Back to GetFilings.com
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2001
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From to
---------- ----------
-------------
Commission File Number 001-13533
NOVASTAR FINANCIAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 74-2830661
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1901 W. 47th Place, Suite 105, Westwood, KS 66205
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (913) 362-1090
-------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
Common Stock, $0.01 par value New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 5, 2002 was approximately $186,201,725 as reported by the
New York Stock Exchange Composite Transactions on such date.
The number of shares of the Registrant's Common Stock outstanding on March 5,
2002 was 10,356,047.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10, 11, 12, and 13 of Part III are incorporated by reference to the
NovaStar Financial, Inc. definitive proxy statement to shareholders, which will
be filed with the Commission no later than 120 days after December 31, 2001.
================================================================================
NOVASTAR FINANCIAL, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
TABLE OF CONTENTS
PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . 13
PART II
Item 5. Market For Registrant's Common Equity and Related Stockholder Matters . . . . . . . . . 14
Item 6. Selected Consolidated Financial Data and Other Data . . . . . . . . . . . . . . . . . . 14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . 40
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . 66
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . 66
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . 66
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K . . . . . . . . . . . 67
1
PART I
ITEM 1. BUSINESS
OVERVIEW
We are a Maryland corporation formed on September 13, 1996 as an investor
in mortgage assets, with a focus on non-conforming mortgage loans. We also
originate single-family non-conforming loans in the name of NovaStar Mortgage,
Inc. (NovaStar Mortgage), our subsidiary.
Management believes the tax-advantaged structure of a real estate
investment trust (REIT) maximizes the after-tax returns from mortgage assets. We
must meet numerous rules established by the Internal Revenue Service to retain
our status as a REIT. In summary, they require us to:
o Restrict investments to certain real estate related assets,
o Avoid certain investment trading and hedging activities, and
o Distribute virtually all taxable income to stockholders.
As long as we maintain our REIT status, distributions to stockholders will
generally be deductible by us for income tax purposes. This deduction
effectively eliminates corporate level income taxes. Management believes it has
and will continue to meet the requirements to maintain our REIT status.
2001 IN REVIEW
During 2001, we originated $1.3 billion in non-conforming loans. We
continue to become more efficient in underwriting and funding wholesale mortgage
loans through the use of our Internet Underwriter(R), or "IU", a webbased
automated underwriting system used by selected customers for non-conforming
residential mortgage loans. Our cost to originate a loan decreased from 3.4% in
2000 to 2.4% in 2001.
Loans are primarily sold through securitization transactions completed by
NovaStar Mortgage. Included in net gains on sales of mortgage assets for the
year ended December 31, 2001 are $21.7 million in gains recognized in two
transactions securitizing a total of $1.2 billion in loans. In addition, we sold
loans aggregating $73.3 million to unrelated third parties for cash, recognizing
net gains of $954,000 with an average price to par of 102.1%.
NovaStar Mortgage retains the servicing rights to loans securitized. During
2001 the loan-servicing portfolio increased from $1.0 billion to $2.0 billion.
During 2001, we expanded our net branch product using the name NovaStar
Home Mortgage, Inc. (NovaStar Home Mortgage). Loan brokers/officers can open a
branch facility under the NovaStar Home Mortgage name. NovaStar provides a
license, loan investors and administrative services to the branch.
Administrative services include accounting, payroll and human resource support.
Branch management must adhere to lending policies we have established. Net
branch income-broker fee income less branch expenses and the administrative fees
paid to NovaStar Home Mortgage-are profits earned by the branch manager.
While the branch is free to broker loans for any approved investor, many of
the loans produced by our branches are funded by NovaStar Mortgage. This
arrangement serves to reduce our overall cost of lending and provides for
enhanced fee income.
At the beginning of 2001, we had 63 branches open. As of December 31, 2001
there were 123 branches in operation located in 32 states.
We have obtained committed financing facilities to fund our mortgage loan
operations. As of December 31, 2001, combined lending arrangements under these
agreements totaled $960 million. Cash and availability under these committed
facilities were $81.1 million.
During the year ended December 31, 2001, we recorded net income of $32.3
million, $3.02 per diluted share. The earnings include a gain of $14.9 million
from the sale of mortgage securities, executed through a securitization
transaction. Our operating results are discussed further under "Management's
Discussion and Analysis of Financial Condition and Results of Operations" of
this annual report.
2
ORGANIZATIONAL STRUCTURE AND OPERATIONS
Historically, REITs were generally limited to holding non-voting preferred
stock in taxable affiliates. As of January 1, 2001, REITs were permitted to hold
taxable affiliates as wholly-owned subsidiaries. The value of all taxable
subsidiaries of a REIT is limited to 20% of the total value of the REIT's
assets. We acquired all of the common stock of NFI Holding Corporation (NFI
Holding) from Scott Hartman and Lance Anderson, our two founders, on January 1,
2001. As a result of this purchase, we own 100% of the common stock of NFI
Holding, which owns 100% of the common stock of NovaStar Mortgage and NovaStar
Home Mortgage. The details of the purchase transaction are described fully in
Note 9 to the consolidated financial statements.
Following is a diagram of the industry in which we operate and our loan
production during 2001 (in thousands). Following the diagram is further
description of our business.
[GRAPH TO BE INSERTED]
MORTGAGE LENDING
We originate and invest in non-conforming residential mortgage loans. We
lend to individuals who generally do not qualify for agency/conventional lending
programs because of a lack of available documentation or previous credit
difficulties, but generally have substantial equity in their homes. Often, these
are individuals or families who have built high-rate consumer debt and are
attempting to use the equity in their home to consolidate debt and lower their
total monthly payments.
Our sales force, which includes 112 account executives, develops and
maintains relationships with a network of independent retail brokers. In 1997
and in much of 1998, we retained our mortgage loans. Since 1998, we have
operated as a seller of whole loans to independent third parties. Two primary
avenues were used for selling mortgage loans: 1) directly to independent, third
parties for cash and 2) through securitization transactions that are treated for
tax and accounting purposes as loan sales. Through these channels, we sold $1.3
billion in loans netting gains of $22.7 million in 2001.
We underwrite, process, fund and service the mortgage loans sourced through
our broker network. Further details regarding the loan originations are
discussed under "Mortgage Originations" section of "Management's Discussion and
Analysis of Financial Condition and Results of Operations".
On a short-term basis, we finance mortgage loans using warehouse lines of
credit and repurchase agreements. In addition, we have access to facilities
secured by our mortgage securities. Details regarding available financing
3
arrangements and amounts outstanding under those arrangements are included in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note 5 to the consolidated financial statements.
For long-term financing, we fund our mortgage loans using asset-backed
bonds (ABB). Primary bonds-AAA through BBB rated-are issued to the public. We
retain the interest only bonds and prepayment penalty bonds, which are AAA
rated. We also retain the right to service the mortgage loans and retain
non-rated, subordinated interests.
Prior to 1999, ABB transactions were executed and designed to meet
accounting rules that resulted in securitizations being treated as financing
transactions. The mortgage loans and related debt continue to be presented on
our consolidated balance sheets, and no gain is recorded.
Beginning in 1999, our securitization transactions have been structured to
qualify as sales for accounting and income tax purposes. The loans and related
bond liability are not recorded in our consolidated financial statements. We do
record the value of the securities and servicing rights we retain, however.
Details regarding ABBs we issued can be found in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and in Notes 3 and 5
to our consolidated financial statements.
LOAN SERVICING
Loan servicing remains a critical part of our business operation. In the
opinion of management, maintaining contact with our borrowers is critical in
managing credit risk and in borrower retention. Non-conforming borrowers are
more prone to late payments and are more likely to default on their obligations
than conventional borrowers. By servicing our loans, we strive to identify
problems with borrowers early and take quick action to address problems.
Borrowers may be motivated to refinance their mortgage loans either by improving
their personal credit or due to a decrease in interest rates. By keeping in
close touch with borrowers, we can provide them with information about company
products to entice them to refinance with us.
LOAN BROKERING BY AFFILIATED BRANCHES
In 1999, we opened our retail mortgage broker business operating under the
name NovaStar Home Mortgage. Branch offices offer conforming and non-conforming
loans to potential borrowers. Loans are brokered for approved investors,
including NovaStar Mortgage. The branches must adhere to a strict set of
established policies regarding their operations. Net income of the branch is
returned to the branch "owner/manager." Administrative functions, including
accounting, payroll and human resources, investor relations and licensing, are
conducted by our central corporate office staff. As of December 31, 2001 we have
123 active branches in 32 states.
MARKET IN WHICH NOVASTAR OPERATES AND COMPETES
We face intense competition in the business of originating, purchasing,
selling and securitizing nonconforming mortgage loans. The number of market
participants is believed to be well in excess of 100 companies and no single
participant holds a dominant share of the non-conforming market. In addition to
other residential mortgage REITs, we compete for non-conforming borrowers with
consumer finance companies, conventional mortgage bankers, commercial banks,
credit unions and thrift institutions. We also compete with life insurance
companies, institutional investors and other well-capitalized publicly owned
mortgage lenders. Many of these competitors are substantially larger than we are
and have considerably greater financial resources than we do.
Competition among industry participants can take many forms, including
convenience in obtaining a loan, amount and term of the loan, customer service,
marketing/distribution channels, loan origination fees and interest rates. To
the extent any competitor significantly expands their activities in the
non-conforming and subprime market, we could be materially adversely affected.
One of our key competitive strengths is our employees and the level of
service they are able to provide our borrowers. By servicing our loan portfolio
directly, we are able to stay in close contact with our borrowers and identify
potential problems early. Standard and Poor's assigned our servicing department
an "Above Average" overall rating and designated NovaStar as a Special Servicer.
During 2001, the branches brokered $1.1 billion in residential mortgage
loans. That volume places us in the top 10 of mortgage brokers, based on volume.
While the branches are free to broker loans for any approved investor, the
investor of choice is often NovaStar Mortgage. This integrated relationship adds
another competitive advantage for us.
4
In addition, regulated mortgage lenders, such as savings and loans and
banks, are subject to regulatory review and must pay for the costs incurred by
the regulator in their examinations. We incur no such regulation fees or costs
and are, therefore, competitively advantaged.
We are also competitively successful due to our:
o experienced management team;
o use of technology to enhance customer service and reduce operating
costs;
o tax advantaged status as a REIT;
o vertical integration-we broker and/or originate, fund, service and
manage mortgage loans;
o access to capital markets to securitize our assets.
RISK MANAGEMENT
Management recognizes the following primary risks associated with the
business and industry in which it operates.
o Credit
o Prepayment
o Liquidity
o Interest Rate/Market
CREDIT RISK
Credit risk is the risk that we will not fully collect the principal we
have invested in mortgage loans or securities. Non-conforming mortgage loans
comprise substantially all of our mortgage loan portfolio and serve as
collateral for our mortgage securities. Our non-conforming borrowers include
individuals who do not qualify for agency/conventional lending programs because
of a lack of available documentation or previous credit difficulties, but have
considerable equity in their homes. Often, they are individuals or families who
have built up high-rate consumer debt and are attempting to use the equity in
their home to consolidate debt and reduce the amount of money it takes to
service their monthly debt obligations.
Our underwriting guidelines are intended to evaluate the credit history of
the potential borrower, the capacity and willingness of the borrower to repay
the loan, and the adequacy of the collateral securing the loan.
Underwriting staff work under the supervision of our Chief Credit Officer.
Underwriters are given approval authority only after their work has been
reviewed for a period of at least two weeks. Thereafter, the Chief Credit
Officer re-evaluates the authority levels of all underwriting personnel on an
ongoing basis. All loans in excess of $350,000 currently require the approval of
an underwriting supervisor. Loans in excess of $500,000 must be approved by our
Chief Credit Officer or our President.
The underwriting guidelines take into consideration the number of times the
potential borrower has recently been late on a mortgage payment and whether that
payment was 30, 60 or 90 days past due. Delinquency on consumer/revolving debt
isalso considered. Discharged bankruptcy filings are allowed under all credit
ratings, however, to obtain an "A" or "B" grade, the borrower must have at least
a one-year seasoning on a discharged Chapter 13 filing and two years for a
Chapter 7 filing. The credit grade that is assigned to the borrower is a
reflection of the borrower's historical credit and the loan-to-value determined
by the amount of documentation the borrower can produce to support income.
Maximum loan-to-value ratios for each credit grade depend on the level of income
documentation provided by the potential borrower. In some instances, when the
borrower exhibits strong compensating factors, exceptions to the underwriting
guidelines may be approved.
Key to our successful underwriting process is the use of IU, our automated
underwriting system. IU provides more consistency in underwriting loans and
allows underwriting personnel to focus more of their time on loans that are not
initially accepted by the IU system.
Table 1 of "Management's Discussion and Analysis of Financial Condition and
Results of Operations" sets forth our mortgage loan portfolio by credit grade,
all of which are non-conforming.
5
A tool for managing credit risk is to diversify the markets in which we
originate and own mortgage loans. Presented in Table 2 of "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
section of this annual report is a breakdown of the geographic diversification
our loans. Detail regarding loan delinquencies and loans charged off are
disclosed in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" under the heading "Provisions for Credit Losses".
We have purchased mortgage insurance on substantially all loans that are
held in our portfolio-on the balance sheet and those that serve as collateral
for our mortgage securities. Our mortgage insurance provides for coverage to a
loan-to-value of 50%, which serves to substantially limit our exposure to credit
risk. The use of mortgage insurance is discussed under "Premiums Paid on
Mortgage Insurance" in "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
PREPAYMENT RISK
The majority of our securities are "interest-only" in nature. These
securities represent the net cash flow-interest income-on the underlying loans
in excess of the cost to finance the loans. When borrowers repay the principal
on their mortgage loans early, the effect is to shorten the period over which
interest is earned, and therefore, reduce the cash flow and yield on our
securities.
We mitigate prepayment risk by originating loans that are originated with a
penalty if the borrower repays the loan in the early months of the loan's life.
For the majority of our loans, a prepayment penalty is charged equal to 80% of
six months interest on the principal balance that is to be paid in full. Table 6
of "Management's Discussion and Analysis of Financial Condition and Results of
Operations" is a summary of the loans originated by NovaStar Mortgage
demonstrating the nature of prepayment penalties. As of December 31, 2001, 46%
of our loans had a prepayment penalty. Of the loans that serve as collateral for
our mortgage securities, 87% had prepayment penalties as of December 31, 2001.
During 2001, 82% of the loans we originated had prepayment penalties. Table 6 of
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" detail, prepayment speeds.
LIQUIDITY RISK
See the "Liquidity and Capital Resources" section of "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for a
discussion of liquidity risks and resources available to us.
INTEREST RATE/MARKET RISK
Our investment policy 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 our market
value
LOAN PRICE VOLATILITY. Under our current mode of operation, we depend
heavily on the market for wholesale non-conforming mortgage loans. To conserve
capital, we may sell loans we originate. Financial results will depend, in part,
on the ability to find purchasers for the loans at prices that cover origination
expenses. Exposure to loan price volatility is reduced as when we acquire and
retain mortgage loans.
INTEREST RATE RISK. When interest rates on our assets do not adjust at the
same rates as our liabilities or when the assets have fixed rates and the
liabilities are adjusting, future earnings potential is affected. We express
this interest rate risk as 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 net asset value will experience an adverse
change when interest rates change. We assess the risk based on the change in
market values given increases and decreases in interest rates. We also assess
the risk based on the impact to net income in changing interest rate
environments.
Management primarily uses financing sources where the interest rate resets
frequently. As of December 31, 2001, borrowings under all financing arrangements
adjust daily, monthly, or quarterly. On the other hand, very few of the mortgage
assets we own, 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 is significantly affected, as the
asset rate resets would lag the borrowing rate resets.
6
To assess interest sensitivity 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.
The following are summaries of the analysis.
INTEREST RATE SENSITIVITY-INCOME
(DOLLARS IN THOUSANDS)
BASIS POINT INCREASE (DECREASE) IN INTEREST RATE (A)
------------------------------------------------------------
AS OF DECEMBER 31, 2001 (200)(D) (100) BASE 100 200
- ----------------------- ---------- --------- --------- --------- ---------
Income (expense) from:
Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A $ 133,173 $ 135,196 $ 136,598 $ 141,106
Liabilities (B) . . . . . . . . . . . . . . . . . . . . . . . . . N/A (35,336) (51,896) (68,801) (86,099)
Interest rate agreements . . . . . . . . . . . . . . . . . . . . . N/A (21,647) (14,636) (7,624) (612)
---------- --------- --------- --------- ---------
Net interest income . . . . . . . . . . . . . . . . . . . . . . . N/A $ 76,190 $ 68,664 $ 60,173 $ 54,395
========== ========= ========= ========= =========
Percent change in net interest income from base . . . . . . . . . N/A 11.0% - (12.4)% (20.8)%
========== ========= ========= ========= =========
Percent change of capital (C) . . . . . . . . . . . . . . . . . . N/A 5.8% - (6.5)% (11.0)%
========== ========= ========= ========= =========
AS OF DECEMBER 31, 2000
- -----------------------
Income (expense) from:
Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 89,542 $ 91,334 $ 93,189 $ 95,138 $ 96,946
Liabilities (B) . . . . . . . . . . . . . . . . . . . . . . . . . (52,263) (60,327) (68,686) (77,207) (85,914)
Interest rate agreements . . . . . . . . . . . . . . . . . . . . . (1,587) (1,587) (1,424) (119) 2,577
---------- --------- --------- --------- ---------
Net interest income . . . . . . . . . . . . . . . . . . . . . . . $ 35,692 $ 29,420 $ 23,079 $ 17,812 $ 13,609
========== ========= ========= ========= =========
Percent change in net interest income from base . . . . . . . . . 54.7% 27.5% - (22.8)% (41.0)%
========== ========= ========= ========= =========
Percent change of capital (C) . . . . . . . . . . . . . . . . . . 11.7% 5.9% - (4.9)% (8.8)%
========== ========= ========= ========= =========
- ---------------
(A) Income of asset, liability or interest rate agreement in a parallel shift
in the yield curve, up and down 1% and 2%.
(B) Includes debt issuance costs, amortization of loan premiums, mortgage
insurance premiums and provisions for credit losses.
(C) Total change in estimated spread income as a percent of total stockholders'
equity as of December 31, 2001 and December 31, 2000.
(D) A decrease in interest rates by 200 basis points (2%) would imply rates on
liabilities at or below zero.
7
INTEREST RATE SENSITIVITY-MARKET VALUE
(DOLLARS IN THOUSANDS)
BASIS POINT INCREASE (DECREASE) IN INTEREST RATE (A)
--------------------------------------------------------
AS OF DECEMBER 31, 2001 (200)(C) (100) 100 200
- ----------------------- ---------- --------- --------- ---------
Change in market values of:
Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A $ 13,158 $ (28,771) $ (67,162)
Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A (2,245) 2,382 6,414
Interest rate agreements . . . . . . . . . . . . . . . . . . . . . N/A (15,505) 15,218 30,236
Cumulative change in market value . . . . . . . . . . . . . . . . . N/A $ (4,592) $ (11,171) $ (30,512)
Percent change of market value portfolio equity (B) . . . . . . . . N/A 3.0% (7.3)% (19.8)%
AS OF DECEMBER 31, 2000
- -----------------------
Change in market values of:
Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,908 $ 2,448 $ (9,763) $ (25,723)
Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,975) (1,624) 1,865 3,818
Interest rate agreements . . . . . . . . . . . . . . . . . . . . . . (591) (524) 2,220 6,479
Cumulative change in market value . . . . . . . . . . . . . . . . . $ 9,342 $ 300 $ (5,678) $ (15,426)
Percent change of market value portfolio equity (B) . . . . . . . . 9.5% 0.3% (5.7)% (15.6)%
- ---------------
(A) Change in market value of assets, liabilities or interest rate agreements
in a parallel shift in the yield curve, up and down 1% and 2%.
(B) Total change in estimated market value as a percent of market value
portfolio equity as of December 31, 2001 and December 31, 2000.
(C) A decrease in interest rates by 200 basis points (2%) would imply rates on
liabilities at or below zero.
INTEREST RATE SENSITIVITY ANALYSIS. The values under the heading "Base" are
management's estimates of spread income for assets, liabilities and interest
rate agreements on December 31, 2001. The values under the headings "100",
"200", "(100)" and "(200)" are management's estimates of the income and change
in market value of those same assets, liabilities and interest rate agreements
assuming that interest rates were 100 and 200 basis points, or 1 and 2 percent
higher and lower. The cumulative change in income or market value represents the
change in income or market value of assets, net of the change in income or
market value of liabilities and interest rate agreements.
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 our interest rate sensitivity and
hedged position quarterly. Although management also evaluates the portfolio
using interest rate increases and decreases less than and greater than one
percent, management focuses on the one percent increase.
ASSUMPTIONS USED IN INTEREST RATE SENSITIVITY ANALYSIS. Management uses a
variety of estimates and assumptions in determining the income and market value
of assets, liabilities and interest rate agreements. 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 December 31, 2001.
Management's analysis for assessing interest rate sensitivity on its
mortgage loans relies significantly on estimates for prepayment speeds. A
prepayment model has been internally developed based upon four main factors:
o Refinancing incentives (the interest rate of the mortgage compared
with the current mortgage rates available to the borrower)
o Borrower credit grades
o Loan-to-value ratios
o Prepayment penalties, if any
8
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 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 because the penalty
is a deterrent to refinancing.
These factors are weighted based on management's experience and an
evaluation of the important trends observed in the non-conforming mortgage
origination industry. Actual results may differ from the estimates and
assumptions used in the model and the projected results as shown in the
sensitivity analyses.
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, loan to value, 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. Prepayment assumptions are also multiplied by a factor
of greater than 100% during periods around rate resets and prepayment penalty
expirations. These assumptions change with levels of interest rates. The actual
historical speeds experienced on our loans shown in Table 6 are weighted average
speeds of all loans in each deal.
As shown above, 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. 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.
HEDGING. 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 mortgage assets and the differences between interest rate
adjustment indices and interest rate adjustment periods of adjustable-rate
mortgage loans and related borrowings.
We use interest rate cap and swap contracts to mitigate the risk of the
cost of variable rate liabilities increasing at a faster rate than the earnings
on 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 our
best interest, given the cost of hedging transactions and the need to maintain
REIT status.
We seek to build a balance sheet and undertake an interest rate risk
management program that is likely, in management's view, to enable us 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 us and a third
party firm or "counter-party". The counterparty agrees to make payments to us in
the future should the one- or three-month LIBOR interest rate rise above the
strike rate specified in the contract. We make either quarterly premium payments
or have chosen to pay the premiums at the beginning 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. When the referenced LIBOR interest rate
rises above the contractual strike rate, we earn cap income. Payments on an
annualized basis equal the contractual notional face amount times the difference
between actual LIBOR and the strike rate. Interest rate swaps have similar
characteristics. However, interest rate swap agreements allow us to pay a fixed
rate of interest while receiving a rate that adjusts with one-month LIBOR.
OTHER RISK FACTORS
Although management considers the risk components set forth above to be its
primary business risks, the following are other risks that should be considered
by our investors. Further information regarding these risks is included in our
registration statements filed with the Commission.
o OUR DEPENDENCE UPON BORROWINGS CAN RESULT IN SIGNIFICANT LIQUIDITY
CONSTRAINTS. Our profitability is dependent upon our ability to borrow
money on favorable terms. In October 1998, the capital markets faced
9
a liquidity crisis with respect to the availability of short-tem
borrowings from major lenders and long-term borrowings through
securitization. We faced significant liquidity constraints.
o WE HAVE A LIMITED OPERATING HISTORY AND INCURRED SIGNIFICANT NET
LOSSES IN 1999 AND 1998.We have not yet developed an extensive
earnings history or experienced a wide variety of interest rate or
market conditions. Historical operating performance may be of limited
relevance in predicting future performance. We have incurred
significant net losses in 1999 and 1998.
o SHOULD WE FAIL TO MAINTAIN REIT STATUS, WE WOULD BE SUBJECT TO TAX AS
A REGULAR CORPORATION. If we fail to maintain our qualification as a
REIT, we would be subject to federal income tax as a regular
corporation. We intend to conduct our business at all times in a
manner consistent with the REIT provisions of the Code.
o CHANGES IN INTEREST RATES MAY ADVERSELY AFFECT RESULTS OF OPERATION.
