NovaStar Financial Announces 2006 and Fourth-Quarter Results

NovaStar Financial, Inc. (NYSE: NFI), a residential lender and mortgage portfolio manager, today reported fourth-quarter and year-end results. For the quarter ended December 31, 2006, NovaStar reported a net loss available to common shareholders of $14.4 million, or $0.39 per fully diluted common share. In the fourth quarter of 2005, net income available to common shareholders was $26.4 million, or $0.84 per fully diluted common share. Full-year 2006 net income available to common shareholders was $66.3 million, representing earnings of $1.92 per fully diluted common share. That full-year result compares with 2005 net income available to common shareholders of $132.5 million, or $4.42 per fully diluted common share. In the fourth quarter, NovaStar recorded a number of significant items (presented as after-tax) that reduced net income: (In thousands, except per share data) Net Earnings Income   per Share Mortgage securities impairments on 2006 vintage $ 17,426  $ 0.47  Loss provision for whole loan repurchases 13,372  0.36  Loan loss provision for 2006-1 securitization 10,254  0.28  Mark-to-market of securities classified as trading 3,659  0.10  "The credit performance of our portfolio, and specifically our 2006 originations, deteriorated during the fourth quarter, resulting in impairments on mortgage securities and additional loss provisions for loans held-in-portfolio in the REIT. Also, our gains upon securitization were reduced during the quarter because of lower whole loan prices. Furthermore, during the fourth quarter, we experienced a greater level of loan repurchase requests due to early payment defaults than we have historically. However, we believe our current reserves are adequate to cover the repurchase risk for all loans sold to date,” said Scott Hartman, Chief Executive Officer. Additional 2006 and Fourth-Quarter Highlights Portfolio of loans under management was $16.3 billion at year-end. Portfolio return on assets was 1.21 percent for 2006 (0.94 percent in the fourth quarter). Nonconforming loan originations were $11.2 billion in 2006, up 21 percent from 2005. Fourth-quarter originations were $2.6 billion, up 20 percent from the same quarter in 2005. Cost of production for 2006 was reduced by 34 basis points, to 2.03 percent, compared to 2005. Fourth-quarter cost of production was 1.87 percent. NovaStar expanded its retail division with an asset purchase resulting in 19 new branches, adding a market channel for low-cost originations that it expects will serve as a platform for future growth. Information Relating to 2007 Dividends NovaStar declared $5.60 per share in dividends to common shareholders in 2006, consistent with guidance provided early in the year. For 2007, NovaStar’s management expects to meet the REIT distribution requirements of distributing at least 90 percent of undistributed 2006 taxable income during 2007. The timing and amount of dividends will be determined by NovaStar’s Board of Directors. In addition, the Board declared a quarterly dividend of $.55625 per share on NovaStar’s 8.90% Class C Cumulative Redeemable Preferred Stock, payable April 2, 2007, to holders of record as of March 5, 2007. Estimated 2006 taxable income available to shareholders was $187 million, and approximately $17 million in dividends declared and paid in 2006 were applicable to 2006 taxable income (see table). Dividend Carry-over Analysis (In millions)   Estimated 2006 REIT taxable income $ 187  Less: 2006 dividends paid to date applied to 2006 taxable income (17)   Estimated 2006 REIT taxable income available to be distributed $ 170  Greg Metz, Senior Vice President and Chief Financial Officer, noted: "As we have discussed in prior conference calls, taxable income from our REIT mortgage securities portfolio will normally exceed GAAP earnings during the early life of the portfolio due to the accelerated income recognition provisions of the tax code. Generally, this timing difference is created because of the different income accrual methods prescribed for the computation of GAAP and tax income. However, over the life of the portfolio, GAAP and tax income will be equal; therefore, in the later life of the portfolio GAAP income will be greater than taxable income. The reversal in timing differences between the recognition of GAAP income and taxable income is occurring and will accelerate as our older vintage securitizations mature. As a result, during the period 2007 through 2011, we expect to recognize little, if any, taxable income. Given this outlook, management is currently evaluating whether it is in shareholders’ best interest to retain the company’s