As Filed with the Securities and Exchange Commission on April 21, 2011

Registration No. 333-171115

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Amendment No. 5

to

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 APRIL 21, 2011

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, EASTERN 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 (the “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”). The Cash and Stock Option and the Stock-Only Option are the “Consideration Options.”

 

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 per share (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 April 15, 2011, the Series C Preferred Stock had an aggregate liquidation preference of $74.8 million and accrued and unpaid dividends of $23.6 million. As of April 15, 2011, the Series D Preferred Stock had an aggregate liquidating preference of $52.5 million and accrued and unpaid dividends of $32.3 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 11 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 timely 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 [ • ], 2011.

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., Eastern Time, ([ • ] 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 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, the amendment and restatement of the charter, 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 matter 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 Preferred Stock have agreed to exchange their shares subject to certain closing 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 April 7, 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

April [ • ], 2011

 

 

 

 

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.

 

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 auxiliary 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 April [ • ], 2011. 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, D.C. 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 about the Company 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 Address and Phone Number of the Company’s Principal Executive Offices		2114 Central Street Suite 600 Kansas City, Missouri 64108 (816) 237-7000

The Company’s Business		The Company operates two majority-owned subsidiaries: StreetLinks LLC (formerly StreetLinks National Appraisal Services LLC), a national residential appraisal and real estate valuation management services company, and Advent Financial Services LLC. Advent provides financial settlement services, along with its distribution partners, mainly through income tax preparation businesses and also 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 Series C Preferred Stock 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”). Series C Holders who otherwise properly submit a Letter of Transmittal but do not elect either the “‘Cash-and-Stock Option” or the “Stock-Only Option” will be deemed to have elected to receive the Cash-and-Stock Option. 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 [ • ], 2011, the Company had 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 37,161,600 shares of Common Stock would be issued in the Series D Exchange. Therefore, 90,353,253 shares of our Common Stock would be outstanding after completion of the Series C Offer and 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. Consent must be received from holders of at least two-thirds of the outstanding Series C Preferred Stock to effect the Series C Offer and the Series D Exchange. Series C Holders are required to deliver consents to participate in the Series C Offer.

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 financial 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 stockholders 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 (other than any cash necessary to cash out fractional shares).
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 [ • ], 2011, was $[ • ]. The last reported sale price of shares of Series C Preferred Stock as quoted by Pink OTC Markets’ inter-dealer quotation service on [ • ], 2011, 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 (defined below), 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, Eastern Time, on [ • ], 2011, unless we extend the period of time for which the Series C 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. 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 at closing of the Series C Offer. We expect the closing 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, and certificates for tendered shares of Series C Preferred Stock must be received by the Exchange Agent at the address issued herein prior to the Expiration Date; and
		• a properly completed and duly executed proxy card indicating “Consent” should be returned in the accompanying return envelope.

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 Common Stock’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 Date, and after [ • ], 2011 for any tendered shares of Series C Preferred Stock not yet accepted for payments by that 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. 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;

		• consent to the Series C Offer and the Series D Exchange by the holders of at least two-thirds of the outstanding Series C Preferred Stock;

		• approval of the Amendments to our charter;

		• participation by the holders of at least two-thirds of the outstanding Series C Preferred Stock; 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 converted into 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 “Remainder Consideration”). The Remainder Consideration will be distributed to the non-tendering former Series C Holders as soon as reasonably practical after, but no sooner than 11 business days after and no later than 180 calender days after, the closing of the Series C Offer. 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. The Series C Offer will not be consummated unless at least two-thirds of the Series C Holders participate in the Series C Offer.

		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.

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 of directors of the Company (the “Board of Directors”) 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 46,400 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 (defined below) of the Board of Directors 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 stockholders at the following annual stockholders’ meeting.

		In accordance with a Voting Agreement with the Company, Messrs. Amster and Igdaloff have agreed to vote “for” all the Proposals, and will consent to the Series C Offer and Series D Exchange. Further, Messrs. Amster and Igdaloff have both indicated that they will tender all of their Series C Preferred Stock and will elect the Stock-Only Option in exchange for their shares. The reason for the aforementioned actions is that Messrs. Amster and Igdaloff believe that the Series C Offer is in the best interest of the Company because, if it closes, it will improve the Company’s capital structure and eliminate the accrued and unpaid dividends on the Series C Preferred Stock, as described in greater detail in “Special Factors — Background of the Series C Offer and Consent Solicitation.” Further, Messrs. Amster and Igdaloff believe that their participation in the Series C Offer is in the best interest of each director because they have the opportunity to select their Consideration Option and each such director wants to receive as much of the Company’s Common Stock in exchange for their Series C Preferred Stock as they are eligible to receive.

		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 of Directors beyond the 2011 Annual Stockholder Meeting. For more information regarding the service on the Board of Directors 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, as amended (the “Exchange Act”).

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/13E-3 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		Neither the Series C Holders nor the Series D Holders will have appraisal rights, or any contract right to petition for fair value, with respect to any matter to be acted upon at the special meeting. The Company will not independently provide such a right. Under Section 3-202(a)(4) of the Maryland General Corporation Law (“MGCL”), stockholders generally have the right to petition for fair value when the charter is amended in a way that substantially affects the stockholders’ rights and alters the contract rights as expressly set forth in the charter. However, Section 3-202(a)(4) of the MGCL provides an exception from this general rule for when the charter reserves the power to amend the charter to alter contract rights. Article XV of the Company’s current charter expressly reserves the power to amend the charter to alter the contract rights of existing stockholders.
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 Series C Preferred Stock;

	•	an amendment to the charter of the Company to eliminate the Series D Preferred Stock; and

	•	an amendment to charter of the Company to increase the number of 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,
		2010				2009				2008				2007				2006
Summary Historical Financial Information:
Weighted average common shares outstanding-basic			9,337,207				9,368,053				9,338,131				9,332,405				8,552,911
Weighted average common shares outstanding-dilutive			9,337,207				9,368,053				9,338,131				9,332,405				8,617,904
Book value per common share-basic		$	(25.01	)		$	(128.47	)		$	(107.52	)		$	(36.30	)		$	51.42
Book value per common share-dilutive			(25.01	)			(128.47	)			(107.52	)			(36.30	)			51.04
Dividends declared per common share			—				—				—				—				22.40
Income (loss) from continuing operations available to common stockholders per share-basic			86.53				(20.97	)			(74.81	)			(51.04	)			5.70
Income (loss) from continuing operations available to common stockholders per share-dilutive			86.53				(20.97	)			(74.81	)			(51.04	)			5.66
Summary Unaudited Pro Forma Historical Financial Information:
Weighted average common shares outstanding-basic			90,322,407				90,353,253				90,323,331				70,188,405				52,376,511
Weighted average common shares outstanding-dilutive			90,322,407				90,353,253				90,323,331				70,188,405				52,441,504
Book value per common share-basic		$	(1.78	)		$	(12.70	)		$	(10.67	)		$	(4.46	)		$	8.74
Book value per common share-dilutive			(1.78	)			(12.70	)			(10.67	)			(4.46	)			8.73
Dividends declared per common share			—				—				—				—				3.78
Income (loss) from continuing operations per share-basic			10.92				(2.00	)			(7.57	)			(6.66	)			1.06
Income (loss) from continuing operations per share-dilutive			10.92				(2.00	)			(7.57	)			(6.66	)			1.06

		For the Years Ended December 31,
		2010				2009				2008				2007				2006
Historical Ratio of Earnings to fixed charges			46.7				(A	)			(A	)			(A	)			1.4
Pro Forma Ratio of Earnings to fixed charges			210.4				(B	)			(B	)			(B	)			(B	)

(A)		Due to losses in the years ended December 31, 2009, 2008 and 2007, the ratio coverage was less than 1:1 for those periods. We would have needed to generate additional earnings of $196.4 million, $699.0 million and $476.3 million, respectively, in order to cover the fixed charges in those periods.

(B)		Item 503(d)(2)(B) of Regulation S-K only allows the pro forma ratio to be shown for the most recent fiscal year and, if applicable, the latest interim period.

 

On March 22, 2011, the Company, NovaStar Capital Trust I/B (“Trust I/B”), NovaStar Capital Trust II/B (“Trust II/B”), Kodiak CDO I, Ltd. (“Kodiak”) and Taberna Preferred Funding I, Ltd. (“RAIT”), entered into an Exchange Agreement (the “TruPS Exchange Agreement”). NovaStar Mortgage, Inc. (“NMI”), which is a wholly-owned subsidiary of the Company, owned all the outstanding common securities of Trust I/B and Trust II/B.

 

Pursuant to the terms of the TruPS Exchange Agreement, the Company purchased from Kodiak all the trust preferred securities issued by Trust II/B having a total liquidation preference of $28,125,000 (the “Kodiak Securities”) and in consideration issued $30,937,500 worth of unsecured series 3 senior notes of the Company to Kodiak (the “Series 3 Notes”) pursuant to the Series 3 Senior Notes Indenture (the “Series 3 Indenture”) between the Company and The Bank of New York Mellon Trust Company, National Association (“BNY”). The Company exchanged the Kodiak Securities with Trust II/B for a like amount of unsecured junior subordinated notes issued by NMI (the “Kodiak Junior Subordinated Notes”). Following this exchange, the indenture governing the Kodiak Junior Subordinated Notes was terminated, the parent guarantee by the Company over the Kodiak Junior Subordinated Notes was terminated, the existing Kodiak Junior Subordinated Notes were cancelled by the Company and Trust II/B was dissolved.

 

Also pursuant to the terms of the TruPS Exchange Agreement, the Company purchased from RAIT one-half of the trust preferred securities issued by Trust I/B having a total liquidation preference of $25,000,000 (the “RAIT Securities”) and in consideration issued $27,500,000 worth of unsecured series 1 senior notes of the Company to RAIT (the “Series 1 Notes”) pursuant to the Series 1 Senior Notes Indenture (the “Series 1 Indenture”). The Company exchanged the RAIT Securities with Trust I/B for a like amount of unsecured junior subordinated notes issued by NMI (the “RAIT Junior Subordinated Notes”). Following this exchange, the existing RAIT Junior Subordinated Notes were cancelled by the Company.

 

On March 22, 2011, the Company, BNY, BNY Mellon Trust of Delaware, the administrative trustees of Trust I/B and Taberna Preferred Funding II, Ltd. (“Fortress”) entered into the First Amendment to The Second Amended and Restated Trust Agreement (the “Amendment Agreement”). Pursuant to the terms of the Amendment Agreement, the trust agreement governing Trust I/B was amended to cause the trustee to receive $27,500,000 worth of unsecured series 2 senior notes of the Company (the “Series 2 Notes”) pursuant to the Series 2 Senior Notes Indenture (the “Series 2 Indenture”) in exchange for the remaining unsecured junior subordinated notes issued by NMI and held by Trust I/B (the “Fortress Junior Subordinated Notes” and, together with the RAIT Junior Subordinated Notes, the “I/B Junior Subordinated Notes”). In exchange for the Series 2 Notes, the trustee simultaneously redeemed all trust preferred securities issued by Trust I/B that remained outstanding, which were held by Fortress and had a total liquidation preference of $25,000,000 (the “Fortress Securities”). Following the exchange and redemption, the indenture that governed the I/B Junior Subordinated Notes was terminated, the parent guarantee by the Company over the I/B Junior Subordinated Notes was terminated, the existing I/B Junior Subordinated Notes were cancelled by the Company and Trust I/B was dissolved.

