New Century faulted for improper accounting

New Century faulted for improper accounting
Court examiner links mortgage lender New Century's downfall to its continued use of improper accounting practices.

LOS ANGELES (AP) -- Bankrupt mortgage lender New Century Financial Corp. used improper accounting practices while making risky loans, creating "a ticking time bomb" that led to the company's rapid downfall, a court examiner said in a report released Wednesday.

Michael J. Missal concluded that New Century engaged in at least seven improper accounting practices that led the company to report incorrect financial information to Wall Street for fiscal 2005 and the first nine months of 2006.

Missal also found that senior management at the Irvine, Calif.-based lender failed to take appropriate steps to manage rising risks caused by the company's aggressive approach to originating loans, often to borrowers who couldn't afford them.

"New Century had a brazen obsession with increasing loan originations, without due regard to the risks associated with that business strategy," Missal's report said. "The increasingly risky nature of New Century's loan originations created a ticking time bomb that detonated in 2007."

In addition, the examiner found that New Century's accounting firm, KPMG LLC, enabled some of the improper accounting practices to continue.

"As an independent auditor they're supposed to look very skeptically at any client, and here they became advocates for the client and in fact even suggested some improper accounting treatment that ultimately started New Century down the road it's taken," Missal told The Associated Press.

The accounting also led to higher bonuses for key executives, the report said.

The report's findings may provide legal ammunition for the trustee appointed to liquidate New Century to sue KPMG and top New Century executives for millions of dollars to help pay off the lender's creditors, Missal said.

New Century spokesman Ronald Low said the company was pleased the examiner's report had been completed so the company's plan for liquidation can continue.

KPMG spokesman Dan Ginsburg said the accounting firm strongly disagreed with the report's conclusions on KPMG's actions.

"We believe that an objective review of the facts and circumstances will affirm our position," Ginsburg said.

New Century had been the second-largest originator of subprime home loans in the U.S. and had a market capitalization in excess of $1 billion several months before seeking Chapter 11 bankruptcy protection in April 2007.

The company collapsed after a spike in mortgage defaults on loans made to borrowers with past credit problems led New Century's lenders to pull funding and demand that it buy back bad loans.

As its financial footing slipped, New Century also warned that it would need to restate financial results from 2005 and 2006 because it failed to tally losses from loan repurchases.

Judge Kevin Carey of the U.S. Bankruptcy Court in Wilmington, Del., appointed Missal last June to examine New Century's accounting practices.

Missal said he conducted more than 100 interviews with New Century employees and others, including New Century's former chief executive, Brad Morrice.

Missal issued a preliminary report in November and a final version at the end of last month, but it was sealed until Wednesday.

The report described New Century, once a Wall Street darling, as a company bent on making loans, layering "the risk of loan products upon the risks of loose underwriting standards."

Some 70 percent of the loans originated by New Century featured low initial "teaser" interest rates designed to increase after a period of time.

The report said 40 percent of the company's loans were so-called stated-income loans that don't require borrowers to verify their income.

The company's predominant criteria for making loans was whether it could resell them on the secondary market, New Century directors and senior managers told investigators.

Even as the housing market began to sour, New Century continued to originate loans with the goal of selling them to investors, the report said.

"Senior management turned a blind eye to the increasing risks of New Century's loan originations and did not take appropriate steps to manage those risks," the report concluded.

One example cited in the report had New Century understating by more than 1000 percent the amount of money it needed to have on reserve to buy back bad loans.

As a result, it reported a profit of $63.5 million in the third quarter of 2006, when it should have reported a quarterly loss, the report said.

New Century also failed to include the interest that it was obligated to pay to investors whenever it was forced to buy back bad loans, the report said.

Missal, however, found no evidence that the lender deliberately manipulated accounting to bolster profits.

Still, investors who lost big when New Century folded last year likely relied upon the financial information when making their decisions to sell or buy its stock.

KPMG severed its ties to New Century a few weeks after the lender sought bankruptcy protection. KPMG did not complete an audit of New Century's 2006 financial results before it resigned as its independent auditor.

New Century has been deluged with investor lawsuits and disclosed last year that it was the target of a criminal inquiry by federal prosecutors in California.

CNN