REIT status beyond 2007 given the asset, income and other REIT related restrictions the company must operate within.” Portfolio Management Loans under management were $16.3 billion at December 31, 2006, up 17 percent from a year earlier but down from the third quarter, due in part to fourth-quarter whole loan sales. NovaStar securitized $1.8 billion in nonconforming loans in the fourth quarter ($8.6 billion for the year). Return on assets in the portfolio was 0.94 percent in the fourth quarter (1.21 percent for the year). On February 8, 2007, NovaStar closed a $375 million collateralized debt obligation (CDO). The assets collateralizing the obligation include securities created through past NovaStar securitizations, as well as mortgage backed securities purchased in the secondary market. The company retained the class D notes and subordinated notes, together representing $43.5 million in principal value. "This CDO accomplishes two things for NovaStar. First, we were able to reduce funding costs on lower-tranche bonds from recent securitizations and second, we tapped an additional opportunity to benefit from our portfolio management capabilities. We believe that investing in higher rated mortgage securities will continue to provide good, risk-adjusted returns for the portfolio. During 2007, we may commit additional equity to purchase or retain mortgage securities. These securities are rated higher in the capital structure than our traditional residual investments and we intend to finance these securities with CDO debt,” said Mike Bamburg, Senior Vice President and Chief Investment Officer. Mortgage Banking Fourth-quarter loan production was $2.6 billion, up 20 percent from a year earlier (full-year originations were $11.2 billion, up 21 percent over 2005). Wholesale production represented 85 percent of fourth-quarter originations, retail 9 percent (with new branches included only in December), and correspondent/bulk 6 percent. Average cost of production was 1.87 percent in the quarter, down from 2.15 percent a year earlier and was 2.03 percent for 2006, down from 2.37 percent in 2005. "NovaStar originated 21 percent more loans in 2006 and made progress on reducing costs. The nonprime market remains very competitive, but we see potential for a more rational business environment as several competitors have withdrawn or put themselves up for sale,” said Lance Anderson, President and Chief Operating Officer. Anderson added, "The key area of focus for our mortgage banking operation is to ensure that the 2007 originations perform better than 2006 and in line with our expectations. In this regard, we have taken several steps which include: (1) Tightening of our underwriting guidelines (2) Limiting the number of exceptions to our underwriting guidelines policy (3) Enhancing our appraisal review process (4) Implementing the use of NovaStar’s Risk Assessment Score (NRAS) to identify loans with unacceptable levels of risk.” Liquidity and Borrowing Capacity As of December 31, 2006, NovaStar had borrowing capacity of $4.25 billion from major lenders. Cash and available liquidity totaled $154 million. Focus on Key Metrics In addition to full reporting under GAAP, NovaStar provides information on key performance metrics related to shareholder value: (In thousands, except per share data) Year Ended December 31, Fourth Quarter (Unaudited) 2006  2005  Change 2006  2005  Change   Earnings Estimated REIT taxable incomea $ 187,280  $ 277,085  -32% $ 29,881  $ 52,409  -43% Net Income (loss) available to common $ 66,285  $ 132,471  -50% $ (14,404) $ 26,445  -154% EPS available to common (diluted) $ 1.92  $ 4.42  -57% $ (0.39) $ 0.84  -146% Return on average common equity 14.3% 31.5% N/A  21.8%   Mortgage Banking – Lending & Originations Nonconforming loan production $ 11,224,088  $ 9,283,138  21% $ 2,645,391  $ 2,198,339  20% Cost of productionb 2.03% 2.37% 1.87% 2.15%   Loan Sales and Securitizations Nonprime whole loan sales $ 2,248,633  $ 1,138,098  98% $ 761,801  $ 420,836  81% (Loss) Gain on nonprime whole loan sales (161) 9,918  -102% (10,934) 941  -1262% Mortgage loans securitized structured as sale 6,075,405  7,621,030  -20% 1,809,716  1,731,570  5% Gain on loans securitized 50,215  58,765  -15% 4,636  5,577  -17%   Portfolio Management – Asset Performance Loans under management $ 16,341,559  $ 13,991,260  17% $ 16,341,559  $ 13,991,260  17% Portfolio net interest income 188,974  235,916  -20% 38,443  60,041  -36% Portfolio return on average assets 1.21% 1.76% 0.94% 1.72%   Common Stock Data and Liquidity High market price per share $ 37.63  $ 48.15  $ 32.81  $ 33.01  Low market price per share 25.70  26.20  26.32  26.20  Dividends declared