NOVATION COMPANIES, INC. - Quarter Report: 2012 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2012



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From to

Commission File Number 001-13533

NOVATION COMPANIES, 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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No 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.



Large accelerated filer	Accelerated filer	Non-accelerated filer	Smaller reporting company
o	o	o	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

The number of shares of the Registrant's Common Stock outstanding on August 3, 2012 was 91,479,519.

NOVATION COMPANIES, INC.

FORM 10-Q

For the Quarterly Period Ended June 30, 2012

TABLE OF CONTENTS



PART I	Financial Information

Item 1.	Financial Statements (Unaudited)	1
	Condensed Consolidated Balance Sheets	1
	Condensed Consolidated Statements of Operations	2
	Condensed Consolidated Statements of Comprehensive Income	3
	Condensed Consolidated Statements of Shareholders’ Equity (Deficit)	4
	Condensed Consolidated Statements of Cash Flows	5
	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30

Item 4.	Controls and Procedures	30

PART II	Other Information	30

Item 1.	Legal Proceedings	30

Item 1A.	Risk Factors	32

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32

Item 3.	Defaults Upon Senior Securities	32

Item 4.	Mine Safety Disclosures	32

Item 5.	Other Information	32

Item 6.	Exhibits	33

	Signatures	34

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited; dollars in thousands, except share and per share amounts)



	June 30, 2012			December 31, 2011
Assets
Current Assets
Cash and cash equivalents	$	17,103		$	11,503
Service fee receivable, net of allowance of $196 and $86, respectively	7,718			6,899
Restricted cash	6,378			1,825
Mortgage securities	4,406			3,878
Deferred income tax asset, net	28,952			—
Notes receivable, net of allowance of $1,054 and $0, respectively	590			2,235
Other	1,854			4,124
Total current assets	67,001			30,464
Non-Current Assets
Property and equipment, net of accumulated depreciation	5,627			5,589
Goodwill	5,336			5,336
Deferred income tax asset, net	34,149			152
Other	2,768			3,060
Total non-current assets	47,880			14,137
Total assets	$	114,881		$	44,601

Liabilities and Shareholders' Equity (Deficit)
Liabilities:
Current Liabilities
Accounts payable	$	8,603		$	7,077
Accrued expenses	9,203			6,331
Deferred revenue	2,485			1,528
Note payable to related party	1,000			—
Other	40			161
Total current liabilities	21,331			15,097
Non-Current Liabilities
Senior notes	80,679			79,654
Note payable to related party	4,113			—
Other	2,618			2,606
Total non-current liabilities	87,410			82,260
Total liabilities	108,741			97,357

Commitments and contingencies (Note 9)

Shareholders' equity (deficit):
Capital stock, $0.01 par value per share, 120,000,000 shares authorized:
Common stock, 91,479,519 and 91,253,653 shares issued and outstanding as of June 30, 2012 and December 31, 2011, respectively	915			913
Additional paid-in capital	740,210			746,276
Accumulated deficit	(738,644		)	(803,400		)
Accumulated other comprehensive income	3,784			3,267
Total Novation Companies, Inc. (“NCI”) shareholders' equity (deficit)	6,265			(52,944		)
Noncontrolling interests	(125		)	188
Total shareholders' equity (deficit)	6,140			(52,756		)
Total liabilities and shareholders' equity (deficit)	$	114,881		$	44,601

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited; dollars in thousands, except share and per share amounts)



	For the Six Months Ended June 30,						For the Three Months Ended June 30,
	2012			2011			2012			2011
Income and Revenues:
Service fee income	$	96,140		$	50,555		$	45,807		$	25,886
Interest income – mortgage securities	3,245			5,640			1,846			2,622
Total	99,385			56,195			47,653			28,508

Costs and Expenses:
Cost of services	80,872			41,479			39,862			22,584
Selling, general and administrative expense	15,639			10,378			8,184			4,845
Other (income) expense	(873		)	1,029			(705		)	295
Total	95,638			52,886			47,341			27,724

Other (expense) income	(957		)	253			56			162
Interest expense	(1,535		)	(1,026		)	(800		)	(714		)

Income (loss) before income tax (benefit) expense	1,255			2,536			(432		)	232
Income tax (benefit) expense	(63,107		)	50			31			19
Net income (loss)	64,362			2,486			(463		)	213
Less: Net income (loss) attributable to noncontrolling interests	(394		)	246			(429		)	(244		)
Net income (loss) attributable to NCI	$	64,756		$	2,240		$	(34	)	$	457
Earnings Per Share attributable to NCI:
Basic	$	0.72		$	6.43		$	—		$	5.55
Diluted	$	0.71		$	6.43		$	—		$	5.55
Weighted average basic shares outstanding	90,469,585			13,890,863			90,566,933			16,538,125
Weighted average diluted shares outstanding	91,488,030			13,890,863			91,736,314			16,538,125

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited; dollars in thousands)



	For the Six Months Ended June 30,					For the Three Months Ended June 30,
	2012			2011		2012			2011
Net income (loss)	$	64,362		$	2,486	$	(463	)	$	213
Other comprehensive income (loss):
Change in unrealized gain on mortgage securities – available-for-sale (Note 10)	517			470		275			643
Total comprehensive income (loss)	64,879			2,956		(188		)	856
Comprehensive income (loss) attributable to noncontrolling interests:
Less: Net income (loss) attributable to noncontrolling interests	(394		)	246		(429		)	(244		)
Total comprehensive income attributable to NCI	$	65,273		$	2,710	$	241		$	1,100

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

(unaudited; dollars in thousands)



	Total NCI Shareholders’ Equity (Deficit)
	Common Stock		Additional Paid-in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income		Noncontrolling Interest			Total Shareholders’ Equity (Deficit)
Balance, December 31, 2011	$	913	$	746,276		$	(803,400	)	$	3,267	$	188		$	(52,756	)
Compensation recognized under stock compensation plans	—		151			—			—		—			151
Issuance of nonvested shares, 225,866 shares	2		(2		)	—			—		—			—
Contributions from noncontrolling interests	—		—			—			—		195			195
Distributions to noncontrolling interests	—		—			—			—		(216		)	(216		)
Acquisition of noncontrolling interests	—		(6,110		)	—			—		(3		)	(6,113		)
Transfer from noncontrolling interests	—		(105		)	—			—		105			—
Net income	—		—			64,756			—		(394		)	64,362
Other comprehensive income	—		—			—			517		—			517
Balance, June 30, 2012	$	915	$	740,210		$	(738,644	)	$	3,784	$	(125	)	$	6,140



	Total NCI Shareholders’ Deficit
	Redeemable Preferred Stock			Convertible Participating Preferred Stock			Common Stock		Additional Paid-in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income		Noncontrolling Interest			Total Shareholders’ Deficit
Balance, December 31, 2010	$	30		$	21		$	94	$	787,363		$	(898,195	)	$	4,411	$	(267	)	$	(106,543	)
Compensation recognized under stock compensation plans	—			—			—		190			—			—		—			190
Accumulating dividends on preferred stock	—			—			—		—			(8,428		)	—		—			(8,428		)
Distributions to noncontrolling interests	—			—			—		—			—			—		(204		)	(204		)
Transfer from noncontrolling interests	—			—			—		(275		)	—			—		275			—
Preferred stock exchange	(30		)	(21		)	810		(39,896		)	95,460			—		—			56,323
Net income	—			—			—		—			2,240			—		246			2,486
Other comprehensive income	—			—			—		—			—			470		—			470
Balance, June 30, 2011	$	—		$	—		$	904	$	747,382		$	(808,923	)	$	4,881	$	50		$	(55,706	)

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited; dollars in thousands)



	For the Six Months Ended June 30,
	2012			2011
Cash flows from operating activities:
Net income	$	64,362		$	2,486
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion of mortgage securities	(513		)	(1,337		)
Provision for bad debt, net	457			—
Amortization of deferred debt issuance costs and senior debentures discount	1,025			559
Fair value adjustments of trading securities, CDO debt and contingent consideration	—			(498		)
Loss on disposal of fixed assets	2			234
Compensation recognized under stock compensation plans	151			190
Depreciation expense	1,269			975
Deferred taxes	(63,101		)	—
Changes in:
Service fee receivable	(925		)	(1,399		)
Restricted cash	(4,553		)	—
Other current assets and liabilities, net	2,301			(858		)
Other noncurrent assets and liabilities, net	(78		)	69
Deferred revenue	957			—
Accounts payable and accrued expenses	4,398			2,072
Net cash provided by operating activities	5,752			2,493

Cash flows from investing activities:
Proceeds from paydowns of mortgage securities	502			1,245
Restricted cash, net	31			214
Proceeds from paydowns of notes receivable	1,700			87
Issuance of notes receivable	(55		)	—
Purchases of property and equipment	(1,309		)	(753		)
Net cash provided by investing activities	869			793

Cash flows from financing activities:
Contributions from noncontrolling interests	195			—
Distributions to noncontrolling interests	(216		)	(204		)
Acquisition of noncontrolling interest	(500		)	—
Paydowns of note payable to related party	(500		)	—
Payments to preferred stockholders for preferred stock exchange	—			(3,005		)
Net cash used in financing activities	(1,021		)	(3,209		)
Net increase in cash and cash equivalents	5,600			77
Cash and cash equivalents, beginning of period	11,503			12,582
Cash and cash equivalents, end of period	$	17,103		$	12,659

Continued

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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

(unaudited; dollars in thousands)



	For the Six Months Ended June 30,
	2012		2011
Cash paid for interest	$	510	$	1,424
Cash received from income tax refunds	1,974		—
Cash received on mortgage securities – available-for-sale with no cost basis	2,732		4,303
Non-cash investing and financing activities:
Acquisition of noncontrolling interests for note payable	5,613		—
Preferred stock dividends accrued, subsequently eliminated	—		8,428

See notes to condensed consolidated financial statements.

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NOVATION COMPANIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of and for the period ended June 30, 2012 (Unaudited)

Note 1. Financial Statement Presentation

Description of Operations – Effective May 23, 2012, NovaStar Financial, Inc. changed its name to Novation Companies, Inc. (“NCI” or the “Company”) to reflect the Company's current business strategy. The Company owns 91% of StreetLinks LLC (“StreetLinks”), a national residential appraisal and mortgage real estate valuation management services company. The Company owned 88% of StreetLinks as of December 31, 2011. See Note 3 to the condensed consolidated financial statements for additional details related to the acquisition. StreetLinks charges a fee for services which is collected from lenders and borrowers. The majority of StreetLinks' business is generated from the management of the appraisal process for its customers. Most of the fee is paid to independent residential appraisers. StreetLinks retains a portion of the fee to cover its costs of managing the process of fulfilling the appraisal order and performing a quality control review of all appraisals. StreetLinks also provides other real estate valuation management services, such as field reviews and value validation.

