1. What appeared to be New Century’s strategic objectives? Describe and evaluate the business model the company had adopted to achieve these objectives.
New Century Financial Corporation was founded in 1995 went public in 1996 and was also listed on NASDAQ. New Century’s primary goal was to originate and sell subprime mortgages. The main activities of the company included generating, retaining, selling, and servicing home mortgage loans for subprime borrowers who couldn’t get finance from other sources. By 2006 New Century expanded its product range to include fixed-rate mortgages, adjustable rate mortgages (ARMs), hybrid mortgages, and interest-only (IO) mortgages. The products were from the two Company’s divisions of Wholesale Loan Division and Retail Mortgage Loan Division, which was different in terms of sales channel (indirect and direct). The corporation employed almost 1,000 account executives & 50,000independent mortgage brokers within its Wholesale Loan Division and it operated 235 sales offices within Retail Mortgage Loan Division.
It was able to generate significant sales volume and achieve tremendous growth with CAGR of 70%percent from 2000- 2004 due to its ability to respond to increasing demand on such loans. Despite increasing competition in the subprime market, the Company still held strong position due to its low cost loan originators. Their major strategic objectives were to consistently achieve strong performance both in TRS and REIT. Their key focus was to lower cost and increase productivity. They did this by broadening the mortgage products and services through appropriate delivery channels as mentioned above and by improving Product mix to optimize execution. Below are the major operations of New Century financial Corporation. Whole loan sales:
New Century sold mortgages in loan pools to investors such as Goldman Sachs, JP Morgan Chase, etc at a premium value above the par because of high interest rates paid by its mortgagors. It should also repurchase the loans if there was any early payment defaults.
Securitization structured as sales:
New Century sod loans through a SPE for the purpose of securitization. New Century also provided credit enhancement by providing additional collateral above the principal value of the securitization. The expected cash flows from this over collateralization should be reported as revenues in the income statement. Securitization structured as financing:
New Century retained a part of securities backed by the securitized loans labelled “mortgage loans held for investment” (LFHI) as an asset on the balance sheet and bonds used to finance them as liabilities. It received interests from the mortgagor and paid out the interest to the bond holders. Lower of Cost or market (LCM) valuation of loans held for sale: All loans apart from LFHI and repurchased loans were classified as loans held for sale. Accounting rules required that the loans held for sale were reported at LCM.
2. What were the primary risks that New Century faces?
New Century had been growing with significantly very high speed. Company’s zeal for increased sales and profits added to the fact that the company was unable to appropriately implement mechanism of underwriting and monitoring loan quality. Thus, overall insignificant attention to effective operations imposed other principal business risk that included improperly handled or evaluated poor underwriting standards for mortgage loan borrowers, poor monitoring of loan quality, as well as improper accounting policies applied with no conformance to GAAP. Due to inappropriate underwriting standards that were a result of insufficient attention to risks of borrowers’ default, New Century Financial was unable to provide proper loan quality. The major factor in poor monitoring of the loans quality was the fact that the company did not worry about the borrowers’ ability to repay the loans as long as the...