UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

_______________

FORM 10-K
x     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    
For the Fiscal Year ended December 31, 20102011
   
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From __________ to__________to __________
_______________

Commission File Number 001-13533
NOVASTAR FINANCIAL, INC.
(Exact Name of Registrant as Specified in its Charter)
Maryland74-2830661
(State or Other Jurisdiction of Incorporation or Organization)(I.R.S. Employer Identification No.)
Organization)
  
2114 Central Street, Suite 600, Kansas City, MO64108
(Address of Principal Executive Office)(Zip Code)

Registrant’s Telephone Number, Including Area Code: (816) 237-7000
_______________
 
Securities Registered Pursuant to Section 12(b) of the Act:
None
  
Securities Registered Pursuant to Section 12(g) of the Act:
Title of Each Class
Common Stock, $0.01 par value
8.9% Series C Cumulative Redeemable Preferred Stock, $0.01 par value
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes oNo x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes oNo x
 
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 xNo o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. xo
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filero    Accelerated filero    Non-accelerated filero    Smaller reporting company
ooox
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No x
  
The aggregate market value of voting and non-voting stock held by non-affiliates of the registrant as of June 30, 20102011 was approximately $8,566,000,$37,949,000, based upon the closing sales price of the registrant’s common stock as quoted by Pink OTC Markets’ inter-dealer quotation service as a OTCQB security.
 
The number of shares of the Registrant’s Common Stock outstanding on March 10, 2011 was 9,368,053.
The number of shares of the Registrant's Common Stock outstanding on March 9, 2012 was 91,253,653.
 
Documents Incorporated by Reference
Items 10, 11, 12, 13 and 14 of Part III are incorporated by reference to the NovaStar Financial, Inc. definitive proxy statement for the 20112012 annual meeting of the shareholders, which will be filed with the Commission no later than 120 days after December 31, 2010.2011.






NOVASTAR FINANCIAL, INC.
FORM 10-K
For the Fiscal Year ended December 31, 20102011

  
TABLE OF CONTENTS 
  
Part I  
   
Item 1.Business3
1
Item 1A.Risk Factors5
2
Item 1B.Unresolved Staff Comments11
7
Item 2.Properties11
7
Item 3.Legal Proceedings11
7
Item 4.Mine Safety DisclosuresRemoved and Reserved12
8
   
Part II  
   
Item 5.Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities12
8
Item 6.Selected Financial Data13
9
Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations13
9
Item 7A.Quantitative and Qualitative Disclosures About Market Risk23
19
Item 8.Financial Statements and Supplementary Data24
20
Item 9.Changes in and Disagreements With Accountants on Accounting and Financial Disclosure58
49
Item 9A.Controls and Procedures58
49
Item 9B.Other Information59
49
   
Part III  
   
Item 10.Directors, Executive Officers and Corporate Governance59
49
Item 11.Executive Compensation59
49
Item 12.Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters59
49
Item 13.Certain Relationships and Related Transactions, and Director Independence59
50
Item 14.Principal Accountant Fees and Services59
50
   
Part IV  
   
Item 15.Exhibits, Financial Statement Schedules60
50





Part I

Forward-Looking Statements
 
Statements in this report regarding NovaStar Financial, Inc. and its business, that are not historical facts are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are those that predict or describe future events and that do not relate solely to historical matters and include statements regarding management's beliefs, estimates, projections, and assumptions with respect to, among other things, our future operations, business plans and strategies, as well as industry and market conditions, all of which are subject to change at any time without notice. Words such as "believe," "expect," "anticipate," "promise," "plan," and other expressions or words of similar meanings, as well as future or conditional auxiliary verbs such as "would," "should," "could," or "may" are generally intended to identify forward-looking statements. Actual results and operations for any future period may vary materially from those discussed herein. Some important factors that could cause actual results to differ materially from those anticipated include: our ability to manage our business; variability in the home mortgage or refinancing market that affects the demand for real estate appraisal services; decreases in cash flows from our mortgage securities; increases in the credit losses on mortgage loans underlying our mortgage securities and our mortgage loans – held in portfolio; our ability to remain in compliance with the agreements governing our indebtedness; impairments on our mortgage assets; increases in prepayment or default rates on our mortgage assets; the outcome of litigation actions pending against us or other legal contingencies; our compliance with applicable local, state and federal laws and regulations; compliance with new accounting pronouncements; the impact of general economic conditions; and the risks that are from time to time included in our filings with the Securities and Exchange Commission (“SEC”), including this report on Form 10-K. Other factors not presently identified may also cause actual results to differ. This report on Form 10-K speaks only as of its date and we expressly disclaim any duty to update the information herein except as required by federal securities laws.

Item 1. Business

NovaStar Financial, Inc. (“NFI” or the “Company”) is a Maryland corporation formed on September 13, 1996. Our strategy is to acquire certain early stage businesses that we consider to be in the technology-enabled services industry.
Prior to significant changes in our business during 2008, we originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and issued mortgage-backed securities. After we discontinued our lending-related businesses, in 2008, we began to transition from our prior business to what we are today. We continue to own some mortgage securities retained during the securitization process.
We own an 88%In 2008, we acquired a majority interest in StreetLinks LLC (“StreetLinks”), a national residential appraisal and mortgage real estate valuation management company. StreetLinks allows its customers, primarily mortgage lenders and brokers, to fully outsource their appraisal management. StreetLinks facilitates its services company.through a unique, proprietary technology system. StreetLinks collects a fee for appraisal services from lenders and borrowers and passes through most of the fee topays independent residential appraisers with whom StreetLinks has a contractual relationship. StreetLinks retains a portion of the fee to cover its costs of managing the process of fulfilling the appraisal order and performing a quality control review of each appraisal. DevelopmentAs of December 31, 2011, we owned 88% of StreetLinks and subsequent to a transaction that occurred on March 8, 2012, we currently own approximately 93% of StreetLinks. See the section titled “Significant Recent Events” in Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-K for a discussion of the business is occurring through increasedCompany's recent acquisition of approximately 5% of additional equity interest of StreetLinks.
StreetLinks also offers its customers the ability to self-manage their appraisal order volumemanagement. Customers execute appraisal management via a separate proprietary software system. This system was acquired by StreetLinks when it purchased 51% of Corvisa, LLC (“Corvisa”) during 2010. StreetLinks acquired the remaining 49% of Corvisa during 2011. Acquisition of the Corvisa technology has allowed us to offer other analytical tools for lenders to manage their mortgage origination business.
In addition to the Corvisa technology platform, we gained a high-quality technology team with our Corvisa acquisition. This team now serves as the technology support for all of the NFI subsidiaries.
In 2009, we add new lending customers.
We ownacquired a 74%majority interest in Advent Financial Services, LLC (“Advent”), which provides financial settlement services, along with its distribution partners, mainly through. Advent allows income tax preparation businesses andpreparers, known in the tax industry as electronic return originators, to outsource their refund settlement services. Advent also provides access to tailored banking accounts, small dollar banking products and related services to meet the needs of low and moderate income level individuals. Advent did not have significant revenues during the year ended December 31, 2010, as it was developing its distribution network.
We own 78% of Advent.
During 2010, StreetLinks completed the acquisition of2011, we purchased 51% of the equity of CorvisaBuild My Move, LLC (“Corvisa”("BMM"). CorvisaSubsequent to the Company's acquisition, BMM changed its name to Mango Moving, LLC ("Mango"). Mango is a technologystart-up, Internet-based company that develops and markets its software products to mortgage lenders. Its primary product is a self-managed appraisal solution for lenders to manage their appraisal process. Other products include analytical tools for lenders to manage their mortgage origination business. Corvisa did not have significant revenues during the year ended December 31, 2010, as it was purchased during November 2010 and was developing its customer base and integrating with StreetLinks.
Prior to significant changes in our business during 2007 and the first quarter of 2008, we originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage backed securities. We retained, through our mortgage securities investment portfolio, significant interests in the nonconforming loans we originated“asset-light” third-party logistics provider market, with the goal of providing high-quality local and purchased,long distance residential and through our servicing platform, serviced allother moving services in competition with national van lines.
While Mango is in a different industry than StreetLinks, these businesses share similarities. They are both vendor management services using proprietary technology. StreetLinks manages a base of appraiser vendors whereas Mango manages bases of moving labor and trucking vendors. Much of the loanstechnology developed for StreetLinks is applicable to the business of Mango.

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Additionally, our extensive experience in which we retained interests. During 2007managing customer service centers applies not only to StreetLinks and early 2008, we discontinued our mortgage lending operationsMango, but also to Advent. Our centralized technology and sold our mortgage servicing rights which subsequently resulted in the closure of our servicing operations.
administrative functions allows us to share resources across all entities, saving time and costs.
Our portfolio of mortgage securities includes interest-only, prepayment penalty, and overcollateralization securities retained from our securitizations of nonconforming, single-family residential mortgage loans which we have accounted for as sales, under applicable accounting rules (collectively, the “residual securities”). Our portfolio of mortgage securitiesgoal is to continue to grow these businesses. We also includes subordinated mortgage securities retained from our securitizations and subordinated home equity loan asset-backed securities (“ABS”) purchased from other ABS issuers (collectively, the “subordinated securities”). These securities have increasingly become less valuable and are generating low rates of cash flow relativeexpect to historical levels.
We may use excess cash to make investmentsacquisitions if we determine that such investments couldthe acquisitions will provide attractive risk-adjusted returns to shareholders, including potentially investing inshareholders. We may acquire new orbusinesses and we may acquire existing operating companies. We have built an infrastructure necessary to quickly scale early stage operating businesses, especially those offering technology-enabled services. We have a high quality technology team with readily available access to additional development capabilities; excellent sales and marketing skills; deep customer service management experience and disciplined strategic, financial and general management capabilities.
During January 2010, events occurred that required the Company to reconsider the accounting for three consolidated loan trusts - NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1. Upon reconsideration, the Company determined that all requirements for derecognition were met under applicable accounting guidelines at the time of the reconsideration event. As a result, the Company derecognized the assets and liabilities of the trusts on January 25, 2010 and recorded a gain during the nine months ended September 30, 2010 of $993.1 million. These transactionsOur acquisitions are discussed in greater detail in Note 4 to the consolidated financial statements. The Company’s collateralized debt obligation (“CDO”) is
During 2011, we completed exchanges of our junior subordinated debentures and our preferred stock to improve our liquidity position, financial condition and provide stability. See Notes 3 and Note 9 to the only trust that is consolidated in the financial statements as of December 31, 2010.
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Our consolidated financial statements have been prepared on a going concern basis of accounting which contemplates continuity of operations, realization of assets, liabilities and commitments in the normal course of business. The Company has experienced significant losses over the past several years and has a significant deficit in stockholders’ equity. Notwithstanding these negative factors, management believesfor further details.
During January 2010, events occurred that its current operations and its cash availability is sufficient forrequired the Company to discharge itsderecognize the assets and liabilities of three consolidated
loan trusts and meet its commitments inrecord a non-cash gain during the normal courseyear ended December 31, 2010 of business. Our current liquidity and the impact thereon of recent operations is$993.1 million. These transactions are discussed in greater detail under the Liquidity and Capital Resources sectionheading, "Impact on Our Financial Statements of Derecognition of Securitized Mortgage Assets" of Item 7. Management’s Discussion7 and Analysis of Financial Condition and Results of Operations.
Refinancing of Trust Preferred Securities
In an effort to improve the Company’s liquidity position, on March 22, 2011, the Company entered into agreements that cancel the existing $78,125,000 aggregate principal amount of Trust Preferred Securities (the “TruPS”) issued in 2009 by certain statutory trusts formed by a wholly-owned subsidiary, NovaStar Mortgage, Inc. (“NMI”).  NMI issued unsecured junior subordinated notes (the “Junior Subordinated Notes”), to support the payment obligations under the TruPS. The Junior Subordinated Notes were guaranteed by the Company. As a result of the transaction, the Junior Subordinated Notes were cancelled. In place of the TruPS and associated Junior Subordinated Notes, the Company issuedNote 18 to the holders of the TruPS unsecured senior notes pursuant to three indentures (collectively, the “Senior Notes”).  The aggregate principal amount of the Senior Notes is $85,937,500, which is a 10% increase in principal over the liquidation value of the TruPS.  The new Senior Notes will accrue interest at a rate of 1% until the earlier to occur of (a) a completed equity offering by the Company or its subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”).The Senior Notes mature on March 30, 2033.consolidated financial statements.
The indentures governing the Senior Notes contain negative covenants that, among other things, restrict the Company’s use of cash (including cash payments for distributions to shareholders). At any time that the Senior Notes accrue interest at the Full Rate, and the Company satisfies certain financial covenants, certain negative covenants and restrictions on cash will not apply. The terms of the Senior Notes and associated agreements are more fully described in the Company’s current report on Form 8-K filed with the SEC on March 22, 2011.
Proposed Recapitalization of Preferred Stock.
As described in the Company’s Form S-4 Registration Statement, as amended (Registration No. 333-171115), filed with the SEC (the “Form S-4”), the Company is proposing to recapitalize the outstanding shares of its 8.90% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (the “Series C Preferred Stock”) and its 9.00% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 (the “Series D1 Preferred Stock”). The Series C Preferred Stock is publicly held, and the Series D1 Preferred Stock is privately held.
Upon the terms and subject to the conditions set forth in the Form S-4, the Company is proposing to exchange, for each outstanding share of Series C Preferred Stock,  at the election of the holder,  either:
The elections made by the holders of the Series C Preferred Stock will be subject to allocation and proration procedures intended to ensure that, in the aggregate, 43,823,600 newly-issued shares of Common Stock and $1,623,000 in cash (plus such other cash that is needed to cash out fractional shares) will be issued to the holders of the Series C Preferred Stock. The proposed Series C Offer will not be made unless and until the Form S-4 is declared effective by the SEC and it is subject to other closing conditions, such as the acceptance of the Series C Offer by at least two-thirds of the outstanding shares of Series C Preferred Stock and the requisite affirmative vote of shareholders in support of certain aspects of the recapitalization.
The proposed Series C Offer is part of a larger recapitalization of the Company, whereby the holders of the Company’s Series D1 Preferred Stock have agreed to exchange their stock for an aggregate of 37,161,600 newly-issued shares of Common Stock and $1,377,000 in cash (the “Series D Exchange”), as described in the Company’s Form 8-K dated December 10, 2010 and filed with the SEC.  The closing of the Series D Exchange is contingent upon the closing of the Series C Offer by not later than June 30, 2011 and the satisfaction of other conditions.
Personnel

As of March 18, 2011, the Series C Preferred Stock had an aggregate liquidation preference of $74.8 million and accrued and unpaid dividends of $23.0 million, and the Series D1 Preferred Stock had an aggregate liquidation preference of $52.5 million and accrued and unpaid dividends of $31.5 million.  The proposed recapitalization, if effected, would eliminate the Series C Preferred Stock and Series D Preferred Stock and their associated liquidation preferences and dividends.
There are multiple conditions to the closing of the Series C Offer and the Series D Exchange that are beyond our control, and we cannot provide you any assurance that these conditions will be satisfied or that the Series C Offer and the Series D Exchange will close.
The Series C Offer has not commenced. This disclosure does not constitute an offer to sell or the solicitation of an offer to buy any securities or a solicitation of any vote or approval. The Form S-4 has not yet become effective. The Company will mail the proxy statement/consent solicitation/prospectus and related Series C Offer materials to the holders of its Series C Preferred Stock who are eligible to participate in the Series C Offer if and after the registration statement on Form S-4 is declared effective. The holders of the Series C Preferred Stock are urged to carefully read the proxy statement/consent solicitation/prospectus and related Series C Offer materials because they contain important information.
The Form S-4 and the Schedule TO/13E-3 filed by the Company to disclose the proposed Series C Offer, each subject to subsequent amendment, are available for free on the SEC website, www.sec.gov. The proxy statement/consent solicitation/prospectus included in the Form S-4 will be available for free from the Company for holders of the Series C Preferred Stock.
Personnel
As of December 31, 2010,2011, we employed, directly or through subsidiaries, an aggregate of 284453 full-time employees. None of our employees are represented by a union or covered by a collective bargaining agreement.

Available Information

Copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to these reports filed or furnished with the SEC are available free of charge through our Internet site (www.novastarfinancial.com) as soon as reasonably practicable after filing with the SEC. References to our website do not incorporate by reference the information on such website into this Annual Report on Form 10-K and we disclaim any such incorporation by reference. Copies of our board committee charters, our board’s Corporate Governance Guidelines, Code of Conduct, and other corporate governance information are available at the Corporate Governance section of our Internet site (www.novastarmortgage.com)(www.novastarfinancial.com), or by contacting us directly. Our investor relations contact information follows.

Investor Relations
2114 Central Street
Suite 600
Kansas City, MO 64108
816.237.7424
Email: ir@novastarfinancial.com

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You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. Information on our website is not incorporated by reference into this report and does not otherwise form a part of this report.

Item 1A. Risk Factors
 
Risk Factors
 
You should carefully consider the risks described below in evaluating our business and before investing in our publicly tradedpublicly-traded securities. Any of the risks we describe below or elsewhere in this report could negatively affect our results of operations, financial condition, liquidity and business prospects. The risks described below are not the only ones facing us. Our business is also subject to the risks that affect many other companies, such as competition, inflation, general economic conditions and geopolitical events.
 
Risks Related to our Business
 
Payment on our mortgage securities will continue to decrease as underlying mortgage loans are repaid and, if the mortgage loans underlying our residual and subordinated securities continue to experience significant credit losses, it will reduce our cash flows, perhaps abruptly, and adversely affect our liquidity.
Our mortgage securities consist of certain residual securities retained from our past securitizations of mortgage loans, which typically consist of interest-only, and over collateralization bonds, and certain investment grade and non-investment grade rated subordinated mortgage securities retained from our past securitizations and purchased from other ABS issuers. These residual and subordinated securities are generally unrated or rated below investment grade and, as such, involve significant investment risk that exceeds the aggregate risk of the full pool of securitized loans. By holding the residual and subordinated securities, we generally retain the “first loss” risk associated with the underlying pool of mortgage loans. As a result, losses on the underlying mortgage loans directly affect our returns on, and cash flows from, these mortgage securities. In addition, if delinquencies and/or losses on the underlying mortgage loans exceed specified levels, the level of over-collateralization required for higher rated securities held by third parties may be increased, further decreasing cash flows presently payable to us.
Increased delinquencies and defaults on the mortgage loans underlying our residual and subordinated mortgage securities have resulted in a decrease in the cash flow we receive from these investments. In the event that decreases in cash flows from our mortgage securities are more severe or abrupt than currently projected, our results of operations, financial condition, and liquidity, and our ability to restructure existing obligations and establish new business operations will be adversely affected.
Our cash flows from mortgage securities are likely to be insufficient to cover our existing expenses in the near future.
As payments on our mortgage securities continue to decrease we will become more dependent on the operations and cash flows of our subsidiaries to meet our obligations.
The cash flows from our mortgage securities have materially decreased and will continue to decrease as the underlying mortgage loans are repaid. As this occurs, we will become more dependent on cash flows generated by StreetLinks, Advent and Corvisa, and will rely on distributions and other payments from StreetLinks and Advent and any new operations we may establish or acquire, to pay our operating expenses and meet our other obligations. If our subsidiaries are unable to make distributions or other payments to us, our ability to meet our obligations will be materially and adversely affected. Payments to us by our subsidiaries, in turn, depends upon their results of operations and cash flows.
Our ability to profitably manage, operate and grow operations is critical to our ability to pay our operating expenses and meet our other obligations and is subject to significant uncertainties and limitations. If we attempt to make any acquisitions, we will incur a variety of costs and may never realize the anticipated benefits.
 

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In light of the current state of declining cash flows from our mortgage securities, our ability to pay our operating expenses and meet our other obligations is dependent upon our ability to successfully operate and grow operations such that they generate positive cash flow. Our ability to start or acquire new businesses is significantly constrained by our limited liquidity and our likely inability to obtain debt financing or to issue equity securities as a result of our current financial condition, including a shareholders’shareholders' deficit, as well as other uncertainties and risks. There can be no assurances that we will be able to successfully operate and grow operations or establish or acquire new business operations.

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If we pursue any new business opportunities, the process of establishing a new business or negotiating the acquisition and integrating an acquired business may result in operating difficulties and expenditures and may require significant management attention. Moreover, we may never realize the anticipated benefits of any new business or acquisition. We may not have, and may not be able to acquire or retain, personnel with experience in any new business we may establish or acquire. In addition, future acquisitions could result in contingent liabilities and/or impairment or amortization expenses related to goodwill and other intangible assets, which could harm our results of operations, financial condition and business prospects.
 
The recapitalizationWe may not benefit us or our stockholders.
As described in the “Recapitalization” subsection of Part I of this Form 10-K, the board of directors of the Company has approved and announced a plan to recapitalize its Series C Preferred Stock and its Series D1 Preferred Stock. The recapitalization may not enhance stockholder value or improve the liquidity and marketability of our Common Stock.
As of December 31, 2010, there were 9,368,053 outstanding shares of Common Stock, 2,990,000 outstanding shares of Series C Preferred Stock and 2,100,000 outstanding shares of Series D1 Preferred Stock. If all of the outstanding Common Stock available for issuance under the recapitalization is issued, there will be approximately 90,353,253 shares of Common Stock outstanding, which is a significant increase the in amount of outstanding shares of Common Stock. Such an increase will dilute our existing common stockholders and may depress the market value and price of our common stock. We cannot predict the price at which our common stock would trade following the recapitalization.
In addition, factors unrelated to our stock or our business, such as the general perception of the recapitalization by the investment community, may cause a decrease in the value of the Common Stock and impair its liquidity and marketability. Prior performance of Common Stock may not be indicative of the performance of Common Stock after the recapitalization. Furthermore, securities markets worldwide have experienced significant price and volume fluctuations over the last several years. This market volatility, as well as general economic, market or political conditions, could cause a reduction in the market price and liquidity of Common Stock following the recapitalization, particularly if the recapitalization is not viewed favorably by the investment community.
The recapitalization may not be successful.
One of the reasons the board approved the recapitalization was to eliminate the accumulated and unpaid dividends owed to our preferred stock holders. Please see the subsection titled “Recapitalization” in Part I of this Form 10-K. If the recapitalization is unsuccessful, we will continue to owe the accumulated and unpaid dividends on our preferred stock and it is very unlikely we will be able to pay or otherwise eliminate these obligations.
We are unlikely to have access to financing on reasonable terms, or at all, that may be necessary for us to continue to operate or to acquire new businesses.
 
We do not currently have in place any agreements or commitments for short-term financing nor any agreements or commitments for additional long-term financing. In light of these factors and current market conditions, our current financial condition, and our lack of significant unencumbered assets, we are unlikely tomay not be able to secure additional financing for existing or new operations or for any acquisition.
 
Various legal proceedings could adversely affect our financial condition, our results of operations and liquidity.
 
In the course of our business, we are subject to various legal proceedings and claims. See Item 3. Legal Proceedings. In addition, we have become subject to various securities and derivative lawsuits, and we may continue to be subject to additional litigation, in some cases on the basis of novel legal theories. The resolution of these legal matters or other legal matters could result in a material adverse impact on our results of operations, liquidity and financial condition.
 
Differences in our actual experience compared to the assumptions that we use to determine the value of our residual mortgage securities and to estimate fair values could further adversely affect our financial position.
 
Our securitizations of mortgage loans that were structured as sales for financial reporting purposes resulted in gain recognition at closing as well as the recording of the residual mortgage securities we retained at fair value. The value of residual securities represents the present value of future cash flows expected to be received by us from the excess cash flows created in the securitization transaction. In general, future cash flows are estimated by taking the coupon rate of the loans underlying the transaction less the interest rate paid to the investors, less contractually specified servicing and trustee fees, and after giving effect to estimated prepayments and credit losses. We estimate future cash flows from these securities and value them utilizing assumptions based in part on projected discount rates, delinquency, mortgage loan prepayment speeds and credit losses. It is extremely difficult to validate the assumptions we use in valuing our residual interests. Even if the general accuracy of the valuation model is validated, valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships which drive the results of the model. Due to deteriorating market conditions, our actual experience has differed significantly from our assumptions, resulting in a reduction in the fair value of these securities and impairments on these securities. If our actual experience continues to differ materially from the assumptions that we used to determine the fair value of these securities, our financial condition, results of operations and liquidity will continue to be negatively affected.

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The value of, and cash flows from, our mortgage securities may further decline due to factors beyond our control.
 
There are many factors that affect the value of, and cash flows from, our mortgage securities, many of which are beyond our control. For example, the value of the homes collateralizing residential loans may decline due to a variety of reasons beyond our control, such as weak economic conditions or natural disasters. Over the past year, residential property values in most states have declined, in some areas severely, which has increased delinquencies and losses on residential mortgage loans, especially where the aggregate loan amounts (including any subordinate loans) are close to or greater than the related property value. A borrower’sborrower's ability to repay a loan also may be adversely affected by factors beyond our control, such as subsequent over-leveraging of the borrower, reductions in personal incomes, and increases in unemployment.
 
In addition, interest-only loans, negative amortization loans, adjustable-rate loans, reduced documentation loans, home equity lines of credit and second lien loans may involve higher than expected delinquencies and defaults. For instance, any increase in prevailing market interest rates may result in increased payments for borrowers who have adjustable rate mortgage loans. Moreover, borrowers with option adjustable rate mortgage loans with a negative amortization feature may experience a substantial increase in their monthly payment, even without an increase in prevailing market interest rates, when the loan reaches its negative amortization cap. The current lack of appreciation in residential property values and the adoption of tighter underwriting standards throughout the mortgage loan industry may adversely affect the ability of borrowers to refinance these loans and avoid default.
 
Each of these factors may be exacerbated by general economic slowdowns and by changes in consumer behavior, bankruptcy

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laws, and other laws.
 
To the extent that delinquencies or losses continue to increase for these or other reasons, the value of our mortgage securities and the mortgage loans held in our portfolio will be further reduced, which will adversely affect our operating results, liquidity, cash flows and financial condition.
 
Risks Related to Our Operating Subsidiaries
 
A prolonged decline in the number of home sales and the originations and refinancings of home loans would decrease appraisal order volume and adversely affect the revenues and profitability of StreetLinks.

StreetLinks, our residential appraisal management company, retains a portion of the fee for appraisal services collected from lenders and borrowers for an independent residential appraisal to cover its costs of managing the process of fulfilling the appraisal order. A prolonged decline in the number of home sales and the originations and refinancings of home loans would cause a decrease in the demand for appraisals. A decreased demand for appraisals would have an adverse effect on the revenues and profitability of StreetLinks.

StreetLinks may be unable to maintain its relationships with its existing lending customers and may be unable to add new lending customers which would decrease appraisal order volume and adversely affect the revenues and profitability of StreetLinks.

StreetLinks has increased its appraisal order volume by adding lending customers and intends to further develop its business through the addition of new lending customers. There is no assurance that StreetLinks will be able to maintain the relationships with its existing lending customers, including one customer that consisted of approximately 14% of service fee revenues during the yearyears ended December 31, 2011 and 2010 or add new lending customers which would decrease appraisal order volume and adversely affect the revenues and profitability of StreetLinks.

Government agencies and regulatory authorities may change or eliminate current restrictions and requirements for appraisals.
 
StreetLinks’StreetLinks' appraisal order volume has increased, in part, as a result of increased restrictions and requirements for appraisals established by government agencies and regulatory authorities such as the Federal Housing Finance Agency and the United States Department of Housing and Urban Development that, among other things, require appraiser independence. Changes in, or elimination of, these restrictions and requirements could adversely affect the demand for StreetLinks’StreetLinks' services and the viability of its business model.
 
Advent may be unable to develop systems and a network of business partners to successfully distribute its products and services.
 
The success of Advent will in large part depend on its ability to develop systems and a network of business partners for the distribution of its products services. To the extent Advent is unable to develop systems and a network of business partners to successfully distribute Advent’sAdvent's products and services, it will have an adverse effect on Advent’sAdvent's business, financial condition and results of operations.
 
Advent’sAdvent's ability to distribute its financial products is, to some extent, dependent on the success of its business partners.
 
Advent anticipates distributing its financial products through business partners such as tax return preparation offices and is to some extent dependent on the success of these business partners. To the extent there is a decrease in the demand for the products or services of Advent’sAdvent's business partners, there may be a decrease in demand for Advent’sAdvent's products and services, which would have an adverse effect on Advent’sAdvent's business, financial condition and results of operations.

7Changes in Regulation of Advent's Business May Impact Results.
Advent's facilitation of bank card and other financial products and services is done in a financial industry that has faced, and may continue to face, increased levels of regulatory scrutiny and rulemaking. New or revised regulations or enforcement perspectives may adversely affect Advent's ability to effectively design, distribute and facilitate its products and services, and may adversely affect Advent's sales channels (e.g., tax return preparation businesses) and funding sources.

Legal proceedings against our operating subsidiaries could adversely affect their business, financial condition and results of operations.
 
In the course of their business, our operating subsidiaries may become subject to legal proceedings and claims and could experience significant losses as a result of litigation defense and resolution costs which would have an adverse effect on their business, financial condition and results of operations.

4


 
Risks Related to Our Discontinued Operations
 
We may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, borrower fraud, or certain borrower defaults, which could further harm our liquidity.
 
When we sold mortgage loans, whether as whole loans or pursuant to a securitization, we made customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our whole loan sale agreements require us to repurchase or substitute mortgage loans in the event we breach any of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower, broker, or employee fraud. Likewise, we are required to repurchase or substitute mortgage loans if we breach a representation or warranty in connection with our securitizations. We have received various repurchase demands as performance of subprime mortgage loans has deteriorated. A majority of repurchase requests have been denied, otherwise a negotiated purchase price adjustment was agreed upon with the purchaser. Enforcement of repurchase obligations against us would further harm our liquidity.
 
Risks Related to Interest Rates
Changes in interest rates may harm our results of operations and equity value.
Our results of operations are likely to be harmed during any period of unexpected or rapid changes in interest rates. Our primary interest rate exposures relate to our mortgage securities, mortgage loans and floating rate debt obligations. Interest rate changes could adversely affect our cash flow, results of operations, financial condition, liquidity and business prospects in the following ways:
In addition, interest rate changes may also further impact our net book value as our mortgage securities are marked to market each quarter. Generally, as interest rates increase, the value of our mortgage securities decreases which decreases the book value of our equity.
Furthermore, shifts in the yield curve, which represents the market’s expectations of future interest rates, also affects the yield required for the purchase of our mortgage securities and therefore their value. To the extent that there is an unexpected change in the yield curve it could have an adverse effect on our mortgage securities portfolio and our financial position.
Risks Related to our Capital Stock
 
There can be no assurance that our common stock or Series C Preferred Stock will continue to be traded in an active market.
 
Our common stock and our Series C Preferred Stock were delisted by the New York Stock Exchange (“NYSE”) in January 2008, as a result of failure to meet applicable standards for continued listing on the NYSE. Our common stock and Series C Preferred Stock areis currently quoted by the Pink OTC Markets’Markets' inter-dealer quotation service as an OTCQB security. If the Company’s tender offer for the outstanding Series C Preferred Stock is successfully consummated, the Series C Preferred Stock will no longer exist and there can be no assurance that an active trading market will be maintained. See the subsection titled “Recapitalization in Part I of this Form 10-K. Trading of securities on the Pink OTC market is generally limited and is effected on a less regular basis than on exchanges, such as the NYSE, and accordingly investors who own or purchase our stock will find that the liquidity or transferability of the stock may be limited.
8

Additionally, a shareholder may find it more difficult to dispose of, or obtain accurate quotations as to the market value of, our stock. If an active public trading market cannot be sustained, the trading price of our common and preferred stock could be adversely affected and your ability to transfer your shares of our common and preferred stock may be limited.
 
We are not likely to pay dividends to our common or preferred stockholdersshareholders in the foreseeable future.
 
We are not required to pay out our taxable income in the form of dividends, as we are no longer subject to a REIT distribution requirement. Instead, paymentPayment of dividends is at the discretion of our board of directors. To preserve liquidity,Under the restrictions of our board of directors has suspended dividend payments on our Series C Preferred Stock and Series D1 Preferred Stock. Dividends on our Series C Preferred Stock and D1 Preferred Stock continue to accrue and the dividend rate on our Series D1 Preferred Stock increased from 9.0% to 13.0%, compounded quarterly, effective January 16, 2008 with respect to all unpaid dividends and subsequently accruing dividends. Nosenior notes, no dividends can be paid on any of our common stock until all accrued and unpaid dividends on our Series C Preferred Stock and Series D1 Preferred Stock are paid in full. Accumulating dividends with respect to our preferred stock will negatively affect the ability of our common stockholders to receive any distribution or other value upon liquidation.stock.
 
The market price and trading volume of our common and preferred stock may be volatile, which could result in substantial losses for our shareholders.
 
The market price of our capital stock can be highly volatile and subject to wide fluctuations. In addition, the trading volume in our capital stock may fluctuate and cause significant price variations to occur. Investors may experience volatile returns and material losses. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our capital stock include:
Our charter permits us to issue additional equity without shareholder approval, which could materially adversely affect our current shareholders.
 
Our charter permits our board of directors, without shareholder approval, to:
In connection with any capital restructuring or in order to raise additional capital, we may issue, reclassify or exchange securities, including debt instruments, preferred stock or common stock. Any of these or similar actions by us may dilute your interest in us or reduce the market price of our capital stock, or both. Our outstanding shares of preferred stock have, and any additional series of preferred stock may also have, a preference on distribution payments that limit our ability to make a distribution to common shareholders. Because our decision to issue, reclassify or exchange securities will depend on negotiations with third parties, market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future issuances, if any. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future. Thus, our shareholders will bear the risk that our future issuances, reclassifications and exchanges will reduce the market price of our stock and/or dilute their interest in us.
 

9
5


Other Risks Related to our Business
 
Our ability to use our net operating loss carryforwards and net unrealized built-in losses could be severely limited in the event of certain transfers of our voting securities.
 
We currently have recorded a significant net deferred tax asset, before valuation allowance, almost all of which relates to certain net operating loss carryforwards and net unrealized built-in-losses. While we believe that it is more likely than not that we will not be able to utilize such losses in the future, the net operating loss carryforwards and net unrealized built-in losses could provide significant future tax savings to us if we are able to use such losses. However, our ability to use these tax benefits may be impacted, restricted or eliminated due to a future “ownership change” within the meaning of Section 382 of the Code. An ownership change could occur that would severely limit our ability to use the tax benefits associated with the net operating loss carryforwards and net unrealized built-in losses, which may result in higher taxable income for us (and a significantly higher tax cost as compared to the situation where these tax benefits are preserved).
 
Some provisions of our charter, bylaws and Maryland law may deter takeover attempts, which may limit the opportunity of our shareholders to sell their common stock at favorable prices.
 
Certain provisions of our charter, bylaws and Maryland law could discourage, delay or prevent transactions that involve an actual or threatened change in control, and may make it more difficult for a third party to acquire us, even if doing so may be beneficial to our shareholders. For example, our board of directors is divided into three classes with three year staggered terms of office. This makes it more difficult for a third party to gain control of our board because a majority of directors cannot be elected at a single meeting. Further, under our charter, generally a director may only be removed for cause and only by the affirmative vote of the holders of at least a majority of all classes of shares entitled to vote in the election for directors together as a single class. Our bylaws make it difficult for any person other than management to introduce business at a duly called meeting requiring such other person to follow certain advance notice procedures. Finally, Maryland law provides protection for Maryland corporations against unsolicited takeover situations.
 
Changes in accounting standards, subjective assumptions and estimates used by management related to complex accounting matters could have an adverse effect on results of operations.
 
Generally accepted accounting principles in the United States and related accounting pronouncements, implementation guidance and interpretations with regard to a wide range of matters, such as stock-based compensation, asset impairment, valuation reserves, income taxes and fair value accounting, are highly complex and involve many subjective assumptions, estimates and judgments by management. Changes in these rules or their interpretations or changes in underlying assumptions, estimates or judgments by management could significantly change our reported results.
 
The recently-enacted Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and other rules and regulations promulgated thereunder could cause additional operating and compliance costs in addition to other uncertainties.
 
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into federal law. The Dodd-Frank Act has had and will continue to have a broad impact on the financial services industry, including significant regulatory and compliance changes. Regulatory agencies will implement new regulations in the future that will establish the parameters of the new regulatory framework and provide a clearer understanding of the legislation’slegislation's effect on our business. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies, the full extent of the impact the Dodd-Frank Act will have on our operations is unclear. Nonetheless, while it is difficult to predict at this time what specific impact the Dodd-Frank Act and certain yet-to-be implemented rules and regulations will have on us, we expect that at a minimum our operating and compliance costs will increase.

The recently-enacted Health Care and Education Reconciliation Act of 2010 and proposed amendments thereto could cause our compensation costs to increase, adversely affecting our results and cash flows.
 
The recently-enacted Health Care and Education Reconciliation Act of 2010 and proposed amendments thereto contain provisions that could materially impact the future healthcare costs of the Company. WhileThe legislation will continue to become effective through a phased approach that will not conclude until 2018, thus the legislation’s ultimate impact of the new legislation remains uncertain, it is possible that these changes could significantly increase our compensation costs which would adversely affect our results and cash flows.
 
Loss of key members of our management could disrupt our business.
 
We are heavily dependent upon certain key personnel and the loss of service of any of these senior executives could adversely affect our business. Our success depends on the Company’sCompany's ability to retain these key executives. The loss of any of these senior executives could have a material adverse effect on our business financial condition and results of operation. We may not be able to retain our existing senior management, fill new positions or vacancies created by expansion or turnover or attract additional qualified senior management personnel.
 

10
6


System interruptions or other technology failures could impair the Company’sCompany's operations.
 
We rely on our computer systems and service providers to consistently provide efficient and reliable service. System interruptions or other system intrusions, which may not be within the Company’sCompany's control, may impair the Company’sCompany's delivery of its products and services, resulting in a loss of customers and a corresponding loss in revenue.

Item 1B. Unresolved Staff Comments
 
None.

Item 2. Properties
 
The executive and administrative offices for the Company are located in Kansas City, Missouri, and consist of approximately 12,142 square feet of leased office space.space, our financial intermediary segment also operates out of this location. As of December 31, 2010,2011, the Company leases approximately 90,000134,000 total square feet of office space throughout the United States for our business, the majority of which is located in Indianapolis, Indiana and Tampa, Florida where StreetLinks, our appraisal management subsidiary,segment, is headquartered.operated. We also maintain smaller offices in other U.S. locations under leases that expire at varying times from 2012 to 2018.

