Case study analysis allows students to apply classroom theory to real-world situations through analyzing situations, defining problems, evaluating alternatives, forming conclusions, and making recommendations. There are several types of case study assignments including preparing a case in advance for discussion, writing a case analysis paper, or analyzing a case threaded throughout a course. The recommended steps for successful case analysis are to gain familiarity with the case, define the issue or problem, conduct an analysis of possible causes and alternatives, and make a justified recommendation supported by an action plan or choice of best alternative.

1. Case Study Analysis
Case study analysis gives students an opportunity to apply
theory learned in the classroom to real world situations. Case
studies do not have discrete answers. Rather, they challenge
students to exercise their own business judgment in a
supportive, educational environment. Students test their
knowledge by analyzing situations; defining problems or issues;
evaluating alternatives and/or forming conclusions to resolve
the problem or issue; and making recommendations.
Types of case study assignments:
Students may be asked to
· Prepare a case in advance, based on criteria developed by the
instructor. The case would then be used as a basis for
discussion.
· Write a case analysis paper, based on criteria developed by the
instructor. The paper may be presented or reviewed by peers.
· Analyze a case that is threaded throughout the course. As part
of the learning process, students acquire knowledge during the
course and apply that knowledge to different aspects of the
case.
Case study analysis steps:
Cases used in the classroom vary from short vignettes to dense,
multi page volumes. It is the responsibility of the instructor to
teach a process which, while useful in the classroom, can be
applied to the real world after the student graduates. Real
world application of the steps used in case study analysis will
vary from those found in the safety of the academia; employees
will gather the information, found conveniently in an academic
written case study, from a dynamic environment.

2. Here are some recommended steps for successful case analysis:
1. Gain familiarity with the case situation. This can be
accomplished by reading the case several times. Read the first
time to appreciate the general story before you begin to form
conclusions or make analysis.
2. Define the issue or problem. To make an analysis or
recommendation, one must first determine what the issue or
problem is. As in the real world, note there may be more than
one problem in a case study analysis. (You can appreciate the
importance of this step if you ever took your car in because it
was running rough and paid for several repairs because the
mechanic didn’t correctly diagnose the problem in the
beginning.)
3. Conduct your analysis. What are the possible causes of the
problem or issue? What alternatives are possible given the facts
presented? This is the most time consuming step, and the step
with the greatest variation. There may be many possibilities. It
might be helpful to list all solutions you can think of before
focusing on the most useful or valid. There is not necessarily a
right answer, but there may be several alternatives that lead to
varying outcomes. The quality of analysis will depend upon
application of theory learned in the classroom and through
research.
4. Make recommendations. Choose the recommendation you
believe to be the best, justify it, and develop it.
Recommendations may be made in the form of an action plan to
solve the problem or issue. Or, recommendations may involve
the choice of the best alternative for resolving the issue or
problem. Recommendations made must be thoroughly developed
and supported.

3. References:
ICFAI Center for Management Research. (nd). Learning with
cases. Retrieved June 22, 2007 from
http://www.icmr.icfai.org/casestudies/lear n_case.htm.
9 - 1 0 9 - 0 3 4
R E V : O C T O B E R 1 4 , 2 0 0 9
_____________________________________________________
_____________________________________________________
______
Professors Krishna Palepu and Suraj Srinivasan and Senior
Researcher Aldo Sesia, Jr. of the Global Research Group
prepared this case. This case
was developed from published sources. HBS cases are
developed solely as the basis for class discussion. Cases are not
intended to serve as
endorsements, sources of primary data, or illustrations of
effective or ineffective management.
Copyright © 2008, 2009 President and Fellows of Harvard
College. To order copies or request permission to reproduce
materials, call 1-800-545-
7685, write Harvard Business School Publishing, Boston, MA
02163, or go to www.hbsp.harvard.edu/educators. This
publication may not be
digitized, photocopied, or otherwise reproduced, posted, or
transmitted, without the permission of Harvard Business School.

