##### Table of Contents





UNITED STATES SECURITIES AND
    EXCHANGE COMMISSIONWashington, D.C.
    20549
      Form 10-Q
  þ

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the
    Quarterly Period Ended March 31,
    2011o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the Transition Period Fromto       Commission File Number
    001-13533
  NOVASTAR FINANCIAL,
    INC.
 (Exact Name of Registrant as
    Specified in its Charter)
  Maryland(State or Other Jurisdiction
    of
    Incorporation or Organization)

74-2830661(I.R.S. Employer
    Identification No.)2114 Central Street,
    Suite 600, Kansas City, MO(Address of Principal
    Executive Office)

64108(Zip Code)   Registrants telephone number, including area code:
    (816) 237-7000
      þ o
   Regulation S-T o o
   12b-2
   Large
    accelerated
    filer o
    Accelerated
    filer o
    Non-accelerated
    filer o
    Smaller
    reporting
    company þ    Rule 12b-2 o þ




---



##### 





NOVASTAR
    FINANCIAL, INC.FORM 10-Q
    For the Quarterly Period Ended March 31, 2011
    TABLE OF CONTENTS
   
 PART I


Financial InformationItem 1.


Financial Statements (Unaudited)


1Condensed Consolidated Balance Sheets


1Condensed Consolidated Statements of
    Operations


2Condensed Consolidated Statement of
    Shareholders Deficit


3Condensed Consolidated Statements of Cash
    Flows


4Notes to Condensed Consolidated Financial
    Statements


6Item 2.


Managements Discussion and Analysis of
    Financial Condition and Results of Operations


28Item 3.


Quantitative and Qualitative Disclosures About
    Market Risk


37Item 4.


Controls and Procedures


37PART II


Other Information


38Item 1.


Legal Proceedings


38Item 1A.


Risk Factors


39Item 2.


Unregistered Sales of Equity Securities and Use
    of Proceeds


39Item 3.


Defaults Upon Senior Securities


39Item 4.


Removed and Reserved


39Item 5.


Other Information


39Item 6.


Exhibits


40Signatures


41EX-31.1EX-31.2EX-32.1EX-32.2




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##### Table of Contents



PART I.
    FINANCIAL INFORMATION  Item 1.
    Financial
    Statements  NOVASTAR
    FINANCIAL, INC.
  CONDENSED
    CONSOLIDATED BALANCE SHEETS
  March 31,


December 31,2011


2010(Unaudited; dollars in thousands, except share and per share
    amounts)ASSETSCurrent AssetsCash and cash equivalents

$
15,592


$
12,582Mortgage securities (includes CDO securities of $1,358 and
    $1,198, respectively)


5,658



5,778Notes receivable, net of allowance of $1,047 and $1,047,
    respectively


3,935



3,965Service fee receivable, net of allowance of $210 and $42,
    respectively


2,146



1,924Other current assets (includes CDO other assets of $276 and
    $299, respectively)


5,850



3,291Total current assets


33,181



27,540Non-Current AssetsProperty and equipment, net of depreciation


4,235



4,821Goodwill


3,170



3,170Other assets


2,009



2,330Total non-current assets


9,414



10,321Total assets

$
42,595


$
37,861LIABILITIES AND SHAREHOLDERS DEFICITLiabilities:Current LiabilitiesAccounts payable

$
5,108


$
4,590Accrued expenses (includes CDO other liabilities of $276 and $0,
    respectively)


6,995



5,883Dividends payable


55,191



50,900Other current liabilities (includes CDO debt of $1,358 and
    $1,497, respectively)


2,971



2,103Total current liabilities


70,265



63,476Non-Current LiabilitiesJunior subordinated debentures






78,086Senior debentures


78,149



Other liabilities


2,870



2,842Total non-current liabilities


81,019



80,928Total liabilities


151,284



144,404Commitments and contingencies (Note 9)Shareholders deficit:Capital stock, $0.01 par value per share,
    50,000,000 shares authorized:Redeemable preferred stock, $25 liquidating preference per share
    ($74,750 in total); 2,990,000 shares, issued and outstanding


30



30Convertible participating preferred stock, $25 liquidating
    preference per share ($52,500 in total); 2,100,000 shares,
    issued and outstanding


21



21Common stock, 9,368,053 shares issued and outstanding


94



94Additional paid-in capital


787,234



787,363Accumulated deficit


(900,702
)


(898,195
)Accumulated other comprehensive income


4,238



4,411Total NovaStar Financial, Inc. (NFI)
    shareholders deficit


(109,085
)


(106,276
)Noncontrolling interests


396



(267
)Total shareholders deficit


(108,689
)


(106,543
)Total liabilities and shareholders deficit

$
42,595


$
37,861    1




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##### Table of Contents



NOVASTAR
    FINANCIAL, INC.
  CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
  For the Three Months Ended March 31,2011


2010(Unaudited; dollars in thousands, except per share
    amounts)Income and Revenues:Service fee income

$
24,669


$
9,647Interest income  mortgage loans






10,848Interest income  mortgage securities


3,018



2,108Total


27,687



22,603Costs and Expenses:Cost of services


18,895



9,069Interest expense  asset-backed bonds






1,416Provision for credit losses






17,433Servicing fees






731Premiums for mortgage loan insurance






308Selling, general and administrative expense


5,533



5,544Gain on derecognition of securitization trusts






(993,131
)Other expense (income)