Item 3. Legal Proceedings
 
Pending Litigation.
 
The Company is a party to various legal proceedings, all of which, exceptproceedings. Except as set forth below, these proceedings are of an ordinary and routine nature, including, but not limited to, breach of contract claims, tort claims, and claims for violations of federal and state consumer protection laws. Furthermore, the Company has received indemnification and loan repurchase demands with respect to alleged violations of representations and warranties made in loan sale and securitization agreements. These indemnification and repurchase demands have not resulted in significant losses to the Company and the number of demands has steadily decreased, but such claims could be significant if multiple loans are involved.
Due to the uncertainty of any potential loss due to pending litigation and due to the Company’s belief that an adverse ruling is not probable for the below-described claims, the Company has not accrued a loss contingency related to the following matters in its consolidated financial statements. Although it is not possible to predict the outcome of any legal proceeding, in the opinion of management, other than thosethe active proceedings described in detail below, such proceedings and actions against the Company should not, individually, or in the aggregate, have a material adverse effect on the Company’sCompany's financial condition, operations and liquidity. Furthermore, due to the uncertainty of any potential loss as a result of pending litigation and due to the Company's belief that an adverse ruling is not probable, the Company has not accrued a loss contingency related to the following matters in its consolidated financial statements. However, a material adverse outcome in one or more of thesethe active proceedings described below could have a material adverse impact on the results of operations in a particular quarter or fiscal year.
On May 21, 2008, a purported class action case was filed in the Supreme Court of the State of New York, New York County, by the New Jersey Carpenters' Health Fund, on behalf of itself and all others similarly situated. Defendants in the case includeincluded NovaStar Mortgage Funding Corporation (“NMFC”) and its individual directors, several securitization trusts sponsored by the Company ("affiliated defendants") and several unaffiliated investment banks and credit rating agencies. The case was removed to the United States District Court for the Southern District of New York. On June 16, 2009, the plaintiff filed an amended complaint. Plaintiff seeks monetary damages, alleging that the defendants violated sections 11, 12 and 15 of the Securities Act of 1933, as amended, by making allegedly false statements regarding mortgage loans that served as collateral for securities purchased by plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss the plaintiff’s claims. Theplaintiff's claims, which the Court granted on March 31, 2011, with leave to amend. Plaintiff filed a second amended complaint on May 16, 2011, and the Company has not ruled on thisagain filed a motion and discovery regardingto dismiss. Because the plaintiff’s claims has not commenced. Thelitigation is procedurally in an early stage, the Company cannot provide an estimate of the range of any loss. The Company believes it hasthat the affiliated defendants have meritorious defenses to the case and expects them to defend the case vigorously.
On December 31, 2009, ITS Financial, LLC (“ITS”) filed a complaint against Advent and the Company alleging a breach of contract by Advent for a contract for services related to tax refund anticipation loans and early season loans. ITS does business as Instant Tax Service. The defendants moved the case to the United States District Court for the Southern District of Ohio. The complaint allegesalleged that the Company worked in tandem and as one entity with Advent in all material respects. The complaint also allegesalleged fraud in the inducement, tortious interference by the Company with the contract, breach of good faith and fair dealing, fraudulent and negligent misrepresentation, and liability of the Company by piercing the corporate veil and joint and several liability. The plaintiff referencesreferenced a $3.0 million loan made by the Company to plaintiffITS and seekssought a judgment declaring that this loan be subject to an offset by the plaintiff’sITS's damages. On September 13, 2010, the Court denied the Company’s motion to transfer the case to the United States District Court for the Western District of Missouri, and on September 29, 2010, the Company and Advent answered the complaint and made a counterclaim against the plaintiffITS for plaintiff’sITS's failure to repay the loan. On February 21, 2011, the Company amended its counterclaim, asserting additional claims against ITS. On October 21, 2011, the plaintiff.Court granted the Company's motion for partial summary judgment on the loan claim and granted a partial summary judgment in favor of the Company with respect to certain claims and damages alleged by ITS. In December 2011, the parties settled the litigation and the case was dismissed. The Company cannot provide an estimatepaid no money to the plaintiff, and the plaintiff agreed to a payment to the Company of approximately $3.9 million. Approximately $1.3 million was paid to the Company at the time of the rangesettlement with the remaining balance to be paid in February 2012. In February 2012, the Company agreed to a modification to the settlement; pursuant to the modification $1.5 million was paid at the time of any loss. The Company believes that the defendants have meritorious defenses to this casemodification and expects to vigorously defend the case and pursue its counterclaims.approximately $1.2 million will be due in February 2013.
11

On July 9, 2010 and on February 11, 2011, Cambridge Place Investment Management, Inc. filed complaints in the Suffolk,

7


Massachusetts Superior Court against NMFC and numerous other entities seeking damages on account of losses associated with residential mortgage-backed securities purchased by plaintiff’splaintiff's assignors. The complaints allege untrue statements and omissions of material facts relating to loan underwriting and credit enhancement. The complaints also allege a violation of Section 410 of the Massachusetts Uniform Securities Act (Chapter 110A of the Massachusetts General Laws). Defendants have removed the first casecases to the United States District Court for the District of Massachusetts, and plaintiff hasfiled motions to remand the cases back to state court. On August 22, 2011, the federal court remanded these cases back to state court, and on October 14, 2011, the plaintiff filed amended complaints. In December 2011, the Company, together with the other defendants in the litigation, filed a motion to remanddismiss the case backcomplaints alleging that the plaintiff lacked standing. Because this litigation is procedurally in its early stage, the Company cannot provide an estimate of the range of any loss. The Company believes that NMFC has meritorious defenses to state court.these claims and expects that the cases will be defended vigorously.
On June 20, 2011, the National Credit Union Administration Board, as liquidating agent of U.S. Central Federal Credit Union, filed an action against NMFC and numerous other defendants in the United States District Court for the District of Kansas, claiming that the defendants issued or underwrote residential mortgage-backed securities pursuant to allegedly false or misleading registration statements, prospectuses, and/or prospectus supplements. On October 12, 2011, the complaint was served on NMFC. On December 20, 2011, NMFC filed a motion to dismiss the plaintiff's complaint and to strike certain paragraphs of the complaint. This litigation is in itsan early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that itNMFC has meritorious defenses to these claimsthe case and expects thatit to defend the cases will be defendedcase vigorously.
On or about July 16, 2010, NovaStar Mortgage, Inc. received a “Purchasers’ Notice of Election to Void Sale of Securities” regarding NovaStar Mortgage Funding Trust Series 2005-4 from the Federal Home Loan Bank of Chicago. The notice was allegedly addressed to several entities including NovaStar Mortgage, Inc. and NMFC. The notice alleges joint and several liability for a rescission of the purchase of a $15.0 million security pursuant to Illinois Securities Law, 815 ILCS section 5/13(A). The notice does not specify the factual basis for the claim, and no legal action to enforce the claim has been filed The Company will assess its defense to the claim if and when the factual basis and additional information supporting the claim is provided.
Item 4. Removed and ReservedMine Safety Disclosures

PARTNot applicable.

Part II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
 
Our common stock is currently quoted by the Pink OTC Markets’ inter-dealer quotation service as an OTCQB security under the symbol “NOVS”. The following table sets forth the high and low bid prices as reported by the Pink OTC Markets’ inter-dealer quotation service, for the periods indicated, and the cash dividends paid or payable per share of common stock.
 
        Dividends
      High     Low     Date Declared     Date Paid     Amount Per Share
2009            
First Quarter $0.65 $0.20 N/A N/A N/A
Second Quarter  1.74  0.55 N/A N/A N/A
Third Quarter  1.35  0.75 N/A N/A N/A
Fourth Quarter  1.28  0.81 N/A N/A N/A
             
2010            
First Quarter $    0.99 $    0.78 N/A N/A N/A
Second Quarter  1.04  0.83 N/A N/A N/A
Third Quarter  0.95  0.66 N/A N/A N/A
Fourth Quarter  0.90  0.38 N/A N/A N/A
             
      Dividends
  High Low Date Declared Date Paid Amount Per Share
2011          
First Quarter $0.51
 $0.38
 N/A N/A N/A
Second Quarter 0.51
 0.35
 N/A N/A N/A
Third Quarter 0.52
 0.33
 N/A N/A N/A
Fourth Quarter 0.45
 0.26
 N/A N/A N/A
2010  
  
      
First Quarter $0.99
 $0.78
 N/A N/A N/A
Second Quarter 1.04
 0.83
 N/A N/A N/A
Third Quarter 0.95
 0.66
 N/A N/A N/A
Fourth Quarter 0.90
 0.38
 N/A N/A N/A
           

As of March 10, 2011,9, 2012, we had approximately 788868 shareholders of record of our common stock, including holders who are nominees for an undetermined number of beneficial owners based upon a review of the securities position listing provided by our transfer agent.

Dividend distributions will be made at the discretion of the Board of Directors and will depend on earnings, financial condition, cost of equity, investment opportunities and other factors as the Board of Directors may deem relevant. In addition, accruedThe indentures governing the Company's Senior Notes contain certain restrictive covenants which prohibit the Company and unpaid dividends on our preferred stock must be paid prior to the declaration ofits subsidiaries, from among other things, making any dividends on our common stock.cash dividend or distribution. We do not expect to declare any stock dividend distributions in the near future.

12

Company Purchases of Equity Securities
(dollars (dollars in thousands)

8


  
Total
Number of
Shares
Purchased
 
Average
Price Paid
per Share
 Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (A)
October 1, 2011 – October 31, 2011 —
 $—
 —
 $1,020
November 1, 2011 – November 30, 2011 —
 —
 —
 1,020
December 1, 2011 – December 31, 2011 —
 —
 —
 1,020
         
Total Number of
SharesApproximate Dollar
Purchased asValue of Shares that
TotalPart of PubliclyMay Yet Be
Number ofAverageAnnouncedPurchased Under the
SharesPrice PaidPlans orPlans or Programs
Purchasedper SharePrograms(A)
October 1, 2010 – October 31, 2010---$     1,020
November 1, 2010 – November 30, 2010---1,020
December 1, 2010 – December 31, 2010---1,020
(A)A current report on Form 8-K was filed on October 2, 2000 announcing that the Board of Directors authorized the Company to repurchase its common shares, bringing the total authorization to $9$9.0 million. The Company has repurchased $8.0 million to date, leaving approximately $1.0 million of shares that may yet be purchased under the plan.

Item 6. Selected Financial Data
 
As a smaller reporting company, we are not required to provide the information required by this Item.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this report.
 
Executive Overview
 
Corporate Overview, Background and Strategy – We are a Maryland corporation formed on September 13, 1996. We ownAs of December 31, 2011, we owned 88% of StreetLinks LLC (“StreetLinks”),and subsequent to a transaction that occurred on March 8, 2012, we currently own approximately 93% of StreetLinks, a national residential appraisal and real estate valuation management servicescompany. StreetLinks collects fees from lenders and borrowers in exchange for a residential appraisals and other valuation services. Typically, the appraisal or other valuation service is provided by an independent residential appraisers.contractor. Most of the fee is passed through to independent residential appraisers with whom StreetLinks has a contractual relationship.the contractor. StreetLinks retains a portion of the fee to cover its costs of managing the process to fulfillof fulfilling the appraisal order and, performfor some services, performing a quality control review of eachthe independent appraisal. StreetLinks also provides other real estate valuation management services, such as field reviews and value validation.a technology product to lenders whereby the lender may manage its own appraisal process. Generally, fees are charged for each transaction processed by the lender.
 
We own 74%78% of Advent Financial Services LLC (“Advent”).Advent. Advent provides financial settlement services along with its distribution partners, mainlyprimarily through income tax preparation businesses and also provides access to tailored banking accounts, small dollar banking products and related services to meet the needs of low and moderate income level individuals. Advent is not a bank, but acts as an intermediary for thesebanking products on behalf of other banking institutions. A primary distribution channel of Advent’sAdvent's bank products is by way of settlement services to electronic income tax return originators. Advent provides a process for the originators to collect refunds from the Internal Revenue Service, distribute fees to various service providers and deliver the net refund to individuals. Individuals may elect to have the net refund dollars deposited into a bank account offered through Advent. Individuals also have the option to have the net refund dollars paid by check or to antheir existing bank account. Regardless of the settlement method, Advent receives a fee from the originator for providing the settlement service. Advent also distributes its banking products via other methods, including through employers and employer service organizations. Advent receives fees from banking institutions and from the bank account owner for services related to the use of the funds deposited to Advent-offered bank accounts.
 
StreetLinks purchasedWe own 51% of Mango, a start-up, Internet-based company in the equity of Corvisa in 2010. Corvisa is“asset-light” third-party logistics provider market. Mango provides local and long distance residential and other moving services at a technology company that develops and markets its software products to mortgage lenders. Its primary product is a self-managed appraisal solution for lenders to manage their appraisal process. Other products include analytical tools for the lender to manage their mortgage origination business.price less than other major national van lines.

Prior to changes in our business in 2007,2010, we originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage securities. We have retained in our mortgage securities investment portfolio significant interests in the nonconforming loans we originated and purchased, and through our servicing platform, serviced all of the loans in which we retained interests. We discontinued our mortgage lending operations and sold our mortgage servicing rights which subsequently resulted in the closing of our servicing operations.originated. The mortgage securities we have retained continue to be a significant source of our cash flow.
 
Significant Recent Events– Beginning in January 20112012 through March 10, 2011, Advent’s business9, 2012, Advent originated approximately 0.3 0.5 million settlement products on behalf of its distribution partners, principally independent income tax preparation businesses. customers. During that time, Advent has received approximately $5.9$7.6 million in gross fees relatingrelated to thesethe settlement products, which are not net of variable or general and administrative expenses. While Advent will continue receiving new applications for refund settlement products, as well as continue receiving deposits throughoutcomplete additional settlements related to the 2011 tax year on behalf of its customers. However, the majority of new applicationssettlements for the current2011 tax seasonyear have been received.  During 2010, Advent originatedcompleted.

On March 8, 2012, Steve Haslam, the Chief Executive Officer of StreetLinks, was appointed the Chief Operating Officer of the Company. As part of the transition of Mr. Haslam to his new position with the Company, and pursuant to the exercise of his rights under his employment agreement with StreetLinks, he sold all of his 1,927 membership units of StreetLinks to the Company pursuant to a nominal numberMembership Interest Purchase Agreement, dated March 8, 2012, by and between Mr. Haslam and the Company (the “Unit Purchase Agreement”). The 1,927 membership units of settlement products.StreetLinks represent approximately 5% of the outstanding StreetLinks membership units. The total purchase price under the Unit Purchase Agreement is $6.1 million, which is payable to

Refinancing of Trust Preferred Securities9


In an effort to improve the Company’s liquidity position,Mr. Haslam as follows: $0.5 million on March 22,8, 2012, $0.5 million on June 30, 2012, $0.3 million on the last day of each quarter thereafter until March 8, 2016, on which date the unpaid principal balance of $1.6 million is to be paid, plus interest on the unpaid balance at the rate of four percent per annum, compounded quarterly.
The Company has a note receivable due from an entity with which it was previously in litigation. As discussed in Note 10 to the consolidated financial statements, during 2011 the Company entered into agreements that cancelagreed to settle the existing $78,125,000 aggregate principallitigation. Pursuant to the settlement, $1.3 million of the amount of Trust Preferred Securities (the “TruPS”) issued in 2009 by certain statutory trusts formed by a wholly-owned subsidiary, NovaStar Mortgage, Inc. (“NMI”).  NMI issued unsecured junior subordinated notes (the “Junior Subordinated Notes”), to support the payment obligationsdue under the TruPS. The Junior Subordinated Notes were guaranteed bynote was repaid at the Company. As a resulttime of settlement. A modification to the settlement was made in February 2012; $1.5 million was repaid at the time of the transaction,modification and the Junior Subordinated Notes were cancelled.remaining note of $1.2 million plus an additional $0.1 million will be due in February 2013.
During the fourth quarter of 2011, StreetLinks acquired the 49% noncontrolling owner interests in Corvisa and now owns 100% of Corvisa. In place ofexchange for the TruPSminority owner interests, StreetLinks paid $1.0 million in cash and associated Junior Subordinated Notes, the Company issuedis obligated to make $1.2 million in payments to the holders offormer minority owners on or before June 30, 2014 if revenues from the TruPS unsecured senior notes pursuant to three indentures (collectively,Corvisa technology products exceed certain thresholds. We have recorded a liability for the “Senior Notes”).  The aggregate principal amount ofcontingent consideration under the Senior Notes is $85,937,500, which is a 10% increase in principal over the liquidation value of the TruPS.  The new Senior Notes will accrue interest at a rate of 1% until the earlier to occur of (a) a completed equity offering by the Company or its subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”).The Senior Notes mature on March 30, 2033.
The indentures governing the Senior Notes contain negative covenants that, among other things, restrict the Company’s use of cash (including cash payments for distributions to shareholders). At any time that the Senior Notes accrue interest at the Full Rate, and the Company satisfies certain financial covenants, certain negative covenants and restrictions on cash will not apply. The terms of the Senior Notesacquisition.

During the fourth quarter of 2011, we acquired 51% of the membership interests in Mango, formerly Build My Move, LLC. Mango provides local and associated agreements arelong-distance residential and other moving services at a price less than other major national van lines. The Company purchased units of Mango that have preferred distribution, liquidation and management rights. The purchase price was $1.7 million. Upon the occurrence of certain conditions related to Mango's financial condition and contractual obligations, we will make additional capital contributions to Mango of up to $0.7 million, $0.3 million of which is contingent upon a former employee not violating a separation agreement (the "Mango Transaction").

At the closing of the Mango Transaction, Mango repaid a $0.3 million loan from a member, redeemed all membership interests owned by Mango's former chief executive officer, for a negotiated price, and also the membership interests and an option owned by W. Lance Anderson, the Company's chief executive officer, for his cost of $0.2 million. With the board's consent, Mr. Anderson had personally invested in a smaller minority stake in Mango in early 2011. As a condition to its later approval of the Mango Transaction (whereby the Company has a majority position and more fully described in the Company’s current report on Form 8-K filed with the SEC on March 22, 2011.
Proposed Recapitalizationcontrol of Preferred Stock.
As described in the Company’s Form S-4 Registration Statement, as amended (Registration No. 333-171115), filed with the SEC (the “Form S-4”)Mango), the Company is proposing to recapitalizeCompany's board required the redemption of Mr. Anderson's membership interests in Mango at his cost.

During the second quarter of 2011, we completed the exchange of all outstanding shares of its 8.90% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (the “Series C Preferred Stock”) and its 9.00% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 (the “Series D1 Preferred Stock”). The Series C Preferred Stock is publicly held, and the Series D Preferred Stock is privately held.
Upon the terms and subject to the conditions set forth in the Form S-4, the Company is proposing to exchange, for each outstanding share of Series C Preferred Stock,  at the election of the holder,  either:
The elections made by the holders of the Series C Preferred Stock will be subject to allocation and proration procedures intended to ensure that, in the aggregate, 43,823,600 newly-issued shares of Common Stock and $1,623,000 in cash (plus such other cash that is needed to cash out fractional shares) will be issued to the holders of the Series C Preferred Stock.   The proposed Series C Offer will not be made unless and until the Form S-4 is declared effective by the SEC and it is subject to other closing conditions, such as the acceptance of the Series C Offer by at least two-thirds of the outstanding shares of Series C Preferred Stock and the requisite affirmative vote of shareholders in support of certain aspects of the recapitalization.

The proposed Series C Offer is part of a larger recapitalization of the Company, whereby the holders of the Company’s Series D1 Preferred Stock have agreed to exchange theirour preferred stock for an aggregate of 37,161,600 newly-issued80,985,600 shares of Common Stocknewly-issued common stock and $1,377,000$3.0 million in cash (the “Series D Exchange”"Recapitalization"), as described in the Company’s Form 8-K dated December 10, 2010 and filed with the SEC.  The closing. Completion of the Series D Exchange is contingent uponRecapitalization eliminated our obligations with respect to outstanding and future preferred dividends and the closingpreferred liquidating preference related to the preferred stock. At the time of the Series C Offer by not later than June 30, 2011 and the satisfaction of other conditions.

As of March 18, 2011, the Series C Preferred Stock had an aggregate liquidation preference of $74.8 million andRecapitalization, there were accrued and unpaid dividends of $23.0approximately $59.3 million on the preferred stock and the Series D1 Preferred Stock had an aggregate liquidationliquidating preference of $52.5 million and accrued and unpaid dividends of $31.5was $127.3 million. The proposed recapitalization, if effected, would eliminate the Series C Preferred Stock and Series D Preferred Stock and their associated liquidation preferences and dividends.

There are multiple conditionsSee Note 3 to the closingconsolidated financial statements for further details.

During the first quarter of 2011, we refinanced our trust preferred securities by entering into agreements that canceled our existing junior subordinated debentures and issued unsecured senior notes (the "Debt Exchange") in order to reduce the Series C OfferCompany's required interest payments and provide stability. See Note 9 to the consolidated financial statements for further details.

We incurred expenses for professional services related to the Recapitalization and the Series DDebt Exchange that are beyond our control,totaling approximately $2.4 million during 2011. The services included engagements for legal counsel, financial advisor, independent accountants and we cannot provide you any assurance thattransfer agent. Additionally, these conditions will be satisfied or thatexpenses included the Series C Offercosts of printing and the Series D Exchange will close.filing material for shareholders.

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Strategy – Management is focused on building the operations of StreetLinks and Advent. With StreetLinks’ acquisition of Corvisa during November 2010, the Company plans to expand its customer base and the real estate valuation management services that it currently provides to customers during fiscal year 2011. See Note 3 to the consolidated financial statements for additional details.subsidiaries. If and when opportunities arise, we intend to use available cash resources to invest in or start businesses that can generate income and cash. Additionally, management will attempt to renegotiate and/or restructure the components of our equity in order to realign the capital structure with our current business model as noted above.
 
The key performance measures for executive management are:
generating income for our shareholders.
The following key performance metrics are derived from our consolidated financial statements for the periods presented and should be read in conjunction with the more detailed information therein and with the disclosure included in this report under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 

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Table 1 —– Summary of Financial Highlights and Key Performance Metrics
(dollars (dollars in thousands; except per share amounts)
  December 31, 
      2010     2009 
Cash and cash equivalents $     12,582 $     7,104 
Net income (loss) available to common shareholders, per diluted share  86.53  (20.97)
        
  December 31,
  2011 2010
Cash and cash equivalents $11,503
 $12,582
Net income available to common shareholders, per diluted share 1.81
 86.53
     

Liquidity – During 2010,2011, we continued to developincrease StreetLinks productivity and significantly increased its appraisal volume.order volume which led to StreetLinks had revenues of $75.2$119.4 million during 2010 in 2011, as compared to $31.1$75.2 million in 2009. during 2010. StreetLinks has producedis producing strong net positive cash flow, and earnings in 2010 andwhich is expected to continue producing net positive cash flow and earnings for the foreseeable future.
During 2011, Advent generated revenues of $6.7 million, but had minimal operations in 2010 as it was in the start-up phase. The majority of the revenues were recognized during the first quarter due to the seasonality of Advent's business as a significant portion of their business is generated during the income tax season.
During 2011, we received $12.9$9.7 million in cash on our mortgage securities portfolio, compared to $18.5$12.9 million in 2009. during 2010. We anticipate that cash received on the securities will continue to decline.
During 2010,2011, we used cash to pay for corporate and administrative costs, investments in Corvisa and BMM, and distributions to noncontrolling interests. We used $3.0 million in cash in the contingent consideration paymentsexchanges of our preferred stock as discussed above. Furthermore we paid significant fees, approximately $2.4 million, for professional services related to the StreetLinks acquisitionRecapitalization and the investment in Corvisa of $1.5 million. Debt Exchange during 2011.

As of December 31, 2010,2011, we have $12.6$11.5 million in unrestricted cash and cash equivalents and $1.4 million of restricted cash which is included in the other noncurrent assets line item of the consolidated balance sheets.
StreetLinks and our portfolio of mortgage securities have been our primary source of cash flows. The cash flows from our mortgage securities will continue to decrease as the underlying mortgage loans are repaid and could be significantly less than the current projections if interest rate increases exceed the current assumptions. Our liquidity consists solely of cash and cash equivalents and future cash flows generated through our operating businesses. Our consolidated financial statements have been prepared on a going concern basis of accounting which contemplates continuity of operations, realization of assets, liabilities and commitments in the normal course of business. The Company has experienced significant losses over the past several years and has a significant deficit in shareholders’ equity. Notwithstanding these negative factors, management believes that its current operations and its unrestricted cash availability is sufficient for the Company to discharge its liabilities and meet its commitments in the normal course of business. See “Liquidity and Capital Resources” for further discussion of our liquidity position and steps we have taken to preserve liquidity levels.
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equivalents. As of December 31, 2010,2011, we had working capital of $15.4 million compared to a working capital deficiency of $35.9 million. This$35.9 million as of December 31, 2010. The increase of approximately $51.3 million was mainly attributable to preferredthe elimination of dividends payable in the Recapitalization.

Potential Impact of $50.9 million being classified as a current liability, althoughChanges in the Valuation Allowance for Deferred Tax Asset – As of December 31, 2011, the Company doeshad a net deferred tax asset, before the valuation allowance (or reserve) of $286.4 million. Based on our analysis of the evidence available as of December 31, 2011, we believed that we would not expectbenefit from the deferred tax asset. Therefore, as of that date, we continued to paymaintain a full reserve against the dividends due to management’s effort to conserve cash.  Ifnet deferred tax asset, resulting in no net deferred tax asset on our balance sheet.  Our analysis is significantly influenced by cumulative losses in recent years.

We continuously evaluate whether we will realize (or benefit from) the deferred tax assets at each reporting date. This analysis considers all available forms of evidence available at the time the analysis is made. The analysis is significantly influenced by objective evidence, such transactions close, the accruedas the cumulative income or loss in recent years. Based upon our most recent results, we could show three years of cumulative income in 2012. As a result, we may release all of, or a portion of, the reserve resulting in an income tax benefit. Any release of all or a portion of the valuation allowance could have a material impact on our financial position and unpaid preferred dividends would be eliminated through the Series C Offer and the Series D Exchange described under the heading “Significant Recent Events.”results of operations in any particular period.

Impact on Our Financial Statements of Derecognition of Securitized Mortgage Assets
– During the first quarter of 2010, certain events occurred that required us to reconsider the accounting for three consolidated loan trusts – NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1. As all requirements for derecognition have been met under applicable accounting guidelines, we derecognized the assets and liabilities of the NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1 trusts in January 2010. The securitized loans in these trusts have suffered substantial losses and through the date of the derecognition we recorded significant allowances for these losses. These losses have created large accumulated deficits for the trust balance sheets. Upon derecognition, all assets, liabilities and accumulated deficits were removed from our consolidated financial statements. A gain of $993.1 million was recognized upon derecognition, representing the net accumulated deficits in these trusts.

The following is summary of balance sheet information for each of the three derecognized loan trusts at the time of the reconsideration event and the resulting gain recognized upon derecognition:
 

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Table 2 —– Assets and Liabilities of Loan Trusts and Gain Recognized upon Derecognition
(dollars (dollars in thousands)
  NHEL 2006-       Eliminations    
       MTA1      NHEL 2006-1      NHEL 2007-1      (A)       Total 
Assets:                    
     Mortgage loans – held-in-                    
          portfolio $528,388  $399,507  $1,033,296  $(8,003) $1,953,188 
     Allowance for loan losses  (147,147)  (115,191)  (440,563)  -   (702,901)
     Accrued interest receivable  6,176   20,521   46,028   -   72,725 
     Real estate owned  11,842   17,919   25,548   -   55,309 
Total assets  399,259   322,756   664,309   (8,003)  1,378,321 
                     
Liabilities:                    
     Asset-backed bonds  588,434   465,164   1,175,608   6,427   2,235,633 
     Due to servicer  17,298   32,835   81,639   -   131,772 
     Other liabilities  9,432   12,368   24,017   (41,770)  4,047 
Total liabilities  615,164   510,367   1,281,264   (35,343)  2,371,452 
                     
     Gain on derecognition of                    
          securitization trusts $     215,905  $     187,611  $     616,955  $       (27,340) $     993,131 
                     
  
NHEL 2006-
MTA1
 NHEL 2006-1 NHEL 2007-1 
Eliminations
(A)
  Total
Assets:          
Mortgage loans – held-in-portfolio $528,388
 $399,507
 $1,033,296
 $(8,003) $1,953,188
Allowance for loan losses (147,147) (115,191) (440,563) —
 (702,901)
Accrued interest receivable 6,176
 20,521
 46,028
 —
 72,725
Real estate owned 11,842
 17,919
 25,548
 —
 55,309
Total assets 399,259
 322,756
 664,309
 (8,003) 1,378,321
Liabilities:          
Asset-backed bonds 588,434
 465,164
 1,175,608
 6,427
 2,235,633
Due to servicer 17,298
 32,835
 81,639
 —
 131,772
Other liabilities 9,432
 12,368
 24,017
 (41,770) 4,047
Total liabilities 615,164
 510,367
 1,281,264
 (35,343) 2,371,452
Gain on derecognition of          
securitization trusts $215,905
 $187,611
 $616,955
 $(27,340) $993,131
           
(A)
(A)Eliminations relate to intercompany accounts at the consolidated financial statement level; there are no intercompany balances between the securitization trusts.

Financial Condition as of December 31, 20102011 as Compared to December 31, 20092010
 
The following provides explanations for material changes in the components of our balance sheet when comparing amounts from December 31, 2011 and December 31, 2010 and December 31, 2009..
 
As discussed previously in this report under the heading “Impact on Our Financial Statements of Derecognition of Securitized Mortgage Assets” significant events occurred related to three securitized loan trusts during the first quarter of 2010 that caused us to derecognize the assets and liabilities of these trusts. Upon derecognition during the first quarter of 2010, all assets and liabilities of the trusts were removed from our consolidated financial statements and, therefore, their balances are zero as of December 31, 2010. These balances are not discussed further in the following comparative analysis:
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Cash and Cash Equivalents– See “Liquidity and Capital Resources” for discussion of our cash and cash equivalents.
 
Mortgage Securities– Substantially all of the mortgage securities we own and classify as trading are non-investment grade (BBB- or lower) and are owned by our CDO, which we consolidate. We organized the securitization prior to 2009 and we retained a residual interest in the CDO. However, due to poor performance of the securities within the CDO, our residual interest is not providing any cash flow to us and has no material value. The value of these securities fluctuates as market conditions change, including short-term interest rates, and based on the performance of the underlying mortgage loans. The liabilities of the securitization trust are included in other current liabilities in our consolidated balance sheet.
The mortgage securities classified as available for sale primarily include the value of fourthree residual interests we own as of December 31, 2011 and were issued by loan securitized trusts we organized prior to 2009.organized. The value of our mortgage securities is dependent on the interest rate environment, specifically the interest margin between the underlying coupon on the mortgage loans and the asset-backed bonds issued by the securitization trust to finance the loans. While interest rates remain low, the net margin has continued to be strong on these securities and therefore the securities provide cash flow to us. As a result, theOne additional security which had value as of these securities has not changed substantiallyDecember 31, 2010 was reduced to zero during the year ended December 31, 2010. Following2011 due to performance of the underlying collateral, which was the main cause for the decrease during the current year. The table below is a summary of our mortgage securities that are classified as available-for-sale.

Table 3 —– Values of Individual Mortgage Securities – Available-for-Sale (dollars in thousands)
  December 31, 2010 December 31, 2009
                        
        Constant Expected       Constant Expected
Securitization Estimated Discount Pre-payment Credit Estimated Discount  Pre-payment Credit
Trust (A)     Fair Value     Rate     Rate     Losses     Fair Value     Rate     Rate     Losses
2002-3 $1,359 25% 17% 1.0% $1,997 25% 15% 1.0%
2003-1  2,355     25           17             2.2         3,469     25           13           2.1       
2003-3  553 25  12  2.5   1,437 25  10  2.7 
2003-4  313 25  15  2.6   - 25  12  2.7 
Total $   4,580          $   6,903         
                         
  December 31, 2011 December 31, 2010
Securitization Trust (A) Estimated Fair Value Discount Rate Constant Pre-payment Rate Expected Credit Losses Estimated Fair Value Discount Rate Constant Pre-payment Rate Expected Credit Losses
2002-3 $1,553
 25% 18% 1.2% $1,359
 25% 17% 1.0%
2003-1 2,160
 25
      19
        2.3
       2,355
 25
      17
        2.2
2003-3 165
 25
 17
 2.1
 553
 25
 12
 2.5
2003-4 —
 25
 19
 2.6
 313
 25
 15
 2.6
Total $3,878
       $4,580
      
                 
(A)
(A)We established the trust upon securitization of the underlying loans, which generally were originated by us.

PropertyThe mortgage securities we own and equipment, net – Propertyclassify as trading are non-investment grade (BBB- or lower) and equipment consistsare owned by our CDO, which we consolidate. The value of furniture and fixtures, office equipment, hardware and computer equipment, software and leasehold improvements. The main increasethese securities has decreased to zero as of December 31, 2010 compared2011 based on the performance of the underlying mortgage loans. The liabilities of the securitization trust which were included in other current liabilities in our consolidated balance sheet have also been reduced to zero as of December 31, 2009 was mainly due to the property and equipment obtained as part of the Corvisa acquisition.2011.
 
NotesService Fee Receivable – In order to maximize the use of our excess cash flow, we have made loans to independent entities during 2009 and 2010. The borrowing entities used the proceeds to finance on-going and current operations. The balance decreasedincreased as of December 31, 2011 compared to December 31, 2010 mainly due to reserves for bad debtsan increase in excess of additions to the notes. Management evaluates for uncollectability based on the likelihood of repayments based upon discussionsservice fee revenues. The service fee receivable balance fluctuates with the borrowerstiming of services provided and financial information.the collection of the fees from customers.

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Other Current Assets– Other current assets include receivables for overpayment of income taxes, prepaid expenses, the current portion of restricted cash, CDO receivables and other miscellaneous receivables. The balance decreasedincreased in 2010December 31, 2011 as compared to 2009December 31, 2010 is primarily due to recording a largereceivable for the overpayment of previously paid income taxes of $2.3 million during 2011. A substantial portion of the restricted cash being released from restriction.receivable was collected subsequent to 2011.
 
Goodwill – PursuantAs part of the purchase price allocation for the acquisition of Mango, $2.2 million was allocated to goodwill during 2011. See Note 4 to the termsconsolidated financial statements for further details of our purchase agreement for StreetLinks, we were obligated to make “earn out” payments to StreetLinks minority owners upon StreetLinks achieving certain earnings targets. The targets were achieved and payments made during the year ended December 31, 2010. These amounts have been recorded as Goodwill.acquisition.
 
Dividends Payable– DividendsAs discussed in Note 3 to the consolidated financial statements, during 2011 we completed the exchange of all outstanding shares of preferred stock. The Recapitalization eliminated all obligations to pay dividends on the preferred stock have not been paid since 2007. These dividends are cumulative and therefore we continuethe dividends payable balance was reduced to accrue these dividends. Dividends on the Series C Preferred Stock are payable in cash and accrue at a rate of 8.9% annually. Dividends on the Series D1 Preferred Stock are payable in cash and accrue at a rate of 13.0% per annum. If such transactions close, thezero. accrued and unpaid dividends would be eliminated through the Series C Offer and the Series D Exchange described under the heading “Significant Recent Events.”


Total Shareholders’ Deficit– As of December 31, 2010,2011, our total liabilities exceeded our total assets by $106.5$52.8 million as compared to $1.1 billion$106.5 million as of December 31, 2009.2010. The significant decrease in our shareholders’ deficit during the year ended December 31, 20102011 results from the Recapitalization of our large net income, driven primarily bypreferred stock. See Note 3 to the gain recognized upon the derecognition of the assets and liabilities of three loan securitization trusts as discussed previously under the heading “Impact on Our Financial Statements of Derecognition of Securitized Mortgage Assets.”consolidated financial statements for further details.

Results of Operations – Consolidated Earnings Comparisons
 
Year ended December 31, 20102011 as Compared to the Year Ended December 31, 20092010
 
Securitization Trusts
Trusts; Gain on Derecognition of Mortgage Assets – As discussed previously in this report under the heading “Impact of Derecognition of Securitized Mortgage Assets on Our Financial Statements” significant events that occurred related to three securitized loan trusts. Prior to 2010, we consolidated the financial statements of these trusts. Upon derecognition during the first quarter of 2010, all assets and liabilities of the trusts were removed from our consolidated financial statements. Prior to derecognition, we recognized interest income, interest expense, gains or losses on derivative instruments which are included in the other expense line item in the table below, servicing fees and premiums for mortgage insurance related to these securitization trusts. These income and expense items were recognized only through the date of derecognition in January 2010. As a result, there was a significant variation in these balances when comparing the year ended December 31, 2011 and December 31, 2010 and 2009. .

The following table presents the items affected by the derecognition and their balances.
 
Table 4 —– Income (Expense) of Consolidated Loan Securitization; Gain on Derecognition
of Mortgage Assets (dollars in thousands)
  For the Year 
  Ended December 31, 
     2010    2009 
Gain on derecognition of securitization trusts $    993,131  $    –��
Interest income – mortgage loans  10,681   130,017 
Interest expense – asset-backed bonds  (1,416)  (21,290)
Provision for credit losses  (17,433)  (260,860)
Servicing fees  (731)  (10,639)
Premiums for mortgage loan insurance  (308)  (6,041)
Other expense  (560)  (1,600)
         

In addition, the securitization trusts segment includes the Company’s CDO which was the main driver of the following consolidated statements of operations line items during the years ended December 31, 2010 and 2009.
  
For the Year
Ended December 31,
  2010
Gain on derecognition of securitization trusts $993,131
Interest income – mortgage loans 10,681
Interest expense – asset-backed bonds (1,416)
Provision for credit losses (17,433)
Servicing fees (731)
Premiums for mortgage loan insurance (308)
Other expense (560)
   
 
Interest Income – mortgage securities – In general, our mortgage securities have been significantly impaired due to national and international economic crises, housing price deterioration and mortgage loan credit defaults. Interest income has declined as these assets have declined.
Appraisal Management
 
Service Fee Income and Cost of Services – We earn fees on the residential appraisals and other valuation services we complete and deliver to our customers, generally residential mortgage lenders. Fee revenue is directly related to the number of appraisals completed (units). Cost of Services includes the cost of the appraisal, which is paid to an independent party, and the internal costs directly associated with completing the appraisal order. The internal costs include compensation and benefits of certain employees, office administration, depreciation of equipment used in the production process, and other expenses necessary to the production process. The following is a summary of production and revenues and expenses.


