UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549FORM 10-Qx QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September 30, 1999.OR¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from to .Commission File Number: 001-13533NovaStar Financial, Inc.(Exact name of registrant as specified in its charter)
Maryland
(State or other jurisdiction of
incorporation or organization) 1901 W. 47th Place,
Suite 105, Westwood, KS
(Address of principal executive offices)
|
74-2830661
(I.R.S. Employer Identification No.)
66205
(Zip Code)
|
(913) 362-1090
(Registrants telephone number, including
area code)
(Former name, former address and former fiscal
year, if changed since last report)
Indicate by check mark whether the registrant (1)
has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange act of 1934 during the preceding 12
months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes
x
No ¨
The number of shares of the registrants
common stock outstanding as of November 10, 1999 was 7,585,069.
|
NOVASTAR FINANCIAL, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 1999
INDEX
Page
|
||||
---|---|---|---|---|
PART I | FINANCIAL INFORMATION | |||
Item 1. | Consolidated Financial Statements : | |||
Balance Sheets | 1 | |||
Statements of Operations | 2 | |||
Statements of Cash Flows | 3 | |||
Notes | 4 | |||
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations | 6 | ||
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 44 | ||
PART II | OTHER INFORMATION | |||
Item 1. | Legal Proceedings | II-1 | ||
Item 2. | Changes in Securities | II-1 | ||
Item 3. | Defaults Upon Senior Securities | II-1 | ||
Item 4. | Submission of Matters to a Vote of Security Holders | II-1 | ||
Item 5. | Other Information | II-1 | ||
Item 6. | Exhibits and Reports on Form 8-K | II-1 | ||
Signatures | II-2 |
NOVASTAR FINANCIAL, INC.
(dollars in thousands, except share amounts)
September
30, 1999 |
December
31, 1998 |
|||||
---|---|---|---|---|---|---|
(unaudited) | ||||||
Assets | ||||||
Cash and cash equivalents | $ 2,347 | $ | ||||
Mortgage loans, net | 699,428 | 945,798 | ||||
Mortgage securities available for sale | 6,953 | | ||||
Accrued interest receivable | 13,866 | 17,608 | ||||
Due from affiliates | 22,044 | 18,521 | ||||
Investment in NFI Holding Corporation | 8,491 | 13 | ||||
Assets acquired through foreclosure | 15,443 | 10,583 | ||||
Other assets | 2,574 | 5,273 | ||||
Total assets | $771,146 | $997,796 | ||||
Liabilities and Stockholders Equity | ||||||
Liabilities: | ||||||
Collateralized mortgage obligations | $656,568 | $891,944 | ||||
Residual interest financing | | 18,000 | ||||
Total borrowings | 656,568 | 909,944 | ||||
Dividends payable | 525 | 2,845 | ||||
Accounts payable and accrued expenses | 1,382 | 2,157 | ||||
Total liabilities | 658,475 | 914,946 | ||||
Stockholders equity: | ||||||
Capital stock, $0.01 par
value, 50,000,000 shares
authorized: |
||||||
Preferred stock,
4,285,714 shares of Class B 7% cumulative
convertible preferred stock issued and outstanding as of September 30, 1999 with a redemption and liquidation value of $7 per share |
43 | | ||||
Common stock, 8,130,069 shares issued and outstanding | 81 | 81 | ||||
Additional paid-in capital | 151,164 | 122,180 | ||||
Accumulated deficit | (31,850 | ) | (32,804 | ) | ||
Accumulated other comprehensive income | | | ||||
Notes receivable from founders | (6,767 | ) | (6,607 | ) | ||
Total stockholders equity | 112,671 | 82,850 | ||||
Total liabilities and stockholders equity | $771,146 | $997,796 | ||||
See notes to consolidated financial statements.
NOVASTAR FINANCIAL, INC.
(unaudited; in thousands, except per share amounts)
For the
Nine
Months Ended September 30, |
For the Three
Months Ended September 30, |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
1999
|
1998
|
1999
|
1998
|
|||||||||
Interest income: | ||||||||||||
Mortgage loans | $52,236 | $56,274 | $15,595 | $22,312 | ||||||||
Mortgage securities | 100 | 22,881 | 100 | 6,485 | ||||||||
Total interest income | 52,336 | 79,155 | 15,695 | 28,797 | ||||||||
Interest expense | 36,059 | 60,948 | 11,206 | 22,088 | ||||||||
Net interest income | 16,277 | 18,207 | 4,489 | 6,709 | ||||||||
Provision for credit losses | 11,499 | 3,400 | 5,634 | 1,179 | ||||||||
Net interest income after provision for credit losses | 4,778 | 14,807 | (1,145 | ) | 5,530 | |||||||
Other income | 3,091 | 2,012 | 1,091 | 919 | ||||||||
Equity in earnings (loss) of NFI Holding Corporation | 1,518 | (2,455 | ) | 576 | (2,446 | ) | ||||||
General and administrative expenses: | ||||||||||||
Loan servicing fees paid to NovaStar Mortgage, Inc. | 3,056 | 2,672 | 936 | 1,184 | ||||||||
Compensation and benefits. | 1,358 | 1,374 | 421 | 478 | ||||||||
Other loan servicing expenses | 1,392 | 491 | 446 | 363 | ||||||||
Professional and outside services | 546 | 649 | 181 | 296 | ||||||||
Fees for other services
provided by (to) NovaStar Mortgage,
Inc. |
287 | 1,934 | (169 | ) | (1,249 | ) | ||||||
Forgiveness of notes receivable from founders | | 812 | | 270 | ||||||||
Office administration | 611 | 681 | 203 | 276 | ||||||||
Other | 103 | 184 | 41 | (9 | ) | |||||||
Total general and administrative expenses | 7,353 | 8,797 | 2,059 | 1,609 | ||||||||
Net income (loss) | $ 2,034 | $ 5,567 | $(1,537 | ) | $ 2,394 | |||||||
Preferred stock dividends | (1,081 | ) | | (525 | ) | | ||||||
Income (loss) available to common stockholders | $ 953 | $ 5,567 | $(2,062 | ) | $ 2,394 | |||||||
Basic earnings (loss) per share | $ 0.12 | $ 0.69 | $ (0.25 | ) | $ 0.29 | |||||||
Diluted earnings (loss) per share | $ 0.11 | $ 0.64 | $ (0.25 | ) | $ 0.29 | |||||||
Dividends declared per common share | $ | $ 1.00 | $ | $ 0.35 | ||||||||
See notes to consolidated financial statements.
NOVASTAR FINANCIAL, INC.
(unaudited; in thousands)
For the Nine
Months
Ended September 30, |
||||||
---|---|---|---|---|---|---|
1999
|
1998
|
|||||
Net cash provided by operating activities | $ 23,504 | $ 9,224 | ||||
Cash flow from investing activities: | ||||||
Mortgage loan repayments | 201,034 | 94,608 | ||||
Mortgage loans sold to others | 4,900 | 7,933 | ||||
Sales of assets acquired through foreclosure | 17,542 | 2,350 | ||||
Investment in NFI Holding Corp. | (7,000 | ) | | |||
Net change in amounts due from affiliates | (8,360 | ) | (265,068 | ) | ||
Mortgage loans purchased from NovaStar Mortgage, Inc. | | (510,267 | ) | |||
Purchases of available-for-sale securities | | (375,051 | ) | |||
Proceeds from sales of available-for-sale securities | | 323,631 | ||||
Proceeds from paydowns on and maturities of available-for-sale securities | | 150,018 | ||||
Net cash provided by (used in) investing activities | 208,116 | (571,846 | ) | |||
Cash flow from financing activities: | ||||||
Proceeds from issuance
of capital stock and exercise of equity instruments,
net of offering costs of $1,240 |
29,029 | (73 | ) | |||
Dividends paid on preferred stock | (556 | ) | | |||
Dividends paid on common stock | (2,845 | ) | (6,062 | ) | ||
Change in short-term borrowings | (18,029 | ) | 29,783 | |||
Payments on collateralized mortgage obligations | (236,872 | ) | (128,847 | ) | ||
Proceeds from issuing collateralized mortgage obligations | | 665,000 | ||||
Debt issuance costs paid on collateralized mortgage obligations | | 2,821 | ||||
Net cash provided by (used in) financing activities | (229,273 | ) | 562,622 | |||
Net increase in cash and cash equivalents | $ 2,347 | | ||||
Cash and cash equivalents, beginning of period | | | ||||
Cash and cash equivalents, end of period | $ 2,347 | $ | ||||
Supplemental disclosure of cash flow information: | ||||||
Note received in exchange for options exercised by founders | $ | $ 4,350 | ||||
Cash paid for interest | $ 36,567 | $ 60,312 | ||||
Dividends payable | $ 525 | $ 2,845 | ||||
Assets acquired through foreclosure | $ 22,570 | $ 9,500 | ||||
See notes to consolidated financial statements.
NOVASTAR FINANCIAL, INC.
September 30, 1999 (Unaudited)
Note 1. Financial Statement
Presentation
The consolidated financial statements as of and for the
periods ended September 30, 1999 and 1998 are unaudited. In the
opinion of management, all adjustments have been made which were of
a normal and recurring nature, necessary for a fair presentation of
the balance sheets and results of operations. The consolidated
financial statements should be read in conjunction with Management
s Discussion and Analysis of Financial Condition and Results
of Operations and the consolidated financial statements of NovaStar
Financial and the notes thereto, included in NovaStar Financial
s annual report to shareholders and annual report on Form 10-K for
the fiscal year ended December 31, 1998.
NovaStar Financial owns 100 percent of the common stock of
three special purpose entities NovaStar Assets Corporation, NovaStar
Certificates Financing Corporation and NovaStar Mortgage Funding
Corporation. NovaStar Financial formed these entities in connection
with the issuance of collateralized mortgage obligations. The
consolidated financial statements of NovaStar Financial include the
accounts of these entities. Significant intercompany accounts and
transactions have been eliminated in consolidation.
NovaStar Financial owns 100 percent of the preferred stock of
NFI Holding Corporation for which it receives 99 percent of any
dividends paid by NFI Holding. The founders of NovaStar Financial
own the voting common stock of NFI Holding. NovaStar Mortgage, Inc.,
NovaStar Capital, Inc. and NovaStar Home Mortgage, Inc. are wholly
owned subsidiaries of NFI Holding. NovaStar Mortgage Funding
Corporation II and NovaStar REMIC Financing Corporation are
subsidiaries of NovaStar Mortgage. NovaStar Financial accounts for
its investment in NFI Holding using the equity method.
Note 2. Stockholders
Equity
In March 1999, NovaStar Financial issued 4,285,714 shares of
Class B 7% cumulative convertible preferred stock. The preferred
shares have no voting rights, are senior to any other class of
NovaStar Financial capital stock and have a stated and liquidation
value of $7 per share. Each holder of the preferred stock is
entitled to quarterly dividends that accrue at 7% per annum on the
stated value. Holders of the Class B preferred shares have the
right, at any time, to convert all or a portion of their preferred
stock into an equal number of shares of common stock. NovaStar
Financial has the right to redeem the Class B preferred stock at any
time on or after March 31, 2002 at a price of $7.00 per share,
payable in cash.
Comprehensive income includes net income and revenues,
expenses, gains and losses that are not included in net income. The
net change is unrealized gain (loss) on available-for-sale
securities in 1999 includes the change in market value of the
economic residual interests of the NovaStar Home Equity Series
1999-1 securitization NovaStar Mortgage issued in January 1999. The
fair market value of this security approximated its amortized cost
as of September 30, 1999. The net change in unrealized gain (loss)
on available-for-sale securities as of September 30, 1998 includes
the change in market value of agency securities. Accordingly,
NovaStar Financial did not own any available-for-sale securities as
of December 31, 1998. Following is a summary of comprehensive income
for the nine and three month periods ended September 30, 1999 and
1998.
For the
Nine Months
Ended September 30, |
For the
Three Months
Ended September 30, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
1999
|
1998
|
1999
|
1998
|
||||||||
Net income (loss) | $2,034 | $ 5,567 | $(1,537 | ) | $2,394 | ||||||
Other
comprehensive incomenet change in
unrealized gain (loss) on available-for-sale securities |
| (9,130 | ) | (1,860 | ) | (4,828 | ) | ||||
Comprehensive income (loss) | $2,034 | $(3,563 | ) | $(3,397 | ) | $2,434 | |||||
Note 3. Earnings Per Share
The computations of basic and diluted EPS for the nine and
three month periods ended September 30, 1999 and 1998 are as
follows (in thousands, except per share amounts):
For the nine
months ended September 30, |
For the three
months ended September 30, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
1999
|
1998
|
1999
|
1998
|
|||||||
Numerator: | ||||||||||
Net Income (loss) | $2,034 | $5,567 | $(1,537 | ) | $2,394 | |||||
Less: Preferred stock dividends | (1,081 | ) | | (525 | ) | | ||||
Income (loss)
available to common
stockholdersbasic and diluted |
$ 953 | $5,567 | $(2,062 | ) | $2,394 | |||||
Denominator: | ||||||||||
Weighted average
common
shares outstandingbasic |
8,130 | 8,033 | 8,130 | 8,124 | ||||||
Warrants | 177 | 555 | | | ||||||
Stock options | 19 | 51 | | 34 | ||||||
Weighted average
common
shares outstandingdiluted |
8,326 | 8,639 | 8,130 | 8,158 | ||||||
Basic earnings (loss) per share | $ 0.12 | $ 0.69 | $ (0.25 | ) | $ 0.29 | |||||
Diluted earnings (loss) per share | $ 0.11 | $ 0.64 | $ (0.25 | ) | $ 0.29 | |||||
The convertible preferred stock issued in March 1999 was not
included in the earnings per share computations as they are
anti-dilutive for the 1999 periods presented. The following stock
options and warrants to purchase shares of common stock were
outstanding during each period presented, but were not included in
the computation of diluted earnings per share because the options
weighted-average exercise price was greater than the average
market price of the common shares for the periods presented,
therefore, the effect would be antidilutive (in thousands, except
per share amounts):
For the nine
months ended September 30, |
For the three
months ended September 30, |
|||||||
---|---|---|---|---|---|---|---|---|
1999
|
1998
|
1999
|
1998
|
|||||
Number of stock options and warrants | 4,402 | 224 | 4,507 | 256 | ||||
Weighted average exercise price | $11.51 | $18.03 | $11.44 | $17.92 |
Note 4. Reclassifications
During 1999, NovaStar Financial reclassified the principal and
interest collections received on the securitized mortgage loan
portfolio to more closely match the timing of the principal and
interest payments made to bondholders of the collateralized mortgage
obligations (CMOs). Under the terms of NovaStar Financials
CMOs, the principal and interest collected by NovaStar Mortgage,
NovaStar Financials servicer, during any given month are held
in trust and remitted to bondholders of the CMOs the following
month. Prior to the reclassification change in 1999, NovaStar
Financial reduced the securitized mortgage loan and accrued interest
balances when mortgage loan payments were received by NovaStar
Mortgage. Thus at any given month-end, NovaStar Financials
mortgage loan balance would reflect the principal and interest
collected during the month. However, the CMO balances would not
reflect these principal and interest payments until the following
month-end. In order to better match the collateral principal and
interest payments with the CMO principal and interest payments, a
reclass was made on NovaStar Financials books to gross up
mortgage loans and accrued interest and reduce the Due from
Affiliates balance. NovaStar Mortgages Due to Affiliates and
restricted cash were also reduced. Similar adjustments were made to
the December 31, 1998 balance sheets of NovaStar Financial and
NovaStar Mortgage to reflect the current year presentation.
In March 1998, the founders exercised options to acquire
289,332 shares of common stock by executing notes payable to
NovaStar Financial. The notes bear interest at one month LIBOR plus
1% are collateralized by the common stock issued, and are
non-recourse in nature which means that NovaStar Financials
recourse is limited to the collateral. Previously, NovaStar
Financial had recorded such notes as assets. In September 1999, such
amounts, including accrued interest, were reclassified as part of
the contra-equity account, notes receivable from founders. A similar
reclassification was made in December 31, 1998 for comparability.
Unpaid principal on the notes was $4,340,000 as of September 30,
1999 while accrued interest on these notes was $261,000.
The following discussion should be read in conjunction with
the preceding consolidated financial statements of NovaStar
Financial and the accompanying notes as well as NovaStar Financial
s annual report to shareholders and annual report on form 10-K
for the fiscal year ended December 31, 1998.
Safe Harbor Statement
Safe Harbor statement under the Private Securities
Litigation Reform Act of 1995: Statements in this discussion
regarding NovaStar Financial, Inc. and its business, which are not
historical facts, are forward-looking statements that
involve risks and uncertainties. Risks and uncertainties, which
could cause results to differ from those discussed in the
forward-looking statements herein, are listed in Risk
Management section of this annual report. In addition, there
are many important factors that could cause actual results to differ
materially from those indicated in the forward-looking statements.
These factors include, but are not limited to, general economic
conditions, interest rate levels and risk, prepayment speeds,
delinquency and loss rates, changes in the asset securitization
industry or the REIT provisions of the Internal Revenue Code, demand
for services and products offered by NovaStar, the impact of
covenants in loan agreements, the degree to which NovaStar Financial
is leveraged, the needs for and availability of financing, access to
capital and other risks identified in NovaStar Financials
Securities and Exchange Commission filings. In addition, it should
be noted that past financial and operational performance of NovaStar
Financial is not necessarily indicative of future financial and
operational performance.
Information
Management intends to provide extensive information about the
financial position and results of operations of NovaStar Financial
in a format that is clear and easy to understand. This report and
other published documents are designed to provide a framework for
understanding NovaStar Financials business and the associated
risks. The manner in which management conducts business and assesses
risks will determine future performance. By providing detailed
information to this extent, investors will be able to evaluate
NovaStar Financial as an investment option and to compare NovaStar
Financial with its competition.
Basis of Presentation
NovaStar Financial owns 100% of the common stock of NovaStar
Assets Corporation, NovaStar Certificates Financing Corporation and
NovaStar Mortgage Funding Corporation. These entities were
established as special purpose entities used in issuance of
collateralized mortgage obligations. The consolidated financial
statements of NovaStar Financial include the financial condition and
results of operations of these entities.
NovaStar Financial also owns 100% of the non-voting preferred
stock of NFI Holding Corporation for which it receives 99% of any
dividends paid by NFI Holding. A significant component of the
financial results of NovaStar Financial are derived from the
operations of NovaStar Mortgage, Inc. Scott Hartman and Lance
Anderson, the founders of NovaStar Financial, own the voting common
stock of NFI Holding and receive 1% of any dividends paid by NFI
Holding. NovaStar Mortgage, Inc. and NovaStar Capital are wholly
owned subsidiaries of NFI Holding. Key officers of NovaStar
Financial serve as officers of NFI Holding, NovaStar Mortgage and
NovaStar Capital, Inc. The founders are the only members of the
Board of Directors of NFI Holding, NovaStar Mortgage and NovaStar
Capital. NovaStar Home Mortgage, Inc. was created in May of 1998 to
provide administrative services to a select group of brokers.
