This Stock may very well be a Ten-Bagger over the next decade.
From nfi-info.net
NovaStar For Dummies
The following is intended as a basic orientation for those new to the company. Also be sure to see the New Investor Information section and NovaStar's history.
Elevator explanation: The simplest explanation for what NFI does is as follows -NFI is a company that creates and sells (securitizes) bonds, using mortgage loans that it buys and originates as the collateral for those bonds. It includes all the hedges and overcollateralization in each bundle of bonds (shielding it from interest rate risk), and it collects income from the sale of the bonds, as well as the income from the interest only pieces that it retains. It has a taxable subsidiary that originates loans, and services them, enabling them to have better control over the performance of the loans collateralizing the bonds, but those activities are essentially cash neutral to the business. NFI is essentially a bond desk, like the bond desks at the large brokerage houses that make the lions share of the income for those houses. So that's the elevator pitch. What follows is a little more in-depth.
NovaStar (NFI) is a non-prime mortgage lender that is organized as a REIT (Real Estate Investment Trust)*. NovaStar specializes in home equity loans to borrowers who do not fit traditional lending guidelines. Many of these borrowers are small business owners unable to document income. Other borrowers have relatively high interest rate credit card debt and use Novastar mortgages to consolidate their debt load and improve their cash flow by accessing the tax-deductible equity in their homes. Typically, mortgage loans are $140K - $150K, on homes priced below $200K.
hey have refined a number of innovations which have resulted in extraordinary growth, and enabled them to take market share from their competitors. First, they divide up the mortgages into two segments — principal, and interest. They pool the principal portion of the loans into $1.5- $2.5 billion bundles, and sell bonds collateralized by them to institutions. The money from the principal then goes to the institutions, and NFI collects 1/2 a percent of the total annually to service the loans. They sell limited time instruments (18 to 24 month duration) called NIMs which are collateralized by the interest portion of the loans, and for that time period the interest portion of the payments goes to the NIM holders. At the end of 18/24 months, the cash keeps coming in, but there are no more NIMs, so it's all cash for the company, free and clear. This unique method of self-financing enables them to turn over their money quickly, which has enabled their phenomenal growth.
NovaStar’s unique and ultra-conservative method of mortgage securitization is what sets NovaStar apart from its competitors. These innovations convert relatively risky mortgages into Moody’s AAA-rated bonds, greatly mitigating both the risk of borrower default and the risk of interest rate fluctuations. NovaStar’s conservative management, growing market share and steady dividends are attracting increasing numbers of both individual and institutional investors seeking stable, reliable income.
NovaStar’s business process is detailed in NFI Deal Flow. A simplified version follows:
Newly originated loans are "bundled" and securitized on a quarterly basis. The bundled mortgages are divided into two segments — principal, and interest. NovaStar pools and securitizes the principal portion into multi-billion dollar lots, and sells the resultant AAA-rated bonds to institutions, collecting 0.5% of the total annually to service the loans. The interest only (IO) portion of the loan bundles is collateralized and sold as limited-time instruments (18 to 24 month duration) called NIMs. For that time period, the IO cash generated goes to the NIM holders. When the NIM’s expire, the remaining IO income is retained by NovaStar, contributing towards Total Earnings. This unique method of loan management provides NovaStar with superior safety margins and efficiency, enabling their phenomenal growth.
Unlike many REITs, gradually rising higher interest rates are favorable for NovaStar. There are two reasons for this: Firstly, when mortgage rates increase, the portfolio, primarily adjustable rate mortgages, also incrementally and correspondingly goes up in value. Secondly, pre-payment of mortgages historically slows down when rates increase. This decline in loan pre-payments causes the IO loan bundles to pay income over a longer period of time, greatly increasing their value to NFI and shareholders.
NovaStar’s loan portfolio is growing rapidly. Monthly portfolio growth equals the difference between loan originations and pay-downs. Therefore, if NovaStar originates $800 million of loans per month and pay-downs are $300 million then the loan portfolio increases by $500 million. Portfolio growth is projected to flatten out as the portfolio size approaches $50 billion.
Any evaluation of NovaStar is incomplete without taking the time to listen to periodic conference calls and/or shareholder meetings. Listeners should note corporate earnings and dividend projections versus what is actually delivered. Shareholder’s of NovaStar find that the company consistently "under-promises and over-delivers". Missouri-style integrity and ethics are an integral part of the NovaStar culture. NovaStar’s managers are recognized as some of the sharpest minds in the mortgage finance industry
Go to the New Investor Information section.
* REITs must pay out 85% of their Taxable Income in the year that they are generated. Under an exemption clause in that rule, NFI has chosen to carry forward a significant potion of their TI, which they will have to pay out by the date of final tax return filing, which, for 2003, was as late as September 15, 2004. They can generate a 35-40% ROE on that money, which makes it a huge revenue adder. As an example, in 2004, Q1 NFI paid $1.35 of dividend and earned $1.72 of TI. Of that $1.35 approximately $1 was carry forward from 2003, meaning that out of the $1.72 they actually carried forward $1.37 of Q1's TI. In Q2 they also paid $1.35, and TI was $2.18, meaning they then carried forward Q1's $1.37 + $.83 of Q2 = $2.20 carried forward for the first half of 2004. If Q's3 and 4 each carry forward roughly the same amount as Q2, then there would be an additional $1.66 added to the $2.20 from Q's 1 and 2, or a total of $3.86 carried forward into 2005. Just to accommodate that amount in Q's 1 and 2 of 2005, without any 2005 TI being included. would require a Q'ly dividend of about $2.00 in 2005. If a $2.00 dividend were to be maintained for the year, then the entire 2005 TI (now estimated to be at least $11.00 or so) would result in a carry over of at least $6.86 into 2006.
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