 

As a result of the above transactions, all trust preferred securities issued by Trust I/B and Trust II/B, which had a total liquidation preference of $78,125,000, were cancelled and Kodiak, RAIT and Fortress now hold, in aggregate, $85,937,500 of unsecured senior notes issued by the Company, which represent a 10% increase in principal over the prior trust preferred securities.

 

This transaction provides the Company with an annual 1% rate of interest on its debt obligations for the next five years, which limits its exposure to an increase in interest rates over that time period. Under the Junior Notes, the rate of interest on the debt had the potential to significantly increase this year.

 

The Series 1 Notes, the Series 2 Notes and the Series 3 Notes (collectively, the “Senior Notes”) were issued pursuant to the Series 1 Indenture, the Series 2 Indenture and the Series 3 Indenture (each an “Indenture” and collectively, the “Indentures”). The Senior Notes and the Indentures are dated March 22, 2011. The terms of each Indenture are substantially identical. Pursuant to the Indentures, the Senior Notes will accrue interest at an annual rate of 1% until the earlier to occur of (a) an Additional Equity Event (as defined

below) or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of LIBOR plus 3.5% (the “Full Rate”). The interest is payable quarterly commencing on March 30, 2011 through March 30, 2033. An “Additional Equity Event” occurs when the Company and/or its subsidiaries consummate one or more equity offerings on or before January 1, 2016 with net aggregate proceeds of $40 million or more.

 

In addition to the negative covenants in the Junior Subordinated Notes, the Indentures contain certain restrictive covenants (the “Negative Covenants”) (subject to certain exceptions in the Indentures) that prohibit the Company, from among other things, incurring debt, permitting any lien upon any of its property or assets, making any cash dividend or distribution payment, acquiring shares of the Company or its subsidiaries, making payment on debt securities of the Company that rank pari passu or junior to the Senior Notes, or disposing of any equity interest in its subsidiaries or all or substantially all of the assets of its subsidiaries.

 

At any time that the Senior Notes accrue interest at the Full Rate, and the Company has satisfied certain financial covenants (the “Financial Covenants”), the Negative Covenants will not apply. Satisfaction of the Financial Covenants requires the Company to demonstrate on a consolidated basis that (1) its Tangible Net Worth is equal to or greater than $40 million, and (2) either (a) the Interest Coverage Ratio is equal to or greater than 1.35x, or (b) the Leverage Ratio is not greater than 95%. “Tangible Net Worth,” “Interest Coverage Ratio” and “Leverage Ratio” have the meanings set forth in the Indentures.

 

The Company does not believe that the above-described transactions have a material effect on the Series C Offer or the Series D Exchange, or the financial information contained herein, except to the extent that the transaction makes it less likely that the Company will be able to pay dividends on the Series C Preferred Stock or Series D Preferred Stock or that the Series C Holders or Series D Holders would receive any distribution on liquidation of the Company. While the transaction seeks to improve the Company’s liquidity position by fixing a low, 1% interest rate on the Senior Notes, it also increases the amount of principal on such notes and obligates the Company to negative covenants restricting payment of dividends, including dividends on the Series C Preferred Stock and the Series D Preferred Stock, as described above.

 

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 December 31, 2010, there were 9,368,053 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. Prior performance of Common Stock may not be indicative of the performance of Common Stock after the Series C Offer and the Series D Exchange. 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 of 1986, as amended (the “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 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.

 

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 $55.9 million as of April 15, 2011, 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 of the Series C Offer or the Series D Exchange. 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.

 

Our available cash and access to additional capital may be limited, which could restrict our ability to grow our businesses.

 

Following the successful completion of the Series C Offer and the Series D Exchange, our available cash will be reduced by approximately $3 million. Moreover, our ability to issue significant amounts of additional equity securities will be limited without risking loss of some or all of our NOLs.

 

Our restricted ability to obtain additional capital could have important consequences, including:

 

 

The proposed acquisition restrictions, which are intended to help preserve our NOLs and other tax attributes, may not be effective or may have unintended negative effects.

 

We have recognized and may continue to recognize substantial net operating losses for U.S. federal income tax purposes, and under the Code, we may “carry forward” these NOLs, in certain circumstances to offset any current and future taxable income and thus reduce our federal income tax liability, subject to certain requirements and restrictions. To the extent that the NOLs do not otherwise become limited, we believe that it will be able to carry forward a substantial amount of NOLs and, therefore, these NOLs are a substantial asset to us. However, if we experience an “ownership change,” as defined in Section 382 of the Code and related Treasury regulations, their ability to use the NOLs could be substantially limited, and the timing of the usage of the NOLs could be substantially delayed, which consequently could significantly impair the value of that asset.

 

To reduce the likelihood of an ownership change, in light of the Series C Offer and the Series D Exchange, we are proposing acquisition restrictions in Article Ten of our proposed Articles of Amendment and Restatement, which are intended to restrict certain acquisitions of our stock to help preserve our ability to utilize our NOLs and other tax attributes by avoiding the limitations imposed by Section 382 of the Code and the related Treasury regulations. The acquisition restrictions are generally designed to restrict or deter direct and indirect acquisitions of our stock if such acquisition would result in a stockholder of the Company becoming a 5-percent stockholder or increase the percentage ownership of our stock that is treated as owned by an existing 5-percent stockholder.

 

Although the acquisition restrictions are intended to reduce the likelihood of an ownership change that could adversely affect the Company, we can give no assurance that such restrictions would prevent all transfers that could result in such an ownership change. There can be no assurance that the acquisition restrictions will be enforceable against all of our stockholders, and they may be subject to challenge on equitable grounds. In particular, it is possible that the acquisition restrictions may not be enforceable against our stockholders who vote against or abstain from voting on the acquisition restrictions or who do not have notice of the restrictions at the time when they subsequently acquire their shares.

 

The acquisition restrictions also will require any person attempting to become a holder of 5% or more (by value) of our stock, as determined under the Code, to seek the approval of the Board of Directors. This may have an unintended “anti-takeover” effect because the Board of Directors may be able to prevent any future takeover. Similarly, any limits on the amount of stock that a stockholder may own could have the effect of making it more difficult for stockholders to replace current management. Additionally, because the acquisition restrictions will have the effect of restricting a stockholder’s ability to dispose of or acquire common stock, the liquidity and market value of the common stock might suffer. The acquisition restrictions will remain in effect until the earliest of (a) the date that is 36 months and one day from the completion of the Series C offer, or (b) such other date as the Board of Directors in good faith determines that the acquisition restrictions are no longer in the best interests of Company and its stockholders. The acquisition restrictions may be waived by the board of directors. Stockholders are advised to monitor carefully their ownership of the Company’s stock and consult their own legal advisors and/or the Company to determine whether their ownership of the Company’s stock approaches the proscribed level.

 

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.

 

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 cash flows and will rely on distributions and other payments from our operating subsidiaries 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. Payment to the Company of dividends, distributions, loans or advances by our subsidiaries are subject to legal restrictions and may become restricted by future debt instruments of the Company or our subsidiaries.

 

Our subsidiaries are separate and distinct legal entities. Any right that we have to receive any assets of or distributions from any of our subsidiaries is limited by applicable law governing the bankruptcy, dissolution, liquidation or reorganization of any such subsidiary, and our ability to realize proceeds from the sale of their assets will be junior to the claims of that subsidiary’s creditors, including trade creditors and holders of debt issued by that subsidiary.

 

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 stockholders’ 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.

 

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.

 

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 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 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 to 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 and 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.

 

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.

 

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. We have issued approximately $85.9 million in Senior Notes, which upon certain events, will carry a coupon of variable 3-month LIBOR plus 3.5%. See the “Recent Developments” section. 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. If the Series C Offer is successfully consummated, the Series C Preferred Stock will no longer exist and there can be no assurance that an active trading market for our Common Stock 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 stockholder 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 D Preferred Stock. Dividends on our Series C Preferred Stock and Series D Preferred Stock continue to accrue and the dividend rate on our Series D 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 D 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. 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.

 

The market price and trading volume of Common Stock may be volatile following the Series C Offer and the Series D Exchange, which could result in substantial losses for our stockholders.

 

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 stockholders.

 

Our charter permits our Board of Directors, without stockholder 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 holders of Common Stock. 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 stockholders 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. 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). We believe the Series C Offer and Series D Exchange will not result in an ownership change, however, future stock issuances, redemptions or transactions by 5-percent stockholders or acquisitions could result in an “ownership change.”

 

We have proposed the adoption of the acquisition restrictions set forth in Article Ten of our proposed Articles of Amendment and Restatement, as described in “Proposal 4 — Charter Amendment To Preserve The Company’s Net Operating Loss Carryforwards — Description of the Acquisition Restrictions,” in order to

reduce the likelihood that we will experience an ownership change under Section 382 of the Code. There can be no assurance, however, that this will prevent the Company from experiencing an ownership change and the adverse consequences that may arise therefrom.

 

Covenant restrictions under our indebtedness may limit our ability to operate our business.

 

Our Senior Notes and the Indentures governing the Senior Notes contain, among other things, covenants that may restrict our and our subsidiaries ability to finance future operations, capital needs or to engage in other business activities. Without the prior consent of the holders of our Senior Notes, the terms of our Senior Notes and the Indentures restrict, among other things, our ability and the ability of our subsidiaries to:

 

• incur indebtedness;

 

• create certain liens;

 

• restrict payments by our subsidiaries to us;

 

• restrict payments by us to our stockholders;

 

• acquire our outstanding shares, or the shares of our subsidiaries;

 

• make payments on debt securities pari passu or junior to the Senior Notes;

 

• dispose of any equity interest in our subsidiaries; and

 

• merge, consolidate, transfer and/or sell assets.

 

There can be no assurance that we will be able to receive the consent of the persons holding the Senior Notes should we have a need to take one of the restricted actions, which such limitation may hinder our ability to operate or grow our business in the future.

 

Some provisions of our charter, bylaws and Maryland law may deter takeover attempts, which may limit the opportunity of our stockholders 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 stockholders. 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 of Directors 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.

 

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 “Dodd-Frank Act”) was signed into federal law. The Dodd-Frank 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 Dodd-Frank Act will be implemented by the various regulatory agencies, the full extent of the impact the Dodd-Frank Act will have on our operations is unclear. Nonetheless, while it is difficult to predict at this time what specific impact the Dodd-Frank 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.

 

Loss of key members of our management could disrupt our business.

 

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. We may not be able to retain our existing senior management, fill new positions or vacancies created by expansion or turnover or attract additional qualified senior management personnel.

 

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 by overnight mail 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 $23.6 million in accrued and unpaid dividends on the Series C Preferred Stock and $32.3 million of accrued and unpaid dividends on the Series D Preferred Stock (through April 15, 2011) 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 to Approve the Amendment and Restatement to the Charter 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 April 7, 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 Common Stock and holders of Series D Preferred Stock (the “Series D Holders”), in each case at the close of business on April 7, 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 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 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, a separate approval by the holders of 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 record holders of Series C Preferred Stock who wish to use the Internet or telephone voting procedures are set forth on the proxy card.