Our results of operations are likely to be adversely affected during
any period of unexpected or rapid changes in interest rates. For
example, a substantial or sustained increase in interest rates could
adversely affect our ability to acquire mortgage loans in expected
volumes necessary to support our fixed overhead expense levels.
o INTEREST RATE FLUCTUATIONS MAY ADVERSELY AFFECT THE VALUE OF MORTGAGE
LOANS HELD-FOR-SALE OR SECURITIZATION. Declines and increases in
interest rates will cause the value of a loan to rise and fall,
respectively, if the yield spread, or basis, between the loan and the
duration-matched treasury remains the same. The basis does fluctuate
over time, however, and we may experience mark-to-market gains and
losses on our unsecuritized portfolio even though interest rates may
have remained stable. This may effect the value of future
securitizations if the decrease in market value on loans was caused by
basis widening in the securitization market, which would make
long-term, non-recourse financing more expensive. Basis changes may
not have an effect on future securitizations if, for example, there
was simply an over supply in the whole loan market and securitization
spreads had remained constant.
o FINANCING WITH REPURCHASE AGREEMENTS MAY LEAD TO MARGIN CALLS IF THE
MARKET VALUE OF MORTGAGE ASSETS DECLINE.We use repurchase agreements
to finance the acquisition of mortgage assets in the short-term. In a
repurchase agreement, we sell an asset and agree to repurchase the
same asset at some period in the future. Generally, the repurchase
agreements we entered into stipulate that we must repurchase the asset
in 30 days. For financial accounting purposes, these arrangements are
treated as secured financings. We retain the assets on our balance
sheet and record an obligation to repurchase the asset. The amount we
may borrow under these arrangements is generally 96% to 98% of the
asset market value. When asset market values decrease, we are required
to repay the margin, or difference in market value. To the extent the
market values of assets financed with repurchase agreements decline
rapidly, we will be required to meet cash margin calls. If cash is
unavailable, we may be forced to default under the terms of the
repurchase agreement. In that event, the lender retains the right to
liquidate the collateral to settle the amount due from us.
o INTENSE COMPETITION IN THE NON-CONFORMING MORTGAGE INDUSTRY MAY RESULT
IN REDUCED NET INCOME OR IN REVISED UNDERWRITING STANDARDS WHICH WOULD
ADVERSELY AFFECT OPERATIONS. We face intense competition from
commercial banks, savings and loans, other independent mortgage
lenders and brokers, and certain other mortgage REITs. In addition,
Fannie Mae and Freddie Mac are expanding their participation in the
non-conforming mortgage loan market we serve. Any increase in the
competition among lenders to originate or purchase non-conforming
mortgage loans may result in either reduced interest income on
mortgage loans compared to present levels or revised underwriting
standards permitting higher loan-to-value ratios on properties
securing non-conforming mortgage loans.
o CURRENT LOAN PERFORMANCE DATA MAY NOT BE INDICATIVE OF FUTURE RESULTS.
Management uses estimates and assumptions based on actual experience
with the mortgage loans. Actual results and the time of certain events
could differ materially from those projected, due to factors including
general economic conditions, fluctuations in interest rates,
fluctuations in prepayment speeds, and fluctuations in losses due to
defaults on mortgage loans. These fluctuations could rise to levels
that would adversely affect profitability.
o FAILURE TO RENEW OR OBTAIN ADEQUATE FUNDING UNDER WAREHOUSE FACILITIES
AND REPURCHASE AGREEMENTS MAY MATERIALLY ADVERSELY IMPACT OUR LENDING
OPERATIONS.We are currently dependent upon a limited number of primary
credit facilities for funding mortgage loan originations and
acquisitions. Any failure to renew or obtain adequate funding under
these financing arrangements could have a material adverse effect on
our lending operations and our overall performance.
10
o FAILURE TO HEDGE EFFECTIVELY AGAINST INTEREST RATE CHANGES MAY
ADVERSELY AFFECT RESULTS OF OPERATIONS. Asset/liability management
hedging strategies involve risk and may not be effective in reducing
our exposure to interest rate changes. Moreover, compliance with the
REIT provisions of the Internal Revenue Code ("the Code") may prevent
us from effectively implementing the strategies that we determine,
absent such compliance, would best insulate us from the risks
associated with changing interest rates.
o WE FACE LOSS EXPOSURE DUE TO THE UNDERLYING REAL ESTATE. A substantial
portion of our mortgage assets consists of single family mortgage
loans or mortgage securities evidencing interests in single family
mortgage loans. We will be subject to the risk of loss on mortgage
assets arising from borrower defaults to the extent not covered by
third-party credit enhancement.
o MARKET FACTORS MAY LIMIT OUR ABILITY TO ACQUIRE MORTGAGE ASSETS AT
YIELDS WHICH ARE FAVORABLE RELATIVE TO BORROWING COSTS. Despite
management's experience in the acquisition of mortgage assets and its
relationships with various mortgage suppliers, there can be no
assurance that we will be able to acquire sufficient mortgage assets
from mortgage suppliers at spreads above our cost of funds.
o RESTRICTIONS ON OWNERSHIP OF CAPITAL STOCK MAY INHIBIT MARKET ACTIVITY
AND THE RESULTING OPPORTUNITY FOR HOLDERS OF OUR CAPITAL STOCK AND
WARRANTS TO RECEIVE A PREMIUM FOR THEIR SECURITIES. In order for us to
meet the requirements for qualification as a REIT, our charter
generally prohibits any person from acquiring or holding, directly or
indirectly, shares of common stock in excess of 9.8% of the
outstanding shares. This restriction may inhibit market activity and
the resulting opportunity for the holders of our common stock to
receive a premium for their stock that might otherwise exist in the
absence of these restrictions.
o MORTGAGE INSURERS MAY NOT PAY CLAIMS RESULTING IN INCREASED CREDIT
LOSSES OR MAY IN THE FUTURE CHANGE THEIR PRICING OR UNDERWRITING
GUIDELINES.We have placed reliance on mortgage insurance to mitigate
the risk of credit losses. However there can be no assurance that the
mortgage insurers will continue to have the financial ability to pay
all claims presented. In addition, insurers have the right to deny a
claim if the loan is not properly serviced or has been defectively
originated. We also have the risk that mortgage insurance providers
will revise their guidelines to an extent where we will no longer be
able to acquire coverage on all of our new production.
o ACCESS TO ADDITIONAL CAPITAL MAY ULTIMATELY CURTAIL GROWTH. Cash is
required to fund loans we originate as financing arrangements allow us
to borrow a percentage, typically 98%, of the mortgage note amount. If
we are unable to obtain sufficient cash resources, we may not sustain
asset growth. Liquidity and capital resources are discussed further
under the "Liquidity and Capital Resources" section presented
elsewhere in this report.
o OUR FAILURE TO COMPLY WITH FEDERAL, STATE OR LOCAL REGULATION OF
MORTGAGE LENDING, OF BROKER COMPENSATION PROGRAMS OR OF OUR LOCAL
BRANCH OPERATIONS COULD ADVERSELY AFFECT OUR OPERATIONS AND
PROFITABILITY. As a mortgage lender, we are subject to many laws and
regulations. Any failure to comply with these rules and their
interpretations or with any future interpretations or judicial
decisions could cause a material adverse impact on our profitability
or a change in the way we do business. For example, several lawsuit
have been filed challenging payments made by a lender to a broker,
similar to payments we make to our independent brokers. Similarly, in
our branch operations, we allow our branch managers considerable
autonomy which could result in greater exposure to third-party claims
where our otherwise effective compliance programs are not strictly
adhered to.
FEDERAL INCOME TAX CONSEQUENCES
GENERAL.We believe we have complied, and intend to comply in the future,
with the requirements for qualification as a REIT under the Code. To the extent
that we qualify as a REIT for federal income tax purposes, we generally will not
be subject to federal income tax on the amount of income or gain that is
distributed to shareholders. However, origination and broker operations are
conducted through NovaStar Mortgage and NovaStar Home Mortgage, which are owned
by NFI Holding - a taxable REIT subsidiary. Consequently, all of the taxable
income of NFI Holding is subject to federal and state corporate income taxes.
The REIT rules generally require that a REIT invest primarily in real
estate-related assets, its activities be passive rather than active and it
distribute annually to our shareholders substantially all of its taxable income.
We could be subject to a number of taxes if we failed to satisfy those rules or
if we acquired certain types of
11
income-producing real property through foreclosure. Although no complete
assurance can be given, we do not expect that we will be subject to material
amounts of such taxes.
Failure to satisfy certain Code requirements could cause loss of REIT
status. If we fail to qualify as a REIT for any taxable year, we would be
subject to federal income tax (including any applicable minimum tax) at regular
corporate rates and would not receive deductions for dividends paid to
shareholders. As a result, the amount of after-tax earnings available for
distribution to shareholders would decrease substantially. While we intend to
operate in a manner that will enable it to qualify as a REIT in future taxable
years, there can be no certainty that such intention will be realized. Loss of
REIT status would reduce the amount of any distributions by taxes due, but the
character of such distributions for tax purposes should be unaffected.
QUALIFICATION AS A REIT. Qualification as a REIT requires that we satisfy a
variety of tests relating to income, assets, distributions and ownership. The
significant tests are summarized below. We will make available more detailed
information regarding our compliance with the REIT rules upon request.
SOURCES OF INCOME.We must satisfy two tests with respect to the sources of
income: the 75% income test, and the 95% income test. The 75% income test
requires that we derive at least 75% of gross income, excluding gross income
from prohibited transactions, from certain real estate-related sources.
Management believes that income qualified for both of the income tests during
2001.
In order to satisfy the 95% income test, at least an additional 20% of
gross income for the taxable year must consist either of income that qualifies
under the 75% income test or dividends and interest.
NATURE AND DIVERSIFICATION OF ASSETS. As of the last day of each calendar
quarter, we must meet three asset tests. Under the 75% of assets test, at least
75% of the value of our total assets must represent cash or cash items
(including receivables), government securities or real estate assets. Under the
10% asset test, we may not own more than 10% of the outstanding securities of
any single non-governmental issuer, if these securities do not qualify under the
75% asset test. There is an exception for electing corporations of which we own
at least 35% of the outstanding securities. We intend to make this election.
Under the 5% asset test, ownership of any stocks or securities that do not
qualify under the 75% asset test must be limited, in respect of any single
non-governmental issuer, to an amount not greater than 5% of the value of our
total assets. The definition of security for this purpose includes financial
contracts and instruments that we acquire in the normal course of business.
If we inadvertently fail to satisfy one or more of the asset tests at the
end of a calendar quarter, such failure would not cause us to lose our REIT
status. We still could avoid disqualification by eliminating any discrepancy
within 30 days after the close of the calendar quarter in which the discrepancy
arose. Management believes that we complied with the asset tests for all
quarters during 2001.
OWNERSHIP OF COMMON STOCK. Our capital stock must be held by a minimum of
100 persons for at least 335 days of each year. In addition, at all times during
the second half of each taxable year, no more than 50% in value of our capital
stock may be owned directly or indirectly by 5 or fewer individuals. We use the
calendar year as our taxable year for income tax purposes. The Code requires us
to send annual information questionnaires to specified shareholders in order to
assure compliance with the ownership tests. Management believes that we have
complied with these stock ownership tests for 2001.
DISTRIBUTIONS.We must distribute at least 90% of our taxable income and any
after-tax net income from certain types of foreclosure property less any
non-cash income. No distributions are required in periods in which there is no
income.
TAXABLE INCOME. We use the calendar year for both tax and financial
reporting purposes. However, there may be differences between taxable income and
income computed in accordance with accounting principles generally accepted in
the United States of America (GAAP). These differences primarily arise from
timing and character differences in the recognition of revenue and expense and
gains and losses for tax and GAAP purposes. Additionally, taxable income does
not include the taxable income of our taxable subsidiary, although the
subsidiary's operating results are included in our GAAP results.
PERSONNEL
As of December 31, 2001, we employed 970 people. Of these, our affiliated
branches employed 594; 347 were employed in our wholesale lending and servicing
operations the remainder in our portfolio management and administrative
functions.
12
ITEM 2. PROPERTIES
Our executive and administrative offices are located in Westwood, Kansas,
and consist of approximately 7,000 square feet of leased office space. The lease
agreements on the premises expire through January 2007. The current annual rent
for these offices is approximately $161,000.
We lease office space for our mortgage lending operations in Orange County,
California and Independence, Ohio. Currently, these offices consist of
approximately 30,000 square feet. The lease on the premise expires January 2006,
and the current annual rent is approximately $553,000.
We also lease office space for our mortgage servicing operation in
Westwood, Kansas. The square footage on these premises is approximately 24,000,
with annual rent of approximately $344,000, and a lease scheduled to expire in
January 2005.
NovaStar Home Mortgage leases space for its net branch operation in
Westwood, Kansas. The square footage for this space is approximately 11,000
square feet. The lease of this space expires December 2004, and the current
annual rent is approximately $228,000.
ITEM 3. LEGAL PROCEEDINGS
We occasionally become involved in litigation arising in the normal course
of business. Management believes that any liability with respect to such legal
actions, individually or in the aggregate, will not have a material adverse
effect on its financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
13
PART II
ITEM 5. A. MARKET FOR REGISTRANT'S COMMON EQUITY
The common stock of NovaStar Financial is traded on the NYSE under the
symbol "NFI". The following table sets forth, for the periods indicated, the
high and low sales prices per share of common stock on the NYSE and the cash
dividends paid or payable per share of capital stock.
COMMON STOCK PRICES CASH DIVIDENDS(A)
- ------------------------------------------- ------------------------------------------------------
CLASS OF PAID OR AMOUNT
HIGH LOW STOCK DECLARED PAYABLE PER SHARE
-------- ------- ------------ ------------ ----------- -------------
1/1/00 to 3/31/00 . . . . $ 4.38 $ 3.13 Preferred 4/26/00 5/10/00 $0.12
4/1/00 to 6/30/00 . . . . 4.19 2.88 Preferred 7/26/00 8/10/00 0.12
7/1/00 to 9/30/00 . . . . 4.06 2.88 Preferred 10/25/00 11/10/00 0.12
10/1/00 to 12/31/00 . . . 4.31 3.56 Preferred 12/20/00 1/10/01 0.12
1/1/01 to 3/31/01 . . . . 6.20 3.75 Preferred 4/27/01 5/10/01 0.12
4/1/01 to 6/30/01 . . . . 8.50 5.55 Preferred and 7/26/01 8/10/01 0.13
Common
7/1/01 to 9/30/01 . . . . 11.80 8.05 Preferred and 10/25/01 11/10/01 0.36
Common
10/1/01 to 12/31/01 . . . . 18.10 10.35 Preferred 12/19/01 1/10/02 0.47
Common 12/19/01 1/14/02 0.47
- ---------------
(A) We did not declare dividends on common stock during 1999 and 2000.
(B) We issued the class B 7% convertible preferred stock in March 1999, which
converted to common stock in February 2002.
As of March 5, 2002, more than 2,000 stockholders held our 10,356,047
shares of common stock as provided by third party brokers and transfer agent
reports.
We intend to make distributions to stockholders of all or substantially all
of taxable income in each year, subject to certain adjustments, so as to qualify
for the tax benefits accorded to a REIT under the Code. All distributions will
be made at the discretion of the Board of Directors and will depend on earnings,
financial condition, maintenance of REIT status and other factors as the Board
of Directors may deem relevant.
B. RECENT SALES OF UNREGISTERED SECURITIES
None.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following selected consolidated financial data are derived from our
audited consolidated financial - statements for the periods presented and should
be read in conjunction with the more detailed information therein and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this annual report. Operating results are not
necessarily indicative of future performance.
14
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------
2001(A) 2000 1999 1998 1997
----------- -------- -------- -------- --------
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Interest income . . . . . . . . . . . . . . . . . . . $ 58,069 $ 47,627 $ 66,713 $100,747 $ 36,961
Interest expense . . . . . . . . . . . . . . . . . . 28,588 34,696 46,758 80,794 28,185
Net interest income before
provision for credit losses . . . . . . . . . . . . 29,481 12,931 19,955 19,953 8,776
Provision for credit losses . . . . . . . . . . . . . 3,773 5,449 22,078 7,430 2,453
Equity in net income (loss)-
NFI Holding . . . . . . . . . . . . . . . . . . . . - 1,123 88 (2,984) 28
Gain (loss) on derivative instruments
and sales of mortgage assets . . . . . . . . . . . 34,616 (826) 351 (14,962) 51
General and administrative expenses . . . . . . . . . 49,443 3,017 3,590 4,379 3,451
Income (loss) before cumulative effect
of change in accounting principle . . . . . . . . . 34,014 5,626 (7,092) (21,821) (1,135)
Cumulative effect of change in
accounting principle(B) . . . . . . . . . . . . . . (1,706) - - - -
Net income (loss) . . . . . . . . . . . . . . . . . . 32,308 5,626 (7,092) (21,821) (1,135)
Basic earnings (loss) per share . . . . . . . . . . . $ 3.22 $ 0.51 $ (1.08) $ (2.71) $ (0.26)
Diluted earnings (loss) per share . . . . . . . . . . $ 3.02 $ 0.50 $ (1.08) $ (2.71) $ (0.26)
AS OF DECEMBER 31,
-----------------------------------------------------
2001 2000 1999 1998 1997
----------- -------- -------- -------- ----------
Consolidated Balance Sheet Data
Mortgage Assets:
Mortgage loans . . . . . . . . . . . . . . . . . . $ 365,560 $375,927 $620,406 $945,798 $ 574,984
Mortgage securities . . . . . . . . . . . . . . . . 71,584 46,650 6,775 - 517,246
Total assets . . . . . . . . . . . . . . . . . . . . 512,380 494,482 689,427 997,754 1,126,252
Borrowings . . . . . . . . . . . . . . . . . . . . . 362,398 382,437 586,868 891,944 1,002,560
Stockholders' equity . . . . . . . . . . . . . . . . 129,997 107,919 100,161 82,808 116,489
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2001 2000 1999 1998 1997
----------- -------- -------- -------- ----------
OTHER DATA
Loans originated, principal . . . . . . . . . . . . . $ 1,338,476 $719,341 $452,554 $878,871 $ 409,974
Branches, end of year . . . . . . . . . . . . . . . . 123 63 1 - -
Loans brokered through branches . . . . . . . . . . . $ 1,087,971 $193,191 - - -
Annualized return on assets . . . . . . . . . . . . . 6.03% 0.97% (0.83)% (1.66)% (0.01)%
Annualized return on equity . . . . . . . . . . . . . 27.04% 5.50% (6.71)% (20.71)% (0.06)%
Taxable income (loss) . . . . . . . . . . . . . . . . $ 5,242 $ 525 $ (90) $ (2,628) $ 1,434
Taxable income (loss) per share . . . . . . . . . . . $ 0.91 $ - $ (.01) $ (0.32) $ 0.18
Dividends declared per common share . . . . . . . . . $ 0.96 $ - $ - $ 1.00 $ 0.28
Dividends declared per preferred share . . . . . . . $ 1.08 $ 0.49 $ 0.37 $ - $ 0.18
Number of account executives . . . . . . . . . . . . 112 85 47 63 36
- --------------------
(A) Includes the assets, liabilities, equity and results of operations for NFI
Holding Corporation. We acquired the common stock of NFI Holding
Corporation on January 1, 2001. Details of this transaction are discussed
in Note 9 to our consolidated financial statements.
(B) Implementation of Statement of Financial Accounting Standards, No. 133 as
discussed in Note 1 to our consolidated financial statements.
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements of NovaStar Financial and the notes thereto
included elsewhere in this report.
SAFE HARBOR STATEMENT
"Safe Harbor" statement under the Private Securities Litigation Reform Act
of 1995: Statements in this discussion regarding NovaStar Financial, Inc.
(NovaStar Financial) and its business, which are not historical facts, are
"forward-looking statements" that involve risks and uncertainties. Certain
matters discussed in this report may constitute forward-looking statements
within the meaning of the federal securities laws that inherently include
certain risks and uncertainties. Actual results and the time of certain events
could differ materially from those projected in or contemplated by the
forward-looking statements due to a number of factors, including general
economic conditions, fluctuations in interest rates, fluctuations in prepayment
speeds, fluctuations in losses due to defaults on mortgage loans, the
availability of non-conforming residential mortgage loans, the availability and
access to financing and liquidity resources, and other risk factors outlined in
the section title "Risk Management." Other factors not presently identified may
also cause actual results to differ. Management continuously updates and revises
these estimates and assumptions based on actual conditions experienced. It is
not practicable to publish all revisions and, as a result, no one should assume
that results projected in or contemplated by the forward-looking statements will
continue to be accurate in the future.
DESCRIPTION OF BUSINESSES
INVESTMENT PORTFOLIO
o We invest in assets generated primarily from our wholesale origination
of non-conforming, single-family, residential mortgage loans.
o We operate as a long-term portfolio investor.
o Financing is provided by issuing asset-backed bonds and entering into
reverse repurchase agreements.
o Earnings are generated from return on mortgage securities and spread
income on the mortgage loan portfolio.
RESIDENTIAL MORTGAGE LENDING AND SERVICING
o Our primary customer is the retail mortgage broker who deals with the
borrower.
o Our 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.
o We finance our loans through short-term warehouse and repurchase
facilities.
o Loans we originate are held-for-sale in either outright sales for cash
or in securitization transactions.
o We service the loans we originate.
AFFILIATED BRANCHES
o Retail mortgage branches that broker loans for 200 investors,
including NovaStar Mortgage, Inc.
o Branches operate under policies we established.
o The net operating income for the branch is returned as compensation to
the branch "owner/manager."
PRESENTATION
On January 1, 2001, we purchased the voting common shares of NFI Holding.
Previously, two members of management owned these securities. Prior to January
1, 2001, the assets and liabilities and operating results of NFI Holding were
not consolidated with that of NovaStar Financial. Beginning January 1, 2001, the
financial statements of NFI Holding are consolidated with those of NovaStar
Financial. For comparative purposes, we have presented
16
prior period information as if the financial results of NFI Holding had been
consolidated with those of NovaStar Financial in relevant analyses that follow.
In these cases, we have marked the pro forma information accordingly. Note 9 of
the consolidated financial statements presents pro forma consolidated operating
results.
SIGNIFICANCE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America and,
therefore, are required to make estimates regarding the values of our assets and
in recording income and expenses. These estimates are based, in part, on our
judgment and assumptions regarding various economic conditions that we believe
are reasonable based on facts and circumstances existing at the time of
reporting. The result of these estimates affect reported amounts of assets at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the periods presented. The following summarizes the
components of our consolidated financial statements where understanding
accounting policies is critical to understand and evaluate our reported
financial results, especially given the significant estimates used in applying
the policies.
MORTGAGE SECURITIES. Our mortgage securities primarily consist of the right
to receive the future cash flow from a pool of securitized mortgage loans. Our
interest in these securities consist of:
- The interest spread between the coupon on the underlying loans and the
cost of financing.
- Prepayment penalties received from borrowers who payoff their loans
early in their life.
- Overcollateralization, which is designed to protect the primary
bondholder from credit loss on the underlying loans.
The cash flow we receive is highly dependent upon interest rate
environment. The cost of financing for the securitized loans is indexed to
short-term interest rates, while the loan coupons are less interest sensitive.
As a result, as rates rise and fall, our cash flow will fall and rise, which in
turn will increase or decrease the value of our mortgage securities. Likewise,
increasing or decreasing cash flow will increase or decrease the yield on our
securities. We adjust our yield (rate of income recognition) prospectively based
on the expectation for cash flow on the securities.
In estimating the value of our mortgage securities and in establishing the
rate of income recognition from the securities, management uses assumptions
regarding economic conditions, including interest rates, principal payment and
prepayment and loan defaults. The rate used to discount the projected cash flow
is critical in the evaluation of our mortgage securities. Information regarding
the assumption we used in the preparation of our consolidated financial
statements is discussed under "Mortgage Securities" in the following discussion
and in Note 3 to our consolidated financial statements.
TRANSFERS OF ASSETS (LOAN SECURITIZATION) AND RELATED GAINS.We combine the
mortgage loans we originate and mortgage securities in pools to serve as
collateral for asset-backed bonds that are issued to the public. The loans or
securities are transferred to a trust designed to serve only for the purpose of
holding the collateral. The owners of the asset-backed bonds have no recourse to
us in the event the collateral does not perform as planned. When these transfers
are executed in a manner such that we have no control over the collateral, the
transfer is accounted for as a sale. We do retain the right to service the
underlying mortgage loans and we also retain certain mortgage securities issued
by the trust (see Mortgage Securities above). A gain on the sale is recorded.
These gains represent a significant portion of our operating results. When we do
have the ability to exert control over the transferred collateral, the assets
remain on our financial records and a liability is recorded for the related
asset-backed bonds.
The gain recognized upon securitization depends on, among other things, the
fair value of the components of the securitization-the loans or securities
transferred, the securities retained and the mortgage servicing rights. The
value of these components is estimated at the time of the securitization. In
estimating these values, management uses assumptions regarding economic
conditions and the make-up of the collateral, including interest rates,
principal payment and prepayment and loan defaults. The rate used to discount
the cash flow projections is critical in the evaluation of our mortgage
securities. Information regarding the assumption we used is discussed under
"Mortgage Securities" in the following preceding discussion and in Note 3 to our
consolidated financial statements.
MORTGAGE LOANS, ALLOWANCE FOR CREDIT LOSSES AND ASSETS ACQUIRED THROUGH
FORECLOSURE. Mortgage loans that are not available-for-sale are recorded at
their cost, adjusted for the amortization of deferred costs and for credit
losses inherent in the portfolio. An allowance is maintained for credit losses.
17
Assets acquired through foreclosure are carried at the lower-of-cost or
estimated fair value less estimated selling costs. The carrying value of the
loan is adjusted at the time of foreclosure using a charge to the allowance for
credit losses.
The allowance, and therefore the related charges to income, is based on the
assessment by management of various factors affecting our mortgage loan
portfolio, including current and projected economic conditions, the makeup of
the portfolio based on credit grade, loan-to-value, delinquency status, mortgage
insurance we purchase and other relevant factors. The allowance is maintained
through ongoing provisions charged to operating income. Significant changes in
the portfolio, our ability to obtain mortgage insurance and/or economic
conditions may affect the allowance for credit losses and net income. The
make-up of our mortgage loan portfolio is discussed below under "Mortgage Loans"
and in Note 2 to our consolidated financial statements. The allowance for credit
losses is discussed below under that heading. We discuss purchased mortgage
insurance under the heading "Premiums Paid for Mortgage Insurance."