734



(573
)Total


25,162



(959,203
)Other income


91



794Interest expense


(312
)


(324
)Income before income tax expense


2,304



982,276Income tax expense


31



412Net income


2,273



981,864Less: Net income (loss) attributable to noncontrolling interests


490



(561
)Net income attributable to NFI

$
1,783


$
982,425Earnings (Loss) Per Share attributable to NFI:Basic

$
(0.27
)

$
87.27Diluted

$
(0.27
)

$
87.27Weighted average basic shares outstanding


9,338,512



9,337,207Weighted average diluted shares outstanding


9,338,512



9,337,207    2




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##### Table of Contents



NOVASTAR
    FINANCIAL, INC.
  CONDENSED CONSOLIDATED STATEMENTS OF
    SHAREHOLDERS DEFICIT
  Total NFI Shareholders DeficitConvertible











AccumulatedRedeemable


Participating





Additional





Other





TotalPreferred


Preferred


Common


Paid-in


Accumulated


Comprehensive


Noncontrolling


ShareholdersStock


Stock


Stock


Capital


Deficit


Income


Interest


Deficit(Unaudited; dollars in thousands)Balance, January 1, 2011

$
30


$
21


$
94


$
787,363


$
(898,195
)

$
4,411


$
(267
)

$
(106,543
)Compensation recognized under stock compensation plans














146















146Accumulating dividends on preferred stock


















(4,290
)










(4,290
)Distributions to noncontrolling interests


























(102
)


(102
)Transfer from noncontrolling interests














(275
)










275



Comprehensive income:Net income


















1,783







490



2,273Other comprehensive income






















(173
)






(173
)Total comprehensive income






























2,100Balance, March 31, 2011

$
30


$
21


$
94


$
787,234


$
(900,702
)

$
4,238


$
396


$
(108,689
)   Total NFI Shareholders DeficitConvertible











AccumulatedRedeemable


Participating





Additional





Other








TotalPreferred


Preferred


Common


Paid-in


Accumulated


Comprehensive





Noncontrolling


ShareholdersStock


Stock


Stock


Capital


Deficit


Income


Other


Interest


Deficit(Unaudited; dollars in thousands)Balance, January 1, 2010

$
30


$
21


$
94


$
786,989


$
(1,868,398
)

$
5,111


$
(70
)

$
(329
)

$
(1,076,552
)Forgiveness of founders notes receivable


























18







18Compensation recognized under stock compensation plans














114



















114Accumulating dividends on preferred stock


















(3,975
)














(3,975
)Other






























2



2Comprehensive income:Net income (loss)


















982,425











(561
)


981,864Other comprehensive income






















1,105











1,105Total comprehensive income


































982,969Balance, March 31, 2010

$
30


$
21


$
94


$
787,103


$
(889,948
)

$
6,216


$
(52
)

$
(888
)

$
(97,424
)    3




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##### Table of Contents



NOVASTAR
    FINANCIAL, INC.
  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
  For the Three Months Ended March 31,2011


2010(Unaudited; dollars in thousands)Cash flows from operating activities:Net income

$
2,273


$
981,864Adjustments to reconcile net income to net cash used in
    operating activities:Accretion of mortgage securities


(602
)


(705
)Provision for bad debt on notes receivable






452Amortization of premiums on mortgage loans






430Amortization of deferred debt issuance costs and senior
    debentures discount


63



448Provision for credit losses






17,433Fair value adjustments of trading securities and CDO debt


(266
)


(180
)Gain on derecognition of securitization trusts






(993,131
)Gains on derivative instruments






(26
)Loss on disposal of fixed assets


234



6Forgiveness of founders promissory notes






18Compensation recognized under stock compensation plans


146



114Depreciation expense


500



188Changes in:Accrued interest receivable






1,300Service Fee Receivable


(222
)


(1,056
)Other assets and other liabilities, net


(1,334
)


3,015Due to servicer






(5,080
)Accounts payable and other liabilities


1,630



1,286Net cash provided by operating activities


2,422



6,376Cash flows from investing activities:Proceeds from paydowns of mortgage securities 
    available-for-sale


594



1,569Proceeds from paydowns of mortgage securities  trading






227Proceeds from repayments of mortgage loans
    held-in-portfolio






15,041Proceeds from sales of assets acquired through foreclosure






15,154Restricted cash, net


215



3,441Proceeds from paydowns of notes receivable


30



426Issuance of notes receivable






(706
)Purchases of property and equipment


(149
)


(2
)Net cash provided by investing activities


690



35,150Cash flows from financing activities:Payments on asset-backed bonds






(35,341
)Distributions to noncontrolling interests


(102
)


Other






(45
)Net cash used in financing activities


(102
)


(35,386
)Net increase in cash and cash equivalents


3,010



6,140Cash and cash equivalents, beginning of period


12,582



7,104Cash and cash equivalents, end of period

$
15,592


$
13,244    4




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##### Table of Contents



Supplemental
    Disclosure of Cash Flow Information
  For the Three MonthsEnded March 31,2011


2010(Unaudited; dollars in thousands)Cash paid for interest

$
653


$
2,577Cash paid for income taxes






256Cash received on mortgage securities 
    available-for-sale
    with no cost basis


2,417



1,403Non-cash investing and financing activities:Assets acquired through foreclosure






6,283Preferred stock dividends accrued, not yet paid


4,290



3,975Transfer of assets and liabilities upon derecognition of
    securitization trusts:Mortgage loans 
    held-in-portfolio,
    net of allowance






1,250,287Accrued interest receivable






72,725Real estate owned






55,309Asset-backed bonds secured by mortgage loans






2,235,629Due to servicer






131,772Other liabilities






4,047    5




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##### Table of Contents



NOVASTAR
    FINANCIAL, INC.



