-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ImsJbyPsPU8FNZ65u5EGoyXyxu0H1epD4ehnzjjQ7avBLgq/PX5/aanxHXbAtpA8 zUt4+G9GnGyb/S/hm5zYdw== 0000950131-99-002060.txt : 19990403 0000950131-99-002060.hdr.sgml : 19990403 ACCESSION NUMBER: 0000950131-99-002060 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990401 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NOVASTAR FINANCIAL INC CENTRAL INDEX KEY: 0001025953 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 742830661 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 001-13533 FILM NUMBER: 99585720 BUSINESS ADDRESS: STREET 1: 1901 W 47TH PLACE STREET 2: STE 105 CITY: WESTWOOD STATE: KS ZIP: 66205 BUSINESS PHONE: 9133621090 MAIL ADDRESS: STREET 1: 1901 WEST 47TH PLACE CITY: WESTWOOD STATE: KS ZIP: 66205 10-Q/A 1 AMENDMENT #3 TO FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q/A Amendment No. 3 to [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _____________. Commission File Number: 001-13533 NovaStar Financial, Inc. ------------------------ (Exact name of registrant as specified in its charter) Maryland 74-2830661 - ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1901 W. 47th Place, Suite 105, Westwood, KS 66205 ------------------------------------------------- (Address of principal executive offices) (Zip Code) (913) 362-1090 -------------- (Registrant's telephone number, including area code) ---------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- The number of shares of the registrant's common stock outstanding as of November 10, 1998 was 8,127,314. NOVASTAR FINANCIAL, INC. FORM 10-Q QUARTER ENDED SEPTEMBER 30, 1998 INDEX
Page PART I FINANCIAL INFORMATION Item 1. Consolidated Financial Statements: Balance Sheets................................................. 1 Statements of Operations....................................... 2 Statements of Cash Flows....................................... 3 Notes.......................................................... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................. 6 PART II OTHER INFORMATION Item 1. Legal Proceedings............................................... 31 Item 2. Changes in Securities........................................... 31 Item 3. Defaults Upon Senior Securities................................. 31 Item 4. Submission of Matters to a Vote of Security Holders............. 31 Item 5. Other Information............................................... 31 Item 6. Exhibits and Reports on Form 8-K................................ 31 Signatures...................................................... 32
NOVASTAR FINANCIAL, INC. CONSOLIDATED BALANCE SHEETS (dollars in thousands, except share amounts) - --------------------------------------------------------------------------------
September 30, 1998 December 31, 1997 (unaudited) Assets Cash and cash equivalents...................................... $ -- $ -- Restricted cash................................................ 55,383 20,424 Mortgage loans................................................. 944,228 574,984 Available-for-sale securities: Mortgage securities........................................... 390,276 517,246 Other......................................................... 18,000 -- Accrued interest receivable.................................... 11,046 7,088 Investment in NFI Holding Corporation.......................... (409) 2,188 Due from NFI Holding Corporation............................... 259,312 -- Other assets................................................... 15,489 4,322 ---------- ---------- Total assets.............................................. $1,693,325 $1,126,252 ========== ========== Liabilities and Stockholders' Equity Liabilities: Collateralized mortgage obligations........................... $ 948,590 $ 408,867 Repurchase agreements......................................... 579,697 556,443 Warehouse line of credit...................................... 46,779 40,250 Accounts payable and accrued expenses......................... 8,411 4,203 ---------- ---------- Total liabilities......................................... 1,583,477 1,009,763 Stockholders' equity: Capital stock, $0.01 par value, 50,000,000 shares authorized: Common stock, 8,127,314 and 7,828,665 shares issued and outstanding, respectively................ 81 78 Additional paid-in capital.................................... 121,358 117,084 Accumulated deficit........................................... (5,416) (2,859) Accumulated other comprehensive income (deficit).............. (4,777) 4,353 Forgivable notes receivable from founders..................... (1,398) (2,167) ---------- ---------- Total stockholders' equity............................... 109,848 116,489 ---------- ---------- Total liabilities and stockholders' equity.................. $1,693,325 $1,126,252 ========== ==========
See notes to consolidated financial statements. 1 NOVASTAR FINANCIAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited; in thousands) - --------------------------------------------------------------------------------
For the Nine Months Ended For the Three Months September 30, Ended September 30, -------------------------- --------------------------- 1998 1997 1998 1997 Interest income: Mortgage loans.............................................. $56,274 $14,749 $22,312 $ 7,670 Mortgage securities......................................... 22,881 6,796 6,485 4,555 ------- ------- ------- ------- Total interest income........................................ 79,155 21,545 28,797 12,225 Interest expense............................................. 60,948 16,224 22,088 9,786 ------- ------- ------- ------- Net interest income.......................................... 18,207 5,321 6,709 2,439 Provision for credit losses.................................. 3,400 1,444 1,179 726 ------- ------- ------- ------- Net interest income after provision for credit losses........ 14,807 3,877 5,530 1,713 Fees from NovaStar Mortgage, Inc............................. 3,766 -- 3,349 -- Other income................................................. 2,012 326 919 259 Equity in earnings (loss) of NFI Holding Corporation......... (2,455) (141) (2,446) 290 General and administrative expenses: Services provided by NovaStar Mortgage, Inc................. 5,700 2,450 2,100 1,200 Loan servicing.............................................. 3,163 694 1,547 123 Compensation and benefits................................... 1,374 701 478 332 Forgiveness of notes receivable from founders............... 812 -- 270 -- Office administration....................................... 681 201 276 89 Professional and outside services........................... 649 430 296 181 Other....................................................... 184 288 (9) 160 ------- ------- ------- ------- Total general and administrative expenses................. 12,563 4,764 4,958 2,085 ------- ------- ------- ------- Net income (loss)............................................ $ 5,567 $ (702) $ 2,394 $ 177 ======= ======= ======= ======= Basic earnings per share..................................... $ 0.69 $ (0.19) $ 0.29 $ 0.05 ======= ======= ======= ======= Diluted earnings per share................................... $ 0.64 $ (0.19) $ 0.29 $ 0.05 ======= ======= ======= ======= Dividends declared per share................................. $ 1.00 $ 0.18 $ 0.35 $ 0.08 ======= ======= ======= ======= Basic weighted average shares outstanding.................... 8,033 3,767 8,124 3,767 ======= ======= ======= ======= Diluted weighted average shares outstanding.................. 8,639 3,767 8,157 3,804 ======= ======= ======= =======
See notes to consolidated financial statements. 2 NOVASTAR FINANCIAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited; in thousands) - --------------------------------------------------------------------------------
For the Nine Months Ended September 30, ------------------------- 1998 1997 Net cash provided by operating activities $ 4,191 $ 3,281 Cash flow from investing activities: Mortgage loans purchased from NovaStar Mortgage, Inc............... (510,267) (229,364) Mortgage loans sold to others...................................... 7,933 -- Mortgage loans purchased from others............................... -- (219,995) Mortgage loan repayments........................................... 125,818 27,402 Purchases of available-for-sale securities......................... (375,051) (380,820) Proceeds from sales of available-for-sale securities............... 323,631 99,794 Proceeds from paydowns on and maturities of available-for-sale securities....................................................... 150,018 22,506 Settlement of amounts payable to brokers........................... -- (12,676) Net change in amounts due from NFI Holding Corporation............. (259,035) 5,861 Investment in NFI Holding Corporation.............................. -- (1,980) --------- --------- Net cash used in investing activities.............................. (536,953) (689,272) Cash flow from financing activities: Net change in restricted cash...................................... (34,959) -- Proceeds from issuing collateralized mortgage obligations.......... 665,000 -- Payments on collateralized mortgage obligations.................... (125,277) -- Net borrowings under repurchase agreements and warehouse line...... 29,783 644,195 Exercise of stock options and warrants............................. 4,365 -- Registration costs of stock options and warrants................... (88) -- Additional private placement offering costs........................ -- (48) Dividends paid..................................................... (6,062) (354) --------- --------- Net cash provided by financing activities.......................... 532,762 643,793 --------- --------- Net increase (decrease) in cash and cash equivalents............... -- (42,198) Cash and cash equivalents, beginning of period..................... -- 46,434 --------- --------- Cash and cash equivalents, end of period........................... $ -- $ 4,236 ========= ========= Supplemental disclosure of cash flow information: Cash paid for interest............................................. $ 60,312 $ 15,416 ========= ========= Dividends payable.................................................. $ 2,845 $ 284 ========= =========
See notes to consolidated financial statements. 3 NOVASTAR FINANCIAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) - -------------------------------------------------------------------------------- Note 1. Financial Statement Presentation The consolidated financial statements as of and for the periods ended September 30, 1998 and 1997 are unaudited. In the opinion of management all adjustments have been made, which were of a normal and recurring nature, necessary for a fair presentation of the balance sheets and results of operations. The consolidated financial statements should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements of the Company and the Notes thereto, included in the Company's Annual Report to Shareholders and Annual Report on Form 10-K for the fiscal year ended December 31, 1997. The Company owns 100 percent of the common stock of three special purpose entities -- NovaStar Assets Corporation, NovaStar Certificates Financing Corporation and NovaStar Mortgage Funding Corporation. The Company formed these entities in connection with the issuance of collateralized mortgage obligations. The consolidated financial statements of the Company include the accounts of these entities. Significant intercompany accounts and transactions have been eliminated in consolidation. The Company owns 100 percent of the preferred stock of NFI Holding Corporation (Holding) for which it receives 99 percent of any dividends paid by Holding. The founders of the Company own the voting common stock of Holding. NovaStar Mortgage, Inc. and NovaStar Capital, Inc. are wholly owned subsidiaries of Holding. Certain key officers of the Company serve as officers of Holding, NovaStar Mortgage and NovaStar Capital. The Company accounts for its investment in Holding using the equity method. Note 2. Subsequent Events As a result of significant liquidity constraints imposed upon the Company by certain key lenders subsequent to September 30, 1998, management took the following actions in October 1998: On October 11, 1998, the Board of Directors of the Company agreed to defer payment of the dividend it declared on September 22, 1998 ($0.35 per share, $2.8 million in total) until January 15, 1999. On various dates during October 1998, the Company and NovaStar Mortgage executed contracts for the sale of all securities owned by the Company and NovaStar Mortgage. All securities sales settled during October at an aggregate loss of $15.4 million. On various dates during October 1998, the Company executed contracts for the termination of interest rate swap agreements with a notional amount of $455 million, representing 42 percent of all interest rate agreements owned by the Company. The terminations settled in October 1998 at an aggregate loss of $8.0 million. The Company continues to own interest rate cap agreements, but has significantly reduced liquidity risk exposure relating to its interest rate agreements. On October 13, 1998, the Company executed a short-term financing agreement with GMAC/Residential Funding Corporation, secured by certain mortgage interests of the Company. Under the terms of the agreement, the Company borrowed $15 million to support immediate cash needs. In addition, the Company agreed to pay a $3 million commitment fee at maturity of the note. The fee serves as incentive for GMAC/RFC to enter the financing arrangement under adverse conditions and to insure that the arrangement would be committed for the 90-day period. The resulting $18 million obligation bears interest at one-month LIBOR plus five percent. Additionally, GMAC/RFC acquired 812,731 warrants for the purchase of the Company's common stock at a price of $4.5625, the closing price of the common stock on October 12, 1998. The Company and GMAC/RFC are presently in negotiations regarding terms to establish a long-term strategic alliance. However, no assurance can be given that the alliance will be established. If a strategic alliance is successfully negotiated, GMAC/RFC has the option to waive $2 million of the commitment fees discussed above in exchange for an additional 811,919 warrants for the purchase of the Company's stock at a price of $4.5625 per share. Additional events, as described below, occurred subsequent to September 30, 1998. Although these events were not a direct result of the event discussed above, they affect the Company's liquidity position. On various dates during October 1998, NovaStar Mortgage accepted bids from third parties for the sale of approximately $221 million, or 94 percent of loans it owned as of September 30, 1998. Final terms of the sales will be determined after due diligence is performed on subject loans. Closings on these sales are expected to be prior to December 31, 1998. Management of NovaStar Mortgage expects to continue marketing its originated loans for sale to third parties. On October 21, 1998, the Company finalized the second closing on the securitization of asset-backed bonds, the first closing of which was during the third quarter. In the second closing, approximately $43 million of loans were added to the trust assets of NovaStar Home Equity Series 1998-2. 4 Note 3. Related Party Receivable Prior to July 1, 1998, the Company acquired all mortgage loans originated by NovaStar Mortgage, Inc. These acquisitions were financed using warehouse and repurchase lending arrangements with commercial and investment banks. During the third quarter of 1998, NovaStar Mortgage discontinued virtually all its sales of mortgage loans to the Company in order to market and sell these loans to third parties. However, the Company continues to provide financing for these loans on behalf NovaStar Mortgage. As a result, the Company has a receivable as of September 30, 1998 of $259.3 million from NovaStar Mortgage. The receivable represents its interest in mortgage loans, restricted cash and other assets related to mortgage loans recorded on the balance sheet of NovaStar Mortgage, Inc. These advances will be repaid when the loans are sold (see Note 2), and the Company will, in turn, repay borrowings. Note 4. Comprehensive Income Effective January 1, 1998, the Company adopted the provisions of Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income." Comprehensive income includes net income and revenues, expenses, gains and losses that are not included in net income. Currently, the only components of comprehensive income for the Company are the net change in the unrealized gain (loss) on available-for-sale securities and net income. The adoption of SFAS No. 130 did not result in an adjustment to assets, liabilities, stockholders' equity or net income. The consolidated balance sheets of the Company as of and for the year ended December 31, 1997 are comparable to those as of September 30, 1998. However, the caption for comprehensive income has appropriately been identified. Following is a summary of comprehensive income for the three- and nine- month periods ended September 30, 1998.