NovaStar Mortgage owns 100% of NovaStar Mortgage Funding Corporation
II and NovaStar REMIC Financing Corporation. Both of these special
purpose entities were created in January 1999 for the issuance of
real estate mortgage investment conduits commonly known as REMICs.
NovaStar Financial accounts for its investment in NFI Holding using
the equity method.
Recent Developments
Stock repurchase. NovaStar Financials Board of
Directors amended its stock repurchase program to increase the
amount of common stock authorized to be acquired up to an aggregate
purchase price of $5 million. Stock repurchases may be made in the
open market, in block purchase transactions, through put options or
through privately negotiated transactions. The timing of repurchases
and the number of shares ultimately repurchased will depend upon
market conditions and corporate requirements. As of November 10,
1999, NovaStar Financial had repurchased 545,000 shares of its
common stock.
Servicing. On October 20, 1999, NovaStar Mortgage was
notified that its servicing department had received an Above
Average Residential Servicer rating from Standard & Poors.
An Above Average rating signifies a high degree of
efficiency and competency in managing portfolios. In addition,
Standard & Poors approved NovaStar Mortgage as a designated
Special Servicer.
Description of Business
Business of NovaStar Financial:
|
|
NovaStar
Financial was founded in 1996 as a specialty finance lender to
invest in mortgage assets;
|
|
NovaStar
Financials assets have primarily come from the wholesale
origination of single-family nonconforming loans by its affiliate,
NovaStar Mortgage;
|
|
NovaStar
Financial operates as a long-term portfolio investor;
|
|
NovaStar
Financials loans are financed on a short-term basis through
a mortgage loan repurchase facility. Long-term financing is
provided through securitization where asset-backed bonds are
issued in financing-structured transactions;
|
|
Earnings
are generated from spread income on the mortgage loan portfolio
and indirectly by gains associated with the sale of loans to
outside parties or through securitization transactions of NovaStar
Mortgage.
|
Business of NovaStar Mortgage:
|
|
NovaStar
Mortgages customer is the retail mortgage broker who deals
with the borrower. NovaStar Mortgages account executives
work with over 2,000 brokers to solicit loans.
|
|
NovaStar
Mortgages borrowers generally are individuals or families
who do not qualify for agency/conventional lending programs
because of a lack of available documentation or previous credit
difficulties. Often, these borrowers have built up high-rate
consumer debt and are attempting to use equity in their home to
consolidate debt and lower their total monthly payments.
|
|
NovaStar
Mortgages loans are financed on a short-term basis through
warehouse facilities. Long-term financing is provided through
securitization where asset-backed bonds are issued in transactions
that are structured as a sale.
|
Notes Receivable from Founders
The founders of NovaStar Financial purchased 216,666 units in
the 1996 private placement in exchange for forgivable promissory
notes. A unit consisted of one share of convertible preferred stock
and one common stock warrant. Principal on these notes is divided
into three equal parts, called tranches, and will be
forgiven if certain incentive performance targets are achieved. The
incentive tests relate to the return generated to investors in the
private placement, including the appreciation in stock price, the
value of the warrants, and dividends paid. One tranche will be
forgiven for each fiscal year NovaStar Financial generates a return
of 15% to investors in the private placement. All three tranches
will be forgiven if a return of 100% is generated within five years.
During the period from the closing of the private placement
through December 31, 1997, NovaStar Financials stock price
averaged $17.08 per share, dividends of $0.28 were declared and the
value of each warrant was $2.08. The combination of these produced a
return to investors in the private placement exceeding 15%. As a
result, the first tranche of these notes was forgiven resulting in a
non-cash charge of $1,083,000 during the fourth quarter of 1997.
NovaStar recorded a non-cash charge of $812,000 to earnings during
the nine months ended September 30, 1998 in anticipation of the
forgiveness of the second tranche. However, this non-cash charge was
reversed in the fourth quarter of 1998 as the incentive performance
targets were not met in 1998. NovaStar Financial has not recognized
any forgiveness of the second tranche in 1999 because management
does not believe the incentive performance targets will be met.
In March 1998, the founders exercised options to acquire
289,332 shares of common stock by executing notes payable to
NovaStar Financial. The notes bear interest at one month LIBOR plus
1% are collateralized by the common stock issued, and are
non-recourse in nature which means that NovaStar Financials
recourse is limited to the collateral. Previously, NovaStar
Financial had recorded such notes as assets. In September 1999, such
amounts, including accrued interest, were reclassified as part of
the contra-equity account, notes receivable from founders. A similar
reclassification was made in December 31, 1998 for comparability.
Unpaid principal on the notes was $4,340,000 as of September 30,
1999 while accrued interest on these notes was $261,000.
Financial Condition of NovaStar Financial, Inc. as
of September 30, 1999 and December 31, 1998
NovaStar Financials balance sheets at September 30, 1999
and December 31, 1998 primarily consist of mortgage loans purchased
from NovaStar Mortgage, which serve as collateral on its
collateralized mortgage obligations. The carrying value of mortgage
loans at September 30, 1999 was $699 million versus $946 million at
December 31, 1998. The carrying value of collateralized mortgage
obligations at September 30, 1999 was $657 million compared with
$892 million at December 31, 1998. The decline in both balance sheet
items is primarily a result of principal paydowns that occurred
during the first nine months of 1999.
During 1999, NovaStar Financial reclassified the principal and
interest collections received on the securitized mortgage loan
portfolio to more closely match the timing of the principal and
interest payments
made to bondholders of the collateralized mortgage obligations
commonly called CMOs. Under the terms of NovaStar Financials
CMOs, the principal and interest collected by NovaStar Mortgage,
NovaStar Financials servicer, during any given month are held
in trust and remitted to bondholders of the CMOs the following
month. Prior to the reclassification change in 1999, NovaStar
Financial reduced the securitized mortgage loan and accrued interest
balances when mortgage loan payments were received by NovaStar
Mortgage. Thus at any given month-end, NovaStar Financials
mortgage loan balance would reflect the principal and interest
collected during the month. However, the CMO balances would not
reflect these principal and interest payments until the following
month. In order to better match the collateral principal and
interest payments with the CMO principal and interest payments, a
reclass was made on NovaStar Financials books to gross up
mortgage loans and accrued interest and reduce the Due from
Affiliates balance. NovaStar Mortgages Due to Affiliates and
restricted cash were also reduced. Similar adjustments were made to
the December 31, 1998 balance sheets of NovaStar Financial and
NovaStar Mortgage to reflect the current year presentation.
Table 1 is a presentation of loans as of September 30, 1999
and December 31, 1998 and their credit grades. Table 2 is a summary
of all mortgage loans owned by NovaStar Financial as of September
30, 1999 and December 31, 1998 by state.
Table 1
Mortgage Loans by Credit Grade
(dollars in thousands)
September 30,
1999 |
December 31,
1998 |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Credit
Grade |
Allowed
Mortgage Lates (A) |
Maximum
Loan-
to-value |
Current
Principal |
Weighted
Average Coupon |
Weighted
Average Loan-to- value |
Current
Principal |
Weighted
Average Coupon |
Weighted
Average Loan-to- value |
|||||||||||||
AA | 0 x 30 | 95 | (B) | $ 93,139 | 9.53 | % | 83.4 | % | $120,427 | 9.51 | % | 83.4 | % | ||||||||
A | 1 x 30 | 90 | 272,177 | 9.89 | 80.1 | 366,913 | 9.84 | 79.7 | |||||||||||||
A | 2 x 30 | 90 | 166,811 | 10.33 | 81.8 | 220,591 | 10.31 | 81.3 | |||||||||||||
B | 3 x 30, 1x 60
5 x 30, 2 x 60, |
85 | 102,011 | 10.77 | 78.2 | 142,346 | 10.62 | 77.9 | |||||||||||||
C | 1 x 90 | 75 | 47,069 | 11.24 | 72.4 | 64,529 | 11.13 | 72.3 | |||||||||||||
D | 6 x 30, 3 x 60,
2 x 90 |
65 | 9,181 | 12.05 | 61.6 | 13,697 | 12.14 | 62.2 | |||||||||||||
Total | $690,388 | 10.20 | % | 79.9 | % | $928,503 | 10.15 | % | 79.5 | % | |||||||||||
(A)
|
Represents the number of times NovaStar Financial allows a
prospective borrower to be late more than 30, 60 or 90 days. For
instance, a 3x30, 1x60 category would afford the prospective
borrower to be more than 30 days late on three separate occasions
and 60 days late no more than one time.
|
(B)
|
Fixed
purchases; all other maximum of 90%.
|
Table 2
Mortgage Loans by State
Percent of Portfolio
(based on current principal balance)
(based on current principal balance)
Collateral
Location |
September 30,
1999 |
December 31,
1998 |
||||
---|---|---|---|---|---|---|
California | 16 | % | 18 | % | ||
Florida | 13 | 12 | ||||
Washington | 7 | 8 | ||||
Oregon | 5 | 5 | ||||
All other states | 59 | 57 | ||||
Total | 100 | % | 100 | % | ||
Table 3 provides a summary of NovaStar Financials
mortgage loans by type and carrying value as of September 30, 1999
and December 31, 1998.
Table 3
Carrying Value of Loans by Product/Type
September 30, 1999 and December 31, 1998
(in thousands)
(in thousands)
Product/Type
|
September
30, 1999 |
December
31, 1998 |
||||
---|---|---|---|---|---|---|
Two and three-year fixed | $386,298 | $526,044 | ||||
Six-month LIBOR and one-year CMT | 54,485 | 91,430 | ||||
30/15-year fixed and balloon | 249,605 | 311,029 | ||||
Outstanding principal | 690,388 | 928,503 | ||||
Premium | 14,410 | 20,868 | ||||
Allowance for credit losses | (5,370 | ) | (3,573 | ) | ||
Carrying Value | $699,428 | $945,798 | ||||
Carrying value as a percent of principal | 101.31 | % | 101.86 | % | ||
Table 4 is a summary of the securities acquired during 1999
and 1998 by quarter.
Table 4
Mortgage Security Acquisitions
Three Months Ended September 30, 1999 and 1998
(dollars in thousands)
(dollars in thousands)
Principal
|
Premium
|
Discount
|
Net
Price to Par |
Weighted
Average Coupon |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
1999: | ||||||||||||
Third quarter
NovaStar Home Equity Series
1999-1 residual interest |
$ 7,243 | $ | $ | | 16.5 | % | ||||||
Second quarter | | | $ | | | |||||||
First quarter | | | $ | | | |||||||
1998: | ||||||||||||
Fourth quarter | $ | $ | $ | | | % | ||||||
Third quarter | | | | | | |||||||
Second quarter
Federal National Mortgage
Association |
80,237 | 823 | | 101.0 | 6.40 | |||||||
First quarter: | ||||||||||||
Federal National Mortgage Association | 40,929 | 444 | | 101.1 | 6.12 | |||||||
Government National Mortgage
Association |
229,130 | 3,726 | (364 | ) | 101.5 | 6.39 |
Since April 1998, NovaStar Financial has not purchased any
agency securities.
In September 1999, NovaStar Financial purchased NovaStar
Mortgages residual interests in the NovaStar Home Equity
Series 199901 securitization transaction. The NovaStar Home
Equity Series 199901 transaction is discussed further under
the Mortgage Loan Sales section of this document. As the
owner of the residual certificate, NovaStar Financial receives the
net cash flow of the NovaStar Home Equity 19991
securitization, which represents the right to receive, over the life
of the securitization, the excess of the weighted average
coupon on the loans securitized over the sum of the interest rate on
the bonds, a normal servicing fee, a trustee fee, an insurance fee
and the credit losses relating to the loans securitized. At
September 30, 1999, the amortized cost of the residual interests
approximated market value. This value represents the present value
of the residual cashflows that NovaStar Financial expects to receive
over the life of the securitization, taking into consideration
estimated prepayment speeds and credit losses, and is discounted at
a rate which management believes is an appropriate risk-adjusted
market rate of return for the residual asset. The residual cashflows
are realized over the life of the securitization as cash
distributions are received from the trust. NovaStar Financial
believes its residual asset is fairly valued at September 30, 1999
but can provide no assurance that future prepayment and loss
experience or changes in the required market discount rate will not
require write-downs of the residual asset. Write-downs would reduce
the income of future periods and could cause NovaStar Financial to
report net losses.
Some key statistics of the NovaStar Home Equity Series 1999
1 mortgage loan collateral at September 30, 1999 are as
follows:
Principal value (in 000s) | $149,841 | ||
Weighted average coupon | 10.1 | % | |
Constant annualized prepayment rate (life) | 11 |
Delinquency statistics of the 19991 securitization are
disclosed in Tables 23 and 24 of Financial Condition of
NovaStar Mortgage as of September 30, 1999 and December 31, 1998.
Short-term Financing Arrangements.
NovaStar Financial is a co-borrower with NovaStar
Mortgage and NovaStar Capital under warehouse lending and master
repurchase agreements with First Union National Bank which are
scheduled to mature in February 2000. As of September 30, 1999,
NovaStar Financial and NovaStar Mortgage can borrow up to $75
million under the warehouse lending agreement and $300 million under
the master repurchase agreement. As of September 30, 1999 and
December 31, 1998, NovaStar Financial had no borrowings outstanding,
and NovaStar Mortgage had borrowings of $22,191,000 and $50,429,000
outstanding, respectively under these arrangements. Borrowings under
these arrangements are secured by mortgage loans. The interest rate
on borrowings under the warehouse lending arrangement is indexed to
the federal funds rate. Under the master repurchase agreement,
borrowings are indexed to one-month LIBOR.
On February 12, 1999, two additional one-year agreements were
executed with First Union whereby NovaStar Financial and/or NovaStar
Mortgage can borrow up to $20 million secured by residual interests
in CMOs issued by NovaStar Financial, its affiliates or
subsidiaries. Borrowings under these arrangements bear interest at
one-month LIBOR plus five percent. As of September 30, 1999,
NovaStar Financial had no borrowings under this financing
arrangement. In connection with executing the renewals and
additional agreements, NovaStar Financial issued warrants to First
Union to acquire 350,000 shares of NovaStar common stock for $6.94
per share. In exchange for the new warrants, First Union returned
186,667 warrants that were purchased in NovaStar Financials
1996 private placement. The new warrants expire on February 12,
2002.-
All arrangements with First Union require NovaStar Financial
and NovaStar Mortgage to maintain minimum tangible net worth, meet
equity ratio tests and comply with other customary debt covenants.
As of December 31, 1998, NovaStar Financial also had a
short-term financing arrangement with GMAC/Residential Funding
Corporation (GMAC/RFC) secured by residual interests in NovaStar
Financials CMOs. In 1998, NovaStar Financial borrowed $15
million from GMAC/RFC, which included a $3 million financing fee. In
connection with the agreement, NovaStar Financial issued 812,731
warrants to GMAC/RFC for the purchase of NovaStar Financials
stock at $4.63 per share and 364,982 tag along warrants to purchase
common stock on the terms of the December 9, 1996 warrants which
were issued at $15.00 per share. NovaStar Financial had no other
short-term borrowings outstanding as of December 31, 1998. In
February of 1999, NovaStar Financial used financing sources at First
Union to pay this debt in full.
Collateralized mortgage obligations.
On a long-term basis, NovaStar Financial finances
its mortgage loans using collateralized mortgage obligations
commonly called CMOs. Investors in CMOs are repaid based on the
performance of the mortgage loans collateralizing the CMOs. These
non-recourse financing arrangements match the loans with the
financing arrangement for long periods of time, as compared to
repurchase agreements that mature frequently with interest rates
that reset frequently and have liquidity risk in the form of margin
calls. Under the terms of its CMOs, NovaStar Financial is entitled
to repurchase the mortgage loan collateral and repay the remaining
CMO when their aggregate principal balance falls below 35% for issue
97-01 and 25% for issues 97-02, 98-01 and 98-02. Subprime mortgage
loans are not readily obtainable financial assets. As a result,
NovaStar Financial retains effective control over the transferred
assets as defined in paragraph 9c. of Statement of Financial
Accounting Standards (SFAS) No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities
and further clarified by paragraph 30 of SFAS No. 125. Accordingly,
NovaStar Financial records its CMO transactions as secured
borrowings, rather than sales of the transferred loans.
Under its CMOs, NovaStar Financial retains the mortgage loans
and incurs the obligation to pay the CMO bondholders. NovaStar
Financial earns the net spread between the interest income on the
loans and the interest expense on the bonds. The spread earned also
is reduced by credit losses on the portfolio. Prepayments on the
mortgage loans serve to reduce the term over which interest spread
is earned. The longer the mortgage collateral is outstanding, the
longer the period of cash flow. To the extent the borrowers prepay,
it shortens the life of the CMO and the period over which cash flow
is received. The cash flow will change when interest rates on the
bonds fluctuate at amounts or times that are different from the
mortgage loan collateral, thereby subjecting NovaStar Financial to
interest rate risk.
Following is a summary of outstanding CMOs as of September 30,
1999 and December 31, 1998 (dollars in thousands):
Table 5
Collateralized Mortgage Obligations
September 30, 1999 and December 31, 1998
(dollars in thousands)
(dollars in thousands)
Collateralized
Mortgage Obligation |
Mortgage Loans
|
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Remaining
Principal |
Interest
Rate |
Estimated
Weighted
Average Months to Call |
(A)
Remaining Principal |
Weighted
Average Coupon |
|||||||||
As of September 30, 1999: | |||||||||||||
NovaStar Home Equity Series: | |||||||||||||
Issue 1997-1 | $ 88,594 | 5.62 | % | | $100,171 | 10.88 | % | ||||||
Issue 1997-2 | 117,126 | 5.62 | 23 | 126,710 | 10.41 | ||||||||
Issue 1998-1 | 205,752 | 5.45 | 36 | 219,442 | 10.05 | ||||||||
Issue 1998-2 | 247,883 | 5.49 | 40 | 258,830 | 9.97 | ||||||||
Unamortized debt issuance
costs |
(2,787) | ||||||||||||
$656,568 | |||||||||||||
As of December 31, 1998: | |||||||||||||
NovaStar Home Equity Series: | |||||||||||||
Issue 1997-1 | $163,419 | 5.88 | % | 29 | $174,516 | 10.56 | % | ||||||
Issue 1997-2 | 164,496 | 5.88 | 31 | 173,858 | 10.37 | ||||||||
Issue 1998-1 | 268,152 | 5.69 | 35 | 277,776 | 10.01 | ||||||||
Issue 1998-2 | 300,161 | 5.74 | 38 | 306,807 | 9.95 | ||||||||
Unamortized debt issuance
costs |
(4,284 | ) | |||||||||||
$891,944 | |||||||||||||
(A)
|
Includes
assets acquired through foreclosure.
|
NovaStar Financial acquires substantially all of its
mortgage assets at a premium. Premiums are amortized as a reduction
of interest income over the estimated lives of the assets. See
Tables 6, 7, 8 and 9 for the impact of principal payments on
amortization. To mitigate the effect of prepayments on interest
income from mortgage loans, NovaStar Financial generally strives to
acquire mortgage loans that have some form of prepayment penalty.
