Executive Compensation and Lock-Up Agreement among NovaStar Financial Inc., Massachusetts Mutual Life Insurance Company, and Jefferies Capital Partners IV LLC (July 16, 2007)

 EXHIBIT 10.6 Execution Copy July 16, 2007 Massachusetts Mutual Life Insurance Company 1295 State Street Springfield, MA 01111 Jefferies Capital Partners IV LLC 520 Madison Avenue New York, New York 10022 Re: Executive Compensation Arrangements Dear Sirs: Reference is made to (i) the Securities Purchase Agreement (the "Purchase Agreement"), dated as of the date hereof, among NovaStar Financial Inc., a Maryland corporation (the "Company"), Massachusetts Mutual Life Insurance Company, a mutual life insurance company ("MassMutual"), Jefferies Capital Partners IV L.P., Jefferies Employee Partners IV LLC and JCP Partners IV LLC (collectively, "Jefferies" and, together with MassMutual, collectively, "Investors"), (ii) the Registration Rights and Shareholders Agreement ("Registration Rights and Shareholders Agreement"), dated as of the date hereof, among the Company and the Investors, (iii) the Standby Purchase Agreement (the "Standby Purchase Agreement" and, together with the Purchase Agreement, the Registration Rights and Shareholders Agreement and the agreements contemplated thereby, the "Transaction Agreements"), dated as of the date hereof, among the Company and the Investors. Capitalized terms not otherwise defined herein shall have the meanings ascribed to such terms in the Purchase Agreement. The undersigned, a stockholder and an officer and/or director of the Company (the "Key Employee") understands that the Company and the Investors intend to enter into the Transaction Agreements, which, among other things, contemplate that the Company will issue and sell to the Investors, and the Investors will purchase from the Company shares of the Company's Series D-1 Preferred Shares and Series D-2 Preferred Shares. In connection with the transactions contemplated by the Transaction Agreements, the Investors and the Key Employee have agreed in principle with respect to the compensation arrangements for the Key Employee set forth on Annex A attached hereto (the "Compensation Arrangements"), which Compensation Arrangements the Investors and the Key Employee acknowledge and agree remain subject to the approval of the Board of Directors of the Company and/or the shareholders of the Company, as applicable, and to definitive legal documentation in form and substance reasonably satisfactory to the Investors and the Key Employee. The Company acknowledges that its Board of Directors has authorized and approved the Company's entry into this letter agreement and approved in principle the Compensation Arrangements. The Investors and the Key Employee each agree that they shall use their respective reasonable best efforts to work with the Company and its Board of Directors to implement the Compensation Arrangements. In the event that it is not possible to effectuate the Compensation Arrangements as currently contemplated on Annex A, the Key Employee and the Investors each hereby agree that they shall consult with each other and 

 negotiate in good faith to provide the Key Employee with a set of compensation awards that are as nearly as equivalent in terms of the economic value, risk and reward, retention characteristics and commitment to the long-term growth in equity value to the Compensation Arrangements. In recognition of the benefits that (a) the transactions contemplated by the Transaction Agreements will confer upon the Key Employee as a stockholder of the Company, (b) the Compensation Arrangements will confer upon the Key Employee as an officer and/or director of the Company and (c) for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged by the Key Employee, the Key Employee hereby agrees with the Investors that, during the period beginning on the date of this letter agreement and ending on the three year anniversary of the date of this letter agreement, the Key Employee will not, without the prior written consent of both Investors, directly or indirectly, (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant for the sale of, or otherwise dispose of or transfer (each, a "Transfer") any shares of the Company's common stock, par value $0.01 per share (the "Common Stock") or any securities convertible into or exchangeable or exercisable for Common Stock, whether now owned or hereafter acquired by the Key Employee or with respect to which the Key Employee has or hereafter acquires the power of disposition, or file, or cause to be filed, any registration statement under the Securities Act of 1933, as amended, with respect to any of the foregoing (collectively, the "Lock-Up Securities") or (ii) enter into any swap or any other agreement or any transaction that transfers, in whole or in part, directly or indirectly, the economic consequence of ownership of the Lock-Up Securities, whether any such swap or transaction is to be settled by delivery of Common Stock or other securities, in cash or otherwise; provided, however, that the restrictions set forth in this paragraph shall be of no further force and effect (A) in the event that the Investors (or their respective Affiliates), at any time, sell or otherwise dispose of more than 20% in the aggregate of the then outstanding (x) Series D-1 Preferred Shares purchased pursuant to the Purchase Agreement (which shall include the Common Shares and/or Series D-2 Preferred Shares into which such Series D-1 Preferred Shares may convert), (y) Series D-2 Preferred Shares which the Investors may purchase in the Rights Offering (which shall include the Common Shares into which such Series D-2 Preferred Shares may convert) and (z) Series D-2 Preferred Shares which the Investors may purchase pursuant to the Standby Purchase Agreement (which shall include the Common Shares into which such Series D-2 Preferred Shares may convert) or (B) upon the death or permanent mental or physical incapacity of the Key Employee. The Key Employee also agrees and consents to the entry of stop transfer instructions with the Company's transfer agent and registrar against the transfer of the Lock-Up Securities except in compliance with the foregoing restrictions. Notwithstanding the foregoing, the Key Employee may Transfer the Lock-Up Securities without the prior written consent of the Investors, as follows: (i) to satisfy the Key Employee's income tax obligations arising from the Key Employee's receipt of the REIT Dividends; provided, that the sale of Lock-Up Securities by the Key Employee shall not occur on or prior to the six-month anniversary of the date of the Key Employee's receipt of the REIT Dividends; (ii) in connection with the Key Employee's participation in the Rights Offering; provided, that (A) the Key Employee shall not Transfer any Lock-Up Securities in connection with the Key Employee's participation in the Rights Offering on a date that is on or prior to the six month anniversary of the date on which the Key Employee purchases securities of the Company in the Rights Offering and (B) the amount of Lock-Up Securities the Key Employee Transfers in 