For the Nine Months For the Three Months Ended September 30 Ended September 30 ------------------- -------------------- 1998 1997 1998 1997 Net income (loss)..................................... $ 5,567 $ (702) $ 2,394 $ 177 Other comprehensive income -- net change in unrealized gain (loss) on available-for-sale securities......... (9,130) 2,255 (4,828) 872 ------- ------ ------- ------ Comprehensive income (loss)........................... $(3,563) $1,553 $(2,434) $1,049 ======= ====== ======= ======
5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the preceding Consolidated Financial Statements of the Company and the Notes thereto as well as the Company's Annual Report to Shareholders and Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Safe Harbor Statement "Safe Harbor" statement under the Private Securities Litigation Reform Act of 1995: Statements in this discussion regarding NovaStar Financial, Inc. (the Company) and its business, which are not historical facts, are "forward-looking statements" that involve risks and uncertainties. Risks and uncertainties, which could cause results to differ from those discussed in the forward-looking statements herein, are listed in the Company's Annual Report filed on form 10K. In addition, there are many important factors that could cause NovaStar's actual results to differ materially from those indicated in the forward-looking statements. These factors include, but are not limited to, general economic conditions, interest rate levels and risk, prepayment speeds, delinquency and loss rates, changes (legislative and otherwise) in the asset securitization industry or the REIT provisions of the Internal Revenue Code, demand for NovaStar's service, the impact of certain covenants in loan agreements of NovaStar, the degree to which NovaStar is leveraged, its needs for and availability of financing, its access to capital and other risks identified in NovaStar's Securities and Exchange Commission filings. In addition, it should be noted that past financial and operational performance of the Company is not necessarily indicative of future financial and operational performance. Basis of Presentation The Company owns 100 percent of the common stock of NovaStar Assets Corporation, NovaStar Certificates Financing Corporation and NovaStar Mortgage Funding Corporation. These entities were established as special purpose entities used in the Company's issuance of collateralized mortgage obligations. The consolidated financial statements of the Company include the financial condition and results of operations of these entities. The Company owns 100 percent of the non-voting preferred stock of NFI Holding Corporation (Holding) for which it receives 99 percent of any dividends paid by Holding. Scott Hartman and Lance Anderson, the Company's founders, own the voting common stock of Holding. NovaStar Mortgage, Inc. is a wholly owned subsidiary of Holding. Certain key officers of the Company serve as officers of Holding and NovaStar Mortgage and the founders are the only members of the Board of Directors of Holding and NovaStar Mortgage. In June 1998, Holding formed NovaStar Capital, Inc. to purchase and sell mortgage loans. The Company accounts for its investment in Holding using the equity method. Events Subsequent to September 30, 1998 As of September 30, 1998, the Company had an arrangement with an lender whereby the Company could borrow up to 50 percent of the value of the residual interests in the Company's collateralized mortgage obligations. Borrowing capacity under this arrangement was in excess of $30 million. However, the lender restricted the Company's access to funds under this arrangement to $25 million as of September 30, 1998. The lender experienced its own liquidity shortage as a result of global market conditions. In order to respond to the liquidity shortage and mitigate exposure to credit risk, the lender restricted its lending to subprime mortgage companies. As a result, the lender withdrew its financing under this arrangement. This event, combined with declining market prices for its securities and off-balance-sheet financial instruments, caused management to take several actions, as discussed in following paragraphs, to restore the Company's liquidity and to reduce further exposure to liquidity risk. As a result of these actions, the Company anticipates incurring a significant net loss during the fourth quarter of 1998. On October 11, 1998, the Board of Directors of the Company agreed to defer payment of the third quarter dividend ($0.35 per share) until January 15, 1999. On various dates during October 1998, the Company and NovaStar Mortgage executed contracts for the sale of all securities owned by the Company and NovaStar Mortgage. All securities sales settled during October at an aggregated loss of $15.4 million. On various dates during October 1998, the Company terminated interest rate swap agreements with a notional amount of $455 million, representing 42 percent of all interest rate agreements owned by the Company. The terminations settled in October 1998 at an aggregate loss of $8.0 million. On October 13, 1998, the Company executed a short-term financing agreement with GMAC/Residential Funding Corporation, secured by certain mortgage interests of the Company. Under the terms of the agreement, the Company received a $15 million loan to support immediate cash needs. The loan bears interest at one- month LIBOR plus five percent. The Company is required to pay a $3 million commitment fee upon maturity of the note. Additionally, GMAC/RFC acquired 812,731 warrants for the purchase of the Company's common stock at a price of $4.5625, the closing price of the common stock on October 12, 1998. The Company and GMAC/RFC are presently in negotiations regarding terms for a long-term strategic alliance. However, no assurances can be given that an alliance will in fact be executed. Upon execution of a strategic alliance, GMAC/RFC will refund $2 million of the commitment fees discussed above and NovaStar will issue additional 811,919 warrants for the purchase of the Company's stock at a price of $4.5625 per share. Additional events, as described below, occurred subsequent to September 30, 1998. Although these events were not a direct result of the above-described events, they affect the Company's liquidity position. 6 On various dates during October 1998, NovaStar Mortgage has accepted bids for the sale of approximately $221 million, or 94 percent of loans it owned as of September 30, 1998. However, final terms of these sales will be determined after due diligence is performed on subject loans. Closing on these sales is expected to take place prior to December 31, 1998. On October 21, 1998, the Company finalized the second closing on the securitization of asset-backed bonds, the first closing of which occurred during the second quarter. In the second closing, approximately $43 million of loans were added to the trust assets of NovaStar Home Equity Series 1998-2. After completing the above transactions, the Company's balance sheet will consist primarily of subprime mortgage loans financed with non-recourse asset- backed bonds. Table I is a condensed balance sheet as of September 30, 1998 with a comparative pro-forma balance sheet assuming the foregoing transactions had been executed on that date, excluding the sales of mortgage loans expected to occur during the fourth quarter. Table I Condensed Balance Sheets September 30, 1998 - --------------------------------------------------------------------------------
September 30, 1998 ------------------------- Actual Pro Forma Assets Cash and cash equivalents........................... $ -- $ 15,638 Restricted cash..................................... 55,383 12,683 Mortgage loans...................................... 944,228 987,781 Available-for-sale securities....................... 408,276 -- Due from NFI Holding Corporation.................... 259,312 215,758 Other assets........................................ 26,126 21,008 ---------- ---------- Total assets...................................... $1,693,325 $1,252,868 ========== ========== Liabilities and Stockholders' Equity Liabilities: Collateralized mortgage obligations................ $ 948,590 $ 948,590 Repurchase agreements.............................. 579,697 151,521 Warehouse line of credit........................... 46,779 35,079 Short-term note payable............................ -- 18,000 Accounts payable and accrued expenses.............. 8,411 8,346 ---------- ---------- Total liabilities................................. 1,583,477 1,161,536 Stockholders' equity................................ 109,848 91,332 ---------- ---------- Total liabilities and stockholders' equity........ $1,693,325 $1,252,868 ========== ==========
In the foreseeable future, the Company does not expect to purchase a significant amount of loans originated by NovaStar Mortgage, and NovaStar Mortgage is expected to sell a majority of the mortgage loans it originates to unrelated entities for cash. Net income for the Company will be generated from the spread on securitized loans, general and administrative expenses and equity in earnings of NFI Holding Corporation. Earnings of NFI Holding Corporation will primarily include gains on the sales of mortgage loans originated by NovaStar Mortgage and general and administrative expenses. Additional information regarding the Company's liquidity position and events subsequent to September 30, 1998 are included in "Liquidity and Capital Resources." Liquidity and Capital Resources Subsequent to September 30, 1998, access to a key financing source was withdrawn, as discussed in "Events Subsequent to September 30, 1998." The events and actions discussed therein are important to the discussion below regarding the liquidity and capital resources of the Company. Liquidity, as used herein, means the need for, access to and uses of cash. The Company's primary needs for cash include the acquisition of mortgage loans, principal repayment and interest on borrowings, operating expenses and dividend payments. The Company's business requires substantial cash to support its operating activities. The Company has a certain amount of cash on hand to fund operations. Principal, interest and fees received on mortgage assets will serve to support the cash needs of the Company. Drawing upon various borrowing arrangements typically satisfies major cash requirements. Historically, the Company demonstrated the ability to access public markets as a source of long- term cash resources. The events in early October 7 1998 changed the liquidity position of the Company. Options available to the Company for financing sources have been restricted. Actions of the Company, during unfavorable market conditions as discussed in "Events Subsequent to September 30, 1998" were taken to restore liquidity and mitigate additional margin call risk. Although these actions will result in a significant net loss for the fourth quarter of 1998, management believes they were necessary under the circumstances. In addition to the mortgage loans that have been securitized and are reflected on the Company's balance sheet, NovaStar Mortgage continues to originate subprime mortgage loans expected to be sold to third parties. As of September 30, 1998, NovaStar Mortgage had $238 million of subprime mortgage loans. The Company provides financing for these loans through its own warehouse and repurchase credit facilities. Sales commitments have been accepted for $221 million of these loans. Management expects to continue selling loans originated by NovaStar Mortgage during the fourth quarter of 1998 and into 1999. Loans financed with warehouse and repurchase credit facilities are subject to changing market valuation and margin calls. Table II is a summary of financing arrangements and available borrowing capacity under those arrangements as of November 9, 1998.
