New Century Financial Corporation New Century Financial Corporation had been the United States’ second largest originator of subprime mortgage loans for over a decade until its filing of Chapter 11 bankruptcy protection on April 2, 2007. It announced on February 7, 2007 that it would have to restate its financial statements for the first three quarters of 2006 due to errors in accounting for its loan repurchase reserves. The restatements would significantly impact the state profits and earnings. Later on March 2, 2007, New Century announced that the company would not be able to file its 2006 annual report on time. After the announcement, New Century’s stock prices dropped dramatically. Because of its previously undisclosed financial and accounting problems, New Century started to margin calls from its warehouse lenders, and many refused to provide further financing to the company. Consequently, New Century faced a liquidity crisis as it had not been able to satisfy $70 million out of the $150 million aggregate margin calls. The company had to stop accepting new loan applications. On March 13, 2007, New York Stock Exchange delisted New Century’s securities. Furthermore, New Century received default and acceleration notices from all of its warehouse lenders and its outstanding repurchase obligations exceeded $7 billion as of March 31, 2007. After it filed for bankruptcy protection, New Century’s independent auditor resigned on April 27, 2007. New Century announced in May, 2007 that its 2005 financial statements were actually also inaccurate. Later on, the Bankruptcy Court Examiner, Michael J. Missal, was appointed to investigate the financial and accounting misstatements and errors or New Century. The Examiner had concluded that New Century had “serious problem in its monitoring of loan quality and key accounting estimates”.
The examiner pointed out that it had at least seven improper accounting practices that were not in conformity with Generally Accepted Accounting Principles, and that it had improper practices with its loan origination and operation. The examiner also investigated the business risks that New Century faced that could easily put the company at stake without strict internal control, proper quality control and operation and management. The examiner also reveals in his report the key internal accounting controls that failed to prevent the accounting errors.
Business Risks The report identified the primary business risks that New Century Financial faced in three general areas: credit risks, market risks, and operational risks.
Credit risks
Its credit risks involved mortgage loan borrowers. Credit risk is a particularly significant risk for New Century and other subprime originators because of the relatively higher risk nature of subprime mortgage borrowers as the loans of subprime lenders are usually given to individuals with low credit score and those whose credit profile does not qualify for a prim mortgage. Since the borrowers are at higher risk of default, they generally pay higher interest rates than prime rates. Thus, subprime originators have higher credit risks as the loans are made to individuals who have high risk of default yet have to pay high rates on loans. New Century discloses the credit risks that it may face in its annual report: * “The mortgage loans that we hold are subject to the risks of delinquency and foreclosure loss, which could result in losses to us” * "We may incur losses on our mortgage loans even if the mortgage loans are insured by the Federal Housing Administration or guaranteed by the Veterans Administration.” * "Our inability to realize cash proceeds from mortgage loan sales and securitizations in excess of the loan acquisition cost could harm our financial position." * "We are subject to losses due to fraudulent and negligent acts on the part of mortgage loan applicants, mortgage brokers, other vendors and our employees."
Market risks
The market