 

Shares of Series C Preferred 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.

 

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 of Series C Preferred Stock 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 the holders of at least two-thirds of all Series C Preferred Stock 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 the holders of at least two-thirds of all Series D Preferred Stock 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 the holders of at least two-thirds of all Series D Preferred Stock 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 the holders of at least two-thirds of all Series C Preferred Stock entitled to vote, and the affirmative vote of the holders of at least two-thirds of all Series D Preferred Stock 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 the holders of at least two-thirds of all Series C Preferred Stock entitled to vote, and the affirmative vote of the holders of at least two-thirds of all Series D Preferred Stock 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 former 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

 

Neither the Series C Holders nor the Series D Holders will have appraisal rights, or any contract right to petition for fair value, with respect to any matter to be acted upon at the special meeting. The Company will not independently provide such a right. Under Section 3-202(a)(4) of the MGCL, stockholders generally have

the right to petition for fair value when the charter is amended in a way that substantially affects the stockholders’ rights and alters the contract rights as expressly set forth in the charter. However, Section 3-202(a)(4) of the MGCL provides an exception from this general rule when the charter reserves the power to amend the charter to alter contract rights. Article XV of the Company’s current charter expressly reserves the power to amend the charter to alter the contract rights of existing stockholders.

 

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 of Directors. Because dividends on the Series C Preferred Stock were in arrears for six or more quarters as of the 2009 Annual Stockholders’ Meeting, two directors, Howard Amster and Barry Igdaloff, were elected at that meeting to serve on the Board of Directors 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 46,400 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 have agreed to vote “for” all the Proposals, and will consent to the Series C Offer and Series D Exchange. Further, Messrs. Amster and Igdaloff have both indicated that they will tender all of their Series C Preferred Stock and will elect the Stock-Only Option in exchange for their shares. The reason for the aforementioned actions is that Messrs. Amster and Igdaloff believe that the Series C Offer is in the best interest of the Company because, if it closes, it will improve the Company’s capital structure and eliminate the accrued and unpaid dividends on the Series C Preferred Stock, as described in greater detail in “Special Factors — Background of the Series C Offer and Consent Solicitation.” Further, Messrs. Amster and Igdaloff believe that their participation in the Series C Offer is in the best interest of each director because they have the opportunity to select their Consideration Option and each such director wants to receive as much of the Company’s Common Stock in exchange for their Series C Preferred Stock as they are eligible to receive.

 

“Householding” of Proxy Materials

 

In December 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.

 

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. The Company will, upon request, reimburse those parties for their reasonable expenses in forwarding proxy materials to the beneficial owners. The Company has engaged Georgeson Inc. to solicit votes from all stockholders entitled to vote at the special meeting. The Company entered into an agreement with Georgeson Inc. for such services on December 10, 2010. Under this agreement, Georgeson Inc. will provide standard proxy solicitor and information agent duties, including, but not limited to, the solicitation of votes, communication with the Company as to vote updates and communication with the vote tabulator, for a fee payble to Georgeson Inc. of $15,000 and the reimbursement of any proxy solicitation-related expenses.

 

Proxy Solicitor

 

We have engaged 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, upon the effectiveness of the Articles of Amendment and Restatement, and without further action on the part of the Company or its stockholders, all shares of Series C Preferred Stock not tendered for exchange will be automatically converted into the right to receive 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 whose holders elect 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 whose holders elect 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 converted into the right to receive its pro rata share of the Remainder Consideration. Holders of these rights will be able to receive their applicable share of the Remainder Consideration as soon as reasonably practicable after, but no sooner than 11 business days after and no later than 180 calendar days after, the closing of the Series C Offer.

 

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, and the Company will not independently provide stockholders with such rights.

 

Vote Required

 

The affirmative vote of the holders 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 is required to approve the amendment to the charter to modify the terms of the Series C Preferred Stock.

 

Board of Directors Recommendation

 

After careful consideration, the 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 its stockholders vote in favor of the Articles amendment to the Company’s charter to eliminate the Series C Preferred Stock.

 

YOUR BOARD OF DIRECTORS 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 Exchange 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 by and among Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC, JCP Partners IV LLC, Massachusetts Mutual Life Insurance Company and NovaStar, dated December 10, 2010 (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 stockholders, 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, and the Company will not independently provide stockholders with such rights.

 

Vote Required

 

The affirmative vote of the holders 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 is required to approve the amendment to the charter to eliminate the terms of the Series D Preferred Stock.

 

Board of Directors Recommendation

 

As a Series C Holder, you will not be entitled to vote on Proposal 2. The Board of Directors 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 A. Your attention is directed to the Articles of Amendment and Restatement, generally, and Article V thereof, specifically.

 

The Series C Offer, the Series D Exchange 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 stock 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 the holders 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 is required to approve the amendment to the charter to increase the number of authorized shares of capital stock of the Company.

 

Board of Directors Recommendation

 

As a Series C Holder, you will not be entitled to vote on Proposal 3. The Board of Directors 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 stockholders, 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 stockholder of the Company, as determined under the Code and applicable regulations; this would include, among other things, an attempted acquisition of Company stock by an existing 5-percent stockholder. 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 Company stock to the extent, generally, that exercise of the option would result in a proscribed level of Company stock ownership. As previously stated, the Board of Directors may waive the acquisition restrictions, and acquisitions of Company 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 Company stock, or options with respect to Company 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 Board of Directors. In deciding whether to approve any proposed transfer, the 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 Board of Directors, unless and until such person owns less than 5% (by value) of Company stock, at which point such person may acquire Company stock only to the extent that, after such acquisition, such person owns less than 5% (by value) of Company 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 stockholders 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, Board of Directors does not intend to discourage offers to acquire substantial blocks of Company stock that would clearly improve stockholder value, taking into account, as appropriate, any loss of the NOLs and other tax attributes. In the case of any such proposed acquisition that Board of Directors determines to be in the best interest of NFI and its stockholders, in light of all factors deemed relevant, Board of Directors 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 Company stock purportedly transferred in contravention of the acquisition restrictions. As a result, requested transfers of Company 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 Company stock would not be entitled to any rights of stockholders 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 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 Company stock or adversely affect the value of Company stock.

Purpose and Effects of the Acquisition Restrictions

 

Without the acquisition restrictions, it is possible that certain transfers of Company 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 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 the Company’s stockholders who vote against or abstain from voting on this Proposal 4. However, the Company believes that the acquisition restrictions are in the best interests of the Company and the Company’s stockholders and are reasonable, and the Company will act vigorously to enforce them against all current and future holders of Company stock regardless of how they vote on this Proposal 4.

 

The Company believes that each of its stockholders who votes in favor of this Proposal 4 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 stockholder would be estopped from challenging the legality, validity or enforceability of the acquisition restrictions. Consequently, all Company stockholders should carefully consider this in determining whether to vote in favor of this Proposal 4.

 

Reasons for the Acquisition Restrictions

 

At December 31, 2010, the Company had associated NOLs of approximately $367.4 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 stockholders, each of whom owns 5% or more (by value) of a company’s stock, increases their aggregate percentage ownership by more than 50 percentage points over the lowest percentage of stock owned by such stockholders 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 stockholder, 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 stockholder. 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 Company 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 Special Committee and the Board of Directors recommend that the acquisition restrictions in Article Ten 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 Company stock and the ability of persons, entities or groups now owning 5% or more (by value) of the Company stock from acquiring additional Company 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 stockholders 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 stockholders.

 

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 stockholders 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 stockholders 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 stockholder 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 stockholders, in light of all factors deemed relevant, the Board of Directors would grant approval for such acquisition to proceed.

 

Vote Required

 

The affirmative vote of the holders 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, 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 of Directors Recommendation

 

The Special Committee, and the Board of Directors, upon the unanimous recommendation of the Special Committee, have approved the actions contemplated by Proposal 4 and have determined that the actions contemplated by Proposal 4 are advisable and favorable to and, therefore, fair to and in the best interests of the Company and the Company’s stockholders. The Special Committee and the Board of Directors recommend that Company’s stockholders vote “FOR” approval of the acquisition restrictions proposal.

 

YOUR BOARD OF DIRECTORS 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 hereto 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 at the special meeting.

 

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 5. 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 NOLs.

 

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 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 Eleven 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:

 

 

 

 

 

 

 

 

Proposal 5 also would approve the filing of the Articles of Amendment and Restatement on the terms as described in this Proposal 5 and as described in the other Proposals. The restatement of the charter is a separate legal act under Maryland law.

 

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, and the Company will not independently provide stockholders with such rights.

 

Vote Required

 

The affirmative vote of the holders 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 is required to approve certain technical 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.

 

Board of Directors Recommendation

 

After careful consideration, the 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, and the related Articles of Amendment and Restatement, 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 OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT YOU VOTE
“FOR”
CERTAIN TECHNICAL CHARTER AMENDMENTS IN CONNECTION WITH
THE OTHER PROPOSALS, TO APPROVE THE AMENDMENT AND RESTATEMENT OF THE CHARTER 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 2012 annual meeting of stockholders and included in the proxy statement and form proxy relating to such meeting, must have been received at the Company’s offices on or before January 6, 2012.

 

In addition, the Company’s bylaws provide that any stockholder wishing to bring any matter, including the nomination of a director, before an annual meeting must have delivered notice to the Corporate Secretary of the Company’s principal executive offices on or before February 7, 2012.

 

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 be named in the proxy statement as a nominee and to serve 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 at the Company’s principal executive offices regarding the requirements for making stockholder proposals and nominating director candidates in the future.

 

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 dividends 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 April 15, 2011, the Company had $55.9 million in accrued preferred dividends, $23.6 million of which related to the Series C Preferred Stock and $32.3 million of which related to the Series D Preferred Stock. As of April 15, 2011, 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 April 15, 2011 was $183.2 million.

 

The Company does not believe that it is likely to produce cash flow before preferred dividends that satisfies or exceeds the Company’s growing dividend requirement, nor does the Company believe it is likely to be able to satisfy payment of its accumulated and unpaid preferred dividends, which will continue to grow to approximately $68.7 million and $88.1 million in 2011 and 2012, respectively, unless and until the Company pays its preferred holders the full amount of accumulated and unpaid preferred dividends. Moreover, the Series D Preferred Stock mandatorily converts to Common Stock in 2016, at which point the liquidating preference of $52.5 million and accumulated and unpaid dividends, which are projected to be $61.7 million at the conversion date, become due. Based on the Company’s financial outlook, the Company does not believe it

will be able to satisfy its obligation to its Series D Holders at or before the conversion date, nor does it does believe it will have cash available to redeem its Series C Preferred Stock in the future, which is perpetual and does not have a maturity date, but which, if redeemed, would require payment of the liquidating preference of $74.8 million and accumulated and unpaid dividends related to the Series C Preferred Stock.

 

Management’s baseline financial projections call for net income after non-controlling interests and before preferred dividends for 2011 and 2012, respectively, of approximately $9.1 million and $14.5 million, while the Company’s preferred dividend requirement for those years will grow to approximately $17.8 million and $19.4 million if no preferred dividends are paid. This year-over-year growth in the Company’s preferred dividend requirement is due to the compounding nature of the Series D Preferred Stock. Even if the Company is able to meet its annual preferred dividend requirements, the Company must pay all accumulated and unpaid dividends on the Series C Preferred Stock and Series D Preferred Stock before making distributions to the holders of the Company’s Common Stock.

