NovaStar Financial, Inc. (NYSE:NFI), one the nation's largest subprime lending and servicing operations, said late yesterday that REIT lost $14.4 million during the fourth quarter of 2006, compared to a $26.4 million profit during the fourth quarter 2005. Annual net income for 2006 dropped nearly 50 percent, falling to $66.3 million from $132.5 million one year ago. As with other large subprime lenders, repurchase claims associated with early payment defaults were cited as a large factor behind the company's poor performance in the fourth quarter. â€œThe credit performance of our portfolio, and specifically our 2006 originations, deteriorated during the fourth quarter, resulting in impairments on mortgage securities and additional loss provisions for loans held-in-portfolio in the REIT," said CEO Scott Hartman. "Also, our gains upon securitization were reduced during the quarter because of lower whole loan prices. Furthermore, during the fourth quarter, we experienced a greater level of loan repurchase requests due to early payment defaults than we have historically." The company said that impairment reserves and repurchase provisions during the fourth quarter totaled more than $44 million, $23.5 million of which was due to expected repurchase claims. Hartman stressed in an earnings conference call that the company believes its current reserves are adequate to cover the repurchase risk for all loans sold to date. He did not comment, however, if the company's reserves were sufficient to cover both repurchases risk and potential loan losses on impaired loans in the company's subprime portfolio. REIT status in doubt The company said it does not expect to report a taxable profit for 2007 through 2011, although it does expect to be profitable under GAAP measures -- and as a result, CFO Greg Metz said NovaStar is "evaluating" whether to retain its current REIT status. (ed note: The company was forced to clarify earlier remarks regarding its profitability after suggesting in its earning release that it would not be profitable for the duration of the next five years; HW, along with other media outlets, originally reported that the company would not be profitable under GAAP.) Loans under management were $16.3 billion at the end of the year, NovaStar reported, up 17 percent from a year earlier but down from the third quarter, due in part to fourth-quarter whole loan sales. NovaStar securitized $1.8 billion in nonconforming loans in the fourth quarter ($8.6 billion for the year). CDO securitization pointed to for future activity The company cited its recent $375 million CDO securitization, which included lower-tranche bonds from the company's recent securitization activity, as an example of its future strategy for mitigating future risk exposure. "We believe that investing in higher rated mortgage securities will continue to provide good, risk-adjusted returns for the portfolio," said Mike Bamburg, senior vice president and chief investment officer. "During 2007, we may commit additional equity to purchase or retain mortgage securities. These securities are rated higher in the capital structure than our traditional residual investments and we intend to finance these securities with CDO debt." The company did not comment on recent reports in the past few weeks that suggest CDO managers may be allocating future capital away from subprime RMBS, especially higher-yielding but risky residual tranches. â€œNovaStar originated 21 percent more loans in 2006 and made progress on reducing costs. The nonprime market remains very competitive, but we see potential for a more rational business environment as several competitors have withdrawn or put themselves up for sale,â€? said Lance Anderson, president and COO. For more information, http://www.novastar.com.