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Table 5 —– Appraisal and Real Estate Valuation Management Services Operations (dollars in thousands,
except unit amounts)
  For the Year Ended December 31, 
  2010 2009 
      Total     Per Unit     Total     Per Unit 
Completed orders (units)  204,786      84,174     
                
Service fee income $75,168  $367 $31,106  $370 
Cost of services  66,475   324  32,221   383 
Selling, general and administrative expense  4,940   24  1,837   22 
Other expense  (65)  -  46   1 
Other income  15   -  -   - 
Net income (loss)  3,833   19  (2,998)  (36)
Less: Net income (loss) attributable to noncontrolling               
     interests  321   2  (829)  (10)
Net income (loss) attributable to NFI $     3,512  $     17 $     (2,169) $     (26)
                
  For the Year Ended December 31,
  2011 2010
  Total Per Unit Total Per Unit
Completed orders (units) 315,726
   204,786
  
Service fee income $119,387
 $378
 $75,168
 $367
Cost of services 104,177
 330
 66,475
 324
Selling, general and administrative expense 8,967
 28
 4,940
 24
Other expense (income) 44
 —
 (65) —
Other income 195
 1
 15
 —
Net income 6,394
 21
 3,833
 19
Less: Net (loss) income attributable to noncontrolling interests (107) —
 321
 2
Net income (loss) attributable to NFI $6,501
 $21
 $3,512
 $17
         

We have generatedThe substantial increasesincrease in order volume throughis mainly due to aggressive sales efforts, leadingwhich led to significant increases in the number of mortgage lender customers, along with gaining additional order volume from existing customers. We have also introducedcontinue to develop new products leadingthat will further diversify StreetLinks' product offerings. The Company expects cash flows to increased order volume. Federal regulatory changes have also contributedcontinue to increased customersincrease in the future due to a larger customer base and order volume. On July 21,further operating efficiencies.

During 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into federal law. Various government agencies are charged with implementing new regulations under the Dodd-Frank Act. When fully implemented, theThe Dodd-Frank Act will modifymodified and provideprovides for new regulation of a wide range of financial activities, including residential real estate appraisals and appraisal management companies.
On October 18, 2010, as required by the Dodd-Frank Act, the Federal Reserve Board issued an interim final rule which amended Regulation Z under the Truth in Lending Act (the “Appraisal Rule”). The Appraisal Rule was subject to a public comment period until December 27, 2010. Compliance with the Appraisal Rule, as amended to account for comments received, becomes mandatory as of April 1, 2011. New requirements under the Dodd-Frank Act and the Appraisal Rule specific to residential real estate appraisals will likely include, but not be limited to, the following:
It is management’smanagement's opinion that the Appraisal Rule and other rules and regulations promulgated under the Dodd-Frank Act will strengthenhave strengthened appraiser reform, leading to greater appraiser independence and greater lender non-compliance liability and will likely increase lender and consumer costs.liability. We believe credible lenders will continue to rely on appraisal management companies to mitigate their appraisal compliance risk and manage their appraisal fulfillment processes. Any impact of theThe Dodd-Frank Act onhas not impacted the CompanyCompany's operating procedures, production or financial results since it became effective and management does not believe that it will not be fully determined until all rules and regulations thereunder, including the Appraisal Rule, have been fully implemented.
The Company also expects cash flows to increase in the future due to a larger customer base and operating efficiencies.
During 2009, we incurred costs to improve our operating infrastructure which were included in all expense categories in this segment. These improvements included adding facilities and equipment and technology enhancements to improve customer satisfaction and drive operating efficiencies. These costs are generally not recurring and therefore our cost per unit has improved.future.
 
CorporateFinancial Intermediary: Service Fee Income and Cost of Services – We earn fees for providing financial settlement services to income tax preparation businesses and consumers. Settlement services are facilitated through arrangements we have made with other independent financial service providers, including our bank partners and data exchange managers. Settlement services consist mainly of collecting income tax refunds on behalf of our customers and distributing fees to independent service providers and the individual taxpayer. As the majority of our business is directly related to income tax refunds, a significant portion of the financial intermediary's operations occur during the first quarter of each year.

Although we are not a bank, we also provide a distribution for a bank to tailored banking accounts, small dollar banking products and related services. We are paid a fee from the bank based on the customers' account activity. In the analysis below, we have included all accounts opened, regardless of whether the account was used and generated fees. Cost of Services includes the direct cost related to providing services, which includes fees to third-party vendors performing services on our behalf. Additionally, internal costs directly associated with completing our services are included in Cost of Services. The internal costs include compensation and benefits of employees, office administration, depreciation of equipment used in the production process, and other expenses necessary to complete services performed.


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Table 6 - Financial Intermediary Segment Operations (dollars in thousands, except unit and per unit amounts)
 For the Year Ended December 31, 2011
Settlements completed315,147
  
Banking accounts enrolled38,171
  
    
 Total Per Unit
Service fee income:   
Settlement$5,879
 $18.65
Banking account distribution860
  
 6,739
  
    
Cost of services3,740
  
Selling, general and administrative expense3,723
  
Other expense215
  
 7,678
  
    
Other income1
  
Net loss(938)  
Less: Net loss attributable to noncontrolling interests(91)  
Net loss attributable to NFI$(847)  
    

We did not have significant financial intermediary activity during the year ended December 31, 2010, as we were developing this segment.

Corporate

Interest Income – Mortgage Securities – The interest on the mortgage securities we own has decreased significantly from $16.9$11.5 million to $9.8$10.3 million in the corporate segment when comparing the year ended December 31, 2011 to the year ended December 31, 2010 as compared to 2009 since the securities have declined in value as their expected future cash flow has decreased significantly.decreased. Management expects that the interest income and cash flow from these securities will continue to decline as the underlying loan collateral is repaid.

Selling, General and Administrative Expenses – Selling, general and administrative expenses have decreasedincreased from $18.7$19.3 million to $14.3$21.5 million for the yearsyear ended December 31, 2011 compared to the year ended December 31, 2010 as compared to 2009, respectively, mainly due to having a concerted effort by managementfull year of Corvisa expenses and the addition of Mango during the fourth quarter. In addition, we paid significant legal, accounting, advisory and other fees to reduce corporate generalcomplete our Recapitalization and administrative expenses.Debt Exchange.

Interest expense on trust preferred securities – Interest expense on trust preferred securities decreasedincreased from$1.1 million to $2.5 million for the year ended December 31, 2009 as2010 compared to the same period in 20102011. The increase is due to the debt issuance cost becoming fully amortized on oneaccretion of the securities duringdebt discount to the year.higher principal balance of the senior notes. See Note 9 to the consolidated financial statements for further details.

Contractual Obligations
 
18

Contractual Obligations
We have entered into certain long-term debt and lease agreements which obligate us to make future payments to satisfy the related contractual obligations.
The following table summarizes our contractual obligations as of December 31, 2010.2011.
 

15


Table 6 —7 – Contractual Obligations
(dollars (dollars in thousands)
  Payments Due by Period
     Less than 1         
Contractual Obligations     Total     Year     1-3 Years     3-5 Years     After 5 Years
Junior subordinated debentures (A) $    97,411 $    781 $    1,563 $    1,563 $    93,504
Operating leases (B)  3,171  1,406  1,692  73  -
Contingent consideration payments               
     related to Corvisa acquisition  450  -  450  -  -
Total obligations  101,032  2,187  3,705  1,636  93,504
                
 Payments Due by Period
Contractual ObligationsTotal     Less than 1 Year     1-3 Years     3-5 Years     After 5 Years
Senior notes (A)$146,709
 $874
 $1,743
 $4,199
 $139,893
Operating leases (B)4,434
 1,468
 1,667
 1,299
 —
Contingent consideration payments related to Corvisa and Mango acquisitions1,154
 150
 1,004
 —
 —
Vendor agreement (C)300
 300
 —
 —
 —
Total obligations$152,597
 $2,792
 $4,414
 $5,498
 $139,893
  
  
  
  
  
(A)The junior subordinated debentures mature in 2035 and 2036. The contractualIn computing the future obligations for these debentures include expectedrelating to the Senior Notes, interest payments on the obligations based on the prevailingare calculated using an interest rate of 1.0% per annum asuntil January 2016 and an effective rate of December 31, 2010 for each respective obligation.3.58% thereafter. The junior subordinated debenturesSenior Notes are assumed to mature in March 2033. The Senior Notes, including the actual interest rates, are described in detail in Note 79 to our consolidated financial statements.
(B)The operating lease obligations do not include rental income of $0.6$0.2 million to be received under sublease contracts.
(C)A vendor agreement requires that the Company pay a vendor in its financial intermediary segment a minimum $0.3 million during the first quarter of 2012 if certain services are provided.

UncertainThe estimated liability associated with uncertain tax positions of $1.1$1.5 million, which areis included in the other liabilities line item of the noncurrent liabilities section of the consolidated balance sheetssheet as of December 31, 2010,2011, are not included in the table above as the timing of payment cannot be reasonably or reliably estimated.

Liquidity and Capital Resources
 
As of December 31, 2010,2011, we had approximately $12.6$11.5 million in unrestricted cash and cash equivalents.
 
Cash on hand and receipts from StreetLinks operations and our mortgage securities are significant sources of liquidity. Service fee income was a substantial source of our cash flows forduring the year ended December 31, 2010. 2011. We have had significant growth during 2010 compared to 20092011 and are currently projecting an increase in service fee income over the course of the next year as we continue to increase our customer base, although we cannot assure the same rate of growth that we have experienced during 2010. New regulations issued by federal agencies, especially those that became effective in the first quarter of 2010, have positively impacted StreetLinks’ sales efforts. Infrastructure changes and added efficiencies gained through automation have decreased selling, general and administrative expenses relative to the increased production. . We anticipate that continued increases in appraisal volume and relatively lower operating costs on a per unit basis will continue to drive positive earnings and cash flow from StreetLinksoperations as compared to prior periods, although we also anticipate a decrease in overall housing market transactions similar to most years during 2011.the winter months.

Advent had increased cash flows from their operations during the year ended December 31, 2011 as compared to the same period in 2010 as there was minimal activity during 2010 given Advent was still in its start-up phase.

Based on the current projections, the cash flows from our mortgage securities will decrease inover the next several monthsyear as the underlying mortgage loans are repaid, and could be significantly less than the current projections if losses on the underlying mortgage loans exceed the current assumptions or if short-term interest rates increase significantly.

Our current projections indicate that sufficient cash and cash flows are and will be available to meet payment needs. However, our mortgage securities cash flows are volatile and uncertain, and the amounts we receive could vary materially from our projections though we believe that the increased cash flows from StreetLinksoperations will offset any reduction in our mortgage securities cash flows. As discussed under the heading “Item 3. Legal Proceedings” inof Part I of this report, we are the subject of various legal proceedings, the outcomeoutcomes of which isare uncertain. We may also face demands in the future that are unknown to us today related to our legacy lending and servicing operations.

If the cash flows from StreetLinksoperations and our mortgage securities are less than currently anticipated, it would negatively affect our results of operations, financial condition, liquidity and business prospects. However, management believes that its current operations and its cash availability are sufficient for the Company to discharge its liabilities and meet its commitments in the normal course of business.

The Company's senior notes contain certain restrictive covenants (the “Negative Covenants”). The Negative Covenants prohibit the Company and its subsidiaries, from among other things, incurring debt, permitting any lien upon any of its property or assets, making any cash dividend or distribution or liquidation payment, acquiring shares of the Company or its subsidiaries, making payment on debt securities of the Company that rank pari passu or junior to the senior notes, or disposing of any equity interest in its subsidiaries or all or substantially allof the assets of its subsidiaries. At any time that the senior notes accrue interest at the full rate and the Company satisfies certain financial covenants (the “Financial Covenants”), the Negative Covenants will not apply. Satisfaction of the Financial Covenants requires the Company to demonstrate on a consolidated basis that (1) its Tangible Net Worth is equal to or greater than $40 million, and (2) either (a) the Interest Coverage Ratio is equal to or greater than 1.35x, or (b) the Leverage Ratio is not greater than 95%. The Company was in compliance with all Negative Covenants as of December 31, 2011, see Note 9 to the consolidated financial statements for additional details.

16


Overview of Cash Flow for the Year ended December 31, 20102011

Following are the primary and simplified sources of cash receipts and disbursements, excluding the impact of the securitization trusts. We have provided a summary of the cash flow for the securitization trusts under “Assets and Liabilities of Consolidated Securitization Trusts.”
19

Table 7 — Primary Sources of Cash Receipts and Disbursements
(dollars in thousands)
  For the Years Ended
  December 31,
     2010    2009
Primary sources:      
Fees received for appraisal and real estate      
     valuation management services $    74,551 $    30,607
Cash flows received from mortgage securities  12,858  18,479
       
Primary uses:      
Payments for appraisals and real estate valuation      
     management services and related      
     administrative expenses  73,071  25,739
Payments of selling, general and administrative      
     expenses  17,157  30,140
Disbursements to StreetLinks’ noncontrolling      
     interests  2,804  -
       

Statement of Cash Flows – Operating, Investing and Financing Activities
The following table provides a summary of our operating, investing and financing cash flows from our consolidated statements of cash flows for the years ended December 31, 20102011 and 2009.2010.
 
Table 8 —– Summary of Operating, Investing and Financing Cash Flows
(dollars (dollars in thousands)
  For the Years Ended 
  December 31, 
  2010  2009 
Consolidated Statements of Cash Flows:                
Cash (used in) provided by operating activities $     6,615  $     67,218 
Cash flows provided by investing activities  34,638   246,616 
Cash flows used in financing activities  (35,775)  (331,520)
         
  
For the Years Ended
December 31,
  2011 2010
Consolidated Statements of Cash Flows:    
Cash provided by operating activities $2,389
 $6,615
Cash flows (used in) provided by investing activities 325
 34,638
Cash flows used in financing activities (3,793) (35,775)
     

Operating Activities The cash. Cash provided by operating activities decreased during the year ended December 31, 2011 over the same period in 20092010. This was primarilydirectly related to the cash flow of the securitized loan trusts (deconsolidated January 2010)in 2010 which were derecognized during the first quarter of 2010. See a discussion ofProduction for both our Financial Intermediary and Appraisal Management segments increased during the impact of the consolidated loan trusts in Note 4year ended December 31, 2011 compared to the consolidated financial statements. The Company is now focusing on its appraisal and real estate valuation management services business. During 2010, StreetLinks had positive operating cash flowssame period in 2010 as compared to 2009 when StreetLinks had negative operating cash flows. Although the Company continues to fund the development of the Advent business, which used approximately $2.5 million in 2010 to pay for operating expenses, the Company anticipates that Advent will have sufficient revenues to cover its expenses in 2011..

Investing Activities. Substantially all of the cash flow from investing activities relates to either payments on securitized loans or sales upon foreclosure of securitized loans. These amounts decreased in 2010 as comparedloans which pertains to 2009 as they were deconsolidatedthe securitized loan trusts derecognized during the first quarter of 2010. Additionally,During the year ended December 31, 2011, the company had a decrease in 2009 and the beginning of 2010, our mortgage loan portfolio declined significantly and borrower defaults increased, resulting in lower repayments of our mortgage loans held-in-portfolio and lower cash proceeds from the salepay downs and maturities of assets acquired through foreclosuremortgage securities as compared to prior years.the same period last year. The Company paid out $2.8 millionalso experienced a decrease in 2010 relatedthe amount of restricted cash released from restrictions during 2011 as compared to contingent consideration earnings targets being achieved from2010 as the 2008 acquisitioncounterparties have released the majority of StreetLinks along with the purchasecash for letters of Corvisa for $1.4 million, net of cash received.credit.

Financing Activities. TheCash flows used in financing activities decreased significantly as compared to prior year. In 2010, cash flows were affected by the payments on asset-backed bonds relatesrelating to bonds issued by securitization loan trusts, which have decreased aswere derecognized during the assets infirst quarter. See the trusts used to pay those bonds have declined.
Future Sources and UsesSecuritization Trusts; Gain on Derecognition of Cash
Primary SourcesSecuritization Trusts section for further details. During the second quarter of Cash
Cash Received from Appraisal and Real Estate Valuation Management Services – As shown in Table 7 above, cash receipts in our appraisal and real estate valuation management service operations are a significant source of cash and liquidity. These receipts have increased significantly as2011, the appraisal volume has increased as discussed previously.
Cash Received From Our Mortgage Securities Portfolio – For the year ended December 31, 2010, we received $12.9 million in proceeds from mortgage securities. The cash flows we receive on our mortgage securities are highly dependent on the interest rate spread between the underlying collateral and the bonds issued by the securitization trusts and default and prepayment experience of the underlying collateral. The following factors have been the significant drivers in the overall fluctuations in these cash flows:
20

In general, if short-term interest rates increase, the spread (cash) we receive will decline.
Primary Uses of Cash
Payments to Independent Appraisers – We are responsible for paying the independent appraisers we contract with to provide residential mortgage appraisals. The cash required for this is funded through receipts from customers and the change in the cash requirements is directly related to the appraisal volume and units completed.
Payments of Selling, General and Administrative Expenses – Selling, general and administrative expenses include the administrative costs of business management and include staff and management compensation and related benefit payments, professional expenses for audit, tax and related services, legal services, rent and general office operational costs.
Contingent Consideration payment to StreetLinks’ noncontrolling interests – During 2010, we distributed $2.8$3.0 million to the noncontrolling interestsholders of StreetLinks upon it achieving certain earnings targets.the outstanding preferred stock as part of the Recapitalization.

Critical Accounting Estimates
 
We prepare our consolidated financial statements in conformity with GAAP and, therefore, are required to make estimates regarding the values of our assets and liabilities and in recording income and expenses. These estimates are based, in part, on our judgment and assumptions regarding various economic conditions that we believe are reasonable based on facts and circumstances existing at the time of reporting. These estimates affect reported amounts of assets, liabilities and accumulated other comprehensive income at the date of the consolidated financial statements and the reported amounts of income, expenses and other comprehensive income during the periods presented. The following summarizes the components of our consolidated financial statements where understanding accounting policies is critical to understanding and evaluating our reported financial results, especially given the significant estimates used in applying the policies. The discussion is intended to demonstrate the significance of estimates to our financial statements and the related accounting policies. Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and the Audit Committee has reviewed our disclosure.
 
Notes Receivable and Allowance for Doubtful Accounts. The Company determines the required allowance for doubtful accounts using information such as the status of the note, borrower’s financial condition, and economic trends and conditions. The Company has aconditions, past payment history and information provided from legal counsel if the note receivable due from an entity with which we are currentlyis in litigation. The balance of this note receivable was $4.4 million and $3.9 million as of December 31, 2010 and 2009, respectively. This note receivable could become completely impaired dependent upon the outcome of the litigation and the financial means of the entity to repay the note.
 
Mortgage Securities – residual interests.Securities. Our residual interestsmortgage securities represent beneficial interests we retained in securitization and resecuritization transactions. The residual securities include interest-only mortgage securities, prepayment penalty bonds and over-collateralization bonds.
 
The residual securities we retained in securitization transactions structured as sales primarily consist of the right to receive the future cash flows from a pool of securitized mortgage loans which include:
Prepayment penalties received from borrowers who pay off their loans early in their life; and

    • 17


    Overcollateralization which is designed to protect the primary bondholder from credit loss on the underlying loans.
    We believe the accounting estimates related to the valuation of our residual securities and establishing the rate of income recognition are “critical accounting estimates” because they can materially affect net income and shareholders’ equity and require us to forecast interest rates, mortgage principal payments, prepayments and loan default assumptions which are highly uncertain and require a large degree of judgment. The rate used to discount the projected cash flows is also critical in the valuation of our residual securities. We use internal, historical collateral performance data and published forward yield curves when modeling future expected cash flows and establishing the rate of income recognized on mortgage securities. We believe the value of our residual securities is appropriate, but can provide no assurance that future changes in interest rates, prepayment and loss experience or changes in the market discount rate will not require write-downs of the residual assets.
    21

    At each reporting date, the fair value of the residual securities is estimated based on the present value of future expected cash flows to be received. Management’s best estimate of key assumptions, including credit losses, prepayment speeds, expected call dates, market discount rates and forward yield curves commensurate with the risks involved, are used in estimating future cash flows. We estimate initial and subsequent fair value for the subordinated securities based on quoted market prices. See Note 5 to the consolidated financial statements for the residual security sensitivity analysis and Note 613 to the consolidated financial statements for the current fair value of our residual securities.securities and the residual security sensitivity analysis.
     
    Goodwill.Goodwill is tested for impairment at least annually and impairments are charged to results of operations only in periods in which the recorded carrying value of reporting unit is more than its estimated fair value. Goodwill is tested for impairment using a two-step process that begins with an estimation of fair value. The first step compares the estimated fair value of StreetLinksa reporting unit with its carrying amount, including goodwill. If the estimated fair value exceeds its carrying amount, goodwill is not considered impaired. However, if the carrying amount exceeds its estimated fair value, a second step would be performed that would compare the implied fair value to the carrying amount of goodwill. An impairment loss would be recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The impairment test in 2011 and 2010 indicated that there was a significant excess of fair value over the carrying amount and no impairment was incurred.
     
    Deferred Tax Asset, netIncome Taxes.. We recorded deferred tax assets and liabilities for the future tax consequences attributable to differences between the GAAP carrying amounts and their respective income tax bases. A deferred tax liability was recognized for all future taxable temporary differences, while a deferred tax asset was recognized for all future deductible temporary differences, operating loss carryforwards and tax credit carryforwards. In accordance with income taxes guidance, we recorded deferred tax assets and liabilities using the enacted tax rate that is expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized.
    In determining the amount of deferred tax assets to recognize in the financial statements, we evaluatethe Company evaluates the likelihood of realizing such benefits in future periods. IncomeThe income taxes guidance requires the recognition of a valuation allowance if it is more likely than not that all or some portion of the deferred tax asset will not be realized. Income taxes guidance indicates the more likely than not threshold is a level of likelihood that is more than 50%.
     
    Under the income taxes guidance, companies are required to identify and consider all available evidence, both positive and negative, in determining whether it is more likely than not that all or some portion of its deferred tax assets will not be realized. Positive evidence includes, but is not limited to the following: cumulative earnings in recent years, earnings expected in future years, excess appreciated asset value over the tax basis and positive industry trends. Negative evidence includes, but is not limited to the following: cumulative losses in recent years, losses expected in future years, a history of operating losses or tax creditscredit carryforwards expiring, and adverse industry trends.
     
    The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. Accordingly, the more negative evidence that exists requires more positive evidence to counter, thus making it more difficult to support a conclusion that a valuation allowance is not needed for all or some of the deferred tax assets. A cumulative lossCumulative losses in recent years isare significant negative evidence that is difficult to overcome when determining the need for a valuation allowance. Similarly, cumulative earnings in recent years represent significant positive objective evidence. If the weight of the positive evidence is sufficient to support a conclusion that it is more likely than not that a deferred tax asset will be realized, a valuation allowance should not be recorded.
     
    We examineThe Company examines and weighweighs all available evidence (both positive and negative and both historical and forecasted) in the process of determining whether it is more likely than not that a deferred tax asset will be realized. We considerThe Company considers the relevancy of historical and forecasted evidence when there has been a significant change in circumstances. Additionally, we evaluatethe Company evaluates the realization of ourits recorded deferred tax assets on an interim and annual basis. We doThe Company does not record a valuation allowance if the weight of the positive evidence exceeds the negative evidence and is sufficient to support a conclusion that it is more likely than not that ourits deferred tax asset will be realized.
     
    If the weighted positive evidence is not sufficient to support a conclusion that it is more likely than not that all or some of ourthe Company's deferred tax assets will be realized, we considerthe Company considers all alternative sources of taxable income identified in determining the amount of valuation allowance to be recorded. Alternative sources of taxable income identified in the income taxes guidance include the following: 1) taxable income in prior carryback year, 2) future reversals of existing taxable temporary differences, 3) future taxable income exclusive of reversing temporary differences and carryforwards, and 4) tax planning strategies.
     
    During January 2010, prior toThe company currently evaluates estimates of uncertainty in income taxes based upon a framework established in the derecognitionincome tax accounting guidance. The guidance prescribes a recognition threshold and measurement standard for the recognition and measurement of securitization trusts, the Allowance for Credit Losses and Real Estate Owned policies were consideredtax positions taken or expected to be critical accounting estimates. Subsequent totaken in a tax return. In accordance with the derecognition of securitization trusts we no longer hold any mortgage loans that require an allowance for credit losses orguidance, the Company evaluates whether a significant amount of real estate owned, therefore estimates related to these items are no longer considered critical followingtax position will more likely than not be sustained upon examination by the derecognition.
    Allowance for Credit Losses. An allowance for credit losses was maintained for mortgage loans held-in-portfolio.appropriate taxing authority. The amount of the allowance was based on the assessment by management of probable losses incurred based on various factors that affected our mortgage loan portfolio, including current economic conditions, the makeup of the portfolio based on credit grade, loan-to-value ratios, delinquency status, mortgage insurance we purchased and other relevant factors. The allowance was maintained through ongoing adjustments to operating income. The assumptions used by management in estimatingCompany measures the amount of benefit to recognize in its financial statements as the allowance for credit losses were highly uncertain and involved a great deallargest amount of judgment.benefit that is greater

    18
    22


    An internally developed migration analysis wasthan 50% likely of being realized upon ultimate settlement. The recognition and measurement of tax benefits is often judgmental, and determinations regarding the primary tool used in analyzing our allowance for credit losses. This tool considered historical information regarding foreclosure and loss severity experience and applied that informationtax benefit can change as additional developments occur relative to the portfolio at the reporting date. We also considered our use of mortgage insurance as a method of managing credit risk and current economic conditions, experience and trends. We paid mortgage insurance premiums on a portion of the loans maintained on our consolidated balance sheets and included the cost of mortgage insurance in our statement of operations.
    Real Estate Owned. Real estate owned, which consisted of residential real estate acquired in satisfaction of loans, was carried at the lower of cost or estimated fair value less estimated selling costs. We estimated fair value at the asset’s liquidation value less selling costs using management’s assumptions which were based on historical loss severities for similar assets. Adjustments to the loan carrying value required at time of foreclosure were charged against the allowance for credit losses. Costs related to the development of real estate were capitalized and those related to holding the property were expensed. Losses or gains from the ultimate disposition of real estate owned were charged or credited to earnings.issue.
     
    Impact of Recently Issued Accounting Pronouncements
     
    In June 2009,April 2011, the Financial Accounting Standards Board (“FASB”("FASB") issued StatementA Creditor's Determination of Financial Accounting Standards (“SFAS”) No. 166, Whether a Restructuring is a Troubled Debt RestructuringAccounting. The update provides additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. The amendments in the update are effective for the Transfers of Financial Assets, an Amendment of FASB Statement No. 140; this statement was codified in December 2009 as Accounting Standards Codification (“ASC”) 860. This guidance is effective for financial asset transfersfirst interim period beginning on January 1, 2010or after June 15, 2011, and willshould be usedapplied retrospectively to determine whether the transfer is accounted for as a sale under GAAP or as a secured borrowing. In addition, also in June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46 (R); this statement was also codified in December 2009 as ASC 810 and governs the consolidation of variable interest entities. The consolidation guidance became effective for all variable interest entities (each a “VIE”) the Company held as of January 1, 2010. As partbeginning of the Company’s adoptionannual period of the amended consolidation guidance, it was required to reconsider the Company’s previous consolidation conclusions pertaining to the Company’s variable interests in VIEs, including: (i) whether an entity is a VIE; and (ii) whether the Company is the primary beneficiary. Based on the Company’s assessment of its involvement in VIEs at January 1, 2010, in accordance with the amended consolidation guidance, the Company determined that it is not the primary beneficiary of any mortgage loan securitization entities in which it held a variable interest, as the Company does not have the power to direct the activities that most significantly impact the economic performance of these entities. The adoption of the amended consolidationadoption. This guidance did not result in the Company consolidating or deconsolidating any VIEs for which it has involvement. It should be noted, however, that the new guidance also required the Company to reassess these conclusions, based upon changes in the facts and circumstances pertaining to the Company’s VIEs,have a significant impact on an ongoing basis; thus, the Company’s assessments may therefore change and could result in a material impact to the Company’s financial statements during subsequent reporting periods. The Company re-evaluated the NHEL 2006-1, NHEL 2006-MTA1, and NHEL 2007-1 securitization transactions and determined that based on the occurrence of certain events during January 2010, the application of the amended guidance resulted in the Company reflecting as sales of financial assets and extinguishment of liabilities the assets and liabilities of the securitization trusts at that date. As a result, the Company derecognized the assets and liabilities of the NHEL 2006-1, NHEL 2006-MTA1, and NHEL 2007-1 securitization trusts and recorded a gain during the year ended December 31, 2010. See Note 4 to theits consolidated financial statements for further details.statements.

    In July 2010,May 2011, the FASB issued DisclosuresAmendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The update provides common requirements for measuring fair value and for disclosing information about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The guidance significantly expands the disclosures that companies must make about the credit quality of financing receivables and the allowance for credit losses. The disclosures asfair value measurements, including a consistent meaning of the endterm “fair value,” which will provide greater comparability of fair value measurements presented and disclosed in financial statements. The amendments in the reporting period became effective for the Company’s interim and annual periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting periodupdate are effective for the Company’s interim and annual periods beginning on or after December 15, 2010.2011, and therefore will be applicable to the Company for the first quarter of 2012. The objectivesCompany does not believe that this guidance will have a significant impact on its consolidated financial statements.

    In June 2011, the FASB issued Presentation of Comprehensive Income, which revises how entities present comprehensive income in their financial statements.  The guidance updates the presentation requirements for reporting the components of comprehensive income and requires that it is reported in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements.  In a continuous statement of comprehensive income, an entity would be required to present the components of the enhanced disclosures areincome statement as presented today, along with the components of other comprehensive income.  In the two-statement approach, an entity would be required to provide financialpresent a statement usersthat is consistent with additional information about the natureincome statement format used today, along with a second statement, which would immediately follow the income statement that would include the components of credit risks inherentother comprehensive income. In December 2011, the FASB deferred the requirement to present components of reclassifications of other comprehensive income on the face of the income statement that had previously been included in the Company’s financing receivables, how credit riskJune 2011 amended standard. The guidance is analyzed and assessed when determining the allowanceeffective for credit losses, and the reasons for the change in the allowance for credit losses.periods beginning after December 15, 2011. The adoption of this guidance requires enhanced disclosures and didwill not have a significant effectimpact on the Company’sCompany's financial statements. See Note 2
    In September 2011, the FASB issued Testing for Goodwill Impairment, which amends previous guidance, to allow companies the consolidatedoption of performing a qualitative assessment before completing step one of the impairment test, calculating the fair value of the reporting unit. If the Company determines on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not greater than the carrying amount, the two-step impairment test would not be required. The amendments are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company does not believe the adoption of this standard will have a material impact on its financial statements for the required disclosures.statements.

    Inflation
    Our mortgage securities, notes receivable, and CDO debt are financial in nature. As a result, interest rates and other factors drive our performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP. As a result, financial activities and the consolidated balance sheets are measured with reference to historical cost or fair market value without considering inflation.
    Item 7A. Quantitative and Qualitative Disclosures about Market Risk

    As a smaller reporting company, we are not required to provide the information required by this Item.

    19
    23



    Item 8. Financial Statements and Supplementary Data

    NOVASTAR FINANCIAL, INC.
    NOVASTAR FINANCIAL, INC.
    CONSOLIDATED BALANCE SHEETS
    (dollars in thousands, except share amounts)
          December 31,     December 31,
      2010 2009
    Assets        
         Current Assets        
              Cash and cash equivalents $12,582  $7,104 
              Mortgage securities (includes CDO securities of $1,198 and $959, respectively)  5,778   7,990 
              Notes receivable, net of allowance of $1,047 and $300, respectively  3,965   4,920 
              Service fee receivable, net of allowance of $42 and $22, respectively  1,924   868 
              Other current assets (includes CDO other assets of $299        
                   and $428, respectively)  3,291   6,633 
         Total current assets  27,540   27,515 
         Securitization Trust Assets        
              Mortgage loans – held-in-portfolio, net of allowance of $0        
                   and $712,614, respectively  -   1,289,474 
              Accrued interest receivable  -   74,025 
              Real estate owned  -   64,179 
         Total securitization trust assets  -   1,427,678 
         Non-Current Assets        
              Property and equipment, net of depreciation  4,821   1,803 
              Goodwill  3,170   - 
              Other assets  2,330   2,495 
         Total non-current assets  10,321   4,298 
                   Total assets $37,861  $1,459,491 
             
    Liabilities and Shareholders’ Deficit        
         Liabilities:        
              Current Liabilities        
                   Accounts payable $4,590  $1,949 
                   Accrued expenses  5,883   6,801 
                   Dividends payable  50,900   34,402 
                   Other current liabilities (includes CDO debt and other liabilities        
                        of $1,497 and $1,396, respectively)  2,103   2,962 
              Total current liabilities  63,476   46,114 
              Securitization Trust Liabilities        
                   Due to servicer  -   136,855 
                   Other securitization trust liabilities  -   3,729 
                   Asset-backed bonds secured by mortgage loans  -   2,270,602 
              Total securitization trust liabilities  -   2,411,186 
              Non-Current Liabilities        
                   Junior subordinated debentures  78,086   77,815 
                   Other liabilities  2,842   928 
              Total non-current liabilities  80,928   78,743 
                        Total liabilities  144,404   2,536,043 
             
         Commitments and contingencies (Note 8)        
             
         Shareholders’ deficit:        
              Capital stock, $0.01 par value, 50,000,000 shares authorized:        
              Redeemable preferred stock, $25 liquidating preference per share        
                   ($74,750 in total); 2,990,000 shares, issued and outstanding  30   30 
              Convertible participating preferred stock, $25 liquidating preference        
                   per share ($52,500 in total); 2,100,000 shares, issued and outstanding  21   21 
              Common stock, 9,368,053, shares issued and outstanding  94   94 
              Additional paid-in capital  787,363   786,989 
              Accumulated deficit  (898,195)  (1,868,398)
              Accumulated other comprehensive income  4,411   5,111 
              Other  -   (70)
                   Total NovaStar Financial, Inc. (“NFI”) shareholders’ deficit  (106,276)  (1,076,223)
              Noncontrolling interests  (267)  (329)
                   Total shareholders’ deficit      (106,543)      (1,076,552)
                        Total liabilities and shareholders’ deficit $37,861  $1,459,491 
     
    CONSOLIDATED BALANCE SHEETS
    (dollars in thousands, except share and per share amounts)
     December 31,
    2011    		 December 31,
    2010
    Assets   
    Current Assets   
    Cash and cash equivalents$11,503
    		 $12,582
    Mortgage securities (includes CDO securities of $0 and $1,198, respectively)3,878
    		 5,778
    Notes receivable, net of allowance of $0 and $1,047, respectively2,235
    		 3,965
    Service fee receivable, net of allowance of $86 and $42, respectively6,899
    		 1,924
    Restricted cash1,825
    		 23
    Other current assets (includes CDO other assets of $0 and $299, respectively)    4,124
    		 3,268
    Total current assets30,464
    		 27,540
    Non-Current Assets   
    Property and equipment, net of accumulated depreciation5,589
    		 4,821
    Goodwill5,336
    		 3,170
    Other assets3,212
    		 2,330
    Total non-current assets14,137
    		 10,321
    Total assets$44,601
    		 $37,861
        
    Liabilities and Shareholders' Deficit   
    Liabilities:   
    Current Liabilities   
    Accounts payable$7,077
    		 $4,590
    Accrued expenses6,331
    		 5,883
    Deferred revenue1,528
    		 896
    Dividends payable—
    		 50,900
    Other current liabilities (includes CDO debt and other liabilities of $0 and $1,497, respectively)161
    		 1,207
    Total current liabilities15,097
    		 63,476
    Non-Current Liabilities   
    Junior subordinated notes—
    		 78,086
    Senior notes79,654
    		 —
    Other liabilities2,606
    		 2,842
    Total non-current liabilities82,260
    		 80,928
    Total liabilities97,357
    		 144,404
        
    Commitments and contingencies (Note 10)

    		 

        
    Shareholders' deficit:   
    Capital stock, $0.01 par value per share, 120,000,000 and 50,000,000 shares authorized, respectively:   
    Redeemable preferred stock, $25 liquidating preference per share ($74,750 in total); 2,990,000 shares, issued and outstanding at December 31, 2010—
    		 30
    Convertible participating preferred stock, $25 liquidating preference per share ($52,500 in total); 2,100,000 shares, issued and outstanding at December 31, 2010—
    		 21
    Common stock, 91,253,653 and 9,368,053 shares issued and outstanding, respectively913
    		 94
    Additional paid-in capital746,276
    		 787,363
    Accumulated deficit(803,400) (898,195)
    Accumulated other comprehensive income3,267
    		 4,411
    Total NovaStar Financial, Inc. (“NFI”) shareholders' deficit(52,944) (106,276)
    Noncontrolling interests188
    		 (267)
    Total shareholders' deficit(52,756) (106,543)
    Total liabilities and shareholders' deficit$44,601
    		 $37,861
        
    See notes to consolidated financial statements.

    20


    NOVASTAR FINANCIAL, INC.
    CONSOLIDATED STATEMENTS OF OPERATIONS
    (unaudited; dollars in thousands, except share and per share amounts)
      For the Year Ended
    December 31,
      2011 2010
    Income and Revenues:    
    Service fee income $126,750
    		 $75,168
    Interest income – mortgage loans on securitization trusts —
    		 10,848
    Interest income – mortgage securities 10,335
    		 11,504
    Total 137,085
    		 97,520
         
    Costs and Expenses:    
    Cost of services 108,541
    		 66,475
    Interest expense – asset-backed bonds —
    		 1,416
    Provision for credit losses on securitization trusts —
    		 17,433
    Servicing fees on securitization trusts —
    		 731
    Premiums for mortgage loan insurance on securitization trusts —
    		 308
    Selling, general and administrative expense 21,548
    		 19,314
    Gain on derecognition of securitization trusts —
    		 (993,131)
    Other (income) expense (70) 390
    Total 130,019
    		 (887,064)
         
    Other income 903
    		 787
    Interest expense (2,471) (1,073)
         
    Income before income tax benefit 5,498
    		 984,298
    Income tax benefit (1,774) (1,356)
    Net income 7,272
    		 985,654
    Less: Net loss attributable to noncontrolling interests (491) (1,048)
    Net income attributable to NFI $7,763
    		 $986,702
    Earnings Per Common Share attributable to NFI:    
    Basic $1.82
    		 $86.53
    Diluted $1.81
    		 $86.53
    Weighted average basic common shares outstanding 52,132,669
    		 9,337,207
    Weighted average diluted common shares outstanding 52,292,322
    		 9,337,207

    See notes to consolidated financial statements.