The Company owns 78% of Advent Financial Services LLC (“Advent”). Advent, along with its distribution partners, provides financial settlement services, mainly for income tax preparation businesses, and also provides access to tailored banking accounts, small dollar banking products and related services to meet the needs of low and moderate-income level individuals. Advent is not a bank, but it acts as an intermediary for banking products on behalf of other banking institutions.

A primary distribution channel of Advent's bank products is through settlement services to electronic income tax return originators. Advent provides a process for the originators to collect refunds from the Internal Revenue Service, distribute fees to various service providers and deliver the net refund to individuals. Individuals may elect to have the net refund dollars deposited to a banking account offered through Advent (developed on a prepaid debit card platform). Individuals also have the option to have the net refund dollars paid by check or to an existing bank account. Regardless of the settlement method, Advent receives a fee for providing the settlement service. Advent also receives fees from banking institutions for services related to the use of the funds deposited to Advent-offered banking accounts.

On October 17, 2011, the Company purchased 51% of the equity of Build My Move, LLC ("BMM") for $1.7 million plus future obligations to make additional capital contributions to BMM of up to $0.7 million. BMM changed its name to Mango Moving, LLC ("Mango") subsequent to the Company's purchase. Mango is a start-up company in the “asset-light” third-party logistics provider market, with the goal of providing high-quality long distance residential moves and moving labor services . See Note 3 to the condensed consolidated financial statements for additional details related to the acquisition.

During 2011, the Company completed the exchange of all outstanding shares of its preferred stock for an aggregate of 80,985,600 shares of newly-issued common stock and $3.0 million in cash (the "Recapitalization"). See Note 14 to the condensed consolidated financial statements for additional details.

During 2011, the Company completed an exchange of its junior subordinated debentures for senior debentures (the "Debt Exchange"). See Note 8 to the condensed consolidated financial statements for further details.

Prior to 2011, the Company originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage-backed securities. The Company retained, through its mortgage securities investment portfolio, interests in the nonconforming loans it originated and purchased, and through its servicing platform, serviced all of the loans in which it retained interests. The Company discontinued its mortgage lending operations and sold its mortgage servicing rights which subsequently resulted in the closing of our servicing operations. The Company continues to hold the nonconforming residential mortgage securities.

Financial Statement Presentation – The Company’s consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the period. The Company uses estimates and judgments in establishing the fair value of its mortgage securities, notes receivable, goodwill, and accounting for income taxes, including the determination of the timing of the establishment or release of the valuation allowance related to the deferred tax asset balances and reserves for uncertain tax positions. While the condensed consolidated financial statements and footnotes reflect the best estimates and judgments of management at the time, actual results could differ significantly from those estimates.

Cash equivalents consist of liquid investments with an original maturity of three months or less. Amounts due from banks and credit card companies of $0.9 million and $0.5 million for the settlement of credit card transactions are included in cash and cash equivalents as of June 30, 2012 and December 31, 2011, respectively, as they are generally collected within three business days. Cash equivalents are stated at cost, which approximates fair value.

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The condensed consolidated financial statements of the Company include the accounts of all wholly-owned and majority-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

The Company's condensed consolidated financial statements are unaudited. In the opinion of management, all necessary adjustments have been made, which were of a normal and recurring nature, for a fair presentation of the condensed consolidated financial statements.

The Company's condensed consolidated financial statements should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements of the Company and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Note 2. New Accounting Pronouncements

In September 2011, the FASB issued Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which amends previous guidance, to allow companies the option of performing a qualitative assessment before completing step one of the impairment test, calculating the fair value of the reporting unit. If the Company determines on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not greater than the carrying amount, the two-step impairment test would not be required. The amendments are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The guidance will be in effect for the Company beginning with the annual goodwill impairment tests to be completed in the fourth quarter of 2012 and is not expected to have a material impact on the Company's consolidated financial statements.

Note 3. Business Combinations and Consolidation

On March 8, 2012, Steve Haslam, the Chief Executive Officer of StreetLinks, was appointed the Chief Operating Officer of the Company. As part of the transition of Mr. Haslam to his new position with the Company, and pursuant to the exercise of his rights under his employment agreement with StreetLinks, he sold all of his 1,927 membership units of StreetLinks to the Company pursuant to a Membership Interest Purchase Agreement, dated March 8, 2012, by and between Mr. Haslam and the Company (the “Unit Purchase Agreement”). At the time of the transaction, the 1,927 membership units of StreetLinks represented approximately 5% of the outstanding StreetLinks membership units. The total purchase price under the Unit Purchase Agreement was $6.1 million, of which $0.5 million was paid on March 8, 2012 and $0.5 million was paid on June 30, 2012. The remainder of this obligation is payable as follows: $0.3 million on the last day of each quarter hereafter until March 8, 2016, on which date the unpaid principal balance of $1.6 million is to be paid, plus interest on the unpaid balance at the rate of 4.0% per annum, compounded quarterly. The additional equity interest acquired as a result of this transaction was offset slightly by the issuance of additional StreetLinks membership units to certain Streetlinks employees during the three months ended June 30, 2012. The issuance of these membership units reduced the Company's equity interest in Streetlinks from approximately 93% to approximately 91%.

On October 17, 2011, pursuant to the terms of a Unit Purchase Agreement between the Company and Build My Move, LLC (“BMM”), the Company acquired 51% of the fully diluted membership interests in BMM. The Company purchased Class C units of BMM, having preferred distribution, liquidation and management rights, in exchange for a purchase price of $1.7 million and, upon the occurrence of certain conditions related to BMM's financial condition and its contractual obligations, the Company has the obligation to make additional capital contributions to BMM up to $0.7 million. The additional capital contribution includes a contingent consideration obligation of up to $0.3 million, which could be payable to a former employee upon compliance with the separation agreement. BMM changed its name to Mango Moving, LLC ("Mango") on October 21, 2011. Mango is a start-up, Internet-based company in the “asset-light” third-party logistics provider market, with the goal of providing high-quality local and long distance residential and other moving services at a price less than other major national van lines. The acquisition of Mango allows the Company to enter a new industry along with taking advantage of synergies from sales, technology and other administrative functions. While Mango is in a different industry than StreetLinks, these businesses share similarities. They are both vendor management services using proprietary technology. StreetLinks manages a base of appraiser vendors whereas Mango manages bases of moving labor and trucking vendors. Much of the technology developed for StreetLinks is applicable to the business of Mango. Additionally, the Company's extensive experience in managing customer service centers also applies to Mango. The Company's centralized technology and administrative functions allows the sharing of resources across all entities, saving time and costs.

On November 10, 2011, StreetLinks acquired the remaining 49% noncontrolling owner interests in Corvisa, LLC ("Corvisa") and now owns 100% of Corvisa. In exchange for the minority owner interests, StreetLinks paid $0.5 million in cash at the time of exchange with an additional $0.5 million payable no later than one year from the exchange date and is also obligated to make $1.2 million in payments to the former minority owners on or before June 30, 2014 if revenues from the Corvisa technology products exceed certain thresholds. The Company recorded a liability of $0.9 million for the estimated contingent consideration under the terms of the acquisition and it is recorded in the noncurrent liabilities line item of the condensed consolidated balance sheet. The effects of this transaction were recorded through shareholders' equity (deficit) in accordance with the relative consolidation guidance.

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The purchase price for the Mango acquisition has been allocated based on the assessment of the fair value of the assets acquired and liabilities assumed, determined based on the Company’s internal operational assessments and other analyses which are Level 3 measurements. Pro forma disclosure requirements have not been included as they are not considered significant. The Company’s financial statements include the results of operation of Mango from the date of acquisition. Revenues and earnings since the acquisition date are not considered material to the Company's financial results. All legal and other related acquisition costs were expensed as incurred and recorded in the selling, general and administrative expense line item of the condensed consolidated statements of operation, and were not material.

A summary of the aggregate amounts of the assets acquired and liabilities assumed and the aggregate consideration paid for Mango for the year ended December 31, 2011 follows (dollars in thousands):



	Total
Assets:
Cash	$	1,141
Service fee receivable, net	92
Other current assets	115
Property and equipment, net	801
Goodwill	2,166
Other noncurrent assets	61
Liabilities:
Accounts payable	(197		)
Accrued expenses	(503		)
Other current liabilities	(19		)
Other noncurrent liabilities	(150		)
Noncontrolling interests	(1,807		)
Total cash consideration	$	1,700

Note 4. Mortgage Securities

As of June 30, 2012 and December 31, 2011, mortgage securities consisted entirely of the Company's investment in the residual securities issued by securitization trusts sponsored by the Company and classified as available-for-sale. Residual securities consist of interest-only, prepayment penalty and overcollateralization bonds. See Note 10 to the condensed consolidated financial statements for details on the Company's fair value methodology.

The following table presents certain information on the Company's portfolio of mortgage securities – available-for-sale as of June 30, 2012 and December 31, 2011 (dollars in thousands):



	Cost Basis		Unrealized Gain		Estimated Fair Value		Average Yield (A)
June 30, 2012	$	622	$	3,784	$	4,406	181.0	%
December 31, 2011	611		3,267		3,878		237.0


(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' equity (deficit.)

There were no other-than-temporary impairments relating to mortgage securities – available-for-sale for the six and three months ended June 30, 2012 and 2011. Maturities of mortgage securities owned by the Company depend on repayment characteristics and experience of the underlying financial instruments.

The following table relates to the securitizations where the Company retained an interest in the assets issued by the securitization trust, a variable interest entity or VIE (dollars in thousands):

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	Size/Principal Outstanding (A)		Assets on Balance Sheet (B)		Liabilities on Balance Sheet		Maximum Exposure to Loss(C)		Year to Date Loss on Sale		Year to Date Cash Flows (D)
June 30, 2012	$	5,893,445	$	4,406	$	—	$	4,406	$	—	$	3,234
December 31, 2011	6,265,564		3,878		—		3,878		—		5,061


(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 the mortgage securities line item of the condensed consolidated balance sheets.


(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)	Year to date cash flows are for the six months ended June 30, 2012 and 2011, respectively.

Prior to 2011, the Company executed a securitization of mortgage securities in what is commonly called a Collateralized Debt Obligation (“CDO”). The Company serves as the CDO's asset manager. The collateral for the CDO consisted of subordinated mortgage securities and included securities retained by the Company in its loan securitizations and purchased from third parties. This securitization was structured legally as a sale but for accounting purposes was accounted for as a financing. Accordingly, the CDO assets (securities) and securitization bond financing were included in the Company's consolidated balance sheet. As of June 30, 2012 and December 31, 2011, the fair value of the assets and liabilities was zero.