During the nine months ended September 30, 1999, NovaStar Financial
collected $2.4 million in prepayment penalties from borrowers
compared with $1.3 million during the same period of 1998. Table 6
is an analysis of mortgage loans and prepayment penalties.
Table 6
Mortgage Loan Prepayment Penalties
September 30, 1999 and December 31, 1998 (dollars
in thousands)
Current
Principal |
Premium
|
Percent
with
Prepayment Penalty |
Weighted Average
|
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Coupon
|
Loan-to-
value |
Remaining
Prepayment Penalty Period (in years) - Loans with Penalty |
|||||||||||||
As of September 30, 1999 | |||||||||||||||
Loans
collateralizing NovaStar
Home Equity Series (CMO): |
|||||||||||||||
1997-1 | $ 97,067 | $ 4,505 | 33 | % | 10.88 | % | 75.4 | % | 0.58 | ||||||
1997-2 | 123,247 | 2,412 | 50 | 10.41 | 79.4 | 0.63 | |||||||||
1998-1 | 214,782 | 3,605 | 73 | 10.05 | 81.2 | 1.11 | |||||||||
1998-2 | 254,908 | 3,869 | 74 | 9.97 | 81.1 | 1.67 | |||||||||
All other loans | 384 | 19 | 10 | 11.83 | 77.6 | 0.13 | |||||||||
Total | $690,388 | $14,410 | 63 | % | 10.20 | % | 80.0 | % | 1.16 | ||||||
Current
Principal |
Premium
|
Percent
with
Prepayment Penalty |
Weighted Average
|
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Coupon
|
Loan-to-
value |
Remaining
Prepayment Penalty Period (in years) - Loans with Penalty |
|||||||||||||
As of December 31, 1998 | |||||||||||||||
Loans
collateralizing NovaStar
Home Equity Series (CMO): |
|||||||||||||||
1997-1 | $170,118 | $ 7,975 | 65 | % | 10.57 | % | 75.1 | % | 0.89 | ||||||
1997-2 | 170,363 | 3,403 | 72 | 10.37 | 78.5 | 1.10 | |||||||||
1998-1 | 275,673 | 4,651 | 69 | 10.01 | 81.1 | 1.51 | |||||||||
1998-2 | 306,586 | 4,703 | 71 | 9.95 | 81.1 | 2.09 | |||||||||
All other loans | 5,763 | 136 | 65 | 9.91 | 80.0 | 1.59 | |||||||||
Total | $928,503 | $20,868 | 70 | % | 10.15 | % | 79.5 | % | 1.52 | ||||||
In periods of decreasing interest rates, borrowers are more
likely to refinance their mortgages to obtain a better interest
rate. Even in rising rate environments, borrowers tend to
collectively repay their mortgage principal balances earlier than is
required by the terms of their mortgages. This is particularly true
for non-conforming borrowers who are seeking to upgrade their credit
rating to obtain a lower interest rate.
Prepayment rates in the table below represent the annualized
principal prepayment rate in the most recent one, three and twelve
month periods and over the life of the pool of loans.
Table 7
Prepayment Speeds
Issue Date
|
Current
Principal Balance |
Weighted
Average Age of Loans at Inception (in months) |
Constant
Prepayment Rate
(Annual Percent) |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
One-
month |
Three-
month |
Twelve-
month |
Life
|
|||||||||||
As of September 30, 1999 | ||||||||||||||
NovaStar Home
Equity
Series: |
||||||||||||||
1997-1 | October 1, 1997 | $ 97,067 | 7 | 44 | 56 | 48 | 39 | |||||||
1997-2 | December 11, 1997 | 123,247 | 3 | 50 | 46 | 34 | 27 | |||||||
1998-1 | April 30, 1998 | 214,782 | 3 | 31 | 29 | 25 | 20 | |||||||
1998-2 | August 18, 1998 | 254,908 | 3 | 30 | 27 | 18 | 17 | |||||||
As of December 31, 1998 | ||||||||||||||
NovaStar Home
Equity
Series: |
||||||||||||||
1997-1 | October 1, 1997 | $170,118 | 7 | 44 | 36 | 33 | 31 | |||||||
1997-2 | December 11, 1997 | 170,363 | 3 | 42 | 32 | 22 | 21 | |||||||
1998-1 | April 30, 1998 | 275,673 | 3 | 20 | 17 | | 12 | |||||||
1998-2 | August 18, 1998 | 306,586 | 3 | 18 | 10 | | 9 |
Table 8 summarizes mortgage asset activity during 1999 and
1998 and Table 9 details the amount of premium as a percent of
principal at quarter end for 1999 and 1998.
Table 8
Mortgage Assets Activity
(in thousands)
Mortgage Loans
|
Mortgage
Securities |
Total
|
||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Principal | Premium | Principal | Premium | Principal | Premium | |||||||||||||
Balance, December 31, 1997 | $559,436 | $17,861 | $ 504,847 | $ 8,205 | $1,064,283 | $26,066 | ||||||||||||
Acquisitions | 207,976 | 3,758 | 270,059 | 3,806 | 478,035 | 7,564 | ||||||||||||
Principal
repayments and
amortization |
(27,224 | ) | (1,160 | ) | (63,892 | ) | (731 | ) | (91,116 | ) | (1,891 | ) | ||||||
Dispositions | | | (310,113 | ) | (5,294 | ) | (310,113 | ) | (5,294 | ) | ||||||||
Balance, March 31, 1998 | 740,188 | 20,459 | 400,901 | 5,986 | 1,141,089 | 26,445 | ||||||||||||
Acquisitions | 290,350 | 5,148 | 80,237 | 823 | 370,587 | 5,971 | ||||||||||||
Principal
repayments and
amortization |
(43,849 | ) | (1,506 | ) | (47,201 | ) | (451 | ) | (91,050 | ) | (1,957 | ) | ||||||
Dispositions | (2,843 | ) | (53 | ) | | | (2,843 | ) | (53 | ) | ||||||||
Balance, June 30, 1998 | 983,846 | 24,048 | 433,937 | 6,358 | 1,417,783 | 30,406 | ||||||||||||
Acquisitions | | | | | | | ||||||||||||
Principal
repayments and
amortization |
(54,745 | ) | (1,442 | ) | (38,925 | ) | (493 | ) | (93,670 | ) | (1,935 | ) | ||||||
Dispositions | (4,666 | ) | (56 | ) | (7,781 | ) | (107 | ) | (12,447 | ) | (163 | ) | ||||||
Balance, September 30, 1998 | 924,435 | 22,550 | 387,231 | 5,758 | 1,311,666 | 28,308 | ||||||||||||
Acquisitions | 42,298 | 458 | | | 42,298 | 458 | ||||||||||||
Principal
repayments and
amortization |
(62,953 | ) | (2,135 | ) | (15,215 | ) | (173 | ) | (78,168 | ) | (2,308 | ) | ||||||
Adjustment(A) | 25,101 | | | | 25,101 | | ||||||||||||
Dispositions | (378 | ) | (5 | ) | (372,016 | ) | (5,585 | ) | (372,394 | ) | (5,590 | ) | ||||||
Balance, December 31, 1998 | $928,503 | $20,868 | $ | $ | $ 928,503 | $20,868 | ||||||||||||
Acquisitions | | | | | | | ||||||||||||
Principal
repayments and
amortization |
(70,883 | ) | (1,830 | ) | | | (70,883 | ) | (1,830 | ) | ||||||||
Dispositions | (4,446 | ) | (79 | ) | | | (4,446 | ) | (79 | ) | ||||||||
Balance, March 31, 1999 | 853,174 | 18,959 | $ | $ | 853,174 | 18,959 | ||||||||||||
Acquisitions | | | | | | | ||||||||||||
Principal
repayments and
amortization |
(77,650 | ) | (2,289 | ) | | | (77,650 | ) | (2,289 | ) | ||||||||
Dispositions | (364 | ) | (12 | ) | | | (364 | ) | (12 | ) | ||||||||
Balance, June 30, 1999 | 775,160 | 16,658 | | | 775,160 | 16,658 | ||||||||||||
Acquisitions | | | 7,243 | | 7,243 | | ||||||||||||
Principal
repayments and
amortization |
(84,772 | ) | (2,248 | ) | (290 | ) | | (85,062 | ) | (2,248 | ) | |||||||
Dispositions | | | | | | | ||||||||||||
Balance, September 30, 1999 | $690,388 | $14,410 | $ 6,953 | $ | $ 697,341 | $14,410 | ||||||||||||
(A)
|
Adjustment due to balance sheet reclassifications that were made
in 1999 and 1998. See the Financial Condition of NovaStar
Financial as of September 30, 1999 and December 31, 1998
section of this document for a description of the
reclassifications that were made to better match the timing of
principal and interest payments of NovaStar Financials
securitized mortgage loan portfolio with the principal and
interest payments of collateralized mortgage obligations.
|
Table 9
Premium as a Percent of Principal
Mortgage
Loans |
Mortgage
Securities |
Total
Mortgage Assets |
|||||||
---|---|---|---|---|---|---|---|---|---|
As of: | |||||||||
September 30, 1999 | 2.09 | % | | % | 2.09 | % | |||
June 30, 1999 | 2.15 | | 2.15 | ||||||
March 31, 1999 | 2.22 | | 2.22 | ||||||
December 31, 1998 | 2.25 | | 2.25 | ||||||
September 30, 1998 | 2.44 | 1.49 | 2.16 | ||||||
June 30, 1998 | 2.44 | 1.47 | 2.14 | ||||||
March 31, 1998 | 2.76 | 1.49 | 2.32 | ||||||
December 31, 1997 | 3.19 | 1.63 | 2.45 |
Stockholders equity.
During the first nine months of 1999, NovaStar Financial
increased its equity from $83 million at December 31, 1998 to $113
million at September 30, 1999. This was primarily a result of the
issuance of 4,285,714 shares of Class B 7% cumulative convertible
preferred stock in March 1999. Gross proceeds on the issuance
aggregated $30 million. The issuance of these preferred shares will
have an impact on future earnings per share as discussed under
Net Income below.
Also, included in the accumulated other comprehensive income
component of stockholders equity as of September 30, 1999 is
the unrealized gain on available-for-sale securities. NovaStar
Mortgage sold its first asset backed bonds in January 1999, which
for accounting and tax purposes was treated as a sale. The economic
residual interests in those transactions have been classified as
available-for-sale securities. In September 1999, NovaStar Financial
purchased this security from NovaStar Mortgage. The amortized cost
of the economic residual interests approximated fair value at
September 30, 1999.
Results of Operations of NovaStar Financial, Inc.Nine Months
Ended September 30, 1999 Compared to the Nine Months Ended
September 30, 1998
|
Net Income
During the nine months ended September 30, 1999, NovaStar
Financial recorded net income of $2.0 million, $0.11 per diluted
share, compared with net income of $5.6 million, $0.64 per diluted
share, for the nine months ended September 30, 1998. In computing
earnings per share, shares issued during the period are weighted for
the portion of the period they are outstanding. If the preferred
shares would have been outstanding for the entire nine months of
1999, NovaStar Financials pro forma diluted earnings per share
for the nine months ended September 30, 1999 would have been the
same as diluted earnings per share for the nine months ended
September 30, 1999 as the preferred shares are considered
anti-dilutive for the nine months ended September 30, 1999.
NovaStar Financials main sources of revenue are interest
earned on its securitized mortgage loan portfolio and prepayment
penalty income. In addition, results indirectly reflect gains from
the sale of whole loan packages to third parties and securitizations
of NovaStar Mortgage.
Net Interest Income
Table 10 presents a summary of the average interest-earning
assets, average interest-bearing liabilities and the related yields
and rates thereon for the nine months ended September 30, 1999 and
1998.
Table 10
Interest Analysis
(dollars in thousands)
Mortgage Loans
|
Mortgage
Securities |
Total
|
|||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Nine months
ended September 30, 1999 |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
||||||||||||||
Interest-earning mortgage assets | $765,073 | $52,236 | 9.10 | % | $ 808 | $ 100 | 16.50 | % | $ 765,845 | $52,336 | 9.11 | % | |||||||||||
Interest-bearing liabilities | |||||||||||||||||||||||
Repurchase agreements | $ | $ | | % | $ | $ | | % | $ | $ | | % | |||||||||||
Collateralized mortgage obligations | 785,547 | 33,782 | 5.73 | | | | 785,547 | 33,782 | 5.73 | ||||||||||||||
Other borrowings | 5,623 | 541 | 12.83 | | | | 5,623 | 541 | 12.83 | ||||||||||||||
Cost of derivative financial | |||||||||||||||||||||||
Instruments hedging liabilities | 1,736 | 1,736 | |||||||||||||||||||||
Total borrowings | $791,170 | $36,059 | 6.08 | % | $ | $ | | % | $ 791,170 | $36,059 | 6.08 | % | |||||||||||
Net interest income | $16,177 | $ 100 | $16,277 | ||||||||||||||||||||
Net interest spread | 3.02 | % | 16.50 | % | 3.03 | % | |||||||||||||||||
Net yield | 2.82 | % | 16.50 | % | 2.83 | % | |||||||||||||||||
Provisions for credit losses | $11,499 | 2.00 | $ | $ | | % | $11,499 | 2.00 | |||||||||||||||
Net interest income after provision
for credit
losses |
$ 4,678 | $ | $ 100 | $ 4,778 | |||||||||||||||||||
Net interest spread after provision
for credit
losses |
1.02 | % | 16.50 | % | 1.03 | % | |||||||||||||||||
Net yield after provision for credit losses | 0.82 | % | 16.50 | % | 0.83 | % | |||||||||||||||||
Mortgage Loans
|
Mortgage
Securities |
Total
|
|||||||||||||||||||||
Nine months
ended September 30, 1998 |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
||||||||||||||
Interest-earning mortgage assets | $781,786 | $56,274 | 9.60 | % | $478,125 | $22,881 | 6.38 | % | $1,259,911 | $79,155 | 8.38 | % | |||||||||||
Interest-bearing liabilities | |||||||||||||||||||||||
Repurchase agreements | $156,854 | $ 7,643 | 6.50 | % | $511,460 | $20,785 | 5.42 | % | $ 668,314 | $28,428 | 5.67 | % | |||||||||||
Collateralized mortgage obligations | 626,960 | 29,659 | 6.31 | | | | 626,960 | 29,659 | 6.31 | ||||||||||||||
Other borrowings | 20,043 | 647 | 4.30 | | | | 20,043 | 647 | 4.30 | ||||||||||||||
Cost of derivative financial | |||||||||||||||||||||||
Instruments hedging liabilities | 1,637 | 577 | 2,214 | ||||||||||||||||||||
Total borrowings | $803,857 | $39,586 | 6.57 | % | $511,460 | 21,362 | 5.57 | % | $1,315,317 | $60,948 | 6.18 | % | |||||||||||
Net interest income | $16,688 | $ 1,519 | $18,207 | ||||||||||||||||||||
Net interest spread | 3.03 | % | 0.81 | % | 2.20 | % | |||||||||||||||||
Net yield | 2.85 | % | 0.42 | % | 1.93 | % | |||||||||||||||||
Provision for credit losses | $ 3,400 | 0.58 | $ | | | $ 3,400 | 0.36 | ||||||||||||||||
Net interest income after provision
for credit
losses |
$13,288 | $ | $1,519 | $14,807 | |||||||||||||||||||
Net interest spread after provision
for credit
losses |
2.45 | % | 0.81 | % | 1.84 | % | |||||||||||||||||
Net yield after provision for credit losses | 2.27 | % | 0.42 | % | 1.57 | % | |||||||||||||||||
Interest income.
NovaStar Financials average interest-earning assets consist
primarily of mortgage loans for the nine months ended September 30,
1999. For the nine months ended September 30, 1998, NovaStar
Financials average interest assets included 60% mortgage loans
and 40% of lower-yielding agency securities. As discussed in
Financial Condition of NovaStar Financial, Inc. as of September 30,
1999 and December 31, 1998, NovaStar Financial sold all of its
agency securities in October 1998 to meet short-term liquidity needs
faced in the fourth quarter of 1998. Agency securities earned $22.9
million for the nine months ended September 30, 1998, or a yield of
6.4%. Mortgage securities income for the nine months ended September
30, 1999 consist of earnings on residual interests NovaStar
Financial purchased from NovaStar Mortgage in September 1999. During
the nine months ended September 30, 1999, mortgage loans earned
$52.2 million, or a yield of 9.1%, compared with $56.3 million, or a
yield of 9.6% for the same period of 1998. In total, assets earned
$52.3 million, or a yield of 9.1% for the nine months ended
September 30, 1999. During the same period of 1998, assets earned
$79.2 million or an 8.4% yield.
As noted in Table 10, interest income is a function of volume
and rates. Increasing the volume of assets will cause future
increases in interest income, while declining balances will reduce
interest income. Market interest rates will also affect future
interest income.
Interest expense.
Average interest-bearing liabilities for the nine months ended
September 30, 1999 consisted of financing costs on mortgage loans,
while average interest bearing liabilities for the nine months ended
September 30, 1998 consisted of 60% mortgage loans and 40% agency
securities. During the fourth quarter of 1998, NovaStar Financial
sold all of its agency securities. Mortgage loan cost of borrowed
funds was $36.1 million for the nine months ended September 30,
1999, or 6.1% of average mortgage loan borrowings compared with
$39.6 million for the same period of 1998, or 6.6% of average
mortgage loan borrowings. Agency security cost of borrowed funds was
$21.4 million during the nine months ended September 30, 1998, or
5.6% of average agency security borrowings. The composition of
interest expense is significantly different for the nine months
ended September 30, 1999 compared with the same period of 1998. This
is due to the following factors:
|
The
majority of mortgage loans serve as collateral on collateralized
mortgage obligations at September 30, 1999. During 1998, the
mortgage loans served as collateral on collateralized mortgage
obligations, warehouse and repurchase facility debt. The change in
financing composition is primarily due to the fact that NovaStar
Financial discontinued purchasing mortgage loans from NovaStar
Mortgage during the last half of 1998. Prior to that point in
time, NovaStar Financial had purchased 100% of NovaStar Mortgage
s loan production. Loans held in portfolio prior to
securitization were financed by repurchase facilities. Under
agreements with NovaStar Mortgage, NovaStar Financial reimbursed
NovaStar Mortgage for its warehousing costs incurred prior to
sale. Repurchase and warehouse facility costs for the nine months
ended September 30, 1998 are included under repurchase agreements
and other borrowings in Table 10.
|
|
NovaStar
sold all of its agency securities in October 1998 and paid off all
related financing on these assets. No agency securities have been
purchased since that time.
|
|
Due to
the liquidity crisis faced in the last quarter of 1998,
GMAC/Residential Funding Corporation provided additional financing
under a residual line that was secured by mortgage interests in
NovaStars asset-backed bonds. This facility carried a
substantially higher interest cost than other borrowing
arrangements. This debt was paid off in February 1999 with funds
from a similar facility provided by First Union National Bank. The
interest on this facility during the nine months ended September
30, 1999 is included as a component of other borrowings in Table
10.
|
Advances under the warehouse line of credit bear interest
based on the federal funds rate plus a spread. NovaStar Financial
and NovaStar Mortgage receive credits to warehouse line interest
based on cash balances maintained with First Union. Advances under
the master repurchase agreement bear interest at rates based on
LIBOR, plus a spread. During the nine months ended September 30,
1999, one-month LIBOR averaged 5.07
percent compared with 5.66 percent for the nine months ended September
30, 1998. Because the Federal Reserve increased the targeted Federal
Funds interest rate in June 1999, management expects effective
borrowing costs to be higher for the second half of 1999. As with
interest income, the cost of funds in the future will largely depend
on market conditions, most notably levels of short-term interest
rates. Rates on other borrowings generally fluctuate with short-term
market interest rates, such as LIBOR or the federal funds rate.
