The following discussion contains forward-looking statements. Important factors that may cause actual results and circumstances to differ materially from those described in such statements are described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008, as well as throughout this Item 2. You are cautioned not to place undue reliance on the forward-looking statements contained in this document. These statements speak only as of the date of this document, and we undertake no obligation to update or revise these statements, except as may be required by law.

Overview

We are a commercial finance company that provides customized debt financing solutions to middle market businesses and commercial real estate borrowers. We principally focus on the direct origination of loans that meet our risk and return parameters. Our direct origination efforts target private equity sponsors, corporate executives, regional banks, real estate investors and a variety of other financial intermediaries to source transaction opportunities. Direct origination provides direct access to customers' management, enhances due diligence, and allows significant input into customers' capital structure and direct negotiation of transaction pricing and terms.

We operate as a single segment and derive revenues from two specialized lending groups:

• Middle Market Corporate, which originates, structures and underwrites senior debt and, to a lesser extent, second lien, mezzanine and subordinated debt, and equity and equity-linked products for companies with annual EBITDA typically between $5 million and $50 million; and

• Commercial Real Estate, which originates, structures and underwrites first mortgage debt and, to a lesser extent, subordinated debt, primarily to finance acquisitions of real estate properties typically valued between $10 million and $50 million.

Subsequent to December 31, 2007, we discontinued the origination of structured products and continue to manage the remaining portfolio within our Middle Market Corporate lending group. As of September 30, 2009, this portfolio had an outstanding balance of $43.9 million.

Market Conditions

While the economy remains weak, economic conditions improved in the third quarter of 2009, showing signs of improvement as GDP growth resumed following a year of steady contraction. While volumes in the loan market remain low, we are seeing areas of improvement, such as the strong rebound of the high-yield market.

Increasing loan values have also led to some improvement in the CLO market where bonds are now trading at higher levels. We expect this favorable trend to continue if there is positive investor sentiment of the macro-economy, default expectations recalibrate, spreads tighten across other types of asset-backed securities and corporate credit continues to improve into 2010.

Although the economy has improved, amendments and renewals of our existing credit facilities obtained in 2009 have been at lower committed amounts, higher interest rates and provide lower advance rates than similar transactions completed in prior periods. While we have been negatively impacted by the trend toward higher cost of borrowing and lower leverage, we believe that we have also benefitted from these market conditions by re-pricing our existing loans when possible, and originating new loans when possible at significantly higher yields and in many cases on more favorable terms.

During the third quarter of 2009, the negative credit migration in our loan portfolio moderated, but the difficult economic conditions continued to have a negative impact on the financial performance of our borrowers and their ability to make their scheduled payments. As such, we continued to increase our allowance for credit losses. We are closely monitoring the credit quality of our loans. We expect additional loan delinquencies, non-accruals, and charge offs to occur due to weak economic conditions.

As a result of the current market and funding conditions, opportunities in the commercial real estate market have slowed, and the quality of our commercial real estate loans' underlying collateral has declined. Should we foreclose on any of our commercial real estate loans, our recovery rates would be negatively impacted by these market and funding conditions. Moreover, refinancing current real estate loans has been and will continue to be difficult. We have not originated any new commercial real estate loans since the first quarter of 2008.

Recent Developments

Bank-Related

On August 14, 2009, the Company terminated the stock purchase agreement previously entered into on January 5, 2009 to acquire Southern Commerce Bank. Concurrent with the termination, the Company withdrew its application to become a bank holding company and related documents filed with the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency.

Liquidity

On November 3, 2009, we amended our credit facility with Citicorp North America, Inc. ("Citicorp"), which reduced the commitment amount under the facility to $150 million from $300 million and extended the facility's liquidity line until November 2010, completing the annual renewal. The amendment is effective as of November 17, 2009.

On July 15, 2009, we amended our credit facility with Wachovia Capital Markets, LLC ("Wachovia") to convert it from a $200 million facility to a $145.7 million secured term debt facility maturing on July 15, 2012.