Note 5. Notes Receivable and Allowance for Doubtful Accounts

The Company has made loans to independent entities that have used the proceeds to finance current and on-going operations. Notes receivable are considered impaired, based on current information and events, if it is probable that the Company will be unable to collect all amounts due that are contractually obligated. The Company determines the required allowance for doubtful accounts using information such as the borrower's financial condition and economic trends and conditions. Recognition of income is suspended and the loan is placed on non-accrual status when management determines that collection of future income is not probable. Accrual is resumed, and previously suspended income is recognized, when the loan becomes contractually current and/or collection doubts are removed. Cash receipts on impaired loans are recorded against the receivable and then to any unrecognized income.

The Company charges off uncollectible notes receivable when repayment of contractually-obligated amounts is not deemed to be probable. There were no amounts charged off during the six and three months ended June 30, 2012 and 2011.

Due to the low number of notes receivable, the Company evaluates each note individually for collectability rather than analyzing by class or credit quality indicator. As a result of this review, the Company established a provision for credit losses of $1.1 million for the six months ended June 30, 2012 related to the note receivable due from ITS Financial, LLC (“ITS”), an entity with which it was previously in litigation. During 2011, the Company agreed to settle the litigation. Pursuant to the original settlement agreement, the Company received approximately $1.3 million of the amount due under the note at the time of settlement. A modification to the original settlement agreement was reached in February 2012, whereby the Company received $1.5 million at the time of the modification, with the remaining note balance of approximately $1.1 million plus an additional $0.1 million due in February 2013. In a complaint dated March 28, 2012, the United States Department of Justice ("DOJ") filed lawsuits against ITS and some of its franchisees. The actions claim that ITS was committing tax fraud against the United States Government and extracting excessive fees from the taxpaying customers. The action seeks to shut down the franchises accused of committing fraud and the entire ITS organization. Due to these lawsuits, the Company established a full allowance of $1.1 million against the note as of June 30, 2012. There was no provision made for credit losses during the three months ended June 30, 2012 or the six and three months ended June 30, 2011.

The remaining $0.6 million and $0.7 million of notes receivable outstanding as of June 30, 2012 and December 31, 2011, respectively, was current.

Activity in the allowance for credit losses on notes receivable is as follows for the six and three months ended June 30, 2012 and 2011 (dollars in thousands):



	For the Six Months Ended June 30,				For the Three Months Ended June 30,
	2012		2011		2012		2011
Balance, beginning of period	$	—	$	1,047	$	1,054	$	1,047
Provision for credit losses	1,054		—		—		—
Balance, end of period	$	1,054	$	1,047	$	1,054	$	1,047

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Note 6. Property and Equipment, Net

All of the Company's property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets. The estimated useful lives of the assets are leasehold improvements, lesser of 5 years or remaining lease term, furniture and fixtures, 5 years, office and computer equipment, 3 to 5 years, and software, 3 years.

Maintenance and repairs are charged to expense. Major renewals and improvements are capitalized. Gains and losses on dispositions are credited or charged to earnings as incurred. Depreciation and amortization expense relating to property and equipment was $1.3 million and $0.6 million, respectively, for the six and three months ended June 30, 2012, as compared to $1.0 million and $0.5 million, respectively, for the six and three months ended June 30, 2011.

The following table shows the Company's property and equipment, net as of June 30, 2012 and December 31, 2011 (dollars in thousands):



	June 30, 2012			December 31, 2011
Furniture, fixtures and office equipment	$	927		$	1,216
Hardware and computer equipment	3,332			2,961
Software	7,357			6,887
Leasehold improvements	1,085			352
Total Cost	12,701			11,416
Less: Accumulated depreciation and amortization	(7,074		)	(5,827		)
Property and equipment, net	$	5,627		$	5,589

Note 7. Goodwill

As of June 30, 2012 and December 31, 2011, goodwill totaled $5.3 million. There was no goodwill activity for the six and three months ended June 30, 2012 and 2011. Goodwill is tested for impairment at least annually and written down and charged to results of operations only in periods in which the recorded value is more than the estimated fair value. For tax purposes, the goodwill is included in the Company's basis in its investments in StreetLinks and Mango as they are limited liability companies. Therefore, it will be non-deductible for tax purposes as long as the Company holds its investments.

Note 8. Borrowings

Senior Notes – In an effort to improve the Company's liquidity position, on March 22, 2011, the Company entered into agreements that canceled the then existing $78.1 million aggregate principal amount of junior subordinated notes (the “Junior Subordinated Notes”). The Junior Subordinated Notes were replaced by unsecured senior notes pursuant to three indentures (collectively, the “Senior Notes”). The aggregate principal amount of the Senior Debentures is $85.9 million. The Senior Notes accrue interest at a rate of 1.0% until the earlier of (a) the completion of an equity offering by the Company or its subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”). Interest on the Senior Notes is paid on a quarterly basis and no principal payments are due until the Senior Notes mature on March 30, 2033.

For accounting purposes the Debt Exchange transactions were considered a modification of a debt instrument as opposed to an extinguishment and new debt. Therefore, the principal amount of the debt will be accreted up to the new principal balance of $85.9 million using the effective interest method from the balance of $80.7 million and $79.7 million as of June 30, 2012 and December 31, 2011, respectively.

The indentures governing the Senior Notes (the “Indentures”) contain certain restrictive covenants (the “Negative Covenants”) subject to certain exceptions in the Indentures, including written consent of the holders of the Senior Notes. The Negative Covenants prohibit the Company and its subsidiaries, from among other things, incurring debt, permitting any lien upon any of its property or assets, making any cash dividend or distribution or liquidation 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. The Negative Covenants remain in effect until both of the following conditions are met: 1) the Senior Notes begin accruing interest at the Full Rate, and 2) the Company satisfies certain financial covenants (the “Financial Covenants”). 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)

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either (a) the Interest Coverage Ratio is equal to or greater than 1.35x, or (b) the Leverage Ratio is not greater than 95%. As the Senior Notes were not accruing interest at the Full Rate, the Negative Covenants, as defined above, were still in effect as of June 30, 2012 and December 31, 2011. As such, the Company was under no obligation to comply with the Financial Covenants during these periods.

The Company was in compliance with all Negative Covenants as of June 30, 2012 and December 31, 2011.

Note Payable to Related Party – As discussed in Note 3 to the condensed consolidated financial statements, on March 8, 2012, Steve Haslam sold all of his membership units of StreetLinks to the Company, approximately 5%, on March 8, 2012. The total purchase price was $6.1 million, of which $0.5 million was paid on March 8, 2012 and $0.5 million was paid on June 30, 2012. The remainder of this obligation is payable as follows: $0.3 million on the last day of each quarter until March 8, 2016, on which date the unpaid principal balance of $1.6 million is to be paid, plus interest on the unpaid balance at the rate of 4.0% per annum, compounded quarterly. The Company's obligation is secured by the StreetLinks' interest purchased.

Note 9. Commitments and Contingencies

As discussed in Note 3 to the condensed consolidated financial statements, the Company is obligated to make payments in the future to the former minority owners of Corvisa of up to $1.2 million if revenue targets are achieved. A liability of $0.9 million, based on management’s estimate of the earnings targets being achieved, is included in the other liabilities line item of the condensed consolidated balance sheets as of June 30, 2012 and December 31, 2011.

The Company also has contingent obligations related to a separation agreement with a former Mango employee of up to $0.3 million. As of June 30, 2012 and December 31, 2011, there was a liability for this contingent obligation of $0.2 million in the other current liabilities and $0.1 million in the other liabilities line items in the consolidated balance sheets.

The Company has received indemnification and loan repurchase demands with respect to alleged violations of representations and warranties (“defects”) made in loan sale and securitization agreements. These demands have been received substantially beginning in 2006 and have continued into 2012. Prior to the Company ceasing the origination of loans in its mortgage lending business, it sold loans to securitization trusts and other third parties and agreed to repurchase a loan due to missing documentation or breaches of representations or warranties made in sale documents that materially adversely affected the value of the loan. Beginning in 1997 and ending in 2007, affiliates of the Company sold loans to securitization trusts and third parties with the potential of such repurchase obligations. The aggregate original principal balance of these loans was $43.1 billion at the time of sale or securitization. The remaining principal balance of these loans is not available as these loans are serviced by third parties and may have been refinanced, sold or liquidated. During 2011 and 2012, the Company has received claims to repurchase loans with original principal balances of approximately $24.6 million. These claims have not been acknowledged as valid by the Company. In some cases, claims were made against affiliates of the Company that have ceased operations and have no or limited assets. The Company has not repurchased any loans in 2011 or 2012.

Historically, repurchases of loans or indemnification of losses where a loan defect has been alleged have been insignificant and any future losses for alleged loan defects have not been deemed to be probable or reasonably estimable; therefore, the Company has recorded no reserves related to these claims. The Company does not use internal groupings for purposes of determining the status of these loans. The Company is unable to develop an estimate of the maximum potential amount of future payments related to repurchase demands because the Company does not have access to information relating to loans sold and securitized and the number or amount of claims deemed probable of assertion is not known nor is it reasonably estimated. Further, the validity of claims received remains questionable. Also, considering that the Company completed its last sale or securitization of loans during 2007, the Company believes that it will be difficult for a claimant to successfully validate any additional repurchase demands. Management does not expect that the potential impact of claims will be material to the Company's financial statements.

Pending Litigation.

The Company is a party to various legal proceedings. Except as set forth below, these proceedings are of an ordinary and routine nature.

Although it is not possible to predict the outcome of any legal proceeding, in the opinion of management, other than the active proceedings described in detail below, proceedings and actions against the Company should not, individually, or in the aggregate, have a material effect on the Company's financial condition, operations and liquidity. Furthermore, due to the uncertainty of any potential loss as a result of pending litigation and due to the Company's belief that an adverse ruling is not probable, the Company has not accrued a loss contingency related to the following matters in its condensed consolidated financial statements. However, a material outcome in one or more of the active proceedings described below could have a material impact on the results of operations in a particular quarter or fiscal year.

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NovaStar Mortgage Funding Corporation (“NMFC”) and its individual directors, several securitization trusts sponsored by the Company ("affiliated defendants") and several unaffiliated investment banks and credit rating agencies. The case was removed to the United States District Court for the Southern District of New York. On June 16, 2009, the plaintiff filed an amended complaint. Plaintiff seeks monetary damages, alleging that the defendants violated sections 11, 12 and 15 of the Securities Act of 1933, as amended, by making allegedly false statements regarding mortgage loans that served as collateral for securities purchased by plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss the plaintiff's claims, which the court granted on March 31, 2011, with leave to amend. Plaintiff filed a second amended complaint on May 16, 2011, and the Company again filed a motion to dismiss. On March 29, 2012, the court dismissed the plaintiff's second amended complaint with prejudice and without leave to replead. The plaintiff filed an appeal. Given the court's ruling in an early stage of the litigation, the Company cannot provide an estimate of the range of any loss. The Company believes that the affiliated defendants have meritorious defenses to the case and expects them to defend the case vigorously.