NOTES TO
    CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


As of and for the period ended March 31, 2011
    (Unaudited) Note 1.
    Financial
    Statement Presentation  Description of Operations
          2006-1, 2007-1.
  Financial Statement Presentation 
 6




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##### Table of Contents



 available-for-sale
        Form 10-K
  Business Plan and Liquidity
        start-up
   7




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##### Table of Contents



Note 2.
    New
    Accounting Pronouncements  A Creditors
    Determination of Whether a Restructuring is a Troubled Debt
    Restructuring
  Note 3.
    Business
    Combinations      TotalAssets:Cash

$
107Other current assets


50Property and equipment, net


3,465Liabilities:Accounts payable


(131
)Accrued expenses


(34
)Other noncurrent liabilities


(459
)Noncontrolling interests


(1,498
)Total cash consideration

$
1,500   Note 4.
    Derecognition
    of Securitization Trusts  2006-1, 2007-1.
  2006-1
 8




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##### Table of Contents



2006-1
  2007-1 2007-1
      TotalAssets:Mortgage loans 
    held-in-portfolio

$
1,953,188Allowance for loan losses


(702,901
)Accrued interest receivable


72,725Real estate owned


55,309Total assets


1,378,321Liabilities:Asset-backed bonds secured by mortgage loans


2,235,633Due to servicer


131,772Other liabilities


4,047Total liabilities


2,371,452Gain on derecognition of securitization trusts

$
993,131   Note 5.
    Securitization
    Transactions  held-in-portfolio
  2006-1 2007-1
  held-in-portfolio held-in-portfolio
 9




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##### Table of Contents



held-in-portfolio
  For the ThreeMonths EndedMarch 31, 2010Balance, beginning of period

$
712,614Provision for credit losses


17,433Charge-offs, net of recoveries


(27,146
)Derecognition of the securitization trusts


(702,901
)Balance, end of period

$
           Securitization transactions.
  Mortgage Loan VIEs. 2006-1
 10




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##### Table of Contents



2007-1
    Collateralized Debt Obligations
    (CDO).
  Variable
    Interest Entities
      Assets After Intercompany Eliminations

Liabilities After Intercompany

Recourse to theConsolidated VIEs

Total Assets

Unrestricted

Restricted(A)

Eliminations

Company(B)March 31, 2011CDO(C)

$
1,634


$



$
1,634


$
1,634


$
December 31, 2010CDO(C)


1,499







1,497



1,497



  11




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##### Table of Contents



(A)
    
    Assets are considered restricted when they cannot be freely
    pledged or sold by the Company.(B)
    
    This column reflects the extent, if any, to which investors have
    recourse to the Company beyond the assets held by the VIE and
    assumes a total loss of the assets held by the VIE.(C)
    
    Assets are primarily recorded in Mortgage securities and
    liabilities are recorded in Other current liabilities.  Securitizations
      Assets on


Liabilities


Maximum


Year to


Year toSize/Principal


Balance


on Balance


Exposure to


Date Loss


Date CashOutstanding(A)


Sheet(B)


Sheet


Loss(C)


on Sale


FlowsMarch 31, 2011

$
6,962,826


$
4,300


$



$
4,300


$



$
2,752December 31, 2010

$
7,189,121


$
4,580


$



$
4,580


$



$
2,838
(D)     (A)
    
    Size/Principal Outstanding reflects the estimated principal of
    the underlying assets held by the VIE.(B)
    
    Assets on balance sheet are securities issued by the entity and
    are recorded in Mortgage securities.(C)
    
    The maximum exposure to loss includes the assets held by the
    Company. The maximum exposure to loss assumes a total loss on
    the referenced assets held by the VIE.(D)
    
    For the three months ended March 31, 2010.  available-for-sale
   12




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##### Table of Contents



Carrying amount/fair value of residual interests

$
4,300Weighted average life (in years)


2.41Weighted average prepayment speed assumption (CPR) (percent)


13.6Fair value after a 10% increase in prepayment speed

$
4,300Fair value after a 25% increase in prepayment speed

$
4,157Weighted average expected annual credit losses (percent of
    current collateral balance)


5.2Fair value after a 10% increase in annual credit losses

$
4,225Fair value after a 25% increase in annual credit losses

$
4,082Weighted average residual cash flows discount rate (percent)


25.0
%Fair value after a 500 basis point increase in discount rate

$
4,169Fair value after a 1000 basis point increase in discount
    rate

$
4,043Market interest rates:Fair value after a 100 basis point increase in market rates

$
2,915Fair value after a 200 basis point increase in market rates

$
1,732     Note 6.
    Mortgage
    Securities  available-for-sale
  March 31, 2011


December 31, 2010Mortgage securities 
    available-for-sale

$
4,300


$
4,580Mortgage securities  trading


1,358



1,198Total mortgage securities

$
5,658


$
5,778   available-for-sale 2006-1, 2007-1, Series 2007-2
  securities  available-for-sale
  Unrealized


