New Century Financial Corporation Case Study

New Century Financial Corporation Case Study

A. What primary business risks did NCF face?

New Century Financial Corporation (New Century) was one of the largest subprime loan originators in the U.S. New Century originated, retained, sold and serviced home mortgage loans mainly designed for subprime borrowers, whose credit score of 620 or below. After going public and being listed on NASDAQ, the value of New Century continued to grow at a fast pace, reaching $56 billion in 2005, according to the Harvard Business School's case study. By late 2005, several analysts recognized difficulties in the subprime market but believed New Century was safe. According to Michael Missal's final report, one analyst said "Based on available data, New Century is one of the lowest cost originators in the space which is a good sign for their long mortgage banking profitability." The company's profitability was backed up early in 2006 by another analyst backed up again. An analyst expressed surprise that "despite the company's aggressive growth, we have found little evidence of deterioration in underwriting and New Century's credit trends remain above industry averages." However, in 2007, 80% of U.S. subprime mortgages were adjustable-rate mortgages, according to the statement of senator Dodd. When the price of houses declined after the second quarter of 2006, it became more difficult to refinance because adjustable-rate mortgages raised interest rates higher, mortgage delinquencies soared. New Century Financial Corporation found out there was misstatement on its financial statement on 2006 which leaded to find out there were another severe misstatement on 2005 and severe dysfunctional internal control over the company.

The second risk the company faces is improper accounting practices not in conformity with GAAP. On the repurchase reserve, residual interest in off-balance-sheet securitizations, loans held for sale, and allowance for loan losses, these four are the major accounting practices lead the company to collapse.

B. What were the primary financial reporting items in NCF's financial statements related to these risks?

There were four financial reporting items in New Century related to risks explained above: Whole loan sales, Securitizations structured as sales, Securitizations structured as financing and Lower of cost or market valuation of loans held for sale. According to the Harvard Business School case study, errors on these items resulted in an overstatement of earni...