FINANCIAL CONDITION OF NOVASTAR FINANCIAL AS OF DECEMBER 31, 2001 AND 2000
MORTGAGE LOANS. Our balance sheet consists primarily of mortgage loans we
have originated. We classify our mortgage loans into two categories:
held-for-sale and held-in-portfolio. A majority of our loans serve as collateral
for asset-backed bonds we have issued and are classified as held-in-portfolio.
The carrying value of held-in-portfolio mortgage loans as of December 31, 2001
was $226 million compared to $376 million as of December 31, 2000.
Loans we have originated, but have not yet sold or securitized, are
classified as "held-for-sale." We expect to sell these loans outright in third
party transactions or in securitization transactions that will be, for tax and
accounting purposes, recorded as sales. We use warehouse lines of credit and
mortgage repurchase agreements to finance our held-for-sale loans.
Premiums are paid on substantially all mortgage loans. Premiums are
amortized as a reduction of interest income over the estimated lives of the
assets. Tables 3 and 6 provide information to analyze the impact of principal
payments on amortization.
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 repay their mortgage principal balances earlier
than is required by the terms of their mortgages. Non-conforming borrowers, as
they update their credit rating, are more likely to refinance their mortgage
loan to obtain a lower interest rate. To mitigate the effect of prepayments on
interest income from mortgage loans, we strive to originate mortgage loans with
prepayment penalties.
Prepayment rates in Table 6 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. This information has not been presented for heldfor- sale
loans as we do not expect to own the loans for a period long enough to
experience material repayments.
Characteristics of the mortgage loans we own are provided in Tables 1
through 6. The operating performance of our mortgage loan portfolio, including
net interest income, allowances for credit losses and effects of hedging, are
discussed under "Results of Operations" and "Interest Rate/Market Risk." Gains
on the sales of mortgage loans, including impact of securitizations treated as
sales, is also discussed under "Results of Operations."
18
TABLE 1
MORTGAGE LOANS BY CREDIT GRADE
(DOLLARS IN THOUSANDS)
DECEMBER 31,
-------------------------------------------------------------
2001 2000
----------------------------- ------------------------------
WEIGHTED WEIGHTED
ALLOWED MAXIMUM WEIGHTED AVERAGE WEIGHTED AVERAGE
CREDIT MORTGAGE LOAN-TO- CURRENT AVERAGE LOAN-TO- CURRENT AVERAGE LOAN-TO-
GRADE LATES (A) VALUE PRINCIPAL COUPON VALUE PRINCIPAL COUPON VALUE
- ----- --------- ----- --------- ------ ----- --------- ------ -----
Held-in-portfolio:
AA . . . . . . . . . . . 0 x 30 95 $ 35,922 9.59% 82.1% $ 56,463 10.17% 82.6%
A . . . . . . . . . . . 1 x 30 90 90,775 10.05 79.1 152,621 10.66 79.4
A- . . . . . . . . . . . 2 x 30 90 53,971 10.52 81.5 88,617 11.30 81.7
B . . . . . . . . . . . 3 x 30, 1 x 60 85 28,400 11.05 77.4 51,001 11.80 78.1
5 x 30, 2 x 60
C . . . . . . . . . . . . 1 x 90 75 15,122 11.53 72.3 22,902 12.30 72.8
D . . . . . . . . . . . . 6 x 30, 3 x 60, 2 x 90 65 2,770 12.15 64.8 4,268 13.13 63.8
-------- --------
$226,960 10.34% 79.3% $375,872 11.02% 79.7%
======== ===== ==== ======== ===== ====
Held-for-sale:
Alt A . . . . . . . . . . 0 x 30 95 $ 11,662 8.74% 85.8%
AAA . . . . . . . . . . . 0 x 30 97(B) 28,892 8.70 74.5
AA . . . . . . . . . . . 0 x 30 95 32,352 9.14 78.9
A . . . . . . . . . . . . 1 x 30 90 25,218 9.21 79.1
A- . . . . . . . . . . . 2 x 30 90 10,964 9.21 79.1
B . . . . . . . . . . . . 3 x 30, 1 x 60, 85 8,828 9.33 74.8
5 x 30, 2 x 60
C . . . . . . . . . . . . 1 x 90 75 599 11.77 75.1
Other . . . . . . . . . . Varies 97 19,713 9.33 94.1
--------
$138,228 9.08% 80.2%
======== ==== ====
- -----------------
(A) Represents the number of times a prospective borrower is allowed to be late
more than 30, 60 or 90 days. For instance, a 3 x 30, 1 x 60 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) 97% on fixed-rate only; all other maximum of 95%.
TABLE 2
MORTGAGE LOANS BY GEOGRAPHIC CONCENTRATION
PERCENT OF CURRENT PRINCIPAL AS OF DECEMBER 31, 2001
HELD-IN-PORTFOLIO HELD-FOR-SALE
----------------- -------------
COLLATERAL LOCATION
Florida . . . . . . . . . . . . . . . 16% 11%
California . . . . . . . . . . . . . . 13 23
Washington . . . . . . . . . . . . . . 6 1
Oregon . . . . . . . . . . . . . . . . 5 2
Texas . . . . . . . . . . . . . . . . 5 3
Michigan . . . . . . . . . . . . . . . 3 7
Ohio . . . . . . . . . . . . . . . . . 4 5
Nevada . . . . . . . . . . . . . . . . 4 2
Tennessee . . . . . . . . . . . . . . 4 2
All other states . . . . . . . . . . . 40 44
--- ---
Total . . . . . . . . . . . . . . . 100% 100%
=== ===
19
TABLE 3
CARRYING VALUE OF MORTGAGE LOANS BY PRODUCT/TYPE
(DOLLARS IN THOUSANDS)
DECEMBER 31,
-----------------------------------
PRODUCT/TYPE 2001 2000
- ------------ ------------- ------------
Held-in-portfolio:
30/15-year fixed and balloon . . . . . . . . . . $128,299 $185,817
Two and three-year fixed . . . . . . . . . . . . 85,145 166,627
Six-month LIBOR and one-year CMT . . . . . . . . 13,516 23,428
-------- --------
Outstanding principal . . . . . . . . . . . . . 226,960 375,872
Deferred broker premium and costs . . . . . . . 4,630 7,745
Allowance for credit losses . . . . . . . . . . (5,557) (7,690)
-------- --------
Carrying value . . . . . . . . . . . . . . . . . $226,033 $375,927
-------- --------
Carrying value as a percent of principal . . . . 99.59% 100.01%
======== ========
Held-for-sale:
30/15-year fixed and balloon . . . . . . . . . . $ 49,013
Two and three-year fixed . . . . . . . . . . . . 89,215
--------
Outstanding principal . . . . . . . . . . . . . 138,228
Deferred broker premium and costs . . . . . . . 1,453
Allowance for credit losses . . . . . . . . . . (154)
--------
Carrying value . . . . . . . . . . . . . . . . . $139,527
========
Carrying value as a percent of principal . . . . 100.94%
========
TABLE 4
MORTGAGE CREDIT ANALYSIS-HELD-IN-PORTFOLIO LOANS
DECEMBER 31, 2001 (DOLLARS IN THOUSANDS)
DEFAULTS AS PERCENT OF CURRENT PRINCIPAL
CREDIT ORIGINAL CURRENT WEIGHTED AVERAGE LOAN- 60-89 90 DAYS AND FORECLOSURE
GRADE BALANCE PRINCIPAL TO-VALUE RATIO DAYS GREATER AND REO TOTAL
- ----- ------- --------- -------------- ---- ------- ------- -----
NOVASTAR HOME EQUITY SERIES 1997-1:
A . . . . . $ 117,904 $ 12,946 73.1 - 2.8 4.3 7.1
A- . . . . 73,499 9,119 77.3 0.2 8.2 12.1 20.5
B . . . . . 53,812 5,445 72.7 1.5 3.1 16.0 20.6
C . . . . . 23,065 2,903 70.7 - 0.9 - 0.9
D . . . . . 9,021 923 69.4 - - - -
NOVASTAR HOME EQUITY SERIES 1997-2:
AA . . . . $ 3,153 $ 347 86.4 - - - -
A . . . . . 104,582 14,520 79.3 1.2 0.8 9.9 11.9
A- . . . . 63,660 9,384 83.0 0.7 1.4 4.2 6.3
B . . . . . 36,727 4,996 79.0 4.3 0.7 15.7 20.7
C . . . . . 11,354 2,376 69.7 - - 6.3 6.3
D . . . . . 1,529 422 60.4 - - 8.4 8.4
NOVASTAR HOME EQUITY SERIES 1998-1:
AA . . . . $ 59,213 $ 12,633 83.3 2.5 0.5 12.1 15.1
A . . . . . 113,457 25,397 80.7 2.8 2.4 11.6 16.8
A- . . . . 63,100 13,666 82.0 1.0 0.7 13.3 15.0
B . . . . . 38,249 7,464 78.4 4.7 2.5 11.5 18.7
C . . . . . 23,029 4,469 75.4 2.6 1.9 17.6 22.1
D . . . . . 5,495 739 63.6 - 25.5 6.4 31.9
NOVASTAR HOME EQUITY SERIES 1998-2:
AA . . . . $ 64,851 $ 22,942 81.5 2.0 0.4 3.2 5.6
A . . . . . 113,557 37,912 80.6 1.4 1.3 9.5 12.2
A- . . . . 70,399 21,802 83.2 1.1 4.0 7.1 12.2
B . . . . . 40,818 10,495 80.0 3.1 1.7 20.8 25.6
C . . . . . 22,335 5,374 72.5 2.3 1.9 14.6 18.8
D . . . . . 2,951 686 61.5 - - 7.6 7.6
---------- --------
Total . . . $1,115,760 $226,960
========== ========
20
TABLE 5
LOSS ANALYSIS-HELD-IN-PORTFOLIO LOANS
DECEMBER 31, 2001
(DOLLARS IN THOUSANDS)
LOANS REPURCHASED FROM TRUSTS
CUMULATIVE LOSSES AS -------------------------------
REPORTED, AS PERCENT OF LOSS AS A % OF
ORIGINAL BALANCE LOSS AMOUNT ORIGINAL BALANCE TOTAL LOSSES
----------------------- ------------- ------------------ --------------
NHES 1997-1 . . . . . . . . 1.78% $3,522 1.27% 3.05%
NHES 1997-2 . . . . . . . . 2.01 6,299 2.85 4.86
NHES 1998-1 . . . . . . . . 2.16 7,685 2.54 4.70
NHES 1998-2 . . . . . . . . 2.03 2,425 0.77 2.80
TABLE 6
MORTGAGE LOAN COUPON AND PREPAYMENT ANALYSIS
(DOLLARS IN THOUSANDS)
REMAINING
PREPAYMENT
PENALTY CONSTANT PREPAYMENT RATE
PERCENT WITH PERIOD (IN YEARS) (ANNUAL PERCENT)
ORIGINAL CURRENT PREPAYMENT FOR LOANS WITH THREE- TWELVE-
ISSUE DATE PRINCIPAL PRINCIPAL PREMIUM PENALTY COUPON PENALTY MONTH MONTH LIFE
---------- --------- --------- ------- ------- ------ ------- ----- ----- ----
AS OF DECEMBER 31, 2001
HELD-IN-PORTFOLIO-SERVING AS
COLLATERAL FOR NOVASTAR HOME EQUITY
SERIES ASSET BACKED BONDS:
Series 1997-1 October 1, 1997 $ 277,301 $ 31,336 $ 1,453 19% 10.90% 0.09 26 37 39
Series 1997-2 December 11, 1997 221,005 32,045 652 22 10.79 0.18 23 37 37
Series 1998-1 April 30, 1998 302,543 64,368 1,050 24 10.45 0.29 34 40 33
Series 1998-2 August 18, 1998 314,911 99,211 1,475 31 10.18 0.48 39 37 28
---------- --------- -------
Total $1,115,760 $ 226,960 $ 4,630 26% 10.34% 0.33
========== ========= ======= == ===== ====
Held-for-sale: $ 138,228 $ 1,453 79% 9.08% 2.35
========= ======= == ===== ====
AS OF DECEMBER 31, 2000
HELD-IN-PORTFOLIO-SERVING AS
COLLATERAL FOR NOVASTAR HOME EQUITY
SERIES ASSET BACKED BONDS:
Series 1997-1 October 1, 1997 $ 277,301 $ 52,282 $ 2,494 25% 11.80% 0.30 37 40 40
Series 1997-2 December 11, 1997 221,005 53,727 1,040 16 11.55 0.28 45 46 36
Series 1998-1 April 30, 1998 302,543 114,367 1,877 33 11.03 0.46 34 41 30
Series 1998-2 August 18, 1998 314,911 155,496 2,334 60 10.57 0.85 38 33 24
---------- --------- -------
Total $1,115,760 $ 375,872 $ 7,745 40% 11.02% 0.57
========== ========= ======= == ===== ====
MORTGAGE SECURITIES-AVAILABLE-FOR-SALE. During 2001, 2000 and 1999, $1.2
billion, $570 million, and $165 million in loans we originated were pooled in
securitization transactions. These transactions were treated as sales for
accounting and tax purposes. We service the loans sold in these securitizations
and we retained the AAA-rated interest-only, prepayment penalties and other
subordinated securities issued in the securitizations. The December 31, 2001
value of the AAA-rated interest-only, prepayment penalties and other
subordinated interests retained in 2001 securitizations was $59.6 million. Under
the section "Mortgage Loan Sales" we discuss the details of the loan
securitization transactions.
21
During the third quarter of 2001, we resecuritized our NMFT 2000-1 and
2000-2 AAA-rated interest-only and prepayment penalty securities and issued
NovaStar CAPS Certificates 2001-C1 (CAPS 2001-C1) in the amount of $29.3
million. A gain of $14.9 million was recognized on this transaction. We retained
a $8.2 million subordinated interest, which entitles us to the remaining cash
flows once the primary bonds of the CAPS 2001-C1 are paid in full.
As of December 31, 2001 and December 31, 2000, the fair value of mortgage
securities was $71.6 million and $46.7 million, respectively. This amount
represents the present value of the securities' cash flows that we expect to
receive over their lives, considering estimated prepayment speeds and credit
losses of the underlying loans, discounted at an appropriate risk-adjusted
market rate of return. The cash flows are realized over the life of the loan
collateral as cash distributions are received from the trust that owns the
collateral. In estimating the fair value of our mortgage securities, management
must make assumptions regarding the future performance and cash flow of the
mortgage loans collateralizing the securities. These estimates are based on
management's judgements about the nature of the loans. We believe the value of
the securities is fair, 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 income of future
periods. Table 7 summarizes our mortgage securities and the underlying
collateral and senior asset-backed bonds. Table 8 provides a summary of the
critical assumptions used in estimating the cash flows of the collateral and the
resulting estimated fair value of the mortgage securities.
22
TABLE 7
MORTGAGE SECURITIES
(DOLLARS IN THOUSANDS)
ASSET-BACKED BONDS MORTGAGE LOANS
ESTIMATED ---------------------- ----------------------------------------
FAIR VALUE WEIGHTED AVERAGE
OF MORTGAGE REMAINING INTEREST REMAINING ESTIMATED
SECURITIES PRINCIPAL RATE PRINCIPAL COUPON MONTHS TO CALL
---------- ----------- ---------- ----------- -------- ----------------
DECEMBER 31, 2001
NMFT 1999-1
- -----------
Subordinated securities
(non-investment grade) . . . . . . $ 3,661 $ 58,738 4.49% $ 62,665 10.23% 46
NMFT 2000-1
- -----------
Interest only (AAA-rated) . . . . . . . -(A)
Prepayment penalty (AAA-rated) . . . . . -(A)
Subordinated securities
(non-investment grade) . . . . . . . 560
----------
560 145,538 2.18 149,400 10.16 44
NMFT 2000-2
- -----------
Interest only (AAA-rated) . . . . . . . -(A)
Prepayment penalty (AAA-rated) . . . . . -(A)
Subordinated securities
(non-investment grade) . . . . . . . 997
----------
997 252,995 2.18 259,037 10.59 41
NMFT 2001-1
- -----------
Interest only (AAA-rated) . . . . . . . 14,132
Prepayment penalty (AAA-rated) . . . . . 3,648
Subordinated securities
(non-investment grade) . . . . . . . 1,016
----------
18,796 367,468 2.28 373,949 10.35 50
NMFT 2001-2
- -----------
Interest only (AAA-rated). . . . . . . . 31,428
Prepayment penalty (AAA-rated) . . . . . 6,130
Subordinated securities
(non-investment grade) . . . . . . . 1,813
----------
39,371 772,296 2.09 784,617 9.70 61
CAPS 2001-C1
- ------------
Subordinated securities
(non-investment grade) . . . . . . . 8,199 19,241 7.25 -(A) -(A) -(A)
---------- ---------- ----------
Total . . . . . . . . . . . . . . . . . $ 71,584 $1,616,276 $1,629,668
========== ========== ==========
DECEMBER 31, 2000
NMFT 1999-1
- -----------
Subordinated securities
(non-investment grade) . . . . . . . $ 6,900 $ 96,521 6.23 $ 103,968 10.66 64
NMFT 2000-1
- -----------
Interest only (AAA-rated) . . . . . . . 11,697
Prepayment penalty (AAA-rated) . . . . . 2,533
Subordinated securities
(non-investment grade) . . . . . . . 720
----------
14,950 210,261 6.11 216,216 10.18 62
NMFT 2000-2
- -----------
Interest only (AAA-rated) . . . . . . . 19,745
Prepayment penalty (AAA-rated) . . . . . 3,729
Subordinated securities
(non-investment grade) . . . . . . . 1,326
----------
24,800 328,025 6.12 333,865 10.57 58
---------- ---------- ----------
Total . . . . . . . . . . . . . . . . . $ 46,650 $ 634,807 $ 654,049
========== ========== ==========
- ------------------
(A) Collateral for the CAPS 2001-C1 security is the AAA-IO and prepayment
penalty mortgage securities of NMFT 2000- 1 and 2000-2. The performance of
the mortgage loan collateral underlying these securities, as presented in
this table, directly affects the performance of the CAPS 2001-C1 security.
23
TABLE 8
CHARACTERISTICS OF LOAN COLLATERAL, VALUATION OF INDIVIDUAL MORTGAGE
SECURITIES AND ASSUMPTIONS
(DOLLARS IN THOUSANDS)
DECEMBER 31, 2001 DECEMBER 31, 2000
------------------------------------------------------------ --------------------------------
NOVASTAR MORTGAGE CAPS
FUNDING TRUST SERIES: 1999-1 2000-1 2000-2 2001-1 2001-2 2001-C1 TOTAL 1999-1 2000-1 2000-2 TOTAL
------ ------ ------ ------ ------ ------- ----- ------ ------ ------ -----
Discount rate (%) . . . . . . 25 40 40 25 25 40 17 17 17
Constant prepayment rate (%) 30 41 44 39 31 43 32 32 32
As a percent of mortgage
loan principal (%):
Delinquent loans
(30 days and greater) . 8.8 3.7 1.9 2.2 - (A) 17.0 5.7 1.1
Loans in foreclosure . . . 6.0 2.8 2.6 1.1 - (A) 5.5 1.6 0.3
Real estate owned . . . . 5.5 1.7 0.8 0.1 - (A) 4.2 0.1 -
Cumulative losses (as reported) 1.8 0.1 - - - (A) 1.0 - -
Cost basis of individual
mortgage securities:
Interest only (AAA- rated) $ - $ - $ - $ 9,272 $26,783 $ - $36,055 $ - $8,961 $15,607 $24,568
Prepayment penalty
(AAA- rated) . . . . . . . - - - 3,325 4,640 - 7,965 - 1,912 3,758 5,670
Subordinated securities
(non-investment grade) 5,366 413 661 619 421 3,094 10,574 5,265 338 642 6,245
Unrealized gain (loss) . (1,705) 147 336 5,580 7,527 5,105 16,990 1,635 3,739 4,793 10,167
------- ------- ------- ------- ------- ------- ------- ------ ------- ------- -------
Total . . . . . . . . $ 3,661 $ 560 $ 997 $18,796 $39,371 $ 8,199 $71,584 $6,900 $14,950 $24,800 $46,650
======= ======= ======= ======= ======= ======= ======= ====== ======= ======= =======
- ------------------------
(A) Collateral for the CAPS 2001-C1 security is the AAA-IO and prepayment
penalty mortgage securities of NMFT 2000-1 and 2000-2. The performance of
the mortgage loan collateral underlying these securities, as presented in
this table, directly effects the performance of the CAPS 2001-C1 security.
Prepayment assumptions used for each transaction have generally risen as
market interest rates and funding costs havedecreased. Discount rates have been
increased to reflect the market appetite for our securities. While interest
rates are declining and the cash flow from our securities are increasing, the
market place has not recognized the value of these securities, especially given
the minimal credit risk of the securities. The discount rate assumption and
other assumptions used for valuing the CAPS 2001-C1 security are discussed in
the "Sales of Mortgage Assets" section of this document.
The performance of the loans serving as collateral for our mortgage
securities is critical to the return our mortgage securities will generate.
Credit quality and prepayment experience characteristics of the loan collateral,
among others, are important to properly analyze the performance of our mortgage
securities. We have presented characteristics of the loans collateralizing our
mortgage securities in Tables 9 through 14. The operating performance of our
mortgage securities portfolio, including net interest income and effects of
hedging are discussed under "Results of Operations" and "Interest Rate/Market
Risk."
24
TABLE 9
LOANS COLLATERALIZING MORTGAGE SECURITIES CREDIT GRADE
(DOLLARS IN THOUSANDS)
DECEMBER 31,
---------------------------------------------------------------
2001 2000
------------------------------- ------------------------------
WEIGHTED WEIGHTED
ALLOWED MAXIMUM WEIGHTED AVERAGE WEIGHTED AVERAGE
CREDIT MORTGAGE LOAN-TO- CURRENT AVERAGE LOAN-TO- CURRENT AVERAGE LOAN-TO-
GRADE LATES (A) VALUE PRINCIPAL COUPON VALUE PRINCIPAL COUPON VALUE
- ----- --------- -------- ---------- ------ -------- --------- ------ --------
AAA . . . . . . . . 0 x 30 97(B) $ 319,360 9.64% 81.0% $143,673 9.71% 80.9%
AA . . . . . . . . 0 x 30 95 482,718 10.17 83.9 175,068 10.25 83.5
A . . . . . . . . . 1 x 30 90 302,271 10.36 81.6 130,237 10.54 81.2
A- . . . . . . . . 2 x 30 90 190,054 10.52 81.0 86,660 10.65 81.3
B . . . . . . . . . 3 x 30, 1 x 60, 85 124,052 10.85 78.0 44,487 11.16 79.3
5 x 30, 2 x 60
C . . . . . . . . . 1 x 90 75 29,549 11.43 68.4 18,398 11.69 70.1
D . . . . . . . . . 6 x 30, 3 x 60, 2 x 90 65 1,425 12.29 62.3 1,568 12.69 61.6
Other . . . . . . . Varies 97 180,239 11.51 93.5 53,958 11.44 92.7
---------- ----- -------- -----
$1,629,668 10.25 $654,049 10.45
========== ===== ======== =====
- -----------------
(A) Represents the number of times a prospective borrower is allowed to be late
more than 30, 60 or 90 days. For instance, a 3 x 30, 1 x 60 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) 97% on fixed-rate purchases; all other maximum of 95%.
TABLE 10
LOANS COLLATERALIZING MORTGAGE SECURITIES
PERCENT OF CURRENT PRINCIPAL AS OF DECEMBER 31, 2001
COLLATERAL LOCATION
FloridaS . . . . . . . . . . . . . . . . . . . . . . . . . . . 14%
California . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Michigan . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Ohio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Nevada . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Tennessee . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Arizona . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Washington . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Colorado . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
All other states . . . . . . . . . . . . . . . . . . . . . . . 35
---
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . 100%
===
TABLE 11
LOANS COLLATERALIZING MORTGAGE SECURITIES
CARRYING VALUE OF LOANS BY PRODUCT/TYPE
(IN THOUSANDS)
DECEMBER 31,
-----------------------
PRODUCT/TYPE 2001 2000
---------- ----------
Two and three-year fixed . . . . . . . . . . . . . . $1,236,328 $ 465,976
Six-month LIBOR and one-year CMT . . . . . . . . . . 2,607 2,492
30/15-year fixed and balloon . . . . . . . . . . . . 390,733 185,581
---------- ----------
Outstanding principal . . . . . . . . . . . . . . . $1,629,668 $ 654,049
========== ==========
Mortgage securities retained . . . . . . . . . . . . $ 71,584 $ 46,650
========== ==========
25
TABLE 12
LOANS COLLATERALIZING MORTGAGE SECURITIES
MORTGAGE LOAN COUPON AND PREPAYMENT PENALTIES
(DOLLARS IN THOUSANDS)
REMAINING CONSTANT PREPAYMENT RATE
PERCENT PREPAYMENT (ANNUAL PERCENT)
WITH PENALTY PERIOD (IN ------------------------
ORIGINAL CURRENT PREPAYMENT YEARS) FOR LOANS THREE- TWELVE-
ISSUE DATE PRINCIPAL PRINCIPAL PENALTY COUPON WITH PENALTY MONTH MONTH LIFE
---------- ---------- --------- ------- ------ ------------ ----- ----- ----
DECEMBER 31, 2001
NOVASTAR MORTGAGE FUNDING TRUST SERIES:
1999-1 . . . . January 29, 1999 $ 164,995 $ 62,665 42 10.23% 0.76 37 37 27
2000-1 (A) . . March 31, 2000 230,138 149,400 88 10.16 1.65 35 30 21
2000-2 (A) . . September 28, 2000 339,688 259,037 93 10.59 1.71 31 22 18
2001-1 . . . . March 31, 2001 415,067 373,949 89 10.35 2.02 18 - 11
2001-2 . . . . September 25, 2001 800,033 784,617 86 9.70 2.25 7 - 6
---------- ----------
Total. . . . . $1,949,921 $1,629,668 87% 10.25% 2.20
========== ========== === =====
DECEMBER 31, 2000
NOVASTAR MORTGAGE FUNDING TRUST SERIES:
1999-1 . . . . January 29, 1999 $ 164,995 $ 103,968 64 10.66 1.23 38 28 21
2000-1 . . . . March 31, 2000 230,138 216,216 94 10.18 2.43 10 - 8
2000-2 . . . . September 28, 2000 339,688 333,865 90 10.57 2.49 5 - 5
---------- ----------
Total. . . . . $ 734,821 $ 654,049 87% 10.45% 2.27
========== ========== === =====
- -----------------
(A) Collateral for the CAPS 2001-C1 security is the AAA-IO and prepayment
penalty mortgage securities of NMFT 2000- 1 and 2000-2. The performance of
the mortgage loan collateral underlying these securities, as presented in
this table, directly effects the performance of the CAPS 2001-C1 security.