    24
    21


    NOVASTAR FINANCIAL, INC.
    CONSOLIDATED STATEMENTS OF OPERATIONS
    (dollars in thousands, except share amounts)
      For the Year Ended
      December 31,
          2010     2009
    Income and Revenues:        
         Service fee income $75,168  $31,106 
         Interest income – mortgage loans on securitization trusts  10,848   131,301 
         Interest income – mortgage securities  11,504   21,656 
    Total  97,520   184,063 
             
    Costs and Expenses:        
         Cost of services  66,475   32,221 
         Interest expense – asset-backed bonds  1,416   21,290 
         Provision for credit losses on securitization trusts  17,433   260,860 
         Servicing fees on securitization trusts  731   10,639 
         Premiums for mortgage loan insurance on securitization trusts  308   6,178 
         Selling, general and administrative expense  19,314   20,777 
         Gain on derecognition of securitization trusts  (993,131)  - 
         Other expense  390   13,905 
    Total  (887,064)  365,870 
             
         Other income  787   887 
         Interest expense on trust preferred securities  (1,073)  (1,128)
              Income (loss) before income tax expense  984,298   (182,048)
              Income tax (benefit) expense  (1,356)  1,108 
              Net income (loss)  985,654   (183,156)
              Less: Net loss attributable to noncontrolling interests  (1,048)  (2,054)
              Net income (loss) attributable to NFI $986,702  $(181,102)
    Earnings (Loss) Per Common Share attributable to NFI:        
              Basic $86.53  $(20.97)
              Diluted $86.53  $(20.97)
    Weighted average basic common shares outstanding       9,337,207        9,368,053 
    Weighted average diluted common shares outstanding  9,337,207   9,368,053 
      
    NOVASTAR FINANCIAL, INC.
    CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT AND COMPREHENSIVE INCOME
    (unaudited; dollars in thousands, except share amounts)
     Total NFI Shareholders’ Deficit    
     
    Redeemable
    Preferred
    Stock
    		 
    Convertible
    Participating
    Preferred
    Stock
    		 
    Common
    Stock
    		 
    Additional
    Paid-in
    Capital
    		 
    Accumulated
    Deficit
    		 
    Accumulated
    Other
    Comprehensive
    Income
    		 
    Noncontrolling
    Interest
    		 
    Total
    Shareholders’
    Deficit
    Balance, December 31, 2010$30
    		 $21
    		 $94
    		 $787,363
    		 $(898,195) $4,411
    		 $(267) $(106,543)
    Compensation recognized under stock compensation plans—
    		 —
    		 —
    		 284
    		 —
    		 —
    		 —
    		 284
    Issuance of nonvested shares, 900,000 shares—
    		 —
    		 9
    		 (9) —
    		 —
    		 —
    		 —
    Accumulating dividends on preferred stock—
    		 —
    		 —
    		 —
    		 (8,428) —
    		 —
    		 (8,428)
    Distributions to noncontrolling interests—
    		 —
    		 —
    		 —
    		 —
    		 —
    		 (788) (788)
    Mango noncontrolling interest from acquisition—
    		 —
    		 —
    		 —
    		 —
    		 —
    		 1,807
    		 1,807
    Acquisition of noncontrolling interests—
    		 —
    		 —
    		 (1,191) —
    		 —
    		 (348) (1,539)
    Transfer from noncontrolling interests—
    		 —
    		 —
    		 (275) —
    		 —
    		 275
    		 —
    Preferred stock exchange(30) (21) 810
    		 (39,896) 95,460
    		 —
    		 —
    		 56,323
    Comprehensive income: 
    		  
    		  
    		  
    		  
    		  
    		  
    		  
    Net income (loss)—
    		 —
    		 —
    		 —
    		 7,763
    		 —
    		 (491) 7,272
    Other comprehensive loss—
    		 —
    		 —
    		 —
    		 —
    		 (1,144) —
    		 (1,144)
    Total comprehensive income—
    		 —
    		 —
    		 —
    		 —
    		 —
    		 —
    		 6,128
    Balance, December 31, 2011$—
    		 $—
    		 $913
    		 $746,276
    		 $(803,400) $3,267
    		 $188
    		 $(52,756)
                   Continued



    See notes to consolidated financial statements.
    22
    25


    NOVASTAR FINANCIAL, INC.
    CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT
    (dollars in thousands, except share amounts)
     
      Total NovaStar Financial, Inc. Shareholders’ Deficit        
         Convertible           Accumulated          
      Redeemable Participating    Additional     Other       Total
      Preferred Preferred Common Paid-in Accumulated Comprehensive     Noncontrolling Shareholders’
       Stock  Stock  Stock  Capital  Deficit  Income  Other  Interest  Deficit
    Balance, January 1, 2009 $30 $21 $94 $786,279 $(1,671,984) $8,926  $(139) $-  $(876,773)
    Forgiveness of founder’s
       notes receivable    		  -  -  -  -  -   -   69   -   69 
    Compensation recognized
       under     stock compensation
       plans
    		  -  -  -  710  -   -   -   -   710 
    Accumulating dividends on
       preferred stock    		  -  -  -  -  (15,312)  -   -   -   (15,312)
    Contribution from
       noncontrolling interests    		  -  -  -  -  -   -   -   525   525 
    Noncontrolling interests
       from acquisitions    		  -  -  -  -  -   -   -   1,200   1,200 
    Comprehensive loss:                                
       Net loss  -  -  -  -  (181,102)  -   -   (2,054)  (183,156)
       Other comprehensive
          loss    		  -  -  -  -  -   (3,815)  -   -   (3,815)
          Total comprehensive
             loss    		  -  -  -  -  -   -   -   -   (186,971)
    Balance,
       December 31, 2009    		 $30 $21 $94 $786,989 $(1,868,398) $5,111  $(70) $(329) $(1,076,552)
     
     Total NFI Shareholders’ Deficit    
     
    Redeemable
    Preferred
    Stock
    		 
    Convertible
    Participating
    Preferred
    Stock
    		 
    Common
    Stock
    		 
    Additional
    Paid-in
    Capital
    		 
    Accumulated
    Deficit
    		 
    Accumulated
    Other
    Comprehensive
    Income
    		 Other 
    Noncontrolling
    Interest
    		 
    Total
    Shareholders’
    Deficit
    Balance, December 31, 2009$30
    		 $21
    		 $94
    		 $786,989
    		 $(1,868,398) $5,111
    		 $(70) $(329) $(1,076,552)
    Forgiveness of founder’s promissory notes—
    		 —
    		 —
    		 —
    		 —
    		 —
    		 70
    		 —
    		 70
    Compensation recognized under stock compensation plans—
    		 —
    		 —
    		 374
    		 —
    		 —
    		 —
    		 —
    		 374
    Accumulating dividends on preferred stock—
    		 —
    		 —
    		 —
    		 (16,499) —
    		 —
    		 —
    		 (16,499)
    Distributions to noncontrolling interests—
    		 —
    		 —
    		 —
    		 —
    		 —
    		 —
    		 (388) (388)
    Noncontrolling interests from acquisitions—
    		 —
    		 —
    		 —
    		 —
    		 —
    		 —
    		 1,498
    		 1,498
    Comprehensive income: 
    		  
    		  
    		  
    		  
    		  
    		  
    		  
    		  
    Net income (loss)—
    		 —
    		 —
    		 —
    		 986,702
    		 —
    		 —
    		 (1,048) 985,654
    Other comprehensive loss—
    		 —
    		 —
    		 —
    		 —
    		 (700) —
    		 —
    		 (700)
    Total comprehensive income—
    		 —
    		 —
    		 —
    		 —
    		 —
    		 —
    		 —
    		 984,954
    Balance, December 31, 2010$30
    		 $21
    		 $94
    		 $787,363
    		 $(898,195) $4,411
    		 $—
    		 $(267) $(106,543)
                      
    See notes to consolidated financial statements.             Concluded


    See notes to consolidated financial statements.
    23
    26


     Total NovaStar Financial, Inc. Shareholders’ Deficit        
        Convertible           Accumulated            
     Redeemable Participating    Additional     Other         Total
     Preferred Preferred Common Paid-in Accumulated Comprehensive     Noncontrolling Shareholders’
     Stock  Stock  Stock  Capital  Deficit  Income  Other  Interest   Deficit
    Balance, January 1, 2010$30 $21 $94 $786,989 $(1,868,398) $5,111  $(70) $(329) $(1,076,552)
    Forgiveness of founder’s
       notes receivable
    		 -  -  -  -  -   -   70   -   70 
    Compensation recognized
       under stock compensation
       plans
    		 -  -  -  374  -   -   -   -   374 
    Accumulating dividends on
       preferred stock
    		 -  -  -  -  (16,499)  -   -   -   (16,499)
    Distributions to
       noncontrolling interests
    		 -  -  -  -  -   -   -   (388)  (388)
    Noncontrolling interests
       from acquisitions
    		 -  -  -  -  -   -   -   1,498   1,498 
    Comprehensive loss:                               
       Net income (loss) -  -  -  -  986,702       -   (1,048)  985,654 
       Other comprehensive
          loss
    		 -  -  -  -  -   (700)  -   -   (700)
          Total comprehensive
             loss
    		 -  -  -  -  -   -   -   -   984,954 
    Balance,
       December 31, 2010
    		$30��$21 $94 $787,363 $(898,195) $4,411  $-  $(267) $(106,543)
      
      
    See notes to consolidated financial statements.                   Concluded
    NOVASTAR FINANCIAL, INC.
    CONSOLIDATED STATEMENTS OF CASH FLOWS
    (dollars in thousands)
     For the Year Ended
    December 31,
     2011 2010
    Cash flows from operating activities:   
    Net income$7,272
    		 $985,654
    Adjustments to reconcile net income to net cash provided by operating activities:   
    Accretion of mortgage securities(2,689) (4,001)
    (Recovery) provision for bad debt on notes receivable(540) 746
    Amortization of premiums on mortgage loans—
    		 430
    Amortization of deferred debt issuance costs and senior debt discount1,568
    		 597
    Provision for credit losses—
    		 17,433
    Fair value adjustments of trading securities, CDO debt and contingent consideration(855) (1,068)
    Gain on derecognition of securitization trusts—
    		 (993,131)
    Gains on derivative instruments—
    		 (26)
    Loss on disposal of property and equipment203
    		 6
    Forgiveness of founders' promissory notes—
    		 70
    Compensation recognized under stock compensation plans284
    		 374
    Depreciation expense1,991
    		 937
    Changes in, exclusive of the effects of acquisitions:
    		  
    Accrued interest receivable—
    		 1,300
    Restricted cash(1,802) —
    Service fee receivable(4,883) (1,056)
    Other current assets and liabilities, net(473) (219)
    Other noncurrent assets and liabilities, net(709) 1,555
    Due to servicer—
    		 (5,080)
    Deferred revenue632
    		 491
    Accounts payable and accrued expenses2,390
    		 1,603
    Net cash provided by operating activities2,389
    		 6,615
        
    Cash flows from investing activities:   
    Proceeds from paydowns of mortgage securities2,035
    		 5,355
    Proceeds from repayments of mortgage loans held-in-portfolio—
    		 15,040
    Proceeds from sales of assets acquired through foreclosure—
    		 15,154
    Restricted cash, net303
    		 3,940
    Proceeds from notes receivable1,440
    		 500
    Proceeds from sale of property and equipment87
    		 —
    Issuance of notes receivable(224) (657)
    Purchases of property and equipment(2,248) (496)
    Acquisition of noncontrolling interest(509) —
    Acquisition of business, net of cash acquired(559) (4,198)
    Net cash (used in) provided by investing activities325
    		 34,638
        
    Cash flows from financing activities:   
    Payments on asset-backed bonds—
    		 (35,341)
    Distributions to noncontrolling interests(788) (388)
    Payments to preferred stockholders for preferred stock exchange(3,005) —
    Other—
    		 (46)
    Net cash used in financing activities(3,793) (35,775)
    Net (decrease) increase in cash and cash equivalents(1,079) 5,478
    Cash and cash equivalents, beginning of period12,582
    		 7,104
    Cash and cash equivalents, end of period$11,503
    		 $12,582
        
       Continued

    27
    24


    NOVASTAR FINANCIAL, INC.
    CONSOLIDATED STATEMENTS OF CASH FLOWS
    (dollars in thousands)
      For the Year Ended December 31,
          2010     2009
    Cash flows from operating activities:        
    Net income (loss) $985,654  $(183,156)
    Adjustments to reconcile net income (loss) to net cash used in operating        
    activities:        
         Impairment on mortgage securities – available-for-sale  -   1,198 
         (Gain) Loss on derivative instruments  (26)  4,665 
         Depreciation expense  937   869 
         Amortization of deferred debt issuance costs  597   2,239 
         Compensation recognized under stock compensation plans  374   710 
         Provision for credit losses  17,433   260,860 
         Amortization of premiums on mortgage loans  430   2,443 
         Interest capitalized on loans held-in-portfolio  -   (1,550)
         Gain on derecognition of securitization trusts             (993,131)  - 
         Forgiveness of founders’ promissory notes  70   69 
         Provision for bad debt on notes receivable  746   - 
         Fair value adjustments of trading securities and CDO debt  (1,068)  6,743 
         Accretion of mortgage securities  (4,001)  (23,528)
         Other  6   - 
         Changes, net of impact of business acquisitions, in:        
              Accrued interest receivable  1,300   3,267 
              Service fee receivable  (1,056)  (749)
              Other assets and other liabilities  1,827   (3,421)
              Due to servicer  (5,080)  19,220 
              Accounts payable and accrued expenses  1,603   (21,566)
              Net cash (used in) provided by operating activities from continuing        
                   operations  6,615   68,313 
              Net cash used in operating activities from discontinued operations  -   (1,095)
              Net cash (used in) provided by operating activities  6,615   67,218 
             
    Cash flows from investing activities:        
    Proceeds from paydowns of mortgage securities  5,355   18,479 
    Proceeds from mortgage loans held-in-portfolio  15,040   98,933 
    Proceeds from sales of assets acquired through foreclosure  15,154   129,815 
    Restricted cash proceeds, net  3,940   705 
    Issuance of notes receivable  (657)  - 
    Proceeds from notes receivable  500   - 
    Purchases of property and equipment  (496)  (1,324)
    Proceeds from disposal of property and equipment  -   6 
    Acquisition of businesses, including contingent consideration paid, net of        
         cash acquired  (4,198)  2 
         Net cash provided by investing activities from continuing operations  34,638              246,616 
    Supplemental Disclosure of Cash Flow Information
    (dollars in thousands)
     For the Year Ended December 31,
     2011 2010
    Cash paid for interest$2,986
    		 $4,272
    Cash paid for income taxes—
    		 170
    Cash received on mortgage securities - available-for-sale with no cost basis7,646
    		 7,503
    Non-cash investing and financing activities:   
    Assets acquired through foreclosure—
    		 6,283
    Exchange of noncontrolling interests' notes receivable for contingent earnings payout—
    		 366
    Preferred stock dividends accrued, subsequently eliminated8,428
    		 16,499
    Obligations incurred in purchase transactions1,330
    		 —
    Transfer of assets and liabilities upon derecognition of securitization trusts:   
    Mortgage loans - held-in-portfolio, net of allowance—
    		 1,250,287
    Accrued interest receivable—
    		 72,725
    Real estate owned—
    		 55,309
    Asset-backed bonds secured by mortgage loans—
    		 2,235,633
    Due to servicer—
    		 131,772
    Other liabilities—
    		 4,047
    Exchange of redeemable preferred stock and convertible participating preferred stock:   
    Elimination of accrued dividends59,328
    		 —
    Cancellation of redeemable preferred stock30
    		 —
    Cancellation of convertible participating preferred stock21
    		 —
    Issuance of common stock810
    		 —
    Decrease of additional paid-in capital39,896
    		 —
    Decrease of accumulated deficit95,460
    		 —
        
    See notes to consolidated financial statements.  Concluded


    Continued
    25
    28


      For the Year Ended December 31,
          2010     2009
    Cash flows from financing activities:        
    Payments on asset-backed bonds  (35,341)  (331,670)
    (Distributions to) Contributions from noncontrolling interest  (388)  150 
    Other  (46)  - 
         Net cash used in financing activities from continuing operations              (35,775)              (331,520)
    Net decrease in cash and cash equivalents  5,478   (17,686)
    Cash and cash equivalents, beginning of year  7,104   24,790 
    Cash and cash equivalents, end of year $12,582  $7,104 
     
     
    SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
    (dollars in thousands)
          For the Year Ended December 31,
      2010     2009
    Cash paid for interest $4,272  $33,726 
    Cash refunded for income taxes  170   38 
    Cash received on mortgage securities – available-for-sale with no cost        
             basis
    		  7,503   1,872 
    Non-cash investing and financing activities:        
         Assets acquired through foreclosure  6,283   123,190 
         Exchange of noncontrolling interests’ notes receivable for contingent        
             earnings payout
    		  366   - 
         Preferred stock dividends accrued, not yet paid  16,499               15,312 
         Transfer of assets and liabilities upon derecognition of securitization trusts:        
             Mortgage loans – held-in-portfolio, net of allowance  1,250,287   - 
             Accrued interest receivable
    		  72,725   - 
             Real estate owned
    		  55,309   - 
             Asset-backed bonds secured by mortgage loans
    		         2,235,633   - 
             Due to servicer
    		  131,772   - 
             Other liabilities
    		  4,047   - 

    See notes to consolidated financial statements.Concluded

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    NOVASTAR FINANCIAL, INC.
    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

    Note 1. Basis of Presentation, Business Plan and Liquidity

    Description of Operations – NovaStar Financial, Inc. and its subsidiaries (“NFI” or the “Company”) currently own 88%approximately 93% of StreetLinks LLC (“StreetLinks”), a national residential appraisal and mortgage real estate valuation management services company. The Company owned 88% of StreetLinks as of December 31, 2011. See Note 19 to the consolidated financial statements for a discussion of the Company's recent acquisition of approximately 5% additional equity interest of StreetLinks. StreetLinks charges a fee for services which is collected from lenders and borrowers. The majority of StreetLinks business is generated from the management of the appraisal process for its customers. Most of the fee is passed through to independent residential appraisers. StreetLinks retains a portion of the fee to cover its costs of managing the process of fulfilling the appraisal order and performing a quality control review of all appraisals. StreetLinks also provides other real estate valuation management services, such as field reviews and value validation.

    The Company owns 74%78% of Advent Financial Services, LLC (“Advent”). The Company originally purchased 70% of Advent,Advent; the additional 4%8% was acquired upon termination of employees’ that heldsubsequently from noncontrolling interests during 2010.interest holders. Advent, provides financial settlement services, along with its distribution partners, provides financial settlement services, mainly throughfor income tax preparation businesses, and also provides access to tailored banking accounts, small dollar banking products and related services to meet the needs of low and moderate income level individuals. Advent is not a bank, but it acts as an intermediary for thesebanking products on behalf of other banking institutions.

    A primary distribution channel of Advent’s bank products is by way of settlement services to electronic income tax return originators. Advent provides a process for the originators to collect refunds from the Internal Revenue Service, distribute fees to various service providers and deliver the net refund to individuals. Individuals may elect to have the net refund dollars depositdeposited to a bank account offered through Advent. Individuals also have the option to have the net refund dollars paid by check or to an existing bank account. Regardless of the settlement method, Advent receives a fee from the originator for providing the settlement service. Advent also distributes its banking products via other methods, including through employers and employer service organizations. Advent receives fees from banking institutions and from the bank account owner for services related to the use of the funds deposited to Advent-offered bank accounts.

    On October 17, 2011, the Company purchased 51% of the equity of Build My Move, LLC ("BMM") for $1.7 million plus future obligations to make additional capital contributions to BMM of up to $0.7 million. BMM changed its name to Mango Moving, LLC ("Mango") subsequent to the Company's purchase. Mango is a start-up, Internet-based company in the “asset-light” third-party logistics provider market, with the goal of providing high-quality local and long distance residential and other moving services at a price less than other major national van lines. See Note 4 to the consolidated financial statements for additional details.
    During 2011, we completed the exchange of all outstanding shares of our preferred stock for an aggregate of 80,985,600 shares of newly-issued common stock and $3.0 million in cash. See Note 3 to the consolidated financial statements for additional details.

    During 2011, the Company completed an exchange of its junior subordinated debentures for senior debentures ("Debt Exchange"). See Note 9 to the consolidated financial statements for further details.
    During 2010, StreetLinks completed the acquisition of 51% of Corvisa, LLC (“Corvisa”). Corvisa is a technology company that develops and markets its software products to mortgage lenders. Its primary product is a self-managed appraisal solution for lenders to manage their appraisal process. Other products include analytical tools for the lender to manage their mortgage origination business. During the fourth quarter of 2011, StreetLinks acquired the remaining 49% noncontrolling owner interests and now owns 100% of Corvisa. In exchange for the minority owner interests, StreetLinks paid $0.5 million in cash at the time of exchange with an additional $0.5 million payable no later than one year from the exchange date and is also obligated to make $1.2 million in payments to the former minority owners on or before June 30, 2014 if revenues from the Corvisa technology products exceed certain thresholds. We have recorded a liability for the contingent consideration under the terms of the acquisition.

    Prior to 2009,2010, the Company originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage-backedmortgage backed securities. The Company retained, through itsowns mortgage securities investment portfolio, significant interests inwhich we retained during the nonconforming loans it originated and purchased, and through its servicing platform, serviced all ofsecuritization process. See Note 5 to the loans in which it retained interests. The Company continues to hold nonconforming residential mortgageconsolidated financial statements for additional details about these securities.

    During January of 2010, certain events occurred that required the Company to reconsider the accounting for three consolidated loan trusts – NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1.trusts. Upon reconsideration, the Company determined that all requirements for derecognition were met under applicable accounting guidelines at the time of the reconsideration event. As a result, the Company derecognized the assets and liabilities of the trusts on January 25, 2010 and recorded a gain during the year ended December 31, 2010 of $993.1 million. These transactions are discussed in greater detail inSee Note 418 to the consolidated financial statements. The Company’s collateralized debt obligation (“CDO”) is the only trust that is consolidated in the financial statements as of December 31, 2010.for additional details about these transactions.

    Financial Statement Presentation– – The Company’s consolidated financial statements have been prepared in conformity with

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    accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the period. The Company uses estimates and judgments in establishing the fair value of its mortgage securities, notes receivable, goodwill, CDO debt and in estimating appropriate accrual rates on mortgage securities – available-for-sale to recognize interest income. While the consolidated financial statements and footnotes reflect the best estimates and judgments of management at the time, actual results could differ significantly from those estimates.

    The consolidated financial statements of the Company include the accounts of all wholly-owned and majority-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

    Business Plan – As discussed above, the Company acquired a majority interest in StreetLinks, an appraisal and real estate valuation management services company during the third quarter of 2008 and increased its ownership percentage in the fourth quarter of 2009. In addition, the Company acquired a majority interest in Advent, a financial services company offering low cost banking products and services, in April 2009. In November 2010, StreetLinks acquired 51% of Corvisa, a technology company that develops and markets its software products to mortgage lenders. Management continues to grow and develop these operating entities. Additionally, the Company will continue to focus on minimizing expenses, preserving liquidity, and exploring additional investments in operating companies.
    30

    Liquidity – The Company had $12.6 million in cash and cash equivalents as of December 31, 2010, which was an increase of $5.5 million from December 31, 2009. In addition to the Company’s operating expenses, the Company has quarterly interest payments due on its junior subordinated debt. The Company’s current projections indicate sufficient available cash and cash flows from StreetLinks and its mortgage securities to meet these payment needs.
    The Company continues its strategy of growing and developing StreetLinks and significantly increasing its appraisal volume. For the year ended December 31, 2010, StreetLinks had revenues of $75.2 million as compared to $31.1 million for the year ended December 31, 2009. StreetLinks had significant growth during 2010 compared to 2009 as new customers were rapidly added. Infrastructure changes and added efficiencies gained through automation have decreased selling, general and administrative expenses relative to the increased production.
    During 2010, the Company received $12.9 million in cash on our mortgage securities portfolio, compared to $18.5 million in 2009. During 2010, the Company used cash to pay for corporate and administrative costs, the contingent consideration payments related to the StreetLinks acquisition and the investment in Corvisa of $1.5 million.
    As of December 31, 2010, the Company had a working capital deficiency of $35.9 million. This was mainly attributable to dividends payable of $50.9 million being classified as a current liability, although the Company does not expect to pay the dividends due to management’s effort to conserve cash. The accrued and unpaid dividends would be eliminated through the recapitalization of the 8.90% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (the “Series C Preferred Stock”) and the 9.00% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 (the “Series D1 Preferred Stock”). See Note 19 to the consolidated financial statements for further details.
    The Company’s consolidated financial statements have been prepared on a going concern basis of accounting which contemplates continuity of operations, realization of assets, liabilities and commitments in the normal course of business. The Company has experienced significant losses over the past several years and has a significant deficit in shareholders’ equity. Notwithstanding these negative factors, management believes that its current operations and its cash availability are sufficient for the Company to discharge its liabilities and meet its commitments in the normal course of business.
    Note 2. Summary of Significant Accounting and Reporting Policies

    Cash and Cash Equivalents and Restricted Cash.The Company considers Cash equivalents consist of liquid investments with an original maturitiesmaturity of three months or lessless. Amounts due from banks and credit card companies of $0.5 million and $0.2 million for the settlement of credit card transactions are included in cash and cash equivalents as of December 31, 2011 and 2010, respectively, as they are generally collected within three business days. Cash equivalents are stated at the date of purchase to be cash equivalents.cost, which approximates fair value. Restricted cash includes funds the Company is required to post as cash collateral or transfer to escrow accounts and its release is subject to contractual requirements and time restrictions. The cash may not be released to the Company without the consent of the counterparties, which is generally at their discretion. The cash could also be subject to the indemnification of losses incurred by the counterparties. Current restrictedRestricted cash is included in the restricted cash line item of the consolidated balance sheets and noncurrent restricted cash of $1.1 million and $1.4 million is included in the other current assets line item of the consolidated balance sheets noncurrent restricted cash is included in the other assets, noncurrent line itemas of the consolidated balance sheets.December 31, 2011 and 2010, respectively.

    The Company maintains cash balances at several major financial institutions in the United States. Accounts at each institution are secured by the Federal Deposit Insurance Corporation up to $250,000 through December 31, 2013. At December 31, 20102011 and 2009,2010, 73% and 86% and 41%, respectively, of the Company’s cash and cash equivalents, including restricted cash, were with one institution. The uninsured balances of the Company’s unrestricted cash and cash equivalents and restricted cash aggregated $12.9$11.8 million and $11.3$12.9 million as of December 31, 20102011 and 2009,2010, respectively.

    Revenue Recognition.Service fee revenues consist primarily of fees for real estate valuation management services provided by StreetLinks. FeesStreetLinks, financial settlement services provided by Advent and logistics fees for moving services provided by Mango. Service fee revenues are recognized in the period in which the product is delivered or the service provided to and accepted by the customer. Deferred revenue is recorded when payments are received in advance of performing our service obligations and is recognized in accordance with the above criteria. When the Company is the principal in its transactions with customers, service fee revenues are recorded on a gross basis. Otherwise, service fee revenues are recorded on a net basis.

    Cost of Services. Cost of Services includes the cost of the appraisal,direct costs to provide services to customers, which is paidare payments to an independent party,parties, and the internal costs directly associated with completing the appraisal order. The internalcustomer orders. Internal costs include compensation and benefits of certain employees, occupancy costs, depreciation of equipment used in the production process, and other expenses necessary to the production process.process, such as compensation and benefits of employees, occupancy costs and depreciation of equipment.

    Earnings Per Share (“EPS”). Basic EPS excludes dilution and is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is calculated assuming all options, nonvested shares and performance based awards on the Company's common stock have been exercised, unless the exercise would be antidilutive.
    As a result of the convertible participating preferred stock being considered participating securities, earnings per share is calculated under the two-class method, which requires disclosure of the more dilutive earnings per share result between the treasury method calculation and the two-class method calculation. For the year ended December 31, 2011, earnings per share was calculated using the treasury method which included the Series D Preferred Stock assumed to be converted to 1,875,000 shares of Common Stock that shared in distributions with common shareholders on a 1:1 basis through the date of the Recapitalization. For the year ended December 31, 2010, the two-class method calculation was more dilutive; therefore, earnings per share is presented following the two-class method which includes convertible participating preferred stock assumed to be converted to 1,875,000 shares of common stock that share in distributions with common shareholders on a 1:1 basis. See Note 15 to the consolidated financial statements for additional details on earnings per share calculation.
    Notes Receivable and Allowance for Doubtful Accounts. To maximize the use of our excess cash, we have made loans to independent entities. The borrowing entity used the proceeds to finance on-going and current operations. Notes receivable are considered delinquent, based on current information and events, if it is probable that we will be unable to collect all amounts due that are contractually obligated. The Company determines the required allowance for doubtful accounts using information such as the borrower’s financial condition and economic trends and conditions. Recognition of income is suspendedSee additional details in Note 6 to the consolidated financial statements.

    Service Fee Receivable and the loan is placed on non-accrual status when management determines that collection of future income is not probable. Accrual is resumed, and previously suspended income is recognized, when the loan becomes contractually current and/or collection doubts are removed. Cash receipts on impaired loans or finance leases are recorded against the receivable and then to any unrecognized income.Allowance for Doubtful Accounts.
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    The Company determines the requiredmaintains an allowance for doubtful accounts using information such as the status of the note, borrower’s financial conditionat an amount estimated to cover potential uncollectible losses. Management analyzes receivables and historical bad debts,

    27


    current economic trends and conditions.conditions, and the length of time receivables are past due in order to establish the allowance for doubtful accounts. The past due or delinquency status of a receivable is based on the contractual payment terms of the receivable, which are generally due within ten to fifteen days for customers that the Company extends credit. All other amounts are due and collected at the time the service is rendered. Reserves for individual accounts are recorded when the Company becomes aware of specific customer circumstances, such as bankruptcy filings, deterioration in the customer’s operating results or financial position, or potential unfavorable outcomes from disputes with customers. The Company charges off uncollectible notesservice fees receivable when repayment of contractually-obligated amounts is not deemed to be probable. There were no amounts charged off during the years ended December 31, 2010 or 2009. Due to the low number of notes receivable, the Company evaluates each note individually for collectability. As a result of this review, there were additional provisions made for credit losses of $0.7 million and $0.3 million during the years ended December 31, 2010 and 2009, respectively. As the Company only has a minimal number of notes receivable and the notes are due from companies, the Company does not analyze its notes receivable by class or by credit quality indicator.
    The Company has a note receivable due from an entity with which we are currently in litigation. The balance of this note receivable was $4.4 million and $3.0 million as of December 31, 2010 and 2009, respectively. This note receivable could become completely impaired dependent upon the outcome of the litigation and the financial means of the entity to repay the note.
    As of December 31, 2010, the remaining $0.6 million of notes receivable was 90 days or more past due and still accruing.
    Activity in the allowance for credit losses on notes receivable is as follows for the year ended December 31, 2010 and 2009, respectively (dollars in thousands):
          2010     2009
    Balance, beginning of period $300 $-
    Provision for credit losses  747  300
    Balance, end of period $    1,047 $    300
           

    The Company had no modifications of notes receivable agreements for the years ended December 31, 2010 or 2009.
    Mortgage Securities – Available-for-Sale.Mortgage securities – available-for-sale represent beneficial interests the Company retains in securitization and resecuritization transactions which includeconsist of residual interests (the “residual securities”). The residual securities include interest-only mortgage securities, prepayment penalty bonds and overcollateralization bonds. The subordinated securities represent investment-grade and non-investment grade rated bonds which are senior to the residual interests but subordinated to the bonds sold to third party investors. Mortgage securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. To the extent that the cost basis of mortgage securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. The specific identification method was used in computing realized gains or losses.

    As previously described, mortgage securities-available-for-sale represent retained beneficial interests in certain components of the cash flows of the underlying mortgage loans to securitization trusts. As payments are received on both the residual and subordinated securities, the payments are applied to the cost basis of the related mortgage securities. Each period, the accretable yield for each mortgage security is evaluated and, to the extent there has been a change in the estimated cash flows, it is adjusted and applied prospectively. The estimated cash flows change as management’s assumptions for credit losses, borrower prepayments and interest rates are updated. The assumptions are established using proprietary models the Company has developed. The accretable yield is recorded as interest income with a corresponding increase to the carrying basis of the mortgage security.

    The Company estimates the fair value of its residual securities retained based on the present value of future expected cash flows to be received. Management’s best estimate of key assumptions, including credit losses, prepayment speeds, market discount rates and forward yield curves commensurate with the risks involved, are used in estimating future cash flows.

    Mortgage Securities – Trading.Mortgage securities – trading consist of mortgage securities purchased by the Company as well as retained by the Company in its securitization transactions. Trading securities are recorded at fair value with gains and losses, realized and unrealized, included in earnings. The Company uses the specific identification method in computing realized gains or losses.
    Mortgage Securities – Trading consisted of four residual securities along with subordinated securities as of December 31, 2010 and one residual security at December 31, 2009 and subordinated securities.

    The Company estimates fair value for the subordinated securities based on quoted market prices obtained from brokers which are compared to internal discounted cash flows.

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    Goodwill. Goodwill represents cost in excess of fair values assigned to the underlying net assets of acquired businesses. The goodwill is currently allocated to the Company’s appraisal management reporting unit and is tested for impairment at least annually or more frequently, when a triggering event occurs. Goodwill is tested for impairment using a two-step process that begins with an estimation of fair value. The first step compares the estimated fair value of StreetLinks,the reporting unit, with its carrying amount, including goodwill. If the estimated fair value exceeds its carrying amount, goodwill is not considered impaired. However, if the carrying amount exceeds its estimated fair value, a second step would be performed that would compare the implied fair value to the carrying amount of goodwill. An impairment loss would be recorded in the consolidated statement of operations to the extent that the carrying amount of goodwill exceeds its implied fair value and recorded in other expense in the statement of operations.value. The impairment test in 2011 and 2010 indicated that there was a significant excess of fair value over the carrying amount and no impairment was incurred.

    Income Taxes. The Company has a deferred tax asset of $286.4 million and $294.7 million as of December 31, 2011 and 2010, respectively. However, the Company has recorded a full valuation allowance against the deferred tax assets. In determining the amount of deferred tax assets to recognize in the financial statements, the Company evaluates the likelihood of realizing such benefits in future periods. The income taxes guidance requires the recognition of a valuation allowance if it is more likely than not that all or some portion of the deferred tax asset will not be realized. Income taxes guidance indicates the more likely than not threshold is a level of likelihood that is more than 50%.

    Under the income taxes guidance, companies are required to identify and consider all available evidence, both positive and negative, in determining whether it is more likely than not that all or some portion of its deferred tax assets will not be realized. Positive evidence includes, but is not limited to the following: cumulative earnings in recent years, earnings expected in future years, excess appreciated asset value over the tax basis and positive industry trends. Negative evidence includes, but is not limited to the following: cumulative losses in recent years, losses expected in future years, a history of operating losses or tax credit carryforwards expiring, and adverse industry trends.

    The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. Accordingly, the more negative evidence that exists requires more positive evidence to counter, thus making it more difficult to support a conclusion that a valuation allowance is not needed for all or some of the deferred tax assets. Cumulative losses in recent years are significant negative evidence that is difficult to overcome when determining the need for a valuation allowance. Similarly, cumulative earnings in recent years represent significant positive objective evidence. If the weight of the positive evidence is sufficient to support a conclusion that it is more likely than not that a deferred tax asset will

    28


    be realized, a valuation allowance should not be recorded.

    The Company examines and weighs all available evidence (both positive and negative and both historical and forecasted) in the process of determining whether it is more likely than not that a deferred tax asset will be realized. The Company considers the relevancy of historical and forecasted evidence when there has been a significant change in circumstances. Additionally, the Company evaluates the realization of its recorded deferred tax assets on an interim and annual basis. The Company does not record a valuation allowance if the weight of the positive evidence exceeds the negative evidence and is sufficient to support a conclusion that it is more likely than not that its deferred tax asset will be realized.

    If the weighted positive evidence is not sufficient to support a conclusion that it is more likely than not that all or some of the Company’sCompany's deferred tax assets will be realized, the Company considers all alternative sources of taxable income identified in determining the amount of valuation allowance to be recorded. Alternative sources of taxable income identified in the income taxes guidance include the following: 1) taxable income in prior carryback year, 2) future reversals of existing taxable temporary differences, 3) future taxable income exclusive of reversing temporary differences and carryforwards, and 4) tax planning strategies.

    The Company currently evaluates estimates of uncertainty in income taxes based upon a framework established in the income tax accounting guidance. The guidance prescribes a recognition threshold and measurement standard for the recognition and measurement of tax positions taken or expected to be taken in a tax return. In accordance with the guidance, the Company evaluates whether a tax position taken by the company will “moremore likely than not”not be sustained upon examination by the appropriate taxing authority. The companyCompany measures the amount of benefit to recognize in its financial statements as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. ItThe recognition and measurement of tax benefits is often judgmental, and determinations regarding the Company’s policy to recognize interest and penalties related to income tax matters in income tax expense (benefit).
    Earnings Per Share (“EPS”). Basic EPS excludes dilution and is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that couldbenefit can change as additional developments occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is calculated assuming all options, restricted stock and performance based awards on the Company’s common stock have been exercised, unless the exercise would be antidilutive.
    As a result of the convertible participating preferred stock being considered participating securities, earnings per share is calculated under the two-class method, which is discussed in the Earnings per Share accounting guidance. In determining the number of diluted shares outstanding, the guidance requires disclosure of the more dilutive earnings per share result between the if-converted method calculation and the two-class method calculation. For the year ended December 31, 2010, the two-class method calculation was more dilutive; therefore, earnings per share is presented following the two-class method which includes convertible participating preferred stock assumed to be converted to 1,875,000 shares of common stock that share in distributions with common shareholders on a 1:1 basis. For the year ended December 31, 2009, as the convertible participating preferred stockholders do not have an obligation to participate in losses, no allocation of undistributed losses was necessary.
    Mortgage Loans. Mortgage loans include loans originated by the Company and acquired from other originators. Mortgage loans are recorded net of deferred loan origination fees and associated direct costs and are stated at amortized cost. Mortgage loan origination fees and associated direct mortgage loan origination costs on mortgage loans held-in-portfolio are deferred and recognized over the estimated life of the loan as an adjustment to yield using the effective yield method. The Company uses actual and estimated cash flows, which consider the actual and future estimated prepayments of the loans, to derive an effective level yield.
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    Interest is recognized as revenue when earned accordingrelative to the terms of the mortgage loans and when, in the opinion of management, it is collectible. For all mortgage loans that do not carry mortgage insurance, the accrual of interest on loans is discontinued when, in management’s opinion, the interest is not collectible in the normal course of business, but in no case beyond when a loan becomes 90 days delinquent. For mortgage loans that do carry mortgage insurance, the accrual of interest is only discontinued when in management’s opinion, the interest is not collectible. Interest collected on non-accrual loans is recognized as income upon receipt.issue.