Estimated


AverageCost Basis


Gain


Fair Value


Yield(A)As of March 31, 2011

$
62


$
4,238


$
4,300



471.6
%As of December 31, 2010


169



4,411



4,580



483.2     (A)
    
    The average yield is calculated from the cost basis of the
    mortgage securities and does not give effect to changes in fair
    value that are reflected as a component of shareholders
    deficit. 13




---



##### Table of Contents



other-than-temporary available-for-sale
    2006-1, 2007-1, Series 2007-2
    Amortized





AverageOriginal Face


Cost Basis


Fair Value


Yield(A)As of March 31, 2011Subordinated securities pledged to CDO

$
369,507


$
57,313


$
1,358Other subordinated securities


215,280







Total

$
584,787


$
57,313


$
1,358



1.86
%As of December 31, 2010Subordinated securities pledged to CDO

$
369,507


$
73,900


$
1,198Other subordinated securities


215,280







Total

$
584,787


$
73,900


$
1,198



1.96
%     (A)
    
    Calculated from the ending fair value of the securities.    Note 7.
    Notes
    Receivable and Allowance for Doubtful Accounts  and/or
     14




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##### Table of Contents



March 31, 2011


March 31, 2010Balance, beginning of period

$
1,047


$
300Provision for credit losses






452Charge-offs






(9
)Balance, end of period

$
1,047


$
743     Note 8.
    Borrowings  Senior
    Debentures
      Junior
    Subordinated Debentures
    Note 9.
    Commitments
    and Contingencies   15




---



##### Table of Contents



Pending
    Litigation.
           16




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##### Table of Contents



Trust Series 2005-4
  Note 10.
    Comprehensive
    Income    For the Three Months Ended March 31,2011


2010Net income

$
2,273


$
981,864Other comprehensive (loss) income:Change in unrealized gain (loss) on mortgage
    securities 
    available-for-sale


(173
)


1,105Other comprehensive income (loss)


(173
)


1,105Total comprehensive income


2,100



982,969Comprehensive (income) loss attributable to noncontrolling
    interests


(490
)


561Total comprehensive income attributable to NFI(A)

$
1,610


$
983,530     (A)
    
    Due to the valuation allowance the Company has recorded on
    deferred income taxes, there is no net income tax expense
    recorded against other comprehensive income (loss).  Note 11.
    Fair
    Value Accounting  Fair
    Value Measurements
  Fair Value Measurements Fair Value Measurements
    
    Level 1  Quoted prices for identical
    instruments in active markets.
    Level 2  Quoted prices for similar
    instruments in active markets; quoted prices for identical or
    similar instruments in markets that are not active; and
    model-derived valuations whose inputs are observable or whose
    significant value drivers are observable.
    Level 3  Instruments whose significant
    value drivers are unobservable.   17




---



##### Table of Contents



Fair Value Measurements at Reporting Date UsingQuoted Prices in





SignificantActive Markets for


Significant Other


UnobservableFair Value at


Identical Assets


Observable Inputs


InputsDescription

March 31, 2011


(Level 1)


(Level 2)


(Level 3)Assets:Mortgage securities  trading

$
1,358


$



$



$
1,358Mortgage securities 
    available-for-sale


4,300











4,300Total assets

$
5,658


$



$



$
5,658Liabilities:Asset-backed bonds secured by mortgage securities

$
1,358


$



$



$
1,358Contingent consideration(A)


450











450Total liabilities

$
1,808


$



$



$
1,808     (A)
    
    The contingent consideration represents the estimated fair value
    of the additional potential earn-out opportunity payable in
    connection with our acquisition of Corvisa that is contingent
    and based upon certain future earnings targets. The company
    estimated the fair value using projected revenue over the
    earn-out period, and applied a discount rate to the projected
    earn-out payments that approximated the weighted average cost of
    capital.  Fair Value Measurements at Reporting Date UsingQuoted Prices in





SignificantActive Markets for


Significant Other


UnobservableFair Value at


Identical Assets


Observable Inputs


InputsDescription

December 31, 2010


(Level 1)


(Level 2)


(Level 3)Assets:Mortgage securities  trading

$
1,198


$



$



$
1,198Mortgage securities 
    available-for-sale


4,580











4,580Total assets

$
5,778


$



$



$
5,778Liabilities:Asset-backed bonds secured by mortgage securities

$
1,198


$



$



$
1,198Contingent consideration(A)


450











450Total liabilities

$
1,648


$



$



$
1,648     (A)
    
    The contingent consideration represents the estimated fair value
    of the additional potential earn-out opportunity payable in
    connection with our acquisition of Corvisa that is contingent
    and based upon certain future earnings targets. The company
    estimated the fair value using projected revenue over the
    earn-out period, and applied a discount rate to the projected
    earn-out payments that approximated the weighted average cost of
    capital. 18




---



##### Table of Contents



Estimated FairValue of MortgageCost Basis


Unrealized Loss


SecuritiesAs of December 31, 2010

$
73,900


$
(72,702
)

$
1,198Increases (decreases) to mortgage securities  tradingAccretion of income


375







375Proceeds from paydowns of securities


(259
)






(259
)Other than temporary impairments


(16,703
)


16,703



Mark-to-market
    value adjustment






44



44Net (decrease) increase to mortgage securities 
    trading


(16,587
)


16,747



160As of March 31, 2011

$
57,313


$
(55,955
)