26
TABLE 13
LOANS COLLATERALIZING MORTGAGE SECURITIES
MORTGAGE CREDIT ANALYSIS
DECEMBER 31, 2001
DEFAULTS AS PERCENT
OF CURRENT PRINCIPAL
---------------------------------------------------
CREDIT ORIGINAL CURRENT WEIGHTED AVERAGE 60-89 90 DAYS AND FORECLOSURE
GRADE BALANCE PRINCIPAL LOAN-TO-VALUE RATIO DAYS GREATER AND REO TOTAL
- ----- --------- --------- ----------------------- ------- ------------- ------------- -------
NOVASTAR MORTGAGE FUNDING TRUST SERIES 1999-1:
AAA $ 4,024 $ 2,071 78.3 - 2.9 - 2.9
AA 30,772 12,437 85.3 0.8 1.6 5.3 7.7
A 50,693 19,018 83.8 3.9 1.8 6.3 12.0
A- 38,953 15,076 82.4 0.9 1.2 10.8 12.9
B 23,135 8,581 79.5 2.6 10.4 17.2 30.1
C 12,959 4,759 71.3 3.3 1.9 28.4 33.6
C- 47 - - - - - -
D 4,412 723 62.8 - - 13.1 13.1
NOVASTAR MORTGAGE FUNDING TRUST SERIES 2000-1: (A)
AAA $ 85,222 $ 55,395 80.6 - 1.4 3.2 4.6
AA 55,874 37,708 83.2 3.0 - 4.6 7.5
A 36,422 24,730 80.9 3.0 2.3 7.1 12.3
A- 23,329 14,329 80.4 1.3 - 5.4 6.7
B 13,089 7,277 80.0 - - 10.9 10.9
C 5,922 3,446 68.6 1.7 - 18.0 19.7
C- 335 - - - - - -
D 51 48 58.0 - - - -
Other 9,894 6,467 92.0 1.6 0.8 2.4 4.8
NOVASTAR MORTGAGE FUNDING TRUST SERIES 2000-2: (A)
AAA $ 57,846 $ 43,593 81.2 2.4 0.2 1.3 3.9
AA 103,454 80,428 83.9 0.6 0.9 5.2 6.7
A 60,735 45,658 81.5 2.0 0.8 4.4 7.3
A- 39,939 29,522 81.4 1.5 5.2 6.7
B 19,843 15,387 77.0 0.7 - 4.9 5.6
C 4,275 3,094 67.1 - - 10.1 10.1
C- 388 532 74.7 - - - -
Other 53,208 40,823 92.8 0.7 4.3 5.0
NOVASTAR MORTGAGE FUNDING TRUST SERIES 2001-1:
AAA $ 70,652 $ 63,821 81.3 0.4 0.1 0.6 1.1
AA 130,278 118,813 84.4 1.4 - 1.4 2.7
A 75,748 67,834 81.6 1.6 - 3.2 4.8
A- 43,418 39,920 80.5 0.8 0.3 4.1 5.2
B 38,186 33,806 77.8 0.5 0.2 2.6 3.4
C 4,863 4,190 66.7 - - 1.9 1.9
C- 50 48 65.0 - - - -
Other 51,872 45,517 94.3 1.1 0.2 2.9 4.3
NOVASTAR MORTGAGE FUNDING TRUST SERIES 2001-2:
Alt. A $ 40,980 $ 40,190 86.5 - - - -
AAA 120,365 118,047 80.9 - - 0.3 0.3
AA 234,977 230,450 82.6 0.2 0.1 0.6 0.8
A 152,307 149,370 81.1 0.6 0.1 0.6 1.2
A- 69,915 68,568 79.6 0.9 - 0.4 1.2
B 56,493 55,404 77.3 1.1 - 1.5 2.6
C 9,890 9,699 66.8 - - - -
C- 222 218 55.3 - - - -
Other 114,884 112,671 90.5 0.5 - 0.1 0.6
---------- ----------
$1,949,921 $1,629,668
========== ==========
- --------------
(A) Collateral for the CAPS 2001-C1 security is the AAA-IO and prepayment
penalty mortgage securities of NMFT 2000-1 and 2000-2. The performance of
the mortgage loan collateral underlying these securities, as presented in
this table, directly effects the performance of the CAPS 2001-C1 security.
27
TABLE 14
MORTGAGE LOSS ANALYSIS-LOANS COLLATERALIZING MORTGAGE SECURITIES
DECEMBER 31, 2001
(DOLLARS IN THOUSANDS)
LOANS REPURCHASED FROM TRUSTS
--------------------------------------
CUMULATIVE LOSSES LOSS AS A % OF TOTAL
AS REPORTED LOSSES ORIGINAL BALANCE LOSSES
------------------- ---------- -------------------- ----------
NMFT 1999-1 . . . . . . . . . . . 1.76% $775 0.47% 2.23%
NMFT 2000-1 (A) . . . . . . . . . 0.09 23 0.01 0.10
NMFT 2000-2 (A) . . . . . . . . . 0.10 34 0.01 0.02
NMFT 2001-1 . . . . . . . . . . . - - - -
NMFT 2001-2 . . . . . . . . . . . - - - -
- -----------------
(A) Collateral for the CAPS 2001-C1 security is the AAA-IO and prepayment
penalty mortgage securities of NMFT 2000- 1 and 2000-2. The performance of
the mortgage loan collateral underlying these securities, as presented in
this table, directly effects the performance of the CAPS 2001-C1 security.
ASSETS ACQUIRED THROUGH FORECLOSURE. As of December 31, 2001, we had 73
properties in real estate owned with a carrying value of $13.2 million compared
to 154 properties with a carrying value of $13.1 million as of December 31,
2000.
MORTGAGE SERVICING RIGHTS. We retain the right to service mortgage loans we
originate and have securitized. Servicing rights for loans we sell to third
parties is not retained. As of December 31, 2001, we have $6.4 million in
capitalized mortgage servicing rights. Note 4 to our consolidated financial
statements provides additional information regarding our mortgage servicing
rights.
OTHER ASSETS. Included in other assets as of December 31, 2001 are advances
on behalf of borrowers for taxes, insurance and other customer service
functions, collateral required under the terms of our derivative instrument
contracts and other miscellaneous assets. Advances on behalf of borrowers for
taxes, insurance and other customer service functions are made by NovaStar
Mortgage, Inc. and aggregate $6.8 million as of December 31, 2001. These amounts
were not included in our consolidated financial statements as of December 31,
2000. Also included in other assets are deposits with our derivative
counterparties made during 2001 in the amount of $8.1 million.
LONG-TERM FINANCING ARRANGEMENTS. On a long-term basis, we finance mortgage
loans by issuing asset-backed bonds. Investors in asset-backed bonds are repaid
based on the performance of the mortgage loans collateralizing the bonds. These
non-recourse financing arrangements match the loans with the financing
arrangement for long periods of time, as compared to lines of credit and
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 our asset-backed bonds we are entitled to repurchase the mortgage loan
collateral and repay the remaining bond obligations when the aggregate
collateral principal balance falls below 35% of their original balance for the
loans in NHES 97-01 and 25% for the loans in NHES 97-02, 98-01 and 98-02. We
have not exercised our right to repurchase any loans and repay bond obligations.
Details for all asset-backed bonds, and the related collateral that we have
issued are in Note 5 of the consolidated financial statements.
SHORT-TERM FINANCING ARRANGEMENTS. Mortgage loan originations are funded
with various financing facilities prior to securitization. Loans originated are
funded initially through one of two committed warehouse lines of credit. Amounts
outstanding and available for borrowing are listed below.
28
TABLE 15
SHORT-TERM FINANCING RESOURCES
DECEMBER 31, 2001
(IN THOUSANDS)
LENDING
CREDIT VALUE OF
LIMIT COLLATERAL BORROWINGS AVAILABILITY
---------- -------------- -------------- ----------------
Unrestricted cash . . . . . . . . . . . . . . . . . . . . . . $30,817
Lines of credit, mortgage and securities
repurchase facilities . . . . . . . . . . . . . . . . . . . . $960,000 $193,616 $143,350 50,266
-------- -------- -------- -------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . $960,000 $193,616 $143,350 $81,083
======== ======== ======== =======
Other details regarding our short-term borrowings are located in Note 5 of the
consolidated financial statements.
STOCKHOLDERS' EQUITY. The increase in our stockholders' equity as of
December 31, 2001 compared to December 31, 2000 is primarily a result of the
following:
o $32.3 million increase due to net income recognized for the year ended
December 31, 2001.
o $21.8 million increase in unrealized gains on mortgage securities
classified as available-for-sale
o $14.9 million decrease due to realized gain on available-sale-mortgage
securities
o $9.9 million decrease in unrealized losses on derivative instruments
used in cash flow hedges
o $2.1 increase due to net settlements on cash flow hedges reclassified
to earnings
o $10.2 million decrease due to dividends on Class B 7% cumulative
convertible preferred stock and common stock.
MORTGAGE LOAN PRODUCTION
Our non-conforming loans are originated through a network of mortgage
brokers throughout the United States. Approximately 2,200 brokers are active
customers and approximately 8,200 are approved. Loans are underwritten and
funded in a centralized facility by our employees. We increased our sales force
from 85 on January 1, 2001 to 112 on December 31, 2001. Our sales force operates
in 46 states, which allows us to mitigate the risk of geographical
concentrations of credit risk.
TABLE 16
WHOLESALE LOAN ORIGINATIONS
(DOLLARS IN THOUSANDS, EXCEPT FOR AVERAGE LOAN BALANCE)
WEIGHTED AVERAGE
AVERAGE PRICE PAID -------------------------- PERCENT WITH
LOAN TO LOAN TO CREDIT PREPAYMENT
NUMBER PRINCIPAL BALANCE BROKER VALUE RATING (A) COUPON PENALTY
------ ----------- --------- ---------- ------- ---------- ------ ------------
2001:
Fourth quarter . . . . 2,956 $ 375,788 $ 127,127 101.6% 81% 5.46 9.3% 80%
Third quarter . . . . 3,182 $ 370,710 $ 116,502 101.0 81 5.43 9.9 81
Second quarter . . . . 2,942 345,955 117,592 101.0 81 5.38 10.0 82
First quarter . . . . 2,099 246,023 117,210 101.1 82 5.41 10.4 82
Total. . . . . . . . . 11,179 $ 1,338,476 $ 119,731 100.7% 81% 5.42 9.8% 81%
2000:
Fourth quarter . . . . 1,768 $ 208,232 $ 117,778 101.1% 82% 5.12 10.7% 86%
Third quarter . . . . 1,793 207,662 115,818 101.1 84 5.20 10.7 90
Second quarter . . . . 1,473 171,375 116,344 101.0 82 5.32 10.5 91
First quarter . . . . 1,232 132,072 107,201 101.1 80 5.45 10.2 93
Total. . . . . . . . . 6,266 $ 719,341 $ 114,801 101.1% 82% 5.28 10.5% 90%
- -----------------
(A) AAA=7, AA=6, A.=5, A=4, B=3, C=2, D=1
29
TABLE 17
QUARTERLY MORTGAGE LOAN ORIGINATIONS BY STATE (BASED ON ORIGINAL PRINCIPAL)
2001 2000
------------------------- -------------------------
COLLATERAL LOCATION FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
------ ----- ------ ----- ------ ----- ------ -----
California. . . . . . . 22% 20% 18% 16% 14% 11% 10% 10%
Florida . . . . . . . . 12 12 16 13 11 12 13 14
Michigan . . . . . . . 6 7 8 9 9 10 11 11
Ohio . . . . . . . . . 5 4 5 6 6 7 8 7
Tennessee . . . . . . . 2 3 4 4 4 4 6 7
Arizona . . . . . . . . 3 3 3 6 4 5 5 5
Washington . . . . . . 2 3 3 2 3 5 5 5
All other states. . . . 48 48 43 44 49 46 42 41
RESULTS OF OPERATIONS
During the year ended December 31, 2001, we earned net income of $32.3
million, $3.02 per diluted share, compared with net income of $5.6 million,
$0.50 per diluted share and a net loss of $7.1 million, $1.08 per diluted share,
for the same periods of 2000 and 1999, respectively.
Our primary sources of revenue are interest earned on our mortgage loan
portfolio and securities and gains from the sales and securitizations of
mortgage loans. Earnings increased in 2001 as compared to 2000 and 1999 for the
following reasons.
1) We have increased the accrual rates on our mortgage securities
portfolio due to better cash flow performance as a result of the
widening spread between the coupon rates on the mortgage loan
collateral and the floating rate bond liability rates. The effect of
the increasing yield on our mortgage securities is displayed in Table
18. Our average security income has increased from 16.5% in 2000 to
24.7% in 2001.
2) We are experiencing lower all-in loan origination costs of production.
A lower cost of production yields a higher net income on the sales and
securitization mortgage securities, given that market selling prices
for the loans has been consistent over the past three years. Our cost
of production is summarized in Table 21.
3) The lower interest rate environment, which widened the interest spread
between loans in warehouse and the cost of our financing facilities,
increases our overall net interest income. The effect of the lower
rates is shown in Table 18.
4) A $29 million resecuritization created a $14.9 million gain in 2001.
Our net loss for 1999 is principally a result of increased provision for
credit losses that aggregated $22.1 million. See discussion under "Provision for
Credit Losses."
NET INTEREST INCOME
Table 18 presents a summary of the average interest-earning assets, average
interest-bearing liabilities and the related yields and rates thereon for the
three years ended December 31, 2001.
30
TABLE 18
INTEREST ANALYSIS
(DOLLARS IN THOUSANDS)
MORTGAGE LOANS MORTGAGE SECURITIES TOTAL
--------------------------------- --------------------------------- --------------------------------
INTEREST ANNUAL INTEREST ANNUAL INTEREST ANNUAL
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE
--------- ---------- -------- --------- ---------- -------- --------- ---------- --------
YEAR ENDED
DECEMBER 31, 2001
HELD-IN-PORTFOLIO
Interest-earning
mortgage assets. . . . . $ 266,287 $ 26,688 10.02% $ 266,287 $ 26,688 10.02%
========= ========== ===== ========= ========== =====
Interest-bearing liabilities:
Asset-backed bonds . . . 285,626 14,874 5.21% 285,626 14,874 5.21%
--------- ---------
Cost of derivative
financial instruments
hedging liabilities . 2,212 2,212
---------- ----------
Total borrowings . . . 285,626 17,086 5.98 285,626 17,086 5.98
========= ---------- ----- --------- ---------- -----
Net interest income. . . . $ 9,602 $ 9,602
---------- ----------
Net interest spread. . . . 4.04 4.04
---- -----
Net yield. . . . . . . . . 3.61 3.61
==== =====
HELD-FOR-SALE
Interest-earning
mortgage assets . . . . . $ 191,972 $ 19,675 10.25% $ 47,408 $ 11,706 24.69% $ 239,380 $ 31,381 13.11%
========= ========== ===== ======== ======== ===== ========= ========== =====
Interest-bearing liabilities:
Other borrowings. . . . . 142,478 8,546 6.00% 37,004 1,911 5.16 179,482 10,457 5.83%
--------- -------- ---------
Cost of derivative
financial instruments
hedging liabilities . . 1,045 - 1,045
---------- -------- ----------
Total borrowings. . . . 142,478 9,591 6.73 37,004 1,911 5.16 179,482 11,502 6.41
========= ========== ===== ======== ======== ===== ========= ========== =====
Net interest income . . . . $ 10,084 $ 9,795 $ 19,879
========== ======== ==========
Net interest spread . . . . 3.52 19.53 6.70
===== ===== =====
Net yield.. . . . . . . . . 5.25 20.66 8.30
===== ===== =====
YEAR ENDED
DECEMBER 31, 2000 (PRO FORMA)
HELD-IN-PORTFOLIO
Interest-earning
mortgage assets . . . . . $ 446,874 $ 44,676 10.00% $ 446,874 $ 44,676 10.00%
========= ========== ===== ========= ========== =====
Interest-bearing liabilities:
Asset-backed bonds . . . . 471,991 33,960 7.20% 471,991 33,960 7.20%
--------- ---------
Cost of derivative
financial instruments
hedging liabilities . . 4 4
---------- ----------
Total borrowings . . . . 471,991 33,964 7.20 471,991 33,964 7.20
========= ---------- ===== ========= ---------- =====
Net interest income. . . . . $ 10,712 $ 10,712
========== ==========
Net interest spread. . . . . 2.80 2.80
===== =====
Net yield. . . . . . . . . . 2.40 2.40
===== =====
31
HELD-FOR-SALE
Interest-earning
mortgage assets. . . . . .$ 127,734 $ 13,188 10.32% $ 17,839 $ 2,951 16.54% $ 145,573 $ 16,139 11.09%
========= ========== ===== ======== ======== ===== ========= ========== =====
Interest-bearing liabilities:
Other borrowings . . . . . 98,220 7,992 8.14% 8,993 732 8.14 107,213 8,724 8.14
--------- --------
Cost of derivative
financial instruments
hedging liabilities . . 219 - 219
---------- -------- ----------
Total borrowings . . . . 98,220 8,211 8.36 8,993 732 8.14 107,213 8,943 8.34
========= ---------- ===== ======== -------- ===== ========= ---------- -----
Net interest income. . . . . $ 4,977 $ 2,219 $ 7,196
========== ======== ==========
Net interest spread. . . . . 1.96 8.40 2.75
===== ===== =====
Net yield. . . . . . . . . . 3.90 12.44 4.94
===== ===== =====
YEAR ENDED
DECEMBER 31, 1999 (PRO FORMA)
HELD-IN-PORTFOLIO
Interest-earning
mortgage assets . . . . .$ 709,371 $ 66,324 9.35% $ 709,371 $ 66,324 9.35%
========= ========== ===== ========= ========== =====
Interest-bearing liabilities:
Asset-backed bonds . . . . 785,547 43,963 5.60% 785,547 43,963 5.60%
Other borrowings . . . . . 4,206 541 12.86 4,206 541 12.86
========= ---------
Cost of derivative
financial instruments
hedging liabilities . . 2,254 2,254 -
---------- ---------- ----
Total borrowings . . . . 789,753 46,758 5.92 789,753 46,758
========= ---------- ===== ========= ----------
Net interest income. . . . . $ 19,566 $ 19,566
========== ==========
Net interest spread. . . . . 3.43 3.43
===== =====
Net yield. . . . . . . . . . 2.76 2.76
===== =====
HELD-FOR-SALE
Interest-earning
mortgage assets. . . . . .$ 108,347 $ 10,132 9.35% $ 2,357 $ 389 16.50% $ 110,704 $ 10,521 9.50%
========= ========== ===== ======== ======== ===== ========= ========== =====
Interest-bearing liabilities:
Asset-backed bonds . . . . - - - - -
--------- ---------- -------- --------- ----------
Other borrowings . . . . . 81,190 5,942 7.32 - 81,190 5,942 7.32
--------- --------
Cost of derivative
financial instruments
hedging liabilities . . - - -
---------- -------- ----------
Total borrowings . . . . 81,190 5,942 7.32 $ - - 81,190 5,942 7.32
========= ---------- ===== ======== -------- ========= ========== =====
Net interest income . . . . $ 4,190 $ 389 $ 4,579
========== ======== ==========
Net interest spread. . . . . 2.03 16.50 2.18
===== ===== =====
Net yield. . . . . . . . . . 3.87 16.50 4.14
===== ===== =====
The mortgage loans we originate and own have relatively high coupons and
generally, in the aggregate, the coupon is not as volatile. As a result, the
average yield on our loans has been consistent. Rates on our financing
arrangements adjust monthly, primarily indexed to one-month LIBOR. As a result,
the cost of financing increases and decreases with short-term market conditions.
Short-term market rates declined dramatically in 2001 and, therefore, our net
interest margin on loans increased dramatically. Interest income on mortgage
loans in the future will depend on the volume of loans we own. Generally, we
expect to increase our loan portfolio as our origination volume increases. The
net margin on our loans will depend on the coupons on the loans and short-term
borrowing rates, which are a function of market demand and economic conditions.
Our securities primarily represent our ownership in the net cash flow of
underlying mortgage loan collateral in excess of bond expenses and cost of
funding. The cost of funding is indexed to one-month LIBOR. As one-month LIBOR
decreased dramatically over the past year, the net cash flow we are receiving
has increased correspondingly. Therefore, our yield (rate of accrual) on these
securities has increased. We experienced average income on our securities of
16.5% in 1999 and 2000. The income increased to 24.7% in 2001 to reflect the
increase in cash flow. If
32
rates continue to remain low, we anticipate the cash flow to continue to be high
on our securities and further increases in income will be generated. Future
interest income will, however, be largely dependent on economic conditions. We
also expect to increase the amount of mortgage securities we own as we
securitize the mortgage loans we originate.
IMPACT OF INTEREST RATE AGREEMENTS. We have executed interest rate
agreements designed to mitigate exposure to interest rate risk. Interest rate
cap agreements require us to pay either a one-time "up front" premium or a
quarterly premium, while allowing us to receive a rate that adjusts with LIBOR
when rates rise above a certain agreedupon rate. Interest rate swap agreements
allow us to pay a fixed rate of interest while receiving a rate that adjusts
with one-month LIBOR. These agreements are used to alter, in effect, the
interest rates on funding costs to more closely match the yield on
interest-earning assets. As expected, as short-term interest rates declined
dramatically in 2001, our expense related to interest rate agreements increased.
PROVISIONS FOR CREDIT LOSSES
We originate and own loans in which the borrower possesses credit risk
higher than that of conforming borrowers. Delinquent loans and losses are
expected to occur. Provisions for credit losses are made in amounts considered
necessary to maintain an allowance at a level sufficient to cover probable
losses inherent in the loan portfolio. Charge-offs are recognized at the time of
foreclosure by recording the value of real estate owned property at its
estimated realizable value. One of the principal methods used to estimate
expected losses is a delinquency migration analysis. This analysis takes into
consideration historical information regarding foreclosure and loss severity
experience and applies that information to the portfolio at the reporting date.
We use several techniques to mitigate credit losses, including pre-funding
audits by quality control personnel and in-depth appraisal reviews. Another loss
mitigation technique allows a borrower to sell their property for less than the
outstanding loan balance prior to foreclosure in transactions known as short
sales, when it is believed that the resulting loss is less than what would be
realized through foreclosure. Loans are charged off in full when the cost of
pursuing foreclosure and liquidation exceed recorded balances. While short sales
have served to reduce the overall severity of losses incurred, they also
accelerate the timing of losses. As discussed further under the caption
"Premiums for Mortgage Loan Insurance", lender paid mortgage insurance is also
used as a means of managing credit risk exposure. Generally, the exposure to
credit loss on insured loans is considered minimal. Management also believes
aggressive servicing is an important element to managing credit risk.
During the three years ended December 31, 2001 we made provisions for
losses of $3.8 million, $5.4 million and $22.1 million, respectively and
incurred net charge-offs of $6.0 million, $8.9 million and $14.5 million,
respectively. The higher provisions in 1999 were due to management's
conclusions, based on historical net chargeoff history, that total losses on
on-balance sheet securitized mortgage loans would be higher and would occur
earlier than originally projected. As our on-balance-sheet loan portfolio
continues to decline, our exposure to credit losses has decreased. Furthermore,
we have acquired mortgage insurance with coverage to a loan-to-value of 50% on a
substantial portion of the loans we own-see discussion of mortgage insurance
under "Premiums for Mortgage Loan Insurance." As a result, our allowance for
credit losses, and related provision, as decreased significantly since 1999. A
rollforward of the allowance for credit losses for the three years ended
December 31, 2001 is presented in Note 2 to the consolidated financial
statements.