Credit

As of September 30, 2009, we had 41 loans with an aggregate outstanding balance of $360.6 million classified as impaired. Twenty-two of these impaired loans with an outstanding balance of $147.6 million were on non-accrual status as of September 30, 2009. During the three months ended September 30, 2009, we recorded $33.3 million of specific provisions for impaired loans.

RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND
2008

NewStar's basic and diluted loss per share for the three and nine months ended September 30, 2009 was $0.21 and $0.63, respectively, on a net loss of $10.3 million and $30.9 million, respectively, compared to net income per share of $0.16 and $0.41, respectively, on net income of $7.6 million and $19.6 million, respectively, for the three and nine months ended September 30, 2008. Our managed loan portfolio was $2.7 billion at September 30, 2009. During the nine months ended September 30, 2009, loans owned by the NewStar Credit Opportunities Fund ("NCOF") decreased $17.6 million to $543.6 million.

Loan portfolio yield

Loan portfolio yield, which is interest income on our loans divided by the average balances outstanding of our loans, was 5.99% and 6.05% for the three and nine months ended September 30, 2009, compared to 7.32% and 7.76% for the three and nine months ended September 30, 2008. The decrease from 2008 to 2009 in loan portfolio yield was primarily driven by a decrease in three-month LIBOR over the prior year, the increase of loans on non-accrual status and, to a lesser extent, changes in product mix and credit spreads in our loan portfolio.

Net interest margin

Net interest margin, which is net interest income divided by average interest earning assets, was 4.16% and 3.88% for the three and nine months ended September 30, 2009, compared to 3.90% and 4.09% for the three and nine months ended September 30, 2008. The primary factors impacting net interest margin were changes in three-month LIBOR, non-accrual loans, our product mix, debt to equity ratio, credit spreads and cost of borrowings.

Efficiency ratio

Our efficiency ratio, which is total operating expenses divided by net interest income before provision for credit losses plus total non-interest income, was 41.57% and 42.08% for the three and nine months ended September 30, 2009, compared to 27.66% and 41.66% for the three and nine months ended September 30, 2008. The increase in our efficiency ratio for the three months ended September 30, 2009 as compared to the three months ended September 30, 2008 was primarily due to an increase in operating expenses due to severance expense, and a decrease in net interest income during the third quarter of 2009 as compared to the third quarter of 2008. The increase in our efficiency ratio during the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008 was primarily due to a decline in net interest income during 2009.

Allowance for credit losses

Allowance for credit losses ratio, which is allowance for credit losses divided by outstanding gross loans excluding loans held-for-sale, was 4.69% at September 30, 2009 and 1.87% as of September 30, 2008. The allowance for credit losses at September 30, 2009 included a specific allowance of $61.0 million and a general allowance of $39.1 million. The allowance for credit losses at September 30, 2008 included a specific allowance of $11.4 million and a general allowance of $33.5 million. The increase in our specific allowance is primarily due to economic conditions. During 2008, we made minor modifications to our general allowance analysis to simplify and more closely align it with our internal credit ratings, which incorporate our ratings migration and loan default experience. During the second quarter of 2009, we adjusted our allowance for credit losses methodology regarding commercial real estate to reflect deteriorating market conditions, which has increased the probability of default for borrowers with high loan to value ratios. We continually evaluate our allowance for credit losses methodology. If we determine that a change in our allowance for credit losses methodology is advisable, as a result of the rapidly changing economic environment or otherwise, the revised allowance methodology may result in higher levels of allowance. Moreover, given current market conditions, actual losses under our current or any revised methodology may differ materially from our estimate.

Delinquent loan rate

Delinquent loan rate, which is total delinquent loans net of charge offs that are 60 days or more past due, divided by outstanding gross loans, was 6.91% as of September 30, 2009 as compared to 0% as of September 30, 2008. Given prevailing economic and market conditions, we expect the delinquent loan rate to increase as weak economic conditions negatively impact the financial performance of our borrowers and their ability to meet their obligations on a timely basis.

