Case 3 – New Century Financial Corporation

1. Describe and evaluate New Century’s business model?

New Century Financial Corporation, headed by founders Brad Morrice, Edward Gotschall, and

Robert, was a firm which specialized in subprime mortgages. The company originated, sold, and

serviced subprime home mortgage loans. New Century was structured as a real estate investment

trust (REIT) and was composed of two operating divisions. The Wholesale Loan Division,

known as New Century Mortgage Corporation, comprised 85% of the firm’s loan originations,

while the Retail Mortgage Loan Division operated under Home123 Corporation.

New Century Mortgage Corporation operated in 33 locations throughout 19 different states …show more content…
Additionally, the methodology used

for the allowance for loan losses (ALL) was known by management to be defective as the

company’s models used poor predictors of future performance to determine the level of reserve

needed. In calculating the repurchase reserve, New Century obtained historic averages and

applied those percentages to loans sold in the last three months as EPD was defined as payment

default occurring in the first three payments. However, since the repurchases were being

processed by several different departments within the company depending on the cause of the

repurchase, there was a backlog in obtaining the data in a timely manner. As loan repurchases

became more frequent, the company continued using stale data causing the reserve calculation to

In addition, the company was not properly applying LCM valuation as stated in its own

company policy. Instead of pooling similar loans to determine to conduct LCM analysis, the firm

was performing the analysis on the disaggregated loans and then grouping the loans together

to conduct valuation on the group as a whole. This method resulted in gains from one loan

group offsetting the losses in another causing the LCM valuation to be significantly flawed.

The residual interest valuation methods used were also flawed as the company was using

discount rates which were lower