 

Below are the projected financial results that have been prepared to guide management, the Special Committee and the Board of Directors in making decisions regarding the recapitalization of the Company. Primarily, these projected financial results are intended for the purpose of evaluating the Company’s ability to meet its contractual obligations to the Series C Holders and Series D Holders. The projections are presented as of September 30, 2010 because these are the projections that were considered by the Special Committee and the Board of Directors before approving the Series C Offer and the Series D Exchange. Certain information regarding the projections, where specifically indicated, is also presented as of December 31, 2010. (Please see the Note at the end of this section regarding the projected financial results.) The Company’s operating subsidiaries have limited operating history. Given the uncertainty about how these subsidiaries will perform, management prepares forecasts using a variety of scenarios. Presented below are two scenarios — a “baseline” forecast and a “low” forecast. In order for the Company to achieve the baseline results shown below, the operating subsidiaries, particularly StreetLinks, would need to produce significant growth during the years presented. The “low” scenario provides a forecast if lower growth is achieved. These two sets of forecasts are intended to provide a reasonable range of expected financial results for the Company. All references throughout this section refer to the “baseline” forecast.

 

The most significant assumption used in developing the projected financial results presented below is the number of orders to be completed by StreetLinks. The assumptions for order volume are based on recent trends and management’s expectation for StreetLink’s share of the appraisal market, new product development and estimates of mortgage lending trends.

 

Other critical assumptions include:

 

 

Projected Operating Results — Baseline Scenario (in thousands):

 

Projected Operating Results — Low Scenario (in thousands):

 

 

The following provides the future dividends payable and accruing based on the contractual obligations of the Series C Preferred Stock and the Series D Preferred Stock and assuming no payments are made.

 

Dividend Requirements of Preferred Stock (in thousands):

 

 

The Company also considered the following factors with respect to its ability to meet its preferred dividend obligations:

 

market, new product development and estimates of mortgage industry trends, there is a high level of uncertainty in the operating results of both StreetLinks and Advent. Factors such as a larger than expected industry-wide downturn in mortgage refinancing activity, regulatory changes, loss of key customers, and inability to continue to build StreetLinks’ customer base, among other factors, may have a material adverse effect on management’s financial projections for StreetLinks.

 

 

 

 

The Company also believes that the value received from a liquidation of its assets today would not be sufficient to cover the liabilities related to the Senior Notes, and thus, the Series C Holders would receive no benefit from a liquidation. Management estimated that the liquidation value of its liabilities in excess of its assets as of September 30, 2010 was $63.6 million (and as of December 31, 2010 was $65.3 million), which included all the trust preferred securities issued by Trust I/B and Trust II/B, which securities had an aggregate principal amount of $78.1 million. As described in the “Recent Developments” section, the trust preferred securities were cancelled and the Company issued Senior Notes which have an aggregate principal amount of $85.9 million. The trust preferred securities ranked, and the Senior Notes now rank, senior to both classes of the Company’s preferred stock and the Company’s Common Stock in liquidation preference.

 

Accumulated and unpaid dividends on the Company’s Series C Preferred Stock totaled $20.0 million as of September 30, 2010 (and $21.6 as of December 31, 2010) and the liquidating preference of the Company’s Series C Preferred Stock is $74.8 million. The Series C Preferred Stock is pari passu in liquidating preference and order of payment to the Series D Preferred Stock, which had accumulated and unpaid dividends of $26.7 million as of September 30, 2010 (and $29.3 million as of December 31, 2010) and has a liquidating preference of $52.5 million. As of September 30, 2010, the aggregate liquidation value of the preferred equity interests is $174.0 million and therefore the negative value to the holders of the Common Stock was $239.3 million. As of December 31, 2010, the aggregate liquidation value of the preferred equity interests is $178.2 million and therefore the negative value to the holders of the Common Stock was $243.5 million.

 

Given the uncertainty inherent in the operating results and projected growth of its operating subsidiaries, StreetLinks and Advent, the Company has not calculated an estimated liquidation value for its investment in operating subsidiaries; however, the Company believes that the liquidation value of its investment in its operating subsidiaries is unlikely to exceed the $238.5 million premium to their current combined book value of $1.0 million as of September 30, 2010 (or the $243.7 million premium to their current combined book value of $(0.2) million as of December 31, 2010) that would be required for the liquidation preference of the Company’s assets to exceed its liabilities and the liquidating preference of its preferred stock.

Information available to the Company regarding a potential liquidation is summarized below as of September 30, 2010. The significant assumptions upon liquidation are as follows:

 

 

 

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 stockholders to pursue a recapitalization of the Company.

 

On May 11, 2010, the Company’s Board of Directors appointed a special committee of disinterested directors (the “Special Committee”) to explore a potential recapitalization of the Company. The Special Committee is comprised entirely of directors who own neither Series C Preferred Stock nor Series D Preferred Stock, and who were not elected by holders of Series C Preferred Stock or Series D Preferred Stock as a class. Serving on the Special Committee is Messrs. Barmore, Burtscher and Mehrer. The Special Committee met four times in 2010 and met once in 2011.

 

In September 2010, the Board of Directors engaged Stifel, Nicolaus & Company, Incorporated (“Stifel”) at the recommendation of the Special Committee to assist it in evaluating a potential recapitalization, to act as the Board of Director’s independent financial advisor and assist the Special Committee in negotiating with the holders of the Series D Preferred Stock. Also in September 2010, the Special Committee began to formulate a transaction structure that would achieve the recapitalization of the Company. Generally, the Special Committee considered during the negotiations with the Series D Holders and while formulating the terms of the Series C Offer the following factors:

 

 

 

Beginning in September 2010, and continuing through October and November, the Special Committee regularly consulted with outside legal and accounting advisors regarding the proposed terms, structure and timing of such a proposed transaction. The outside legal advisors, Bryan Cave LLP and Venable LLP, and the outside accounting advisor, Deloitte and Touche LLP, were engaged by the Board of Directors to assist with matters related to the Series C Offer, though the Special Committee would also consult with these advisors as needed. During this time the Special Committee negotiated with employee-representatives of Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC, JCP Partners IV LLC, and Massachusetts Mutual Life Insurance Company on the terms of a potential recapitalization that would eventually result in what is now the Series D Exchange.

 

The Special Committee considered that the book value of the Company would improve because dividends payable, which were $46.7 million as of September 30, 2010 (and were $50.9 million as of December 31, 2010), would be removed from the balance sheet. The pro forma impact of the transaction is provided in detail under the heading “Capitalization.”

 

The Special Committee also considered the impact of the recapitalization on the Company’s earnings per share. Dividends accumulating on the preferred stock must be subtracted from income in calculating earnings per share. Therefore, eliminating the preferred stockholder dividends would increase earnings per share. However, the recapitalization would also increase the aggregate number of shares outstanding. The Company has not conducted an analysis to calculate the impact of the recapitalization on expected future earnings per share. The impact of the recapitalization on historical earnings per share, on a pro forma basis, is provided under the heading “Summary Historical and Unaudited Pro Forma Financial Information.” The Special Committee concluded that any negative impact to the earnings per share that may occur from the recapitalization is outweighed by the elimination of the outstanding and future dividend obligation as discussed earlier in this “Special Factors” section.

 

The Special Committee considered the impact on the Company’s liquidity. The Company has experienced constrained and reduced liquidity in recent years. However, the Special Committee deemed it appropriate to use a limited amount of cash and concluded to offer up to $3 million to effectuate the recapitalization. The Special Committee concluded that using that amount of cash would not present a severe liquidity risk to the Company.

 

The Special Committee considered the impact of the recapitalization on the potential value of the Company’s NOLs. The Company has approximately $324.4 million of NOLs available. In the event of an “ownership change,” as defined in Section 382 of the Code, the use of the NOLs would be severely limited. Generally, an “ownership change” defined in the Code occurs if one or more stockholders, 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 stockholders over the preceding three-year period. The shares issued in the recapitalization have been limited to prevent an “ownership change.” The Company has received a private letter ruling from the IRS regarding the proposed recapitalization, which provides guidance with respect to the treatment of the Series D Holders and significantly reduces the risk that the NOLs will not be preserved. The applicability of the private letter ruling would need to be reevaluated if there are significant changes to the actual transactions completed by the Company. However because the total number of shares of Common Stock that may be issued pursuant to the recapitalization is approaching the maximum number of shares that the Company can issue and preserve its NOLs, additional transactions involving sales of Company stock by 5-percent stockholders and stock issuances and redemptions in the near term is restricted. Therefore, there is a risk that the NOLs may not be preserved in the future. See “Proposal 4 — Charter Amendment to Preserve the Company’s Net Operating Loss Carryforwards.”

 

The following items were the material points negotiated between the Special Committee and the Series D Holders:

 

 

 

Simultaneous with the negotiations with the Series D Holders, the Special Committee formulated the terms of the Series C Offer. The Special Committee did not negotiate the terms of the Series C Offer. The Special Committee formulated the terms of the Series C Offer with the aid of the Stifel and the Company’s legal advisors, and through consultation with members of the Board of Directors elected by the Series C Holders. The following items were the material points considered by the Special Committee in formulating the terms of the Series C Offer:

 

 

On December 10, 2010 the Special Committee and the Board of Directors of the Company approved the Exchange Agreement establishing the terms of the Series D Exchange, the Voting Agreement and the terms of the Series C Offer, as more fully described below in the “— Findings and Conclusions of the Special Committee” and “— Findings and Conclusions of the Board of Directors” subsections in both the “Special Factors” and the “Fairness of the Series C Offer to the Holders of Common Stock” sections. Also on December 10, 2010, the Company issued a press release announcing the recapitalization and the future filing of the special meeting proxy statement with the SEC. The Board of Directors has discussed the possibility of enacting a shareholder rights plan in the future as an additional measure of protection for the Company’s NOLs.

 

On April 14, 2011, the Special Committee and the Board of Directors each reconfirmed their approval of the Series D Exchange and the terms of the Series C Offer upon review of the same factors as reviewed by the Special Committee and the Board of Directors, respectively, on December 10, 2010, and in the case of the Board of Directors, upon recommendation of the Special Committee to reconfirm its approval.

 

Note: Management’s financial projections and liquidation value estimates presented in this section and throughout the proxy statement/consent solicitation/prospectus are subject to a number of risks and uncertainties, and are inherently uncertain and unpredictable. While the Company’s financial projections and liquidation value estimates are based on assumptions that management believes to be reasonable, these were not prepared with a view toward public disclosure or with a view toward complying with the guidelines established by the American Institute of Certified Public Accountants with respect to prospective financial information. The assumptions may be incomplete, incorrect or adversely affected by unanticipated events. Actual results and liquidation values will vary from these projections and estimates and the variations may be material and adverse. The projected results and liquidation value estimates were intended to be used by management, the Special Committee and the Board of Directors solely for the purpose of evaluating the proposed recapitalization. Stockholders should not place undue reliance on the prospective financial information or use these results for any other purpose than to evaluate the recapitalization and the proposals presented herein. These projections should be viewed as part of this proxy statement/consent solicitation/

prospectus and should be considered alongside other disclosures herein, including Risk Factors, Capitalization, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Description of Business. Stockholders should not expect the Company to update these forecasts beyond the date of the proxy statement/consent solicitation/prospectus. Neither the Company’s independent auditors, nor any other independent accountants, have compiled, examined, or performed any procedures with respect to the prospective financial information contained herein, nor have they expressed any opinion or any other form of assurance on such information or its achievability, and assume no responsibility for, and disclaim any association with, the prospective financial information.