Table II Liquidity Resources November 9, 1998 (dollars in thousands) - ------------------------------------------------------------------------------------------------------ Maximum Borrowing Value of Resource Limit Collateral Borrowings Availability First Union National Bank: Committed warehouse line of credit................. $ 75,000 $ 34,895 $ 16,913 $17,982 Committed secured whole loan repurchase agreement.. 100,000 85,816 85,816 Merrill Lynch Mortgage Capital, Inc. ................ 150,100 150,100 -- Residual financing available under CMOs.............. 18,000 (A) 18,000 -- -------- ------- Total............................................ $270,829 $17,982 ======== ======= Total availability as percent of: Total assets....................................... 1.06% ===== Total stockholders' equity......................... 16.37% =====
- -------------- (A) The Company's estimates of the value of the residuals range from $50 to $70 million. During the nine months ended September 30, 1998, the Company's operating and financing activities generated cash of $4 million and $533 million, while investing activities used cash of $537 million. Forgivable Notes Receivable from Founders The Company's founders purchased 216,666 units in the 1996 private placement in exchange for forgivable promissory notes. A unit consisted of one share of convertible preferred stock and one common stock warrant. Principal on these notes will be forgiven if certain incentive performance targets are achieved. The incentive tests relate to the return generated to investors in the private placement, including the appreciation in the Company's stock price, the value of the warrants, and dividends paid. One tranche will be forgiven for each fiscal year the Company generates a return of 15 percent to investors in the private placement. All three tranches will be forgiven if the Company generates a 100 percent return within five years. For the period from the closing of the private placement through December 31, 1997, the Company generated a return exceeding 15 percent to the private placement investors and the first tranche of these notes was forgiven resulting in a non-cash charge of $1,083,000 during the fourth quarter of 1997. Based on the Company's performance and stock price during the first three quarters of the year, the Company's management anticipated forgiveness of the second tranche of these notes. As a result, non-cash charges to earnings have been recorded during the first three quarters of 1998 in the amount of $812,000. Based on actions taken by management as described in "Events Subsequent to September 30, 1998" and the current value of Company's stock, it appears unlikely that the second tranche of the notes receivable from founders will be forgiven. Final determination regarding forgiveness will be made during the fourth quarter of 1998. If the second tranche is not forgiven, all amounts that have been charged off during 1998 will be reinstated. 8 Financial Condition During the nine months ended September 30, 1998, NovaStar Mortgage originated approximately 8,000 subprime residential mortgage loans with an aggregate principal amount of $735 million, of which $498 million was acquired by the Company. However, unlike previous periods, the Company discontinued virtually all its purchase of NovaStar Mortgage's loan originations during the third quarter of 1998 as NovaStar Mortgage intends to sell the majority of its third quarter production to independent third parties. The Company's balance sheet continues to become more heavily weighted toward subprime mortgage loans. As of September 30, 1998, subprime mortgage loans comprise 71 percent of the mortgage assets owned by the Company compared with 51 percent at December 31, 1997. During the nine months ended September 30, 1998, the Company sold $7.5 million of loans purchased from NovaStar Mortgage to unrelated third parties for cash, recognizing gains on these transactions of $315,000. The Company also completed two securitizations during the nine months ended September 30, 1998, pooling $618 million of mortgage loans as collateral of which $43 million was added during the fourth quarter of 1998. Table III is a summary of wholesale loan originations and bulk acquisitions for 1998 and 1997. Table IV presents a more detailed analysis of wholesale loan originations.
Table III Wholesale Loan Originations (A) and Bulk Acquisitions (B) Nine Months Ended September 30, 1998 and Year Ended December 31, 1997 (dollars in thousands) - ---------------------------------------------------------------------------------------------- Wholesale Originations (A) Bulk Acquisitions (B) Total -------------------------------------------------------------------------- Number Principal Number Principal Number Principal of Loans Amount of Loans Amount of Loans Amount 1998: Third quarter... 2,576 $232,333 79 $ 8,165 2,655 $240,498 Second quarter.. 3,133 294,303 -- -- 3,133 294,303 First quarter... 2,033 207,976 -- -- 2,033 207,976 ----- -------- ----- ----------- ----- -------- 1998 total...... 7,742 $734,612 79 $ 8,165 7,821 $742,777 ===== ======== ===== ======== ===== ======== 1997: Fourth quarter.. 1,552 $183,012 -- $ -- 1,552 $183,012 Third quarter... 1,025 136,582 -- -- 1,025 136,582 Second quarter.. 509 77,692 530 49,808 1,039 127,500 First quarter... 68 12,688 1,422 157,432 1,490 170,120 ----- -------- ----- -------- ----- -------- 1997 total...... 3,154 $409,974 1,952 $207,240 5,106 $617,214 ===== ======== ===== ======== ===== ========
- ---------------- (A) Loans originated by NovaStar Mortgage (B) First two quarters of 1997 represent bulk acquisitions by NFI; third quarter of 1998 represents bulk acquisitions by NovaStar Capital, Inc. 9
Table IV 1998 and 1997 Quarterly Wholesale Loan Originations (A) (dollars in thousands) - -------------------------------------------------------------------------------------------------------------- Weighted Average ----------------------------- Average Loan-to- Credit Percent with Number Loan Price Paid to Value Rating (B) Coupon Prepayment of Loans Principal Balance Broker Penalty 1998: Third quarter... 2,576 $232,333 $ 90 101.4 81% 4.37 10.11% 79% Second quarter.. 3,133 294,303 94 101.3 81 4.43 9.93 71 First quarter... 2,033 207,976 102 101.4 81 4.45 9.93 65 ----- -------- 1998 total........ 7,742 $734,612 95 101.4 81 4.42 9.99 72 ===== ======== 1997: Fourth quarter.. 1,552 $183,012 118 101.6 81 4.32 10.09 71 Third quarter... 1,025 136,582 133 101.6 79 4.21 10.12 66 Second quarter.. 509 77,692 153 102.1 77 4.23 10.17 84 First quarter... 68 12,688 187 102.3 75 4.22 9.64 78 ----- -------- 1997 total........ 3,154 $409,974 130 101.7 79 4.26 10.10 73 ===== ========
- ----------------- (A) Loans originated by NovaStar Mortgage (B) AAA=7, AA=6, A=5, A-=4, B=3, C=2, D=1 The Company's subprime borrowers generally include individuals that do not qualify for agency/conventional lending programs because of a lack of available documentation or previous credit difficulties, but have equity in their homes. Often, they are individuals or families who have built up high-rate consumer debt and are attempting to use the equity in their home to consolidate debt and lower their monthly payments. The credit grade assigned is a function of the relative strength or weakness of the borrower's credit and/or the nature and extent of documents that can be provided to support income. NovaStar Mortgage underwrites the loans acquired by the Company using guidelines that have been approved by the Company. Table V is a presentation of loans as of September 30, 1998 and their credit grades.
Table V Mortgage Loans by Credit Grade September 30, 1998 (dollars in thousands) - ---------------------------------------------------------------------------------------- Maximum Weighted Weighted Allowed Loan-to- Current Average Average Credit Rating Mortgage Lates value Principal Coupon Loan-to-value AA........... 0 x 30 95 $115,975 9.48 83.3% A............ 1 x 30 90 367,921 9.82 79.6 A-........... 2 x 30 90 222,011 10.25 80.7 B............ 3 x 30, 1 x 60 85 141,165 10.52 77.5 5 x 30, 2 x 60, C............ 1 x 90 80 62,965 11.09 72.3 D............ 6 x 30, 3 x 60, 2 x 90 65 14,398 11.97 62.2 -------- Total...... $924,435 10.11 79.2 ========
Table VI is a summary of loans originated by NovaStar Mortgage by state. Table VII is a summary of all mortgage loans owned by the Company as of September 30, 1998 by state. 10 Table VI Mortgage Loan Originations by State (A) Nine Months Ended September 30, 1998 and Year Ended December 31, 1997 - ---------------------------------------------------------------------
Percent of Total Originations during Quarter (based on original principal balance) ----------------------------------------------------------------------------------- 1998 1997 ------------------------------- ---------------------------------------- Collateral Location Third Second First Fourth Third Second First Florida.................. 17% 16% 12% 9% 10% 8% 1% California............... 6 9 15 19 24 26 40 Washington............... 5 6 7 8 11 16 15 Michigan................. 5 5 5 5 3 -- -- Texas.................... 5 3 3 3 4 7 2 North Carolina........... 5 3 2 1 1 -- 1 Ohio..................... 4 5 2 2 2 2 -- Nevada................... 4 3 6 5 4 2 -- Oregon................... 3 4 5 6 6 9 7 Maryland................. 2 3 4 5 6 5 13 Utah..................... 2 3 3 6 6 9 13 Virginia................. 2 2 2 5 6 2 -- Oklahoma................. -- 1 1 1 1 2 5 All other states......... 40 40 35 26 17 12 4
- ------------------------- (A) Loans originated by NovaStar Mortgage, Inc. Table VII Mortgage Loans by State As of September 30, 1998 - ------------------------
Percent of Portfolio (based on original principal balance) Collateral Location Percent California............... 19% Florida.................. 12 Washington............... 8 Oregon................... 5 All other states......... 56
As of September 30, 1998, the carrying value of mortgage securities totaled $390.3 million compared with $517.2 million as of December 31, 1997. As more of the Company's capital is allocated to subprime mortgage loans, less is available for mortgage securities. As a result, during the nine months ended September 30, 1998, the Company sold mortgage securities with an amortized cost of $323.3 million compared with $100.6 million for the period ended September 30, 1997. The Company acquired mortgage securities with an aggregate cost of $354.9 million for the period ended September 30, 1998 compared with $376.0 million for the same period of 1997. Tables VIII and XI are summaries of the securities acquired during 1998 and 1997 by quarter and the portfolio as of September 30, 1998. 11 Table VIII Mortgage Security Acquisitions Nine Months Ended September 30, 1998 and Year Ended December 31, 1997 (dollars in thousands) - ------------------------------------------------------------------------------
Net Weighted Price to Average Principal Premium Discount Par Coupon 1998: Third quarter $ -- $ -- $ -- -- -- % Second quarter - Federal National Mortgage..... 80,237 823 -- 101.0 6.40 Association................................. First quarter: Federal National Mortgage Association....... 40,929 444 -- 101.1 6.12 Government National Mortgage Association.... 229,130 3,726 (364) 101.5 6.39 1997: Fourth quarter: Federal National Mortgage Association....... 46,779 1,856 -- 104.0 8.00 Government National Mortgage Association.... 233,546 2,649 (1,457) 100.5 5.74 Third quarter - Federal Home Loan Mortgage..... 2,202 87 -- 104.0 7.40 Corporation.................................... Second quarter: Federal National Mortgage Association....... 247,219 5,174 -- 102.1 7.48 Federal Home Loan Mortgage Corporation...... 102,083 2,450 -- 102.4 6.90 First quarter: Federal National Mortgage Association....... 7,491 231 -- 103.1 7.57 Government National Mortgage Association.... 8,931 174 -- 101.9 7.13
Table IX Mortgage Security Portfolio As of September 30, 1998 (dollars in thousands) - --------------------------------------------------------------------------------
Gross --------------------------- Weighted Unamortized Unaccreted Carrying Average Principal Premium Discount Value Coupon Federal National Mortgage Association.......... $259,860 $5,565 $ -- $265,424 7.04% Government National Mortgage Association....... 123,211 282 (225) 123,268 5.40 Federal Home Loan Mortgage Corporation......... 4,160 136 -- 4,296 7.54 -------- ------ ----- -------- $387,231 $5,983 $(225) 392,989 6.52% ======== ====== ===== Net unrealized loss (2,713) -------- Carrying value $390,276 ========
As described under the section labeled "Events Subsequent to September 30, 1998", all of the securities portfolio at September 30, 1998 was sold in October 1998 at losses aggregating $15.4 million. Mortgage loan originations are funded with various warehouse facilities prior to securitization. Loans originated through the lending operations of NovaStar Mortgage have typically been funded initially through a $75 million warehouse line with First Union National Bank under which the Company and NovaStar Mortgage are co-borrowers. The Company also uses repurchase agreements to finance mortgage loan purchases. Funds borrowed against master repurchase agreements are also used to acquire loans from NovaStar Mortgage. Residual financing is another short-term borrowing instrument currently available to the Company. Using individual assets as collateral for repurchase agreements, the Company has financed acquisitions of agency-issued mortgage securities. These agreements have been executed with a number of reputable securities dealers. Under the terms of all financing arrangements, lending institutions require "over-collateralization" from the Company. The value of the collateral generally must exceed the allowable borrowing by two to five percent. As a result, the Company must have capital available to cover this "haircut." Table X displays the amounts outstanding under borrowing arrangements as of September 30, 1998. 12 Table X Borrowings September 30, 1998 (dollars in thousands) - --------------------------------------------------------------------------------
As of September 30, 1998 ---------------------------------- Weighted Average Daily Weighted Days to Balance During the Average Reset or Nine Months Ended Rate Maturity Balance September 30, 1998 Repurchase agreements secured by mortgage securities.......... 5.44% 4 $397,176 $511,460 Master repurchase agreement secured by mortgage loans......... 6.38 31 182,521 156,854 -------- Total repurchase agreements................................. 579,697 Warehouse line of credit...................................... Demand 46,779 20,043 -------- Total borrowings............................................ $626,476 ========
On a long-term basis, the Company finances its mortgage loans using collateralized mortgage obligations (CMOs). Investors in CMOs are repaid based on the performance of the mortgage loans collateralizing the CMOs. CMOs are outstanding as long as the mortgage loans are outstanding. However, under the CMOs issued by NovaStar, the Company has the right to reacquire the mortgage loans collateralizing the CMO when certain events occur. These non-recourse financing arrangements match the loans with the financing arrangement for long periods of time, as compared to repurchase agreements that mature frequently with interest rates that reset frequently and have liquidity risk in the form of margin calls. Table XI displays the amounts outstanding under collateralized mortgage obligations as of September 30, 1998. Table XI Collateralized Mortgage Obligations September 30, 1998 (dollars in thousands) - --------------------------------------------------------------------------------
Collateralized Mortgage Obligation Underlying Mortgage Loans --------------------------- ---------------------------------------------- Estimated Weighted Weighted Remaining Interest Carrying Average Average Months Principal Rate Value Coupon to Maturity NovaStar Home Equity Series: Issue 1997-1................... $181,770 5.97% $192,084 10.43% 24 Issue 1997-2................... 179,371 5.84 184,013 10.45 26 Issue 1998-1................... 283,020 5.70 290,240 10.14 24 Issue 1998-2................... 308,986 5.70 273,308 (A) 9.99 37 Debt issuance costs, net....... (4,557) -- -------- -------- $948,590 $939,645 ======== ========
------------------------------ (A) Does not include $43 million of loans added as collateral during October 1998. In periods of decreasing interest rates, borrowers are more likely to refinance their mortgages to obtain a lower interest rate and monthly payment. Even in rising rate environments, borrowers tend to collectively repay their mortgage principal balances earlier than is required by the terms of their mortgages. This is particularly true for subprime borrowers who are seeking to upgrade their credit rating to obtain a lower interest rate. Table XII displays the historical prepayment speeds for mortgage loans collateralizing the Company's CMOs. Table XVI provides an analysis of prepayment characteristics of the Company's mortgage loan portfolio. 13
Table XII Prepayment Speed - -------------------------------------------------------------------------------- Constant Prepayment Rate (Annual Percent) ------------------------------------------ One-month Three-month Twelve-month Life As of September 30, 1998 NovaStar Home Equity Series: 1997-1....................... 35.5 34.9 -- 29.8 1997-2....................... 28.3 26.0 -- 17.7 1998-1....................... 13.3 12.8 -- 9.6 1998-2....................... 9.4 -- -- 7.8 As of December 31, 1997 NovaStar Home Equity Series: 1997-1....................... 18.6 15.7 -- 15.7 1997-2....................... 10.5 -- -- 10.5
To mitigate the Company's exposure to prepayment risk and in order for the Company to retain those borrowers whose credit is considered desirable, the Company created a portfolio retention department in the latter part of 1997 that encourages borrowers who have satisfactorily met their obligations to refinance or rate modify their loans with NovaStar. Of the loans that prepaid during the first nine months of 1998, $11.5 million, or ten percent of the loans were successfully refinanced and $1.9 million, or two percent of the loans, were rate-modified. For the third quarter of 1998, $5.1 million, or eleven percent of the loans were successfully refinanced and $1.2 million or three percent of the loans were rate-modified. Although these loans are considered prepayments for the purposes of the information in Table XII, they remain in the NovaStar loan portfolio. Table XIII summarizes quarterly mortgage asset activity during 1998 and 1997 and Table XIV details the amount of premium as a percent of principal at quarter end for 1998 and 1997.