Delinquent loan rate for accruing loans 60 days or more past due

Delinquent loan rate for accruing loans 60 days or more past due, which is total delinquent accruing loans net of charge offs that are 60 days or more past due, divided by outstanding gross loans, was 1.69% as of September 30, 2009 as compared to 0% as of September 30, 2008. Given prevailing economic and market conditions, we expect the delinquent accruing loan rate to increase as weak economic conditions negatively impact the financial performance of our borrowers and their ability to meet their obligations on a timely basis.

Non-accrual loan rate

Non-accrual loan rate is defined as total balances outstanding of loans on non-accrual status divided by the total outstanding balance of our loans held for investment. Loans are put on non-accrual status if they are 90 days or more past due or if management believes that there is reasonable doubt as to collectibility in the normal course of business. The non-accrual loan rate was 6.84% as of September 30, 2009 and 1.10% as of September 30, 2008. As of September 30, 2009 and 2008 the aggregate outstanding value of non-accrual loans was $147.6 million and $26.4 million, respectively. Given prevailing economic and market conditions, we expect the non-accrual loan rate to increase as weak economic conditions impair our borrowers' ability to fully repay principal and interest under the terms of their loan agreement.

Non-performing asset rate

Non-performing asset rate is defined as the sum of total balances outstanding of loans on non-accrual status and other real estate owned, divided by the sum of the total outstanding balance of our loans held for investment and other real estate owned. The non-performing asset rate was 7.08% as of September 30, 2009 and 1.39% as of September 30, 2008. As of September 30, 2009 and 2008 the sum of the aggregate outstanding value of non-accrual loans was $153.2 million and $33.4 million, respectively. Given prevailing economic and market conditions, we expect the non-performing asset rate to increase as weak economic conditions impair our borrowers' ability to fully repay principal and interest under the terms of their loan agreement.

Net charge off rate

Net charge off rate as a percentage of loan portfolio is defined as annualized charge offs net of recoveries divided by the total outstanding balance of our loans held for investment. A charge off occurs when management believes that all or part of the principal of a particular loan is no longer recoverable and will not be repaid. For the three and nine months ended September 30, 2009, the net charge off rate was 3.27% and 2.91%, compared to 0.87% and 0.81% for the three and nine months ended September 30, 2008. We expect the net charge off rate to increase as economic conditions impair our borrowers' ability to fully repay principal and interest under the terms of their loan agreement.

Return on average assets

Return on average assets, which is net income divided by average total assets, was not meaningful for the three and nine months ended September 30, 2009 as we had net losses. Return on average assets was 1.15% and 1.00% for the three and nine months ended September 30, 2008.

Return on average equity

Return on average equity, which is net income divided by average equity, was not meaningful for the three and nine months ended September 30, 2009 as we had net losses. Return on average equity was 5.26% and 4.68% for the three and nine months ended September 30, 2008.

Review of Consolidated Results

A summary of NewStar's consolidated financial results for the three and nine
months ended September 30, 2009 and 2008 follows:



                                                 Three Months Ended              Nine Months Ended
                                                   September 30,                   September 30,
                                                2009            2008           2009            2008
                                                                  ($ in thousands)
Net interest income:
Interest income                               $  33,675       $ 44,903       $ 104,626       $ 142,925
Interest expense                                  9,197         19,864          34,374          64,771

Net interest income                              24,478         25,039          70,252          78,154
Provision for credit losses                      32,577         11,960          94,061          20,294

Net interest income (loss) after provision
for credit losses                                (8,099 )       13,079         (23,809 )        57,860

Non-interest income:
Fee income                                          388            725           1,242           3,652
Asset management income                             758          1,699           2,218           4,826
Gain on derivatives                                 126            746             492             791
Gain on sale of loans and debt securities            -           1,022              -              283
Loss on investments in debt securities               -              (6 )            -             (931 )
Loss on residual interest in
securitization                                       -              --              -             (631 )
Other income (expense)                           (1,139 )        1,350           2,255           2,295

Total non-interest income                           133          5,536           6,207          10,285

Operating expenses:
Compensation and benefits                         7,578          5,161          19,891          26,241
Occupancy and equipment                             769            795           2,330           2,568
General and administrative expenses               2,580          2,500          10,654           8,036

Total operating expenses                         10,927          8,456          32,875          36,845