 

Considerations by the Special Committee and the Board of Directors of the Company

 

On December 10, 2010, the Special Committee met 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 draft Schedule TO-I/13E-3, 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. At the same meeting and at the meeting of the Board of Directors that immediately followed, the Special Committee and the Board of Directors also reviewed a detailed presentation by representatives of Stifel regarding the financial and comparative analyses on which Stifel’s opinion was based and considered the opinion of Stifel, dated as of December 10, 2010, that, subject to the factors, assumptions, qualifications and limitations set forth in the opinion, as of the date of the opinion, the Series C Offer and the Series D Exchange were fair, from a financial point of view, to the holders of Common Stock. A summary of the presentations and opinion delivered by Stifel and additional information regarding Stifel’s selection and qualifications are set forth in the subsection “Opinion of NovaStar’s Financial Advisor” in the “Fairness of the Series C Offer to the Holders of Common Stock” section. A copy of the presentation of Stifel to the Board of Directors, dated December 10, 2010, was filed as Exhibit (c)(2) to Amendment No. 3 to Schedule TO-I/13E-3 filed by the Company on April 14, 2011, and is incorporated herein by reference.

 

On April 14, 2011, the Special Committee met to again review the terms of the Series C Offer, the Consent Solicitation and the Series D Exchange as of that date. The Special Committee received a report from management as to the status of the Series C Offer, the Consent Solicitation and the Series D Exchange as of the meeting date. At the same meeting, and at the meeting of the Board of Directors that immediately followed, the Special Committee and the Board of Directors also reviewed a detailed presentation by representatives of Stifel regarding the financial and comparative analyses on which Stifel’s bring-down opinion was based and considered the bring-down opinion of Stifel, dated as of April 14, 2011, that, subject to the factors, assumptions, qualifications and limitations set forth in the bring-down opinion, as of the date of the bring-down opinion, the Series C Offer and the Series D Exchange were fair, from a financial point of view, to the holders of Common Stock. A summary of the presentation and bring-down opinion delivered by Stifel is set forth in the subsection “Bring-Down Opinion of NovaStar’s Financial Advisor” in the “Fairness of the Series C Offer to the Holders of Common Stock” section. A copy of the presentation of Stifel to the Board of Directors, dated April 14, 2011, was filed as Exhibit (c)(4) to Amendment No. 3 to Schedule TO-I/13E-3 filed by the Company on April 14, 2011, and is incorporated herein by reference.

 

At the December 10, 2010 meeting and the April 14, 2011 meeting, the Special Committee considered and discussed certain factors that affect the fairness of the transaction to the Company’s stockholders, including:

 

 

The Special Committee also considered several factors at the December 10, 2010 meeting and the April 14, 2011 meeting that specifically affected the fairness of the transaction to the holders of the Company’s Common Stock. These factors are discussed below in the subsection titled “Considerations by the Special Committee and the Board of Directors of the Company’’ in the “Fairness of the Series C Offer to the Holders of Common Stock” section.

 

At the December 10, 2010 meeting and the April 14, 2011 meeting, the Special Committee considered that the Series C Holders will be giving up all rights to accrued and unpaid dividends and the liquidation preference currently associated with their Series C Preferred Stock, but it determined that the elimination of the accrued and unpaid dividends and the associated liquidation preference is in the best interest of the Company.

 

Immediately following both the Special Committee meeting on December 10, 2010 and the Special Committee meeting on April 14, 2011, the Board of Directors met to review the terms of the Series C Offer and Series D Exchange as of each date. At the December 10, 2010 meeting and the April 14, 2011 meeting, the Board of Directors reviewed and conducted the same analysis as to fairness issues and as to positive and negative factors as the Special Committee.

 

Findings and Conclusions of the Special Committee

 

After a thorough review of the above circumstances and factors related to the Series C Offer with management, and with advice from its financial advisor and legal counsel, the Special Committee concluded that the potential advantages and gains of conducting the Series D Exchange and Series C Offer outweigh the possible disadvantages and costs. The Special Committee also concluded that the terms of the Series C Offer are advisable, fair to the Company’s unaffiliated Series C Holders, including both those who participate in the Series C Offer and those who do not, from substantive and procedural points of view, and in the best interest of the Company and its stockholders, including the Series C Holders. In reaching this conclusion, the Special Committee considered, and conducted an independent review of, the following factors related to the fairness of the Series C Offer to the Series C Holders:

 

Factors Indicating Substantive Fairness to the Unaffiliated Series C Holders

 

 

 

 

Factors Indicating Substantive Non-Fairness to the Unaffiliated Series C Holders

 

 

Factors Indicating Procedural Fairness to the Unaffiliated Series C Holders

 

 

 

 

Factors Indicating Procedural Non-Fairness to the Unaffiliated Series C Holders

 

 

Before recommending the Series C Offer to the Board of Directors, the Special Committee also considered that the consideration offered to the Series C Holders and the Series D Holders in the recapitalization is approaching the maximum value that the Company could offer without jeopardizing the Company’s needed liquidity or the Company’s important deferred tax asset. The Special Committee deemed it appropriate to use a limited amount of cash to effectuate the recapitalization. The Special Committee concluded to offer up to $3 million total cash and that using that amount of cash would not present a severe liquidity risk to the Company. Further, the Company has NOLs of approximately $324.4 million. 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 stockholders, 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 stockholders 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 stockholder, subject to certain exceptions. Because the NOLs are important Company assets, the Special Committee concluded that the recapitalization must be structured in a manner that would not result in an ownership change that could jeopardize the use of these deferred tax assets. Thus, the amount of new Common Stock issuable by the Company in the recapitalization, and thus to the Series C Holders, is limited to that which it could issue without effecting an ownership change. If the

Series C Offer and Series D Exchange close, the Company will issue over 90% of this amount of Common Stock in the recapitalization.

 

The Special Committee did not consider purchase prices paid by the Company for any Series C Preferred Stock within the last two years because no such purchases were made. Further, the Special Committee did not consider any firm offers during the prior two years for the merger or consolidation of the Company into or with another company, the sale or transfer of a substantial part of the Company’s assets, or the purchase of the Company’s securities that would enable the purchaser to exercise control of the Company because no such firm offers were made. Before recommending to the Board of Directors that it approve the Series C Offer, the Special Committee also concluded that the Series C Offer is advisable and fair to the Common Stock holders. See the “Findings and Conclusions of the Special Committee” subsection of the “Fairness of the Series C Offer to the Holders of Common Stock” section.

 

For the foregoing reasons and the reasons described in the “Fairness of the Series C Offer to the Holders of Common Stock” section, the Special Committee recommended to the Board of Directors that it approve the Series C Offer at the December 10, 2010 Special Committee meeting and recommended to the Board of Directors that it reconfirm its approval of the Series C Offer at the April 14, 2011 Special Committee meeting. The foregoing review by the Special Committee is not intended to be exhaustive but, rather, includes material factors considered by the Special Committee. In reaching its decision to recommend to the Board of Directors that it approve the Series C Offer, the Special Committee 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 Special Committee 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 Special Committee 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.

 

Findings and Conclusions of the Board of Directors

 

After a thorough review of the circumstances and factors related to the Series C Offer with management, and with advice from its financial advisor and legal counsel and upon recommendation of the Special Committee, the Board of Directors as a whole also 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 of Directors also concluded that the terms of the Series C Offer are advisable, fair to the Company’s Series C Holders, including both those who participate in the Series C Offer and those who do not, from substantive and procedural points of view, and in the best interest of the Company and its stockholders, including the Series C Holders. In reaching this conclusion, the Board of Directors considered, and conducted an independent review of, the following factors related to the fairness of the Series C Offer to the Series C Holders:

 

Factors Indicating Substantive Fairness to the Unaffiliated Series C Holders

 

 

 

 

 

Factors Indicating Substantive Non-Fairness to the Unaffiliated Series C Holders

 

 

Factors Indicating Procedural Fairness to the Unaffiliated Series C Holders

 

 

 

 

Factors Indicating Procedural Non-Fairness to the Unaffiliated Series C Holders

 

 

Before approving the Series C Offer, the Board of Directors also considered that the consideration offered to the Series C Holders and the Series D Holders in the recapitalization is approaching the maximum value that the Company could offer without jeopardizing the Company’s needed liquidity or the Company’s important deferred tax asset. The Board of Directors agreed with the Special Committee’s conclusion that it was appropriate to use a limited amount of cash to effectuate the recapitalization. The Board of Directors also concurred with the Special Committee’s conclusion that it was appropriate to offer up to $3 million total cash and that using that amount of cash would not present a severe liquidity risk to the Company. Further, the Company has NOLs of approximately $324.4 million. 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 stockholders, 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 stockholders 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 stockholder, subject to certain exceptions. Because the NOLs are important Company assets, the Board of Directors concluded that the recapitalization must be structured in a manner that would not result in an ownership change that could jeopardize the use of these deferred tax assets. Thus, the amount of new Common Stock issuable by the Company in the recapitalization, and thus to the Series C Holders, is limited to that which it could issue without effecting an ownership change. If the Series C Offer and Series D Exchange close, the Company will issue over 90% of this amount of Common Stock in the recapitalization.

 

The Board of Directors did not consider purchase prices paid by the Company for any Series C Preferred Stock within the last two years because no such purchases were made. Further, the Board of Directors did not consider any firm offers during the prior two years for the merger or consolidation of the Company into or with another company, the sale or transfer of a substantial part of the Company’s assets, or the purchase of the Company’s securities that would enable the purchaser to exercise control of the Company because no such firm offers were made. Before approving the Series C Offer, the Board of Directors also concluded that the Series C Offer is advisable and fair to the Common Stock holders. See the “Findings and Conclusions of the Board of Directors” subsection of the “Fairness of the Series C Offer to the Holders of Common Stock” section.

 

For the foregoing reasons and the reasons described in the “Fairness of the Series C Offer to the Holders of Common Stock” section, the Board of Directors approved the Series C Offer at the December 10, 2010 Board of Directors meeting and reconfirmed its approval of the Series C Offer at the April 14, 2011 Board of Directors meeting. The foregoing review by the Board of Directors is not intended to be exhaustive but, rather, includes material factors considered by the Board of Directors. In reaching its decision to approve the Series C Offer, the Board of Directors 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 of Directors 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 of Directors 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 fairness of the Series C Offer, and the recapitalization as a whole, to the holders of Common Stock was also an important consideration of the Special Committee and the Board of Directors. Prior to the Special Committee’s recommendation to the Board of Directors that the Board of Directors approve the Series C Offer, and prior to the Board of Directors’ approval of the Series C Offer, the Special Committee and the Board of Directors each concluded that the Series C Offer is fair to the holders of Common Stock from both substantive and a procedural points of view. Though the Company will seek approval of the holders of the Common Stock for the Proposals to be considered at the special meeting, the Company will not seek consent from the holders of the Company’s Common Stock to approve the Series C Offer or Series D Exchange. Nonetheless, the Board of Directors recognizes that it owes important fiduciary duties to all of the Company’s stockholders. Further, the Company believes it is important to present all material considerations by the Special Committee and the Board of Directors to the Series C Holders to allow the Series C Holders to make an informed investment decision. Thus, the factors considered by the Special Committee and the Board of Directors that relate to the fairness of the Series C Offer to the holders of Common Stock are set forth below.