 connection with his participation in the Rights Offering shall be materially the same as the amount of securities purchased by the Key Employee in the Rights Offering (as determined on an as-converted basis); (iii) to serve as collateral pledged by the Key Employee as security for obligations of the Key Employee under any bona fide loan or financing arrangement; provided, that all such pledged Lock-Up Securities in the aggregate do not exceed 25% of the Lock-Up Securities held by the Key Employee at the time of such pledge; (iv) following the 12-month anniversary of the date of this letter agreement, the Key Employee shall be permitted to Transfer up to 25% of the Lock-Up Securities held by the Key Employee as of such 12-month anniversary to the extent that the Trading Price of the Common Stock equals or exceeds $10 per share as of the date of this letter agreement (which Trading Price shall be adjusted to take into account any stock splits, combinations or stock dividends (including the REIT Dividend) effected by the Company after the date of this letter agreement); (v) following the 24-month anniversary of the date of this letter agreement, the Key Employee shall be permitted to Transfer up to an additional 25% of the Lock-Up Securities held by the Key Employee as of such 24-month anniversary to the extent that the Trading Price of the Common Stock equals or exceeds $13 per share as of the date of this letter agreement (which Trading Price shall be adjusted to take into account any stock splits, combinations or stock dividends (including the REIT Dividend) effected by the Company after the date of this letter agreement); (vi) for estate planning purposes to any trust for the direct or indirect benefit of the Key Employee or the Immediate Family of the Key Employee, provided that the trustee of the trust agrees to be bound in writing by the restrictions set forth herein, and provided further that any such Transfer shall not involve a disposition for value; and (vii) any other voluntary Transfer to a member of the Immediate Family of the Key Employee, provided that the Immediate Family member agrees to be bound in writing by the restrictions set forth herein, and provided further that any such Transfer shall not involve a disposition for value. For purposes of this letter agreement, (a) "Trading Price" means with respect to shares of Common Stock, on any day, that are (i) listed on a United States securities exchange, the weighted average of the last sales price of such stock for the ten Business Day period prior to such day on the largest United States securities exchange on which such stock shall have traded on such day, or if such day is not a day on which a United States securities exchange is open for trading, on the immediately preceding day on which such securities exchange was open, and (ii) not listed on a United States securities exchange but are included in The NASDAQ Stock Market System (including the NASDAQ Global Market), the last sales price on such system of such shares on such day, or if such day is not a trading day, on the immediately preceding trading day; and (b) "Immediate Family" means any relationship by blood, marriage or adoption, not more remote than first cousin. The Key Employee also hereby agrees to waive any applicable "change of control" provisions set forth in the Key Employee's Employment Agreement with respect to the transactions contemplated by the Transaction Agreements. [Remainder of Page Intentionally Blank] 

 Very truly yours, Signature: /s/ Michael L. Bamburg ------------------------------- Print Name: Michael L. Bamburg ------------------------------ Agreed and Acknowledged: MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY By: Babson Capital Management LLC, its investment adviser By: /s/ Larry N. Port ------------------------------ Name: Larry N. Port Title: Managing Director JEFFERIES CAPITAL PARTNERS IV L.P. JEFFERIES EMPLOYEE PARTNERS IV LLC JCP PARTNERS IV LLC By: JEFFERIES CAPITAL PARTNERS IV LLC, as Manager By: /s/ Brian P. Friedman ------------------------------ Name: Brian P. Friedman Title: Managing Member NOVASTAR FINANCIAL, INC. By: /s/ Gregory S. Metz ------------------------------ Name: Gregory S. Metz Title: Senior Vice President, Chief Financial Officer and Assistant Secretary 

 ANNEX A KEY EMPLOYEE COMPENSATION ARRANGEMENTS 1. Awards to the Key Employee under the NovaStar Financial, Inc. Executive Bonus Plan shall only be payable in Restricted Shares in a manner consistent with the terms of the Key Employee's existing compensation arrangements with the Company. 2. The Key Employee will be entitled to receive 1,000,000 Options subject to the following terms and conditions: a) Initial strike price for the Options shall equal the weighted average conversion price of the Convertible Shares owned by the Investors (following the issuance of the REIT Dividends) b) Options will vest 100% on the three year anniversary of the date of this letter agreement c) The Key Employee will forfeit 100% of the Options if the Key Employee has not remained continuously employed by the Company during the period beginning on the date of this letter agreement and ending on the three year anniversary of the date of this letter agreement 3. The Key Employee will not be entitled to receive any long-term incentive awards under the Company's employee benefit plans during the period beginning on the date of this letter agreement and ending on the three year anniversary of the date of this letter agreement. Following the three year anniversary of this letter agreement, the Compensation Committee of the Board of Directors of the Company shall be permitted to approve and grant long-term incentive awards to the Key Employee.