Auditing

Deloitte Forecloses on NovaStar Stock Offerings

Without support from its auditor, the subprime-mortgage lender shelves its preferred stock offerings and begins a restructuring instead.
Stephen TaubSeptember 4, 2007

In another blow to the already reeling sub-prime industry, NovaStar Financial’s efforts to sell some $150 million in preferred stock were torpedoed by Deloitte & Touche. Alarmed by the impact of the subprime meltdown on NovaStar, the auditor refused to participate in the preferred stock sales unless NovaStar restated its 2006 results, and warned the company that the restatement would carry a “going concern” paragraph stating the auditor’s doubts about NovaStar’s ability to remain in business.

As a result, the subprime-mortgage lender announced Tuesday said it will not proceed with an offering of its 9 percent Series D-2 Mandatory Convertible Preferred Stock, which are convertible into common shares at $28. It had previously agreed to conduct the offering in connection with its sale of $48.8 million of its 9 percent Series D-1 Preferred Stock to affiliates of MassMutual Capital Partners LLC and funds managed by Jefferies Capital Partners IV LLC. NovaStar’s stock dropped more than 15 percent Tuesday on the news.

Under that deal, MassMutual and Jefferies had entered into a standby purchase agreement with NovaStar to purchase any shares of Series D-2 Preferred Stock not subscribed for in the rights offering. NovaStar said it canceled plans for the rights offering because it didn’t think it would meet all the necessary conditions for filing a registration statement for the offering.

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The company noted in its June 30 quarterly report that the problems in the subprime mortgage industry were affecting NovaStar’s operations, liquidity and financial condition during 2007. In its most recent announcement, it said those conditions worsened after its quarterly report was filed.

As a result, Deloitte & Touche LLP, NovaStar’s auditors, advised the company in the last week of August that it was not willing to issue a consent or otherwise be associated with the rights offering unless the company reissued its 2006 financial statements to include footnote disclosures regarding the company’s problems related to the subprime market. Deloitte also advised NovaStar that its reissued report would include an explanatory paragraph about the uncertainty of NovaStar’s ability to continue as a “going concern.”

NovaStar’s announcement said it would not be able to complete its 2006 financial statements and Deloitte’s audit report by August 30. Both MassMutual and Jefferies indicated that they were not willing to waive or extend the requirement of the standby purchase agreement, according to the announcement.

Without the expected cash from the offering, the company said it will take several steps to restructure the company’s overall operations. For example, it will focus primarily on managing the company’s portfolio of securitized residential loans, which totaled $15.45 billion as of June 30, 2007, and mortgage securities. It will reduce its retail lending organization from approximately 400 employees to about 125 employees and close 12 retail origination offices, concentrating retail activities in four offices. The company has also suspended new lending through the wholesale channel.

“We are pulling back to focus on NovaStar’s core strengths and preserve liquidity,” said CEO Scott Hartman. “In better times for the industry, operating a sizeable mortgage banking business to feed loans into the portfolio made strategic sense. But the secondary market has deteriorated substantially, so we are modifying our business model and further reducing costs for this difficult environment.”