NEW CENTURY FINANCIAL CORPORATION

New Century Financial Corporation

Abstract

This paper is aimed to analyze the performance of New Century Financial Corporation's internal accounting control systems. The primary business risks of NCF are credit risk, market risk and operational risk. These are affecting various financial reporting items including repurchase reserve, residual interest in off-balance-sheet securitizations, loans held for sale and Allowance for loan losses. During the 2007, company announced that it would restate the previous year financial statements due to calculation and estimation errors. After few months, it realized the loss of millions. Subsequently, it filed for bankruptcy cover. An examiner was assigned by the Bankruptcy court which presented his report after evaluating the conditions of the company. The report highlighted seven financial reporting errors. Besides this, it enlightens lack of proper internal controls in the company process. Loan quality has always been compromised to feed the demand of investors. The company's external auditor was also found involved in showing lack of professionalism because it was unable to detect issues in the financial reporting of the NCF. Senior management has also loosened quality insurance tools. Internal Audit department also didn't question calculation methods. Mortgage loans are complex financial security which is needs latest technology tools to evaluate them but the company had always relied on defective and obsolete excel based valuation model which had been updated as the assumptions underlying the model changed. Board members focus entirely on residual interest because it was very volatile. At the same time, they completely relied on the auditor's report for the accuracy of the company financial reporting. The paper has taken an in-depth approach to analyze the issue from multiple dimensions so that we can reach a meaningful conclusion in the end.

New Century Financial Corporation

Background

New Century Financial Corporation (New Century) was founded by Brad Morrice, Edward, and Robert Cole in 1995. Their main business was to originate, retain, sell and service home mortgage loans designed for subprime borrowers. Subprime mortgage is a loan to an individual with a FICO (Fair Isaac Corporation) credit score of 620 or below (FICO score ranges from 300 to 850, therefore subprime borrowers are at higher risk of default). In 1997 New Century went public and was listed on NASDAQ. From 2001 to 2005 the company reached its highest and in 2005 it had become one of the largest subprime loan originators in the U.S. In 2004 the company became a Real Estate Investment Trust (REIT) and began trading on the NYSE. New Century expanded its product and by 2006 it was also offering fixed-rate mortgages, adjustable rate mortgages, hybrid mortgages, and interest-only mortgages.

Timing of the end of New Century

Management informed in late January 2007 that it had been calculating its loan repurchase incorrectly since second quarter of 2006 (when it changed its methodology).

In the following month (February 2007) it announced it was going to restate the first, second and third quarters of 2006 financial statements due to errors in calculating allowances for loan ...