolidated balance sheet, is established when loans are sold, and is calculated as the estimated fair value of losses reasonablyless estimated to occur overselling costs. We estimate fair value at the life of the contractual obligation. Management estimates inherent lossesasset’s liquidation value less selling costs using management’s assumptions which are based uponon historical loss trends and frequency and severity of lossesseverities for similar assets. Adjustments to the loan product sales. The adequacycarrying value required at time of this reserve is evaluatedforeclosure are charged against the allowance for credit losses. Costs related to the development of real estate are capitalized and adjusted as required. The provision for losses recognized atthose related to holding the sale date is included inproperty are expensed. Losses or gains from the consolidated statementsultimate disposition of income as a reduction of gains on sales of mortgage assets.real estate owned are charged or credited to earnings.
held-in-portfolio.
The fair value of MSRs is highly sensitiveexpected cash flows used to changes in assumptions. Changes in prepayment speed assumptions have the greatest impact onmeasure the fair value of MSRs.the asset. FSP SFAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and must be applied prospectively to intangible assets acquired after the effective date. The Company does not expect that adoption of FSP SFAS 142-3 will have a significant impact on the Company’s consolidated financial statements.
Financial Condition asconsolidated VIE, (iii) the nature of December 31, 2006risks related to the Company’s involvement with the VIE and December 31, 2005
Mortgage Loans - Held-for-Sale.
The following table summarizes(iv) the activityimpact on financial results related to the Company’s involvement with the VIE. Certain disclosures are also required where the Company is a non-transferor sponsor or servicer of our mortgage loans classified as held-for-salea QSPE. FSP FAS 140-4 and FIN 46(R)-8 is effective for the years endedfirst reporting period ending after December 31, 2006 and 2005.
Table 2 — Rollforward of Mortgage Loans - Held-for-Sale
(dollars in thousands)
For the Year Ended December 31, | ||||||||
2006 | 2005 | |||||||
Beginning principal balance | $ | 1,238,689 | $ | 719,904 | ||||
Originations and purchases | 11,233,844 | 9,282,404 | ||||||
Borrower repayments | (77,490 | ) | (9,908 | ) | ||||
Sales to third parties | (2,248,633 | ) | (1,156,216 | ) | ||||
Sales in securitizations | (6,075,405 | ) | (7,621,030 | ) | ||||
Transfers to real estate owned | (15,376 | ) | (712 | ) | ||||
Repurchase of mortgage loans from securitization trusts | 192,821 | 13,976 | ||||||
Transfers of mortgage loans (to) from held-in-portfolio | (2,616,559 | ) | 10,271 | |||||
Ending principal balance | 1,631,891 | 1,238,689 | ||||||
Loans under removal of accounts provision | 107,043 | 44,382 | ||||||
Net Premium | 7,891 | 12,015 | ||||||
Allowance for the lower of cost or fair value | (5,006 | ) | (3,530 | ) | ||||
Mortgage loans held-for-sale | $ | 1,741,819 | $ | 1,291,556 | ||||
Our portfolio of mortgage loans held-for-sale increased to $1.7 billion at December 31, 2006 from $1.3 billion at December 31, 2005. This increase is a result of a larger volume of originations and purchases during 2006 as well as the timing of our securitizations.
The following table provides information on the FICO scores, weighted average coupons and original weighted average loan-to-values for our loans classified as held-for-sale as of December 31, 2006 and 2005.
Table 3 — Mortgage Loans – Held-for-Sale by FICO Score
(dollars in thousands)
As of December 31, 2006 | As of December 31, 2005 | |||||||||||||||||
FICO Score | Current Principal | Weighted Average Coupon | Original Weighted Average Loan- to-Value | Current Principal | Weighted Average Coupon | Original Weighted Average Loan- to-Value | ||||||||||||
FICO score not available | $ | 577 | 10.89 | % | 63.0 | % | $ | 900 | 10.52 | % | 80.3 | % | ||||||
540 and below | 134,147 | 9.68 | 79.7 | 78,250 | 9.40 | 76.4 | ||||||||||||
540 to 579 | 248,559 | 9.21 | 81.4 | 149,150 | 9.03 | 79.5 | ||||||||||||
580 to 619 | 336,457 | 8.90 | 84.6 | 231,002 | 8.50 | 81.6 | ||||||||||||
620 to 659 | 392,316 | 8.60 | 84.7 | 301,879 | 8.01 | 82.1 | ||||||||||||
660 and above | 519,835 | 8.11 | 83.1 | 477,508 | 7.49 | 81.8 | ||||||||||||
Total | $ | 1,631,891 | 8.69 | % | 83.2 | % | $ | 1,238,689 | 8.11 | % | 81.2 | % | ||||||
The following table provides information on the collateral location for our loans classified as held-for-sale as of December 31, 2006 and December 31, 2005.
Table 4 — Mortgage Loans – Held-for-Sale by Collateral Location
As of December 31, 2006 | As of December 31, 2005 | |||||||
Collateral Location | Percent of Total | Collateral Location | Percent of Total | |||||
Florida | 19 | % | California | 22 | % | |||
California | 12 | Florida | 21 | |||||
Michigan | 5 | Virginia | 5 | |||||
Maryland | 4 | Maryland | 5 | |||||
All other states (each less than 4% of total) | 60 | All other states (each less than 5% of total) | 47 | |||||
Total | 100 | % | Total | 100 | % | |||
The following table provides information on the product type for our loans classified as held-for-sale as of December 31, 2006 and 2005.
Table 5 — Mortgage Loans – Held-for-Sale by Product Type
(dollars in thousands)
As of December 31, | ||||||
Product Type | 2006 | 2005 | ||||
2-Year Fixed | $ | 621,108 | $ | 601,626 | ||
2-Year Fixed 40/30 | 301,488 | 35,525 | ||||
30-Year Fixed | 220,473 | 127,276 | ||||
MTA (Option ARM) | 177,032 | 90,596 | ||||
2-Year Fixed Interest-only | 140,899 | 265,664 | ||||
30/15-Year Fixed | 68,225 | 76,148 | ||||
Other Products | 102,666 | 41,854 | ||||
Total | $ | 1,631,891 | $ | 1,238,689 | ||
The following table provides delinquency information for our loans classified as held-for-sale as well as assets acquired through foreclosure (real estate owned) as of December 31, 2006 and 2005.
Table 6 — Mortgage Loans – Held-for-Sale Delinquencies and Real Estate Owned
(dollars in thousands)
As of December 31, | ||||||||||||
2006 | 2005 | |||||||||||
Current Principal | Percent of Total | Current Principal | Percent of Total | |||||||||
Current | $ | 1,613,112 | 99 | % | $ | 1,236,848 | 100 | % | ||||
30-59 days delinquent | 5,777 | — | 474 | — | ||||||||
60-89 days delinquent | 1,351 | — | 209 | — | ||||||||
90 + days delinquent | 1,349 | — | 283 | — | ||||||||
In process of foreclosure | 10,302 | 1 | 875 | — | ||||||||
Total principal | $ | 1,631,891 | 100 | % | $ | 1,238,689 | 100 | % | ||||
Real estate owned | $ | 12,110 | $ | 529 | ||||||||
Mortgage Loans - Held-in-Portfolio.
The following table summarizes the activity of our mortgage loans classified as held-in-portfolio for the years ended December 31, 2006 and 2005.
Table 7 — Rollforward of Mortgage Loans - Held-in-Portfolio
(dollars in thousands)
For the Year Ended December 31, | ||||||||
2006 | 2005 | |||||||
Beginning principal balance | $ | 29,084 | $ | 58,859 | ||||
Borrower repayments | (551,796 | ) | (16,673 | ) | ||||
Capitalization of interest | 29,541 | — | ||||||
Transfers of mortgage loans from (to) held-for-sale | 2,616,559 | (10,271 | ) | |||||
Transfers to real estate owned | (21,620 | ) | (2,831 | ) | ||||
Ending principal balance | 2,101,768 | 29,084 | ||||||
Net unamortized premium | 37,219 | 455 | ||||||
Amortized cost | 2,138,987 | 29,539 | ||||||
Allowance for credit losses | (22,452 | ) | (699 | ) | ||||
Mortgage loans held-in-portfolio | $ | 2,116,535 | $ | 28,840 | ||||
Our portfolio of mortgage loans held-in-portfolio increased to $2.1 billion at December 31, 2006 from $28.8 million at December 31, 2005. During the first quarter of 2006 we transferred mortgage loans with a principal balance of $2.6 billion from the held-for-sale classification to the held-in-portfolio classification due to our change in securitization strategies with respect to these loans. Included in this total is approximately $1.0 billion of monthly treasury average (MTA) loans we purchased during the period. During the second quarter of 2006 we completed two securitization transactions structured as financings using these loans as the underlying collateral.
The following table provides information on the FICO scores, weighted average coupons and original weighted average loan-to-values for our loans classified as held-in-portfolio as of December 31, 2006 and 2005.
Table 8 — Mortgage Loans – Held-in-Portfolio by FICO Score
(dollars in thousands)
As of December 31, 2006 | As of December 31, 2005 | |||||||||||||||||
FICO Score | Current Principal | Weighted Average Coupon | Original Weighted Average Loan- to-Value | Current Principal | Weighted Average Coupon | Original Weighted Average Loan- to-Value | ||||||||||||
FICO score not available | $ | 14,605 | 7.85 | % | 73.6 | % | $ | 892 | 10.35 | % | 76.8 | % | ||||||
540 and below | 79,552 | 9.66 | 75.6 | 4,283 | 10.23 | 77.5 | ||||||||||||
540 to 579 | 163,578 | 9.25 | 78.3 | 5,581 | 10.01 | 80.6 | ||||||||||||
580 to 619 | 255,777 | 8.81 | 81.0 | 8,718 | 9.84 | 83.6 | ||||||||||||
620 to 659 | 368,232 | 8.24 | 79.5 | 5,781 | 9.65 | 81.1 | ||||||||||||
660 and above | 1,220,024 | 8.09 | 77.4 | 3,829 | 9.44 | 80.2 | ||||||||||||
Total | $ | 2,101,768 | 8.35 | % | 78.2 | % | $ | 29,084 | 9.85 | % | 81.0 | % | ||||||
The following table provides information on the collateral location for our loans classified as held-in-portfolio as of December 31, 2006 and 2005.
Table 9 — Mortgage Loans – Held-in-Portfolio by Collateral Location
As of December 31, 2006 | As of December 31, 2005 | |||||||
Collateral Location | Percent of Total | Collateral Location | Percent of Total | |||||
California | 42 | % | Florida | 12 | % | |||
Florida | 19 | North Carolina | 8 | |||||
All other states (each less than 5% of total) | 39 | All other states (each less than 8% of total) | 80 | |||||
Total | 100 | % | Total | 100 | % | |||
The following table provides information on the product type for our loans classified as held-in-portfolio as of December 31, 2006 and 2005.
Table 10 — Mortgage Loans – Held-in-Portfolio by Product Type
(dollars in thousands)
As of December 31, | ||||||
Product Type | 2006 | 2005 | ||||
MTA (Option ARM) | $ | 1,042,415 | $ | — | ||
2-Year Fixed | 608,188 | 7,332 | ||||
2-Year Fixed Interest-only | 190,349 | — | ||||
30-Year Fixed | 135,576 | 7,551 | ||||
Other Products | 125,240 | 14,201 | ||||
Total | $ | 2,101,768 | $ | 29,084 | ||
The following table provides delinquency information for our loans classified as held-in-portfolio as well as assets acquired through foreclosure (real estate owned) as of December 31, 2006 and 2005.
Table 11 — Mortgage Loans – Held-in-Portfolio Delinquencies and Real Estate Owned
(dollars in thousands)
As of December 31, | ||||||||||||
2006 | 2005 | |||||||||||
Current Principal | Percent of Total | Current Principal | Percent of Total | |||||||||
Current | $ | 2,013,541 | 96 | % | $ | 26,098 | 90 | % | ||||
30-59 days delinquent | 29,316 | 1 | 914 | 3 | ||||||||
60-89 days delinquent | 15,593 | 1 | 657 | 2 | ||||||||
90 + days delinquent | 5,080 | — | 387 | 1 | ||||||||
In process of foreclosure | 38,238 | 2 | 1,028 | 4 | ||||||||
Total principal | $ | 2,101,768 | 100 | % | $ | 29,084 | 100 | % | ||||
Real estate owned | $ | 19,472 | $ | 1,052 | ||||||||
Mortgage Securities Available-for-Sale.
The following tables summarize our mortgage securities – available for sale portfolio and the current assumptions and assumptions at the time of securitization as of December 31, 2006 and 2005:
Table 12 — Valuation of Individual Mortgage Securities – Available-for-Sale and Assumptions
(dollars in thousands)
As of December 31, 2006
Securitization Trust | Cost (A) | Unrealized | Estimated | Current Assumptions | Assumptions at Trust Securitization | |||||||||||||||||||||||
Discount Rate | Constant Prepayment Rate | Expected Credit Losses (B) | Discount Rate | Constant Prepayment Rate | Expected Credit Losses (B) | |||||||||||||||||||||||
NMFT Series: | ||||||||||||||||||||||||||||
2002-3 | $ | 3,384 | $ | 56 | $ | 3,440 | 20 | % | 35 | % | 0.4 | % | 20 | % | 30 | % | 1.0 | % | ||||||||||
2003-1 | 9,398 | 418 | 9,816 | 20 | 32 | 1.3 | 20 | 28 | 3.3 | |||||||||||||||||||
2003-2 | 5,458 | 2,450 | 7,908 | 20 | 31 | 0.8 | 28 | 25 | 2.7 | |||||||||||||||||||
2003-3 | 5,255 | 254 | 5,509 | 20 | 29 | 0.8 | 20 | 22 | 3.6 | |||||||||||||||||||
2003-4 | 3,509 | 1,513 | 5,022 | 20 | 38 | 1.0 | 20 | 30 | 5.1 | |||||||||||||||||||
2004-1 | 13,511 | 3,170 | 16,681 | 20 | 47 | 1.3 | 20 | 33 | 5.9 | |||||||||||||||||||
2004-1 (D) | 132 | — | 132 | 20 | N/A | N/A | N/A | N/A | N/A | |||||||||||||||||||
2004-2 | 14,321 | 4,492 | 18,813 | 20 | 47 | 1.3 | 26 | 31 | 5.1 | |||||||||||||||||||
2004-2 (D) | 1,322 | 60 | 1,382 | 20 | N/A | N/A | N/A | N/A | N/A | |||||||||||||||||||
2004-3 | 24,939 | 8,982 | 33,921 | 19 | 48 | 1.5 | 19 | 34 | 4.5 | |||||||||||||||||||
2004-4 | 16,237 | 8,684 | 24,921 | 20 | 56 | 1.3 | 26 | 35 | 4.0 | |||||||||||||||||||
2005-1 | 20,525 | 4,558 | 25,083 | 15 | 60 | 1.7 | 15 | 37 | 3.6 | |||||||||||||||||||
2005-2 | 13,831 | 67 | 13,898 | 13 | 54 | 1.5 | 13 | 39 | 2.1 | |||||||||||||||||||
2005-3 | 13,047 | 1,169 | 14,216 | 15 | 51 | 1.5 | 15 | 41 | 2.0 | |||||||||||||||||||
2005-3 (C) | 47,814 | (1,131 | ) | 46,683 | N/A | N/A | N/A | N/A | N/A | N/A | ||||||||||||||||||
2005-3 (D) | 6,423 | 1,473 | 7,896 | 15 | N/A | N/A | N/A | N/A | N/A | |||||||||||||||||||
2005-4 | 11,087 | 1,194 | 12,281 | 15 | 49 | 2.0 | 15 | 43 | 2.3 | |||||||||||||||||||
2005-4 (D) | 5,278 | 1,143 | 6,421 | 15 | N/A | N/A | N/A | N/A | N/A | |||||||||||||||||||
2006-2 | 13,835 | — | 13,835 | 15 | 46 | 3.2 | 15 | 44 | 2.4 | |||||||||||||||||||
2006-3 | 13,746 | — | 13,746 | 15 | 45 | 4.3 | 15 | 43 | 3.0 | |||||||||||||||||||
2006-4 | 19,019 | — | 19,019 | 15 | 45 | 3.5 | 15 | 43 | 2.9 | |||||||||||||||||||
2006-5 | 22,181 | — | 22,181 | 15 | 44 | 4.8 | 15 | 43 | 3.9 | |||||||||||||||||||
2006-6 | 26,508 | — | 26,508 | 15 | 42 | 3.9 | 15 | 41 | 3.7 | |||||||||||||||||||
Total | $ | 310,760 | $ | 38,552 | $ | 349,312 | ||||||||||||||||||||||
As of December 31, 2005
Securitization Trust | Cost (A) | Unrealized | Estimated | Current Assumptions | Assumptions at Trust Securitization | |||||||||||||||||||||||
Discount Rate | Constant Prepayment Rate | Expected Credit Losses (B) | Discount Rate | Constant Prepayment Rate | Expected Credit Losses (B) | |||||||||||||||||||||||
NMFT Series: | ||||||||||||||||||||||||||||
2000-1 | $ | 521 | $ | 596 | $ | 1,117 | 15 | % | 36 | % | 1.3 | % | 15 | % | 27 | % | 1.0 | % | ||||||||||
2000-2 | — | 907 | 907 | 15 | 37 | 1.0 | 15 | 28 | 1.0 | |||||||||||||||||||
2001-1 | — | 1,661 | 1,661 | 20 | 40 | 1.3 | 20 | 28 | 1.2 | |||||||||||||||||||
2001-2 | — | 3,701 | 3,701 | 20 | 31 | 0.7 | 25 | 28 | 1.2 | |||||||||||||||||||
2002-1 | 1,632 | 2,184 | 3,816 | 20 | 41 | 0.7 | 20 | 32 | 1.7 | |||||||||||||||||||
2002-2 | 2,415 | 542 | 2,957 | 20 | 43 | 1.4 | 25 | 27 | 1.6 | |||||||||||||||||||
2002-3 | 4,127 | 1,132 | 5,259 | 20 | 44 | 0.4 | 20 | 30 | 1.0 | |||||||||||||||||||
2003-1 | 30,815 | 5,941 | 36,756 | 20 | 39 | 1.3 | 20 | 28 | 3.3 | |||||||||||||||||||
2003-2 | 11,043 | 8,330 | 19,373 | 20 | 39 | 0.8 | 28 | 25 | 2.7 | |||||||||||||||||||
2003-3 | 18,261 | 6,860 | 25,121 | 20 | 37 | 0.7 | 20 | 22 | 3.6 | |||||||||||||||||||
2003-4 | 11,070 | 12,191 | 23,261 | 20 | 46 | 0.8 | 20 | 30 | 5.1 | |||||||||||||||||||
2004-1 | 17,065 | 13,142 | 30,207 | 20 | 56 | 1.3 | 20 | 33 | 5.9 | |||||||||||||||||||
2004-2 | 18,368 | 13,432 | 31,800 | 20 | 55 | 1.4 | 26 | 31 | 5.1 | |||||||||||||||||||
2004-3 | 36,502 | 17,287 | 53,789 | 19 | 53 | 1.5 | 19 | 34 | 4.5 | |||||||||||||||||||
2004-4 | 34,473 | 16,102 | 50,575 | 20 | 54 | 1.5 | 26 | 35 | 4.0 | |||||||||||||||||||
2005-1 | 44,387 | 8,481 | 52,868 | 15 | 53 | 1.8 | 15 | 37 | 3.6 | |||||||||||||||||||
2005-2 | 37,377 | 1,296 | 38,673 | 13 | 51 | 1.5 | 13 | 39 | 2.1 | |||||||||||||||||||
2005-3 | 46,627 | — | 46,627 | 15 | 47 | 2.0 | 15 | 41 | 2.0 | |||||||||||||||||||
2005-3 (C) | 45,058 | (2,247 | ) | 42,811 | N/A | N/A | N/A | N/A | N/A | N/A | ||||||||||||||||||
2005-4 | 34,366 | — | 34,366 | 15 | 43 | 2.3 | 15 | 43 | 2.3 | |||||||||||||||||||
Total | $ | 394,107 | $ | 111,538 | $ | 505,645 | ||||||||||||||||||||||
As of December 31, 2006 and 2005 the fair value of our mortgage securities – available-for-sale was $349.3 million and $505.6 million, respectively. The decline is mostly due to compressed margins, credit impairments and normal paydowns. During 2006 and 2005 we retained residual mortgage securities – available-for-sale with a cost basis of $155.0 million and $289.5 million, respectively, from securitizations treated as sales during the year. This decrease is primarily due to the fact that we structured two securitizations as on-balance sheet transactions during 2006. During 2006 and 2005 we recognized impairments on mortgage securities – available-for-sale of $30.7 million and $17.6 million, respectively. The increase in impairments was caused by deterioration in credit quality of the loans in our portfolio.15, 2008. See Note 43 to the consolidated financial statements for the additional disclosures required by the FSP.
The previous tables demonstrate how the increase in housing prices from 2002 through 2005 positively impacted our security performance and how the current deteriorationother-than-temporary impairment when it is “probable” that there has been an adverse change in the housing marketholder’s best estimate of cash flows from the cash flows previously projected. This amendment aligns the impairment guidance under EITF 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, with the guidance in SFAS No. 115. FSP EITF 99-20-1 retains and re-emphasizes the other-than-temporary impairment guidance and disclosures in pre-existing GAAP and SEC requirements. FSP EITF 99-20-1 is negatively impacting this performance. An increase in home priceseffective for interim and annual reporting periods ending after December 15, 2008. The Company does not expect the adoption of FSP EITF 99-20-1 will generally leadhave a material impact on its consolidated financial statements.
We have experienced periods prior to 2004 when the interest expense on asset-backed bonds declined significantly due to reductions in short-term interest rates. As a result, the spread between the coupon interest and the bond cost was unusually high and our cost basis in many of our older mortgage securities was significantly reduced due to the dramatic increase in cash flows. When our cost basis in the residual securities reaches zero, the remaining future cash flows received on the securities are recognized entirely as income. This was the case of the residual securities we retained from the 2000-2, 2001-1 and 2001-2 securitizations at December 31, 2005 as shown in the table above.
During the first quarter of 2006, to ensure we maintained our REIT qualification, we contributed certain bonds from the REIT to the TRS. We isolated derivative cash flows received from certain residual securities and created the CT Bonds. We then contributed the CT Bonds from the REIT to our TRS. This transaction may add volatility to future reported GAAP earnings because both the IO Bonds and CT Bonds will be evaluated separately for impairment. Historically, the CT Bonds have acted as an economic hedge for the IO Bonds that are retained at the REIT, thus mitigating the impairment risk to the IO Bonds in a rising interest rate environment. As a result of transferring the CT Bonds to the TRS, the IO and CT Bonds will be valued separately creating the risk of earnings volatility resulting from other-than-temporary impairment charges. For example, in a rising rate environment, the IO bond will generally decrease in value while the CT Bond will increase in value. If the decrease in value of the IO Bond is deemed to be other than temporary in nature, we would record an impairment charge through the income statement for such decrease. At the same time, any increase in value of the CT Bond would be recorded in accumulated other comprehensive income.
Summary of Securitizations.
The following tables provide a summary of the loans collateralizing our securitizations structured as sales as well as the outstanding asset backed bonds which were outstanding at December 31, 2006 and 2005:
Table 13 — Summary of Securitizations
(dollars in thousands)
As of December 31, 2006
Securitization | Issue Date | Loan Collateral | Asset Backed Bonds | |||||||||||||||||||||
Original Principal | Current Principal | Weighted Average Coupon | Percent of Loans With Prepayment Penalties | Prepayment Penalty Period for Penalty (Yrs.) | Remaining Principal | Weighted Average Interest Rate | Estimated Months to Call | |||||||||||||||||
NMFT Series: | ||||||||||||||||||||||||
2002-3 | 9/27/2002 | $ | 750,003 | $ | 73,038 | 8.92 | % | 39 | % | 0.25 | $ | 69,709 | 6.05 | % | 3 | |||||||||
2003-1 | 2/27/2003 | 1,300,141 | 173,155 | 8.09 | 38 | 0.34 | 161,034 | 6.17 | 10 | |||||||||||||||
2003-2 | 6/12/2003 | 1,499,998 | 214,894 | 7.92 | 41 | 0.52 | 205,224 | 6.14 | 13 | |||||||||||||||
2003-3 | 9/16/2003 | 1,499,374 | 282,333 | 7.62 | 41 | 0.64 | 273,863 | 6.23 | 23 | |||||||||||||||
2003-4 | 11/20/2003 | 1,499,732 | 260,628 | 8.27 | 36 | 0.62 | 253,505 | 6.37 | 15 | |||||||||||||||
2004-1 | 3/11/2004 | 1,750,000 | 309,992 | 9.01 | 41 | 0.49 | 287,573 | 6.39 | 12 | |||||||||||||||
2004-2 | 6/16/2004 | 1,399,999 | 274,380 | 9.06 | 54 | 0.63 | 249,761 | 6.33 | 14 | |||||||||||||||
2004-3 | 9/9/2004 | 2,199,995 | 496,297 | 9.31 | 50 | 0.65 | 452,297 | 6.38 | 16 | |||||||||||||||
2004-4 | 11/18/2004 | 2,500,000 | 642,881 | 9.43 | 38 | 0.31 | 613,188 | 6.22 | 16 | |||||||||||||||
2005-1 | 2/22/2005 | 2,100,000 | 903,930 | 7.75 | 42 | 0.29 | 879,083 | 5.83 | 20 | |||||||||||||||
2005-2 | 5/27/2005 | 1,799,992 | 972,061 | 7.65 | 73 | 0.49 | 963,061 | 5.80 | 27 | |||||||||||||||
2005-3 | 9/22/2005 | 2,499,983 | 1,566,120 | 7.45 | 71 | 0.67 | 1,499,111 | 5.72 | 32 | |||||||||||||||
2005-4 | 12/15/2005 | 1,599,999 | 1,109,493 | 7.89 | 70 | 0.84 | 1,056,693 | 5.69 | 36 | |||||||||||||||
2006-2 | 6/19/2006 | 1,021,102 | 870,831 | 8.76 | 68 | 1.11 | 852,451 | 5.54 | 42 | |||||||||||||||
2006-3 | 6/29/2006 | 1,100,000 | 992,739 | 8.97 | 67 | 1.21 | 967,989 | 5.55 | 45 | |||||||||||||||
2006-4 | 8/29/2006 | 1,025,359 | 951,206 | 9.25 | 60 | 1.15 | 922,495 | 5.52 | 45 | |||||||||||||||
2006-5 | 9/28/2006 | 1,300,000 | 1,250,254 | 9.37 | 61 | 1.24 | 1,218,404 | 5.55 | 48 | |||||||||||||||
2006-6 | 11/30/2006 | 1,250,000 | 1,242,134 | 9.06 | 63 | 1.38 | 1,209,009 | 5.55 | 52 | |||||||||||||||
Total | $ | 28,095,677 | $ | 12,586,366 | 8.52 | % | 60 | % | 0.84 | $ | 12,134,450 | 5.77 | % | |||||||||||
As of December 31, 2005
Loan Collateral | Asset Backed Bonds | |||||||||||||||||||||||
Securitization | Issue Date | Original Principal | Current Principal | Weighted Average Coupon | Percent of Loans With Prepayment Penalties | Prepayment Penalty Period for Loans w/ Penalty (Yrs.) | Remaining Principal | Weighted Average Interest Rate | Estimated Months to Call | |||||||||||||||
NMFT Series: | ||||||||||||||||||||||||
2000-1 | 3/31/2000 | $ | 230,138 | $ | 14,899 | 10.25 | % | — | % | — | $ | 13,966 | 5.40 | % | — | |||||||||
2000-2 | 9/28/2000 | 339,688 | 19,671 | 10.34 | — | — | 18,828 | 6.22 | — | |||||||||||||||
2001-1 | 3/31/2001 | 415,067 | 36,504 | 10.24 | 26 | 0.05 | 35,736 | 5.13 | — | |||||||||||||||
2001-2 | 9/25/2001 | 800,033 | 80,033 | 9.74 | 42 | 0.25 | 76,483 | 4.83 | 2 | |||||||||||||||
2002-1 | 3/28/2002 | 499,998 | 63,126 | 9.10 | 42 | 0.43 | 59,970 | 4.80 | 7 | |||||||||||||||
2002-2 | 6/28/2002 | 310,000 | 43,692 | 9.61 | 38 | 0.48 | 41,288 | 4.79 | 9 | |||||||||||||||
2002-3 | 9/27/2002 | 750,003 | 116,150 | 8.56 | 34 | 0.55 | 112,085 | 4.78 | 11 | |||||||||||||||
2003-1 | 2/27/2003 | 1,300,141 | 275,785 | 8.05 | 34 | 0.61 | 234,639 | 5.63 | 20 | |||||||||||||||
2003-2 | 6/12/2003 | 1,499,998 | 346,390 | 7.86 | 58 | 0.83 | 327,640 | 5.40 | 22 | |||||||||||||||
2003-3 | 9/16/2003 | 1,499,374 | 451,033 | 7.68 | 58 | 0.99 | 428,533 | 5.25 | 31 | |||||||||||||||
2003-4 | 11/20/2003 | 1,499,732 | 476,251 | 8.04 | 53 | 0.90 | 458,251 | 5.25 | 25 | |||||||||||||||
2004-1 | 3/11/2004 | 1,750,000 | 750,080 | 7.57 | 60 | 0.67 | 727,330 | 4.94 | 23 | |||||||||||||||
2004-2 | 6/16/2004 | 1,399,999 | 681,199 | 7.43 | 79 | 0.83 | 655,999 | 4.96 | 25 | |||||||||||||||
2004-3 | 9/9/2004 | 2,199,995 | 1,206,415 | 7.73 | 81 | 0.96 | 1,162,415 | 5.01 | 28 | |||||||||||||||
2004-4 | 11/18/2004 | 2,500,000 | 1,498,414 | 7.59 | 76 | 0.84 | 1,467,164 | 4.96 | 29 | |||||||||||||||
2005-1 | 2/22/2005 | 2,100,000 | 1,543,209 | 7.62 | 71 | 0.95 | 1,516,959 | 4.78 | 32 | |||||||||||||||
2005-2 | 5/27/2005 | 1,799,992 | 1,527,351 | 7.69 | 69 | 1.14 | 1,518,351 | 4.74 | 38 | |||||||||||||||
2005-3 | 9/22/2005 | 2,499,983 | 2,378,349 | 7.52 | 66 | 1.27 | 2,310,849 | 4.69 | 44 | |||||||||||||||
2005-4 (A) | 12/15/2005 | 1,221,055 | 1,213,728 | 7.95 | 64 | 1.35 | 1,528,673 | 4.60 | 51 | |||||||||||||||
Total | $ | 24,615,196 | $ | 12,722,279 | 7.72 | % | 67 | % | 1.01 | $ | 12,695,159 | 4.87 | % | |||||||||||
The following table provides information on the FICO scores, weighted average coupons and original weighted average loan-to-values for our loans collateralizing our securitizations structured as sales as of December 31, 2006 and 2005.
Table 14 — Mortgage Loans Collateralizing Mortgage Securities by FICO Score
(dollars in thousands)
As of December 31, 2006 | As of December 31, 2005 | |||||||||||||||||
FICO Score | Current Principal | Weighted Average Coupon | Original Weighted Average Loan- to-Value | Current Principal | Weighted Average Coupon | Original Weighted Average Loan- to-Value | ||||||||||||
FICO score not available | $ | 7,733 | 10.08 | % | 69.4 | % | $ | 10,004 | 9.54 | % | 70.2 | % | ||||||
540 and below | 922,909 | 9.85 | 77.1 | 965,704 | 8.99 | 78.0 | ||||||||||||
540 to 579 | 1,942,624 | 9.28 | 79.6 | 1,981,585 | 8.44 | 79.5 | ||||||||||||
580 to 619 | 2,728,305 | 8.79 | 82.5 | 2,505,987 | 7.93 | 82.1 | ||||||||||||
620 to 659 | 2,923,022 | 8.27 | 82.6 | 2,946,485 | 7.47 | 82.3 | ||||||||||||
660 and above | 4,061,773 | 7.85 | 83.0 | 4,312,514 | 7.16 | 83.0 | ||||||||||||
Total | $ | 12,586,366 | 8.52 | % | 81.9 | % | $ | 12,722,279 | 7.72 | % | 81.7 | % | ||||||
The following table provides information on the collateral location for our loans collateralizing our securitizations structured as sales as of December 31, 2006 and 2005.
Table 15 — Mortgage Loans Collateralizing Mortgage Securities by Collateral Location
As of December 31, 2006 | As of December 31, 2005 | |||||||
Collateral Location | Percent of Total | Collateral Location | Percent of Total | |||||
Florida | 20 | % | California | 18 | % | |||
California | 15 | Florida | 18 | |||||
Texas | 5 | Texas | 5 | |||||
All other states (each less than 5% of total) | 60 | All other states (each less than 5% of total) | 59 | |||||
Total | 100 | % | Total | 100 | % | |||
The following table provides information on the product type for our loans collateralizing our securitizations structured as sales as of December 31, 2006 and 2005.
Table 16 — Mortgage Loans Collateralizing Mortgage Securities by Product Type
(dollars in thousands)
As of December 31, | ||||||
Product Type | 2006 | 2005 | ||||
2-Year Fixed | $ | 6,078,256 | $ | 7,112,368 | ||
30-Year Fixed | 2,353,660 | 2,156,910 | ||||
2-Year Fixed Interest-only | 1,655,605 | 1,780,297 | ||||
2-Year Fixed 40/30 | 899,385 | 20,435 | ||||
30/15-Year Fixed | 484,363 | 418,590 | ||||
15-Year Fixed | 356,506 | 418,237 | ||||
3-Year Fixed | 278,350 | 426,511 | ||||
Other Products | 480,241 | 388,931 | ||||
Outstanding principal | $ | 12,586,366 | $ | 12,722,279 | ||
The following table provides delinquency information for our loans collateralizing our securitizations structured as sales as of December 31, 2006 and 2005.
Table 17 — Mortgage Loans Collateralizing Mortgage Securities Delinquencies and Real Estate Owned
(dollars in thousands)
As of December 31, | ||||||||||||
2006 | 2005 | |||||||||||
Current Principal | Percent of Total | Current Principal | Percent of Total | |||||||||
Current | $ | 11,488,283 | 91 | % | $ | 12,210,770 | 96 | % | ||||
30-59 days delinquent | 288,209 | 2 | 106,918 | 1 | ||||||||
60-89 days delinquent | 148,986 | 1 | 63,413 | 0 | ||||||||
90 + days delinquent | 67,622 | 1 | 68,337 | 1 | ||||||||
In process of foreclosure | 347,285 | 3 | 167,898 | 1 | ||||||||
Real estate owned | 245,981 | 2 | 104,943 | 1 | ||||||||
Total principal and real estate owned | $ | 12,586,366 | 100 | % | $ | 12,722,279 | 100 | % | ||||
Mortgage Securities – Trading.
The following tables provide a summary of our portfolio of trading securities at December 31, 2006 and 2005:
Table 18 — Mortgage Securities - Trading
(dollars in thousands)
As of December 31, 2006
S&P Rating | Original Face | Amortized Cost Basis | Fair Value | Number of Securities | Weighted Average Yield | |||||||||
A+ | $ | 2,199 | $ | 2,202 | $ | 2,195 | 1 | 6.40 | % | |||||
A | 15,692 | 15,444 | 15,466 | 3 | 6.96 | |||||||||
A- | 13,432 | 12,338 | 12,227 | 4 | 10.52 | |||||||||
BBB+ | 53,657 | 51,442 | 51,367 | 14 | 8.56 | |||||||||
BBB | 99,795 | 93,035 | 92,750 | 24 | 9.71 | |||||||||
BBB- | 135,890 | 121,971 | 120,003 | 28 | 11.94 | |||||||||
BB+ | 31,733 | 25,584 | 25,181 | 8 | 16.25 | |||||||||
BB | 13,500 | 10,029 | 10,172 | 3 | 19.50 | |||||||||
Total | $ | 365,898 | $ | 332,045 | $ | 329,361 | 85 | 11.03 | % | |||||
As of December 31, 2005
S&P Rating | Original Face | Amortized Cost Basis | Fair Value | Number of Securities | Weighted Average Yield | |||||||||
A | $ | 11,200 | $ | 10,858 | $ | 10,881 | 1 | 8.00 | % | |||||
BBB+ | 11,200 | 9,391 | 9,193 | 1 | 13.00 | |||||||||
BBB | 12,000 | 8,825 | 9,045 | 1 | 17.00 | |||||||||
BBB- | 20,000 | 14,115 | 14,619 | 1 | 19.00 | |||||||||
Total | $ | 54,400 | $ | 43,189 | $ | 43,738 | 4 | 14.59 | % | |||||
As of December 31, 2006, mortgage securities – trading consisted of subordinated securities which were retained from our securitization transactions in 2005 and 2006 as well as subordinated securities purchased from other issuers during 2006. As of December 31, 2005 mortgage securities – trading consisted of subordinated securities which were retained from our securitization transactions in 2005. The aggregate fair market value of these securities as of December 31, 2006 and December 31, 2005 was $329.4 million and $43.7 million, respectively. Management estimates their fair value based on quoted market prices. The market value of our mortgage securities – trading fluctuates inversely with bond spreads in the market. Generally, as bond spreads widen (i.e. investors demand more return), the value of our mortgage securities – trading will decline, alternatively, as they tighten, the market value of our mortgage securities – trading will increase. We recognized net trading (losses) gains of $(3.2) million and $0.5 million for the years ended December 31, 2006 and 2005, respectively. As bond spreads have continued to widen into early 2007, we could experience additional mark-to-market losses on our mortgage securities – trading if this trend does not reverse.