 

Though the Series C Holders will hold Common Stock immediately following the closing of the Series C Offer, the fairness of the Series C Offer to the holders of Common Stock is of limited relevance to the Series C Holders. While the Special Committee and the Board of Directors each concluded that the terms of the Series C Offer are fair to the Company’s unaffiliated Series C Holders and to the holders of the Company’s Common Stock, the interests of the holders of the Common Stock may, in fact, be adverse to the interests of the Series C Holders. The following section is presented to provide the Series C Holders with a complete understanding of the information and the factors considered by the Special Committee and the Board of Directors before the Special Committee recommended approval of the Series C Offer to the Board of Directors and before the Board of Directors approved the Series C Offer.

Considerations by the Special Committee and the Board of Directors of the Company

 

On December 10, 2010, the Special Committee and the Board of Directors each met to review the terms of the proposed recapitalization. At these meetings of the Special Committee and the Board of Directors, the Special Committee and the Board of Directors discussed certain factors that specifically affected the fairness of recapitalization to the holders of the Company’s Common Stock.

 

On April 14, 2011, the Special Committee and the Board of Directors each met to again review the terms of the Series C Offer, the Consent Solicitation and the Series D Exchange. At these meetings, the Special Committee and the Board of Directors discussed the same factors that specifically affected the fairness of the recapitalization to the holders of the Company’s Common Stock that were discussed at the December 10, 2010 meetings.

 

At both the December 10, 2010 meetings and the April 14, 2011 meetings, the Special Committee and Board of Directors each considered as factors that positively affected the fairness of the recapitalization to the holders of the Company’s Common Stock the following:

 

 

At both the December 10, 2010 meetings and the April 14, 2011 meetings, the Special Committee and Board of Directors each considered as factors that negatively affected the fairness of the recapitalization to the holders of the Company’s Common Stock the following:

 

 

Opinion of NovaStar’s Financial Advisor

 

Stifel acted as financial advisor to the Company’s Board of Directors in connection with the recapitalization and related matters. Stifel is a nationally recognized investment banking and securities firm with membership on all the principal United States securities exchanges and expertise in transactions similar to the recapitalization. As part of its investment banking activities, Stifel is regularly engaged in the independent valuation of businesses and securities in connection with mergers, acquisitions, underwritings, sales and distributions of listed and unlisted securities, private placements and valuations for estate, corporate and other purposes.

 

The Company received bids from six investment banks seeking to act as the financial advisor in connection with the recapitalization, one of such investment banks was Stifel. Stifel had advised the Board of Directors in the original issuance of the Series D Preferred Stock and it has been involved with certain other Company capital transactions. The Company’s management and the Board of Directors considered that Stifel had strong experience in the capital markets and believed that Stifel had the relevant experience to assist with the recapitalization. Stifel demonstrated a high desire to work with the Company again and presented a very reasonable fee proposal. For the aforementioned reasons, the Company’s management recommended that the Board of Directors hire Stifel for advice with the recapitalization and for the fairness opinion.

 

On December 10, 2010, Stifel gave a detailed presentation during which Stifel rendered its oral opinion, which was later confirmed in writing, to the Board of Directors that, as of the date of Stifel’s written opinion, the financial terms of the potential recapitalization were fair to the holders of the Company’s Common Stock,

from a financial point of view. Stifel’s opinion will be made available for inspection and copying at the principal executive offices of the Company at 2114 Central Street, Suite 600, Kansas City, Missouri 64108, during its regular business hours by any interested equity security holder of the subject company or representative who has been so designated in writing.

 

This “Opinion of NovaStar’s Financial Advisor” subsection provides a summary of Stifel’s opinion as well as the December 10, 2010 presentation delivered by representatives of Stifel to the Board of Directors. The full text of Stifel’s written opinion, dated December 10, 2010, which sets forth the assumptions made, matters considered and limitations of the review undertaken, is attached as Appendix B to this proxy statement/consent solicitation/prospectus and is incorporated herein by reference. Stifel has provided its consent to using such opinion in this proxy statement/consent solicitation/prospectus. Holders of the Company’s Common Stock are urged to, and should, read Stifel’s opinion carefully and in its entirety in connection with this proxy statement/consent solicitation/prospectus. The summary of the opinion of Stifel set forth in this proxy statement/consent solicitation/prospectus is qualified in its entirety by reference to the full text of such opinion. The opinion of Stifel will not reflect any developments that may occur or may have occurred after the date of its opinion and prior to the completion of the recapitalization.

 

No limitations were imposed by the Board of Directors or the Special Committee on the scope of Stifel’s investigation or the procedures to be followed by Stifel in rendering its opinion. In arriving at its opinion, Stifel did not ascribe a specific range of values to the Company or any class of its securities. Stifel’s opinion is based on the financial and comparative analyses described below. Stifel’s opinion was for the information of, and directed to, the Special Committee and the Board of Directors for their information and assistance in connection with the consideration of the financial terms of the recapitalization. Stifel’s opinion was not intended to be, and does not constitute, a recommendation to the Special Committee, the Board of Directors or any stockholder of the Company as to how the Special Committee, the Board of Directors or any of the Company’s stockholders should vote on the recapitalization terms or any aspect thereof, or whether or not any of the Company’s stockholders should elect the Cash-and-Stock Option or the Stock-Only Option in connection with the Series C Offer, or whether or not any of the Company’s stockholders should enter into the Exchange Agreement or any voting, stockholders’ or affiliate agreement with respect to the recapitalization or any aspect thereof, or exercise any dissenters’ or appraisal rights that may be available to such stockholder or member. In addition, Stifel’s opinion does not compare the relative merits of the recapitalization (or any aspect thereof) with any other alternative transaction or business strategy which may have been available to the Special Committee, the Board of Directors or the Company to proceed with or effect the recapitalization (or any aspect thereof). Stifel was not requested to, and Stifel did not, explore alternatives to the recapitalization or solicit the interest of any other parties in pursuing transactions with the Company.

 

In connection with its opinion, Stifel, among other things:

 

 

 

 

 

 

In rendering its opinion, Stifel relied upon and assumed, without independent verification, the accuracy and completeness of all of the financial and other information that was provided to Stifel by or on behalf of the Company or StreetLinks, or that was otherwise reviewed by Stifel, and did not assume any responsibility for independently verifying any of such information.

 

With respect to the financial forecasts supplied to Stifel by the Company, Stifel has assumed that they were reasonably prepared on the basis reflecting the best currently available estimates and judgments of Company’s management as to the future operating and financial performance of the Company and StreetLinks, as applicable, and that they provided a reasonable basis upon which Stifel could form its opinion. Such forecasts and projections were not prepared with the expectation of public disclosure. All such projected financial information is based on numerous variables and assumptions that are inherently uncertain, including, without limitation, factors related to general economic and competitive conditions. Accordingly, actual results could vary significantly from those set forth in such projected financial information. Stifel has relied on this projected information without independent verification or analysis and does not in any respect assume any responsibility for the accuracy or completeness thereof.

 

Stifel also assumed, without independent verification and with the Company’s consent, that there were no material changes in the assets, liabilities, financial condition, results of operations, business or prospects of the Company or StreetLinks since the date of the last financial statements made available to Stifel prior to rendering its opinion. Stifel did not make or obtain any independent evaluation, appraisal or physical inspection of the Company’s or StreetLinks’ respective assets or liabilities, the collateral securing any of such assets or liabilities, or the collectability of any such assets. Estimates of values of companies and assets do not purport to be appraisals or necessarily reflect the prices at which companies or assets may actually be sold. Because such estimates are inherently subject to uncertainty, Stifel assumes no responsibility for their accuracy. Stifel relied on advice of the Company’s counsel as to certain legal and tax matters with respect to the Company, the proxy statement/consent solicitation/prospectus, the Exchange Agreement and the recapitalization and other transactions and other matters contained or contemplated therein. Stifel has assumed, with the Company’s consent, that there are no factors that would delay or subject to any adverse conditions any necessary regulatory or governmental approvals and that all conditions to the recapitalization will be satisfied and not waived. In addition, Stifel has assumed that the definitive proxy statement/consent solicitation/prospectus and Exchange Agreement will not differ materially from the draft Stifel reviewed. Stifel has also assumed that the recapitalization will be consummated substantially on the terms and conditions described in the proxy statement/consent solicitation/prospectus and Exchange Agreement, each without any waiver of material terms or conditions by the Company or any other party to any transaction contemplated therein, and that obtaining any necessary regulatory approvals or satisfying any other conditions for consummation of the recapitalization or any other related transaction will not have an adverse effect on the Company.

 

Stifel’s opinion is necessarily based on economic, market, financial and other conditions as they exist on, and on the information made available to Stifel as of, the date of the letter. It is understood that subsequent developments may affect the conclusions reached in the opinion and that Stifel does not have any obligation to

update, revise or reaffirm Stifel’s opinion, except as otherwise set forth in Stifel’s engagement letter agreement with the Company. Stifel also did not perform or rely upon certain analyses that Stifel would customarily prepare for the Company in connection with a fairness opinion because such analyses were deemed not to be meaningful for various reasons.

 

Stifel’s opinion is limited to whether the financial terms of the recapitalization are fair to the Company’s holders of Common Stock, from a financial point of view. Stifel’s opinion does not consider, include or address: (i) any other strategic alternatives currently (or which have been or may be) contemplated by the Board of Directors, the Special Committee or the Company; (ii) the legal, tax or accounting consequences of the recapitalization (or any aspect thereof) on the Company or its stockholders including, without limitation, whether or not the recapitalization will trigger an “ownership change” pursuant to Section 382 of the Code or otherwise affect the tax status of the Company’s NOLs; (iii) the fairness of the amount or nature of any compensation to any of the Company’s officers, directors or employees, or class of such persons, relative to the compensation to the holders of the Company’s securities; (iv) the effect of the recapitalization (or any aspect thereof) on, or the fairness of the consideration to be received by, holders of any class of securities of the Company other than the Common Stock, or any class of securities of any other party to any transaction contemplated by the proxy statement/consent solicitation/prospectus or the Exchange Agreement; (v) any advice or opinions provided by any other advisor to the Company or any other party to the recapitalization; (vi) any other transaction contemplated by the proxy statement/consent solicitation/prospectus or the Exchange Agreement other than the recapitalization; (vii) any potential transaction by any party to the proxy statement/consent solicitation/prospectus or the Exchange Agreement which is not contemplated by the proxy statement/consent solicitation/prospectus or the Exchange Agreement; (viii) the effect of any pending or threatened litigation involving any party to the proxy statement/consent solicitation/prospectus or the Exchange Agreement on the recapitalization (or any aspect thereof) or any other transaction contemplated by the proxy statement/consent solicitation/prospectus or the Exchange Agreement; or (ix) the fairness of the Series C Offer, the Series D Exchange or any other individual aspect of the recapitalization without taking into account the other aspects of the recapitalization. Furthermore, Stifel’s opinion does not express any opinion as to the prices, trading range or volume at which the securities of the Company will trade following public announcement or consummation of the recapitalization or any aspect thereof.

