As Filed with the Securities and Exchange Commission on December 10, 2010

Registration No. 333-      

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form S-4

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

NOVASTAR FINANCIAL, INC.

(Exact name of Company as specified in its charter)

 

 

2114 Central Street

Suite 600

Kansas City, Missouri 64108

(816) 237-7000

(Address, including zip code, and telephone number, including area code, of Company’s principal executive offices)

 

W. Lance Anderson

Chairman and Chief Executive Officer

2114 Central Street

Suite 600

Kansas City, Missouri 64108

(816) 237-7000

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

Copies of all communications to:

 

Gregory G. Johnson, Esq.

Bryan Cave LLP

One Kansas City Place

1200 Main Street

Suite 3500

Kansas City, Missouri 64105

(816) 374-3200

 

Approximate date of commencement of proposed sale to the public:  As soon as practicable after the effective date of this Registration Statement and satisfaction or of all other conditions to the transactions described in the enclosed proxy statement/consent solicitation/prospectus.

 

If the securities being registered on this form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box.  o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462 (d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

If applicable, place an X in the box to designate the appropriate rule provision relied upon in conducting this transaction:

 

Exchange Act Rule 13e-4(i) (Cross-Border Issuer Tender Offer)  o

 

Exchange Act Rule 14d-1(d) (Cross-Border Third Party Tender Offer)  o

 

CALCULATION OF REGISTRATION FEE

 

 

The Company hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Company shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

SUBJECT TO COMPLETION, DATED DECEMBER 10, 2010

Proxy Statement/Consent Solicitation/Prospectus

 

 

Offer to Exchange Each Outstanding Share of

Series C Preferred Stock

of

NovaStar Financial, Inc.

For, at the Election of the Holder,

Common Stock Only

or

Common Stock and Cash

and

Solicitation of Consents Relating to the Recapitalization

 

THE SERIES C OFFER, CONSENT SOLICITATION AND WITHDRAWAL RIGHTS WILL EXPIRE AT 12:00 MIDNIGHT, CENTRAL TIME, ON [ • ], 2011 UNLESS THE OFFER IS EXTENDED.

 

NovaStar Financial, Inc. (“NFI” or the “Company”) is offering (the “Series C Offer”), upon the terms and subject to the conditions set forth in this document and in the related letter of transmittal, to exchange each share of its 8.90% Series C Cumulative Redeemable Preferred Stock of the Company, par value $0.01 per share (the “Series C Preferred Stock”), held by you for, at your election, either:

 

 

Series C Holders’ elections will be subject to allocation and proration procedures intended to ensure that, in the aggregate, 43,823,600 newly-issued shares of Common Stock and $1,623,000 in cash (plus such other cash that is needed to cash out fractional shares) will be issued to Series C Holders (the “Offer Consideration”).

 

As of the date of this proxy statement/consent solicitation/prospectus, there are 2,990,000 shares of Series C Preferred Stock outstanding, each of which has a par value of $0.01 per share. The Series C Offer is part of a larger recapitalization of the Company, whereby the holders of the Company’s 9.00% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 (the “Series D Preferred Stock”), have agreed to exchange their stock for an aggregate of 37,161,600 newly-issued shares of Common Stock and $1,377,000 in cash (the “Series D Exchange”). As of September 30, 2010, the Series C Preferred Stock had an aggregate liquidation preference of $74.8 million and accrued and unpaid dividends of $20.0 million. As of September 30, 2010, the Series D Preferred Stock had an aggregate liquidating preference of $52.5 million and accrued and unpaid dividends of $26.7 million. Our common stock and Series C Preferred Stock are currently quoted by Pink OTC Markets’ inter-dealer quotation service as an OTCQB security under the symbol “NOVS” and “NOVSP,” respectively. The Series D Preferred Stock is privately held.

 

As part of the Series C Offer, we are soliciting consents from the holders of the Series C Preferred Stock (the “Series C Holders”) to effect the Series C Offer and the Series D Exchange. We refer to our solicitation of these consents as the “Consent Solicitation.” Series C Holders are required to deliver consents to effect the Series C Offer and the Series D Exchange in order to participate in the Series C Offer, and Series C Holders may not deliver consents unless they surrender their Series C Preferred Stock for exchange in the Series C Offer.

 

Our Series C Offer and Consent Solicitation is subject to the conditions listed under “The Series C Offer and Consent Solicitation — Certain Conditions of the Series C Offer and Consent Solicitation.” One of the conditions to the Series C Offer and Consent Solicitation is the final completion of the Series D Exchange. There are multiple conditions to the closing of the Series C Offer and the Series D Exchange that are beyond our control, and we cannot provide you any assurance that these conditions will be satisfied or that the Series C Offer and the Series D Exchange will close.

 

Exchange of the Series C Preferred Stock and an investment in the common stock involves risks. See “Risk Factors” beginning on page 9 of this document for a discussion of factors that you should consider in connection with the Series C Offer and Consent Solicitation.

 

 

 

 

IMPORTANT

 

If you wish to tender all of your shares of Series C Preferred Stock, and deliver your consent to the Series C Offer and Series D Exchange and your proxy, you should follow the instructions beginning on page [ • ] of this document. If you wish to withdraw your tender, you may do so by following the instructions set forth in this proxy statement/consent solicitation/prospectus. Any holder who withdraws a prior tender may tender for different Consideration Option by submitting a new Letter of Transmittal to the Exchange Agent.

 

Neither the Securities and Exchange Commission nor any state securities authority has approved or disapproved this transaction or these securities or determined the fairness of merits of this transaction or proxy statement/consent solicitation/prospectus, or determined if this proxy statement/consent solicitation/prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

 

ADDITIONAL INFORMATION

 

We engaged Georgeson Inc. to act as the information agent in connection with the Series C Offer. Requests for assistance or additional copies of this document or the related letter of transmittal should be delivered to Georgeson Inc., 199 Water Street, 26^th Floor, New York, NY, 10038-3560. Questions may be directed to Georgeson Inc. at (212) 440-9800 for banks and brokers, and at (866) 695-6074 for all other callers (toll-free).

The date of this Proxy Statement/Consent Solicitation/Prospectus is [ • ], 2010.

NOTICE OF SPECIAL MEETING OF STOCKHOLDERS

 

To the Holders of Our Series C Preferred Stock:

 

You are cordially invited to attend the special meeting of the stockholders of NovaStar Financial, Inc., a Maryland corporation (the “Company”), to be held on [ • ], 2011 at [ • ], a.m., Central Time, at the Hyatt Regency Crown Center Hotel, 2345 McGee Street, Kansas City, Missouri 64108, for the following purposes:

 

1. To approve an amendment to the charter of the Company to eliminate the Company’s 8.90% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (the “Series C Preferred Stock”), and the applicable Articles Supplementary;

 

2. To approve an amendment to the charter of the Company to eliminate the Company’s 9.00% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 (the “Series D Preferred Stock”), and the applicable Articles Supplementary;

 

3. To approve an amendment to the charter of the Company to increase the number of the authorized shares of capital stock of the Company from 50,000,000 to 120,000,000;

 

4. To approve an amendment to the charter of the Company to preserve the Company’s net operating loss carryforwards;

 

5. To approve certain technical amendments to the charter of the Company in connection with the foregoing proposals, and to remove provisions previously required by the Company’s former status as a real estate investment trust; and

 

6. To transact such other business as may properly come before the special meeting and any postponement or adjournment thereof.

 

As a holder of Series C Preferred Stock, you will be entitled to vote on proposals 1, 4 and 5 above. Depending on the subject of any additional proposals properly brought before the special meeting, you may also be entitled to vote on other business properly brought before the meeting. At the meeting, the holders of the Common Stock and the holders of the Series D Preferred Stock will be entitled to vote on all business properly brought before the meeting, including proposals 1, 2, 3, 4 and 5 above. A proxy statement/consent solicitation/prospectus describing the matters to be considered at the special meeting to which you will be entitled to vote is attached to this notice.

 

The Board of Directors is calling this special meeting in connection with a recapitalization of the Company involving (i) an exchange of all outstanding shares of Series D Preferred Stock, by which the private holders of the Series D Stock have agreed to exchange their shares subject to certain conditions beyond their control, and (ii) an offer to exchange all outstanding shares of Series C Preferred Stock, together with a consent solicitation seeking consents to effectuate the Series C Offer and Series D Exchange. Please see the attached proxy statement/consent solicitation/prospectus for additional information related to these transactions.

 

The Board of Directors has fixed the close of business on [ • ], 2011 as the record date for determination of stockholders entitled to notice of, and to vote at, the special meeting and any postponement or adjournment thereof.

 

By Order of the Board of Directors

 

Rodney E. Schwatken

Chief Financial Officer, Chief Accounting Officer and Secretary

 

Kansas City, Missouri

December [ • ], 2010

 

 

 

Some of the statements in the proxy statement/consent solicitation/prospectus summary, including under the sections titled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Description of Business” and elsewhere in this proxy statement/consent solicitation/prospectus constitute forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels or activity, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, those listed under “Risk Factors” and elsewhere in this proxy statement/consent solicitation/prospectus.

 

Terminology such as “may,” “will,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of such terms or other comparable terminology, as well as future or conditional verbs such as “would,” “should,” “could,” or “may” are generally intended to identify forward-looking statements. No assurances can be given that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, regarding the impact they will have on the results of operations or financial condition of the Company. Moreover, neither we, nor any other person assumes responsibility for the accuracy and completeness of such statements.

 

This proxy statement/consent solicitation/prospectus has been generally prepared as of December [ • ]. There may be changes in the affairs of the Company and/or other matters after that date which are not reflected in this document and we will not undertake to update all such information unless required by law.

 

We have filed with the Securities and Exchange Commission (“SEC”) a Registration Statement on Form S-4 under the Securities Act with respect to the offered Common Stock in this proxy statement/consent solicitation/prospectus. Additional information is contained in the Registration Statement and you should refer to the Registration Statement and its exhibits for this information. The Registration Statement and exhibits and schedules filed as a part thereof, may be inspected, without charge, at the SEC public reference room located at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. You may also obtain copies of the materials described above at prescribed rates by writing to the SEC, Public Reference Section, 100 F Street, NE, Washington, D.C. 20549.

 

You may also access information on NFI at the SEC website at: http://www.sec.gov. The SEC website contains reports, proxy and information statements regarding companies that file electronically with the SEC. Copies of all or any portion of the Registration Statement may be obtained from the public reference section of the SEC upon payment of the prescribed fees.

 

If you would like additional copies of this proxy statement/consent solicitation/prospectus, or if you have questions about the Series C Offer or Consent Solicitation, you should contact:

 

Georgeson Inc.
199 Water Street, 26^th Floor
New York, NY 10038-3560
Banks and Brokers Call (212) 440-9800
All Others Call Toll-Free (866) 695-6074

 

This proxy statement/consent solicitation/prospectus contains certain business and financial information about the Company that is not included in or delivered with this document. You may request a copy of any document that we have filed with the SEC at no cost, by writing the Company at 2114 Central Street, Suite 600, Kansas City, Missouri 64108. To receive timely delivery of the requested documents in advance of the Expiration Date, your request should be received no later than [ • ], 2011.

 

We have not authorized anyone to give any information or make any representation about our Series C Offer or Consent Solicitation that is different from, or in addition to, that contained in this proxy statement/

consent solicitation/prospectus or in any of the materials that we have incorporated into this proxy statement/consent solicitation/prospectus. Therefore, if anyone gives you information of this sort, you should not rely on it. If you are in a jurisdiction where offers to exchange or sell, or solicitations of offers to exchange or purchase, the securities offered by this document are unlawful, or if you are a person to whom it is unlawful to direct these types of activities, then the Series C Offer and Consent Solicitation presented in this document do not extend to you. We are not aware, however, of any jurisdiction in which the transactions of this type would be unlawful.

 

TABLE OF CONTENTS

 

 

THE SERIES C OFFER AND CONSENT SOLICITATION SUMMARY

The Company		NovaStar Financial, Inc.
The Company’s Address and Phone Number		2114 Central Street Suite 600 Kansas City, Missouri 64108 (816) 237-7000
The Company’s Business		The Company operates two majority-owned subsidiaries: StreetLinks National Appraisal Services LLC, a national residential appraisal and real estate valuation management services company and Advent Financial Services LLC, a start-up business which provides access to tailored banking accounts, small dollar banking products and related services to low and moderate income level individuals. We also own a portfolio of nonconforming residential mortgage securities. Prior to 2008, we originated, securitized, sold and serviced residential nonconforming mortgage loans.
Common Stock		Common Stock, par value $0.01 per share (OTCQB: NOVS)
Series C Preferred Stock		8.90% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (OTCQB: NOVSP)
Series C Offer		An offer to exchange each share of its Series C Preferred Stock of the Company, par value $0.01 per share, for, at the election of each holder, either:
		• 3 shares of newly-issued common stock of the Company, par value $0.01 (the “Common Stock”) and $2.00 in cash (the “Cash-and-Stock Option”); or
		• 19 shares of newly-issued Common Stock (the “Stock-Only Option”).
		Series C Holders’ elections will be subject to allocation and proration procedures intended to ensure that, in the aggregate, 43,823,600 newly-issued shares of Common Stock and $1,623,000 in cash (plus such other cash that is needed to cash out fractional shares) will be issued to Series C Holders (the “Offer Consideration”). See “The Series C Offer and Consent Solicitation — General” and “— Series C Offer Consideration Explanation and Examples.”
Common Stock Outstanding Before the Series C Offer		As of [ • ], 2010, the Company has 9,368,053 shares of Common Stock outstanding.
Common Stock Outstanding After the Series C Offer		Assuming that 100% of the shares of Series C Preferred Stock are accepted for exchange in the Series C Offer, 43,823,600 shares of Common Stock would be issued in the Series C Offer, and 90,353,253 shares of our Common Stock would be outstanding after completion of the Series C Offer and the issuance of

		37,161,600 shares of Common Stock in the Series D Exchange. Consent from our Series C Holders is required to make the Series C Offer and complete the Series D Exchange.
Outstanding Shares of Series C Preferred Stock Prior to the Series C Offer		2,990,000 shares
Consent Solicitation		As part of the Series C Offer, we are soliciting the consent of Series C Holders to the Series C Offer and the Series D Exchange. Series C Holders are required to deliver consents to participate in the Series C Offer, and Series C Holders are not required to deliver consents unless they surrender their Series C Preferred Stock for exchange in the Series C Offer. Series C Holders who validly surrender their Series C Preferred Stock for exchange in the Series C Offer will be deemed to have consented to the Series C Offer and the Series D Exchange.
Reasons for the Series C Offer		The Series C Offer is being conducted, along with the Series D Exchange, to eliminate the Company’s large and growing obligation to its preferred stockholders, which the Company believes impedes its growth and strategic opportunities available to it and has a negative impact on cash available to all shareholders in the future.
Offer Consideration		The total aggregate consideration offered is 43,823,600 newly-issued shares of Common Stock and $1,623,000 in cash. Regardless of the number of Series C Preferred Stock tendered for each Consideration Option, the Company will not issue more than 43,823,600 shares of Common Stock or pay out more than $1,623,000 in cash.
Trading and Related Matters		The Common Stock issuable pursuant to the Series C Offer is being registered under the Securities Act of 1933, as amended, and will be freely tradable, except by our affiliates.
Differences in Rights of Our Common Stock and Series C Preferred Stock		The Series C Preferred Stock and Common Stock have different rights. For more information about these differences, see “The Series C Offer and Consent Solicitation — Differences in Rights of Our Common Stock and Series C Preferred Stock.”
Market Price Information		The last reported sale price of shares of Common Stock as quoted by Pink OTC Markets’ inter-dealer quotation service on [ • ], 2010, was $[ • ]. The last reported sale price of shares of Series C Preferred Stock as quoted by Pink OTC Markets’ inter-dealer quotation service on [ • ], 2010, was $[ • ].
Series D Exchange		The Series D Exchange is the exchange of all issued and outstanding shares of the Company’s 9.00% Series D1 Mandatory Convertible Preferred Stock, par value $0.01, for an aggregate of 37,161,600 newly-issued shares of Common Stock and $1,377,600 in cash.
Recapitalization		The Series C Offer and the Series D Exchange, together with the Amendments, are part of the Company’s plan of recapitalization to improve the Company’s capital structure.

Expiration Date		The Series C Offer and Consent Solicitation will expire at 12:00 midnight, Central time, on [ • ], 2011, unless we extend the period of time for which this exchange offer is open, in which case the term “Expiration Date” means the latest time and date on which the Series C Offer and Consent Solicitation, as so extended, expires. However, we may extend the Series C Offer and Consent Solicitation under certain circumstances.
Settlement Date		The settlement date in respect of Series C Preferred Stock validly surrendered and accepted for exchange in the Series C Offer will occur promptly following the Expiration Date. We expect the Settlement Date to be within three business days after the Expiration Date.
How to Tender Series C Preferred Stock for Exchange and Deliver Consents to the Series C Offer		For you to validly tender shares of Series C Preferred Stock pursuant to our Series C Offer and Consent Solicitation:
		• a properly completed and duly executed letter of transmittal, along with any required signature guarantees, and any other required documents, must be received by the Exchange Agent at the address listed herein, and certificates for tendered shares of Series C Preferred Stock must be received by us at the respective address; and
		• you must comply with the guaranteed delivery procedures set forth in “The Series C Offer and Consent Solicitation — Procedure for Tendering Shares.”
Fractional Shares		Fractional shares of Common Stock will not be tendered in exchange for Series C Preferred Stock. Instead, each Series C Holder who otherwise would have been entitled to receive a fraction of a share of the Company’s Common Stock will receive an amount in cash equal to the product obtained by multiplying the fractional share interest to which such Series C Holder would otherwise be entitled by the Company’s average closing price over the 10-day period preceding the Expiration Date.
Partial Tenders		We will not accept partial tender of your shares. To participate in the Series C Offer, a Series C Holder must tender all Series C Preferred Stock held by that Series C Holder.
Withdrawal Rights		Your tender of shares of Series C Preferred Stock pursuant to the Series C Offer and Consent Solicitation is irrevocable, except that shares of Series C Preferred Stock tendered pursuant to the Series C Offer and Consent Solicitation may be withdrawn at any time prior to the expiration of the Series C Offer and Consent Solicitation.
		For a withdrawal to be effective, a written or facsimile transmission notice of withdrawal must be timely received by the Exchange Agent at the address set forth on the Letter of Transmittal and must specify the name, address and social security number of the person having tendered the shares of Series C Preferred Stock to be withdrawn, the certificate number or numbers for such shares and the name of the registered holder, if different from that of the person who tendered

		such shares of Series C Preferred Stock. See “The Series C Offer and Consent Solicitation — Withdrawal Rights.”
Conditions Precedent to the Series C Offer		Our obligation to accept shares for exchange in the Series C Offer is conditioned upon, among other things:
		• the completion of the Series D Exchange;
		• receipt of consent to the Series C Offer and the Series D Exchange by the holders of two-thirds of the outstanding Series C Preferred Stock;
		• approval of the Amendments to our charter; and
		• the effectiveness of the registration statement of which the proxy statement/consent solicitation/prospectus is a part.
		For a description of all of the conditions to the Series C Offer, see “The Series C Offer and Consent Solicitation — Conditions to the Series Offer.”
Consequences of Failure to Exchange Outstanding Series C Preferred Stock		If the Series C Offer closes, all shares of Series C Preferred Stock that are not tendered in the Series C Offer and Consent Solicitation will be automatically cancelled and will then represent the right to receive, prorata per share of Series C Preferred Stock that remain outstanding, the cash and Common Stock remaining from the Offer Consideration after the Series C Offer closes. The remaining Offer Consideration will be distributed to the non-tendering former Series C Holders within 30 days of the Expiration Date, as extended. Any Series C Holder who does not participate in the Series C Offer will have no control over the approximate mix of cash and Common Stock he, she or it will receive, though it is likely that he, she or it will receive the Stock-Only Option for some of his, her or its shares and the Cash-and-Stock Option for the other shares.
		Further, if holders of at least two-thirds of the Series C Preferred Stock do not participate and the Company is not able to complete the recapitalization, the Company may not be able to meet its long-term financial obligations unless the Company undertake some other remedial measure. This could result in a material adverse effect to the Company, which could include bankruptcy.
Interest of Certain Persons in the Series C Offer and Consent Solicitation		Howard Amster and Barry Igdaloff are directors of the Company who were elected to serve on the Board by the Series C Holders. Mr. Amster owns 172,366 shares of Series C Preferred Stock and is the trustee of two trusts which own 44,600 shares of Series C Preferred Stock, collectively. Mr. Igdaloff owns 207,649 shares of Series C Preferred Stock and as a registered investment advisor he controls an additional 100,125 shares.