We expect to continue to retain, acquire and aggregate various ABScomply with the intention of securing non-recourse long-term financing through securitizations while retaining the risk of the underlying securities by investingadditional disclosure requirements beginning in the equity and subordinated debt pieces of the CDO.
Mortgage Servicing Rights.
We retain the right to service mortgage loans we originate, purchase and have securitized. Servicing rights for loans we sell to third parties are not retained and we have not purchased the right to service those loans. As of December 31, 2006, we had $62.8 million in capitalized mortgage servicing rights compared with $57.1 million as of December 31, 2005. This increase was due to the addition of $39.5 million in capitalized mortgage servicing rights from securitizations structured as sales we completed during 2006 offset by amortization of mortgage servicing rights of $33.6 million for 2006.
Warehouse Notes Receivable.
Warehouse notes receivable increased to $39.5 million at December 31, 2006 from $25.4 million at December 31, 2005. These notes receivable represent warehouse lines of credit provided to a network of approved mortgage lenders. The increase in warehouse notes receivable from 2005 to 2006 is a result of growth in this business.
Accrued Interest Receivable.
Accrued interest receivable increased to $37.7 million at December 31, 2006 from $4.9 million at December 31, 2005. This increase is directly related to the significant increase in our loan balances at December 31, 2006 from December 31, 2005.
Real Estate Owned.
Real estate owned increased to $21.5 million at December 31, 2006 from $1.2 million at December 31, 2005. This increase is directly related to the significant increase in our mortgage loan held-in-portfolio balances at December 31, 2006 from December 31, 2005. The stated amount of real estate owned on our consolidated balance sheet is net of expected future losses on the sale of the property. In addition, we experienced a higher rate of delinquencies from loan borrowers in 2006 which brought about an increase in foreclosures.
Derivative Instruments, net.
Derivative instruments, net increased to $16.8 million at December 31, 2006 from $12.8 million at December 31, 2005. These amounts include the collateral (margin deposits) required under the terms of our derivative instrument contracts, net of the derivative instrument market values. Due to the nature of derivative instruments we use, the margin deposits required will generally increase as interest rates decline and decrease as interest rates rise. On the other hand, the market value of our derivative instruments will decline as interest rates decline and increase as interest rates rise.
Short-term Borrowings.
Mortgage loan originations and purchases are funded with various financing facilities prior to securitization or sales to third parties. Repurchase agreements are used as interim, short-term financing before loans are sold or transferred in our securitization transactions. In addition we finance certain of our mortgage securities by using repurchase agreements. As of December 31, 2006 we had $2.2 billion in short-term borrowings compared to $1.4 billion at December 31, 2005. The balances outstanding under our short-term repurchase agreements fluctuate based on lending volume, equity and debt issuances, financing activities and cash flows from other operating and investing activities. See Table 35 for further discussion of our financing availability and liquidity.
Asset-backed bonds.
We have issued asset-backed bonds secured by mortgage loans and securities as a means for long-term financing. As of December 31, 2006 we had $2.1 billion in asset-backed bonds compared to $152.6 million at December 31, 2005. We executed two loan securitizations treated as financings during 2006 which increased our asset-backed bonds by $2.5 billion. This increase was partially offset by bond payments during the year.
Junior Subordinated Debentures.
Junior subordinated debentures increased to $83.0 million at December 31, 2006 from $48.7 million at December 31, 2005. On April 18, 2006 we issued $36.1 million aggregate principal amount of unsecured floating rate junior subordinated debentures and received net proceeds of $33.9 million.
Stockholders’ Equity.
The decrease in our shareholders’ equity as of December 31, 2006 compared to December 31, 2005 is a result of the following increases and decreases.
Shareholders’ equity increased by:
$72.9 million due to net income recognized for the year ended December 31, 2006;
$148.8 million due to issuance of common stock;
$30.0 million due to impairment on mortgage securities – available for sale reclassified to earnings;
$2.5 million due to compensation recognized under incentive stock plans;
$0.9 million due to issuance of stock under incentive stock plans;
$7.2 million due to tax benefit derived from the capitalization of an affiliate; and
$0.2 million due to the increase in unrealized gains on derivative instruments used in cash flow hedges.
Shareholders’ equity decreased by:
$0.3 million due to adjustments on derivatives instruments used in cash flow hedges reclassified to earnings;
$99.7 million due to the decrease in unrealized gains on mortgage securities classified as available-for-sale;
$5.1 million due to the decrease in unrealized gain on mortgage securities – available-for-sale related to repurchase of mortgage loans from securitization trusts;
$198.2 million due to dividends accrued or paid on common stock;
$6.7 million due to dividends accrued or paid on preferred stock; and
$2.2 million due to dividend equivalent rights (DERs) paid in cash.
Results of Operations
December 31, 2006 as Compared to December 31, 2005
During the twelve months ended December 31, 2006 we earned net income available to common shareholders of $66.3 million, or $1.92 per diluted share compared with $132.5 million or $4.42 per diluted share for the same period in 2005.
As discussed under “Executive Overview of Performance,” net income available to common shareholders decreased during the twelve months ended December 31, 2006 as compared to the same period in 2005 due primarily to:
Decline in gains on sales of mortgage assets of $23.4 million. This was due primarily to an increase of $25.4 million to the reserve for losses related to loan repurchases on loans we sold to third parties. Because of the performance of our 2006 loan production, we anticipate a greater level of loan repurchase requests than we have had historically, requiring us to increase this reserve.
Increase in provision for credit losses of $29.1 million due to the securitization of $2.6 billion of mortgage loans during the second and third quarters of 2006 structured as financings. An allowance for loan losses was recorded for estimated probable losses within the mortgage loans. Most of this increase is due to the initial establishment of the reserve, yet, the provision is higher than anticipated due to increased delinquency rates.
Increase in impairments on mortgage securities – available-for-sale of $13.1 million. These impairments were driven largely by increasing credit loss assumptions mostly in our 2006 vintage residual securities.
Interest income from our securities portfolio as well as the net yield on these securities declined. Although the overall balance of our mortgage securities increased in 2006 from 2005 because of the purchase and retention of subordinated securities, interest income – mortgage securities decreased by $24.0 million from
2005 and the net yield also decreased by 12.29% from 2005. These declines were primarily a result of the addition of lower-yielding securities and the erosion in our portfolio of residual securities caused by margin compression, credit deterioration and normal paydowns.
December 31, 2005 as Compared to December 31, 2004.
During the twelve months ended December 31, 2005, we earned net income available to common shareholders of $132.5 million, or $4.42 per diluted share, compared with net income of $109.1 million, or $4.24 per diluted share for the same period of 2004.
Net income available to common shareholders increased during the twelve months ended December 31, 2005 as compared to the same period in 2004 due primarily to:
Increase in income generated by our mortgage securities – available-for-sale portfolio, which increased to $505.6 million as of December 31, 2005 from $489.2 million as of December 31, 2004. The higher average balance along with a higher net yield on our mortgage securities in 2005 led to the increase in income on our mortgage securities.
Increase in interest income on servicing funds we hold as custodian driven by higher short-term interest rates in 2005 compared to 2004.
Increase in gains on derivative instruments due to the significant increase in short-term interest rates.
All three of these factors were able to offset the decline in gains on sales of mortgage assets which resulted from the decline in mortgage banking profit margins.
Net Interest Income.
We earn interest income primarily on our mortgage assets which include mortgage securities available-for-sale, mortgage securities trading, mortgage loans held-in-portfolio and mortgage loans held-for-sale. In addition we earn interest income on servicing funds we hold as custodian along with general operating funds. Interest expense consists primarily of interest paid on borrowings secured by mortgage assets, which includes warehouse repurchase agreements and asset backed bonds.
The following table provides the components of net interest income for the years ended December 31, 2006, 2005 and 2004.
Table 19 — Net Interest Income
(dollars in thousands)
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Interest income: | ||||||||||||
Mortgage securities | $ | 164,858 | $ | 188,856 | $ | 133,633 | ||||||
Mortgage loans held-for-sale | 157,807 | 105,104 | 83,571 | |||||||||
Mortgage loans held-in-portfolio | 134,604 | 4,311 | 6,673 | |||||||||
Other interest income | 37,621 | 22,456 | 6,968 | |||||||||
Total interest income | 494,890 | 320,727 | 230,845 | |||||||||
Interest expense: | ||||||||||||
Short-term borrowings secured by mortgage loans | 121,628 | 58,492 | 31,411 | |||||||||
Short-term borrowings secured by mortgage securities | 14,237 | 1,770 | 4,836 | |||||||||
Other short-term borrowings | 488 | — | — | |||||||||
Asset-backed bonds secured by mortgage loans | 88,117 | 1,810 | 2,980 | |||||||||
Asset-backed bonds secured by mortgage securities | 3,860 | 15,628 | 13,255 | |||||||||
Junior subordinated debentures | 7,001 | 3,055 | — | |||||||||
Total interest expense | 235,331 | 80,755 | 52,482 | |||||||||
Net interest income before provision for credit losses | 259,559 | 239,972 | 178,363 | |||||||||
Provision for credit losses | (30,131 | ) | (1,038 | ) | (726 | ) | ||||||
Net interest income | $ | 229,428 | $ | 238,934 | $ | 177,637 | ||||||
Our net interest income decreased to $229.4 million for the year ended December 31, 2006 from $238.9 million for December 31, 2005. While our interest income increased in 2006 due to higher average mortgage loan balances, this increase was offset by an increase in our interest expense as a result of higher average outstanding debt balances as well as increases in the cost of this financing, due to increasing short-term interest rates. In addition, the significant increase in our provision for credit losses reduced our net interest income for 2006 as compared to 2005. The increase in the provision for credit losses in 2006 is due largely to the transfer of $2.7 billion of mortgage loans from the held-for-sale classification to the held-in-portfolio classification during the first quarter of 2006 as a result of securitizing these loans in transactions structured as financings, which were completed during the third quarter of 2006. A provision for loan losses was recorded for estimated probable losses within our portfolio of mortgage loans classified as held-in-portfolio. Also contributing to the increase in the provision for credit losses in 2006 is deterioration in credit quality of our loans. Our allowance for credit losses will be impacted in the future by our securitization strategies as well as delinquency and loss rates in our portfolio of mortgage loans held-in-portfolio.
Activity in the allowance for credit losses on mortgage loans – held-in-portfolio is as follows for the three years ended December 31, (dollars in thousands):
2006 | 2005 | 2004 | ||||||||||
Balance, beginning of period | $ | 699 | $ | 507 | $ | 1,319 | ||||||
Provision for credit losses | 30,131 | 1,038 | 726 | |||||||||
Charge-offs, net of recoveries | (8,378 | ) | (846 | ) | (1,538 | ) | ||||||
Balance, end of period | $ | 22,452 | $ | 699 | $ | 507 | ||||||
As shown in table 20, below, our average net security yield decreased to 29.82% for 2006 from 42.11% for 2005 and 32.77% for 2004. The decrease in our average security yield from 2005 to 2006 is primarily a result of margin compression as well as our retention and purchase of lower-yielding residual and subordinated securities. The increase in yield from 2004 to 2005 is a result of lowering credit loss assumptions in 2005 due to better than expected performance as a result of substantial housing price appreciation.
The following table presents the average balances for our mortgage securities, mortgage loans held-for-sale, mortgage loans held-in-portfolio and our repurchase agreement and securitization financings for those assets with the corresponding yields for the years ended December 31, 2006, 2005 and 2004.
Table 20 — Net Interest Income Analysis
(dollars in thousands)
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Mortgage securities interest analysis | ||||||||||||
Average balances: | ||||||||||||
Mortgage securities (A) | $ | 492,155 | $ | 407,119 | $ | 352,608 | ||||||
Short-term borrowings secured by mortgage securities | 223,715 | 42,376 | 167,822 | |||||||||
Asset-backed bonds secured by mortgage securities | 54,836 | 227,733 | 166,868 | |||||||||
Yield analysis: | ||||||||||||
Interest income (A) | 33.50 | % | 46.39 | % | 37.90 | % | ||||||
Interest expense short-term borrowings | 6.36 | % | 4.18 | % | 2.88 | % | ||||||
Interest expense asset backed bonds | 7.04 | % | 6.86 | % | 7.94 | % | ||||||
Total financing expense | 6.50 | % | 6.44 | % | 5.41 | % | ||||||
Net interest spread | 27.00 | % | 39.95 | % | 32.49 | % | ||||||
Net yield (B) | 29.82 | % | 42.11 | % | 32.77 | % | ||||||
Mortgage loans held-for-sale interest analysis | ||||||||||||
Average balances: | ||||||||||||
Mortgage loans held-for-sale | $ | 1,757,246 | $ | 1,338,716 | $ | 1,198,534 | ||||||
Short-term borrowings secured by mortgage loans held-for-sale | 1,680,337 | 1,242,388 | 1,172,607 | |||||||||
Yield analysis: | ||||||||||||
Interest income | 8.98 | % | 7.85 | % | 6.97 | % | ||||||
Interest expense short-term borrowings | 6.01 | % | 4.67 | % | 2.68 | % | ||||||
Net interest spread | 2.97 | % | 3.18 | % | 4.29 | % | ||||||
Net yield (B) | 3.24 | % | 3.51 | % | 4.35 | % | ||||||
Mortgage loans held-in-portfolio interest analysis | ||||||||||||
Average balances: | ||||||||||||
Mortgage loans held-in-portfolio | $ | 1,790,302 | $ | 47,857 | $ | 75,337 | ||||||
Asset-backed bonds secured by mortgage loans held-in-portfolio | 1,511,650 | 42,916 | 70,687 | |||||||||
Short-term borrowings secured by mortgage loans held-in-portfolio | 327,609 | — | — | |||||||||
Yield analysis: | ||||||||||||
Interest income | 7.52 | % | 9.01 | % | 8.86 | % | ||||||
Interest expense asset backed bonds | 5.83 | % | 4.22 | % | 4.22 | % | ||||||
Interest expense short-term borrowings | 5.53 | % | — | % | — | % | ||||||
Total financing expense | 5.78 | % | 4.22 | % | 4.22 | % | ||||||
Net interest spread | 1.74 | % | 4.79 | % | 4.64 | % | ||||||
Net yield (B) | 1.58 | % | 5.23 | % | 4.90 | % | ||||||
Mortgage Portfolio Net Interest Income. Our portfolio income comes from mortgage loans either directly (mortgage loans held-in-portfolio and mortgage loans held-for-sale) or indirectly (mortgage securities). Table 21 attempts to look through the balance sheet presentation of our portfolio income and present income as a percentage of average assets under management. The net interest income for mortgage securities, mortgage loans held-in-portfolio and mortgage loans held-for-sale reflects the income after interest expense, hedging and credit expense (mortgage insurance and provision for credit losses). This metric allows us to be more easily compared to other finance companies or financial institutions that use on balance sheet portfolio accounting, where return on assets is a common performance calculation.
Our portfolio net interest yield on assets was 1.21% for the year ended December 31, 2006 as compared to 1.76% and 1.70% respectively, for the same periods of 2005 and 2004. The decrease in yield from 2006 and 2005 can be attributed primarily to the addition of lower-yielding securities and recording a higher provision for credit losses in 2006 compared to 2005.
The increase in yield from 2004 to 2005 can be attributed to the lower than expected credit losses due to rising housing prices which resulted in the lowering of our credit loss assumptions on certain mortgage securities available-for-sale as previously discussed. In addition, net settlement expense on non-cash flow hedging derivatives was lower in 2005 compared with 2004 as short-term interest rates increased in 2005.
We generally expect our net interest yield on portfolio assets to be in the range of 1% to 1.25% over the long-term. Table 21 shows the net interest yield on assets under management during the years ended December 31, 2006, 2005 and 2004.
Table 21 — Mortgage Portfolio Management Net Interest Income Analysis
(dollars in thousands)
Mortgage Securities – Available-for-Sale | Mortgage Loans Held-in-Portfolio | Mortgage for-Sale | Total | |||||||||||||
For the Year Ended: | ||||||||||||||||
December 31, 2006 | ||||||||||||||||
Interest income (A) | $ | 139,021 | $ | 134,604 | $ | 157,807 | $ | 431,432 | ||||||||
Interest expense: | ||||||||||||||||
Short-term borrowings | — | 18,120 | 103,508 | 121,628 | ||||||||||||
Asset-backed bonds | — | 88,117 | — | 88,117 | ||||||||||||
Total interest expense (B) | — | 106,237 | 103,508 | 209,745 | ||||||||||||
Mortgage portfolio net interest income before other expense | 139,021 | 28,367 | 54,299 | 221,687 | ||||||||||||
Other (expense) income (C) | — | (36,401 | ) | 3,688 | (32,713 | ) | ||||||||||
Mortgage portfolio net interest income (expense) | $ | 139,021 | $ | (8,034 | ) | $ | 57,987 | $ | 188,974 | |||||||
Average balance of the underlying loans | $ | 12,057,038 | $ | 1,790,302 | $ | 1,757,246 | $ | 15,604,586 | ||||||||
Net interest yield on assets | 1.15 | % | (0.45 | %) | 3.30 | % | 1.21 | % | ||||||||
December 31, 2005 | ||||||||||||||||
Interest income (A) | $ | 188,856 | $ | 4,311 | $ | 105,104 | $ | 298,271 | ||||||||
Interest expense: | ||||||||||||||||
Short-term borrowings | — | — | 58,492 | 58,492 | ||||||||||||
Asset-backed bonds | — | 1,810 | — | 1,810 | ||||||||||||
Total interest expense (B) | — | 1,810 | 58,492 | 60,302 | ||||||||||||
Mortgage portfolio net interest income before other expense | 188,856 | 2,501 | 46,612 | 237,969 | ||||||||||||
Other income (expense) (C) | 1,651 | (1,124 | ) | (2,580 | ) | (2,053 | ) | |||||||||
Mortgage portfolio net interest income | $ | 190,507 | $ | 1,377 | $ | 44,032 | $ | 235,916 | ||||||||
Average balance of the underlying loans | $ | 12,006,929 | $ | 47,857 | $ | 1,338,716 | $ | 13,393,502 | ||||||||
Net interest yield on assets | 1.59 | % | 2.88 | % | 3.29 | % | 1.76 | % | ||||||||
December 31, 2004 | ||||||||||||||||
Interest income (A) | $ | 133,633 | $ | 6,673 | $ | 83,571 | $ | 223,877 | ||||||||
Interest expense: | ||||||||||||||||
Short-term borrowings | — | — | 31,411 | 31,411 | ||||||||||||
Asset-backed bonds | — | 2,980 | 2,980 | |||||||||||||
Total interest expense (B) | — | 2,980 | 31,411 | 34,391 | ||||||||||||
Mortgage portfolio net interest income before other expense | 133,633 | 3,693 | 52,160 | 189,486 | ||||||||||||
Other income (expense) (C) | 368 | (1,253 | ) | (23,123 | ) | (24,008 | ) | |||||||||
Mortgage portfolio net interest income | $ | 134,001 | $ | 2,440 | $ | 29,037 | $ | 165,478 | ||||||||
Average balance of the underlying loans | $ | 8,431,708 | $ | 75,337 | $ | 1,198,534 | $ | 9,705,579 | ||||||||
Net interest yield on assets | 1.59 | % | 3.24 | % | 2.42 | % | 1.70 | % | ||||||||
Gains on Sales of Mortgage Assets.
The following table shows the changes and makeup of our gains on sales of mortgage assets for the three years ended December 31, 2006, 2005 and 2004.
Table 22 — Gains on Sales of Mortgage Assets
(dollars in thousands)
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Gains on sales of mortgage loans transferred in securitizations | $ | 50,215 | $ | 58,765 | $ | 144,252 | ||||||
Gains on sales of mortgage loans to third parties – nonconforming | 28,456 | 13,183 | — | |||||||||
Reserve for losses-loans sold to third parties | (28,617 | ) | (3,265 | ) | — | |||||||
Gains on sales of mortgage loans to third parties – conforming | — | 370 | 1,436 | |||||||||
Losses on sales of real estate owned | (7,166 | ) | (880 | ) | (738 | ) | ||||||
Gains on sales of trading securities | 351 | — | — | |||||||||
Elimination of gains from discontinued operations | (1,490 | ) | (3,025 | ) | — | |||||||
Gains on sales of mortgage assets | $ | 41,749 | $ | 65,148 | $ | 144,950 | ||||||
Gains on sales of mortgage assets were $41.7 million for the year ended December 31, 2006 compared to $65.1 million and $145.0 million for the years ended for December 31, 2005 and 2004, respectively. The decrease in gains recognized between 2006 and 2005 is due primarily to an increase of $25.4 million to the reserve for losses in 2006 related to loan repurchases on sales to third parties due to an increase in the number of repurchase requests we received from third parties. The decrease in gains recognized between 2005 and 2004 is a result of a $0.7 billion decline in loans securitized as well as significant profit margin compression driven by a whole loan price decline period over period.
Activity in the reserve for repurchases is as follows for the three years ended December 31, (dollars in thousands):
2006 | 2005 | 2004 | |||||||||
Balance, beginning of period | $ | 2,345 | $ | — | $ | — | |||||
Provision for repurchased loans | 28,617 | 3,265 | — | ||||||||
Charge-offs, net | (6,189 | ) | (920 | ) | — | ||||||
Balance, end of period | $ | 24,773 | $ | 2,345 | $ | — | |||||
The following table provides a summary of our mortgage loan securitizations treated as sales by year with the significant assumptions used at the time of securitization to value the residual securities we retained.
Table 23 — Mortgage Loans Transferred in Securitizations Structured as Sales
(dollars in thousands)
For the Year Ended December 31, | Principal Amount | Whole Loan Price Used in the Initial Valuation of Retained Interests | Net Gain Recognized | Initial Cost Basis of Retained Securities | Weighted Average Assumptions Underlying Initial Value of Mortgage Securities – Available-for-Sale | |||||||||||||||
Constant Prepayment Rate | Discount Rate | Expected Total Credit Losses, Net | ||||||||||||||||||
2006 | $ | 6,075,405 | 101.86 | $ | 50,215 | $ | 244,978 | 43 | % | 15 | % | 3.20 | % | |||||||
2005 | $ | 7,621,030 | 102.00 | $ | 58,765 | $ | 332,420 | 40 | % | 15 | % | 2.47 | % | |||||||
2004 | $ | 8,329,804 | 103.28 | $ | 144,252 | $ | 381,833 | 33 | % | 22 | % | 4.77 | % | |||||||
The following table summarizes our sales of nonconforming loans to third parties for the years ended December 31, 2006 and 2005. There were no sales of nonconforming loans to third parties for the year ended December 31, 2004. This table shows the impact of the provision for losses related to loan repurchases on our net gain (loss) recognized from loan sales in 2006 and 2005. This table also shows the impact of the lower whole loan sales prices on the gains recognized. We will continue to sell loans to third parties which do not possess the economic characteristics which meet our long-term portfolio management objectives.
Table 24 — Mortgage Loan Sales to Third Parties – Nonconforming
(dollars in thousands)
For the Year Ended December 31, | Principal Amount | Net (Loss)Gain Recognized | Weighted Average Price to Par of the Loans Sold | |||||||
2006 | $ | 2,248,633 | $ | (161 | ) | 101.57 | % | |||
2005 | $ | 1,138,098 | $ | 9,918 | 102.01 | % | ||||
Gains (Losses) on Derivative Instruments.
We have entered into derivative instrument contracts that do not meet the requirements for hedge accounting treatment, but contribute to our overall risk management strategy by serving to reduce interest rate risk related to short-term borrowing rates. Additionally, we transfer certain of these derivative instruments into our securitization trusts when they are structured as sales to provide interest rate protection to the third-party bondholders. Prior to the date when we transfer these derivatives, changes in the fair value of these derivative instruments and net settlements with counterparties are credited or charged to current earnings. The derivative instruments we use to mitigate interest rate risk will generally increase in value as short-term interest rates increase and decrease in value as rates decrease. Fair value, at the date of securitization, of the derivative instruments transferred into securitizations structured as sales is included as part of the cost basis of the mortgage loans securitized. Derivative instruments transferred into a securitization trust are administered by the trustee in accordance with the trust documents. Any cash flows from these derivatives projected to flow to our residual securities are included in the valuation. The gains (losses) on derivative instruments can be summarized for the years ended December 31, 2006, 2005 and 2004 as follows:
Table 25—Gains (Losses) on Derivative Instruments
(dollars in thousands)
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Increase in fair value | $ | 3,854 | $ | 15,224 | $ | 10,586 | ||||||
Net settlement income (expense) | 9,837 | 4,657 | (19,065 | ) | ||||||||
Losses on commitments to originate mortgage loans | (1,693 | ) | (1,726 | ) | (426 | ) | ||||||
Gains (losses) on derivative instruments | $ | 11,998 | $ | 18,155 | $ | (8,905 | ) | |||||
Impairment on Mortgage Securities – Available-for-Sale.
To the extent that the cost basis of mortgage securities – available-for-sale exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. For the years ended December 31, 2006, 2005 and 2004, we recorded an impairment loss on our mortgage securities available-for-sale of $30.7 million, $17.6 million and $15.9 million, respectively. The increase in impairments in 2006 was primarily driven by an increase in projected losses due to the credit quality of the loans declining in 2006 from 2005. The following table summarizes the impairment on our mortgage securities – available-for-sale by mortgage security for the years ended December 31, 2006, 2005 and 2004.
Table 26 — Impairment on Mortgage Securities – Available-for-Sale by Mortgage Security
(dollars in thousands)
For the Year Ended December 31, | |||||||||
2006 | 2005 | 2004 | |||||||
Mortgage Securities – Available-for-Sale: | |||||||||
NMFT Series 1999-1 | $ | — | $ | 117 | $ | 87 | |||
NMFT Series 2004-1 | 15 | — | — | ||||||
NMFT Series 2004-4 | — | — | 6,484 | ||||||
NMFT Series 2004-2 | — | — | 7,384 | ||||||
NMFT Series 2004-3 | — | — | 1,947 | ||||||
NMFT Series 2004-4 | — | 1,496 | — | ||||||
NMFT Series 2005-1 | — | 1,426 | — | ||||||
NMFT Series 2005-2 | — | 7,027 | — | ||||||
NMFT Series 2005-3 | 531 | 7,553 | — | ||||||
NMFT Series 2005-4 | 7,739 | — | — | ||||||
NMFT Series 2006-2 | 7,879 | — | — | ||||||
NMFT Series 2006-3 | 8,620 | — | — | ||||||
NMFT Series 2006-4 | 5,906 | — | — | ||||||
Impairment on mortgage securities – available-for-sale | $ | 30,690 | $ | 17,619 | $ | 15,902 | |||
Fee Income.
Our fee income declined slightly to $29.0 million for the year ended December 31, 2006 from $30.7 million for 2005 and 2004. Fee income primarily consists of service fee income. Service fees are paid to us by either the investor or the borrower on mortgage loans serviced. Fees paid by investors on loans serviced are determined as a percentage of the principal collected for the loans serviced and are recognized in the period in which payments on the loans are received. These fees are approximately 0.50% of the outstanding balance of the loans being serviced. Fees paid by borrowers on loans serviced are considered ancillary fees related to loan servicing and include late fees and processing fees. Revenue is recognized on fees received from borrowers when an event occurs that generates the fee and they are considered to be collectible. Servicing fees received from the securitization trusts were $59.2 million, $59.8 million and $41.5 million for the years ended December 31, 2006, 2005 and 2004, respectively.
The amortization of mortgage servicing rights is also included in fee income. Mortgage servicing rights are amortized in proportion to and over the estimated period of net servicing income. Generally, as the size of our servicing portfolio increases the amortization expense will increase. In addition the amortization of mortgage servicing rights is impacted by our assumptions regarding prepayment speeds for the loans being serviced for investors. During periods of increasing loan prepayments, the amortization on our mortgage servicing rights generally will increase. See Table 12 for a summary of our expected prepayment rate assumptions by securitization trust. Amortization of mortgage servicing rights increased to $33.6 million for 2006 as compared with $28.4 million for 2005 and $16.9 million for 2004. This increase is amortization from 2005 to 2006 is a result of a larger balance of mortgage servicing rights period over period.
Origination fees are received from borrowers at the time of loan closing and deferred until the related loans are sold or securitized in transactions structured as sales. For securitizations structured as financings this fee income is deferred and amortized into interest income over the life of the loans using a level yield method.
Premiums for Mortgage Loan Insurance.
The use of mortgage insurance is one method of managing the credit risk in the mortgage asset portfolio. Premiums for mortgage insurance on loans maintained on our balance sheet are paid by us and are recorded as a portfolio cost and are included in the income statement under the caption “Premiums for Mortgage Loan Insurance”. These premiums totaled $12.4 million, $5.7 million and $4.2 million in 2006, 2005 and 2004, respectively. The increase in premiums on mortgage loan insurance for 2006 as compared to 2005 and 2004 is due to the increase in loans-held-in-portfolio as a result of structuring two loan securitizations as financings during the second quarter of 2006.
Some2009.
We intend to continue to use mortgage insurance coverage as a credit management tool as we continue to originate, purchase and securitize mortgage loans. Mortgage insurance claims on loans where a defect occurred in the loan origination process willfinancial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The FSP shall be paid byeffective for interim and annual reporting periods ending after June 15, 2009 , but early adoption is permitted for interim periods ending after March 15, 2009. The Company plans to adopt the mortgage insurer. The assumptions we useprovisions of this Staff Position during second quarter 2009; however its adoption is not expected to value our mortgage securities – available-for-sale consider this risk. Forhave a material impact on its consolidated financial statements.
We have the risk that mortgage insurance providers will revise their guidelines to an extent where we will no longer be able to acquire coverage on all of our new loan production. Similarly, the providers may also increase insurance premiums to a point where the cost of coverage outweighs its benefit. We monitor the mortgage insurance market and currently anticipate being able to obtain affordable coverage to the extent we deem it is warranted.
General and Administrative Expenses.
The main categories of our general and administrative expenses are; compensation and benefits, office administration, professional and outside services, loan expense, marketing expense and other expense. Compensation and benefits includes employee base salaries, benefit costs and incentive compensation awards. Office administration includes items such as rent, depreciation, telephone, office supplies, postage, delivery, maintenance and repairs. Professional and outside services include fees for legal, accounting and other consulting services. Loan expense primarily consists of expenses relating to the underwriting of mortgage loans that do not fund successfully and servicing costs. Marketing expenses primarily consists of costs for purchased loan leads, advertising and business promotion. Other expense primarily includes miscellaneous banking fees and travel and entertainment expenses. General and administrative expenses increased from $184.6 million and $168.3 millionActivity for the years ended December 31, 2005Asset or Liability Have Significantly Decreased and 2004, respectively, to $201.3 million for the same period of 2006. The increase is primarily related to increased commissions expenses due to a 21% increase in loan originations in 2006 compared with 2005. Also contributing to the increaseIdentifying Transactions That Are Not Orderly” (“FSP FAS 157-4”). FSP FAS 157-4 provides guidance on estimating fair value when market activity has decreased and on identifying transactions that are higher legal costs in 2006 as a result of litigation.
Other Operational Data
Loan Fundings.
The following table summarizes our loan production for the year ended December 31, 2006 and 2005. We have separated MTA (option ARM) bulk loan purchased in the first quarter of 2006 from our normal originations and purchases because of the unique nature of these purchases. These purchases were executed solely for the purpose of adding qualified assets to the REIT.
Table 27 — Nonconforming Loan Originations and Purchases
(dollars in thousands, except for average loan balance)
Number | Principal | Average | Price Paid | Weighted Average | Percent with | |||||||||||||||||
Loan to Value | FICO Score | Coupon | ||||||||||||||||||||
2006: | 60,332 | $ | 10,232,681 | $ | 169,606 | 100.8 | % | 83 | % | 625 | 8.71 | % | 61 | % | ||||||||
MTA Bulk Purchases | 2,415 | 991,407 | 410,520 | 103.4 | 74 | 713 | 6.89 | 68 | ||||||||||||||
2006 Total: | 62,747 | $ | 11,224,088 | $ | 178,878 | 101.1 | % | 82 | % | 633 | 8.55 | % | 62 | % | ||||||||
2005: | 58,542 | $ | 9,283,138 | $ | 158,572 | 101.1 | % | 82 | % | 632 | 7.66 | % | 65 | % | ||||||||
We originated and purchased $11.2 billion in nonconforming loans for the year ended December 31, 2006 compared to $9.3 billion in 2005. The weighted average coupon on the loans originated in 2006 was 89 basis points higher than the weighted average coupon on the loans originated in 2005. We continue to pursue opportunities to increase our market share while ensuring that the loans we originate generate good risk-adjusted returns. As discussed in Industry Overview and Known Material Trends and Uncertainties we have taken several steps to position ourselves for a deteriorating credit environment which may impact our origination volumes going forward.
The adjustable-rate loan product we commonly refer to as our MTA product increased from approximately 1% of total loan originations during the year ended December 31, 2005 to approximately 12% during the year ended December 31, 2006. Included in the 2006 originationsnot orderly. Additionally, entities are bulk purchases of $991.4 million in loans of this same product type which we executed with the intention to securitize these loans. This product is also commonly referred to as an “option ARM”, “negative amortization ARM”, “pay-option” or “MTA” loan within the mortgage industry. We refer to this product as MTA, which stands for monthly treasury average. The monthly treasury average is the interest rate index for a majority of the loans of this product type which we have originated or purchased.
The interest rates for MTA loans are generally fixed for one, two or three months following their origination and then adjust monthly. These loans allow the borrower to defer making the full interest payment for at least the first year of the loan. After this “option” period, minimum monthly payments increase by no more than 7.50% per year unless the unpaid balance increases to a specified limit, which is no more than 125% of the original loan amount, at which time a new monthly payment amount adequate to repay the loan over its remaining contractual life is established. To ensure that contractual loan payments are adequate to repay a loan, the fully amortizing loan payment amount is re-established every five years.
Due to the MTA loans’ amortization characteristics, the loss that we would realize in the event of default may be higher than that realized on a “traditional” loan that results in the payment of principal. Our MTA loans contain features that address the risk of borrower default and the increased risk of loss in the event of default. Specifically, our underwriting standards conform to those required to makedisclose in interim and annual periods the MTA loans salable intoinputs and valuation techniques used to measure fair value. This FSP is effective for interim and annual periods ending after June 15, 2009. The Company does not expect the secondary market atadoption of FSP FAS 157-4 will have a material impact on its financial condition or results of operation, although it will require additional disclosures.
Our MTA loan portfolio has a relatively high initial loan quality, with a weighted average original FICO score (a measure of credit rating) of 708 and weighted average original loan-to-value (“LTV”) of 80.4% at December 31, 2006. We only originate MTA loans to borrowers who can qualify at the loan’s fully indexedentity’s nonconvertible debt borrowing rate when interest rates.cost is recognized in subsequent periods. This high credit quality notwithstanding, lower initial payment requirements of MTA loans may increase the credit risk inherent in our portfolio of loans held-in-portfolio and our portfolio of loans held-for-sale. ThisFSP is because when the required monthly paymentseffective for pay-option loans eventually increase (in a period not to exceed 60 months), borrowers may be less able to pay the increased amounts and, therefore, more likely to default on the loan, than a borrower with an amortizing loan. Our exposure to this higher credit risk is increased by any negative amortization that has been added to the principal balance.
The following is a summary of the our MTA loan originations and purchases for year ended December 31, 2006 and 2005 as well as information on the negative amortization on these loans during the time periods presented:
Table 28 — Summary of MTA Loan Activity
(dollars in thousands)
2006 | 2005 | |||||||
MTA loans originated during the period | $ | 355,941 | $ | 91,232 | ||||
MTA bulk purchases during the period | 991,407 | — | ||||||
Total MTA originations or purchases | $ | 1,347,348 | $ | 91,232 | ||||
MTA loan portfolio at period end | $ | 1,219,447 | $ | 76,148 | ||||
Accumulated negative amortization during the period | $ | 29,541 | $ | 251 | ||||
Number of loans with negative amortization during the period | 3,295 | 172 | ||||||
Original Weighted Average LTV at period end | 80.4 | % | 77.1 | % | ||||
Original Weighted Average FICO score at period end | 708 | 707 | ||||||
Cost of Production.
The cost of production table below includes all costs paid and fees collected during the loan origination cycle, including loans that do not fund. This distinction is important as we can only capitalize as deferred broker premium and costs, those costs (net of fees) directly associated with a “funded” loan. Costs associated with loans that do not fund are recognized immediately as a component of general and administrative expenses. For loans held-for-sale, deferred net costs are recognized when the related loans are sold outright or transferred in securitizations. For loans held-in-portfolio, deferred net costs are recognized over the life of the loan as a reduction to interest income. The cost of our production is also critical to our financial results as it is a significant factor in the gains we recognize. Increased efficiencies in the nonconforming lending operation correlate to lower general and administrative costs and higher gains on sales of mortgage assets.
Table 29 —Cost of Production, as a Percent of Principal
For the Year Ended December 31, | Overhead Costs | Premium Paid to Broker, Net of Fees | Total Cost | ||||||
2006 | 1.49 | % | 0.54 | % | 2.03 | % | |||
2005 | 1.82 | % | 0.55 | % | 2.37 | % | |||
2004 | 1.94 | % | 0.83 | % | 2.77 | % |
We were able to reduce our overhead costs in both 2006 and 2005 from prior comparative years as a result of significant cost reduction and process improvement initiatives. During 2006, we were able to only slightly reduce the premium paid to broker, net of fees collected after significantly reducing this cost in 2005 from 2004. Our premiums paid to brokers are driven largely by market competition.