Net interest income and spread.
Net interest income on mortgage loans during the
nine months ended September 30, 1999 was $16.2 million, or 2.8% of
average interest-earning mortgage loans, compared with $16.7
million, or 2.9% for the nine months ended September 30, 1998. Net
interest spread on mortgage loans was 3.0% for the nine months ended
September 30, 1999 and 1998. Net interest income on economic
residual interests, classified as mortgage securities during the
nine months ended September 30, 1999 was $100,000, or 16.5% of
average interest-earning mortgage securities compared with net
interest income on agency securities classified as mortgage
securities of $1.5 million, or 0.4% of average interest-earning
agency securities for the same period of 1998. Net interest spread
on mortgage securities was 16.5% for the nine months ended September
30, 1999 compared with 0.8% for the nine months ended September 30,
1998. The significant increase in net margin and spread for the nine
months ended September 30, 1999 compared with the nine months ended
September 30, 1998 is due to the change in NovaStar Financials
asset and liability composition. During the latter part of 1998,
NovaStar Financial sold all agency securities and paid off related
financing. NovaStar Financial has not purchased any more of these
lower-yielding mortgage assets. Net interest income and the spread
are functions of asset yields relative to its costs of funds. The
volume of assets and liabilities and how well the spread between
earnings on assets and the cost of funds is managed will dictate
future net interest income.
Impact of interest rate agreements.
NovaStar Financial has entered into interest
rate agreements designed to mitigate exposure to interest rate risk.
Interest rate cap agreements require NovaStar Financial to pay a
monthly fixed premium while allowing it to receive a rate that
adjusts with LIBOR, when rates rise above a certain agreed-upon
rate. These agreements are used to alter, in effect, the interest
rates on funding costs to more closely match the yield on
interest-earning assets.
During the nine months ended September 30, 1999 and 1998, net
interest expense incurred on hedging agreements was $1.7 million and
$2.2 million, respectively, which is included as a component of
interest expense. The following table provides details of the
interest rate agreements as of September 30, 1999 and December 31,
1998.
Table 11
Interest Rate Agreements
September 30, 1999 and December 31, 1998
(dollars in thousands)
Notional
Value |
Unrealized
|
Weighted
Days to Maturity |
Weighted
Average Cap Rate |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Gains
|
Losses
|
||||||||||
As of September 30, 1999: | |||||||||||
Interest rate cap agreements | $530,000 | $376 | $ 813 | 544 | 6.32 | % | |||||
As of December 31, 1998: | |||||||||||
Interest rate cap agreements | $625,000 | $ | $2,483 | 734 | 6.27 | % | |||||
Other Income
Other income during the nine months ended September 30, 1999
primarily consists of prepayment penalties of $2.4 million, net
gains recognized on the sale of real estate owned of $74,000,
interest earned on securitization funds held in trust of $173,000,
and interest earned on notes receivable from founders of $368,000.
Other income for the same period of 1998 consisted of prepayment
penalties of $1.1 million, interest
earned on notes receivable from founders of $241,000, gains on
mortgage loan sales of $315,000, net gains on mortgage security
sales of $16,000 and interest earned on securitization funds held in
trust of $337,000.
Provisions for Credit Losses
NovaStar Financial makes provisions for loan losses in amounts
considered necessary to maintain allowances at levels sufficient to
cover probable losses inherent in the loan portfolio at the
reporting date. The level of probable losses is estimated using
migration analysis. The analysis takes information about actual
foreclosure and loss severity experience and applies that
information to the portfolio at the reporting date. Chargeoffs are
recognized at the time of foreclosure by recording the value of
repossessed property at its realizable value. Subsequent gains or
losses on dispositions, if any, are recorded in operations.
NovaStar Financial uses several different loss mitigation
techniques, including targeted pre-funding audits by quality control
personnel and increased appraisal reviews. Borrowers are allowed to
sell property for less than the outstanding loan balance prior to
foreclosure otherwise known as short sales, when it is believed
resulting losses are less than those that would be realized through
foreclosure.
In August of 1998, NovaStar Financial and NovaStar Mortgage
executed an agreement with, Radian Guaranty, Inc. (Radian), formerly
Commonwealth Mortgage Acceptance Corporation (CMAC), whereby Radian
will provide insurance coverage on mortgage loans. As of September
30, 1999 and December 31, 1998, approximately 29% and 26% of the
loans owned by NovaStar Financial and substantially all of the loans
owned by NovaStar Mortgage are covered under this agreement. During
the nine months ended September 30, 1999, total premiums paid to
Radian totaled $1.3 million and are included as a component of loan
servicing expense in the financial statements. Management believes
that its exposure to credit loss on loans insured by Radian is
minimal. Management expects that a substantial portion of loans
originated in future periods will be covered under similar insurance
arrangements.
During the nine months ended September 30, 1999, NovaStar
Financial made provisions of $11.5 million and incurred net
chargeoffs of $9.7 million, compared to provisions of $3.4 million
and net chargeoffs of $3.0 million for the same period of 1998.
Chargeoffs in 1999 include $1.6 million resulting from short sales
and loans fully charged off prior to foreclosure. While management
believes the short sales have served to reduce NovaStar Financial
s overall losses, they led to higher levels of losses in 1999
than expected. Notwithstanding the short sale activity, the higher
level of chargeoffs in 1999 has led management to conclude that
total losses will be higher, and will occur earlier in the life of
the loan portfolio, than originally projected. As a result, 1999
provisions have been substantially higher than prior years.
Management believes that the loss migration techniques employed,
including those described above, will reduce the overall losses to
be incurred. In the opinion of management, the allowance for credit
losses at September 30, 1999 is adequate to cover losses inherent in
the portfolio at that date. If losses do not develop as the
migration analysis indicates, future provisions will be increased or
decreased as necessary.-
As of September 30, 1999, NovaStar Financial had 174 loans in
real estate owned with a carrying value of $15.4 million compared to
126 loans with a carrying value of $10.6 million as of December 31,
1998.
Table 12 is a rollforward of the allowance for credit losses
during 1999 and 1998.
Table 12
Rollforward of Allowance for Credit Losses
1999
|
1998
|
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September
30 |
June 30
|
March 31
|
December 31
|
September
30 |
June 30
|
March 31
|
|||||||||||||||
Beginning balance | $ 3,573 | $ 3,492 | $ 3,573 | $ 2,757 | $ 3,341 | $2,871 | $2,313 | ||||||||||||||
Provision for credit losses | 5,634 | 3,566 | 2,299 | 4,030 | 1,179 | 1,145 | 1,076 | ||||||||||||||
Amounts charged
off, net
of recoveries |
(3,837 | ) | (3,485 | ) | (2,380 | ) | (3,214 | ) | (1,763 | ) | (675 | ) | (518 | ) | |||||||
Ending Balance | $ 5,370 | $ 3,573 | $ 3,492 | $ 3,573 | $ 2,757 | $3,341 | $2,871 | ||||||||||||||
Loans owned by NovaStar Financial are serviced by NovaStar
Mortgage. Details regarding the delinquencies, defaults, and loss
statistics of the loan servicing portfolio are presented in Tables
23 and 24, in Financial Condition of NovaStar Mortgage as of
September 30, 1999 and December 31, 1998.
General and Administrative Expenses
General and administrative expenses for the nine months ended
September 30, 1999 and 1998 are provided in Table 13. Table 14
displays the relationship of portfolio expenses to net interest
income during 1999 and 1998 by quarter.
Table 13
General and Administrative Expenses
(dollars in thousands)
Nine Months
Ended September 30, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|
1999
|
1998
|
|||||||||
Percent of
Net Interest Income |
Percent of
Net Interest Income |
|||||||||
Compensation and benefits | $1,358 | 8.3 | % | $1,374 | 7.5 | % | ||||
Loan servicing | 1,392 | 8.6 | 491 | 2.7 | ||||||
Professional and outside services | 546 | 3.4 | 649 | 3.6 | ||||||
Office administration | 611 | 3.8 | 681 | 3.7 | ||||||
Other | 103 | 0.6 | 184 | 1.0 | ||||||
Total portfolio-related expenses | 4,010 | 24.7 | % | 3,379 | 18.5 | % | ||||
Forgiveness of notes receivable from founders | | 812 | ||||||||
Fees for services provided by NovaStar Mortgage, Inc. | 3,343 | 4,606 | ||||||||
Total general and administrative expenses | $7,353 | $8,797 | ||||||||
Efficiency Ratio(A) | 38.0 | % | 43.5 | % | ||||||
(A)
|
The
efficiency ratio is calculated by dividing general and
administrative expenses by the sum of net interest income and
other income.
|
Table 14
Portfolio Related Expenses as a
Percent of Net Interest Income
1999 and 1998
Percent of
Net
Interest Income |
Efficiency
Ratio |
|||||
---|---|---|---|---|---|---|
1999: | ||||||
Third quarter | 28.7 | % | 36.9 | % | ||
Second quarter | 19.8 | 22.9 | ||||
First quarter | 25.8 | 52.3 | ||||
1998: | ||||||
1998 | 25.6 | 5,747.0 | ||||
Fourth quarter | 89.7 | (14.1 | ) | |||
Third quarter | 22.3 | 21.1 | ||||
Second quarter | 19.3 | 58.9 | ||||
First quarter | 14.8 | 55.0 |
Compensation and benefits includes employee base salaries,
benefit costs and incentive compensation awards and has remained
relatively consistent for the nine months ended September 30, 1999
compared with the same period of 1998.
Loan servicing for the nine months ended September 30, 1999
consists principally of the fees paid to Radian as discussed under
the Provisions for Credit Losses. This line-item also
includes the direct costs associated with the mortgage loan
servicing operation that are paid directly to independent third
parties for such things as property appraisals and borrower location
services. NovaStar loans were not covered by insurance until the
third quarter of 1998, which caused the increase in loan servicing
costs from 1998 to 1999.
Professional and outside services include fees for legal,
accounting services and annual and quarterly reports. In the normal
course of business, fees are incurred for professional services
related to general corporate matters and specific transactions.
Office administration includes items such as rent, depreciation,
telephone, office supplies, postage, delivery, maintenance and
repairs.
The following is a summary of the fees, in thousands, paid to
(received from) NovaStar Mortgage for the nine months ended
September 30, 1999 and 1998:
Nine Months
Ended September 30, |
||||||
---|---|---|---|---|---|---|
1999
|
1998
|
|||||
Amounts paid to NovaStar Mortgage: | ||||||
Loan servicing fees | $3,056 | $2,672 | ||||
Administrative fees | 1,263 | 5,700 | ||||
Amounts received from NovaStar Mortgage: | ||||||
Purchase commitment fee | | (3,766 | ) | |||
Interest income | (976 | ) | | |||
$3,343 | $4,606 | |||||
The fees for services provided by NovaStar Mortgage
represent the following:
|
Administrative fees for services, including the development of
loan products, underwriting, funding, and quality control.
|
|
Servicing
fees to NovaStar Mortgage. NovaStar Mortgage receives 50 basis
points on the collected principal balance of NovaStar Financial
loans serving as collateral on CMOs.
|
|
Purchase
commitment fee. A fee NovaStar Mortgage pays to NovaStar
Financial, if it chooses to retain the mortgage loans it
originates or sells them to third parties.
|
|
Interest
income. Interest payments NovaStar Mortgage pays to NovaStar
Financial for financing loan fundings and various operating costs
of NovaStar Mortgage.
|
The increase in loan servicing fees paid to NovaStar Mortgage
for the nine months ended September 30, 1999 compared with the nine
months ended September 30, 1998 is due to the increase in NovaStar
Financials average securitized mortgage loan portfolio
serviced by NovaStar Mortgage.
The decline in the administrative fees paid to NovaStar
Mortgage during these same periods is partly a result of the
reduction in NovaStar Mortgages production volumes as
indicated in Table 21. The decline in 1999 originations reflect
decisions made by management as a result of constrained liquidity
circumstances the subprime mortgage industry faced during the latter
part of 1998. Accordingly, the administrative fees NovaStar
Financial paid to NovaStar Mortgage during this same period were
reduced. This agreement was cancelled on April 1, 1999, since
NovaStar Financial is no longer purchasing loans from NovaStar
Mortgage. Accordingly, NovaStar Financial is no longer utilizing the
services as outlined in the agreement.
The decrease in purchase commitment fees for the nine months
ended September 30, 1999 compared with the same period of 1998 is
due to the discontinuance of this intercompany agreement beginning
January 1, 1999.
The increase in interest income for the nine months ended
September 30, 1999 compared with the same period of 1998 is due to
this intercompany agreement that went into effect April 1, 1999.
Equity in Earnings (Loss) of NFI Holding
Corporation
For the nine months ended September 30, 1999, NFI Holding
recorded net income of $1.5 million compared with a net loss of $2.5
million for the same period of 1998. NovaStar Financial records its
portion of the loss as equity in net loss of NFI Holding in its
income statement. NFI Holdings net loss includes the net
earnings of NovaStar Mortgage and NovaStar Capital, subsidiaries of
NFI Holding as discussed under Basis of Presentation.
NFI Holdings financial position and results of operation for
the nine month period ended September 30, 1999 and 1998 are
discussed further under the heading NFI Holding Corporation
.
Results of Operations of NovaStar Financial, Inc.
Three Months Ended September 30, 1999 Compared to the Three
Months Ended September 30, 1998.
Net Income
During the three months ended September 30, 1999, NovaStar
Financial recorded a net loss of $1.5 million, $0.25 per diluted
share, compared with net income of $2.4 million, $0.29 per diluted
share, for the three months ended September 30, 1998.
Net Interest Income
Table 15 presents a summary of the average interest-earnings
assets, average interest-bearing liabilities and the related yields
and rates thereon for the three months ended September 30, 1999 and
1998.
Table 15
Interest Analysis
Three Months Ended September 30, 1999 and 1998
(dollars in thousands)
Mortgage Loans
|
Mortgage
Securities |
Total
|
|||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September 30,
1999 |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
||||||||||||||
Interest-earning mortgage assets | $690,323 | $15,595 | 9.04 | % | $2,424 | $100 | 16.50 | % | $692,747 | $15,695 | 9.06 | % | |||||||||||
Interest-bearing liabilities | |||||||||||||||||||||||
Repurchase agreements | $ | $ | | % | $ | $ | | % | $ | $ | | % | |||||||||||
Collateralized mortgage obligations | 706,685 | 10,626 | 6.01 | | | | 706,685 | 10,626 | 6.01 | ||||||||||||||
Other borrowings | | | | | | | | | | ||||||||||||||
Cost of derivative
financial Instruments
hedging liabilities |
580 | 0.33 | | $ 580 | 0.33 | ||||||||||||||||||
Total borrowings | $706,685 | $11,206 | 6.34 | % | $ | $ | | % | $706,685 | $11,206 | 6.34 | % | |||||||||||
Net interest income | $ 4,389 | $100 | |||||||||||||||||||||
Net interest spread | 2.70 | % | 16.50 | % | $ 4,489 | 2.72 | % | ||||||||||||||||
Net yield | 2.54 | % | 16.50 | % | 2.59 | % | |||||||||||||||||
Provision for credit losses | $ 5,634 | 3.26 | % | $ | $ 5,634 | 3.25 | % | ||||||||||||||||
Net interest
income after provisions for
credit losses |
$(1,245 | ) | $100 | $(1,145 | ) | ||||||||||||||||||
Net interest
spread after provision for
credit losses |
(0.56 | )% | 16.50 | % | (0.53 | )% | |||||||||||||||||
Net yield after
provision for credit
losses |
(0.72 | )% | 16.50 | % | (0.66 | )% | |||||||||||||||||
Mortgage Loans
|
Mortgage
Securities |
Total
|
|||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September 30,
1998 |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/ Rate |
Average
Balance |
Interest
Income/ Expense |
Annual
Yield/Rate |
||||||||||||
Interest-earning mortgage assets | $927,132 | $22,312 | 9.63 | % | $412,335 | $6,483 | 6.29 | % | $1,339,467 | $28,797 | 8.60 | % | |||||||||
Interest-bearing liabilities | |||||||||||||||||||||
Repurchase agreements | $144,041 | $ 2,303 | 6.40 | % | $419,901 | $6,121 | 5.83 | % | $ 563,942 | $ 8,424 | 5.98 | % | |||||||||
Collateralized mortgage obligations | 821,739 | 12,734 | 6.20 | | | | 821,739 | 12,734 | 6.20 | ||||||||||||
Other borrowings | 10,446 | 111 | 4.25 | | | | 10,446 | 111 | 4.25 | ||||||||||||
Cost of derivative financial
Instruments
hedging liabilities |
638 | 181 | 819 | ||||||||||||||||||
Total borrowings | $976,226 | $15,786 | 6.47 | % | $419,901 | $6,302 | 6.00 | % | $1,396,127 | $22,088 | 6.33 | % | |||||||||
Net interest income | $ 6,528 | $ 181 | $ 6,709 | ||||||||||||||||||
Net interest spread | 3.16 | % | 0.29 | % | 2.27 | % | |||||||||||||||
Net yield | 2.82 | % | 0.18 | % | 2.00 | % | |||||||||||||||
Provision for credit losses | $ 1,179 | (0.51 | )% | $ | $ 1,179 | (0.35 | )% | ||||||||||||||
Net interest income after provision
for
credit losses |
$ 5,349 | $ 181 | $ 5,530 | ||||||||||||||||||
Net interest spread after provision
for
credit losses |
2.65 | % | 0.18 | % | 1.92 | % | |||||||||||||||
Net yield after provision for credit
losses |
2.31 | % | 0.18 | % | 1.65 | % | |||||||||||||||
Average interest-earning assets for the three months ended
September 30, 1999 primarily consisted of mortgage loans, while
average interest-bearing assets for the three months ended September
30, 1998 consisted of 70% mortgage loans and 30% agency securities.