On July 9, 2010 and on February 11, 2011, Cambridge Place Investment Management, Inc. filed complaints in the Suffolk, Massachusetts Superior Court against NMFC and numerous other entities seeking damages on account of losses associated with residential mortgage-backed securities purchased by plaintiff's assignors. The complaints allege untrue statements and omissions of material facts relating to loan underwriting and credit enhancement. The complaints also allege a violation of Section 410 of the Massachusetts Uniform Securities Act (Chapter 110A of the Massachusetts General Laws). Defendants removed the cases to the United States District Court for the District of Massachusetts, and plaintiff filed motions to remand the cases back to state court. On August 22, 2011, the federal court remanded these cases back to state court, and on October 14, 2011, the plaintiff filed amended complaints. In December 2011, the Company, together with the other defendants in the litigation, filed a joint motion to dismiss the complaints alleging that the plaintiff lacked standing. On March 12, 2012 the court denied the defendants' motion to dismiss for lack of standing, and the defendants sought an interlocutory appeal of the denial, which the appellate court declined to hear. On April 26, 2012, the defendants filed a joint motion to dismiss the plaintiff's complaints for a failure to state a claim. Because this litigation is procedurally in its early stage, the Company cannot provide an estimate of the range of any loss. The Company believes that NMFC has meritorious defenses to these claims and expects that the cases will be defended vigorously.

On June 20, 2011, the National Credit Union Administration Board, as liquidating agent of U.S. Central Federal Credit Union, filed an action against NMFC and numerous other defendants in the United States District Court for the District of Kansas, claiming that the defendants issued or underwrote residential mortgage-backed securities pursuant to allegedly false or misleading registration statements, prospectuses, and/or prospectus supplements. On October 12, 2011, the complaint was served on NMFC. On December 20, 2011, NMFC filed a motion to dismiss the plaintiff's complaint and to strike certain paragraphs of the complaint. On July 25, 2012 the court granted the motion in part and denied the motion in part. Plaintiff was granted leave to amend the complaint. This litigation is in an early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that NMFC has meritorious defenses to the case and expects it to defend the case vigorously.

On May 30, 2012, Woori Bank filed an action against NovaStar ABS CDO I, Inc. and NovaStar ABS CDO I, Ltd. (collectively, “NCDO”) and certain other unrelated entities in the United States District Court for the Southern District of New York, claiming common law fraud, negligent misrepresentation and unjust enrichment based on allegations that defendants knew that NCDO securities purchased by plaintiff involved more risk than their ratings suggested. On July 30, 2012, NCDO filed a motion to dismiss plaintiff's complaint against NCDO. This litigation is in an early stage, and the Company cannot provide an estimate of the range of any loss. The Company believes that NCDO has meritorious defenses to the case and expects NCDO to defend the case vigorously.

Note 10. Fair Value Accounting

Fair Value Measurements

The Company's valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These two types of inputs create the following fair value hierarchy:

•Level 1 – Valuations based on quoted prices in active markets for identical assets and liabilities.

•Level 2 – Valuations based on observable inputs in active markets for similar assets and liabilities, other than Level 1 prices, such as quoted interest or currency exchange rates.

•Level 3 – Valuations based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies based on internal cash flow forecasts.

The following tables present for each of the fair value hierarchy levels, the Company's assets and liabilities which are measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011 (dollars in thousands):

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			Fair Value Measurements at Reporting Date Using
Description	Fair Value at June 30, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Mortgage securities – available-for-sale	$	4,406	$	—	$	—	$	4,406

Liabilities:
Contingent consideration (A)	$	1,154	$	—	$	—	$	1,154

(A) The contingent consideration represents the estimated fair value of the additional potential amounts payable in connection with our acquisitions of Mango and Corvisa, $0.3 million and $0.9 million, respectively.



			Fair Value Measurements at Reporting Date Using
Description	Fair Value at December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Mortgage securities – available-for-sale	$	3,878	$	—	$	—	$	3,878

Liabilities:
Contingent consideration (A)	$	1,154	$	—	$	—	$	1,154

Valuation Methods and Processes

The Company estimates the fair value of all items subject to fair value accounting using present value techniques and generally does not have the option to choose other valuation techniques for these items. There have been no significant changes to the Company's financial statements as a result from changes to the Company's valuation techniques as of June 30, 2012 compared to December 31, 2011.

An independent entity has been engaged to prepare projected future cash flows of the Company's mortgage securities for each reporting period (quarterly) used by management to estimate fair value. The Company's internal finance and accounting staff reviews and monitors the work of the independent entity, including analysis of the assumptions used, retrospective review and preparing an overall conclusion of the value and process. All other fair value analysis, consisting of simple cash flow estimates and discounting techniques, is conducted internally by the Company's internal financial staff. The Company's fair value process is conducted under the supervision of the Chief Financial Officer.

Mortgage securities – available-for-sale. Mortgage securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. To the extent that the cost basis of mortgage securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. The specific identification method is used in computing realized gains or losses. The Company uses the discount rate methodology for determining the fair value of its residual securities. The fair value of the residual securities is estimated based on the present value of future expected cash flows to be received. Management's best estimate of key assumptions, including credit losses, prepayment speeds, forward yield curves and discount rates commensurate with the risks involved, are used in estimating future cash flows.

Mortgage securities – trading. Trading securities are recorded at fair value with gains and losses, realized and unrealized, included in earnings. The Company uses the specific identification method in computing realized gains or losses. The Company estimates fair value based on the present value of expected future cash flows using management's best estimates of credit losses, prepayment rates, forward yield curves, and discount rates, commensurate with the risks involved. Due to the unobservable inputs used by the Company in determining the expected future cash flows, the Company determined its valuation methodology for residual securities would qualify as Level 3.

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Contingent consideration. The fair value of the Mango contingent consideration was estimated using a probability analysis of compliance with the separation agreement and a discount rate was applied to the projected earn-out payments that approximated the weighted average cost of capital. The key input was management's estimation of probability that the employee will comply with the agreement. The Company estimated the fair value of the Corvisa contingent consideration using projected revenue over the earn-out period, and applied a discount rate commensurate with the risks involved to the projected earn-out payments. The key inputs for the projected revenue analysis were the number of units completed and the average amount of revenue per unit.

The following table presents certain quantitative information about the significant unobservable inputs used in the fair value measurement for items measured at fair value on a recurring basis using significant unobservable inputs (Level 3).




Description	Valuation Techniques	Significant Unobservable Inputs	Range
Assets:
Mortgage securities – available-for-sale	Present value analysis	Prepayment rates	5.2% – 9.5%
		Weighted average life (years)	2.0 – 2.0
Liabilities:
Contingent consideration	Present value analysis	Revenue growth	2.3% – 2.5%
		Discount rate	15.0% – 15.0%

The Company's mortgage securities – available-for-sale, as discussed in Note 4 to the condensed consolidated financial statements, are measured at fair value. These securities are valued at each reporting date using significant unobservable inputs (level 3) by discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The Company has no other assets measured at fair value.

The significant unobservable inputs used in the fair value measurement of mortgage securities – available-for-sale are prepayment rates and the weighted average life for the underlying mortgage loan collateral. Using a faster (higher) estimated prepayment rate would decrease the value of the securities. The Company uses a weighted average life of 2 years from the reporting date for the expected future estimated cash flows. The future cash flows are highly-dependent upon the performance of the underlying collateral of mortgage loans and the nonperformance risk of the collateral is the key reason the Company utilizes such a short weighted average life in its calculation. Assuming a shorter weighted average life would decrease the estimated value of the mortgage securities. Alternatively, assuming a longer weighted average life would increase the estimated value of the mortgage securities.

The Company has a liability recorded at fair value that is the estimated additional potential earn-out opportunity payable in connection with its acquisition of Corvisa. The payment is contingent on future revenue generated from the original Corvisa technology platform. The obligation is valued at each reporting date using significant unobservable inputs (level 3). The Company estimated the fair value using projected revenue over the earn-out period, and applied a discount rate commensurate with the risks involved to the projected earn-out payments. The Company has no other liabilities measured at fair value.

The significant unobservable input used in the fair value measurement of the contingent consideration liability is the growth of the forecasted revenue to be generated from the original Corvisa technology platform and the discount rate used in the present value calculation. The Company generally assumes that the forecasted revenue required in order for the earnings targets to be achieved will be realized. Assuming that the required revenue will not be realized would decrease the estimated fair value of the contingent consideration liability. Assuming a higher discount rate would decrease the estimated fair value of the contingent consideration liability, whereas assuming a lower discount rate would increase the estimated fair value of the contingent consideration liability.

The following tables provide a reconciliation of the beginning and ending balances for the Company's mortgage securities – available-for-sale which are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six and three months ended June 30, 2012 and 2011 (dollars in thousands):

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	For the Six Months Ended June 30,
	2012			2011
Balance, beginning of period	$	3,878		$	4,580
Increases (decreases) to mortgage securities – available-for-sale:
Accretion of income (A)	513			636
Proceeds from paydowns of securities (A)	(502		)	(757		)
Mark-to-market value adjustment	517			470
Net increases (decreases) to mortgage securities – available-for-sale	528			349
Balance, end of period	$	4,406		$	4,929

(A) Cash received on mortgage securities with no cost basis was $2.7 million and $4.3 million for the six months ended June 30, 2012 and 2011, respectively.



	For the Three Months Ended June 30,
	2012			2011
Balance, beginning of period	$	4,085		$	4,300
Increases (decreases) to mortgage securities – available-for-sale:
Accretion of income (A)	264			409
Proceeds from paydowns of securities (A)	(218		)	(423		)
Mark-to-market value adjustment	275			643
Net increases (decreases) to mortgage securities – available-for-sale	321			629
Balance, end of period	$	4,406		$	4,929

(A) Cash received on mortgage securities with no cost basis was $1.6 million and $1.9 million for the three months ended June 30, 2012 and 2011, respectively.