PREPAYMENT PENALTY INCOME
A large percentage of the loans we originate require the borrower to pay a
cash penalty if they pay off their loan early in the loan's life, generally
within two years of origination. This income serves to mitigate and offset
prepayment risk and the amortization expense of premiums we paid to loan
brokers. The penalty is generally six months of interest on 80% of the unpaid
principal at prepayment. Prepayment penalty income was $790,000, $1.8 million
and $3.1 million during the three years ended December 31, 2001, 2000 and 1999,
respectively. The decrease is due to the decreasing loans in our portfolio and
its seasoning, as the prepayment penalty periods expire.
PREMIUMS FOR MORTGAGE LOAN INSURANCE
The use of mortgage insurance is one method of managing the credit risk in
the mortgage asset portfolio. As of December 31, 2001, approximately 94% of the
loans we service are covered by mortgage insurance. Premiums for mortgage
insurance on loans maintained on our balance sheet are recorded as a portfolio
cost and included in
33
the income statement under the caption "Premiums for Mortgage Loan Insurance"
and totaled $2.7 million, $1.3 million and $1.7 million in 2001, 2000 and 1999,
respectively.
It is important to note that substantially all of the mortgage loans that
serve as collateral for our mortgage securities carry mortgage insurance. This
serves to reduce credit loss exposure in those mortgage pools. Insurance
premiums on these loans are paid from the collateral proceeds and, therefore,
are not included in the amount of total premiums for mortgage loan insurance
expense in our statement of operations.
We intend to continue to purchase mortgage insurance coverage on the
majority of newly originated loans as they are securitized. However, we have the
risk that mortgage insurance providers will revise their guidelines to an extent
where we will no longer be able to acquire coverage on all of our new
production. Similarly, the providers may also increase insurance premiums to a
point where the cost of coverage outweighs its benefit. We monitor the mortgage
insurance market and currently anticipate being able to obtain affordable
coverage on a substantial portion of its future production.
SALES OF MORTGAGE ASSETS
We execute securitization transactions in which we transferred mortgage
loan collateral to an independent trust. In those transactions, we retain the
AAA-rated interest-only and non-investment grade subordinated securities. In
addition, we continue to service the loan collateral. These transactions are
structured as sales for accounting and income tax reporting. Whole loan sales
have also been executed whereby we sell loans to third parties. In the outright
sales of mortgage loans, we retain no assets or servicing rights.
TABLE 19
QUARTERLY MORTGAGE LOAN SALES (A)
(DOLLARS IN THOUSANDS)
OUTRIGHT MORTGAGE LOAN SALES MORTGAGE LOANS
-------------------------------------------------- TRANSFERRED IN SECURITIZATIONS
WEIGHTED -----------------------------------
PERCENT AVERAGE PERCENT
PRINCIPAL OF TOTAL NET GAIN PRICE TO PRINCIPAL OF TOTAL NET GAIN
AMOUNT SALES RECOGNIZED PAR (B) AMOUNT SALES RECOGNIZED
----------- ---------- ------------ ----------- ----------- ---------- ------------
2001:
Fourth quarter . . . $ 25,524 7.1% $ 235 101.7 $ 334,501 92.9% $ 5,497
Third quarter. . . . 19,511 4.0 84 102.0 465,532 96.0 7,330
Second quarter . . . 17,516 7.9 373 102.3 203,647 92.1 3,959
First quarter . . . 10,773 4.8 262 102.9 211,420 95.2 4,944
Total . . . . . . . $ 73,324 5.7% $ 954 102.1 $ 1,215,100 94.3% $21,730
2000 (PRO FORMA):
Fourth quarter . . . $ 46,158 23.4% $1,666 104.6 $ 151,277 76.6% $ 3,227
Third quarter. . . . 50,334 21.1 1,552 104.4 188,734 78.9 3,584
Second quarter . . . 27,799 21.5 661 103.8 101,675 78.5 1,392
First quarter . . . 48,548 27.5 1,204 104.0 128,171 72.5 1,544
Total . . . . . . . $ 172,839 23.3% $5,083 104.2 $ 569,857 76.7% $ 9,747
- ----------------
(A) Does not include conforming loan sales
(B) The loans we have sold in 2001 have been in higher credit grades and lower
coupons than those sold in 2000. As a result, market prices are lower.
For mortgage loans transferred in securitizations, we allocate our basis in
the mortgage loans between the portion of the mortgage loans sold and the
retained assets, securities and servicing rights, based on the relative fair
values of those portions at the time of sale. The values of these servicing
assets are determined by discounting estimated future cash flows using the cash
out method. The weighted average assumptions used for the valuation of our
retained assets at the time of securitization were constant prepayment rates of
28 to 30, projected losses of 1.3%, average life of 2.7 years and a discount
rate of 19.9%.
During the third quarter of 2001, we resecuritized AAA-rated interest-only
and prepayment penalty securities issued in 2000. This transaction, CAPS 2001-1,
was structured as a sale for financial reporting and income tax
34
purposes. Senior bonds in the amount of $29.3 million were sold to the public.
We retained a subordinated interest, the CAPS 2001-1 C1 bond, and recognized a
gain of $14.9 million. For tax purposes, this gain was capital in nature and
offsets existing capital losses we incurred in 1998.
Cash will be paid on the bond we retained only when the senior bond is
fully repaid. The retained portion of the CAPS 2001-1 C1 bond is valued using a
40% discount rate, projected losses of 1.4% and constant prepayment rate of 38
to 40. These default and prepayment assumptions are consistent with our
valuation of the underlying mortgage loan collateral of the securities sold in
the CAPS 2001-1 C1 transaction. The discount rate reflects the uncertain nature
of the cash flow on the bond we retained.
FEE INCOME
Fee income primarily consists of fees from two sources - servicing fees
from investors and borrowers and broker fees from loan investors. As a loan
servicer, we collect normal fees for servicing loans that collateralize
assetbacked bonds. These fees are generated at the rate of 50 basis points of
the principal balance and are earned as interest is collected from borrowers. In
addition, we collect fees directly from the borrower in the normal course of
servicing loans for such items as late payment assessments and processing fees
for special handling.
Loan investors who fund the loans we broker pay fees to our branches. These
fees constitute standard broker "premiums" for the types of loans we broker. As
discussed below under Branch Operations, the net income of the branches accrues
to the branch manager.
GENERAL AND ADMINISTRATIVE EXPENSES
TABLE 20
GENERAL AND ADMINISTRATIVE EXPENSES
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
-----------------------------------
2000 1999
2001 (PRO FORMA) (PRO FORMA)
-------- ----------- -----------
Compensation and benefits . . . . . . . . $ 28,226 $17,184 $12,811
Travel and entertainment . . . . . . . . . 7,807 3,265 1,531
Office administration . . . . . . . . . . 6,638 6,438 6,805
Professional and outside services. . . . . 2,044 2,200 1,655
Loan expense . . . . . . . . . . . . . . . 1,964 1,851 1,841
Other . . . . . . . . . . . . . . . . . . 2,764 1,778 234
Total general and administrative expenses $ 49,443 $32,716 $24,877
Compensation and benefits includes employee base salaries, benefit costs
and incentive compensation awards. The increase in compensation and benefits is
primarily the result of an increase in the number of NovaStar Home Mortgage
branches.
Professional and outside services include fees for legal and accounting
services. 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.
COST OF PRODUCTION. Our quarter-to-quarter wholesale loan production costs
steadily declined as a result of increased efficiencies in the mortgage lending
operation. During the third quarter of 1999, we introduced IU, a webbased
origination system that has allowed us to increase production volumes without
adding proportionate infrastructure. Account executive costs typically are
higher in the first few months of employment and are expected to decline as the
sales force becomes more productive with added experience and exposure to our
loan products and markets.
35
TABLE 21
WHOLESALE LOAN COSTS OF
PRODUCTION, AS A PERCENT OF PRINCIPAL
GROSS PREMIUM PAID TOTAL
LOAN TO BROKER, NET OF ACQUISITION
PRODUCTION FEES COLLECTED COST
2001:
Fourth quarter . . . . . . . 1.90% 0.50% 2.40%
===== ===== =====
Third quarter. . . . . . . . 1.93% 0.47% 2.40%
===== ===== =====
Second quarter . . . . . . . 1.86% 0.49% 2.35%
===== ===== =====
First quarter . . . . . . . 2.37% 0.54% 2.91%
===== ===== =====
2000:
Fourth quarter . . . . . . . 2.81% 0.50% 3.31%
===== ===== =====
Third quarter. . . . . . . . 2.56% 0.51% 3.07%
===== ===== =====
Second quarter . . . . . . . 2.97% 0.50% 3.47%
===== ===== =====
First quarter . . . . . . . 3.32% 0.52% 3.84%
===== ===== =====
MORTGAGE LOAN SERVICING
Loan servicing is a critical part of our business. In the opinion of
management, maintaining contact with borrowers is vital in managing credit risk
and in borrower retention. Non-conforming borrowers are prone to late payments
and are more likely to default on their obligations than conventional borrowers.
We strive to identify issues and trends with borrowers early and take quick
action to address such matters.
TABLE 22
SUMMARY OF SERVICING OPERATIONS
(DOLLARS IN THOUSANDS EXCEPT PER LOAN COST)
2001
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------------- ----------------- ----------------- ----------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT %
---------- ---- ---------- ---- ---------- ---- ---------- ----
Unpaid principal . . . . . . $1,994,448 $1,756,523 $1,501,844 $1,263,773
========== ========== ========== ==========
Number of loans . . . . . . 17,425 15,916 13,916 11,999
========== ========== ========== ==========
Servicing income, net of
amortization of mortgage
servicing rights . . . . . . $ 1,560 0.31 $ 1,691 0.39 $ 1,366 0.36 $ 1,465 0.46
Costs of servicing . . . . . 1,303 0.26 1,269 0.29 1,166 0.31 1,238 0.39
---------- ---- ---------- ---- ---------- ---- ---------- ----
Net servicing income . . . . $ 257 0.05 $ 422 0.10 $ 200 0.05 $ 227 0.07
========== ==== ========== ==== ========== ==== ========== ====
Annualized costs of servicing
per unit . . . . . . . . . . $ 299.11 $ 318.92 $ 335.15 $ 412.70
========== ========== ========== ==========
2000
Unpaid principal . . . . . . $1,112,615 $1,016,951 $ 970,026 $ 872,702
========== ========== ========== ==========
Number of loans . . . . . . 10,774 10,041 9,683 8,919
========== ========== ========== ==========
Servicing income, net of
amortization of mortgage
servicing rights . . . . . . $ 1,473 0.53 $ 1,392 0.55 $ 1,321 0.54 $ 1,219 0.56
Costs of servicing . . . . . 1,185 0.43 1,095 0.43 1,015 0.42 1,064 0.49
---------- ---- ---------- ---- ---------- ---- ---------- ----
Net servicing income . . . . $ 288 0.10 $ 297 0.12 $ 306 0.12 $ 155 0.07
========== ==== ========== ==== ========== ==== ========== ====
Annualized costs of servicing
per unit . . . . . . . . . . $ 439.95 $ 436.21 $ 419.29 $ 477.18
========== ========== ========== ==========
36
AFFILIATED BRANCHES
We operate our mortgage brokerage unit under the name NovaStar Home
Mortgage. Our first branch was opened in December 1999. Following is a summary
of the operations.
TABLE 23
BRANCH OPERATIONS
(DOLLARS IN THOUSANDS)
2001 2000
--------------------------------------- -----------------------------------------
DECEMBER SEPTEMBER JUNE MARCH DECEMBER SEPTEMBER JUNE MARCH
31 30 30 31 31 30 30 31
--------- ----------- ------- -------- --------- ----------- ------- --------
Branches (end of
quarter) . . . . . . . . . 123 105 86 77 63 48 24 16
Loans originated . . . . . . . 2,891 2,147 1,911 1,126 867 533 272 103
Fee income . . . . . . . . . . $2,974 $3,896 $4,570 $4,840 $3,955 $2,283 $1,093 $330
General and
administrative costs . . . $3,014 $3,950 $4,548 $4,840 $3,662 $2,277 $1,093 $328
Personnel . . . . . . . . . . 594 471 355 288 252 162 107 81
Under our agreements with branch managers, fee income generated by the
branches, excluding our management fee, is paid to the branch manager as
compensation. Fees we retain are designed to cover our management costs and
generate a profit. For the fees we retain, we provide administrative functions
for the branches, including accounting, human resources, license/registration
and loan investor management. The following table summarizes the branch
management fee income and costs.
TABLE 24
BRANCH MANAGEMENT
(DOLLARS IN THOUSANDS)
2001 2000
----------------------------------------- -------------------------------------
DECEMBER SEPTEMBER JUNE MARCH DECEMBER SEPTEMBER JUNE MARCH
31 30 30 31 31 30 30 31
---------- ----------- ------- --------- ---------- ---------- ------ --------
Fee income . . . . . . . . . . . . $1,336 $885 $738 $450 $343 $210 $101 $31
General and
administrative costs . . . . . $1,016 $747 $580 $494 $590 $362 $219 $93
Personnel . . . . . . . . . . . . 32 15 16 15 12 11 6 5
TAXABLE INCOME
In order that we retain our REIT status, we are required to distribute
virtually all of our taxable income to our shareholders. Dividends on our
preferred shareholders are required and, therefore, are considered in the
distribution requirements prior to any distribution to common shareholders.
37
TABLE 25
TAXABLE NET INCOME
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
2001 2000 1999
---------- --------- --------
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 32,308 $ 5,626 $(7,092)
Equity in net income of NFI Holding Corp. . . . . . . . . . . . . . . (1,723) (1,123) (88)
Cumulative effect of a change in accounting principle . . . . . . . . 1,384 - -
Interest rate agreement amortization . . . . . . . . . . . . . . . . (1,024) - -
Residual purchase commitment fee . . . . . . . . . . . . . . . . . . (1,630) - -
Credit losses, net of provision . . . . . . . . . . . . . . . . . . . (2,133) (3,415) 7,532
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 888 461 (442)
Use of capital loss carryfoward . . . . . . . . . . . . . . . . . . . (14,946) - -
Use of net operating loss carryforward . . . . . . . . . . . . . . . (2,718) (11) -
-------- ------- -------
Taxable net income before preferred dividends . . . . . . . . . . . . 10,406 1,549 (90)
Preferred dividends . . . . . . . . . . . . . . . . . . . . . . . . . (5,164) (1,551) -
Taxable net income available to common shareholders . . . . . . . . . $ 5,242 $ (2) $ (90)
======== ======== =======
Taxable net income per common shareholder . . . . . . . . . . . . . . $ 0.91 $ - $ (0.01)
======== ======== =======
LIQUIDITY AND CAPITAL RESOURCES
Liquidity means the need for, access to and uses of cash. Our 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. Mortgage asset sales,
principal, interest and fees collected on mortgage assets support cash needs.
Drawing upon various borrowing arrangements typically satisfies major cash
requirements. As shown in Table 15, we have $81.1 million in immediately
available funds, including $30.8 million in cash.
Mortgage lending requires significant cash to fund loan originations. Our
warehouse lending arrangements, including repurchase agreements, support the
mortgage lending operation. Our warehouse mortgage lenders allow us to borrow
the greater of the market value of the loans or 98% of the outstanding
principal. Funding for the difference -generally 2% of the principal-must come
from other cash inflows. We use operating cash inflow in the form of cash
flowfrom mortgage securities, principal and interest on mortgage loans, fee
income to support loan originations. In addition, proceeds from equity offerings
have been used to support operations. Our immediately available funds would
support funding more than $4 billion in loans, assuming no other demands on cash
and assuming a 2% "haircut".
Loans financed with warehouse and repurchase credit facilities are subject
to changing market valuation and margin calls. The market value of our loans are
dependent on a variety of economic conditions, including interest rates (and
borrower demand) and end investor desire and capacity. Market values have been
consistent over the past three years. However, there is no guaranty that the
prices will remain constant. To the extent the value of the loans declines
significantly, we would be required to repay portions of the amounts we have
borrowed. The value of our "recourse" loans (classified as available-for-sale)
as of December 31, 2001 would need to decline by nearly 60% before we would use
all immediately available funds, assuming no other constraints on our
immediately available funds.
We have no recourse for loans financed with asset-backed bonds and, as
such, there is minimal liquidity risk.
The derivative financial instruments we use also subject us to "margin
call" risk. Under our interest rate swaps, we pay a fixed rate to the
counterparties while they pay us a floating rate. While floating rates are low,
on a net basis we are paying the counterparty. In order to mitigate credit
exposure to us, the counterparty required us to post margin deposits with them.
As of December 31, 2001, we have approximately $8.1 million on deposit. Further
declining interest rates would subject us to additional exposure for cash margin
calls.However, the asset side of the balance sheet should increase in value in a
further declining interest rate scenario. Incoming cash on our mortgage loans
and securities is a principal source of cash. The volume of cash depends on,
among other things, interest rates. While short-term interest rates (the basis
for our funding costs) are low and the coupon
38
rates on our loans are high, our net interest margin (and therefore incoming
cash flow) is high. Severe and immediate changes in interest rates will impact
the volume of our incoming cash flow. To the extent rates increase dramatically,
our funding costs will increase quickly. While many of our loans are adjustable,
they typically will not reset as quickly as our funding costs. This circumstance
would temporarily reduce incoming cash flow. As noted above, derivative
financial instruments are used to mitigate the effect of interest rate
volatility. In this rising rate situation, our interest rate swaps and caps
would provide additional cash flows to mitigate the lower cash on loans and
securities.
Loans we originate can be sold to a third party, which also generates cash
to fund on-going operations. When market prices exceed our cost to originate, we
believe we can operate in this manner, provided that the level of loan
originations is at or near the capacity of its production infrastructure. In
1999, we sold a substantial portion of the loans we originated. We securitized
much of our loan production in 2000 and 2001. Selling loans to third parties
provides another means for cash flow, should we need additional liquidity.
Cash activity during the three years ended December 31, 2001 is presented
in the consolidated statement of cash flows.
As noted above, proceeds from equity offerings have supported our
operations. Since inception, we have raised $143 million in net proceeds through
private and public equity offerings. Equity offerings provide another avenue as
a future liquidity source.
INFLATION
Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates and other factors drive our performance far more than
does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and dividends are based on taxable income. In
each case, our financial activities and financial position are measured with
reference to historical cost or fair market value without considering inflation.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Note 1 of the consolidated financial statements 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.
39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOVASTAR FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31,
-----------------------
2001 2000
---------- ----------
ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30,817 $ 2,518
Mortgage loans-held-in-portfolio . . . . . . . . . . . . . . . . . . . . . . . 226,033 375,927
Mortgage loans-held-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . 139,527 -
Mortgage securities-available-for-sale . . . . . . . . . . . . . . . . . . . . 71,584 46,650
Advances to and investment in NFI Holding Corporation . . . . . . . . . . . . . - 45,415
Assets acquired through foreclosure . . . . . . . . . . . . . . . . . . . . . . 13,185 13,054
Mortgage servicing rights . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,445 -
Accrued interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . . 5,495 9,151
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,294 1,767
--------- ---------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 512,380 $ 494,482
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Asset-backed bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 219,048 $ 357,437
Short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . 143,350 25,000
Accounts payable and other liabilities . . . . . . . . . . . . . . . . . . 15,227 3,601
Dividends payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,758 525
--------- ---------
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382,383 386,563
Commitments and contingencies
Stockholders' equity:
Capital stock, $0.01 par value, 50,000,000 shares authorized:
Class B, convertible preferred stock, 4,285,714 shares issued and
outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 43
Common stock, 5,804,255 and 6,094,595 shares issued
and outstanding, respectively . . . . . . . . . . . . . . . . . . . . . . 58 61
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . 137,860 141,997
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (15,887) (37,976)
Accumulated other comprehensive income . . . . . . . . . . . . . . . . . . . . 9,177 10,168
Notes receivable from founders . . . . . . . . . .. . . . . . . . . . . . . . . (1,254) (6,374)
--------- ---------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . 129,997 107,919
--------- ---------
Total liabilities and stockholders' equity . . . . . . . . . . . . . . . $ 512,380 $ 494,482
========= =========
See notes to consolidated financial statements.
40
NOVASTAR FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEAR ENDED
DECEMBER 31,
---------------------------------
2001 2000 1999
-------- -------- ----------
Interest income:
Mortgage loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 46,363 $ 44,676 $ 66,324
Mortgage securities . . . . . . . . . . . . . . . . . . . . . . . . . . 11,706 2,951 389
-------- -------- --------
Total interest income . . . . . . . . . . . . . . . . . . . . . . . . . 58,069 47,627 66,713
Interest expense:
Financing for mortgage loans . . . . . . . . . . . . . . . . . . . . . . 26,677 33,964 46,758
Financing for mortgage securities . . . . . . . . . . . . . . . . . . . 1,911 732 -
-------- -------- --------
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . 28,588 34,696 46,758
Net interest income before provision for credit losses . . . . . . . . . . 29,481 12,931 19,955
Provision for credit losses . . . . . . . . . . . . . . . . . . . . . . . . (3,773) (5,449) (22,078)
-------- -------- --------
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,708 7,482 (2,123)
Gain (loss) on derivative instruments and sales of mortgage assets . . . . 34,616 (826) 351
Fee income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,142 - -
Net fees for services provided by NovaStar Mortgage, Inc. . . . . . . . . . - (21) (4,031)
Prepayment penalty income . . . . . . . . . . . . . . . . . . . . . . . . . 790 1,776 3,143
Premiums for mortgage loan insurance . . . . . . . . . . . . . . . . . . . (2,655) (1,272) (1,731)
Equity in net income of NFI Holding Corporation . . . . . . . . . . . . . . - 1,123 88
Other income, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,856 381 801
General and administrative expenses:
Compensation and benefits . . . . . . . . . . . . . . . . . . . . . . . . 28,226 1,485 1,804
Travel and public relations . . . . . . . . . . . . . . . . . . . . . . . 7,807 - -
Office administration . . . . . . . . . . . . . . . . . . . . . . . . . . 6,638 751 804
Professional and outside services . . . . . . . . . . . . . . . . . . . . 2,044 690 801
Loan expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,964 - -
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,764 91 181
-------- -------- --------
Total general and administrative expenses . . . . . . . . . . . . . . . . 49,443 3,017 3,590
-------- -------- --------
Income (loss) before cumulative effect of a change in
accounting principle . . . . . . . . . . . . . . . . . . . . . . . . . . 34,014 5,626 (7,092)
Cumulative effect of a change in accounting principle . . . . . . . . . . . (1,706) - -
-------- -------- --------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,308 5,626 (7,092)
Dividends on preferred shares . . . . . . . . . . . . . . . . . . . . . . . (5,025) (2,100) (1,606)
-------- -------- --------
Net income (loss) available to common shareholders . . . . . . . . . . . . . $ 27,283 $ 3,526 $ (8,698)
======== ======== ========
Basic earnings (loss) per share-before cumulative effect of a
change in accounting principle . . . . . . . . . . . . . . . . . . . . . $ 3.38 $ 0.51 $ (1.08)
Basic loss per share due to cumulative effect of a change in
accounting principle . . . . . . . . . . . . . . . . . . . . . . . . . . (0.16) - -
-------- -------- --------
Basic earnings (loss) per share . . . . . . . . . . . . . . . . . . . . . . $ 3.22 $ 0.51 $ (1.08)
======== ======== ========
Diluted earnings (loss) per share-before cumulative effect of a
change in accounting principle . . . . . . . . . . . . . . . . . . . . . $ 3.18 $ 0.50 $ (1.08)
Diluted loss per share due to cumulative effect of a change in
accounting principle . . . . . . . . . . . . . . . . . . . . . . . . . . (0.16) - -
-------- -------- --------
Diluted earnings (loss) per share . . . . . . . . . . . . . . . . . . . . . $ 3.02 $ 0.50 $ (1.08)
======== ======== ========
Weighted average basic shares outstanding . . . . . . . . . . . . . . . . . 10,025 11,137 8,032
======== ======== ========
Weighted average diluted shares outstanding . . . . . . . . . . . . . . . . 10,691 11,143 8,032
======== ======== ========
Dividends declared per common share . . . . . . . . . . . . . . . . . . . . $ 0.96 $ - $ -
======== ======== ========
See notes to consolidated financial statements.