During the fourth quarter of 1998, NovaStar Financial sold all of
its agency securities. Mortgage loan interest income was $15.6
million for the three months ended September 30, 1999, or a yield of
9.0% compared with $22.3 million for the same period of 1998, or a
yield of 9.6%. For the three months ended September 30, 1999,
interest earned on economic residual interests was $100,000, or a
yield of 16.5%. Agency securities earned $6.5 million, or a yield of
6.3% during the three months ended September 30, 1998.
Average interest-bearing liabilities for the three months
ended September 30, 1999 consisted of financing costs on mortgage
loans, while average interest-bearing liabilities for the three
months ended September 30, 1998 was a mix of mortgage loans and
agency security financings. Mortgage loan financing costs were $11.2
million for the three months ended September 30, 1999, or 6.3% of
average mortgage loan borrowings compared with $15.8 million for the
same period of 1998, or 6.5% or average mortgage loan borrowings.
Agency security financing costs were $6.3 million during the three
months ended September 30, 1998, or 6.0% of average agency security
borrowings.
Net interest income on mortgage loans during the three months
ended September 30, 1999 was $4.4 million, or 2.5% of average
interest-earning mortgage loans, compared with $6.5 million or 2.8%
of average interest-earning mortgage loans for the three months
ended September 30, 1998. Net interest spread on mortgage loans was
2.7% for the three months ended September 30, 1999 compared with
3.2% for the same period of 1998. Net interest income on economic
residual interests, classified as mortgage securities during the
three months ended September 30, 1999 was $100,000, or 16.5% of
average interest-mortgage securities compared with net interest
income on agency securities classified as mortgage securities of
$181,000 million, or 0.2% of average interest-earning agency
securities for the same period of 1998. Net interest spread on
mortgage securities was 16.5% for the three months ended September
30, 1999 compared with 0.3% for the three months ended September 30,
1998. The increase in net margin and spread for the three months
ended September 30, 1999 compared with the three months ended
September 30, 1998 is due to the change in NovaStar Financials
asset and liability composition as discussed under Results of
OperationsNine Months Ended September 30, 1999 Compared to
Nine Months Ended September 30, 1998.
During the three months ended September 30, 1999 and 1998,
net interest expense was incurred on hedging agreements of $580,000
and $819,000, respectively, which is included as a component of
interest expense.
Other Income
Other income during the three months ended September 30, 1999
primarily consists of prepayment penalties of $769,000, net gains
recognized on the sale of real estate owned properties of $91,000,
interest earned on securitization funds held in trust of $62,000,
and interest earned on notes receivable from founders of $126,000.
Other income for the same period of 1998 primarily consisted of
prepayment penalties of $426,000, net gains on mortgage asset sales
of $108,000 and interest earned on notes receivable from founders of
$72,000.
Provisions for Credit Losses
During the three months ended September 30, 1999, NovaStar
Financial provided $5.6 million to the allowance for credit losses,
compared with $1.2 million during the same period of 1998.
Charge-offs during the three months ended September 30, 1999 were
$3.8 million compared with $1.8 million during the same period of
1998. See discussion of Provisions for Credit Losses
under Results of Operations of NovaStar Financial, Inc.
Nine Months Ended September 30, 1999 Compared to the Nine Months
Ended September 30, 1998.
General and Administrative Expenses
General and administrative expenses for the three months ended
September 30, 1999 and 1998 are provided in Table 16.
Table 16
General and Administrative Expenses
(dollars in thousands)
Three Months
Ended September 30, |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
1999
|
1998
|
||||||||||
Percent
of Net Interest Income |
Percent
of Net Interest Income |
||||||||||
Compensation and benefits | $ 421 | 9.4 | % | $ 478 | 10.6 | % | |||||
Professional and outside services | 181 | 4.0 | 296 | 6.6 | |||||||
Other loan servicing | 446 | 9.9 | 363 | 8.1 | |||||||
Office administration | 203 | 4.5 | 276 | 6.1 | |||||||
Other | 41 | 0.9 | (9 | ) | (0.2 | ) | |||||
Total portfolio-related expenses | $1,292 | 28.7 | % | $1,404 | 31.2 | % | |||||
Forgiveness of notes receivable from founders | 270 | ||||||||||
Fees for services provided by NovaStar Mortgage, Inc. | 767 | (65 | ) | ||||||||
Total general and administrative expenses | $2,059 | $1,609 | |||||||||
Efficiency Ratio (A) | 36.9 | % | 28.8 | % | |||||||
(A)
|
The
efficiency ratio is calculated by dividing general and
administrative expenses by the sum of net interest income and
other income.
|
Compensation and benefits remained relatively stable, totaling
$421,000 for the three months ended September 30, 1999 compared with
$478,000 for the same period of 1998.
Professional and outside services for the three months ended
September 30, 1999 was $181,000 compared with $296,000 for the three
months ended September 30, 1998. Professional and outside services
include fees for legal and accounting services, costs of contract
laborers, costs to publish annual and quarterly reports, etc. The
amount of and variance in these costs is dependent on the timing of
services performed.
Other loan servicing for the three months ended September 30,
1999 was $446,000 compared with $363,000 for the three months ended
September 30, 1998. Other loan servicing in 1999 consists
principally of the fees paid to Radian as discussed under the
Provisions for Credit Losses. This line-item also includes the
direct costs associated with the mortgage loan servicing operation
that are paid directly to independent third parties for such things
as property appraisals and borrower location services. NovaStar
loans were not covered by insurance until the third quarter of 1998,
which caused the increase in loan servicing costs from 1998 to 1999.
The following is a summary of the fees, in thousands, paid to
NovaStar Mortgage for the three months ended September 30, 1999 and
1998:
Three Months
Ended September 30, |
||||||
---|---|---|---|---|---|---|
1999
|
1998
|
|||||
Amounts paid to NovaStar Mortgage: | ||||||
Loan servicing fees | $936 | $1,184 | ||||
Administrative fees | 115 | 2,100 | ||||
Amounts paid to NovaStar Mortgage: | ||||||
Purchase commitment fee | | (3,349 | ) | |||
Interest income | (284 | ) | | |||
$767 | $ (65 | ) | ||||
The decrease in loan servicing fees paid to NovaStar Mortgage
for the three months ended September 30, 1999 compared with the
three months ended September 30, 1998 is due to the decline in
NovaStar Financials mortgage loan portfolio collateralizing
CMOs.
The decline in the administrative fees paid to NovaStar
Mortgage during these same periods is a result of NovaStar Financial
discontinued paying these fees to NovaStar Mortgage in April 1999.
The decrease in purchase commitment fees for the three months
ended September 30, 1999 compared with the same period of 1998 is
due to the discontinuance of this intercompany agreement beginning
January 1, 1999. This line-item still includes NovaStar Financial
s portion of system departmental costs.
The increase in interest income for the three months ended
September 30, 1999 compared with the same period of 1998 is due to
this intercompany agreement went into effect April 1, 1999.
Equity in Earnings (Loss) of NFI Holding
Corporation
For the three months ended September 30, 1999, NFI Holding
recorded net income of $583,000 compared with a net loss of $2.5
million for the same period of 1998. NFI Holdings financial
position and results of operation for the three month periods ended
September 30, 1999 and 1998 are discussed further under the heading
NFI Holding Corporation.-
Taxable Income (Loss)
Income reported for financial reporting purposes as calculated
in accordance with generally accepted accounting principles (GAAP)
differs from income computed for income tax purposes. This
distinction is important as dividends paid are based on taxable
income. Table 17 is a summary of the differences between net income
or loss reported for GAAP and taxable income for 1999 and 1998.
Table 17
Taxable Income (Loss)
1999 and 1998 (in thousands)
1999
|
1998
|
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Third
Quarter |
Second
Quarter |
First
Quarter |
Fourth
Quarter |
Third
Quarter |
Second
Quarter |
First
Quarter |
|||||||||||||||
Net income (loss) | $(1,537 | ) | $ 1,845 | $ 1,726 | $(27,388 | ) | $ 2,394 | $1,894 | $1,279 | ||||||||||||
Use of net
operating loss
carryforward |
| (1,153 | ) | (1,475 | ) | | | | | ||||||||||||
Results of NFI
Holding and
subsidiaries |
(577) | 674 | (551 | ) | 320 | 2,447 | | 271 | |||||||||||||
Provision for credit losses | 5,634 | 3,566 | 2,299 | 4,030 | 1,179 | 1,145 | 1,076 | ||||||||||||||
Loans charged-off | (3,836 | ) | (3,484 | ) | (2,380 | ) | (3,214 | ) | (1,763 | ) | (675 | ) | (518 | ) | |||||||
Capital losses | | | | 14,963 | | | | ||||||||||||||
Other, net | 397 | 397 | 381 | (370 | ) | 96 | 208 | (2 | ) | ||||||||||||
Estimated taxable
income
(loss) |
$ 81 | $ 1,845 | $ | $(11,659 | ) | $ 4,353 | $2,572 | $2,106 | |||||||||||||
The net loss realized during the 1998 fourth quarter resulted
in NovaStar Financial incurring a net loss for both financial
reporting and income tax purposes for the 1998 fiscal year. NovaStar
Financial has a net operating loss carryforward of approximately
$2.6 million available to offset taxable income in 1999, and thereby
reduce the amount of required distributions under REIT guidelines.
In addition, the $0.35 per common share, $2.8 million dividend paid
on April 15, 1999 and the $556,000 of preferred dividends paid in
May and August 1999 represent distributions of 1999 taxable income.
Consequently, NovaStar Financial does not anticipate declaring any
further dividends on common stock for 1999. NovaStar Financial
expects the common stock dividend paid in April 1999 to be
designated as a return of capital. NovaStar Financial anticipates
that it will return to its previous policy of declaring dividends on
common stock in 2000.
NFI Holding Corporation
Since NovaStar Financial discontinued purchasing loans from
NovaStar Mortgage and holding them in portfolio in the latter part
of 1998, NovaStar Mortgage has had a larger impact on NovaStar
Financials operational results. Instead of selling loans to
NovaStar Financial, NovaStar Mortgage has sold loans to outside
third parties. Through its indirect equity ownership of NFI Holding,
NovaStar Financial has shared in the profits of NovaStar Mortgage
s loan sales.
The following table presents NFI Holdings consolidated
financial statements as of September 30, 1999 and 1998, which
primarily consist of the assets, liabilities, and operational
results of NovaStar Mortgage. Accordingly, the discussion that
follows focuses on NovaStar Mortgage.
Table 18
NFI Holding Corporation
Condensed Consolidated Balance Sheets
(in thousands)
(in thousands)
September
30,
1999 |
December 31,
1998 |
|||
---|---|---|---|---|
(unaudited) | ||||
Assets | ||||
Cash and cash equivalents. | $ 947 | $ 5,759 | ||
Mortgage loans. | 103,258 | 216,839 | ||
Other assets | 8,649 | 4,492 | ||
Total assets | $112,854 | $227,090 | ||
Liabilities and Stockholders Equity | ||||
Borrowings | $ 72,620 | $203,341 | ||
Due to NovaStar Financial, Inc. | 22,044 | 18,521 | ||
Accounts payable and other liabilities | 9,699 | 5,215 | ||
Stockholders equity | 8,491 | 13 | ||
Total liabilities and stockholders equity | $112,854 | $227,090 | ||
NFI Holding Corporation
Condensed Consolidated Statements of Operations
(unaudited; in thousands)
For the Nine
Months Ended September 30, |
For the Three
Months Ended September 30, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
1999
|
1998
|
1999
|
1998
|
||||||||
Interest income | $ 8,542 | $ 6,539 | $3,122 | $ 3,745 | |||||||
Interest expense. | 4,358 | 4,809 | 1,543 | 2,391 | |||||||
Net interest income | 4,184 | 1,730 | 1,579 | 1,354 | |||||||
Other income: | |||||||||||
Administrative servicing
fees received from NovaStar
Financial |
3,343 | 4,606 | 767 | (65 | ) | ||||||
Fees from third parties | 707 | 2,305 | 152 | 687 | |||||||
Net gain on sales of mortgage loans | 9,189 | 1,209 | 3,101 | 798 | |||||||
Total other income | 13,239 | 8,120 | 4,020 | 1,420 | |||||||
General and administrative expenses | 15,889 | 12,330 | 5,250 | 5,246 | |||||||
Income (loss) before taxes | 1,534 | (2,480 | ) | 349 | (2,472 | ) | |||||
Income tax expense | | | (234 | ) | | ||||||
Net income or (loss) | $ 1,534 | $ (2,480) | $ 583 | $(2,472 | ) | ||||||
Financial Condition of NovaStar Mortgage, Inc. as
of September 30, 1999 and December 31, 1998
Mortgage Loan Originations.
NovaStar Mortgage originated 3,100 subprime residential mortgage
loans during the nine months ended September 30, 1999 with an
aggregate principal amount of $313 million. Virtually all of
NovaStar Mortgages mortgage assets at September 30, 1999 and
December 31, 1998 consist of subprime mortgage loans that will be
sold directly to independent buyers of whole loans or through
securitization transactions that are treated for tax and accounting
purposes as sales.
Table 19 is a summary of wholesale loan originations for
1999 and 1998. Table 20 presents a summary of mortgage loan sales of
NovaStar Mortgage during 1999 and 1998. Table 21 is a summary of
loan costs for NovaStar Mortgage relative to its wholesale loan
originations.
Table 19
1999 and 1998 Quarterly Wholesale Loan Originations
NovaStar Mortgage, Inc.
(dollars in thousands)
Number
of Loans |
Principal
|
Average
Loan Balance |
Price Paid to
Broker |
Weighted Average
|
Percent with
Prepayment Penalty |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Loan to
Value |
Credit
Rating (A) |
Coupon
|
|||||||||||||||||
1999: | |||||||||||||||||||
Third quarter | 1,139 | $118,379 | $104 | 100.8 | 82 | % | 5.29 | 9.87 | % | 91 | % | ||||||||
Second quarter | 1,120 | 111,952 | 100 | 100.9 | 82 | 5.16 | 9.80 | 89 | |||||||||||
First quarter | 865 | 82,495 | 95 | 100.5 | 80 | 4.95 | 9.87 | 89 | |||||||||||
1999 total | 3,124 | $312,826 | $100 | 100.7 | 82 | % | 5.15 | 9.84 | % | 90 | % | ||||||||
1998: | |||||||||||||||||||
Fourth quarter | 1,501 | $133,739 | $ 89 | 100.8 | 81 | % | 4.75 | 9.78 | % | 88 | % | ||||||||
Third quarter | 2,655 | 240,498 | 90 | 101.4 | 81 | 4.37 | 10.11 | 79 | |||||||||||
Second quarter | 3,133 | 294,303 | 94 | 101.3 | 81 | 4.43 | 9.93 | 71 | |||||||||||
First quarter | 2,033 | 207,976 | 102 | 101.4 | 81 | 4.45 | 9.93 | 65 | |||||||||||
1998 total | 9,322 | $876,516 | $ 94 | 101.3 | 81 | % | 4.47 | 9.96 | % | 74 | % | ||||||||
(A)
|
AAA=7,
AA=6, A=5, A-=4, B=3, C=2, D=1
|
Table 20
Mortgage Loan Sales to Third PartiesNovaStar
Mortgage, Inc.
Nine Months Ended September 30, 1999 and Year
Ended December 31, 1998
(dollars in thousands)
Principal
Amount |
Gain
Recognized |
Weighted
Average Price To Par |
Percent
Gain of Principal |
||||||
---|---|---|---|---|---|---|---|---|---|
1999: | |||||||||
Third quarter | $106,759 | $2,969 | 104.2 | 2.79 | % | ||||
Second quarter | 97,281 | 2,875 | 104.4 | 2.96 | |||||
First quarter | 73,743 | 1,576 | 103.6 | 2.14 | |||||
1999 total | $277,783 | $7,420 | 104.1 | 2.80 | % | ||||
1998: | |||||||||
Fourth quarter | $108,800 | $1,985 | 103.6 | 1.82 | % | ||||
Third quarter | 18,133 | 826 | 106.0 | 4.56 | |||||
Second quarter | 6,742 | 173 | 106.0 | 2.57 | |||||
First quarter | | | | | |||||
1998 total | $133,675 | $2,984 | 104.0 | 2.23 | % | ||||
Table 21
Costs of Loan ProductionNovaStar Mortgage,
Inc.
Nine Months Ended September 30, 1999 and Year
Ended December 31, 1998
(dollars in thousands)
1999
|
1998
|
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Third
Quarter |
Second
Quarter |
First
Quarter |
Fourth
Quarter |
Third
Quarter |
Second
Quarter |
First
Quarter |
|||||||||||||||
Gross costs of loan production (A) | $ 4,972 | $ 4,487 | $ 5,062 | $ 7,109 | $ 5,606 | $ 4,783 | $ 3,853 | ||||||||||||||
Fees collected | (556 | ) | (374 | ) | (284 | ) | (386 | ) | (631 | ) | (946 | ) | (774 | ) | |||||||
Net costs of loan production | $ 4,416 | $ 4,113 | $ 4,778 | $ 6,723 | $ 4,975 | $ 3,837 | $ 3,079 | ||||||||||||||
Wholesale loan
origination
principal |
118,379 | 111,952 | 82,495 | 133,739 | 240,498 | 294,303 | 207,974 | ||||||||||||||
Premium paid to broker | 921 | 948 | 441 | 1,043 | 3,439 | 3,679 | 2,935 | ||||||||||||||
Total acquisition cost (B) | $123,716 | $117,013 | $87,714 | $141,505 | $248,912 | $301,819 | $213,988 | ||||||||||||||
Costs as a percent of principal: | |||||||||||||||||||||
Gross loan production | 4.2 | % | 4.0 | % | 6.1 | % | 5.3 | % | 2.3 | % | 1.6 | % | 1.9 | % | |||||||
Fees collected (C) | (0.5 | )% | (0.3 | )% | (0.3 | )% | (0.3 | )% | (0.2 | )% | (0.3 | )% | (0.4 | )% | |||||||
Net loan production | 3.7 | % | 3.7 | % | 5.8 | % | 5.0 | % | 2.1 | % | 1.3 | % | 1.5 | % | |||||||
Premium paid to broker | 0.8 | % | 0.8 | % | 0.5 | % | 0.8 | % | 1.4 | % | 1.3 | % | 1.4 | % | |||||||
Total acquisition cost | 4.5 | % | 4.5 | % | 6.3 | % | 5.8 | % | 3.5 | % | 2.6 | % | 2.9 | % | |||||||
(A)
|
Loan
production general and administrative expenses as reported for
GAAP, plus deferred loan costs.
|
(B)
|
Principal, premium and general and administrative expenses
associated with loan production.
|
(C)
|
During
the second quarter of 1999, NovaStar Mortgage gave brokers the
option on all original full package submissions to 1) have the
underwriting fee NovaStar Mortgage charged waived or 2) pay the
underwriting fee and receive an extra 50 basis points in premium
from NovaStar Mortgage. Prior to this point in time, the
underwriting fee charged by NovaStar Mortgage was waived on all
original full package submissions.
|
Table 22 is a summary of loans originated by NovaStar
Mortgage by state for 1999 and 1998 by quarter. As of September 30,
1999, NovaStar Mortgage had 41 account executives covering 44 states.