There was no activity during the six and three months ended June 30, 2012 for the Company's mortgage securities – trading as they were determined to have no value as of December 31, 2011. The following table provides a reconciliation of the beginning and ending balances for the Company's mortgage securities – trading which are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six and three months ended June 30, 2011 (dollars in thousands):



	For the Six Months Ended June 30, 2011			For the Three Months Ended June 30, 2011
Balance, beginning of period	$	1,198		$	1,358
Increases (decreases) to mortgage securities – trading:
Accretion of income	701			326
Proceeds from paydowns of securities	(488		)	(229		)
Mark-to-market value adjustment	(987		)	(1,031		)
Net increase to mortgage securities – trading	(774		)	(934		)
Balance, end of period	$	424		$	424

The following table provides a summary of the impact to earnings for the six and three months ended June 30, 2012 and 2011 from the Company's assets and liabilities which are measured at fair value on a recurring and nonrecurring basis (dollars in thousands):

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		Fair Value Adjustments for the
		Six Months Ended June 30,					Three Months Ended June 30,
Asset or Liability Measured at Fair Value	Fair Value Measurement Frequency	2012		2011			2012		2011			Statement of Operations Line Item Impacted
Mortgage securities – trading	Recurring	$	—	$	(987	)	$	—	$	(1,031	)	Other income (expense)
Contingent consideration (A)	Nonrecurring	—		150			—		150			Other income (expense)
Asset-backed bonds secured by mortgage securities	Recurring	—		1,335			—		1,113			Other income (expense)
Total fair value gains (B)		$	—	$	498		$	—	$	232

(A) The contingent consideration represents the estimated fair value of the additional potential earn-out opportunity payable in connection with the acquisition of Corvisa that is contingent and based upon certain future earnings targets.

(B) The Company did not have any impairments relating to mortgage securities – available-for-sale or fair value adjustments relating to the contingent consideration for the six and three months ended June 30, 2012 and 2011.

The following disclosure of the estimated fair value of financial instruments presents amounts that have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimation methodologies could have a material impact on the estimated fair value amounts. The fair value of short-term financial assets and liabilities, such as service fees receivable, notes receivable, and accounts payable and accrued expenses are not included in the following table as their fair value approximates their carrying value.

The estimated fair values of the Company's financial instruments are as follows as of June 30, 2012 and December 31, 2011 (dollars in thousands):



	As of June 30, 2012				As of December 31, 2011
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:
Restricted cash	$	7,434	$	7,352	$	2,912	$	2,836
Mortgage securities – available-for-sale	4,406		4,406		3,878		3,878
Financial liabilities:
Senior notes	$	80,679	$	10,952	$	79,654	$	10,273
Note payable to related party	5,113		3,257		—		—

For the items in the table above not measured at fair value in the statement of financial position but for which the fair value is disclosed, the fair value has been estimated using Level 3 methodologies, based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow calculations based on internal cash flow forecasts. No assets or liabilities have been transferred between levels during any period presented.

Restricted cash – The fair value of restricted cash was estimated by discounting estimated future release of the cash from restriction.

Mortgage securities – available-for-sale – See Valuation Methods section above for fair value method utilized.

Senior notes – The fair value is estimated by discounting future projected cash flows using a discount rate commensurate with the risks involved. The value of the Senior Notes was calculated assuming that the Company would be required to pay interest at a rate of 1.0% per annum until January 2016, at which time the Company would be required to start paying the Full Rate of three-month LIBOR plus 3.5% until maturity in March 2033. The three-month LIBOR used in the analysis was projected using a forward interest rate curve.

Note payable to related party – The fair value of the note payable to related party is estimated by discounting future projected principal and interest payment cash flows using a discount rate commensurate with the risks involved. As of June 30, 2012, the future projected interest payments were calculated assuming the stated rate of 4.0% per annum until maturity in March 2016.

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Note 11. Income Taxes

The Company had a deferred tax asset of $286.4 million as of December 31, 2011 which had been reduced by a full valuation allowance. After evaluating positive and negative evidence available as of June 30, 2012, the Company determined that it is more likely than not that it will realize a portion of its deferred tax assets. The Company's analysis was significantly influenced by the fact that it reached three years of cumulative positive earnings in the first quarter of 2012. The Company, therefore, released a portion of its valuation allowance and recognized a net deferred tax asset of approximately $63.1 million on its balance sheet as of June 30, 2012. The Company recorded an income tax benefit of $63.1 million for the six months ended June 30, 2012 for the portion of the change in valuation allowance arising from expected realization of deferred tax assets in future years. Activity for the three months ended June 30, 2012 was not significant. The Company will continue to assess the need for a valuation allowance in future periods.

The Company has considered all available evidence, both positive and negative, such as historical levels of income and future forecasts of taxable income, among other items, in determining whether a full or partial release of our valuation allowance is required. Our estimates require the exercise of significant judgment. The Company based our estimate of realizable deferred tax assets in part on business plans and expectations about future outcomes. In the event that the actual results differ from these estimates in future periods, the Company may need to adjust the valuation allowance which could materially impact our financial position and results of operation.

The change in unrealized gain on mortgage securities – available-for-sale in the condensed consolidated statements of comprehensive income is not shown net of taxes as the Company has a valuation allowance recorded on a portion of its deferred tax assets.

Note 12. Segment Reporting

During the three months ended June 30, 2012, the Company changed its segment reporting structure by including Logistics as a separate operating unit. Historically, this segment has been aggregated with the Corporate operating segment based on the insignificant results of its operations. Due to recent and expected growth of the Logistics segment management deems it appropriate to segregate this segment. Prior period comparatives have not been updated to reflect this change in segmentation as the operations of this segment are not material.

The Company reviews, manages and operates its business in four segments: Corporate, Appraisal Management, Financial Intermediary, and Logistics. Corporate operating results include mortgage securities retained from securitizations and corporate general and administrative expenses. Appraisal Management operations include the service fee income and related expenses from the Company's majority-owned subsidiary, StreetLinks. The Financial Intermediary segment consists of the financial settlement service fee income and related expenses from a majority-owned subsidiary of the Company, Advent. The Logistics segment represents service fee income and related expenses from the Company's majority-owned subsidiary, Mango. Management evaluates segment performance based on income before income taxes, which is prior to the allocation of losses attributable to the noncontrolling interests.

The following is a summary of the operating results of the Company's segments for the six and three months ended June 30, 2012 and 2011 and a summary of their financial positions as of June 30, 2012 and December 31, 2011 (dollars in thousands):



	Corporate			Appraisal Management		Financial Intermediary		Logistics			Eliminations			Total
For the Six Months Ended June 30, 2012
Service fee income	$	4,333		$	84,529	$	9,007	$	2,615		$	(4,344	)	$	96,140
Interest income	3,736			—		—		—			(491		)	3,245
Interest expense	1,535			19		472		—			(491		)	1,535
Depreciation and amortization expense (A)	136			921		47		165			—			1,269
Income (loss) before income tax benefit	(587		)	3,110		436		(1,704		)	—			1,255
Additions to long-lived assets	547			550		73		139			—			1,309

As of June 30, 2012
Total assets (B) (C)	$	98,175		$	20,019	$	6,977	$	3,999		$	(14,289	)	$	114,881

(A) Amounts are included in the cost of services and selling, general and administrative expense line items of the condensed consolidated

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statements of operations.

(B) Logistics segment includes goodwill of $2.2 million resulting from the acquisition of Mango.

The intersegment service fee income consists of a guaranty fee of approximately $1.0 million paid by the Financial Intermediary segment to the Corporate segment for Corporate's guarantee of the Financial Intermediary segment's performance under its contract with its banking partner. It also includes fees charged by the Corporate segment to the Appraisal Management, Financial Intermediary, and Logistics segments for operational support provided by the Corporate segment's employees. The intersegment interest income and interest expense consists of interest charged by the Corporate segment to the Appraisal Management, Financial Intermediary, and Logistics segments for borrowings.



	Corporate			Appraisal Management		Financial Intermediary		Eliminations			Total
For the Six Months Ended June 30, 2011
Service fee income	$	—		$	44,041	$	6,514	$	—		$	50,555
Interest income	5,640			—		—		—			5,640
Interest expense	1,026			—		—		—			1,026
Depreciation and amortization expense (A)	88			846		41		—			975
Income (loss) before income tax benefit	(1,376		)	2,089		1,823		—			2,536
Additions to long-lived assets	18			728		7		—			753

As of December 31, 2011
Total assets (B) (C)	$	34,657		$	17,197	$	2,261	$	(9,514	)	$	44,601

(A) Amounts are included in the cost of services and selling, general and administrative expense line items of the condensed consolidated statements of operations.

(B) Corporate segment includes goodwill of $2.2 million resulting from the acquisition of Mango.



	Corporate			Appraisal Management		Financial Intermediary			Logistics			Eliminations			Total
For the Three Months Ended June 30, 2012
Service fee income	$	1,989		$	42,792	$	1,014		$	2,012		$	(2,000	)	$	45,807
Interest income	2,096			—		—			—			(250		)	1,846
Interest expense	800			9		241			—			(250		)	800
Depreciation and amortization expense (A)	79			465		25			72			—			641
Income (loss) before income tax benefit	(111		)	1,538		(1,136		)	(723		)	—			(432		)
Additions to long-lived assets	258			249		49			117			—			673

(A) Amounts are included in the cost of services and selling, general and administrative expense line items of the condensed consolidated statements of operations.

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	Corporate			Appraisal Management		Financial Intermediary			Eliminations		Total
For the Three Months Ended June 30, 2011
Service fee income	$	—		$	25,155	$	731		$	—	$	25,886
Interest income	2,622			—		—			—		2,622
Interest expense	714			—		—			—		714
Depreciation and amortization expense (A)	45			424		6			—		475
Income (loss) before income tax benefit	(442		)	1,438		(764		)	—		232
Additions to long-lived assets	2			599		3			—		604

(A) Amounts are included in the cost of services and selling, general and administrative expense line items of the condensed consolidated statements of operations.

Note 13. Earnings per Share

Earnings per share was calculated using the treasury method for all periods presented. For the six and three months ended June 30, 2011, this calculation included the Company's 9.0% Series D1 Mandatory Convertible Preferred Stock, par value $0.01 per share (the "Series D Preferred Stock"), which was assumed to be converted to 1,875,000 shares of common stock that shared in distributions with common shareholders on a 1:1 basis through the date of the Recapitalization.

