New Century Financial

Topics: Interest, Mortgage, Mortgage loan Pages: 9 (1442 words) Published: April 17, 2014
Case 3 – New Century Financial Corporation

1. Describe and evaluate New Century’s business model?

New Century Financial Corporation, headed by founders Brad Morrice, Edward Gotschall, and

Robert, was a firm which specialized in subprime mortgages. The company originated, sold, and

serviced subprime home mortgage loans. New Century was structured as a real estate investment

trust (REIT) and was composed of two operating divisions. The Wholesale Loan Division,

known as New Century Mortgage Corporation, comprised 85% of the firm’s loan originations,

while the Retail Mortgage Loan Division operated under Home123 Corporation.

New Century Mortgage Corporation operated in 33 locations throughout 19 different states

and relied heavily on independent mortgage brokers to identify potential borrowers and assist

them through the loan process until the loans were closed by New Century. This division also

purchased funded loans from other lenders and expedited the loan underwriting process through

its web-based system known as FastQual. The Retail division was composed of 235 sales offices

throughout 35 states, a call center, and a web site. This division was aggressive in its approach to

seek out potential borrowers and close loans earning it the nickname “CloseMore University.”

The company typically originated loans and used short-term loans to fund new mortgages

until they were sold within 30 to 90 days of origination. New Century’s income was generated

from the difference between the lending rate and rate at which the loans could be sold or

financed and from servicing loans. Loans were sold either as whole loan sales where mortgages

were pooled together and sold to investors or as securitizations structured as sales. The company

also carried securitizations structured as financing as assets on their books and used the bonds

to finance the securitized loans as liabilities, thereby generating income based on the difference

between interest received from borrowers and interest paid to bondholders.

2. What were the primary risks faced by New Century?

New Century’s business model enabled the firm to grow rapidly from 2001 through 2006

as access to capital markets expanded and regulations were relaxed. Loan securitization

allowed lenders to spread credit risk over a larger number of investors creating an

environment where companies like New Century could lend to subprime borrowers at

higher rates while financing their operations with the lower interest rates provided by

the highly liquid mortgage-backed securities (MBS) markets. These factors fueled the

company’s growth, but caused the firm to be highly sensitive to risks of increasing interest

rates, declining home sales, and default by less creditworthy borrowers. New Century’s

aggressive strategies in pursuing subprime borrowers resulted in increased risk of asset

Additionally, the short-term credit the company obtained in order to finance loan

origination was contingent on New Century meeting certain debt covenants and financial

ratios. Increases in interest rates or regulations or the inability to move new loans off its

balance sheet could cause the company to be unable to obtain financing to continue funding

loans. Likewise, a decrease in the difference between the interest rate at which it could

borrow and the interest rate at which new loans could be closed, would affect income and

may result in noncompliance with net income requirements or debt-ratios imposed by New

Finally, the loans which New Century sold were pooled together. The investment banks

which purchased the loans would perform a due diligence review on only 25 percent of

the pool before negotiating the composition and price of the mortgage pool. A “kick-out”

clause was included to allow for buyers to reject part of the loan pool for defects such as...
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