    The mortgage loan portfolio is collectively evaluated for impairment as the individual loans are smaller-balance and are homogeneous in nature. For mortgage loans held-in-portfolio, the Company maintains an allowance for credit losses inherent in the portfolio at the consolidated balance sheet dates. The allowance is based upon the assessment by management of various factors affecting its mortgage loan portfolio, including current economic conditions, the makeup of the portfolio based on credit grade, loan-to-value, delinquency status, historical credit losses, whether the Company purchased mortgage insurance and other factors deemed to warrant consideration. The allowance is maintained through ongoing adjustments to operating income. The assumptions used by management regarding key economic indicators are highly uncertain and involve a great deal of judgment.
    An internally developed migration analysis is the primary tool used in analyzing the adequacy of the allowance for credit losses. This tool takes into consideration historical information regarding foreclosure and loss severity experience and applies that information to the portfolio at the reporting date. Management also takes into consideration the use of mortgage insurance as a method of managing credit risk. The Company pays mortgage insurance premiums on loans maintained on the consolidated balance sheets and includes the cost of mortgage insurance in the consolidated statements of income.
    Management’s estimate of expected losses could increase if the actual loss experience is different than originally estimated. In addition, the estimate of expected losses could increase if economic factors change the value that can be reasonably expected to obtain from the sale of the property. If actual losses increase, or if amounts reasonably expected to be obtained from property sales decrease, the provision for losses would increase.
    Real Estate Owned. Real Estate Owned, which consists of residential real estate acquired in satisfaction of loans, is carried at the lower of cost or estimated fair value less estimated selling costs. Adjustments to the loan carrying value required at time of foreclosure are charged against the allowance for credit losses. Costs related to the development of real estate are capitalized and those related to holding the property are expensed. Losses or gains from the ultimate disposition of Real Estate Owned are charged or credited to earnings.
    Premiums for Mortgage Loan Insurance. The Company uses lender paid mortgage insurance to mitigate the risk of loss on loans that are originated. For those loans held-in-portfolio, the premiums for mortgage insurance are expensed by the Company as the costs of the premiums are incurred. For those loans sold in securitization transactions accounted for as a sale, the independent trust assumes the obligation to pay the premiums and obtains the right to receive insurance proceeds.
    Due to Servicer. Principal and interest payments (the “monthly repayment obligations”) on asset-backed bonds secured by mortgage loans recorded on the Company’s consolidated balance sheets are remitted to bondholders on a monthly basis by the securitization trust (the “remittance period”). Funds used for the monthly repayment obligations are based on the monthly scheduled principal and interest payments of the underlying mortgage loan collateral, as well as actual principal and interest collections from borrower prepayments. When a borrower defaults on a scheduled principal and interest payment, the servicer must advance the scheduled principal and interest to the securitization trust to satisfy the monthly repayment obligations. The servicer must continue to advance all delinquent scheduled principal and interest payments each remittance period until the loan is liquidated. Upon liquidation, the servicer may recover their advance through the liquidation proceeds. During the period the servicer has advanced funds to a securitization trust which the Company accounts for as a financing, the Company records a liability representing the funds due back to the servicer.
    New Accounting Pronouncements

    In June 2009,April 2011, the Financial Accounting Standards Board (“FASB”("FASB") issued StatementA Creditor's Determination of Financial Accounting Standards (“SFAS”) No. 166, Whether a Restructuring is a Troubled Debt RestructuringAccounting. The update provides additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. The amendments in the update are effective for the Transfers of Financial Assets, an Amendment of FASB Statement No. 140; this statement was codified in December 2009 as Accounting Standards Codification (“ASC”) 860. This guidance is effective for financial asset transfersfirst interim period beginning on January 1, 2010or after June 15, 2011, and willshould be usedapplied retrospectively to determine whether the transfer is accounted for as a sale under GAAP or as a secured borrowing. In addition, also in June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46 (R); this statement was also codified in December 2009 as ASC 810 and governs the consolidation of variable interest entities. The consolidation guidance became effective for all variable interest entities (each a “VIE”) the Company held as of January 1, 2010. As partbeginning of the Company’s adoptionannual period of the amended consolidation guidance, it was required to reconsider the Company’s previous consolidation conclusions pertaining to the Company’s variable interests in VIEs, including: (i) whether an entity is a VIE; and (ii) whether the Company is the primary beneficiary. Based on the Company’s assessment of its involvement in VIEs at January 1, 2010, in accordance with the amended consolidation guidance, the Company determined that it is not the primary beneficiary of any mortgage loan securitization entities in which it held a variable interest, as the Company does not have the power to direct the activities that most significantly impact the economic performance of these entities. The adoption of the amended consolidationadoption. This guidance did not result in the Company consolidating or deconsolidating any VIEs for which it has involvement. It should be noted, however, that the new guidance also required the Company to reassess these conclusions, based upon changes in the facts and circumstances pertaining to the Company’s VIEs,have a significant impact on an ongoing basis; thus, the Company’s assessments may therefore change and could result in a material impact to the Company’s financial statements during subsequent reporting periods. The Company re-evaluated the NHEL 2006-1, NHEL 2006-MTA1, and NHEL 2007-1 securitization transactions and determined that based on the occurrence of certain events during January 2010, the application of the amended guidance resulted in the Company reflecting as sales of financial assets and extinguishment of liabilities the assets and liabilities of the securitization trusts during the at that date. As a result, the Company derecognized the assets and liabilities of the NHEL 2006-1, NHEL 2006-MTA1, and NHEL 2007-1 securitization trusts and recorded a gain during the year ended December 31, 2010. See Note 4 to theits consolidated financial statements for further details.statements.

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    In July 2010,May 2011, the FASB issued DisclosuresAmendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The update provides common requirements for measuring fair value and for disclosing information about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The guidance significantly expands the disclosures that companies must make about the credit quality of financing receivables and the allowance for credit losses. The disclosures asfair value measurements, including a consistent meaning of the endterm “fair value,” which will provide greater comparability of fair value measurements presented and disclosed in financial statements. The amendments in the reporting period became effective for the Company’s interim and annual periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting periodupdate are effective for the Company’s interim and annual periods beginning on or after December 15, 2010.2011, and therefore will be applicable to the Company for the first quarter of 2012. The objectivesCompany does not believe that this guidance will have a significant impact on its consolidated financial statements.

    In June 2011, the FASB issued Presentation of Comprehensive Income, which revises how entities present comprehensive income in their financial statements.  The guidance updates the presentation requirements for reporting the components of comprehensive income and requires that it is reported in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements.  In a continuous statement of comprehensive income, an entity would be required to present the components of the enhanced disclosures areincome statement as presented today, along with the components of other comprehensive income.  In the two-statement approach, an entity would be required to provide financialpresent a statement usersthat is consistent with additional information about the natureincome statement format used today, along with a second statement, which would immediately follow the income statement that would include the components of credit risks inherentother comprehensive income. In December 2011, the FASB deferred the requirement to present components of reclassifications of other comprehensive income on the face of the income statement that had previously been included in the Company’s financing receivables, how credit riskJune 2011 amended standard. The guidance is analyzed and assessed when determining the allowanceeffective for credit losses, and the reasons for the change in the allowance for credit losses.periods beginning after December 15, 2011. The adoption of this guidance requires enhanced disclosures and didwill not have a significant effectimpact on the Company’sCompany's financial statements. See “Notes Receivable
    In September 2011, the FASB issued Testing for Goodwill Impairment, which amends previous guidance, to allow companies the option of performing a qualitative assessment before completing step one of the impairment test, calculating the fair value of the reporting unit. If the Company determines on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not greater than the carrying amount, the two-step impairment test would not be required. The amendments are effective for interim and Allowanceannual goodwill impairment tests performed for Doubtful Accounts” section abovefiscal years beginning after December 15, 2011. The Company does not believe the adoption of this standard will have a material impact on its financial statements.

    Note 3. Recapitalization of Preferred Stock.

    Series D Exchange. On June 23, 2011, the Company completed the exchange of all outstanding shares of the Company's 9.0% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 per share (the "Series D Preferred Stock"), for an aggregate of 37,162,000 shares of newly-issued Common Stock and $1.4 million in cash. Completion of this exchange eliminated the required disclosures.Series D Preferred Stock and Company's obligations with respect to outstanding and future preferred dividends and the preferred liquidating preference related to the Series D Preferred Stock. Immediately before the exchange, as of June 23, 2011,

    29


    there were accrued and unpaid dividends of approximately $34.5 million on the Series D Preferred Stock and the aggregate liquidating preference was $52.5 million.

    The shares of Common Stock issued in the exchange were issued pursuant to an exemption from registration under Regulation D of the Securities Act of 1933, as amended, and therefore are "restricted securities." The Company entered into a registration rights agreement with the holders of Series D Preferred Stock (the "Series D Holders") which obligates the Company to register the Common Stock when the restrictions are lifted.

    Series C Offer. On June 27, 2011, the Company completed the exchange offer for all the outstanding shares of the 8.90% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (the "Series C Preferred Stock"), for an aggregate of 43,823,600 shares of Common Stock and $1.6 million of cash. Completion of the transaction eliminated the Series C Preferred Stock and the Company's obligations with respect to outstanding and future preferred dividends and the preferred liquidating preference related to the Series C Preferred Stock. Immediately before the exchange, as of June 27, 2011, there were accrued and unpaid dividends of approximately $24.8 million on the Series C Preferred Stock and the aggregate liquidating preference was $74.8 million.

    Note 4. Business Combinations and Consolidation
     
    Note 3. Business CombinationsOn October 17, 2011, pursuant to the terms of a Unit Purchase Agreement between the Company and Build My Move, LLC (“BMM”), the Company acquired 51% of the fully diluted membership interests in BMM. BMM is a start-up, Internet-based company in the “asset-light” third party logistics provider market, with the goal of providing high-quality local and long distance residential and other moving services at a price less than other major national van lines. The Company purchased Class C units of BMM, having preferred distribution, liquidation and management rights, in exchange for a purchase price of $1.7 million and, upon the occurrence of certain conditions related to BMM's financial condition and its contractual obligations, the Company has the obligation to make additional capital contributions to BMM up to $0.7 million. The additional capital contribution includes a contingent consideration obligation of up to $0.3 million, which could be payable to a former employee upon compliance with the separation agreement. The full $0.3 million is included in the accrued expenses line item of the consolidated financial statements. BMM changed its name to Mango Moving, LLC ("Mango") on October 21, 2011. The acquisition of Mango allows the Company to enter a new industry along with taking advantage of synergies from sales, technology and other administrative functions. While Mango is in a different industry than StreetLinks, these businesses share similarities. They are both vendor management services using proprietary technology. StreetLinks manages a base of appraiser vendors whereas Mango manages bases of moving labor and trucking vendors. Much of the technology developed for StreetLinks is applicable to the business of Mango. Additionally, the Company's extensive experience in managing customer service centers also applies to Mango. The Company's centralized technology and administrative functions allows the sharing of resources across all entities, saving time and costs.

    On November 4, 2010, StreetLinks completed the acquisition of 51% of Corvisa, LLC (“Corvisa”). Corvisa is a technology company that develops and markets its software products to mortgage lenders. Its primary product is a self-managed appraisal solution for lenders to manage their appraisal process. Other products include analytical tools for the lender to manage their mortgage origination business. The purchase price was comprised of $1.5 million of cash, plus contingent consideration related to an earn-out opportunity based on future net income. The amount of the future payments that the Company could be required to make under the earn-out opportunity iswas $0.6 million, with the understanding that the targets must be achieved by December 31, 2012. This earn-out opportunity was canceled as part of the acquisition of the remaining 49% Corvisa noncontrolling interest, see additional details below. The acquisition of Corvisa and its technology has allowed us to offer other analytical tools for lenders to manage their mortgage origination business.

    On November 10, 2011, StreetLinks acquired the remaining 49% noncontrolling owner interests in Corvisa, LLC ("Corvisa") and now owns 100% of Corvisa. In exchange for the minority owner interests, StreetLinks paid $0.5 million in cash at the time of exchange with an additional $0.5 million payable no later than one year from the exchange date and is also obligated to make $1.2 million in payments to the former minority owners on or before June 30, 2014 if revenues from the Corvisa technology products exceed certain thresholds. We have recorded a liability of $0.9 million for the estimated contingent consideration under the terms of the acquisition and it is recorded in the noncurrent liabilities line item of the consolidated balance sheet. The effects of this transaction were recorded through shareholders' deficit in accordance with the relative consolidation guidance.

    The purchase price for the Mango and Corvisa acquisition hasacquisitions have been allocated based on the assessment of the fair value of the assets acquired and liabilities assumed, determined based on the Company’s internal operational assessments and other analyses which are Level 3 measurements. Pro forma disclosure requirements have not been included as they are not considered significant. The Company’s financial statements include the results of operation of Mango and Corvisa from the datedates of acquisition. Revenues and earnings since the acquisition dates during the respective year of acquisition are not considered material to the Company's financial results. All legal and other related acquisition costs were expensed as incurred and recorded in the selling, general and administrative expense line item of the consolidated statements of operation, and were not material.


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    A summary of the aggregate amounts of the assets acquired and liabilities assumed and the aggregate consideration paid for Mango for the year ended December 31, 2011 and Corvisa for the year ended December 31, 2010 follows (dollars in thousands):
     For the Year Ended
    December 31,
     2011 2010
    Assets:   
    Cash$1,141
    		 $107
    Service fee receivable, net92
    		 —
    Other current assets115
    		 50
    Property and equipment, net801
    		 3,465
    Goodwill2,166
    		 —
    Other noncurrent assets61
    		 —
    Liabilities:   
    Accounts payable(197) (131)
    Accrued expenses(503) (34)
    Other current liabilities(19) —
    Other noncurrent liabilities(150) (459)
    Noncontrolling interests(1,807) (1,498)
    Total cash consideration$1,700
    		 $1,500
        
          Total
    Assets:    
         Cash $107 
         Other current assets  50 
         Property and equipment, net  3,465 
    Liabilities:    
         Accounts payable  (131)
         Accrued expenses  (34)
         Other noncurrent liabilities  (459)
         Noncontrolling interests  (1,498)
         Total cash consideration $    1,500 
         


    See Note 13 to the consolidated financial statements regarding contingent consideration payment on a prior year acquisition.
    Note 4. Derecognition of Securitization Trusts
    During January of 2010, certain events occurred that required the Company to reconsider the accounting for three consolidated loan trusts: NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1.
    During the first quarter of 2010, the Company attempted to sell the mezzanine-level bonds the Company owns from the NHEL 2006-1 and NHEL 2006-MTA1 securitization trusts. No bids were received for the bonds, which prompted a reconsideration of the Company’s conclusion with respect to the trusts’ consolidation. As all requirements for derecognition have been met under applicable accounting guidelines, the Company derecognized the assets and liabilities of the NHEL 2006-1 and NHEL 2006-MTA1 trusts as of January 25, 2010.
    35

    During January of 2010, the final derivative of the NHEL 2007-1 loan securitization trust expired. The expiration of this derivative is a reconsideration event. As all requirements for derecognition have been met under applicable accounting guidelines, the Company derecognized the assets and liabilities of the 2007-1 securitization trust as of January 25, 2010.
    The securitized loans in these derecognized trusts have suffered substantial losses and through the date of derecognition the Company recorded significant allowances for these losses. These losses have created large accumulated deficits for the trust balance sheets. Upon derecognition, all assets, liabilities and accumulated deficits were removed from our consolidated financial statements. A gain of $993.1 million was recognized upon derecognition, representing the net accumulated deficits in these trusts.
    The assets and liabilities of the securitization trusts and the resulting gain recognized upon derecognition consisted of the following at the time of the reconsideration event (dollars in thousands):
          Total
    Assets:    
         Mortgage loans – held-in-portfolio $    1,953,188 
         Allowance for loan losses  (702,901)
         Accrued interest receivable  72,725 
         Real estate owned  55,309 
    Total assets  1,378,321 
         
    Liabilities:    
         Asset-backed bonds secured by mortgage loans  2,235,633 
         Due to servicer  131,772 
         Other liabilities  4,047 
    Total liabilities  2,371,452 
         
         Gain on derecognition of securitization trusts $993,131 
         

    Note 5. Mortgage Loans – Held-in-Portfolio and Securitization Transactions
    Mortgage loans – held-in-portfolio, all of which are secured by residential properties, consisted of the following as of December 31, 2009 (dollars in thousands):
      December 31,
          2009
    Mortgage loans – held-in-portfolio (A):    
         Outstanding principal $    1,985,483 
         Net unamortized deferred origination costs  16,605 
         Amortized cost  2,002,088 
         Allowance for credit losses  (712,614)
         Mortgage loans – held-in-portfolio $1,289,474 
         Weighted average coupon  6.94%
         
    (A)The Company did not hold any mortgage loans-held-in-portfolio as of December 31, 2010 due to the derecognition of the securitization trusts, see Note 4 to the consolidated financial statements for further details.
    As of December 31, 2009, mortgage loans held-in-portfolio consisted of loans that the Company had securitized in structures that were accounted for as financings. These securitizations were structured legally as sales, but for accounting purposes were treated as financings under the “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” guidance. See below for details of the Company’s securitization transactions that were structured as financings.
    At inception, the NHEL 2006-1 and NHEL 2006-MTA1 securitizations did not meet the qualifying special purpose entity criteria necessary for derecognition because after the loans were securitized the securitization trusts were able to acquire derivatives relating to beneficial interests retained by the Company; additionally, the Company had the unilateral ability to repurchase a limited number of loans back from the trusts. The NHEL 2007-1 securitization did not meet the qualifying special purpose entity criteria necessary for derecognition because of the excessive benefit the Company received at inception from the derivative instruments delivered into the trust to counteract interest rate risk.
    36

    Accordingly, the loans in these securitizations remained on the balance sheet as “Mortgage loans – held-in-portfolio” through January 2010. Given this treatment, retained interests were not created, and securitization bond financing were reflected on the balance sheet as a liability. The Company recorded interest income on loans held-in-portfolio and interest expense on the bonds issued in the securitizations. Deferred debt issuance costs and discounts related to the bonds were amortized on a level yield basis over the estimated life of the bonds.
    Mortgage loans – held-in-portfolio are serviced by a third party entity. There was not a significant number or amount of servicer modified loans during the year ended December 31, 2010 due to the derecognition of securitization trusts, see Note 4 to the consolidated financial statements for further details. During the year ended December 31, 2009, the servicer modified loans totaling $230.0 million in principal with weighted-average interest rates of 8.59% and 4.87% before and after modification, respectively. The modifications are offered to borrowers experiencing financial difficulties and serve to reduce monthly payments and defer unpaid interest. The Company’s estimates for the allowance for loan losses and related provision include the projected impact of the modified loans.
    At December 31, 2009 all of the loans classified as held-in-portfolio were pledged as collateral for financing purposes.
    The table below presents quantitative information about delinquencies, net credit losses, and components of securitized financial assets and other assets managed together with them (dollars in thousands):
      For the Year Ended December 31, 2009
         Principal Amount of   
      Total Principal Amount of Loans 60 Days or More   
          Loans (A)     Past Due     Net Credit Losses (B)
    Loans securitized $6,570,308 $3,296,863 $735,892
    Loans held-in-portfolio  2,138,500  1,243,731  321,097
    Total loans securitized or held-         
    in-portfolio $8,708,808 $4,540,594 $1,056,989
              
    (A)Includes assets acquired through foreclosure.
    (B)Represents the realized losses as reported by the securitization trusts for each period presented.

    Collateral for 25% and 23% of the mortgage loans held-in-portfolio outstanding as of December 31, 2009 was located in California and Florida, respectively. Interest only loan products made up 10% of the loans classified as held-in-portfolio as of December 31, 2009. In addition, as of December 31, 2009, moving treasury average (“MTA”) loan products made up 26% of the loans classified as held-in-portfolio. These MTA loans had $1.6 million in negative amortization during 2009. The Company has no other significant concentration of credit risk on mortgage loans.
    Mortgage loans – held-in-portfolio that the Company has placed on non-accrual status totaled $712.6 million at December 31, 2009. At December 31, 2009 the Company had $433.4 million in mortgage loans – held-in-portfolio past due 90 days or more, which were still accruing interest. These loans carried mortgage insurance and the accrual will be discontinued when in management’s opinion the interest is not collectible.
    Activity in the allowance for credit losses on mortgage loans – held-in-portfolio is as follows for the year ended December 31, 2010 and 2009, respectively (dollars in thousands):
          2010     2009
    Balance, beginning of period $    712,614  $    776,001 
    Provision for credit losses  17,433   260,860 
    Charge-offs, net of recoveries  (27,146)  (324,247)
    Derecognition of the securitization trusts  (702,901)  - 
    Balance, end of period $-  $712,614 
             

    Certain tables below present the assets and liabilities of consolidated and unconsolidated VIEs in which the Company has a variable interest in the VIE. For consolidated VIEs, these amounts are net of intercompany balances. The tables also present the Company’s exposure to loss resulting from its involvement with consolidated VIEs and unconsolidated VIEs in which the Company holds a variable interest as of December 31, 2010 and December 31, 2009. The Company’s maximum exposure to loss is based on the unlikely event that all of the assets in the VIEs become worthless.
    37

    The Company’s only continued involvement, relating to these transactions, is retaining interests in the VIEs which are included in the mortgage securities line item in the consolidated financial statements.
    For the purposes of this disclosure, transactions with VIEs are categorized as follows:
    Securitization transactions. Securitization transactions include transactions where the Company transferred mortgage loans and accounted for the transfer as a sale and thus are not consolidated. This category is reflected in the securitization section of this Note.
    Mortgage Loan VIEs. The Company initially consolidated securitization transactions that are structured legally as sales, but for accounting purposes are treated as financings as defined by the previous FASB guidance. The NHEL 2006-1 and NHEL 2006-MTA1 securitizations, at inception, did not meet the criteria necessary for derecognition under the previous FASB guidance and related interpretations because after the loans were securitized the securitization trusts were able to acquire derivatives relating to beneficial interests retained by the Company; additionally, the Company had the unilateral ability to repurchase a limited number of loans back from the trust. These provisions were removed effective September 30, 2008. Since the removal of these provisions did not substantively change the transactions’ economics, the original accounting conclusion remained the same. During January 2010, certain events occurred that required the Company to reconsider the accounting for these mortgage loan VIEs. Upon reconsideration, the Company determined that all requirements for derecognition were met under applicable accounting guidelines at the time of the reconsideration event. As a result, the Company derecognized the assets and liabilities of the trusts and these mortgage loan VIEs are now considered securitization transactions. See Note 4 to the consolidated financial statements for further details.
    At inception, the NHEL 2007-1 securitization did not meet the qualifying special purpose entity criteria necessary for derecognition under the previous FASB guidance and related interpretations because of the excessive benefit the Company received at inception from the derivative instruments delivered into the trust to counteract interest rate risk. During January 2010, certain events occurred that required the Company to reconsider the accounting for this mortgage loan VIE. Upon reconsideration, the Company determined that all requirements for derecognition were met under applicable accounting guidelines at the time of the reconsideration event. As a result, the Company derecognized the assets and liabilities of the trust and this mortgage loan VIE is now considered a securitization transaction. See Note 4 to the consolidated financial statements for further details.
    These transactions must be re-assessed during each quarterly period and could require reconsolidation and related disclosures in future periods. The Company has no control over the mortgage loans held by these VIEs due to their legal structure. The beneficial interest holders in these trusts have no recourse to the general credit of the Company; rather, their investments are paid exclusively from the assets in the trust.
    Collateralized Debt Obligations. The collateral for the Company’s CDO transaction consisted of subordinated securities which the Company retained from its securitization transactions as well as subordinated securities purchased from other issuers. The CDO was structured legally as a sale, but for accounting purposes was accounted for as a financing as it did not meet the qualifying special purpose entity criteria under the applicable accounting guidance. Accordingly, the securities remain on the Company’s consolidated balance sheet, retained interests were not created, and securitization bond financing replaced the short-term debt used to finance the securities. In accordance with Consolidation accounting guidance, the Company is required to re-assess during each quarterly period and the Company determined that it should continue to be consolidated.
    Variable Interest Entities
    The Consolidation accounting guidance requires an entity to consolidate a VIE if that entity is considered the primary beneficiary. VIEs are required to be reassessed for consolidation when reconsideration events occur. See Mortgage Loan VIEs above for details relating to current period reconsideration events.
    The table below provides the disclosure information required for VIEs that are consolidated by the Company (dollars in thousands):
         Assets After Intercompany Liabilities After  
         Eliminations Intercompany Recourse to the
    Consolidated VIEs     Total Assets     Unrestricted     Restricted (A)     Eliminations     Company (B)
    December 31, 2010               
         CDO(C) $1,499 $- $1,497 $1,497 $-
    December 31, 2009               
         Mortgage Loan VIEs(D) $    1,435,671 $- $1,427,501 $2,453,181 $-
         CDO(C)  1,389  -  1,387  1,387  -
                    
    (A)Assets are considered restricted when they cannot be freely pledged or sold by the Company.

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    (B)This column reflects the extent, if any, to which investors have recourse to the Company beyond the assets held by the VIE and assumes a total loss of the assets held by the VIE.
    (C)For the CDO, assets are primarily recorded in “Mortgage securities” and “Other current assets” and liabilities are recorded in “Other current liabilities.”
    (D)For Mortgage Loan VIEs, assets are primarily recorded in “Mortgage loans – held-in-portfolio.” Liabilities are primarily recorded in “Asset-backed bonds secured by mortgage assets.”
    Securitization Transactions
    Prior to changes in its business in 2007, the Company securitized residential nonconforming mortgage loans. The Company’s involvement with VIEs that are used to securitize financial assets consists of holding securities issued by VIEs.
    The following table relates to securitizations where the Company is the retained interest holder of assets issued by the entity (dollars in thousands):
      Size/Principal Assets on Liabilities on Maximum Year to Year to
      Outstanding Balance Balance Exposure to Date Loss Date Cash
          (A)     Sheet (B)     Sheet     Loss(C)     on Sale     Flows
    December 31, 2010 $     7,189,121(D) $     4,580 $- $4,580 $- $     11,362
    December 31, 2009  6,570,308   7,031 $-  7,031 $-  15,867
                        
    (A)Size/Principal Outstanding reflects the estimated principal of the underlying assets held by the VIE.
    (B)Assets on balance sheet are securities issued by the entity which are recorded in “Mortgage securities.”
    (C)The maximum exposure to loss assumes a total loss on the retained interests held by the Company.
    (D)Due to derecognition of securitization trusts during the year ended December 31, 2010, size/principal outstanding includes NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1 as of December 31, 2010.

    Retained interests are recorded in the consolidated balance sheet at fair value within mortgage securities. The Company estimates fair value based on the present value of expected future cash flows using management’s best estimates of credit losses, prepayment rates, forward yield curves, and discount rates, commensurate with the risks involved. Retained interests are either held as trading securities, with changes in fair value recorded in the consolidated statements of operations, or as available-for-sale securities, with changes in fair value included in accumulated other comprehensive income.
    The following table presents information on retained interests held by the Company as of December 31, 2010 arising from the Company’s residential mortgage-related securitization transactions. The pre-tax sensitivities of the current fair value of the retained interests to immediate 10% and 25% adverse changes in assumptions and parameters are also shown (dollars in thousands):
             
    Carrying amount/fair value of residual interests $    4,580 
    Weighted average life (in years)  2.73 
    Weighted average prepayment speed assumption (CPR) (percent)  13.6 
         Fair value after a 10% increase in prepayment speed $4,249 
         Fair value after a 25% increase in prepayment speed $3,820 
    Weighted average expected annual credit losses (percent of current collateral balance)  25.7 
         Fair value after a 10% increase in annual credit losses $4,379 
         Fair value after a 25% increase in annual credit losses $4,100 
    Weighted average residual cash flows discount rate (percent)  25.0%
         Fair value after a 500 basis point increase in discount rate $4,461 
         Fair value after a 1000 basis point increase in discount rate $4,347 
    Market interest rates:    
         Fair value after a 100 basis point increase in market rates $3,401 
         Fair value after a 200 basis point increase in market rates $2,053 
         

    The preceding sensitivity analysis is hypothetical and should be used with caution. In particular, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independent of changes in any other assumption; in practice, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Further, changes in fair value based on a 10% or 25% variation in an assumption or parameter generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear.
    39

    Note 6.5. Mortgage Securities

    Mortgage securities consist of $3.9 million of securities classified as available-for-sale and trading as of December 31, 2011. As of December 31, 2010, mortgage securities consisted of $4.6 million of available-for-sale securities and $1.2 million of securities classified as trading.

    As of December 31, 2009.
      December 31,
          2010     2009
    Mortgage securities – available-for-sale $     4,580 $     6,903
    Mortgage securities – trading  1,198  1,087
    Total mortgage securities $5,778 $7,990
           

    As of December 31,2011 and 2010, mortgage securities – available-for-sale consisted entirely of the Company’sCompany's investment in the residual securities issued by securitization trusts sponsored by the Company, but did not include the NHEL 2006-1, NHEL 2006-MTA1, NHEL 2007-1, and NMFT Series 2007-2 residual securities, which were designated as trading. As of December 31, 2009, mortgage securities – available-for-sale consisted entirely of the Company’s investment in the residual securities issued by securitization trusts sponsored by the Company, but did not include the NMFT Series 2007-2 residual security, which was designated as trading.Company. Residual securities consist of interest-only, prepayment penalty and overcollateralization bonds. Management estimatesSee Note 13 to the consolidated financial statements for details on the Company's fair value of the residual securities by discounting the expected future cash flows of the collateral and bonds.methodology.

    The following table presents certain information on the Company’sCompany's portfolio of mortgage securities – available-for-sale as of December 31, 20102011 and December 31, 20092010 (dollars in thousands):
         Unrealized Estimated Fair Average
          Cost Basis     Gain     Value     Yield (A)
    As of December 31, 2010 $169 $4,411 $4,580 483.2%
    As of December 31, 2009  1,792  5,111  6,903 132.9 
                 
     Cost Basis Unrealized Gain Estimated Fair Value Average Yield (A)
    December 31, 2011611
    		 3,267
    		 3,878
    		 237.0%
    December 31, 2010169
    		 4,411
    		 4,580
    		 483.2
            
    (A)
    (A)The average yield is calculated from the cost basis of the mortgage securities and does not give effect to changes in fair value that are reflected as a component of shareholders’shareholders' deficit.


    During the year ended December 31, 2009, management concluded that the decline in value on certain securities in the Company’sThere were no other-than-temporary impairments relating to mortgage securities – available-for-sale portfolio were other-than-temporary. As a result,for the Company recognized impairments on mortgage securities – available-for-sale of $1.2 million during the yearyears ended December 31, 2009. There were no impairments for the year ended December 31, 2010.2011 and 2010.

    Maturities of mortgage securities owned by the Company depend on repayment characteristics and experience of the underlying financial instruments.

    The Company's mortgage securities – trading were valued at zero as of December 31, 2011. As of December 31, 2010, mortgage securities – trading consisted of the NHEL 2006-1, NHEL 2006-MTA1, NHEL 2007-1, and NMFT Series 2007-2 residual securities and subordinated securities retained by the Company from securitization transactions as well as subordinated securities purchased from other issuers in the open market. As of December 31, 2009, mortgage securities – trading consisted of the NMFT Series 2007-2 residual security and subordinated securities retained by the Company from securitization transactions as well as subordinated securities purchased from other issuers in the open market. Management estimates the fair value of the residual securities by discounting the expected future cash flows of the collateral and bonds. The fair value of the subordinated securities is estimated based on quoted broker prices which are compared to internal discounted cash flows. Refer to Note 1113 for a description of the valuation methods as of December 31, 20102011 and December 31, 2009.2010.

    The following table summarizes the Company’sCompany's mortgage securities – trading as of December 31, 2010 and December 31, 2009 (dollars in thousands):
         Amortized Cost    Average
          Original Face     Basis     Fair Value     Yield (A)
    As of December 31, 2010            
    Subordinated securities pledged to CDO $369,507 $73,900 $1,198   
    Other subordinated securities  215,280  -  -   
    Total $584,787 $73,900 $1,198 1.96%
                 
    As of December 31, 2009            
    Subordinated securities pledged to CDO $332,489 $103,638 $959   
    Other subordinated securities  102,625  -  -   
    Residual securities  -  374  128   
    Total $435,114 $104,012 $1,087 4.79%
                 
    (A)Calculated from the ending fair value of the securities.

    40
    31


     Original Face     Amortized Cost Basis     Fair Value     Average Yield (A)
    As of December 31, 2010       
    Subordinated securities pledged to CDO$369,507
    		 $73,900
    		 $1,198
    		  
    Other subordinated securities215,280
    		 —
    		 —
    		  
    Total$584,787
    		 $73,900
    		 $1,198
    		 1.96%
      
    		  
    		  
    		  
    (A) Calculated from the ending fair value of the securities.

    The Company recognized net trading losses of $0.2$1.4 million and $0.2 million for the yearyears ended December 31, 2011 and 2010 as compared to net trading losses of $11.8 million for the year ended December 31, 2009., respectively. These net trading lossesamounts are included in the other expense line on the Company’sCompany's consolidated statements of operations.

    Note 6. Notes Receivable and Allowance for Doubtful Accounts

    The Company has made loans to independent entities that have used the proceeds to finance current and on-going operations. Notes receivable are considered impaired, based on current information and events, if it is probable that we will be unable to collect all amounts due that are contractually obligated. The Company determines the required allowance for doubtful accounts using information such as the borrower's financial condition and economic trends and conditions. Recognition of income is suspended and the loan is placed on non-accrual status when management determines that collection of future income is not probable. Accrual is resumed, and previously suspended income is recognized, when the loan becomes contractually current and/or collection doubts are removed. Cash receipts on impaired loans are recorded against the receivable and then to any unrecognized income.
    The Company writes off uncollectible notes receivable when repayment of contractually-obligated amounts is not deemed to be probable. There was $0.5 million charge off, which had previously been reserved, during the year ended December 31, 2011 and there were no amounts written off during the year ended December 31, 2010. Due to the low number of notes receivable, the Company evaluates each note individually for collectability rather than analyzing by class or credit quality indicator. As a result of this review, there were (recoveries) provisions made for credit losses of $(0.5) million and $0.7 million for the years ended December 31, 2011 and 2010, respectively. Along with the extension of repayment terms and additional borrowings, the Company had one modification of a note receivable agreement for the year ended December 31, 2011, see details in the following paragraph. The Company had no modifications of notes receivable agreements for the year ended December 31, 2010.
    The Company has a note receivable due from an entity with which it was previously in litigation. As discussed in Note 10 to the consolidated financial statements, during 2011 the Company agreed to settle the litigation. Pursuant to the settlement, approximately $1.3 million of the amount due under the note was paid at the time of settlement. A modification to the settlement was reached in February 2012, $1.5 million was paid at the time of the modification and the remaining note balance of approximately $1.1 million plus an additional $0.1 million will be due in February 2013. In addition to the $1.5 million included in notes receivable as of December 31, 2011, the Company has a net receivable of $1.1 million in other assets, $1.2 million of principal net of a $0.1 million discount which will be recognized straight line until its due date in February 2013.
    The remaining $0.7 million of notes receivable outstanding as of December 31, 2011 was classified as current. As of December 31, 2010, the remaining $0.6 million of notes receivable was 90 days or more past due and still accruing interest.
    Activity in the allowance for credit losses on notes receivable is as follows for the years ended December 31, 2011 and 2010 (dollars in thousands):
     For the Year Ended
    December 31,
     2011 2010
    Balance, beginning of period$1,047
    		 $300
    (Recovery) provision for credit losses(540) 747
    Write-offs(507) —
    Balance, end of period$—
    		 $1,047
        

    Note 7. Property and Equipment, Net

    All of the Company's property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets. The estimated useful lives of the assets that are leasehold improvements, lesser of 5 years or remaining lease term, furniture and fixtures, 5 years, office and computer equipment, 3 to 5 years, and software, 3 years.

    Maintenance and repairs are charged to expense. Major renewals and improvements are capitalized. Gains and losses on

    32


    dispositions are credited or charged to earnings as incurred. Depreciation and amortization expense relating to property and equipment was $2.0 million and $0.9 million for the years ended December 31, 2011 and 2010, respectively.

    The following table shows the Company's property and equipment, net as of December 31, 2011 and December 31, 2010 (dollars in thousands):
     December 31,
    2011    		 December 31,
    2010
    Furniture, fixtures and office equipment$1,216
    		 $803
    Hardware and computer equipment2,961
    		 2,148
    Software6,887
    		 5,794
    Leasehold improvements352
    		 258
    Total Cost11,416
    		 9,003
    Less: Accumulated depreciation and amortization(5,827) (4,182)
    Property and equipment, net$5,589
    		 $4,821
     

    Note 8. Goodwill

    Goodwill totaled $5.3 million and $3.2 million as of December 31, 2011 and December 31, 2010, respectively. As part of the purchase price allocation for the acquisition of Mango, $2.2 million was allocated to goodwill during the year ended December 31, 2011. See Note 4 to the consolidated financial statements for further details of the acquisition. During the year ended December 31, 2010, payments of approximately $3.2 million were made to the former majority owners of StreetLinks upon certain earnings targets being achieved. As all consideration paid had previously been assigned to the assets acquired and liabilities assumed, the $3.2 million was recorded as goodwill during the year ended December 31, 2010. There are no remaining contingent consideration payments that could be required for the StreetLinks acquisition.