Table XIII Mortgage Assets Activity (thousands) - --------------------------------------------------------------------------------------------------------------- Mortgage Loans Mortgage Securities Total ------------------- ------------------- -------------------- Principal Premium Principal Premium Principal Premium Balance, January 1, 1997................ $ -- $ -- $ 12,821 $ 434 $ 12,821 $ 434 Acquisitions............................ 170,120 10,530 16,422 405 186,542 10,935 Principal repayments and amortization... (338) (53) (977) (28) (1,315) (81) --------- ------- --------- ------- ---------- ------- Balance, March 31, 1997................. 169,782 10,477 28,266 811 198,048 11,288 Acquisitions............................ 127,500 4,100 349,302 7,624 476,802 11,724 Principal repayments and amortization... (6,989) (420) (2,332) (133) (9,321) (553) Dispositions............................ -- -- (98,267) (2,309) (98,267) (2,309) --------- ------- --------- ------- ---------- ------- Balance, June 30, 1997.................. 290,293 14,157 276,969 5,993 567,262 20,150 Acquisitions............................ 136,582 2,449 2,202 87 138,784 2,536 Principal repayments and amortization... (22,227) (913) (19,291) (383) (41,518) (1,296) --------- ------- --------- ------- ---------- ------- Balance, September 30, 1997............. 404,648 15,693 259,880 5,697 664,528 21,390 Acquisitions............................ 183,012 3,314 280,325 3,048 463,337 6,362 Principal repayments and amortization... (28,224) (1,146) (26,095) (363) (54,319) (1,509) Dispositions............................ -- -- (9,263) (177) (9,263) (177) --------- ------- --------- ------- ---------- ------- Balance, December 31, 1997.............. 559,436 17,861 504,847 8,205 1,064,283 26,066 Acquisitions............................ 207,976 3,758 270,059 3,806 478,035 7,564 Principal repayments and amortization... (27,224) (1,160) (63,892) (731) (91,116) (1,891) Dispositions............................ -- -- (310,113) (5,294) (310,113) (5,294) --------- ------- --------- ------- ---------- ------- Balance, March 31, 1998................. 740,188 20,459 400,901 5,986 1,141,089 26,445 Acquisitions............................ 290,350 5,148 80,237 823 370,587 5,971 Principal repayments and amortization... (43,849) (1,506) (47,201) (451) (91,050) (1,957) Dispositions............................ (2,843) (53) -- -- (2,843) (53) --------- ------- --------- ------- ---------- ------- Balance, June 30, 1998.................. 983,846 24,048 433,937 6,358 1,417,783 30,406 Acquisitions............................ -- -- -- -- -- -- Principal repayments and amortization... (54,745) (1,442) (38,925) (493) (93,670) (1,935) Dispositions............................ (4,666) (56) (7,781) (107) (12,447) (163) --------- ------- --------- ------- ---------- ------- Balance, September 30, 1998............. $ 924,435 $22,550 $ 387,231 $ 5,758 $1,311,666 $28,308 ========= ======= ========= ======= ========== =======
14
Table XIV Premium as a Percent of Principal - -------------------------------------------------------------------------------- Total Mortgage Mortgage Mortgage Loans Securities Assets As of: September 30, 1998....... 2.44% 1.49% 2.16% June 30, 1998............ 2.44 1.47 2.14 March 31, 1998........... 2.76 1.49 2.32 December 31, 1997........ 3.19 1.63 2.45 September 30, 1997....... 3.88 2.19 3.22 June 30, 1997............ 4.88 2.16 3.55 March 31, 1997........... 6.17 2.87 5.70
Results of Operations -- Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30, 1997 Net Loss During the nine months ended September 30, 1998, the Company recorded net income of $5,567,000, a diluted $0.64 per share, compared with a net loss of $702,000, a diluted $0.19 per share, for the nine months ended September 30, 1997. Net Interest Income Interest Income. The Company had average interest-earning assets of $1.3 billion during the nine months ended September 30, 1998, including $781.8 million of mortgage loans and $478.1 million of mortgage securities compared with average interest-earning assets of $351.6 million during the nine months ended September 30, 1997. During the nine months ended September 30, 1998, mortgage loans earned $56.3 million, or a yield of 9.6 percent, compared with $14.7 million, or a yield of 9.1 percent for the nine months ended September 30, 1997. Mortgage securities earned $22.9 million for the nine months ended September 30, 1998, or a yield of 6.4 percent, compared with $6.8 million, or a yield of 6.7 percent for the nine months ended September 30, 1997. In total, assets earned $79.2 million, or a 8.4 percent yield for the nine months ended September 30, 1998. During the nine months ended September 30, 1997, assets earned $21.5 million or an 8.2 percent yield. A substantial portion of the mortgage assets owned by the Company have interest rates that fluctuate with short-term market interest rates. However, many of these assets have initial coupons that are lower than current market rates ("teaser" rates). Rates on the Company's assets are expected to increase to their full potential as the assets "season". Table XV is a summary of the Company's mortgage assets by type, presenting their current and fully indexed weighted-average coupons.
Table XV Mortgage Assets by Product/Type and Weighted Average Coupon September 30, 1998 (dollars in thousands) - -------------------------------------------------------------------------------- Weighted Average Coupon ---------------- Outstanding Fully Product/Type Principal Current Indexed Mortgage loans: Two and three year fixed/adjustable thereafter.. $ 521,535 10.15% 10.90% Fixed rate (30 Yr, 15 Yr, 30/15)................ 301,087 10.02 -- Other (1 year CMT, 6 month LIBOR)............... 101,813 10.19 10.81 ---------- Total mortgage loans........................ 924,435 Mortgage securities issued by: Federal National Mortgage Association........... 259,860 7.04 6.64 Government National Mortgage Association........ 123,211 5.40 6.87 Federal Home Loan Mortgage Corporation.......... 4,160 7.54 6.81 ---------- Total mortgage securities................... 387,231 ---------- Total............................................. $1,311,666 ==========
15 The Company acquires substantially all of its mortgage assets at a premium. Premiums are amortized as a reduction of interest income over the estimated lives of the assets. See Tables XII, XIII and XIV for the dollar impact of principal payments on amortization. To mitigate the effect of prepayments on interest income from mortgage loans, the Company generally strives to acquire mortgage loans that have some form of prepayment penalty. During the nine months ended September 30, 1998 and the third quarter of 1998, the Company collected $1.3 million and $625,000, respectively, in prepayment penalties from borrowers. Table XVI is an analysis of mortgage loans and prepayment penalties. Prepayments on mortgage loans of the Company have been consistent with management's expectations. Table XVI Mortgage Loan Prepayment Penalties September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------------------------------- Weighted Average ------------------------------------ Remaining Percent with Prepayment Penalty Current Prepayment Loan-to- Period (in years) Principal Premium Penalty Coupon value Loans with Penalty Loans collateralizing NovaStar Home Equity Series (CMO): 1997-1....................... $183,760 $ 9,375 70.6% 10.45% 75.02% 1.44 1997-2....................... 181,329 3,049 70.8 10.31 78.14 1.77 1998-1....................... 286,746 4,306 68.7 9.99 81.04 2.43 1998-2....................... 268,312 5,266 69.6 9.90 80.88 3.13 All other loans................. 4,288 554 70.1 9.39 81.96 3.41 -------- ------- Total........................... $924,435 $22,550 69.8 10.11 79.24 2.31 ======== =======
As noted above, interest income is a function of volume and rates. Management will continue to monitor the market for mortgage securities and whole loan mortgage pools and will acquire mortgage assets that are appropriate for its overall asset/liability strategy. Increasing the volume of assets will cause future increases in interest income, while declining balances will reduce interest income. Market interest rates will also affect future interest income. Interest Expense. The cost of borrowed funds for the Company was $60.9 million during the nine months ended September 30, 1998, or 6.2 percent of average borrowings, compared with $16.2 million for the nine months ended September 30, 1997, or 6.4 percent of average borrowings. Advances under the warehouse line of credit bear interest based on the Federal Funds rate, plus a spread. The Company receives credits to warehouse line interest based on restricted cash balances maintained with First Union. Advances under the master repurchase agreement bear interest at rates based on LIBOR, plus a spread. During the nine months ended September 30, 1998 and 1997, the one-month LIBOR averaged 5.6 percent. As with interest income, the Company's cost of funds in the future will largely depend on market conditions, most notably levels of short-term interest rates. Rates on other borrowings generally fluctuate with short-term market interest rates, such as LIBOR or the Federal Funds rate. Table XVII presents a summary of the average interest-earning assets, average interest-bearing liabilities and the related yields and rates thereon for the nine months ended September 30, 1998. Table XVII Interest Analysis Nine Months Ended September 30, 1998 (dollars in thousands)
- ---------------------------------------------------------------------------------------------------------------------------------- Mortgage Loans Mortgage Securities Total -------------------------- --------------------------- ---------------------------- Interest Annual Interest Annual Interest Annual Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate Mortgage Assets......................... $781,786 $56,274 9.60% $478,125 $22,881 6.38% $1,259,911 $79,l55 8.38% ======== ======== ========== Liabilities............................. Repurchase agreements.................. $156,854 7,643 6.50% $511,460 20,785 5.42% $ 668,314 28,428 5.67% Collateralized mortgage obligations.... 626,960 29,659 6.31 626,960 29,659 6.31 Other borrowings....................... 20,043 647 4.30 21,492 647 4.01 -------- ---------- Cost of derivative financial 577 Instruments hedging liabilities....... 1,637 ------- 2,214 ------- ------- Total borrowings.................... $803,857 39,586 6.57 $511,460 21,362 5.57 $1,316,766 60,948 6.18 ======== ------- ======== ------- ========== ------- Net interest income.................... $16,688 $ 1,519 $18,207 ======= ======= ======= Net interest spread.................... 3.03% 0.81% 2.20% ==== ==== ==== Net yield.............................. 2.85% 0.42% 1.93% ==== ==== ====
16 Net Interest Income and Spread. Net interest income during the nine months ended September 30, 1998 was $18.2 million or 1.93 percent of average interest- earning assets, compared with 5.3 million, or 2.02 percent of average interest- earning assets during the nine months ended September 30, 1997. Net interest spread for the Company was 2.20 percent during the nine months ended September 30, 1998 compared with 1.73 percent during the nine months ended September 30, 1997. Net interest income and the spread are functions of the yield of the Company's assets relative to its costs of funds. The Company's cost of funds has remained relatively low and stable during 1998. This lower cost of funds offsets, to some degree, the lower yield on "teased" assets discussed above. The volume of assets and liabilities and how well the Company manages the spread between earnings on assets and the cost of funds will dictate future net interest income. Impact of Interest Rate Agreements. The Company has entered into certain interest rate agreements and financial futures contracts designed to mitigate exposure to interest rate risk. Interest rate cap agreements require the Company to pay a monthly fixed premium while allowing it to receive a rate that adjusts with LIBOR, when rates rise above a certain agreed-upon rate. Other agreements executed by the Company include simple fixed to floating interest rate swaps. These agreements are used to alter, in effect, the interest rates on funding costs to more closely match the yield on interest-earning assets. During the nine months ended September 30, 1998, the Company incurred net interest expense on these agreements of $2.2 million, which is included as a component of interest expense. The net interest expense for the same period ending September 30, 1997 was $808,000. Table XVIII details the Company's interest rate agreements as of September 30, 1998 (dollars in thousands): Table XVIII Interest Rate Agreements As of September 30, 1998 (dollars in thousands)
