Fitch Downgrades NovaStar's Subprime Servicers Rating To 'RPS3+'

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded NovaStar Mortgage, Inc.'s (NovaStar) residential primary servicer rating for subprime product to 'RPS3+' from 'RPS2-' and removed it from Rating Watch Negative. In addition, Fitch has assigned NovaStar its 'RSS3+' special servicer rating. NovaStar is a subsidiary of NovaStar Financial Inc. (NFI).

The downgrade reflects the challenging subprime mortgage environment and uncertainties regarding NFI's profitability, as well as concerns that the company's financial challenges may negatively impact its ongoing servicing operation and the company's servicing quality. On March 26, 2007, Fitch had placed NovaStar's servicer rating on Rating Watch Negative. At that time, NFI reported in its 10K that the company may fail to satisfy the profitability covenant under one of its warehouse repurchase facilities if the company's GAAP net income, determined on a pre-tax basis, was not greater than $1 for the six months ended March 31, 2007, and that the company was seeking a waiver of the covenant and developing contingency plans should that waiver not be granted. On April 10, 2007, NFI announced that it had hired Deutsche Bank to explore strategic alternatives, including a sale of the company.

Also, the company announced that it had reached an agreement with Wachovia for two additional funding facilities totaling $100 million. Subsequently, the company announced it had secured an additional $1.9 billion line with Wachovia. Management anticipates collapsing its previously existing funding lines into the new one. During its 1Q07 earnings conference call, NFI announced the company had decided to de-REIT as of January 1, 2008. Absent the resulting $84 million gain, the company would have reported a $39 million loss. While Fitch believes the decision is a favorable one, freeing the company from the operating rules for REITs and enabling, among other things, a more aggressive accumulation of capital, it is unlikely to help the company in the short run as it seeks to manage its liquidity and strategic challenges in the midst of a difficult operating environment. Fitch believes the company would benefit from higher levels of originations, further tightening of spreads in the secondary loan market and a lower cost structure.

NovaStar's servicing operations and the corporate headquarters of its parent, NFI, are located in Kansas City, MO. As of February 28, 2007, NovaStar's servicing portfolio had grown to over 104,000 loans totaling $16.3 billion from 98,800 loans totaling $14.2 billion as of Jan. 31, 2006. More than 95% of the portfolio is included in residential mortgage-backed securities (RMBS) transactions. Fitch completed its on-site operational review in April 2007, which confirmed that NovaStar's servicing operations continue to perform at a level consistent with the prior year. The special servicer rating is based on NovaStar's ability to service, collect, and liquidate subprime loans, and both ratings reflect the company's experienced management team, competent use of technology, and effective default management strategies and asset liquidation procedures. Since Fitch's prior review, NovaStar strengthened its default management staff, adding 40 collectors, eight loss mitigators, and six foreclosure representatives to prepare for anticipated increases in delinquencies and to position the company for potential third party and special servicing opportunities. The company continues to enhance its technology, with the addition of electronic billing statements, payoff statements and the ability to handle debit card transactions to its customer website. NovaStar also upgraded its predictive dialer system and implemented destination tracking in its planet code system to track outgoing mail in addition to inbound mail. The company created a special solutions counseling unit in 2006 to identify and assist borrowers with approaching ARM resets, and continues to report success with its Launchpoint program, which assists out-of-work delinquent borrowers with the process of finding a job.

Fitch does not formally rate the credit or financial strength of Novastar or its parent, NFI. However, a company's financial condition is an important component of Fitch's servicer rating process. Though NFI's recent agreement with Wachovia for additional funding facilities may relieve the company's short term liquidity pressure and afford NFI additional time to seek strategic alternatives, the rating actions reflect challenges that still face the company in funding its ongoing servicing operations and maintaining its servicing quality in an increasingly challenging subprime mortgage environment. Fitch will continue to monitor Novastar's financial condition and ability to maintain long term stable funding and its impact on loan servicing and operational capabilities, as well as the company's ability to maintain performance in a rising delinquency environment.

Fitch has rated 13 residential RMBS transactions collateralized by Novastar originated mortgage loans. All of the transactions are serviced by Novastar. The servicer rating downgrade will not have a direct immediate impact on the ratings of outstanding Novastar serviced transactions. Fitch will continue to closely monitor the performance of the Novastar serviced transactions.

Fitch rates residential mortgage primary, master, and special servicers on a scale of 1 to 5, with 1 being the highest rating. Within some rating levels, Fitch further differentiates ratings by plus (+) and minus (-) as well as the flat rating. For more information on Fitch's residential servicer rating program, please see Fitch's report 'Rating U.S. Residential Mortgage Servicers,' dated Nov. 29, 2006, which is available on the Fitch Ratings web site at www.fitchratings.com.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.