April 5 (Bloomberg) -- NovaStar Financial Inc., the subprime home lender whose stock has plunged 80 percent this year, will stop financing independent mortgage bankers.

WarehouseUSA Capital Corp., a unit of NovaStar, said on its Web site that as of March 30, it's no longer accepting applications from mortgage bankers for credit lines and that the so-called warehouse lending business will close. New loans under existing agreements are scheduled to end April 27, the notice said. The shutdown won't affect lending by NovaStar itself, said Roswell, Georgia-based WarehouseUSA.

Independent mortgage lenders including NovaStar rely on ``warehouse'' credit lines from larger institutions to provide money for loans and keep them in business. Bankers have become reluctant to extend those credit lines after late payments and defaults on subprime mortgages surged to four-year highs in 2006. The pullback helped send at least five rival subprime lenders including New Century Financial Corp. into bankruptcy.

``By doing this, NovaStar is reducing its exposure to smaller lenders who might bring them nasty surprises,'' said Scott Valentin, an analyst at Friedman Billings Ramsey & Co. who rates the shares ``underperform.'' ``It also frees up resources as liquidity becomes an issue while Wall Street pulls back from financing subprime lenders.''

Quality Control

Federal regulators have said smaller state-licensed mortgage brokers and bankers contributed to the deteriorating quality of subprime loans by focusing too much on the fees they'd earn and not enough on whether borrowers could afford the loans.

Dick Johnson, spokesman for Kansas City, Missouri-based NovaStar, confirmed that the unit was in the process of closing and said it was a ``small part'' of the company's business and ``wasn't material from a financial standpoint.''

``The company's main business is making loans itself and managing the loan portfolio,'' Johnson said in an interview. ``By shutting this unit down, the company has decided to focus on its main business.''

Last month NovaStar said it was cutting about 350 jobs, or 17 percent of its workforce, because of ``changing conditions in the mortgage market.'' Johnson said he didn't know if the WarehouseUSA unit's closure would mean more firings. NovaStar was the 19th-largest lender of subprime mortgages last year, according to Inside Mortgage Finance, an industry publication.

Packaging

NovaStar and other mortgage lenders make loans to homeowners, which they then sell in packages to investors. Some including NovaStar also serve as conduits, passing on some of the credit lines obtained from banks and investment firms to smaller mortgage firms.

The smaller firms then sell loans back to the mortgage lender to be included in the packages sold to investors.

When warehouse credit lines are cut off, mortgage companies may be forced out of business. More than 40 have sought buyers or closed in the last 12 months.

Unlike most mortgage companies, NovaStar packages and sells a minority of its loans, about 20 percent, said Valentin. That means the company hasn't faced the same flood of delinquent loans being returned by Wall Street banks.

When loans go bad, the company can work with homeowners to modify the terms and keep them current in their payments, Valentin said.

Dividend in Question

NovaStar's biggest cash crunch probably will result from its obligation to pay hefty dividends because it's listed as a real estate investment trust, Valentin said.

``When you can't sell your loans in the secondary market for a good profit because there's no interest in them and cut new loan production drastically, where do you get the cash to pay those dividends?'' he said.

Subprime loans are made to people with lower credit scores or high debt burdens. The loans typically have rates at least two or three percentage points above safer prime loans. They made up about a fifth of all new mortgages last year, according to the Washington-based Mortgage Bankers Association.

Shares of NovaStar climbed 22 cents, or 4.3 percent, to $5.31 at 4:01 p.m. in New York Stock Exchange composite trading, paring earlier gains of as much as 10 percent.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

Last Updated: April 5, 2007 16:12 EDT