The following table is a reconciliation of our lending division’s overhead costs included in our cost of production to general and administrative expenses of the mortgage lending and loan servicing segment as shown in Note 16 to the consolidated financial statements presented in accordance with GAAP. We believeissued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company does not expect the adoption of this presentation of our cost of production provides useful information to investors regarding our financial performance because it more accurately reflects the direct costs of loan production and allows us to monitor the performance of our core operations, which is more difficult to do when looking at GAAP financial statements, and provides useful information regarding our financial performance. Management uses this measure for the same purpose. However, this presentation is not intended to be used as a substitute for financial results prepared in accordance with GAAP.
Table 30 – Reconciliation of Overhead Costs, Non-GAAP Financial Measure
(dollars in thousands, except lending overhead as a percentage)
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Mortgage lending general and administrative expenses (A) | $ | 150,281 | $ | 135,665 | $ | 136,089 | ||||||
Direct origination costs classified as a reduction in gain-on-sale | 29,923 | 54,020 | 52,179 | |||||||||
Other non-lending overhead expenses | (12,535 | ) | (21,075 | ) | (24,733 | ) | ||||||
Lending overhead costs | 167,669 | 168,610 | 163,535 | |||||||||
Premium paid to broker, net of fees collected | 59,771 | 51,830 | 69,619 | |||||||||
Total cost of loan production | $ | 227,440 | $ | 220,440 | $ | 233,154 | ||||||
Loan production, principal (B) | $ | 11,224,088 | $ | 9,283,138 | $ | 8,424,361 | ||||||
Total cost of production, as a percentage of loan production | 2.03 | % | 2.37 | % | 2.77 | % | ||||||
Mortgage Loan Servicing.
Servicing income, before amortization of mortgage servicing rights includes fee income and interest income, which is earned on custodial bank accounts. The costs of servicing include the general and administrative expenses incurred by our servicing operation as well as allocated corporate expenses.
Our annualized servicing income per loan before tax per unit increased to $177 for the year ended December 31, 2006 from $57 for the year ended December 31, 2005 and $2 for the year ended December 31, 2004. These increases are due largely to higher interest income earned on funds held as custodian which is a result of higher average balances in the accounts. In addition we are earning higher rates of interest on these funds due to the increase in short-term interest rates during the periods presented.
Table 31 — Summary of Servicing Operations
(dollars in thousands, except per loan cost)
2006 | 2005 | 2004 | ||||||||||||||||||||||
Amount | Per Loan (B) | Amount | Per Loan (B) | Amount | Per Loan (B) | |||||||||||||||||||
Unpaid principal at period end (A) | $ | 16,659,784 | $ | 14,030,697 | $ | 12,151,196 | ||||||||||||||||||
Number of loans at period end (A) | 107,237 | 98,287 | 87,543 | |||||||||||||||||||||
Average unpaid principal during the period (A) | $ | 15,753,024 | $ | 13,547,325 | $ | 9,881,848 | ||||||||||||||||||
Average number of loans during the period (A) | 104,044 | 96,726 | 72,415 | |||||||||||||||||||||
Servicing income, before amortization of mortgage servicing rights | $ | 86,939 | $ | 836 | $ | 68,370 | $ | 707 | $ | 41,793 | $ | 577 | ||||||||||||
Costs of servicing | (34,968 | ) | (336 | ) | (34,515 | ) | (357 | ) | (24,698 | ) | (341 | ) | ||||||||||||
Net servicing income, before amortization of mortgage servicing rights | 51,971 | 500 | 33,855 | 350 | 17,095 | 236 | ||||||||||||||||||
Amortization of mortgage servicing rights | (33,639 | ) | (323 | ) | (28,364 | ) | (293 | ) | (16,934 | ) | (234 | ) | ||||||||||||
$ | 18,332 | $ | 177 | $ | 5,491 | $ | 57 | $ | 161 | $ | 2 | |||||||||||||
Income Taxes
Since our inception, NFI has elected to be treated as a REIT for federal income tax purposes. So long as NFI maintains its status as a REIT, NFI is not required to pay any corporate level income taxes as long as we distribute 100 percent of our taxable income in the form of dividend distributions to our shareholders. To maintain our REIT status, NFI must meet certain requirements prescribed by the Code. We are, however, currently evaluating whether it is in shareholders’ best interests to retain our REIT status.
Below is a summary of the taxable net income available to common shareholders for the years ended December 31, 2006, 2005 and 2004.
Table 32 — Taxable Net Income
(dollars in thousands except per share)
For the Year Ended December 31, | ||||||||||||
2006 Estimated | 2005 Actual | 2004 Actual | ||||||||||
Consolidated net income | $ | 72,938 | $ | 139,124 | $ | 115,389 | ||||||
Equity in net loss (income) of NFI Holding Corporation | 5,512 | 24,678 | (2,517 | ) | ||||||||
Consolidation eliminations between the REIT and TRS | 10,955 | 2,073 | 2,800 | |||||||||
REIT net income | 89,405 | 165,875 | 115,672 | |||||||||
Adjustments to net income to compute taxable income | 97,875 | 111,210 | 141,148 | |||||||||
Taxable income before preferred dividends | 187,280 | 277,085 | 256,820 | |||||||||
Preferred dividends | (6,653 | ) | (6,653 | ) | (6,265 | ) | ||||||
Taxable net income available to common shareholders | $ | 180,627 | $ | 270,432 | $ | 250,555 | ||||||
Taxable net income per common share (A) | $ | 4.85 | $ | 8.40 | $ | 9.04 | ||||||
The primary differences between REIT net income and taxable income are due to the recognition of income on our portfolio of interest-only mortgage securities – available-for-sale, the deductibility of impairment losses on our mortgage securities, and the timing of deductibility of loan losses. Generally, the accrual of interest on interest-only securities is accelerated for income tax purposes. This is the result of the current original issue discount rules as promulgated under Code Sections 1271 through 1275. On September 30, 2004, the IRS released Announcement 2004-75. This Announcement describes rules that may be included in proposed regulations regarding the timing of income and/or deductions attributable to interest-only securities. As of December 31, 2006, no proposed regulations have been issued. Generally, impairment losses on securities are not deductible for income tax purposes until the losses become realized. The timing of deductibility for loan losses for income tax purposes is usually delayed compared to GAAP, because bad debts are not deductible for tax purposes until they become worthless.
The decline in estimated REIT taxable income for the year ended December 31, 2006 when compared to the same period in 2005 was primarily the result of a few significant items. The REIT’s GAAP net income decreased by $76.5 million from the year ended December 31, 2005 to the year ended December 31, 2006. Next, we structured two securitizations (NHES Series 2006-1 and NHES 2006-MTA1) as financing for both GAAP and tax purposes. Typically these securitizations would have been structured as sales and we would have retained certain of the residual securities from the transaction. These residual securities would normally generate taxable income in the form of original issue discount that is in excess of book income during the early life of the security. However, because the transactions were structured as financings, the acceleration of original issue discount did not occur on these transactions. Finally, interest rate derivative instruments held by the REIT increased taxable income during the year ended December 31, 2006 compared to the same period in 2005 due to the increase in LIBOR during 2006.
In order to satisfy ongoing REIT income tests we transferred certain securities that had historically been held by the REIT to the TRS. These securities receive income from derivative instruments that is not qualified REIT income. This transfer caused the derivative income to be recognized by the TRS instead of the REIT.
To maintain our qualification as a REIT, NFI is required to declare dividend distributions of at least 90 percent of our taxable income by the filing date of our federal tax return, including extensions. Any taxable income that has not been declared to be distributed by this date is subject to corporate income taxes. At this time, NFI has distributed all of its 2005 taxable income by the required distribution date. Accordingly, we have not accrued any corporate income tax for NFI for the year ended December 31, 2006.
As a REIT, NFI may be subject to a federal excise tax. An excise tax is incurred if NFI distributes less than 85 percent of its taxable income by the end of the calendar year. As part of the amount distributed by the end of the calendar year, NFI may include dividends that were declared in October, November or December and paid on or before January 31 of the following year. To the extent that 85 percent of our taxable income exceeds our dividend distributions in any given year, an excise tax of 4 percent is due and payable on the shortfall. For the year ended December 31, 2006 and 2005 we accrued excise tax expense of $4.6 million and $7.3 million, respectively. Excise tax is reflected in the other component of general and administrative expenses on our consolidated statements of income. As of December 31, 2006 and 2005, accrued excise tax payable was $4.7 million and $6.5 million, respectively. The excise tax payable is reflected as a component of accounts payable and other liabilities on our consolidated balance sheets.
NFI Holding Corporation, a wholly-owned subsidiary of NFI, and its subsidiaries (collectively known as “the TRS”) are treated as “taxable REIT subsidiaries.” The TRS is subject to corporate income taxes and files a consolidated federal income tax return. The TRS reported net income (loss) from continuing operations before income taxes of $(3.0) million for the year ended December 31, 2006 compared with $(19.6) million and $42.8 million for the same periods of 2005 and 2004, respectively. This resulted in an income tax (benefit) expense of $(1.8) million for the year ended December 31, 2006 compared with $(6.6) million and $16.8 million for the same periods in 2005 and 2004, respectively. The $(1.8) million tax benefit on $(3.0) million of loss from continuing operations in the year ended December 31, 2006 is exclusive of the deferral of $7.0 million tax expense related to the $18.5 million intercompany gain, which is eliminated in our consolidated statements of income. Additionally, the TRS reported a net (loss) income from discontinued operations before income taxes of $(6.8) million for the year ended December 31, 2006 compared with $(18.6) million and $(37.5) million for the same periods of 2005 and 2004, respectively. This resulted in an income tax benefit of $(2.5) million for the year ended December 31, 2006 compared with $(6.9) million and $(14.0) million for the same periods of 2005 and 2004, respectively.
During the past five years, we believe that a minority of our shareholders have been non-United States holders. Accordingly, we anticipate that NFIFSP will qualify as a “domestically-controlled REIT” for United States federal income tax purposes. Investors who are non-United States holders should contact their tax advisor regarding the United States federal income tax consequences of dispositions of shares of a “domestically-controlled REIT.”
Contractual Obligations
We have entered into certain long-term debt, hedging and lease agreements, which obligate us to make future payments to satisfy the related contractual obligations.
The following table summarizes our contractual obligations as of December 31, 2006, with the exception of short-term borrowing arrangements.
Table 33 — Contractual Obligations
(dollars in thousands)
Payments Due by Period | |||||||||||||||
Contractual Obligations | Total | Less than 1 Year | 1-3 Years | 4-5 Years | After 5 Years | ||||||||||
Long—term debt (A) | $ | 2,295,544 | $ | 790,589 | $ | 1,073,920 | $ | 431,035 | $ | — | |||||
Junior subordinated debentures (B) | 301,558 | 7,531 | 15,062 | 15,062 | 263,903 | ||||||||||
Operating leases (C) | 45,727 | 11,656 | 22,159 | 10,538 | 1,374 | ||||||||||
Purchase obligations (D) | 11,791 | 11,791 | — | — | — | ||||||||||
Premiums due to counterparties related to interest rate cap agreements | 3,916 | 1,793 | 1,455 | 495 | 173 | ||||||||||
Total | $ | 2,658,536 | $ | 823,360 | $ | 1,112,596 | $ | 457,130 | $ | 265,450 | |||||
We recorded deferred lease incentives, which will be amortized into rent expense over the life of the respective lease. Deferred lease incentives as of December 31, 2006 and 2005 were $3.0 million and $3.5 million, respectively.
We also entered into various sublease agreements for office space formerly occupied by us. We received approximately $861,000 in 2006 under these agreements compared to approximately $53,000 and $1.2 million in 2005 and 2004, respectively.
As of December 31, 2006 we had expected cash requirements for the payment of interest of $9.3 million on our debt obligations. The future amount of these interest payments will depend on the outstanding amount of our borrowings as well as the underlying rates for our variable rate borrowings. As of December 31, 2006 we had expected cash requirements for taxes of $5.9 million. The amount of taxes to be paid in the future will depend on taxable income in future periods as well as the amount and timing of dividend payments and other factors.
Liquidity and Capital Resources
Substantial cash is required to support our business operations. We strive to maintain adequate liquidity at all times to cover normal cyclical swings in funding availability and mortgage demand and to allow us to meet abnormal and unexpected funding requirements.
We believe that current cash balances, currently available financing facilities, capital raising capabilities and cash flows generated from our mortgage portfolio should adequately provide for required dividend payments and needs for business operations. However, if we are unable to raise capital in the future, we may not be able to grow as planned. Refer to “Risk Factors” for additional information regarding risks that could adversely affect our liquidity.
Factors management considers important in determining whether to finance our operations via warehouse and repurchase facilities, resecuritization or other asset-backed bond issuances or equity or debt offerings are as follows:
The financing costs involved.
The dilutive effect to our common shareholders.
The market price of our common stock.
Subordination rights of lenders and shareholders.
Collateral and other covenant requirements.
We had $150.5 million in cash and cash equivalents at December 31, 2006, which was a decrease of $114.2 million from December 31, 2005. At December 31, 2005 we had $264.7 million in cash and cash equivalents, which was a decrease of $3.9 million from December 31, 2004. One factor causing the decrease during 2006 is that we distributed two dividend payments during the fourth quarter of 2006 which increased our dividends paid significantly from 2005. In prior years, we generally have paid the dividend declared during the fourth quarter in January of the following year. Yet, in 2006, we distributed our fourth quarter dividend prior to December 31, 2006. Another significant factor is the amount of capital we have invested in haircuts related to our subordinated mortgage securities portfolio. As we purchase and aggregate these securities in preparation for a CDO securitization we leverage these securities at advance rates ranging from 75% to 89% of market value. These haircuts are funded from our cash reserves. Any subsequent margin calls are funded from our cash reserves as well.
The following table provides a summary of our operating, investing and financing cash flows as taken from our consolidated statements of cash flows for the years ended December 31, 2006, 2005 and 2004.
Table 34 — Summary of Operating, Investing and Financing Cash Flows
(dollars in thousands)
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Consolidated Statements of Cash Flows: | ||||||||||||
Cash used in operating activities | $ | (3,510,910 | ) | $ | (727,181 | ) | $ | (565,706 | ) | |||
Cash flows provided by investing activities | 809,307 | 467,017 | 376,215 | |||||||||
Cash flows provided by financing activities | 2,587,431 | 256,295 | 339,874 |
Operating Activities. Net cash used in operating activities increased to $(3.5) billion for the year ended December 31, 2006 from $(0.7) billion and $(0.6) billion for the years ended December 31, 2005 and 2004, respectively. This increase is due primarily to the issuance of $2.5 billion in asset-backed bonds secured by our mortgage loans held-in-portfolio in 2006. Because the loans securing these transactions were not sold in securitizations, the transactions are presented as financing activities rather than operating activities on our consolidated statements of cash flows for the year ended December 31, 2006. We had no loan securitization transactions structured as financings for accounting purposes during 2005 and 2004.
In addition, our cash used for originations and purchases of mortgage loans held-for-sale increased by $1.9 billion and $2.7 billon from 2005 and 2004, respectively. This is due to an increase in our overall loan production during 2006 compared to the prior two years. This increase was offset somewhat by the cash provided to us in 2006 from our sales on mortgage loans held-for-sale to third parties.
Investing Activities. Net cash provided by investing activities increased to $809.3 million for the year ended December 31, 2006 from $467.0 million and $376.2 million for the years ended December 31, 2005 and 2004, respectively. This increase is due primarily to higher repayments of our mortgage loans held-in-portfolio during 2006 compared to 2005 and 2004. This increase is offset somewhat by a decrease in paydowns on our mortgage securities – available-for-sale during 2006 compared to 2005 and 2004.
Financing Activities. Net cash provided by financing activities increased to $2.6 billion for the year ended December 31, 2006 from $0.3 billion and $0.3 billion for the years ended December 31, 2005 and 2004, respectively. This increase is due primarily to the issuance of $2.5 billion in asset-backed bonds secured by our mortgage loans held-in-portfolio during 2006. Because the loans securing these transactions were not sold in securitizations, the transactions are presented as financing activities rather than operating activities on our consolidated statements of cash flows for the year ended December 31, 2006.
Primary Uses of Cash
Investments in New Mortgage Securities.We retain significant interests in the nonconforming loans we originate and purchase through our mortgage securities investment portfolio. We require capital in our securitizations to fund the primary bonds we retain, overcollateralization, securitization expenses and our operating costs to originate the mortgage loans.
Our investments in new mortgage securities should generally increase or decrease in conjunction with our mortgage loan production. In 2005, because we began retaining certain subordinated primary bonds, the amount of capital needed for our securitizations increased. We will continue to retain certain subordinated primary bonds when we feel they provide attractive risk-adjusted returns. In addition in 2006 we began purchasing subordinated bonds from other issuers, which also requires capital. For the year ended December 31, 2006 we retained residual securities with a cost basis of $155.0 million and subordinated securities with a cost basis of $90.0 million from our securitization transactions. In addition we purchased subordinated securities with a cost basis of $205.1 million from other issuers. For the years ended December 31, 2005 and 2004 we retained residual securities with a cost basis of $289.5 million and $381.8 million, respectively. In 2005 we retained subordinated securities with a cost basis of $42.9 million from our securitization transactions. In 2005 we purchased no subordinated securities from other issuers. In 2004 we purchased subordinated securities with a cost basis of $143.2 million from other issuers.
Originations and Purchases of Mortgage Loans.Mortgage lending requires significant cash to fund loan originations and purchases. The capital invested in our mortgage loans is outstanding until we sell or securitize the loans. Initial capital invested in our mortgage loans includes premiums paid to the brokers plus any haircut required upon financing, which is generally determined by the value and type of the mortgage loan being financed. A haircut is the difference between the principal balance of a mortgage loan and the amount we can borrow from a lender when using that loan to secure the debt. As values of mortgage loans have decreased in 2005 and 2006, lenders have required larger haircuts, which has required us to invest more capital in our mortgage loans. Lender haircuts for performing loans have generally been between zero and two percent of the principal balance of our mortgage loans. In the future haircuts may fluctuate as the values for the market for our loans fluctuate. Margin compression within the mortgage banking industry has also resulted in a decline in the premiums we paid to brokers for our mortgage loans to 0.8% for the year ended December 31, 2006, excluding the premiums we paid to acquire our MTA bulk pools, from 1.1% and 1.3% for the years ended December 31, 2005 and 2004, respectively. We paid a premium of 3.4% to acquire our MTA bulk pools during 2006. For the years ended December 31, 2006, 2005 and 2004 we used $11.3 billion, $9.4 billion and $8.5 billion in cash for the origination and purchase of mortgage loans held-for-sale, respectively.
Repayments of Long-Term Borrowings.Our payments on asset-backed bonds increased to $565.2 million for the year ended December 31, 2006 from $363.9 million and $254.9 million for years ended 2005 and 2004, respectively. Long-term borrowing repayments will fluctuate with the timing of new issuances of long-term debt and their respective maturities. See “Primary Sources of Cash - Net Proceeds From Issuances of Long-Term Debt.”
Common and Preferred Stock Dividend Payments. To maintain our qualification as a REIT, we must distribute at least 90% of our REIT taxable income to our common shareholders in the form of dividend payments. Historically, we have generally declared dividends equal to 100% of our REIT taxable income. The amount and timing of future dividends are determined by our Board of Directors based on REIT tax requirements as well as our financial condition and business trends at the time of declaration. We are currently evaluating whether it is in shareholders’ best interests to retain our REIT status.
We declared common stock dividends per share of $5.60, $5.60 and $6.75 for the years ended December 31, 2006, 2005 and 2004, respectively. Preferred stock dividends declared per share were $2.23, $2.23 and $2.11 for the years ended December 31, 2006, 2005 and 2004, respectively.
Loan Sale and Securitization Repurchases. In the ordinary course of business, we sell whole pools of loans with recourse for borrower defaults. When whole pools are sold as opposed to securitized, the third party has recourse against us for certain borrower defaults. Because the loans are no longer on our balance sheet, the recourse component is considered a guarantee. During 2006, we sold $2.2 billion of loans with recourse for borrower defaults compared to $1.1 billion in 2005. We maintained a $24.8 million recourse reserve related to these guarantees as of December 31, 2006 compared with a reserve of $2.3 million as of December 31, 2005. We paid $21.3 million in cash to repurchase loans sold to third parties in 2006 and paid $2.3 million in 2005. The recourse reserve is our estimate of the loss we expect to incur in repurchasing the loan and then either liquidating or reselling the loan. The cash we must have on hand to repurchase these loans is much higher as we generally must reimburse the investor for the remaining unpaid principal balance, any premium recapture, any unpaid accrued interest and any other out-of-pocket advances in accordance with the loan sale agreement. Repurchased loans will subsequently be financed on our warehouse repurchase agreements if eligible and then liquidated or sold. See discussion of haircuts on these loans below in “Primary Sources of Cash – Change in Short-Term Borrowings, net (Warehouse Lending Arrangements).”
We also sell loans to securitization trusts and make a guarantee to cover losses suffered by the trust resulting from defects in the loan origination process. Defects may occur in the loan documentation and underwriting process, either through processing errors made by us or through intentional or unintentional misrepresentations made by the borrower or agents during those processes. If a defect is identified, we are required to repurchase the loan. As of December 31, 2006 and December 31, 2005, we had loans sold with recourse with an outstanding principal balance of $12.6 billion and $12.7 billion, respectively. Historically, repurchases of loans from securitization trusts where a defect has occurred have been insignificant. As a result, and because we have received no significant requests to repurchase loans from our securitization trusts as of December 31, 2006, we have not recorded any reserves related to these guarantees.
We have amended certain of our lending agreements to provide for financing of nonperforming repurchased loans. Please see “Primary Sources of Cash – Change in Short-Term Borrowings, net (Warehouse Lending Arrangements)” for further discussion of these amendments and the liquidity they provide.
Primary Sources of Cash
Change in Short-Term Borrowings, net (Warehouse Lending Arrangements). Mortgage lending requires significant cash to fund loan originations and purchases. Our warehouse lending arrangements, which include repurchase agreements generally having one-year terms, support our mortgage lending operation. Our warehouse repurchase agreements have various collateral advance rates depending on the collateral type or delinquency status. Generally, for performing mortgage loans our lending agreements provide for advances at the lesser of 98% of market value or 100% of par. Funding for the difference, or “haircut”, must come from cash on hand. Advance rates on nonperforming assets are generally tiered down depending on the delinquency severity and can range as low as 70% of the lesser of market value or principal balance. For our mortgage securities financings, our lending agreements have advance rates ranging from 40% to 90% of the market value, depending on the type, age and rating of the security. Most of our subordinated securities have an advance rate of 80% while our residual securities generally have an advance rate of 75%. Our proceeds from changes in short-term borrowings increased to $741.1 million for the year ended December 31, 2006 from $499.7 million and $53.8 million for the years ended December 31, 2005 and 2004, respectively. At December 31, 2006 we had $3 million of collateral lending value pledged under these agreements and available for financing. However, we had not utilized all borrowing capacity that would be available under these agreements upon the pledge of additional collateral.
Loans financed with warehouse repurchase credit facilities and securities financed with repurchase agreements are subject to changing market valuation and margin calls. The market value of our loans is dependent on a variety of economic conditions, including interest rates, borrower demand, borrower creditworthiness, and end investor desire and capacity. Market values of our loans have declined over the past year, but have remained in excess of par. However, there is no certainty that the prices will remain in excess of par. The market value of our securities is also dependent on a variety of economic conditions, including interest rates, default rates on the underlying loans and market demand for the types of securities we retain from our securitizations and purchase from other issuers. To the extent the value of the loans or securities declines below the required market value margin set forth in the lending agreements, we would be required to repay portions of the amounts we have borrowed.
All of our warehouse repurchase credit facilities include numerous representations, warranties and covenants, including requirements to maintain a certain minimum net worth, minimum equity ratios and other customary debt covenants. Events of default under these facilities include material breaches of representations or warranties, failure to comply with covenants, material adverse effects upon or changes in our business, assets, or financial condition, and other customary matters. Events of default under certain of our facilities also include termination of our status as servicer with respect to certain securitized loan pools and failure to maintain profitability over consecutive quarters. If we were unable to make the necessary representations and warranties at the time we need financing, we would not be able to obtain needed funds. In addition, if we breach any covenant or an event of default otherwise occurs under any warehouse repurchase credit facility under which borrowings are outstanding, the lenders under all existing warehouse repurchase credit facilities could demand immediate repayment of all outstanding amounts because all of our warehouse repurchase credit facilities contain cross-default provisions. While management believes we are in compliance with all applicable material covenants as of December 31, 2006, any future breach or noncompliance could have a material adverse effect on our financial condition. We may fail to satisfy the profitability covenant under one of our warehouse repurchase facilities if our GAAP net income, determined on a pre-tax basis, is not greater than $1 for the six months ended March 31, 2007. In the event that we do not obtain a modification or waiver of this requirement, the borrowing capacity under this facility would not be available to us so long as we remained out of compliance. Further, if at the time of noncompliance we continued to have borrowings outstanding under this facility, the breach would permit lenders under each of our warehouse repurchase facilities to accelerate all amounts then outstanding. While we currently have borrowings outstanding under this facility, we have the unilateral right to prepay these borrowings at any time. The borrowing capacity currently existing and expected to exist under our other warehouse repurchase agreements is adequate to permit a transfer of all collateral from this facility and management believes is adequate to maintain our current level of operations.
During 2006, we entered into three new securities repurchase agreements (the “residual repurchase facilities”) with credit limits aggregating $450 million. These facilities provide financing for our residual securities but can only be used for our newer residual securities, starting with the NMFT Series 2005-3. Each has a three-year term but contains a one-year revolving period at which time either party can terminate the right to enter into additional financings under the facility. Two of these agreements each provide for additional capacity of $150 million beyond the capacity we already have with our master repurchase agreements (“MRA”) for those particular lenders. One of the agreements does not provide for additional capacity beyond the maximum capacity we have in place under the MRA for that particular lender and essentially acts as a sub-limit underneath the overall capacity. At December 31, 2006 we had fully borrowed against the lending value of the collateral then pledged under these agreements, but had not utilized all borrowing capacity that would be available under these agreements upon the pledge of additional collateral.
In late 2006 and early 2007, we amended our lending agreements to provide for sub-limits for non-performing assets such as early payment defaults, first payment defaults, loans delinquent greater than 90 days, and real estate owned to help accommodate our financing needs in the current mortgage environment of rising delinquencies and loan repurchase requests. We have added $90 million of capacity for these assets and expect to add additional capacity in the first half of 2007. Advance rates on these assets are in a range of 70% to 95% of market value. This additional capacity can also be used to help finance the delinquent loans which come back on our balance sheet when we call an off-balance sheet securitization.
We also entered into a new securities repurchase agreement (the “CDO aggregation facility”) in 2006, having a one-year term, to provide for a maximum of $500 million of financing for the securities which we accumulate for our future CDO securitizations. This agreement provides for advance rates ranging from 50% to 89% of the security’s market value. The advance rates on trading securities which we have purchased as of December 31, 2006 range from 75% to 89%.
We also have the ability to leverage our receivables arising from servicing related advances as a source of liquidity. These receivables primarily represent advances we have made to securitization trusts as well as on behalf of borrowers for taxes and insurance. This loan agreement provides for capacity of $80 million, secured by the receivables, with an advance rate of 85%-90%. Capacity that we utilize under this facility reduces borrowing capacity available to us under the warehouse repurchase agreement that we have with this lender. This capacity also functions as a sub-limit underneath the overall MRA capacity for that particular lender. At December 31, 2006 we had fully borrowed against the lending value of the collateral then pledged under these agreements, but had not utilized all borrowing capacity that would be available under these agreements upon the pledge of additional collateral.
As shown in Table 35, we had $153.5 million in immediately available funds as of December 31, 2006 to support our mortgage lending and mortgage portfolio operations. We have borrowed approximately $2.2 billion of the $4.3 billion in mortgage securities, mortgage loans and servicing advance financing facilities, leaving approximately $2.1 billion available upon the pledge of eligible mortgage loans, securities or other collateral to support the mortgage lending and mortgage portfolio operations.
Table 35 — Short-term Financing Resources
(dollars in thousands)
Credit Limit | Lending Value of Collateral | Borrowings | Immediately Available Funds | |||||||||
Unrestricted cash | $ | 150,522 | ||||||||||
Mortgage securities, mortgage loans and servicing advance repurchase facilities | $ | 4,250,000 | $ | 2,155,208 | $ | 2,152,208 | 3,000 | |||||
Total | $ | 4,250,000 | $ | 2,155,208 | $ | 2,152,208 | $ | 153,522 | ||||
Cash Received From Our Mortgage Securities Portfolio.A major driver of cash flows from investing activities are the proceeds we receive from our mortgage securities—available-for-sale portfolio. For the year ended December 31, 2006 we received $327.2 million in proceeds from repayments on mortgage securities—available-for-sale as compared to $453.8 million and $346.6 million for years ended 2005 and 2004, respectively. The cash flows we receive on our mortgage securities—available-for-sale are highly dependent on the interest rate spread between the underlying collateral and the bonds issued by the securitization trusts and default and prepayment experience of the underlying collateral. The following factors have been the significant drivers in the overall fluctuations in these cash flows:
The coupons on the underlying collateral of our mortgage securities have increased modestly while the interest rates paid on the bonds issued by the securitization trusts have dramatically risen over the last couple of years.
The lower spreads are due in part to higher credit losses due to the substantial decline in housing price appreciation of the underlying collateral during 2006.
We have lower average balances of our mortgage securities—available-for-sale portfolio as our paydowns have increased faster than our addition of new bonds from our securitizations.
Proceeds from Repayments of Mortgage Loans. For the year ended December 31, 2006 we received $629.3 million in proceeds from the repayments of our portfolio of mortgage loans held-for-sale and mortgage loans held-in-portfolio compared to $26.6 million and $59.8 million for the years ended 2005 and 2004, respectively. The significant increase in repayments is due to a larger portfolio of mortgage loans held-in-portfolio in the current year as compared to 2005 and 2004.
Net Proceeds from Securitizations of Mortgage Loans. We depend on the capital markets to finance the mortgage loans we originate and purchase. The primary bonds we issue in our loan securitizations are sold to large, institutional investors and U.S. government-sponsored enterprises. If the non-conforming loan industry continues to experience credit difficulties, our ability to access the securitization market on favorable terms may be negatively affected. The net proceeds from sales of mortgage loans held-for-sale in securitizations decreased to $5.9 billion for the year ended December 31, 2006 from $7.4 billion and $8.2 billion for the years ended 2005 and 2004, respectively.
Net Proceeds from Sales of Mortgage Loans to Third Parties.We also depend on third party investors to provide liquidity for our mortgage loans. We generally will sell loans to third party investors that do not possess the economic characteristics meeting our long-term portfolio management objectives. For the years ended December 31, 2006, 2005 and 2004 we received net proceeds from the sales of mortgage loans held-for-sale to third parties of $2.3 billion, $1.2 billion and $64.5 million, respectively. The increase in proceeds from sales of mortgage loans to third parties is a result of the environment of tighter margins in the mortgage banking industry. These tighter margins prompted us to sell loans to third parties rather than adding them to our securitized portfolio due to unattractive returns.
Net Proceeds from Issuances of Long-Term Debt.The resecuritization of our mortgage securities—available-for-sale, on balance sheet securitizations, collateralized debt obligations as well as private debt offerings provide long-term sources of liquidity.
We received net proceeds of $1.3 billion and $1.2 billion, respectively, through the issuance of NHES Series 2006-1 and NHES Series 2006-MTA1 during the year ended December 31, 2006. These asset-backed bonds are collateralized by mortgage loans – held-in-portfolio on our consolidated balance sheet.
In 2005 we began retaining various subordinate investment-grade securities from our securitization transactions that were previously held in the form of overcollateralization bonds. We also purchase subordinated securities from other ABS issuers. We will continue to retain, acquire and aggregate various types of ABS as well as synthetic assets with the intention of securing non-recourse long-term financing using our portfolio of mortgage securities – trading as collateral. We executed our first CDO in February 2007.
We periodically issue asset-backed bonds (NIMs) secured by our mortgage securities – available-for-sale as a means for long-term non-recourse financing for these assets.
We received net proceeds of $33.9 million from the issuance of unsecured floating rate junior subordinated debentures during the year ended December 31, 2006 and $48.4 million for the year ended December 31, 2005 from the issuance of similar debentures. We had no issuances of these debentures in 2004. We will continue to take advantage of this market when we feel we can issue debt at more attractive costs than issuing capital stock.
Net Proceeds from Issuances Equity or Debt or the Retention of Cash Flow. If our board of directors determines that additional financing is required, we may raise the funds through additional equity offerings, debt financings, retention of cash flow (subject to provisions in the Code concerning distribution requirements and taxability of undistributed REIT taxable income, so long as we remain a REIT) or a combination of these methods. In the event that our board of directors determines to raise additional equity capital, it has the authority, without stockholder approval, subject to applicable law and NYSE regulations, to issue additional common stock or preferred stock in any manner and on terms and for consideration it deems appropriate up to the amount of authorized stock set forth in our charter. Since inception, we have raised $563.5 million in net proceeds through private and public equity offerings.
In 2006, we sold 2,938,200 shares of common stock under our Direct Stock Purchase and Dividend Reinvestment Plan (DRIP) raising $85.4 million in net proceeds, 2,000,000 shares of common stock were sold in a registered controlled equity offering raising $57.5 million in net proceeds and we issued 130,444 shares of common stock under the stock-based compensation plan raising $0.6 million in net proceeds.
In 2005, we completed a public offering of 1,725,000 shares of common stock raising $57.9 million in net proceeds. Additionally, we sold 2,609,320 shares of common stock under our DRIP raising $83.6 million in net proceeds and 148,797 shares of common stock under the stock-based compensation plan raising $0.7 million.
In 2004, we completed a public offering of 1,725,000 shares of common stock raising $70.1 million in net proceeds. Additionally, we sold 1,104,488 shares of common stock under our DRIP raising $49.4 million in net proceeds and 433,181 shares of common stock under the stock-based compensation plan raising $2.0 million. We also sold 2,990,000 shares of redeemable preferred stock raising $72.1 million in net proceeds.
Other Liquidity Factors
The derivative financial instruments we use also subject us to “margin call” risk. Under our interest rate swaps, we pay a fixed rate to the counterparties while they pay us a floating rate. When floating rates are lower than the fixed rate on the interest rate swap, we are paying the counterparty. In order to mitigate credit exposure to us, the counterparty requires us to post margin deposits with them. As of December 31, 2006, we had approximately $5.7 million on deposit with counterparties. A decline in interest rates would subject us to additional exposure for cash margin calls. However, when short-term interest rates (the basis for our funding costs) are low and the coupon rates on our loans are high, our net interest margin (and therefore incoming cash flow) is high which should offset any requirement to post additional collateral. Severe and immediate changes in interest rates will impact the volume of our incoming cash flow. To the extent rates increase dramatically, our funding costs will increase quickly. While many of our loans are adjustable, they typically will not reset as quickly as our funding costs. This circumstance would reduce incoming cash flow. As noted above, derivative financial instruments are used to mitigate the effect of interest rate volatility. In this rising rate situation, our interest rate swaps and caps would provide additional cash flows to mitigate the lower cash flow on loans and securities.
Table 33 details our major contractual obligations due over the next 12 months and beyond. Management believes cash and cash equivalents on hand combined with other available liquidity sources including: 1) proceeds from mortgage loan sales and securitizations, 2) cash received on our mortgage securities available-for-sale, 3) draw downs on mortgage loan and securities repurchase agreements, 4) proceeds from private and public debt and equity offerings and 5) proceeds from resecuritizations will be adequate to meet our liquidity needs for the next twelve months. In addition, we do not believe our long-term growth plans will be constrained due to a lack of available liquidity resources. However, we can provide no assurance, that, if needed, the liquidity resources we utilize will be available or will be available on terms we consider favorable. Factors that can affect our liquidity are discussed in the “Risk Factors” section of this document.
Off-Balance Sheet Arrangements
As discussed previously, we pool the loans we originate and purchase and typically securitize them to obtain long-term financing for the assets. The loans are transferred to a trust where they serve as collateral for asset-backed bonds, which the trust issues to the public. Our ability to use the securitization capital market is critical to the operations of our business.
External factors that are reasonably likely to affect our ability to continue to use this arrangement would be those factors that could disrupt the securitization capital market. A disruption in the market could prevent us from being able to sell the securities at a favorable price, or at all. Factors that could disrupt the securitization market include an international liquidity crisis such as occurred in the fall of 1998, sudden changes in interest rates, a terrorist attack, outbreak of war or other significant event risk, and market specific events such as a default of a comparable type of securitization. If we were unable to access the securitization market, we may still be able to finance our mortgage operations by selling our loans to investors in the whole loan market. We were able to do this following the liquidity crisis in 1998; however, there can be no assurance that in a future liquidity crisis that we would be able to obtain sufficient liquidity to support our historic operations.
Specific items that may affect our ability to use the securitizations to finance our loans relate primarily to the performance of the loans that have been securitized. Extremely poor loan performance may lead to poor bond performance and investor unwillingness to buy bonds supported by our collateral. Our financial performance and condition has little impact on our ability to securitize, as evidenced by our ability to securitize in 1998, 1999 and 2000 when ourits financial condition was weak. There is no assurance, however, that we will be able to securitize loans in the future if we have poor loan performance.
We have commitments to borrowers to fund residential mortgage loans as well as commitments to purchase and sell mortgage loans to third parties. Asor results of December 31, 2006, we had outstanding commitments to originate and purchase loans of $774.0 million and $11.8 million, respectively. We had no outstanding commitments to sell loans at December 31, 2006. As of December 31, 2005, we had outstanding commitments to originate, purchase and sell loans of $545.4 million, $33.4 million and $93.6 million, respectively. The commitments to originate and purchase loans do not necessarily represent future cash requirements, as some portion of the commitments are likely to expire without being drawn upon or may be subsequently declined for credit or other reasons.