		Messrs. Amster and Igdaloff did not serve on the special committee of the Board which considered the recapitalization, including the Series C Offer.
		Messrs. Amster and Igdaloff will be entitled to participate in the Series C Offer and Consent Solicitation on the same terms as are being offered to other Series C Holders. Including the shares in trust for which Mr. Amster is the trustee, Messrs. Amster and Igdaloff will have the power to vote 426,415 shares of Preferred C Stock, or 14.26% of the outstanding Series C Preferred Stock. Further, Messrs. Amster and Igdaloff are both parties to a Voting Agreement with the Company, dated December 10, 2010, pursuant to which the Company agreed to include Messrs. Amster and Igdaloff on the management’s proposed slate of directors presented to the Company shareholders at the following Annual Shareholders’ Meeting.
		Messrs. Amster and Igdaloff have both indicated that they will elect the Stock-Only Option in exchange for their Series C Preferred Stock.
		As part of the Series C Offer and Consent Solicitation, and one of the amendments to the charter contemplated by a proposal to be considered at the meeting, Messrs. Amster and Igdaloff will not automatically continue to serve on the Board beyond the 2011 Annual Shareholder Meeting. For more information regarding the Board service of Messrs. Amster and Igdaloff, see “Directors, Executive Officers and Control Persons — Series C Directors.”
Material U.S. Federal Income Tax Considerations		As discussed below under “Material United States Federal Income Tax Considerations — Tax Consequences to Holders of Series C Preferred Stock” any loss on your Series C Preferred Stock will not be recognized. In addition, if you have gain on your Series C Preferred Stock, you may recognize taxable income on the receipt of cash and shares of Common Stock in exchange for shares of our Series C Preferred Stock in the Series C Offer. We urge you to carefully consider the discussion set forth below under “Material United States Federal Income Tax Considerations — Tax Consequences to Holders of Series C Preferred Stock” and to consult your own tax advisors regarding the Series C Offer in light of your own particular circumstances.
Plans and Proposals		Other than the Series C Offer and the Series D Exchange, we do not have any plans, proposals or negotiations that would result in any material change in our corporate structure or business, nor do we have any plans, proposals or negotiations which would relate to or result in our Common Stock becoming eligible for termination of registration under Section 12(g)(4) of the Securities Exchange Act of 1934.
Exchange Agent		Computershare Trust Company, N.A.
Transfer Agent		Computershare Trust Company, N.A.
Information Agent		Georgeson Inc.
Regulatory Approvals		We are not aware of any other material regulatory approvals necessary to complete the Series C Offer, other than the obligation

		to file a Schedule TO/13E3 with the Securities and Exchange Commission (the “SEC”) and to otherwise comply with applicable securities laws.
Appraisal Rights and Right to Petition for Fair Value		No stockholder of the Company will have appraisal rights with respect to any matter to be acted upon at the special meeting.
		However, dissenting Series C Holders will have the right to petition for the fair value of their Series C Preferred Stock if the Series C Offer is consummated. For more information regarding the right to demand Fair Value, see “The Series C Offer and Consent Solicitation — Appraisal Rights and the Right to Petition for Fair Value.”
Further Information		If you have questions regarding the Series C Offer or the Consent Solicitation or the procedures for exchanging your Series C Preferred Stock in the Series C Offer, or if you require additional Series C Offer materials, please contact:
		Georgeson Inc. 199 Water Street, 26th Floor New York, NY 10038-3560 Banks and Brokers Call (212) 440-9800 All Others Call Toll-Free (866) 695-6074

 

SUMMARY HISTORICAL AND UNAUDITED PRO FORMA FINANCIAL INFORMATION

	•	an amendment to the charter of the Company to eliminate the Company’s 8.90% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (the “Series C Preferred Stock”);
	•	an amendment to the charter of the Company to eliminate the Company’s 9.00% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 (the “Series D Preferred Stock”); and
	•	an amendment to charter of the Company to increase the number of the authorized shares of capital stock of the Company from 50,000,000 to 120,000,000.

	•	increase common shares outstanding by 43,823,600 for the full exchange of the Series C Preferred Stock effective as of the date of its original issuance on January 15, 2004;
	•	increase common shares outstanding by 37,161,600 for the full exchange of the Series D Preferred Stock effective as of the date of its original issuance on July 16, 2007; and
	•	exclude the accrued and unpaid dividends on the Series C Preferred Stock and Series D Preferred Stock because the effect of the pro forma adjustments is to reflect that neither the Series C Preferred Stock or Series D Preferred Stock were issued.

		As of and for the Years Ended December 31,
		2009				2008				2007				2006				2005
Summary Historical Financial Information:
Weighted average common shares outstanding-basic			9,368,053				9,338,131				9,332,405				8,552,911				7,417,267
Weighted average common shares outstanding-dilutive			9,368,053				9,338,131				9,332,405				8,617,904				7,498,232
Book value per common share-basic		$	(128.47	)		$	(107.52	)		$	(36.30	)		$	51.42			$	65.99
Book value per common share-dilutive			(128.47	)			(107.52	)			(36.30	)			51.04				65.28
Dividends declared per common share			—				—				—				22.40				22.40
Income (loss) from continuing operations available to common shareholders per share-basic			(20.97	)			(74.81	)			(51.04	)			5.70				15.42
Income (loss) from continuing operations available to common shareholders per share-dilutive			(20.97	)			(74.81	)			(51.04	)			5.66				15.25

		As of and for the Years Ended December 31,
		2009				2008				2007				2006				2005
Summary Unaudited Pro Forma Historical Financial Information:
Weighted average common shares outstanding-basic			90,353,253				90,323,331				70,188,405				52,376,511				51,240,867
Weighted average common shares outstanding-dilutive			90,353,253				90,323,331				70,188,405				52,441,504				51,321,832
Book value per common share-basic		$	(12.70	)		$	(10.67	)		$	(4.46	)		$	8.74			$	9.77
Book value per common share-dilutive			(12.70	)			(10.67	)			(4.46	)			8.73				9.76
Dividends declared per common share			—				—				—				3.78				3.34
Income (loss) from continuing operations per share-basic			(2.00	)			(7.57	)			(6.66	)			1.06				2.36
Income (loss) from continuing operations per share-dilutive			(2.00	)			(7.57	)			(6.66	)			1.06				2.36

		As of and for the Nine Months Ended September 30,
		2010				2009
Summary Historical Financial Information:
Weighted average common shares outstanding-basic			9,337,207				9,368,053
Weighted average common shares outstanding-dilutive			9,337,207				9,368,053
Book value per common share-basic		$	(24.49	)		$	(125.54	)
Book value per common share-dilutive			(24.49	)			(125.54	)
Dividends declared per common share			—				—
Income (loss) from continuing operations available to common shareholders per share-basic			104.30				(17.98	)
Income (loss) from continuing operations available to common shareholders per share-dilutive			104.30				(17.98	)
Summary Unaudited Pro Forma Historical Financial Information:
Weighted average common shares outstanding-basic			90,322,407				90,353,253
Weighted average common shares outstanding-dilutive			90,322,407				90,353,253
Book value per common share-basic		$	(1.78	)		$	(12.44	)
Book value per common share-dilutive			(1.78	)			(12.44	)
Dividends declared per common share			—				—
Income (loss) from continuing operations per share-basic			10.92				(1.74	)
Income (loss) from continuing operations per share-dilutive			10.92				(1.74	)

 

In deciding whether to tender your shares of Series C Preferred Stock pursuant to the Series C Offer and Consent Solicitation, you should read carefully this proxy statement/consent solicitation/prospectus and the documents to which we refer you. You should also carefully consider the following factors.

 

Risks Related to Series C Offer

 

The Series C Offer and Series D Exchange may not benefit us or our stockholders.

 

The Series C Offer and Series D Exchange may not enhance stockholder value or improve the liquidity and marketability of our Common Stock. As of [ • ], 2010, there were [ • ] outstanding shares of Common Stock, 2,990,000 shares of Series C Preferred Stock and 2,100,000 shares of Series D Preferred Stock. If all of the outstanding Common Stock available for issuance under the Series C Offer and the Series D Exchange is issued, there will be approximately 90,353,253 shares of Common Stock outstanding.

 

This recapitalization will significantly increase the outstanding shares of Common Stock. It may result in an immediate decrease in the market value of the Common Stock. In addition, factors unrelated to our stock or our business, such as the general perception of the Series C Offer and Consent Solicitation by the investment community, may cause a decrease in the value of the Common Stock and impair its liquidity and marketability. Furthermore, securities markets worldwide have experienced significant price and volume fluctuations over the last several years. This market volatility, as well as general economic, market or political conditions, could cause a reduction in the market price and liquidity of Common Stock following the Series C Offer and Consent Solicitation and Series D Exchange, particularly if the Series C Offer and Consent Solicitation and Series D Exchange is not viewed favorably by the investment community.

 

If completion of our Series C Offer does not qualify as a reorganization under the Internal Revenue Code, you may be taxed on the full amount of the consideration you receive from us.

 

We believe that the exchange of Common Stock and cash, if any, for all of a holder’s Series C Preferred Stock pursuant to the Series C Offer should be treated for federal income tax purposes as a recapitalization within the meaning of Section 368 of the Internal Revenue Code. In such case, Series C Holders who participate in the Series C Offer will not recognize gain or loss other than to the extent that they receive cash in the Series C Offer or securities for accrued and unpaid dividends.

 

The tax treatment described above, however, is not free from doubt. If we complete our Series C Offer in a manner in which the Series C Offer does not qualify for the tax treatment described above, you may be taxed on any gain you realize up to the full Offer Consideration.

 

It is unlikely that we will pay any dividends on any shares of our Common Stock you receive in the Series C Offer in the foreseeable future.

 

Regardless of whether we exchange all of our outstanding Series C Preferred Stock and Series D Preferred Stock, it is unlikely that we will pay any cash or stock dividends on any shares of our Common Stock in the foreseeable future.

 

If we do not complete the Series C Offer and Series D Exchange, we may not be able to meet our long-term financial obligations.

 

Because the Series D Preferred Stock is subject to mandatory conversion in the future, and because there are accrued and unpaid dividends on all classes of preferred stock of $46,700,000 as of September 30, 2010, we must take some remedial measure or we may not able to meet our long-term financial obligations. If we are not able to complete the recapitalization and we do not take some other action in the future to address these issues, it could result in a material adverse effect to the Company, which could include bankruptcy.

Tendering stockholders may be required to return their consideration if a court were to determine that the Series C Offer constituted a fraudulent transfer under federal or state laws.

 

A payment or transfer of property can subsequently be voided if a court finds that the payment or transfer constituted a “fraudulent” transfer. There are generally two standards used by courts to determine whether a transfer was fraudulent under federal or state law.

 

 

Litigation seeking to void the Series C Offer or Series D Exchange as fraudulent transfers would have to be commenced by our creditors or someone acting on their behalf, such as a bankruptcy trustee. If such litigation is instituted, we cannot assure you as to what standard a court would apply in order to determine whether we were “insolvent” as of the date the Series C Offer and Series D Exchange was closed, or that a court would not determine that we were insolvent on the date of closing. We can also not assure you that a court would not determine that the Series C Offer or Series D Exchange constituted fraudulent transfers on another ground.

 

The definition of “insolvent” varies under three potentially applicable statutes. The measure of insolvency for purposes of the foregoing will vary depending upon the law of the jurisdiction which is being applied. Under the Bankruptcy Code, we would be considered insolvent if the sum of all our liabilities is greater than the value of all our property at a fair valuation. The foregoing standards are applied on a case-by-case basis to determine the insolvency of a particular person. Because there can be no assurance which jurisdiction’s fraudulent transfer law would be applied by a court, there can be no assurance as to what standard a court would apply in order to determine insolvency.

 

If a court determines the Series C Offer or Series D Exchange constituted fraudulent transfers, the Series C Offer or Series D Exchange could be voided. If the Series C Offer is deemed a fraudulent transfer, holders of the Series C Preferred Stock that successfully tender their shares may be required to return the consideration received for their Series C Preferred Stock, and such holders would be returned to their original position as a holder of Series C Preferred Stock.

 

Risks Related to our Business

 

Payment on our mortgage securities will continue to decrease as underlying mortgage loans are repaid and if the mortgage loans underlying our residual and subordinated securities continue to experience significant credit losses, which will reduce our cash flows, perhaps abruptly, and adversely affect our liquidity.

 

Our mortgage securities consist of certain residual securities retained from our past securitizations of mortgage loans, which typically consist of interest-only, and over collateralization bonds, and certain investment grade and non-investment grade rated subordinated mortgage securities retained from our past securitizations and purchased from other ABS issuers. These residual and subordinated securities are generally unrated or rated below investment grade and, as such, involve significant investment risk that exceeds the aggregate risk of the full pool of securitized loans. By holding the residual and subordinated securities, we generally retain the “first loss” risk associated with the underlying pool of mortgage loans. As a result, losses on the underlying mortgage loans directly affect our returns on, and cash flows from, these mortgage securities. In addition, if delinquencies and/or losses on the underlying mortgage loans exceed specified levels, the level of over-collateralization required for higher rated securities held by third parties may be increased, further decreasing cash flows presently payable to us.

Increased delinquencies and defaults on the mortgage loans underlying our residual and subordinated mortgage securities have resulted in a decrease in the cash flow we receive from these investments. In the event that decreases in cash flows from our mortgage securities are more severe or abrupt than currently projected, our results of operations, financial condition, and liquidity, and our ability to restructure existing obligations and establish new business operations will be adversely affected.

 

Our cash flows from mortgage securities are likely to be insufficient to cover our existing expenses in the near future.

 

As payments on our mortgage securities continue to decrease we will become more dependent on the operations and cash flows of our subsidiaries to meet our obligations.

 

Our principal assets are our equity interests in our operating subsidiaries, as well as approximately $16.8 million in cash and cash equivalents as of September 30, 2010. The cash flows from our mortgage securities have materially decreased and will continue to decrease as the underlying mortgage loans are repaid. As this occurs, we will become more dependent on the results of operations and cash flows generated by StreetLinks and Advent, and will rely on distributions and other payments from StreetLinks and Advent and any new operations we may establish or acquire, to pay our operating expenses and meet our other obligations. If our subsidiaries are unable to make distributions or other payments to us, our ability to meet our obligations will be materially and adversely affected.

 

Our ability to profitably manage, operate and grow operations is critical to our ability to pay our operating expenses and meet our other obligations and is subject to significant uncertainties and limitations. If we attempt to make any acquisitions to grow operations, we will incur a variety of costs and may never realize the anticipated benefits.

 

In light of the current state of declining cash flows from our mortgage securities, our ability to pay our operating expenses and meet our other obligations is dependent upon our ability to successfully operate and grow operations such that they generate positive cash flow. Our ability to start or acquire new businesses is significantly constrained by our limited liquidity and our likely inability to obtain debt financing or to issue equity securities as a result of our current financial condition, including a shareholders’ deficit, as well as other uncertainties and risks. There can be no assurances that we will be able to successfully operate and grow operations or establish or acquire new business operations.

 

If we pursue any new business opportunities, the process of establishing a new business or negotiating the acquisition and integrating an acquired business may result in operating difficulties and expenditures and may require significant management attention. Moreover, we may never realize the anticipated benefits of any new business or acquisition. We may not have, and may not be able to acquire or retain, personnel with experience in any new business we may establish or acquire. In addition, future acquisitions could result in contingent liabilities and/or impairment/amortization expenses related to goodwill and other intangible assets, which could harm our results of operations, financial condition and business prospects.

 

We are unlikely to have access to financing on reasonable terms, or at all, that may be necessary for us to continue to operate or to acquire new businesses.

 

We do not currently have in place any agreements or commitments for short-term financing nor any agreements or commitments for additional long-term financing. In light of these factors and current market conditions, our current financial condition, and our lack of significant unencumbered assets, we are unlikely to be able to secure additional financing for existing or new operations or for any acquisition.

 

Attempts to renegotiate and/or restructure the components of our equity in order to realign the capital structure with our current business model may be unsuccessful.

 

We expect to attempt to renegotiate and/or restructure the components of our equity in order to realign the capital structure with our current business model. In the event we are unsuccessful, we may not be able to pay the accumulated dividends on our preferred stock or redeem such stock.

Renegotiating and/or restructuring our equity may involve the issuance of a substantial number of shares of our common stock.

 

To successfully renegotiate and/or restructure our equity we may have to issue a substantial number of shares our common stock. Such an issuance will dilute our existing common stockholders and may depress the market value and price of our common stock. We cannot predict the price at which our common stock would trade following such an issuance.

 

Various legal proceedings could adversely affect our financial condition, our results of operations and liquidity.

 

In the course of our business, we are subject to various legal proceedings and claims. See “Description of Business — Legal Proceedings.” In addition, we have become subject to various securities and derivative lawsuits, and we may continue to be subject to additional litigation, in some cases on the basis of novel legal theories. The resolution of these legal matters or other legal matters could result in a material adverse impact on our results of operations, liquidity and financial condition.

 

Risks Related to Our Operating Subsidiaries

 

A prolonged decline in the number of home sales and the originations and refinancings of home loans would decrease appraisal order volume and adversely affect the revenues and profitability of StreetLinks.

 

StreetLinks, our residential appraisal management company, retains a portion of the fee for appraisal services collected from lenders and borrowers for an independent residential appraisal to cover its costs of managing the process of fulfilling the appraisal order. A prolonged decline in the number of home sales and the originations and refinancings of home loans would cause a decrease in the demand for appraisals. The decreased demand for appraisals would have an adversely affect the revenues and profitability of StreetLinks.

 

StreetLinks may be unable to maintain its relationships with its existing lending customers and may be unable to add new lending customers which would decrease appraisal order volume and adversely affect the revenues and profitability of StreetLinks.

 

StreetLinks has increased its appraisal order volume by adding lending customers and intends to further develop its business through the addition of new lending customers. There is no assurance that StreetLinks will be able to maintain the relationships with its existing lending customers or add new lending customers which would decrease appraisal order volume and adversely affect the revenues and profitability of StreetLinks.

 

Government agencies and regulatory authorities may change or eliminate current restrictions and requirements for appraisals.

 

StreetLinks’ appraisal order volume has increased, in part, as a result of increased restrictions and requirements for appraisals established by government agencies and regulatory authorities such as the Federal Housing Finance Agency and the United States Department of Housing and Urban Development that, among other things, require appraiser independence. Changes in or elimination of these restrictions and requirements could adversely affect the demand for StreetLinks’ services and the viability of its business model.

 

Advent may be unable to develop systems and a network of business partners to successfully distribute its products and services.