    Goodwill is tested for impairment at least annually and written down and charged to results of operations only in periods in which the recorded value is more than the estimated fair value. For tax purposes, the goodwill is included in the Company's basis in its investment in Mango and StreetLinks as they are limited liability companies. Therefore, it will be non-deductible for tax purposes as long as the Company holds its investment in Mango and StreetLinks.

    Goodwill activity is as follows for the years ended December 31, 2011 and 2010 (dollars in thousands):
     
    For the Year Ended
    December 31,
     2011 2010
    Balance, beginning of period$3,170
    		 $—
    StreetLinks earnings target payment—
    		 3,170
    Mango acquisition2,166
    		 —
    Balance, end of period$5,336
    		 $3,170
        

    Note 9. Borrowings
     
    Senior Notes –In an effort to improve the Company's liquidity position, on March 22, 2011, the Company entered into agreements that canceled the then existing $78.1 million aggregate principal amount of junior subordinated notes (the “Junior Subordinated Notes”). The Junior Subordinated Notes were replaced by unsecured senior notes pursuant to three indentures (collectively, the “Senior Notes”). The aggregate principal amount of the Senior Debentures is $85.9 million. The Senior Notes accrue interest at a rate of 1% until the earlier of (a) the completion of an equity offering by the Company or its subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”). Interest on the Senior Notes is paid on a quarterly basis and no principal payments are due until the Senior Notes mature on March 30, 2033.

    NFI’sFor accounting purposes the Debt Exchange transactions were considered a modification of a debt instrument as opposed to an extinguishment and new debt. Therefore, the principal amount of the debt will be accreted up to the new principal balance of $85.9 million using the effective interest method, using the effective interest method from the current balance of $79.7 million as of December 31, 2011.

    The indentures governing the Senior Notes (the “Indentures”) contain certain restrictive covenants (the “Negative Covenants”) subject to certain exceptions in the Indentures, including written consent of the holders of the Senior Notes. The Negative Covenants prohibit the Company and its subsidiaries, from among other things, incurring debt, permitting any lien upon any of its

    33


    property or assets, making any cash dividend or distribution or liquidation payment, acquiring shares of the Company or its subsidiaries, making payment on debt securities of the Company that rank pari passu or junior to the Senior Notes, or disposing of any equity interest in its subsidiaries or all or substantially allof the assets of its subsidiaries. At any time that the Senior Notes accrue interest at the Full Rate and the Company satisfies certain financial covenants (the “Financial Covenants”), the Negative Covenants will not apply. Satisfaction of the Financial Covenants requires the Company to demonstrate on a consolidated basis that (1) its Tangible Net Worth is equal to or greater than $40 million, and (2) either (a) the Interest Coverage Ratio is equal to or greater than 1.35x, or (b) the Leverage Ratio is not greater than 95%. The Financial Covenants are not applicable to the Company as of December 31, 2011 as the Senior Notes are not accruing interest at the Full Rate.

    The Company was in compliance with all Negative Covenants as of December 31, 2011.

    Junior Subordinated Notes –Prior to March 22, 2011, NFI's wholly-owned subsidiary NovaStar Mortgage, Inc. (“NMI”) had approximately $78.1 million in principal amount of unsecured notes (collectively, the “Notes”) outstanding to NovaStar Capital Trust I and NovaStar Capital Trust II (collectively, the “Trusts”) which secured trust preferred securities issued by the Trusts. $50.0 million of the principal amount had maturity dates in March 2035 and the remaining $28.1 million had maturity dates in June 2036. NFI had guaranteed NMI's obligations under the Notes. NMI failed to make quarterly interest payments that were due on all payment dates in 2008 and through April 24, 2009 on these Notes.
    On April 24, 2009 (the “Exchange Date”), the parties executed the necessary documents to complete an exchange of the Notes for new preferred obligations. On the Exchange Date, the Company paid interest due through December 31, 2008 in the aggregate amount of $5.3 million. The Notes mature in 2035 and 2036 at which time the total principal amount is due.
    The new preferred obligations required quarterly distributions of interest to the holders at a rate equal to 1.0% per annum beginning January 1, 2009 through December 31, 2009, subject to reset to a variable rate equal toannum. As discussed above, the three-month LIBOR plus 3.5% upon the occurrence of an “Interest Coverage Trigger.” For purposes of the new preferred obligations, an Interest Coverage Trigger occured when the ratio of EBITDA for any quarter ending on or after December 31, 2008 to the product as of the last day of such quarter, of the stated liquidation value of all outstanding Preferred Securities (i) multiplied by 7.5%, (ii) multiplied by 1.5 and (iii) divided by 4, equals or exceeds 1.00 to 1.00. Beginning January 1, 2010 until the earlier of February 18, 2019 or the occurrence of an Interest Coverage Trigger, the unpaid principal amount of the new preferred obligations bore interest at a rate of 1.0% per annum and, thereafter, at a variable rate, reset quarterly, equal to the three-month LIBOR plus 3.5% per annum. The Company did not exceed the Interest Coverage Trigger during the year ended December 31, 2010. See Note 19 for discussion of the Trust Preferred Securities transaction in which theJunior Subordinated Notes were cancelled.exchanged for Senior Notes and the Trusts were dissolved.
     
    Collateralized Debt Obligation Issuance (“CDO”)
    The collateral for the Company’s CDO consists of subordinated securities which– As discussed in Note 18, prior to 2010 the Company retained from its loan securitizations as well as subordinatedexecuted a securitization of mortgage securities purchased from other issuers. This securitization was structured legally asin what is commonly called a sale, but for accounting purposes was accounted for as a financing. This securitization did not meet the qualifying special purpose entity criteria. Accordingly, the securities remain on the Company’s consolidated balance sheets, retained interests were not created, and securitization bond financing replaced the short-term debt used to finance the securities.Collateralized Debt Obligation (“CDO”). The Company records interest income on the securities and interest expense on the bonds issued in the securitization over the lifeliabilities of the relatedCDO had no value as of December 31, 2011, as the CDO is a non-recourse financing and the associated mortgage securities and bonds.
    had no value at December 31, 2011. The Company elected theliabilities were carried at a fair value option for the asset-backed bonds issued from NovaStar ABS CDO I. The election was made for these liabilities to help reduce income statement volatility which otherwise would arise if the accounting method for this debt was not matched with the fair value accounting for the mortgage securities. Fair value is estimated using quoted market prices. The Company recognized fair value adjustments of $1.2 and $5.1 million for the years endedat December 31, 2010, and 2009, respectively, which isare included in the other expense line item on the consolidated statements of operations.
    On January 30, 2008, an event of default occurred under the CDO bond indenture agreement due to the noncompliance of certain overcollateralization tests. As a result, the trustee, upon notice and at the direction of a majority of the secured noteholders, may declare all of the secured notes to be immediately due and payable including accrued and unpaid interest. No such notice has been given as of March 22, 2011. As therecurrent liabilities. There is no recourse to the Company it does not expect any significant impact to its financial condition, cash flows or results of operation as a resultfor the obligations of the event of default.CDO.
     
    Asset-backed Bonds (“ABB”). The Company issued ABB secured by its mortgage loans and ABB secured by its mortgage securities – trading in certain transactions treated as financings as a means for long-term non-recourse financing. For financial reporting purposes, the mortgage loans held-in-portfolio and mortgage securities – trading, as collateral, are recorded as assets of the Company and the ABB are recorded as debt. Interest and principal on each ABB is payable only from principal and interest on the underlying mortgage loans or mortgage securities collateralizing the ABB. Interest rates reset monthly and are indexed to one-month LIBOR. The estimated weighted-average months to maturity are based on estimates and assumptions made by management. The actual maturity may differ from expectations.
    For ABB secured by mortgage loans, the Company retained a “clean up” call option to repay the ABB, and reacquire the mortgage loans, when the remaining unpaid principal balance of the underlying mortgage loans falls below 10% of their original amounts. The Company subsequently sold all of these clean up call rights, to the buyer of its mortgage servicing rights. The Company did retain separate independent rights to require the buyer of its mortgage servicing rights to repurchase loans from the trusts and subsequently sell them to the Company. The Company does not expect to exercise any of the call rights that it retained. The Company had no ABB transactions for the year ended December 31, 2010.
    41
    The following is a summary of outstanding ABB and related loans (dollars in thousands):
      Asset-backed Bonds Mortgage Loans
             Estimated       
             Weighted       
          Weighted Average       
          Average Months     Weighted
      Remaining Interest to Call or Remaining Average
         Principal    Rate    Maturity    Principal    Coupon
    As of December 31, 2010:                
    ABB Secured by Mortgage Securities:                
         NovaStar ABS CDO I $     324,662(A) 0.81% 12   (B)  (B)
     
    As of December 31, 2009:                
    ABB Secured by Mortgage Loans:                
         NHES Series 2006-1 $475,360  0.52% 72 $     399,913  8.03%
         NHES Series 2006-MTA1  602,068  0.48  51  532,696  3.84 
         NHES Series 2007-1  1,201,517  0.50  106  1,052,873  6.99 
         Unamortized debt issuance costs, net  (8,343)            
      $2,270,602             
    ABB Secured by Mortgage Securities:                
         NovaStar ABS CDO I $323,999(A) 0.80% 16   (B)  (B)
     
    (A)The NovaStar ABS CDO I ABB are carried at a fair value of $1.2 million and $1.0 million at December 31, 2010 and 2009, respectively and are included in the other current liabilities line item of the consolidated balance sheets.
    (B)Collateral for the NovaStar ABS CDO I are subordinated mortgage securities.
    The expected repayment requirements relating to the CDO at December 31, 2010 are difficult to estimate as they are based on anticipated receipts from underlying mortgage security collateral. In the event that receipts from the underlying collateral are adversely impacted by credit losses, there could be insufficient receipts available to repay the CDO principal. As there is no recourse to the Company, it only expects to pay out the amounts that it receives from the collateral.
    Note 8. Commitments and Contingencies
    Commitments. The Company leases office space under various operating lease agreements. Rent expense for 2010 and 2009 aggregated $1.3 million and $1.9 million, respectively. At December 31, 2010, future minimum lease commitments under those leases are as follows (dollars in thousands):
     Lease
     Obligations
    2011$      1,406
    2012 969
    2013 723
    2014 73
    2015 -
     $3,171
     

    The Company has sublease agreements for office space formerly occupied by the Company and received approximately $0.6 million and $0.7 million during the years ended December 31, 2010 and 2009, respectively.
    Contingencies
    The Company has a contingent obligation related to a Corvisa earn-out agreement based on future net income of up to $0.6 million, which could be due to the former owners of Corvisa. A liability of $0.5 million, based on management’s estimate of Corvisa achieving its earnings targets, is included in the other liabilities line item of the consolidated balance sheets as of December 31, 2010.
    42

    Pending Litigation.
    The Company is a party to various legal proceedings, all of which, except as set forth below, are of an ordinary, routine nature, including, but not limited to, breach of contract claims, tort claims, and claims for violations of federal and state consumer protection laws. Furthermore, the Company has received indemnification and loan repurchase demands with respect to alleged violations of representations and warranties made in loan sale and securitization agreements. These indemnification and repurchase demands have not resulted in significant losses to the Company and the number of demands has steadily decreased, but such claims could be significant if multiple loans are involved.
    Due to the uncertainty of any potential loss due to pending litigation and due to the Company’s belief that an adverse ruling is not probable for the below-described claims, the Company has not accrued a loss contingency related to the following matters in its consolidated financial statements. Although it is not possible to predict the outcome of any legal proceeding, in the opinion of management, other than those proceedings described in detail below, such proceedings and actions should not, individually, or in the aggregate, have a material adverse effect on the Company’s financial condition and liquidity. However, a material adverse outcome in one or more of these proceedings could have a material adverse impact on the results of operations in a particular quarter or fiscal year.
    On May 21, 2008, a purported class action case was filed in the Supreme Court of the State of New York, New York County, by the New Jersey Carpenters' Health Fund, on behalf of itself and all others similarly situated. Defendants in the case include NovaStar Mortgage Funding Corporation (“NMFC”) and its individual directors, several securitization trusts sponsored by the Company, and several unaffiliated investment banks and credit rating agencies. The case was removed to the United States District Court for the Southern District of New York. On June 16, 2009, the plaintiff filed an amended complaint. Plaintiff seeks monetary damages, alleging that the defendants violated sections 11, 12 and 15 of the Securities Act of 1933 by making allegedly false statements regarding mortgage loans that served as collateral for securities purchased by plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss the plaintiff’s claims. The Court has not ruled on this motion and discovery regarding the plaintiff’s claims has not commenced. The Company cannot provide an estimate of the range of any loss. The Company believes it has meritorious defenses to the case and expects to defend the case vigorously.
    On December 31, 2009, ITS Financial, LLC (“ITS”) filed a complaint against Advent and the Company alleging a breach of contract by Advent for a contract for services related to tax refund anticipation loans and early season loans. ITS does business as Instant Tax Service. The defendants moved the case to the United States District Court for the Southern District of Ohio. The complaint alleges that the Company worked in tandem and as one entity with Advent in all material respects. The complaint also alleges fraud in the inducement, tortious interference by the Company with the contract, breach of good faith and fair dealing, fraudulent and negligent misrepresentation, and liability of the Company by piercing the corporate veil and joint and several liability. The plaintiff references a $3.0 million loan made by the Company to plaintiff and seeks a judgment declaring that this loan be subject to an offset by the plaintiff’s damages. On September 13, 2010, the Court denied the Company’s motion to transfer the case to the United States District Court for the Western District of Missouri, and on September 29, 2010, the Company answered the complaint and made a counterclaim against the plaintiff for plaintiff’s failure to repay the loan. On February 21, 2011, the Company amended its counterclaim, asserting additional claims against the plaintiff. The Company cannot provide an estimate of the range of any loss. The Company believes that the defendants have meritorious defenses to this case and expects to vigorously defend the case and pursue its counterclaims.
    On July 9, 2010 and on February 11, 2011, Cambridge Place Investment Management, Inc. filed complaints in the Suffolk, Massachusetts Superior Court against NMFC and numerous other entities seeking damages on account of losses associated with residential mortgage-backed securities purchased by plaintiff’s assignors. The complaints allege untrue statements and omissions of material facts relating to loan underwriting and credit enhancement. The complaints also allege a violation of Section 410 of the Massachusetts Uniform Securities Act, (Chapter 110A of the Massachusetts General Laws). Defendants have removed the first case to the United States District Court for the District of Massachusetts, and plaintiff has filed a motion to remand the case back to state court. This litigation is in its early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that it has meritorious defenses to these claims and expects that the cases will be defended vigorously.
    On or about July 16, 2010, NovaStar Mortgage, Inc. received a “Purchasers’ Notice of Election to Void Sale of Securities” regarding NovaStar Mortgage Funding Trust Series 2005-4 from the Federal Home Loan Bank of Chicago. The notice was allegedly addressed to several entities including NovaStar Mortgage, Inc. and NMFC. The notice alleges joint and several liability for a rescission of the purchase of a $15.0 million security pursuant to Illinois Securities Law, 815 ILCS section 5/13(A). The notice does not specify the factual basis for the claim, and no legal action to enforce the claim has been filed The Company will assess its defense to the claim if and when the factual basis and additional information supporting the claim is provided.
    Note 9. Shareholders’ Equity
    To preserve liquidity, the Company’s Board of Directors has suspended the payment of dividends on its Series C Preferred Stock and its Series D1 Preferred Stock. As a result, dividends continue to accrue on the Series C Preferred Stock and Series D1 Preferred Stock. Total accrued dividends payable related to the Series C Preferred Stock and Series D1 Preferred Stock were $50.9 million and $34.4 million as of December 31, 2010 and 2009, respectively. All accrued and unpaid dividends on the Company’s preferred stock must be paid prior to any payments of dividends or other distributions on the Company’s common stock. In addition, since dividends on the Series C Preferred Stock were in arrears for six or more quarterly periods (whether or not consecutive), the holders of the Series C Preferred Stock, voting as a single class, elected two additional directors to the Company’s Board of Directors, as described below. The Company does not expect to pay the dividends due to management’s intent to restructure its capital.
    43

    On March 17, 2009, the Company notified the holders of the Series C Preferred Stock that the Company would not make the dividend payment on the Series C Preferred Stock due on March 31, 2009. Because dividends on the Series C Preferred Stock are presently in arrears for six quarters, under the terms of the Articles Supplementary to the Company’s Charter that established the Series C Preferred Stock, the holders of the Series C Preferred Stock had the right, as of March 31, 2009, to elect two additional directors to the Company’s board of directors. At the Company’s Annual Meeting of Shareholders on June 25, 2009, the holders of the Series C Preferred Stock elected two additional directors of the Company to serve until such time that that all dividends accumulated and due on the Series C Preferred Stock have been paid fully paid.
    Dividends on the Series C Preferred Stock are payable in cash and accrue at a rate of 8.9% annually. Accrued and unpaid dividends payable related to the Series C Preferred Stock were approximately $21.6 million and $15.0 million as of December 31, 2010 and 2009, respectively.
    Dividends on the Series D1 Preferred Stock are payable in cash and accrue at a rate of 13.0% per annum. In addition, holders of the Series D1 Preferred Stock are entitled to participate in any common stock dividends on an as converted basis. The Company’s board of directors has suspended the payment of dividends on the Company’s Series D1 Preferred Stock. As a result, dividends continue to accrue on the Series D1 Preferred Stock, and the dividend rate on the Series D1 Preferred Stock increased from 9.0% to 13.0%, compounded quarterly, effective October 16, 2007 with respect to all unpaid dividends and subsequently accruing dividends. Accrued and unpaid dividends payable related to the Series D1 Preferred Stock were approximately $29.3 million and $19.4 million as of December 31, 2010 and 2009, respectively.
    The Series D1 Preferred Stock is convertible into the Company’s 9.0% Series D2 Mandatory Convertible Preferred Stock having a par value of $0.01 per share and an initial liquidation preference of $25.00 per share (“Series D2 Preferred Stock”) upon the later of (a) July 16, 2009, or (b) the date on which the shareholders of the Company approve certain anti-dilution protection for the Series D1 Preferred Stock and Series D2 Preferred Stock that, upon such shareholder approval, would apply in the event the Company issues additional common stock for a price below the price at which the Series D1 Preferred Stock (or the Series D2 Preferred Stock into which the Series D1 Preferred Stock has been converted, if any) may be converted into common stock. The rights, powers and privileges of the Series D2 Preferred Stock are substantially similar to those of the Series D1 Preferred Stock, except that accrued and unpaid dividends on the Series D2 Preferred Stock can be added to the common stock conversion and liquidation valueof the Series D2 Preferred Stock in lieu of cash payment, and the dividend rate on the Series D2 Preferred Stock is fixed in all circumstances at 9.0%.
    The Series D1 Preferred Stock (or the Series D2 Preferred Stock into which the Series D1 Preferred stock has been converted, if any) is convertible into the Company’s common stock at any time at the option of the holders. The Series D1 Preferred Stock (or the Series D2 Preferred Stock into which the Series D1 Preferred stock has been converted, if any) is currently convertible into 1,875,000 shares of common stock based upon an initial conversion price of $28.00 per share, subject to adjustment as provided above or certain other extraordinary events. On July 16, 2016, the Series D1 Preferred Stock (or the Series D2 Preferred Stock into which the Series D1 Preferred stock has been converted, if any) will automatically convert into shares of common stock.
    During the years ended December 31, 2010 and 2009, there were no shares of common stock issued under the Company’s stock-based compensation plan.
    The Company’s Board of Directors has approved the repurchase of up to $9 million of the Company’s common stock. No shares were repurchased during 2010 and 2009. The Company has repurchased $8.0 million prior to 2009, leaving approximately $1.0 million of shares that may yet be purchased under the repurchase plan. Under Maryland law, shares repurchased under the repurchase plan are to be returned to the Company’s authorized but unissued shares of common stock. Common stock purchased under the repurchase plan is charged against additional paid-in capital.
    44

    Note 10. Commitments and Contingencies
    Commitments – The Company leases office space under various operating lease agreements. Rent expense for 2011 and 2010 aggregated $1.2 million and $1.3 million, respectively. At December 31, 2011, future minimum lease commitments under those leases are as follows (dollars in thousands):
     Lease
     Obligations
    2012$1,467
    20131,158
    2014509
    2015387
    2016912
     $4,433
     

    The Company has sublease agreements for office space formerly occupied by the Company and received approximately $0.4 million and $0.6 million during the years ended December 31, 2011 and 2010, respectively.
    Contingencies – The Company has a contingent obligation related to a Corvisa earn-out agreement based on future net income of up to $1.2 million and $0.6 million as of December 31, 2011 and 2010, respectively, which could be due to the former owners of Corvisa. The increase in the potential obligation is due to the Company's acquisition of the remaining noncontrolling interests of Corvisa during November 2011. See Note 4 to the consolidated financial statements for further details. A liability of $0.9 million and $0.5 million, based on management’s estimate of Corvisa achieving its earnings targets, is included in the other liabilities line item of the consolidated balance sheets as of December 31, 2011 and December 31, 2010, respectively.

    The Company also has contingent obligations related to a Mango separation agreement with a former employee of up to $0.3 million as of December 31, 2011. As of December 31, 2011, there was a liability for this contingent obligation of $150.0 thousand in the other current liabilities and $150.0 thousand in the other liabilities line items in the consolidated balance sheets, respectively.

    The Company has also entered into an agreement that requires it to pay a vendor a minimum of $0.3 million during the first quarter of 2012 if certain services are provided by the vendor.

    The Company has received indemnification and loan repurchase demands with respect to alleged violations of representations and warranties (“defects”) made in loan sale and securitization agreements. These demands have been received substantially

    34


    beginning in 2006 and have continued into 2011. Prior to the Company ceasing the origination of loans in its mortgage lending business, it sold loans to securitization trusts and other third parties and agreed to repurchase a loan due to missing documentation or breaches of representations or warranties made in sale documents that materially adversely affected the value of the loan.

    Beginning in 1997 and ending in 2007, affiliates of the Company sold loans to securitization trusts and third parties with the potential of such repurchase obligations. The aggregate original principal balance of these loans was $43.1 billion at the time of sale or securitization. The remaining principal balance of these loans is not available as these loans are serviced by third parties and may have been refinanced, sold or liquidated. During 2010 and 2011, the Company has received claims to repurchase loans with original principal balances of approximately $30.8 million. These claims have not been acknowledged as valid by the Company. In some cases, claims were made against affiliates of the Company that have ceased operations and have no or limited assets. The Company has not repurchased any loans in 2010 or 2011.

    Historically, repurchases of loans or indemnification of losses where a loan defect has been alleged have been insignificant and any future losses for alleged loan defects have not been deemed to be probable or reasonably estimable; therefore, the Company has recorded no reserves related to these claims. The Company does not use internal groupings for purposes of determining the status of these loans. The Company is unable to develop an estimate of the maximum potential amount of future payments related to repurchase demands because the Company does not have access to information relating to loans sold and securitized and the number or amount of claims deemed probable of assertion is not known nor is it reasonably estimated. Further, the validity of claims received remains questionable. Also, considering that the Company completed its last sale or securitization of loans during 2007, the Company believes that it will be difficult for a claimant to successfully validate any additional repurchase demands. Management does not expect that the potential impact of claims will be material to the Company's financial statements.

    Pending Litigation – The Company is a party to various legal proceedings. Except as set forth below, these proceedings are of an ordinary and routine nature, including, but not limited to, breach of contract claims, tort claims, and claims for violations of federal and state consumer protection laws.

    Although it is not possible to predict the outcome of any legal proceeding, in the opinion of management, other than the active proceedings described in detail below, proceedings and actions against the Company should not, individually, or in the aggregate, have a material effect on the Company's financial condition, operations and liquidity. Furthermore, due to the uncertainty of any potential loss as a result of pending litigation and due to the Company's belief that an adverse ruling is not probable, the Company has not accrued a loss contingency related to the following matters in its consolidated financial statements. However, a material outcome in one or more of the active proceedings described below could have a material impact on the results of operations in a particular quarter or fiscal year.
    On May 21, 2008, a purported class action case was filed in the Supreme Court of the State of New York, New York County, by the New Jersey Carpenters' Health Fund, on behalf of itself and all others similarly situated. Defendants in the case included NovaStar Mortgage Funding Corporation (“NMFC”) and its individual directors, several securitization trusts sponsored by the Company ("affiliated defendants") and several unaffiliated investment banks and credit rating agencies. The case was removed to the United States District Court for the Southern District of New York. On June 16, 2009, the plaintiff filed an amended complaint. Plaintiff seeks monetary damages, alleging that the defendants violated sections 11, 12 and 15 of the Securities Act of 1933, as amended, by making allegedly false statements regarding mortgage loans that served as collateral for securities purchased by plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss the plaintiff's claims, which the Court granted on March 31, 2011, with leave to amend. Plaintiff filed a second amended complaint on May 16, 2011, and the Company has again filed a motion to dismiss. Because the litigation is procedurally in an early stage, the Company cannot provide an estimate of the range of any loss. The Company believes that the affiliated defendants have meritorious defenses to the case and expects them to defend the case vigorously.
    On December 31, 2009, ITS Financial, LLC (“ITS”) filed a complaint against Advent and the Company alleging a breach of contract by Advent for a contract for services related to tax refund anticipation loans and early season loans. ITS does business as Instant Tax Service. The defendants moved the case to the United States District Court for the Southern District of Ohio. The complaint alleged that the Company worked in tandem and as one entity with Advent in all material respects. The complaint also alleged fraud in the inducement, tortious interference by the Company with the contract, breach of good faith and fair dealing, fraudulent and negligent misrepresentation, and liability of the Company by piercing the corporate veil and joint and several liability. The plaintiff referenced a $3.0 million loan made by the Company to ITS and sought a judgment declaring that this loan be subject to an offset by ITS's damages. On September 29, 2010, the Company and Advent answered the complaint and made a counterclaim against ITS for ITS's failure to repay the loan. On February 21, 2011, the Company amended its counterclaim, asserting additional claims against ITS. On October 21, 2011, the Court granted the Company's motion for partial summary judgment on the loan claim and granted a partial summary judgment in favor of the Company with respect to certain claims and damages alleged by ITS. In December 2011, the parties settled the litigation and the case was dismissed. The Company paid no money to the plaintiff, and the plaintiff agreed to a payment to Company of approximately $3.9 million. Approximately $1.3 million was paid to the Company at the time of the settlement with the remaining balance to be paid in February 2012. In February 2012, the Company agreed to a modification to the settlement; pursuant to the modification $1.5 million was paid at the time of the modification and approximately $1.2 million will be due in February 2013.

    35


    On July 9, 2010 and on February 11, 2011, Cambridge Place Investment Management, Inc. filed complaints in the Suffolk, Massachusetts Superior Court against NMFC and numerous other entities seeking damages on account of losses associated with residential mortgage-backed securities purchased by plaintiff's assignors. The complaints allege untrue statements and omissions of material facts relating to loan underwriting and credit enhancement. The complaints also allege a violation of Section 410 of the Massachusetts Uniform Securities Act (Chapter 110A of the Massachusetts General Laws). Defendants removed the cases to the United States District Court for the District of Massachusetts, and plaintiff filed motions to remand the cases back to state court. On August 22, 2011, the federal court remanded these cases back to state court, and on October 14, 2011, the plaintiff filed amended complaints. In December 2011, the Company, together with the other defendants in the litigation, filed a motion to dismiss the complaints alleging that the plaintiff lacked standing. Because this litigation is procedurally in its early stage, the Company cannot provide an estimate of the range of any loss. The Company believes that NMFC has meritorious defenses to these claims and expects that the cases will be defended vigorously.
    On June 20, 2011, the National Credit Union Administration Board, as liquidating agent of U.S. Central Federal Credit Union, filed an action against NMFC and numerous other defendants in the United States District Court for the District of Kansas, claiming that the defendants issued or underwrote residential mortgage-backed securities pursuant to allegedly false or misleading registration statements, prospectuses, and/or prospectus supplements. On October 12, 2011, the complaint was served on NMFC. On December 20, 2011, NMFC filed a motion to dismiss the plaintiff's complaint and to strike certain paragraphs of the complaint. This litigation is in an early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that NMFC has meritorious defenses to the case and expects it to defend the case vigorously.
    Note 11. Shareholders’ Deficit
    During the second quarter of 2011, we completed the exchange of all outstanding shares of our preferred stock for an aggregate of 80,985,600 shares of newly-issued common stock and $3.0 million in cash. Completion of this exchange eliminated our obligations with respect to outstanding and future preferred dividends and the preferred liquidating preference related to the preferred stock. At the time of the exchange, there were accrued and unpaid dividends of approximately $59.3 million on the preferred stock and the aggregate liquidating preference was $127.3 million. See Note 3 to the consolidated financial statements for further details.

    There was 0.9 million shares of nonvested shares issued to the non-employee directors during the year ended December 31, 2011. During the year ended December 31, 2010, there were no shares of common stock issued under the Company’s stock-based compensation plan.
    The Company’s Board of Directors has approved the repurchase of up to $9.0 million of the Company’s common stock. No shares were repurchased during 2011 and 2010. The Company has repurchased $8.0 million prior to 2009, leaving approximately $1.0 million of shares that may yet be purchased under the repurchase plan. Under Maryland law, shares repurchased under the repurchase plan are to be returned to the Company’s authorized but unissued shares of common stock. Common stock purchased under the repurchase plan is charged against additional paid-in capital.

    Note 12. Comprehensive Income
     
    Comprehensive income includes revenues, expenses, gains and losses that are not included in net income. The following is a roll-forwardschedule of accumulated other comprehensive income for the years ended December 31, 20102011 and 20092010 (dollars in thousands):
     For the Year Ended
     December 31,
     2010 2009
    Net income (loss)$    985,654      $    (183,156)
    Other comprehensive (loss) income:       
    Change in unrealized loss on mortgage securities – available-for-sale (700)  (5,106)
      
    Change in unrealized gain (loss) on derivative instruments used in cash flow hedges -   8 
    Impairment on mortgage securities – available-for-sale reclassified to earnings -   1,198 
    Net settlements of derivative instruments used in cash flow hedges reclassified to earnings -   85 
    Other comprehensive loss (700)  (3,815)
    Total comprehensive income (loss) 984,954   (186,971)
    Comprehensive loss attributable to noncontrolling interests 1,048   2,054 
    Total comprehensive income (loss) attributable to NovaStar Financial, Inc.$983,906  $(184,917)
     
      
    For the Year Ended
    December 31,
      2011 2010
    Net income $7,272
    		 $985,654
    Other comprehensive loss:  
    		  
    Change in unrealized loss on mortgage securities – available-for-sale (1,144) (700)
    Other comprehensive loss (1,144) (700)
    Total comprehensive income 6,128
    		 984,954
    Comprehensive loss attributable to noncontrolling interests (491) (1,048)
    Total comprehensive income attributable to NovaStar Financial, Inc. $5,637
    		 $983,906
         

    Accumulated other comprehensive income was comprised of unrealized gains relating to the mortgage securities – available-for-sale as of December 31, 20102011 and 2009.
    Note 11. Fair Value Accounting
    For financial reporting purposes, the Company follows a fair value hierarchy that is used to measure the fair value of assets and liabilities. This hierarchy prioritizes relevant market inputs in order to determine an “exit price” or the price at which an asset could be sold or a liability could be transferred in an orderly process that is not a forced liquidation or distressed sale at the date of measurement.
    Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These two types of inputs create the following fair value hierarchy:
    • 2010Level 1—Quoted prices for identical instruments in active markets.
    • Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
    • Level 3—Instruments whose significant value drivers are unobservable.
    The Company determines fair value based upon quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The methods the Company uses to determine fair value on an instrument specific basis are detailed in the section titled “Valuation Methods,” below.
    The following tables present for each of the fair value hierarchy levels, the Company’s assets and liabilities related to continuing operations which are measured at fair value on a recurring basis as of December 31, 2010 and 2009 (dollars in thousands):
         Fair Value Measurements at Reporting Date Using
            Quoted Prices in            
      Fair Value at Active Markets for Significant Other Significant
         December 31, Identical Assets Observable Inputs Unobservable
    Description 2010 (Level 1) (Level 2) Inputs (Level 3)
    Assets            
    Mortgage securities – trading $1,198 $- $- $1,198
    Mortgage securities – available-            
         for-sale  4,580  -  -  4,580
              Total Assets $5,778 $- $- $5,778
     
    Liabilities            
    Asset-backed bonds secured by            
         mortgage securities $1,198 $- $- $1,198
    Contingent consideration (A)  450        450
    Total Liabilities $1,648 $- $- $1,648
     
    (A)The contingent consideration represents the estimated fair value of the additional potential earn-out opportunity payable in connection with our acquisition of Corvisa that is contingent based upon certain future earnings targets. The company estimated the fair value using projected revenue over the earn-out period, and applied a discount rate to the projected earn-out payments that approximated the weighted average cost of capital.

    45

         Fair Value Measurements at Reporting Date Using
            Quoted Prices in            
      Fair Value at Active Markets for Significant Other Significant
         December 31, Identical Assets Observable Inputs Unobservable
    Description 2009 (Level 1) (Level 2) Inputs (Level 3)
    Assets            
    Mortgage securities – trading $      1,087 $      - $      - $      1,087
    Mortgage securities – available-            
         for-sale  6,903  -  -  6,903
              Total Assets $7,990 $- $- $7,990
     
    Liabilities            
    Asset-backed bonds secured by            
         mortgage securities $968 $- $- $968
    Derivative instruments, net  157  -  157  -
    Total Liabilities $1,125 $- $157 $968
     

    The following tables provide a reconciliation of the beginning and ending balances for the Company’s mortgage securities – trading which are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from December 31, 2009 to December 31, 2010 (dollars in thousands):
             Estimated Fair
         Unrealized Value of Mortgage
     Cost Basis     Loss     Securities
    As of December 31, 2009$      104,013  $      (102,926) $                  1,087 
         Increases (decreases) to mortgage securities – trading:           
         Accretion of income 1,766   -   1,766 
         Proceeds from paydowns of securities (1,497)  -   (1,497)
         Other than temporary impairments (30,382)  30,382   - 
         Mark-to-market value adjustment -   (158)  (158)
    Net increase (decrease) to mortgage securities (30,113)  30,224   111 
    As of December 31, 2010$73,900   (72,702)  1,198 
     

             Estimated Fair
         Unrealized Value of Mortgage
     Cost Basis     Loss     Securities
    As of December 31, 2008$     433,968  $      (426,883) $                 7,085 
         Increases (decreases) to mortgage securities – trading:           
         Accretion of income 10,713   -   10,713 
         Proceeds from paydowns of securities (4,885)  -   (4,885)
         Other than temporary impairments (335,783)  335,783   - 
         Mark-to-market value adjustment -   (11,826)  (11,826)
    Net increase (decrease) to mortgage securities (329,955)  323,957   (5,998)
    As of December 31, 2009$104,013  $(102,926) $1,087 
     

    The following tables provide a reconciliation of the beginning and ending balances for the Company’s mortgage securities – available-for-sale which are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from December 31, 2009 to December 31, 2010 and December 31, 2008 to December 31, 2009 (dollars in thousands):
             Estimated Fair
         Unrealized Value of Mortgage
     Cost Basis     Gain     Securities
    As of December 31, 2009$         1,794  $          5,109  $                 6,903 
         Increases (decreases) to mortgage securities:           
         Accretion of income (A) 2,235   -   2,235 
         Proceeds from paydowns of securities (A) (B) (3,858)  -   (3,858)
         Other (2)  2   - 
         Mark-to-market value adjustment     (700)  (700)
    Net decrease to mortgage securities (1,625)  (698)  (2,323)
    As of December 31, 2010$169   4,411   4,580 
     
    (A)Cash received on mortgage securities with no cost basis was $7.5 million for the year ended December 31, 2010.
    (B)For mortgage securities with a remaining cost basis, the Company reduces the cost basis by the amount of cash that is contractually due from the securitization trusts. In contrast, for mortgage securities in which the cost basis has previously reached zero, the Company records in interest income the amount of cash that is contractually due from the securitization trusts. In both cases, there are instances where the Company may not receive a portion of this cash until after the consolidated balance sheets reporting date. Therefore, these amounts are recorded as receivables from the securitization trusts, which are included in the other assets line on the Company’s consolidated balance sheets. As of December 31, 2010, the Company had no receivables from securitization trusts related to mortgage securities available-for-sale with a remaining or zero cost basis.

    46

             Estimated Fair
         Unrealized Value of Mortgage
     Cost Basis     Gain     Securities
    As of December 31, 2008$     3,771  $     9,017  $                12,788 
         Increases (decreases) to mortgage securities:           
         Accretion of income (A) 12,815   -   12,815 
         Proceeds from paydowns of securities (A) (B) (13,594)  -   (13,594)
         Impairment on mortgage securities – available-for-sale (1,198)  -   (1,198)
         Mark-to-market value adjustment -   (3,908)  (3,908)
    Net decrease to mortgage securities (1,977)  (3,908)  (5,885)
    As of December 31, 2009$1,794  $5,109  $6,903 
     
    (A)Cash received on mortgage securities with no cost basis was $1.9 million for the year ended December 31, 2009.
    (B)For mortgage securities with a remaining cost basis, the Company reduces the cost basis by the amount of cash that is contractually due from the securitization trusts. In contrast, for mortgage securities in which the cost basis has previously reached zero, the Company records in interest income the amount of cash that is contractually due from the securitization trusts. In both cases, there are instances where the Company may not receive a portion of this cash until after the consolidated balance sheets reporting date. Therefore, these amounts are recorded as receivables from the securitization trusts, which are included in the other assets line on the Company’s consolidated balance sheets. As of December 31, 2009, the Company had receivables from securitization trusts of $12.5 million, related to mortgage securities available-for-sale with a remaining cost basis. At December 31, 2009, there were no receivables from securitization trusts related to mortgage securities with a zero cost basis.
    The following table provides quantitative disclosures about the fair value measurements for the Company’s assets which are measured at fair value on a nonrecurring basis as of December 31, 2009 (dollars in thousands):
        Fair Value Measurements at Reporting Date Using
        Quoted Prices in     
        Active Markets for Significant Other Significant
          Real Estate     Identical Assets     Observable Inputs     Unobservable Inputs
    Fair Value at Owned (A)   (Level 1)   (Level 2)   (Level 3)
    December 31, 2009 64,179 $-  $- $64,179
     
    (A)The Company did not hold any Real Estate Owned as of December 31, 2010.
    At the time a mortgage loan held-in-portfolio becomes real estate owned, the Company records the property at the lower of its carrying amount or fair value. Upon foreclosure and through liquidation, the Company evaluates the property's fair value as compared to its carrying amount and records a valuation adjustment when the carrying amount exceeds fair value. Any valuation adjustments at the time the loan becomes real estate owned is charged to the allowance for credit losses.
    The following table provides a summary of the impact to earnings from the Company’s assets and liabilities which are measured at fair value on a recurring and nonrecurring basis (dollars in thousands):
          Fair Value     Fair Value Adjustments For      
    Asset or Liability Measured at Measurement the Year Ended December 31, Statement of Operation Line
    Fair Value Frequency 2010     2009 Item Impacted
    Mortgage securities – trading Recurring $          (158) $         (11,826) Other expense
    Mortgage securities – available-            
         for-sale Recurring  -   (1,198) Other expense
    Real estate owned Nonrecurring  (178)  (9,164) Provision for credit losses
    Derivative instruments, net Recurring  157   (7,361) Other expense
    Asset-backed bonds secured by            
         mortgage securities Recurring  1,226   5,083  Other expense
    Total fair value losses   $1,047  $(24,466)  
     

    47

    Valuation Methods.
     