In the ordinary course of business, we sell whole pools of loans to investors with recourse for borrower defaults. We also sell loans to securitization trusts and make a guarantee to cover losses suffered by the trust resulting from defects in the loan origination process. See “Liquidity and Capital Resources – Primary Uses of Cash – Loan Sale and Securitization Repurchases” for further discussion of these guarantees and recourse obligations.
operation.
Impact of Recently Issued Accounting Pronouncements
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”, an amendment of FASB Statements No. 133 and SFAS No. 140 (“SFAS 155”). This statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. It also clarifies which interest-only strips and principal-only strips are not subject to FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). The statement also establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or hybrid financial instruments that contain an embedded derivative requiring bifurcation. The statement also clarifies that concentration of credit risks in the form of subordination are not embedded derivatives, and it also amends SFAS 140 to eliminate the prohibition on a Qualifying Special Purpose Entity (“QSPE”) from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006.
In January 2007, the FASB provided a scope exception under FAS 155 for securitized interests that only contain an embedded derivative that is tied to the prepayment risk of the underlying prepayable financial assets, and for which the investor does not control the right to accelerate the settlement. If a securitized interest contains any other embedded derivative (for example, an inverse floater), then it would be subject to the bifurcation tests in FAS 133, as would securities purchased at a significant premium. Following the issuance of the scope exception by the FASB, changes in the market value of our investment securities would continue to be made through other comprehensive income, a component of stockholders’ equity. We do not expect that the adoption of FAS 155 will have a material impact on our financial position, results of operations or cash flows. However, to the extent that certain of our future investments in securitized financial assets do not meet the scope exception adopted by the FASB, our future results of operations may exhibit volatility if such investments are required to be bifurcated or marked to market value in their entirety through the income statement, depending on the election made.
In March 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 156, “Accounting for Servicing of Financial Assets”, an amendment of SFAS No. 140 (“SFAS 156”). This statement requires that an entity separately recognize a servicing asset or a servicing liability when it undertakes an obligation to service a financial asset under a servicing contract in certain situations. Such servicing assets or servicing liabilities are required to be initially measured at fair value, if practicable. SFAS 156 also allows an entity to choose one of two methods when subsequently measuring its servicing assets and servicing liabilities: (1) the amortization methodor (2) the fair value measurement method. The amortization method existed under SFAS 140 and remains unchanged in (1) allowing entities to amortize their servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and (2) requiring the assessment of those servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date. The fair value measurement method allows entities to measure their servicing assets or servicing liabilities at fair value each reporting date and report changes in fair value in earnings in the period the change occurs. SFAS 156 introduces the notion ofclassesand allows companies to make a separate subsequent measurement election for each class of its servicing rights. In addition, SFAS 156 requires certain comprehensive roll-forward disclosures that must be presented for each class. The Statement is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, so long as the entity has not yet issued financial statements, including financial statements for any interim period, for that fiscal year. We do not expect the adoption of SFAS 156 will have a material impact on our consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or to be taken on a tax return. This interpretation also provides additional guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation is effective for fiscal years after December 15, 2006. We will adopt the provisions of FIN 48 beginning in the first quarter of 2007. The cumulative effect of applying the provisions of FIN 48 will be reported as an adjustment to the opening balance of retained earnings on January 1, 2007. We do not expect the adoption of FIN 48 to have a material impact to our consolidated financial statements; however, we are still in the process of completing our evaluation of the impact of adopting FIN 48.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. This accounting standard is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are still evaluating the impact the adoption of this statement will have on our consolidated financial statements.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB No. 108”). SAB No. 108 provides guidance regarding the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of materiality assessments. The method established by SAB No. 108 requires each of our financial statements and the related financial statement disclosures to be considered when quantifying and assessing the materiality of the misstatement. The provisions of SAB 108 are effective for financial statements issued for fiscal years beginning after December 31, 2006. We are still evaluating the impact the adoption of this statement will have on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. This accounting standard is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are still evaluating the impact the adoption of this statement will have on our consolidated financial statements.
See discussion under “Interest Rate/Market Risk” in “Item 1. Business”.
December 31, | ||||||||
2006 | 2005 | |||||||
Assets | ||||||||
Cash and cash equivalents | $ | 150,522 | $ | 264,694 | ||||
Mortgage loans – held-for-sale | 1,741,819 | 1,291,556 | ||||||
Mortgage loans – held-in-portfolio, net of allowance of $22,452 and $699, respectively | 2,116,535 | 28,840 | ||||||
Mortgage securities – available-for-sale | 349,312 | 505,645 | ||||||
Mortgage securities – trading | 329,361 | 43,738 | ||||||
Mortgage servicing rights | 62,830 | 57,122 | ||||||
Deferred income tax asset, net | 47,188 | 30,780 | ||||||
Servicing related advances | 40,923 | 26,873 | ||||||
Warehouse notes receivable | 39,462 | 25,390 | ||||||
Accrued interest receivable | 37,692 | 4,866 | ||||||
Real estate owned | 21,534 | 1,208 | ||||||
Derivative instruments, net | 16,816 | 12,765 | ||||||
Other assets | 74,269 | 42,257 | ||||||
Total assets | $ | 5,028,263 | $ | 2,335,734 | ||||
Liabilities and Shareholders’ Equity | ||||||||
Liabilities: | ||||||||
Short-term borrowings secured by mortgage loans | $ | 1,631,773 | $ | 1,238,122 | ||||
Short-term borrowings secured by mortgage securities | 503,680 | 180,447 | ||||||
Other short-term borrowings | 16,755 | — | ||||||
Asset-backed bonds secured by mortgage loans | 2,067,490 | 26,949 | ||||||
Asset-backed bonds secured by mortgage securities | 9,519 | 125,630 | ||||||
Junior subordinated debentures | 83,041 | 48,664 | ||||||
Due to securitization trusts | 107,043 | 44,382 | ||||||
Dividends payable | 1,663 | 45,070 | ||||||
Accounts payable and other liabilities | 92,729 | 62,250 | ||||||
Total liabilities | 4,513,693 | 1,771,514 | ||||||
Commitments and contingencies (Note 9) | ||||||||
Shareholders’ equity: | ||||||||
Capital stock, $0.01 par value, 50,000,000 shares authorized: | ||||||||
Redeemable preferred stock, $25 liquidating preference per share; 2,990,000 shares, issued and outstanding | 30 | 30 | ||||||
Common stock, 37,261,252 and 32,193,101 shares, issued and outstanding, respectively | 373 | 322 | ||||||
Additional paid-in capital | 741,748 | 581,580 | ||||||
Accumulated deficit | (263,572 | ) | (128,554 | ) | ||||
Accumulated other comprehensive income | 36,548 | 111,538 | ||||||
Other | (557 | ) | (696 | ) | ||||
Total shareholders’ equity | 514,570 | 564,220 | ||||||
Total liabilities and shareholders’ equity | $ | 5,028,263 | $ | 2,335,734 | ||||
December 31, | ||||||||
2008 | 2007 | |||||||
Assets | ||||||||
Unrestricted cash and cash equivalents | $ | 24,790 | $ | 25,364 | ||||
Restricted cash | 6,046 | 8,998 | ||||||
Mortgage loans – held-in-portfolio, net of allowance of $776,001 and $230,138, respectively | 1,772,838 | 2,870,013 | ||||||
Mortgage securities - trading | 7,085 | 109,203 | ||||||
Mortgage securities - available-for-sale | 12,788 | 33,371 | ||||||
Real estate owned | 70,480 | 76,614 | ||||||
Accrued interest receivable | 77,292 | 61,704 | ||||||
Other assets | 5,704 | 37,244 | ||||||
Assets of discontinued operations | 1,441 | 8,255 | ||||||
Total assets | $ | 1,978,464 | $ | 3,230,766 | ||||
Liabilities and Shareholders’ Deficit | ||||||||
Liabilities: | ||||||||
Asset-backed bonds secured by mortgage loans | $ | 2,599,351 | $ | 3,065,746 | ||||
Asset-backed bonds secured by mortgage securities | 5,376 | 74,385 | ||||||
Short-term borrowings secured by mortgage securities | - | 45,488 | ||||||
Junior subordinated debentures | 77,323 | 83,561 | ||||||
Due to servicer | 117,635 | 56,450 | ||||||
Dividends payable | 19,088 | 3,816 | ||||||
Accounts payable and other liabilities | 33,928 | 53,392 | ||||||
Liabilities of discontinued operations | 2,536 | 59,416 | ||||||
Total liabilities | 2,855,237 | 3,442,254 | ||||||
Commitments and contingencies (Note 7) | ||||||||
Shareholders’ deficit: | ||||||||
Capital stock, $0.01 par value, 50,000,000 shares authorized: | ||||||||
Redeemable preferred stock, $25 liquidating preference per share; 2,990,000 shares, issued and outstanding | 30 | 30 | ||||||
Convertible participating preferred stock, $25 liquidating preference per share; 2,100,000 shares, issued and outstanding | 21 | 21 | ||||||
Common stock, 9,368,053 and 9,439,273 shares, issued and outstanding, respectively | 94 | 94 | ||||||
Additional paid-in capital | 786,279 | 786,342 | ||||||
Accumulated deficit | (1,671,984 | ) | (996,649 | ) | ||||
Accumulated other comprehensive income (loss) | 8,926 | (1,117 | ) | |||||
Other | (139 | ) | (209 | ) | ||||
Total shareholders’ deficit | (876,773 | ) | (211,488 | ) | ||||
Total liabilities and shareholders’ deficit | $ | 1,978,464 | $ | 3,230,766 |
OPERATIONS
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Interest income | $ | 494,890 | $ | 320,727 | $ | 230,845 | ||||||
Interest expense | 235,331 | 80,755 | 52,482 | |||||||||
Net interest income before provision for credit losses | 259,559 | 239,972 | 178,363 | |||||||||
Provision for credit losses | (30,131 | ) | (1,038 | ) | (726 | ) | ||||||
Net interest income | 229,428 | 238,934 | 177,637 | |||||||||
Other operating income (expense): | ||||||||||||
Gains on sales of mortgage assets | 41,749 | 65,148 | 144,950 | |||||||||
Gains (losses) on derivative instruments | 11,998 | 18,155 | (8,905 | ) | ||||||||
Impairment on mortgage securities – available-for-sale | (30,690 | ) | (17,619 | ) | (15,902 | ) | ||||||
Fee income | 29,032 | 30,678 | 30,668 | |||||||||
Premiums for mortgage loan insurance | (12,419 | ) | (5,672 | ) | (4,218 | ) | ||||||
Other income (expense), net | 647 | (784 | ) | (272 | ) | |||||||
Total other operating income | 40,317 | 89,906 | 146,321 | |||||||||
General and administrative expenses: | ||||||||||||
Compensation and benefits | 124,156 | 100,492 | 87,887 | |||||||||
Office administration | 27,491 | 28,453 | 26,496 | |||||||||
Professional and outside services | 21,020 | 18,120 | 17,207 | |||||||||
Loan Expense | 7,416 | 13,155 | 14,411 | |||||||||
Marketing | 4,908 | 2,817 | 6,386 | |||||||||
Other | 16,270 | 21,593 | 15,873 | |||||||||
Total general and administrative expenses | 201,261 | 184,630 | 168,260 | |||||||||
Income from continuing operations before income tax (benefit) expense | 68,484 | 144,210 | 155,698 | |||||||||
Income tax (benefit) expense | (8,721 | ) | (6,617 | ) | 16,756 | |||||||
Income from continuing operations | 77,205 | 150,827 | 138,942 | |||||||||
Loss from discontinued operations, net of income tax | (4,267 | ) | (11,703 | ) | (23,553 | ) | ||||||
Net income | 72,938 | 139,124 | 115,389 | |||||||||
Dividends on preferred shares | (6,653 | ) | (6,653 | ) | (6,265 | ) | ||||||
Net income available to common shareholders | $ | 66,285 | $ | 132,471 | $ | 109,124 | ||||||
Basic earnings per share: | ||||||||||||
Income from continuing operations available to common shareholders | $ | 2.07 | $ | 4.86 | $ | 5.24 | ||||||
Loss from discontinued operations, net of income tax | (0.13 | ) | (0.40 | ) | (0.93 | ) | ||||||
Net income available to common shareholders | $ | 1.94 | $ | 4.46 | $ | 4.31 | ||||||
Diluted earnings per share: | ||||||||||||
Income from continuing operations available to common shareholders | $ | 2.04 | $ | 4.81 | $ | 5.15 | ||||||
Loss from discontinued operations, net of income tax | (0.12 | ) | (0.39 | ) | (0.91 | ) | ||||||
Net income available to common shareholders | $ | 1.92 | $ | 4.42 | $ | 4.24 | ||||||
Weighted average basic shares outstanding | 34,212 | 29,669 | 25,290 | |||||||||
Weighted average diluted shares outstanding | 34,472 | 29,993 | 25,763 | |||||||||
Dividends declared per common share | $ | 5.60 | $ | 5.60 | $ | 6.75 | ||||||
For the Year Ended December 31, | ||||||||
2008 | 2007 | |||||||
Interest income | $ | 235,009 | $ | 366,246 | ||||
Interest expense | 114,980 | 228,369 | ||||||
Net interest income before provision for credit losses | 120,029 | 137,877 | ||||||
Provision for credit losses | (707,364 | ) | (265,288 | ) | ||||
Net interest expense after provision for credit losses | (587,335 | ) | (127,411 | ) | ||||
Other operating expense: | ||||||||
Gains on debt extinguishment | 6,418 | - | ||||||
Losses on derivative instruments | (18,094 | ) | (10,997 | ) | ||||
Fair value adjustments | (25,743 | ) | (85,803 | ) | ||||
Impairments on mortgage securities – available-for-sale | (23,100 | ) | (98,692 | ) | ||||
Servicing fee expense | (13,596 | ) | (2,592 | ) | ||||
Appraisal fee income | 2,524 | - | ||||||
Appraisal fee expense | (1,693 | ) | - | |||||
Premiums for mortgage loan insurance | (15,847 | ) | (16,462 | ) | ||||
Other (expense) income, net | (19 | ) | 392 | |||||
Total other operating expense | (89,150 | ) | (214,154 | ) | ||||
General and administrative expenses: | ||||||||
Office administration | 9,407 | 12,565 | ||||||
Professional and outside services | 7,019 | 21,811 | ||||||
Compensation and benefits | 5,944 | 27,688 | ||||||
Other appraisal management expenses | 1,170 | - | ||||||
Other expense (income) | 881 | (2,644 | ) | |||||
Total general and administrative expenses | 24,421 | 59,420 | ||||||
Loss from continuing operations before income tax (benefit) | (700,906 | ) | (400,985 | ) | ||||
Income tax (benefit) expense | (17,594 | ) | 66,512 | |||||
Loss from continuing operations | (683,312 | ) | (467,497 | ) | ||||
Income (loss)from discontinued operations, net of income tax | 22,830 | (256,780 | ) | |||||
Net loss | $ | (660,482 | ) | $ | (724,277 | ) | ||
Basic earnings per share: | ||||||||
Loss from continuing operations available to common shareholders | $ | (74.81 | ) | $ | (51.04 | ) | ||
Income (loss) from discontinued operations, net of income tax | 2.44 | (27.51 | ) | |||||
Net loss available to common shareholders | $ | (72.37 | ) | $ | (78.55 | ) | ||
Diluted earnings per share: | ||||||||
Loss from continuing operations available to common shareholders | $ | (74.81 | ) | $ | (51.04 | ) | ||
Income (loss) from discontinued operations, net of income tax | 2.44 | (27.51 | ) | |||||
Net loss available to common shareholders | $ | (72.37 | ) | $ | (78.55 | ) | ||
Weighted average basic shares outstanding | 9,338,131 | 9,332,405 | ||||||
Weighted average diluted shares outstanding | 9,338,131 | 9,332,405 |
DEFICIT
Preferred Stock | Common Stock | Additional Paid-in Capital | Accumulated Deficit | Accumulated Other Comprehensive Income | Other | Total Shareholders’ Equity | |||||||||||||||||||
Balance, January 1, 2004 | $ | — | $ | 245 | $ | 231,294 | $ | (15,522 | ) | $ | 85,183 | $ | (976 | ) | $ | 300,224 | |||||||||
Forgiveness of founders’ notes receivable | — | — | — | — | — | 140 | 140 | ||||||||||||||||||
Issuance of common stock, 2,829,488 shares | — | 28 | 121,306 | — | — | — | 121,334 | ||||||||||||||||||
Issuance of preferred stock, 2,990,000 shares | 30 | — | 72,089 | — | — | — | 72,119 | ||||||||||||||||||
Issuance of stock under stock compensation plans, 433,181 shares | — | 4 | 3,811 | — | — | — | 3,815 | ||||||||||||||||||
Compensation recognized under stock compensation plans | — | — | 1,810 | — | — | — | 1,810 | ||||||||||||||||||
Dividend equivalent rights (DERs) on vested options | — | — | 1,900 | (1,900 | ) | — | — | — | |||||||||||||||||
Dividends on common stock ($6.75 per share) | — | — | — | (177,056 | ) | — | — | (177,056 | ) | ||||||||||||||||
Dividends on preferred stock ($2.11 per share) | — | — | — | (6,265 | ) | — | — | (6,265 | ) | ||||||||||||||||
Tax benefit derived from stock compensation plans | — | — | 897 | — | — | — | 897 | ||||||||||||||||||
Comprehensive income: | |||||||||||||||||||||||||
Net income | 115,389 | 115,389 | |||||||||||||||||||||||
Other comprehensive loss | (6,063 | ) | (6,063 | ) | |||||||||||||||||||||
Total comprehensive income | 109,326 | ||||||||||||||||||||||||
Balance, December 31, 2004 | $ | 30 | $ | 277 | $ | 433,107 | $ | (85,354 | ) | $ | 79,120 | $ | (836 | ) | $ | 426,344 | |||||||||
Redeemable Preferred Stock | Convertible Participating Preferred Stock | Common Stock | Additional Paid-in Capital | Accumulated Deficit | Accumulated Other Comprehensive (Loss) Income | Other | Total Share- holders’ Equity (Deficit) | |||||||||||||||||||||||||
Balance, January 1, 2007 | $ | 30 | $ | - | $ | 93 | $ | 742,028 | $ | (263,572 | ) | $ | 36,548 | $ | (557 | ) | $ | 514,570 | ||||||||||||||
Cumulative effect adjustment from adoption of SFAS 157 | - | - | - | - | 5,430 | - | - | 5,430 | ||||||||||||||||||||||||
Cumulative effect adjustment from adoption of SFAS 159 | - | - | - | - | (1,131 | ) | 1,131 | - | - | |||||||||||||||||||||||
Cumulative effect adjustment from adoption of FIN 48 | - | - | - | - | (1,072 | ) | - | - | (1,072 | ) | ||||||||||||||||||||||
Forgiveness of founders’ notes receivable | - | - | - | - | - | - | 348 | 348 | ||||||||||||||||||||||||
Issuance of preferred stock, 2,100,000 shares | - | 21 | - | 43,591 | - | - | - | 43,612 | ||||||||||||||||||||||||
Preferred stock beneficial conversion feature | - | - | - | 3,825 | (3,825 | ) | - | - | - | |||||||||||||||||||||||
Issuance of common stock, 35,094 shares | - | - | - | 3,190 | - | - | - | 3,190 | ||||||||||||||||||||||||
Issuance of stock under stock compensation plans, 88,867 shares | - | - | 1 | 209 | - | - | - | 210 | ||||||||||||||||||||||||
Compensation recognized under stock compensation plans | - | - | - | 707 | - | - | - | 707 | ||||||||||||||||||||||||
Dividends on preferred stock ($1.67 per share declared) | - | - | - | (8,805 | ) | - | - | (8,805 | ) | |||||||||||||||||||||||
Reversal of tax benefit derived from capitalization of affiliates | - | - | - | (7,195 | ) | - | - | (7,195 | ) | |||||||||||||||||||||||
Other | - | - | (13 | ) | 603 | - | - | 590 | ||||||||||||||||||||||||
Comprehensive loss: | ||||||||||||||||||||||||||||||||
Net loss | - | - | - | - | (724,277 | ) | - | - | (724,277 | ) | ||||||||||||||||||||||
Other comprehensive loss | - | - | - | - | - | (38,796 | ) | - | (38,796 | ) | ||||||||||||||||||||||
Total comprehensive loss | - | - | - | - | - | - | - | (763,073 | ) | |||||||||||||||||||||||
Balance, December 31, 2007 | $ | 30 | $ | 21 | $ | 94 | $ | 786,342 | $ | (996,649 | ) | $ | (1,117 | ) | $ | (209 | ) | $ | (211,488 | ) |
Balance, January 1, 2005 Forgiveness of founders’ notes receivable Issuance of common stock, 4,334,320 shares Issuance of stock under stock compensation plans, 148,797 shares Compensation recognized under stock compensation plans Dividend equivalent rights (DERs) on vested options Dividends on common stock ($5.60 per share) Dividends on preferred stock ($2.23 per share) Other Comprehensive income: Net income Other comprehensive income Total comprehensive income Balance, December 31, 2005 Preferred
Stock Common
Stock Additional
Paid-in
Capital Accumulated
Deficit Accumulated
Other
Comprehensive
Income Other Total
Shareholders’
Equity $ 30 $ 277 $ 433,107 $ (85,354 ) $ 79,120 $ (836 ) $ 426,344 — — — — — 140 140 — 43 145,313 — — — 145,356 — 2 921 — — — 923 — — 2,226 — — — 2,226 — — 304 (4,369 ) — — (4,065 ) — — — (171,302 ) — — (171,302 ) — — — (6,653 ) — — (6,653 ) — — (291 ) — — (291 ) 139,124 139,124 32,418 32,418 171,542 $ 30 $ 322 $ 581,580 $ (128,554 ) $ 111,538 $ (696 ) $ 564,220
Continued
Balance, January 1, 2006 Forgiveness of founders’ notes receivable Issuance of common stock, 4,938,200 shares Issuance of stock under stock compensation plans, 130,444 shares Compensation recognized under stock compensation plans Dividend equivalent rights (DERs) on vested options Dividends on common stock ($5.60 per share) Dividends on preferred stock ($2.23 per share) Common stock repurchased, 493 shares Tax benefit derived from capitalization of affiliate Other Comprehensive income: Net income Other comprehensive loss Total comprehensive loss Balance, December 31, 2006 Preferred
Stock Common
Stock Additional
Paid-in
Capital Accumulated
Deficit Accumulated
Other
Comprehensive
Income Other Total
Shareholders’
Equity $ 30 $ 322 $ 581,580 $ (128,554 ) $ 111,538 $ (696 ) $ 564,220 — — — — — 139 139 — 50 148,741 — — — 148,791 — 1 906 — — — 907 — — 2,548 — — — 2,548 — — 825 (3,084 ) — — (2,259 ) — — — �� (198,219 ) — — (198,219 ) — — — (6,653 ) — — (6,653 ) — — (17 ) — — — (17 ) — — 7,173 — — — 7,173 — — (8 ) — — — (8 ) 72,938 72,938 (74,990 ) (74,990 ) (2,052 ) $ 30 $ 373 $ 741,748 $ (263,572 ) $ 36,548 $ (557 ) $ 514,570
Redeemable Preferred Stock | Convertible Participating Preferred Stock | Common Stock | Additional Paid-in Capital | Accumulated Deficit | Accumulated Other Comprehensive (Loss) Income | Other | Total Share- holders’ Deficit | |||||||||||||||||||||||||
Balance, January 1, 2008 | $ | 30 | $ | 21 | $ | 94 | $ | 786,342 | $ | (996,649 | ) | $ | (1,117 | ) | $ | (209 | ) | $ | (211,488 | ) | ||||||||||||
Forgiveness of founders’ notes receivable | - | - | - | - | - | - | 70 | 70 | ||||||||||||||||||||||||
Compensation recognized under stock compensation plans | - | - | - | (63 | ) | - | - | - | (63 | ) | ||||||||||||||||||||||
Accumulating dividends on preferred stock | - | - | - | - | (15,273 | ) | - | - | (15,273 | ) | ||||||||||||||||||||||
Other | - | - | - | - | 420 | - | - | 420 | ||||||||||||||||||||||||
Comprehensive loss: | ||||||||||||||||||||||||||||||||
Net loss | - | - | - | - | (660,482 | ) | - | - | (660,482 | ) | ||||||||||||||||||||||
Other comprehensive loss | - | - | - | - | - | 10,043 | - | 10,043 | ||||||||||||||||||||||||
Total comprehensive loss | - | - | - | - | - | - | - | (650,439 | ) | |||||||||||||||||||||||
Balance, December 31, 2008 | $ | 30 | $ | 21 | $ | 94 | $ | 786,279 | $ | (1,671,984 | ) | $ | 8,926 | $ | (139 | ) | $ | (876,773 | ) |
NOVASTAR FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Cash flows from operating activities: | ||||||||||||
Net Income | $ | 72,938 | $ | 139,124 | $ | 115,389 | ||||||
Loss from discontinued operations | 4,267 | 11,703 | 23,553 | |||||||||
Income from continuing operations | 77,205 | 150,827 | 138,942 | |||||||||
Adjustments to reconcile net income to net cash used in operating activities: | ||||||||||||
Amortization of mortgage servicing rights | 33,639 | 28,364 | 16,934 | |||||||||
Retention of mortgage servicing rights | (39,474 | ) | (43,476 | ) | (39,259 | ) | ||||||
Impairment on mortgage securities – available-for-sale | 30,690 | 17,619 | 15,902 | |||||||||
(Gains) losses on derivative instruments | (11,998 | ) | (18,155 | ) | 8,905 | |||||||
Depreciation expense | 7,266 | 7,433 | 6,090 | |||||||||
Amortization of deferred debt issuance costs | 3,408 | 5,683 | 5,036 | |||||||||
Compensation recognized under stock compensation plans | 2,548 | 2,226 | 1,810 | |||||||||
Provision for credit losses | 30,131 | 1,038 | 726 | |||||||||
Amortization of premiums on mortgage loans | 10,409 | 376 | 699 | |||||||||
Interest capitalized on loans held-in-portfolio | (29,541 | ) | — | — | ||||||||
Forgiveness of founders’ promissory notes | 139 | 140 | 140 | |||||||||
Provision for deferred income taxes | (8,589 | ) | (12,727 | ) | (1,322 | ) | ||||||
Accretion of available-for-sale and trading securities | (158,984 | ) | (172,019 | ) | (100,666 | ) | ||||||
Gains on sales of mortgage assets | (2,275 | ) | (21,672 | ) | (105,691 | ) | ||||||
Losses (gains) on trading securities | 3,192 | (549 | ) | — | ||||||||
Originations and purchases of mortgage loans held-for-sale | (11,275,926 | ) | (9,379,682 | ) | (8,539,944 | ) | ||||||
Proceeds from repayments of mortgage loans held-for-sale | 77,490 | 9,908 | 27,979 | |||||||||
Repurchase of mortgage loans from securitization trusts | (183,814 | ) | (6,784 | ) | — | |||||||
Proceeds from sale of mortgage loans held-for-sale to third parties | 2,260,845 | 1,176,518 | 64,476 | |||||||||
Proceeds from sale of mortgage loans held-for-sale in securitizations | 5,922,975 | 7,428,063 | 8,173,829 | |||||||||
Purchase of mortgage securities - trading | (205,078 | ) | — | (143,153 | ) | |||||||
Proceeds from paydowns of mortgage securities - trading | 9,436 | — | — | |||||||||
Proceeds from sale of mortgage securities - trading | 11,223 | 143,153 | — | |||||||||
Changes in: | ||||||||||||
Servicing related advances | (13,890 | ) | (6,752 | ) | (707 | ) | ||||||
Accrued interest receivable | (69,475 | ) | (35,296 | ) | (23,753 | ) | ||||||
Derivative instruments, net | (392 | ) | 2,509 | 13,553 | ||||||||
Other assets | (24,420 | ) | (9,809 | ) | (13,740 | ) | ||||||
Accounts payable and other liabilities | 30,154 | 19,572 | (24,692 | ) | ||||||||
Net cash used in operating activities from continuing operations | (3,513,106 | ) | (713,492 | ) | (517,906 | ) | ||||||
Net cash provided by (used in) operating activities from discontinued operations | 2,196 | (13,689 | ) | (47,800 | ) | |||||||
Net cash used in operating activities | (3,510,910 | ) | (727,181 | ) | (565,706 | ) | ||||||
Cash flows from investing activities: | ||||||||||||
Proceeds from paydowns on mortgage securities - available-for-sale | 327,218 | 453,750 | 346,558 | |||||||||
Purchase of mortgage securities – available-for-sale | (1,922 | ) | — | — | ||||||||
Proceeds from repayments of mortgage loans held-in-portfolio | 551,796 | 16,673 | 31,781 | |||||||||
Proceeds from sales of assets acquired through foreclosure | 2,341 | 1,909 | 4,905 | |||||||||
Acquisition of retail branches | (60,105 | ) | — | — | ||||||||
Purchases of property and equipment | (10,021 | ) | (5,315 | ) | (7,029 | ) | ||||||
Net cash provided by investing activities | 809,307 | 467,017 | 376,215 | |||||||||
Continued
Cash flows from financing activities: Proceeds from issuance of asset-backed bonds, net of debt issuance costs Payments on asset-backed bonds Payments on asset-backed bonds due to exercise of redemption provisions Proceeds from issuance of capital stock and exercise of equity instruments, net of offering costs Net change in short-term borrowings Proceeds from the issuance of junior subordinated debentures Repurchase of common stock Dividends paid on vested stock options Dividends paid on preferred stock Dividends paid on common stock Net cash provided by financing activities from continuing operations Net cash (used in) provided by financing activities from discontinued operations Net cash provided by financing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year For the Year Ended December 31, 2006 2005 2004 2,505,457 128,921 506,745 (565,188 ) (363,861 ) (254,867 ) (18,788 ) (7,822 ) — 143,478 142,114 193,615 741,082 499,715 53,761 33,917 48,428 — (17 ) — — (2,725 ) (2,113 ) — (4,990 ) (6,653 ) (6,265 ) (237,352 ) (195,760 ) (132,346 ) 2,594,874 242,969 360,643 (7,443 ) 13,326 (20,769 ) 2,587,431 256,295 339,874 (114,172 ) (3,869 ) 150,383 264,694 268,563 118,180 $ 150,522 $ 264,694 $ 268,563
See notes to consolidated financial statements. | Concluded |
For the Year Ended December 31, | ||||||||
2008 | 2007 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (660,482 | ) | $ | (724,277 | ) | ||
Income (loss) from discontinued operations | 22,830 | (256,780 | ) | |||||
Loss from continuing operations | (683,312 | ) | (467,497 | ) | ||||
Adjustments to reconcile loss from continuing operations to net cash used in operating activities: | ||||||||
Impairment on mortgage securities - available-for-sale | 23,100 | 98,692 | ||||||
Losses on derivative instruments | 18,094 | 10,997 | ||||||
Depreciation expense | 1,124 | 2,865 | ||||||
Amortization of deferred debt issuance costs | 3,081 | 1,696 | ||||||
Compensation recognized under stock compensation plans | (63 | ) | 707 | |||||
Provision for credit losses | 707,364 | 265,288 | ||||||
Amortization of premiums on mortgage loans | 13,366 | 4,805 | ||||||
Interest capitalized on loans held-in-portfolio | (19,858 | ) | (41,973 | ) | ||||
Forgiveness of founders’ promissory notes | 70 | 348 | ||||||
Provision for deferred income taxes | (13,805 | ) | 41,620 | |||||
Fair value adjustments | 25,743 | 85,803 | ||||||
Accretion of available-for-sale and trading securities | (50,399 | ) | (99,773 | ) | ||||
Gains on debt extinguishment | (6,418 | ) | - | |||||
Changes in: | ||||||||
Accrued interest receivable | (15,588 | ) | (31,855 | ) | ||||
Derivative instruments, net | 673 | 3,496 | ||||||
Other assets | 5,654 | 37,283 | ||||||
Due to servicer | 61,185 | 56,450 | ||||||
Accounts payable and other liabilities | (26,030 | ) | 34,515 | |||||
Net cash provided by operating activities from continuing operations | 43,981 | 3,467 | ||||||
Net cash used in operating activities from discontinued operations | (14,415 | ) | (449,255 | ) | ||||
Net cash provided by (used in) operating activities | 29,566 | (445,788 | ) | |||||
Cash flows from investing activities: | ||||||||
Proceeds from paydowns on mortgage securities - available-for-sale | 26,899 | 188,443 | ||||||
Proceeds from paydowns of mortgage securities - trading | 59,912 | 46,731 | ||||||
Purchase of mortgage securities - trading | - | (21,957 | ) | |||||
Proceeds from sale of mortgage securities - trading | - | 7,420 | ||||||
Proceeds from repayments of mortgage loans held-in-portfolio | 288,243 | 824,060 | ||||||
Proceeds from sales of assets acquired through foreclosure | 114,194 | 6,288 | ||||||
Restricted cash proceeds (payments) | 2,952 | (8,998 | ) | |||||
Purchases of property and equipment | (25 | ) | (3,132 | ) | ||||
Acquisition of businesses, net of cash acquired | (710 | ) | - | |||||
Net cash provided by investing activities | 491,465 | 1,038,855 | ||||||
Net cash provided by investing activities from discontinued operations | 2,114 | 34,208 | ||||||
Net cash provided by investing activities | 493,579 | 1,073,063 |
For the Year Ended December 31, | ||||||||
2008 | 2007 | |||||||
Cash flows from financing activities: | ||||||||
Proceeds from issuance of asset-backed bonds | - | 2,111,415 | ||||||
Payments on asset-backed bonds | (477,662 | ) | (797,101 | ) | ||||
Proceeds from issuance of capital stock and exercise of equity instruments, net of offering costs | - | 47,012 | ||||||
Net change in short-term borrowings | (45,488 | ) | (458,192 | ) | ||||
Repurchase of trust preferred debt | (550 | ) | - | |||||
Dividends paid on vested options | - | (405 | ) | |||||
Dividends paid on preferred stock | - | (6,653 | ) | |||||
Net cash (used in) provided by financing activities from continuing operations | (523,700 | ) | 896,076 | |||||
Net cash used in financing activities from discontinued operations | (19 | ) | (1,648,509 | ) | ||||
Net cash (used in) provided by financing activities | (523,719 | ) ) | (752,433 | ) | ||||
Net decrease in cash and cash equivalents | (574 | ) | (125,158 | ) | ||||
Cash and cash equivalents, beginning of period | 25,364 | 150,522 | ||||||
Cash and cash equivalents, end of period | $ | 24,790 | $ | 25,364 |
For the Years Ended December 31, | ||||||||
2008 | 2007 | |||||||
Cash paid for interest | $ | 111,949 | $ | 310,293 | ||||
Cash paid for income taxes | 3,679 | 6,012 | ||||||
Cash received on mortgage securities – available-for-sale with no cost basis | 3,401 | 3,475 | ||||||
Non-cash investing and financing activities: | ||||||||
Transfer of loans to held-in-portfolio from held-for-sale | - | 1,880,340 | ||||||
Transfer of mortgage securities available-for-sale to trading (A) | - | 46,683 | ||||||
Assets acquired through foreclosure | 108,172 | 120,148 | ||||||
Cost basis of securities retained in securitizations | - | 56,387 | ||||||
Tax benefit derived from capitalization of affiliate | - | 7,195 | ||||||
Preferred stock dividends accrued, not yet paid | 15,273 | 3,816 |
(A) Transfer was made upon adoption of SFAS 159. |
See notes to consolidated financial statements. | Concluded |
Business Plan
it retained interests.
2008:
· | The Company received $42.8 million in cash from its unsecuritized mortgage securities portfolio. |
· | The Company used $45.5 million in cash to fully repay all secured borrowings and terminate all secured lending agreements. As a result, the Company has no short-term borrowing capacity or agreements currently available. |
· | The Company paid general and administrative expenses, including those related to its discontinued lending and servicing operations, totaling $37.1 million. |
· | The Company invested $0.7 million in StreetLinks. |
In conjunction with the mortgage servicing rights sale in 2007, the removal of accounts provision was transferred to the buyer which resulted in the removal of the mortgage loans subject to the removal of accounts provision from the Company’s balance sheet. See Note 14 for further discussion of the removal of accounts provision and sale of mortgage servicing rights.
Management believes the best estimate of the initial value of the residual securities it retains in a whole loan securitization is derived from the market value of the pooled loans.
The Company estimates initial and subsequent fair value for the subordinated securities based on quoted market prices obtained from brokers.
prices obtained from brokers. The Company estimates subsequent fair value for the subordinated securities based on quoted market prices obtained from brokers which are compared to internal discounted cash flows.
| |||
| |||
|
The principal balance of Depreciation expense related to continuing operations for the Company’s propertyyears ended December 31, 2008 and equipment2007 was $41.8$1.1 million and $29.8$2.9 million, as ofrespectively. There was no depreciation expense related to discontinued operations for the year ended December 31, 2006 and 2005, respectively. The accumulated2008. For 2007, depreciation recorded on the property and equipmentexpense related to discontinued operations was $23.7 million and $16.7 million as of December 31, 2006 and 2005, respectively.
$6.0 million.
Due to Securitization TrustsDue to securitization trusts represents the fair value of the mortgage loans the Company hashad the right to repurchase from the securitization trusts. The servicing agreements the Company executesexecuted for loans it hashad securitized include a removal of accounts provision which givesgave it the right, not the obligation, to repurchase mortgage loans from the trust. The removal of accounts provision cancould be exercised for loans that are 90 days to 119 days delinquent. Upon exercise of the call options, the related obligation to the trusts iswas removed from the Company’s balance sheet.
Management believes the best estimate of the initial value of the residual securities it retains in a whole loan securitization is derived from the market value of the pooled loans.
