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New Century's (NEW) announcement yesterday that it'll need to restate several quarters because of "errors related to its allowance for loan repurchase losses" could be a preview of what could happen at NovaStar (NFI). This line is particularly pertinent:

The company's methodology for estimating the volume of repurchase claims to be included in the repurchase reserve calculation did not properly consider, in each of the first three quarters of 2006, the growing volume of repurchase claims outstanding that resulted from the increasing pace of repurchase requests that occurred in 2006...

Furthermore, the loans in question were repurchased because of early-payment defaults "by the underlying borrowers or based on alleged violations of misrepresentations and warranties in connection with the sale of these loans," otherwise known as "defects." As I noted in a this post, loan defects, caused by improper underwriting, can force NovaStar to repurchase loans. NovaStar has reserved slightly for whole loan sales and not at all for securitizations, which account for the bulk of its loan sales.

Stifel, Nicolaus came out with a report Wednesday saying that it is "very concerned" about the 2007 outlook for subprime lenders "as we believe profitability could be squeezed well beyond expectations. Among the issues, it says , is a sharp deterioration in credit. "These trends are clearly evident" at Novastar, "where 2006 delinquency trends have become progressively worse with each deal. All 2006 deals are aging worse than the worst prior deal..."

Source: NovaStar Heading for Fall?