4. K R I S H N A P A L E P U
S U R A J S R I N I V A S A N
A L D O S E S I A J R .
New Century Financial Corporation
New Century had a brazen obsession with increasing loan
originations, without regard to the risks
associated with that business strategy. . . . The increasingly
risky nature of New Century’s loan originations
created a ticking time bomb that detonated in 2007.
— Bankruptcy Examiner’s Final Report, February 29, 2008
In early 2005, New Century Financial Corporation (New
Century) was flying high. The company,
founded 10 years earlier, had become one of the largest
subprime loan originators in the U.S. Its
stock price was trading at historical highs, and earnings per
share for 2004 were 80% higher than in
2002. Yet barely 15 months later, New Century was in a
liquidity crisis.
In November 2006, Taj Bindra became the new CFO at New
Century; one month later, he started
asking questions about the company’s mortgage loan repurchase
reserves. In February 2007, the
company announced that it needed to restate its financial results
for the first three quarters of fiscal
year 2006 because of accounting errors related to its mortgage
loan repurchase obligations.1 The news
drove New Century’s lenders to initiate margin calls and refuse
to provide any new financing. In

5. March, management announced that the company had stopped
taking mortgage loan applications
and would not file its 2006 annual report on time. On April 2,
2007, New Century filed for Chapter 11
bankruptcy protection.
U.S. Subprime Mortgage Industry—Early 1990s to 2008
In the early 1990s, subprime mortgages were a small percentage
of the total number and value of
mortgages originated in the U.S. But by 2005 subprime
mortgage lending had become a $625 billion
industry, accounting for 20% of all mortgage originations.2 In
the new millennium alone, subprime
mortgage originations grew 216% from 2001 to 2006 (see
Exhibit 1). While there were different
definitions of a subprime mortgage, it was generally considered
a loan to an individual with a FICOa
credit score of 620 or below; in other words, to a person whose
risk profile did not qualify for a prime
mortgage. Typically, subprime borrowers, because they were at
higher risk of default, paid 200 to 300
a FICO was an acronym for the Fair Isaac Corporation, which
created the scoring system to measure an individual’s
creditworthiness. FICO scores ranged from 300 to 850.
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6. 109-034 New Century Financial Corporation
2
basis pointsb over prime rates and higher up-front origination
fees.3 Subprime mortgages included
loans to purchase homes and to refinance pre-existing
mortgages.c
The subprime industry’s growth was driven by an increase in
access to capital markets through
loan securitization—the pooling and reselling of loans to
investors—in the 1990s and early 2000s.
Securitization of loans backed by real assets such as
automobiles and homes experienced significant
growth, since these assets were homogenous and credit risk was
spread over a large number of
individuals (and was thus diversifiable). With growth in a liquid
market for mortgage-backed
securities, mortgage originators could sell the loans, transfer the
credit risk to other investors, and
gain liquidity to originate more loans. Other factors also oi led
the industry’s growth. Legislation in
the 1980s removed interest-rate caps, which meant that lenders
could charge higher rates for
mortgage and home equity loans and, therefore, lend to
borrowers with higher risk profiles. The Tax
Reform Act of 1986 prevented individuals from deducting
interest they paid on consumer loans but
allowed them to deduct interest they paid on loans secured by
their homes and a second residence.
Low interest rates, rising house values, and a proliferation of
nontraditional mortgages (e.g., hybrid
mortgages where the borrower paid a fixed rate for the first few
years and then a variable rate for the