    Mortgage securities – trading. Trading securities are recorded at fair value with gains and losses, realized and unrealized, included in earnings. The Company uses the specific identification method in computing realized gains or losses.
    Upon the closing of its NMFT Series 2007-2 securitization, the Company classified the residual security it retained as trading. The Company also classified the NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1 residual securities as trading upon the derecognition of these securitization trusts. The Company estimates fair value based on the present value of expected future cash flows using management’s best estimates of credit losses, prepayment rates, forward yield curves, and discount rates, commensurate with the risks involved. Due to the unobservable inputs used by the Company in determining the expected future cash flows, the Company determined its valuation methodology for residual securities would qualify as Level 3. See “Mortgage securities – available-for-sale" for further discussion of the Company’s valuation policies relating to residual securities.
    Mortgage securities – available-for-sale. Mortgage securities – available-for-sale represent residual securities the Company retained in securitization and resecuritization transactions. Mortgage securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. To the extent that the cost basis of mortgage securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. The specific identification method is used in computing realized gains or losses. The Company uses the discount rate methodology for determining the fair value of its residual securities. The fair value of the residual securities is estimated based on the present value of future expected cash flows to be received. Management’s best estimate of key assumptions, including credit losses, prepayment speeds, the market discount rates and forward yield curves commensurate with the risks involved, are used in estimating future cash flows.
    Derivative instruments. The fair value of derivative instruments is estimated by discounting the projected future cash flows using appropriate market rates.
    Asset-backed bonds secured by mortgage securities. See discussion under “Fair Value Option for Financial Assets and Financial Liabilities.”
    Real estate owned. Real estate owned is carried at the lower of cost or fair value less estimated selling costs. The Company estimates fair value at the asset’s liquidation value less selling costs using management’s assumptions which are based on historical loss severities for similar assets.
    Fair Value Option for Financial Assets and Financial Liabilities
    Under the fair value option guidance, the Company may elect to report most financial instruments and certain other items at fair value on an instrument-by-instrument basis with changes in fair value reported in earnings. After the initial adoption, the election is made at the acquisition of an eligible financial asset, financial liability, or firm commitment or when certain specified reconsideration events occur. The fair value election may not be revoked once an election is made.
    The Company elected the fair value option for the asset-backed bonds issued from the CDO, which the Company closed in the first quarter of 2007. The Company elected the fair value option for these liabilities to help reduce earnings volatility which otherwise would arise if the accounting method for this debt was not matched with the fair value accounting for the related mortgage securities – trading. The asset-backed bonds which are being carried at fair value are included in the “Other current liabilities“ line item on the consolidated balance sheets. The change in the asset-backed bonds balance is due to the fair value adjustments since adoption of the guidance. The Company has not elected fair value accounting for any other consolidated balance sheets items as allowed by the guidance from Fair Value Option for Financial Assets and Financial Liabilities.
    The following table shows the difference between the unpaid principal balance and the fair value of the asset-backed bonds secured by mortgage securities for which the Company has elected fair value accounting as of December 31, 2010 and December 31, 2009 (dollars in thousands):
      Unpaid Principal Year to Date Gain   
    Unpaid Principal Balance as of     Balance     Recognized     Fair Value
    December 31, 2010 $       324,662 $       1,226 $       1,198
    December 31, 2009  323,999  5,083  968
     

    48

    Substantially all of the change in fair value of the asset-backed bonds during the year ended December 31, 2010 is considered to be related to specific credit risk as all of the bonds are floating rate.
    Note 12. Property13. Fair Value Accounting

    For financial reporting purposes, the Company follows a fair value hierarchy that is used to measure the fair value of assets and Equipment, Netliabilities. This hierarchy prioritizes relevant market inputs in order to determine an “exit price” or the price at which an asset

    36


    could be sold or a liability could be transferred in an orderly process that is not a forced liquidation or distressed sale at the date of measurement.

    Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These two types of inputs create the following fair value hierarchy:
    Level 1 – Valuations based on quoted prices in active markets for identical assets and liabilities.
    Level 2 – Valuations based on observable inputs in active markets for similar assets and liabilities, other than Level 1 prices, such as quoted interest or currency exchange rates.
    Level 3 – Valuations based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies based on internal cash flow forecasts.
    The Company determines fair value based upon quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The methods the Company uses to determine fair value on an instrument specific basis are detailed in the section titled “Valuation Methods,” below.
     
     December 31,
     2010     2009
    Furniture, fixtures and office equipment$       803  $       709 
    Hardware and computer equipment 2,148   1,773 
    Software 5,794   2,301 
    Leasehold improvements 258   258 
      9,003   5,041 
    Less: Accumulated depreciation and amortization (4,182)  (3,238)
     $4,821  $1,803 
     

    All of the Company’s property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets. The estimated useful lives of the assets are leasehold improvements, lesser of 5 years or remaining lease term, furniture and fixtures, 5 years, office and computer equipment, 3 to 5 years and software, 3 years.
    Maintenance and repairs are charged to expense. Major renewals and improvements are capitalized. Gains and losses on dispositions are credited or charged to earnings as incurred. Depreciation and amortization expense relating to property and equipment was $0.9 millionfollowing tables present for each of the fair value hierarchy levels, the Company’s assets and liabilities which are measured at fair value on a recurring basis as of December 31, 2011 and 2010 (dollars in thousands):
        Fair Value Measurements at Reporting Date Using
    Description Fair Value at December 31, 2011 (A) 
    Quoted Prices in Active Markets for Identical Assets
    (Level 1)
    		 
    Significant Other Observable Inputs
    (Level 2)
    		 
    Significant Unobservable Inputs
    (Level 3) (A)
    Assets:        
    Mortgage securities – available-for-sale $3,878
    		 $—
    		 $—
    		 $3,878
    Total assets $3,878
    		 $—
    		 $—
    		 $3,878
             
    Liabilities:        
    Contingent consideration (B) $1,154
    		 $—
    		 $—
    		 $1,154
    Total liabilities $1,154
    		 $—
    		 $—
    		 $1,154
             
    (A) The Company's mortgage securities – trading and asset-backed bonds secured by mortgage securities were valued at zero as of December 31, 2011.
    (B) The contingent consideration represents the estimated fair value of the additional potential amounts payable in connection with our acquisitions of Mango and Corvisa, $0.3 million and $0.9 million, respectively.
        Fair Value Measurements at Reporting Date Using
    Description Fair Value at December 31, 2010 
    Quoted Prices in Active Markets for Identical Assets
    (Level 1)
    		 
    Significant Other Observable Inputs
    (Level 2)
    		 Significant Unobservable Inputs (Level 3)
    Assets:        
    Mortgage securities – trading $1,198
    		 $—
    		 $—
    		 $1,198
    Mortgage securities – available-for-sale 4,580
    		 —
    		 —
    		 4,580
    Total assets $5,778
    		 $—
    		 $—
    		 $5,778
             
    Liabilities:        
    Asset-backed bonds secured by mortgage securities $1,198
    		 $—
    		 $—
    		 $1,198
    Contingent consideration (A) 450
    		 —
    		 —
    		 450
    Total liabilities $1,648
    		 $—
    		 $—
    		 $1,648
             
    (A) The contingent consideration represents the estimated fair value of the additional potential earn-out opportunity payable in connection with our acquisition of Corvisa that is contingent and based upon certain future earnings targets.

    37


    The following tables provide a reconciliation of the beginning and ending balances for the Company's mortgage securities – trading which are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 20102011 and 2009,2010, respectively (dollars in thousands):
     For the Year Ended
    December 31,
     2011 2010
    Balance, beginning of period$1,198
    		 $1,087
    Increases (decreases) to mortgage securities – trading:   
    Accretion of income973
    		 1,766
    Proceeds from paydowns of securities(761) (1,497)
    Mark-to-market value adjustment(1,410) (158)
    Net (decrease) increase to mortgage securities – trading(1,198) 111
    Balance, end of period$—
    		 $1,198
        

    The following tables provide a reconciliation of the beginning and ending balances for the Company's mortgage securities – available-for-sale which are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2011 and 2010 (dollars in thousands):
     For the Year Ended
    December 31,
     2011 2010
    Balance, beginning of period$4,580
    		 $6,903
    Increases (decreases) to mortgage securities – available-for-sale:   
    Accretion of income (A)1,716
    		 2,235
    Proceeds from paydowns of securities (A) (B)(1,274) (3,858)
    Mark-to-market value adjustment(1,144) (700)
    Net decrease to mortgage securities – available-for-sale(702) (2,323)
    Balance, end of period$3,878
    		 $4,580
        
    (A) Cash received on mortgage securities with no cost basis was $7.6 million and $7.5 million for the years ended December 31, 2011 and 2010, respectively.

    Note 13. GoodwillThe following table presents information on mortgage securities – available-for-sale held by the Company as of December 31, 2011 arising from the Company's residential mortgage-related securitization transactions. The pre-tax sensitivities of the current fair value of the retained interests to immediate 10% and 25% adverse changes in assumptions and parameters are also shown (dollars in thousands):
      
    Carrying amount/fair value of residual interests$3,878
    Weighted average life (in years)2.00
    Weighted average prepayment speed assumption (CPR) (percent)17.5
    Fair value after a 10% increase in prepayment speed$3,804
    Fair value after a 25% increase in prepayment speed$3,689
    Weighted average expected annual credit losses (percent of current collateral balance)5.5
    Fair value after a 10% increase in annual credit losses$3,786
    Fair value after a 25% increase in annual credit losses$3,734
    Weighted average residual cash flows discount rate (percent)25.0%
    Fair value after a 500 basis point increase in discount rate$3,720
    Fair value after a 1000 basis point increase in discount rate$3,571
    Market interest rates: 
    Fair value after a 100 basis point increase in market rates$2,558
    Fair value after a 200 basis point increase in market rates$1,408
      

    The preceding sensitivity analysis is hypothetical and should be used with caution. In particular, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independent of changes in any other assumption; in

    38


    practice, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Further, changes in fair value based on a 10% or 25% variation in an assumption or parameter generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear.

    The following table provides a reconciliation of the beginning and ending balances for the Company's contingent consideration liability which is measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2011 and 2010 (dollars in thousands):
     For the Year Ended
    December 31,
     2011 2010
    Balance, beginning of period$450
    		 $—
    Acquisition of Corvisa—
    		 450
    Fair value adjustment(150) —
    Acquisition of Corvisa noncontrolling interest (A)554
    		 —
    Acquisition of Mango300
    		 —
    Balance, end of period$1,154
    		 $450
        
    (A) As part of the Corvisa noncontrolling interest acquisition, the previous contingent consideration payable of $0.3 million was canceled, the new contingent consideration payable amount was estimated at $0.9 million.

    The following table provides a summary of the impact to earnings for the years ended December 31, 2011 and 2010 from the Company's assets and liabilities which are measured at fair value on a recurring and nonrecurring basis (dollars in thousands):

      Fair ValueFair Value Adjustments For the 
      Measurement Year Ended December 31, Statement of Operations
    Asset or Liability Measured at Fair Value Frequency 2011 2010 Line Item Impacted
    Mortgage securities – trading Recurring $(1,410) $(158) Other income (expense)
    Real estate owned (A) Nonrecurring —
    		 (178) Provision for credit losses
    Derivative instruments, net (A) Recurring —
    		 157
    		 Other income (expense)
    Contingent consideration (B) Recurring 150
    		 —
    		 Other income (expense)
    Asset-backed bonds secured by mortgage securities Recurring 1,198
    		 1,226
    		 Other income (expense)
    Total fair value gains (C)   $(62) $1,047
    		  
             
    (A)
    The Company did not hold any real estate owned or derivative instruments as of December 31, 2011 or December 31, 2010.
    (B) The contingent consideration represents the change in the estimated fair value of the additional potential amounts payable in connection with our acquisitions of Corvisa and Mango.
    (C)
    The Company did not have any impairments relating to mortgage securities – available-for-sale for the years ended December 31, 2011 and 2010.

    Valuation Methods

    Mortgage securities – trading. Trading securities are recorded at fair value with gains and losses, realized and unrealized, included in earnings. The Company uses the specific identification method in computing realized gains or losses. The Company estimates fair value based on the present value of expected future cash flows using management's best estimates of credit losses, prepayment rates, forward yield curves, and discount rates, commensurate with the risks involved. Due to the unobservable inputs used by the Company in determining the expected future cash flows, the Company determined its valuation methodology for residual securities would qualify as Level 3.

    Mortgage securities – available-for-sale. Mortgage securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. To the extent that the cost basis of mortgage securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. The specific identification method is used in computing realized gains or losses. The Company uses the discount rate methodology for determining the fair value of its residual securities. The fair value of the residual securities is estimated based on the present value of future expected cash flows to be received. Management's best estimate of key assumptions, including credit losses, prepayment speeds, forward yield curves and discount rates commensurate with the risks involved, are used in estimating future cash flows.


    39


    Contingent consideration. The fair value of the Mango contingent consideration was estimated using a probability analysis of compliance with the separation agreement and a discount rate was applied to the projected earn-out payments that approximated the weighted average cost of capital. The key input was management's estimation of probability that the employee will comply with the agreement. The Company estimated the fair value of the Corvisa contingent consideration using projected revenue over the earn-out period, and applied a discount rate to the projected earn-out payments that approximated the weighted average cost of capital. The key inputs for the projected revenue analysis were the number of units completed and the average amount of revenue per unit.

    Asset-backed bonds secured by mortgage securities. See discussion under “Fair Value Option for Financial Assets and Financial Liabilities.”

    Fair Value Option for Financial Assets and Financial Liabilities

    The Company elected the fair value option for asset-backed bonds issued from the CDO to help reduce earnings volatility which otherwise would arise if the accounting method for this debt was not matched with the fair value accounting for the related mortgage securities. The asset-backed bonds which are being carried at fair value are included in the “Other current liabilities” line item on the consolidated balance sheets, the asset-backed bonds had no value as of December 31, 2011 and an estimated fair value of $1.2 million as of December 31, 2010. The Company recognized fair value adjustments of $1.2 million and $1.2 million for the years ended December 31, 2011 and 2010, respectively, which is included in the “Other expenses” line item on the consolidated statements of operations. Substantially all of the change in fair value of the asset-backed bonds during the years ended December 31, 2011 and 2010 is considered to be related to specific credit risk as all of the bonds are floating rate.

    The following table shows the difference between the unpaid principal balance and the fair value of the asset-backed bonds secured by mortgage securities for which the Company has elected fair value accounting as of December 31, 2011 and 2010 (dollars in thousands):
    Unpaid Principal Balance as of Unpaid Principal Balance Year to Date Gain Recognized Fair Value
    December 31, 2011 $325,375
    		 $2,069
    		 $—
    December 31, 2010 324,662
    		 1,226
    		 1,198
           

    The following disclosure of the estimated fair value of financial instruments presents amounts that have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimation methodologies could have a material impact on the estimated fair value amounts. The fair value of short-term financial assets and liabilities, such as cash, service fees receivable, notes receivable, and accounts payable and accrued expenses are not included in the following table as their fair value approximates their carrying value.

    The estimated fair values of the Company’s financial instruments are as follows as of December 31, 2011 and 2010 (dollars in thousands):
      December 31, 2011 December 31, 2010
      Carrying Value Fair Value Carrying Value Fair Value
    Financial assets:        
    Restricted cash 2,912
    		 2,836
    		 1,413
    		 1,341
    Mortgage securities – trading —
    		 —
    		 1,198
    		 1,198
    Mortgage securities – available-for-sale 3,878
    		 3,878
    		 4,580
    		 4,580
    Financial liabilities:        
    Borrowings:        
    Asset-backed bonds secured by mortgage securities —
    		 —
    		 1,198
    		 1,198
    Junior subordinated notes —
    		 —
    		 78,086
    		 17,988
    Senior notes 79,654
    		 10,273
    		 —
    		 —
             

    Restricted Cash – The fair value of restricted cash was estimated by discounting estimated future release of the cash from restriction.

    Mortgage securities – trading - See Valuation Methods section above for fair value method utilized.

    40



    Mortgage securities – available-for-sale - See Valuation Methods section above for fair value method utilized.

    Asset-backed bonds secured by mortgage securities – See Valuation Methods section above for fair value method utilized.

    Senior notes and Junior subordinated notes – The fair value is estimated by discounting future projected cash flows using a discount rate commensurate with the risks involved. As of December 31, 2011, the value of the Senior Notes was calculated assuming that the Company would be required to pay interest at a rate of 1.0% per annum until January 2016, at which time the Company would be required to start paying the Full Rate of three-month LIBOR plus 3.5% until maturity in March 2033. The three-month LIBOR used in the analysis was projected using a forward interest rate curve. As of December 31, 2010, goodwill totaled $3.2 millionthe value of the Junior Notes was calculated assuming that the Company would be required to pay interest at the Full Rate of three-month LIBOR plus 3.5% until maturity in March 2035 and June 2036. The large discrepancy between the estimated fair value of the Senior Notes and the Junior Notes was included inmainly attributable to the Appraisal management reporting unit. There was no goodwillassumption that the Company would be paying 1.0% per annum on the Senior Notes until January 2016 compared to the Full Rate for the entire term on the Junior Notes. The overall forward interest rate curve also decreased as of December 31, 2009.
    Goodwill activity is2011 to the forward interest rate curve used as follows for the year endedof December 31, 2010 and 2009, respectively (dollars in thousands):
     For the Years Ended
     December 31,
     2010     2009
    Balance, beginning of period$       - $       - 
    Advent acquisition -  1,190 
    StreetLinks contingent consideration payment (A) 3,170  - 
    Impairments -  (1,190)
    Balance, end of period$3,170 $- 
     
    (A)There are no remaining contingent consideration payments that could be required for the StreetLinks acquisition.
    Duringcausing the year ended December 31, 2010,estimated interest payments of approximately $3.2 million were madeat the Full Rate to be less even with a higher principal balance. See Note 9 to the former majority ownersconsolidated financial statements for further details of StreetLinks upon certain earnings targets being achieved. In accordance with the Business Combinations guidance that was utilized by the Company at the time of acquisition during August 2008, any contingent payments made in excess of amounts assigned to assets acquiredJunior Notes and liabilities recognized should be recorded as goodwill. As all consideration paid had previously been assigned to the assets acquired and liabilities assumed, the $3.2 million was recorded as goodwill during the year ended December 31, 2010. For tax purposes, the goodwill is included in the Company’s basis in its investment in Streetlinks as it is a limited liability company, therefore it will be non-deductible for tax purposes as long as the Company holds its investment in StreetLinks.Senior Notes.

    Note 14. Segment Reporting
     
    The Company reviews, manages and operates its business in three segments: corporate, appraisal management and financial intermediary. Corporate operating results include mortgage securities retained from securitizations, corporate general and administrative expenses, and income generated from Mango as they were not significant. Appraisal management operations include the service fee income and related expenses from the Company's majority-owned direct subsidiary, StreetLinks, and its wholly-owned indirect subsidiary, Corvisa. The financial intermediary segment consists of the financial settlement service fee income and related expenses from Advent. This segment had significant operations during the year ended December 31, 2011, and therefore is now managed as its own segment. Operations of Advent had been included in the Corporate segment information in the same period in 2010 as it was in its start-up phase and its operating activities were not significant. The Securitization trusts segment is no longer its own segment due to the derecognition of the securitization trusts which occurred in January 2010. See Note 18 to the condensed consolidated financial statements for further details. Management evaluates segment performance based upon income before income tax benefit, which is prior to the allocation of losses attributable to the noncontrolling interests.

    The following is a summary of the operating results of the Company’s segments as of and for the years ended December 31, 2011 and 2010 (dollars in thousands):
     Corporate Appraisal Management Financial Intermediary Eliminations Total
    For the Year Ended December 31, 2011         
    Service fee income$624
    		 $119,387
    		 $6,739
    		 $—
    		 $126,750
    Interest income10,959
    		 —
    		 —
    		 (624) 10,335
    Interest expense2,471
    		 8
    		 616
    		 (624) 2,471
    Depreciation and amortization expense (A)195
    		 1,732
    		 64
    		 —
    		 1,991
    Income (loss) before income tax benefit42
    		 6,394
    		 (938) —
    		 5,498
    Additions to long-lived assets (B)3,080
    		 1,860
    		 275
    		 —
    		 5,215
              
    As of December 31, 2011         
    Total assets (B) (C)$34,657
    		 $17,197
    		 $2,261
    		 $(9,514) $44,601
              
    (A) Amounts are included in the cost of services and selling, general and administrative expense line item of the consolidated statements of operations.
    (B)
    Corporate segment includes goodwill of $2.2 million which relates to Mango.
    (C)Appraisal management segment includes goodwill of $3.2 million which relates to StreetLinks.

    As of December 31, 2010, the Company reviewed, managed and operated its business in three segments: securitization trusts, corporate and appraisal management. Securitization trusts’trusts' operating results are driven from the income generated on the on-balance sheet securitizations less associated costs. Corporate operating results include income generated from mortgage securities retained from securitizations, corporate

    41


     Corporate Appraisal Management Securitization Trusts Eliminations Total
    For the Year Ended December 31, 2010         
    Service fee income$—
    		 $75,168
    		 $—
    		 $—
    		 $75,168
    Interest income9,816
    		 —
    		 12,369
    		 167
    		 22,352
    Interest expense1,073
    		 —
    		 —
    		 —
    		 1,073
    Depreciation and amortization expense (A)268
    		 669
    		 —
    		 —
    		 937
    (Loss) income before income tax benefit(1,570) 3,833
    		 982,284
    		 (249) 984,298
    Additions to long-lived assets (B)278
    		 6,854
    		 —
    		 —
    		 7,132
              
    As of December 31, 2010         
    Total assets (B)$30,144
    		 $13,781
    		 $1,497
    		 $(7,561) $37,861
              
    (A) Amounts are included in the cost of services and selling, general and administrative expenses and Advent as it did not have significant operations in the periods. Appraisal management operations include the appraisal fee income and related expenses from the Company’s majority-owned subsidiaries StreetLinks and Corvisa.
    49 

    The following is a summary of the operating results of the Company’s segments for the years ended December 31, 2010 and 2009 (dollars in thousands):
    For the Year ended December 31, 2010
                        
     Securitization     Appraisal        
      Trusts   Corporate    Management  Eliminations   Total
    Income and Revenues:                   
         Service fee income$       -  $    -  $          75,168  $       -  $  75,168 
         Interest income – mortgage                   
              loans 10,681   -   -   167   10,848 
         Interest income – mortgage                   
              securities 1,688   9,816   -   -   11,504 
    Total 12,369   9,816   75,168   167   97,520 
     
    Costs and Expenses:                   
         Cost of services -   -   66,475   -   66,475 
         Interest expense – asset-                   
              backed bonds 1,416   -   -   -   1,416 
         Provision for credit losses 17,433   -   -   -   17,433 
         Servicing fees 731   -   -   -   731 
         Premiums for mortgage loan                   
              insurance 308   -   -   -   308 
         Selling, general and                   
              administrative expense 40   14,334   4,940   -   19,314 
         Gain on disposition of mortgage                   
              loans (993,131)  -   -   -   (993,131)
         Other expenses (income) 3,288   (3,249)  (65)  416   390 
    Total (969,915)  11,085   71,350   416   (887,064)
     
         Other income -   772   15   -   787 
         Interest expense on trust                   
              preferred securities -   (1,073)  -   -   (1,073)
     
    Income (loss) before income tax                   
              expense 982,284   (1,570)  3,833   (249)  984,298 
    Income tax expense -   (1,356)  -   -   (1,356)
    Net income (loss) 982,284   (214)  3,833   (249)  985,654 
    Less: Net (loss) income                   
              attributable to noncontrolling                   
              interests -   (1,369)  321   -   (1,048)
    Net income (loss) attributable to                   
              NFI$982,284  $1,155  $3,512  $(249) $986,702 
     
    Depreciation and amortization                   
              expense (A)$-  $268  $669  $-  $937 
     
    December 31, 2010:                   
    Total assets$1,497  $30,144  $13,781 (B) $(7,561) $37,861 
     
    Additions to long-lived assets$-  $278  $6,854 (B) $-  $7,132 
     
    (A)Amounts are included in the cost of services and selling, general and administrative expense line item of the consolidated statements of operations.
    (B)IncludesAppraisal management segment includes goodwill of $3.2 million.million which relates to StreetLinks.

    50

    For the Year Ended December 31, 2009
                        
     Securitization     Appraisal        
      Trusts   Corporate    Management   Eliminations   Total
    Income and Revenues:                   
         Service fee income$     -  $   -  $        31,106  $       -  $  31,106 
         Interest income – mortgage                   
              loans 130,017   -   -   1,284   131,301 
         Interest income – mortgage                   
              securities 7,234   16,940   -   (2,518)  21,656 
    Total 137,251   16,940   31,106   (1,234)  184,063 
     
    Costs and Expenses:                   
         Cost of services -   -   32,221   -   32,221 
         Interest expense – asset-                   
              backed bonds 21,290   -   -   -   21,290 
         Provision for credit losses 260,860   -   -   -   260,860 
         Servicing fees 10,639   -   -   -   10,639 
         Premiums for mortgage loan                   
              insurance 6,041   137   -   -   6,178 
         Selling, general and                   
              administrative expense 238   18,702   1,837   -   20,777 
         Other expenses 1,600   11,749   46   510   13,905 
    Total 300,668   30,588   34,104   510   365,870 
     
         Other income 117   770   -   -   887 
         Interest expense on trust                   
              preferred securities -   (1,128)  -   -   (1,128)
     
    Loss before income tax expense (163,300)  (14,006)  (2,998)  (1,744)  (182,048)
    Income tax expense -   1,108   -   -   1,108 
    Net loss (163,300)  (15,114)  (2,998)  (1,744)  (183,156)
    Less: Net loss attributable to                   
              noncontrolling interests -   (1,225)  (829)  -   (2,054)
    Net loss attributable to NFI$(163,300) $(13,889) $(2,169) $(1,744) $(181,102)
     
    Depreciation and amortization                   
              expense (A)$-  $438  $431  $-  $869 
     
    December 31, 2009:                   
    Total assets$1,437,059  $26,706  $4,164  $(8,438) $1,459,491 
     
    Additions to long-lived assets$-  $654  $774  $-  $1,428 
      
    (A)Amounts are included in the cost of services and selling, general and administrative expense line item of the consolidated statements of operations.
    Revenues from one customer of the appraisal management segment, approximately $17.1 million and $10.6 million, were in excess of 10% of total consolidated revenues for the yearyears ended December 31, 2010. There were no customers with revenues in excess of 10% during the year ended December 31, 2009.2011 and 2010, respectively.

    51

    Note 15. Earnings Per Share
     
    The following table presents computations of basic and dilutedFor the year ended December 31, 2011, earnings per share was calculated using the treasury method which included the Series D Preferred Stock assumed to be converted to 1,875,000 shares of Common Stock that shared in distributions with common shareholders on a 1:1 basis through the date of the Recapitalization. See Note 3 to the condensed consolidated financial statements for further details. The weighted average common shares outstanding for the yearsyear ended December 31, 2010 and 2009 are as follows (dollars in thousands, except per share amounts):
    2011As a result also include the effect of the convertible participating preferred stock beingnewly-issued Common Stock issued in the Recapitalization.

    Prior to the June 2011 Recapitalization, the Series D Preferred Stock were considered participating securities and therefore the earnings per share information below is calculated under the two-class method which is discussed infor the Earnings per Shareyear ended December 31, 2010 accounting guidance.. In determining the number of diluted shares outstanding, the relevant guidance requires disclosure of the more dilutive earnings per share result between the if-converted method calculation and the two-class method calculation. For the year ended December 31, 2010, the two-class method calculation was more dilutive; therefore, the earnings per share information below is presented following the two-class method which includes convertible participating preferred stock assumed to be converted to 1,875,000 shares of common stock that share in distributions with common shareholders on a 1:1 basis. For

    The computations of basic and diluted earnings per share for the yearyears ended December 31, 2009,2011 and 2010 (dollars in thousands, except share and per share amounts) are as the convertible participating preferred stockholders do not have an obligation to participate in losses, no allocation of undistributed losses was necessary.follows:
     

     For the Year Ended
     December 31,
     2010     2009
    Numerator:       
         Net income (loss)$    985,654  $    (183,156)
         Less loss attributable to noncontrolling interests (1,048)  (2,054)
         Dividends on preferred shares (16,499)  (15,312)
         Allocation of undistributed income to convertible participating preferred stock (162,246)  - 
         Income (loss) available to common shareholders$807,957  $(196,414)
     
    Denominator:       
         Weighted average common shares outstanding – basic and diluted 9,337,207   9,368,053 
     
    Basic earnings per share:       
         Net income (loss)$105.56  $(19.55)
         Less loss attributable to noncontrolling interests (0.11)  (0.22)
         Dividends on preferred shares (1.77)  (1.64)
         Allocation of undistributed income to convertible participating preferred stock (17.37)  - 
         Net income (loss) available to common shareholders$86.53  $(20.97)
     
    Diluted earnings per share:       
         Net income (loss)$105.56  $(19.55)
         Less loss attributable to noncontrolling interests (0.11)  (0.22)
         Dividends on preferred shares (1.77)  (1.64)
         Allocation of undistributed income to convertible participating preferred stock (17.37)  - 
         Net income (loss) available to common shareholders$86.53  $(20.97)
     
    42


     For the Year Ended
    December 31,
     2011 2010
    Numerator:   
    Net income$7,272
    		 $985,654
    Less loss attributable to noncontrolling interests(491) (1,048)
    Dividends on preferred shares(8,428) (16,499)
    Net effect of preferred stock exchange (A)95,460
    		 —
    Allocation of undistributed income to convertible participating preferred stock—
    		 (162,246)
    Net income available to common shareholders$94,795
    		 $807,957
        
    Denominator:   
    Weighted average common shares outstanding - basic52,132,669
    		 9,337,207
        
    Weighted average common shares outstanding - dilutive:   
    Weighted average common shares outstanding - basic52,132,669
    		 9,337,207
    Nonvested shares159,653
    		 —
    Weighted average common shares outstanding - dilutive52,292,322
    		 9,337,207
        
    Basic earnings per share:   
    Net income$0.14
    		 $105.56
    Less loss attributable to noncontrolling interests(0.01) (0.11)
    Dividends on preferred shares(0.16) (1.77)
    Net effect of preferred stock exchange (A)1.83
    		 —
    Allocation of undistributed income to convertible participating preferred stock—
    		 (17.37)
    Net income available to common shareholders$1.82
    		 $86.53
        
    Diluted earnings per share:   
    Net income$0.14
    		 $105.56
    Less loss attributable to noncontrolling interests(0.01) (0.11)
    Dividends on preferred shares(0.16) (1.77)
    Net effect of preferred stock exchange (A)1.82
    		 —
    Allocation of undistributed income to convertible participating preferred stock—
    		 (17.37)
    Net income available to common shareholders$1.81
    		 $86.53
        
    (A)
    The net effect of the preferred stock exchange includes amounts attributable to the Series C Offer and the Series D Exchange and was calculated in accordance with applicable Earnings per Share guidance. The Series C Offer amount is calculated as the difference between (1) the fair value of the consideration transferred to the holders of the Series C Preferred Stock and (2) the carrying amount of the Series C Preferred Stock. The Series D Exchange amount consists of the excess of (1) the fair value of all securities and other consideration transferred by the Company to the Series D Holders over (2) the fair value of securities issuable pursuant to the original conversion terms.

    The following table presentsweighted-average stock options to purchase shares of common stock thatCommon Stock were outstanding during each period presented, but were not included in the computation of diluted earnings (loss) per share because the number of shares assumed to be repurchased, as calculated was greater than the number of shares to be obtained upon exercise, therefore, the effect would be antidilutive (in thousands, except exercise prices):
     For the Year Ended
     December 31,
       2010     2009
    Number of stock options (in thousands) 282  114
    Weighted average exercise price of stock options$      21.91 $      52.98
     
    52
     
    For the Year Ended
    December 31,
     2011 2010
    Number of stock options677
    		 282
    Weighted average exercise price of stock options$8.38
    		 $21.91
        
     
    The Company granted 0.4 million options to purchase shares of Common Stock at an exercise price of $0.51, of which the weighted average outstanding amount is included in the table above. The Company also granted 0.9 million nonvested shares to

    43


    its non-employee directors on August 9, 2011, approximately 0.7 million of which were not included in the earnings per share as they were anti-dilutive for the year ended December 31, 2011. The Company had 27,354 and 30,846 of additional nonvested shares outstanding as of December 31, 2011 and December 31, 2010, respectively which have original cliff vesting schedules ranging between five and ten years. The nonvested shares for each period were not included in the earnings per share because they were anti-dilutive.

    Note 16. Income Taxes
     
    The components of income tax expense (benefit)benefit for the years ended December 31, 20102011 and 20092010 were as follows (dollars in thousands):
      For the Year Ended
      December 31,
          2010     2009
    Current:        
    Federal $(1,038) $1,192 
    State and local  (318)  (84)
    Total current  (1,356)  1,108 
             
    Total income tax (benefit) expense $(1,356) $1,108 
     
      
    For the Year Ended
    December 31,
      2011 2010
    Current:  
    		  
    Federal $(1,519) $(1,038)
    State and local (255) (318)
    Total income tax benefit $(1,774) $(1,356)
         

    The Company recorded a receivable for the overpayment of previously paid income taxes of $2.3 million during 2011 which is reflected in the amounts above. A substantial portion of the receivable was collected subsequent to 2011. There was an accrued interest receivable of $0.1 million as of December 31, 2011.

    A reconciliation of the expected federal income tax expense (benefit) using the federal statutory tax rate of 35% to the Company’s actual income tax expense (benefit)benefit and resulting effective tax rate from continuing operations for the years ended December 31, 20102011 and 20092010 were as follows (dollars in thousands):
      
    For the Year Ended
    December 31,
      2011 2010
    Income tax at statutory rate $2,068
    		 $344,871
    State income taxes, net of federal tax benefit 179
    		 14,734
    Valuation allowance (8,524) (382,565)
    Change in state tax rate —
    		 10,583
    Adjustment to deferred tax asset 3,161
    		 4,271
    Recapitalization cost 774
    		 —
    Derecognition of securitized trust —
    		 8,409
    Uncertain tax positions 558
    		 380
    Other 10
    		 (2,039)
    Total income tax benefit $(1,774) $(1,356)
         
      For the Year Ended
      December 31,
          2010     2009
    Income tax at statutory rate $344,871  $     (62,998)
    State income taxes, net of federal tax benefit  14,734   (3,201)
    Valuation allowance       (382,565)  72,119 
    Interest and penalties  (89)  (218)
    Change in state tax rate  10,583   (7,768)
    Adjustment to net operating loss  4,271   2,079 
    Derecognition of securitization trust  8,409   - 
    Other  (1,570)  1,095 
    Total income tax (benefit) expense $(1,356) $1,108 
     


    The 2010 income tax benefit shown above, does not reflect the ($2.0 million) income tax benefit recorded as part of the “Gain on Deconsolidation of Securitization Trusts.” The gain relates to the removal of the income tax payable and uncertain tax position related to the securitization trusts that were derecognized during the year.
     

    44


    Significant components of the Company’s deferred tax assets and liabilities at December 31, 20102011 and 20092010 were as follows (dollars in thousands):
      December 31, 2011 December 31, 2010
    Deferred tax assets:    
    Basis difference – investments $157,256
    		 $162,675
    Federal net operating loss carryforwards 114,329
    		 113,527
    Allowance for loan losses —
    		 440
    State net operating loss carryforwards 12,185
    		 15,055
    Other 2,641
    		 3,048
    Gross deferred tax asset 286,411
    		 294,745
    Valuation allowance (284,491) (292,528)
    Deferred tax asset 1,920
    		 2,217
    Deferred tax liabilities:    
    Other 1,920
    		 2,217
    Deferred tax liability 1,920
    		 2,217
    Net deferred tax asset $—
    		 $—
         
      December 31, December 31,
          2010     2009
    Deferred tax assets:        
         Basis difference – investments $162,675  $389,027 
         Federal net operating loss carryforwards  113,527   163,280 
         Allowance for loan losses  440   93,715 
         State net operating loss carryforwards  15,055   18,719 
         Excess inclusion income  -   2,291 
         Other  3,048   9,801 
    Gross deferred tax asset  294,745   676,833 
         Valuation allowance         (292,528)         (674,823)
    Deferred tax asset  2,217   2,010 
             
    Deferred tax liabilities:        
         Other  2,217   2,010 
    Deferred tax liability  2,217   2,010 
             
    Net deferred tax asset $-  $- 
     


    Based on the evidence available as of December 31, 2011 and 2010, the Company believes that it is not more likely than not that the Company will not realize its net deferred tax assets. Based on this conclusion, the Company recordedhad a valuation allowance of $292.5$284.5 million for deferred tax assets as of December 31, 2011 compared to $292.5 million as of December 31, 2010 compared to $674.8 million as.

    As of December 31, 2009. This large decrease was mainly attributable to the derecognition of securitization trusts during the year ended December 31, 2010.
    53

    As of December 31, 2010,2011, the Company had a federal net operating loss of approximately $324.4$326.8 million. The federal net operating loss may be carried forward to offset future taxable income, subject to applicable provisions of the Code, including substantial limitations in the event of an “ownership change” as defined in Section 382 of the Code. If not used, this net operating loss will expire in years 2025 through 2030.2031. The Company has state net operating loss carryovers arising from both combined and separate filings from as early as 2004. The state net operating loss carryovers may expire as early as 20112012 and as late as 2030.2031.
     
