New Century and KPMG Accused of Improper Accounting Practices

March 26, 2008 No Comments »

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Defunct subprime mortgage lender New Century and its accounting firm KPMG were slammed in a saga of a report written by court examiner Michael J. Missal, released Wednesday.

The 581-page document chronicles the rise and fall of the Irvine, CA-based company, which originated $357 million during its inaugural year in 1996, and just ten years later, became the second largest residential subprime mortgage originator in the United States.

A year later New Century collapsed in a matter of months after revealing the need to restate its 2006 financial statements, leading to margin calls, the delisting of its stock, and an eventual bankruptcy filing.

Missal found that the lender took part in at least seven “wide-ranging improper accounting practices” suggested by KPMG in the two years preceding the company’s fall, most which fell outside “generally accepted accounting principles.”

“New Century engaged in a number of significant improper and imprudent practices related to its loan originations, operations, accounting and financial reporting processes,” the report said.

“KPMG contributed to certain of these accounting and financial reporting deficiencies by enabling them to persist and, in some instances, precipitating the Company’s departures from applicable accounting standards.”

This led to false profits that should have been reported as losses, allowing the company to meet analyst estimates when they should have warned that earnings would fall below expectations.

The report alleged that New Century had a “brazen obsession with increasing loan originations” and did so with little regard for risk, noting that originations swelled from $14 billion in 2002 to roughly $60 billion in 2006.

“The increasingly risky nature of New Century’s loan originations created a ticking time bomb that detonated in 2007,” the report said.

Seventy percent of the loans originated had teaser rates, 40 percent were stated income loans, and a large number were 80/20 loans whose performance was described by a New Century Senior Officer as “horrendous.”

Loan exceptions, or those that didn’t originally fit underwriting guidelines, were rampant and appraisals were riddled with “deficiencies” that Senior Management “turned a blind eye to.”

The report also noted that New Century had no quality standards, and originated on the basis of securitization, not a borrower’s ability to repay a loan.

And as early as 2004, senior management was well aware of the alarming rate of early mortgage payment defaults, but suggestions to address the issue were ignored.

That led to a large number of investor “kickouts” that ended up on the company’s books, eventually causing their precipitous fall.

“Between 2004 and the end of 2006, investors rejected approximately $800 million in loans simply due to missing documentation, and billions of dollars of loans for other reasons.”

“Investor kickouts resulted in millions of dollars in additional expenses for New Century to correct and maintain these loans, wasting New Century’s assets and further impairing liquidity.”

This is quite a read, and really provides a candid window into the disaster that was subprime lending.

Take a gander at the entire report here and here.

(photo: grdloizaga)

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