41
NOVASTAR FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS'EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONVERTIBLE ADDITIONAL
PREFERRED COMMON PAID-IN ACCUMULATED
STOCK STOCK CAPITAL DEFICIT
------------ ---------- ------------ ------------
BALANCE, JANUARY 1, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $81 $120,907 $(32,804)
Proceeds from preferred stock issuance, net of costs of $1,323 . . . . . . . . 43 - 28,635 -
Exercise of stock options, 3,750 shares . . . . . . . . . . . . . . . . . . . . - - 8 -
Issuance of additional notes receivable from founders . . . . . . . . . . . . - - - -
Warrants issued. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - 350 -
Common stock repurchased 673,400 shares . . . . . . . . . . . . . . . . . . . - (6) (1,871) -
Interest accrued on notes receivable from founders, net of payments . . . . . - - - -
Change in fair value of restricted stock awards underlying forgivable notes. . . - - (442) -
Dividends on preferred stock ($0.37 per share) . . . . . . . . . . . . . . . . . - - - (1,606)
Comprehensive income (loss)
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (7,092)
Other comprehensive income-change in unrealized gain (loss)
on available-for-sale securities . . . . . . . . . . . . . . . . . -
Total comprehensive income (loss) . . . . . . . . . . . . . . (7,092)
BALANCE, DECEMBER 31, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . 43 75 147,587 (41,502)
Exercise of stock options, 10,000 shares . . . . . . . . . . . . . . . . . . . - - 24 -
Common stock repurchased, 1,376,766 shares . . . . . . . . . . . . . . . . . . - (14) (5,704) -
Change in fair value of restricted stock awards underlying forgivable notes. . . - - 90 -
Dividends on preferred stock ($0.49 per share) . . . . . . . . . . . . . . . . - - - (2,100)
--- --- -------- ---------
Comprehensive income
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,626
Other comprehensive income-change in unrealized gain
on available-for-sale securities . . . . . . . . . . . . . . . . . . -
Total comprehensive income . . . . . . . . . . . . . . . . . . 5,626
---------
BALANCE, DECEMBER 31, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 61 141,997 (37,976)
Common stock repurchased, 115,147 shares . . . . . . . . . . . . . . . . . . . - (1) (653) -
Return of common stock underlying founders' notes receivable,
289,332 shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3) (4,337) - -
Forgiveness of founders' notes receivable . . . . . . . . . . . . . . . . . . - - - -
Payment of founders' notes receivable . . . . . . . . . . . . . . . . . . . . - - - -
Exercise of stock options, 113,250 shares . . . . . . . . . . . . . . . . . . - 1 853 - -
Dividends on common stock ($0.96 per share) . . . . . . . . . . . . . . . . . - - - (5,194)
Dividends on preferred stock ($1.08 per share) . . . . . . . . . . . . . . . . - - - (5,025)
Comprehensive income
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,308
Other comprehensive income. . . . . . . . . . . . . . . . . . . . . . -
Total comprehensive income . . . . . . . . . . . . . . . . . . 32,308
---------
BALANCE, DECEMBER 31, 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . $43 $ 58 $137,860 $(15,887)
=== === ======== =========
ACCUMULATED
OTHER TOTAL
COMPRE- NOTES STOCK-
HENSIVE RECEIVABLE HOLDERS'
INCOME (LOSS) FROM FOUNDERS EQUITY
--------------- ---------------- -----------
BALANCE, JANUARY 1, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $(6,337) $ 81,847
Proceeds from preferred stock issuance, net of costs of $1,323 . . . . . . . . - - 28,678
Exercise of stock options, 3,750 shares . . . . . . . . . . . . . . . . . . . - - 8
Issuance of additional notes receivable from founders . . . . . . . . . . . . - (70) (70)
Warrants issued. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - 350
Common stock repurchased 673,400 shares . . . . . . . . . . . . . . . . . . . - - (1,877)
Interest accrued on notes receivable from founders, net of payments . . . . . - (319) (319)
Change in fair value of restricted stock awards underlying forgivable notes. . - 442 -
Dividends on preferred stock ($0.37 per share) . . . . . . . . . . . . . . . . - - (1,606)
Comprehensive income (loss)
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (7,092)
Other comprehensive income-change in unrealized gain (loss)
on available-for-sale securities . . . . . . . . . . . . . . . . . 242 242
-------- --------
Total comprehensive income (loss) . . . . . . . . . . . . . . 242 (6,850)
BALANCE, DECEMBER 31, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . 242 (6,284) 100,161
Exercise of stock options, 10,000 shares . . . . . . . . . . . . . . . . . . . - - 24
Common stock repurchased, 1,376,766 shares . . . . . . . . . . . . . . . . . . - - (5,718)
Change in fair value of restricted stock awards underlying forgivable notes. . - (90) -
Dividends on preferred stock ($0.49 per share) . . . . . . . . . . . . . . . . - - (2,100)
-------- --------
Comprehensive income
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 5,626
Other comprehensive income-change in unrealized gain
on available-for-sale securities . . . . . . . . . . . . . . . . . 9,926 9,926
Total comprehensive income . . . . . . . . . . . . . . . . . . 9,926 15,552
-------- --------
BALANCE, DECEMBER 31, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . 10,168 (6,374) 107,919
Common stock repurchased, 115,147 shares . . . . . . . . . . . . . . . . . . . - - (654)
Return of common stock underlying founders' notes receivable,
289,332 shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 4,340 -
Forgiveness of founders' notes receivable . . . . . . . . . . . . . . . . . . - 139 139
Payment of founders' notes receivable . . . . . . . . . . . . . . . . . . . . - 641 641
Exercise of stock options, 113,250 shares . . . . . . . . . . . . . . . . . . - - 854
Dividends on common stock ($0.96 per share) . . . . . . . . . . . . . . . . . - - (5,194)
Dividends on preferred stock ($1.08 per share) . . . . . . . . . . . . . . . . - - (5,025)
Comprehensive income
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 32,308
Other comprehensive income. . . . . . . . . . . . . . . . . . . . . . (991) (991)
Total comprehensive income . . . . . . . . . . . . . . . . . . (991) 31,317
-------- --------
BALANCE, DECEMBER 31, 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,177 $(1,254) $129,997
======== ========
See notes to consolidated financial statements.
42
NOVASTAR FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------------
2001 2000 1999
---------- ---------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 32,308 $ 5,626 $ (7,092)
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Cumulative effect of change in accounting principle . . . . . . . 1,706 - -
Amortization of premiums on mortgage assets . . . . . . . . . . . 3,208 4,944 8,088
Amortization of mortgage servicing rights . . . . . . . . . . . . 2,131 - -
Amortization of deferred debt costs . . . . . . . . . . . . . . . 1,022 1,141 2,271
Forgiveness of founders' promissory notes . . . . . . . . . . . . 139 - -
Provision for credit losses . . . . . . . . . . . . . . . . . . . 3,773 5,449 22,078
Net change in mortgage loans held for sale . . . . . . . . . . . (98,867) - 4,932
Equity in net income of NFI Holding Corporation . . . . . . . . . - (1,123) (88)
Losses (gains) on derivative instruments and sales of
mortgage assets . . . . . . . . . . . . . . . . . . . . . . . . (34,616) 826 (351)
Changes in:
Accrued interest receivable . . . . . . . . . . . . . . . . . . 3,817 3,301 5,156
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . (28,187) (814) 73
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . 1,325 1,869 (300)
-------- ------- -------
Net cash provided by (used in) operating activities . . . . . (52,670) 21,219 34,767
CASH FLOWS FROM INVESTING ACTIVITIES:
Mortgage loan repayments-held-in-portfolio . . . . . . . . . . . . . 125,198 201,880 260,109
Proceeds from paydowns on available-for-sale securities . . . . . . 28,484 3,653 882
Sales of available-for-sale securities . . . . . . . . . . . . . . . 31,632 - -
Sales of assets acquired through foreclosure . . . . . . . . . . . . 20,466 35,263 24,228
Net assets acquired in acquisition of common stock of
NFI Holding Corporation . . . . . . . . . . . . . . . . . . . . . 872 - -
Payment on founders' promissory notes . . . . . . . . . . . . . . . 641 - -
Net change in advances to and investment in
NFI Holding Corporation . . . . . . . . . . . . . . . . . . . . . - (48,526) (15,127)
-------- ------- -------
Net cash provided by investing activities . . . . . . . . . . 204,207 192,270 270,092
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on asset-backed bonds . . . . . . . . . . . . . . . . . . . (139,411) (230,572) (307,318)
Change in short-term borrowings . . . . . . . . . . . . . . . . . . 81,450 25,000 (18,029)
Proceeds from issuance of capital stock and exercise of equity
instruments, net of offering costs . . . . . . . . . . . . . . . 854 24 28,686
Dividends paid on preferred stock . . . . . . . . . . . . . . . . . (3,150) (2,100) (1,081)
Dividends paid on common stock . . . . . . . . . . . . . . . . . . . (2,836) - (2,845)
Common stock repurchases . . . . . . . . . . . . . . . . . . . . . . (654) (5,718) (1,877)
-------- ------- -------
Net cash used in financing activities . . . . . . . . . . . . (63,747) (213,366) (302,464)
-------- ------- -------
Net increase in cash and cash equivalents . . . . . . . . . . . . . . . 28,299 123 2,395
Cash and cash equivalents, beginning of year . . . . . . . . . . . . . 2,518 2,395 -
-------- ------- -------
Cash and cash equivalents, end of year . . . . . . . . . . . . . . . . $ 30,817 $ 2,518 $ 2,395
======== ======= =======
See notes to consolidated financial statements.
43
NOVASTAR FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
FINANCIAL STATEMENT PRESENTATION The Company's consolidated financial
statements have been prepared in conformity with accounting principles generally
accepted in the United States of America and prevailing practices within the
financial services industry. The preparation of financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of income and expense during the period. The Company uses estimates and
employs the judgements of management in determining the amount of its allowance
for credit losses, amortizing premiums or accreting discounts on its mortgage
assets, amortizing mortgage servicing rights and establishing the fair value of
its mortgage securities, derivative instruments, mortgage servicing rights and
estimating appropriate accrual rates on mortgage securities. While the
consolidated financial statements and footnotes reflect the best estimates and
judgments of management at the time, actual results could differ significantly
from those estimates. For example, it is possible that credit losses or
prepayments could rise to levels that would adversely affect profitability if
those levels were sustained for more than brief periods.
The consolidated financial statements of the Company include the accounts
of all wholly owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated during consolidation.
The Company purchased 100% of the common stock of NFI Holding Corporation
on January 1, 2001 (see Note 9). Prior to this date, the Company owned 100% of
the nonvoting preferred stock of NFI Holding Corporation, for which it received
99% of any dividends paid by NFI Holding Corporation. The founders of the
Company owned 100% of the common stock of NFI Holding Corporation. The
consolidated financial statements as of December 31, 2001, and for the year then
ended, include the accounts of NFI Holding Corporation with significant
intercompany account and transactions eliminated in consolidation. Prior to
January 1, 2001, the Company accounted for its investment in NFI Holding
Corporation using the equity method.
CASH AND CASH EQUIVALENTS The Company considers investments with original
maturities of three months or less at the date of purchase to be cash
equivalents.
MORTGAGE LOANS Mortgage loans include loans originated and acquired in
bulk pools from other originators and securities dealers. Mortgage loans are
recorded net of deferred loan origination fees and associated direct costs and
are stated at amortized cost. Mortgage loans held-for-sale are carried at the
lower of cost or market. Loan origination fees and associated direct costs are
deferred and recognized over the life of the loan as an adjustment to yield
using a method that approximates the interest method. Amortization includes the
effect of prepayments.
Interest is recognized as revenue when earned according to the terms of
the mortgage loans and when, in the opinion of management, it is collectible.
The accrual of interest on loans is discontinued when, in management's opinion,
the interest is not collectible in the normal course of business, but in no case
beyond when a loan becomes ninety days delinquent. Interest collected on
non-accrual loans is recognized as income upon receipt.
The Company maintains an allowance for credit losses inherent in the
portfolio at the balance sheet date. The allowance is based upon the assessment
by management of various factors affecting its mortgage loan portfolio,
including current economic conditions, the makeup of the portfolio based on
credit grade, loan-to-value, delinquency status, historical credit losses,
Company purchased mortgage insurance and other factors deemed to warrant
consideration. The allowance is maintained through ongoing provisions charged to
operating income and is reduced by loans that are charged off.
MORTGAGE SECURITIES The Company classifies all of its mortgage securities
as available-for-sale and, therefore, reports them at their estimated fair value
with unrealized gains and losses reported as a separate component of
stockholders' equity. Interest income is recognized using the effective yield
method. Premiums are amortized and discounts are accreted as yield adjustments
over the estimated lives of the securities using the interest method.
Amortization includes the effect of prepayments.
The fair value of mortgage securities retained by the Company in the
securitization of mortgage loans is based on the present value of future
expected cash flows to be received. Management's best estimate of key
assumptions, including credit losses, prepayment speeds and forward yield curves
commensurate with the risks involved, are used in estimating future cash flows.
44
ASSETS ACQUIRED THROUGH FORECLOSURE Real estate owned, which consists of
residential real estate acquired in satisfaction of loans, is carried at the
lower of cost or estimated fair value less estimated selling costs. Adjustments
to the loan carrying value required at time of foreclosure are charged against
the allowance for credit losses. Costs related to the development of real estate
are capitalized and those related to holding the property are expensed. Losses
or gains from the ultimate disposition of real estate owned are charged or
credited to operating income.
MORTGAGE SERVICING RIGHTS Originated mortgage servicing rights are
recorded at cost based upon the relative fair values of the transferred loans
and the servicing rights. Mortgage servicing rights are amortized over the
expected life of the related loans. Periodically, the Company evaluates the
carryingvalue of capitalized mortgage servicing rights based on their estimated
fair value. If the estimated fair value is less than the carrying amount of the
mortgage servicing rights, the mortgage servicing rights are written down to the
amount of the estimated fair value. The mortgage loans underlying the mortgage
servicing rights are pools of homogenous, non-conforming residential loans. For
assessment of impairment, the loans are stratified at the time the loans are
securitized, which generally coincides with the date of origination of the
loans.
TRANSFERS OF ASSETS The Company uses the financial components approach
when accounting for transfers of mortgage loans in whole loan sales, repurchase
agreements and securitization transactions. When the Company retains control
over transferred mortgage loans, transactions are accounted for as secured
borrowings rather than as sales. When the Company sells mortgage loans in
securitization transactions, it may retain one or more subordinated bond classes
and servicing rights for the loans. The gain on the assets sold depends in part
on the previous carrying amount of the financial assets involved in the
transfer, allocated between the assets sold and the retained interests based on
their relative fair value at the date of transfer. To determine fair value, the
Company generally estimates fair value based on the present value of future
expected cash flows estimated using management's best estimate of the key
assumptions, including credit losses, prepayment speeds, forward yield curves,
and discount rates commensurate with the risks involved.
Borrowings under repurchase agreements included in the accompanying
consolidated balance sheets represent the principal amount of funds received in
the transfer.
STOCK-BASED COMPENSATION Stock options are accounted for based on the
specific terms of the options granted. Options with variable terms, including
those options for which the strike price has been adjusted and generally options
issued by the Company with dividend equivalent rights, create compensation
expense to the extent the market price of the stock exceeds the strike price. No
expense is recognized for options with fixed terms.
INCOME TAXES The Company intends to operate and qualify as a Real Estate
Investment Trust (REIT) under the requirements of the Internal Revenue Code.
Therefore, the Company, and its qualified REIT subsidiaries, will generally not
be subject to federal income taxes at the corporate level on taxable income
distributed to stockholders. Requirements for qualification as a REIT include
various restrictions on common stock ownership and the nature of assets and
sources of income. Prior to January 1, 2001, a REIT must also distribute at
least 95% of its annual taxable income to its stockholders. As a result of a
change in IRS Tax Code, beginning January 1, 2001, the Company will be required
to distribute 90% of its annual taxable income to its stockholders in order to
retain its REIT status. If in any tax year, the Company does not qualify as a
REIT, it will be taxed as a corporation and distributions to stockholders will
not be deductible in computing taxable income. If the Company fails to qualify
as a REIT in any tax year, it will not be permitted to qualify for the
succeeding four years. The most significant difference between earnings as
presented herein and taxable income relates to provisions made to the allowance
for credit losses, which are not deductible for income tax purposes. NFI Holding
Corporation has not elected REIT-status and files a consolidated federal income
tax return with its subsidiaries.
Because the Company has paid or will pay dividends in amounts
approximating its taxable income or has incurred net operating losses, no
provision for income taxes has been provided in the accompanying consolidated
financial statements.
NET EARNINGS (LOSS) PER SHARE Basic earnings (loss) per share (EPS)
excludes dilution and is computed by dividing net income (loss) available to
common stockholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Diluted EPS is calculated assuming all options
and warrants on the Company's common stock have been exercised and the
convertible preferred stock is converted, unless the exercise would be
anti-dilutive.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY During 1998, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
45
HEDGING ACTIVITIES." As amended by SFAS No. 137, "ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES -DEFERRAL OF THE EFFECTIVE DATE OF FASB
STATEMENT NO. 133" and SFAS No. 138, "ACCOUNTING FOR CERTAIN DERIVATIVE
INSTRUMENTS AND CERTAIN HEDGING ACTIVITIES, AN AMENDMENT OF FASB STATEMENT NO.
133," SFAS No. 133 standardizes the accounting for derivative instruments,
including certain instruments embedded in other contracts, by requiring that an
entity recognize those items as assets or liabilities in the balance sheet and
measure them at fair value. If certain conditions are met, an entity may elect
to designate a derivative instrument either as a cash flow hedge, a fair value
hedge or a hedge of foreign currency exposure. SFAS No. 133 requires derivative
instruments to be recorded at their fair value with hedge ineffectiveness
recognized in earnings. The Company adopted SFAS No. 133 on January 1, 2001 and
recorded a charge to earnings of $1.7 million and an increase in accumulated
other comprehensive income of $34,000. The transition adjustments resulted from
adjusting the carrying value of certain interest rate cap agreements to their
fair value.
The Company uses derivative instruments with the objective of hedging
interest rate risk. Interest rates on liabilities of the Company adjust
frequently, while interest rates on the Company's assets adjust annually, or not
at all. The fair value of the Company's derivative instruments along with any
margin accounts associated with the contracts are included in other assets. Any
changes in fair value of derivative instruments related to hedge effectiveness
are reported in accumulated other comprehensive income. Changes in fair value of
derivative instruments related to hedge ineffectiveness and non-hedge activity
are recorded as adjustments to earnings. For those derivative instruments that
do not qualify for hedge accounting, changes in the market value of the
instruments are recorded as adjustments to earnings.
NEW ACCOUNTING PRONOUNCEMENTS During September 2000, the FASB issued SFAS
No. 140, "ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES-A REPLACEMENT OF FASB STATEMENT NO. 125."
Although SFAS No. 140 revised many of the rules regarding securitizations, it
continues to require an entity to recognize the financial and servicing assets
it controls and the liabilities it has incurred and to derecognize financial
assets when control has been surrendered in accordance with the criteria
provided in the Statement. This statement was effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001 and was effective for recognition and reclassification of
collateral for fiscal years ending after December 15, 2000. Disclosure
provisions of SFAS No. 140 were implemented for the 2000 financial statements of
the Company. The Company's securitization and resecuritization transactions were
subject to the provisions of SFAS No. 140 beginning April 2001.
During 1999, the FASB issued Emerging Issues Task Force (EITF) No. 99-20,
"RECOGNITION OF INTEREST INCOME AND IMPAIRMENT ON PURCHASED AND RETAINED
BENEFICIAL INTERESTS IN SECURITIZED FINANCIAL ASSETS." Effective April 1, 2001,
EITF No. 99-20 provides guidance on the recognition of interest income from, and
measurement of retained beneficial interests and was effective beginning April
1, 2001. The implementation of EITF 99-20 did not have a material effect on the
Company's consolidated financial statements.
During 2001, the FASB issued EITF D-95, "EFFECT OF PARTICIPATING
CONVERTIBLE SECURITIES ON THE COMPUTATION OF BASIC EARNINGS PER SHARE." EITF
D-95 requires that participating securities that are convertible into common
stock be included in the computation of basic earnings per share. In accordance
with the requirements of this standard, earnings per share for all periods
presented have been restated to reflect the provisions of EITF D-95.
During 2001, the FASB issued SFAS No. 141, "BUSINESS COMBINATIONS," and
SFAS No. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS." SFAS No. 141 requires the
purchase method of accounting for business combinations and eliminates the
pooling-of-interests method. Business combinations consummated subsequent to
June 30, 2001 are to be accounted for under the provisions of the new statement.
SFAS No. 142, which is effective for the Company on January 1, 2002, requires,
among other things, the discontinuance of goodwill amortization. In addition,
the statement includes provisions for the reclassification of the useful lives
of existing recognized intangibles as goodwill, reassessment of the useful lives
of existing recognized intangibles, reclassification of certain intangibles out
of previously reported goodwill and identification of reporting units for the
purpose of assessing potential future impairments of goodwill. Implementation of
these statements have had no impact on the Company's financial statements.
During 2001, the FASB also issued SFAS No. 143, "ACCOUNTING FOR ASSET
RETIREMENT OBLIGATIONS" and SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT ON
DISPOSAL OF LONG-LIVED ASSETS." These statements are effective on January 1,
2003 and January 1, 2002, respectively. Implementation of these statements is
not expected to have a material effect on the company's consolidated financial
statements.
RECLASSIFICATIONS Certain reclassifications of prior years amounts have
been made to conform to current year presentation.
46
NOTE 2. MORTGAGE LOANS
Mortgage loans, all of which are secured by residential properties,
consisted of the following as of December 31 (in thousands):
2001 2000
-------- --------
MORTGAGE LOANS-HELD-IN-PORTFOLIO:
Outstanding principal . . . . . . . . . . . . . . . . $226,960 $375,872
Net unamortized premium . . . . . . . . . . . . . . . 4,630 7,745
-------- --------
Amortized cost . . . . . . . . . . . . . . . . . . . 231,590 383,617
Allowance for credit losses . . . . . . . . . . . . . (5,557) (7,690)
-------- --------
Mortgage loans-held-in-portfolio . . . . . . . . . . $226,033 $375,927
======== ========
MORTGAGE LOANS-HELD-FOR-SALE:
Outstanding principal . . . . . . . . . . . . . . . . $138,228
Net unamortized premium . . . . . . . . . . . . . . . 1,453
--------
Amortized cost . . . . . . . . . . . . . . . . . . . 139,681
Allowance for credit losses . . . . . . . . . . . . . (154)
--------
Mortgage loans-held-for-sale . . . . . . . . . . . . $139,527
========
Activity in the allowance for credit losses is as follows for the three
years ended December 31, 2001 (in thousands):
2001 2000 1999
-------- ------- --------
Balance, January 1 . . . . . . . . . . . . . . . . $ 7,690 $11,105 $ 3,573
Amount acquired in the purchase of the
common stock of NFI Holding Corporation . . . 254 - -
Provision for credit losses . . . . . . . . . . . 3,773 5,449 22,078
Amounts charged off, net of recoveries . . . . . . (6,006) (8,864) (14,546)
-------- ------- --------
Balance, December 31 . . . . . . . . . . . . . . . $ 5,711 $ 7,690 $ 11,105
======== ======= ========
Recoveries were not significant in the three years ended December 31,
2001.
All mortgage loans serve as collateral for borrowing arrangements
discussed in Note 5. The weighted-average interest rate on loans as of December
31, 2001 and 2000 was 9.90% and 11.02%, respectively.
Collateral for 16%, 14% and 5% of the mortgage loans outstanding as of
December 31, 2001 was located in California, Florida and Michigan, respectively.
The Company has no other significant concentration of credit risk.
Details of loan securitization transactions are as follows (in thousands):
ALLOCATED VALUE OF RETAINED INTERESTS
--------------------------------------------------------------
MORTGAGE
NET BOND SERVICING SUBORDINATED VALUE OF GAIN
PROCEEDS RIGHTS BOND CLASSES LOANS SOLD RECOGNIZED
----------- ---------- ------------- ---------- ----------
YEAR ENDED DECEMBER 31, 2001
NMFT Series 2001-2 . . . . . . . . . . . $ 785,509 $3,816 $36,942 $ 800,033 $12,745
NMFT Series 2001-1 . . . . . . . . . . . 407,372 1,837 22,628 415,067 8,985
---------- ------ ------- ---------- -------
$1,192,881 $5,653 $59,570 $1,215,100 $21,730
========== ====== ======= ========== =======
YEAR ENDED DECEMBER 31, 2000
NMFT Series 2000-2 . . . . . . . . . . . $ 332,566 $1,416 $20,137 $ 347,308 $ 6,811
NMFT Series 2000-1 . . . . . . . . . . . 225,168 1,577 13,233 237,042 2,936
---------- ------ ------- ---------- -------
$ 557,734 $2,993 $33,370 $ 584,350 $ 9,747
========== ====== ======= ========== =======
YEAR ENDED DECEMBER 31, 1999
NMFT Series 1999-1 . . . . . . . . . . . $ 159,042 $ 766 $ 8,973 $ 167,176 $ 1,605
---------- ------ ------- ---------- -------
$ 159,042 $ 766 $ 8,973 $ 167,176 $ 1,605
========== ====== ======= ========== =======
47
In the securitizations, the Company retains interest-only and other
subordinated interests in the underlying cash flows and servicing
responsibilities. The Company receives annual servicing fees approximating 0.50%
of the outstanding balance and rights to future cash flows arising after the
investors in the securitization trusts have received the return for which they
contracted. The investors and securitization trusts have no recourse to the
Company's assets for failure of borrowers to pay when due. The value of the
Company's interests is subject to credit, prepayment, and interest rate risks on
the transferred financial assets.
Servicing fees received from the securitization trusts were $4.9 million,
$1.6 million and $482,000 for the years ended December 31, 2001, 2000 and 1999,
respectively. No purchases of delinquent or foreclosed loans were made on
securitizations in which the Company did not maintain control over the mortgage
loans transferred during the three years ended December 31, 2001.