 

Stifel is not a legal, tax, regulatory or bankruptcy advisor. Stifel has not considered any legislative or regulatory changes recently adopted or currently being considered by the United States Congress, the various federal banking agencies, the SEC, or any other regulatory bodies, or any changes in accounting methods or generally accepted accounting principles that may be adopted by the SEC or the Financial Accounting Standards Board, or any changes in regulatory accounting principles that may be adopted by any or all of the federal banking agencies. Stifel’s opinion is not a solvency opinion and does not in any way address the solvency or financial condition of the Company.

 

In connection with rendering its opinion, Stifel performed a variety of financial analyses that are summarized below. Such summary does not purport to be a complete description of such analyses. Stifel believes that its analyses and the summary set forth herein must be considered as a whole and that selecting portions of such analyses and the factors considered therein, without considering all factors and analyses, could create an incomplete view of the analyses and processes underlying its opinion. The preparation of a fairness opinion is a complex process involving subjective judgments and is not necessarily susceptible to partial analysis or summary description. In arriving at its opinion, Stifel considered the results of all of its analyses as a whole and did not attribute any particular weight to any analyses or factors considered by it. The range of valuations resulting from any particular analysis described below should not be taken to be Stifel’s view of the actual value of the Company. In its analyses, Stifel made numerous assumptions with respect to industry performance, business and economic conditions, and other matters, many of which are beyond the control of the Company. Any estimates contained in Stifel’s analyses are not necessarily indicative of actual future values or results, which may be significantly more or less favorable than suggested by such estimates. Estimates of values of companies do not purport to be appraisals or necessarily reflect the actual prices at which companies or their securities actually may be sold. No company or transaction utilized in Stifel’s analyses was identical to the Company or the recapitalization. Accordingly, an analysis of the results described below is not mathematical; rather, it involves complex considerations and judgments concerning differences in

financial and operating characteristics of the companies and other facts that could affect the public trading value of the companies to which they are being compared. None of the analyses performed by Stifel was assigned a greater significance by Stifel than any other, nor does the order of analyses described represent relative importance or weight given to those analyses by Stifel. The analyses described below do not purport to be indicative of actual future results, or to reflect the prices at which the Company’s securities may trade in the public markets, which may vary depending upon various factors, including changes in interest rates, dividend rates, market conditions, economic conditions and other factors that influence the price of securities.

 

In accordance with customary investment banking practice, Stifel employed generally accepted valuation methods in reaching its opinion. The following is a summary of the material financial analyses that Stifel used in providing its opinion. Some of the summaries of financial analyses are presented in tabular format. In order to understand the financial analyses used by Stifel more fully, you should read the tables together with the text of each summary. The tables alone do not constitute a complete description of Stifel’s financial analyses, including the methodologies and assumptions underlying the analyses, and if viewed in isolation could create a misleading or incomplete view of the financial analyses performed by Stifel. The summary data set forth below do not represent and should not be viewed by anyone as constituting conclusions reached by Stifel with respect to any of the analyses performed by it in connection with its opinion. Rather, Stifel made its determination as to the fairness to holders of the Common Stock of the financial terms of the recapitalization, from a financial point of view, on the basis of its experience and professional judgment after considering the results of all of the analyses performed. Accordingly, the data included in the summary tables and the corresponding imputed ranges of value for the Company should be considered as a whole and in the context of the full narrative description of all of the financial analyses set forth in the following pages, including the assumptions underlying these analyses. Considering the data included in the summary table without considering the full narrative description of all of the financial analyses, including the assumptions underlying these analyses, could create a misleading or incomplete view of the financial analyses performed by Stifel.

 

Context for the Decision to Pursue an Exchange of the Preferred Stock.  Stifel considered a number of situational factors relevant to its analysis, including, but not limited to the following:

 

 

 

 

Financial Impact of the Recapitalization.  Stifel reviewed certain estimated future operating and financial information based on two cases of projected financial results developed by the Company for the 12-month periods ending December 31, 2011 and December 31, 2012 and the potential incremental financial impact of the recapitalization which estimates are shown in the table below. Based on this analysis, on a pro forma basis,

the recapitalization is forecasted to be accretive to the Company’s earnings per share for each of the 12-month periods ending December 31, 2011 and December 31, 2012. The relevant estimates reviewed were as follows:

 

 

Additionally, Stifel reviewed the Company’s book value per share, a range of estimated adjusted common equity per share (as defined below), and gross estimated deferred tax asset per share as of September 30, 2010 and the potential incremental financial impact of the recapitalization on these figures, which estimates are shown in the table below. These estimates were made for the purposes of Stifel’s evaluation process only. These figures are not determined in accordance with GAAP.

 

For purposes of Stifel’s analysis:

 

 

 

Based on this analysis, the recapitalization is expected to be accretive to the Company’s earnings per share in 2011 and 2012; accretive to the Company’s September 30, 2010 book value per share and adjusted book value per share; and dilutive to the Company’s gross deferred tax asset per share. The estimates of future operating and financial information for the Company were based on the estimated balance sheet of the Company as of the date of the Exchange Agreement, but also give effect to several events which, at the date of the Exchange Agreement had not yet occurred but were assumed to occur in the future.

Liquidation Analysis.  Stifel estimated the value of the common equity of the Company assuming the liquidation of all of the assets and liabilities of the Company at their estimated realizable values. For purposes only of Stifel’s evaluation process, management provided Stifel with low and high estimates of fair market values. Stifel utilized this information to establish the estimates shown in the table below.

 

 

 

 

Based on this analysis the recapitalization is expected to be accretive or neutral to the Company’s liquidation value per common share.

 

Omitted Analyses.  Stifel considered including several analyses traditionally employed in fairness opinions but determined that these analyses would not be appropriate because of several complicating factors, including:

 

 

 

 

Based upon Stifel’s consideration of the context for the decision to pursue an exchange of the preferred stock, the financial impact of the recapitalization, being accretive to the Company’s earnings per share, book value per share and adjusted book value per share, and the impact of the recapitalization being accretive or neutral to the liquidation value of the Common Stock, and the other factors and analyses described herein, Stifel determined that the financial terms of the potential recapitalization were fair to the holders of the Company’s Common Stock, from a financial point of view.

 

Stifel’s opinion was among the many factors taken into consideration by the Company’s Special Committee and the Board of Directors in making their determination to approve the recapitalization on December 10, 2010. The amount of Offer Consideration was determined by the Board of Directors and was not recommended by Stifel.

 

Stifel, which is unaffiliated with the Company, entered into an engagement letter with the Company’s Board of Directors and the Company, dated September 8, 2010, under which Stifel has received retainer fees of $50,000 for each of the months September 2010 through April 2011, an opinion fee of $200,000, and a bring-down opinion fee of $100,000. Stifel will not receive any significant payment or compensation contingent upon successful consummation of the recapitalization or any aspect thereof. In addition, the Company has agreed to indemnify Stifel for certain liabilities arising out of Stifel’s engagement. In the past, Stifel has performed investment banking services for the Company from time to time for which Stifel received customary compensation. Stifel may seek to provide investment banking services to the Company or its respective affiliates

in the future, for which Stifel would seek customary compensation. In the ordinary course of business, Stifel and its clients trade in the securities of the Company and, accordingly, may at any time hold a long or short position in such securities. No material relationship existed during the past two years or is mutually understood to be contemplated, nor was any compensation received or to be received as a result of the relationship between (i) Stifel, its affiliates or unaffiliated representatives and (ii) the Company or its affiliates.

 

Bring-Down Opinion of Novastar’s Financial Advisor

 

On April 14, 2011, Stifel gave a detailed presentation during which Stifel rendered its oral bring-down opinion, which was later confirmed in writing, to the Board of Directors that, as of the date of Stifel’s written bring-down opinion, the financial terms of the potential recapitalization were still fair to the holders of the Company’s Common Stock, from a financial point of view. The Board of Directors requested a bring-down opinion to be delivered on April 14, 2011 because the original opinion was delivered on December 10, 2010. Stifel’s bring-down opinion will be made available for inspection and copying at the principal executive offices of the Company at 2114 Central Street, Suite 600, Kansas City, Missouri 64108, during its regular business hours by any interested equity security holder of the subject company or representative who has been so designated in writing.

 

This “Bring-Down Opinion of NovaStar’s Financial Advisor” subsection provides a summary of Stifel’s bring-down opinion as well as the April 14, 2011 presentation delivered by representatives of Stifel to the Board of Directors. The full text of Stifel’s written bring-down opinion, dated April 14, 2011, which sets forth the assumptions made, matters considered and limitations of the review undertaken, is attached as Appendix C to this proxy statement/consent solicitation/prospectus and is incorporated herein by reference. Stifel has provided its consent to using such bring-down opinion in this proxy statement/consent solicitation/prospectus. Holders of the Company’s Common Stock are urged to, and should, read Stifel’s bring-down opinion carefully and in its entirety in connection with this proxy statement/consent solicitation/prospectus. The summary of the bring-down opinion of Stifel set forth in this proxy statement/consent solicitation/prospectus is qualified in its entirety by reference to the full text of such bring-down opinion. The bring-down opinion of Stifel will not reflect any developments that may occur or may have occurred after the date of its opinion and prior to the completion of the recapitalization.

 

No limitations were imposed by the Board of Directors or the Special Committee on the scope of Stifel’s investigation or the procedures to be followed by Stifel in rendering its bring-down opinion. In arriving at its bring-down opinion, Stifel did not ascribe a specific range of values to the Company or any class of its securities. Stifel’s bring-down opinion is based on the financial and comparative analyses described below. Stifel’s bring-down opinion was for the information of, and directed to, the Special Committee and the Board of Directors for their information and assistance in connection with the consideration of the financial terms of the recapitalization. Stifel’s bring-down opinion was not intended to be, and does not constitute, a recommendation to the Special Committee, the Board of Directors or any stockholder of the Company as to how the Special Committee, the Board of Directors or any the Company’s stockholders should vote on the recapitalization terms or any aspect thereof, or whether or not any of the Company’s stockholders should elect the Cash-and-Stock Option or the Stock-Only Option in connection with the Series C Offer, or whether or not any of the Company’s stockholders should enter into the Exchange Agreement or any voting, stockholders’ or affiliate agreement with respect to the recapitalization or any aspect thereof, or exercise any dissenters’ or appraisal rights that may be available to such stockholder or member. In addition, Stifel’s bring-down opinion does not compare the relative merits of the recapitalization (or any aspect thereof) with any other alternative transaction or business strategy which may have been available to the Special Committee, the Board of Directors or the Company to proceed with or effect the recapitalization (or any aspect thereof). Stifel was not requested to, and Stifel did not, explore alternatives to the recapitalization or solicit the interest of any other parties in pursuing transactions with the Company.