 

The success of Advent, our start up operation which will provide access to tailored banking accounts, small dollar banking products and related services to meet the needs of low and moderate income level individuals, will in large part depend on its ability to develop systems and a network of business partners for the distribution of its products services. To the extent Advent is unable to develop systems and a network of business partners to successfully distribute Advent’s products and services, it will have an adverse effect on Advent’s business, financial condition and results of operations.

Advent’s ability to distribute its financial products is, to some extent, dependent on the success of its business partners.

 

Advent anticipates distributing its financial products through business partners such as tax preparation offices and is to some extent dependent on the success of these business partners. To the extent there is a decrease in the demand for the products or services of Advent’s business partners, there may be a decrease in demand for Advent’s products and services, which would have an adverse effect on Advent’s business, financial condition and results of operations.

 

Federal and state legislators and regulators have increasingly taken an active role in regulating financial products of the type Advent anticipates offering, and the continuation of this trend could impede or prevent Advent’s ability to facilitate these financial products and harm its business.

 

From time to time, government officials at the federal and state levels introduce and enact legislation and regulations proposing to regulate or prevent the facilitation of financial products. Certain of the proposed legislation and regulations could, if adopted, increase costs to Advent and its business partners that provide its financial products, or could negatively impact or eliminate the ability of Advent to provide financial products through Advent’s business partners such as tax return preparation offices, which could have an adverse effect on Advent’s business, financial condition and results of operations.

 

Many states have statutes regulating, through licensing and other requirements, the activities of brokering loans and providing credit repair services to consumers as well as payday loan laws and local usury laws. Certain state regulators are interpreting these laws in a manner that could adversely affect the manner in which financial products are facilitated or permitted. If Advent is required to change business practices or otherwise comply with these statutes it could have a material adverse effect on its business, financial condition and results of operations.

 

Legal proceedings against our operating subsidiaries could adversely affect their business, financial condition and results of operations.

 

In the course of their business, our operating subsidiaries may become subject to legal proceedings and claims and could experience significant losses as a result of litigation defense and resolution costs which would have an adverse effect on their business, financial condition and results of operations.

 

Differences in our actual experience compared to the assumptions that we use to determine the value of our residual mortgage securities and to estimate reserves could further adversely affect our financial position.

 

Our securitizations of mortgage loans that were structured as sales for financial reporting purposes resulted in gain recognition at closing as well as the recording of the residual mortgage securities we retained at fair value. The value of residual securities represents the present value of future cash flows expected to be received by us from the excess cash flows created in the securitization transaction. In general, future cash flows are estimated by taking the coupon rate of the loans underlying the transaction less the interest rate paid to the investors, less contractually specified servicing and trustee fees, and after giving effect to estimated prepayments and credit losses. We estimate future cash flows from these securities and value them utilizing assumptions based in part on projected discount rates, delinquency, mortgage loan prepayment speeds and credit losses. It is extremely difficult to validate the assumptions we use in valuing our residual interests. Even if the general accuracy of the valuation model is validated, valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships which drive the results of the model. Due to deteriorating market conditions, our actual experience has differed significantly from our assumptions, resulting in a reduction in the fair value of these securities and impairments on these securities. If our actual experience continues to differ materially from the assumptions that we used to determine the fair value of these securities, our financial condition, results of operations and liquidity will continue to be negatively affected.

The value of, and cash flows from, our mortgage securities may further decline due to factors beyond our control.

 

There are many factors that affect the value of, and cash flows from, our mortgage securities, many of which are beyond our control. For example, the value of the homes collateralizing residential loans may decline due to a variety of reasons beyond our control, such as weak economic conditions or natural disasters. Over the past year, residential property values in most states have declined, in some areas severely, which has increased delinquencies and losses on residential mortgage loans generally, especially where the aggregate loan amounts (including any subordinate loans) are close to or greater than the related property value. A borrower’s ability to repay a loan also may be adversely affected by factors beyond our control, such as subsequent over-leveraging of the borrower, reductions in personal incomes, and increases in unemployment.

 

In addition, interest-only loans, negative amortization loans, adjustable-rate loans, reduced documentation loans, home equity lines of credit and second lien loans may involve higher than expected delinquencies and defaults. For instance, any increase in prevailing market interest rates may result in increased payments for borrowers who have adjustable rate mortgage loans. Moreover, borrowers with option ARM mortgage loans with a negative amortization feature may experience a substantial increase in their monthly payment, even without an increase in prevailing market interest rates, when the loan reaches its negative amortization cap. The current lack of appreciation in residential property values and the adoption of tighter underwriting standards throughout the mortgage loan industry may adversely affect the ability of borrowers to refinance these loans and avoid default.

 

Each of these factors may be exacerbated by general economic slowdowns and by changes in consumer behavior, bankruptcy laws, and other laws.

 

To the extent that delinquencies or losses continue to increase for these or other reasons, the value of our mortgage securities and the mortgage loans held in our portfolio will be further reduced, which will adversely affect our operating results, liquidity, cash flows and financial condition.

 

Risks Related to Our Discontinued Operations

 

We may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, borrower fraud, or certain borrower defaults, which could further harm our liquidity.

 

When we sold mortgage loans, whether as whole loans or pursuant to a securitization, we made customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our whole loan sale agreements require us to repurchase or substitute mortgage loans in the event we breach any of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower, broker, or employee fraud. Likewise, we are required to repurchase or substitute mortgage loans if we breach a representation or warranty in connection with our securitizations. We have received various repurchase demands as performance of subprime mortgage loans has deteriorated. A majority of repurchase requests have been denied, otherwise a negotiated purchase price adjustment was agreed upon with the purchaser. Enforcement of repurchase obligations against us would further harm our liquidity.

 

Risks Related to Interest Rates

 

Changes in interest rates may harm our results of operations and equity value.

 

Our results of operations are likely to be harmed during any period of unexpected or rapid changes in interest rates. Our primary interest rate exposures relate to our mortgage securities and floating rate debt obligations that arise if the applicable trigger is met. Interest rate changes could adversely affect our cash flow, results of operations, financial condition, liquidity and business prospects in the following ways:

 

 

 

In addition, interest rate changes may also further impact our net book value as our mortgage securities are marked to market each quarter. Generally, as interest rates increase, the value of our mortgage securities decreases which decreases the book value of our equity.

 

Furthermore, shifts in the yield curve, which represents the market’s expectations of future interest rates, also affects the yield required for the purchase of our mortgage securities and therefore their value. To the extent that there is an unexpected change in the yield curve it could have an adverse effect on our mortgage securities portfolio and our financial position.

 

Risks Related to our Capital Stock

 

There can be no assurance that our common stock or Series C Preferred Stock will continue to be traded in an active market.

 

Our common stock and our Series C Preferred Stock were delisted by the New York Stock Exchange (“NYSE”) in January 2008, as a result of failure to meet applicable standards for continued listing on the NYSE. Our common stock and Series C Preferred Stock are currently quoted by Pink OTC Markets’ inter-dealer quotation service as an OTCQB security. However, there can be no assurance that an active trading market will be maintained. Trading of securities on the Pink OTC Market is generally limited and is effected on a less regular basis than on exchanges, such as the NYSE, and accordingly investors who own or purchase our stock will find that the liquidity or transferability of the stock may be limited.

 

Additionally, a shareholder may find it more difficult to dispose of, or obtain accurate quotations as to the market value of, our stock. If an active public trading market cannot be sustained, the trading price of our common and preferred stock could be adversely affected and your ability to transfer your shares of our common and preferred stock may be limited.

 

We are not likely to pay dividends to our common or preferred stockholders in the foreseeable future.

 

To preserve liquidity, our board of directors has suspended dividend payments on our Series C Preferred Stock and Series D1 Preferred Stock. Dividends on our Series C Preferred Stock and D1 Preferred Stock continue to accrue and the dividend rate on our Series D1 Preferred Stock increased from 9.0% to 13.0%, compounded quarterly, effective January 16, 2008 with respect to all unpaid dividends and subsequently accruing dividends. No dividends can be paid on any of our common stock until all accrued and unpaid dividends on our Series C Preferred Stock and Series D1 Preferred Stock are paid in full. Accumulating dividends with respect to our preferred stock will negatively affect the ability of our common stockholders to receive any distribution or other value upon liquidation.

 

The market price and trading volume of our common and preferred stock may be volatile, which could result in substantial losses for our shareholders.

 

The market price of our capital stock can be highly volatile and subject to wide fluctuations. In addition, the trading volume in our capital stock may fluctuate and cause significant price variations to occur. Investors may experience volatile returns and material losses. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our capital stock include:

 

 

 

Our charter permits us to issue additional equity without shareholder approval, which could materially adversely affect our current shareholders.

 

Our charter permits our board of directors, without shareholder approval, to:

 

 

In connection with any capital restructuring or in order to raise additional capital, we may issue, reclassify or exchange securities, including debt instruments, preferred stock or common stock. Any of these or similar actions by us may dilute your interest in us or reduce the market price of our capital stock, or both. Our outstanding shares of preferred stock have, and any additional series of preferred stock may also have, a preference on distribution payments that limit our ability to make a distribution to common shareholders. Because our decision to issue, reclassify or exchange securities will depend on negotiations with third parties, market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future issuances, if any. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future. Thus, our shareholders will bear the risk that our future issuances, reclassifications and exchanges will reduce the market price of our stock and/or dilute their interest in us.

 

Other Risks Related to our Business

 

Our ability to use our net operating loss carryforwards and net unrealized built-in losses could be severely limited in the event of certain transfers of our voting securities.

 

We currently have recorded a significant net deferred tax asset, before valuation allowance, almost all of which relates to certain loss carryforwards and net unrealized built-in-losses. While we believe that it is more

likely than not that we will not be able to utilize such losses in the future, the net operating loss carryforwards (“NOLs”) and net unrealized built-in losses could provide significant future tax savings to us if we are able to use such losses. However, our ability to use these tax benefits may be impacted, restricted or eliminated due to a future “ownership change” within the meaning of Section 382 of the Code. We do not have the ability to prevent such an ownership change from occurring. Consequently, an ownership change could occur that would severely limit our ability to use the tax benefits associated with the NOLs and net unrealized built-in losses, which may result in higher taxable income for us (and a significantly higher tax cost as compared to the situation where these tax benefits are preserved).

 

Some provisions of our charter, bylaws and Maryland law may deter takeover attempts, which may limit the opportunity of our shareholders to sell their common stock at favorable prices.

 

Certain provisions of our charter, bylaws and Maryland law could discourage, delay or prevent transactions that involve an actual or threatened change in control, and may make it more difficult for a third party to acquire us, even if doing so may be beneficial to our shareholders. For example, our board of directors is divided into three classes with three year staggered terms of office. This makes it more difficult for a third party to gain control of our board because a majority of directors cannot be elected at a single meeting. Further, under our charter, generally a director may only be removed for cause and only by the affirmative vote of the holders of at least a majority of all classes of shares entitled to vote in the election for directors together as a single class. Our bylaws make it difficult for any person other than management to introduce business at a duly called meeting requiring such other person to follow certain advance notice procedures. Finally, Maryland law provides protection for Maryland corporations against unsolicited takeover situations.

 

The accounting for our mortgage assets may result in volatility of our results of operations and our financial statements.

 

The accounting treatment applicable to our mortgage assets is dependent on various factors outside of our control and may significantly affect our results of operations and financial statements. As current turmoil in the subprime industry continues to affect the characteristics of our mortgage assets we may be required to adjust the accounting treatment of our assets. As a result of this, stockholders must undertake a complex analysis to understand our earnings (losses), cash flows and financial condition.

 

Changes in accounting standards, subjective assumptions and estimates used by management related to complex accounting matters could have an adverse effect on results of operations.

 

Generally accepted accounting principles in the United States and related accounting pronouncements, implementation guidance and interpretations with regard to a wide range of matters, such as stock-based compensation, asset impairment, valuation reserves, income taxes and fair value accounting, are highly complex and involve many subjective assumptions, estimates and judgments by management. Changes in these rules or their interpretations or changes in underlying assumptions, estimates or judgments by management could significantly change our reported results.

 

The recently-enacted Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and other rules and regulations promulgated thereunder could cause additional operating and compliance costs in addition to other uncertainties.

 

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was signed into federal law. The Act will have a broad impact on the financial services industry, including significant regulatory and compliance changes. Regulatory agencies will implement new regulations in the future that will establish the parameters of the new regulatory framework and provide a clearer understanding of the legislation’s effect on our business. Given the uncertainty associated with the manner in which the provisions of the Act will be implemented by the various regulatory agencies, the full extent of the impact the Act will have on our operations is unclear. Nonetheless, while it is difficult to predict at this time what

specific impact the Act and certain yet-to-be implemented rules and regulations will have on us, we expect that at a minimum our operating and compliance costs will increase.

 

The recently-enacted Health Care and Education Reconciliation Act of 2010 and proposed amendments thereto could cause our compensation costs to increase, adversely affecting our results and cash flows.

 

The recently-enacted Health Care and Education Reconciliation Act of 2010 and proposed amendments thereto contain provisions that could materially impact the future healthcare costs of the Company. While the legislation’s ultimate impact remains uncertain, it is possible that these changes could significantly increase our compensation costs which would adversely affect our results and cash flows.

 

Our business relies on key personnel.

 

We are heavily dependent upon certain key personnel and the loss of service of any of these senior executives could adversely affect our business. Our success depends on the Company’s ability to retain these key executives. The loss of any of these senior executives could have a material adverse effect on our business financial condition and results of operation.

 

System interruptions or other technology failures could impair the Company’s operations.

 

We rely on our computer systems and service providers to consistently provide efficient and reliable service. System interruptions or other system intrusions, which may not be within the Company’s control, may impair the Company’s delivery of its products and services, resulting in a loss of customers and a corresponding loss in revenue.

 

 

 

 

Assumes all Series C Shares are tendered.

 

 

Computershare Trust Company, N.A.
c/o Voluntary Corporate Actions
P.O. Box 43011
Providence, RI 02940-3011

 

Or, you may return it to the Exchange Agent via courier at:

 

Computershare Trust Company, N.A.
c/o Voluntary Corporate Actions
Suite V
250 Royall Street
Canton, MA 02021

 

 

 

 

Georgeson Inc.
199 Water Street, 26^th Floor
New York, NY 10038-3560
Banks and Brokers Call (212) 440-9800
All Others Call Toll-Free (866) 695-6074

 

 

Georgeson Inc.
199 Water Street, 26^th Floor
New York, NY 10038-3560
Banks and Brokers Call (212) 440-9800
All Others Call Toll-Free (866) 695-6074

 

 

Proposals to Be Considered at the Special Meeting

 

The following proposals will be presented to the stockholders entitled to vote thereon for consideration at the special meeting:

 

 

Collectively, these proposals will be referred to herein as the “Proposals.” The amendments to be approved in the Proposals are referred to herein as the “Amendments.”

 

As described in the subsections titled “Record Date and Voting Rights,” “Voting of Proxies” and “Quorum and Votes Required for Approval of Proposals” below, as a Series C Holder you will be entitled to vote on Proposal 1, Proposal 4 and Proposal 5, and possibly other business properly brought before the special meeting and you will not be entitled to vote on Proposal 2 or Proposal 3.

 

Reasons for the Special Meeting and Consideration of the Proposals

 

As described below in the “Background of the Series C Offer and Consent Solicitation” subsection of this proxy statement/consent solicitation/prospectus, the Series C Offer, along with the Series D Exchange, are part

of the Company’s recapitalization to improve the Company’s capital structure. If the Series C Offer and Series D Exchange are consummated, approximately $20.0 million in accrued and unpaid dividends on the Series C Preferred Stock and $26.7 million of accrued and unpaid dividends on the Series D Preferred Stock (through September 30, 2010) will be eliminated, and no further dividends on such preferred stock will accrue. Further, the obligation to pay the aggregate liquidating preference would be eliminated as well.

 

In order to properly effectuate the Series C Offer and the Series D Exchange, the five Proposals to be considered at the special meeting must be approved by the Company’s stockholders entitled to vote on each Proposal. See “Proposal 1 — Charter Amendment to Eliminate the Series C Preferred Stock,” “Proposal 2 — Charter Amendment to Eliminate the Series D Preferred Stock,” “Proposal 3 — Charter Amendment to Increase the Number of Authorized Shares of Capital Stock of the Company,” “Proposal 4 — Charter Amendment to Preserve the Company’s Net Operating Loss Carryforwards” and “Proposal 5 — Technical Charter Amendments in Connection with the Other Proposals and to remove Provisions Previously-Required by the Company’s Former Status as a Real Estate Investment Trust” for the full description of the reasons for and effects of each Proposal.

 

Record Date and Voting Rights

 

Our Series C Preferred Stock is generally deemed a non-voting security. However, as provided in the Articles Supplementary to the charter governing the Series C Preferred Stock, the Series C Holders are entitled to vote their shares of Series C Preferred Stock on limited items that may affect their rights. On Proposal 1, Proposal 4, and Proposal 5 the Series C Holders at the close of business on [ • ], 2011, the record date, are entitled to vote at the special meeting, and are thus, entitled to notice thereof. As of the record date, there were 2,990,000 shares of Series C Preferred Stock outstanding.

 

Holders of shares of NFI’s Common Stock and holders of NovaStar Financial’s 9.00% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 per share (the “Series D Preferred Stock”), in each case at the close of business on [ • ], 2011, the record date, are entitled to notice of, and to vote on Proposal 1, Proposal 2, Proposal 3, Proposal 4 and Proposal 5 at the special meeting. On the record date, 9,368,053 shares of Common Stock and 2,100,000 shares of Series D Preferred Stock were outstanding. This proxy statement/consent solicitation/prospectus only solicits proxies from the Series C Holders.

 

Each holder of Series C Preferred Stock (a “Series C Holder”) is entitled to one vote for each share of Series C Preferred Stock held as of the record date. Each holder of Common Stock is entitled to one vote for each share of Common Stock held as of the record date. Each holder of Series D Preferred Stock (a “Series D Holder”) is entitled to one vote for each share of Common Stock into which the Series D Preferred Stock held as of the record date is convertible, in the aggregate. The outstanding Series D Preferred Stock is convertible into 1,875,000 shares of Common Stock, in the aggregate. Further, on each of the Proposals (defined below), a separate approval by at least two-thirds of the Company’s outstanding Series C Preferred Stock or Series D Preferred Stock, or both classes, is required. Consequently, the aggregate number of votes entitled to be cast at the special meeting and any additional separate approvals of the Series C Holders or Series D Holders is as follows:

 

Voting of Proxies

 

If you are not planning on attending the special meeting to vote your shares in person, your shares of Series C Preferred Stock cannot be voted until either a signed proxy card is returned to the Company or voting instructions are submitted by using the Internet or by calling a specifically designated telephone number. To give the Company the power to vote your shares of Series C Preferred Stock at the special meeting, the proxy card that accompanies this proxy statement/consent solicitation/prospectus should be returned to the Company in the enclosed return envelope. Specific instructions for Series C Holders of record who wish to use the Internet or telephone voting procedures are set forth on the proxy card.

 

Shares of stock represented by properly executed proxies received in time for the special meeting will be voted in accordance with the choices specified in the proxies. Unless contrary instructions are indicated on the proxy:

 

 

The management and the Board of Directors know of no matters to be brought before the special meeting other than as set forth herein. To date, the Company has not received any stockholder proposals. If any other matter of which the management and Board of Directors are not now aware is properly presented to the stockholders for action, it is the intention of the proxy holders to vote in their discretion on all matters on which the shares represented by such proxy are entitled to vote.

 

Revocability of Proxy

 

The giving of your proxy does not preclude your right to vote in person should you so desire. A proxy may be revoked at any time prior to its exercise by delivering a written statement to the Corporate Secretary that the proxy is revoked, by presenting a later-dated proxy, or by attending the special meeting and voting in person.