$
1,358   Estimated FairValue of MortgageCost Basis


Unrealized Loss


SecuritiesAs of December 31, 2009

$
104,013


$
(102,926
)

$
1,087Increases (decreases) to mortgage securities  tradingAccretion of income


278







278Proceeds from paydowns of securities


(227
)






(227
)Other than temporary impairments


(15,876
)


15,876



Mark-to-market
    value adjustment






(354
)


(354
)Net (decrease) increase to mortgage securities 
    trading


(15,825
)


15,522



(303
)As of March 31, 2010

$
88,188



(87,404
)


784   available-for-sale
  Estimated FairValue of MortgageCost Basis


Unrealized Gain


SecuritiesAs of December 31, 2010

$
169


$
4,411


$
4,580Increases (decreases) to mortgage securities 
    available-for-saleAccretion of income(A)


227







227Proceeds from paydowns of securities(A) (B)


(334
)






(334
)Mark-to-market
    value adjustment






(173
)


(173
)Net (decrease) increase to mortgage securities 
    available-for-sale


(107
)


(173
)


(280
)As of March 31, 2011

$
62


$
4,238


$
4,300     (A)
    
    Cash received on mortgage securities with no cost basis was
    $2.4 million for the three months ended March 31, 2011. 19




---



##### Table of Contents



(B)
    
    For mortgage securities with a remaining cost basis, the Company
    reduces the cost basis by the amount of cash that is
    contractually due from the securitization trusts. In contrast,
    for mortgage securities in which the cost basis has previously
    reached zero, the Company records in interest income the amount
    of cash that is contractually due from the securitization
    trusts. In both cases, there are instances where the Company may
    not receive a portion of this cash until after the balance sheet
    reporting date. Therefore, these amounts are recorded as
    receivables from the securitization trusts. As of March 31,
    2011, the Company had no receivables from securitization trusts.  Estimated FairValue of MortgageCost Basis


Unrealized Gain


SecuritiesAs of December 31, 2009

$
1,794


$
5,109


$
6,903Increases (decreases) to mortgage securities 
    available-for-saleAccretion of income(A)


427







427Proceeds from paydowns of securities(A) (B)


(1,569
)






(1,569
)Mark-to-market
    value adjustment






1,105



1,105Net (decrease) increase to mortgage securities 
    available-for-sale


(1,142
)


1,105



(37
)As of March 31, 2010

$
652


$
6,214


$
6,866     (A)
    
    Cash received on mortgage securities with no cost basis was
    $1.4 million for the three months ended March 31, 2010.(B)
    
    For mortgage securities with a remaining cost basis, the Company
    reduces the cost basis by the amount of cash that is
    contractually due from the securitization trusts. In contrast,
    for mortgage securities in which the cost basis has previously
    reached zero, the Company records in interest income the amount
    of cash that is contractually due from the securitization
    trusts. In both cases, there are instances where the Company may
    not receive a portion of this cash until after the balance sheet
    reporting date. Therefore, these amounts are recorded as
    receivables from the securitization trusts. As of March 31,
    2010, the Company had no receivable due from securitization
    trusts.    Fair Value AdjustmentsFair Value

For the Three MonthsAsset or Liability Measured at

Measurement

Ended March 31,


Statement of Operation LineFair Value

Frequency

2011


2010


Item ImpactedMortgage securities  trading

Recurring

$
44


$
(354
)

Other income (expense)Mortgage securities 
    available-for-sale

Recurring









Other income (expense)Real estate owned(A)

Nonrecurring






(178
)

Provision for credit lossesDerivative instruments, net

Recurring






157


Other income (expense)Asset-backed bonds secured by mortgage securities

Recurring


222



534


Other income (expense)Total fair value losses



$
266


$
159     (A)
    
    The Company did not hold any Real Estate Owned as of
    March 31, 2011.  Valuation
    Methods
  Mortgage securities 
    trading.
 20




---



##### Table of Contents



Mortgage securities 
    available-for-sale. available-for-sale
  Derivative instruments.
  Asset-backed bonds secured by mortgage
    securities.
  Real estate owned.
  Fair
    Value Option for Financial Assets and Financial
    Liabilities
      Unpaid Principal


Year to Date GainUnpaid Principal Balance as of

Balance


Recognized


Fair ValueMarch 31, 2011

$
324,841


$
222


$
1,358December 31, 2010


324,662



534
(A)


1,198     (A)
    
    For the Three Months Ended March 31, 2010.  Note 12.
    Property
    and Equipment, Net   21




---



##### Table of Contents



March 31,


December 31,2011


2010Furniture, fixtures and office equipment

$
832


$
803Hardware and computer equipment


2,174



2,148Software


5,480



5,794Leasehold improvements


258



258Less: Accumulated depreciation and amortization


(4,509
)


(4,182
)$
4,235


$
4,821   Note 13.
    Goodwill      Note 14.
    Income
    Taxes    Accounting for Uncertainty in Income Taxes
  Note 15.
    Segment
    Reporting  start-up
 22




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##### Table of Contents



For the
    Three Months Ended March 31, 2011
  Appraisal


FinancialCorporate


Management


Intermediary


Eliminations


TotalIncome and Revenues:Service fee income

$



$
18,886


$
5,783


$



$
24,669Interest income  mortgage securities


3,018















3,018Total


3,018



18,886



5,783







27,687Costs and Expenses:Cost of services






16,694



2,201







18,895Selling, general and administrative expense


3,713



1,521



791



(492
)


