New Century Financial – It’s KPMG Again

By • Mar 14th, 2007 • Category: Pure Content

Many are coming here via Google.  Go to this post for more current commentary and information.

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New Century probe deepens
New Century Financial, the US subprime lender scrambling to avoid bankruptcy, hit further troubles on Tuesday as it revealed that it was facing a preliminary investigation by the Securities and Exchange Commission and that it had received a grand jury subpoena from the Department of Justice. The struggling backer of high-risk mortgages revealed that it was under criminal investigation by the US Attorney’s Office in the Central District of California at the end of February. It had already admitted that the SEC had asked for a meeting.

The US Attorney is examining trading in New Century’s securities and accounting errors in how much it set aside for loan losses. …The halt, ordered by the New York Stock Exchange, came after New Century said its banks had either cut off credit or signalled their intention to do so, increasing the likelihood of an imminent bankruptcy filing or asset liquidation.…In a filing with the Securities and Exchange Commission on Monday, New Century said lenders including Bank of America, Barclays, Citigroup, Credit Suisse, Goldman Sachs and Morgan Stanley had issued letters saying the company was in default. New Century also said its bankers had demanded that it accelerate its obligation to buy back outstanding mortgage loans financed under the lending arrangements. New Century said if its bankers demanded accelerated repurchase of all outstanding mortgages, it would cost the company $8.4bn, which it does not have…

I looked quickly at the 2005 Annual Report for New Century to find out who their auditors are and to see how “rapid” this decline really was. Interestingly, besides noticing that KPMG now has another worry at its doorstep, I didn’t see too much in the way of discussion in the “Risks” section of the risk that is now causing this worldwide financial crisis. There are 17 pages of discussion of general and REIT specific risk associated with this company, but no mention of the specific risk of the potential for their banks to accelerate the repurchase of mortgage loans financed under their significant number of lending arrangements. Although there is a detailed discussion of these lending arrangements later in the report, it does not seem that reserves or capital/liquidity requirements were sufficient to cover the possibility that one of or more lenders could for some reason decide to call the loans. Did the ratios drop? Were they delivering their monthly compliance certificates to all the lenders? Were those accurate and truthful? Did the lenders have the right to call the loans unilaterally? It does say that if one called the loans it is likely that all would. Didn’t someone think that this would be a very big number (US 8.4 billion) if that happened?

The detailed technical ins and outs of this business are beyond my experience. But I find it very curious that no matter how much auditing and disclosing goes on, we continue to see “rapid, unexpected declines” in once high-flying companies that suddenly teeter on the edge of bankruptcy, even though the best and the brightest are supposedly “Keeping Watch” for us as their auditors.

Credit Facilities
(From the New Century Financial 2005 Annual Report)
We need to borrow substantial sums of money each quarter to originate and purchase mortgage loans. We need separate credit arrangements to finance these loans until we have aggregated one or more pools for sale or securitization. The amount of credit we seek to have available is based on our expectation of future origination volume. We have credit facilities with Bank of America, N.A., Barclays Bank PLC, Bear Stearns Mortgage Capital Corporation, Citigroup Global Markets Realty Corp., Credit Suisse First Boston Mortgage Capital LLC, Deutsche Bank Securities, Inc., IXIS Real Estate Capital Inc. (formerly known as CDC Mortgage Capital Inc.), Morgan Stanley Mortgage Capital Inc., UBS Real Estate Securities, and we also have an asset-backed commercial paper facility. We use these facilities to finance the actual funding of our loan originations and purchases and to aggregate pools of mortgage loans pending sale through securitizations or whole loan sales. We typically sell all of our mortgage loans within one to three months of their funding and pay down the credit facilities with the proceeds.

Our credit facilities contain certain customary covenants, which, among other provisions, require us to maintain specified levels of liquidity, net worth and debt-to-equity ratios, restrict indebtedness and investments and require compliance with applicable laws. The minimum level of liquidity required under our credit facilities is $125.0 million, the minimum amount of net worth required is approximately $750.0 million, and debt-to-equity ratio limitations range from 12 to 1 to 16 to 1 and generally exclude non-recourse debt. We deliver compliance certificates on a monthly and quarterly basis to our lenders to certify to our continued compliance with the covenants.If we fail to comply with any of these covenants, the lender has the right to terminate the facility and require immediate repayment. In addition, if we default under one facility, it would generally trigger a default under our other facilities.

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10 Responses »

  1. it is very difficult to sue the auditor. So… who really cares. It is not the first time for an auditor to cook the books.

  2. As an ex-auditor in public practice, it is very tough to successfully sue the auditors. It’s too early to presume anything (auditors at fault or the company). In short, the root of this issue will be whether or not KPMG should have been aware of the risk and was the disclosure that was made – was it adequate. Obviously, the only way to determine what KPMG knew and when is through a long draw-out legal battle, and more than likely, that is what we will see. That is unless KPMG can figure out another way to score a deal with the Dept. of Justice like it did when it had it’s tax-shelter debacle (They created a tax shelter investment vehicle known as Blips which cut the gov’t out of a good amount of tax dollars) a couple of years ago. Who knows. The funny thing is the KPMG audits a good chunk of the Federal Gov’t. I think they’ll figure out a way to at least minimize the damage of their own auditors.

  3. [...] blog has tracked this story from the beginning. Go here, here, here and here for [...]

  4. [...] since 2007.  My first post to mention subprime was March 14, 2007.  In that post, discussing KPMG and New Century, I talked about something that even the esteemed short David Einhorn missed: Repurchase risk was [...]

  5. [...] you about the poor disclosure practices surrounding repurchase risk. It was all the way back in March of 2007 and I was referring to the lack of disclosures surrounding New Century Financial. In a filing with [...]

  6. [...] you about the poor disclosure practices surrounding repurchase risk. It was all the way back in March of 2007 and I was referring to the lack of disclosures surrounding New Century Financial. In a filing with [...]

  7. [...] McKenna first reported on poor disclosures at a KPMG audited company in 2007. That company was New Century. It hadn’t disclosed anything about repurchase risk in earlier filings with the Securities and Exchange Commission. But, suddenly, it was revealing that banks were demanding that it buy back mortgages it had sold. If all the mortgages were put back to the company, New Century said it would be on the hook for $8.4 billion. [...]

  8. [...] role in the latest crisis is only recently being examined. I’ve been pushing hard for that since 2007 when we started to see the subprime crisis and the failures of mortgage originators and home [...]

  9. [...] McKenna first reported on poor disclosures at a KPMG audited company in 2007. That company was New Century. It hadn’t disclosed anything about repurchase risk in earlier filings with the Securities and Exchange Commission. But, suddenly, it was revealing that banks were demanding that it buy back mortgages it had sold. If all the mortgages were put back to the company, New Century said it would be on the hook for $8.4 billion. [...]

  10. [...] first blog post on this site to use the word “subprime” was about New Century Financial, a KPMG client, mortgage originator, and one of the first failures of the coming [...]

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