 

Solicitation of Proxies

 

The costs of this solicitation of the Series C Holders and of proxies of the Series C Holders by the Board of Directors will be borne by the Company. Proxy solicitations will be made by mail and also may be made by personal interview, telephone, facsimile transmission and telegram. Banks, brokerage house nominees and other fiduciaries are requested to forward the proxy soliciting material to the beneficial owners and to obtain authorization for the execution of proxies. NFI will, upon request, reimburse those parties for their reasonable expenses in forwarding proxy materials to the beneficial owners. NFI may engage an outside firm to solicit votes. If such a firm is engaged subsequent to the date of this proxy statement, the cost is estimated to be less than $10,000, plus reasonable out-of-pocket expenses.

 

Broker Non-Votes

 

If the shares you own are held in “street name” by a bank, brokerage firm or other nominee, your nominee, as the record holder of your shares, is required to vote your shares according to your instructions. In order to vote your shares, you will need to follow the directions your nominee provides to you. If you do not give instructions to your nominee, your nominee will not have discretionary authority to vote your shares on any of the Proposals and a broker non-vote will result.

 

Because the required vote for approval on each Proposal is based on all shares entitled to vote at the special meeting, and all shares of the Series C Preferred Stock or Series D Preferred Stock entitled to vote on

certain proposals, a broker non-vote will act as a vote “against” the Proposal(s) for which you do not give instructions.

 

Quorum and Votes Required for Approval of Proposals

 

The presence, in person or by proxy, of stockholders entitled to cast a majority of all of the votes entitled to be cast (including the Series D Preferred Stock on an as-converted into Common Stock basis) constitutes a quorum for the transaction of business at the special meeting. Both abstentions and broker non-votes will be considered present and entitled to vote for the purpose of determining the presence of a quorum. Because there were 14,233,053 eligible votes as of the record date, we will need at least 7,116,527 votes present in person or by proxy at the special meeting for a quorum to exist.

 

Proposal 1:  The affirmative vote of a majority of all shares entitled to vote at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock, the Series C Holders and the Series D Holders, and the affirmative vote of at least two-thirds of all Series C Holders entitled to vote is required to approve the amendment to the charter to eliminate the Series C Preferred Stock.

 

Proposal 2:  The affirmative vote of a majority of all shares entitled to vote at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock and the Series D Holders, and the affirmative vote of at least two-thirds of all Series D Holders entitled to vote is required to approve the amendment to the charter to eliminate the Series D Preferred Stock.

 

Proposal 3:  The affirmative vote of a majority of all shares entitled to vote at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock and the Series D Holders, and the affirmative vote of at least two-thirds of all Series D Holders entitled to vote is required to approve the amendment to the charter to increase the number of authorized shares of capital stock of the Company.

 

Proposal 4:  The affirmative vote of a majority of all shares entitled to vote at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock, the Series C Holders and the Series D Holders, the affirmative vote of at least two-thirds of all Series C Holders entitled to vote, and the affirmative vote of at least two-thirds of all Series D Holders entitled to vote is required to approve the amendment to the charter to preserve the Company’s net operating loss carryforwards.

 

Proposal 5:  The affirmative vote of a majority of all shares entitled to vote at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock, the Series C Holders and the Series D Holders, and the affirmative vote of at least two-thirds of all Series C Holders entitled to vote, and the affirmative vote of at least two-thirds of all Series D Holders entitled to vote is required to approve certain technical amendments in connection with the other Proposals and to remove provisions previously-required by the Company’s for status as a real estate investment trust.

 

For purposes of all five Proposals, abstentions will have the same effect as a vote against the Proposals.

 

Appraisal Rights and the Right to Petition for Fair Value

 

No stockholder of the Company will have appraisal rights with respect to any matter to be acted upon at the special meeting.

 

However, dissenting Series C Holders will have the right to petition for the fair value of their Series C Preferred Stock if the Series C Offer is consummated. Fair value will be determined as of the close of business on the day of the upcoming special meeting. To be eligible to receive the fair value for the Series C Preferred Stock, the dissenting Series C Holder must file a written objection with the Company at or before the special meeting. To receive fair value through this process, the Series C Holder may not vote in favor of the Proposals or consent to the Series C Offer or the Series D Exchange, and the Series C Holder must make a written demand to the Company for payment of his, her or its Series C Preferred Stock within 20 days after the charter containing the Amendments are accepted by state of Maryland.

The Series D Holders will have this same right to petition for fair value of their Series D Preferred Stock, though the Series D Holders have executed the Exchange Agreement (described below) under which the Series D Holders will exchange all of their Series D Preferred Stock for Common Stock and cash. Thus, we do not anticipate that there will be any dissenting Series D Holders.

 

Interest of Certain Persons in Matters to be Acted Upon at the Special Meeting

 

Pursuant to the Articles Supplementary to the Company’s charter, whenever dividends on the Series C Preferred Stock are in arrears for six or more quarters (whether or not consecutive) the Series C Holders have the right to elect two additional directors to the Board. Because dividends on the Series C Preferred Stock were in arrears for six or more quarters as of the 2009 Annual Shareholders’ Meeting, two directors, Howard Amster and Barry Igdaloff, were elected at that meeting to serve on the Board by the Series C Holders.

 

Mr. Amster owns 172,366 shares of Series C Preferred Stock and is the trustee of two trusts which own 44,600 shares of Series C Preferred Stock, collectively. Mr. Igdaloff owns 207,649 shares of Series C Preferred Stock and as a registered investment advisor he controls an additional 100,125 shares. Messrs. Amster and Igdaloff will be entitled to participate in the Series C Offer and Consent Solicitation on the same terms as are being offered to other Series C Holders and will vote their Series C Preferred Stock at the special meeting. In accordance with a Voting Agreement with the Company, Messrs. Amster and Igdaloff will vote “for” the Proposals described in this proxy statement/consent solicitation/prospectus.

 

“Householding” of Proxy Materials

 

In December of 2000, the Securities and Exchange Commission adopted rules that permit companies and intermediaries (e.g., brokers) to satisfy the delivery requirements for proxy statements with respect to two or more security holders sharing the same address by delivering a single proxy statement addressed to those security holders. This process is commonly referred to as “householding.”

 

A single proxy statement will be delivered to multiple stockholders sharing an address unless contrary instructions have been received from an affected stockholder. Once you have received notice from your broker that it will be “householding” communications to your address, “householding” will continue until you are notified otherwise or until you revoke your consent. If you or another stockholder of record with whom you share an address wish to receive a separate Annual Report or Proxy Statement, we will promptly deliver it to you if you request it by writing to: NovaStar Financial, Inc., Investor Relations, 2114 Central Street, Suite 600, Kansas City, MO 64108. If you or another stockholder of record with whom you share an address wish to receive a separate Annual Report or Proxy Statement in the future, you may telephone toll-free 1-800-884-4225 or write to Computershare, P.O. Box 43078, Providence, Rhode Island 02940-3078.

 

Stockholders who currently receive multiple copies of the proxy statement at their address and would like to request “householding” of their communications should contact their broker.

 

Proxy Solicitor

 

We have engage Georgeson Inc. to act as the proxy solicitor for this proxy solicitation. If you have questions regarding the proxy solicitation, please contact Georgeson Inc. at:

 

199 Water Street, 26^th Floor

New York, NY 10038-3560

Banks and Brokers Call (212) 440-9800

All Others Call Toll-Free (866) 695-6074

 

General

 

In connection with the Series C Offer, the Company has determined to amend its charter to eliminate the Series C Preferred Stock and the applicable Series C Preferred Stock Articles Supplementary. The proposed Articles of Amendment and Restatement attached to this proxy statement as Appendix A implement such an amendment by deleting from the Company’s existing charter all references and the terms applicable to the Series C Preferred Stock but for conversion mechanics applicable to any shares Series C Preferred Stock that are not tendered in the Series C Offer. Such residual shares of Series C Preferred Stock will be converted into the residual pro rata share of cash and Common Stock remaining after completion of the Series C Offer. The following description, which summarizes the amendment to the Company’s charter to eliminate the Series C Preferred Stock and applicable Series C Preferred Stock Articles Supplementary, is qualified in its entirety by reference to the proposed Articles of Amendment and Restatement attached to this proxy statement as Appendix A.

 

The Series C Offer and the other transactions contemplated herein, including the Amendment and Restatement of the Company’s charter, will not occur if the charter amendment to eliminate the Series C Preferred Stock is not approved at the special meeting.

 

Elimination of Series C Preferred Stock

 

If the Series C Offer and transactions contemplated thereby are approved and effected, the holders of Series C Preferred Stock electing to tender in the Series C Offer will exchange their shares of Series C Preferred Stock for 3 shares of newly-issued Common Stock and $2.00 in cash (the “Cash-and-Stock Option”) or 19 shares of newly-issued Common Stock (the “Stock-Only Option”). The actual mix of cash and Common Stock a Series C Holder will receive upon tender may be adjusted according to the number of other Series C Holders who elect the Cash-and-Stock Option and the number of other Series C Holders who elect the Stock-Only Option. For more information regarding the adjustment and the mix of Common Stock each Series C Holder who tenders can anticipate receiving, see “The Series C Offer and Consent Solicitation — General” and “— Series C Offer Consideration Explanation and Examples.”

 

Immediately following the completion of the Series C Offer transactions, upon the effectiveness of the Articles of Amendment and Restatement, and without further action on the part of the Company or its shareholders, all shares of Series C Preferred Stock not tendered for exchange will be automatically cancelled and changed into the sum of “A” dollars plus “B” shares of Common Stock (the “Remainder Consideration”), according to the following calculation:

 

A = $1,623,000 − ($2.00 * X)

 

B = 43,823,600 − (19 * Y)

 

Where “X” equals the number of shares of Series C Preferred Stock electing the Cash-and-Stock Option that are tendered for exchange in the Series C Offer, but in any event no more than 811,650.

 

Where “Y” equals the number of shares of Series C Preferred Stock electing the Stock-Only Option that are tendered for exchange in the Series C Offer, but in any event no more than 2,178,350.

 

Each share of Series C Preferred Stock not tendered for exchange will be automatically cancelled and will then represent the right to receive its pro rata share of the Remainder Consideration.

 

The terms of the Series C Preferred Stock are described under “Description of Securities — Series C Preferred Stock.” The terms of the Common Stock are described under “Description of Securities — Common Stock.” The Series C Preferred Stock and Common Stock have different rights. For more information about these differences, see “The Series C Offer and Consent Solicitation — Differences in Rights of Our Common Stock and Series C Preferred Stock.”

No Appraisal Rights

 

No stockholder of the Company will have appraisal rights with respect to any matter to be acted upon at the special meeting. However, dissenting Series C Holders will have the right to petition for the fair value of their Series C Preferred Stock if the Series C Offer is consummated. For more information regarding the right to demand Fair Value, see “The Series C Offer and Consent Solicitation — Appraisal Rights and the Right to Petition for Fair Value.”

 

Vote Required

 

The affirmative vote of a majority of the votes cast at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock, the Series C Holders and the Series D Holders, and the affirmative vote of at least two-thirds of all Series C Holders is required to approve the amendment to the charter to modify the terms of the Series C Preferred Stock.

 

Board Recommendation

 

After careful consideration, the Company’s board of directors determined that the charter amendment to the Company’s charter to eliminate the Series C Preferred Stock is advisable and directed that it be submitted to the Company’s stockholders for their approval. The Company’s board of directors recommends that stockholders vote in favor of the articles amendment to the Company’s charter to eliminate the Series C Preferred Stock.

 

YOUR BOARD RECOMMENDS THAT YOU VOTE
“FOR”
THE CHARTER AMENDMENT TO ELIMINATE THE SERIES C PREFERRED STOCK

 

 

General

 

In connection with the Series D Exchange, the Company has determined to amend its charter to eliminate the Series D Preferred Stock and the applicable Series D Preferred Stock Articles Supplementary. The proposed Articles of Amendment and Restatement attached to this proxy statement as Appendix A implement such an amendment by deleting from the Company’s existing charter all references and the terms applicable to the Series D Preferred Stock. The following description, which summarizes the amendment to the Company’s charter to eliminate the Series D Preferred Stock and applicable Series D Preferred Stock Articles Supplementary, is qualified in its entirety by reference to the proposed Articles of Amendment and Restatement attached to this proxy statement as Appendix A.

 

The Series D Offer and the other transactions contemplated herein, including the Amendment and Restatement of the Company’s charter, will not occur if the charter amendment to eliminate the Series D Preferred Stock is not approved at the special meeting.

 

Elimination of Series D Preferred Stock

 

If the Series D Exchange and transactions contemplated thereby are approved and effected, the holders of Series D Preferred Stock will exchange all issued and outstanding shares of the Series D Preferred Stock for an aggregate of 37,161,600 newly-issued shares of Common Stock and $1,377,000 in cash. Under the Exchange Agreement, at the completion of the Series C Offer, the Series D Holders collectively shall tender to the Company all 2,100,000 shares of issued and outstanding Series D Preferred Stock and receive an aggregate of 37,161,600 newly-issued shares of Common Stock and $1,377,000 in cash. After the Series D Exchange there will be no more issued or outstanding shares of Series D Preferred Stock. If each of the proposals is approved by Company’s shareholders, the Company will file the Company’s Articles of Amendment and Restatement with the State Department of Assessments and Taxation of Maryland to eliminate both the Series C Preferred Stock and the Series D Preferred Stock from the Company’s charter.

The terms of the Series D Preferred Stock are described under “Description of Securities — Series D Preferred Stock”. The terms of the Common Stock are described under “Description of Securities — Common Stock”.

 

No Appraisal Rights

 

No stockholder of the Company will have appraisal rights with respect to any matter to be acted upon at the special meeting. However, the Series D Holders will have the right to petition for fair value of their Series D Preferred Stock, though the Series D Holders have executed the Exchange Agreement (see “Review and Approval of Transaction with Related Parties; Related Party Transactions — Agreements and Transactions with the Series D Holders”), under which the Series D Holders will exchange all of their Series D Preferred Stock for Common Stock and cash. For more information regarding the right to demand Fair Value, see “The Series C Offer and Consent Solicitation — Appraisal Rights and the Right to Petition for Fair Value.”

 

Vote Required

 

The affirmative vote of a majority of the votes cast at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock and the Series D Holders, and the affirmative vote of at least two-thirds of all Series D Holders is required to approve the amendment to the charter to eliminate the terms of the Series D Preferred Stock.

 

Board Recommendation

 

As a Series C Holder, you will not be entitled to vote on Proposal 2. The Board will recommend to the holders of the Common Stock and the Series D Preferred Stock that they vote “for” the charter Amendment to eliminate the Series D Preferred Stock.

 

General

 

In order to issue the number of shares of Common Stock called for under the Series C Offer and the Series D Exchange, the Company’s charter must be amended to increase the authorized capital stock. The proposed Articles of Amendment and Restatement include such an amendment. The following description, which summarizes the amendment to the Company’s charter to change the authorized capital stock, is qualified in its entirety by reference to the proposed Articles of Amendment and Restatement attached to this proxy statement as Appendix C. Your attention is directed to the Articles of Amendment and Restatement, generally, and Article V thereof, specifically.

 

The Series C Offer and the other transactions contemplated herein, including the Amendment and Restatement of the Company’s charter, will not occur if the charter amendment to increase the number of authorized shares of capital stock of the Company is not approved at the special meeting.

 

Changes to Authorized Capital Stock

 

If approved, the amendment to the Company’s charter to change its authorized capital will provide that following the filing of the Company’s Articles of Amendment and Restatement with the State Department of Assessments and Taxation of Maryland, the Company will be authorized to issue an aggregate of 120,000,000 shares of capital stock, par value $0.01 per share, all of which initially will be classified as Common Stock. The board of directors will, however, continue to have the right to classify or reclassify any authorized but unissued shares of capital stock.

Vote Required

 

The affirmative vote of a majority of the votes cast at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock and the Series D Holders, and the affirmative vote of at least two-thirds of all Series D Holders is required to approve the amendment to the charter to increase the number of authorized shares of capital stock of the Company.

 

Board Recommendation

 

As a Series C Holder, you will not be entitled to vote on Proposal 3. The Board will recommend to the holders of the Common Stock and the Series D Preferred Stock that they vote “for” the charter Amendment to increase the number of authorized shares of Common Stock of the Company.

 

Description of the Acquisition Restrictions

 

The following is a brief summary of the acquisition restrictions, which are contained in Article Ten of the Company’s proposed Articles of Amendment and Restatement, a copy of which is attached as Appendix A to this document and is incorporated herein by reference. You are urged to read the full text of the acquisition restrictions.

 

The proposed acquisition restrictions would generally apply until the date that is 36 months and one day after completion of the Series C Offer (or earlier, if the Company’s board of directors in good faith determines that the acquisition restrictions are no longer in the best interests of the Company and its shareholders, which date is referred to as the “restriction release date”). Any attempted direct or indirect sale, transfer, assignment, exchange, issuance, grant, redemption, repurchase, conveyance, pledge or other disposition, whether voluntary or involuntary, and whether by operation of law or otherwise, by any person other than the Company of the Company’s Common Stock or any other securities that would be treated as the Company’s “stock” under Section 382 of the Code and the applicable regulations to a person or group of persons who own, or who would own as a result of such transfer, 5% or more (by value) of the Company’s stock would be restricted. Thus, the restrictions also restrict any attempted transfer of stock that would result in the identification of a new “5-percent shareholder” of NFI, as determined under the Code and applicable regulations; this would include, among other things, an attempted acquisition of NFI stock by an existing 5-percent shareholder. For these purposes, numerous rules of attribution, aggregation and calculation prescribed under the Code (and applicable treasury regulations) will be applied in determining whether the 5% threshold has been met and whether a group exists. The acquisition restrictions may also apply in certain cases to proscribe the creation or transfer of various “options,” which are broadly defined, in respect of the NFI stock to the extent, generally, that exercise of the option would result in a proscribed level of NFI stock ownership. As previously stated, the Company board of directors may waive the acquisition restrictions, and acquisitions of NFI stock directly from the Company, whether by way of option exercise or otherwise, are not subject to the acquisition restrictions.

 

Generally, the restrictions are imposed only with respect to the number of shares of NFI stock, or options with respect to NFI stock, purportedly transferred in excess of the threshold established in the acquisition restrictions, which is referred to in this document as the “excess stock.” In any event, the restrictions would not prevent a valid transfer if either the transferor or the purported transferee obtains the approval of the Company’s board of directors. In deciding whether to approve any proposed transfer, the NFI board of directors would consider whether the transfer would result in the application of any limitations under Section 382 of the Code by the Company of its NOLs and other tax attributes.

 

If the proposal is approved, the acquisition restrictions would remain in effect until the restriction release date, unless Article Ten of the Company’s charter is otherwise amended to remove the restrictions in accordance with the provisions of Maryland law and the Company’s charter.

The acquisition restrictions will not apply to the following:

 

 

Any person permitted to acquire or own 5% or more (by value) of Company stock pursuant to any of the foregoing bullet points will not be permitted to acquire any additional Company stock at any time until after the restriction release date, without the approval of the Company’s board of directors, unless and until such person owns less than 5% (by value) of NFI stock, at which point such person may acquire NFI stock only to the extent that, after such acquisition, such person owns less than 5% (by value) of the NFI stock.

 

The Company believes the acquisition restrictions are narrowly tailored to minimize their anti-takeover effects, that they are limited to the extent believed to be appropriate for protecting the ability of the Company to use its NOLs and other tax attributes and that they are in the best interest of all shareholders of the Company. For example, they have only a limited duration, which is determined by the application of the Code. Similarly, there are numerous exceptions which would not have been included if not narrowly tailored to protect such NOLs and other tax attributes. In addition, the Company’s board of directors does not intend to discourage offers to acquire substantial blocks of NFI stock that would clearly improve shareholder value, taking into account, as appropriate, any loss of the NOLs and other tax attributes. In the case of any such proposed acquisition that the Company’s board determines to be in the best interest of NFI and its shareholders, in light of all factors deemed relevant, the Company’s board would grant approval for such acquisition to proceed.