 

In connection with its bring-down opinion, Stifel, among other things:

 

 

 

 

 

 

 

 

 

 

 

 

 

In rendering its bring-down opinion, Stifel relied upon and assumed, without independent verification, the accuracy and completeness of all of the financial and other information that was provided to Stifel by or on behalf of the Company, Advent or StreetLinks, or that was otherwise reviewed by Stifel, and did not assume any responsibility for independently verifying any of such information.

 

With respect to the financial forecasts supplied to Stifel by the Company, Stifel has assumed that they were reasonably prepared on the basis reflecting the best currently available estimates and judgments of Company’s management as to the future operating and financial performance of the Company, Advent and StreetLinks, as applicable, and that they provided a reasonable basis upon which Stifel could form its bring-down opinion. Such forecasts and projections were not prepared with the expectation of public disclosure. All such projected financial information is based on numerous variables and assumptions that are inherently uncertain, including, without limitation, factors related to general economic and competitive conditions. Accordingly, actual results could vary significantly from those set forth in such projected financial information. Stifel has relied on this projected information without independent verification or analysis and does not in any respect assume any responsibility for the accuracy or completeness thereof.

 

Stifel also assumed, without independent verification and with the Company’s consent, that there were no material changes in the assets, liabilities, financial condition, results of operations, business or prospects of the Company, Advent or StreetLinks since the date of the last financial statements made available to Stifel prior to rendering its bring-down opinion. Stifel did not make or obtain any independent evaluation, appraisal or physical inspection of the Company’s, Advent’s or StreetLinks’ respective assets or liabilities, the collateral securing any of such assets or liabilities, or the collectability of any such assets. Estimates of values of companies and assets do not purport to be appraisals or necessarily reflect the prices at which companies or assets may actually be sold. Because such estimates are inherently subject to uncertainty, Stifel assumes no responsibility for their accuracy. Stifel relied on advice of the Company’s counsel as to certain legal and tax matters with respect to the Company, the proxy statement/consent solicitation/prospectus, the Exchange Agreement and the recapitalization and other transactions and other matters contained or contemplated therein.

Stifel has assumed, with the Company’s consent, that there are no factors that would delay or subject to any adverse conditions any necessary regulatory or governmental approvals and that all conditions to the recapitalization will be satisfied and not waived. In addition, Stifel has assumed that the definitive proxy statement/consent solicitation/prospectus and Exchange Agreement will not differ materially from the draft Stifel reviewed. Stifel has also assumed that the recapitalization will be consummated substantially on the terms and conditions described in the proxy statement/consent solicitation/prospectus and Exchange Agreement each without any waiver of material terms or conditions by the Company or any other party to any transaction contemplated therein, and that obtaining any necessary regulatory approvals or satisfying any other conditions for consummation of the recapitalization or any other related transaction will not have an adverse effect on the Company.

 

Stifel’s bring-down opinion is necessarily based on economic, market, financial and other conditions as they exist on, and on the information made available to Stifel as of, the date of the bring-down opinion. It is understood that subsequent developments may affect the conclusions reached in the bring-down opinion and that Stifel does not have any obligation to update, revise or reaffirm Stifel’s bring-down opinion, except as otherwise set forth in Stifel’s engagement letter agreement with the Company. Stifel also did not perform or rely upon certain analyses that Stifel would customarily prepare for the Company in connection with a fairness opinion because such analyses were deemed not to be meaningful for various reasons.

 

Stifel’s bring-down opinion is limited to whether the financial terms of the recapitalization are fair to the Company’s holders of Common Stock, from a financial point of view. Stifel’s bring-down opinion does not consider, include or address: (i) any other strategic alternatives currently (or which have been or may be) contemplated by the Board of Directors, the Special Committee, or the Company; (ii) the legal, tax or accounting consequences of the recapitalization (or any aspect thereof) on the Company or its stockholders including, without limitation, whether or not the recapitalization will trigger an “ownership change” pursuant to Section 382 of the Code or otherwise affect the tax status of the Company’s NOLs; (iii) the fairness of the amount or nature of any compensation to any of the Company’s officers, directors or employees, or class of such persons, relative to the compensation to the holders of the Company’s securities; (iv) the effect of the recapitalization (or any aspect thereof) on, or the fairness of the consideration to be received by, holders of any class of securities of the Company other than the Common Stock, or any class of securities of any other party to any transaction contemplated by the proxy statement/consent solicitation/prospectus or the Exchange Agreement; (v) any advice or opinions provided by any other advisor to the Company or any other party to the recapitalization; (vi) any other transaction contemplated by the proxy statement/consent solicitation/prospectus or the Exchange Agreement other than the recapitalization; (vii) any potential transaction by any party to the proxy statement/consent solicitation/prospectus or the Exchange Agreement which is not contemplated by the proxy statement/consent solicitation/prospectus or the Exchange Agreement; (viii) the effect of any pending or threatened litigation involving any party to the proxy statement/consent solicitation/prospectus or the Exchange Agreement on the recapitalization (or any aspect thereof) or any other transaction contemplated by the proxy statement/consent solicitation/prospectus or the Exchange Agreement; or (ix) the fairness of the Series C Offer, the Series D Exchange or any other individual aspect of the recapitalization without taking into account the other aspects of the recapitalization. Furthermore, Stifel’s bring-down opinion does not express any opinion as to the prices, trading range or volume at which the securities of the Company will trade following public announcement or consummation of the recapitalization or any aspect thereof.

 

Stifel is not a legal, tax, regulatory or bankruptcy advisor. Stifel has not considered any legislative or regulatory changes recently adopted or currently being considered by the United States Congress, the various federal banking agencies, the SEC, or any other regulatory bodies, or any changes in accounting methods or generally accepted accounting principles that may be adopted by the SEC or the Financial Accounting Standards Board, or any changes in regulatory accounting principles that may be adopted by any or all of the federal banking agencies. Stifel’s bring-down opinion is not a solvency opinion and does not in any way address the solvency or financial condition of the Company.

 

In connection with rendering its bring-down opinion, Stifel performed a variety of financial analyses that are summarized below. Such summary does not purport to be a complete description of such analyses. Stifel believes that its analyses and the summary set forth herein must be considered as a whole and that selecting portions of such analyses and the factors considered therein, without considering all factors and analyses,

could create an incomplete view of the analyses and processes underlying its bring-down opinion. The preparation of a fairness opinion is a complex process involving subjective judgments and is not necessarily susceptible to partial analysis or summary description. In arriving at its bring-down opinion, Stifel considered the results of all of its analyses as a whole and did not attribute any particular weight to any analyses or factors considered by it. The range of valuations resulting from any particular analysis described below should not be taken to be Stifel’s view of the actual value of the Company. In its analyses, Stifel made numerous assumptions with respect to industry performance, business and economic conditions, and other matters, many of which are beyond the control of the Company. Any estimates contained in Stifel’s analyses are not necessarily indicative of actual future values or results, which may be significantly more or less favorable than suggested by such estimates. Estimates of values of companies do not purport to be appraisals or necessarily reflect the actual prices at which companies or their securities actually may be sold. No company or transaction utilized in Stifel’s analyses was identical to the Company or the recapitalization. Accordingly, an analysis of the results described below is not mathematical; rather, it involves complex considerations and judgments concerning differences in financial and operating characteristics of the companies and other facts that could affect the public trading value of the companies to which they are being compared. None of the analyses performed by Stifel was assigned a greater significance by Stifel than any other, nor does the order of analyses described represent relative importance or weight given to those analyses by Stifel. The analyses described below do not purport to be indicative of actual future results, or to reflect the prices at which the Company’s securities may trade in the public markets, which may vary depending upon various factors, including changes in interest rates, dividend rates, market conditions, economic conditions and other factors that influence the price of securities.

 

In accordance with customary investment banking practice, Stifel employed generally accepted valuation methods in reaching its bring-down opinion. The following is a summary of the material financial analyses that Stifel used in providing its bring-down opinion. Some of the summaries of financial analyses are presented in tabular format. In order to understand the financial analyses used by Stifel more fully, you should read the tables together with the text of each summary. The tables alone do not constitute a complete description of Stifel’s financial analyses, including the methodologies and assumptions underlying the analyses, and if viewed in isolation could create a misleading or incomplete view of the financial analyses performed by Stifel. The summary data set forth below do not represent and should not be viewed by anyone as constituting conclusions reached by Stifel with respect to any of the analyses performed by it in connection with its bring-down opinion. Rather, Stifel made its determination as to the fairness to holders of the Common Stock of the financial terms of the recapitalization, from a financial point of view, on the basis of its experience and professional judgment after considering the results of all of the analyses performed. Accordingly, the data included in the summary tables and the corresponding imputed ranges of value for the Company should be considered as a whole and in the context of the full narrative description of all of the financial analyses set forth in the following pages, including the assumptions underlying these analyses. Considering the data included in the summary table without considering the full narrative description of all of the financial analyses, including the assumptions underlying these analyses, could create a misleading or incomplete view of the financial analyses performed by Stifel.

 

Context for the Decision to Pursue an Exchange of the Preferred Stock.  Stifel considered a number of situational factors relevant to its analysis, including, but not limited to the following:

 

 

 

 

 

Financial Impact of the Recapitalization.  Stifel reviewed certain estimated future operating and financial information based on Management’s Expected Case developed by the Company for the 12-month periods ending December 31, 2011, December 31, 2012 and December 31, 2013 and the potential incremental financial impact of the recapitalization which estimates are shown in the table below. Based on this analysis, on a pro forma basis, the recapitalization is forecasted to be accretive to the Company’s earnings per share for each of the 12-month periods. The relevant estimates reviewed were as follows:

 

 

Additionally, Stifel reviewed the Company’s book value per share, a range of estimated adjusted common equity per share (as defined below), and gross estimated deferred tax asset per share as of December 31, 2010 and the potential incremental financial impact of the recapitalization on these figures, which estimates are shown in the table below. These estimates were made for the purposes of Stifel’s evaluation process only. These figures are not determined in accordance with GAAP.

 

For purposes of Stifel’s analysis:

 

 

 

 

 

Based on this analysis, the recapitalization is expected to be accretive to the Company’s earnings per share in 2011, 2012 and 2013; accretive to the Company’s December 31, 2010 book value per share and adjusted book value per share; and dilutive to the Company’s gross deferred tax asset per share. The estimates of future operating and financial information for the Company were based on the estimated balance sheet of the Company as of the date of the Exchange Agreement, but also give effect to several events which, at the date of the Exchange Agreement had not yet occurred but were assumed to occur in the future.

 

Liquidation Analysis.  Stifel estimated the value of the common equity of the Company assuming the liquidation of all of the assets and liabilities of the Company at their estimated realizable values. For purposes only of Stifel’s evaluation process, management provided Stifel with low and high estimates of fair market values. Stifel utilized this information to establish the estimates shown in the table below.

 

 

 

 

Based on this analysis the recapitalization is expected to be accretive or neutral to the Company’s liquidation value per common share.

 

Market Performance Summary.  Stifel reviewed the trading levels of the Common Stock and Series C Preferred Stock during the period since the announcement of the Series C Offer, as well as the implied aggregate value of the equity securities of the Company.