A hedging strategy gone wrong at NovaStar Financial Corp. could have compromised its real estate investment trust status, according to company executives. This event might have had a more negative implication on the subprime lender than the income draining moves it has deployed to prevent it. If a company fails to meet the relatively rigid accounting standards required for REIT status, it would lose its loan portfolio's tax-exempt status.
NovaStar in the first quarter reported revenue that was sharply down from year-ago levels, and warned that accounting changes could lead to increased impairments within its mortgage portfolio. Meanwhile, fellow subprime lender Aames Investment Corp. on March 16 announced it would shed its REIT status, and Encore Mortgage parent company ECC Credit announced two weeks later that it was considering doing the same. Switching from a REIT to a C-Corp could help the companies improve liquidity and take advantage of net operating loss carry-overs, at least temporarily reducing taxes, according to Barclays Capital.