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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: rubed who wrote (8152)	6/21/2004 8:57:42 PM
From: rubed	Read Replies (2) \| Respond to of 116555

By Herb Greenberg, CBS MarketWatch.com Last Update: 2:04 PM ET June 3, 2004 Shining on NovaStar -- yet again! Last week's item here about one of NovaStar's newest disclosures caused the Hostile React-O-Meter to do its usual out-of-control spinning. Most of the unfriendly fire focused on how a certain columnist (cough, cough) simply doesn't understand that the disclosure in question -- about cash received from the prior sale of certain mortgage securities - is proof that NovaStar will in the future be getting buckets full of cash tied to previously booked gains on the sale of securities. One reader even suggested that it's "risk-free" cash. To say any or all of this is complex, would be an understatement, so about the only thing anybody can say with certainty is that nothing is risk-free and nothing guarantees the company will get all of the cash from these previously booked gains. The amount it gets depends on any number of factors, including various assumptions regarding such future events as the speed of prepayments (which have actually been faster than expected for the most recently originated mortgages) as well as assurances that the loans were made properly. Loans made properly? What could that idiot Greenberg possibly mean by that? In its SEC filings, the company says that it guarantees to cover losses to investors in those loan packages "should origination defects occur." It describes defects as "documentation and underwriting errors, judgments, early payment defaults and fraud." According to the latest 10-Q, as of March 31, NovaStar (NFI: news, chart, profile) had sold loans "with recourse for origination defects" totaling $7.6 billion. (That's billion with a "b." Recourse, of course, means NovaStar could be on the hook for that much in the worst-case scenario.) How does that compare to prior quarters? It's higher, according to a spokesman, but you wouldn't necessarily know it by reading the disclosures. (Unless, maybe, you're a lawyer.) Until two quarters ago, rather than simply disclosing the amount sold "with recourse," NovaStar relied on a rather obtuse disclosure that said the company "had sold loans without recourse, except for loans with defects in the origination process..." As it turns out -- and I only know this from talking to the company -- all of those loans were with recourse! Why not simply say so in the first place? Good question. And why care? As previously noted here, the company is suing PMI, which has insured many of its loans, for the mortgage insurer's refusal to settle up claims on loans that had defaulted. PMI (PMI: news, chart, profile) has cited material omissions and errors in loan documents. Also as previously reported, NovaStar has done a one-eighty on plans to boost by a big leap the size of its already rapidly growing branch system; it has actually closed branches, and has made a point of saying that it has shifted more "sales management" and "compliance staff" into the field. (Why does it need more compliance staff?) Interpret any way you wish, but at the risk of sounding like a broken record: investors buying into a company almost exclusively for a dividend that yields a robust 14 percent had better just remember that with that high reward they get higher risk. In the end, the company may prove worrywarts wrong, but to repeat this company's motto: too much hubris can have a way of being humbling.