5,533Other expenses (income)


360



30



204



140



734Total


4,073



18,245



3,196



(352
)


25,162Other income


433



10







(352
)


91Interest expense


(312
)














(312
)Income (loss) before income tax expense


(934
)


651



2,587







2,304Income tax expense


31















31Net income (loss)


(965
)


651



2,587







2,273Less: Net income (loss) attributable to noncontrolling interests






(183
)


673







490Net income (loss) attributable to NFI

$
(965
)

$
834


$
1,914


$



$
1,783Depreciation and amortization expense(A)

$
43


$
422


$
35


$



$
500Additions to long-lived assets

$
16


$
129


$
4


$



$
149March 31, 2011:Total assets(B)

$
26,267


$
15,001


$
3,318


$
(1,991
)

$
42,595     (A)
    
    Amounts are included in the cost of services and selling,
    general and administrative expense line item of the consolidated
    statements of operations.(B)
    
    Appraisal management segment includes goodwill of
    $3.2 million.   23




---



##### Table of Contents



For the
    Three Months Ended March 31, 2010
  Securitization





AppraisalTrusts


Corporate


Management


Eliminations


TotalIncome and Revenues:Service fee income

$



$



$
9,647


$



$
9,647Interest income  mortgage loans


10,681











167



10,848Interest income  mortgage securities


246



1,862











2,108Total


10,927



1,862



9,647



167



22,603Costs and Expenses:Cost of services










9,069







9,069Interest expense  asset-backed bonds


1,416















1,416Provision for credit losses


17,433















17,433Servicing fees


731















731Premiums for mortgage loan insurance


297



11











308Selling, general and administrative expense


14



4,756



774







5,544Gain on derecognition of securitization trusts


(993,131
)














(993,131
)Other expenses (income)


560



(1,222
)


19



70



(573
)Total


(972,680
)


3,545



9,862



70



(959,203
)Other income






794











794Interest expense






(324
)










(324
)Income (loss) before income tax expense


983,607



(1,213
)


(215
)


97



982,276Income tax expense






412











412Net income (loss)


983,607



(1,625
)


(215
)


97



981,864Less: Net loss attributable to noncontrolling interests






(535
)


(26
)






(561
)Net income (loss) attributable to NFI

$
983,607


$
(1,090
)

$
(189
)

$
97


$
982,425Depreciation and amortization expense(A)

$



$
72


$
116


$



$
188Additions to long-lived assets

$



$
2


$



$



$
2December 31, 2010:Total assets(B)

$
1,497


$
30,144


$
13,781


$
(7,561
)

$
37,861     (A)
    
    Amounts are included in the cost of services and selling,
    general and administrative expense line item of the consolidated
    statements of operations.(B)
    
    Appraisal management segment includes goodwill of
    $3.2 million.  Note 16.
    Earnings
    per Share  Earnings per Share
 24




---



##### Table of Contents



For the Three MonthsEnded March 31,2011


2010Numerator:Net income

$
2,273


$
981,864Less income (loss) attributable to noncontrolling interests


490



(561
)Dividends on preferred shares


(4,290
)


(3,975
)Allocation of undistributed income to convertible participating
    preferred stock






(163,625
)Income (loss) available to common shareholders

$
(2,507
)

$
814,825Denominator:Weighted average common shares outstanding  basic


9,338,512



9,337,207Weighted average common shares outstanding  dilutive:Weighted average common shares outstanding  basic


9,338,512



9,337,207Stock options






Weighted average common shares outstanding  dilutive


9,338,512



9,337,207Basic earnings per share:Net income

$
0.24


$
105.16Less income (loss) attributable to noncontrolling interests


0.05



(0.06
)Dividends on preferred shares


(0.46
)


(0.43
)Allocation of undistributed income to convertible participating
    preferred stock






(17.52
)Net income (loss) available to common shareholders

$
(0.27
)

$
87.27Diluted earnings per share:Net income

$
0.24


$
105.16Less income (loss) attributable to noncontrolling interests


0.05



(0.06
)Dividends on preferred shares


(0.46
)


(0.43
)Allocation of undistributed income to convertible participating
    preferred stock






(17.52
)Net income (loss) available to common shareholders

$
(0.27
)

$
87.27     For the Three MonthsEnded March 31,2011


2010Number of stock options (in thousands)


368



277Weighted average exercise price of stock options

$
16.89


$
22.22  25




---



##### Table of Contents



Note 17.
    Fair
    Value of Financial Instruments      As of March 31, 2011


As of December 31, 2010Carrying Value


Fair Value


Carrying Value


Fair ValueFinancial assets:Cash and cash equivalents

$
15,592


$
15,592


$
12,582


$
12,582Restricted cash


3,918



3,816



1,413



1,341Mortgage securities  trading


1,358



1,358



1,198



1,198Mortgage securities 
    available-for-sale


4,300



4,300



4,580



4,580Financial liabilities:Borrowings:Asset-backed bonds secured by mortgage securities


1,358



1,358



1,198



1,198Senior debentures


78,149



9,863







Junior subordinated debentures










78,086



17,988   Cash and cash equivalents
  Restricted Cash
  Mortgage securities- trading 
  Mortgage securities 
    available-for-sale
  Asset-backed bonds secured by mortgage
    securities
  Senior debentures
  Junior subordinated debentures
 26