    The activity in the accrued liability for unrecognized tax benefits for the years ended December 31, 20102011 and 20092010 was as follows (dollars in thousands):
     
    For the Year Ended
    December 31,
         2010     2009 2011 2010
    Beginning balance $906 $480  $966
    		 $906
    Gross decreases – tax positions in prior period - - 
    Gross increases – tax positions in current period 470 674  615
    		 470
    Lapse of statute of limitations       (143)       (248) (88) (143)
    Other  (267)  -  —
    		 (267)
    Ending balance $966 $906  $1,493
    		 $966
        

    As of December 31, 20102011 and 2009,2010, the total gross amount of unrecognized tax benefits was $1.0$1.5 million and $0.9$1.0 million, respectively, which also represents the total amount of unrecognized tax benefits that would impact the effective tax rate. The Company anticipates a reduction of unrecognized tax benefits in the amount of $0.1$0.4 million due the lapse of statute of limitations in the next twelve months. The Company does not expect any other significant change in the liability for unrecognized tax benefits in the next twelve months.
     
    It is the Company’s policy to recognize interest and penalties related to income tax matters in income tax expense. InterestThe benefit for interest and penalties recorded in income tax expense was $0.1$0.2 million and $0.2$0.1 million for the years ended December 31, 20102011 and 2009,2010, respectively. There was accrued interest and penalties of $0.1 million as of December 31, 2011. Accrued interest and penalties payable were $0.1 million and $1.9 million as of December 31, 2010 and 2009, respectively..
     
    The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state and local jurisdictions. Tax years 20062007 to 20102011 remain open to examination for U.S. federal income tax. Tax years 20052006 to 20102011 remain open for major state tax jurisdictions.
     
    Management believes it has adequately provided for potential tax liabilities that may be assessed for years in which the statute of limitations remains open. However, if there were an assessment of any material liability it may adversely affect the Company’s financial condition and liquidity.
    Note 17. Employee Benefit Plans

    45


     
    Eligible employees may save for retirement through pretax contributions in defined contribution plans offered by the Company. Employees of the Company may contribute up to the statutory limit. The Company may elect to match a certain percentage of participants’ contributions. No contributions were made to the plans for the yearyears ended December 31, 2011 and 2010. There were $0.1 million in contributions made to the plans for the year ended December 31, 2009. The Company may also elect to make a discretionary contribution, which is allocated to participants based on each participant’s compensation. There were no contributions made to the plans during the yearyears ended December 31, 2011 and 2010. For 2009, $0.4 million was contributed to the plan’s participants, all of which came from the plan’s forfeitures account.
     
    The Company maintains a stock compensation plan. As a resultThe aggregate value and expense associated with the grants under the plan is not material to the Company's consolidated statements.
    Note 18. Securitization Transactions
    Prior to 2010, the Company securitized mortgage loans. For three of the differential betweensecuritizations (NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1), the exercise pricetransactions were structured legally as sales, but for accounting purposes were treated as financings. Accordingly, the loans in these securitizations remained as assets and securitization bond financing were reflected as a liabilities. The Company recorded interest income on loans held-in-portfolio and interest expense on the bonds issued in the securitizations. During the first quarter of 2010, certain events occurred that required the Company to reconsider the accounting for these consolidated loan trusts.
    During January of 2010, the Company attempted to sell the mezzanine-level bonds the Company owns from the NHEL 2006-1 and NHEL 2006-MTA1 securitization trusts and the current market pricefinal derivative of the options outstanding, it is not likely thatNHEL 2007-1 loan securitization trust expired. These events prompted a reconsideration of the stock compensation plan will have a significant impact onCompany's consolidation conclusion. As all requirements for derecognition had been met under applicable accounting guidelines, the Company’sCompany derecognized the assets and liabilities of the three consolidated securitizations as of January 25, 2010. Upon derecognition, all assets, liabilities and accumulated deficits were removed from our consolidated financial statements and, accordingly, additional information relative tostatements. A gain of $993.1 million was recognized upon derecognition, representing the number of options and related expenses is not included herein.
    Note 18. Fair Value of Financial Instrumentsnet accumulated deficits in these trusts.
     
    The following disclosureassets and liabilities of the estimated fair value of financial instruments presents amounts that have been determined using available market informationsecuritization trusts and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicativeresulting gain recognized upon derecognition consisted of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimation methodologies could have a material impact onfollowing at the estimated fair value amounts.
    54

    The estimated fair valuestime of the Company’s financial instruments are as follows as of December 31, 2010 and 2009reconsideration event (dollars in thousands):
     
      2010 2009
          Carrying Value     Fair Value     Carrying Value     Fair Value
    Financial assets:              
         Cash and cash equivalents $12,582 $          12,582 $7,104  $7,104 
         Restricted cash  1,413  1,341  5,342   5,206 
         Mortgage loans – held-in-portfolio  -  -  1,289,474   1,160,527 
         Mortgage securities – trading  1,198  1,198  1,087   1,087 
         Mortgage securities – available-for-sale  4,580  4,580  6,903   6,903 
         Notes receivable  3,965  3,965  4,920   4,920 
         Accrued interest receivable  -  -  74,025   74,025 
    Financial liabilities:              
         Borrowings:              
              Asset-backed bonds secured by              
                   mortgage loans  -  -       2,270,602        1,297,980 
              Asset-backed bonds secured by              
                   mortgage securities  1,198  1,198  968   968 
              Junior subordinated debentures  78,086  17,988  77,815   6,225 
         Accrued interest payable  345  345  751   751 
    Derivative instruments:  -  -  (157)  (157)
      
     Total
    Assets: 
    Mortgage loans – held-in-portfolio$1,953,188
    Allowance for loan losses(702,901)
    Accrued interest receivable72,725
    Real estate owned55,309
    Total assets1,378,321
      
    Liabilities: 
    Asset-backed bonds secured by mortgage loans2,235,633
    Due to servicer131,772
    Other liabilities4,047
    Total liabilities2,371,452
      
    Gain on derecognition of securitization trusts$993,131
      

    CashIn other mortgage loan securitizations executed by the Company, transactions were structured as a sale legally and cash equivalents – The fair valuefor accounting purposes. At the time of cash and cash equivalents approximates its carrying value.
    Restricted Cash – The fair value of restricted cash was estimatedsecuritization, the loans in these securitizations were removed from the Company's balance sheet. However, the Company retained the residual interest securities issued by discounting estimated future release of the cash from restriction.
    securitization trust. These retained interests were classified as Mortgage loans – held-in-portfolio – The fair value of mortgage loans – held-in-portfolio was estimated using the carrying value less a market discount. The internal rate of return is less than what an outside investor would require due to the embedded credit risk, therefore a market discount is required to get to the fair value. The fair value of mortgage loans – held-in-portfolio approximated its carrying value at December 31, 2009.
    Mortgage securities- trading – SeeSecurities, which are described more fully in Note 115 to the consolidated financial statements for fair value method utilized.statements.
     
    Mortgage securities – available-for-sale – See Note 11The following table relates to the securitizations where the Company retained an interest in the assets issued by the securitization trust, a variable interest entity or VIE (dollars in thousands):

    46


     Size/Principal Outstanding (A) Assets on Balance Sheet (B) Liabilities on Balance Sheet Maximum Exposure to Loss(C) Year to Date Loss on Sale Year to Date Cash Flows
    December 31, 2011$6,265,564
    		 $3,878
    		 $—
    		 $3,878
    		 $—
    		 $8,920
    December 31, 20107,189,121
    		 4,580
    		 —
    		 4,580
    		 —
    		 11,362
               
    (A)Size/Principal Outstanding reflects the estimated principal of the underlying assets held by the VIE.
    (B)Assets on balance sheet are securities issued by the entity and are recorded in Mortgage securities.
    (C)The maximum exposure to loss includes the assets held by the Company. The maximum exposure to loss assumes a total loss on the referenced assets held by the VIE.

    Prior to 2010, the Company executed a securitization of mortgage securities in what is commonly called a Collateralized Debt Obligation (“CDO”). The Company serves as the CDO's asset manager. The collateral for the CDO consisted of subordinated mortgage securities and included securities retained by the Company in its loan securitizations and purchased from third parties. This securitization was structured legally as a sale, but for accounting purposes was accounted for as a financing. Accordingly, the CDO assets (securities) and securitization bond financing were included in the Company's consolidated financial statements for fair value method utilized.
    Notes receivable – The fair value of notes receivable approximates its carrying value.
    Accrued interest receivable – The fair value of accrued interest receivable approximates its carrying value.
    Asset-backed bonds secured by mortgage loans – The fair value of asset-backed bonds secured by mortgage loans andbalance sheet. During the related accrued interest payable was estimated usingyear ended December 31, 2011, the fair value of mortgage loans – held-in-portfolio as the trusts have no recourseassets and liabilities were reduced to the Company’s other, unsecuritized assets.
    Asset-backed bonds secured by mortgage securities –The faira value of asset-backed bonds secured by mortgage securities and the related accrued interest payable is approximated using quoted market prices.
    Junior subordinated debentures –zero. As of December 31, 2010, the fair value of junior subordinated debentures is estimated by discounting future projected cash flows using a discount rate commensurate with the risks involved. As of December 31, 2009, the fair value of junior subordinated debentures is estimated using the price from the repurchase transaction that the Company completed during 2008.assets and liabilities were valued at $1.2 million.
    Accrued interest payable – The fair value of accrued interest payable approximates its carrying value.
    Derivative instruments – The fair value of derivative instruments is estimated by discounting the projected future cash flows using appropriate rates.
    55

    Note 19. Subsequent Events
     
    RefinancingOn March 8, 2012, Steve Haslam, the Chief Executive Officer of Trust Preferred Securities
    In an effort to improveStreetLinks, was appointed the Company’s liquidity position, on March 22, 2011, the Company entered into agreements that cancel the existing $78,125,000 aggregate principal amountChief Operating Officer of Trust Preferred Securities (the “TruPS”) issued in 2009 by certain statutory trusts formed by a wholly-owned subsidiary, NovaStar Mortgage, Inc. (“NMI”).  NMI issued unsecured junior subordinated notes (the “Junior Subordinated Notes”), to support the payment obligations under the TruPS. The Junior Subordinated Notes were guaranteed by the Company. As a resultpart of the transaction, the Junior Subordinated Notes were cancelled. In placetransition of the TruPS and associated Junior Subordinated Notes,Mr. Haslam to his new position with the Company, issuedand pursuant to the holdersexercise of his rights under his employment agreement with StreetLinks, he sold all of his 1,927 membership units of StreetLinks to the TruPS unsecured senior notesCompany pursuant to three indentures (collectively, the “Senior Notes”).  The aggregate principal amount of the Senior Notes is $85,937,500, which is a 10% increase in principal over the liquidation value of the TruPS.  The new Senior Notes will accrue interest at a rate of 1% until the earlier to occur of (a) a completed equity offeringMembership Interest Purchase Agreement, dated March 8, 2012, by the Company or its subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”).The Senior Notes mature on March 30, 2033.
    The indentures governing the Senior Notes contain negative covenants that, among other things, restrict the Company’s use of cash (including cash payments for distributions to shareholders). At any time that the Senior Notes accrue interest at the Full Rate,and between Mr. Haslam and the Company satisfies certain financial covenants, certain negative covenants and restrictions on cash will not apply.
    Proposed Recapitalization(the “Unit Purchase Agreement”). The 1,927 membership units of Preferred Stock.
    As described in the Company’s Form S-4 Registration Statement, as amended (Registration No. 333-171115), filed with the SEC (the “Form S-4”), the Company is proposing to recapitalize the outstanding shares of its Series C Preferred Stock and its Series D1 Preferred Stock. The Series C Preferred Stock is publicly held, and the Series D Preferred Stock is privately held.
    Upon the terms and subject to the conditions set forth in the Form S-4, the Company is proposing to exchange, for each outstanding share of Series C Preferred Stock, at the election of the holder, either:
    • 3 shares of newly-issued Common Stock of the Company, and $2.00 in cash; or
    • 19 shares of newly-issued Common Stock (the “Series C Offer”).
    The elections made by the holders of the Series C Preferred Stock will be subject to allocation and proration procedures intended to ensure that, in the aggregate, 43,823,600 newly-issued shares of Common Stock and $1,623,000 in cash (plus such other cash that is needed to cash out fractional shares) will be issued to the holders of the Series C Preferred Stock. The proposed Series C Offer will not be made unless and until the Form S-4 is declared effective by the SEC and it is subject to other closing conditions, such as the acceptance of the Series C Offer by at least two-thirdsStreetLinks represent approximately 5% of the outstanding shares of Series C Preferred Stock andStreetLinks membership units. The total purchase price under the requisite affirmative vote of shareholders in support of certain aspects of the recapitalization.
    The proposed Series C OfferUnit Purchase Agreement is part of a larger recapitalization of the Company, whereby the holders of the Company’s Series D1 Preferred Stock have agreed$6.1 million, which is payable to exchange their stock for an aggregate of 37,161,600 newly-issued shares of Common Stock and $1,377,000 in cash (the “Series D Exchange”). The closing of the Series D Exchange is contingent upon the closing of the Series C Offer by not later thanMr. Haslam as follows: $0.5 million on March 8, 2012, $0.5 million on June 30, 2011 and2012, $0.3 million on the satisfactionlast day of other conditions.each quarter thereafter until March 8, 2016, on which date the unpaid principal balance of $1.6 million is to be paid, plus interest on the unpaid balance at the rate of four percent per annum, compounded quarterly.


    As of March 18, 2011, the Series C Preferred Stock had an aggregate liquidation preference of $74.8 million and accrued and unpaid dividends of $23.0 million, and the Series D1 Preferred Stock had an aggregate liquidation preference of $52.5 million and accrued and unpaid dividends of $31.5 million. The proposed recapitalization, if effected, would eliminate the Series C Preferred Stock and Series D Preferred Stock and their associated liquidation preferences and dividends.
    47
    There are multiple conditions to the closing of the Series C Offer and the Series D Exchange that are beyond our control, and we cannot provide you any assurance that these conditions will be satisfied or that the Series C Offer and the Series D Exchange will close.
    56


    REPORT OF INDEPENDENT OF REGISTERED PUBLIC ACCOUNTING FIRM

    To the Board of Directors and Stockholders of
    NovaStar Financial, Inc.
    Kansas City, Missouri

    We have audited the accompanying consolidated balance sheets of NovaStar Financial, Inc. and subsidiaries (the "Company") as of December 31, 20102011 and 2009,2010, and the related consolidated statements of operations, shareholders’shareholders' deficit and comprehensive income, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

    We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

    In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the CompanyNovaStar Financial, Inc. and subsidiaries as of December 31, 20102011 and 2009,2010, and the results of itstheir operations and itstheir cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.

    /s/ DELOITTE & TOUCHE LLP
    Kansas City, Missouri
    March 15, 201222, 2011

    57

    48


    Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
     
    None.

    Item 9A. Controls and Procedures
     
    Disclosure Controls and Procedures
     
    The Company maintains a system of disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the federal securities laws, including this report, is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed under the federal securities laws is accumulated and communicated to the Company’s management on a timely basis to allow decisions regarding required disclosure. The Company’s principal executive officer and principal financial officer evaluated the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(d)) as of the end of the period covered by this report and concluded that the Company’s controls and procedures were effective.

    Internal Control over Financial Reporting

    Management’s Report on Internal Control over Financial Reporting

    Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934. This internal control system has been designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of the Company’s published financial statements.

    All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

    Management of the Company has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010.2011. To make this assessment, management used the criteria for effective internal control over financial reporting described in Internal Control—Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management has excluded from the scope of its assessment of internal control over financial reporting the operations and related assets of Corvisa,Mango, which the Company acquired on November 4, 2010. At December 31, 2010,October 17, 2011. As of and for the year ended December 31, 2010,2011, the amounts subject to the internal control over financial reporting arising from this acquisition represented 9.0%9.8% of our consolidated total assets, (2.9%(7.0%) of our consolidated net assets, 0.1%0.5% of our consolidated total revenue, and 0.0%(2.9%) of our consolidated net income. Based on that evaluation and its assessment, management concluded that the Company’s internal control over financial reporting is effective as of December 31, 2010 and the outstanding material weakness2011, mentioned below, was remediated during this period. A material weakness is a deficiency, or combination of deficiencies, in internal controls over financial reporting, such that it is reasonably possible that a material misstatement in the company’s annual or interim financial statements and related disclosures will not be prevented or detected on a timely basis..

    Changes in Internal Control over Financial Reporting

    There were no changes in our internal controls over financial reporting during the three months ended December 31, 20102011 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting other than the remediation of the material weakness discussed above. During the quarter ended December 31, 2010, the Company implemented additional review controls over financial reporting, in particular related to the preparation and review of the financial statements. In addition, certain duties have been transitioned to other members of the department to mitigate control risks. As a result, management believes that the Company has remediated the material weakness for segregation of duties.reporting.

    58

    Item 9B. Other Information
     
    None.

    PARTPart III

    Item 10. Directors, Executive Officers and Corporate Governance

    Information with respect to Items 401, 405 and 407(d)(4) and (d)(5) of Regulation S-K is incorporated by reference to the information included in our Proxy Statement for the 20112012 Annual Meeting of Shareholders.

    Item 11. Executive Compensation
     
    Information with respect to Items 402 and 407(e)(4) and (e)(5) of Regulation S-K is incorporated by reference to the information included in our Proxy Statement for the 20112012 Annual Meeting of Shareholders.

    Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
     
    Information with respect to Items 403 of Regulation S-K is incorporated by reference to the information included in our Proxy Statement for the 20112012 Annual Meeting of Shareholders.

    49



    Item 13. Certain Relationships and Related Transactions, and Director Independence
     
    Information with respect to Item 404 and 407(a) of Regulation S-K is incorporated by reference to the information included in our Proxy Statement for the 20112012 Annual Meeting of Shareholders.

    Item 14. Principal Accountant Fees and Services

    Information with respect to Item 9(e) of Schedule 14A is incorporated by reference to the information included in our Proxy Statement for the 20112012 Annual Meeting of Shareholders.

    59 

    PARTPart IV
     
    Item 15. Exhibits and Financial Statements Schedules

    Financial Statements and Schedules
     
    (1)The financial statements as set forth under Item 8 of this report on Form 10-K are included herein.
    (2)The required financial statement schedules are omitted because the information is disclosed elsewhere herein.

    Exhibit Listing
    Exhibit No. Description of Document
    3.11(1)
    		 Articles of Amendment and Restatement of NovaStar Financial, Inc. (including all amendments and applicable Articles Supplementary)
    3.1.12(2)
    		 CertificateArticles Supplementary of AmendmentSeries F Participating Stock of the RegistrantNovaStar Financial, Inc.
    3.23(3)
    		 Amended and Restated Bylaws of the Registrant, adopted July 27, 2005
    3.2.14(4)
    		 Amendment to the Amended and Restated Bylaws of the Registrant
    4.15(5)
    		 Specimen Common Stock Certificate
    4.26(6)
    		 Specimen Preferred Stock Certificate
    4.37(7)
    		 Registration Rights Agreement, dated March 15, 2011, between the Company and W. Lance Anderson
    4.4 (8)
    		Registration Rights Agreement, dated June 23, 2011, among NovaStar Financial, Inc., Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC, JCP Partners IV LLC and Massachusetts Mutual Life Insurance Company
    4.5 (9)
    		Rights Agreement, dated as of September 15, 2011, by and between NovaStar Financial, Inc. and Computershare Trust Company, N.A., as rights agent, incorporated by reference to Exhibit 4.1 of the Company's Form 8-A filed with the SEC on September 21, 2011.
    10.18(10)
    		 Employment Agreement, dated as of January 7, 2008, by and between NovaStar Financial, Inc. and Rodney E. Schwatken.
    10.29(11)
    		 Form of Indemnification Agreement for Officers and Directors of NovaStar Financial, Inc. and its Subsidiaries
    10.310(12)
    		 NovaStar Financial Inc. 2004 Incentive Stock Plan
    10.411(13)
    		 Amendment One to the NovaStar Financial, Inc. 2004 Incentive Stock Option Plan
    10.512(14)
    		 Stock Option Agreement under NovaStar Financial, Inc. 2004 Incentive Stock Plan
    10.613(15)
    		 Restricted Stock Agreement under NovaStar Financial, Inc. 2004 Incentive Stock Plan
    (1) Incorporated by reference to Exhibit 3.1 to Form 8-K filed by the Registrant with the SEC on June 29, 2011 (File No. 001-13533).
    (2) Incorporated by reference to Exhibit 3.1 to Form 8-K filed by the Registrant with the SEC on September 21, 2011 (File No. 001-13533).
    (3) Incorporated by reference to Exhibit 3.3.1 to Form 10-Q filed by the Registrant with the SEC on August 5, 2005 (File No. 001-13533).
    (4) Incorporated by reference to Exhibit 3.2.1 to Form 8-K filed by the Registrant with the SEC on March 16, 2009 (File No. 001-13533).
    (5) Incorporated by reference to Exhibit 4.1 to Form 10-Q filed by the Registrant with the SEC on August 5, 2005 (File No. 001-13533).
    (6) Incorporated by reference to Exhibit 4.3 to Form 8-A/A filed by the Registrant with the SEC on January 20, 2004 (File No. 001-13533).
    (7) Incorporated by reference to Exhibit 4.1 to Form 8-K filed by the Registrant with the SEC on March 21, 2011 (File No. 001-13533).
    (8) Incorporated by reference to Exhibit 4.1 to Form 8-K filed by the Registrant with the SEC on June 29, 2011 (File No. 001-13533).
    (9) Incorporated by reference to Exhibit 4.1 to Form 8-K filed by the Registrant with the SEC on September 21, 2011 (File No. 001-13533).
    (10) Incorporated by reference to Exhibit 10.1 to Form 8-K/A filed by the Registrant with the SEC on January 10, 2008 (File No. 001-13533).
    (11) Incorporated by reference to Exhibit 10.10 to Form 8-K filed by the Registrant with the SEC on November 16, 2005 (File No. 001-13533).
    (12) Incorporated by reference to Exhibit 10.15 to Form S-8 filed by the Registrant with the SEC on June 30, 2004 (Registration No. 333-116998).
    (13) Incorporated by reference to Exhibit 10.46 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007 (File No. 001-13533).
    (14) Incorporated by reference to Exhibit 10.25.1 to Form 8-K filed by the Registrant with the SEC on February 4, 2005 (File No. 001-13533).
    (15) Incorporated by reference to Exhibit 10.25.2 to Form 8-K filed by the Registrant with the SEC on February 4, 2005 (File No. 001-13533).

    50


    Exhibit No.Description of Document
    10.714(16)
    		 Performance Contingent Deferred Stock Award Agreement under NovaStar Financial, Inc. 2004 Incentive Stock Plan
    10.815(17)
    		 NovaStar Financial, Inc. Executive Bonus Plan
    10.916(18)
    		 2005 Compensation Plan for Independent Directors (effective through August 8, 2011)
    10.1017(19)
    		 NovaStar Financial, Inc. Long Term Incentive Plan
    10.1118(20)
    		 Securities Purchase Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC
    ____________________

    1Incorporated by reference to Exhibit 3.1 to Form 10-Q filed by the Registrant on August 9, 2007 (File No. 001-13533).
    2Incorporated by reference to Exhibit 3.1 to Form 8-K filed by the Registrant with the SEC on May 26, 2005 (File No. 001-13533).
    3Incorporated by reference to Exhibit 3.3.1 to Form 10-Q filed by the Registrant with the SEC on August 5, 2005 (File No. 001-13533).
    4Incorporated by reference to Exhibit 3.2.1 to Form 8-K filed by the Registrant with the SEC on March 16, 2009 (File No. 001-13533).
    5Incorporated by reference to Exhibit 4.1 to Form 10-Q filed by the Registrant with the SEC on August 5, 2005 (File No. 001-13533).
    6Incorporated by reference to Exhibit 4.3 to Form 8-A/A filed by the Registrant with the SEC on January 20, 2004 (File No. 001-13533).
    7Incorporated by reference to Exhibit 4.1 to Form 8-K filed by the Registrant with the SEC on March 21, 2011 (File No. 001-13533).
    8Incorporated by reference to Exhibit 10.1 to Form 8-K/A filed by the Registrant with the SEC on January 10, 2008 (File No. 001-13533).
    9Incorporated by reference to Exhibit 10.10 to Form 8-K filed by the Registrant with the SEC on November 16, 2005 (File No. 001-13533).
    10Incorporated by reference to Exhibit 10.15 to Form S-8 filed by the Registrant with the SEC on June 30, 2004 (Registration No. 333-116998).
    11Incorporated by reference to Exhibit 10.46 to Form 10-Q filed by the Registrant with the SEC on May 10, 2007 (File No. 001-13533).
    12Incorporated by reference to Exhibit 10.25.1 to Form 8-K filed by the Registrant with the SEC on February 4, 2005 (File No. 001-13533).
    13Incorporated by reference to Exhibit 10.25.2 to Form 8-K filed by the Registrant with the SEC on February 4, 2005 (File No. 001-13533).
    14Incorporated by reference to Exhibit 10.25.3 to Form 8-K filed by the Registrant with the SEC on February 4, 2005 (File No. 001-13533).
    15Incorporated by reference to Exhibit 10.26 to Form 8-K filed by the Registrant with the SEC on March 15, 2007 (File No. 001-13533).
    16Incorporated by reference to Exhibit 10.30 to Form 8-K filed by the Registrant with the SEC on February 11, 2005 (File No. 001-13533).
    17Incorporated by reference to Exhibit 10.34 to Form 8-K filed by the Registrant with the SEC on February 14, 2006 (File No. 001-13533).
    18Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 (File No. 001-13533).
    60

    10.1219(21) Standby Purchase Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC
    10.1320(22)
    		 Registration Rights and Shareholders Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC
    10.1421(23)
    		 Letter Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC, and Scott Hartman
    10.1522(24)
    		 Letter Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC, and Lance Anderson
    10.1623(25)
    		 Letter Agreement, dated July 16, 2007, by and among NovaStar Financial, Inc., Massachusetts Mutual Life Insurance Company, Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC, and Mike Bamburg
    10.1724(26)
    		 Confidential Settlement Term Sheet Agreement, dated March 17, 2008, between American Interbanc Mortgage LLC, NovaStar Financial, Inc., NovaStar Mortgage, Inc., NFI Holding Corp., and NovaStar Home Mortgage, Inc. (Complete Agreement Filed Due to Expiration of Confidential Treatment Request)
    10.1825(27)
    		 Amended and Restated Trust Agreement, dated as of February 18, 2009, by and among, NovaStar Mortgage, Inc., The Bank of New York Mellon Trust Company, National Association, BNY Mellon Trust of Delaware and certain administrative trustees (including the form of Preferred Securities Certificate) (I/B)
    10.1926(28)
    		 Junior Subordinated Indenture, dated as of February 18, 2009, between NovaStar Mortgage, Inc. and The Bank of New York Mellon Trust Company, National Association (I/B)
    10.2027(29)
    		 Parent Guarantee Agreement, dated as of February 18, 2009, between NovaStar Financial, Inc. and The Bank of New York Mellon Trust Company, National Association (I/B)
    10.2128(30)
    		 Amended and Restated Trust Agreement, dated as of February 18, 2009, by and among, NovaStar Mortgage, Inc., The Bank of New York Mellon Trust Company, National Association, BNY Mellon Trust of Delaware and certain administrative trustees (including the form of Preferred Securities Certificate) (II/B)
    10.2229(31)
    		 Junior Subordinated Indenture, dated as of February 18, 2009, between NovaStar Mortgage, Inc. and The Bank of New York Mellon Trust Company, National Association (II/B)
    10.2330(32)
    		 Parent Guarantee Agreement, dated as of February 18, 2009, between NovaStar Financial, Inc. and The Bank of New York Mellon Trust Company, National Association (II/B)
    10.2431(33)
    		 Securities Purchase Agreement, dated as of April 26, 2009, by and among NovaStar Financial, Inc., Advent Financial Services, LLC and Mark A. Ernst
    ____________________

    19 
    (16) Incorporated by reference to Exhibit 10.25.3 to Form 8-K filed by the Registrant with the SEC on February 4, 2005 (File No. 001-13533).
    (17) Incorporated by reference to Exhibit 10.26 to Form 8-K filed by the Registrant with the SEC on March 15, 2007 (File No. 001-13533).
    (18) Incorporated by reference to Exhibit 10.30 to Form 8-K filed by the Registrant with the SEC on February 11, 2005 (File No. 001-13533).
    (19) Incorporated by reference to Exhibit 10.34 to Form 8-K filed by the Registrant with the SEC on February 14, 2006 (File No. 001-13533).
    (20) Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 (File No. 001-13533).
    (21) Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 (File No. 001-13533).
    20(22) Incorporated by reference to Exhibit 10.3 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 (File No. 001-13533).
    21(23) Incorporated by reference to Exhibit 10.4 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 (File No. 001-13533).
    22(24) Incorporated by reference to Exhibit 10.5 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 (File No. 001-13533).
    23(25) Incorporated by reference to Exhibit 10.6 to Form 8-K filed by the Registrant with the SEC on July 20, 2007 (File No. 001-13533).
    24(26) Incorporated by reference to Exhibit 10.55 to Form 10-Q filed by the Registrant with the SEC on April 27, 2009 (File No. 001-13533).
    25(27) Incorporated by reference to Exhibit 10.56 to Form 8-K filed by the Registrant with the SEC on February 24, 2009 (File No. 001-13533).
    26(28) Incorporated by reference to Exhibit 10.57 to Form 8-K filed by the Registrant with the SEC on February 24, 2009 (File No. 001-13533).
    27(29) Incorporated by reference to Exhibit 10.58 to Form 8-K filed by the Registrant with the SEC on February 24, 2009 (File No. 001-13533).
    28(30) Incorporated by reference to Exhibit 10.59 to Form 8-K filed by the Registrant with the SEC on February 24, 2009 (File No. 001-13533).
    29(31) Incorporated by reference to Exhibit 10.60 to Form 8-K filed by the Registrant with the SEC on February 24, 2009 (File No. 001-13533).
    30(32) Incorporated by reference to Exhibit 10.61 to Form 8-K filed by the Registrant with the SEC on February 24, 2009 (File No. 001-13533).
    31(33) Incorporated by reference to Exhibit 10.62 to Form 8-K filed by the Registrant with the SEC on April 30, 2009 (File No. 001-13533).


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    Exhibit No.Description of Document
    10.2532(34)
    		 Release and Settlement Agreement dated as of June 30, 2009 by and between NovaStar Financial, Inc. and EHMD, LLC, EHD Holdings, LLC and EHD Properties, LLC
    10.2633(35)
    		 Voting agreement, dated December 10, 2010, between the Company and Howard M. Amster and Barry A. Igdaloff
    10.2734(36)
    		 Exchange Agreement, dated December 10, 2010, between the Company and the holders of the Company’sCompany's 9.0% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 per share
    10.2835(37)
    		 Stock Option Agreement, dated March 15, 2011, between the Company and W. Lance Anderson
    10.2936(38)
    		 Exchange Agreement, dated as of March 22,, 2011, by and among NovaStar Financial, Inc., NovaStar Capital Trust I/B, NovaStar Capital Trust II/B, Taberna Preferred Funding I, Ltd. and Kodiak CDO I, Ltd.
    10.3037(39)
    		 First Amendment to The Second Amended and Restated Trust Agreement, dated as of March 22,, 2011, by and among NovaStar Mortgage, Inc., The Bank of New York Mellon Trust Company, National Association, BNY Mellon Trust of Delaware, certain administrative trustees and Taberna Preferred Funding II, Ltd.
    10.3138(40)
    		 Series 1 Senior Notes Indenture, dated as of March 22,, 2011, by and among NovaStar Financial, Inc. and The Bank Of New York Mellon Trust Company, National Association
    10.3239(41)
    		 Series 2 Senior Notes Indenture, dated as of March 22,, 2011, by and among NovaStar Financial, Inc. and The Bank Of New York Mellon Trust Company, National Association
    10.3340(42)
    		 Series 3 Senior Notes Indenture, dated as of March 22,, 2011, by and among NovaStar Financial, Inc. and The Bank Of New York Mellon Trust Company, National Association
    10.34 (43)
    		2011 Compensation Plan for Independent Directors
    10.35 (44)
    		Membership Interest Purchase Agreement, dated March 8, 2012, by and between NovaStar Financial, Inc. and Steve Haslam
    10.36 (45)
    		Employment Agreement, dated as of March 8, 2012, by and between NovaStar Financial, Inc. and Steve Haslam
    10.37 (46)
    		Stock Option Agreement, dated March 8, 2012, by and between NovaStar Financial, Inc. and Steve Haslam
    10.38 (47)
    		Employment Agreement, dated as of March 2, 2012, by and between NovaStar Financial, Inc. and Matthew Lautz
    10.39 (48)
    		Employment Agreement, dated as of March 1, 2012, by and between NovaStar Financial, Inc. and Brett Monger
    10.40 (49)
    		Stock Option Agreement, dated March 8, 2012, by and between NovaStar Financial, Inc. and Brett Monger
    10.41 (50)
    		Amended and Restated NovaStar Financial, Inc. 2004 Incentive Stock Plan
    11.141(51)
    		 Statement Regarding Computation of Per Share Earnings
    14.142(52)
    		 NovaStar Financial, Inc. Code of Conduct
    21.1 Subsidiaries of the Registrant
    23.1 ConsentsConsent of Deloitte & Touche LLP
    31.1 Chief Executive Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    31.2 Principal Financial Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    (34) Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on July 1, 2009 (File No. 001-13533).
    (35) Incorporated by reference to Exhibit (d)(1) to the Schedule TO/13E-3 filed by the Registrant with the SEC on December 10, 2010 (File No. 005-52325).
    (36) Incorporated by reference to Exhibit (d)(2) to the Schedule TO/13E-3 filed by the Registrant with the SEC on December 10, 2010 (File No. 005-52325).
    (37) Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on March 21, 2011 (File No. 001-13533).
    (38) Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    (39) Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    (40) Incorporated by reference to Exhibit 10.3 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    (41) Incorporated by reference to Exhibit 10.4 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    (42) Incorporated by reference to Exhibit 10.5 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    (43) Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on August 15, 2011 (File No. 001-13533).
    (44) Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on March 9, 2012 (File No. 001-13533).
    (45) Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on March 9, 2012 (File No. 001-13533).
    (46) Incorporated by reference to Exhibit 10.3 to Form 8-K filed by the Registrant with the SEC on March 9, 2012 (File No. 001-13533).
    (47) Incorporated by reference to Exhibit 10.4 to Form 8-K filed by the Registrant with the SEC on March 9, 2012 (File No. 001-13533).
    (48) Incorporated by reference to Exhibit 10.5 to Form 8-K filed by the Registrant with the SEC on March 9, 2012 (File No. 001-13533).
    (49) Incorporated by reference to Exhibit 10.6 to Form 8-K filed by the Registrant with the SEC on March 9, 2012 (File No. 001-13533).
    (50) Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on March 6, 2012 (File No. 001-13533).
    (51) See Note 16 to the consolidated financial statements.
    (52) Incorporated by reference to Exhibit 14.1 to Form 8-K filed by the Registrant with the SEC on February 14, 2006 (File No. 001-13533).


    52


    Exhibit No.Description of Document
    32.1 Chief Executive Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    32.2 Principal Financial Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    ____________________

    32101 Incorporated by referenceThe following financial information from NovaStar Financial, Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (Extensible Business Reporting Language) includes: (i) Consolidated Statements of Income for the nine and three months ended September 30, 2011 and 2010, (ii) Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010, (iii) Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010, and (iv) the Notes to Consolidated Financial Statements, tagged as blocks of text. In accordance with Regulation S-T, the XBRL-formatted interactive data files that comprise this Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on July 1, 2009 (File No. 001-13533).
    33Incorporated by reference to Exhibit (d)(1) to the Schedule TO/13E-3 filed by the Registrant on December 10, 2010 (File No. 005-52325).
    34Incorporated by reference to Exhibit (d)(2) to the Schedule TO/13E-3 filed by the Registrant on December 10, 2010 (File No. 005-52325).
    35Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on March 21, 2011 (File No. 001-13533).
    36Incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    37Incorporated by reference to Exhibit 10.2 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    38Incorporated by reference to Exhibit 10.3 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    39Incorporated by reference to Exhibit 10.4 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    40Incorporated by reference to Exhibit 10.5 to Form 8-K filed by the Registrant with the SEC on March 22, 2011 (File No. 001-13533).
    41See Note 16 to the consolidated financial statements.
    42Incorporated by reference to Exhibit 14.1 to Form 8-K filed by the Registrant with the SEC on February 14, 2006 (File No. 001-13533).101 shall be deemed “furnished” and not “filed.”


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    Signatures
     
    Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
     
     NOVASTAR FINANCIAL, INC
     (Registrant)
      
    DATE:March 22, 201115, 2012/s/ W. LANCE ANDERSON
     W. Lance Anderson, Chairman of the Board
     of Directors and Chief Executive Officer

    Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and dates indicated.
     
    DATE:March 22, 201115, 2012 /s//s/ W. LANCE ANDERSON
      W. Lance Anderson, Chairman of the Board
      of Directors and Chief Executive Officer
      (Principal(Principal Executive Officer)
      
    DATE:March 22, 201115, 2012 /s//s/ RODNEY E. SCHWATKEN
      Rodney E. Schwatken, Chief Financial Officer
      (Principal Financial Officer)
    DATE:March 15, 2012/s/ BRETT A. MONGER
    Brett A. Monger, Vice President,
    Controller and Chief Accounting Officer
      (Principal Financial(Principal Accounting Officer)
      
    DATE:March 22, 201115, 2012 /s//s/ EDWARD W. MEHRER
      Edward W. Mehrer, Director
      
    DATE:March 22, 201115, 2012 /s//s/ GREGORY T. BARMORE
      Gregory T. Barmore, Director
      
    DATE:March 22, 201115, 2012 /s//s/ ART N. BURTSCHER
      Art N. Burtscher, Director
      
    DATE: March 22, 2011  /s/ DONALD M. BERMAN
      Donald M. Berman, Director
      
    DATE:March 22, 201115, 2012 /s//s/ HOWARD M. AMSTER
      Howard M. Amster, Director
      
    DATE:March 22, 201115, 2012 /s//s/ BARRY A. IGDALOFF
      Barry A. Igdaloff, Director



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