per common share $ 5.60  $ 5.60  $ -  $ 1.40  Book value per common share (diluted) 11.73  15.08  -22% 11.73  15.08  -22% Cash and available liquidity (mil.) $ 154  $ 279  -45% $ 154  $ 279  -45% (a) 2005 is actual (b) As required by Regulation G, a reconciliation of cost of production to the most directly comparable GAAP financial measure is set forth in the table attached as Exhibit 1 to this press release. The NovaStar fourth-quarter investor conference call is scheduled for 4:00 p.m. Central time (5:00 p.m. Eastern time) on February 20, 2007. The conference call will be webcast live and archived on the Company’s website at www.novastarmortgage.com. To participate in the call, please contact 877-704-5381 approximately 15 minutes before the scheduled start of the call. A copy of the presentation slides will be available on the website approximately one hour before the start of the conference call. For investors unable to participate in the live event, a replay will be available until February 27, 2007, at 888-203-1112. The confirmation code for the replay is 5093421. About NovaStar NovaStar Financial, Inc. (NYSE: NFI) is a specialty finance company that originates, purchases, invests in and services residential nonprime loans. The company specializes in single-family mortgages, involving borrowers whose loan size, credit details or other circumstances fall outside conventional mortgage agency guidelines. A Real Estate Investment Trust (REIT) founded in 1996, NovaStar efficiently brings together the capital markets, a nationwide network of mortgage brokers and American families financing their homes. NovaStar is headquartered in Kansas City, Missouri, and has lending operations nationwide. For more information, including quarterly portfolio data, please visit our website at www.novastarmortgage.com. This Press Release contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, regarding management’s beliefs, estimates, projections, and assumptions with respect to, among other things, the Company’s future operations, business plans and strategies, as well as industry and market conditions, all of which are subject to change at any time without notice. Actual results and operations for any future period may vary materially from those projected herein and from past results discussed herein. Some important factors that could cause actual results to differ materially from those anticipated include: our ability to successfully integrate acquired businesses or assets with our existing business; our ability to generate sufficient liquidity on favorable terms; the size, frequency and structure of our securitizations; impairments on our mortgage assets; interest rate fluctuations on our assets that differ from our liabilities; increases in prepayment or default rates on our mortgage assets; changes in assumptions regarding estimated loan losses and fair value amounts; changes in origination and resale pricing of mortgage loans; our compliance with applicable local, state and federal laws and regulations or opinions of counsel relating thereto and the impact of new local, state or federal legislation or regulations or opinions of counsel relating thereto or court decisions on our operations; the initiation of margin calls under our credit facilities; the ability of our servicing operations to maintain high performance standards and maintain appropriate ratings from rating agencies; our ability to expand origination volume while maintaining an acceptable level of overhead; our ability to adapt to and implement technological changes; the stability of residual property values; the outcome of litigation or regulatory actions pending against us or other legal contingencies; compliance with new accounting pronouncements; the impact of general economic conditions; and the risks that are from time to time included in our filings with the SEC, including our Annual Report on Form 10-K, for the year ended December 31, 2005 and our quarterly report on form 10-Q, for the period ending September 30, 2006. Other factors not presently identified may also cause actual results to differ. Words such as "believe,” "expect,” "anticipate,” "promise,” "plan,” and other expressions or words of similar meanings, as well as future or conditional verbs such as "will,” "would,” "should,” "could,” or "may” are generally intended to identify forward-looking statements. This document speaks only as of its date and we expressly disclaim any duty to update the information herein.                 