 

Article Ten would provide that all certificates representing the Company’s stock bear the following legend:

 

“THE TRANSFER OF SECURITIES REPRESENTED BY THIS CERTIFICATE IS (AND OTHER SECURITIES OF THE CORPORATION MAY BE) SUBJECT TO RESTRICTION PURSUANT TO ARTICLE TEN OF THE CORPORATION’S ARTICLES OF AMENDMENT AND RESTATEMENT. THE CORPORATION WILL FURNISH A COPY OF ITS ARTICLES OF AMENDMENT AND RESTATEMENT SETTING FORTH THE POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS OF EACH CLASS OF STOCK OR SERIES THEREOF AND THE QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS OF SUCH PREFERENCES AND/OR RIGHTS TO THE HOLDER OF RECORD OF THIS CERTIFICATE WITHOUT CHARGE UPON WRITTEN REQUEST ADDRESSED TO THE CORPORATION AT ITS PRINCIPAL PLACE OF BUSINESS.”

 

In accordance with the acquisition restrictions, the Company will not permit any of its employees or agents, including the transfer agent, to record any transfer of NFI stock purportedly transferred in contravention of the acquisition restrictions. As a result, requested transfers of NFI stock may be delayed or refused.

 

The proposed Articles of Amendment and Restatement provide that any transfer attempted in contravention of the acquisition restrictions would be null and void from the start, even if the transfer has been recorded by the transfer agent and new certificates issued. The purported transferee of the NFI stock would not be entitled to any rights of shareholders with respect to the excess stock, including the right to vote the excess stock, or to receive dividends or distributions in liquidation in respect thereof, if any. If the Company determines that a purported transfer has violated the acquisition restrictions, the Company will require the purported transferee to surrender the shares of excess stock and any dividends and other distributions the purported transferee has received on them to an agent designated by the Company’s board of directors. The agent will then sell the shares of excess stock in one or more arm’s-length transactions provided that nothing will require the agent to sell the shares of excess stock within any specific time frame if, in the agent’s discretion, the sale would disrupt the market for the NFI stock or adversely affect the value of the NFI stock.

Purpose and Effects of the Acquisition Restrictions

 

Without the acquisition restrictions, it is possible that certain transfers of NFI stock could, under Section 382 of the Code and applicable treasury regulations, result in limitations on the ability of the Company to utilize fully the substantial NOLs and other tax attributes currently available to them for U.S. federal income tax purposes. The Company’s board of directors believes it is in the Company’s best interests to attempt to prevent the imposition of such limitations by adopting the proposed acquisition restrictions.

 

The Company believes that, absent a court determination:

 

 

It is possible that the acquisition restrictions may not be enforceable against NFI’s shareholders who vote against or abstain from voting on the amendment. However, the Company believes that the acquisition restrictions are in the best interests of the Company and the Company’s shareholders and are reasonable, and the Company will act vigorously to enforce them against all current and future holders of NFI stock regardless of how they vote on the amendment.

 

The Company believes that each of its shareholders who votes in favor of the amendment will in effect have consented to the acquisition restrictions and therefore will be bound by them. In those circumstances, the Company intends to assert that any such shareholder would be estopped from challenging the legality, validity or enforceability of the acquisition restrictions. Consequently, all Company shareholders should carefully consider this in determining whether to vote in favor of the proposal.

 

Reasons for the Acquisition Restrictions

 

At December 31, 2009, the Company had associated NOLs of approximately $300 million. NOLs may be carried forward to offset taxable income in future years and eliminate income taxes otherwise payable on such future taxable income, subject to certain adjustments. The Company believes its NOLs could provide significant future tax savings, depending upon the amount of taxable income in future taxable years. If the Company does not have sufficient taxable income in future years to use the tax benefits before they expire, the Company will lose the benefit of these NOLs permanently.

 

The benefit of the Company’s NOLs, can be reduced substantially as a result of Section 382 of the Code. Section 382 of the Code limits the use of NOLs by a company that has undergone an “ownership change,” as defined in Section 382 of the Code. Generally, an “ownership change” occurs if one or more shareholders, each of whom owns 5% or more (by value) of a company’s stock, increase their aggregate percentage ownership by more than 50 percentage points over the lowest percentage of stock owned by such shareholders over the preceding three-year period. For this purpose, all holders who each own less than 5% of a company’s stock (by value) are generally treated together as one “5-percent shareholder,” subject to certain exceptions. In addition, certain attribution and constructive ownership rules, which generally attribute ownership of stock to the ultimate beneficial owner thereof without regard to ownership by nominees, trusts, corporations, partnerships or other entities, are applied in determining the level of stock ownership of a particular shareholder. Options (including warrants) to acquire capital stock may be treated as if they had been exercised, on an option-by-option basis, if the issuance, transfer or structuring of the option meets certain tests. All percentage determinations are based on the fair market value of a company’s capital stock, including any preferred stock that is voting or convertible (or otherwise participates in corporate growth to any significant extent). If a company experiences an ownership change, the amount of taxable income in any taxable year (or portion thereof) subsequent to the ownership change that can be offset by NOLs existing prior to such ownership change generally cannot exceed the product of (x) the aggregate value of the company’s stock and (y) the federal long-term tax-exempt rate. Certain complex subgroup rules may apply to such determinations.

The acquisition restrictions are designed to restrict transfers of NFI stock that could cause an “ownership change” under Section 382 of the Code and, therefore, could limit the ability of the Company to utilize its substantial NOLs currently available for U.S. federal income tax purposes. The Series C Offer and Series D Exchange will increase the likelihood that the Company will experience such an ownership change and, therefore, that the NOLs could be subject to such limitations.

 

Anti-Takeover Effect

 

The Company’s special committee and the Company’s board of directors recommend that the acquisition restrictions in Article X of the proposed Articles of Amendment and Restatement be approved for the reasons set forth in this document. However, you should be aware that the acquisition restrictions may have an “anti-takeover” effect because they restrict the ability of a person or entity, or group of persons or entities, from accumulating in the aggregate 5% or more (by value) of the NFI stock and the ability of persons, entities or groups now owning 5% or more (by value) of the NFI stock from acquiring additional NFI stock. The acquisition restrictions discourage or prohibit a merger, some tender or exchange offers, proxy contests or accumulations of substantial blocks of shares for which some shareholders might receive a premium above market value. In addition, the acquisition restrictions may delay the assumption of control by a holder of a large block of capital stock and the removal of incumbent directors and management, even if such removal may be beneficial to some or all of the Company’s shareholders.

 

The indirect “anti-takeover” effect of the acquisition restrictions is not the reason for the acquisition restrictions. The special committee and the board of directors have considered the acquisition restrictions to be reasonable and in the best interests of the Company and its shareholders because, among other things the acquisition restrictions reduce some of the risks that the Company will be unable to utilize its substantial NOLs described above. In the opinion of the special committee and the board of directors, the fundamental importance to the Company’s shareholders of maintaining the availability of such tax assets outweigh the indirect anti-takeover effect the acquisition restrictions may have. In addition, the special committee and the board of directors do not intend to discourage offers to acquire substantial blocks of Common Stock that would clearly improve shareholder value, taking into account, as appropriate, any loss of the NOLs. In the case of any such proposed acquisition that the board of directors determines to be in the best interest of the Company and its shareholders, in light of all factors deemed relevant, the board would grant approval for such acquisition to proceed.

 

Vote Required

 

The affirmative vote of a majority of the votes cast at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock, the Series C Holders and the Series D Holders, the affirmative vote of at least two-thirds of all Series C Holders, and the affirmative vote of at least two-thirds of all Series D Holders is required to approve the amendment to the charter to preserve the Company’s net operating loss carryforwards.

 

Board Recommendation

 

The Company’s special committee, and the Company’s board of directors, upon the unanimous recommendation of the Company’s special committee, have approved Proposal 4 and have determined that Proposal 4 is advisable and favorable to and, therefore, fair to and in the best interests of the Company and the Company’s shareholders. The Company’s special committee and the Company’s board of directors recommend that Company’s shareholders vote “FOR” approval of the acquisition restrictions proposal.

 

YOUR BOARD RECOMMENDS THAT YOU VOTE

“FOR”

THE CHARTER AMENDMENT TO PRESERVE

THE COMPANY’S NET OPERATING LOSS CARRYFORWARDS

 

General

 

In connection with the Series C Offer and the Series D Exchange, the Company has determined to amend and restate its charter in substantially the form of Articles of Amendment and Restatement attached as Appendix A. The Series C Offer, the Series D Exchange and the amendments to the Company’s charter will not occur if the Articles of Amendment and Restatement is not approved.

 

The Amendment and Restatement

 

The Articles of Amendment and Restatement is attached to this proxy statement in its entirety as Appendix A, and you are encouraged to read it carefully when determining how to vote on this proposal. The Articles of Amendment and Restatement effect the amendments described in Proposals 1 through 4 above, including to (A) eliminate the Company’s Series C Preferred Stock and associated Articles Supplementary following the exchange for, or conversion of, Series C Preferred Stock into a cash and Common Stock, (B) eliminate the Company’s Series D Preferred Stock and associated Articles Supplementary following its exchange for Common Stock, (C) increase the Company’s authorized capital stock and (D) implement certain acquisition restrictions to preserve the Company’s net operating loss carryforwards.

 

In addition to the changes described above to the Company’s charter, the Articles of Amendment and Restatement effect amendments to the charter to eliminate charter provisions that were previously relevant when the Company was taxed as a Real Estate Investment Trust (a “REIT”). Due to a decline in the Company’s business prospects, market capitalization and liquidity, on September 17, 2007, the Company announced that it would not proceed with declaring a dividend on its Common Stock that was required in order to satisfy the requirements to distribute $157 million in 2006 taxable income to preserve its status as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). The change in tax status was retroactive to January 1, 2006. The provisions related to preserving the Company’s former tax status as a REIT that will be eliminated in the Articles of Amendment and Restatement are the Company’s current charter as Article XI and include generally the following restrictions:

 

 

In addition, the Articles of Amendment and Restatement in the form as attached as Appendix A will include other less significant amendments or adjustments to the charter, including the following:

 

 

 

Vote Required

 

The affirmative vote of a majority of the votes cast at the special meeting (at which a quorum is present), which vote will include the votes of the holders of our Common Stock and the Series D Holders, and the affirmative vote of at least two-thirds of all Series D Holders is required to approve certain technical amendments in connection with the other Proposals and to remove provisions previously-required by the Company’s for status as a Real Estate Investment Trust.

 

Board Recommendation

 

After careful consideration, the Company’s board of directors determined that certain charter amendments in connection with the other proposals and to remove provisions previously-required by the Company’s former status as a real estate investment trust is advisable and directed that consideration of these amendments be submitted to the Company’s stockholders for their approval. The Company’s board of directors recommends that stockholders vote in favor of the charter amendments in connection with the other proposals and to remove provisions previously-required by the Company’s former status as a real estate investment trust.

 

YOUR BOARD UNANIMOUSLY RECOMMENDS THAT YOU VOTE
“FOR”
CERTAIN TECHNICAL CHARTER AMENDMENTS IN CONNECTION WITH
THE OTHER PROPOSALS AND TO REMOVE PROVISIONS PREVIOUSLY-REQUIRED
BY THE COMPANY’S FORMER STATUS AS A REAL ESTATE INVESTMENT TRUST

 

The Board of Directors knows of no other matters which may be presented for stockholder action at the meeting. However, if other matters do properly come before the meeting, it is intended that the persons named in the proxies will vote upon them in accordance with their discretion.

 

Any stockholder proposal, including the nomination of a director, intended to be presented at the 2011 annual meeting of stockholders and included in the proxy statement and form proxy relating to such meeting, must be received at NovaStar Financial’s offices on or before December 31, 2010.

 

In addition, the NovaStar Financial bylaws provide that any stockholder wishing to bring any matter, including the nomination of a director, before an annual meeting must deliver notice to the Corporate Secretary of NovaStar Financial, Inc. at the Company’s principal executive offices on or before January 30, 2011.

 

The stockholder’s notice must set forth (a) as to each person whom the stockholder proposes to nominate for election or reelection as a director all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors pursuant to Regulation 14A under the Securities Act of 1934, as amended (including such person’s written consent to being named in the proxy statement as a nominee and to servicing as a director if elected); (b) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and of the beneficial owner, if any, on whose behalf the proposal is made; and (c) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made, (i) the name and address of such stockholder, as they appear on the Company’s corporate books, and of such beneficial owner and (ii) the class and number of shares of the Company’s stock which are owned beneficially and of record by such stockholder and such beneficial owner.

 

You may contact the Secretary of NovaStar Financial, Inc. at the Company’s principal executive offices regarding the requirements for making stockholder proposals and nominating director candidates.

 

Background of the Series C Offer and Consent Solicitation

 

In 2007, to preserve liquidity, the Company’s Board of Directors suspended the payment of dividends on the Company’s Series C Preferred Stock and Series D Preferred Stock. Since then, preferred dividends have accrued and will continue to accrue at a rate of 8.90% per annum for the Series C Preferred Stock and a default rate of 13.0%, compounded quarterly, for the Series D Preferred Stock. Dividends on the Series D Preferred Stock compound quarterly, both with respect to the unpaid dividend and all subsequently accumulating dividends, and will continue to accrue at the default rate until the board of directors authorizes and the Company pays to the Series D Holders all accumulated and unpaid dividends on the Series D Preferred Stock (otherwise the dividend rate is 9.0% per annum). As of September 30, 2010, the Company had $46.7 million in accrued preferred dividends, $20.0 million of which related to the Series C Preferred Stock and $26.7 million of which related to the Series D Preferred Stock. As of September 30, 2010 the aggregate liquidating preference of the Series C Preferred Stock and the Series D Preferred Stock, which does not include accrued and unpaid dividends, was $74.8 million and $52.5 million, respectively. Therefore, the aggregate obligation as of September 30, 2010 is $174.0 million.

 

The Company believes that, based on its projected financial results, the cumulative nature of the preferred dividends on the Series C Preferred Stock and the Series D Preferred Stock and the compounding nature of the Series D Preferred Stock dividends, the Company is unlikely to produce cash flow before preferred dividends that exceeds the Company’s growing preferred dividend requirement, which will grow to approximately $17.8 million, $19.4 million and $21.1 million, in 2011, 2012 and 2013, respectively, if the Company does not pay any cash preferred dividends. Even then, the Company must pay all accumulated and unpaid dividends on the Series C Preferred Stock and Series D Preferred Stock before making any

distributions to the Company’s common shareholders. If the Company does not pay any cash preferred dividends, accumulated and unpaid dividends on the Series C Preferred Stock and Series D Preferred Stock will grow to approximately $68.7 million, $88.1 million and $109.2 million, in 2011, 2012 and 2013, respectively. The Company believes that this growing obligation to its preferred shareholders will impede the growth of, and strategic options available to, the Company and may lead to other material adverse effects to the Company, including bankruptey or liquidation. The Company also believes that the value received from a liquidation of its assets today would not exceed the value of its liabilities and liquidating preference of its preferred stock.

 

Conclusions of the Board of Directors of the Company

 

Based on a consideration of the above described factors and the options available to the Company, the Company determined that it was in its best interest and the best interest of its shareholders to pursue a recapitalization of the Company.

 

On May 11, 2010, the Company’s board of directors (the “Board”) appointed a special committee of disinterested directors (the “Special Committee”) to explore a potential recapitalization of the Company, and in September 2010, the Board engaged Stifel, Nicolaus & Company, Incorporated (“Stifel”) to assist it in evaluating a potential recapitalization and act as the Board’s independent financial advisor. The Special Committee is comprised entirely of directors who own neither Series C Preferred Stock or Series D Preferred Stock, and who were not elected by holders of Series C Preferred Stock or Series D Preferred Stock as a class. The consideration being offered to the Series D Holders and Series C Holders under the Series D Exchange and the Series C Offer, respectively, was determined based on discussions and negotiations with the Series D Holders and Board members elected by the Series C Holders, as well as management’s, the Special Committee’s and the Board’s consideration of the impact of the transaction on the potential value of the Company’s NOLs, liquidity, book value and earnings per share, as well as dilution to the Company’s existing holders of its Common Share.

 

On December 10, 2010, the Special Committee met telephonically to review the terms of the proposed transaction. The Special Committee reviewed and discussed the terms of the Exchange Agreement, Voting Agreement, Registration Rights Agreement, Articles of Amendment and Restatement, and the joint Schedule 13e-3/TO, as well as the draft registration statement on Form S-4.

 

The Special Committee received a report from management as to the negotiations for the contemplated transactions. The Special Committee also reviewed an opinion conveyed and delivered by Stifel to the Board. Stifel discussed the terms of the proposed transaction and the fairness of the transaction from the financial standpoint to the holders of the Company’s Common Stock.

 

The Special Committee considered and discussed certain factors that affect the fairness of the transaction, including:

 

 

The Special Committee considered as factors that positively affected the fairness of the transaction to the holders of the Company’s Common Stock the following:

 

 

The Special Committee considered as factors that negatively affected the fairness of the transaction to the holders of the Company’s Common Stock the following:

 

 

Immediately following the Special Meeting, the Board met telephonically to review the terms of the proposed transaction. Stifel also discussed the terms of the proposed transaction and the fairness of the transaction from the financial standpoint to the holders of the Company’s Common Stock with the Board. The Board reviewed and conducted the same analysis as to fairness issues and as to positive and negative factor as the Special Committee.

 

After a thorough review of the above circumstances and factors with management, and with advice from its financial advisor and legal counsel, the Board concluded that the potential advantages and gains of conducting the Series D Exchange and Series C Offer outweigh the possible disadvantages and costs. The Board also concluded that the terms of the Series C Offer are advisable, fair to the Company’s unaffiliated shareholders from financial and procedural points of view, and in the best interest of the Company and its shareholders. This conclusion was based on the experience and knowledge of the Board members as business people. The Board’s opinion was further bolstered by the recommendation of the Special Committee and the analysis and opinion that the Board received from Stifel.

 

The foregoing review by the Board is not intended to be exhaustive but, rather, includes material factors considered by the Board. In reaching its decision to approve the Series C Offer, the Board did not attempt to quantify or assign any relative weights to the factors considered, and individual directors may have given different weights to different factors. The Board considered all factors as a whole, and, overall, considered them to be favorable to, and to support, the determination to approve the proposed Series C Offer and Series D Exchange. The Board does not make any recommendation to the Series C Holders as to whether or not they should, individually or in the aggregate, participate in the Series C Offer.

 

The following description contains, among other information, a summary of the Series C Offer and Consent Solicitation and the related letter of transmittal (the “Letter of Transmittal”) and is qualified in its entirety by references to the full text of the Letter of Transmittal which is incorporated herein by reference to this proxy statement/consent solicitation/prospectus. Stockholders are urged to read carefully the Letter of Transmittal.

 

General

 

We hereby offer, upon the terms and subject to the conditions of the exchange offer described in this proxy statement/consent solicitation/prospectus and the related Letter of Transmittal, to exchange each share of our Series C Preferred Stock validly tendered on or prior to the Expiration Date and not withdrawn, for, at your election, either: (a) 3 shares of newly-issued common stock and $2.00 in cash (the “Cash-and-Stock Option”), or (b) 19 shares of newly-issued Common Stock (the “Stock-Only Option”). The Cash-and-Stock Only Option and the Stock-Only Option are the “Consideration Options.”

