NovaStar no longer a REIT

NovaStar has decided not to distribute a $157 million dividend related to its 2006 income. As a REIT (Real Estate Investment Trust), NovaStar would have to distribute at least 90% of its income to shareholders, but the company is dropping its REIT status, thus losing some tax exemptions. The company is also in danger of suspension or delisting from the NYSE due to the change in its status, but officials said the company is “in continuing discussions with the NYSE”.

Back in February, NovaStar said it was considering dropping its REIT status, but this summer it announced plans to distribute dividends to satisfy REIT distribution requirements. The new decision suggests that those plans are no longer relevant. The termination of NovaStar’s status is retroactive, effective January 1, 2006.

NovaStar makes the news

NovaStar was one of the first lenders to get hit by the subprime meltdown, but it hasn’t stopped making the headlines ever since stock prices started freefalling in February. The big news this time is that its auditor, Deloitte & Touche, warns the lender may be unable to continue operating as a going concern – i.e., it may have to close down, soon, joining the ranks of more than 100 mortgage lenders that imploded this year, no big surprise. In fact, NovaStar has done really well surviving this far.

NovaStar canceled a $101 million stock offering, because it figured that, given the current market conditions and its stock price, the offering wouldn’t be in the shareholders’ best interest. Christopher Brendler, an analyst at Stifel Nicolaus said NovaStar is “having trouble with cash flows”. Another analyst - Friedman, Billings, Ramsey‘s Scott Valentin - said NovaStar will probably have to liquidate with the proceeds “being used to pay creditors”, leaving nothing to common equity holders. The lender announced that it will be cutting 275 jobs and closing 12 retail lending offices, leaving it with a staff of 600 or so. At the end of last year, NovaStar employed more than 2,000 people. The company announced that it will be modifying its business model and focusing on managing its portfolio of securitized loans. NovaStar shares dropped 16% to $7.16 on the news.

American Home Mortgage: nearly bankrupt?

In a news release issued yesterday, July 31, American Home Mortgage (AHM) announced that it is “experiencing a hindering of access to its traditional lending facilities” and will be unable to fund its lending obligations. The lender has paid “very significant” margin calls in recent weeks and “has substantial unpaid margin calls pending”. AHM has retained Lazard, the same company that served now-bankrupt New Century, to assist in evaluating “strategic options”, including liquidation of its assets.

Shares dropped more than 90% immediately after trading was resumed, to close at $1.04. According to analysts, a bankruptcy or major restructuring is very likely because AHM can not function without its financing. Shareholders will probably be left with nothing. The whole story looks a lot like the subprime lender meltdown, only that now it’s Alt-A.

Lawsuits seeking class action status are already being filed against AHM. Charges include failing to disclose substantial information that affected its earnings and resulted in overstating its financial results.

Shares of other lenders were affected, too, with Countrywide down 3.8% to $28.17, Fremont General declining 11% to $5.77 and NovaStar losing 25% at $9.64.

NovaStar pays $5.1 million to settle class-action law suit

NovaStar, one of the subprime borrowers hardest hit by the current Real Estate market slowdown, has agreed to pay $5.1 million to settle a lawsuit accusing it of charging excessive interest rates to cover broker fees. The sum includes $3.3 million in payments to 1,600 class members and $1.8 million for legal fees.

As problems in the subprime sector started emerging, borrowers and investors began filing class-action lawsuits against subprime lenders, accusing them of various wrongdoings. Some law suits are already getting settled, and I guess this comes as a relief to many. NovaStar said it does not admit any liability, and decided to settle the case because it was an obstacle to a possible sale. Officials claim that the company has followed “standard practices in the mortgage industry that comply with the law and applicable regulations” – which doesn’t say much, since regulation has been quite loose on lending practices and many procedures that became standard within the industry were not in borrowers’ best interest.

Meanwhile, mortgage rates eased somewhat this week, but are still higher than earlier in the year. Interest on 30-year fixed rate mortgages averaged 6.69 this week, down from 6.74% a week ago. 15-year fixed-rate loans dropped to 6.37% from 6.43% last week, 5-year hybrid adjustable-rate mortgages were at 6.31%, down from 6.37%, while 1-year adjustable loans averaged 5.66%, compared to 5.75% a week earlier.

NovaStar accused of discrimination

On May 9, the National Community Reinvestment Coalition filed a lawsuit against NovaStar Mortgage, a subsidiary of NovaStar Financial, accusing the lender of repeatedly violating the Fair Housing Act. NovaStar is said to have repeatedly refused to provide financing for row houses, homes in Indian reservations and on houses that may be used to care for disabled adults.

Such practices are considered a discrimination against ethnic minorities and people with disabilities, because row houses tend to be occupied by African Americans and Latinos, and homes in reservations by Native Americans.

NovaStar called the charges “baseless”, and explained that row houses are associated with appraisal fraud, while homes located in reservations are governed by “different sets of laws”. The Coalition also intends to file lawsuits against other lenders involved in similar practices.

NovaStar cutting staff

NovaStar is the next mortgage lender to reduce workforce. On Friday, March 16, it was announced that the company is planning some 350 layoffs, or 17% of its staff, in its wholesale loan origination group, including 50 employees at its Kansas City headquarters. Operation centers in California and Ohio will be affected by the cut, too.

The reductions aim to align the company to current market realities and will be implemented gradually, concluding in the second quarter of 2007. NovaStar’s loan servicing organization will not be affected by the reduction.

The lender said it will continue to focus on solid lending guidelines and lower loan origination costs. Shares rose 14.6% to $5.90.

Class action against NovaStar

Various law firms are beginning to file lawsuits seeking class action status on behalf of NovaStar stockholders who’ve purchased stock between May 4, 2006 and February 20, 2007. The company is believed to have knowingly concealed the following facts: its projections were based on defective assumptions about loan delinquencies, because internal controls weren’t operating; its financial statements were misstated due to improper accounting practices which did not allow for loan losses; NovaStar would have to tighten its underwriting guidelines which would result in lower origination volumes and therefore lower earnings; the company could not guarantee it would maintain its taxable income and its Real Estate Investment Trust (REIT) status.

The company’s stock closed at $8.48 on Friday, according to the New York Stock Exchange website. Earlier in the week, its shares traded at $17.33. The press has named the NovaStar depreciating process a “free fall” and there’s reason enough: various investors say they suspected something wasn’t right long before the news came out and now anyone who still holds these stocks is trying to get rid of them.

On February 20th, the company announced it earned negative income in the fourth quarter of 2006, sending shares of subprime lenders on a rollercoaster ride downwards. It seems that stockholders in the subprime sector are starting to treat bad news on any company as an indicator of hardships in the entire industry, even though we’re often told that each company’s accounting policies and financial practices are different. Thus when a company goes down it drags other subprime lenders with it. This happened when New Century said it had overstated its earnings for 2006 due to accounting mistakes and it happened again last week after NovaStar reported financial loss in 2006. The free fall has so far caused several companies to lose half their value and I wonder, where is the bottom? Another lending company, Eagle First Mortgage, was shut down over the weekend, so how many more will have to collapse before the market is back on track? And how long is it going to take?

Meanwhile, the ABX.HE index, which tracks credit default swaps (CDS) on subprime mortgage-backed securities, fell to a record low of 69.39 on Friday, down from more than 90 earlier in February. As subprime lenders go bankrupt or report poor results, investors have begun to avoid purchasing these securities and indexes take a plunge.