For purposes of valuing the Company’s securities, it is important to know that the
· | Whole Loan Sales Whole loan sales represent loans sold to third parties with servicing released. Gains and losses on whole loan sales are recognized in the period the sale occurs and the Company has determined that the criteria for sales treatment has been achieved as it has surrendered control over the assets transferred. The Company generally has an obligation to repurchase whole loans sold in circumstances in which the borrower fails to make up to the first |
· | Loans and Securities Sold Under Agreements to Repurchase (Repurchase Agreements)Repurchase agreements represent legal sales of loans or mortgage securities and a related agreement to repurchase the loans or mortgage securities at a later date. Repurchase agreements are accounted for as secured borrowings because the Company has not surrendered control of the transferred assets as it is both entitled and obligated to repurchase the transferred assets prior to their maturity. Repurchase agreements are classified as short-term borrowings in the Company’s consolidated balance sheet. |
· | Securitization Transactions |
· | Resecuritization Transactions |
adequacy of this reserve is evaluated and adjusted as required. The provision for losses recognized at the sale date is included in the consolidated statementsoperating results of incomediscontinued operations as a reduction of gains (losses) on sales of mortgage assets.
· | Appraisal Fees Appraisal fees are collected as part of the appraisal management process performed by StreetLinks based on negotiated rates with each appraiser. Revenue is recognized when the appraisal is completed and provided to the lender or borrower, depending on who placed the order. |
· | Broker FeesBroker fees are paid by other lenders for placing loans with third-party investors (lenders) and are based on negotiated rates with each lender to whom the Company brokers loans. Revenue is recognized upon loan origination and delivery. |
· | Loan Origination Fees Loan origination fees represent fees paid to the Company by borrowers and are associated with the origination of mortgage loans. Loan origination fees are determined based on the type and amount of loans originated. Loan origination fees and direct origination costs on mortgage loans held-in-portfolio are deferred and recognized over the life of the loan using the level yield method. Loan origination fees and direct origination costs on mortgage loans held-for-sale are deferred and considered as part of the carrying value of the loan when sold. |
· | Service Fee Income Service fees are paid to the Company by either the investor on mortgage loans serviced or the borrower. Fees paid by investors on loans serviced are determined as a percentage of the principal collected for the loans serviced and are recognized in the period in which payments on the loans are received. Fees paid by borrowers on loans serviced are considered ancillary fees related to loan servicing and include late fees and processing fees. Revenue is recognized on fees received from borrowers when an event occurs that generates the fee and they are considered to be collectible. |
Prior to adoption of SFAS 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows. SFAS 123(R) requires the cash flows resulting from the tax benefits of tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. Additionally, the write-off of deferred tax assets relating to the excess of recognized compensation cost over the tax deduction resulting from the award will continue to be reflected within operating cash flows.
Income TaxesThe Company is taxed as a Real Estate Investment Trust (“REIT”)REIT under Section 857 of the Internal Revenue Code of 1986, as amended (the “Code”).Code. As a REIT, the Company generally iswas not subject to federal income tax. To maintain its qualification as a REIT, the Company musthad to distribute at least 90% of its REIT taxable income to its shareholders and meet certain other tests relating to assets, income and income. Ifownership. However, the Company fails to qualify as a REIT in any taxable year, the Company will be subject to federal income tax on its taxable income at regular corporate rates. The Company may also be subject to certain state and local taxes. Under certain circumstances, even though the Company qualifies as a REIT, federal income and excise taxes may be due on its undistributed taxable income. Because the Company has paid or intends to pay dividends in the amount of its taxable income by the statutorily required due date, no provision for income taxes has been provided in the accompanying financial statements related to the REIT. However, NFI Holding Corporation, a wholly-owned subsidiary, and its subsidiaries have not elected REIT-status and, therefore, are subject to corporate income taxes. Accordingly, a provision for income taxes has been provided for the Company’s non-REIT subsidiaries.
The Company hashad elected to treat NFI Holding Corporation and its subsidiaries as taxable REIT subsidiaries (collectively the “TRS”). In general, the TRS maycould hold assets that the Company cannotcould not hold directly and generally maycould engage in any real estate or non-real estate related business. The subsidiaries comprising the TRS arewere subject to corporate federal and state income tax and arewere taxed as regular C corporations. However, special rules do apply
The TRS recordsof deferred tax assets to recognize in the financial statements, the Company evaluates the likelihood of realizing such benefits in future periods. FASB Statement 109 “Accounting for Income Taxes” (“SFAS 109”) requires the recognition of a valuation allowance if it is more likely than not that all or some portion of the deferred tax asset will not be realized. SFAS 109 indicates the more likely than not threshold is a level of likelihood that is more than 50 percent.
Discontinued Operations2007.
2007.
In January 2007, the FASB provided a scope exception under SFAS 155 for securitized interests that only contain an embedded derivative that is tied2008. The minority interest related to the prepayment riskStreetlinks purchase is shown as a component of the underlying prepayable financial assets, and for which the investor does not control the right to accelerate the settlement. If a securitized interest contains any other embedded derivative (for example, an inverse floater), then it would be subject to the bifurcation tests in SFAS 133, as would securities purchased at a significant premium.shareholders’ deficit. The Company does not expect that the adoption of SFAS 155 willthis standard may have a materialan impact on the Company’s financial position, resultsaccounting of operations or cash flows. However,net income and shareholders’ deficit attributed to the extent that certain of the Company’sStreetLinks and any future investments in securitized financial assets do not meet the scope exception adopted by the FASB, the Company’s future results of operations may exhibit volatility if such investments are required to be bifurcated or marked to market value in their entirety through the income statement, depending on the election made by the Company.
acquisitions.
statements but could result in additional disclosures.
In September 2006, the FASB issuedasset. FSP SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. This accounting standard142-3 is effective for financial statements issued for fiscal years beginning after NovemberDecember 15, 2007.2008 and must be applied prospectively to intangible assets acquired after the effective date. The Company is still evaluating the impact thedoes not expect that adoption of this statementFSP SFAS 142-3 will have a significant impact on itsthe Company’s consolidated financial statements.
In February 2007,condition or results of operation.
FASB has been deliberating on a technical interpretation of GAAP with respect to the accounting for transactions where assets are purchased and simultaneously financed through a repurchase agreement with the same party and whether these transactions create derivatives requiring a “net” presentation instead of the acquisition of assets and related financing obligation. The Company’s current accounting for these transactions is to record the transactions as an acquisition of assets and related financing obligation. The alternative accounting treatment would be to record any net cash representing the “haircut” amount as a deposit and the forward leg of the repurchase agreement (that is, the obligation to purchase the financial asset(s) at the end of the repo term) as a derivative. Because the FASB has not issued any guidance on this matter as of the filing date of this report, the Company has not changed its accounting treatment for this item. During the first quarter of 2006, the Company purchased approximately $1.0 billion of mortgage loans from counterparties which were subsequently financed through repurchase agreements with that same counterparty. As of December 31, 2006, the entire $1.0 billion of mortgage loans purchased during the first quarter remained on the Company’s consolidated balance sheet but they were no longer financed with repurchase agreements as they had been securitized in transactions structured as financings and the short-term repurchase agreements were replaced with asset backed bond financing. Additionally, during 2006 the Company purchased $64.1 million of securities from counterparties which were subsequently financed through repurchase agreements with the same counterparties. As of December 31, 2006 the market value of these securities which remained on the Company’s consolidated balance sheet was $62.9 million. If the Company would be required to change its current accounting based on this interpretation the Company does not believe that there would be a material impact on its consolidated statements of income, however, total assets and total liabilities would be reduced by approximately $50.9 million at December 31, 2006. In addition, cash flows from operating and financing activities would be reduced by approximately $50.9 million for the year ended December 31, 2006. The Company believes its liquidity would be unchanged, and it does not believe the economics of the transactionsfinancial condition or its taxable income or status as a REIT would be affected.
Reclassifications Reclassifications to prior year amounts have been made to conform to current year presentation, as follows.
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company has reclassified the operating results of NHMI and its branches through December 31, 2006, as discontinued operations in the Consolidated Statements of Income for the years ended 2006, 2005 and 2004.
The Company earns interest income from funds the Company holds as custodian and earns interest from corporate operating cash. The Company has reclassified these earnings from “Other Income, net” to “Interest Income” on the consolidated statements of income for the years ended 2005 and 2004. The amount of other income reclassified to interest income for 2005 and 2004 was $21.5 million and $6.8 million, respectively.
operation.
– Held-in-Portfolio
2006 | 2005 | |||||||
Mortgage loans – held-for-sale: | ||||||||
Outstanding principal | $ | 1,631,891 | $ | 1,238,689 | ||||
Loans under removal of accounts provision | 107,043 | 44,382 | ||||||
Net deferred origination costs | 7,891 | 12,015 | ||||||
Allowance for the lower of cost or fair value | (5,006 | ) | (3,530 | ) | ||||
Mortgage loans – held-for-sale | $ | 1,741,819 | $ | 1,291,556 | ||||
Weighted average coupon | 8.69 | % | 8.11 | % | ||||
Percent of loans with prepayment penalties | 58 | % | 65 | % | ||||
Mortgage loans – held-in-portfolio: | ||||||||
Outstanding principal | $ | 2,101,768 | $ | 29,084 | ||||
Net unamortized deferred origination costs | 37,219 | 455 | ||||||
Amortized cost | 2,138,987 | 29,539 | ||||||
Allowance for credit losses | (22,452 | ) | (699 | ) | ||||
Mortgage loans – held-in-portfolio | $ | 2,116,535 | $ | 28,840 | ||||
Weighted average coupon | 8.35 | % | 9.85 | % | ||||
Percent of loans with prepayment penalties | 61 | % | 0 | % | ||||
During 2006
December 31, 2008 | December 31, 2007 | |||||||
Mortgage loans – held-in-portfolio: | ||||||||
Outstanding principal | $ | 2,529,791 | $ | 3,067,737 | ||||
Net unamortized deferred origination costs | 19,048 | 32,414 | ||||||
Amortized cost | 2,548,839 | 3,100,151 | ||||||
Allowance for credit losses | (776,001 | ) | (230,138 | ) | ||||
Mortgage loans – held-in-portfolio | $ | 1,772,838 | $ | 2,870,013 | ||||
Weighted average coupon | 8.00 | % | 8.59 | % |
During 1997 and 1998, the Company completed the securitization of loans in transactions that were structured as financing arrangements for accounting purposes. 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. Under the terms of the asset-backed bonds issued in the securitizations, the Company is entitled to repurchase the mortgage loan collateral and repay the remaining bond obligations when the aggregate collateral principal balance falls below 35% of their original balance for the loans in Series 97-01 and 25% for the loans in Series 97-02, Series 98-01 and Series 98-02. During the fourth quarter of 2006, the Company exercised this option for Series 1998-1 and Series 1998-2 and retired the related asset-backed bonds, which had a remaining balance of $18.8 million. During the fourth quarter of 2005, the Company exercised this option for Series 1997-1 and Series 1997-2 and retired the related asset-backed bonds, which had a remaining balance of $7.8 million. The Company transferred $20.4 million and $10.3 million of mortgage loans associated with these asset backed bonds from the held-in-portfolio classification to held-for-sale in 2006 and 2005, respectively, with the intent to sell or securitize the loans.
The servicing agreements the Company executes for loans it has securitized include a “clean up” call option which gives it the right, not the obligation, to repurchase mortgage loans from the trust. The clean up call option can be exercised when the aggregate principal balance of the mortgage loans has declined to ten percent or less of the original aggregated mortgage loan principal balance. During the twelve months ended December 31, 2006, the Company exercised the “clean up” call option on NMFT Series 2000-1, NMFT Series 2000-2, NMFT Series 2001-1, NMFT Series 2001-2, NMFT Series 2002-1 and NMFT Series 2002-2 and repurchased loans with a remaining principal balance of $192.8 million from these trusts for $184.7 million in cash. The trusts distributed the $184.7 million to retire the bonds held by third parties. The repurchased mortgage loans are included in the mortgage loans held-for-sale classification on the Company’s consolidated balance sheets and it is the Company’s intention to sell or securitize these loans. On September 25, 2005, the Company exercised the “clean up” call option on NMFT Series 1999-1 and repurchased loans with a remaining principal balance of $14.0 million from the trust for $6.8 million in cash. The trust distributed the $6.8 million to retire the bonds held by third parties.
At December 31, 2006, the Company had the right, not the obligation, to repurchase $73.0 million of mortgage loans from the NMFT Series 2002-3 securitization trust under the Company’s clean up call option.
Collateral for 19% and 12% of the mortgage loans held-for-sale outstanding as of December 31, 2006 was located in Florida and California, respectively. Collateral for 42% and 19% of the mortgage loans held-in-portfolio outstanding as of December 31, 2006 was located in California and Florida, respectively. As of December 31, 2006 interest only loan products made up 10% of the loans classified both as held-for-sale and held-in-portfolio. In addition as of December 31, 2006 MTA loan products made up 11% and 50% of the loans classified as held-for-sale and held-in-portfolio, respectively. These MTA loans had $29.5 million in negative amortization during 2006. The Company has no other significant concentration of credit risk on mortgage loans.
At December 31, 2006 a majority of the loans classified as held-for-sale and all of the loans classified as held-in-portfolio were pledged as collateral for financing purposes.
Loans that the Company has placed on non-accrual status totaled $48.8 and $3.7 million at December 31, 2006 and 2005, respectively. At December 31, 2006 the Company had $57.4 million in loans past due 90 days or more, which were still accruing interest as compared to $7.2 million at December 31, 2005. These loans carried mortgage insurance and the accrual will be discontinued when in management’s opinion the interest is not collectible.
Activity in the allowance for credit losses on mortgage loans – held-in-portfolio is as follows for the three years ended December 31, (dollars in thousands):
2006 | 2005 | 2004 | ||||||||||
Balance, beginning of period | $ | 699 | $ | 507 | $ | 1,319 | ||||||
Provision for credit losses | 30,131 | 1,038 | 726 | |||||||||
Charge-offs, net of recoveries | (8,378 | ) | (846 | ) | (1,538 | ) | ||||||
Balance, end of period | $ | 22,452 | $ | 699 | $ | 507 | ||||||
Note 3. Loan Securitizations and Loan Sales
The Company executes loan securitization transactions which are accounted for as sales of loans. Derivative instruments are also transferred into the trusts as part of each of these sales transactions to reduce interest rate risk to the third-party bondholders.
Details of the securitizations structured as sales for the three years ended December 31, are as follows
(dollars in thousands):
Net Bond | Allocated Value of Retained Interests | Principal Balance | Fair Value of Derivative Instruments Transferred | Gain Recognized | |||||||||||||||
Mortgage Servicing Rights | Subordinated Bond Classes | ||||||||||||||||||
2006: | |||||||||||||||||||
NMFT Series 2005-4 (A) | $ | 378,944 | $ | 2,258 | $ | 9,416 | $ | 378,944 | $ | 259 | $ | 1,203 | |||||||
NMFT Series 2006-2 | 999,790 | 6,041 | 40,858 | 1,021,102 | 6,015 | 11,942 | |||||||||||||
NMFT Series 2006-3 | 1,072,258 | 6,516 | 47,408 | 1,100,000 | 5,073 | 10,209 | |||||||||||||
NMFT Series 2006-4 | 993,841 | 7,040 | 51,956 | 1,025,359 | 1,818 | 14,401 | |||||||||||||
NMFT Series 2006-5 | 1,264,695 | 8,969 | 46,762 | 1,300,000 | 1,732 | 5,675 | |||||||||||||
NMFT Series 2006-6 | 1,213,447 | 8,650 | 48,578 | 1,250,000 | 2,811 | 6,785 | |||||||||||||
$ | 5,922,975 | $ | 39,474 | $ | 244,978 | $ | 6,075,405 | $ | 17,708 | $ | 50,215 | ||||||||
2005: | |||||||||||||||||||
NMFT Series 2005-1 | $ | 2,066,840 | $ | 11,448 | $ | 88,433 | $ | 2,100,000 | $ | 13,669 | $ | 18,136 | |||||||
NMFT Series 2005-2 | 1,783,102 | 9,751 | 62,741 | 1,799,992 | 2,364 | 29,202 | |||||||||||||
NMFT Series 2005-3 | 2,425,088 | 14,966 | 104,206 | 2,499,983 | 9,194 | 3,947 | |||||||||||||
NMFT Series 2005-4 (A) | 1,153,033 | 7,311 | 77,040 | 1,221,055 | 5,232 | 7,480 | |||||||||||||
$ | 7,428,063 | $ | 43,476 | $ | 332,420 | $ | 7,621,030 | $ | 30,459 | $ | 58,765 | ||||||||
2004: | |||||||||||||||||||
NMFT Series 2003-4 (B) | $ | 472,391 | $ | 1,880 | $ | 22,494 | $ | 479,810 | $ | — | $ | 9,015 | |||||||
NMFT Series 2004-1 | 1,722,282 | 7,987 | 92,059 | 1,750,000 | (13,848 | ) | 64,112 | ||||||||||||
NMFT Series 2004-2 | 1,370,021 | 6,244 | 67,468 | 1,399,999 | 15,665 | 8,961 | |||||||||||||
NMFT Series 2004-3 | 2,149,260 | 9,520 | 104,901 | 2,199,995 | (6,705 | ) | 40,443 | ||||||||||||
NMFT Series 2004-4 | 2,459,875 | 13,628 | 94,911 | 2,500,000 | 5,617 | 21,721 | |||||||||||||
$ | 8,173,829 | $ | 39,259 | $ | 381,833 | $ | 8,329,804 | $ | 729 | $ | 144,252 | ||||||||
In the securitizations, the Company retains residual securities (representing interest-only securities, prepayment penalty bonds and overcollateralization bonds) and certain subordinated securities representing subordinated interests in the underlying cash flows and servicing responsibilities. The value of the Company’s retained securities is subject to credit, prepayment, and interest rate risks on the transferred financial assets.
During 2006 and 2005, U.S. government-sponsored enterprises purchased 49% and 51%, respectively, of the bonds sold to the third-party investors in the Company’s securitization transactions. The investors and securitization trusts have no recourse to the Company’s assets for failure of borrowers to pay when due except when defects occur in the loan documentation and underwriting process, either through processing errors made by the Company or through intentional or unintentional misrepresentations made by the borrower or agents during those processes. Refer to Note 9 for further discussion.
For the Year Ended December 31, | ||||||||||||||||||||||||
Total Principal Amount of Loans (A) | Principal Amount of Loans 60 Days or More Past Due | Net Credit Losses During the Year Ended December 31, (B) | ||||||||||||||||||||||
2008 | 2007 | 2008 | 2007 | 2008 | 2007 | |||||||||||||||||||
Loans securitized | $ | 8,121,668 | $ | 10,087,692 | $ | 3,371,720 | $ | 1,806,141 | $ | 469,182 | $ | 231,814 | ||||||||||||
Loans held-in-portfolio | 2,684,213 | 3,215,695 | 1,270,261 | 572,943 | 155,765 | 15,458 | ||||||||||||||||||
Total loans securitized or held-in-portfolio | $ | 10,805,881 | $ | 13,303,387 | $ | 4,641,981 | $ | 2,379,084 | $ | 624,947 | $ | 247,272 |
(A) | Includes assets acquired through foreclosure. |
(B) | Represents the realized losses as reported by the securitization trusts for each period presented. |
These The NHES 2006-1 and NHES 2006-MTA1 securitizations are structured legally as sales, but for accounting purposes are treated as financings under SFAS No. 140. These securitizations doat inception did not meet the qualifying special purpose entity criteria necessary for derecognition under SFAS No. 140 and related interpretations because after the loans arewere securitized the securitization trusts may acquire derivatives relating to beneficial interests retained by the Company and,Company; additionally, the Company, as servicer, subjecthad the unilateral ability to applicable contractual provisions, has discretion to call (other thanrepurchase a clean-up call)limited number of loans back from the trust. These provisions were removed effective September 30, 2008. Since the removal of these provisions did not substantively change the transactions’ economics, the original accounting conclusion remains the same. The NHES 2007-1 securitization does not meet the qualifying special purpose entity criteria necessary for derecognition under SFAS 140 and related interpretations because of the excessive benefit the Company received at inception from the derivative instruments delivered into the trust to counteract interest rate risk.
Net Bond Proceeds | Principal Balance of Loans Financed | |||||
NHES Series 2006-1 | $ | 1,317,346 | $ | 1,350,000 | ||
NHES Series 2006-MTA1 | 1,188,111 | 1,199,913 | ||||
$ | 2,505,457 | $ | 2,549,913 | |||
As described in Note 1, fair value of the residual securities at the date of securitization is either measured by the whole loan price methodology or the discount rate methodology. For the whole loan price methodology, an implied yield (discount rate) is calculated based on the value derived and using projected cash flows generated using key economic assumptions. Comparatively, under the discount rate methodology, the Company assumes a discount rate that it feels is commensurate with current market conditions. Key economic assumptions used to project cash flows at the time of loan securitization during the three years ended December 31, 2006 were as follows:
NovaStar Mortgage Funding Trust Series | Constant Prepayment Rate | Average Life (in Years) | Expected Total Credit Mortgage Insurance (A) | Discount Rate | |||||||
2006-6 | 41 | % | 2.19 | 3.7 | % | 15 | % | ||||
2006-5 | 43 | 2.11 | 3.9 | 15 | |||||||
2006-4 | 43 | 2.07 | 2.9 | 15 | |||||||
2006-3 | 43 | 2.15 | 3.0 | 15 | |||||||
2006-2 | 44 | 2.02 | 2.4 | 15 | |||||||
2005-4 | 43 | 2.12 | 2.3 | 15 | |||||||
2005-3 | 41 | 2.06 | 2.0 | 15 | |||||||
2005-2 | 39 | 2.02 | 2.1 | 13 | |||||||
2005-1 | 37 | 2.40 | 3.6 | 15 | |||||||
2004-4 | 35 | 2.29 | 4.0 | 26 | |||||||
2004-3 | 34 | 2.44 | 4.5 | 19 | |||||||
2004-2 | 31 | 2.70 | 5.1 | 26 | |||||||
2004-1 | 33 | 2.71 | 5.9 | 20 |
Securitization Name | Date Issued | Principal Balance of Loans Pledged | Bonds Issued (A) | Net Bond Proceeds | Interest Rate Spread Over One Month LIBOR (A)(B) | ||||||||||||
2007: | |||||||||||||||||
NHES 2007-1 | February 28, 2007 | $ | 1,888,756 | $ | 1,794,386 | $ | 1,784,662 | 0.10%-1.75% |
(A) |
(B) | The interest rate for the |
Fair value of the subordinated securities at the date of securitization is based on quoted market prices.
The Company executes sales of loans to third parties with servicing released. Gains
2006 | 2005 | 2004 | |||||||||
Balance, beginning of period | $ | 2,345 | $ | — | $ | — | |||||
Provision for repurchased loans | 28,617 | 3,265 | — | ||||||||
Charge-offs, net | (6,189 | ) | (920 | ) | — | ||||||
Balance, end of period | $ | 24,773 | $ | 2,345 | $ | — | |||||
2008 | 2007 | |||||||
Balance, beginning of period | $ | 230,138 | $ | 22,452 | ||||
Provision for credit losses | 707,364 | 265,288 | ||||||
Charge-offs, net of recoveries | (161,501 | ) | (57,602 | ) | ||||
Balance, end of period | $ | 776,001 | $ | 230,138 |
Assets after intercompany eliminations | Liabilities after intercompany | Recourse to | ||||||||||||||||||
Consolidated VIEs | Total Assets | Unrestricted | Restricted (A) | eliminations | the Company(B) | |||||||||||||||
December 31, 2008 | ||||||||||||||||||||
Mortgage Loan VIEs(C) | $ | 1,930,063 | - | $ | 1,920,610 | $ | 2,730,280 | - | ||||||||||||
CDOs(D) | 7,242 | - | 6,842 | 8,557 | - |
(A) | Assets are considered restricted when they cannot be freely pledged or sold by the Company. |
(B) | This column reflects the extent, if any, to which investors have recourse to the Company beyond the assets held by the VIE and assumes a total loss of the assets held by the VIE. |
(C) | For Mortgage Loan VIEs, assets are primarily recorded in Mortgage loans – held-in-portfolio. Liabilities are primarily recorded in Asset-backed bonds secured by mortgage loans. |
(D) | For the CDO, assets are primarily recorded in Mortgage securities – trading and liabilities are recorded in Asset-backed bonds secured by mortgage securities. |
Size/Principal Outstanding (A) | Assets on Balance Sheet(B) | Liabilities on Balance Sheet(B) | Maximum Exposure to Loss(C) | 2008 Loss on Sale | 2008 Cash Flows | |||||||||||||||||||
Residential mortgage loans(D) | $ | 8,121,668 | $ | 15,919 | $ | - | $ | 15,919 | $ | - | $ | 58,891 |
(A) | Size/Principal Outstanding reflects the estimated principal of the underlying assets held by the VIE/SPEs. |
(B) | Assets and Liabilities on the Company’s Balance Sheet reflect the effect of FIN 39 balance sheet netting, if applicable. |
(C) | The maximum exposure to loss includes the following: the assets held by the Company – including the value of derivatives that are in an asset position and retained interests in the VIEs/SPEs; and the notional amount of liquidity and other support generally provided through total return swaps. The maximum exposure to loss for liquidity and other support assumes a total loss on the referenced assets held by the VIE. |
(D) | For Residential mortgage loans QSPEs, assets on balance sheet are primarily securities issued by the entity and are recorded in Mortgage securities-available-for-sale and Mortgage securities-trading. |
Carrying amount/fair value of residual interests | $ | 13,493 | ||
Weighted average life (in years) | 2.7 | |||
Weighted average prepayment speed assumption (CPR) (percent) | 18 | |||
Fair value after a 10% increase in prepayment speed | $ | 12,721 | ||
Fair value after a 25% increase in prepayment speed | $ | 11,867 | ||
Weighted average expected annual credit losses (percent of current collateral balance) | 24.1 | |||
Fair value after a 10% increase in annual credit losses | $ | 11,842 | ||
Fair value after a 25% increase in annual credit losses | $ | 10,335 | ||
Weighted average residual cash flows discount rate (percent) | 24.1 | |||
Fair value after a 500 basis point increase in discount rate | $ | 12,859 | ||
Fair value after a 1000 basis point increase in discount rate | $ | 12,286 | ||
Market interest rates: | ||||
Fair value after a 100 basis point increase in market rates | $ | 7,921 | ||
Fair value after a 200 basis point increase in market rates | $ | 5,098 |
Mortgage
Cost Basis | Unrealized Gain | Unrealized Losses Less Than Twelve Months | Estimated Fair Value | Average Yield (A) | ||||||||||||
As of December 31, 2006 | $ | 310,760 | $ | 39,683 | $ | (1,131 | ) | $ | 349,312 | 41.84 | % | |||||
As of December 31, 2005 | 394,107 | 113,785 | (2,247 | ) | 505,645 | 47.32 |
Cost Basis | Unrealized Gain | Unrealized Losses Less Than Twelve Months | Estimated Fair Value | Average Yield (A) | ||||||||||||||||
As of December 31, 2008 | $ | 3,771 | $ | 9,017 | - | $ | 12,788 | 38.2 | % | |||||||||||
As of December 31, 2007 | 33,302 | 69 | - | 33,371 | 26.9 |
(A) | The average yield is calculated from the cost basis of the mortgage securities and does not give effect to changes in fair value that are reflected as a component of shareholders’ equity. |
During the twelve months ended December 31, 2006, the Company exercised the “clean up” call option on NMFT Series 2000-1, NMFT Series 2000-2, NMFT Series 2001-1, NMFT Series 2001-2, NMFT Series 2002-1 and NMFT Series 2002-2. The mortgage loans were repurchased from the trusts and cash was paid to retire the bonds held by third parties. Along with the cash paid to the trusts, any remaining cost basis of the related mortgage securities and mortgage servicing rights, $6.6 million, became part of the cost basis of the repurchased mortgage loans.
During the twelve months ended December 31, 2005, the Company exercised the “clean up” call option on NMFT Series 1999-1. The mortgage loans were repurchased from the trusts and cash was paid to retire the bonds held by third parties. Along with the cash paid to the trusts, any remaining cost basis of the related mortgage securities, $7.4 million, became part of the cost basis of the repurchased mortgage loans.
The following table is a roll-forward ofwithin its mortgage securities – available-for-sale from January 1, 2005 to December 31, 2006 (in thousands):
Cost Basis | Unrealized (Loss) | Estimated Fair Mortgage Securities | ||||||||||
As of January 1, 2005 | $ | 409,946 | $ | 79,229 | $ | 489,175 | ||||||
Increases (decreases) to mortgage securities: | ||||||||||||
New securities retained in securitizations | 289,519 | 2,073 | 291,592 | |||||||||
Accretion of income (A) | 171,734 | — | 171,734 | |||||||||
Proceeds from paydowns of securities (A) (B) | (452,050 | ) | — | (452,050 | ) | |||||||
Impairment on mortgage securities - available-for-sale | (17,619 | ) | 17,619 | — | ||||||||
Transfer of securities to mortgage loans held-for-sale due to repurchase of mortgage loans from securitization trust (C) | (7,423 | ) | — | (7,423 | ) | |||||||
Mark-to-market value adjustment | — | 12,617 | 12,617 | |||||||||
Net (decrease) increase to mortgage securities | (15,839 | ) | 32,309 | 16,470 | ||||||||
As of December 31, 2005 | 394,107 | 111,538 | 505,645 | |||||||||
Increases (decreases) to mortgage securities: | ||||||||||||
New securities retained in securitizations | 154,990 | 2,462 | 157,452 | |||||||||
Purchase of securities | 1,922 | — | 1,922 | |||||||||
Accretion of income (A) | 142,879 | — | 142,879 | |||||||||
Proceeds from paydowns of securities (A) (B) | (346,047 | ) | — | (346,047 | ) | |||||||
Impairment on mortgage securities - available-for-sale | (30,690 | ) | 30,690 | — | ||||||||
Transfer of securities to mortgage loans held-for-sale due to repurchase of mortgage loans from securitization trusts (D) | (6,401 | ) | (5,153 | ) | (11,554 | ) | ||||||
Mark-to-market value adjustment | — | (100,985 | ) | (100,985 | ) | |||||||
Net decrease to mortgage securities | (83,347 | ) | (72,986 | ) | (156,333 | ) | ||||||
As of December 31, 2006 | $ | 310,760 | $ | 38,552 | $ | 349,312 | ||||||
available-for-sale.
During 2005 and 2004, the Company securitized the interest-only, prepayment penalty and overcollateralization securities of various securitizations and issued NovaStar Net Interest Margin Certificates (NIMs). These resecuritizations were accounted for as secured borrowings. In accordance with SFAS No. 140, control over the transferred assets was not surrendered and thus the transactions were recorded as financings for the mortgage securities. The detail of these transactions is shown in Note 8.
As of December 31, 2006, key economic assumptions and the sensitivity of the current fair value of the Company’s residual securities to immediate adverse changes in those assumptions are as follows, on average for the portfolio (dollars in thousands):
Carrying amount/fair value of residual interests (A) | $ | 302,629 | |
Weighted average life (in years) | 1.2 | ||
Weighted average prepayment speed assumption (CPR) (percent) | 47 | ||
Fair value after a 10% increase in prepayment speed | $ | 303,916 | |
Fair value after a 25% increase in prepayment speed | $ | 311,749 | |
Weighted average expected annual credit losses (percent of current collateral balance) | 3.2 | ||
Fair value after a 10% increase in annual credit losses | $ | 280,773 | |
Fair value after a 25% increase in annual credit losses | $ | 254,792 | |
Weighted average residual cash flows discount rate (percent) | 16 | ||
Fair value after a 500 basis point increase in discount rate | $ | 288,135 | |
Fair value after a 1000 basis point increase in discount rate | $ | 274,641 | |
Market interest rates: | |||
Fair value after a 100 basis point increase in discount rate | $ | 253,831 | |
Fair value after a 200 basis point increase in discount rate | $ | 218,956 |
These sensitivities are hypothetical and should be used with caution. As the analysis indicates, changes in fair value based on a 10% or 25% change in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.
The actual static pool credit loss as of December 31, 2006 was 0.42% and the cumulative projected static pool credit loss for the life of the securities is 1.86%. Static pool losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets.
The table below presents quantitative information about delinquencies, net credit losses, and components of securitized financial assets and other assets managed together with them (dollars in thousands):
For the Year Ended December 31, | Net Credit Losses During the Year Ended December 31, | |||||||||||||||||||
Total Principal Amount of Loans (A) | Principal Amount of Loans 60 Days or More Past Due | |||||||||||||||||||
2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||||
Loans securitized (B) | $ | 12,586,366 | $ | 12,722,279 | $ | 809,874 | $ | 404,592 | $ | 73,784 | $ | 38,639 | ||||||||
Loans held-for-sale | 1,647,063 | 1,238,953 | 25,112 | 1,897 | 7,166 | 1,027 | ||||||||||||||
Loans held-in-portfolio | 2,108,129 | 30,028 | 78,384 | 3,124 | 1,605 | (C) | 1,072 | (C) | ||||||||||||
Total loans managed or securitized (D) | $ | 16,341,558 | $ | 13,991,260 | $ | 913,370 | $ | 409,613 | $ | 82,555 | $ | 40,738 | ||||||||
Original Face | Amortized Cost Basis | Fair Value | Average Yield (A) | |||||||||
As of December 31, 2006 | $ | 365,898 | $ | 332,045 | $ | 329,361 | 13.12 | % | ||||
As of December 31, 2005 | 54,400 | 43,189 | 43,738 | 14.59 |
Original Face | Amortized Cost Basis | Fair Value | Average Yield (A) | |||||||||||||
As of December 31, 2008 | ||||||||||||||||
Subordinated securities pledged to CDO | $ | 332,489 | $ | 321,293 | $ | 4,798 | ||||||||||
Other subordinated securities | 102,625 | 96,723 | 1,582 | |||||||||||||
Residual securities | - | 15,952 | 705 | |||||||||||||
Total | $ | 435,114 | $ | 433,968 | $ | 7,085 | 9.55 | % | ||||||||
As of December 31, 2007 | ||||||||||||||||
Subordinated securities pledged to CDO | $ | 332,489 | $ | 314,046 | $ | 60,870 | ||||||||||
Other subordinated securities | 102,625 | 92,049 | 23,592 | |||||||||||||
Residual securities | - | 41,275 | 24,741 | |||||||||||||
Total | $ | 435,114 | $ | 447,370 | $ | 109,203 | 13.85 | % |
2007, respectively, which are included in the fair value adjustments line of the Company’s consolidated statements of operations.
these securities of $3.1 million during the year ended December 31, 2007, which is included in the fair value adjustments line on the Company’s consolidated statements of operations.
Note 6. Mortgage Servicing Rights
The Company records mortgage servicing rights arising from On May 9, 2008, the transfer of loansshort-term borrowings collateralized by the Company’s trading securities were repaid and the collateral was released back to the securitization trusts. The following schedule summarizesCompany. Other than the carrying value of mortgage servicing rights andsubordinated securities pledged to the activity during 2006, 2005 and 2004 (dollars in thousands):
2006 | 2005 | 2004 | ||||||||||
Balance, January 1 | $ | 57,122 | $ | 42,010 | $ | 19,685 | ||||||
Amount capitalized in connection with transfer of loans to securitization trusts | 39,474 | 43,476 | 39,259 | |||||||||
Amortization | (33,639 | ) | (28,364 | ) | (16,934 | ) | ||||||
Transfer of cost basis to mortgage loans held-for-sale due to securitization calls | (127 | ) | — | — | ||||||||
Balance, December 31 | $ | 62,830 | $ | 57,122 | $ | 42,010 | ||||||
The estimated fair value of the servicing rights aggregated $74.2 million and $71.9 million at December 31, 2006 and December 31, 2005, respectively. The fair value is estimated by discounting estimated future cash flows from the servicing assets using discount rates that approximate current market rates. The fair valueCDO, there were no trading securities pledged as collateral as of December 31, 2006 was determined utilizing2008.
Mortgage servicing rights are amortized in proportion to and over the estimated period of net servicing income. The estimated amortization expense for 2007, 2008, 2009, 2010, 20111.0% per annum and, thereafter, is $29.6 million, $15.2 million, $6.8 million, $3.6 million, $2.3 millionat a variable rate, reset quarterly, equal to the three-month LIBOR plus 3.5% per annum.
securitization bond financing replaced the short-term debt used to finance the securities. The Company receives annual servicing fees approximating 0.50% ofrecords interest income on the outstanding balancesecurities and rights to future cash flows arising afterinterest expense on the investorsbonds issued in the securitization trusts have receivedover the returnlife of the related securities and bonds.
The Company holds, as custodian, principal and interest collected from borrowers on behalf of the securitization trusts, as well as funds collected from borrowers to ensure timely payment of hazard and primary mortgage insurance and property taxes related to the properties securing the loans. These funds are not owned by the Company and are held in trust. The Company held, as custodian, $545.2 million and $585.1 million at December 31, 2006 and 2005, respectively.
Note 7. Warehouse Notes Receivable
The Company had $39.5 million and $25.4 million due from borrowers at December 31, 2006 and 2005, respectively. These notes receivable represent warehouse lines of credit provided to a network of approved mortgage borrowers. The weighted average interest rate on these notes receivable is indexed to one-month LIBOR and was 9.12% and 7.89% at December 31, 2006 and 2005, respectively. The allowance for losses the Company recorded on these notes receivable was insignificant as of December 31, 2006 and 2005.