7. remainder of the loan’s maturity) also hastened the industry’s
growth.
By 1997 subprime mortgage originations constituted about $125
billion, or 15%, of the $859 billion
mortgage originations in the U.S. The industry hit a bump
during the Russian debt crisis of 1998. The
flight to higher-quality credit by debt investors reduced demand
for subprime mortgage
securitizations, creating liquidity problems for subprime
mortgage originators. This slowed industry
growth; some subprime lenders went bankrupt and the surviving
firms focused more on credit
quality. However, damage was limited, in part because the
increase in home prices in the late 1990s
limited defaults by borrowers, reducing losses for investors.
Between 2001 and 2003, subprime
mortgage originations were only around 8% of all residential
mortgage originations. By 2003, a
combination of factors—rising home prices, increasing focus of
commercial banks toward retail
lending, fairly low loan default rates among subprime
borrowers, availability of many nontraditional
mortgage products (such as interest-only mortgages or
adjustable rate mortgages), and historically low
mortgage-interest rates—led to a rapid increase in subprime
mortgage originations, and consequently,
in subprime securitizations.4 (See Exhibit 2 for subprime
securitizations from 2001 to 2006.)
The subprime mortgage industry involved numerous parties that
included borrowers
(mortgagors), mortgage brokers, lenders (banks, credit unions,
mortgage companies), investment
banks, rating agencies, and investors. Subprime mortgage
lending companies conducted three lines

8. of business—loan origination, loan sale or securitization, and
loan servicing. Loan origination
involved the selling of mortgage loans, processing the loan
applications, and funding the mortgages
based on lenders’ underwriting standards. While some loans
remained on the balance sheets of the
originators, many were either sold outright primarily to
investment banks, which then moved them
into a special purpose entity (SPE), or to SPEs that the
originators themselves had established. In both
cases, pools of loans were securitized and sold as mortgage-
backed securities (MBSs) to investors,
such as pension funds and hedge funds.d As borrowers made
principal and interest payments, the
funds were passed through to the investors. Loan servicing
referred to collecting payments from
mortgagors and paying the holders of the loans, as well as
paying real estate taxes and insurance to
b A unit that is equal to 1/100th of 1%. 300 basis points = 3%.
c Alt-A was a category of mortgage that fell between prime and
subprime. Borrowers with good current credit scores but who
did not provide sufficient verification of their income, or had
high debt-to-income ratios, could qualify for Alt-A mortgages.
Rates and fees for Alt-A mortgages were higher than those for
prime borrowers but lower than those for subprime borrowers.
d In some cases, large investors turned MBSs into collateralized
mortgage obligations (CMOs), which were more complex
forms of MBSs.
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9. Advanced Auditing Theory and Application-7-1-19-1 taught by
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New Century Financial Corporation 109-034
3
the appropriate parties. Most originators did this before a loan
sale or securitization; some did it
afterward and received a fee for the service.
After more than a decade of strong, if not spectacular, growth,
the subprime market weakened in
2006 and collapsed in the fall of 2007 as interest rates increased
and home prices dropped. Loan
delinquencies and home foreclosures were on the rise.
Investors’ appetite for subprime
securitizations waned, which meant the liquidity that was so
vital to the rapid growth became
constrained. (Exhibit 3 illustrates simplistically the industry’s
troubles.) The collapse reverberated
across the financial services industry and financial markets.
Hardest hit were some of the biggest
names in the financial services industry including Citigroup,
Bear Stearns, UBS, and Merrill Lynch,
each absorbing devastating losses. The deterioration in market
conditions had a huge impact on the
mortgage lending industry in 2006 and 2007. Many companies
undertook large write-downs in the
value of their mortgage-related assets. One of the largest
mortgage lenders in the U.S., Countrywide
Financial Corp., was acquired by Bank of America. Over 150
companies, both subprime and prime

10. lenders, were reported to have failed in 2007. While other
subprime mortgage lenders also failed in
2007, New Century’s troubles “were an early contributor to the
subprime meltdown,” according to
the bankruptcy court examiner.5
Company Background
In 1995, Brad Morrice, Edward Gotschall, and Robert Cole
founded New Century. In 2005, Cole
was the chairman and chief executive officer, Morrice was vice
chairman and chief operating officer,
and Gotschall was vice chairman–finance of New Century.
Before starting New Century, all three
had extensive experience in the real estate industry and had
worked together as senior executives in
Plaza Home Mortgage Corp., a publicly traded savings and loan
company specializing in the
origination and servicing of residential mortgage loans. Cole
had earlier been the president of an
international real estate development company and president of
operating subsidiaries of NBD
Bancorp and Public Storage, Inc. From 1990 to 1993, Morrice
was a partner in a law firm where he
specialized in legal representation of mortgage banking
companies. Similarly, Gotschall had
mortgage banking experience as chief financial officer of
Mortgage Network Inc, a retail mortgage
banking company.
New Century originated, retained, sold, and serviced home
mortgage loans designed for
subprime borrowers.6 In 1996, the company originated over
$350 million in loans in its first full year
of operation.7 The next year, New Century went public and was
listed on NASDAQ. In 2001, the