The computations of basic and diluted earnings per share for the six and three months ended June 30, 2012 and 2011 (dollars in thousands, except share and per share amounts) are as follows:

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	For the Six Months Ended June 30,						For the Three Months Ended June 30,
	2012			2011			2012			2011
Numerator:
Net income	$	64,362		$	2,486		$	(463	)	$	213
Less income attributable to noncontrolling interests	(394		)	246			(429		)	(244		)
Dividends on preferred shares	—			(8,428		)	—			(4,138		)
Net effect of the Recapitalization (A)	—			95,460			—			95,460
Income (loss) available to common shareholders	$	64,756		$	89,272		$	(34	)	$	91,779

Denominator:
Weighted average common shares outstanding – basic	90,469,585			13,890,863			90,566,933			16,538,125

Weighted average common shares outstanding – dilutive:
Weighted average common shares outstanding – basic	90,469,585			13,890,863			90,566,933			16,538,125
Stock options	596,928			—			814,455			—
Nonvested shares	421,517			—			354,926			—
Weighted average common shares outstanding – dilutive	91,488,030			13,890,863			91,736,314			16,538,125

Basic earnings per share:
Net income	$	0.71		$	0.18		$	(0.01	)	$	0.01
Less income attributable to noncontrolling interests	(0.01		)	0.02			(0.01		)	(0.01		)
Dividends on preferred shares	—			(0.60		)	—			(0.25		)
Net effect of the Recapitalization (A)	—			6.87			—			5.78
Net income (loss) available to common shareholders	$	0.72		$	6.43		$	—		$	5.55

Diluted earnings per share:
Net income	$	0.70		$	0.18		$	(0.01	)	$	0.01
Less income attributable to noncontrolling interests	(0.01		)	0.02			(0.01		)	(0.01		)
Dividends on preferred shares	—			(0.60		)	—			(0.25		)
Net effect of the Recapitalization (A)	—			6.87			—			5.78
Net income (loss) available to common shareholders	$	0.71		$	6.43		$	—		$	5.55

(A)

The net effect of the Recapitalization includes amounts attributable to the Series C Offer and the Series D Exchange and was calculated in accordance with applicable Earnings per Share guidance. The Series C Offer amount is calculated as the difference between (1) the fair value of the consideration transferred to the holders of the Series C Preferred Stock and (2) the carrying amount of the Series C Preferred Stock. The Series D Exchange amount consists of the excess of (1) the fair value of all securities and other consideration transferred by the Company to the Series D Holders over (2) the fair value of securities issuable pursuant to the original conversion terms. See Note 14 to the condensed consolidated financial statements for further details.

The following weighted-average stock options to purchase shares of Common Stock were outstanding during each period presented, but were not included in the computation of diluted earnings (loss) per share because the number of shares assumed to be repurchased, as calculated was greater than the number of shares to be obtained upon exercise, therefore, the effect would be antidilutive (in thousands, except exercise prices):



	For the Six Months Ended June 30,				For the Three Months Ended June 30,
	2012		2011		2012		2011
Number of stock options	6,311		547		7,131		724
Weighted average exercise price of stock options	$	1.11	$	11.53	$	0.79	$	8.83

During the first three months of the six months ended June 30, 2012, the Company granted 6.9 million options to purchase

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shares of Common Stock at a weighted average exercise price of $0.77. The weighted average impact of 5.3 million shares and 6.0 million shares are included in the table above for the six and three months ended June 30, 2012, respectively. Of the 6.9 million total options granted, 5.3 million relate to a non-discretionary anti-dilution provision adjustment to preserve the benefits and potential benefits of grants issued prior to the Recapitalization. These options maintained the original exercise prices and vesting terms of the respective initial grants. There were no options granted during the three months ended June 30, 2012.

The Company had approximately 0.9 million and 30,000 of additional nonvested shares outstanding as of June 30, 2012 and June 30, 2011, respectively which have original cliff vesting schedules ranging between five and ten years. Of these, approximately 0.6 million shares were not included in the calculation of earnings per share for the six and three months ended June 30, 2012, while 30,000 nonvested shares were not included in the calculation of earnings per share for the six and three months ended June 30, 2011, because they were anti-dilutive.

Note 14. Recapitalization of Preferred Stock.

Series D Exchange. On June 23, 2011, the Company completed the exchange of all outstanding shares of the Company's Series D Preferred Stock for an aggregate of 37,162,000 shares of newly-issued Common Stock and $1.4 million in cash (the "Series D Exchange"). Completion of this exchange eliminated the Series D Preferred Stock and Company's obligations with respect to outstanding and future preferred dividends and the preferred liquidating preference related to the Series D Preferred Stock. As of June 23, 2011, there were accrued and unpaid dividends of approximately $34.5 million on the Series D Preferred Stock and the aggregate liquidating preference was $52.5 million.

The shares of Common Stock issued in the exchange were issued pursuant to an exemption from registration under Regulation D of the Securities Act of 1933, as amended, and therefore are "restricted securities." The Company entered into a registration rights agreement with the holders of Series D Preferred Stock (the "Series D Holders") which obligates the Company to register the Common Stock when the restrictions are lifted. Under the terms of the Series D Exchange, the Series D Holders are generally not permitted to sell or transfer the Common Stock for three years from issuance. However, the restriction may be lifted earlier if an ownership change occurs which results in the loss of the Company's existing net operating loss carryforwards ("NOLs") or if the board of directors determines that the Company's NOLs will not be realized in whole or in part.

Series C Offer. On June 27, 2011, the Company completed the exchange offer for all the outstanding shares of the 8.90% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (the "Series C Preferred Stock"), for an aggregate of 43,823,600 shares of Common Stock and $1.6 million of cash. Completion of the transaction eliminated the Series C Preferred Stock and the Company's obligations with respect to outstanding and future preferred dividends and the preferred liquidating preference related to the Series C Preferred Stock. As of June 27, 2011, there were accrued and unpaid dividends of approximately $24.8 million on the Series C Preferred Stock and the aggregate liquidating preference was $74.8 million.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Statements in this report regarding Novation Companies, Inc. and its business, that are not historical facts are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are those that predict or describe future events and that do not relate solely to historical matters and include statements regarding management's beliefs, estimates, projections, and assumptions with respect to, among other things, our future operations, business plans and strategies, as well as industry and market conditions, all of which are subject to change at any time without notice. Words such as "believe," "expect," "anticipate," "promise," "plan," and other expressions or words of similar meanings, as well as future or conditional auxiliary verbs such as "would," "should," "could," or "may" are generally intended to identify forward-looking statements. Actual results and operations for any future period may vary materially from those discussed herein. Some important factors that could cause actual results to differ materially from those anticipated include: our ability to manage our business; variability in the home mortgage or refinancing market that affects the demand for real estate appraisal services; changes in the regulatory environments within which our subsidiaries operate; our ability to develop new relationships and maintain existing relationships with both customers and business partners; decreases in cash flows from our mortgage securities; our ability to remain in compliance with the agreements governing our indebtedness; the outcome of litigation actions pending against us or other legal contingencies; our compliance with applicable local, state and federal laws and regulations; compliance with new accounting pronouncements; the impact of general economic conditions; and the risks that are from time to time included in our filings with the Securities and Exchange Commission (“SEC”), including this report on Form 10-Q. Other factors not presently identified may also cause actual results to differ. This report on Form 10-Q speaks only as of its date and we expressly disclaim any duty to update the information herein except as required by applicable law.

Executive Overview

The following Management's Discussion and Analysis of Financial Condition and Operating Results (“MD&A”)

should be read in conjunction with the preceding unaudited condensed consolidated financial statements of Novation Companies, Inc. and its subsidiaries (the “Company,” ”Novation,” “NCI,” “we” or “us”) and the notes thereto as well as the Company's Annual Report on Form 10-K for the year ended December 31, 2011. MD&A includes the following sections:


•	Corporate Overview, Background and Strategy – a brief overview of our business, current strategy, and significant recent events.


•	Critical Accounting Policies – an update, since December 31, 2011, of our discussion accounting policies that impact our financial statements and involve a high degree of judgment or complexity. This section also includes the impact of new accounting standards.


•	Consolidated Results of Operations – an analysis of our results of operations for the six and three months ended June 30, 2012 as presented in our unaudited Condensed Consolidated Financial Statements.


•	Segment Results of Operations – an analysis of our results of operations for the six and three months ended June 30, 2012 as presented in our unaudited Condensed Consolidated Financial Statements for our reporting segments.


•	Liquidity and Capital Resources – an analysis of our cash flows and financial commitments.

Corporate Overview, Background and Strategy

Our Business

We are a Maryland corporation formed on September 13, 1996. Effective May 23, 2012, we changed our name to Novation Companies, Inc. to reflect our current business strategy. We own 91% of StreetLinks LLC (“StreetLinks”), a national residential appraisal and real estate valuation management company. StreetLinks collects fees from lenders and borrowers in exchange for residential appraisals and other valuation services. Typically, the appraisal or other valuation service is provided by an independent contractor. Most of the fee is passed through to the contractor. StreetLinks retains a portion of the fee to cover its costs of managing the process of fulfilling the order and, for some services, performing a quality control review of the independent appraisal. StreetLinks also provides a technology product to lenders whereby the lender may manage its own appraisal process and a fee is earned per transaction processed by the lender.

We own 78% of Advent Financial Services LLC (“Advent”). Advent provides financial settlement services, for income tax preparation businesses and also provides access to tailored banking accounts, small dollar banking products and related services to meet the needs of low and moderate-income level individuals. Advent is not a bank but acts as an intermediary for banking products on behalf of other banking institutions. A primary distribution channel of Advent's bank products is by way of settlement services to electronic income tax return originators. Advent provides a process for the originators to collect refunds from the Internal Revenue Service, distribute fees to various service providers and deliver the net refund to individuals. Individuals may elect to have the net refund dollars deposited into a bank account offered through Advent. Individuals also have the option to have the net refund dollars paid by check or to an existing bank account. Regardless of the settlement method, Advent receives a fee from the originator for providing the settlement service. Advent receives fees from banking institutions and

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from the bank account owner for services related to the use of the funds deposited to Advent-offered bank accounts.

We own 51% of Mango Moving, LLC. Mango is an "asset-light" third party logistics provider of long-distance residential moves and moving labor services.

Prior to 2011, we originated, purchased, securitized, sold, invested in and serviced residential nonconforming mortgage loans and mortgage securities. We retained, in our mortgage securities investment portfolio, significant interests in the nonconforming loans we originated and purchased, and through our servicing platform, serviced all of the loans in which we retained interests. We discontinued our mortgage lending operations and sold our mortgage servicing rights which subsequently resulted in the closing of our servicing operations. The mortgage securities we retained continue to be a source of our cash flow.

The Company's condensed consolidated financial statements as of June 30, 2012 and for the six and three months ended June 30, 2012 and 2011 are unaudited. In the opinion of management, all necessary adjustments have been made, which were of a normal and recurring nature, for a fair presentation of the condensed consolidated financial statements.

Our Strategy

Management is focused on building its operating subsidiaries, all of which are early-stage businesses in the technology-enabled services sector. If and when opportunities arise, we intend to use available cash resources to invest in or start businesses that can generate income and cash.

The key performance measures for executive management are:


•	generating income and long-term value for our shareholders, and


•	maintaining and/or generating adequate liquidity to sustain us and allow us to take advantage of acquisition opportunities.