Note 8. Borrowings
Short-term Borrowings The following tables summarize the Company’s repurchase agreements for the periods indicated (dollars in thousands):
Maximum Borrowing Capacity | Rate | Days to Reset | Balance | ||||||||
December 31, 2006 | |||||||||||
Short-term borrowings (indexed to one-month LIBOR): | |||||||||||
Repurchase agreement expiring November 15, 2007 (D) | $ | 1,000,000 | 5.77 | % | 1 | $ | 393,746 | ||||
Repurchase agreement expiring April 14, 2007 (F) | 800,000 | 6.00 | 11 | 436,302 | |||||||
Repurchase agreement expiring January 6, 2007 (A) (F) | 800,000 | 5.77 | 25 | 371,860 | |||||||
Repurchase agreement expiring November 9, 2007 (F) | 750,000 | 5.77 | 12 | 429,733 | |||||||
Repurchase agreement expiring May 31, 2007 (E) | 500,000 | 6.00 | 1 | 322,906 | |||||||
Repurchase agreement expiring June 28, 2009 (E) | 150,000 | 7.10 | 1 | 60,000 | |||||||
Repurchase agreement expiring April 12, 2009 (E) | 150,000 | 7.10 | 25 | 40,127 | |||||||
Repurchase agreement expiring July 31, 2009 (B) (E) | 150,000 | 7.13 | 1 | 40,449 | |||||||
Loan and receivables agreement expiring January 6, 2007 (A) (B) | 80,000 | 6.02 | 3 | 16,755 | |||||||
Repurchase agreement, expiring January 10, 2007 (C) (D) | 100,000 | 6.32 | 12 | 40,330 | |||||||
Total short-term borrowings | $ | 2,152,208 | |||||||||
December 31, 2005 | |||||||||||
Short-term borrowings (indexed to one-month LIBOR): | |||||||||||
Repurchase agreement expiring November 15, 2006 (D) | $ | 1,000,000 | 4.98 | % | 1 | $ | 388,056 | ||||
Repurchase agreement expiring April 14, 2006 (F) | 800,000 | 5.30 | 13 | 262,867 | |||||||
Repurchase agreement expiring February 6, 2006 (F) | 800,000 | 5.12 | 25 | 422,452 | |||||||
Repurchase agreement expiring September 29, 2006 (F) | 750,000 | 5.25 | 9 | 327,339 | |||||||
Repurchase agreement expiring August 4, 2006 (F) | 100,000 | — | 25 | — | |||||||
Loan and receivables agreement expiring October 6, 2006 (B) (G) | 80,000 | — | — | — | |||||||
Repurchase agreement, expiring December 1, 2006 (D) | 50,000 | 5.38 | 12 | 17,855 | |||||||
Total short-term borrowings | $ | 1,418,569 | |||||||||
The following table presents certain information“Fair value adjustments” line item on the Company’s repurchase agreements for the periods indicated (dollars in thousands):
For the Year Ended December 31, | ||||||||
2006 | 2005 | |||||||
Maximum month-end outstanding balance during the period | $ | 3,978,629 | $ | 2,362,995 | ||||
Average balance outstanding during the period | 2,282,715 | 1,294,452 | ||||||
Weighted average rate for period | 5.98 | % | 4.66 | % | ||||
Weighted average interest rate at period end | 5.95 | % | 5.15 | % |
The Company’s mortgage loans, certain mortgage securities and certain servicing related advances are pledged as collateral on these borrowings.
Allconsolidated statements of the Company’s warehouse repurchase credit facilities include numerous representations, warranties and covenants, including requirements to maintain a certain minimum net worth, minimum equity ratios and other customary debt covenants. Events of default under these facilities include material breaches of representations or warranties, failure to comply with covenants, material adverse effects upon or changes in business, assets, or financial condition, and other customary matters. Events of default under certain of the Company’s facilities also include termination of our status as servicer with respect to certain securitized loan pools and failure to maintain profitability over consecutive quarters. In addition, if the Company breaches any covenant oroperations.
In the event that the Company does not obtain a modification or waiver of any breach of a covenant requirement, the borrowing capacity under such breached facility would not be availableno recourse to the Company, so longit does not expect any significant impact to its financial condition, cash flows or results of operation as the Company remained out of compliance. Further, if at the time of noncompliance the Company continued to have borrowings outstanding under such breached facility, the breach would permit lenders under eacha result of the Company’s other warehouse repurchase facilities to accelerate all amounts then outstanding. The Company also has the unilateral right to prepay the borrowings at any time. Management believes the borrowing capacity currently existing and expected to exist under the Company’s warehouse repurchase agreements is adequate to permit a transferevent of all collateral from any breached facility and is adequate to maintain the Company’s current level of operations.
Repurchase agreements generally contain margin calls under which a portion of the borrowings must be repaid if the fair value of the mortgage securities – available-for-sale, mortgage securities - trading or mortgage loans collateralizing the repurchase agreements falls below a contractual ratio to the borrowings outstanding.
Accrued interest on the Company’s repurchase agreements was $6.7 million as of December 31, 2006 as compared to $3.2 million as of December 31, 2005.
In connection with the lending agreement with UBS Warburg Real Estate Securities, Inc. (“UBS”), NovaStar Mortgage SPV I (“NovaStar Trust”), a Delaware statutory trust, has been established by NMI as a wholly owned special-purpose warehouse finance subsidiary whose assets and liabilities are included in the Company’s consolidated financial statements.
NovaStar Trust has agreed to issue and sell to UBS mortgage notes (the “Notes”). Under the agreements that document the issuance and sale of the Notes:
all assets which are from time to time owned by NovaStar Trust are legally owned by NovaStar Trust and not by NMI.
NovaStar Trust is a legal entity separate and distinct from NMI and all other affiliates of NMI.
the assets of NovaStar Trust are legally assets only of NovaStar Trust, and are not legally available to NMI and all other affiliates of NMI or their respective creditors, for pledge to other creditors or to satisfy the claims of other creditors.
none of NMI or any other affiliate of NMI is legally liable on the debts of NovaStar Trust, except for an amount limited to 10% of the maximum dollar amount of the Notes permitted to be issued.
the only assets of NMI resulting from the issuance and sale of the Notes are:
As of December 31, 2006, NovaStar Trust had the following assets:
As of December 31, 2006, NovaStar Trust had the following liabilities and equity:
Asset-backed Bonds (“ABB”). The Company issued ABB secured by its mortgage loans and ABB secured by its mortgage securities - trading in certain transactions treated as financings as a means for long-term non-recourse financing. For financial reporting and tax purposes, the mortgage loans held-in-portfolio and mortgage securities - trading, as collateral, are recorded as assets of the Company and the ABB are recorded as debt. Interest and principal on each ABB is payable only from principal and interest on the underlying mortgage loans or mortgage securities collateralizing the ABB. Interest rates reset monthly and are indexed to one-month LIBOR. The estimated weighted-average months to maturity isare based on estimates and assumptions made by management. The actual maturity may differ from expectations. However,
The following table summarizes theno ABB transactions for the year ended December 31, 20062008.
Date Issued | Bonds Issued (A)(B) | Interest Rate Spread Over LIBOR (A) | Loans Pledged | |||||||
NHES Series 2006-1 | April 28, 2006 | $ | 1,320,974 | 0.06%-1.95% | $ | 1,350,000 | ||||
NHES Series 2006-MTA 1 | June 8, 2006 | 1,189,785 | 0.19%-0.65% | 1,199,913 |
Date Issued | Bonds Issued (A)(B) | Interest Rate Spread Over LIBOR (A) | Par Amount of Collateral Pledged | ||||||||
2007: | |||||||||||
NovaStar ABS CDO I | February 8, 2007 | $ | 331,500 | 0.32%-2.25% | $ | 374,862 | |||||
NHES Series 2007-1 | February 28, 2007 | 1,794,386 | 0.10%-1.75% | 1,888,756 |
(A) | The amounts shown do not include subordinated bonds retained by the Company. |
(B) | The bonds issued for the NHES 2006-MTA1 securitization include $19.2 million in Class X Notes. The Class X Notes are AAA-rated and are entitled to interest-only cash flows. |
The Company issued net interest margin certificates (“NIMs”) secured by its mortgage securities available-for-sale as a means for long-term financing. For financial reporting and tax purposes, the mortgage securities available-for-sale collateral are recorded as assets of the Company and the NIMs are recorded as debt. The performance of the mortgage loan collateral underlying these securities directly affects the performance of these bonds. Interest rates are fixed at the time of issuance and do not adjust over the life of the bonds. The estimated weighted average months to maturity are based on estimates and assumptions made by management. The actual maturity may differ from expectations. There were no NIMs transactions in the year ended December 31, 2006.
The following table summarizes the NIMs transactions for the year ended December 31, 2005 (dollars in thousands):
Date Issued | Bonds Issued | Interest Rate | Collateral (NMFT Series) (A) | |||||||
Issue 2005-N1 | June 22, 2005 | $ | 130,875 | 4.78 | % | 2005-1 and 2005-2 |
Asset-backed Bonds | Mortgage Loans | |||||||||||||||
Remaining Principal | Weighted Average Interest Rate | Estimated Weighted Average Months to Call or Maturity | Remaining (A) | Weighted Average Coupon | ||||||||||||
As of December 31, 2006: | ||||||||||||||||
ABB: | ||||||||||||||||
NHES Series 2006-1 | $ | 1,042,202 | 5.61 | % | 40 | $ | 1,059,353 | 8.58 | % | |||||||
NHES Series 2006-MTA1 | 1,032,842 | 5.60 | 49 | 1,042,415 | 8.12 | |||||||||||
Unamortized debt issuance costs, net | (7,554 | ) | ||||||||||||||
$ | 2,067,490 | $ | 2,101,768 | |||||||||||||
NIMs: | ||||||||||||||||
Issue 2005-N1 | $ | 9,558 | 4.78 | % | 5 | (D | ) | (D | ) | |||||||
Unamortized debt issuance costs, net | (39 | ) | ||||||||||||||
$ | 9,519 | |||||||||||||||
As of December 31, 2005: | ||||||||||||||||
ABB: | ||||||||||||||||
NHES Series 1998-1 | $ | 9,391 | 4.78 | % | 33 | $ | 10,933 | 9.91 | % | |||||||
NHES Series 1998-2 | 17,558 | 4.79 | 48 | 19,095 | 9.82 | |||||||||||
$ | 26,949 | $ | 30,028 | |||||||||||||
NIMs: | ||||||||||||||||
Issue 2004-N2 | $ | 3,557 | 4.46 | % | 1 | (B | ) | (B | ) | |||||||
Issue 2004-N3 | 49,475 | 3.97 | 9 | (C | ) | (C | ) | |||||||||
Issue 2005-N1 | 73,998 | 4.78 | 22 | (D | ) | (D | ) | |||||||||
Unamortized debt issuance costs, net | (1,400 | ) | ||||||||||||||
$ | 125,630 | |||||||||||||||
Asset-backed Bonds | Mortgage Loans | |||||||||||||||||||
Remaining Principal | Weighted Average Interest Rate | Estimated Weighted Average Months to Call or Maturity | Remaining Principal | Weighted Average Coupon | ||||||||||||||||
As of December 31, 2008: | ||||||||||||||||||||
ABB Secured by Mortgage Loans: | ||||||||||||||||||||
NHES Series 2006-1 | $ | 553,668 | 0.33 | % | 84 | $ | 528,766 | 8.95 | % | |||||||||||
NHES Series 2006-MTA1 | 683,757 | 0.75 | 40 | 680,127 | 5.80 | |||||||||||||||
NHES Series 2007-1 | 1,372,015 | 0.78 | 116 | 1,320,898 | 8.76 | |||||||||||||||
Unamortized debt issuance costs, net | (10,090 | ) | ||||||||||||||||||
$ | 2,599,351 | |||||||||||||||||||
ABB Secured by Mortgage Securities: | ||||||||||||||||||||
NovaStar ABS CDO I | $ | 325,930 | (A) | 3.08 | % | 26 | (B) | (B) | ||||||||||||
As of December 31, 2007: | ||||||||||||||||||||
ABB Secured by Mortgage Loans: | ||||||||||||||||||||
NHES Series 2006-1 | $ | 716,768 | 5.17 | % | 24 | $ | 694,101 | 8.49 | % | |||||||||||
NHES Series 2006-MTA1 | 750,048 | 5.14 | 19 | 753,787 | 8.23 | |||||||||||||||
NHES Series 2007-1 | 1,611,592 | 5.17 | 30 | 1,619,849 | 8.79 | |||||||||||||||
Unamortized debt issuance costs, net | (12,662 | ) | ||||||||||||||||||
$ | 3,065,746 | (A) | ||||||||||||||||||
ABB Secured by Mortgage Securities: | ||||||||||||||||||||
NovaStar ABS CDO I | $ | 331,500 | 5.56 | % | 32 | (B) | (B) |
(A) |
(B) | Collateral for the |
Asset-backed Bonds | |||
2007 | $ | 693,318 | |
2008 | 598,868 | ||
2009 | 380,091 | ||
2010 | 284,677 | ||
2011 | 127,648 | ||
Thereafter | — | ||
$ | 2,084,602 | ||
Junior Subordinated Debentures.In April 2006, the Company established NovaStar Capital Trust II (“NCTII”), a statutory trust organized under Delaware law for the sole purpose of issuing trust preferred securities. NovaStar Mortgage, Inc. (“NMI”) owns all of the common securities of NCTII. On April 18, 2006, NCTII issued $35 million in unsecured floating rate trust preferred securities to other investors. The trust preferred securities require quarterly interest payments. The interest rate is floating at the three-month LIBOR rate plus 3.5% and resets quarterly. The trust preferred securities are redeemable, at NCTII’s option, in whole or in part, anytime without penalty on or after June 30, 2011, but are mandatorily redeemable when they mature on June 30, 2036. If they are redeemed on or after June 30, 2011, but prior to maturity, the redemption price will be 100% of theevent that principal amount plus accrued and unpaid interest.
The proceedsreceipts from the issuance ofunderlying collateral are adversely impacted by credit losses, there could be insufficient principal receipts available to repay the trust preferred securities and the common securities of NCTII were loaned to NMI in exchange for $36.1 million of junior subordinated debentures of NMI, which are the sole assets of NCTII. The terms of the junior subordinated debentures match the terms of the trust preferred securities. The debentures are subordinate and junior in right of payment to all present and future senior indebtedness and certain other financial obligations of the Company. NovaStar Financial entered into a guarantee for the purpose of guaranteeing the payment of any amounts to be paid by NMI under the terms of the debentures. NovaStar Financial may not declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to any of its capital stock if there has occurred and is continuing an event of default under the guarantee. Following payment by the Company of offering costs, the Company’s net proceeds from the offering aggregated $33.9 million.
The assets and liabilities of NCTII are not consolidated into the consolidated financial statements of the Company. Accordingly, the Company’s equity interest in NCTII is accounted for using the equity method. Interest on the junior subordinated debt is included in the Company’s consolidated statements of income as interest expense—subordinated debt and the junior subordinated debentures are presented as a separate category on the consolidated balance sheets.
In March 2005, the Company established NovaStar Capital Trust I (“NCTI”), a statutory trust organized under Delaware law for the sole purpose of issuing trust preferred securities. NMI owns all of the common securities of NCTI. On March 15, 2005, NCTI issued $50 million in unsecured floating rate trust preferred securities to other investors. The trust preferred securities require quarterly interest payments. The interest rate is floating at the three-month LIBOR rate plus 3.5% and resets quarterly. The trust preferred securities are redeemable, at NCTI’s option, in whole or in part, anytime without penalty on or after March 15, 2010, but are mandatorily redeemable when they mature on March 15, 2035. If they are redeemed on or after March 15, 2010, but prior to maturity, the redemption price will be 100% of the principal amount plus accrued and unpaid interest.
The proceeds from the issuance of the trust preferred securities and from the sale of 100% of the common stock of NCTI to the Company were loaned to the Company in exchange for $51.6 million of junior subordinated debentures of the Company, which are the sole assets of NCTI. The terms of the junior subordinated debentures match the terms of the trust preferred securities. The debentures are subordinate and junior in right of payment to all present and future senior indebtedness and certain other financial obligations of the Company. NovaStar Financial entered into a guarantee for the purpose of guaranteeing the payment of any amounts to be paid by NMI under the terms of the debentures. If an event of default has occurred and is continuing under the junior subordinated debentures, NMI may not declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any shares of its capital stock. In addition, NovaStar Financial may not declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to any of its capital stock if there has occurred and is continuing an event of default under the guarantee. Following payment by the Company of offering costs, the Company’s net proceeds from the offering aggregated $48.4 million.
The assets and liabilities of NCTI are not consolidated into the consolidated financial statements of the Company. Accordingly, the Company’s equity interest in NCTI is accounted for using the equity method. Interest on the junior subordinated debt is included in the Company’s consolidated statements of income as interest expense—subordinated debt and the junior subordinated debentures are presented as a separate category on the consolidated balance sheets.
ABB principal.
Asset-backed Bonds | ||||
2009 | $ | 660,463 | ||
2010 | 556,296 | |||
2011 | 371,597 | |||
2012 | 332,824 | |||
2013 | 147,498 | |||
Thereafter | 867,432 | |||
$ | 2,936,110 |
Commitments. The Company has commitments to borrowers to fund residential mortgage loans as well as commitments to purchase and sell mortgage loans to third parties. At December 31, 2006, the Company had outstanding commitments to originate and purchase loans of $774.0 million and $11.8 million, respectively. The Company had no outstanding commitments to sell loans at December 31, 2006. At December 31, 2005, the Company had outstanding commitments to originate, purchase and sell loans of $545.4 million, $33.4 million and $93.6 million, respectively. The commitments to originate and purchase loans do not necessarily represent future cash requirements, as some portion of the commitments are likely to expire without being drawn upon.
In the ordinary course of business, the Company sells whole pools of loans with recourse for borrower defaults. When whole pools are sold as opposed to securitized, the third party has recourse against the Company for certain borrower defaults. Because the loans are no longer on the Company’s balance sheet, the recourse component is considered a guarantee. During 2006 the Company sold $2.2 billion of loans with recourse for borrower defaults as compared to $1.1 billion in 2005. The Company maintained a $24.8 million reserve related to these guarantees as of December 31, 2006 compared with a reserve of $2.3 million as of December 31, 2005. During the course of 2006 the Company paid $21.3 million in cash to repurchase loans sold to third parties. In 2005, the Company paid $2.3 million in cash to repurchase loans sold to third parties.
In the ordinary course of business, the Company sells loans to securitization trusts and guarantees losses suffered by the trusts resulting from defects in the loan origination process. Defects may occur in the loan documentation and underwriting process, either through processing errors made by the Company or through intentional or unintentional misrepresentations made by the borrower or agents during those processes. If a defect is identified, the Company is required to repurchase the loan. As of December 31, 2006 and 2005 the Company had loans sold with recourse with an outstanding principal balance of $12.6 billion and $12.7 billion, respectively. Historically, repurchases of loans where a defect has occurred have been insignificant; therefore, the Company has recorded no reserves related to these guarantees.
The Company leases office space under various operating lease agreements. Rent expense for 2006, 20052008 and 2004,2007, under leases related to continuing operations, aggregated $8.7 million, $11.0$4.8 million and $15.9$3.9 million, respectively. At December 31, 2006,2008, future minimum lease commitments under those leases are as follows (dollars in thousands):
Lease Obligations | |||
2007 | $ | 11,656 | |
2008 | 11,395 | ||
2009 | 10,764 | ||
2010 | 7,958 | ||
2011 | 2,580 | ||
Thereafter | 1,374 |
Lease Obligations | ||||
2009 | $ | 4,718 | ||
2010 | 4,656 | |||
2011 | 677 | |||
2012 | 225 | |||
2013 | 187 | |||
$ | 10,463 |
no sublease agreements included in continuing operations during 2008. The Company has also entered into variousa sublease agreementsagreement during 2007 for office space formerly occupied by the Company. The Company received approximately $861,000, $53,000$44,000 in 2007 under this agreement.
Lease Receipts | |||
2007 | $ | 1,101 | |
2008 | 1,130 | ||
2009 | 1,163 | ||
2010 | 405 | ||
2011 | — | ||
Thereafter | — |
the consolidated financial statements.
In the wake of the securitiespending class action the Company has also been named as a nominal defendant in several derivative actions brought against certain of the Company’s officers and directors in Missouri and Maryland.lawsuits. The complaints in these actions generally claim that the defendants are liable to the Company for failing to monitor corporate affairs so as to ensure compliance with applicable state licensing and regulatory requirements.
In April 2005, three putative class actions filed against NHMI and certain of its affiliates were consolidated for pre-trial proceedings in the United States District Court for the Southern District of Georgia entitledIn Re NovaStar Home Mortgage, Inc. Mortgage Lending Practices Litigation. These cases contend that NHMI improperly shared settlement service fees with limited liability companies in which NHMI had an interest (the “LLCs”), in violation of the fee splitting and anti-referral provisions of the federal Real Estate Settlement Procedures Act (“RESPA”), and also allege certain violations of state law and civil conspiracy. Plaintiffs seek treble damages with respect to the RESPA claims, disgorgement of fees with respect to the state law claims as well as other damages, injunctive relief, and attorneys’ fees. In addition, two other related class actions have been filed in state courts.Miller v. NovaStar Financial, Inc., et al., was filed in October 2004 in the Circuit Court of Madison County, Illinois andJones et al. v. NovaStar Home Mortgage, Inc., et al., was filed in December 2004 in the Circuit Court for Baltimore City, Maryland. In theMiller case, plaintiffs allege a violation of the Illinois Consumer Fraud and Deceptive Practices Act and civil conspiracy and contend certain LLCs provided settlement services without the borrower’s knowledge. The plaintiffs in theMiller case seek a disgorgement of fees, other damages, injunctive relief and attorney’s fees on behalf of the class of plaintiffs. In theJones case, the plaintiffs allege the LLCs violated the Maryland Mortgage Lender Law by acting as lenders and/or brokers in Maryland without proper licenses and contend this arrangement amounted to a civil conspiracy. The plaintiffs in the Jones case seek a disgorgement of fees and attorney’s fees. In January 2007, all of the plaintiffs and NHMI agreed upon a nationwide settlement. Since not all class members will elect to be parttotal amount of the settlement is $7.25 million, and it will be paid by the Company’s insurance carriers. The settlement agreement contains no admission of fault or wrongdoing by the Company estimatedor other defendants. On April 28, 2009, the Court approved the settlement.
In December 2005, a putative class action was filed against NMIas such no amounts have been accrued in the United States District Court for the Western District of Washington entitledPierce et al. v. NovaStar Mortgage, Inc. Plaintiffs contend that NMI failed to disclose prior to closing that a broker payment would be made on their loans, which was an unfair and deceptive practice in violation of the Washington Consumer Protection Act. Plaintiffs seek excess interest charged, and treble damages as provided in the Washington Consumer Protection Act and attorney’s fees. On October 31, 2006, the district court granted plaintiffs’ motion to certify a Washington state class. NMI sought to appeal the grant of class certification; however, a panel of the Ninth Circuit Court of Appeals denied the request for interlocutory appeal so review of the class certification order must wait until after a final judgment is entered, if necessary. The case is set for trial on April 23, 2007. NMI believes that it has valid defenses to plaintiffs’ claims and it intends to vigorously defend against them.
In December 2005, a putative class action was filed against NHMI in the United States District Court for the Middle District of Louisiana entitledPearson v. NovaStar Home Mortgage, Inc. Plaintiff contends that NHMI violated the federal Fair Credit Reporting Act (“FCRA”) in connection with its use of pre-approved offers of credit. Plaintiff seeks (on his own behalf, as well as for others similarly situated) statutory damages, other nominal damages, punitive damages and attorney’s fees and costs. In January 2007, the named plaintiff and NHMI agreed to settle the lawsuit for a nominal amount.
consolidated financial statements.
While management, Furthermore, the Company has received indemnification and loan repurchase demands with respect to alleged violations of representations and warranties made in loan sale and securitization agreements. These indemnification and repurchase demands have been addressed without significant loss to the Company, but such claims can be significant when multiple loans are involved. Deterioration of the housing market may increase the risk of such claims.
8.90% annually. Accrued and unpaid dividends payable related to the Series C Preferred Stock were approximately $8.3 million as of December 31, 2008 and $11.0 million as of May 27, 2009Note 10. Shareholders’ Equity.
The Company also sold 2,000,000 shares of its common stock during 2006 in a registered controlled equity offering. The Company raised $57.5 million in proceeds from these sales, which were net of $0.5 million in expenses related to the offering.
2007.
On January 20, 2006, the Company initiated offers to rescind certain shares of its common stock issued pursuant to its 401(k) plan and DRIP that may have been sold in a manner that may not have complied with the registration requirements of applicable securities laws. The Company repurchased 493 shares of its common stock from eligible investors who accepted the rescission offers as of March 31, 2006, the date the rescission offers expired.
In June 2005, the Company completed a firm-commitment underwritten public offering of 1,725,000 shares of its common stock at $35.00 per share. The Company raised $57.9 million in net proceeds from this offering.
In connection with various regulatory lending requirements, certain wholly-owned subsidiaries
For the Year Ended December 31, | ||||||||
2008 | 2007 | |||||||
Net loss | $ | (660,482 | ) | $ | (724,277 | ) | ||
Other comprehensive income (loss): | ||||||||
Change in unrealized loss on mortgage securities – available-for-sale | (14,152 | ) | (138,306 | ) | ||||
Change in unrealized gain on derivative instruments used in cash flow hedges | (1,364 | ) | (736 | ) | ||||
Impairment on mortgage securities - available-for-sale reclassified to earnings | 23,100 | 98,692 | ||||||
Valuation allowance for deferred taxes | - | 1,855 | ||||||
Net settlements of derivative instruments used in cash flow hedges reclassified to earnings | 2,459 | (301 | ) | |||||
Other comprehensive income (loss) | 10,043 | (38,796 | ) | |||||
Total comprehensive loss | $ | (650,439 | ) | $ | (763,073 | ) |
· | Level 1—Quoted prices for identical instruments in active markets |
· | Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. |
· | Level 3—Instruments whose significant value drivers are unobservable. |
Description | December 31, 2006 (Carrying value prior to adoption) | Cumulative-effect Adjustment to January 1, 2007 Accumulated Deficit | January 1, 2007 (Carrying value after adoption) | |||||||||
Mortgage securities – trading | $ | 329,361 | $ | 5,430 | $ | 334,791 |
Fair Value Measurements at Reporting Date Using | ||||||||||||||||
Description | Fair Value at December 31, 2008 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Assets | ||||||||||||||||
Mortgage securities -trading | $ | 7,085 | $ | - | $ | - | $ | 7,085 | ||||||||
Mortgage securities – available-for-sale | 12,788 | - | - | 12,788 | ||||||||||||
Total Assets | $ | 20,066 | $ | - | $ | - | $ | 20,066 | ||||||||
Liabilities | ||||||||||||||||
Asset-backed bonds secured by mortgage securities | $ | 5,376 | $ | - | $ | - | $ | 5,376 | ||||||||
Derivative instruments, net | 9,102 | 9,102 | ||||||||||||||
Total Liabilities | $ | 14,478 | $ | - | $ | 9,102 | $ | 5,376 |
Description | Fair Value at December 31, 2007 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Assets | ||||||||||||||||
Mortgage securities -trading | $ | 109,203 | $ | - | $ | 84,462 | $ | 24,741 | ||||||||
Mortgage securities – available-for-sale | 33,371 | - | - | 33,371 | ||||||||||||
Derivative instruments, net | (6,896 | ) | - | (6,896 | ) | - | ||||||||||
Total Assets | $ | 135,678 | $ | - | $ | 77,566 | $ | 58,112 | ||||||||
Liabilities | ||||||||||||||||
Asset-backed bonds secured by mortgage securities | $ | 74,385 | $ | - | $ | 74,385 | $ | - |
Cost Basis | Unrealized Loss | Estimated Fair Value of Mortgage Securities | ||||||||||
As of December 31, 2007 | $ | 41,275 | $ | (16,534 | ) | $ | 24,741 | |||||
Increases (decreases) to mortgage securities-trading: | ||||||||||||
Securities transferred from level 2 to level 3 | 414,080 | (395,359 | ) | 18,721 | ||||||||
Accretion of income | 23,652 | - | 23,652 | |||||||||
Proceeds from paydowns of securities | (45,039 | ) | - | (45,039 | ) | |||||||
Mark-to-market value adjustment | - | (14,990 | ) | (14,990 | ) | |||||||
Net increase (decrease) to mortgage securities | 392,693 | (410,349 | ) | (17,656 | ) | |||||||
As of December 31, 2008 | $ | 433,968 | $ | (426,883 | ) | $ | 7,085 |
Cost Basis | Unrealized Loss | Estimated Fair Value of Mortgage Securities | ||||||||||
As of December 31, 2006 | $ | - | $ | - | $ | - | ||||||
Increases (decreases) to mortgage securities-trading: | ||||||||||||
New securities retained in securitizations | 56,387 | 226 | 56,613 | |||||||||
Accretion of income | 3,102 | - | 3,102 | |||||||||
Proceeds from paydowns of securities | (18,214 | ) | - | (18,214 | ) | |||||||
Mark-to-market value adjustment | - | (16,760 | ) | (16,760 | ) | |||||||
Net increase (decrease) to mortgage securities | 41,275 | (16,534 | ) | 24,741 | ||||||||
As of December 31, 2007 | $ | 41,275 | $ | (16,534 | ) | $ | 24,741 |
Cost Basis | Unrealized Gain | Estimated Fair Value of Mortgage Securities | ||||||||||
As of December 31, 2007 | $ | 33,302 | $ | 69 | $ | 33,371 | ||||||
Increases (decreases) to mortgage securities: | ||||||||||||
Accretion of income (A) | 7,988 | - | 7,988 | |||||||||
Proceeds from paydowns of securities (A) (B) | (14,419 | ) | - | (14,419 | ) | |||||||
Impairment on mortgage securities - available-for-sale | (23,100 | ) | - | (23,100 | ) | |||||||
Mark-to-market value adjustment | - | 8,948 | 8,948 | |||||||||
Net decrease to mortgage securities | (29,531 | ) | 8,948 | (20,583 | ) | |||||||
As of December 31, 2008 | $ | 3,771 | $ | 9,017 | $ | 12,788 |
(A) | Cash received on mortgage securities with no cost basis was $3.4 million for the year ended December 31, 2008. |
(B) | For mortgage securities with a remaining cost basis, the Company reduces the cost basis by the amount of cash that is contractually due from the securitization trusts. In contrast, for mortgage securities in which the cost basis has previously reached zero, the Company records in interest income the amount of cash that is contractually due from the securitization trusts. In both cases, there are instances where the Company may not receive a portion of this cash until after the balance sheet reporting date. Therefore, these amounts are recorded as receivables from the securitization trusts, which are included in the other assets line on the Company’s consolidated balance sheets. As of December 31, 2008 the Company had no receivables from securitization trusts related to mortgage securities available-for-sale with a remaining or zero cost basis. |
Cost Basis | Unrealized Gain | Estimated Fair Value of Mortgage Securities | ||||||||||
As of December 31, 2006 | $ | 310,760 | $ | 38,552 | $ | 349,312 | ||||||
Increases (decreases) to mortgage securities: | ||||||||||||
Transfer to mortgage securities – trading upon adoption of SFAS 159 | (47,814 | ) | 1,131 | (46,683 | ) | |||||||
Accretion of income (A) | 48,778 | - | 48,778 | |||||||||
Proceeds from paydowns of securities (A) (B) | (179,730 | ) | - | (179,730 | ) | |||||||
Impairment on mortgage securities - available-for-sale | (98,692 | ) | 98,692 | - | ||||||||
Mark-to-market value adjustment | - | (138,306 | ) | (138,306 | ) | |||||||
Net decrease to mortgage securities | (277,458 | ) | (38,483 | ) | (315,941 | ) | ||||||
As of December 31, 2007 | $ | 33,302 | $ | 69 | $ | 33,371 |
(A) | Cash received on mortgage securities with no cost basis was $3.5 million for the year ended December 31, 2007. |
(B) | For mortgage securities with a remaining cost basis, the Company reduces the cost basis by the amount of cash that is contractually due from the securitization trusts. In contrast, for mortgage securities in which the cost basis has previously reached zero, the Company records in interest income the amount of cash that is contractually due from the securitization trusts. In both cases, there are instances where the Company may not receive a portion of this cash until after the balance sheet reporting date. Therefore, these amounts are recorded as receivables from the securitization trusts, which are included in the other assets line on the Company’s consolidated balance sheets. As of December 31, 2007, the Company had receivables from securitization trusts of $12.5 million, related to mortgage securities available-for-sale with a remaining cost basis. At December 31, 2007 there were no receivables from securitization trusts related to mortgage securities with a zero cost basis. |
Fair Value Measurements at Reporting Date Using | ||||||||||||||||
Description | Fair Value at December 31, 2008 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Real estate owned | $ | 70,480 | $ | - | $ | - | $ | 70,480 |
Description | Fair Value at December 31, 2007 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Real estate owned | $ | 76,614 | $ | - | $ | - | $ | 76,614 |
Fair Value Adjustments For the Year Ended December 31 | |||||||||||
Asset or Liability Measured at Fair Value | Fair Value Measurement Frequency | 2008 | 2007 | Statement of Operation Line Item Impacted | |||||||
Mortgage securities - trading | Recurring | $ | (88,715 | ) | $ | (342,918 | ) | Fair value adjustments | |||
Mortgage securities – available-for-sale | Recurring | (23,100 | ) | (98,692 | ) | Impairment on mortgage securities – available-for-sale | |||||
Derivative instruments, net | Recurring | (2,627 | ) | (14,027 | ) | (Losses) gains on derivative instruments | |||||
Asset-backed bonds secured by mortgage securities | Recurring | 62,973 | 257,115 | Fair value adjustments | |||||||
Total fair value gains (losses) | $ | (51,469 | ) | $ | (198,522 | ) |
Unpaid Principal Balance | Gain Recognized | Balance at Fair Value | ||||||||||
As of December 31, 2008 | $ | 324,243 | $ | 62,973 | $ | 5,376 | ||||||
As of December 31, 2007 | 331,500 | 257,115 | 74,385 |
7.
held-in-portfolio.
Notional Amount | Fair Value | Maximum Days to Maturity | ||||||
As of December 31, 2006: | ||||||||
Non-hedge derivative instruments | $ | 1,375,000 | $ | 7,111 | 1,606 | |||
Cash flow hedge derivative instruments | 810,000 | 4,050 | 756 | |||||
As of December 31, 2005: | ||||||||
Non-hedge derivative instruments | $ | 1,555,000 | $ | 8,395 | 1,820 |
Notional Amount | Fair Value | Maximum Days to Maturity | ||||||||||
As of December 31, 2008: | ||||||||||||
Non-hedge derivative instruments | $ | 461,500 | $ | (9,034 | ) | 390 | ||||||
Cash flow hedge derivative instruments | 40,000 | (68 | ) | 25 | ||||||||
As of December 31, 2007: | ||||||||||||
Non-hedge derivative instruments | $ | 1,101,500 | $ | (6,406 | ) | 756 | ||||||
Cash flow hedge derivative instruments | 300,000 | (490 | ) | 391 |
The derivative financial instruments the Company uses also subject them to “margin call” risk. The Company’s deposits with derivative counterparties were $5.7 million and $4.4 million as of December 31, 2006 and 2005, respectively.
$68,000.
Comprehensive income includes revenues, expenses, gains and losses that are not included in net income. The following is a rollforward of accumulated other comprehensive income for the three years ended December 31, 2006 (dollars in thousands):
For the Year Ended December 31, | |||||||||||
2006 | 2005 | 2004 | |||||||||
Net Income | $ | 72,938 | $ | 139,124 | $ | 115,389 | |||||
Other comprehensive (loss) income: | |||||||||||
Change in unrealized gain on mortgage securities – available-for-sale, net of tax | (99,703 | ) | 14,690 | (24,462 | ) | ||||||
Change in unrealized gain on mortgage securities – available-for-sale due to repurchase of mortgage loans from securitization trusts | (5,153 | ) | — | — | |||||||
Impairment on mortgage securities - available-for-sale reclassified to earnings | 30,009 | 17,619 | 15,902 | ||||||||
Reclassification adjustment into income for derivatives used in cash flow hedges | (315 | ) | 109 | 2,497 | |||||||
Change in unrealized gain on derivative instruments used in cash flow hedges | 172 | — | — | ||||||||
Other comprehensive (loss) income | (74,990 | ) | 32,418 | (6,063 | ) | ||||||
Total comprehensive (loss) income | $ | (2,052 | ) | $ | 171,542 | $ | 109,326 | ||||
Note 13. Interest Income
For the Year Ended December 31, | |||||||||
2006 | 2005 | 2004 | |||||||
Interest income: | |||||||||
Mortgage securities | $ | 164,858 | $ | 188,856 | $ | 133,633 | |||
Mortgage loans held-for-sale | 157,807 | 105,104 | 83,571 | ||||||
Mortgage loans held-in-portfolio | 134,604 | 4,311 | 6,673 | ||||||
Other interest income (A) | 37,621 | 22,456 | 6,968 | ||||||
Total interest income | $ | 494,890 | $ | 320,727 | $ | 230,845 | |||
For the Year Ended December 31, | ||||||||
2008 | 2007 | |||||||
Interest income: | ||||||||
Mortgage securities | $ | 46,997 | $ | 102,500 | ||||
Mortgage loans held-in-portfolio | 186,601 | 258,663 | ||||||
Other interest income (A) | 1,411 | 5,083 | ||||||
Total interest income | $ | 235,009 | $ | 366,246 |
(A) | Other interest income |
For the Year Ended December 31, | |||||||||
2006 | 2005 | 2004 | |||||||
Interest expense: | |||||||||
Short-term borrowings secured by mortgage loans | $ | 121,628 | $ | 58,492 | $ | 31,411 | |||
Short-term borrowings secured by mortgage securities | 14,237 | 1,770 | 4,836 | ||||||
Other short-term borrowings | 488 | — | — | ||||||
Asset-backed bonds secured by mortgage loans | 88,117 | 1,810 | 2,980 | ||||||
Asset-backed bonds secured by mortgage securities | 3,860 | 15,628 | 13,255 | ||||||
Junior subordinated debentures | 7,001 | 3,055 | — | ||||||
Total interest expense | $ | 235,331 | $ | 80,755 | $ | 52,482 | |||
For the Year Ended December 31, | ||||||||
2008 | 2007 | |||||||
Interest expense: | ||||||||
Short-term borrowings secured by mortgage securities | $ | 436 | $ | 23,649 | ||||
Asset-backed bonds secured by mortgage loans | 95,012 | 178,937 | ||||||
Asset-backed bonds secured by mortgage securities | 13,271 | 17,635 | ||||||
Junior subordinated debentures | 6,261 | 8,148 | ||||||
Total interest expense | $ | 114,980 | $ | 228,369 |
Prior to 2004,
On November 4, 2005, the Company adopted a formal plan to terminate substantially all of the remaining NHMI branches by June 30, 2006. 31, 2008 and 2007.