11. company’s subprime loan originations and purchases exceeded
$6.2 billion and continued to grow at
a fast pace, reaching $56 billion in 2005 (see Exhibit 4). The
company grew its product offerings such
that by 2006, New Century provided fixed-rate mortgages,
adjustable rate mortgages (ARMs), hybrid
mortgages (adjustable rates converting to fixed rates at a later
date), and interest-only (IO) mortgages,
whereby the borrower paid interest only and no principal for the
first few years. The new products
also changed the risk profile of New Century loans: ARMs, IO
products, 100% loan-to-value loans,
and stated income loans were considered more risky than fixed-
rate fully amortizing loans.8 (See
Exhibit 5 for a breakdown of originations by loan type from
2004 to Q1–Q3 2006.) In 2004, New
Century restructured into a real estate investment trust (REIT)e
and began trading on the NYSE.
e New Century became an REIT in 2004. REITs were entities
that invested in different kinds of real estate or real estate
assets.
Mortgage REITs lent money to property owners and developers
or invested in financial instruments secured by mortgages.
According to the Internal Revenue Code, REITs were required
to pay out at least 90% of their income before taxes to
shareholders. (Source: U.S. Securities and Exchange
Commission at http://www.sec.gov/answers/reits.htm, accessed
June 2,
2008.)
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2020.
109-034 New Century Financial Corporation
4
The company operated two loan divisions: The Wholesale Loan
Division (named New Century
Mortgage Corporation) and the Retail Mortgage Loan Division
(named Home123 Corporation). (See
Appendix A for an overview of New Century’s loan origination
process.) The Wholesale Loan
Division operated 33 centers in 19 U.S. states and originated
around 85% of the company’s loans
using a network of almost 1,000 account executives and about
50,000 independent mortgage brokers,
who were responsible for identifying potential borrowers,
assisting them in completing loan
applications, and acting as liaison between borrowers and New
Century until the loans closed. The
division also purchased funded loans from other lenders.
Further, New Century maintained a web-
based loan underwriting process called FastQual. The Retail
Mortgage Loan Division, which
operated 235 sales offices in 35 states, plus a telemarketing unit
and website, worked directly with
potential borrowers. The drive to sign mortgages was so fierce
that New Century dubbed its loan
department “CloseMore University.” 9,10
Investors richly rewarded New Century for this growth with a
compounded annual return of
about 70% from December 31, 2000 to December 31, 2004.

13. (See Exhibit 6 for historical stock prices,
Exhibit 7 for annual sales and diluted earnings per share 1997 to
2005, and Exhibit 8 for the
company’s income statements and balance sheets from 1999 to
Q3 2006.)
By late 2005, several analysts following New Century
recognized difficulties and competitive
pressures in the subprime market but believed that New Century
was well positioned relative to its
peers. One analyst commented in September 2005, “Based on
available data, [New Century] is one of
the lowest cost originators in the space which is a good sign for
their long term mortgage banking
profitability.”11 Early in 2006, one analyst expressed surprise
that “despite the company’s aggressive
growth, we have found little evidence of deterioration in
underwriting and [New Century’s] credit
trends remain above industry averages.” However, others started
raising concerns about the
company’s loan quality. Wrote one analyst in September 2006
about New Century’s loan quality
versus its competitors: “[New Century’s loan] pools generally
showed higher levels of asset quality
deterioration as measured by the sum of seriously delinquent
and foreclosed loans.” Another analyst
wrote in October 2006: “The [loans] most susceptible to credit
deterioration at the company were the
2005 and 2006 vintages, which we would contend are those that
benefited most from increasingly
more lax underwriting standards.” Further, The Center for
Financial Research and Analysis (CFRA),
a unit of RiskMetrics Group that identifies and reports on
companies showing early warning signals
of financial or operational distress, had raised concerns about
New Century’s earnings quality in a