The following key performance metrics are derived from our condensed consolidated financial statements for the periods presented and should be read in conjunction with the more detailed information therein and with the disclosure included in this report under the heading “Management's Discussion and Analysis of Financial Condition and Results of Operations.”

Table 1 – Summary of Financial Highlights and Key Performance Metrics (dollars in thousands; except per share amounts)



	For the Six Months Ended June 30,
	2012		2011
Net income available to common shareholders per diluted share	$	0.71	$	6.43

	June 30, 2012		December 31, 2011
Unrestricted cash and cash equivalents	$	17,103	$	11,503

Significant Recent Events

As of June 30, 2012, the Company determined that it is more likely than not that it will realize a portion of its deferred tax assets. Therefore, the Company released $63.1 million of its valuation allowance for the six months ended June 30, 2012, which resulted in a net deferred tax asset of $63.1 million as of June 30, 2012. See Note 11 to the condensed consolidated financial statements for further details.

Steve Haslam, the Company's Chief Operating Officer, sold all of his membership units, representing approximately 5% of the outstanding units of StreetLinks, to the Company on March 8, 2012. The total purchase price was $6.1 million, $1.0 million of which was paid during the six months ended June 30, 2012. The remainder is payable as follows: $0.3 million on the last day of each quarter until March 8, 2016, on which date the unpaid principal balance of $1.6 million is to be paid, plus interest on the unpaid balance at the rate of 4.0% per annum, compounded quarterly.

Critical Accounting Policies

In our Annual Report on Form 10-K for the year ended December 31, 2011, we disclose critical accounting policies, that require management to use significant judgment or that require significant estimates. Management regularly reviews the selection and application of our critical accounting policies. There have been no updates to the critical accounting policies contained in our Annual Report on Form 10-K for the year ended December 31, 2011.

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Impact of Recently Issued Accounting Pronouncements

Consolidated Results of Operations

Service Fee Income and Cost of Services

See discussion within the Segment Results of Operations section below.

Interest Income – Mortgage Securities

The interest on the mortgage securities we own has decreased when comparing the six and three months ended June 30, 2012 to the same periods in 2011 as the cash flow on the securities have decreased mainly due to poor performance of the underlying collateral. Management expects that the interest income and cash flow from these securities will continue to decline as the underlying loan collateral is written down or off.

Selling, General and Administrative

Selling, general and administrative expenses have increased to $15.6 million and $8.2 million for the six and three months ended June 30, 2012, respectively, from $10.4 million and $4.8 million for the same periods in 2011. This increase was driven by the acquisition of Mango, as it was acquired in the fourth quarter of 2011 and threfore its results are not included for the six and three months ended June 30, 2011. The increase was also due to growth across all operating segments along with the Corporate segment and the increased workforce and infrastructure to help support the existing and expected increase in operations.

Interest Expense

Interest expense has increased to $1.5 million and $0.8 million for the six and three months ended June 30, 2012 from $1.0 million and $0.7 million for the six and three months ended June 30, 2011. The increase is due to the accretion of the debt discount to the higher principal balance of the Senior Notes. See Note 8 to the condensed consolidated financial statements for further details.

Income Tax Benefit

During the six months ended June 30, 2012, the Company released $63.1 million of its valuation allowance against its deferred tax assets. See Note 11 to the condensed consolidated financial statements for further details.

Segment Results of Operations

Appraisal Management

We manage the process of residential home appraisals for our customers, generally residential mortgage lenders. We earn fees when our service is completed and the appraisal is delivered to our customer. We also provide other valuation services and provide transaction-based technology for mortgage lenders to manage their own appraisal process. Fee revenue is directly related to the number of completed orders or transactions. Cost of services includes the direct cost of the appraisal or other service, when applicable, which is paid to an independent party, and the internal costs directly associated with completing the appraisal order. The internal costs include compensation and benefits, office administration, depreciation of equipment used in the production process, and other expenses necessary to the production process.

Following is an analysis of the results of operations from the Appraisal Management segment.

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Table 2 – Appraisal Management Segment Operations (dollars in thousands, except unit and per unit amounts)



	For the Six Months Ended June 30,								For the Three Months Ended June 30,
	2012				2011				2012				2011
	Total		%		Total		%		Total		%		Total			%
Service fee income:
Full service appraisal management	$	83,827	99.2	%	$	43,637	99.1	%	$	42,396	99.1	%	$	24,942		99.2	%
Other valuation services and transactions	702		0.8		404		0.9		396		0.9		213			0.8
Total service fee income	84,529		100.0		44,041		100.0		42,792		100.0		25,155			100.0

Cost of services	75,714		89.6		38,723		87.9		38,288		89.5		22,029			87.6
Selling, general and administrative expense	5,709		6.8		3,371		7.7		2,970		6.9		1,850			7.3
Other expense	1		—		25		0.1		1		—		(5		)	—

Other income, net	5		—		167		0.4		5		—		157			0.6

Net income before income taxes	$	3,110	3.6	%	$	2,089	4.7	%	$	1,538	3.6	%	$	1,438		5.7	%

Completed orders:
Full service appraisal management	218,878				118,999				111,260				67,883
Other valuation services and transactions	38,002				10,452				21,077				5,897

Service Fee Income

The large increase in service fee income in the Appraisal Management segment is directly related to the increase in completed orders and transactions. The substantial increase in order volume is mainly due to our sales efforts, which led to increases in the number of mortgage lender customers, along with gaining additional order volume from existing customers.

Cost of Services

As a percentage of service fee income, direct costs of services are consistent when comparing the six and three months ended June 30, 2012 to the same periods in 2011. This is due to the fact that fees charged by appraisers have largely remained unchanged. The indirect cost of services have also remained fairly consistent as a percentage of revenues. Changes in the fee income and cost of service per unit, and therefore net margin, from period to period may be impacted by the mix of the appraisal products completed, as margins for other valuation and transaction-based services are significantly different from full service appraisal management services.

Selling, General and Administrative

The selling, general and administrative expenses are higher when comparing the six and three months ended June 30, 2012 to the same periods in 2011. However, as a percentage of service fee income, these expenses are lower as many of these costs have not increased proportionate to production. A significant portion of these amounts are related to compensation and benefits for administrative and sales employees which have increased but at a slightly slower rate than revenue.

Financial Intermediary

We earn fees for providing financial settlement services to income tax preparation businesses and consumers. Settlement services are facilitated through arrangements we have made with other independent financial service providers, including our bank partners and data exchange managers. Settlement services consist mainly of collecting income tax refunds on behalf of our customers, distributing fees to independent service providers and delivering the refund, net of fees, to the individual taxpayer. As the majority of our business is directly related to income tax refunds, a significant portion of the financial intermediary's operations occur during the first quarter of each year.

Although we are not a bank, we also provide distribution for a bank to tailored banking accounts, small dollar banking products and related services. We are paid a fee from the bank based on the customers' account activity. In the analysis below, we have

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included all accounts opened (titled banking accounts enrolled), regardless of whether the account was used and generated fees. Cost of Services includes the direct cost related to providing services, which includes fees to third-party vendors performing services on our behalf. Additionally, internal costs directly associated with completing our services are included in Cost of Services. The internal costs include compensation and benefits of employees, office administration, depreciation of equipment used in the production process, and other expenses necessary to complete services performed.

Following is an analysis of the results of operations from the Financial Intermediary segment.

Table 3 – Financial Intermediary Segment Operations (dollars in thousands, except unit and per unit amounts)



	For the Six Months Ended June 30,								For the Three Months Ended June 30,
	2012				2011				2012					2011
	Total		%		Total		%		Total			%		Total			%
Service fee income:
Settlement	$	8,074	89.6	%	$	5,795	89.0	%	$	793		78.2	%	$	544		74.4	%
Banking account distribution	933		10.4		719		11.0		221			21.8		187			25.6
Total service fee income	9,007		100.0		6,514		100.0		1,014			100.0		731			100.0
																	—
Cost of services	4,880		54.2		2,756		42.3		1,003			98.9		555			75.9
Selling, general and administrative expense	2,207		24.5		1,731		26.6		906			89.3		940			128.6
Guaranty fees - NCI	1,012		11.2		—		—		—			—		—			—
Interest expense - NCI	472		5.3		204		3.1		241			23.8		—			—
Total expenses	8,571		95.2		4,691		72.0		2,150			212.0		1,495			204.5
Net income (loss) before income taxes	$	436	4.8	%	$	1,823	28.0	%	$	(1,136	)	(112.0	)%	$	(764	)	(104.5	)%

Settlements of federal income tax refunds (A)	569,167				313,063				51,571					28,618
Banking accounts enrolled	42,280				36,621				3,412					4,215

(A) Advent processes both federal and state income tax refunds. However, many taxpayers have no state refund and others may have more than one state tax refund. For this analysis, the number of state refunds have not been included. The number of federal income tax refunds generally represents the number of individual taxpayers using Advent services.

Service Fee Income

The large increase in service fee income in the Financial Intermediary segment is due to a significant increase in the number of settlements and enrollments, which was driven by continued sales and marketing efforts coupled with our current strategy to drive transaction volume through a reduction in our settlement and other service fee rates. We hope this will attract not only additional customers, but also additional business partners through which we can promote our services.

Cost of Services

The increase in cost of services for the six and three months ended June 30, 2012 when compared to the same periods in 2011 is due to the increased transaction volume over the same period. The increase in cost of services as a percentage of service fee income is due primarily to the Financial Intermediary segment's current strategy. While this strategy has driven additional service fee income dollars and volume, this strategy has also reduced margins during the six and three months ended June 30, 2012. In addition, this segment had higher operational costs than we expect to incur in the long term, as we continue to grow this business and supporting functions. Management of this segment is in the process of evaluating operations with the intent to increase margin in future periods.

Selling, General and Administrative

Selling, general and administrative expenses were higher during the six and three months ended June 30, 2012 when compared to the same periods in 2011. The Financial Intermediary segment incurred additional costs to administer the settlement programs, including compensation and related expenses for non-production staff and fees for professional services.

Guarantee Fees and Interest Expense

During the quarter ended March 31, 2012, NCI charged a guaranty fee of approximately $1.0 million to the Financial Intermediary segment for NCI's guarantee of Advent's performance under its contract with its settlement services banking partner. Interest was also charged on amounts borrowed from NCI.

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Logistics

We provide affordable long-distance moves and moving labor services via our nationwide network of licensed, independent moving professionals. Service fee income is directly related to the number of completed moves. Cost of services includes the direct costs of a move (such as loading, transportation, and unloading services), which are paid to independent parties, and the internal costs directly associated with completing a move. The internal costs include compensation and benefits, office administration, depreciation of equipment used in the production process, and other expenses necessary to complete the production process.