Fair value of the subordinated bond classes at the date of securitization
is measured by estimating the net present value of expected cash flows of the
loan collateral. Key economic assumptions used to project cash flows at the time
of loan securitization during the three years ended December 31, 2001 were as
follows:
MORTGAGE LOAN COLLATERAL FOR
NOVASTAR MORTGAGE FUNDING TRUST SERIES
-------------------------------------------------
2001-2 2001-1 2000-2 2000-1 1999-1
------ ------ ------ ------ ------
Constant prepayment rate . . 28% 28% 28% 27% 30%
Average life (in years) . . 2.61 2.54 2.81 2.88 3.05
Expected total credit losses, net
of mortgage insurance . . . 1.2% 1.2% 1.0% 1.0% 2.5%
Discount rate . . . . . . . 25.0% 20.0% 15.0% 15.0% 16.5%
NOTE 3. MORTGAGE SECURITIES-AVAILABLE-FOR-SALE
Available-for-sale mortgage securities consisted of the Company's
investment in the AAA-rated interest-only, prepayment penalty and other
subordinated securities that the Company issued. The primary bonds were sold to
parties independent of the Company. Management estimates their fair value by
discounting the expected future cash flow of the collateral and bonds. The
amortized cost, unrealized gains and losses and estimated fair value of mortgage
securities as of December 31, 2001 and 2000 were as follows (in thousands):
GROSS UNREALIZED
AMORTIZED ----------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ------- ------ ----------
As of December 31,2001 . . . . . . . . $54,594 $18,695 $1,705 $71,584
As of December 31,2000 . . . . . . . . 36,483 10,167 - 46,650
Maturities of mortgage securities owned by the Company depend on repayment
characteristics and experience of the underlying financial instruments. The
Company expects the securities it owns as of December 31, 2001 to mature in one
to five years.
All mortgage securities owned by the Company are pledged for borrowings as
discussed in Note 5.
On September 26, 2001, the Company securitized interest-only and
prepayment penalty securities and issued NovaStar CAPS Certificates Series
2001-C1 in the amount of $29.3 million. A gain of $14.9 million was recognized
on this transaction. A subordinated security, valued by the Company at $8.2
million, was retained entitling the Company to receive cash flows of the
collateral once the primary bonds are paid.
48
As of December 31, 2001, key economic assumptions and the sensitivity of
the current fair value of retained interests owned by the Company to immediate
adverse changes in those assumptions are as follows, on average for the
portfolio (dollars in thousands):
Carrying amount/fair value of retained interests . . . . . . . . . . . . . . . . . . $71,584
Average life (in years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.9
PREPAYMENT SPEED ASSUMPTION (CPR) . . . . . . . . . . . . . . . . . . . . . . . . . 34
Fair value after a 10% increase . . . . . . . . . . . . . . . . . . . . . . . . . $69,218
Fair value after a 20% increase . . . . . . . . . . . . . . . . . . . . . . . . . $67,445
EXPECTED ANNUAL CREDIT LOSSES (PERCENT OF CURRENT COLLATERAL BALANCE) . . . . . . . 1.4
Fair value after a 10% increase . . . . . . . . . . . . . . . . . . . . . . . . . $70,477
Fair value after a 20% increase . . . . . . . . . . . . . . . . . . . . . . . . . 69,370
RESIDUAL CASH FLOWS DISCOUNT RATE (%) . . . . . . . . . . . . . . . . . . . . . . . 25
Fair value after a 200 basis point increase . . . . . . . . . . . . . . . . . . . $69,347
Fair value after a 400 basis point increase . . . . . . . . . . . . . . . . . . . $67,041
MARKET INTEREST RATES
Fair value after a 50 basis point increase . . . . . . . . . . . . . . . . . . . . $60,987
Fair value after a 100 basis point increase . . . . . . . . . . . . . . . . . . . $50,460
These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in fair value based on a 10% variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower prepayments
and increased credit losses), which might magnify or counteract the
sensitivities.
Actual and projected static pool credit losses in retained interests are
as follows:
CREDIT LOSSES (PERCENT OF ORIGINAL PRINCIPAL BALANCE) 2001
---------------------------------------------------- -----
Projected as of December 31, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . 0.56%
Projected as of December 31, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . 0.32
Actual as of December 31, 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . 0.03
Static pool losses are calculated by summing the actual and projected
future credit losses and dividing them by the original balance of each pool of
assets.
The table below presents quantitative information about delinquencies, net
credit losses, and components of securitized financial assets and other assets
managed together with them (in thousands):
DECEMBER 31,
---------------------------------------------------------------------------
PRINCIPAL AMOUNT OF NET CREDIT LOSSES
TOTAL PRINCIPAL AMOUNT LOANS 30 DAYS OR DURING THE YEAR ENDED
OF LOANS (A) MORE PAST DUE DECEMBER 31
-------------------------- ----------------------- -----------------------
2001 2000 2001 2000 2001 2000
---------- ---------- -------- -------- -------- --------
Loans securitized . . . . . . . . . $1,629,668 $ 654,049 $ 91,268 $ 31,689 $ 1,968 $ 1,185
Loans held for sale . . . . . . . . 131,639 82,173 17,102 1,588 565 1,555
Loans held in portfolio . . . . . . 233,141 376,393 41,291 68,771 5,811 11,109
---------- ---------- -------- -------- -------- --------
Total loans managed or
Securitized . . . . . . . . . . . . $1,994,448 $1,112,615 $149,661 $102,048 $ 8,344 $13,849
========== ========== ======== ======== ======== =======
- -----------------------
(A) Includes assets acquired through foreclosure.
49
NOTE 4. MORTGAGE SERVICING
As discussed in Note 2, the Company records mortgage servicing rights
arising from the transfer of loans to the securitization trusts. The following
schedule summarizes the carrying value of mortgage servicing rights and the
activity during 2001 (in thousands).
2001
-------
Balance, January 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ -
Amount acquired in purchase of common stock of NFI Holding
Corporation, net of accumulated amortization of $2,968 . . . . . . . . . . . . . . 2,922
Amount capitalized in connection with transfer of loans to securitization trusts . . 5,654
Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,131)
-------
Balance, December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,445
=======
The estimated fair value of the servicing assets aggregated $6.6 million
at December 31, 2001. The fair value is estimated by either discounting
estimated future cash flows from the servicing assets using discount rates that
approximate current market rates or obtaining third-party bids. The fair value
as of December 31, 2001 was determined utilizing a 25% discount rate, credit
losses net of mortgage insurance (as a percent of current principal balance) of
1.3% and an annual prepayment rate of 35%.
NOTE 5. BORROWINGS
ASSET-BACKED BONDS (ABB) The Company also issued ABB secured by its
mortgage loans as a means for long-term financing. For financial reporting and
tax purposes, the mortgage loans held in portfolio as collateral are recorded as
assets of the Company and the ABB are recorded as debt. Interest and principal
on each ABB is payable only from principal and interest on the underlying
mortgage loans collateralizing the ABB. Interest rates reset monthly and are
indexed to one-month LIBOR. The estimated weighted-average months to maturity is
based on estimates and assumptions made by management. The actual maturity may
differ from expectations. However, the Company retains the option to repay the
ABB, and reacquire the mortgage loans, when the remaining unpaid principal
balance of the underlying mortgage loans falls below 35% of their original
amounts for issue 1997-1 and 25% on 1997-2, 1998-1 and 1998-2.
50
Following is a summary of outstanding ABB and related loans (dollars in
thousands):
MORTGAGE LOANS
--------------------------------------
ESTIMATED
ASSET-BACKED BONDS WEIGHTED
---------------------- WEIGHTED AVERAGE
REMAINING INTEREST REMAINING AVERAGE MONTHS
PRINCIPAL RATE PRINCIPAL (A) COUPON TO CALL
--------- -------- ------------- -------- ---------
AS OF DECEMBER 31, 2001:
NovaStar Home Equity Series:
Issue 1997-1 . . . . . . . . . . . . . . . . . . . . $ 29,942 2.41% $ 33,035 10.90% -
Issue 1997-2 . . . . . . . . . . . . . . . . . . . . 30,629 2.44 33,525 10.79 -
Issue 1998-1 . . . . . . . . . . . . . . . . . . . . 59,751 2.33 68,326 10.45 -
Issue 1998-2 . . . . . . . . . . . . . . . . . . . . 98,790 2.31 104,855 10.18 9
Unamortized debt issuance costs, net . . . . . . . . (64)
--------
$219,048
========
AS OF DECEMBER 31, 2000:
NovaStar Home Equity Series:
Issue 1997-1 . . . . . . . . . . . . . . . . . . . . $ 48,121 7.13% $ 52,910 11.80% -
Issue 1997-2 . . . . . . . . . . . . . . . . . . . . 51,114 6.91 55,736 11.55 1
Issue 1998-1 . . . . . . . . . . . . . . . . . . . . 105,780 6.92 117,121 11.03 11
Issue 1998-2 . . . . . . . . . . . . . . . . . . . . 153,508 6.86 163,039 10.57 23
Unamortized debt issuance costs, net . . . . . . . . (1,086)
--------
$357,437
========
- ----------------------
(A) Includes assets acquired through foreclosure.
SHORT-TERM BORROWINGS The following table summarizes the Company's
short-term borrowings as of December 31, 2001 and 2000 (dollars in thousands):
WEIGHTED AVERAGE DAILY
MAXIMUM DAYS TO BALANCE
BORROWING AVERAGE RESET OR DURING THE
CAPACITY RATE MATURITY BALANCE YEAR
---------- -------- ---------- --------- --------------
DECEMBER 31, 2001
REPURCHASE AGREEMENTS (INDEXED TO ONE-MONTH LIBOR):
Agreement expiring October 29, 2002 . . . . . . . $300,000 2.88% 10 $ 19,989
Agreement expiring October 22, 2002 . . . . . . . 200,000 - - -
Agreement expiring July 30, 2002 . . . . . . . . 200,000 - - -
Agreement expiring October 22, 2002 . . . . . . . 50,000 2.37 29 40,000
Agreement expiring July 30, 2002 . . . . . . . . 50,000 2.54 10 22,000
Agreement expiring October 29, 2002 . . . . . . . 25,000 - - -
-------- --------
Total repurchase agreements . . . . . . . . . 825,000 81,989 $129,034
WAREHOUSE AGREEMENTS:
Agreement expiring October 29, 2002
(indexed to Federal funds rate) . . . . . . . 75,000 3.32 Demand 46,111
Agreement expiring February 19, 2002
(indexed to one-month LIBOR) . . . . . . . . . 60,000 3.47 Demand 15,250
-------- --------
Total warehouse lines of credit . . . . . . . 135,000 61,361 50,448
-------- -------- --------
Total short-term borrowings . . . . . . . . $960,000 $143,350 $179,482
======== ======== ========
DECEMBER 31, 2000
Repurchase agreement
expiring December 17, 2001 . . . . . . . . . . $ 25,000 7.71 10 $ 25,000 $ 9,172
======== ======== ========
The Company's mortgage loans and securities are pledged as collateral on
borrowings. All short-term financing arrangements require the Company to
maintain minimum tangible net worth, meet a minimum equity ratio test and comply
with other customary debt covenants. The Company complies with all debt
covenants.
51
NOTE 6. DERIVATIVE INSTRUMENTS AND HEDGE ACTIVITY
The Company's objective and strategy for using derivative instruments is
to mitigate the risk of increased costs on its variable rate liabilities during
a period of rising rates. The Company's primary goals for managing interest rate
risk are to maintain the net interest margin between its assets and liabilities
and diminish the effect of changes in general interest rate levels on the market
value of the Company.
The derivative instruments used by the Company to manage this risk are
interest rate caps and interest rate swaps. Interestrate caps are contracts in
which the Company pays either an up front premium or quarterly premium to a
counterparty. In return, the Company receives payments from the counterparty
when interest rates rise above a certain rate specified in the contract. The
interest rate swap agreements to which the Company is party stipulate that the
Company pay a fixed rate of interest to the counterparty and the counterparty
pays the company a variable rate of interest based on the notional amount of the
contract. The liabilities the Company hedges are asset-backed bonds and
borrowings under its warehouse, mortgage loan and mortgage security repurchase
agreements as discussed in Note 5.
All of the Company's derivative instruments that meet the hedge accounting
criteria of SFAS No. 133 are considered cash flow hedges. The Company does have
some derivative instruments that do not meet the requirements for hedge
accounting as of December 31, 2001. However, they contribute to the Company's
overall risk management strategy by serving to reduce interest rate risk on
average short-term borrowings used to fund loans held for sale. The following
tables present derivative instruments as of December 31, 2001 (dollars in
thousands):
MAXIMUM
NOTIONAL DAYS TO
AMOUNT FAIR VALUE MATURITY
AS OF DECEMBER 31, 2001:
Cash flow hedge derivative instruments . . . . . . . . . . . $335,000 $(8,044) 839
Non-hedge derivative instruments . . . . . . . . . . . . . . 595,000 (1,804) 1,090
-------- -------
Total derivative instruments . . . . . . . . . . . . . . $930,000 $(9,848)
======== =======
During the three years ended December 31, 2001, the Company recognized
$2,278,000, $4,000 and $2,254,000, respectively, in net expense on derivative
instruments qualifying as cash flow hedges, which is recorded as a component of
interest expense, financing on mortgage loans. The 2001 net expense on
derivative instruments is made up of the following components (in thousands):
Cash flow hedge ineffectiveness . . . . . . . . . . . . . . . . . . . . . . . . . $ (243)
Net settlement costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,087)
Other amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
-------
Total net expense on cash flow hedges . . . . . . . . . . . . . . . . . . . . $(2,278)
=======
The net amount included in other comprehensive income expected to be
reclassified into earnings within the next twelve months is a charge to earnings
of approximately $6.9 million.
Information regarding the Company's financial instruments with
off-balance-sheet risk as of December 31, 2000 is as follows (dollars in
thousands):
UNREALIZED WEIGHTED WEIGHTED
NATIONAL ----------------- DAYS TO AVERAGE
VALUE GAINS LOSSES MATURITY CAP RATE
-------- ----- ------ -------- --------
Interest rate cap agreements . . . . . . . . . . . . $340,000 $ - $1,349 400 6.76%
======== ===== =====
The Company's derivative instruments involve, to varying degrees, elements
of credit and market risk in addition to the amount recognized in the
consolidated financial statements.
CREDIT RISK The Company's exposure to credit risk on derivative
instruments is limited to the cost of replacing contracts should the
counterparty fail. The Company seeks to minimize credit risk through the use of
credit approval and review processes, the selection of only the most
creditworthy counterparties, continuing review and monitoring of all
counterparties, exposure reduction techniques and thorough legal scrutiny of
agreements. Before
52
engaging in negotiated derivative transactions with any counterparty, the
Company has in place fully executed written agreements. Agreements with
counterparties also call for full two-way netting of payments. Under these
agreements, on each payment exchange date all gains and losses of counterparties
are netted into a single amount, limiting exposure to the counterparty to any
net positive value.
MARKET RISK The potential for financial loss due to adverse changes in
market interest rates is a function of the sensitivity of each position to
changes in interest rates, the degree to which each position can affect future
earnings under adverse market conditions, the source and nature of funding for
the position, and the net effect due to offsetting positions. The derivative
instruments utilized leave the Company in a market position that is designed to
be a better position than if the derivative instrument had not been used in
interest rate risk management.
OTHER RISK CONSIDERATIONS The Company is cognizant of the risks involved
with derivative instruments and has policies and procedures in place to mitigate
risk associated with the use of derivative instruments in ways appropriate to
its business activities, considering its risk profile as a limited end-user.
NOTE 7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments presents amounts that have been determined using available market
information and appropriate valuation methodologies. However, considerable
judgment is required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts that could be realized in a current market exchange.
The use of different market assumptions or estimation methodologies could have a
material impact on the estimated fair value amounts.
The estimated fair values of the Company's financial instruments are as
follows as of December 31 (in thousands).
2001 2000
------------------------- -----------------------
CARRYING CARRYING
VALUE FAIR VALUE VALUE FAIR VALUE
----------- ------------ ---------- -----------
Financial assets:
Mortgage loans:
Held-in-portfolio . . . . . . . . . . . . . $226,033 $227,071 $375,927 $371,904
Held-for-sale . . . . . . . . . . . . . . . 139,527 143,009 - -
Mortgage securities-available-for-sale . . . . 71,584 71,584 46,650 46,650
Mortgage servicing rights. . . . . . . . . . . 6,445 6,647 - -
Financial liabilities:
Borrowings:
Asset-backed bonds . . . . . . . . . . . . 219,048 218,131 357,437 357,646
Short-term . . . . . . . . . . . . . . . . 143,350 143,350 25,000 25,000
Derivative financial instruments . . . . . . . . (9,848) (9,848) 1,510 161
The fair value of mortgage assets, of derivative instruments and
borrowings is estimated by discounting projected future cash flows at
appropriate rates. Expected prepayments are used in estimating the fair value of
mortgage assets. The fair values of cash and cash equivalents and accrued
interest receivable and payable approximates their carrying value.
NOTE 8. STOCKHOLDERS'EQUITY
On March 29, 1999, the Company completed a private placement of preferred
stock by issuing 4,285,714 shares of class B, 7% cumulative convertible
preferred stock for $7 per share and received net proceeds of $28.7 million. The
preferred stock pays a dividend equal to the greater of 7% or the dividend rate
paid on common stock. On or after January 31, 2002, the Company can notify
holders of the preferred stock of its intent to redeem the preferred stock at $7
per share. The holders have the option to convert each preferred share into one
share of common stock within 30 days of the date of the Company's redemption
notice.
As of December 31, 2001, the Company has 1,162,731 warrants outstanding
for the purchase of Company common stock. The exercise price on 350,000 of the
warrants is $6.94 and expire in 2002. Warrants of 812,731 expiring in 2003 have
an exercise price of $4.56. These warrants were issued in connection with the
execution of short-term financing arrangements in 1998 and 1999, which have
matured.
53
The Company's Board of Directors has approved the purchase of up to
$9,000,000 of the Company's common stock. During the year ended December 31,
2001 and 2000, 115,147 and 1,376,766 shares, respectively, were purchased. The
aggregate purchase price for these shares was $654,000 and $5,718,000,
respectively. The purchased shares have been returned to the Company's
authorized but unissued shares of common stock. All common stock purchases are
charged against additional paid-in capital.
Accumulated other comprehensive income includes revenues, expenses, gains
and losses that are not included in net income. Following is a rollforward of
accumulated other comprehensive income for the three years ended December 31,
2001 (in thousands).
2001
------------------------------------------
DERIVATIVE AVAILABLE-FOR-SALE
AVAILABLE- INSTRUMENTS SECURITIES
FOR-SALE USED IN CASH FLOW --------------------
SECURITIES HEDGES TOTAL 2000 1999
---------- ----------------- --------- -------- ------
Balance, January 1 . . . . . . . . . . . . . $ 10,168 $ - $ 10,168 $ 242 $ -
Change in unrealized gain (loss) . . . . . . 21,768 (9,882) 11,886 9,926 242
Implementation of SFAS No. 133 . . . . . . . - 34 34 - -
Net settlements reclassified to earnings . . - 2,087 2,087 - -
Realized gain reclassified to earnings . . . (14,946) - (14,946) - -
Other amortization . . . . . . . . . . . . . - (52) (52) - -
-------- -------- --------- ------- -----
Other comprehensive income (loss). . . . . . (991) 9,926 242
--------- ------- -----
Balance, December 31 . . . . . . . . . . . . $ 16,990 $(7,813) $ 9,177 $10,168 $ 242
======== ======== ========= ======= =====
NOTE 9. TRANSACTIONS WITH FOUNDERS
In connection with the initial formation and capitalization of the
Company, the two founders acquired 216,666 shares of common stock along with
warrants to acquire 216,666 additional shares in exchange for non-recourse
forgivable promissory notes. Pursuant to the terms of the agreements, the notes
were to be forgiven if certain incentive targets were met. The targets were met
in 1997, and notes related to 72,222 shares were forgiven. The incentive targets
were not met in 1998, 1999, or 2000 and, accordingly, no debt forgiveness
occurred in those years. For accounting purposes, the arrangement has been
accounted for as a restricted stock award, and the notes receivable included in
the accompanying consolidated balance sheets have been adjusted to an amount
equal to the fair value of the remaining unearned shares at each balance sheet
date. The Company added $260,000 of accrued interest recognized in 1997 on these
notes from the founders to the principal of new notes. The warrants were not
exercised and expired in 2001.
During 1998, the founders exercised options to acquire 289,332 shares of
common stock in exchange for nonrecourse promissory notes aggregating
$4,340,000.
The Company advanced $584,000 to the founders for the payment of their
personal tax liability arising from the 1997 forgiveness referred to above and
advanced $70,000 in order for the founders to inject capital into NFI Holding
Corporation in 1999. Additionally, accrued interest balances related to the
borrowings above aggregated $579,000 at December 31, 2000 and December 31, 1999.
No interest was recorded or received by the Company during 2001 and 2000
relating to the above notes. Interest income recorded by the Company related to
the notes aggregated $496,000 in 1999. Interest paid by the founders aggregated
$177,000 in 1999.
On January 1, 2001, the Company and its founders entered into a series of
transactions, which resulted in a significant modification of the transactions
described above. The founders returned the 289,332 shares of common stock
acquired in 1998 and the Company cancelled the related non-recourse debt.
Additionally, the Company purchased the voting common stock of NFI Holding
Corporation from the founders for $370,000. The number of common shares
purchased from the founders was 1,000 at a $0.01 par value. This business
combination was treated under the purchase accounting method. As a result of
this purchase, NFI Holding Corporation became a wholly-owned subsidiary of the
Company on January 1, 2001. The Company also repurchased the 72,222 shares
acquired by the founders in 1997, paying $271,000.
The founders used the $641,000 received from the sale of NFI Holding
Corporation and Company common stock to repay a portion of their obligations
described above. The remaining obligations, aggregating $1,393,000
54
have been rewritten into new non-recourse, non interest-bearing promissory
notes. Those notes will be forgiven and charged to expense in equal installments
over 10 years as long as the Company employs the founders on December 31st of
each year. The notes will be forgiven in full in the event of a change in
control. During the year ended December 31, 2001, the Company recognized
$139,000 in compensation expense related to these notes. The founders have each
pledged 72,222 shares of common stock as collateral for these loans. The
activity on January 1, 2001 can be summarized as follows (in thousands):
Balance of forgivable notes, December 31, 2000 . . . . . . . . . . . . . . $ 6,374
Cash received from founders . . . . . . . . . . . . . . . . . . . . . . . (641)
Return of shares subject to non-recourse notes . . . . . . . . . . . . . . (4,340)
-------
Balance of forgivable notes, January 1, 2001 . . . . . . . . . . . . . . . $ 1,393
=======
Following is a summary of the Company's consolidated operating results for
the year ended December 31, 2001 and unaudited pro forma results for the year
ended December 31, 2000 as though the acquisition of the common stock of NFI
Holding Corporation had occurred at the beginning of those periods:
PRO FORMA
2001 2000
------- -------
Interest income:
Mortgage loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $46,363 $57,864
Mortgage securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,706 2,951
------- -------
Total interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58,069 60,815
Interest expense:
Financing for mortgage loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,677 41,987
Financing for mortgage securities . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,911 920
------- -------
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,588 42,907
------- -------
Net interest income before provision for credit losses . . . . . . . . . . . . . . . . . . 29,481 17,908
Provision for credit losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,773) (5,623)
------- -------
Net interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,708 12,285
Gain on derivative instruments and sales of mortgage assets. . . . . . . . . . . . . . . . 34,616 13,967
Fee income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,142 9,908
Prepayment penalty income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 790 1,776
Premiums for mortgage loan insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,655) (1,272)
Other income, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,856 1,677
General and administrative expenses:
Compensation and benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,226 17,184
Travel and public relations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,807 3,265
Office administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,638 6,438
Professional and outside services . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,044 2,200
Loan expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,964 1,851
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,764 1,777
------- -------
Total general and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . 49,443 32,715
------- -------
Income (loss) before cumulative effect of a change in accounting principle . . . . . . . . 34,014 5,626
Cumulative effect of a change in accounting principle. . . . . . . . . . . . . . . . . . . (1,706) -
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,308 5,626
Dividends on preferred shares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,025) (2,100)
------- -------
Net income (loss) available to common shareholders . . . . . . . . . . . . . . . . . . . . $27,283 $ 3,526
======= =======
Basic earnings (loss) per share-before cumulative effect of a
change in accounting principle. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3.38 $ 0.51
Basic loss per share due to the cumulative effect of a change in accounting principle $ (0.16) $ -
------- -------
Basic earnings (loss) per share. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3.22 $ 0.51
======= =======
Diluted earnings (loss) per share-before cumulative effect of a
change in accounting principle. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3.18 $ 0.50
Diluted loss per share due to the cumulative effect of a change in accounting principle $ (0.16) $ -
------- -------
Diluted earnings (loss) per share. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3.02 $ 0.50
======= =======
55
NOTE 10. STOCK OPTION PLAN
The Company's 1996 Stock Option Plan (the Plan) provides for the grant of
qualified incentive stock options (ISOs), non-qualified stock options (NQSOs),
deferred stock, restricted stock, performance shares, stock appreciation and
limited stock awards, and dividend equivalent rights (DERs). ISOs may be granted
to the officers and employees of the Company. NQSOs and awards may be granted to
the directors, officers, employees, agents and consultants of the Company or any
subsidiaries. Under the terms of the Plan, the number of shares available for
issuance is equal to 10 % of the Company's outstanding common stock. Unless
previously terminated by the Board of Directors, the Plan will terminate on
September 1, 2006.