 

The total aggregate consideration offered under this Series C Offer is 43,823,600 newly-issued shares of Common Stock and $1,623,000 in cash (plus any additional cash needed to cash out the fractional shares of Common Stock) (the “Offer Consideration”). Regardless of the number of Series C Preferred Stock tendered for each Consideration Option, the Company will not issue more than 43,823,600 shares of Common Stock or pay out more than $1,623,000 in cash, other than any cash needed to cash out fractional shares which total

includes the remaining Offer Consideration distributed to non-tendering Series C Holders, if any. If you participate in the Series C Offer, you must elect to receive either the Cash-and-Stock Option or the Stock-Only Option. You may not elect to tender some of your Series C Preferred Stock for one option and some of your Series C Preferred Stock for the other.

 

The actual mix of cash and Common Stock a Series C Holder will receive upon tender may be adjusted according to the number of other Series C Holders who elect the Cash-and-Stock Option and the number of other Series C Holders who elect the Stock-Only Option, as there is not a sufficient amount of Common Stock or cash in the Series C Offer to fully provide the Cash-and-Stock Option to more than 27.15% of the Series C Holders or to fully provide the Stock-Only Option to more than 72.85% of the Series C Holders, before pro rata adjustments would apply.

 

As of [ • ], 2010, the Company had 2,990,000 shares of Series C Preferred Stock outstanding. If exactly 811,650 shares of Series C Preferred Stock are exchanged for the Cash-and-Stock Option and exactly 2,178,350 shares of Series C Preferred Stock are exchange for the Stock-Only Option, every Series C Holder will receive the Consideration Option for each share of his, her or its Series C Preferred Stock that the Series C Holder selected.

 

Assuming 100% of the Series C Holders participate in the Series C Offer, and less than 811,650 shares are tendered for the Cash-and-Stock Option, all the Series C Holders who elect the Cash-and-Stock Option will receive $2.00 and 3 shares of Common Stock per tendered share of Series C Preferred Stock, as elected. However, in that case, any Series C Holder who tenders his, her or its shares and elected the Stock-Only Option will receive fewer than 19 shares of Common Stock, but, he, she or it will receive some cash. Assuming 100% of the Series C Holders participate in the Series C Offer, and less than 2,178,350 shares are tendered for the Stock-Only Option, all the Series C Holders who elect the Stock-Only Option will receive 19 shares of Common Stock per tendered share of Series C Preferred Stock, as elected. However, in that case, any Series C Holder who tenders his, her or its shares and elects the Cash-and-Stock Option may receive less than $2.00 in cash, but, in that case, he, she or it will receive more than 3 shares of Common Stock. For examples of Offer Consideration to be paid to each tendering Series C Holder, see “— Series C Offer Consideration Explanation and Examples.”

 

As part of the Series C Offer, the Company is soliciting consent to the Series C Offer the Series D Exchange from all Series C Holders. The Articles Supplementary governing the Series C Preferred Stock contains certain conversion and exchange restrictions. Thus, we are soliciting your consent to complete the Series C Offer regardless of any applicable conversion or exchange restrictions. Further, such consent is required to pay cash in the Series D Exchange. Consent can be given to the Series C Offer and the Series D Exchange by completing the proxy card accompanying this proxy statement/consent solicitation/prospectus and mailing it to the Company in the enclosed return envelope.

 

We reserve the right to amend the Series C Offer or Consent Solicitation, including the composition or amount of the Offer Consideration, for any reason. If we so amend the Series C Offer or Consent Solicitation, we will extend the Series C Offer and Consent Solicitation for a period of ten business days if the Series C Offer or Consent Solicitation is scheduled to expire prior thereto.

 

The term “Expiration Date” means 12:00 midnight, Central Time, on [ • ], 2011 unless and until we extend the period of time for which the exchange offer is open, in which event the term “Expiration Date” means the latest time and date at which the Series C Offer and Consent Solicitation, as so extended, expires. See “Series C Offer and Consent Solicitation — Extension, Termination and Amendment” and “— Conditions of the Series C Offer and Consent Solicitation.”

 

Tendering Series C Holders will not be obligated to pay any brokerage commissions. Except as set forth in Instruction 6 of the Letter of Transmittal, transfer taxes on the exchange of Series C Preferred Stock pursuant to the Series C Offer and Consent Solicitation will be paid by or on behalf of NFI.

 

Our obligation to exchange the Offer Consideration for Series C Preferred Stock pursuant to the Series C Offer and Consent Solicitation is subject to a number of conditions referred to below under “The Series C Offer and Consent Solicitation — Conditions of the Series C Offer and Consent Solicitation.”

If by 12:00 midnight, Central Time, on [ • ], 2011, or any later time to which the Expiration Date and this Series C Offer and Consent Solicitation have been extended, all of the conditions to the Series C Offer and Consent Solicitation have not been satisfied or waived, we may elect either to: (a) extend the Expiration Date and this Series C Offer and Consent Solicitation and retain all shares of Series C Preferred Stock theretofore tendered until the expiration of the Expiration Date and this Series C Offer and Consent Solicitation, as extended, subject to the right of a tendering stockholder to withdraw his, her or its Series C Preferred Stock; (b) waive the remaining conditions (other than the effectiveness of the registration statement of which this proxy statement/consent solicitation/prospectus is a part), extend the Series C Offer and Consent Solicitation for a period of ten business days if the Series C Offer and Consent Solicitation are scheduled to expire prior thereto and thereafter exchange all tendered shares of Series C Preferred Stock; or (c) terminate the Series C Offer and Consent Solicitation and exchange none of the Series C Preferred Stock and return all tendered shares of Series C Preferred Stock. We will not accept for exchange any shares of Series C Preferred Stock pursuant to the Series C Offer and Consent Solicitation until such time as the registration statement has become effective. See “The Series C Offer and Consent Solicitation — Exchange of Shares; Offer Consideration” and “— Conditions of the Series C Offer and Consent Solicitation — Effective Registration Statement.” We expect that the Series C Offer and Consent Solicitation will close promptly after all of these conditions have been satisfied.

 

Any shares of Series C Preferred Stock tendered and accepted for exchange will be cancelled.

 

Eligible for Termination of Registration under the Exchange Act

 

After the Series C Offer and Consent Solicitation, we anticipate that we will have fewer than three hundred Series C Holders, and thus, our Series C Preferred Stock will be eligible for termination of registration under Section 12(g)(4) of the Securities Exchange Act of 1934 (the “Exchange Act”) Because we anticipate the tender offer of the Series C Preferred Stock will make the Series C Preferred Stock eligible for termination of registration under the Exchange Act, we will file a Joint Schedule 13E-3/TO.

 

Differences in Rights of Our Common Stock and Series C Preferred Stock

 

Differences in the rights represented by our Common Stock and Series C Preferred Stock are summarized below.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Series C Offer Consideration Explanation and Examples

 

As described above, a Series C Holder who tenders his, her or its Series C Preferred Stock is not guaranteed to receive the Consideration Option elected for each of the Series C Holders shares. If exactly 811,650 shares of Series C Preferred Stock are exchanged for the Cash-and-Stock Option and exactly 2,178,350 shares of Series C Preferred Stock are exchange for the Stock-Only Option, every Series C Holder will receive the Consideration Option for each share of his, her or its Series C Preferred Stock that the Series C Holder selected.

 

Assuming 100% of the Series C Holders participate in the Series C Offer, and less than 811,650 shares are tendered for the Cash-and-Stock Option, all the Series C Holders who elect the Cash-and-Stock Option will receive the Cash-and-Stock Option for every tendered share of Series C Preferred Stock, as elected. However, in that case, any Series C Holder who tenders his, her or its shares and elected the Stock-Only Option will receive the Stock-Only Option for some of the shares of Series C Preferred Stock tendered for exchange and the Cash-and-Stock Option for the rest of the shares of Series C Preferred Stock tendered for exchange.

 

Assuming 100% of the Series C Holders participate in the Series C Offer, and less than 2,178,350 shares are tendered for the Stock-Only Option, all the Series C Holders who elect the Stock-Only Option will receive the Stock-Only Option for every tendered share of Series C Preferred Stock, as elected. However, in that case, any Series C Holder who tenders his, her or its shares and elects the Cash-and-Stock Option will receive the Cash-and-Stock Option for some of the shares of Series C Preferred Stock tendered for exchange and the Stock-Only Option for the rest of the shares of Series C Preferred Stock tendered for exchange.

 

Examples of the Consideration Options to be received for the Series C Preferred Stock assuming all the shares of Series C Preferred Stock are exchanged in the Series C Offer and Consent Solicitation:

 

 

Assumes all Series C Shares are tendered.

 

Fractional Shares

 

Fractional shares of Common Stock will not be tendered in exchange for Series C Preferred Stock. Instead, each Series C Holder who otherwise would have been entitled to receive a fraction of a share of the Company’s Common Stock will receive an amount in cash equal to the product obtained by multiplying the fractional share interest to which such Series C Holder would otherwise be entitled by the Company’s average closing price over the 10-day period preceding the Expiration Date.

 

Partial Tenders

 

Partial tenders will not be accepted. To participate in the Series C Offer, a Series C Holder must tender all Series C Preferred Stock held by that Series C Holder.

 

Extension, Termination and Amendment

 

We expressly reserve the right, in our sole discretion, at any time on or prior to the Expiration Date, to extend the period of time during which the Series C Offer and Consent Solicitation are to remain open by giving written notice of such extension to the holders of Series C Preferred Stock. There can be no assurance that we will exercise our rights to extend the Expiration Date and this Series C Offer and Consent Solicitation. If we amend the Series C Offer and Consent Solicitation, we will extend the Expiration Date and this Series C

Offer and Consent Solicitation for a period of ten business days if the Series C Offer and Consent Solicitation are scheduled to expire prior thereto. During any such extension, all shares of Series C Preferred Stock previously tendered and not withdrawn will remain subject to the Series C Offer and Consent Solicitation, subject to the right of a tendering stockholder to withdraw his, her or its Series C Preferred Stock. See “The Series C Offer and Consent Solicitation — Withdrawal Rights.” We reserve the right to amend or terminate the Series C Offer and Consent Solicitation and not exchange or accept for exchange any Series C Preferred Stock not theretofore exchanged, or accepted for exchange, upon the failure of any of the conditions of the Series C Offer and Consent Solicitation to be satisfied or waived on or before the Expiration Date. Any such extension, termination, amendment or delay will be followed as promptly as practicable by public announcement thereof, such announcement in the case of an extension to be issued no later than 9:00 a.m., Central Time, on the next business day after the previously scheduled Expiration Date. Without limiting the manner in which we may choose to make such public announcement, we will not, unless otherwise required by rules of the SEC, have any obligation to make any such public announcement other than by making a release through PR Newswire. If, prior to the Expiration Date, we increase the consideration offered to holders of Series C Preferred Stock, such increase will be applicable to all Series C Holders whose shares of Series C Preferred Stock are accepted for exchange pursuant to the Series C Offer and Consent Solicitation and, if at the time notice of such increase is first published, sent or given to Series C Holders, the Series C Offer and Consent Solicitation are scheduled to expire at any time earlier than the expiration of a period ending on the tenth business day from and including the date that such notice is first so published, sent or given, the Series C Offer and Consent Solicitation will be extended until the expiration of such period of ten business days. For purposes of the Series C Offer and Consent Solicitation, a “business day” means any day other than a Saturday, Sunday or federal holiday and consists of the time period from 12:00 midnight through 11:59 p.m., Central Time.

 

Exchange of Shares; Offer Consideration

 

Upon the terms and subject to the conditions of the Series C Offer, the acceptance for exchange and the exchange of the outstanding shares of Series C Preferred Stock validly tendered and not withdrawn will be made promptly after the Expiration Date.

 

For purposes of the Series C Offer and Consent Solicitation, we will be deemed to have accepted for exchange and thereby acquired tendered Series C Preferred Stock as, if and when we give written notice to tendering holders of Series C Preferred Stock of our acceptance of the tenders of such shares of Series C Preferred Stock. Delivery of the Offer Consideration in exchange for the Series C Preferred Stock pursuant to the Series C Offer and Consent Solicitation will be made by us with or promptly after the Expiration Date of such notice. We expect the settlement date to be within three business days after the Expiration Date. Under no circumstances will interest be paid by us by reason of any delay in making such exchange.

 

If any tendered shares of Series C Preferred Stock are not acceptable for exchange pursuant to the terms and conditions of the Series C Offer and Consent Solicitation for any reason, or if certificates are submitted for more shares of Series C Preferred Stock than are tendered, certificates for such un-exchanged Series C Preferred Stock will be returned to the tendering stockholder promptly following consummation or termination of the Series C Offer and Consent Solicitation.

 

Consequences for Failure to Participate

 

If the Series C Offer closes, all shares of Series C Preferred Stock that are not tendered in the Series C Offer and Consent Solicitation will be automatically converted into the right to receive, prorata per share of Series C Preferred Stock that remain outstanding after the closing, the remaining Offer Consideration. The remaining Offer Consideration will be distributed pro rata per share to the non-tendering former Series C Holders within 30 days of the Expiration Date, as extended. Any Series C Holder who does not participate in the Series C Offer will have no control over the approximate mix of cash and Common Stock he, she or it will receive.

 

Further, if holders of at least two-thirds of the Series C Preferred Stock do not participate and the Company is not able to complete the recapitalization, the Company may not be able to meet its long-term financial obligations unless the Company undertakes some other remedial measure. This could result in a material adverse effect to the Company, which could include bankruptcy.

Procedure for Tendering Shares and Notice of Guaranteed Delivery

 

To tender shares of Series C Preferred Stock pursuant to the Series C Offer and Consent Solicitation, a properly completed and duly executed Letter of Transmittal (or facsimile thereof), together with the certificates representing the tendered Series C Preferred Stock and any other required documents, must be transmitted to and received by the Exchange Agent on the Letter of Transmittal. Because you must consent to the Series C Offer and the Series D Exchange to participate in the Series C offer, you must complete the proxy card that accompanies this proxy statement/consent solicitation/prospectus and mail it to the Company in the enclosed return envelope. The method of delivery of all required documents is as the option and risk of the tendering stockholder. If delivery is by mail, registered mail with return receipt requested, properly insured, is recommended.

 

If you have already tendered your Series C Preferred stock for the Stock-Only Option or Cash-and-Stock Option, you do not need to take any further action to receive your portion of the Offer Consideration. If you wish to revoke your prior tender, you may do so by following the instructions set forth above under “Withdrawal Rights.” Any holder who withdraws a prior tender may tender for different Offer Consideration by submitting a new Letter of Transmittal to the Exchange Agent.

 

Signatures on all Letters of Transmittal must be guaranteed by a firm that is a member of a registered national securities exchange or of the National Association of Securities Dealers, Inc., or by a commercial bank or trust company having an officer or correspondent in the United States or by any other “eligible guarantor institution” as defined in Rule 17Ad-15 under the Securities Exchange Act of 1934, as amended (each of the foregoing being an “Eligible Institution”), in cases where shares of Series C Preferred Stock are tendered by a registered holder of Series C Preferred Stock who has completed either the box entitled “Special Payment Instructions” or the box entitled “Special Delivery Instructions” on the Letter of Transmittal. If the certificates are registered in the name of a person other than the signer of the Letter of Transmittal, the certificates must be endorsed or accompanied by appropriate stock powers, signed exactly as the name or names of the registered owner or owners appear on the certificates, with the signature(s) on the certificates or stock powers guaranteed as described above.

 

If a Series C Holder desires to tender shares of Series C Preferred Stock pursuant to the Series C Offer, and such Series C Holder’s certificates are not immediately available or time will not permit his, her or its Letter of Transmittal, stock certificates or any other required documents to reach the Exchange Agent prior to the Expiration Date, that Series C Holder’s tender may nevertheless be effected if all the following conditions are met: (a) such tender is made by or through an Eligible Institution (as defined in the Letter of Transmittal); (b) a properly completed and duly executed Notice of Guaranteed Delivery, substantially in the form provided by us herewith is received by the Exchange Agent as provided below on or prior to the Expiration Date; and (c) the certificates for all tendered shares of Series C Preferred Stock, together with a properly completed and duly executed Letter of Transmittal (or facsimile thereof) and any other documents required by the Letter of Transmittal, are received by the Exchange Agent within five business days after the date of execution of such Notice of Guaranteed Delivery.

 

The Notice of Guaranteed Delivery may be delivered by hand to the Exchange Agent or transmitted by telegram, telex, facsimile transmission or mail to the Exchange Agent and must include a signature guaranteed by an Eligible Institution in the form set forth in such Notice.

 

In any event, the exchange of Offer Consideration for Series C Preferred Stock tendered and accepted for exchange pursuant to the Series C Offer and Consent Solicitation will be made only after timely receipt by the Exchange Agent of certificates therefore properly completed, duly executed Letter(s) of Transmittal and any other required documents. In addition, the Company must receive the proxy card with Series C Holder’s consent to the Series C Offer and Series D Exchange before Offer Consideration for Series C Preferred Stock tendered and excepted for exchange will be paid or issued by the Company for those shares of Series C Preferred Stock.

 

To avoid backup federal income tax withholding with respect to the Offer Consideration received by a Series C Holder pursuant to the Series C Offer and Consent Solicitation, the Series C Holder must provide the Exchange Agent with his, her or its correct taxpayer identification number or certify that he, she or it is not

subject to backup federal income tax withholding by completing the Substitute Form W-9 included in the Letter of Transmittal.

 

All questions as to the validity, form, eligibility (including time of receipt) and acceptance of any tender of Series C Preferred Stock will be determined by us in our sole discretion, and our determination will be final and binding. We reserve the absolute right to reject any or all tenders determined by it not to be in proper form or the acceptance of or exchange for which may, in the opinion of our counsel, be unlawful. We also reserve the absolute right to waive, on or prior to the Expiration Date, any of the conditions of the Series C Offer and Consent Solicitation which we are legally permitted to waive (other than the effectiveness of the Registration Statement) or any defect or irregularity in the tender of any shares of Series C Preferred Stock. No tender of Series C Preferred Stock will be deemed to have been validly made until all defects and irregularities have been cured or waived. Our interpretation of the terms and conditions of the Series C Offer and Consent Solicitation (including the Letter of Transmittal and instructions thereto) will be final and binding. Neither we nor any other person will be under any duty to give notification of any defects or irregularities in the tender of any shares of Series C Preferred Stock or will incur any liability for failure to give any such notification.

 

A tender of Series C Preferred Stock pursuant to the procedures described above will constitute a binding agreement between the tendering Series C Holder and Company upon the terms and subject to the conditions of the Series C Offer and Consent Solicitation.

 

Withdrawal Rights

 

Shares of Series C Preferred Stock tendered pursuant to the Series C Offer and Consent Solicitation may be withdrawn at any time prior to the Expiration Date.

 

For a withdrawal to be effective, a written or facsimile transmission notice of withdrawal must be timely received by the Exchange Agent at the address set forth on the Letter of Transmittal and must specify the name, address and social security number of the person having tendered the shares of Series C Preferred Stock to be withdrawn, the certificate number or numbers for such shares and the name of the registered holder, if different from that of the person who tendered such shares of Series C Preferred Stock.

 

If certificates have been delivered or otherwise identified to the Exchange Agent, the name of the registered holder and the serial numbers of the particular certificates evidencing the shares of Series C Preferred Stock withdrawn must also be furnished to the Exchange Agent as aforesaid prior to the physical release of such certificates. All questions as to the form and validity (including time of receipt) of notices of withdrawal will be determined by us in our discretion, and our determination will be final and binding. Neither we nor any other person will be under any duty to give notification of any defects or irregularities in any notice of withdrawal or will incur any liability for failure to give any such notification. Any shares of Series C Preferred Stock properly withdrawn will be deemed not to have been validly tendered for purposes of the Series C Offer and Consent Solicitation. However, withdrawn shares of Series C Preferred Stock may be re-tendered by following one of the procedures described under “— Procedure for Tendering Shares” at any time prior to the Expiration Date.