- --------------------------------------------------------------------------------------------------------------------- Weighted Average Unrealized Weighted Interest Rate Accrued Interest Notional -------------- Days to Cap ------------------- ------------------- Value Gains Losses Maturity Rate Receivable Payable Receivable Payable Interest rate swap agreements -- fixed rate pay............ $ 455,000 $ -- $ 7,845 674 NA 5.64% 6.11% $2,671 $2,736 Interest rate cap agreements.. 625,000 -- 3,645 710 6.27% NA NA -- -- ---------- ----- ------- $1,080,000 $ -- $11,490 ========== ===== =======
As discussed in the section, "Events Subsequent to September 30, 1998", the Company terminated all swap agreements and paid off the liabilities pertaining to these hedging instruments in October 1998, recognizing losses aggregating $8.0 million. Fees from NovaStar Mortgage, Inc. The Company and NovaStar Mortgage are party to a Mortgage Loan Sale and Purchase Agreement whereby the Company has committed to acquire the wholesale loan originations of NovaStar Mortgage. Under the terms of the agreement, if NovaStar Mortgage chooses to sell its loan originations to other parties, it pays a fee to the Company for not delivering its production under the purchase commitment. During the first two quarters of 1998, the Company acquired virtually all of the mortgage loans originated by NovaStar Mortgage. As a result, there were no significant fees paid to the Company during the first half of 1998. During the 1998 third quarter, NovaStar Mortgage retained substantially all of its production with the intent of selling loans to third parties. Under the terms of the Mortgage Loan Sale and Purchase Agreement, NovaStar Mortgage remitted fees aggregating $3.8 million to the Company during the nine months ended September 30, 1998. Other Income The Company may deem it appropriate to sell securities and loans, from time to time, to reallocate the Company's capital. During the nine months ended September 30, 1998, the Company recognized $108,000 in net gains on sales of mortgage securities with a principal balance of $318 million. Also, during this same period, the company sold two separate pools of loans (principal of $7.5 million) recognizing gains of $315,000. Additional components of other income during the nine months ended September 30, 1998 are prepayment penalties of $1.3 million and interest earned on notes receivable from founders of $300,000. As discussed in "Events Subsequent to September 30, 1998" the Company and NovaStar Mortgage sold all mortgage securities at an aggregate loss of $15.4 million during October 1998. 17 Provisions for Credit Losses The Company provides regular reserves for credit losses, including principal and interest, on its mortgage loans. Management continuously evaluates the potential for credit losses for mortgage loans held in its portfolio. Since the Company has limited actual performance history for its loan portfolio, losses have been provided for primarily based on general industry trends and on the judgement of management. The Company believes that loan defaults occur throughout the life of a loan or group of loans. As a result, provisions for credit losses are recorded against income over the estimated life of the loans, rather than immediately upon acquisition of the loan. During the nine months ended September 30, 1998, the Company provided $3.4 million for credit losses, compared with $1.4 million during the nine months ended September 30, 1997. During the third quarter of 1998, the Company and NovaStar Mortgage executed an agreement with Commonwealth Mortgage Acceptance Corporation (CMAC) whereby CMAC will provide insurance coverage on certain mortgage loans owned by the Company and NovaStar Mortgage. As of September 30, 1998, approximately 29 percent of the loans owned by the Company and substantially all of the loans owned by NovaStar Mortgage are covered under this agreement. During the third quarter of 1998, total premiums paid to CMAC totaled $291,000, which are included as a component of loan servicing expenses on the Company's financial statements. Management believes that its exposure to credit loss on loans insured by CMAC is minimal and, therefore, has not included these loans in determining its loan loss provision. Management expects that a substantial portion of loans originated in future periods will be covered under similar insurance arrangements. The Company charges off a loan when in management's best judgment the loan is uncollectable. In addition, the Company will charge off a loan to the lower of cost or market when it takes title of the property collateralizing the loan. As of September 30, 1998, the Company had 86 loans in real estate owned with a principal balance of $9.6 million and a carrying value of $7.3 million. Charge-offs during the nine months ended September 30, 1998 were $3.0 million. The Company had no charge-offs during the same period of 1997. As the portfolio continues to season, management expects that the actual loss rate may continue to increase. Table XIX is a rollforward of the reserve for credit losses during 1998 and 1997.
Table XIX Rollforward of Reserve for Credit Losses Nine Months Ended September 30, 1998 and Year Ended December 31, 1997 - ----------------------------------------------------------------------------------------------------------------------- 1998 1997 --------------------------------- ----------------------------------------------- September 30 June 30 March 31 December 31 September 30 June 30 March 31 Beginning balance................ $ 3,341 $2,871 $2,313 $1,444 $ 718 $170 $ -- Provision for credit losses.... 1,179 1,145 1,076 1,009 726 548 170 Amounts charged off, net of recoveries.................... (1,763) (675) (518) (140) -- -- -- ------- ------ ------ ------ ------ ---- ---- Ending Balance................... $ 2,757 $3,341 $2,871 $2,313 $1,444 $718 $170 ======= ====== ====== ====== ====== ==== ====
Table XX is a summary of delinquent loans as of September 30, 1998 and 1997 by quarter. Table XXI provides summaries of the Company's delinquencies, defaults, and loss statistics as of September 30, 1998 and 1997 by quarter. Other information regarding the credit quality of the Company's mortgage loans are provided in Tables V, VI and VII.
Table XX Loan Delinquencies (90 days and greater) Nine Months Ended September 30, 1998 and Year Ended December 31, 1997 (A) - -------------------------------------------------------------------------------------------------------------------------- 1998 1997 --------------------------------- ----------------------------------------------- September 30 June 30 March 31 December 31 September 30 June 30 March 31 Mortgage loans collateralizing NovaStar Home Equity series (CMO): 1997-1 (Issued October 1, 1997)... 5.97% 5.86% 4.39% 2.71% -- -- -- 1997-2 (Issued December 11, 1997). 4.97 4.72 2.23 -- -- -- -- 1998-1 (Issued April 30, 1998).... 2.06 -- -- -- -- -- -- 1998-2 (Issued April 30, 1998).... 0.40 -- -- -- -- -- -- All mortgage loans.................. 2.45 2.53 2.28 1.80 1.47% -- --
- -------------------- (A) Includes loans in foreclosure or bankruptcy. 18
Table XXI Delinquencies, Defaults and Losses September 30, 1998 (dollars in thousands) - -------------------------------------------------------------------------------------------------------------------- NovaStar Home Equity Series ------------------------------------------ 1997-1 1997-2 1998-1 1998-2 Other (A) All Loans Loan servicing portfolio................... $187,838 $185,093 $286,891 $267,744 $251,295 $1,178,861 ======== ======== ======== ======== ======== ========== Reserve for Credit Losses: Balance, July 1, 1998.................... $ 1,446 $ 1,118 $ 585 $ -- $ 192 $ 3,341 Provision for credit losses.............. 179 204 460 270 65 1,179 Amounts charged off, net of recoveries... (575) (957) (233) -- 3 (1,763) -------- -------- -------- -------- -------- ---------- Balance, September 30, 1998............ $ 1,050 $ 365 $ 812 $ 270 $ 260 $ 2,757 ======== ======== ======== ======== ======== ========== Defaults as a percent of loan servicing Portfolio, September 30, 1998: Delinquent loans......................... 3.99% 5.19% 3.05% 2.84% 0.55% 2.95% ======== ======== ======== ======== ======== ========== Loans in foreclosure..................... 4.87 3.57 1.94 0.82 0.14 2.02 ======== ======== ======== ======== ======== ========== Real estate owned........................ 2.24 1.99 0.15 -- 0.50 0.81 ======== ======== ======== ======== ======== ==========
- ----------------------------------------------------------------------------------------------------------------------- 1998 1997 --------------------------------- ----------------------------------------------- September 30 June 30 March 31 December 31 September 30 June 30 March 31 Total defaults: Delinquent loans............... 2.95% 1.95% 1.92 1.76% 4.44% 3.09% -- ==== ==== ==== ==== ==== ==== === Loans in foreclosure........... 2.02 2.28 2.29 2.05 0.47 0.01 -- ==== ==== ==== ==== ==== ==== === Real estate owned (%).......... 0.81 0.52 0.24 0.05 -- -- -- ==== ==== ==== ==== ==== ==== ===
- --------------- (A) Primarily loans owned by NovaStar Mortgage, Inc. General and Administrative Expenses General and administrative expenses for the nine months ended September 30, 1998 and September 30, 1997 are provided in table XXII. Table XXIII displays the relationship of portfolio expenses to net interest income during the nine months ended September 30, 1998 and 1997 by quarter. 19 Table XXII General and Administrative Expenses Nine Months Ended September 30, 1998 and September 30, 1997 (dollars in thousands) - --------------------------------------------------------------------------------
Nine Months Ended Nine Months Ended September 30, 1998 September 30, 1997 ------------------------ ----------------------- Percent of Percent of Net Interest Net Interest Income Income Loan servicing........................................... $3,163 27.5% $ 701 13.2% Compensation and benefits................................ 1,374 11.9 694 13.0 Professional and outside services........................ 649 5.6 430 8.1 Office administration.................................... 681 5.9 201 3.8 Other.................................................... 184 1.6 288 5.4 ------- ---- ------ ---- Total portfolio-related expenses......................... 6,051 52.6% 2,314 43.5% ==== ==== Forgiveness of notes receivable from founders............ 812 Administrative services provided by NovaStar Mortgage.... 5,700 2,450 ------- ------ Total................................................... $12,563 $4,764 ======= ======
Table XXIII Portfolio Related Expenses as a Percent of Net Interest Income Nine Months Ended September 30, 1998 (dollars in thousands) - --------------------------------------------------------------------------------
Percent of Net Interest Income 1998: Third quarter................................ 38.6% Second quarter............................... 33.6 First quarter................................ 26.3 1997: Fourth quarter............................... 65.9 Third quarter................................ 36.3 Second quarter............................... 62.1 First quarter................................ 42.0