All options have been granted at exercise prices greater than or equal to
the estimated fair value of the underlying stock at the date of grant.
Outstanding options vest over four years and expire ten years after the date of
grant. The following table summarizes option activity under the 1996 Plan for
2001, 2000 and 1999, respectively:
2001 2000 1999
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES PRICE SHARES PRICE SHARES PRICE
Outstanding at the
beginning of year . . . . . . . . 541,910 $ 7.63 357,720 $10.16 384,060 $13.37
Granted . . . . . . . . . . . . . . . 112,000 13.44 249,500 3.74 119,000 6.94
Exercised . . . . . . . . . . . . . . (113,250) 5.60 (10,000) 1.26 (3,750) 1.67
Canceled . . . . . . . . . . . . . . (1,740) 18.00 (55,310) 7.57 (141,590) 16.39
--------- -------- --------
Outstanding at the
end of year. . . . . . . . . . . . 538,920 $ 9.23 541,910 $ 7.63 357,720 $10.16
======== ====== ======== ====== ========= ======
Exercisable at the
end of year. . . . . . . . . . . . 203,045 $12.37 184,745 $11.63 141,890 $11.10
======== ====== ======== ====== ========= ======
Compensation expense
relating to variable awards. . . . $ 704
========
Pursuant to a resolution of the Company's compensation committee of the
Board of Directors dated December 21, 1999, the exercise price for 104,000 stock
options issued to employees was decreased to $7.00. These options are included
in the granted and canceled amounts during 1999 in the table above. Of these,
69,000 were issued originally in 1997 with an exercise price of $18.00 per
common share and 35,000 were issued in 1998 at an exercise price of $17.01 per
share. No changes were made to the vesting periods or expiration dates.
Certain options granted during 2001, 2000 and 1999 were granted with DERs.
In December 2001, the Company's Board of Directors approved that substantially
all outstanding stock options and future stock option grants have DERs attached
to them. Under the terms of the DERs, a recipient is entitled to receive
additional shares of stock upon the exercise of options. The DERs accrue at a
rate equal to the number of options outstanding times the dividends per share
amount at each dividend date. The accrued DERs convert to shares based on the
stock's fair value on the dividend declaration date. Certain of the options
exercised in 2001, 2000 and 1999 had DERs attached to them when issued. As a
result of these exercises, an additional 889, 838 and 104 shares of common stock
were issued in 2001, 2000 and 1999, respectively. As discussed in Note 9, the
Company's two founders exercised options to acquire 289,332 shares of common
stock in 1998, which were returned to the Company January 1, 2001.
56
The following table presents information on stock options outstanding as
of December 31, 2001:
OUTSTANDING EXERCISABLE
WEIGHTED ----------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
CONTRACTUAL LIFE EXERCISE EXERCISE
EXERCISE PRICE QUANTITY (YEARS) PRICE QUANTITY PRICE
-------------- --------- ---------------- --------- -------- ---------
$3.06-$5.88 . . . . . . . . . . . . . . . 228,750 8.93 $ 3.78 34,125 $ 3.91
$6.38-$8.35 . . . . . . . . . . . . . . . 99,750 6.87 6.76 59,250 6.64
$15.11-$20.81 . . . . . . . . . . . . . . 210,420 7.81 16.70 109,670 18.10
------- -------
538,920 8.11 $ 9.38 203,045 $12.37
======= ==== ====== ======= ======
In accordance with accounting principles generally accepted in the United
States of America, the Company has chosen to not record the fair value of stock
options at their grant date. If the expense had been recorded the Company's net
income (loss) for the three years ended December 31, 2001 would have been $32.0
million, $5.5 million and $(8.8) million. Diluted earnings (loss) per share for
the three years ended December 31, 2001 would have been $2.99, $0.49 and
$(1.10). The following table summarizes the weighted average fair value of the
granted options, determined using the Black-Scholes option pricing model and the
assumptions used in their determination:
2001 2000 1999
---- ---- ----
Weighted average:
Fair value, at date of grant . . . . . . . . . . . . . . . . . . . . . . . . . . . $9.54 $2.63 $2.39
Expected life in years. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 7 7
Annual risk-free interest rate. . . . . . . . . . . . . . . . . . . . . . . . . . . 5.0% 5.1% 6.0%
Volatility. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 3.5 4.1
Dividend yield. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.0% 5.0% 5.0%
NOTE 11. SEGMENT REPORTING
The Company manages and operates in four business segments: mortgage
portfolio, mortgage lending and servicing, branch operations and branch
management. Mortgage portfolio operating results are driven from the income
generated on the assets we manage less associated management costs. Mortgage
lending and servicing operations include the marketing, underwriting and funding
of loan production. Servicing operations represent the income and costs to
service our on and off -balance sheet loans (see Note 2). Branch operations
include the collective income generated by NovaStar Home Mortgage brokers and
the associated operating costs. Branch management costs include the
corporate-level income and costs to support branch operations. The Company's
operations were restructured into this decentralized organizational structure
beginning January 1, 2001 as branch operations and management became more
significant to the overall performance of the Company. Prior to 2001, the
Company managed its operations under one industry segment: the origination,
servicing and management of non-conforming mortgage loans. As such, it is not
practicable to provide segment information for 2000 and 1999. Following is a
summary of income and assets by the Company's primary operating units for the
year ended December 31, 2001 (in thousands).
57
MORTGAGE
LENDING
MORTGAGE AND BRANCH BRANCH
PORTFOLIO SERVICING OPERATIONS MANAGEMENT TOTAL
--------- ---------- ---------- ---------- ---------
Interest income . . . . . . . . . . $ 38,306 $ 19,678 $ 85 $ 58,069
Interest expense. . . . . . . . . . 18,970 9,618 - 28,588
-------- --------- -------- ------- --------
Net interest income . . . . . . . . 19,336 10,060 85 29,481
Provision for losses. . . . . . . . (3,608) (165) - (3,773)
Fee income. . . . . . . . . . . . . - 3,453 16,280 $ 3,409 23,142
Gain on derivative instruments and
sales of mortgage loans . . . . . 14,745 19,700 - 171 34,616
Other income (expense). . . . . . . 639 (648) - - (9)
General and administrative expenses (3,681) (26,573) (16,352) (2,837) (49,443)
-------- --------- -------- ------- --------
Income before cumulative effect of
a change in accounting principle 27,431 5,827 13 743 34,014
Cumulative effect of a change
in accounting principle . . . . . (1,385) (321) - - (1,706)
-------- --------- -------- ------- --------
Net income. . . . . . . . . . . . . $ 26,046 $ 5,506 $ 13 $ 743 $ 32,308
======== ======== ======== ======= ========
DECEMBER 31, 2001:
Total assets . . . . . . . . . . . . . $344,676 $152,593 $ 826 $14,285 $512,380
======== ======== ======== ======= ========
Intersegment revenues and expenses that were eliminated in consolidation
were as follows:
2001
----------
Amounts paid to mortgage lending and servicing from mortgage portfolio:
Loan servicing fees . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,573
Administrative fees . . . . . . . . . . . . . . . . . . . . . . . . . 704
Amounts received from mortgage lending and servicing to mortgage portfolio:
Intercompany interest income. . . . . . . . . . . . . . . . . . . . . (3,931)
Guaranty, commitment, loan sale, and securitization fees. . . . . . . (3,871)
NOTE 12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN THOUSANDS):
2001 2000 1999
--------- --------- --------
Cash paid for interest . . . . . . . . . . . . . . . . . . $ 28,918 $ 34,610 $ 48,397
========= ========= ========
Non-cash items:
Dividends payable. . . . . . . . . . . . . . . . . . . . $ 4,758 $ 525 $ 525
========= ========= ========
Securities retained in securitizations . . . . . . . . . $ (62,577) $ (33,371) $ -
========= ========= ========
Issuance of warrants . . . . . . . . . . . . . . . . . . $ - $ - $ 350
========= ========= ========
Assets acquired through foreclosure. . . . . . . . . . . $ 20,159 $ 34,596 $ 30,966
========= ========= ========
58
Non-cash activities related to the acquisition of common stock of NFI
Holding Corporation on January 1, 2001 were as follows (in thousands):
Operating activities:
Increase in mortgage loans held-for-sale . . . . . . . . . . . . . . $ (81,733)
==========
Increase in other assets . . . . . . . . . . . . . . . . . . . . . . $ (11,132)
==========
Decrease in other liabilities. . . . . . . . . . . . . . . . . . . . $ (9,422)
==========
Investing activities:
Increase in realestate owned . . . . . . . . . . . . . . . . . . . . $ (892)
==========
Financing activities:
Increase in borrowings . . . . . . . . . . . . . . . . . . . . . . . $ 36,900
==========
Non-cash financing activities related to founders' notes receivable:
Decrease in founders' notes receivable . . . . . . . . . . . . . . . $ 4,340
==========
Decrease in additional paid-in capital . . . . . . . . . . . . . . . $ (4,340)
==========
NOTE 13. COMMITMENTS AND CONTINGENCIES
The Company makes commitments to borrowers to fund residential mortgage
loans. The time between the date a commitment is made and the ultimate funding
is short and, therefore, the volume of outstanding commitments at any time is
not material.
The Company leases other office space under various operating lease
agreements. Rent expense for 2001, 2000 and 1999, aggregated $1,955,000,
$180,000 and $116,000 respectively. Future minimum lease commitments under those
leases are as follows (in thousands).
LEASE
OBLIGATIONS
-----------
2002 . . . . . . . . . . . . . . $1,008
2003 . . . . . . . . . . . . . . 984
2004 . . . . . . . . . . . . . . 868
2005 . . . . . . . . . . . . . . 217
2006 . . . . . . . . . . . . . . 161
Thereafter . . . . . . . . . . . 13
In the normal course of its business, the Company is subject to various
legal proceedings and claims, the resolution of which, in the opinion of
management, will not have a material adverse effect on the Company's financial
condition or results of operations.
NOTE 14. TRANSACTIONS WITH AND CONDENSED FINANCIAL STATEMENTS OF NFI
HOLDING CORPORATION AND SUBSIDIARIES
Under the terms of loan servicing agreements, NovaStar Mortgage, Inc., a
wholly-owned subsidiary of NFI Holding Corporation, services loans owned by the
Company. Individual agreements have been executed for each pool of loans serving
as collateral for the Company's ABB.
During 1998, the Company and NovaStar Mortgage were parties to a mortgage
loan purchase and sale agreement. Under the terms of the agreement, the Company
purchased mortgage loans originated by NovaStar Mortgage at prices that varied
with the nature and terms of the underlying mortgage loans. The agreement was
modified effective January 1, 1998 to include a purchase commitment fee. If
NovaStar Mortgage chose to retain the mortgage loans it originated or sold them
to third parties, it paid a fee to the Company for not delivering its loan
production under the purchase commitment. Under the terms of an administrative
outsourcing services agreement, the Company paid NovaStar Mortgage a fee for
providing certain services, including the development of loan
59
products and information systems, underwriting, funding, and quality control.
The agreement was terminated effective March 31, 1999.
Effective April 1, 1999, the Company entered an intercompany loan and
guarantee agreement with NovaStar Mortgage. Under the terms of this agreement,
NovaStar Mortgage pays interest on amounts it borrows from the Company. As of
December 31, 2000, NovaStar Mortgage had $2,729,000 in borrowings from the
Company outstanding. Interest on the borrowings accrues at the Federal funds
rate plus 1.75%. In addition, NovaStar Mortgage is required to pay guaranty fees
in the amount 0.25% of the loans sold by NovaStar Mortgage for which the Company
has guaranteed the performance of NovaStar Mortgage.
Effective July 1, 2000, NovaStar Mortgage entered into intercompany
agreements with the Company to recognize the value of the credit enhancement
support that the financial position of NovaStar Financial lends to NovaStar
Mortgage. These agreements include a loan servicing support fee, a financing
commitment fee, a residual purchase commitment, and a guaranty spread fee. In
addition, the Company entered into a securitization consulting agreement whereby
NovaStar Mortgage pays a fee to the Company for expertise in negotiating and
coordinating the securitization transactions executed by NovaStar Mortgage. Fees
for these agreements are based on transaction volumes.
Following is a summary of the fees paid to (received from) NovaStar
Mortgage (in thousands):
2000 1999
----- -----
Amounts paid to NovaStar Mortgage:
Loan servicing fees . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,502 $ 3,886
Administrative fees . . . . . . . . . . . . . . . . . . . . . . . . . 625 1,258
Amounts received from NovaStar Mortgage:
Intercompany interest income. . . . . . . . . . . . . . . . . . . . . . (395) (1,113)
Guaranty, commitment, loan sale and securitization fees . . . . . . . . (2,711) -
------- -------
$ 21 $ 4,031
======= =======
On January 1, 2001, the Company purchased all of the common stock of NFI
Holding Corporation. With this purchase, NFI Holding Corporation became a part
of the Company's consolidated financial statements. Accordingly, the above 2001
intercompany fees were eliminated upon consolidation.
Following are the condensed consolidated balance sheet and statements of
income of NFI Holding Corporation as of December 31, 2000 (in thousands):
NFI HOLDING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,242
Mortgage loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78,812
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,764
--------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 91,818
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,900
Due to NovaStar Financial, Inc . . . . . . . . . . . . . . . . . . . . . . . 37,316
Accounts payable and other liabilities . . . . . . . . . . . . . . . . . . . 9,421
--------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83,637
Stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,181
--------
Total liabilities and stockholders' equity . . . . . . . . . . . . . . . . $ 91,818
========
60
NFI HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED
DECEMBER 31,
--------------------
2000 1999
-------- ---------
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,485 $11,473
Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,211 5,942
------- -------
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . 6,274 5,531
Provision for credit losses . . . . . . . . . . . . . . . . . . . . . . . . 174 860
------- -------
Net interest income after provision for credit losses . . . . . . . . . . . 6,100 4,671
Other income:
Fees from third parties . . . . . . . . . . . . . . . . . . . . . . . . 9,908 905
Fees received from, net of paid to, NovaStar
Financial, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 4,031
Net gain on sales of mortgage assets. . . . . . . . . . . . . . . . . . 14,793 11,767
------- -------
Total other income. . . . . . . . . . . . . . . . . . . . . . . . . . 24,722 16,703
General and administrative expenses . . . . . . . . . . . . . . . . . . 29,689 21,285
------- -------
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,133 $ 89
======= =======
NOTE 15. EARNINGS PER SHARE
The computations of basic and diluted EPS computations for the years ended
December 31, 2001, 2000 and 1999 are as follows (in thousands except per share
amounts):
YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
--------- -------- -------
NUMERATOR . . . . . . . . . . . . . . . . . . . . . . . $32,308 $ 5,626 $(8,698)
====== ====== ========
DENOMINATOR:
Weighted average common shares outstanding - basic
Common shares outstanding . . . . . . . . . . . . . . 5,739 6,851 8,032
Convertible preferred stock . . . . . . . . . . . . . 4,286 4,286 -
------ ------ --------
10,025 11,137 8,032
====== ====== ========
Weighted average common shares outstanding - dilutive
Stock options . . . . . . . . . . . . . . . . . . . . 189 6 -
Warrants. . . . . . . . . . . . . . . . . . . . . . . 477 - -
------ ------ --------
Weighted average common shares outstanding - dilutive. . 10,691 11,143 8,032
====== ====== ========
Basic earnings (loss) per share. . . . . . . . . . . . . $ 3.22 $ 0.51 $ (1.08)
====== ====== ========
Diluted earnings (loss) per share. . . . . . . . . . . . $ 3.02 $ 0.50 $ (1.08)
====== ====== ========
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 EPS because the exercise price was greater than the
average market price of the common shares for the periods presented, therefore,
the effect would be antidilutive:
YEAR ENDED DECEMBER 31,
--------------------------
2001 2000 1999
------ ------ ------
Number of stock options and warrants (in thousands) . . . . . . . . . 210 5,706 4,700
Weighted average exercise price . . . . . . . . . . . . . . . . . . . $16.33 $ 9.97 $11.21
61
NOTE 16. CONDENSED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Following is condensed consolidated quarterly operating results for the
Company (in thousands, except per share amounts):
2001 QUARTERS 2000 QUARTERS
------------------------------------ -----------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
------ ------ ------- ------ ------ ------ ------ ------
Net interest income . . . . . . . . $5,574 $6,741 $ 9,404 $7,762 $3,114 $2,835 $2,151 $2,612
Provision for credit losses . . . . 519 1,119 1,134 1,001 1,579 1,213 1,212 1,445
Income before cumulative
effect of a change in
accounting principle . . . . . . 4,719 4,188 18,936 6,171 1,212 146 1,978 2,290
Gain (loss) on derivative
instruments and sales of
mortgage assets. . . . . . . . . 5,023 9,563 28,548 8,518 (92) 54 (684) (104)
Cumulative effect of a change in
accounting principle . . . . . . 1,706 - - - - - - -
Net income. . . . . . . . . . . . . 3,013 4,188 18,936 6,171 1,212 146 1,978 2,290
Dividends on preferred stock. . . . 525 557 2,505 1,438 525 525 525 525
Net income (loss) available to
common shareholders. . . . . . . 2,488 3,631 16,431 4,733 686 (379) 1,453 1,765
Basic earnings
(loss) per share -
Before cumulative effect
of a change In accounting
principle. . . . . . . . . . . . 0.47 0.42 1.89 0.61 0.09 (0.05) 0.21 0.29
Basic loss per share due
to cumulative effect of
a change in accounting
principle. . . . . . . . . . . . (0.17) - - - - - - -
------ ------ ------- ------ ------ ------ ------ ------
Basic earnings (loss)
per share. . . . . . . . . . . . 0.30 0.42 1.89 0.61 0.09 (0.05) 0.21 0.29
Diluted earnings (loss)
per share - before
cumulative effect of a
change in accounting principle . 0.47 0.40 1.76 0.56 0.09 (0.05) 0.21 0.29
Diluted loss per share due to
cumulative effect of a
change in accounting principle . (0.17) - - - - - - -
------ ------ ------- ------ ------ ------ ------ ------
Diluted earnings (loss) per share . 0.30 0.40 1.76 0.56 0.09 (0.05) 0.18 0.22
NOTE 17. SUBSEQUENT EVENT
As discussed in Note 8, the Company has the right to redeem its preferred
stock for $7 per share and the preferred shareholders have an option to convert
their preferred shares into common shares. On February 13, 2002, the Company
notified the preferred shareholders of its intent to redeem the preferred
shares. On February 21, 2002 the preferred shareholders exercised their options
to convert to common shares.
62
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
NovaStar Financial, Inc.
Westwood, Kansas
We have audited the accompanying consolidated balance sheet of NovaStar
Financial, Inc. and subsidiaries (the "Company") as of December 31, 2001, and
the related consolidated statements of income, stockholders' equity, and cash
flows for the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit. The
consolidated financial statements of the Company for the years ended December
31, 2000 and 1999 were audited by other auditors whose report, dated February 9,
2001, expressed an unqualified opinion on those financial statements.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such 2001 consolidated financial statements present
fairly, in all material respects, the financial position of the Company as of
December 31, 2001, and the results of its operations and its cash flows for the
year then ended in conformity with accounting principles generally accepted in
the United States of America.
Kansas City, Missouri
February 11, 2002,
except as to Note 17 which
is dated February 21, 2002
63
INDEPENDENT AUDITORS' REPORT
The Board of Directors
NovaStar Financial, Inc.:
We have audited the accompanying consolidated balance sheet of NovaStar
Financial, Inc. and subsidiaries as of December 31, 2000 and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the years in the two-year period ended December 31, 2000. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of NovaStar
Financial, Inc. and subsidiaries as of December 31, 2000 and the results of
their operations and their cash flows for each of the years in the two-year
period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States of America.
KPMG LLP
Kansas City, Missouri
February 9, 2001
64
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Information with respect to Item 401 of Regulation S-K is incorporated by
reference to the information included on NovaStar Financial's Proxy Statement
dated March 12, 2002, for the Annual Meeting of Shareholders to be held at May
30, 2002 at 10:00 a.m., Central Daylight Time, at the NovaStar Financial, Inc.
Corporate Offices, 1901 W. 47th Place, Suite 100,Westwood, Kansas 66205.
65
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to Item 401 of Regulation S-K is incorporated by
reference to the information included on NovaStar Financial's Proxy Statement
dated March 12, 2002, for the Annual Meeting of Shareholders to be held at May
30, 2002 at 10:00 a.m., Central Daylight Time, at the NovaStar Financial, Inc.
Corporate Offices, 1901 W. 47th Place, Suite 100,Westwood, Kansas 66205.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to Item 402 of Regulation S-K is incorporated by
reference to the information included on NovaStar Financial's Proxy Statement
dated March 12, 2002, for the Annual Meeting of Shareholders to be held at May
30, 2002 at 10:00 a.m., Central Daylight Time, at the NovaStar Financial, Inc.
Corporate Offices, 1901 W. 47th Place, Suite 100,Westwood, Kansas 66205.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to Item 403 of Regulation S-K is incorporated by
reference to the information included on NovaStar Financial's Proxy Statement
dated March 12, 2002, for the Annual Meeting of Shareholders to be held at May
30, 2002 at 10:00 a.m., Central Daylight Time, at the NovaStar Financial, Inc.
Corporate Offices, 1901 W. 47th Place, Suite 100,Westwood, Kansas 66205.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information with respect to Item 404 of Regulation S-K is incorporated by
reference to the information included on NovaStar Financial's Proxy Statement
dated March 19, 2001, for the Annual Meeting of Shareholders to be held at May
30, 2002 at 10:00 a.m., Central Daylight Time, at the NovaStar Financial, Inc.
Corporate Offices, 1901 W. 47th Place, Suite 100,Westwood, Kansas 66205.
66
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Schedules
(1) The financial statements as set forth under Item 8 of this
report on Form 10-K are included herein.
(2) The required financial statement schedules are omitted because
they are not applicable to NovaStar Financial.
(b) Reports on Form 8K
o NovaStar Financial has filed no Form 8-K's during the fourth
quarter of 2001 and through the date of this filing in the first
quarter of 2002.
(c) Exhibit Listing
67
EXHIBIT NO. DESCRIPTION OF DOCUMENT
- ----------- -----------------------
3.1* Articles of Amendment and Restatement of the Registrant
3.3* Bylaws of the Registrant
3.3a***** Amendment to Bylaws of the Registrant, adopted February 2, 2000
3.4**** Articles Supplementary of NovaStar Financial, Inc. dated as of
March 24, 1999, as filed with the Maryland Department of
Assessment and Taxation.
4.1* Specimen Common Stock Certificate
4.3**** Specimen certificate for Preferred Stock
10.6* Form of Master Repurchase Agreement for mortgage loan financing
10.7* Mortgage Loan Warehousing Agreement dated as of November 24,
1997 between First Union National Bank of North Carolina,
NovaStar Mortgage, Inc. and the Registrant.
10.14* 1996 Executive and Non-Employee Director Stock Option Plan, as
last amended December 6, 1996.
10.23*** Warrant Agreement dated as of February 12, 1999 between the
Registrant and First Union National Bank.
10.24**** Warrant Agreement, dated as of March 10, 1999, by and between
NovaStar Financial, Inc. and Residential Funding Corporation,
and related Guaranty Warrant, Tag Along Warrant and
Registration Rights Agreement as filed with April 6, 1999 8-K
of NovaStar Financial, Inc.
11.1****** Statement regarding computation of per share earnings.
21.1 Subsidiaries of the Registrant
23.4 Consents of Deloitte & Touche LLP and KPMG, LLP
- -----------------
* Incorporated by reference to the correspondingly numbered exhibit to
the Registration Statement on Form S-11 (373-32327) filed by the
Registrant with the SEC on July 29 1997, as amended.
** Incorporated by reference to the correspondingly numbered exhibit to
Form 8-K filed by the Registrant with the SEC on December 22, 1998.
*** Incorporated by reference to the correspondingly numbered exhibit to
Form 8-K filed by the Registrant with the SEC on February 23, 1999.
**** Incorporated by reference to the correspondingly numbered exhibit to
Form 8-K filed by the Registrant with the SEC on April 5, 1999.
***** Incorporated by reference to the correspondingly numbered exhibit to
the Annual Report on Form 10-K filed by the Registrant with the SEC
on March 20, 2000.
****** Incorporated by reference to the correspondingly numbered exhibit to
the Quarterly Report on Form 10-Q filed by the Registrant with the
SEC on November 13, 2000.
****** See Note 15 to the consolidated financial statements.
68
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NovaStar Financial, Inc.
(Registrant)
Date: March 8, 2002 By: /s/ Scott F. Hartman
-------------------------------------
Scott F. Hartman, Chairman of the Board
of Directors and Chief Executive Officer
Date: March 8, 2002 By: /s/ W. Lance Anderson
-------------------------------------
W. Lance Anderson, President,
Chief Operating Officer and Director
Date: March 8, 2002 By: /s/ Rodney E. Schwatken
-------------------------------------
Rodney E. Schwatken, Vice President,
Secretary and Treasurer
(Chief Accounting Officer)
Date: March 8, 2002 By: /s/ Edward W. Mehrer
-------------------------------------
Edward W. Mehrer, Director
Date: March 8, 2002 By: /s/ Gregory T. Barmore
-------------------------------------
Gregory T. Barmore, Director
Date: March 8, 2002 By: /s/ Art N. Burtscher
-------------------------------------
Art N. Burtscher, Director
69