Income (loss) before income taxes               (18,893 )       10,159         (50,477 )        31,300
Income tax expense (benefit)                     (6,957 )        2,580         (17,948 )        11,656

Net income (loss) before noncontrolling
interest                                        (11,936 )        7,579         (32,529 )        19,644
Net loss attributable to noncontrolling
interest                                          1,674             -            1,674              -

Net income (loss)                             $ (10,262 )     $  7,579       $ (30,855 )     $  19,644

Comparison of the Three Months Ended September 30, 2009 and 2008

Interest income. Interest income decreased $11.2 million, to $33.7 million for the three months ended September 30, 2009 from $44.9 million for the three months ended September 30, 2008. The decrease was primarily due to a decrease in the yield on average interest earning assets to 5.73% from 7.00%, primarily driven by a decrease in three-month LIBOR and the increase in loans on non-accrual status. Average three-month LIBOR decreased from 2.91% for the three months ended September 30, 2008 to 0.40% for the three months ended September 30, 2009.

Interest expense. Interest expense decreased $10.7 million, to $9.2 million for the three months ended September 30, 2009 from $19.9 million for the three months ended September 30, 2008. The decrease was primarily due to a decrease in our cost of borrowings. The decrease in our cost of borrowings, to 2.10% from 4.04% was primarily attributable to a decrease in three-month LIBOR and increased use of lower cost term debt securitizations.

Net interest margin. Net interest margin increased to 4.16% for the three months ended September 30, 2009 from 3.90% for the three months ended September 30, 2008. The increase in net interest margin was primarily due to an increase in interest yields on 2009 re-pricings and a decrease in our average cost of interest bearing liabilities, partially offset by a decrease in our average yield on interest earning assets and non-payment of interest income from non-accrual loans. The decrease in yield and cost is primarily due to a decrease in LIBOR. The net interest spread, the difference between gross yield on our interest earning assets and the total cost of our interest bearing liabilities, increased to 3.63% from 2.97%. LIBOR floor provisions included in our customer contracts and an increase in interest spreads offset our increasing cost of funds during the third quarter, resulting in a net gain of 20 basis points to the net interest margin. The net interest margin was further impacted by non-accrual loans which contributed an additional nine basis point loss.

The following table summarizes the yield and cost of interest earning assets and interest bearing liabilities for the three months ended September 30, 2009 and 2008:

                                          Three Months Ended September 30, 2009            Three Months Ended September 30, 2008
                                                                             ($ in thousands)
                                                             Interest      Average                            Interest      Average
                                           Average           Income/       Yield/           Average           Income/       Yield/
                                           Balance           Expense        Cost            Balance           Expense        Cost
Total interest earning assets          $      2,333,502    $     33,675       5.73 %    $      2,551,689    $     44,903       7.00 %
Total interest bearing liabilities            1,738,064           9,198       2.10             1,958,274          19,864       4.04

Net interest spread                                        $     24,478       3.63 %                        $     25,039       2.97 %

Net interest margin                                                           4.16 %                                           3.90 %

Provision for credit losses. The provision for credit losses increased to $32.6 million for the three months ended September 30, 2009 from $12.0 million for the three months ended September 30, 2008. The increase in the provision was primarily due to $33.3 million of specific provisions recorded during the three months ended September 30, 2009 for impaired loans.

In accordance with ASC 310 (formerly SFAS No. 5, Accounting for Contingencies), a base allowance is provided for loans that are not impaired. The Company employs a variety of internally developed and third-party modeling and estimation tools for measuring credit risk, which are used in developing an allowance for loan losses on outstanding loans. The Company's allowance framework addresses economic conditions, capital market liquidity and industry circumstances from both a top-down and bottoms-up perspective. The Company considers and evaluates changes in economic conditions, credit availability, industry and multiple obligor concentrations in assessing both probabilities of default and loss severities as part of the general component of the allowance for loan losses.

On at least a quarterly basis, loans are internally risk-rated based on individual credit criteria, including loan type, loan structures (including balloon and bullet structures common in the Company's Middle Market Corporate and Commercial Real Estate cash flow loans), borrower industry, payment capacity, location and quality of collateral if any (including the Company's Commercial Real Estate loans). Borrowers provide the Company with financial information on either a monthly or quarterly basis. Ratings, corresponding assumed default rates and assumed loss severities are dynamically updated to reflect any changes in borrower condition or profile.

