Could Novastar be a Sign of Life in Sub-Prime?

To see the most battered investments over the last couple of months, one need look no further than the companies who gave out risky loans. A quick look at that charts of NovaStar Financial (NFI) and American Home Mortgage (AHM) one can see the disaster that has plagued the industry.

With defaults rising, and credit problems seemingly spreading throughout the entire market its easily to let fire, get out and watch the world burn, while these companies struggle to stay afloat and remain in business. New Century Financial was not so lucky as it went bankrupt earlier in the year, and with AHM filing for Chapter 11 it seems like it won't be far behind. AHM's high for the year is $36 and now the stock sits at about $0.40! Yes that's right 40 cents for this mortgage player. Investors actions are speaking volumes as AHM tries to shield itself with bankruptcy protection. Seemingly days after it announced that it was laying off a vast majority of its workforce. No stop-gap measures could save this play it seems.

NFI was also in a lot of trouble even though it managed to work out a deal to get $150Million in funding recently. Trouble persisted as analysts came out saying even that wasn't enough and the company was doomed. Add to that the spreading word that more hedge funds invested in this industry are now worthless or close to worthless and you've got a fire sale spreading throughout the investment banking community.

Goldman Sachs stepped up and announced a new fund that will be going into the industry and it is to be valued at $20Billion. A sign of life? Maybe, but there's a lot of work to be done here. NFI also had problems last week announcing that it will suspend some loans that have not yet been processed. This news made the stock fall further as it dipped to about $4/share. A reverse 4 for 1 split went into effect last week and since then the stock has not drifted but been battered to the downside. That is until news today from the company that it will indeed be going back into the business of giving sub-prime loans. Now is this a sign that the winds are changing or is this a desperate ploy from a company that is still on the hook for a paying out a trust dividend this year? That much is not clear yet as it may take months and maybe years for this industry to climb out of this hole. However on the news NFI stock shot from the low $4/share to over $7/share. Volatile trading that reaped glorious rewards for day traders of the stock. However for NFI to think of coming back to earlier year highs it must do a lot more business in a lot longer period of time. Only the most patient of investors will probably stick with this company until, if ever, the institutional players see the market leveling and signs of undisputed life and profitability emerging.

Till then stay away from the chaos that is risky lending.

Disclosure: Author is long NFI