As discussed in Note 12, prior period comparatives for this segment have not been updated, as Mango was acquired during the fourth quarter of 2011 and therefore there are no results included in the Company's results for the six and three month periods ended June 30, 2011. As such, the following discussion regarding the results of operations of this segment will focus primarily on the activity within this segment for the six and three month periods ended June 30, 2012.

Table 4 – Logistics Segment Operations (dollars in thousands, except unit and per unit amounts)



	For the Six Months Ended June 30, 2012					For the Three Months Ended June 30, 2012
	Total			%		Total			%
Service fee income:
Labor-only	$	1,384		52.9	%	$	1,042		51.8	%
Direct-to-consumer	946			36.2		756			37.6
Transportation-only and other	285			10.9		214			10.6
Total service fee income	2,615			100.0		2,012			100.0

Cost of services	2,586			98.9		1,740			86.5
Selling, general and administrative expense	1,702			65.1		995			49.4
Other expense	31			1.2		—			—
Total expenses	4,319			165.2		2,735			135.9
Net loss before income taxes	$	(1,704	)	(65.2	)%	$	(723	)	(35.9	)%

Completed moves:
Labor-only	2,501					1,736
Direct-to-consumer	277					234
Transportation-only and other	48					41

Service Fee Income

Service fee income in the Logistics segment is directly related to the number of moves completed by Mango. Completed moves are tracked by three verticals; labor-only, direct-to-consumer, and transportation-only and other. Labor-only consists of labor services referred through third parties that offer portable moving and self-storage solutions to consumers. Direct-to-consumer moves are full-service moves that are offered directly to consumers. Leads for these types of moves are generally obtained through Internet sources. Transportation-only and other moves consist of services provided to third parties' customers when they cannot fulfill the transportation with their own transportation fleet. This vertical also includes corporate relocation services provided to employees and clients of our corporate partners. The substantial increase in move volume during the current year is due primarily to our sales and marketing efforts and the seasonality of the moving business.

Cost of Services

Generally, the large increase in direct costs of services is due to the substantial increase in move volume. Changes in the fee income and cost of service per unit, and therefore the net margin, from period to period may be impacted by the mix of the completed moving services and storage solutions.

Selling, General and Administrative

As the Logistics segment is still in the early stages of development, selling, general and administrative expenses are significantly higher as a percentage of service fee income than we would anticipate going forward. As we continue to grow and develop this business, we anticipate this percentage will decline, as many of these costs do not increase proportionate to production.

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Liquidity and Capital Resources

As of June 30, 2012, we had approximately $17.1 million in unrestricted cash and cash equivalents and $7.4 million of restricted cash, $6.4 million of which is included in the other current assets line item of the condensed consolidated balance sheets and $1.1 million in the other noncurrent assets line item. The bank that provides financial settlement services for Advent requires cash collateral in an account and its release is subject to contractual requirements. The balance in this account increased from December 31, 2011 due to the high volume of transactions that Advent processed during the six months ended June 30, 2012; $4.7 million was subsequently released from restriction in July 2012.

Service fee income was a substantial source of our cash flows during the six months ended June 30, 2012. We have had significant growth during the six months ended June 30, 2012 as compared to the same period in 2011, and are currently projecting an increase in service fee income over the course of the next year as we continue to increase our customer base, although we cannot assure the same rate of growth that we have experienced will continue in future periods. Our current projections indicate that sufficient cash and cash flows are and will be available to meet payment needs. However, our mortgage securities cash flows are volatile and uncertain, and the amounts we receive could vary materially from our projections though we believe that the increased cash flows from operations will offset any reduction in our mortgage securities cash flows. As discussed under the heading “Item 1. Legal Proceedings” of Part II of this report, we are the subject of various legal proceedings, the outcomes of which are uncertain. We may also face demands in the future that are unknown to us today related to our legacy lending and servicing operations. However, management believes that its current operations and its cash availability are sufficient for the Company to discharge its liabilities and meet its commitments in the normal course of business.

The indentures governing the Senior Notes (the “Indentures”) contain restrictive covenants (the “Negative Covenants”) subject to exceptions in the Indentures, including written consent of the holders of the Senior Notes. The Negative Covenants prohibit NCI and its subsidiaries, from among other things, incurring debt, permitting any lien upon any of its property or assets, making any cash dividend or distribution or liquidation payment, acquiring our shares or equity in our subsidiaries, making payment on our debt securities that rank pari passu or junior to the Senior Notes, or disposing of any equity interest in our subsidiaries or all or substantially all of the assets of our subsidiaries. The Senior Notes accrue interest at a rate of 1.0% until the earlier of (a) the completion of an equity offering by NCI or our subsidiaries that results in proceeds of $40 million or more or (b) January 1, 2016. Thereafter, the Senior Notes will accrue interest at a rate of three-month LIBOR plus 3.5% (the “Full Rate”). Interest on the Senior Notes is paid on a quarterly basis and no principal payments are due until the Senior Notes mature on March 30, 2033. The Negative Covenants remain in effect until both of the following conditions are met: 1) the Senior Notes begin accruing interest at the Full Rate, and 2) the Company satisfies certain financial covenants (the “Financial Covenants”). 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%. As the Senior Notes were not accruing interest at the Full Rate, the Negative Covenants, as defined above, were still in effect as of June 30, 2012 and December 31, 2011. As such, the Company was under no obligation to comply with the Financial Covenants during these periods.

The only significant change to the Company's contractual obligations as presented in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011, is the addition of the note payable to related party. See Note 8 to the condensed consolidated financial statements for repayment terms and other details.

Overview of Cash Flow for the Six Months Ended June 30, 2012

The following table provides a summary of our operating, investing and financing cash flows as taken from our condensed consolidated statements of cash flows for the six months ended June 30, 2012 and 2011.

Table 5 – Summary of Operating, Investing and Financing Cash Flows (dollars in thousands)



	For the Six Months Ended June 30,
	2012			2011
Consolidated Statements of Cash Flows:
Cash provided by operating activities	$	5,752		$	2,493
Cash flows provided by investing activities	869			793
Cash flows used in financing activities	(1,021		)	(3,209		)

Operating Activities

Cash provided by operating activities increased during the six months ended June 30, 2012 over the same period in 2011. This was directly related to the increased production for all of our operating segments.

Investing Activities

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During the six months ended June 30, 2012, the Company had a large decease in proceeds from paydowns and maturities of securities as compared to the same period last year mainly due to poor performance of the underlying collateral. However, as discussed in Note 5 to the condensed consolidated financial statements, the Company received a large note receivable payment of $1.5 million during the six months ended June 30, 2012. During the six months ended June 30, 2012, we also purchased a larger amount of property and equipment as compared to the same period in the prior year to support growth in the operating businesses.

Financing Activities

During the six months ended June 30, 2012, the Company paid approximately $1.0 million toward the acquisition of an additional equity interest in StreetLinks. During the same period in 2011, the Company paid approximately $3.0 million to holders of preferred stock as part of the Recapitalization.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As a smaller reporting company, we are not required to provide the information required by this Item.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company maintains a system of disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the federal securities laws, including this report, is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed under the federal securities laws is accumulated and communicated to the Company's management on a timely basis to allow decisions regarding required disclosure. The Company's principal executive officer and principal financial officer evaluated the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(d)) as of the end of the period covered by this report and concluded that the Company's controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There were no changes in our internal controls over financial reporting during the three months ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Pending Litigation.

The Company is a party to various legal proceedings. Except as set forth below, these proceedings are of an ordinary and routine nature.

On May 21, 2008, a purported class action case was filed in the Supreme Court of the State of New York, New York County, by the New Jersey Carpenters' Health Fund, on behalf of itself and all others similarly situated. Defendants in the case included NovaStar Mortgage Funding Corporation (“NMFC”) and its individual directors, several securitization trusts sponsored by the Company ("affiliated defendants") and several unaffiliated investment banks and credit rating agencies. The case was removed to the United States District Court for the Southern District of New York. On June 16, 2009, the plaintiff filed an amended complaint. Plaintiff seeks monetary damages, alleging that the defendants violated sections 11, 12 and 15 of the Securities Act of 1933, as amended, by making allegedly false statements regarding mortgage loans that served as collateral for securities purchased by plaintiff and the purported class members. On August 31, 2009, the Company filed a motion to dismiss the plaintiff's claims, which the court granted on March 31, 2011, with leave to amend. Plaintiff filed a second amended complaint on May 16, 2011, and the Company again filed a motion to dismiss. On March 29, 2012, the court dismissed the plaintiff's second amended complaint with prejudice and without leave to replead. The plaintiff filed an appeal. Given the court's ruling in an early

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stage of the litigation, the Company cannot provide an estimate of the range of any loss. The Company believes that the affiliated defendants have meritorious defenses to the case and expects them to defend the case vigorously.

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Item 1A. Risk Factors

Risk Factors

There have been no material changes to the risk factors previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(dollars in thousands, except per share amounts)



	Issuer Purchases of Equity Securities
	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (A)
April 1, 2012 - April 30, 2012	—	—	—	$	1,020
May 1, 2012 - May 31, 2012	—	—	—	$	1,020
June 1, 2012 - June 30, 2012	—	—	—	$	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

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

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Item 6. Exhibits

Exhibit Listing



Exhibit No.		Description of Document
11.1 ⁽¹⁾		Statement Regarding Computation of Per Share Earnings
31.1		Chief Executive Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Principal Financial Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Chief Executive Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Principal Financial Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		The following financial information from Novation Companies, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, formatted in XBRL (Extensible Business Reporting Language) includes: (i) Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011, (ii) Consolidated Statements of Operations for the six and three months ended June 30, 2012 and 2011, (iii) Consolidated Statements of Comprehensive Income for the six and three months ended June 30, 2012 and 2011, (iv) Consolidated Statements of Shareholders' Equity for the six and three months ended June 30, 2012 and 2011, (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011, and (vi) the Notes to Consolidated Financial Statements, tagged as blocks of text. In accordance with Regulation S-T, the XBRL-formatted interactive data files that comprise this Exhibit 101 shall be deemed “furnished” and not “filed.”
(1) See Note 13 to the condensed consolidated financial statements.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		NOVATION COMPANIES, INC.

DATE:	August 10, 2012	/s/ W. Lance Anderson
		W. Lance Anderson, Chairman of the Board of Directors and Chief Executive Officer
		(Principal Executive Officer)

DATE:	August 10, 2012	/s/ Rodney E. Schwatken
		Rodney E. Schwatken, Chief Financial Officer
		(Principal Financial Officer)

DATE:	August 10, 2012	/s/ Brett A. Monger
		Brett A. Monger, Vice President and Chief Accounting Officer
		(Principal Accounting Officer)