---



##### Table of Contents



Note 18.
    Proposed
    Recapitalization of Preferred Stock.  Form S-4 No. 333-171115), Form S-4),
  Form S-4,
  
    3 shares of newly-issued Common Stock of the Company, and
    $2.00 in cash; or
    19 shares of newly-issued Common Stock (the
    Series C Offer).  Form S-4
       27




---



##### Table of Contents



Item 2.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  Form 10-K
  Executive
    Overview
  Corporate Overview, Background and Strategy
        Significant
    Recent Events  Proposed Recapitalization of Preferred
    Stock.
  Form S-4 No. 333-171115), Form S-4),
 28




---



##### Table of Contents



Form S-4,
  
    3 shares of newly-issued common stock of the Company, par
    value $0.01 per share (the Common Stock), and $2.00
    in cash; or
    19 shares of newly-issued Common Stock (the
    Series C Offer).  Form S-4
        Critical Accounting Policies  Form 10-K Form 10-K
  Strategy and/or
    
    maintaining
    and/or
    generating adequate liquidity to sustain us and allow us to take
    advantage of investment opportunity, and
    generating income for our shareholders.   29




---



##### Table of Contents



Table
    1  Summary of Financial Highlights and Key
    Performance Metrics
 (Dollars in thousands; except per share amounts)
  March 31,


December 31,2011


2010Unrestricted cash and cash equivalents


$15,592



$12,582   For the Three MonthsEnded March 31,2011


2010Net (loss) income available to common shareholders per diluted
    share


$(0.27
)


$87.27   Liquidity available-for-sale.
        Impact on
    Our Financial Statements of Derecognition of Securitized
    Mortgage Assets
  2006-1, 2007-1. 2006-1, 2007-1
 30




---



##### Table of Contents



Table
    2  Assets and Liabilities of Loan Trusts and Gain
    Recognized upon Derecognition
 (Dollars in thousands)
  NHEL 2006 -MTA1


NHEL 2006 - 1


NHEL 2007 - 1


Eliminations(A)


TotalAssets:Mortgage loans 
    held-in-portfolio

$
528,388


$
399,507


$
1,033,296


$
(8,003
)

$
1,953,188Allowance for loan losses


(147,147
)


(115,191
)


(440,563
)






(702,901
)Accrued interest receivable


6,176



20,521



46,028







72,725Real estate owned


11,842



17,919



25,548







55,309Total assets


399,259



322,756



664,309



(8,003
)


1,378,321Liabilities:Asset-backed bonds


588,434



465,164



1,175,608



6,427



2,235,633Due to servicer


17,298



32,835



81,639







131,772Other liabilities


9,432



12,368



24,017



(41,770
)


4,047Total liabilities


615,164



510,367



1,281,264



(35,343
)


2,371,452Gain on derecognition of securitization trusts

$
215,905


$
187,611


$
616,955


$
(27,340
)

$
993,131     (A)
    
    Eliminations relate to intercompany accounts at the consolidated
    financial statement level, there are no intercompany balances
    between the securitization trusts.  Impact of
    Recently Issued Accounting Pronouncements
  A Creditors
    Determination of Whether a Restructuring is a Troubled Debt
    Restructuring
  Financial
    Condition as of March 31, 2011 as Compared to
    December 31, 2010
    Cash and Cash Equivalents
  Mortgage Securities
   31




---



##### Table of Contents



available-for-sale
  Table
    3  Values of Individual Mortgage
    Securities 
    Available-for-Sale
    (Dollars in thousands)
  March 31, 2011


December 31, 2010Constant


Expected








Constant


ExpectedSecuritization

Estimated


Discount


Pre-payment


Credit


Estimated


Discount


Pre-payment


CreditTrust(A)

Fair Value


Rate


Rate


Losses


Fair Value


Rate


Rate


Losses2002  3

$
1,573



25
%


16
%


1.1
%

$
1,359



25
%


17
%


1.0
%2003  1


2,286



25



15



2.2



2,355



25



17



2.22003  3


401



25



12



1.9



553



25



12



2.52003  4


40



25



14



2.4



313



25



15



2.6Total

$
4,300














$
4,580     (A)
    
    We established the trust upon securitization of the underlying
    loans, which generally were originated by us.  Other Current Assets
  Dividends Payable
  Senior Debentures and Junior Subordinated
    Debentures
  Results
    of Operations  Consolidated Earnings
    Comparisons
  Securitization Trusts; Gain on Derecognition of
    Securitization Trusts
 32




---



##### Table of Contents



Table
    4  Income (Expense) of Consolidated Loan
    Securitization; Gain on Disposition of Mortgage Assets (Dollars
    in thousands)
  For the Three MonthsEnded March 31,2010Gain on derecognition of securitization trusts

$
993,131Interest income  mortgage loans


10,681Interest expense  asset-backed bonds


(1,416
)Provision for credit losses


(17,433
)Servicing fees


(731
)Premiums for mortgage loan insurance


(297
)Other expense


(560
)   Selling, General and Administrative Expenses
  Appraisal Management: Service Fee Income and Cost of
    Services
  Table
    5  Appraisal Management Segment Operations (Dollars
    in thousands, except unit and per unit amounts)
  For the Three Months Ended March 31,2011


2010Total


Per Unit


Total


Per UnitCompleted appraisal orders (units)