Table 22
Mortgage Loan Originations by StateNovaStar
Mortgage, Inc.
1999 and 1998
Percent of
Total Originations during Quarter
(based on original principal balance) |
|||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
1999
|
1998
|
||||||||||||||||||||
Collateral
Location |
Third
|
Second
|
First
|
Fourth
|
Third
|
Second
|
First
|
||||||||||||||
Florida | 15 | % | 12 | % | 15 | % | 24 | % | 17 | % | 16 | % | 12 | % | |||||||
Michigan | 10 | 10 | 12 | 6 | 5 | 5 | 5 | ||||||||||||||
Ohio | 12 | 10 | 8 | 9 | 4 | 5 | 2 | ||||||||||||||
California | 10 | 8 | 6 | 2 | 6 | 9 | 15 | ||||||||||||||
Arizona | 5 | 7 | 4 | 2 | 3 | 3 | 3 | ||||||||||||||
Tennessee | 4 | 6 | 9 | 6 | 4 | 4 | 4 | ||||||||||||||
Washington | 4 | 5 | 3 | 3 | 5 | 6 | 7 | ||||||||||||||
Pennsylvania | 4 | 4 | 4 | 5 | 4 | 3 | 2 | ||||||||||||||
North Carolina | 1 | 1 | 2 | 4 | 5 | 3 | 2 | ||||||||||||||
Texas | 2 | 1 | 2 | 3 | 5 | 3 | 3 | ||||||||||||||
All other states | 33 | 36 | 35 | 36 | 42 | 43 | 45 |
NovaStar Mortgages loan originations are funded through
warehouse and repurchase facilities at First Union and are discussed
further in Financial Condition of NovaStar Financial as of
September 30, 1999 and December 31, 1998 and Results of
Operations of NovaStar Financial, Inc.Nine Months Ended
September 30, 1999 Compared to the Nine Months Ended September 30,
1998.
Mortgage Loan Sales. In a
securitization executed by NovaStar Mortgage during the first
quarter of 1999, $165 million in loans were sold to a Special
Purpose Entity (SPE), of which $26 million settled in April 1999.
Proceeds of bonds issued by the SPE, $160 million, were used to pay
for the mortgage loans acquired from NovaStar Mortgage. The loans
were sold without recourse by NovaStar Mortgage. NovaStar Mortgage
retained a residual certificate issued by the SPE. In September
1999, NovaStar Financial purchased the economic residual interests.
NovaStar Mortgage also retained loan servicing rights for the loans
sold to the SPE. The value of the retained interests in the mortgage
servicing rights has been recorded as an asset and the loans sold
have been removed from the balance sheet of NovaStar Mortgage.
NovaStar Mortgage allocated its basis in the mortgage loans
between the portion of the mortgage loans sold and the retained
assets based on the relative fair values of those portions at the
time of sale. The values of these assets were determined by
discounting estimated future cash flows using the cash out method.
Following are the significant values and assumptions used in
determining the values of the assets sold and values of the
resulting retained assets.
Estimated average value of mortgage loans sold | 103.0 | % | |
Assumptions used in determining future cash flow: | |||
Estimated prepayment speeds | 30 to 35 CPR | ||
Estimated rate of default | 70 CDR | ||
Discount rate | 16.5 | % | |
Value of residual certificate | $ 9,700,000 | ||
Value of mortgage servicing rights | $ 646,000 | ||
Aggregate gain | $ 1,605,000 |
Of the aggregate gain recognized in the securitization,
$355,000 was recorded upon the April closing.
NovaStar Mortgage also sold $278 million of its whole loan
portfolio to unrelated third parties for cash at a net gain of $7.4
million at an average price of 104 during the nine months ended
September 30, 1999. Table 20 of Financial Condition of
NovaStar Mortgage, Inc. as of September 30, 1999 and December 31,
1998 provides a quarterly analysis of NovaStar Mortgages
mortgage loan sales to third parties.
Mortgage loan servicing.
Loan servicing is a critical part of NovaStar Mortgages
business. The majority of the loans serviced by NovaStar Mortgage
are owned by NovaStar Financial. In the opinion of management,
maintaining contact with borrowers is vital in managing credit risk
and in borrower retention. Subprime borrowers are prone to late
payments and are more likely to default on their obligations than
conventional borrowers. NovaStar Mortgage strives to identify issues
and trends with borrowers early and take quick action to address
such matters.
Table 23 is a summary of delinquent loans in NovaStar Mortgage
s servicing portfolio as of September 30, 1999 and 1998 by
quarter. Table 24 provides summaries of delinquencies, defaults, and
loss statistics as of September 30, 1999 and 1998 by quarter. The
information presented in both tables include mortgage loans owned by
NovaStar Financial and its affiliates. Other information regarding
the credit quality of NovaStar Financials mortgage loans is
provided in Table 1.
Table 23
Loan Delinquencies (90 days and greater) (A)
1999 and 1998
1999
|
1998
|
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September
30 |
June 30
|
March 31
|
December 31
|
September
30 |
June 30
|
March 31
|
|||||||||||||||
Mortgage loans
collateralizing NovaStar
Home Equity series (CMO): |
|||||||||||||||||||||
1997-1
(Issued October 1, 1997) |
6.32 | % | 5.13 | % | 4.37 | % | 5.45 | % | 5.97 | % | 5.86 | % | 4.39 | % | |||||||
1997-2
(Issued December 11, 1997) |
4.92 | 4.03 | 5.38 | 5.62 | 4.97 | 4.72 | 2.23 | ||||||||||||||
1998-1
(Issued April 30, 1998) |
5.32 | 4.13 | 4.64 | 4.44 | 2.06 | | | ||||||||||||||
1998-2
(Issued August 18, 1998) |
4.06 | 3.94 | 3.72 | 2.35 | 0.40 | | | ||||||||||||||
1999-1
(Issued January 29, 1999) (B) |
3.41 | 3.39 | 2.35 | | | | | ||||||||||||||
All loans in servicing portfolio | 5.80 | 5.15 | 5.00 | 3.35 | 2.45 | 2.53 | 2.28 |
(A)
|
Includes
loans in foreclosure or bankruptcy.
|
(B)
|
This
securitization was treated as a sale under SFAS 125 and
accordingly the mortgage loans and related liability are not
included on NovaStars balance sheet.
|
Table 24
Delinquencies, Defaults and Losses
September 30, 1999 and December 31, 1998
(dollars in thousands)
NovaStar Home
Equity Series (A) |
|||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September 30,
1999 |
1997-1
|
1997-2
|
1998-1
|
1998-2
|
1999-1
|
Other (C)
|
All
Loans |
||||||||||||||
Loan servicing portfolio (B) | $ 96,399 | $120,542 | $214,518 | $252,359 | $149,942 | $ 135,583 | $969,343 | ||||||||||||||
Allowance for Credit Losses: | |||||||||||||||||||||
Balance, January 1, 1999 | $ 816 | $ 1,049 | $ 1,163 | $ 346 | $ | $ 353 | $ 3,727 | ||||||||||||||
Provision for credit losses | 2,250 | 2,649 | 3,099 | 2,444 | | 1,020 | 11,462 | ||||||||||||||
Amounts charged off, net of
recoveries |
(1,705 | ) | (2,438 | ) | (3,264 | ) | (2,039 | ) | | (243 | ) | (9,689 | ) | ||||||||
Balance, September 30, 1999 | $ 1,361 | $ 1,260 | $ 998 | $ 751 | $ | $ 1,130 | $ 5,500 | ||||||||||||||
Defaults as a percent of loan servicing | |||||||||||||||||||||
Delinquent loans (D) | 7.43 | % | 6.14 | % | 4.48 | % | 5.66 | % | 4.92 | % | 0.15 | % | 4.75 | % | |||||||
Loans in foreclosure | 5.56 | 4.33 | 4.66 | 3.50 | 3.23 | 1.86 | 3.79 | ||||||||||||||
Real estate owned | 3.91 | 3.83 | 3.09 | 1.84 | 0.80 | 0.65 | 2.24 | ||||||||||||||
NovaStar Home
Equity Series (A) |
|||||||||||||||||||||
December 31,
1998 |
1997-1
|
1997-2
|
1998-1
|
1998-2
|
Other (C)
|
All Loans
|
|||||||||||||||
Loan servicing portfolio (B) | $168,255 | $167,685 | $273,583 | $301,857 | $268,587 | $1,179,967 | |||||||||||||||
Allowance for Credit Losses: | |||||||||||||||||||||
Balance, January 1, 1998 | $ 1,063 | $ 967 | $ | $ | $ 283 | $ 2,313 | |||||||||||||||
Provision for credit losses | 1,895 | 2,257 | 1,878 | 222 | 1,388 | 7,640 | |||||||||||||||
Amounts charged off, net of
recoveries |
(2,142 | ) | (2,175 | ) | (715 | ) | 124 | (1,318 | ) | (6,226 | ) | ||||||||||
Balance, December 31, 1998 | $ 816 | $ 1,049 | $ 1,163 | $ 346 | $ 353 | $ 3,727 | |||||||||||||||
Defaults as a percent of loan servicing | |||||||||||||||||||||
Delinquent loans (D) | 6.45 | % | 5.95 | % | 4.89 | % | 4.06 | % | 2.01 | % | 4.40 | % | |||||||||
Loans in foreclosure | 2.63 | 2.96 | 3.60 | 2.06 | 0.40 | 2.25 | |||||||||||||||
Real estate owned | 3.54 | 2.76 | 1.01 | 0.09 | 0.23 | 1.21 | |||||||||||||||
1999
|
1998
|
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September
30 |
June 30
|
March 31
|
December 31
|
September 30
|
June 30
|
March 31
|
|||||||||||||||
Total defaults: | |||||||||||||||||||||
Delinquent
loans |
4.75 | % | 5.21 | % | 4.12 | % | 4.40 | % | 2.95 | % | 1.95 | % | 1.92 | % | |||||||
Loans in
foreclosure |
3.79 | 3.36 | 3.39 | 2.25 | 2.02 | 2.28 | 2.29 | ||||||||||||||
Real estate
owned |
2.24 | 2.20 | 1.66 | 1.21 | 0.81 | 0.52 | 0.24 | ||||||||||||||
(A)
|
Loans
owned by NovaStar Financial
|
(B)
|
Includes
assets acquired through foreclosure
|
(C)
|
Includes
loans owned by NovaStar Financial, NovaStar Mortgage and NovaStar
Capital
|
(D)
|
Includes
loans delinquent 30 days or greater
|
The following table presents a summary of the mortgage loan
activity of NovaStar Mortgage for 1999 and 1998.
Table 25
Mortgage Loan ActivityNovaStar Mortgage, Inc.
(dollars in thousands)
1999
|
1998
|
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Principal
|
Premium
|
Principal
|
Premium
|
|||||||||
Balance, January 1 | $ 206,495 | $ 3,114 | $ | $ | ||||||||
Originations | 82,495 | 997 | 207,976 | 3,758 | ||||||||
Sales to NovaStar Financial, Inc. | | | (207,976 | ) | (3,758 | ) | ||||||
Sales to third parties | (71,829 | ) | (649 | ) | | | ||||||
Sales in securitization transactions | (132,451 | ) | (2,109 | ) | | | ||||||
Principal repayments and amortization | (1,963 | ) | (45 | ) | | | ||||||
Balance, March 31 | $ 82,747 | $ 1,308 | $ | $ | ||||||||
Originations | 111,952 | 1,641 | 294,303 | 5,207 | ||||||||
Sales to NovaStar Financial, Inc. | | | (290,350 | ) | (5,148 | ) | ||||||
Sales to third parties | (64,225 | ) | (1,368 | ) | (3,953 | ) | (59 | ) | ||||
Sales in securitization transactions | (25,436 | ) | (259 | ) | | | ||||||
Principal repayments and amortization | (1,703 | ) | (46 | ) | | | ||||||
Balance, June 30 | $ 103,335 | $ 1,276 | $ | $ | ||||||||
Originations | 118,379 | 1,865 | 240,498 | 4,035 | ||||||||
Sales to NovaStar Financial, Inc. | | | | | ||||||||
Sales to third parties | (127,080 | ) | (1,992 | ) | (12,836 | ) | (517 | ) | ||||
Principal repayments and amortization | (2,828 | ) | (37 | ) | (1,567 | ) | (7 | ) | ||||
Balance, September 30 | $ 91,806 | $ 1,112 | $ 226,095 | $ 3,511 | ||||||||
Originations | 133,739 | 1,821 | ||||||||||
Sales to NovaStar Financial, Inc. | | | ||||||||||
Sales to third parties | (116,886 | ) | (2,156 | ) | ||||||||
Principal repayments and amortization | (36,453 | ) | (62 | ) | ||||||||
Balance, December 31 | $ 206,495 | $ 3,114 | ||||||||||
Results of Operations of NovaStar Mortgage, Inc.
Nine Months Ended September 30, 1999 Compared to the Nine
Months Ended September 30, 1998
The following table presents a summarized income statement of
NovaStar Mortgage, Inc. for the nine months ended September 30, 1999
and 1998:
Table 26
NovaStar Mortgage, Inc.Statements of
Operations
Nine Months Ended September 30 (dollars in
thousands)
1999
|
1998
|
||||
---|---|---|---|---|---|
Net interest income | $4,096 | $ 1,691 | |||
Services provided to NovaStar Financial, Inc. | 3,343 | 4,606 | |||
Fees from third parties | 676 | 2,302 | |||
Gains on sale of mortgage assets | 9,042 | 1,209 | |||
Expenses: | |||||
Production | 6,745 | 6,118 | |||
Servicing | 3,508 | 2,145 | |||
Other | 4,595 | 3,863 | |||
Net income (loss) | $2,309 | $(2,318 | ) | ||
The following summarizes changes in net earnings of NovaStar
Mortgage for the nine months ended September 30, 1999 compared with
the same period of 1998:
|
Beginning
July 1, 1998, NovaStar Mortgage retained its mortgage loan
production to sell to third parties or securitize versus selling
them directly to NovaStar Financial. Prior to this point in time,
NovaStar Financial acquired 100% of NovaStar Mortgages
wholesale loan production. Accordingly, NovaStar Mortgage
recognized $4.1 million in net interest income on these loans for
the nine months ended September 30, 1999. The net interest income
NovaStar Mortgage recognized in 1998 also includes net interest
earned on agency securities. NovaStar Mortgage sold all of its
agency securities during the latter part of 1998.
|
|
The
administrative fee agreement between NovaStar Financial and
NovaStar Mortgage was cancelled on April 1, 1999. These fees are
included in services provided to NovaStar Financial, Inc. The
other components of this financial statement line-item are
discussed further in the Results of Operations of NovaStar
Financial, Inc.Nine Months Ended September 30, 1999 compared
to the Nine Months Ended September 30, 1998.
|
|
During
the nine months ended September 30, 1999, NovaStar Mortgage
recognized net gains of $9.0 million on mortgage loan sales. $1.6
million of the gains recognized was a result of the closing of
NovaStar Mortgages first securitization transaction. The
remainder of the gain is due to various mortgage loan sales to
independent third parties. NovaStar Mortgage recognized $211,000
and $998,000 on sales of mortgage securities and mortgage loans,
respectively, during the same period of 1998.
|
|
NovaStar
Mortgages wholesale origination operation was not operating
at full capacity during the nine months ended September 30, 1999
compared with the nine months ended September 30, 1998. NovaStar
Mortgages costs of loan production as a percent of principal
averaged 4.3% for the first nine months of 1999 versus 1.6% during
the first nine months of 1998 as detailed in Table 19.
Accordingly, in 1999 NovaStar Mortgage capitalized a lower
percentage of its origination costswhich under GAAP are
amortized as an adjustment of the yield over the life of the loan
versus expensed in the period incurred. Management estimates that
if the wholesale origination channel was operating at full
capacity, NovaStar Mortgages costs of loan production would
be 2.252.50%.-
|
|
NovaStar
Mortgages servicing staff increased from September 30, 1998
to September 30, 1999. This increase is due to growth in the loan
servicing portfolio, which averaged $900 million for the nine
months ended September 30, 1998 compared with $1.1 billion for the
nine months ended September 30, 1999.
|
|
NovaStar
Mortgage remitted $231,000 in premium payments to Radian during
the nine months ended September 30, 1999, which are included as a
component of other expenses. The agreement with CMAC was executed
during the third quarter of 1998.
|
|
Other
departments of NovaStar Mortgage, including systems, quality
control, and administration added staff from September 30, 1998 to
September 30, 1999 to compensate for general company growth.
|
|
Other
expense for the nine months ended September 30, 1999 also includes
the development and design costs incurred for NovaStar Mortgage
s portion of the automated underwriting and origination
system, Internet Underwriter, which was introduced during the
third quarter of 1999.
|
Results of Operations of NovaStar Mortgage, Inc.
Three Months Ended September 30, 1999 Compared to the Three
Months Ended September 30, 1998.
The following table presents a summarized income statement of
NovaStar Mortgage, Inc. for the three months ended September 30,
1999 and 1998:
Table 27
NovaStar Mortgage, Inc.Statements of
Operations
Three Months Ended September 30 (dollars in
thousands)
1999
|
1998
|
|||||
---|---|---|---|---|---|---|
Net interest income | $1,493 | $ 1,314 | ||||
Services provided to NovaStar Financial, Inc. | 768 | (65 | ) | |||
Fees from third parties | 131 | 685 | ||||
Gains on sale of mortgage assets | 2,998 | 798 | ||||
Expenses: | ||||||
Production | 2,077 | 2,556 | ||||
Servicing | 1,171 | 839 | ||||
Other | 1,601 | 1,647 | ||||
Income before taxes | 541 | (2,310 | ) | |||
Income tax expense | (234 | ) | | |||
Net income | $ 775 | $(2,310 | ) | |||
The following summarizes the explanation for the increase in
net earnings of NovaStar Mortgage for the three months ended
September 30, 1999 compared with the same period of 1998:
|
Net
interest income for the three months ended September 30, 1999 was
generated from NovaStar Mortgages mortgage loan portfolio.
