EPDs Affect NovaStar Financial Earnings

Subprime wholesaler NovaStar Financial Inc. here saw its share price plunge 50% last week after reporting a fourth-quarter loss and raising the possibility that it would "de-REIT."

The company - whose 52-week high is $38 compared to last Thursday's low of $9 - has been a target of short sellers who believe its current $5.80 dividend is now doomed.

In the fourth quarter, the top 20 ranked subprime funder lost $14.4 million, compared to a profit of $26.4 million in the same period a year earlier. Its annual profit fell 50% to $66 million.

The company admitted it is suffering from the same malaise as many other subprime wholesalers: early payment defaults, poor whole loan prices and impairment charges.

In its earnings statement, the nonprime lender signaled that it might move to end its status as a real estate investment trust. REITs must pay out 90% of their earnings in the form of dividends to shareholders. (Hurt by EPDs and razor-thin profit margins, several publicly traded nonprime REITs are currently in financial trouble.)

Last Wednesday, when the company's share price went into a freefall, it blamed the plunge on what it called mistaken media reports about its profit outlook through 2011. The non-depository did not cite any specific news organization and would not respond to a telephone call placed to it by National Mortgage News.

Also last Wednesday, with its share price spiraling down more than 42%, it issued a statement saying it would "generally" be profitable on a GAAP basis over the next several years but will show little "if any" taxable income from 2007 to 2011. (Its earnings came out last Tuesday, after the market closed.)

In its earnings statement the company said, "Taxable income from our REIT mortgage securities portfolio will normally exceed GAAP earnings during the early life of the portfolio due to the accelerated income recognition provisions of the tax code. Generally, this timing difference is created because of the different income accrual methods prescribed for the computation of GAAP and tax income."

It added, "However, over the life of the portfolio, GAAP and tax income will be equal. Therefore, in the later life of the portfolio, GAAP income will be greater than taxable income. The reversal in timing differences between the recognition of GAAP income and taxable income is occurring and will accelerate as our older vintage securitizations mature. As a result, during the period 2007 through 2011, we expect to recognize little, if any, taxable income."

In the fourth quarter, it funded $2.6 billion, a 20% increase from the same quarter last year. It predicts that a more "rational" business environment could be on the horizon as its competitors fail or put themselves up for sale.

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