Tag: Subprime

SEC Goes After Sub-Prime Lender

new-century

The Securities and Exchange Commission charged three former top officers of New Century Financial Corporation with securities fraud for misleading investors as New Century’s subprime mortgage business was collapsing in 2006. At the time of the fraud, New Century was one of the largest subprime lenders in the nation.

In its complaint, the SEC alleges that New Century disclosures generally sought to assure investors that its business was not at risk and was performing better than its peers. However, New Century failed to disclose important negative information, including dramatic increases in early loan defaults, loan repurchases, and pending loan repurchase requests. The complaint also alleges that Dodge and Kenneally fraudulently accounted for expenses related to bad loans that it had to repurchase.

The SEC’s complaint names as defendants:

  • Former CEO and co-founder Brad A. Morrice
  • Former CFO Patti M. Dodge
  • Former Controller David N. Kenneally

It was interesting to see the SEC bring this case after the Department of Justice lost a similar case against two former Bear Stearns hedge fund managers. In both cases, there were some public statements about how they would weather the subprime crisis. In the Bear Stearns case, it was a private fund. In this New Century it was a public company. The argument is both cases is that the principals were hiding their knowledge of the underlying losses.

The SEC is charging the New Century trio with accounting fraud as part of their scheme to hide the losses from the subprime loans going bad. Part of the downfall may have been its conversion in 2004 to become a mortgage REIT. While this structure reduces the amount of taxes it needs to pay, it also requires the company to distribute at least 90% of its annual taxable income. That means New Century would have trouble accumulating capital for operations and keeping reserves for future losses.

The complaint is a fun read because it takes you through the greed of the subprime marketplace as New Century introduces new products that, in hindsight, are increasingly riskier. As the losses accumulated, the disclosure got murkier and murkier. The SEC sees the disclosure as “false and misleading.”

New Century’s trademarked byline was “A new shade of blue chip.” It seems like red (as in the ink) would have been a better color choice.

References:

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Subprime Lending Settlement in Massachusetts

Attorney General Martha Coakley

Massachusetts Attorney General Martha Coakley’s Office announced that it has reached a settlement agreement with Goldman Sachs & Co stemming from the office’s investigation of subprime lending and securitization markets. The Attorney General’s Office has been investigating the role of investment banks in the origination and securitization of subprime loans in Massachusetts.

The Attorney General’s Office began its investigation into the securitization of subprime loans in December 2007, investigating whether securitizers may have:

  • facilitated the origination of “unfair” loans under Massachusetts law;
  • failed to ascertain whether loans purchased from originators complied with the originators’ stated underwriting guidelines;
  • failed to take sufficient steps to avoid placing problem loans in securitization pools;
  • been aware of allegedly unfair or problem loans;
  • failed to correct inaccurate information in securitization trustee reports concerning repurchases of loans; and
  • failed to make available to potential investors certain information concerning allegedly unfair or problem loans, including information obtained during loan diligence and the pre-securitization process, as well as information concerning their practices in making repurchase claims relating to loans both in and out of securitizations.

The settlement didn’t involve court action and Goldman didn’t acknowledge wrongdoing.

Under the agreement, Goldman will restructure loans for borrowers whose loans it holds. The Attorney General said there are about 714 of those borrowers. Goldman’s borrowers with first mortgages could see their principal reduced 25% to 35%, and those with second mortgages held  could see principal reduced 50% or more. Reducing those loan amounts will cost Goldman $50 million. It has also agreed to have its subsidiary, Litton Loan Servicing LP, help qualified borrowers who are in trouble on their loans to avoid foreclosure. Goldman will also pay the state $10 million. Delinquent borrowers will be required to make a “reasonable monthly payment” while trying to sell or refinance their homes.

References:

The Subprime Boomerang: After the Writedowns Comes the Litigation

boomerang

Securities Docket put on a great webinar on The Subprime Boomerang: After the Writedowns Comes the Litigation.

Bruce Carton moderated a panel of Veronica Rendon of Arnold & Porter, Richard Swanson of Arnold & Porter and Jeff Nielsen of Navigant Consulting, Inc.

Jeff started off my showing how much complicated the picture is for securitized lending compared to traditional lend hold lenders. There is now a dozen + parties involved with very different interests. There are lawsuits between many of these relationships with fingers being pointed in many different directions.  There are also lawsuits within the parties as shareholders are bringing securities class action suits against the investors. Some of the parties changed roles through the the lifecycle of the loan. (Such as the originator becoming an investor.) Here is a snapshot of the parties:

securitization

Jeff identified 866 subprime related federal filings, including borrower class actions, securities class actions, contract claims, employee class actions and bankruptcy related claims. Of those 576 are in 2008. California has 17% of the suits and New York has 33%. (California has some tough laws that are the basis of borrower lawsuits.) They are also seeing two new cases for every case that is resolved.

Veronica pointed out that the securitization market grew from $157 billion in 200 to $1200 billion in 2006. That was staggering growth over a very short period of time.

Now we are in a period of rising interest rates, declining home prices, rising unemployment and forced sales.

Unfortunately 50% of adjustable rate mortgage originations over past four years have been subprime. There was some bad underwriting with lots of no-doc loans and high debt-to-income ratios.

The current bulk of suits are now “stock drop” case because the institutions failed to disclose their exposure to subprime risk.

Richard focused on some interesting aspects of the pleadings, hearings and decisions coming out of the cases.

There are increasing suits by purchasers of subprime assets. Lots of the focus on misrepresentations in the offering documents and a failure to disclose risks. These are generally very sophisticated parties doing war including state law claims.

There are also criminal investigations on the horizon. Both the FBI and SEC are looking at possibly bringing charges.

You can listen to webcast and see the slides on the  Securities Docket Webcasts page.