The monthly administrative service fee paid by the Company to NovaStar Mortgage represents compensation for certain services, including the development of loan products, underwriting, funding, and quality control. The increase in this fee for the nine months ended September 30, 1998 compared with September 30, 1997 is primarily a result of an increase in the extent of services required. Compensation and benefits include employee base salaries, benefit costs and incentive bonus awards. The increase in compensation and benefits for the nine months ended September 30, 1998 compared with the nine months ended September 30, 1997 is due to adding portfolio, accounting and finance management staff throughout 1997 and 1998. In addition, during the first nine months of 1998 the Company recognized $812,000 of expense for the anticipated forgiveness of a second tranche of founders' debt, as mentioned earlier in the Forgivable Notes Receivable from Founders section of this document. No debt forgiveness was recognized during the same period of 1997. Loan servicing consists of direct costs associated with the mortgage loan servicing operation. The fee the Company pays for servicing its mortgage loan portfolio is based on volume as well as number of delinquencies and foreclosures. During the first six months of 1997, the Company contracted the servicing of its mortgage portfolio with an independent third party. Beginning July 15, 1997, NovaStar Mortgage began servicing the Company's mortgage loan portfolio. The increase in loan servicing during the nine months ended September 30, 1998 compared with September 30, 1997 is primarily due to the significant growth in the Company's mortgage loan portfolio during the period ended September 30, 1998 compared with September 30, 1997. 20 Professional and outside services include fees for legal and accounting services. In the normal course of business, the Company incurs fees for professional services related to general corporate matters and specific transactions. Office administration includes items such as rent, depreciation, telephone, office supplies, postage, delivery, maintenance and repairs. The increases in both these financial statement captions can be attributable to additional personnel and the general growth of the Company. Equity in Earnings (Loss) of NFI Holding Corporation For the nine months ended September 30, 1998, NFI Holding Corporation (Holding) recorded a net loss of $2.48 million compared with a net loss of $143,000 for the nine months ended September 30, 1997. The Company records its portion of these losses as equity in net loss of Holding in its income statement, which includes the net loss of its affiliates--NovaStar Mortgage and NovaStar Capital, Inc. Net income generated by Holding is primarily a function of the fees earned by NovaStar Mortgage relating to the origination and servicing of loans for the Company and the costs of these activities. The significant increase in the net loss of NFI Holding for the nine months ended September 30, 1998 compared with the same period of 1997 is for the following reasons: . During the last half of 1998, NovaStar Mortgage retained its mortgage loan production to sell to third parties versus selling them to NovaStar Financial. Prior to this point in time, NovaStar Financial acquired 100% of NovaStar Mortgage's wholesale loan production. Accordingly, NovaStar Mortgage recognized $1.7 million in net interest income on these loans for the nine months ended September 30, 1998. . NovaStar Mortgage paid NovaStar Financial commitment fees aggregating $3.8 million for the nine months ended September 30, 1998. No commitment fees were paid to NovaStar Financial for the same period of 1997. As discussed under "Fees from NovaStar Mortgage, Inc.", NovaStar Mortgage is required to pay NovaStar Financial a commitment fee when it does not sell its mortgage loan production to NovaStar Financial. These fees are netted against services provided to NovaStar Financial Inc., as included in NFI Holding Corporation's Statement of Operations in Table XXV. . Servicing fees NovaStar mortgage received from NovaStar Financial increased from $68,000 during the nine months ended September 30, 1997 to $4.1 million for the same period of 1998. These fees are included as a component of services provided to NovaStar Financial, Inc. as detailed in NFI Holding Corporation's Statement of Operations in Table XXV. This increase is partly due to NovaStar Mortgage did not begin servicing NovaStar Financial's loans until July 15,1997 whereas NovaStar Mortgage serviced NovaStar Financial's loans for all of 1998. The increase is also due to the growth in NovaStar Financial's mortgage loan portfolio during the two periods. The servicing fee is based on 50 basis points on the outstanding principal balance when loans are securitized and a flat fee per loan prior to securitization. . Outsourcing fees increased from $2.5 million during the nine months ended September 30, 1997 to $5.7 million during the same period of 1998. As discussed under "General and Administrative Expenses", the increase in this fee is a result of the growth in the extent of services required as well as higher loan volumes. These fees are included as a component of services provided to NovaStar Financial, Inc. as detailed in NFI Holding Corporation's Statement of Operations in Table XXV. . During the nine month period ended September 30, 1998, NovaStar Mortgage recognized net gains of $1.0 million on the sale of $25 million of subprime residential mortgage loan production. NovaStar Mortgage did not sell any of its mortgages assets during the same period of 1997. . General and administration expenses increased from $12.3 million for the nine months ended September 30, 1997 to $12.3 million for the same period of 1998. This increase corresponds to the growth in NovaStar Mortgage's wholesale loan origination volume during the same periods. Tables XXIV and XXV are summary financial statements for NFI Holding Corporation as of and for the nine months ended September 30, 1998 and 1997. Table XXVI is a summary of loan costs for NovaStar Mortgage relative to its wholesale loan originations. Table XXIV NFI Holding Corporation--Balance Sheet September 30 (dollars in thousands) - --------------------------------------------------------------------------------
1998 1997 Assets Restricted cash............................... $ 18,997 $ -- Mortgage loans................................ 238,207 -- Mortgage securities........................... 8,686 -- Other assets.................................. 5,186 9,326 -------- ------ Total assets................................ $271,076 $9,326 ======== ====== Liabilities and stockholders' equity Securities under repurchase agreements........ $ 8,559 $ -- Due to NovaStar Financial, Inc................ 259,312 -- Other liabilities............................. 3,614 7,470 -------- ------ Total liabilities............................. 271,485 7,470 Stockholders' equity.......................... (409) 1,857 -------- ------ Total liabilities and stockholders' equity.. $271,076 $9,326 ======== ======
21 Table XXV NFI Holding Corporation -- Statement of Operations Nine Months Ended September 30 (dollars in thousands) - ---------------------------------------------------------------------- 1998 1997 Net interest income............................. $ 1,730 $ -- Services provided to NovaStar Financial, Inc.... 6,031 2,518 Fees from third parties......................... 879 640 Gains on sale of mortgage assets................ 1,209 -- General and administration expenses............. (12,329) (3,301) -------- ------- Net loss........................................ $ (2,480) $ (143) ======== =======
Table XXVI Cost of Loan Production -- NovaStar Mortgage, Inc. Nine Months Ended September 30, 1998 and Year Ended December 31, 1997 (dollars in thousands) - ------------------------------------------------------------------------------
1998 1997 ---------------------------------------------------------------------------------------- Third Second First Fourth Third Second First Quarter Quarter Quarter Quarter Quarter Quarter Quarter Total costs of loan production (A)..... $ 4,975 $ 3,837 $ 3,079 $ 2,096 $ 1,938 $ 1,401 $ 410 Wholesale loan origination -- principal 232,333 294,303 207,974 183,012 136,582 77,692 12,688 Premium paid to broker................. 3,322 3,679 2,935 2,896 2,119 1,618 295 -------- -------- -------- -------- -------- ------- ------- Total acquisition cost (B)............. $240,630 $301,819 $213,988 $188,004 $140,639 $80,711 $13,393 ======== ======== ======== ======== ======== ======= ======= Costs as a percent of principal: Loan production...................... 2.1% 1.3% 1.5% 1.1% 1.4% 1.8% 3.2% === === === === === === === Premium paid to broker............... 1.4% 1.3% 1.4% 1.6% 1.6% 2.1% 2.3% === === === === === === === Total acquisition cost............... 3.6% 2.6% 2.9% 2.7% 3.0% 3.9% 5.6% === === === === === === ===
- ---------------- (A) Loan production general and administrative as reported for GAAP, plus net deferred loan costs. (B) Principal, premium and general administrative expenses associated with loan production. Value of Mortgages Added through Wholesale Operations By establishing a wholesale lending operation to originate subprime residential mortgage loans, NovaStar has developed a process to add mortgage assets to its balance sheet at amounts management believes are below what it would generally cost, in most market environments, to acquire the same assets in bulk through open market purchases. In effect, the value created by generating assets at this lower cost is creating future economic benefit, or value, for our stockholders. This added value is demonstrated in the estimated fair value of our loan portfolio. The values presented in tables XXVII and XXVIII are management's estimates based on market conditions as of September 30, 1998. As discussed in "Events Subsequent to September 30, 1998," market conditions changed during October 1998. The change in market conditions has, among other things, caused supply of to be greater than demand for subprime mortgage loans. As a result, the prices reflected below may not be indicative of market prices subsequent to September 30, 1998. Management estimates the weighted-average value of its mortgage loan portfolio as of September 30, 1998 to be between 103 and 104 (in terms of price to par). Table XXVII provides estimates of the value of the mortgage loans in the portfolio and assumptions used in generating those estimates. Estimated values can vary dramatically based upon assumptions used. As presented in Table XXVI, during 1998, NovaStar originated mortgage loans at an all-in cost of 103.6 percent of principal, including direct costs of acquisition, such as broker premiums, and general overhead expenses. This cost is higher than in recent quarters. However, NovaStar Mortgages operated during the third quarter at less than full capacity. If NovaStar Mortgage had operated at or near full capacity, the all-in cost would be similar to prior quarters. Direct costs of acquisition are capitalized as premium and amortized as an adjustment of yield over the life of the loan. 22 The weighted-average premium on mortgage loans outstanding at September 30, 1998 represented 2.44 percent of principal. Using the estimated market values from above, this implies an estimated unrealized gain (or additional value) in the Company's mortgage loan portfolio at September 30, 1998 of between 1.0 and 2.0 percent. Applying this percent to the balance of mortgage loans outstanding of $1.2 billion results in an estimated unrealized gain of between $12 and $24 million. This additional value results in an estimated mark-to-market equity of between $122 and $134 million, or $15 per outstanding share.