For the same period of 1998, net interest income was also
generated from lower-yielding agency security investments. The
change in portfolio composition between the two periods is
discussed under Results of Operations of NovaStar Mortgage,
Inc.Nine Months Ended September 30, 1999 Compared to the
Nine Months Ended September 30, 1998.
|
|
The
administrative fee agreement between NovaStar Financial and
NovaStar Mortgage was cancelled on April 1, 1999. These fees are
included in services provided to NovaStar Financial, Inc. The
other components of this financial statement line-item are
discussed further in the Results of Operations of NovaStar
Financial, Inc.Nine Months Ended September 30, 1999 compared
to the Nine Months Ended September 30, 1998.
|
|
During
the three months ended September 30, 1999, NovaStar Mortgage
recognized net gains of $3.0 million on mortgage loan sales.
NovaStar Mortgage recognized net gains of $823,000 on mortgage
loan sales during the three months ended June 30, 1998. Also
included in this line-item for the three months ended September
30, 1998 are agency securities losses of $25,000.
|
NovaStar Capital, Inc.
NovaStar Capital, Inc. was formed to focus on acquiring
nonconforming residential mortgage loans from banks, thrifts and
credit unions. Management is building a sales force of account
executives to develop a nationwide network of financial institutions
to complement the wholesale origination operation of NovaStar
Mortgage. Management believes this is another effective means of
acquiring mortgage loans at a low-cost versus secondary market
purchases. The short-term intent is to treat these loans similar to
NovaStar Mortgages wholesale loan originationsto hold in
portfolio to be sold either to independent third parties or in
securitizations. NovaStar Capital originated 116 mortgage loans with
a principal value of $10.4 million during the nine months ended
September 30, 1999. At September 30, 1999, NovaStar Capital had
total assets of $10.6 million, which include primarily mortgage
loans.
During the nine months ended September 30, 1999 and the three
months ended September 30, 1999, NovaStar Capital incurred net
losses of $760,000 and $397,000, respectively. NovaStar Capital
s operations for these periods primarily consist of compensation
costs. NovaStar Capital also sold $4.7 million of mortgage loans
recognizing net gains of $146,000 for the nine months ended
September 30, 1999. During the third quarter of 1999, NovaStar
Capital sold $3.8 million of mortgage loans for a net gain of
$103,000.
Value of Mortgages Added through Wholesale
Operations
By establishing a wholesale lending operation to originate
subprime residential mortgage loans, NovaStar developed a process to
add mortgage assets to its balance sheet at amounts management
believes are below what it would generally cost, in most market
environments, to acquire the same assets in bulk through open market
purchases. While this lower cost generation has not been possible
during most of 1999, for the reasons described below, management
believes that improvements in the efficiency of the wholesale
lending operation will permit value creation for shareholders in
future periods.
Management estimates the weighted-average value of its
mortgage loan portfolio as of September 30, 1999 to be between 101
and 104 in terms of price to par, based upon certain return
assumptions and secondary market prices. The values presented in
Tables 28 and 29 are managements estimates based on market
conditions as of September 30, 1999. Management believes the
inherent returns in the mortgage loans it is originating should
warrant a value of 105. Any value assigned to September 30, 1999
loans should take into consideration at what value the loans could
be sold in the open market. During the first nine months of 1999,
NovaStar Financial sold a number of whole loan packages at a
weighted average price of 104.11. Tables 28 and 29 provide management
s estimates of the value of the mortgage loans in its
portfolio and 1999 third quarter production and the assumptions used
for estimating fair value. Because any estimated value can vary
dramatically based upon the assumptions used, a range of assumptions
is used to determine the estimated value.
During 1999, NovaStar Mortgage originated mortgage loans at an
all-in cost of 105.0% of principal, including direct costs of
acquisition, such as broker premiums, and general overhead expenses.
Table 21 displays costs of production for each quarter. The cost of
production during the first nine months of 1999 and 1998 third and
fourth quarters is higher than previous quarters as a result of
lower production levels. NovaStar Mortgage operated at less than
full capacity during the second half of 1998, partly by design. If
NovaStar Mortgage had operated at or near full capacity, the all-in
cost would be more in the range of 3.0 to 3.5. Direct costs of
acquisition are capitalized as premium and amortized as an
adjustment of yield over the life of the loan.
As of September 30, 1999, the weighted average premium on
mortgage loans outstanding is 2.1% of principal. Depending on which
assumptions are used, the estimated fair value of loans generally
ranges from
102104% of principal, implying inherent gains of up to 2%. These
amounts would be generally consistent with current whole loan prices
being up to 2%. These amounts would be generally consistent with
current whole loan prices being realized in secondary market sales
transactions. Management has performed extensive analysis regarding
the value of its securitized loan portfolio, using both whole loan
prices and discounted cash flow scenarios. Depending on which
scenario is used, management believes that NovaStar Financials
mark-to-market equity ranges from $106 million to $120 million. This
equates to an estimated fair value per diluted share that ranges
from $8.80 to $10.00.
Table 28
Estimated Market Price on Entire Loan Portfolio
As of September 30, 1999
Estimated
Market Price |
||||||
---|---|---|---|---|---|---|
Two- and Three-year Fixed Loan Products |
||||||
Bond Equivalent Yield | 9.71% | 9.96% | 10.21% | |||
Spread to Index | 3.75% | 4.00% | 4.25% | |||
Assumed Prepayment
Speed (CPR) |
||||||
35 | 103.9% | 103.6% | 103.3% | |||
40 | 103.5% | 103.2% | 103.0% | |||
45 | 103.0% | 102.8% | 102.6% |
Estimated
Market Price |
||||||
---|---|---|---|---|---|---|
30/15-year
Fixed and
Balloon Loan Products (Three-year Treasury) |
||||||
Bond Equivalent Yield | 9.42% | 9.67% | 9.92% | |||
Spread to Index | 3.75% | 4.00% | 4.25% | |||
Assumed Prepayment
Speed (CPR) |
||||||
25 | 102.7% | 102.6% | 102.6% | |||
30 | 102.1% | 102.1% | 102.1% | |||
35 | 101.5% | 101.6% | 101.7% |
One-year CMT
Loan
Products |
||||||
---|---|---|---|---|---|---|
Bond Equivalent Yield | 9.68% | 9.93% | 10.18% | |||
Spread to Index | 4.50% | 4.75% | 5.00% | |||
Assumed Prepayment
Speed (CPR) |
||||||
50 | 101.9% | 101.9% | 101.9% | |||
55 | 101.6% | 101.6% | 101.6% | |||
60 | 101.8% | 101.3% | 101.4% |
Six-month LIBOR
Loan
Products |
|||||||
---|---|---|---|---|---|---|---|
Bond Equivalent Yield | 9.71% | 9.96% | 10.21% | ||||
Spread to Index | 3.75% | 4.00% | 4.25 | % | |||
Assumed Prepayment
Speed (CPR) |
|||||||
50 | 104.0% | 103.8% | 103.6% | ||||
55 | 103.7% | 103.5% | 103.3% | ||||
60 | 103.3% | 103.2% | 103.1% |
Table 29
Estimated Market Price of Loans Originated in
Third Quarter of 1999
Estimated
Market Price |
||||||
---|---|---|---|---|---|---|
Two- and
Three-year
Fixed Loan Products |
||||||
Bond Equivalent Yield | 9.21% | 9.46% | 9.71% | |||
Spread to Index | 3.25% | 3.50% | 3.75% | |||
Assumed Prepayment
Speed (CPR) |
||||||
25 | 105.7% | 104.9% | 104.4% | |||
30 | 105.0% | 104.4% | 103.9% | |||
35 | 104.4% | 103.8% | 103.4% |
Estimated
Market Price |
||||||
---|---|---|---|---|---|---|
30/15-year
Fixed and
Balloon Loan Products |
||||||
Bond Equivalent Yield | 8.92% | 9.17% | 9.42% | |||
Spread to Index | 3.25% | 3.50% | 3.75% | |||
Assumed Prepayment
Speed (CPR) |
||||||
15 | 104.9% | 104.5% | 104.2% | |||
20 | 104.1% | 103.8% | 103.6% | |||
25 | 103.2% | 103.1% | 103.0% |
Liquidity and Capital Resources
Liquidity means the need for, access to and uses of
cash. The primary needs for cash include the acquisition of mortgage
loans, principal repayment and interest on borrowings, operating
expenses and dividend payments. Substantial cash is required to
support the operating activities of the business, especially the
mortgage origination operation. Principal, interest and fees
received on mortgage assets and residual interests
on CMOs will serve to support cash needs. Drawing upon various
borrowing arrangements typically satisfies major cash requirements.
During the first nine months of 1999, NovaStar Financial also
improved its equity and liquidity positions significantly by:
|
Increasing borrowing capacity with First Union National Bank to
$395 million in February 1999.
|
|
Raising
additional capital through the issuance of 4 million shares of
Class B 7% cumulative convertible preferred stock in March 1999;
gross proceeds aggregating $30 million.
|
Historically, NovaStar Financial demonstrated the ability to
access public capital markets as a source of long-term cash
resources. The events in early October 1998 changed the liquidity
position of NovaStar Financial and many other subprime companies and
REITs. The number of options available to NovaStar Financial with
regard to financing and capital resources have been restricted.
The actions taken by management in the fourth quarter of 1998
to restore liquidity and mitigate additional margin call risk have
significantly reduced cash requirements. The mortgage loans owned by
NovaStar Financial have minimal liquidity risk as they are financed
with non-recourse CMOs. Management expects that interest income on
the loans will generate sufficient cash to meet financing and
operating costs.
NovaStar Mortgage requires substantial cash to fund loan
originations and operating costs. As of September 30, 1999, NovaStar
Mortgage owned $92.8 million of subprime mortgage loans. NovaStar
Mortgage provides financing for these loans through warehouse and
repurchase credit facilities at First Union. Loans financed with
warehouse and repurchase credit facilities are subject to changing
market valuation and margin calls. Management expects to continue
selling loans originated by NovaStar Mortgage or securitizing those
loans at a profit to meet the significant cash needs of the
wholesale loan operation. Management believes NovaStar Financial can
operate indefinitely in this manner, provided that the level of loan
originations are at or near the capacity of its production
infrastructure.
Table 30 is a summary of financing arrangements and available
borrowing capacity under those arrangements as of September 30, 1999:
Table 30
Liquidity Resources
September 30, 1999
(dollars in thousands)
(dollars in thousands)
Maximum
Borrowing Limit |
Value of
Collateral |
Borrowings
|
Availability
|
|||||||
---|---|---|---|---|---|---|---|---|---|---|
Resource | ||||||||||
Cash | $ 3,294 | |||||||||
First Union National Bank (A): | ||||||||||
Committed warehouse line of credit | $75,000 | $43,650 | $22,191 | 21,459 | ||||||
Committed secured whole
loan repurchase
agreement |
300,000 | 50,429 | 50,429 | | ||||||
Committed residual
financing available under
CMOs |
20,000 | (B | ) | | 20,000 | |||||
Total. | $72,620 | $44,753 | ||||||||
Total availability as a percent of: | ||||||||||
Total assets | 6 | % | ||||||||
Total stockholders equity | 40 | % | ||||||||
(A)
|
Value of
collateral and borrowings include amounts for both NovaStar
Financial and NovaStar Mortgage as they are co-borrowers under the
arrangements with First Union National Bank.
|
(B)
|
Management estimates the value of the residuals range from $60 to
$75 million and does not include the value of mortgage servicing
rights.
|
Cash activity during the nine months ended September 30,
1999 and 1998 are presented in the consolidated statement of cash
flows.
Capital allocation guidelines.
Managements goal is to balance between the
under-utilization of leverage, which reduces returns to
stockholders, and the over-utilization of leverage, which could
reduce the ability of NovaStar to meet its obligations during
adverse market conditions. Capital allocation guidelines have been
approved by the Board of Directors. The guidelines are intended to
keep NovaStar properly leveraged by:
|
Matching
the amount of leverage allowed to the riskiness on return and
liquidity of an asset; and
|
|
Monitoring the credit and prepayment performance of each
investment to adjust the required capital.
|
This analysis takes into account hedging instruments and other
risk programs discussed below. Balance sheet leverage is controlled
by monitoring capital allocation. Following presents a summary of
the capital allocation guidelines for the following levels of
capital for various types of assets it owns.
Capital Allocation Guidelines
September 30, 1999
Asset Category
|
(A)
Minimum Lender Haircut |
(B)
Estimated Price Duration |
(C)
Duration Spread Cushion |
(D)
Liquidity Spread Cushion |
(E)
(c + d) Total Spread Cushion |
(F)
(b x e) Equity Cushion (% of MV) |
(F)
(a + f) CAG Equity Required |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Agency-issued: | ||||||||||||||||||
Conventional ARMs | 3.00 | % | 3.50 | % | 50 | | 50 | 1.75 | % | 4.75 | % | |||||||
GNMA ARMs | 3.00 | 4.50 | 50 | | 50 | 2.25 | 5.25 | |||||||||||
GNMA Fixed Rates | 3.00 | 5.00 | 50 | | 50 | 2.50 | 5.50 | |||||||||||
Mortgage loans: | ||||||||||||||||||
Collateral for warehouse
financing |
2.00 | 3.00 | 100 | 50 | 150 | 4.50 | 7.50 | |||||||||||
Collateral for
Securitizations (H) |
5.00 | | | | | | 5.00 | |||||||||||
Delinquent | 100.00 | | | | | | 100.00 | |||||||||||
Hedging | | | | | | | 5.45 | |||||||||||
Other | 100.00 | | | | | | 100.00 |
(A)
|
Indicates
the minimum amount of equity a typical lender would require with
an asset from the applicable asset category. There is some
variation in haircut levels among lenders. From the lender
perspective, this is a cushion to protect capital in
case the borrower is unable to meet a margin call. The size of the
haircut depends on the liquidity and price volatility of the
asset. Agency securities are very liquid, with price volatility in
line with the fixed income markets, which means a lender requires
a smaller haircut. On the other extreme, B rated
securities and securities not registered with the Securities and
Exchange Commission are substantially less liquid, and have more
price volatility than agency securities, which results in a lender
requiring a larger haircut. Particular securities that are
performing below expectations would also typically require a
larger haircut.
|
(B)
|
Duration
is the price-weighted average term to maturity of financial
instruments cash flows.
|
(C)
|
Estimated
cushion need to protect against investors requiring a higher
return compared to treasury securities, assuming constant interest
rates.
|
(D)
|
Estimated
cushion required due to a potential imbalance of supply and demand
resulting in a wider bid/ask spread.
|
(E)
|
Sum of
duration (C) and liquidity (D) spread cushions.
|
(F)
|
Product
of estimated price duration (B) and total spread cushion. The
additional equity, as determined by management, to reasonably
protect the NovaStar Financial from lender margin calls. The size
of each cushion is based on managements experience with the
price volatility and liquidity in the various asset categories.
Individual assets that have exposure to substantial credit risk
will be measured individually and the leverage adjusted as actual
delinquencies, defaults and losses differ with managements
expectations.
|
(H)
|
Capital
allocation guidelines for economic residuals evaluated similarly
as whole loans.
|
Implementation of the capital allocation guidelines
mark to market. Each month,
assets are marked to market. Market values of the mortgage loan
portfolio are calculated internally using assumptions for losses,
prepayments and discount rates. Mortgage securities are valued using
independent market quotes. The face amount of all financing used for
securities and mortgage loans is subtracted from the current market
value of the assets and hedges. This is the current market value of
equity. This number is compared to the required capital as
determined by the capital allocation guidelines. If the actual
equity falls below the capital required by the capital allocation
guidelines, NovaStar Financial must prepare a plan to bring the
actual capital above the level required by the capital allocation
guidelines.
Each quarter, management presents to the Board of Directors
the results of the capital allocation guidelines compared to actual
equity. Management may propose changing the capital required for a
class of investments or for an individual investment based on its
prepayment and credit performance relative to the market and the
ability of the management to predict or hedge the risk of the asset.
Table 31 is a summary of the capital allocation for NovaStar
Financial as they apply to mortgage assets and hedging instruments
during 1999 and 1998.
Table 31
Required Equity
1999
|
1998
|
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September
30 |
June 30
|
March 31
|
December 31
|
September
30 |
June 30
|
March 31
|
|||||||||||||||
Category | |||||||||||||||||||||
Mortgage loans: | |||||||||||||||||||||
Current
unsecuritized loans |
$ 5,278 | $ 4,397 | $ 3,823 | $12,648 | $ 14,567 | $ 21,566 | $ 23,628 | ||||||||||||||
Delinquent
unsecuritized loans |
2,329 | 868 | 1,197 | 1,685 | 452 | 601 | 1,200 | ||||||||||||||
Securitized
loans |
41,587 | 47,000 | 49,894 | 64,548 | 55,822 | 37,766 | 23,478 | ||||||||||||||
Mortgage
securities |
| | | | 19,514 | 24,904 | 27,426 | ||||||||||||||
Other assets | 13,878 | 13,501 | 13,861 | 12,536 | 20,682 | 13,782 | 10,733 | ||||||||||||||
Hedging
instruments |
(24) | (35 | ) | (100 | ) | (179 | ) | (688 | ) | (232 | ) | (203 | ) | ||||||||
Required equity | 63,048 | 65,731 | 68,675 | 91,238 | 110,349 | 98,387 | 86,262 | ||||||||||||||
Stockholders
equity |
112,671 | 121,237 | 119,712 | 87,204 | 109,848 | 114,875 | 115,798 | ||||||||||||||
Market value in
excess of the carrying value of assets and hedges |
(9,949 | ) | 8,536 | 1,482 | 5,961 | 2,331 | 31,999 | 20,685 | |||||||||||||
Excess equity | $39,674 | $ 64,042 | $ 52,519 | $ 1,927 | $ 1,830 | $ 48,487 | $ 50,221 | ||||||||||||||
Inflation
Virtually all assets and liabilities of NovaStar Financial are
financial in nature. As a result, interest rates and other factors
drive company performance far more than does inflation. Changes in
interest rates do not necessarily correlate with inflation rates or
changes in inflation rates. The financial statements of NovaStar
Financial are prepared in accordance with generally accepted
accounting principles and the dividends are based on taxable income.
In each case, financial activities and balance sheet are measured
with reference to historical cost or fair market value without
considering inflation.
Impact of Recently Issued Accounting Pronouncements
Note 1 to the consolidated financial statements of the annual
report to shareholders and annual report on Form 10-K for the year
ended December 31, 1998 describes certain recently issued accounting
pronouncements. Management believes the implementation of these
pronouncements and others that have gone into effect since the date
of these reports, will not have a material impact on the
consolidated financial statements.
The Year 2000
NovaStar Financial, NovaStar Mortgage and NovaStar Capital,
collectively, NovaStar Financial and affiliates are highly dependent
on purchased and leased computer software to conduct business. In
addition, NovaStar Financial and affiliates are highly dependent on
computer software used by market counterparties and vendors,
including banks, in conducting business. Management recognizes that
some computer software may not have the ability to correctly
identify dates beyond December 31, 1999. Successful modification of
computer software, or the vendors successful modification of
their programs, to be year 2000 compliant is critical to the
viability of NovaStar Financial and affiliates.
