NovaStar Financial
(NYSE-NFI)
www.novastarmortgage.com
2006 Fourth Quarter Earnings
Conference Call
February 20, 2007
Safe Harbor Statement
This Presentation contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended, regarding management’s beliefs, estimates, projections, and assumptions with respect to, among other things,
the Company’s future operations, business plans and strategies, as well as industry and market conditions, all of which are
subject to change at any time without notice. Actual results and operations for any future period may vary materially from those
projected herein and from past results discussed herein. Some important factors that could cause actual results to differ
materially from those anticipated include: our ability to successfully integrate acquired businesses or assets with our existing
business; our ability to generate sufficient liquidity on favorable terms; the size, frequency and structure of our securitizations;
impairments on our mortgage assets; interest rate fluctuations on our assets that differ from our liabilities; increases in
prepayment or default rates on our mortgage assets; changes in assumptions regarding estimated loan losses and fair value
amounts; changes in origination and resale pricing of mortgage loans; our compliance with applicable local, state and federal
laws and regulations or opinions of counsel relating thereto and the impact of new local, state or federal legislation or regulations
or opinions of counsel relating thereto or court decisions on our operations; the initiation of margin calls under our credit
facilities; the ability of our servicing operations to maintain high performance standards and maintain appropriate ratings from
rating agencies; our ability to expand origination volume while maintaining an acceptable level of overhead; our ability to adapt
to and implement technological changes; the stability of residual property values; the outcome of litigation or regulatory actions
pending against us or other legal contingencies; compliance with new accounting pronouncements; the impact of general
economic conditions; and the risks that are from time to time included in our filings with the SEC, including our Annual Report
on Form 10-K, for the year ended December 31, 2005 and our quarterly report on form 10-Q, for the period ending September 30,
2006. Other factors not presently identified may also cause actual results to differ. Words such as “believe,” “expect,”
“anticipate,” “promise,” “plan,” and other expressions or words of similar meanings, as well as future or conditional verbs such
as “will,” “would,” “should,” “could,” or “may” are generally intended to identify forward-looking statements. This document
speaks only as of its date and we expressly disclaim any duty to update the information herein.
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Presentation Overview
Q4 Earnings Overview
Credit Review
2007 Outlook
Mortgage Banking
Portfolio Strategies
Taxable income analysis
Detailed Q4 Earnings review
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Q4 2006 Earnings Review
GAAP loss of $0.39 / share
Credit-related charges
REIT charges (pre-tax = after-tax)
Mortgage securities impairments – ($17M)
Loan loss reserve increase for on-balance sheet deal 06-1 Q4 - ($10M)
TRS charges
Increase to loan buy-back reserve – ($13M)
Other non-credit items
Settled six NHMI Branch-related class action suits ($3M)
MTM loss on trading securities for CDO – ($4M) from spread
widening
This will create quarterly noise
Spreads have continued to widen in Q1 2007 – could have a negative
impact on Q1 earnings
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Credit Review
Keys to good loan performance
Stable housing market (systemic risk)
Appropriate underwriting guidelines
Appropriate exceptions to guidelines
Solid appraisal management process
Ability to identify and eliminate unacceptable
layered risk
Strong servicing operation
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Credit Review
How do we improve performance?
Housing market is beyond our control
Tightened underwriting guidelines both in:
Loan characteristics that impact performance, and
LTV, FICO, Documentation Type, DTI, etc
Policies on verification of critical information
Seasoning of funds, property seasoning, income verification, etc
Enhanced appraisal management process:
Tighter tolerance levels on value estimates
Enhanced appraisal review process
Tightened exceptions to guidelines
Increased staffing levels in our delinquency
management and loss mitigation areas
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Credit Review
Why do we expect these changes will
improve performance?
Q4 2005 through end of 2006 production was
run against new, tighter guidelines
Impact was positive; but not sufficient
Conclusion: Need to identify and eliminate
unacceptable levels of layered risk within our
guidelines
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Credit Review
Identifying and reducing layered risk using
NovaStar’s Risk Assessment Score (NRAS)
Computed NRAS on all loans originated from the Q4
2005 through the end of 2006
Eliminated the highest risk scores from production and
appended performance data from fourth quarter 2005
through year end 2006
Risk performance fell within acceptable historical
standards with a negligible drop in coupon
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Mortgage Banking Trends
Q4 2006 costs / production were good
Gain-on-sale margins continue to be tight when
adjusted for risks
Premium recapture
Loan buyback
Rates still need to come up (or credit risk go down)
More lenders continue to go out of business – good
for remaining competitors
We expect 2007 originations to perform better
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2007 Mortgage
Banking Outlook
Expect to grow NovaStar retail platform via
integration of acquired assets (Q4)
First half 2007 production could be lower as
brokers adjust to tighter guideline implementation
Expect better quality and economics during the
year
Still need to continue focus on cost control
Growth may come in second half of the year
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Portfolio
Strategies for 2007
Generally constructive on 2007 subprime
investment given guideline changes, tighter
appraisal processes and pricing
improvement
Housing price direction still unknown
Move up the capital structure
Allocate more capital to CDO equity (BBB mortgage
securities / CDS)
Sell a greater portion of loans or residuals that we
create
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Portfolio Strategy - 2007
Consequences
Higher rated mortgage securities investments are held
in the taxable REIT subsidiary (TRS)
Doesn’t generate REIT taxable income, earnings in
TRS creates capital for reinvestment
Mortgage securities financed with CDOs have a much
longer duration than normal subprime residual
investments
Longer stream of earnings
Capital turns over less quickly
Selling more whole loans or residuals may shrink the
portfolio and reduce REIT taxable income
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Taxable income dynamics
“REIT-only” taxable income drives dividend
distribution requirements
At year-end 2006 the tax/GAAP income difference
was approximately $370 million
We expect that this difference will reverse from 2007
– 2011 as the securitizations are called that caused the
high taxable income
Little or no taxable income from 2007 – 2011
Results in little / no dividend requirement to shareholders
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Dividend strategy
(2008+)
Little / no required dividend distributions starting
in 2008
Dividend strategy set by NFI Board
Any dividends will be driven by our cost of equity and
investment opportunities
Can retain approximately $370M of capital in
REIT without paying taxes
Retained earnings in the REIT should build book value
starting in 2008
Given restrictions, is it in shareholder’s interests to
remain a REIT???
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Q4 ’06
Earnings Review
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Gain on Sale
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2007 Dividend Distributions
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Production
10.2b
9.3b
8.4b
2006 production excludes Q1 MTA bulk
purchase of $991M
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Cost of Production
See exhibit 1 for Reg. G disclosure on non-GAAP item
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2007 Capital Planning
Liquidity
$154M of cash and available liquidity as of
Dec. ‘06
Cash on hand plus expected cash generated by
portfolio is sufficient for dividend payments during
the year and business operations
Additional equity required to grow the investment
portfolio and take advantage of good investment
opportunities in 2007
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Questions
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