Exhibit 1 NovaStar Financial Inc. Reconciliation of GAAP General and Administrative Expenses to Cost of Loan Production (dollars in thousands, except loan production as a percentage)   The following table is a reconciliation of overhead costs included in our cost of production to general and administrative expenses, presented in accordance with accounting principles generally accepted in the United States of America (GAAP) and the resulting cost of production. We believe this presentation provides useful information regarding our financial performance because it more accurately reflects the direct costs of loan production and allows us to monitor the performance of our core operations, which is more difficult to do when looking at GAAP financial statements, and provides useful information regarding our financial performance. Management uses this measure for the same purpose. However, this presentation is not intended to be used as a substitute for financial results prepared in accordance with GAAP.     For the Twelve Months For the Three Months Ended December 31, Ended December 31, 2006  2005  2006  2005  General and administrative expenses $201,261  $184,630  $53,589  $43,964  Mortgage portfolio management general and administrative expenses (16,012) (14,450) (4,346) (2,521) Loan servicing general and administrative expenses (34,968) (34,517) (9,102) (9,332) Mortgage lending general and administrative expenses 150,281  135,663  40,141  32,111  Direct origination costs classified as a reduction in gain-on-sale 29,923  54,020  7,108  12,050  Other expenses (A) (12,535) (21,073) (2,354) (3,075) Lending overhead costs 167,669  168,610  44,895  41,086  Premium paid to broker, net of fees collected 59,771  51,830  4,512  6,086  Total cost of loan production $227,440  $220,440  $49,407  $47,172    Loan production, principal $11,224,088  $9,283,138  $2,645,391  $2,198,339  Total cost of production, as a percentage 2.03% 2.37% 1.87% 2.15%                 (A) Consists of non-lending overhead.           NovaStar Financial, Inc. CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND OTHER DATA (dollars in thousands, except per share amounts) (unaudited)   For the Three Months Ended For the Twelve Months Ended 12/31/2006  9/30/2006  12/31/2005  12/31/2006  12/31/2005  NovaStar Financial, Inc. Income Statement Data Interest income $ 128,942  $ 148,485  $ 85,115  $ 494,890  $ 320,727  Interest expense 67,774  75,366  22,158  235,331  80,755  Net interest income before credit losses 61,168  73,119  62,957  259,559  239,972  Provision for credit losses (recoveries) (10,255) (10,286) 12  (30,131) (1,038) Net interest income 50,913  62,833  62,969  229,428  238,934    Other operating income (expense): (Losses) gains on sales of mortgage assets (9,278) 27,709  4,686  41,749  65,148  Gains (losses) on derivative instruments 4,144  (6,877) 4,880  11,998  18,155  Impairment on mortgage securities available-for-sale (17,441) (6,796) (7,553) (30,690) (17,619) Fee income 6,903  7,671  5,833  29,032  30,678  Premiums for mortgage loan insurance (3,124) (3,145) (1,664) (12,419) (5,672) Other (expense) income, net (1,780) (2,044) (206) 647  (784) Total other operating (expense) income: (20,576) 16,518  5,976  40,317  89,906    General and administrative expenses 53,589  49,053  43,964  201,261  184,630    (Loss) income from continuing operations before tax (benefit) expense (23,252) 30,298  24,981  68,484  144,210  Income tax (benefit) expense (11,398) 1,813  (5,924) (8,721) (6,617) (Loss) income from continuing operations (11,854) 28,485  30,905  77,205  150,827  (Loss) income from discontinued operations, net of income tax (2,550) 94  (2,796) (4,267) (11,703) Net (loss) income (14,404) 28,579  28,109  72,938  139,124  Preferred dividends -  (3,327) (1,664) (6,653) (6,653) Net (loss) income available to common shareholders $ (14,404) $ 25,252  $ 26,445  $ 66,285  $ 132,471    Basic earnings per share (Loss) income from continuing operations available to common shareholders $ (0.32) $ 0.73  $ 0.94  $ 2.07  $ 4.86  (Loss) income from discontinued operations, net of income tax (0.07) -  (0.09) (0.13) (0.40) Net (loss) income available to common shareholders $ (0.39) $ 0.73  $ 0.85  $ 1.94  $ 4.46  Diluted earnings per share (Loss) income from continuing operations available to common shareholders $ (0.32) $ 0.73  $ 0.93  $ 2.04  $ 4.81  (Loss) income from discontinued operations, net of income tax (0.07) -  (0.09) (0.12) (0.39) Net (loss) income available to common shareholders $ (0.39) $ 0.73  $ 0.84  $ 1.92  $ 4.42    Dividends declared per common share $ -  $ 2.80  $ 1.40  $ 5.60  $ 5.60  Dividends declared per preferred share $ -  $ 1.11  $ 0.56  $ 2.23  $ 2.23  Book value per diluted share $ 11.73  $ 12.80  $ 15.08  $ 11.73  $ 15.08                                For the Three Months Ended For the Twelve Months