Thuy “Lynn” Vu
NovaStar Financial: A short seller’s Battle 1) Identify/ describe NovaStar business model. Key business risks faced by NovaStar and how do they impact financial statements? * Structured as REIT. * Offered wide range of mortgage loan products to sub-prime borrower * Three segments: a) mortgage lending and loan servicing, b) mortgage portfolio management, c) branch operations. * Key Business Risks: + credit loss in portfolio +interest rate risk with lending long-term& borrow that short- term, +collateral risk driven by housing prices. * How do they impact financial statements: credit loss risk affect allowance for loss, higher bad debt expense. Interest rate risk will reflect in long-term asset and short-term debt. 2) What accounting estimates allow you to assess these risks? * Gain on sale accounting estimate: in mortgage sale, fair value is estimated mostly depends on “management’s estimate of the discount rate, prepayment speed and credit loss assumption.” * How do they perform based on these accounting number? Assumptions that NovaStar used were very inconsistent. For example, in the second quarter of 2005, when interest rate declined, instead of raising its prepayment speeds across the board, they decreased interest rate on some mortgage pool and decreased its loss assumption on most pool; and then this assumption did not even hold up for 90 days. 3) Do you agree that NovaStar is a fraudulent business? Which part of his thesis is resonated the most with you? * We agree that Nova Star is a fraudulent business. * We can include from “Fraudulent Underwriting practice” and “Dividend Equivalent