 

Lost or Missing Certificates

 

If a Series C Holder desires to tender Series C Preferred Stock pursuant to the Series C Offer and Consent Solicitation but the certificate evidencing such Series C Preferred Stock has been mutilated, lost, stolen or destroyed, the Series C Holder should write to or telephone us at the address or telephone number listed below about procedures for obtaining a replacement certificate for such Series C Preferred Stock.

 

Computershare Trust Company N.A.

P.O. Box 43078

Providence, Rhode Island 02940-3078

1-800-884-4225

Attention: Lost and Securities

 

Conditions of the Series C Offer and Consent Solicitation

 

Our obligation to accept Series C Preferred Stock pursuant to the Series C Offer and Consent Solicitation is subject to a number of conditions, which are described below:

 

Effective registration statement:  The Series C Offer is conditioned upon the Registration Statement, of which this proxy statement/consent solicitation/prospectus is a part, becoming effective. This is a non-waivable condition of the Series C Offer and Consent Solicitation.

 

Receipt of Series C Holder’s Consents.  The Series C Offer is conditioned upon the Company’s receipt of consent to the Series C Offer and the Series D Exchange by the holders of two-thirds of the outstanding Series C Preferred Stock.

 

Approval of the Amendments to our Charter.  The Series C Offer is conditioned upon the approval by the shareholders entitled to vote on each Proposal presented at the special meeting of each Amendment.

 

Completion of the Series D Exchange.  The Series C Offer is conditioned upon the completion of the exchange of all issued and outstanding shares of the Company’s Series D Preferred Stock for an aggregate of 37,161,600 newly-issued shares of Common Stock and $1,377,600 in cash.

 

In addition, we will not be required to accept for exchange or, subject to any applicable rules or regulations of the SEC, exchange any Series C Preferred Stock tendered for exchange and may postpone the acceptance for exchange of any Series C Preferred Stock tendered for exchange, and may terminate or amend the Series C Offer and Consent Solicitation as provided in this document if at any time on or after the date of this Series C Offer and Consent Solicitation and before the Expiration Date, any of the following conditions have occurred:

 

No Adverse Proceeding.  There shall have been instituted or threatened or be pending any action or proceeding before or by any court or governmental, regulatory or administrative agency or instrumentality, or by any other person, in connection with the Series C Offer or Consent Solicitation that is, or is reasonably likely to be, in our reasonable judgment, materially adverse to our business, operations, properties, condition (financial or otherwise), assets, liabilities or prospects.

 

A Material Adverse Development in Proceedings.  There shall have occurred any material adverse development, in our reasonable judgment, with respect to any action or proceeding concerning us.

 

An Adverse Order or Law.  An order, statute, rule, regulation, executive order, stay, decree, judgment or injunction shall have been proposed, enacted, entered, issued or promulgated by any court or administrative agency or instrumentality that, in our reasonable judgment, would or might prohibit, prevent, restrict or delay consummation of the Series C Offer or Consent Solicitation that is, or is reasonably likely to be, materially adverse to our business, operations, properties, condition (financial or otherwise), assets, liabilities or prospects.

 

A Suspension of Trading, the Commencement of Hostilities, or Other Serious Event.  There shall have occurred:

 

 

 

The foregoing conditions are for our sole benefit and may be asserted by us on or before the Expiration Date regardless of the circumstances giving rise to any such conditions or may be waived on or before the Expiration Date by us in whole or in part, except to the extent that any such conditions arise out of any action or inaction by us or any of our affiliates. The failure by us to exercise any of the foregoing rights will not be deemed a waiver of any such right, and each such right will be deemed a continuing right which may be asserted at any time and from time to time on or before the Expiration Date.

 

Waiver of Conditions

 

We reserve the absolute right (but are not obligated), subject to the rules and regulations of the SEC, to waive on or before the Expiration Date any of the conditions of the Series C Offer other than the condition regarding the effectiveness of the registration statement.

 

If any of the waivable conditions are not satisfied prior to the Expiration Date, we may, subject to applicable law:

 

 

Source of Funds

 

We intend to fund all cash payments to holders pursuant to the Series C Offer, including any payments for fractional shares of Common Stock, with cash on hand.

 

Fees and Expenses

 

The Company will pay all expenses of the Series C Offer including, but not limited to, the filing, legal, accounting and appraisal fees, soliciting expenses and printing costs. Brokers, dealers, commercial banks and trust companies will be reimbursed by us for customary mailing and handling expenses incurred by them in forwarding material to their customers.

 

Interest of Certain Persons in the Series C Offer

 

Pursuant to the Articles Supplementary to the Company’s charter, whenever dividends on the Series C Preferred Stock are in arrears for six or more quarters (whether or not consecutive) the Series C Holders have the right to elect two additional directors to the Board. Because dividends on the Series C Preferred Stock were in arrears for six or more quarters as of the 2009 Annual Shareholders’ Meeting, two directors, Howard Amster and Barry Igdaloff, were elected at that meeting to serve on the Board by the Series C Holders.

 

As part of the Series C Offer and Consent Solicitation, and the Amendment contemplated by a Proposal 1, Messrs. Amster and Igdaloff will not automatically continue to serve on the Board beyond the special meeting. However, under the Voting Agreement, dated December 10, 2010, the Company and Messrs. Amster and Igdaloff have mutually agreed that following a successful conclusion to the Series C Offer, the Company will use its reasonable best efforts to expand the Company’s Board by two positions and appoint Messrs. Amster and Igdaloff to fill the newly-created positions. Moreover, at the next annual meeting of shareholders of the Company occurring after the completion of the Series C Offer, the Company will use its reasonable best efforts to nominate Messrs. Amster and Igdaloff to three-year terms as directors of the

Company’s Board and Messrs. Amster and Igdaloff will accept such nominations. Further, under the Voting Agreement, Messrs. Amster and Igdaloff will vote “for” the Proposals. For more information regarding the structure of the Board upon filing the revised charter and the Board service of Messrs. Amster and Igdaloff, see “Directors, Executive Officers and Control Persons — Classified Directors” and “ — Series C Directors,” respectively.

 

Messrs. Amster and Igdaloff did not serve on the special committee of the Board which considered the recapitalization, including the Series C Offer.

 

Mr. Amster owns 172,366 shares of Series C Preferred Stock and is the trustee of two trusts which own 44,600 shares of Series C Preferred Stock, collectively. Mr. Igdaloff owns 207,649 shares of Series C Preferred Stock and as a registered investment advisor he controls an additional 100,125 shares. Messrs. Amster and Igdaloff will be entitled to participate in the Series C Offer and Consent Solicitation on the same terms as are being offered to other Series C Holders.

 

Messrs. Amster and Igdaloff have both indicated that they will elect the Stock-Only Option in exchange for their Series C Preferred Stock.

 

Appraisal Rights and the Right to Petition for Fair Value

 

No stockholder of the Company will have appraisal rights with respect to any matter to be acted upon at the special meeting. However, dissenting Series C Holders will have the right to petition for the fair value of their Series C Preferred Stock if the Series C Offer is consummated. Fair value will be determined as of the close of business on the day of the upcoming special meeting. To be eligible to receive the fair value for the Series C Preferred Stock, the dissenting Series C Holder must file a written objection with the Company at or before the special meeting. To receive fair value through this process, the Series C Holder may not vote in favor of the Proposals or consent to the Series C Offer or Series D Exchange, and the Series C Holder must make a written demand to the Company for payment of his, her or its Series C Preferred Stock within 20 days after the charter containing the Amendments are accepted by state of Maryland.

 

The Series D Holders will have this same right to petition for fair value of their Series D Preferred Stock, though the Series D Holders have executed the Exchange Agreement (see “Review and Approval of Transaction with Related Parties; Related Party Transactions — Agreements and Transactions with the Series D Holders”) under which the Series D Holders will exchange all of their Series D Preferred Stock for Common Stock and cash. Thus, we do not anticipate that there will be any dissenting Series D Holders.

 

Exchange Agent

 

We have engaged Computershare Trust Company, N.A. to act as the Exchange Agent for the Series C Offer and Consent Solicitation.

 

The following table sets forth our capitalization as of September 30, 2010 (in thousands):

 

 

You should read this information together with our financial statements and the notes to those statements appearing elsewhere in this proxy statement/consent solicitation/prospectus.

 

The following table sets forth the actual accrued and unpaid dividends and the aggregate liquidating preferences of the Series C Preferred Stock and Series D Preferred Stock on the same bases as the preceding table. The accrued and unpaid dividends on the Series C Preferred Stock and the Series D Preferred Stock are assumed to be forgiven when giving effect to the Series C Offer and Series D Exchange.

 

 

In October 1997, our registration statement for our initial public offering of Common Stock became effective and our Common Stock shares commenced trading on the New York Stock Exchange (the “NYSE”) under the symbol “NFI.” In January 2008, our Common Stock was delisted from the NYSE and is currently quoted by Pink OTC Markets’ inter-dealer quotation service as an OTCQB security under the symbol “NOVS.” There were approximately [ • ] holders of record of Common Stock as of [ • ], 2010.

 

The table below sets forth, for the periods indicated, the high and low sales prices of our Common Stock as reported by the NYSE and as quoted by Pink OTC Markets’ inter-dealer quotation service.

 

Sales Prices

 

 

 

 

On December [ • ], 2010, the closing price of our Common Stock as quoted by Pink OTC Markets’ inter-dealer quotation service was $[ • ] per share.

 

Dividend distributions will be made at the discretion of the Board of Directors and will depend on earnings, financial condition, cost of equity, investment opportunities and other factors as the Board of Directors may deem relevant. In addition, accrued and unpaid dividends on our Series C Preferred Stock and Series D Preferred Stock must be paid prior to the declaration of any dividends on our Common Stock. We do not expect to declare any cash or stock dividend distributions in the near future.

 

We did not pay dividends on our Common Stock in 2008 or 2009, nor have we paid dividends on our Common Stock in 2010.

 

The following discussion and analysis relates to our financial condition and results of operations for the relevant periods and is based on, and should be read in conjunction with, our financial statements appearing elsewhere in this prospectus. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Risk Factors.” See “Cautionary Note Regarding Forward-Looking Statements” for cautionary statements concerning forward-looking statements.

 

Executive Overview

 

Corporate Overview, Background and Strategy — We are a Maryland corporation formed on September 13, 1996. We own 88% of StreetLinks National Appraisal Services LLC (“StreetLinks”), a national residential appraisal and real estate valuation management services company. StreetLinks collects fees from lenders and borrowers in exchange for a residential appraisal provided by an independent residential appraiser. Most of the fee is passed through to an independent residential appraiser with whom StreetLinks has a contractual relationship. StreetLinks retains a portion of the fee to cover its costs of managing the process to fulfill the appraisal order and perform a quality control review of each appraisal. StreetLinks also provides other real estate valuation management services, such as field reviews and value validation.

 

We own 70% of Advent Financial Services LLC (“Advent”), a start-up business which provides access to tailored banking accounts, small dollar banking products and related services to low and moderate income level individuals. Advent began its operations in December 2009. Through this start-up period, management is evaluating the Advent business model to determine its long-term viability. As anticipated by management, Advent has not been a significant contributor to our 2010 operations and management believes this will remain the case through at least year end.

 

StreetLinks owns 51% of Corvisa LLC (“Corvisa”), a technology company that develops and markets its software products to mortgage lenders. Its primary product is a self-managed appraisal solution for lenders to manage their appraisal process. Other products include analytical tools for lender to manage their mortgage origination business.

 

Prior to changes in our business in 2007, we originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage securities. We retained, in our mortgage securities investment portfolio, significant interests in the nonconforming loans we originated and purchased, and through our servicing platform, serviced all of the loans in which we retained interests. We discontinued our mortgage lending operations and sold our mortgage servicing rights which subsequently resulted in the closing of our servicing operations. The mortgage securities we retained continue to be a primary source of our cash flow. Because of severe declines in housing prices and national and international economic crises which led to declining values of our investments in mortgage loans and securities, we suffered significant losses during 2009. Liquidity constraints forced us to reduce operations and administrative staff and take other measures to conserve cash.

 

Significant Recent Events — On November 4, 2010, StreetLinks completed the acquisition of 51% of Corvisa, see Note 16 to the condensed consolidated financial statements for the quarterly period ended September 30, 2010 for additional details.

 

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was signed into federal law. Various government agencies are charged with implementing new regulations under the Act. When fully implemented, the Act will modify and provide for new regulation of a wide range of financial activities, including residential real estate appraisals and appraisal management companies.

 

On October 18, 2010, as required by the Act, the Federal Reserve Board issued an interim final rule which amended Regulation Z under the Truth in Lending Act (the “Appraisal Rule”). The Appraisal Rule is subject to a public comment period until December 17, 2010. Compliance with the Appraisal Rule, as

amended to account for comments received, becomes mandatory as of April 1, 2011. New requirements under the Appraisal Rule specific to residential real estate appraisals will likely include, but not be limited to, the following:

 

 

It is management’s opinion that the Appraisal Rule and other rules and regulations promulgated under the Act will strengthen appraiser reform, leading to greater appraiser independence and greater lender non-compliance liability and will likely increase lender and consumer costs. We believe credible lenders will continue to rely on appraisal management companies to mitigate their appraisal compliance risk and manage their appraisal fulfillment processes. Any impact of the Act on the Company will not be fully determined until all rules and regulations thereunder, including the Appraisal Rule, have been fully implemented.

 

Subsequent to December 31, 2009, certain events occurred that required us to reconsider the accounting for three consolidated loan trusts — NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1. Upon reconsideration we determined that all requirements for derecognition were met under applicable accounting guidelines at the time of the reconsideration event. As a result, we derecognized the assets and liabilities of the trusts and recorded a gain during 2010 of $993.1 million. These transactions are discussed in greater detail in this report under the heading “Impact on Our Financial Statements of Derecognition of Securitized Mortgage Assets.”

 

Critical Accounting Policies — We prepare our consolidated financial statements in conformity with GAAP and, therefore, are required to make estimates regarding the values of our assets and liabilities and in recording income and expenses. These estimates are based, in part, on our judgment and assumptions regarding various economic conditions that we believe are reasonable based on facts and circumstances existing at the time of reporting. These estimates affect reported amounts of assets, liabilities and accumulated other comprehensive income at the date of the consolidated financial statements and the reported amounts of income, expenses and other comprehensive income during the periods presented. The following summarizes the components of our consolidated financial statements where understanding accounting policies is critical to understanding and evaluating our reported financial results, especially given the significant estimates used in applying the policies. The discussion is intended to demonstrate the significance of estimates to our financial statements and the related accounting policies. Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and the Audit Committee has reviewed our disclosure.

 

Mortgage Securities — Available-for-Sale and Trading.  Our mortgage securities — available-for-sale and trading represent beneficial interests we retained in securitization and resecuritization transactions which include residual securities and subordinated securities as well as bonds issued by others which we have purchased. The residual securities include interest-only mortgage securities, prepayment penalty bonds and over-collateralization bonds. The subordinated securities represent bonds which are senior to the residual securities but are subordinated to the bonds sold to third-party investors. All of the subordinated securities retained by us have been classified as trading.

 

The residual securities we retained in securitization transactions structured as sales primarily consist of the right to receive the future cash flows from a pool of securitized mortgage loans which include:

 

 

 

The subordinated securities we retained in our securitization transactions have a stated principal amount and interest rate. The performance of the securities is dependent upon the performance of the underlying pool of securitized mortgage loans. The interest rates these securities earn are variable and are subject to an available funds cap as well as a maximum rate cap. The securities receive principal payments in accordance with a payment priority which is designed to maintain specified levels of subordination to the senior bonds within the respective securitization trust. Because the subordinated securities are rated lower than AA, they are considered low credit quality and we account for the securities based on guidance set forth from Beneficial Interests in Securitized Financial Assets using the effective yield method. The fair value of the subordinated securities is based on quoted third-party market prices compared to estimates based on discounting the expected future cash flows of the collateral and bonds.

 

The cash flows we receive are highly dependent upon the interest rate environment. The interest rates on the bonds issued by the securitization trust are indexed to short-term interest rates, while the coupons on the pool of loans held by the securitization trust are less interest rate sensitive. As a result, as rates rise and fall, our cash flows will fall and rise, because the cash we receive on our residual securities is dependent on this interest rate spread. As our cash flows fall and rise, the value of our residual securities will decrease or increase. Additionally, the cash flows we receive are dependent on the default and prepayment experience of the borrowers of the underlying mortgage security collateral. Increasing or decreasing cash flows will increase or decrease the yield on our securities.

 

We believe the accounting estimates related to the valuation of our mortgage securities — available-for-sale and establishing the rate of income recognition on the mortgage securities — available-for-sale and trading are “critical accounting estimates,” because they can materially affect net income and shareholders’ equity and require us to forecast interest rates, mortgage principal payments, prepayments and loan default assumptions which are highly uncertain and require a large degree of judgment. The rate used to discount the projected cash flows is also critical in the valuation of our residual securities. We use internal, historical collateral performance data and published forward yield curves when modeling future expected cash flows and establishing the rate of income recognized on mortgage securities. We believe the value of our residual securities is appropriate, but can provide no assurance that future changes in interest rates, prepayment and loss experience or changes in the market discount rate will not require write-downs of the residual assets. For mortgage securities classified as available-for-sale, impairments would reduce income in future periods when deemed other-than-temporary.

 

As previously described, our mortgage securities available-for-sale and trading represent retained beneficial interests in certain components of the cash flows of the underlying mortgage loans to securitization trusts. Income recognition for our mortgage securities — available-for-sale and trading is based on the effective yield method. Under the effective yield method, as payments are received, they are applied to the cost basis of the mortgage-related security. Each period, the accretable yield for each mortgage security is evaluated and, to the extent there has been a change in the estimated cash flows, it is adjusted and applied prospectively. The estimated cash flows change as management’s assumptions about credit losses, borrower prepayments and interest rates are updated. The assumptions are established using internally developed models. We prepare analyses of the yield for each security using a range of these assumptions. The accretable yield used in recording interest income is generally set within a range of assumptions. The accretable yield is recorded as interest income with a corresponding increase to the cost basis of the mortgage security.

 

At each reporting period subsequent to the initial valuation of the residual securities, the fair value of the residual securities is estimated based on the present value of future expected cash flows to be received. Management’s best estimate of key assumptions, including credit losses, prepayment speeds, expected call dates, market discount rates and forward yield curves commensurate with the risks involved, are used in estimating future cash flows. We estimate initial and subsequent fair value for the subordinated securities based on quoted market prices. See Note 3 to the consolidated financial statements for the fiscal year ended December 31, 2009 for the residual security sensitivity analysis and Note 4 to the consolidated financial

statements for the fiscal year ended December 31, 2009 for the current fair value of our residual securities. See Note 4 to the condensed consolidated financial statements for the quarterly period ended September 30, 2010 for the residual security sensitivity analysis and Note 5 to the condensed consolidated financial statements for the period ended September 30, 2010 for the current fair value of our residual securities.

 

To the extent that the cost basis of mortgage securities — available-for-sale exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss.

 

Allowance for Credit Losses.  An allowance for credit losses is maintained for mortgage loans held-in-portfolio. The amount of the allowance is based on the assessment by management of probable losses incurred based on various factors affecting our mortgage loan portfolio, including current economic conditions, the makeup of the portfolio based on credit grade, loan-to-value ratios, delinquency status, mortgage insurance we purchase and other relevant factors. The allowance is maintained through ongoing adjustments to operating income. The assumptions used by management in estimating the amount of the allowance for credit losses are highly uncertain and involve a great deal of judgment.