For Middle Market Corporate loans, the data set used to construct probabilities of default in its allowance for loan losses model, Moody's CRD Private Firm Database, contains only middle market loans and incorporates attributes relevant to the Company's loans. The Company also considers the quality of the loan terms in determining a loan loss in the event of default.

For Commercial Real Estate loans, the Company employs two mechanisms to capture the impact of industry and economic conditions. First, a loan's risk rating, and thereby its assumed default likelihood, can be adjusted to account for overall commercial real estate market quality. Second, to the extent that economic or industry trends adversely affect a borrower's loan-to-value ratio enough to impact its repayment ability, the Company applies a stress multiplier to the loan's probability of default. The multiplier is designed to account for default characteristics that are difficult to quantify when market conditions cause commercial real estate prices to decline.

Additionally, when determining the amount of the general allowance, the Company supplements the base amount with a judgmental amount which is governed by a score card system comprised of ten weighted risk factors. The risk factors are designed based on those outlined in the Comptrollers of the Currency's Allowance for Loan and Lease Losses Handbook. The Company also performs a ratio analysis of comparable money center banks, regional banks and finance companies. While the Company does not rely on this peer group comparison to set the level of allowance for credit losses, it does assist management in identifying market trends and serves as an overall reasonable check on the allowance for credit losses computation.

In accordance with ASC 310 (formerly SFAS No. 114, "Accounting by Creditors for Impairment of a Loan"), a loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impairment of a loan is based upon either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral if the loan is collateral dependent, depending on the circumstances and our collection strategy. Impaired loans are identified based on the loan-by-loan risk rating process described above. It is the Company's policy that during the reporting period to record a specific provision for credit losses for all loans for which we have serious doubts as to the ability of the borrowers to comply with the present loan repayment terms.

Impaired loans at September 30, 2009 and December 31, 2008 were in both Commercial Real Estate and in Middle Market Corporate, over a range of industries impacted by the then current economic environment including the following: Buildings and Commercial Real Estate, Healthcare, Broadcast and Entertainment, Nondurable Consumer Products, Energy and Chemical Services, Industrial and Other Business Services. For impaired Middle Market Corporate loans, the Company measured impairment based on expected cash flows utilizing relevant information provided by the borrower and consideration of other market conditions or specific factors impacting recoverability. Such amounts are discounted based on original loan terms. For impaired Commercial Real Estate loans, the Company determined that the loans were collateral dependent and measured impairment based on the fair value of the related collateral utilizing recent appraisals from third-party appraisers, as well as internal estimates of market value.

Non-interest income. Non-interest income decreased $5.4 million, to $0.1 million for the three months ended September 30, 2009 from $5.5 million for the three months ended September 30, 2008. The decrease is primarily due to a $1.6 million decline in the fair value of other real estate owned at the end of the quarter, as well as the loss of $1.7 million attributable to the consolidation of the noncontrolling interest of the entity which owns the other real estate owned, a $0.9 million decrease in asset management income, a $0.6 million decrease in gain on derivatives, a $0.3 million decrease in fee income, and a $1.0 million gain on sale of loans and debt securities during the three months ended September 30, 2008, partially offset by a $1.2 million gain recognized in connection with the repurchase of debt.

Operating expenses. Operating expenses increased $2.5 million, to $10.9 million for the three months ended September 30, 2009 from $8.5 million for the three months ended September 30, 2008. Employee compensation and benefits increased $2.4 million primarily due to severance expense and an increase in incentive compensation, partially offset by lower headcount. General and administrative expenses and occupancy and equipment expenses were approximately equal.

Income taxes. For the three months ended September 30, 2009 and 2008, we provided for income taxes based on an effective tax rate of 37% and 25%, respectively. Our effective tax rate for 2009 reflects the impact of nondeductible compensation expenses incurred in connection with our initial public offering. As of September 30, 2009 and December 31, 2008, we had net . . .