2007 in accordance with SFAS 144.
December 31, | December 31, | |||||||
2008 | 2007(A) | |||||||
Assets | ||||||||
Mortgage loans - held-for-sale | $ | 1,117 | $ | 5,253 | ||||
Real estate owned | 324 | 2,574 | ||||||
Other assets | - | 428 | ||||||
Total assets | $ | 1,441 | $ | 8,255 | ||||
Liabilities | ||||||||
Short-term borrowings secured by mortgage loans | $ | - | $ | 19 | ||||
Accounts payable and other liabilities | 2,536 | 59,397 | ||||||
Total liabilities | $ | 2,536 | $ | 59,416 |
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Interest income | $ | 230 | $ | 790 | $ | 41 | ||||||
Interest expense | (194 | ) | (88 | ) | (108 | ) | ||||||
Gains on sales of mortgage assets | 1,490 | 3,025 | — | |||||||||
Fee income | 6,056 | 36,605 | 134,250 | |||||||||
Other income (expense) | 154 | (81 | ) | 19 | ||||||||
General and administrative expenses | (14,531 | ) | (58,886 | ) | (171,707 | ) | ||||||
Loss before income tax benefit | (6,795 | ) | (18,635 | ) | (37,505 | ) | ||||||
Income tax benefit | (2,528 | ) | (6,932 | ) | (13,952 | ) | ||||||
Loss from discontinued operations | $ | (4,267 | ) | $ | (11,703 | ) | $ | (23,553 | ) | |||
For the Years Ended December 31, | ||||||||
2008 | 2007 | |||||||
Interest income | $ | 1,173 | $ | 102,648 | ||||
Interest expense | (12 | ) | 79,483 | |||||
Net interest income | 1,185 | 23,165 | ||||||
Other operating (expense) income: | ||||||||
Gains (losses) on sales of mortgage assets | 1,281 | (2,579 | ) | |||||
Gains (losses) on derivative instruments | - | (4,913 | ) | |||||
Valuation adjustment on mortgage loans – held-for-sale | (3,331 | ) | (101,125 | ) | ||||
Fee income | 903 | 22,900 | ||||||
Premiums for mortgage loan insurance | - | (2,668 | ) | |||||
Other income | 409 | (6,777 | ) | |||||
Total other operating expense | (738 | ) | (95,162 | ) | ||||
General and administrative expenses (A) | 36,187 | (184,783 | ) | |||||
Gain (loss) from discontinued operations before income tax expense | 36,634 | (256,780 | ) | |||||
Income tax expense | 13,804 | - | ||||||
Gain (loss) income from discontinued operations | $ | 22,830 | $ | (256,780 | ) |
(A) | The general and administrative expenses line includes the reversal of a $45.2 million liability during year ended December 31, 2008 which was recorded in connection with the judgment rendered against NHMI in the California Action by AIM, the settlement of which became final as of September 11, 2008. |
December 31, 2008 | December 31, 2007 | |||||||
Mortgage loans – held-for-sale: | ||||||||
Outstanding principal | $ | 15,578 | $ | 17,545 | ||||
Allowance for the lower of cost or fair value | (14,461 | ) | (12,292 | ) | ||||
Mortgage loans – held-for-sale | $ | 1,117 | $ | 5,253 | ||||
Weighted average coupon | 10.13 | % | 10.23 | % |
For the Year Ended December 31, | ||||||||
2008 | 2007 | |||||||
Balance, beginning of period | $ | 12,292 | $ | 5,006 | ||||
Valuation adjustment on mortgage loans - held-for-sale | 3,331 | 101,125 | ||||||
Transfer from the reserve for loan repurchases | - | 23,206 | ||||||
Transfer to cost basis of mortgage loans – held-in-portfolio | - | (14,843 | ) | |||||
Reduction due to loans securitized or sold to third parties | - | (82,384 | ) | |||||
Transfers to real estate owned | 239 | (19,818 | ) | |||||
Charge-offs, net of recoveries | (1,401 | ) | - | |||||
Balance, end of period | $ | 14,461 | $ | 12,292 |
Allocated Value of Retained Interests | ||||||||||||||||||||||||
Net Bond Proceeds | Mortgage Servicing Rights | Subordinated Bond Classes | Principal Balance of Loans Sold | Fair Value of Derivative Instruments Transferred | Gain Recognized | |||||||||||||||||||
NMFT Series 2007-2 | $ | 1,331,299 | $ | 9,766 | $ | 56,387 | $ | 1,400,000 | $ | 4,161 | $ | 4,981 |
NovaStar Mortgage Funding Trust Series | Constant Prepayment Rate | Average Life (in Years) | Expected Total Credit Losses, Net of Mortgage Insurance (A) | Discount Rate | ||||||||||||
2007-2 | 34 | % | 2.31 | 5.7 | % | 20 | % |
(A) | Represents expected credit losses for the life of the securitization up to the expected date in which the related asset-backed bonds can be called. |
For the Years Ended December 31, | ||||||||
2008 | 2007 | |||||||
Balance, beginning of period | $ | 2,153 | $ | 24,773 | ||||
Provision for repurchased loans | (1,782 | ) | 3,254 | |||||
Transfer to the allowance for the lower of cost of fair value on mortgage loans – held for sale | - | (23,206 | ) | |||||
Charge-offs, net | (276 | ) | (2,668 | ) | ||||
Balance, end of period | $ | 95 | $ | 2,153 |
Balance, beginning of period | $ | 62,830 | ||
Amount capitalized in connection with transfer of loans to securitization trusts | 9,766 | |||
Amortization | (25,252 | ) | ||
Sale of mortgage servicing rights | (47,344 | ) | ||
Balance, end of period | $ | - |
Maximum Borrowing Capacity | Rate | Days to Reset | Balance | |||||||
December 31, 2007 | ||||||||||
Short-term borrowings (indexed to one- month LIBOR): | ||||||||||
Repurchase agreement expiring May 8, 2008 (A) | $ | 1,900,000 | 4.57 | % | 1 | $ | 19 |
(A) | Eligible collateral for this agreement was both mortgage loans and mortgage securities. The maximum borrowing capacity under this facility was reduced by the amount of borrowings outstanding from time to time with this lender under related facilities. |
2007 (A) | ||||
Maximum month-end outstanding balance during the period | $ | 2,339,431 | ||
Average balance outstanding during the period | 865,495 | |||
Weighted average rate for period | 6.80 | % | ||
Weighted average interest rate at period end | 4.57 | % |
(A) | Information pertaining to the year ended December 31, 2008, was not included as the outstanding balance was paid off during May 2008. |
Lease Obligations | ||||
2009 | $ | 1,465 | ||
2010 | 1,057 | |||
2011 | 497 | |||
2012 | 212 |
Lease Receipts | ||||
2009 | $ | 681 | ||
2010 | 576 | |||
2011 | 419 | |||
2012 | 177 |
Fair Value Measurements at Reporting Date Using | |||||||||||||||||
Description | Fair Value at December 31, 2008 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
Mortgage loans-held-for-sale | $ | 1,117 | $ | - | $ | - | $ | 1,117 | |||||||||
Real estate owned | 324 | - | - | 324 | |||||||||||||
Total | $ | 1,441 | $ | - | $ | - | $ | 1,441 |
Description | Fair Value at December 31, 2007 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Mortgage loans-held-for-sale | $ | 5,253 | $ | - | $ | - | $ | 5,253 | ||||||||
Real estate owned | 2,574 | - | - | 2,574 | ||||||||||||
Total | $ | 7,827 | $ | - | $ | - | $ | 7,827 |
Asset or Liability Measured at Fair Value | Fair Value Measurement Frequency | Fair Value Adjustments for the Year Ended December 31, 2008 | Fair Value Adjustments for the Year Ended December 31, 2007 | Statement of Operations Line Item Impacted | |||||||
Mortgage loans held-for-sale | Nonrecurring | $ | (3,331 | ) | $ | (101,125 | ) | Valuation adjustment on mortgage loans – held-for-sale | |||
Real estate owned | Nonrecurring | (656 | ) | (6,250 | ) | (Losses) gains on sales of mortgage assets | |||||
Total fair value losses | $ | (3,987 | ) | $ | (107,375 | ) |
statements of operations. The Company had no liability as of December 31, 2007 remaining to be paid under the Exit Plans.
2008 | 2007 | |||||||||||||||
Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||||
Financial assets: | ||||||||||||||||
Mortgage loans – held-for-sale | $ | 1,117 | $ | 1,117 | $ | 5,253 | $ | 5,253 | ||||||||
Financial liabilities: | ||||||||||||||||
Short-term borrowings | - | - | 19 | 19 |
The
Following is a summary of themanagement segment’s operating results of the Company’s segments for the years ended December 31, 2006, 20052008 and 2004,2007 are the same as reclassified to reflect the change in segment structure and the resultsCompany’s consolidated statements of the discontinued operations for the years ended December 31, 2005 and December 31, 2004 (dollars in thousands):
For the Year Ended December 31, 2006
Mortgage Portfolio Management | Mortgage Lending | Loan Servicing | Eliminations | Total | ||||||||||||||||
Interest income | $ | 303,600 | $ | 162,631 | $ | 28,659 | $ | — | $ | 494,890 | ||||||||||
Interest expense | 124,333 | 128,024 | — | (17,026 | ) | 235,331 | ||||||||||||||
Net interest income before provision for credit losses | 179,267 | 34,607 | 28,659 | 17,026 | 259,559 | |||||||||||||||
Provision for credit losses | (30,131 | ) | — | — | — | (30,131 | ) | |||||||||||||
Gains on sales of mortgage assets | 362 | 60,693 | — | (19,306 | ) | 41,749 | ||||||||||||||
Premiums for mortgage loan insurance | (6,269 | ) | (6,150 | ) | — | — | (12,419 | ) | ||||||||||||
Fee income | 4,987 | 5,738 | 24,641 | (6,334 | ) | 29,032 | ||||||||||||||
Gains on derivative instruments | 109 | 11,889 | — | — | 11,998 | |||||||||||||||
Impairment on mortgage securities – available- for-sale | (30,690 | ) | — | — | — | (30,690 | ) | |||||||||||||
Other income (expense), net | 13,646 | (2,307 | ) | — | (10,692 | ) | 647 | |||||||||||||
General and administrative expenses | (16,012 | ) | (150,281 | ) | (34,968 | ) | — | (201,261 | ) | |||||||||||
Income (loss) from continuing operations before income tax expense | 115,269 | (45,811 | ) | 18,332 | (19,306 | ) | 68,484 | |||||||||||||
Income tax expense (benefit) | 9,466 | (18,054 | ) | 7,020 | (7,153 | ) | (8,721 | ) | ||||||||||||
Income (loss) from continuing operations | 105,803 | (27,757 | ) | 11,312 | (12,153 | ) | 77,205 | |||||||||||||
Loss from discontinued operations, net of income tax | — | (4,267 | ) | — | — | (4,267 | ) | |||||||||||||
Net income (loss) | $ | 105,803 | $ | (32,024 | ) | $ | 11,312 | $ | (12,153 | ) | $ | 72,938 | ||||||||
December 31, 2006: | ||||||||||||||||||||
Total assets | $ | 3,234,848 | $ | 2,137,297 | $ | 41,123 | $ | (385,005 | ) | $ | 5,028,263 |
For the Year Ended December 31, 2005
Mortgage Portfolio Management | Mortgage Lending | Loan Servicing | Eliminations | Total | ||||||||||||||||
Interest income | $ | 196,407 | $ | 106,069 | $ | 18,251 | $ | $ | 320,727 | |||||||||||
Interest expense | 19,028 | 74,646 | — | (12,919 | ) | 80,755 | ||||||||||||||
Net interest income before provision for credit losses | 177,379 | 31,423 | 18,251 | 12,919 | 239,972 | |||||||||||||||
Provision for credit losses | (1,038 | ) | — | — | — | (1,038 | ) | |||||||||||||
(Losses) gains on sales of mortgage assets | (27 | ) | 67,248 | — | (2,073 | ) | 65,148 | |||||||||||||
Premiums for mortgage loan insurance | (341 | ) | (5,331 | ) | — | — | (5,672 | ) | ||||||||||||
Fee income | — | 9,174 | 21,755 | (251 | ) | 30,678 | ||||||||||||||
Gains on derivative instruments | 248 | 17,907 | — | — | 18,155 | |||||||||||||||
Impairment on mortgage securities – available- for-sale | (17,619 | ) | — | — | — | (17,619 | ) | |||||||||||||
Other income (expense), net | 19,671 | (7,788 | ) | — | (12,667 | ) | (784 | ) | ||||||||||||
General and administrative expenses | (14,450 | ) | (135,665 | ) | (34,515 | ) | — | (184,630 | ) | |||||||||||
Income (loss) from continuing operations before income tax expense | 163,823 | (23,032 | ) | 5,491 | (2,072 | ) | 144,210 | |||||||||||||
Income tax expense (benefit) | 168 | (8,035 | ) | 2,062 | (812 | ) | (6,617 | ) | ||||||||||||
Income (loss) from continuing operations | 163,655 | (14,997 | ) | 3,429 | (1,260 | ) | 150,827 | |||||||||||||
Loss from discontinued operations, net of income tax | — | (11,703 | ) | — | (11,703 | ) | ||||||||||||||
Net income (loss) | $ | 163,655 | $ | (26,700 | ) | $ | 3,429 | $ | (1,260 | ) | $ | 139,124 | ||||||||
December 31, 2005: | ||||||||||||||||||||
Total assets | $ | 968,740 | $ | 1,508,283 | $ | 27,553 | $ | (168,842 | ) | $ | 2,335,734 |
For the Year Ended December 31, 2004
Mortgage Portfolio Management | Mortgage Lending | Loan Servicing | Eliminations | Total | ||||||||||||||||
Interest income | $ | 142,960 | $ | 83,718 | $ | 4,167 | $ | — | $ | 230,845 | ||||||||||
Interest expense | 21,071 | 39,658 | — | (8,247 | ) | 52,482 | ||||||||||||||
Net interest income before provision for credit losses | 121,889 | 44,060 | 4,167 | 8,247 | 178,363 | |||||||||||||||
Provision for credit losses | (726 | ) | — | — | — | (726 | ) | |||||||||||||
Gains on sales of mortgage assets | 360 | 147,390 | — | (2,800 | ) | 144,950 | ||||||||||||||
Premiums for mortgage loan insurance | (528 | ) | (3,690 | ) | — | — | (4,218 | ) | ||||||||||||
Fee income | — | 10,399 | 20,692 | (423 | ) | 30,668 | ||||||||||||||
Losses on derivative instruments | (111 | ) | (8,794 | ) | — | — | (8,905 | ) | ||||||||||||
Impairment on mortgage securities – available- for-sale | (15,902 | ) | — | — | — | (15,902 | ) | |||||||||||||
Other income (expense), net | 13,997 | (6,445 | ) | — | (7,824 | ) | (272 | ) | ||||||||||||
General and administrative expenses | (7,473 | ) | (136,089 | ) | (24,698 | ) | — | (168,260 | ) | |||||||||||
Income from continuing operations before income tax expense | 111,506 | 46,831 | 161 | (2,800 | ) | 155,698 | ||||||||||||||
Income tax expense | — | 16,722 | 160 | (126 | ) | 16,756 | ||||||||||||||
Income from continuing operations | 111,506 | 30,109 | 1 | (2,674 | ) | 138,942 | ||||||||||||||
Loss from discontinued operations, net of income tax | — | (23,553 | ) | — | (23,553 | ) | ||||||||||||||
Net income | $ | 111,506 | $ | 6,556 | $ | 1 | $ | (2,674 | ) | $ | 115,389 | |||||||||
December 31, 2004 | ||||||||||||||||||||
Total assets | $ | 1,078,064 | $ | 929,621 | $ | 21,022 | $ | (167,396 | ) | $ | 1,861,311 |
Intersegment revenues and expenses that were eliminated in consolidation were as follows for the years ended 2006, 2005 and 2004 (dollars in thousands):
2006 | 2005 | 2004 | ||||||||||
Amounts paid to (received from) mortgage portfolio management from (to) mortgage lending: | ||||||||||||
Interest income on intercompany debt | $ | 17,026 | $ | 12,819 | $ | 8,200 | ||||||
Guaranty, commitment, loan sale and securitization fees | 5,061 | 9,494 | 10,833 | |||||||||
Interest income on warehouse borrowings | — | 100 | 47 | |||||||||
Gains on sales of mortgage securities – available-for-sale retained in securitizations | (2,462 | ) | (2,073 | ) | (2,800 | ) | ||||||
Gains on sales of mortgage loans | (16,844 | ) | — | — | ||||||||
Amounts paid to (received from) mortgage portfolio management from (to) loan servicing: | ||||||||||||
Loan servicing fees | $ | (6,264 | ) | $ | (251 | ) | $ | (423 | ) | |||
Amounts paid to (received from) mortgage lending from (to) loan servicing: | ||||||||||||
Loan servicing fees | $ | (70 | ) | $ | — | $ | — |
operations.
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Numerator: | ||||||||||||
Income from continuing operations | $ | 77,205 | $ | 150,827 | $ | 138,942 | ||||||
Dividends on preferred shares | (6,653 | ) | (6,653 | ) | (6,265 | ) | ||||||
Income from continuing operations available to common shareholders | 70,552 | 144,174 | 132,677 | |||||||||
Loss from discontinued operations, net of income tax | (4,267 | ) | (11,703 | ) | (23,553 | ) | ||||||
Net income available to common shareholders | $ | 66,285 | $ | 132,471 | $ | 109,124 | ||||||
Denominator: | ||||||||||||
Weighted average common shares outstanding – basic | 34,212 | 29,669 | 25,290 | |||||||||
Weighted average common shares outstanding – dilutive: | ||||||||||||
Weighted average common shares outstanding – basic | 34,212 | 29,669 | 25,290 | |||||||||
Stock options | 237 | 316 | 435 | |||||||||
Restricted stock | 23 | 8 | 38 | |||||||||
Weighted average common shares outstanding – dilutive | 34,472 | 29,993 | 25,763 | |||||||||
Basic earnings per share: | ||||||||||||
Income from continuing operations | $ | 2.26 | $ | 5.09 | $ | 5.49 | ||||||
Dividends on preferred shares | (0.19 | ) | (0.23 | ) | (0.25 | ) | ||||||
Income from continuing operations available to common shareholders | 2.07 | 4.86 | 5.24 | |||||||||
Loss from discontinued operations, net of income tax | (0.13 | ) | (0.40 | ) | (0.93 | ) | ||||||
Net income available to common shareholders | $ | 1.94 | $ | 4.46 | $ | 4.31 | ||||||
Diluted earnings per share: | ||||||||||||
Income from continuing operations | $ | 2.23 | $ | 5.03 | $ | 5.39 | ||||||
Dividends on preferred shares | (0.19 | ) | (0.22 | ) | (0.24 | ) | ||||||
Income from continuing operations available to common shareholders | 2.04 | 4.81 | 5.15 | |||||||||
Loss from discontinued operations, net of income tax | (0.12 | ) | (0.39 | ) | (0.91 | ) | ||||||
Net income available to common shareholders | $ | 1.92 | $ | 4.42 | $ | 4.24 | ||||||
For the Year Ended December 31, | ||||||||
2008 | 2007 | |||||||
Numerator: | ||||||||
Loss from continuing operations | $ | (683,312 | ) | $ | (467,497 | ) | ||
Dividends on preferred shares | (15,273 | ) | (8,805 | ) | ||||
Loss from continuing operations available to common shareholders | (698,585 | ) | (476,302 | ) | ||||
Income (loss) from discontinued operations, net of income tax | 22,830 | (256,780 | ) | |||||
Loss available to common shareholders | $ | (675,755 | ) | $ | (733,082 | ) | ||
Denominator: | ||||||||
Weighted average common shares outstanding – basic | 9,338,131 | 9,332,405 | ||||||
Weighted average common shares outstanding – dilutive: | ||||||||
Weighted average common shares outstanding – basic | 9,338,131 | 9,332,405 | ||||||
Stock options | - | - | ||||||
Restricted stock | - | - | ||||||
Weighted average common shares outstanding – dilutive | 9,338,131 | 9,332,405 | ||||||
Basic earnings per share: | ||||||||
Loss from continuing operations | $ | (73.17 | ) | $ | (50.10 | ) | ||
Dividends on preferred shares | (1.64 | ) | (0.94 | ) | ||||
Loss from continuing operations available to common shareholders | (74.81 | ) | (51.04 | ) | ||||
Income (loss) from discontinued operations, net of income tax | 2.44 | ) | (27.51 | ) | ||||
Net loss available to common shareholders | $ | (72.37 | ) | $ | (78.55 | ) | ||
Diluted earnings per share: | ||||||||
Loss from continuing operations | $ | (73.17 | ) | $ | (50.10 | ) | ||
Dividends on preferred shares | (1.64 | ) | (0.94 | ) | ||||
Loss from continuing operations available to common shareholders | (74.81 | ) | (51.04 | ) | ||||
Income (loss) from discontinued operations, net of income tax | 2.44 | ) | (27.51 | ) | ||||
Net loss available to common shareholders | $ | (72.37 | ) | $ | (78.55 | ) |
For the Year Ended December 31, | |||||||||
2006 | 2005 | 2004 | |||||||
Number of stock options and warrants (in thousands) | 247 | 93 | 15 | ||||||
Weighted average exercise price | $ | 35.20 | $ | 40.58 | $ | 33.59 |
For the Year Ended December 31, | ||||||
2008 | 2007 | |||||
Number of stock options and restricted stock (in thousands) | 206 | 340 | ||||
Weighted average exercise price of stock options | $ | 57.36 | $ | 35.88 |
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Current: | ||||||||||||
Federal | $ | 105 | $ | 5,153 | $ | 16,548 | ||||||
State and local | (237 | ) | 957 | 1,530 | ||||||||
Total current | (132 | ) | 6,110 | 18,078 | ||||||||
Deferred: (A) | ||||||||||||
Federal | (7,374 | ) | (11,176 | ) | (1,258 | ) | ||||||
State and local | (1,215 | ) | (1,551 | ) | (64 | ) | ||||||
Total deferred | (8,589 | ) | (12,727 | ) | (1,322 | ) | ||||||
Total income tax (benefit) expense | $ | (8,721 | ) | $ | (6,617 | ) | $ | 16,756 | ||||
For the Year Ended December 31, | ||||||||
2008 | 2007(A) | |||||||
Current: | ||||||||
Federal | $ | (2,804 | ) | $ | 21,422 | |||
State and local | (985 | ) | 3,470 | |||||
Total current | (3,789 | ) | 24,892 | |||||
Deferred: | ||||||||
Federal | (12,293 | ) | 36,706 | |||||
State and local | (1,512 | ) | 4,914 | |||||
Total deferred | (13,805 | ) | 41,620 | |||||
Total income tax expense (benefit) | $ | (17,594 | ) | $ | 66,512 |
(A) | Does not reflect the deferred tax effects of unrealized gains and losses on mortgage securities-available-for-sale and derivative financial instruments that are included in shareholders’ equity. As a result of these tax effects, shareholders’ equity |
For the Year Ended December 31, | ||||||||||||
2006 | 2005 | 2004 | ||||||||||
Income tax at statutory rate | $ | (7,507 | ) | $ | (6,857 | ) | $ | 14,989 | ||||
Taxable gain on security sale to REIT | — | — | 1,342 | |||||||||
State income taxes, net of federal tax benefit | (944 | ) | (386 | ) | 953 | |||||||
Nondeductible expenses | 423 | 601 | 240 | |||||||||
Cash surrender value of company owned life insurance | (270 | ) | — | — | ||||||||
Reduction of estimated income tax accruals | — | — | (904 | ) | ||||||||
Other | (423 | ) | 25 | 136 | ||||||||
Total income tax (benefit) expense | $ | (8,721 | ) | $ | (6,617 | ) | $ | 16,756 | ||||
For the Year Ended December 31, | ||||||||
2008 | 2007 | |||||||
Income tax at statutory rate | $ | (245,317 | ) | $ | (140,345 | ) | ||
State income taxes, net of federal tax benefit | (12,028 | ) | (29,618 | ) | ||||
Tax effect of REIT termination effective January 1, 2006 | - | (51,476 | ) | |||||
Valuation allowance | 250,161 | 276,967 | ||||||
Interest and penalties | 1,581 | 8,132 | ||||||
Tax benefit of gain recorded in discontinued operations | (13,804 | ) | - | |||||
Other | 1,813 | 2,852 | ||||||
Total income tax expense (benefit) | $ | (17,594 | ) | $ | 66,512 |
December 31, | ||||||||
2006 | 2005 | |||||||
Deferred tax assets: | ||||||||
Federal net operating loss carryforwards | $ | 19,055 | $ | 22,569 | ||||
Excess inclusion income | 10,884 | 16,489 | ||||||
Basis difference - investments | 10,639 | — | ||||||
Mark-to-market adjustment on held-for-sale loans | 7,866 | 2,123 | ||||||
Deferred compensation | 8,158 | 5,997 | ||||||
Loan sale recourse obligations | 9,272 | 1,049 | ||||||
State net operating loss carryforwards | 2,474 | 7,469 | ||||||
Deferred lease incentive income | 2,262 | 2,353 | ||||||
Accrued expenses, other | 2,216 | 1,333 | ||||||
Other | 2,152 | 900 | ||||||
Gross deferred tax asset | 74,978 | 60,282 | ||||||
Valuation allowance | (685 | ) | (5,498 | ) | ||||
Deferred tax asset | 74,293 | 54,784 | ||||||
Deferred tax liabilities: | ||||||||
Mortgage servicing rights | 23,675 | 21,246 | ||||||
Other | 3,430 | 2,758 | ||||||
Deferred tax liability | 27,105 | 24,004 | ||||||
Net deferred tax asset | $ | 47,188 | $ | 30,780 | ||||
December 31, 2008 | December 31, 2007 | |||||||
Deferred tax assets: | ||||||||
Basis difference – investments | $ | 377,129 | $ | 229,371 | ||||
Federal net operating loss carryforwards | 93,783 | 60,335 | ||||||
Accrued litigation | 75 | 17,887 | ||||||
Allowance for loan losses | 106,073 | 25,375 | ||||||
State net operating loss carryforwards | 13,922 | 14,964 | ||||||
Deferred compensation | - | 7,070 | ||||||
Excess inclusion income | 3,918 | 4,932 | ||||||
Loan sale recourse obligations | 36 | 811 | ||||||
Other | 9,980 | 8,650 | ||||||
Gross deferred tax asset | 604,916 | 369,395 | ||||||
Valuation allowance | (601,110 | ) | (368,312 | ) | ||||
Deferred tax asset | 3,806 | 1,083 | ||||||
Deferred tax liabilities: | ||||||||
Other | 3,806 | 1,083 | ||||||
Deferred tax liability | 3,806 | 1,083 | ||||||
Net deferred tax asset | $ | - | $ | - |
years 2025 through 2028. The valuation allowance included in the Company’s deferred tax assets at December 31, 2006 and 2005 represents variousCompany has state net operating loss carryforwards for which it is morecarryovers arising from both combined and separate filings from as early as 2004. The loss carryovers may expire as early as 2010 and as late as 2028.
2008 | 2007 | |||||||
Beginning balance | $ | 6,329 | $ | 962 | ||||
Gross decreases – tax positions in prior period | (5,367 | ) | - | |||||
Gross increases – tax positions in current period | - | 5,367 | ||||||
Lapse of statute of limitations | (482 | ) | - | |||||
Ending balance | $ | 480 | $ | 6,329 |
which the statute of limitations remains open. However, if there were an assessment of any material liability it may adversely affect the Company’s financial condition, liquidity and ability to continue as a going concern.
2007. As a result of the Exit Plans described in Note 14, the Plan was subject to a partial termination during 2007.
2007. The DCP was terminated effective December 31, 2007 and all assets, which included $7.5 million in cash and Company stock, were distributed in January 2008 as a result of prior distribution elections and such termination.
2008 | 2007 | |||||||
Weighted average: | ||||||||
Fair value, at date of grant | $ | 1.40 | $ | 10.06 | ||||
Expected life in years | 10 | 5 | ||||||
Annual risk-free interest rate | 3.84 | % | 4.46 | % | ||||
Volatility | 84.3 | % | 65.0 | % | ||||
Dividend yield | 0.0 | % | 0.0 | % |
Stock Options | Number of Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value (in thousands) | ||||||||
Outstanding at the beginning of the year | 401,168 | $ | 18.39 | |||||||||
Granted | 162,040 | 31.74 | ||||||||||
Exercised | (59,000 | ) | 10.39 | |||||||||
Forfeited or expired | (6,480 | ) | 20.86 | |||||||||
Outstanding at the end of the year | 497,728 | $ | 23.65 | 7.17 | $ | 1,493 | ||||||
Exercisable at the end of the year | 287,179 | $ | 16.02 | 6.02 | $ | 3,052 | ||||||
Stock options expected to vest at the end of the year | 190,063 | $ | 27.39 | 8.70 | $ | (1,474 | ) | |||||
2008:
Stock Options | Number of Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value (in thousands) | |||||||
Outstanding at the beginning of the year | 267,342 | $ | 47.81 | ||||||||
Granted | 5,000 | 1.65 | |||||||||
Exercised | - | - | |||||||||
Forfeited or expired | (111,945 | ) | 34.62 | ||||||||
Outstanding at the end of the year | 160,397 | $ | 55.63 | 5.01 | $ | (8,880 | ) | ||||
Exercisable at the end of the year | 114,612 | $ | 65.32 | 3.80 | $ | (7,456 | ) | ||||
Stock options expected to vest at the end of the year | 22,835 | $ | 38.29 | 8.05 | $ | (1,424 | ) |
Stock Options | Number of Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value (in thousands) | |||||||
Outstanding at the beginning of the year | 124,432 | $ | 94.60 | ||||||||
Granted | 217,101 | 15.08 | |||||||||
Exercised | (6,875 | ) | 30.48 | ||||||||
Forfeited or expired | (67,316 | ) | 37.41 | ||||||||
Outstanding at the end of the year | 267,342 | $ | 47.81 | 7.94 | $ | (12,009 | ) | ||||
Exercisable at the end of the year | 81,499 | $ | 77.45 | 5.52 | $ | (6,076 | ) | ||||
Stock options expected to vest at the end of the year | 41,468 | $ | 68.23 | 8.56 | $ | (2,710 | ) |
Pursuant to a resolution of the Company’s compensation committee of the Board of Directors dated December 14, 2005, 227,455 and 70,363 options issued to employees and directors, respectively, were modified. The Company modified all options that were either unvested as of January 1, 2005 or were granted during 2005. For employee options, the rate at which DERs accrue was modified from sixty percent of the dividend per share amount to one hundred percent and the form in which DERs will be paid was modified from stock to cash upon vesting. For director options, only the form in which DERs will be paid was modified from stock to cash upon vesting. These options were granted and canceled during the fourth quarter of 2005. No modifications were made to the exercise prices, vesting periods or expiration dates. At the date of modification, the canceled options were revalued and the modified options were initially valued. The incremental difference between the value of the modified option and the canceled option will be amortized into compensation expense over the remaining vesting period.
2007.
2006 | 2005 (A) | 2004 | ||||||||||
Weighted average: | ||||||||||||
Fair value, at date of grant | $ | 12.48 | $ | 14.25 | $ | 21.24 | ||||||
Expected life in years | 5 | 2 | 6 | |||||||||
Annual risk-free interest rate | 4.7 | % | 4.4 | % | 4.7 | % | ||||||
Volatility | 37.5 | % | 33.3 | % | 65.2 | % | ||||||
Dividend yield | 0.0 | % | 0.0 | % | 0.0 | % |
restricted stock during 2008. The Company granted and issued shares of restricted stock during 2006, 2005 and 2004. The 2006 restricted stock2007. These awards vest at the end of 5 years the 2005 restricted stock awards vest at the end of 10 years and the 2004 restricted stock awards vest equally over four years.
2007 which is the end of the three-year period, the targets were not achieved and the shares were subsequently forfeited.
2007.
Number of Shares | Weighted Average Grant Date Fair Value | |||||
Outstanding at the beginning of year | 169,969 | $ | 27.81 | |||
Granted | 62,182 | 31.19 | ||||
Vested | (9,714 | ) | 45.36 | |||
Forfeited | (1,560 | ) | 43.51 | |||
Outstanding at the end of period | 220,877 | $ | 27.88 | |||
2008 and 2007.
December 31, 2008 | December 31, 2007 | |||||||||||||||
Number of Shares | Weighted Average Grant Date Fair Value | Number of Shares | Weighted Average Grant Date Fair Value | |||||||||||||
Outstanding at the beginning of year | 107,211 | $ | 36.50 | 55,219 | $ | 111.52 | ||||||||||
Granted | - | - | 115,463 | 16.72 | ||||||||||||
Vested | (1,745 | ) | 185.68 | (2,237 | ) | 185.68 | ||||||||||
Forfeited | (71,220 | ) | 33.96 | (61,234 | ) | 28.55 | ||||||||||
Outstanding at the end of period | 34,246 | $ | 38.38 | 107,211 | $ | 36.50 |
$16.72.
2006 | 2005 | |||||||||||
Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||
Financial assets: | ||||||||||||
Cash and cash equivalents | $ | 150,522 | $ | 150,522 | $ | 264,694 | $ | 264,694 | ||||
Mortgage loans: | ||||||||||||
Held-for-sale | 1,741,819 | 1,757,965 | 1,291,556 | 1,298,244 | ||||||||
Held-in-portfolio | 2,116,535 | 2,141,028 | 28,840 | 29,452 | ||||||||
Mortgage securities - available-for-sale | 349,312 | 349,312 | 505,645 | 505,645 | ||||||||
Mortgage securities - trading | 329,361 | 329,361 | 43,738 | 43,738 | ||||||||
Mortgage servicing rights | 62,830 | 74,177 | 57,122 | 71,897 | ||||||||
Warehouse notes receivable | 39,462 | 39,462 | 25,390 | 25,390 | ||||||||
Deposits with derivative instrument counterparties | 5,655 | 5,655 | 4,370 | 4,370 | ||||||||
Accrued interest receivable | 37,692 | 37,692 | 4,866 | 4,866 | ||||||||
Financial liabilities: | ||||||||||||
Borrowings: | ||||||||||||
Short-term | 2,152,208 | 2,152,208 | 1,418,569 | 1,418,569 | ||||||||
Asset-backed bonds secured by mortgage loans | 2,067,490 | 2,067,490 | 26,949 | 26,949 | ||||||||
Asset-backed bonds secured by mortgage securities | 9,519 | 9,467 | 125,630 | 123,965 | ||||||||
Junior subordinated debentures | 83,041 | 83,041 | 48,664 | 48,664 | ||||||||
Accrued interest payable | 9,327 | 9,327 | 2,837 | 2,837 | ||||||||
Derivative instruments: | ||||||||||||
Interest rate cap agreements | 4,634 | 4,634 | 5,105 | 5,105 | ||||||||
Interest rate swap agreements | 6,527 | 6,527 | 3,290 | 3,290 |
2008 | 2007 | |||||||||||||||
Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||||
Financial assets: | ||||||||||||||||
Cash and cash equivalents | $ | 24,790 | $ | 24,790 | $ | 25,364 | $ | 25,364 | ||||||||
Restricted cash | 6,046 | 5,595 | 8,998 | 8,998 | ||||||||||||
Mortgage loans - held-in-portfolio | 1,772,838 | 1,772,838 | 2,870,013 | 2,459,105 | ||||||||||||
Mortgage securities - trading | 7,085 | 7,085 | 109,203 | 109,203 | ||||||||||||
Mortgage securities - available-for-sale | 12,788 | 12,788 | 33,371 | 33,371 | ||||||||||||
Accrued interest receivable | 77,292 | 77,292 | 61,704 | 61,704 | ||||||||||||
Financial liabilities: | ||||||||||||||||
Borrowings: | ||||||||||||||||
Asset-backed bonds secured by mortgage loans | 2,599,351 | 1,772,838 | 3,065,746 | 2,410,894 | ||||||||||||
Asset-backed bonds secured by mortgage securities | 5,376 | 5,376 | 74,385 | 74,385 | ||||||||||||
Short-term | - | - | 45,488 | 45,488 | ||||||||||||
Junior subordinated debentures | 77,323 | 6,248 | 83,561 | 83,561 | ||||||||||||
Accrued interest payable | 10,242 | 10,242 | 6,903 | 6,903 | ||||||||||||
Derivative instruments: | ||||||||||||||||
Interest rate cap agreements | (8 | ) | (8 | ) | (85 | ) | (85 | ) | ||||||||
Interest rate swap agreements | 9,302 | 9,302 | 9,441 | 9,441 | ||||||||||||
Credit-default swap agreements | (193 | ) | (193 | ) | (2,460 | ) | (2,460 | ) |
Mortgage securities- trading – The fair value of mortgage securities - trading is estimated using quoted market prices.