 

An internally developed migration analysis is the primary tool used in analyzing our allowance for credit losses. This tool takes into consideration historical information regarding foreclosure and loss severity experience and applies that information to the portfolio at the reporting date. We also take into consideration our use of mortgage insurance as a method of managing credit risk and current economic conditions, experience and trends. We pay mortgage insurance premiums on a portion of the loans maintained on our Consolidated Balance Sheets and have included the cost of mortgage insurance in our statement of operations.

 

Approximately 20% of our loans held in portfolio were greater than 90 days delinquent at December 31, 2008, and approximately 20% were in foreclosure. As of December 31, 2009, this delinquency percentage decreased to approximately 16% while loans in foreclosure increased to approximately 36%. As loans transition into REO status, an estimated loss is recorded until the property is sold or liquidated. For the NHEL 2006-1 and NHEL 2006-MTA1 transactions, we valued REO property at 50% of its current principal balance as of December 31, 2009, compared to 55% as of December 31, 2008. Because of the increased loss severity, NHEL 2007-1 property was valued at 35% in 2009; a 5% decrease from 2008. Our estimate of expected losses could increase if our actual loss experience is different than originally estimated. In addition, our estimate of expected losses could increase if economic factors change the value we could reasonably expect to obtain from the sale of the property.

 

The Company did not hold any mortgage loans-held-in-portfolio as of September 30, 2010 due to the derecognition of the securitization trusts and therefore did not have an allowance for credit losses during 2010. See Note 3 to the condensed consolidated financial statements for the quarterly period ended September 30, 2010 for further details.

 

Real Estate Owned.  Real Estate Owned, which consists of residential real estate acquired in satisfaction of loans, is carried at the lower of cost or estimated fair value less estimated selling costs. We estimate fair value at the asset’s liquidation value less selling costs using management’s assumptions which are based on historical loss severities for similar assets. Adjustments to the loan carrying value required at time of foreclosure are charged against the allowance for credit losses. Costs related to the development of real estate are capitalized and those related to holding the property are expensed. Losses or gains from the ultimate disposition of real estate owned are charged or credited to earnings.

 

The Company did not hold any real estate owned as of September 30, 2010 due to the derecognition of the securitization trusts. See Note 3 to the condensed consolidated financial statements for the quarterly period ended September 30, 2010 for further details.

 

CDO Asset-Backed Bonds (“CDO ABB”).  We elected the fair value option for the asset-backed bonds issued from NovaStar ABS CDO I in 2007. We elected the fair value option for these liabilities to help reduce earnings volatility which otherwise would arise if the accounting method for this debt was not matched with the fair value accounting for the related mortgage securities — trading. Fair value is estimated using quoted market prices of the underlying assets.

The asset-backed bonds which are being carried at fair value are included in the “Other current liabilities” line item on the Consolidated Balance Sheets. We recognize fair value adjustments for the change in fair value of the bonds which are included in the “Other expense” line item on the Consolidated Statements of Operations. We calculate interest expense for these asset-backed bonds based on the prevailing coupon rates of the specific classes of debt and record interest expense in the period incurred. Interest expense amounts are included in the “Interest expense” line item of the Consolidated Statements of Operations.

 

Deferred Tax Asset, net.  We recorded deferred tax assets and liabilities for the future tax consequences attributable to differences between the GAAP carrying amounts and their respective income tax bases. A deferred tax liability was recognized for all future taxable temporary differences, while a deferred tax asset was recognized for all future deductible temporary differences, operating loss carryforwards and tax credit carryforwards. In accordance with Income Taxes guidance, we recorded deferred tax assets and liabilities using the enacted tax rate that is expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized.

 

In determining the amount of deferred tax assets to recognize in the financial statements, we evaluate the likelihood of realizing such benefits in future periods. Income Taxes guidance requires the recognition of a valuation allowance if it is more likely than not that all or some portion of the deferred tax asset will not be realized. Income Taxes guidance indicates the more likely than not threshold is a level of likelihood that is more than 50%.

 

Under Income Taxes guidance, companies are required to identify and consider all available evidence, both positive and negative, in determining whether it is more likely than not that all or some portion of its deferred tax assets will not be realized. Positive evidence includes, but is not limited to the following: cumulative earnings in recent years, earnings expected in future years, excess appreciated asset value over the tax basis and positive industry trends. Negative evidence includes, but is not limited to the following: cumulative losses in recent years, losses expected in future years, a history of operating losses or tax credits carryforwards expiring and adverse industry trends.

 

The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. Accordingly, the more negative evidence that exists requires more positive evidence to counter, thus making it more difficult to support a conclusion that a valuation allowance is not needed for all or some of the deferred tax assets. A cumulative loss in recent years is significant negative evidence that is difficult to overcome when determining the need for a valuation allowance. Similarly, cumulative earnings in recent years represent significant positive objective evidence. If the weight of the positive evidence is sufficient to support a conclusion that it is more likely than not that a deferred tax asset will be realized, a valuation allowance should not be recorded.

 

We examine and weigh all available evidence (both positive and negative and both historical and forecasted) in the process of determining whether it is more likely than not that a deferred tax asset will be realized. We consider the relevancy of historical and forecasted evidence when there has been a significant change in circumstances. Additionally, we evaluate the realization of our recorded deferred tax assets on an interim and annual basis. We do not record a valuation allowance if the weight of the positive evidence exceeds the negative evidence and is sufficient to support a conclusion that it is more likely than not that our deferred tax asset will be realized.

 

If the weighted positive evidence is not sufficient to support a conclusion that it is more likely than not that all or some of our deferred tax assets will be realized, we consider all alternative sources of taxable income identified in determining the amount of valuation allowance to be recorded. Alternative sources of taxable income identified in Income Taxes guidance include the following: 1) taxable income in prior carryback year, 2) future reversals of existing taxable temporary differences, 3) future taxable income exclusive of reversing temporary differences and carryforwards, and 4) tax planning strategies.

 

Strategy — Management is focused on building the operations of StreetLinks and Advent. With the acquisition of Corvisa subsequent to September 30, 2010, the Company plans to expand its customer base and the real estate valuation management services that it currently provides to customers. See Note 16 to the

condensed consolidated financial statements for the quarterly period ended September 30, 2010 for additional details. If and when opportunities arise, we intend to use available cash resources to invest in or start businesses that can generate income and cash. Additionally, management will attempt to renegotiate and/or restructure the components of our equity in order to realign the capital structure with our current business model.

 

The key performance measures for executive management are:

 

 

The following key performance metrics are derived from our condensed consolidated financial statements for the periods presented and should be read in conjunction with the more detailed information therein and with the disclosure included in this report under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Table 1 — Summary of Financial Highlights and Key Performance Metrics
(dollars in thousands; except per share amounts)

 

 

 

 

Liquidity as of September 30, 2010 — During the first nine months of 2010 we continued to develop StreetLinks and significantly increased its appraisal volume. For the nine months ended September 30, 2010, StreetLinks had revenues of $50.2 million, as compared to $22.0 million for the same period in 2009. For the year ended December 31, 2009, StreetLinks had revenues of $31.1 million, as compared to $2.5 million in 2008. StreetLinks incurred significant start-up expenses to develop its infrastructure in 2009, which have not been incurred during 2010. As a result, StreetLinks has produced net positive cash flow and earnings in 2010 and is expected to continue producing net positive cash flow and earnings for the foreseeable future. During the nine months ended September 30, 2010, we received $7.7 million in cash on our securities portfolio, compared to $16.4 million for the same period in 2009. During 2009, we received $18.5 million in cash on our securities portfolio.

 

During the first three quarters, we used cash to pay for corporate and administrative costs and invest in Advent. We intend to continue to invest in Advent during the fourth quarter of 2010. However, we will limit the negative impact on liquidity and do not believe that Advent will be a significant use or source of cash for the remainder of 2010.

 

As of September 30, 2010, we have $16.8 million in unrestricted cash and cash equivalents. On November 4, 2010, StreetLinks completed the acquisition of 51% of Corvisa for $1.5 million of cash plus contingent consideration related to an earn-out opportunity based on future net income. The amount of the future payments that the Company could be required to make under the earn-out opportunity is $0.6 million, see Note 16 to the condensed consolidated financial statements for the quarterly period ended September 30, 2010 for additional details.

StreetLinks and our mortgage securities are our primary source of cash flows. The cash flows from our mortgage securities will continue to decrease as the underlying mortgage loans are repaid and could be significantly less than the current projections if interest rate increases exceed the current assumptions. Our liquidity consists solely of cash and cash equivalents and future cash flows generated through our operating businesses. Our condensed consolidated financial statements have been prepared on a going concern basis of accounting which contemplates continuity of operations, realization of assets, liabilities and commitments in the normal course of business. The Company has experienced significant losses over the past several years and has a significant deficit in shareholders’ equity. Notwithstanding these negative factors, management believes that its current operations and its cash availability is sufficient for the Company to discharge its liabilities and meet its commitments in the normal course of business. See “Liquidity and Capital Resources” for further discussion of our liquidity position and steps we have taken to preserve liquidity levels.

 

As of September 30, 2010, we had a working capital deficiency of $29.3 million. This was mainly attributable to dividends payable of $46.6 million being classified as a current liability, although the Company does not expect to pay the dividends due to management’s effort to conserve cash.

 

Impact on Our Financial Statements of Derecognition of Securitized Mortgage Assets

 

During the first quarter of 2010, certain events occurred that required us to reconsider the accounting for three consolidated loan trusts — NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1. As all requirements for derecognition have been met under applicable accounting guidelines, we derecognized the assets and liabilities of the NHEL 2006-1, NHEL 2006-MTA1 and NHEL 2007-1 trusts during the nine months ending September 30, 2010. The securitized loans in these trusts have suffered substantial losses and through the date of the derecognition we recorded significant allowances for these losses. These losses have created large accumulated deficits for the trust balance sheets. Upon derecognition, all assets, liabilities and accumulated deficits were removed from our condensed consolidated financial statements. The Company also recognized certain securities with no value that were retained and were previously eliminated. A gain of $993.1 million was recognized upon derecognition, representing the net accumulated deficits in these trusts.

 

The following is summary balance sheet information for each of the three derecognized loan trusts at the time of the reconsideration event and the resulting gain recognized upon derecognition:

 

Table 2 — Assets and Liabilities of Loan Trusts and Gain Recognized upon Derecognition
(dollars in thousands)

 

 

 

Impact of Recently Issued Accounting Pronouncements

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 166, Accounting for the Transfers of Financial Assets, an Amendment of FASB Statement No. 140; this statement was codified in December 2009 as Accounting Standards Codification (“ASC”) 860. This guidance is effective for financial asset transfers beginning on January 1, 2010 and will be used to determine whether the transfer is accounted for as a sale under GAAP or as a secured borrowing. In addition, also in June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R); this statement was also codified in December 2009 as ASC 810 and governs the consolidation of variable interest entities. The consolidation guidance became effective for all VIEs the Company held as of January 1, 2010. As part of the Company’s adoption of the amended consolidation guidance, it was required to reconsider the Company’s previous consolidation conclusions pertaining to the Company’s variable interests in VIEs, including: (i) whether an entity is a VIE; and (ii) whether the Company is the primary beneficiary. Based on the Company’s assessment of its involvement in VIEs at January 1, 2010, in accordance with the amended consolidation guidance, the Company determined that it is not the primary beneficiary of any mortgage loan securitization entities in which it held a variable interest, as the Company does not have the power to direct the activities that most significantly impact the economic performance of these entities. The adoption of the amended consolidation guidance did not result in the Company consolidating or deconsolidating any VIEs for which it has involvement. It should be noted, however, that the new guidance also required the Company to reassess these conclusions, based upon changes in the facts and circumstances pertaining to the Company’s VIEs, on an ongoing basis; thus, the Company’s assessments may therefore change and could result in a material impact to the Company’s financial statements during subsequent reporting periods. The Company re-evaluated the NHEL 2006-1, NHEL 2006-MTA1, and NHEL 2007-1 securitization transactions and determined that based on the occurrence of certain events during January 2010, the application of the amended Transfers and Servicing guidance resulted in the Company reflecting as sales of financial assets and extinguishment of liabilities the assets and liabilities of the securitization trusts during the nine month period ended September 30, 2010. As a result, the Company derecognized the assets and liabilities of the NHEL 2006-1, NHEL 2006-MTA1, and NHEL 2007-1 securitization trusts and recorded a gain during the nine months ended September 30, 2010. See Note 3 to the condensed consolidated financial statements for the quarterly period ended September 30, 2010 for further details.

 

In March 2010, the FASB issued new guidance clarifying the scope exemption for embedded credit-derivative features. Embedded credit-derivative features related only to the transfer of credit risk in the form of subordination of one financial instrument to another are not subject to potential bifurcation and separate accounting. However, other embedded credit-derivative features are required to be analyzed to determine whether they must be accounted for separately. Additional guidance on whether embedded credit-derivative features in financial instruments issued by structures such as collateralized debt obligations (“CDOs”) and synthetic CDOs are subject to bifurcation and separate accounting. To simplify compliance with this new guidance, an entity may make a one-time election to apply the fair value option to any investment in a beneficial interest in securitized financial assets, regardless of whether such investments contain embedded derivative features. This new guidance is effective as of July 1, 2010, with early adoption being permitted at April 1, 2010. The adoption of this guidance did have a significant impact on our results of operations or financial position.

 

In July 2010, the FASB issued Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The guidance will significantly expand the disclosures that companies must make about the credit quality of financing receivables and the allowance for credit losses. The disclosures as of the end of the reporting period are effective for the Company’s interim and annual periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for the Company’s interim and annual periods beginning on or after December 15, 2010. The objectives of the

enhanced disclosures are to provide financial statement users with additional information about the nature of credit risks inherent in the Company’s financing receivables, how credit risk is analyzed and assessed when determining the allowance for credit losses, and the reasons for the change in the allowance for credit losses. The adoption of this guidance requires enhanced disclosures and is not expected to have a significant effect on the Company’s financial statements.

 

Inflation

 

Virtually all of our assets and liabilities are financial in nature. As a result, interest rates and other factors drive our performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP. As a result, financial activities and the Consolidated Balance Sheets are measured with reference to historical cost or fair market value without considering inflation.

 

Financial Condition as of September 30, 2010 as Compared to December 31, 2009

 

The following provides explanations for material changes in the components of our balance sheet when comparing amounts from September 30, 2010 and December 31, 2009.

 

As discussed previously in this report under the heading “Impact on Our Financial Statements of Derecognition of Securitized Mortgage Assets” significant events occurred related to three securitized loan trusts during the first quarter of 2010 that caused us to derecognize the assets and liabilities of these trusts. Upon derecognition during the first quarter of 2010, all assets and liabilities of the trusts were removed from our consolidated financial statements and, therefore, their balances are zero as of September 30, 2010. These balances are not discussed further in the following comparative analysis:

 

 

Cash and Cash Equivalents — See “Liquidity and Capital Resources” for discussion of our cash and cash equivalents.

 

Mortgage Securities — Substantially all of the mortgage securities we own and classify as trading are non-investment grade (BBB- or lower) and are owned by our CDO, which we consolidate. We organized the securitization prior to 2009 and we retained a residual interest in the CDO. However, due to poor performance of the securities within the CDO, our residual interest is not providing any cash flow to us and has no value. The value of these securities fluctuates as market conditions change, including short-term interest rates, and based on the performance of the underlying mortgage loans. The liabilities of the securitization trust are included in Other Current Liabilities in our Condensed Consolidated Balance Sheet.

 

The mortgage securities classified as available for sale include primarily the value of four residual interests we own and were issued by loan securitized trusts we organized prior to 2009. The value of our mortgage securities is dependent on the interest rate environment, specifically the interest margin between the underlying coupon on the mortgage loans and the asset-backed bonds issued by the securitization trust to finance the loans. While interest rates remain low, the net margin has continued to be strong on these securities and therefore the securities provide cash flow to us. As a result, the value of these securities has not changed substantially during the nine months ended September 30, 2010. Following is a summary of our mortgage securities that are classified as available-for-sale.

Table 3 — Values of Individual Mortgage Securities — Available-for-Sale
(dollars in thousands)

 

 

 

 

Notes Receivable — To maximize the use of our excess cash flow, we have made loans to independent entities. The borrowing entity used the proceeds to finance on-going and current operations. The decrease in the balance primarily results from payments received in excess of new borrowings.

 

Other Current Assets — Other current assets include restricted cash expected to be released from restriction within one year from the reporting date, short-term investments, prepaid expenses and other miscellaneous receivables. Restrictions were lifted on approximately $1.8 million of cash that was restricted as of December 31, 2009, resulting in the substantial change in this category.

 

Goodwill — Pursuant to the terms of our purchase agreement for StreetLinks, we are obligated to make “earn out” payments to StreetLinks minority owners upon StreetLinks achieving certain earnings targets. The targets were achieved during the nine months ended September 30, 2010. These amounts have been recorded as Goodwill.

 

Accounts Payable — Accounts payable includes amounts due to vendors in the normal course of business. The increase in accounts payable results from the increased StreetLinks volume of business, which leads to higher payments due to independent appraisers at the end of the quarter.

 

Accrued Expenses — Accrued expenses include estimated unpaid obligations to employees, service providers, vendors and other business partners. The amount of accrued expenses varies based on timing of incurred but unpaid services.

 

Dividends Payable — Dividends on Series C Preferred Stock and Series D Preferred Stock we issued prior to 2009 have not been paid since 2007. These dividends are cumulative and therefore we continue to accrue these dividends.

 

Total Shareholders’ Deficit — As of September 30, 2010, our total liabilities exceeded our total assets by $102.6 million as compared to $1.1 billion as of December 31, 2009. The significant decrease in our shareholders’ deficit during the nine and three months ended September 30, 2010 results from our large net income, driven primarily by the gain recognized upon the derecognition of the assets and liabilities of three loan securitization trusts as discussed previously under the heading “Impact on Our Financial Statements of Derecognition of Securitized Mortgage Assets.”

 

Financial Condition as of December 31, 2009 as Compared to December 31, 2008

 

Cash and Cash Equivalents.  See “Liquidity and Capital Resources” for discussion of our cash and cash equivalents.

 

Mortgage Securities.  The securities we own are generally securities we retained after the securitization of mortgage loans we originated prior to 2008. For all loan securitizations, we retained the residual interest bond, which means we receive the net of the principal and interest received on the underlying loans within the

securitized trust less the principal and interest paid on the bonds issued by the trust, mortgage insurance premiums, servicing fees and other miscellaneous fees. For any loans that incur prepayment penalty fees, we receive those fees through the residual interest. In some securitization transactions, we also retained regular principal and interest bonds. Generally, these bonds were the lowest rated bonds issued by the trust or these bonds were not rated. Additionally, we have purchased some mortgage securities in the open market from unrelated entities. Upon acquisition of the bonds, we classified the securities as either trading or available-for-sale. No changes have been made to the classifications.

 

Significant deterioration in the quality of the mortgage loans serving as collateral for our mortgage securities has caused a devaluation of the securities. In general, the default rate on the underlying loans has continued to increase over the past two years. Defaults are the result of national economic conditions that have led to job losses, severe declines in housing prices and the inability for credit-challenged individuals to refinance mortgage loans. In many cases, the securities we own have ceased to generate cash flow and we expect cash flow to continue to decline during the coming year.

 

We have classified our mortgage securities either as available for sale or trading, as follows:

 

Table 4 — Estimated Fair Value of Mortgage Securities
(dollars in thousands)

 

 

The following tables provide additional details of our mortgage securities.

 

Table 5 — Values of Individual Mortgage Securities — Available-for-Sale
(dollars in thousands)