51,116







25,527Service fee income

$
18,886


$
369


$
9,647


$
378Cost of services


16,694



327



9,069



355Selling, general and administrative expense


1,521



29



774



30Other expense


30



1



19



1Other income


10











Net income (loss)


651



12



(215
)


(8
)Less: Net loss attributable to noncontrolling interests


(183
)


(4
)


(26
)


(1
)Net income (loss) attributable to NFI

$
834


$
16


$
(189
)

$
(7
)    33




---



##### Table of Contents




    appraisers must be paid customary and reasonable
    compensation,
    regulatory agencies must implement uniform appraisal standards
    for all federal appraisals,
    appraisal management companies must register with state
    agencies, and
    regulatory agencies must implement certain quality control
    standards for automated valuation models.    Financial Intermediary: Service Fee Income and Cost of
    Services
      Table
    6  Financial Intermediary Segment Operations (Dollars
    in thousands, except unit and per unit amounts)
  For the Three MonthsEnded March 31, 2011Settlements completed


284,445Banking accounts enrolled


32,406   34




---



##### Table of Contents



Total


Per UnitService fee income:Settlement

$
5,251


$
18.46Banking account distribution


532


$
16.425,783Cost of services


2,201Selling, general and administrative expense


791Other expense


2043,196Net income


2,587Less: Net income attributable to noncontrolling interests


673Net income attributable to NFI

$
1,914     Corporate: Interest Income  Mortgage
    Securities
  Selling, General and Administrative Expenses
  Interest expense
  Contractual
    Obligations
    Table
    7  Contractual Obligations (Dollars in
    thousands)
  As of March 31, 2011Payments Due by PeriodLess than








After 5Contractual Obligations

Total


1 Year


1 - 3 Years


3 - 5 Years


YearsSenior debentures

$
147,158


$
874


$
871


$
3,019


$
142,394Operating leases


2,807



1,358



843



606



Contingent consideration payments related to Corvisa acquisition


450







450







Vendor agreement


300



300











Total obligations

$
150,715


$
2,532


$
2,164


$
3,625


$
142,394    35




---



##### Table of Contents



Liquidity
    and Capital Resources
      start-up
       36




---



##### Table of Contents



Overview
    of Cash Flow for the Three Months Ended March 31,
    2011
  Summary
    of Statement of Cash Flows  Operating, Investing and
    Financing Activities
    Table
    8  Summary of Operating, Investing and Financing Cash
    Flows (Dollars in thousands)
  For the Three Months Ended March 31,2011

2010Consolidated Statements of Cash Flows:Cash provided by operating activities

$
2,422


$
6,376Cash flows provided by investing activities


690



35,150Cash flows used in financing activities


(102
)


(35,386
)   Operating Activities.
  Investing Activities.
  Financing Activities.
  Item 3.
    Quantitative
    and Qualitative Disclosures About Market Risk    Item 4.
    Controls
    and Procedures  Disclosure
    Controls and Procedures
  Rules 13a-15(e) 15d-15(d))
  Changes
    in Internal Control over Financial Reporting
   37




---



##### Table of Contents



PART II.
    OTHER INFORMATION  Item 1.
    Legal
    Proceedings  Pending
    Litigation.
           38




---



##### Table of Contents



Trust Series 2005-4
  Item 1A.
    Risk
    Factors  Risk
    Factors
  Form 10-K
  Item 2.
    Unregistered
    Sales of Equity Securities and Use of Proceeds (Dollars in
    thousands)  Issuer Purchases of Equity SecuritiesTotal Number ofShares

Approximate DollarPurchased as

Value of SharesPart of Publicly

That May Yet BeTotal Number

Average

Announced

Purchased Underof Shares

Price Paid

Plans or

the Plans orPurchased

per Share

Programs

Programs(A)January 1  January 31, 2011













$
1,020February 1  February 28, 2011













$
1,020March 1, 2010  March 31, 2011













$
1,020     (A)
    
    A current report on
    Form 8-K
    was filed on October 2, 2000 announcing that the Board of
    Directors authorized the Company to repurchase its common
    shares, bringing the total authorization to $9 million. The
    Company has repurchased $8.0 million to date, leaving
    approximately $1.0 million of shares that may yet be
    purchased under the plan.  Item 3.
    Defaults
    Upon Senior Securities    Item 4.
    Removed
    and Reserved  Item 5.
    Other
    Information   39




---



##### Table of Contents



Item 6.
    Exhibits  Exhibit Listing
  ExhibitNo.

Description of Document11
.1(1)

Statement Regarding Computation of Per Share Earnings31
.1

Chief Executive Officer Certification 
    Section 302 of the Sarbanes-Oxley Act of 200231
.2

Principal Financial Officer Certification 
    Section 302 of the Sarbanes-Oxley Act of 200232
.1

Chief Executive Officer Certification 
    Section 906 of the Sarbanes-Oxley Act of 200232
.2

Principal Financial Officer Certification 
    Section 906 of the Sarbanes-Oxley Act of 2002     (1)
    
    See Note 16 to the condensed consolidated financial
    statements. 40




---



##### Table of Contents



SIGNATURES      DATE: May 11, 2011

/s/  W.
    Lance AndersonW.
    Lance Anderson, Chairman of the Board of Directors and Chief
    Executive Officer
    (Principal Executive Officer)DATE: May 11, 2011

/s/  Rodney
    E.
    SchwatkenRodney
    E. Schwatken, Chief Financial Officer
    (Principal Financial Officer) 41