NovaStar Financial Agrees to Purchase $940 million Bulk Loan Pool; Company Also Announces Flexibility in Securitization Structures

NovaStar Financial, Inc. (NYSE: NFI), a residentialmortgage lender and portfolio investor, today announced the signing ofa definitive agreement to buy approximately $940 million ofnonconforming mortgage loans, pending due-diligence. The companyintends to permanently finance these mortgage assets by including themin an asset-backed securitization during the second quarter of 2006.This securitization is expected to be structured as a financingtransaction for both financial reporting (GAAP) and federal income taxpurposes. Until that time, NovaStar will temporarily finance theseassets through a previously negotiated warehouse line of credit withthe seller.

In addition to the securitization of the recently purchasedmortgage loans, NovaStar announced that it intended to structure itsfirst securitization in 2006, a $1.35 billion transaction, as anon-balance sheet financing transaction for both GAAP and tax purposes.

"We intend to maintain flexibility with respect to our overallbusiness strategy, including our ability to structure securitizationsas sales or financings for GAAP and tax purposes. This flexibilityallows us to continue providing shareholders with the tax benefitsassociated with NovaStar's REIT status, while complying with certainincome and asset tests to maintain our tax advantaged structure. Inorder to satisfy these tests in a variety of interest rateenvironments, it may be necessary to periodically add additional realestate assets to our GAAP and tax balance sheets throughsecuritizations treated as financings. By structuring thesecuritization of these mortgage loans as financings, we will addapproximately $2.6 billion of REIT qualified assets to our balancesheet. In addition, these transactions will provide greater qualifiedreal estate income for various REIT income tests," said Greg Metz,NovaStar's Chief Financial Officer.

The company anticipates that structuring these securitizations asfinancings will reduce GAAP earnings in the first quarter of 2006,since 1) For these transactions, NovaStar will not report a gain onsale as it would if the securitizations were accounted for as sales,which has been the typical method over the last several years, and 2)NovaStar will establish an initial loan loss reserve related tomaintaining the loans on its balance sheet. However, for the fullyear, NovaStar does not believe structuring these transactions asfinancings will have a material impact on reported GAAP earnings oraffect its previous 2006 dividend guidance of at least $5.60 percommon share. Furthermore, the company stated that the initialdifference in net income will reverse itself over the remaining lifeof the transaction.

Given the structure of the securitization transactions, NovaStarexpects that a portion of its 2006 taxable income will be consideredexcess inclusion income. Tax exempt entities that receive thesedividends may be subject to income tax on the portion of NovaStar'sdividends that constitute excess inclusion income as unrelatedbusiness taxable income.

"It is our understanding that 2006 dividends, which relate to thedistribution of 2005 taxable income, will not be impacted by theexcess inclusion generated in 2006. As disclosed previously, 2006dividends will initially be applied to our obligation to disburse 2005taxable income. It is estimated that $209 million in 2005 taxableincome remains to be distributed. We recommend that current andprospective shareholders seek counsel from their individual taxadvisor with respect to this matter," Metz added.

In a securitization structured as a financing, no gain isrecognized at the time of securitization, the mortgage loans remain onthe balance sheet and the asset-backed bonds issued to third partiesare recorded as debt. Income recognized using this structure will moreclosely follow cash flow trends. In addition, the company will berequired to establish an initial loan loss reserve at the time of thesecuritization and maintain that reserve at an appropriate level infuture periods.

NovaStar has typically qualified for sale accounting treatmentwhen securitizing mortgage assets. In a sale, a gain is recognized atthe time of securitization, the mortgage loans are removed from thebalance sheet and new mortgage securities (retained interests) arerecorded on the balance sheet. Income is accrued through the life ofthe securities using a level yield method.

About NovaStar

NovaStar Financial, Inc. (NYSE: NFI) is a specialty financecompany that originates, purchases, invests in and servicesresidential nonconforming loans. The company specializes insingle-family mortgages, involving borrowers whose loan size, creditdetails or other circumstances fall outside conventional mortgageagency guidelines. A Real Estate Investment Trust (REIT) founded in1996, NovaStar efficiently brings together the capital markets, anationwide network of mortgage brokers and American families financingtheir homes. NovaStar is headquartered in Kansas City, Missouri, andhas lending operations nationwide.

For more information, including quarterly portfolio data, pleasevisit our website at www.novastarmortgage.com.

Certain matters discussed in this release constituteforward-looking statements within the meaning of the federalsecurities laws. Forward-looking statements are those that predict ordescribe future events and that do not relate solely to historicalmatters. Forward-looking statements are subject to risks anduncertainties and certain factors can cause actual results to differmaterially from those anticipated. Some important factors that couldcause actual results to differ materially from those anticipatedinclude: our ability to generate sufficient liquidity on favorableterms; the size and frequency of our securitizations; interest ratefluctuations on our assets that differ from our liabilities; increasesin prepayment or default rates on our mortgage assets; changes inassumptions regarding estimated loan losses and fair value amounts;changes in origination and resale pricing of mortgage loans; ourcompliance with applicable local, state and federal laws andregulations or opinions of counsel relating thereto and the impact ofnew local, state or federal legislation or regulations or opinions ofcounsel relating thereto or court decisions on our operations; theinitiation of margin calls under our credit facilities; the ability ofour servicing operations to maintain high performance standards andmaintain appropriate ratings from rating agencies; our ability toexpand origination volume while maintaining an acceptable level ofoverhead; our ability to adapt to and implement technological changes;the stability of residual property values; the outcome of litigationor regulatory actions pending against us or other legal contingencies;the impact of losses resulting from natural disasters; the impact ofgeneral economic conditions; and the risks that are from time to timeincluded in our filings with the SEC, including our Annual Report onForm 10-K, for the year ended December 31, 2005. Other factors notpresently identified may also cause actual results to differ. Thisdocument speaks only as of its date and we expressly disclaim any dutyto update the information herein.