Table XXVII Estimated Market Price on Entire Loan Portfolio As of September 30, 1998 - --------------------------------------------------------------------------------------------------------------------------- Estimated Market Price Estimated Market Price ------------------------- ------------------------ Two- and Three-year Six-month LIBOR Loan Fixed Loan Products Products ------------------------- ------------------------ Bond Equivalent Yield............ 8.25% 8.50% 8.75% Bond Equivalent Yield............ 9.00% 9.25% 9.50% Spread to Index.................. 3.00% 3.25% 3.50% Spread to Index.................. 3.75% 4.00% 4.25% Assumed Prepayment Speed (CPR)... Assumed Prepayment Speed (CPR)... 30............................... 105.6% 105.0% 104.4% 35............................... 104.6% 104.1% 103.6% 35............................... 104.7% 104.2% 103.7% 40............................... 104.4% 103.5% 103.1% 40............................... 104.0% 103.6% 103.2% 45............................... 103.4% 102.9% 102.5% 30/15-year Fixed and One-year CMT Loan Balloon Loan Products Products (Three-year Treasury) ------------------------- ------------------------ Bond Equivalent Yield............ 7.64% 7.89% 8.14% Bond Equivalent Yield............ 7.75% 8.00% 8.25% Spread to Index.................. 3.25% 3.50% 3.75% Spread to Index.................. 3.50% 3.75% 4.00% Assumed Prepayment Speed (CPR)... Assumed Prepayment Speed (CPR)... 30............................... 104.9% 104.3% 103.7% 25............................... 106.3% 105.6% 104.9% 35............................... 104.1% 103.6% 103.2% 30............................... 105.4% 104.9% 104.3% 40............................... 103.6% 103.2% 102.7% 35............................... 104.7% 104.2% 103.7% Table XXVIII Estimated Market Price of Loans Originated in Third Quarter of 1998 Third Quarter 1998 - --------------------------------------------------------------------------------------------------------------------------- Estimated Market Price Estimated Market Price ------------------------- ------------------------ Two- and Three-year Six-month LIBOR Loan Fixed Loan Products Products ------------------------- ------------------------ Bond Equivalent Yield............ 8.25% 8.50% 8.75% Bond Equivalent Yield............ 7.50% 7.75% 8.00% Spread to Index.................. 3.00% 3.25% 3.50% Spread to Index.................. 2.25% 2.50% 2.75% Assumed Prepayment Speed (CPR)... Assumed Prepayment Speed (CPR)... 30............................... 105.4% 104.9% 104.3% 30............................... 104.2% 103.6% 103.0% 35............................... 104.6% 104.1% 103.6% 35............................... 103.6% 103.1% 102.6% 40............................... 103.9% 103.5% 103.1% 40............................... 103.1% 102.7% 102.3% One-year CMT Loan 30/15-year Fixed and Products Balloon Loan Products ------------------------- ------------------------ Bond Equivalent Yield............ 7.64% 7.89% 8.14% Bond Equivalent Yield............ 7.75% 8.00% 8.25% Spread to Index.................. 3.25% 3.50% 3.75% Spread to Index.................. 3.50% 3.75% 4.00% Assumed Prepayment Speed (CPR)... Assumed Prepayment Speed (CPR)... 30............................... 104.3% 103.7% 103.1% 25............................... 106.4% 105.7% 105.1% 35............................... 103.7% 103.2% 102.7% 30............................... 105.5% 105.0% 104.4% 40............................... 103.2% 102.8% 102.3% 35............................... 104.8% 104.3% 103.8%
23 Table XXIX Carrying Value of Loans by Product/Type As of September 30, 1998 (in thousands) - -----------------------------------------------------------------
Product/Type Amount Two- and three-year fixed.................... $521,535 Six-month LIBOR.............................. 61,342 One-year CMT................................. 40,471 30/15-year fixed and balloon................. 301,087 -------- Outstanding principal.................... 924,435 Premium...................................... 22,550 Reserve for credit losses.................... (2,757) -------- Carrying Value........................... $944,228 ======== Carrying value as a percent of principal..... 102.4% ========
Results of Operations -- Three Months Ended September 30, 1998 Compared to Three Months Ended September 30, 1997 Net Income During the three months ended September 30, 1998, the Company realized net income of $2.4 million compared with net income of $177,000 for the same period of 1997. The components of net income are discussed in the following paragraphs. Net Interest Income Table XXX presents a summary of the average interest-earning assets, average interest-bearing liabilities and the related yields and rates thereon for the three months ended September 30, 1998. Table XXX Interest Analysis Three Months Ended September 30, 1998 (dollars in thousands) - --------------------------------------------------------------------------------
Mortgage Loans Mortgage Securities Total ---------------------------- --------------------------- ------------------------------ Interest Annual Interest Annual Interest Annual Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate Mortgage Assets......................... $927,132 $22,312 9.63% $412,335 $6,485 6.29% $1,339,467 $28,797 8.60% ======== ======== ========== Liabilities............................. Repurchase agreements................. $144,041 2,303 6.40% $419,901 6,121 5.83% $ 563,942 8,424 5.98% Collateralized mortgage obligations... 821,739 12,734 6.20 821,739 12,734 6.20 Other borrowings...................... 10,446 111 4.25 10,446 111 4.25 -------- --------- Cost of derivative financial Instruments hedging liabilities....... 638 181 819 ------- ------ ------- Total borrowings.................... $976,226 15,786 6.47 $419,901 6,302 6.00 $1,396,127 $22,088 6.33 ======== ------- ======== ------ ========== ======= Net interest income................... $ 6,526 $ 183 $ 6,709 ======= ====== ======= Net interest spread................... 3.16% 0.29% 2.27% ==== ==== ==== Net yield............................. 2.82% 0.18% 2.00% ==== ==== ====
The Company had average interest-earning assets of $1.34 billion during the three months ended September 30, 1998, compared with $629.0 million for the three months ended September 30, 1997. During the three month period ended September 30, 1998, mortgage securities earned $6.5 million, or a yield of 6.3 percent, while mortgage loans earned $22.3 million, or a yield of 9.6 percent. For the same period of 1997, mortgage securities earned $4.6 million, or a yield of 6.6 percent, while mortgage loans earned $7.7 million, or a yield of 8.7 percent. In total, assets earned $28.8 million -- a yield of 8.6 percent for the period ending September 30, 1998 compared with $12.2 million, or a yield of 7.8 percent for the period ending September 30, 1997. During the three months ended September 30, 1998, borrowed funds for the Company averaged $1.4 billion on which interest was incurred of $22.1 million, or 6.3 percent. In comparison, for the three months ended September 30, 1997, borrowed 24 funds for the Company averaged $593.2 million on which interest was incurred of $9.8 million, or 6.6 percent. Rates on other borrowings generally fluctuate with short-term market interest rates, such as LIBOR or the Federal Funds rate. Net interest income during the three months ended September 30, 1998 was $6.7 million, or 2.00 percent of average interest-earning assets compared with $2.4 million, or 1.53 percent of average interest-earning assets for the three month period ending September 30, 1997. Net interest spread for the Company was 2.27 percent versus 1.18 percent during the three months ended September 30, 1998 and September 30, 1997, respectively. Provisions for Credit Losses During the three months ended September 30, 1998, the Company provided $1.2 million for credit losses compared with $726,000 for the three months ended September 30, 1997. Credit losses recognized during the three-month period ended September 30, 1998 were $1.8 million. The Company recognized no losses on its mortgage loan portfolio during the three-month period ended September 30, 1997. As mentioned earlier, reserves are maintained for losses management expects to incur on loans in the portfolio. Fees provided by NovaStar Mortgage, Inc. and Other Income Fees paid by NovaStar Mortgage to the Company in accordance with the Mortgage Loan Sale and Purchase Agreement aggregated $3.3 million during the third quarter 1998. During the three months ended, September 30, 1998, the Company recognized a $200,000 gain on sale of mortgage loans, pooling $4.7 million of mortgage loans in the transaction. Also, included in other income during the third quarter of 1998, are prepayment penalties of $625,000 and interest on founders' notes receivable of $129,000. General and Administrative Expenses General and administrative expenses during the three months ended September 30, 1998 and September 30, 1997, respectively, were $5.0 million and $2.1 million. Consistent with prior periods, the single largest component of general and administrative expenses is the administrative outsourcing fee paid to NovaStar Mortgage, which was $2.1 million for the three month period ending September 30, 1998 compared with $1.2 million for the three month period ended September 30, 1997. Compensation and benefits totaled $478,000 during the third quarter of 1998 compared with $332,000 for the third quarter of 1997. Professional and outside services include legal fees and contract labor for the development of information systems. These expenses were $296,000 and $181,000 for the third quarter of 1998 and 1997, respectively. Loan servicing costs were $1.5 million compared with $123,000 for the three month period ending September 30, 1998 and 1997, respectively. Loan servicing costs include direct costs of managing the loan portfolio which are not reimbursable by the borrower. In addition, loan servicing costs include fees associated with the service provider who services the Company's loans. These fees were paid to NovaStar Mortgage in 1998 and to an outside party during the same period of 1997 as the Company outsourced this service until July 15, 1997. The loans servicing fee charged by NovaStar Mortgage increased dramatically during the fourth quarter of 1997 and into 1998 after NovaStar Financial securitized its loans. The fee increased to 50 basis points on the outstanding principal when loans are securitized from a flat fee per loan prior to their securitization. Equity in Earnings (Loss) of NFI Holding Corporation For the three months ended September 30, 1998, Holding recognized a net loss of $2.5 million of which the Company recorded its portion. For the same period of 1997, Holding realized a net income of 293,000. As mentioned earlier, the increase in the net loss is largely due to the fee from NovaStar Mortgage to the Company as NFI did not acquire any of NovaStar Mortgage's production during the third quarter of 1998. This loss was partly offset by realized gains of $798,000 on the sale of mortgage securities and loans. Taxable Income (Loss) Income reported for financial reporting purposes as calculated in accordance with generally accepted accounting principles (GAAP) differs from income computed for income tax purposes. This distinction is important as dividends paid are based on taxable income. Table XXXI is a summary of the differences between the Company's net income or loss reported for GAAP the three month period ended September 30, 1998 and 1997 by quarter and its taxable income. 25
Table XXXI Taxable Income (Loss) Nine months Ended September 30, 1998 (in thousands) - --------------------------------------------------------------------------------------------------------- 1998 1997 -------------------------------------------------------------------- Third Second First Fourth Third Second First Quarter Quarter Quarter Quarter Quarter Quarter Quarter Net income (loss).................. $ 2,394 $1,894 $1,279 $ (433) $ 177 $(1,073) $194 Results of Holding and subsidiary.. 2,447 -- 273 (169) (393) 126 408 Provision for credit losses........ 1,179 1,145 1,076 1,009 726 547 171 Loans charged-off.................. (1,762) (675) (518) (140) Other, net......................... 95 208 (4) 296 (4) (8) -- ------- ------ ------ ------ ----- ------- ---- Taxable income (loss).............. $ 4,353 $2,572 $2,106 $ 563 $ 506 $ (408) $773 ======= ====== ====== ====== ===== ======= ====
As discussed under "Events Subsequent to September 30, 1998," the Company executed several transactions during October 1998 that included the sale of assets and termination of hedging arrangements. Management anticipates the significant losses resulting from these transactions will eliminate taxable income for 1998. Interest rate sensitivity. In its assessment of the interest sensitivity and as an indication of the Company's exposure to interest rate risk, management relies on models of financial information in a variety of interest rate scenarios. Using these models, the fair value and interest rate sensitivity of each financial instrument (or groups of similar instruments) is estimated, and then aggregated to form a comprehensive picture of the risk characteristics of the balance sheet. These amounts contain estimates and assumptions regarding prepayments and future interest rates. Actual economic conditions may produce results significantly different from the results depicted below. However, management believes the interest sensitivity model used is a valuable tool to manage the Company's exposure to interest rate risk. Table XXXII details the Company's Interest Rate Sensitivity as of September 30, 1998.