NovaStar Financial and affiliates use three major, and a
number of smaller, internal automation solutions to conduct its
business operations. The three computer systems considered the most
significant to operations are as follows:
The internally
developed loan origination and database system
|
The externally
provided loan servicing system
|
The purchased
accounting system
|
In addition, NovaStar Financial and affiliates integrate with
a number of outside entities in normal business transactions.
Interfaces with other businesses and third party solution providers
are used to conduct some business processes. Other processes are
supported by systems created internally.
NovaStar Financial and affiliates are using the Federal
Financial Institutions Examination Councils (FFIEC) Year
2000 Project Management Awareness document to guide year 2000
readiness efforts. Each program/system interface used by NovaStar
Financial and affiliates are being reviewed and tested for year 2000
compliance. The FFIEC guide calls for a three-phase approach to
assess year 2000 compliance. Based on this three-phase approach
NovaStar Financials and affiliates projected timeline is
as follows:
[Chart of timeline]
In the assessment phase, management determined which
business processes/interfaces rely on dates and date arithmetic.
Most business processes/interfaces rely on dates and date
arithmetic. All internally developed business processes/interfaces
have been tested for compliance. Based on these tests, all software
and automation solutions created by NovaStar Financial and
affiliates are year 2000 compliant. NovaStar Financial and
affiliates have updated all internal operating systems and software
with year 2000 compliant versions. NovaStar Financial and affiliates
are still working with market counterparties and vendors to document
that they have assessed software for year 2000 compliance.
Solution updates to non-compliant Year 2000 software were made
in the correction phase. Corrections on NovaStar Financial and
affiliates developed software were made internally and were
insignificant. NovaStar Financial and affiliates are requiring all
market counterparties and vendors to document they have made all
corrections.-
NovaStar Financial and affiliates staff conducted mock
business as if it was in the year 2000 during the second
quarter of 1999the validation phase of NovaStar Financial
s and affiliates year 2000 readiness efforts. During this
phase, NovaStar Financial and affiliates tested all internally
developed software.-
NovaStar Financial and affiliates have contacted all
significant outside market counterparties and vendors to obtain
documentation regarding their process and status for assuring year
2000 compliance. Management has asked that each party adhere to the
same FFIEC guidelines and to provide documents of progress during
each phase. NovaStar Financial and affiliates have received written
confirmation from Alltel Residential Lending Solutions, vendor of
NovaStar Mortgages servicing system and Baan/CODA, vendor of
NovaStar Financials and affiliates accounting system
stating that the versions currently used are fully year 2000
compliant. The Baan/CODA accounting system was successfully tested
internally for Year 2000 compliance.
All internally developed software was designed to be year 2000
compliant. In addition, management has contacted its significant
financial counterparty, First Union National Bank, who has completed
their internal review of year 2000 compliance. NovaStar Financial
and affiliates have received written confirmation that First Union
National Bank is Year 2000 compliant.
Management believes the greatest risk in regard to year 2000
compliance is the software and systems used to service its subprime
mortgage loans. NovaStar Mortgage services the loans owned by
NovaStar Financial. NovaStar Mortgage uses systems developed by
Alltel for loan servicing. If these systems fail, NovaStar Mortgage
will not be able to continue on a manual basis. In this worst case
scenario, loans would not be serviced until the failed system could
be remedied. If the loans go unserviced for an extended
period of
timeseveral weeksthe result could have a material adverse impact to NovaStar Financial and NovaStar Mortgage.-
timeseveral weeksthe result could have a material adverse impact to NovaStar Financial and NovaStar Mortgage.-
NovaStar Financial and affiliates are also at significant risk
in the event the systems of financial institutions, on which
NovaStar Financial and NovaStar Mortgage are relying for financing
and cash management fail. In a worst case scenario, NovaStar
Financial and NovaStar Mortgage may not be able to meet financial
obligations during the period of failure - an unknown
timeframe. The result could have a material adverse impact on
NovaStar Financial and NovaStar Mortgage.
NovaStar Financial and affiliates are exposed to smaller risks
in the event other systems, including those developed internally,
fail to perform beyond December 31, 1999. However, management
believes functions, other than servicing, can be maintained on a
manual basis should systems fail. Although processing and
performance would be slow, risk of material adverse impact to
NovaStar Financial and affiliates for these systems failure is
expected to be minimal.-
Management expects, through the completion of its year 2000
plan, the likelihood of a material business disruption is not
significant. The major risks presented above involve year 2000
remediation efforts of third party vendors used by NovaStar
Financial and NovaStar Mortgage. Based on the information provided,
management believes these vendors will meet their obligation for
resolution of year 2000 issues.-
Management estimates it has incurred less than $75,000 in
costs to date in carrying out its year 2000 compliance plan and
estimates it will spend less than $100,000 in completing the plan.
However, the costs could increase dramatically if management
determines that any market counterparty will not be year 2000
compliant.
Interest Rate/Market Risk
Loan Price volatility.
Under its current mode of operation, NovaStar Financial depends
heavily on the market for wholesale subprime mortgage loans. To
conserve capital, NovaStar Mortgage and NovaStar Capital may sell
loans it originates. The financial results of NovaStar Financial
will depend, in part, on the ability to find purchasers for the
loans at prices that cover origination expenses. Exposure to loan
price volatility will be reduced as NovaStar Financial resumes
acquisition and retention of its subprime mortgage loans.
Interest rate risk.
Interest rate risk is the risk that the market value of assets will
increase or decrease at different rates than that of the
liabilities. Expressed another way, this is the risk that NovaStar
Financials net asset value will experience an adverse change
when interest rates change. When interest rates on the assets do not
adjust at the same rates as our liabilities or when the assets are
fixed rates and the liabilities are adjusting, future earnings
potential is affected. Management primarily uses financing sources
where the interest rate resets frequently. As of September 30, 1999,
borrowings under all financing arrangements adjust daily, monthly,
or quarterly. On the other hand, very few of the mortgage assets
owned by NovaStar Financial, as of September 30, 1999, adjust on a
monthly or daily basis. Most of the mortgage loans contain features
where their rates are fixed for some period of time and then adjust
frequently thereafter. For example, one of our loan products is the
2
/
28 loan. This loan is fixed for its first two
years and then adjusts every six months thereafter.
While short-term borrowing rates are low and long-term asset
rates are high, this portfolio structure produces good results.
However, if short-term interest rates rise rapidly, earning
potential could be significantly affected as the asset rate resets
would lag borrowing rate resets. The converse can be
true when sharp declines in short-term interest rates cause interest
costs to fall faster than asset rate resets, thereby increasing
earnings.-
In its assessment of the interest sensitivity and as an
indication of exposure to interest rate risk, management relies on
models of financial information in a variety of interest rate
scenarios. Using these models, the fair value and interest rate
sensitivity of each financial instrument, or groups of similar
instruments is estimated, and then aggregated to form a
comprehensive picture of the risk characteristics of the balance
sheet. The risks are analyzed on both an income and market value
basis.
Table 32 is a summary of the analysis as of September 30,
1999 and December 31, 1998.
Table 32
Interest Rate Sensitivity-Income
September 30, 1999 and December 31, 1998
As of September
30, 1999 |
Basis Point
Increase (Decrease)
in Interest Rate(A) |
||||||||
---|---|---|---|---|---|---|---|---|---|
(100)
|
Base(B)
|
100
|
|||||||
Income from: | |||||||||
Assets | $68,719 | $71,435 | $73,953 | ||||||
Liabilities | 45,618 | 52,079 | 58,386 | ||||||
Interest rate agreements | (1,433 | ) | (1,433 | ) | 221 | ||||
Net spread income | $21,668 | $17,923 | $15,788 | ||||||
Cumulative change in income from base (B) | $ 3,745 | | $(2,135 | ) | |||||
Percent change from base spread income (C) | 20.9 | % | | (11.9 | )% | ||||
Percent change of capital(D) | 3.3 | % | | (1.9 | )% | ||||
(A)
|
Income of
asset, liability or interest rate agreement in a parallel shift in
the yield curve, up and down 1%.
|
(B)
|
Total
change in estimated spread income, in dollars, from base.
Base is the estimated spread income
at September 30, 1999. |
(C)
|
Total
change in estimated spread income, as a percent, from base.
|
(D)
|
Total
change in estimated spread income as a percent of total
stockholders equity at September 30, 1999.
|
Basis Point
Increase (Decrease)
in Interest Rate(F) |
|||||||||
---|---|---|---|---|---|---|---|---|---|
As of December
31, 1998 |
(100)
|
Base(G)
|
100
|
||||||
Income from: | |||||||||
Assets | $80,507 | $82,310 | $83,966 | ||||||
Liabilities | 47,546 | 55,259 | 63,233 | ||||||
Interest rate agreements | (2,244 | ) | (2,244 | ) | 107 | ||||
Net spread income | $30,717 | $24,807 | $20,840 | ||||||
Cumulative change in income from base (G) | $ 5,910 | | $ 3,967 | ||||||
Percent change from base spread income (H) | 23.8 | % | | (16.0 | )% | ||||
Percent change of capital(I) | 6.77 | % | | (4.54 | )% | ||||
(F)
|
Income of
asset, liability or interest rate agreement in a parallel shift in
the yield curve, up and down 1%.
|
(G)
|
Total
change in estimated spread income, in dollars, from base.
Base is the estimated spread income at December
31, 1998.
|
(H)
|
Total
change in estimated spread income, as a percent, from base.
|
(I)
|
Total
change in estimated spread income as a percent of total
stockholders equity at December 31, 1998.
|
Table 33
Interest Rate SensitivityMarket Value
September 30, 1999 and December 31, 1998
Basis Point
Increase (Decrease)
in Interest Rate(A) |
||||||||
---|---|---|---|---|---|---|---|---|
As of September
30, 1999 |
(100)
|
Base(B)
|
100
|
|||||
Market values of: | ||||||||
Assets | $826,686 | $818,438 | $808,062 | |||||
Liabilities | 780,922 | 778,810 | 776,414 | |||||
Interest rate agreements | 378 | 1,725 | 5,232 | |||||
Net market value | $ 46,142 | $ 41,353 | $ 36,878 | |||||
Cumulative change in market value from base (B) | $ 4,789 | | $ (4,475 | ) | ||||
Percent change of
market value portfolio
equity (C) |
4.5 | % | $ | (4.2 | )% | |||
(A)
|
Market
value of assets, liabilities or interest rate agreements in a
parallel shift in the yield curve, up and down 1%.
|
(B)
|
Total
change in estimated market value, in dollars, from base.
Base is the estimated market value at September
30, 1999.
|
(C)
|
Total
change in estimated market value as a percent of market value
portfolio equity at September 30, 1999.
|
Basis Point
Increase (Decrease)
in Interest Rate(D) |
||||||||
---|---|---|---|---|---|---|---|---|
As of December
31, 1998 |
(100)
|
Base(E)
|
100
|
|||||
Market values of: | ||||||||
Assets | $933,171 | $919,955 | $905,059 | |||||
Liabilities | 883,706 | 882,992 | 882,279 | |||||
Interest rate agreements | 271 | 1,194 | 3,969 | |||||
Net market value | $ 49,736 | $ 38,157 | $ 26,749 | |||||
Cumulative change in market value from base (E) | $ 11,579 | | $(11,408 | ) | ||||
Percent change of market value portfolio equity (F) | 12.4 | % | | (12.2 | )% | |||
(D)
|
Market
value of assets, liabilities or interest rate agreements in a
parallel shift in the yield curve, up and down 1%.
|
(E)
|
Total
change in estimated market value, in dollars, from base.
Base is the estimated market value at December
31, 1998.
|
(F)
|
Total
change in estimated market value as a percent of market value
portfolio equity at December 31, 1998.
|
Interest rate sensitivity analysis.
The values under the heading Base are
managements estimates of spread income and market value for
assets, liabilities and interest rate agreements on September 30,
1999 and December 31, 1998. The values under the headings 100
and (100) are managements estimates of the
income and market value of those same assets, liabilities and
interest rate agreements assuming that interest rates were 100 basis
points, or 1 percent higher and lower. The cumulative change in
income or market value represents the change in income or market
value of assets from base, net of the change in income or market
value of liabilities and interest rate agreements from base.
The interest sensitivity analysis is prepared monthly. If the
analysis demonstrates that a 100 basis point shift, up or down in
interest rates would result in 25 percent or more cumulative
decrease in income from base, or a 10% cumulative decrease in market
value from base, policy requires management to adjust the portfolio
by adding or removing interest rate cap or swap agreements. The
Board of Directors reviews and approves NovaStar Financials
interest sensitivity and hedged position quarterly.
Assumptions used in interest rate sensitivity analysis.
Management uses estimates in
determining the income and market value of assets, liabilities and
interest rate agreements. The estimation process is dependent
upon a variety of assumptions, especially in determining the income
and market value of its subprime mortgage loan holdings. The
estimates and assumptions have a significant impact on the results
of the interest rate sensitivity analysis, the results of which are
shown as of September 30, 1999 and December 31, 1998.
Managements analysis for assessing interest rate
sensitivity on its subprime mortgage loans relies significantly on
estimates for prepayment speeds. A prepayment model has been
internally developed based upon four main factors:
|
Refinancing incentives (the interest rate of the mortgage compared
with the current mortgage rates available to the borrower)
|
|
Borrower
credit grades
|
|
Loan-to-value ratios
|
|
Prepayment penalties, if any
|
Generally speaking, when market interest rates decline,
borrowers are more likely to refinance their mortgages. The higher
the interest rate a borrower currently has on his or her mortgage
the more incentive he or she has to refinance the mortgage when
rates decline. In addition, the higher the credit grade, the more
incentive there is to refinance when credit ratings improve. When a
borrower has a low loan-to-value ratio, he or she is more likely to
do a cash-out refinance. Each of these factors
presumably increases the chance for higher prepayment speeds during
the term of the loan. On the other hand, prepayment penalties serve
to mitigate the risk that loans will prepay, under the assumption
that the penalty is a deterrent to refinancing.-
These factors are weighted based on managements
experience and an evaluation of the important trends observed in the
subprime mortgage origination industry. Actual results may differ
from the estimates and assumptions used in the model and the
projected results as shown in the above table.
NovaStar Financials projected prepayment rates in each
interest rate scenario start at a prepayment speed less than 5% in
month one and increase to a long-term prepayment speed in nine to 18
months, to account for the seasoning of the loans. The long-term
prepayment speed ranges from 20% to 40% and depends on the
characteristics of the loan which include type of product (ARM or
fixed rate), note rate, credit grade, LTV, gross margin, weighted
average maturity and lifetime and periodic caps and floors. This
prepayment curve is also multiplied by a factor of 60% on average
for periods when a prepayment penalty is in effect on the loan.
These assumptions change with levels of interest rates. The actual
historical speeds experienced on NovaStar Financials loans
shown in Table 7 are weighted average speeds of all loans in each
deal.
As shown in Table 7, actual prepayment rates on loans that
have been held in portfolio for shorter periods are slower than long
term prepayment rates used in the interest rate sensitivity
analysis. However, this table also indicates that as pools of loans
held in portfolio season, the actual prepayment rates are more
consistent with the long term prepayment rates used in the interest
sensitivity analysis.
The investment policy for NovaStar Financial sets the
following general goals:
(1)
|
Maintain
the net interest margin between assets and liabilities, and
|
(2)
|
Diminish
the effect of changes in interest rate levels on the market value
of assets.
|
Although management evaluates the portfolio using interest
rate increases and decreases greater than one percent, management
focuses on the one percent increase. The investment policy for
NovaStar Financial allows for no more than a 25 percent decrease in
the spread income of the portfolio and for no more than a 10%
decrease in the market value of the portfolio when interest rates
rise or fall by one percent.
Sensitivity as of September 30, 1999 and December 31,
1998. As shown in the above table, if
interest rates were to decrease one percent (-100 basis points), the
spread income would increase by an estimated 3.3% and 6.8% as of
September 30, 1999 and December 31, 1998, respectively. If interest
rates rise by one percent (+100 basis points), the spread income
would decrease by an estimated 1.9% and 4.5% as of September 30,
1999 and December 31, 1998, respectively. If interest rates were to
decrease one percent, the market value of portfolio equity would
increase by an estimated 4.5% and 12.4% as of September 30, 1999 and
December 31, 1998, respectively. If interest rates rise by one
percent, the market value of portfolio equity would decrease by an
estimated 4.2% and 12.2% as of September 30, 1999 and December 31,
1998, respectively.
Hedging with off-balance-sheet financial instruments.
In order to address a mismatch of
assets and liabilities, the hedging section of the investment policy
is followed, as approved by the Board. Specifically, the interest
rate risk management program is formulated with the intent to offset
the potential adverse effects resulting from rate adjustment
limitations on its mortgage assets and the differences between
interest rate adjustment indices and interest rate adjustment
periods of its adjustable-rate mortgage loans and related borrowings.
NovaStar Financial uses interest rate cap and swap agreements
and financial futures contracts to mitigate the risk of the cost of
its variable rate liabilities increasing at a faster rate than the
earnings on its assets during a period of rising rates. In this way,
management intends generally to hedge as much of the interest rate
risk as determined to be in the best interest of NovaStar Financial,
given the cost of hedging transactions and the need to maintain REIT
status.
NovaStar Financial seeks to build a balance sheet and
undertake an interest rate risk management program that is likely,
in managementss view, to enable NovaStar Financial to maintain
an equity liquidation value sufficient to maintain operations given
a variety of potentially adverse circumstances. Accordingly, the
hedging program addresses both income preservation, as discussed in
the first part of this section, and capital preservation concerns.
Interest rate cap agreements are legal contracts between
NovaStar Financial and a third party firm or counter-party
. The counter-party agrees to make payments to NovaStar
Financial in the future should the one- or three-month LIBOR
interest rate rise above the strike rate specified in the contract.
NovaStar Financial either makes quarterly premium payments or has
chosen to pay the premiums upfront to the counterparties under
contract. Each contract has a fixed notional face amount, on which
the interest is computed, and a set term to maturity. Should the
reference LIBOR interest rate rise above the contractual strike
rate, NovaStar Financial will earn cap income. Payments on an
annualized basis equal the contractual notional face amount times
the difference between actual LIBOR and the strike rate.
NOVASTAR FINANCIAL, INC.
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.-
NOVASTAR
FINANCIAL, INC.
|
DATE: November 12, 1999
/S
/ SCOTT
F. HARTMAN
|
|
Scott F. Hartman
|
Chairman of the
Board, Secretary and
|
Chief Executive
Officer
|
(Principal
Executive Officer)
|
DATE: November 12, 1999
/S
/ RODNEY
E. SCHWATKEN
|
|
Rodney E. Schwatken
|
Vice President,
Controller and
|
Assistant
Treasurer
|
(Principal
Accounting Officer)
|