Ended 12/31/2006  9/30/2006  12/31/2005  12/31/2006  12/31/2005  NovaStar Financial, Inc. Other Data: Servicing portfolio $ 16,659,784  $ 16,355,553  $ 14,030,697  $ 16,659,784  $ 14,030,697  Nonconforming loans sold to third parties $ 761,801  $ 693,777  $ 420,836  $ 2,248,633  $ 1,138,098  Loans securitized in transactions structured as sales, principal $ 1,809,716  $ 2,174,900  $ 1,731,570  $ 6,075,405  $ 7,621,030  Loans securitized in transactions structured as financings, principal $ -  $ 138,690  $ -  $ 2,549,913  $ -  Percent of securitized loans covered by mortgage insurance 53% 52% 53% 53% 53% Weighted average coupon of mortgage loans - held for sale 8.69% 9.05% 8.11% 8.69% 8.11%   Weighted average coupon of mortgage loans - held in portfolio 8.35%   8.23%   9.85%   8.35%   9.85%   NovaStar Financial, Inc. CONDENSED CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per share amounts) (unaudited)   As of 12/31/2006  9/30/2006  12/31/2005  NovaStar Financial, Inc. Balance Sheet Data Assets Cash and cash equivalents $ 150,522  $ 182,157  $ 264,694  Mortgage loans - held for sale 1,741,819  1,532,755  1,291,556  Mortgage loans - held in portfolio, net of allowance of $22,452 and $699, respectively 2,116,535  2,391,914  28,840  Mortgage securities - available for sale 349,312  428,787  505,645  Mortgage securities - trading 329,361  270,925  43,738  Mortgage servicing rights 62,830  60,483  57,122  Deferred income tax asset, net 47,188  41,642  30,780  Servicing related advances 40,923  33,030  26,873  Warehouse notes receivable 39,462  59,756  25,390  Accrued interest receivable 37,692  37,296  4,866  Real estate owned 21,534  14,460  1,208  Derivative instruments, net 16,816  14,201  12,765  Other assets 74,269  68,730  42,257  Total assets $ 5,028,263  $ 5,136,136  $ 2,335,734    Liabilities and Shareholders' Equity Liabilities Short-term borrowings secured by mortgage loans $ 1,631,773  $ 1,500,117  $ 1,238,122  Short-term borrowings secured by mortgage securities 503,680  404,809  180,447  Other short-term borrowings 16,755  15,045  -  Asset-backed bonds secured by mortgage loans 2,067,490  2,323,160  26,949  Asset-backed bonds secured by mortgage securities 9,519  19,554  125,630  Junior subordinated debentures 83,041  82,908  48,664  Due to securitization trusts 107,043  73,795  44,382  Dividends payable 1,663  105,008  45,070  Accounts payable and other liabilities 92,729  69,092  62,250  Total liabilities 4,513,693  4,593,488  1,771,514    Shareholders' equity Redeemable preferred stock 30  30  30  Common stock 373  363  322  Additional paid-in-capital 741,748  714,760  581,580  Accumulated deficit (263,572) (247,031) (128,554) Accumulated other comprehensive income 36,548  75,118  111,538  Other (557) (592) (696) Total shareholders' equity 514,570  542,648  564,220  Total liabilities and shareholders' equity $ 5,028,263  $ 5,136,136  $ 2,335,734                        NovaStar Financial, Inc. LOAN ORIGINATION DATA (dollars in thousands) (unaudited)   For the Three Months Ended 12/31/2006  As a % of Total 9/30/2006  As a % of Total 12/31/2005  As a % of Total Nonconforming loan origination volume Origination channel Wholesale (A) $ 2,244,860  85% $ 2,671,330  91% $ 1,714,035  78% Correspond-ent/ Bulk (A) 163,737  6% 51,958  2% 132,127  6% Retail (B) 236,794  9% 212,591  7% 352,177  16% Total $ 2,645,391  100% $ 2,935,879  100% $ 2,198,339  100%   Funding days in the quarter 60  63  60  Avg. originat-ions per funding day $ 44,090  $ 46,601  $ 36,639                                (A) Starting in April of 2006 correspondent loans purchased on a flow basis are being included in the wholesale channel. Prior periods have been reclassified to reflect this change. (B) Branch production volumes are considered a part of our retail operations and are included within the retail production volumes shown above.       For the Three Months Ended 12/31/06 WeightedAverageCoupon WeightedAverageLTV WeightedAverageFICO Percentof Total   Summary by Credit Grade 660 and above 7.89% 84.1% 702  27% 620 to 659 8.58% 84.1% 639  25% 580 to 619 8.85% 83.9% 600  23% 540 to 579 9.20% 79.7% 559  17% 539 and below 9.66% 77.0% 527  8%   8.64% 82.7% 625  100%   Summary by Program Type 2-Year Fixed 9.14% 83.6% 609  40% 2-Year Fixed 40/30 8.55% 83.1% 624  20% 30-Year Fixed 8.48% 79.3% 619  16% 2-Year Fixed Interest-only 8.10% 82.5% 658  10% 30/15-Year Fixed 11.32% 97.4% 668  4% 30-Year MTA 1.95% 78.9% 702  3% 40/30-Year Fixed 8.23% 78.7% 623  3% Other Products 8.33% 77.6% 632  4%   8.64% 82.7% 625  100%   Weighted Average Coupon without MTA 8.84%         Note: The origination data on this report includes loans secured by second mortgages.