1025953--4/1/2008--NOVASTAR_FINANCIAL

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Risks Related to Recent Changes in Our Business The subprime loan market has largely ceased to operate, which has adversely affected our business and may adversely affect our ability to continue as a going concern. Payments on our mortgage securities are currently our only source of cash flows and will decrease in the next several months. Absent the reestablishment of profitable operations and reduction of our expenses from discontinued operations and other obligations, our cash flows will not be sufficient for us to continue as a going concern. To the extent that the mortgage loans underlying our residual and subordinated securities continue to experience significant credit losses, our liquidity and ability to continue as a going concern will be adversely affected. There can be no assurance that we will have access to financing necessary to support our business and assets. Further, if we are unable to remain in compliance with agreements governing our indebtedness or to obtain waivers of any noncompliance, we will not be able to continue as a going concern. Various legal proceedings could adversely affect our financial condition, our results of operations, liquidity and our ability to continue as a going concern. There can be no assurance that our common stock or Series C Preferred Stock will continue to be traded in an active market. We are not likely to pay dividends to our common or preferred stockholders in the near future. Risks Related to Mortgage Asset Financing, Sale, and Investment Activities 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 and ability to continue as a going concern. 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. Risks Related to Interest Rates and Our Hedging Strategies Changes in interest rates may harm our results of operations and equity value. Risks Related to Credit Losses Further delinquencies and losses with respect to residential mortgage loans, particularly in the sub-prime sector, may cause us to recognize additional losses, which would further adversely affect our operating results, liquidity, financial condition, business prospects and ability to continue as a going concern. Loans made to nonconforming mortgage borrowers entail relatively higher delinquency and default rates which will result in higher loan losses. We face loss exposure due to fraudulent and negligent acts on the part of loan applicants, employees, mortgage brokers and other third parties. The value of, and cash flows from, our mortgage securities may further decline due to factors beyond our control. Mortgage insurers may not pay claims resulting in increased credit losses. A prolonged economic slowdown or a decline in the real estate market could further harm our results of operations. Geographic concentration of mortgage loans increases our exposure to risks in those areas. To the extent that we have a large number of loans in an area hit by a natural disaster, we may suffer losses. As a result of our sale of our mortgage servicing rights, we no longer possess the ability to identify and address potential or actual delinquencies and defaults on the mortgage loans underlying our residual and subordinated securities. Risks Related to the Legal and Regulatory Environment in Which We Operate We are subject to the risk that provisions of our loan agreements may be unenforceable. Failure to qualify for an exemption from regulation as an investment company could harm our business. Failure to comply with federal, state or local regulation of, or licensing requirements with respect to, our business could harm our financial condition and ability to recommence mortgage banking operations. Risks Related to Our Capital Stock The market price and trading volume of our common and preferred stock may be volatile, which could result in substantial losses for our shareholders. We may issue additional shares that may cause dilution and may depress the price of our common stock. Other Risks Related to our Business You should exercise caution in reviewing our consolidated financial statements. Our ability to use our net operating loss carryforwards and net unrealized built-in losses could be severely limited if transfer restrictions are not adopted or are not effective in preventing an ownership change from occurring. Our business could be adversely affected if we experienced an interruption in or breach of our communication or information systems or if we were unable to safeguard the security and privacy of the personal financial information we receive. 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.

Full 10-K form ▸

1025953--4/1/2008--NOVASTAR_FINANCIAL_INC