Table XXXII Interest Rate Sensitivity (A) (B) September 30, 1998 - ------------------------------------------------------------------------------------------------ Basis Point Increase (Decrease) in Interest Rate (C) ---------------------------------------------------- (100) Base (D) 100 ---------- ---------- ---------- Market value of: Assets............................. $1,715,188 $1,703,308 $1,687,861 Liabilities........................ 1,594,020 1,593,078 1,592,136 Interest rate agreements........... 69 571 2,977 ---------- ---------- ---------- Net market value..................... $ 121,237 $ 110,801 $ 98,702 ========== ========== ========== Cumulative change in value(D)........ $ 10,436 -- $ (12,099) ========== ========== ========== Percent change from base assets(E)... 0.83% -- (0.95)% ========== ========== ========== Percent change of capital(F)......... 9.50% -- (11.01)% ========== ========== ==========
- --------------- (A) Management analyzes the interest sensitivity of the Company and NovaStar Mortgage on a combined basis. The assets and liabilities of NovaStar Mortgage consist primarily of mortgage loans with a carrying value of $238,207 and securities with a current face of $8.5 million and their related repurchase agreement financing. (B) Reflects the sale of all securities and all swap terminations made in October 1998. (C) Value of asset, liability or interest rate agreement in a parallel shift in the yield curve, up and down 1%. (D) Total change in estimated market value, in dollars, from "base." "Base" is the estimated market value at October 15, 1998. (E) Total change in estimated market value, as a percent, from base. (F) Total change in estimated market value as a percent of total stockholders' equity at September 30, 1998. Interest Rate Sensitivity Analysis. The values under the heading "Base" are management's estimates of market values of the Company's assets, liabilities and interest rate agreements on September 30, 1998. The values under the headings "100" and "(100)" are management's estimates of the market value of those same assets, liabilities and interest rate agreements assuming that interest rates were 100 basis points (1%) higher and lower. The cumulative change in value represents the change in value of assets from base, net of the change in value of liabilities and interest rate agreements from base. The interest sensitivity analysis is prepared regularly (at least monthly). If the analysis demonstrates that a 100 basis point shift (up or down) in interest rates would result in 10% or more cumulative change in value from base, management will modify the Company's portfolio by adding or removing interest rate cap or swap agreements. 26 Sensitivity as of September 30, 1998. As shown in the table above, if interest rates were to decrease one percent (-100 basis points), the value of the Company's capital would increase by an estimated 9.50 percent. If interest rates rise by one percent (+100 basis points), the value of the Company's capital would decrease by an estimated 11.01 percent. Capital Allocation Guidelines (CAG). The Company's goal is to strike a balance between the under-utilization of leverage, which reduces returns to stockholders, and the over-utilization of leverage, which could reduce the Company's ability to meet its obligations during adverse market conditions. The Company's CAG have been approved by the Board of Directors. The CAG are intended to keep the Company properly leveraged by (i) matching the amount of leverage allowed to the riskiness (return and liquidity) of an asset and (ii) monitoring the credit and prepayment performance of each investment to adjust the required capital. This analysis takes into account the Company's various hedges and other risk programs discussed below. In this way, the use of balance sheet leverage will be controlled. Following presents a summary of the Company's CAG for the following levels of capital for the types of assets it owns. Table XXXIII Capital Allocation Guidelines September 30, 1998
- --------------------------------------------------------------------------------------------------------------------------------- (A) (B) (C) (D) (E) (F) (F) Minimum Duration Liquidity (c+d) (bxe) (a + f) Lender Estimated Price Spread Spread Total Spread Equity Cushion CAG Equity Asset Category Haircut Duration Cushion Cushion Cushion (% of MV) Required -------------- Agency-issued: Conventional ARMs....... 3.00% 3.50% 50 -- 50 1.75% 4.75% GNMA ARMs............... 3.00 4.50 50 -- 50 2.25 5.25 GNMA Fixed Rates........ 3.00 5.00 50 -- 50 2.50 5.50 Corporate Bonds......... 10.00 3.50 225 25 250 8.75 18.75 Mortgage loans: Collateral for warehouse financing.... 2.00 3.00 100 50 150 4.50 7.50 Collateral for CMO...... 5.80 -- -- -- -- -- 5.80 Delinquent.............. 100.00 -- -- -- -- -- 100.00 Hedging.................. -- -- -- -- -- -- 5.80 Other.................... 100.00 -- -- -- -- -- 100.00
- ------------------------------------------------------ (A) Indicates the minimum amount of equity a typical lender would require with an asset from the applicable asset category. There is some variation in haircut levels among lenders. From the lender perspective, this is a "cushion" to protect capital in case the borrower is unable to meet a margin call. The size of the haircut depends on the liquidity and price volatility of the asset. Agency securities are very liquid, with price volatility in line with the fixed income markets, which means a lender requires a smaller haircut. On the other extreme, "B" rated securities and securities not registered with the Securities and Exchange Commission (the "Commission") are substantially less liquid, and have more price volatility than Agency securities, which results in a lender requiring a larger haircut. Particular securities that are performing below expectations would also typically require a larger haircut. (B) Duration is the price-weighted average term to maturity of financial instruments' cash flows. (C) Estimated cushion need to protect against investors requiring a higher return compared to Treasury securities, assuming constant interest rates. (D) Estimated cushion required due to a potential imbalance of supply and demand resulting in a wider bid/ask spread. (E) Sum of duration (C) and liquidity (D) spread cushions. (F) Product of estimated price duration (B) and total spread cushion. The additional equity, as determined by management, to reasonably protect the Company from lender margin calls. The size of each cushion is based on management's experience with the price volatility and liquidity in the various asset categories. Individual assets that have exposure to substantial credit risk will be measured individually and the leverage adjusted as actual delinquencies, defaults and losses differ with management's expectations. Each quarter, management presents to the Board of Directors the results of the CAG compared to actual equity. Management may propose changing the capital required for a class of investments or for an individual investment based on its prepayment and credit performance relative to the market and the ability of the Company to predict or hedge the risk of the asset. Table XXXIV is a summary of the capital allocation for NovaStar as they apply to the Company's mortgage assets and hedging instruments during 1998 and 1997. 27
Table XXXIV Required Equity - ---------------------------------------------------------------------------------------------------------------------- 1998 1997 ---------------------------------- ----------------------------------------------- Category September 30 June 30 March 31 December 31 September 30 June 30 March 31 Mortgage loans: Current........................ $ 14,567 $ 21,566 $ 23,628 $ 6,675 $ 33,832 $22,780 $15,958 Delinquent..................... 452 601 1,200 1,600 2,376 -- -- Securitized loans.............. 55,822 37,766 23,478 22,500 -- -- -- Mortgage securities.............. 19,514 24,904 27,426 36,170 12,763 13,549 1,646 Other assets..................... 20,682 13,782 10,733 -- -- -- -- Hedging instruments.............. (688) (232) (203) 5,500 427 1,787 2,804 -------- -------- -------- -------- --------- ------- ------- Required equity.................. 110,349 98,387 86,262 72,445 49,398 38,116 20,408 Stockholders' equity............. 109,848 114,875 115,798 116,489 47,036 46,337 46,202 Market value in excess of the carrying value of assets and hedges (A)...................... 2,331 31,999 20,685 -- -- -- -- -------- -------- -------- -------- --------- ------- ------- Excess equity.................... $ 1,830 $ 48,487 $ 50,221 $ 44,044 ($ 2,362) $ 8,221 $25,794 ======== ======== ======== ======== ========= ======= =======
- ----------------- (A) The Company revised its CAG model during the first quarter of 1998 to include the market value in excess of the carrying value of assets and hedges as the Company has the ability to borrow against this residual. Inflation Virtually all of the Company's assets and liabilities are financial in nature. As a result, interest rates and other factors drive the Company's performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. The Company's financial statements are prepared in accordance with generally accepted accounting principles and the Company's dividends are based upon the Company's taxable income. In each case, the Company's activities and balance sheet are measured with reference to historical cost or fair market value without considering inflation. Impact of Recently Issued Accounting Pronouncements Note 1 to the consolidated financial statements of the Annual Report to Shareholders and Annual Report on Form 10-K for the year ended December 31, 1997 describes certain recently issued accounting pronouncements. Management believes the implementation of these pronouncements and others that have gone into effect since the date of these reports, will not have a material impact on the consolidated financial statements. During June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133). SFAS No. 133 requires that entities recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Derivatives meeting certain conditions may be designated as hedging instruments, for which SFAS No. 133 prescribes accounting treatment, depending on the type of hedge. For those derivatives not designated as a hedging instrument, the gain or loss is recognized in earnings in the period of change. For the Company, SFAS No. 133 must be applied not later than for the fiscal year beginning January 1, 2000. Management is currently evaluating the impact of SFAS No. 133 to the company's financial statements. Statement of Financial Accounting Standards No. 134, Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise was issued by the FASB during October 1998. SFAS No. 134 amends SFAS No. 65 and 115, and requires entities to classify retained mortgage-backed securities after the securitization of mortgage loans held for sale in accordance with SFAS No. 115. However, a mortgage banking enterprise must classify as trading retained mortgage-backed securities that it commits to sell before or during the securitization process. This statement is effective for the first fiscal quarter beginning after December 15, 1998. Management does not expect the adoption of this standard to have a material impact on the Company's financial position and results of operations. 28 The Year 2000 The Company is highly dependent on purchased and leased computer software to conduct business. In addition, the Company is highly dependent on computer software used by market counterparties and vendors, including banks, in conducting business. The Company recognizes that some computer software may not have the ability to correctly identify dates beyond December 31, 1999. The Company's successful modification of computer software, or the vendors' successful modification of their programs, to be year 2000 compliant is critical to the Company's viability. NovaStar uses three major, and a number of smaller, internal automation solutions to conduct its business operations. The three computer systems considered the most significant to the Company's operations are as follows: . The internally developed loan origination and database system . The externally provided loan servicing system . The purchased accounting system In addition, the Company integrates with a number of outside entities in our normal business transactions. Interfaces with other businesses and third party solution providers are used to conduct some of our business processes. Certain other processes are supported by systems created internally. NovaStar is using the Federal Financial Institutions Examination Council's (FFIEC) "Year 2000 Project Management Awareness" document to guide our year 2000 readiness effort. Each program/system interface used by the Company is being reviewed and tested for year 2000 compliance. The FFIEC guide calls for a three-phase approach to assess year 2000 compliance. In the Assessment Phase, the Company has determined which business processes/interfaces rely on dates and date arithmetic. Most of the Company's business processes/interfaces rely on dates and date arithmetic. These business processes/interfaces are being tested internally for compliance. The Company has asked its market counterparties and vendors to document that they have assessed software for year 2000 compliance. Solution updates to non-compliant Year 2000 software should be made in the Correction Phase. Corrections on Company developed software will be made internally and are expected to be insignificant. The Company is requiring all market counterparties and vendors to document they have made all corrections. The Company will conduct "mock" business as if it is in the year 2000 during the Validation Phase. During this phase, the Company will test all internally developed software as well as vendor software. NovaStar has contacted all of its significant outside market counterparties and vendors to obtain documentation regarding their process and status for assuring year 2000 compliance. The Company has asked that each party adhere to the same FFIEC guidelines and to provide documents of progress during each phase. Recent status reports have been received from Alltel Residential Lending Solutions (vendor of the Company's servicing system) and Baan/CODA (vendor of the Company's accounting system) and are as follows: . Alltel, vendor of the servicing platform expects to complete testing by December 31, 1998 and maintains they will be fully year 2000 compliant by the first quarter of 1999. . Baan/CODA, vendor of the accounting system has provided the Company written confirmation that the version the Company currently uses is fully year 2000 compliant. All internally developed software was designed to be year 2000 compliant. In addition, the Company has contacted its significant financial counterparty, First Union National Bank, who is completing their internal review of year 2000 compliance. The Company believes that its greatest risk in regards to year 2000 compliance is the software and systems used to service its subprime mortgage loans. NovaStar Mortgage, Inc., an affiliate of the Company, services the Company's loans. NovaStar Mortgage uses systems developed by Alltel for loan servicing. If these systems fail, NovaStar Mortgage will not be able to continue on a manual basis. In this worst case scenario, loans would not be serviced until the failed system could be remedied. If the loans go "unserviced" for an extended period of time -- several weeks -- the result could have a material adverse impact on the Company. The Company is also at significant risk in the event the systems of financial institutions, on which the Company is relying for financing and cash management, fail. In a worst case scenario, the Company and NovaStar Mortgage may not be able to meet financial obligations during the period of failure -- an unknown timeframe. The result could have a material adverse impact on the Company. The Company is exposed to smaller risks in the event other systems, including those developed internally, fail to perform beyond December 31, 1999. However, management believes functions, other than servicing, can be maintained on a manual basis should systems fail. Although processing and performance would be slow, risk of material adverse impact to the Company for these systems failures is expected to be minimal. Management expects, through the completion of its year 2000 plan, the likelihood of a material business disruption is not significant. The major risks presented above involve year 2000 remediation efforts of third party vendors used by the Company. 29 Based on the information provided, the Company believes these vendors will meet their obligation for resolution of year 2000 issues. The Company estimates it has incurred less than $75,000 in costs to date in carrying out its year 2000 compliance plan and estimates it will spend less than $100,000 in completing the plan. However, the costs could increase dramatically if the Company determines that any market counterparty will not be year 2000 compliant. The Company has not developed formal contingency plans to be used in the event any of its hardware, software or other computerized systems, or those of a vendor, are not ready for the year 2000. A full contingency plan will be developed prior to March 31, 1999. 30 PART II. OTHER INFORMATION Item 1. Legal Proceedings As of September 30, 1998, there were no material legal proceedings pending to which the Company was a party or of which any of its property was subject. Item 2. Changes in Securities Not applicable Item 3. Defaults upon Senior Securities Not applicable Item 4. Submission of Matters of Vote of Security Holders Not applicable Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits filed with this report are as follows: 10.1 Master repurchase agreement with First Union National Bank 10.2 Primary mortgage insurance agreement with Commonwealth Mortgage Assurance Company 11.1 Schedule regarding computation of per share earnings 21.1 Subsidiaries of the Registrant 27.1 Financial data schedule 99.1 Press release dated October 29, 1998 (b) The Company has filed the following Form 8-K's: . Regarding certain amendments made to its charter filed on July 6, 1998. . Regarding announcement of current market conditions and postponement of the third quarter dividend filed on October 12, 1998. . Regarding announcement of $15 million 90-day committed secured financing agreement to address immediate liquidity needs filed on October 13, 1998. . Regarding announcement of steps taken to address immediate liquidity needs filed on October 15, 1998. 31 NOVASTAR FINANCIAL, INC. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NOVASTAR FINANCIAL, INC. DATE: April 1, 1999 /s/ Rodney E. Schwatken ----------------------- Rodney E. Schwatken Vice President, Controller and Assistant Treasurer (Principal Accounting Officer) 32 -----END PRIVACY-ENHANCED MESSAGE-----