Mortgage servicing rights – The fair value of mortgage servicing rights is calculated based on abroker prices and compared to internal discounted cash flow methodology incorporating numerous assumptions, including servicing income, servicing costs, market discount rates and prepayment speeds.flows.
Deposits with derivative instrument counterparties – The fair value of deposits with counterparties approximates their carrying value.
Borrowings – The fair value of short-term borrowings asset-backed bonds secured by mortgage loansapproximates their carrying value as the borrowings bear interest at rates that approximate market rates for similar borrowings. The fair value of junior subordinated debentures approximates their carrying value as the borrowings were restructured in 2009 and the principal balance did not change. As of December 31, 2007, the fair value of junior subordinated debentures approximates their carrying value as the borrowings bear interest at rates that approximate current market rates for similar borrowings. The fair value of asset-backed bonds secured by mortgage securities is determined byloans was estimated using the presentfair value of future payments based on interest rate conditionsmortgage loans – held-in-portfolio at December 31, 2006 and 2005.2008 as the trusts have no recourse to the Company’s other, unsecuritized assets. The fair value of asset-backed bonds secured by mortgage loans was estimated using observable market prices for similar borrowings at December 31, 2007. The fair value of asset-backed bonds secured by mortgage securities is approximated using quoted market prices.
(dollars in thousands)
2006 | 2005 | 2004 | ||||||||
Cash paid for interest | $ | 242,014 | $ | 79,880 | $ | 51,431 | ||||
Cash paid (received) for income taxes | 2,836 | (4,712 | ) | 27,944 | ||||||
Cash received on mortgage securities – available-for-sale with no cost basis | 5,407 | 17,564 | 32,244 | |||||||
Cash received for dividend reinvestment plan | 5,937 | 3,903 | 1,839 | |||||||
Non-cash investing and financing activities: | ||||||||||
Cost basis of securities retained in securitizations | 244,978 | 332,420 | 381,833 | |||||||
Change in loans under removal of accounts provision | 62,661 | 23,452 | 6,455 | |||||||
Transfer of cost basis of residual securities and mortgage servicing rights to mortgage loans held-for-sale due to securitization calls | 6,528 | 7,423 | — | |||||||
Transfer of loans to held-in-portfolio from held-for-sale | 2,663,731 | — | — | |||||||
Assets acquired through foreclosure | 25,601 | 2,891 | 3,558 | |||||||
Dividends payable | 1,663 | 45,070 | 73,431 | |||||||
Tax benefit derived from capitalization of affiliate | 7,173 | — | — | |||||||
Restricted stock issued in satisfaction of prior year accrued bonus | 283 | 262 | 1,816 |
Note 23. Condensed Quarterly Financial Information (unaudited)
On November 4, 2005,February 18, 2009, the Company, adopted a formal planNMI, NovaStar Capital Trust I and NovaStar Capital Trust II (the “Trusts”) and the trust preferred security holders entered into agreements to terminate allsettle the claims of the remaining NHMI branches.trust preferred security holders arising from NMI’s failure to make the scheduled quarterly interest payments on unsecured notes (collectively, the “Notes”) outstanding to the Trusts which secure trust preferred securities issued by the Trusts. As part of the settlement, the existing preferred obligations would be exchanged for new preferred obligations. The Company considers a branchsettlement and exchange were contingent upon, among other things, the dismissal of the involuntary Chapter 7 bankruptcy. On March 9, 2009, the Bankruptcy Court entered an order dismissing the involuntary proceeding. On April 27, 2009 (the “Exchange Date”), the parties executed the necessary documents to be discontinued upon its termination date, which iscomplete the point in time whenExchange. On the operations cease. The provisions of SFAS No. 144 require the results of operations associated with those branches terminated subsequent to January 1, 2004 to be classified as discontinued operations and segregated from the Company’s continuing results of operations for all periods presented. As of June 30, 2006,Exchange Date, the Company had terminated all NHMI branches and related operations. The Company has presented the operating results of NHMI as discontinued operations in the Consolidated Statements of Income for the years ended December 31, 2006, 2005 and 2004. The Company’s condensed consolidated quarterly operating results for the three months ended March 31, June 30, September 30, and December 31, 2006 and 2005 as revised from amounts previously reported to account for all branches discontinuedpaid interest due through December 31, 2006 are as follows (dollars2008, in thousands, except per share amounts):
2006 Quarters | 2005 Quarters | |||||||||||||||||||||||||||||||
First | Second | Third | Fourth | First | Second | Third | Fourth | |||||||||||||||||||||||||
Net interest income before credit (losses) recoveries | $ | 57,743 | $ | 67,529 | $ | 73,119 | $ | 61,168 | $ | 48,995 | $ | 58,794 | $ | 69,226 | $ | 62,957 | ||||||||||||||||
Credit (losses) recoveries | (3,545 | ) | (6,045 | ) | (10,286 | ) | (10,255 | ) | (619 | ) | (100 | ) | (331 | ) | 12 | |||||||||||||||||
Gains (losses) on sales of mortgage assets | 33 | 23,285 | 27,709 | (9,278 | ) | 18,246 | 32,525 | 9,691 | 4,686 | |||||||||||||||||||||||
Gains (losses) on derivative instruments | 8,591 | 6,140 | (6,877 | ) | 4,144 | 14,601 | (7,848 | ) | 6,522 | 4,880 | ||||||||||||||||||||||
Income (loss) from continuing operations before income tax expense (benefit) | 20,674 | 40,764 | 30,298 | (23,252 | ) | 40,746 | 41,531 | 36,952 | 24,981 | |||||||||||||||||||||||
Income tax (benefit) expense | (4,579 | ) | 5,443 | 1,813 | (11,398 | ) | 2,190 | (1,175 | ) | (1,708 | ) | (5,924 | ) | |||||||||||||||||||
Income (loss) from continuing operations | 25,253 | 35,321 | 28,485 | (11,854 | ) | 38,556 | 42,706 | 38,660 | 30,905 | |||||||||||||||||||||||
(Loss) income from discontinued operations, net of income tax | (1,225 | ) | (586 | ) | 94 | (2,550 | ) | (3,353 | ) | (3,187 | ) | (2,367 | ) | (2,796 | ) | |||||||||||||||||
Net income (loss) | 24,028 | 34,735 | 28,579 | (14,404 | ) | 35,203 | 39,519 | 36,293 | 28,109 | |||||||||||||||||||||||
Dividends on preferred stock | 1,663 | 1,663 | 3,327 | — | 1,663 | 1,663 | 1,663 | 1,664 | ||||||||||||||||||||||||
Net income (loss) available to common shareholders | 22,365 | 33,072 | 25,252 | (14,404 | ) | 33,540 | 37,856 | 34,630 | 26,445 | |||||||||||||||||||||||
Basic earnings per share: | ||||||||||||||||||||||||||||||||
Income (loss) from continuing operations available to common shareholders | $ | 0.73 | $ | 1.02 | $ | 0.73 | $ | (0.32 | ) | $ | 1.33 | $ | 1.42 | $ | 1.21 | $ | 0.94 | |||||||||||||||
Loss from discontinued operations, net | (0.04 | ) | (0.02 | ) | — | (0.07 | ) | (0.12 | ) | (0.11 | ) | (0.08 | ) | (0.09 | ) | |||||||||||||||||
Net income (loss) available to common shareholders | $ | 0.69 | $ | 1.00 | $ | 0.73 | $ | (0.39 | ) | $ | 1.21 | $ | 1.31 | $ | 1.13 | $ | 0.85 | |||||||||||||||
Diluted earnings per share: | ||||||||||||||||||||||||||||||||
Income (loss) from continuing operations available to common shareholders | $ | 0.73 | $ | 1.01 | $ | 0.73 | $ | (0.32 | ) | $ | 1.31 | $ | 1.40 | $ | 1.20 | $ | 0.93 | |||||||||||||||
Loss from discontinued operations, net | (0.04 | ) | (0.02 | ) | — | (0.07 | ) | (0.12 | ) | (0.11 | ) | (0.08 | ) | (0.09 | ) | |||||||||||||||||
Net income (loss) available to common shareholders | $ | 0.69 | $ | 0.99 | $ | 0.73 | $ | (0.39 | ) | $ | 1.19 | $ | 1.29 | $ | 1.12 | $ | 0.84 | |||||||||||||||
Note 24. Subsequent Events
On February 8, 2007the aggregate amount of $5.3 million. In addition, the Company closedpaid $0.3 million in legal and administrative costs on behalf of the Trusts.
On February 28 2007, the Company executed a securitization, NovaStar Mortgage Funding Trust (“NMFT”) Series 2007-1, which offered 17 rated classestwelve months ended April 30, 2010, an additional payment of certificates with a face value of $1,845,384,000. The Company will initially retain the M-6 through M-11 certificates, which collectively represent $106.7 million in principal. The Company also retained the Class C certificate, which was not covered by the prospectus. Class C has a notional amount of $1.9 billion, entitles the Company to excess interest and prepayment penalty fee cash flow from the underlying loan collateral and serves as over collateralization. Other than prepayment penalty fee cash flow, Class C is subordinated to the other classes, all of which were offered pursuant to the prospectus. On February 28, 2007, $1.9 billion in loans collateralizing NMFT Series 2007-1 were delivered to the trust. The transaction will be treated as a financing for GAAP reporting purposes and as a sale for tax purposes. The assets and accompanying debt will remain on the balance sheet of the Company’s taxable REIT subsidiary.
$2.0 million.
February 28, 2007
reporting as of December 31, 2008.
There
opinion.
statements and included an explanatory paragraph regarding the Company’s ability to continue as a going concern.
8140 Ward Parkway,
600
816.237.7424
64108
Because our common stock is listed on the NYSE, our chief executive officer is required to make an annual certification to the NYSE stating that he is not aware of any violation by NovaStar Financial, Inc. of the NYSE Corporate Governance listing standards. Following our 2006 Annual Meeting of Shareholders, our chief executive officer submitted such annual certification to the NYSE. In addition,
Matters.
Equity Compensation Plan Information
Plan Category | Number of Securities to Exercise of Outstanding Options, Warrants and Rights | Weighted Average Exercise Price of Outstanding Options, Warrants and Rights | Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Shares Reflected in the First Column) | |||||
Equity compensation plans approved by stockholders | 618,383 | (A) | $ | 19.04 | 1,912,088 | |||
Equity compensation plans not approved by stockholders | — | — | — | |||||
Total | 618,383 | $ | 19.04 | 1,912,088 | ||||
Equity Compensation Plan Information | |||||||||
Plan Category | Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights | Weighted Average Exercise Price of Outstanding Options, Warrants and Rights | Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Shares Reflected in the First Column) | ||||||
Equity compensation plans approved by stockholders | 160,397 | (A) | $ | 55.63 | 535,594 | (B) | |||
Equity compensation plans not approved by stockholders | - | - | - | ||||||
Total | 160,397 | $ | 55.63 | 535,594 |
(A) | Certain of the options have dividend equivalent rights (DERs) attached to them when issued. As of December 31, |
(B) | Represents shares that may be issued pursuant to the Company’s 2004 Incentive Stock Plan, which provides for the grant of qualified incentive stock options, non-qualified stock options, deferred stock, restricted stock, restricted stock units, performance share awards, dividend equivalent rights and stock appreciation awards. |
(1) | The financial statements as set forth under Item 8 of this report on Form 10-K are included herein. |
(2) | The required financial statement schedules are omitted because the information is disclosed elsewhere herein. |
Exhibit No. | Description of Document | |
2.11 | Servicing Rights Transfer Agreement, dated as of October 12, 2007, between Saxon Mortgage Services, Inc. and NovaStar Mortgage, Inc. | |
3.12 | Articles of Amendment and Restatement of | |
3.1.13 | Certificate of Amendment of the Registrant | |
Amended and Restated Bylaws of the Registrant, adopted July 27, 2005 | ||
4.15 | Specimen Common Stock Certificate | |
Specimen Preferred Stock Certificate | ||
Employment Agreement, dated September 30, 1996, between the Registrant and Scott F. Hartman | ||
Amendment dated December 20, 2006 to the Employment Agreement dated September 30, 1996 between NovaStar Financial Inc., and Scott F. Hartman. | ||
Employment Agreement, dated September 30, 1996, between the Registrant and W. Lance Anderson | ||
Amendment dated December 20, 2006 to the Employment Agreement dated September 30, 1996 between NovaStar Financial Inc., and W. Lance Anderson. | ||
Employment Agreement between NovaStar Mortgage, Inc. and David A. Pazgan, Executive Vice President of NovaStar Mortgage, Inc. | ||
Amendment dated December 20, 2006 to the Employment Agreement dated July 15, 2004 between NovaStar Mortgage Inc., and Dave Pazgan. | ||
10.413 | Separation and Consulting Agreement, dated as of October 16, 2007 among NovaStar Mortgage and David A. Pazgan. | |
10.514 | Employment Agreement between NovaStar Financial, Inc. and Jeffrey D. Ayers, Senior Vice President, General Counsel and Secretary | |
Employment Agreement between NovaStar Financial, Inc. and Gregory S. Metz, Senior Vice President and Chief Financial Officer | ||
Amendment dated December 20, 2006 to the Employment Agreement dated July 15, 2004 between NovaStar Financial Inc., and Gregory Metz. |
1 | Incorporated by reference to Exhibit 2.1 to Form 10-Q filed by the Registrant on November 14, 2007. |
2 | Incorporated by reference to Exhibit 3.1 to Form 10-Q filed by the Registrant on August 9, 2007. |
3 | Incorporated by reference to Exhibit 3.1 to Form 8-K filed by the Registrant with the SEC on May 26, 2005. |
4 | Incorporated by reference to Exhibit 3.3.1 to Form 10-Q filed by the Registrant with the SEC on August 5, 2005. |
5 | Incorporated by reference to Exhibit 4.1 to Form 10-Q filed by the Registrant with the SEC on August 5, 2005. |
6 | Incorporated by reference to Exhibit 4.3 to Form 8-A/A filed by the Registrant with the SEC on January 20, 2004. |
7 | Incorporated by reference to Exhibit 10.8 to Form S-11 filed by the Registrant with the SEC on July 29, 1997. |
8 | Incorporated by reference to Exhibit 10 to Form 8-K filed by the Registrant with the SEC on December 21, 2006. |
9 | Incorporated by reference to Exhibit 10.9 to Form S-11 filed by the Registrant with the SEC on July 29, 1997. |
10 | Incorporated by reference to Exhibit 10 to Form 8-K filed by the Registrant with the SEC on December 21, 2006. |
11 | Incorporated by reference to Exhibit 10.27 to Form 8-K filed by the Registrant with the SEC on February 11, 2005. |
12 | Incorporated by reference to an Exhibit 10 to Form 8-K filed by the Registrant with the SEC on December 21, 2006. |
13 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on October 18, 2007 |
14 | Incorporated by reference to Exhibit 10.28 to Form 10-K filed by the Registrant with the SEC on March 1, 2007. |
15 | Incorporated by reference to Exhibit 10.31to Form 8-K filed by the Registrant with the SEC on February 11, 2005. |
Exhibit No. | Description of Document | |
Separation and Consulting Agreement, dated as of January 3, 2008, by and between NovaStar Financial, Inc. and Gregory Metz. | ||
Employment Agreement between NovaStar Financial, Inc. and Michael L. Bamburg, | ||
10.1119 | Employment Agreement, dated as of January 7, 2008, by and between NovaStar Financial, Inc. and Rodney E. | |
10.1220 | Form of Indemnification Agreement for Officers and Directors of NovaStar Financial, Inc. and its Subsidiaries | |
NovaStar Mortgage, Inc. Deferred Compensation Plan Amended and Restated Effective as of December 31, 2007 | ||
Amended and Restated Trust Agreement for the NovaStar Mortgage, Inc. Deferred Compensation Plan | ||
10.13.223 | Amendment One to the Amended and Restated Trust Agreement for the NovaStar Mortgage, Inc. Deferred Compensation Plan | |
10.1424 | 1996 Executive and Non-Employee Director Stock Option Plan, as last amended December 6, 1996 | |
10.1525 | NovaStar Financial Inc. 2004 Incentive Stock Plan | |
10.15.126 | Amendment One to the NovaStar Financial, Inc. 2004 Incentive Stock Option Plan | |
10.15.227 | Stock Option Agreement under NovaStar Financial, Inc. 2004 Incentive Stock Plan | |
10.15.328 | Restricted Stock Agreement under NovaStar Financial, Inc. 2004 Incentive Stock Plan | |
10.15.429 | Performance Contingent Deferred Stock Award Agreement under NovaStar Financial, Inc. 2004 Incentive Stock Plan | |
10.1630 | NovaStar Financial, Inc. Executive Bonus Plan | |
10.1731 | 2005 Compensation Plan for Independent Directors | |
10.1832 | NovaStar Financial, Inc. Long Term Incentive Plan | |
10.1933 | Purchase Agreement, dated March 15, 2005, among | |
Amended and Restated Trust Agreement, dated March 15, 2005, between | ||
Junior Subordinated Indenture, dated March 15, 2005, between |
18 | Incorporated by reference to Exhibit 10.32 to Form 8-K filed by the Registrant with the SEC on March 28, 2007. |
19 | Incorporated by reference to Exhibit 10.1 to Form 8-K/A filed by the Registrant with the SEC on January 10, 2008. |
20 | Incorporated by reference to Exhibit 10.10 to Form 8-K filed by the Registrant with the SEC on November 16, 2005. |
21 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on December 21, 2007. |
22 | Incorporated by reference to Exhibit 4.6 to Form S-8 filed by the Registrant with the SEC on November 29, 2006. |
23 | Incorporated by reference to Exhibit 10.45.1 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
24 | Incorporated by reference to Exhibit 10.14 to Form S-11 filed by the Registrant with the SEC on July 29, 1997. |
25 | Incorporated by reference to Exhibit 10.15 to Form S-8 filed by the Registrant with the SEC on June 30, 2004. |
26 | Incorporated by reference to Exhibit 10.46 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
27 | Incorporated by reference to Exhibit 10.25.1 to Form 8-K filed by the Registrant with the SEC on February 4, 2005. |
28 | Incorporated by reference to Exhibit 10.25.2 to Form 8-K filed by the Registrant with the SEC on February 4, 2005. |
29 | Incorporated by reference to Exhibit 10.25.3 to Form 8-K filed by the Registrant with the SEC on February 4, 2005. |
30 | Incorporated by reference to Exhibit 10.26 to Form 8-K filed by the Registrant with the SEC on March 15, 2007. |
31 | Incorporated by reference to Exhibit 10.30 to Form 8-K filed by the Registrant with the SEC on February 11, 2005. |
32 | Incorporated by reference to Exhibit 10.34 to Form 8-K filed by the Registrant with the SEC on February 14, 2006. |
33 | Incorporated by reference to Exhibit 10.34 to Form 10-Q filed by the Registrant with the SEC on May 5, 2005. |
34 | Incorporated by reference to Exhibit 4.4 to Form 10-Q filed by the Registrant with the SEC on May 5, 2005. |
35 | Incorporated by reference to Exhibit 4.5 to Form 10-Q filed by the Registrant with the SEC on May 5, 2005. |
Exhibit No. | Description of Document | |
Parent Guarantee Agreement, dated March 15, 2005, between | ||
Purchase Agreement, dated April 18, 2006, among NovaStar Financial, Inc., NovaStar Mortgage, Inc., NovaStar Capital Trust II and Kodiak Warehouse LLC | ||
Amended and Restated Trust Agreement, dated April 18, 2006, between NovaStar Mortgage, Inc., JPMorgan Chase Bank, NA Chase Bank USA, NA and certain administrative trustees as well as the form of security representing the Junior Subordinated Notes and the form of Trust Preferred Securities Certificate | ||
Junior Subordinated Indenture, dated April 18, 2006 between NovaStar Mortgage, Inc., NovaStar Financial, Inc. and JPMorgan Chase Bank, NA | ||
Parent Guarantee Agreement, dated April 18, 2006, between NovaStar Financial, Inc. and JP Morgan Chase Bank, NA | ||
10.2741 | Master Repurchase Agreement (2007 Residual Securities), dated as of April 18, 2007, among Wachovia Investment Holdings, LLC, Wachovia Capital Markets, LLC, NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC and NovaStar Certificates Financial Corporation | |
Amendment Number One to Master Repurchase Agreement (Residual Securities), dated as of May 10, 2007, among Wachovia Investment Holdings, LLC, Wachovia Capital Markets, LLC, NovaStar Mortgage, Inc., NovaStar Certificates Financing, LLC, NovaStar Certificates Financing Corporation, NovaStar Financial, Inc., NFI Holding Corporation and HomeView Lending, Inc. | ||
Amendment Number Two, dated as of September 7, 2007, to the Master Repurchase Agreement (2007 Residual Securities), dated as of April 18, 2007, among Wachovia Investment Holdings, LLC, Wachovia Capital Markets LLC, NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corp., NovaStar Financial, Inc. and NFI Holding Corporation | ||
10.27.344 | Letter Agreement (Release of Security Interest relating to Master Repurchase Agreement (2007 Residual Securities)), dated as of January 4, 2008, by and among NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corporation, NFI Holding Corporation, NovaStar Financial, Inc., HomeView Lending, Inc., Wachovia Investment Holdings, LLC, and Wachovia Capital Markets, LLC. | |
10.2845 | Guaranty, dated as of April 18, 2007, made by NovaStar Financial, Inc., NFI Holding Corporation, NovaStar Mortgage Inc. and Homeview Lending, Inc. in favor of Wachovia Investment Holdings, LLC | |
10.2946 | Collateral Security, Setoff and Netting Agreement, dated as of April 18, 2007, among Wachovia Bank, NA, Wachovia Investment Holdings, LLC, Wachovia Capital Markets, LLC, NovaStar Financial, Inc., NovaStar Mortgage, Inc. and certain of their respective affiliates | |
10.3047 | Master Repurchase Agreement (2007 Servicing Rights), dated as of April 25, 2007, among Wachovia Bank, N.A., Wachovia Capital Markets, LLC, and NovaStar Mortgage, Inc | |
10.30.148 | Amendment Number One to Master Repurchase Agreement (2007 Servicing Rights), dated as of May 10, 2007, among Wachovia Bank, N.A., Wachovia Capital Markets, LLC, NovaStar Mortgage, Inc., NovaStar Financial, Inc., NovaStar Holding Corporation and HomeView Lending, Inc. | |
10.30.249 | Amendment Number Two, dated as of September 7, 2007 to Master Repurchase Agreement (2007 Servicing Rights), dated as of April 25, 2007, among Wachovia Bank, N.A., Wachovia Capital Markets, LLC, NovaStar Mortgage, Inc., NovaStar Financial, Inc., NovaStar Holding Corporation and HomeView Lending, Inc. |
36 | Incorporated by reference to Exhibit 4.6 to Form 10-Q filed by the Registrant with the SEC on May 5, 2005. |
37 | Incorporated by reference to Exhibit 10.38 to Form 8-K filed by the Registrant with the SEC on April 24, 2006. |
38 | Incorporated by reference to Exhibit 10.39 to Form 8-K filed by the Registrant with the SEC on April 24, 2006. |
39 | Incorporated by reference to Exhibit 10.40 to Form 8-K filed by the Registrant with the SEC on April 24, 2006. |
40 | Incorporated by reference to Exhibit 10.41exhibit to Form 8-K filed by the Registrant with the SEC on April 24, 2006. |
41 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on April 25, 2007. |
42 | Incorporated by reference to Exhibit 10.4 to Form 8-K filed by the Registrant with the SEC on May 15, 2007 |
43 | Incorporated by reference to Exhibit 10.5 to Form 8-K filed by the Registrant with the SEC on September 12, 2007. |
44 | Incorporated by reference to Exhibit 10.2to Form 8-K filed by the Registrant with the SEC on January 10, 2008. |
45 | Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on April 25, 2007. |
46 | Incorporated by reference to Exhibit 10.3 to Form 8-K filed by the Registrant with the SEC on April 25, 2007. |
47 | Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on May 1, 2007. |
48 | Incorporated by reference to Exhibit 10.3 to Form 8-K filed by the Registrant with the SEC on May 15, 2007 |
49 | Incorporated by reference to Exhibit 10.4 to Form 8-K filed by the Registrant with the SEC on September 12, 2007. |
Exhibit No. | Description of | |
10.30.350 | Amendment Number Three, dated as of October 22, 2007, to the Master Repurchase Agreement (2007 Servicing Rights), dated as of April 25, 2007, among Wachovia Bank, N.A., as Buyer, Wachovia Capital Markets, LLC, as Agent, NovaStar Mortgage, Inc., as Seller and a Guarantor, and NovaStar Financial, Inc., NFI Holding Corporation, and HomeView Lending, Inc., as Guarantors. | |
10.3151 | Guaranty and Pledge Agreement, dated as of April 25, 2007, made by NovaStar Financial, Inc., NFI Holding Corporation, NovaStar Mortgage Inc. and HomeView Lending, Inc. in favor of Wachovia Bank, N.A. | |
10.3252 | Amended and Restated Master Repurchase Agreement, dated January 5, 2007, among DB Structured Products, Inc., Aspen Funding Corp., and Newport Funding Corp., as Buyers, and NovaStar Financial, Inc., NovaStar Mortgage, Inc., NovaStar Certificates Financing Corporation, NovaStar Certificates Financing LLC, Acceleron Lending, Inc., and HomeView Lending, Inc., as Sellers | |
10.3353 | Master Repurchase Agreement, dated August 2, 2006, among Aspen Funding Corp., Newport Funding Corp., and Deutsche Bank Securities, Inc., as Buyers, and NovaStar Certificates Financing Corporation, NovaStar Certificates Financing LLC, and NovaStar Mortgage, Inc., as Sellers | |
10.3454 | Guaranty dated August 2, 2006, by NovaStar Financial, Inc., as Guarantor, in favor of Buyers | |
10.3555 | Amended and Restated Master Netting Agreement dated January 5, 2007, among DB Structured Products, Inc., Aspen Funding Corp., and Newport Funding Corp., and NovaStar Financial, Inc., NovaStar Mortgage, Inc., NovaStar Certificates Financing Corporation, NovaStar Certificates Financing LLC, Acceleron Lending, Inc., and HomeView Lending, Inc. | |
10.3656 | Master Repurchase Agreement dated May 19, 2006 between Greenwich Capital Financial Products, Inc., as Buyer, and NovaStar Mortgage, Inc., NovaStar Financial, Inc., NovaStar Home Mortgage, Inc., NovaStar Certificates Financing Corporation, NovaStar Certificates Financing LLC, HomeView Lending, Inc., and Acceleron Lending, Inc., as Sellers | |
10.36.157 | Amendment Number One to Master Purchase Agreement, dated September 20, 2006, among NovaStar Mortgage, Inc., NovaStar Financial, Inc., NovaStar Home Mortgage, Inc., NovaStar Certificates Financing Corporation, NovaStar Certificates Financing LLC, HomeView Lending, Inc., and Acceleron Lending, Inc., as Sellers, and Greenwich Capital Financial Products, Inc., as Buyer | |
10.36.258 | Amendment Number Two to Master Purchase Agreement, dated October 27, 2006, among NovaStar Mortgage, Inc., NovaStar Financial, Inc., NovaStar Home Mortgage, Inc., NovaStar Certificates Financing Corporation, NovaStar Certificates Financing LLC, HomeView Lending, Inc., and Acceleron Lending, Inc., as Sellers, and Greenwich Capital Financial Products, Inc., as Buyer | |
10.36.359 | Amendment Number Three to Master Purchase Agreement, dated November 9, 2006, among NovaStar Mortgage, Inc., NovaStar Financial, Inc., NovaStar Home Mortgage, Inc., NovaStar Certificates Financing Corporation, NovaStar Certificates Financing LLC, HomeView Lending, Inc., and Acceleron Lending, Inc., as Sellers, and Greenwich Capital Financial Products, Inc., as Buyer | |
10.3760 | Master Repurchase Agreement dated June 30, 2006 between Greenwich Capital Financial Products, Inc., as Buyer, and NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, and NovaStar Certificates Financing Corporation, as Sellers | |
10.3861 | Guaranty dated June 30, 2006, by NovaStar Financial, Inc., as Guarantor, in favor of Buyer | |
10.3962 | Sales Agreement between NovaStar Financial, Inc. and | |
Master Repurchase Agreement (2007 Whole Loan), dated as of May 9, 2007, among Wachovia Bank, N.A., NFI Repurchase Corporation, NMI Repurchase Corporation, HomeView Lending, Inc., NMI Property Financing, Inc., NovaStar Financial, Inc., NFI Holding Corporation and NovaStar Mortgage, Inc. |
50 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on October 25, 2007. |
51 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on May 1, 2007. |
52 | Incorporated by reference to Exhibit 10.58 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
53 | Incorporated by reference to Exhibit 10.59 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
54 | Incorporated by reference to Exhibit 10.60 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
55 | Incorporated by reference to Exhibit 10.61 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
56 | Incorporated by reference to Exhibit 10.62 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
57 | Incorporated by reference to Exhibit 10.62.1 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
58 | Incorporated by reference to Exhibit 10.62.2 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
59 | Incorporated by reference to Exhibit 10.62.3 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
60 | Incorporated by reference to Exhibit 10.63 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
61 | Incorporated by reference to Exhibit 10.64 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007. |
62 | Incorporated by reference to Exhibit 1.1 to Form 8-K filed by the Registrant with the SEC on September 8, 2006. |
Exhibit No. | Description of Document | |
10.40.164 | Amendment Number One, dated as of September 7, 2007, to the Master Repurchase Agreement (2007 Whole Loan), dated as of May 9, 2007, among Wachovia Bank, N.A., NFI Repurchase Corporation, NMI Repurchase Corporation, HomeView Lending, Inc., NMI Property Financing, Inc., NovaStar Financial, Inc., NFI Holding Corporation and NovaStar Mortgage, Inc. | |
10.4165 | Guaranty, dated as of May 9, 2007, among NovaStar Financial, Inc., NFI Holding Corporation, NovaStar Mortgage, Inc., HomeView Lending, Inc. and Wachovia Bank, NA | |
10.4266 | Master Repurchase Agreement (2007 Non-Investment Grade Securities), dated as of May 31, 2007, among Wachovia Investment Holdings, LLC, Wachovia Capital Markets, LLC, NovaStar Mortgage, Inc., NovaStar Certificates Financing, LLC, NovaStar Certificates Financing Corporation, NFI Holding Corporation and NovaStar Financial, Inc. | |
10.42.167 | Amendment Number One, dated as of September 7, 2007, to the Master Repurchase Agreement (Non-Investment Grade Securities), dated as of May 31, 2007, among Wachovia Investment Holdings, LLC, Wachovia Capital Markets LLC, NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, and NovaStar Certificates Financing Corp. | |
10.4368 | Guaranty, dated as of May 31, 2007, among NovaStar Financial, Inc., NFI Holding Corporation and Wachovia Investment Holdings, LLC | |
10.4469 | Master Repurchase Agreement (2007 Investment Grade Securities), dated as of May 31, 2007, among Wachovia Bank, N.A., Wachovia Capital Markets, LLC, NovaStar Mortgage, Inc., NovaStar Certificates Financing, LLC, NovaStar Certificates Financing Corporation, NFI Holding Corporation and NovaStar Financial, Inc. | |
10.44.170 | Amendment Number One, dated as of September 7, 2007, to the Master Repurchase Agreement (Investment Grade Securities), dated as of May 31, 2007, among Wachovia Bank, N.A., Wachovia Capital Markets LLC, NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corp., and NovaStar Financial, Inc. |
and NFI Holding Corporation. | ||
10.4571 | Guaranty, dated as of May 31, 2007, among NovaStar Financial, Inc., NFI Holding Corporation and Wachovia Bank, N.A. | |
10.4672 | Waiver Agreement dated August 17, 2007 by and among NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corporation, NFI Repurchase Corporation, NMI Repurchase Corporation, NMI Property Financing, Inc., HomeView Lending, Inc., NovaStar Financial, Inc., NFI Holding Corporation, Wachovia Bank, N.A., Wachovia Capital Markets, LLC and Wachovia Investment Holdings, LLC. | |
10.46.173 | Waiver Agreement, dated as of November 7, 2007, by and among NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corporation, NFI Repurchase Corporation, NMI Repurchase Corporation, NMI Property Financing, Inc., HomeView Lending, Inc., NovaStar Financial, Inc., NFI Holding Corporation, Wachovia Bank, N.A. and Wachovia Investment Holdings, LLC. | |
10.46.274 | Waiver Agreement, dated as of November 30, 2007, by and among NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corporation, NFI Repurchase Corporation, NMI Repurchase Corporation, NMI Property Financing, Inc., HomeView Lending, Inc., NovaStar Financial, Inc., NFI Holding Corporation, Wachovia Bank, N.A. and Wachovia Investment Holdings, LLC. | |
10.46.375 | Waiver Agreement, dated as of December 7, 2007, by and among NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corporation, NFI Repurchase Corporation, NMI Repurchase Corporation, NMI Property Financing, Inc., HomeView Lending, Inc., NovaStar Financial, Inc., NFI Holding Corporation, Wachovia Bank, N.A. and Wachovia Investment Holdings, LLC. |
64 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on September 12, 2007 |
65 | Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on May 15, 2007 |
66 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on June 6, 2007 |
67 | Incorporated by reference to Exhibit 10.3 to Form 8-K filed by the Registrant with the SEC on September 12, 2007 |
68 | Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on June 6, 2007 |
69 | Incorporated by reference to Exhibit 10.3 to Form 8-K filed by the Registrant with the SEC on June 6, 2007 |
70 | Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on September 12, 2007 |
71 | Incorporated by reference to Exhibit 10.4 to Form 8-K filed by the Registrant with the SEC on June 6, 2007 |
72 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on August 23, 2007 |
73 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on November 14, 2007. |
74 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on December 5, 2007. |
75 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on December 10, 2007. |
Exhibit No. | Description of Document | |
10.46.476 | Waiver Agreement, dated as of January 4, 2008, by and among NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corporation, NFI Repurchase Corporation, NMI Repurchase Corporation, NMI Property Financing, Inc., HomeView Lending, Inc., NovaStar Financial, Inc., NFI Holding Corporation, Wachovia Bank, N.A. and Wachovia Investment Holdings, LLC. | |
10.46.577 | Waiver Agreement, dated February 4, 2008, by and among NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corporation, NFI Repurchase Corporation, NMI Repurchase Corporation, NMI Property Financing, Inc., HomeView Lending, Inc., NovaStar Financial, Inc., NFI Holding Corporation, Wachovia Bank, N.A. and Wachovia Investment Holdings, LLC. | |
10.46.678 | Waiver Agreement, dated February 11, 2008, by and among NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corporation, NFI Repurchase Corporation, NMI Repurchase Corporation, NMI Property Financing, Inc., HomeView Lending, Inc., NovaStar Financial, Inc., NFI Holding Corporation, Wachovia Bank, N.A. and Wachovia Investment Holdings, LLC. | |
10.46.779 | Waiver Agreement, dated March 11, 2008, by and among NovaStar Mortgage, Inc., NovaStar Certificates Financing LLC, NovaStar Certificates Financing Corporation, NFI Repurchase Corporation, NMI Repurchase Corporation, NMI Property Financing, Inc., HomeView Lending, Inc., NovaStar Financial, Inc., NFI Holding Corporation, Wachovia Bank, N.A. and Wachovia Investment Holdings, LLC. | |
10.4780 | Securities Purchase Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC | |
10.4881 | Standby Purchase Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC | |
10.4982 | Registration Rights and Shareholders Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC | |
10.5083 | Letter Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC, and Scott Hartman | |
10.5184 | Letter Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC, and Lance Anderson | |
10.5285 | Letter Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC, and Mike Bamburg | |
11.186 | Statement | |
14.187 | NovaStar Financial, Inc. Code of Conduct | |
21.1 | Subsidiaries of the Registrant | |
23.1 | Consents of Deloitte & Touche LLP | |
31.1 | Chief Executive Officer Certification - Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Principal Financial Officer Certification - Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Chief Executive Officer Certification - Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2 | Principal Financial Officer Certification - Section 906 of the Sarbanes-Oxley Act of 2002 |
Incorporated by reference to |
Incorporated by reference to Exhibit |
Incorporated by reference to |
Incorporated by reference to Exhibit |
Incorporated by reference to Exhibit |
81 | Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 |
82 | Incorporated by reference to Exhibit 10.3 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 |
83 | Incorporated by reference to Exhibit 10.4 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 |
84 | Incorporated by reference to Exhibit 10.5 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 |
85 | Incorporated by reference to Exhibit 10.6 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 |
86 | See Note 16 |
Incorporated by reference to the correspondingly numbered exhibit to Form 8-K filed by the Registrant with the SEC on February 14, 2006. |
Pursuant to the requirements of Section 13 or 15(d) 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 | ||
(Registrant) | ||
| ||
/s/ W. LANCE ANDERSON | ||
W. Lance Anderson, Chairman of the Board | ||
of Directors and Chief Executive Officer |
DATE: May 27, 2009 | ||
/s/ W. LANCE ANDERSON | ||
of Directors and Chief Executive Officer | ||
(Principal Executive Officer) | ||
DATE: | /s/ RODNEY E. SCHWATKEN | |
| ||
Rodney E. Schwatken, Chief Financial Officer and Chief Accounting Officer | ||
(Principal Financial Officer) | ||
DATE: |
| |
/s/ EDWARD W. MEHRER | ||
Edward W. Mehrer, Director | ||
DATE: | /s/ GREGORY T. BARMORE | |
Gregory T. Barmore, Director | ||
DATE: | /s/ ART N. BURTSCHER | |
Art N. Burtscher, Director | ||
DATE: | /s/ DONALD M. BERMAN | |
Donald M. Berman, Director |
135