14. report it published on November 6, 2006.12,13
Business and Accounting Policies
New Century temporarily financed the mortgage loans it made
using short-term credit from other
financial institutions, called “warehouse loans,” which provided
liquidity to continue loan originations
while earlier loans were being sold. To maintain credit facilities
with warehouse lenders, New
Century was required to maintain certain liquidity and debt-
ratio covenants and to be subject to
margin calls.14 The lenders needed to be provided with timely
financial statements that conformed to
U.S. generally accepted accounting principles (GAAP), and
many lenders required that New Century
report at least $1 of net income for any rolling two-quarter
period.15
Loans were typically sold or securitized within 30 to 90 days of
origination.16 While New Century
sold the majority of its loans as whole loans or as securitized
loans, it also retained loans on its
balance sheet through securitizations structured as financings.
(See Exhibit 9 for a breakdown of
New Century’s whole loan sales and securitizations.) New
Century derived income from the
difference between its lending rate and the rate at which it could
either sell the loans or borrow to
finance them. It also received income from servicing the loans
it had sold or securitized.
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15. BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
New Century Financial Corporation 109-034
5
Whole loan sales New Century sold mortgages in loan pools to
investors—financial
institutions such as Goldman Sachs, JP Morgan Chase, Lehman
Bros., and Morgan Stanley. Buyers
would perform due diligence on the loans by reviewing about
25% of the pool, after which both
parties would negotiate the final composition of the pool and
the price. If during due diligence the
investors found the loans unsatisfactory (e.g., due to faulty
documentation, unacceptable exceptions
to underwriting guidelines, or incorrect appraisal), they could
reject or “kick-out” a portion of the
package.17 New Century sold the loans at a premium above the
par value of the loan because the
interest rate paid by mortgagors was higher than the rate at
which New Century sold the loans to the
investors.f
New Century’s loan purchase agreements with investment banks
required the company to
repurchase the loans if they suffered an early payment default
or “EPD” (when a borrower defaulted
on any of the first three loan payments), if it was found that
New Century misrepresented its loans
(e.g., overstated the value of the property used as collateral), or
in the case of borrower fraud. In fact,
about 90% of New Century’s repurchases were caused by first-

16. payment defaults where the borrower
failed to make their first payment. The value of such
repurchased loans were substantially impaired
and typically resold at steep discounts.18 New Century sold
these repurchased and kicked-out loans
as “scratch-and-dent” loan pools at discount to their outstanding
principal. (See Exhibit 10 for loan
quality indicators—first and early payment defaults, loan sale
premiums, kick-outs, loans sold at a
discount (i.e., scratch-and-dent loans), and the percent of stated
income and 80/20 loans originated.)
Accounting rules required companies to establish loss reserves
for repurchases of loans. New
Century estimated future repurchases based on the amount of
loans sold in the prior three months
and its actual historical repurchase rate. The loss reserves
needed to cover (1) premium recapture,
(2) interest recapture, and (3) future loss severity. “Premium
recapture” was the amount of the
premium over par that New Century received when it sold the
loan and was required to return in the
event of a default. “Interest recapture” was the amount of
interest the investor should have received
but did not because the mortgagor failed to make loan
payments. New Century needed to pay the
loan purchaser for the interest the purchaser did not receive.
“Future loss severity” was the expected
loss due to the difference between the principal to be repaid and
the fair value of the repurchased
loan at the repurchase date.
Securitizations structured as sales In securitizations structured
as sales, New Century sold
loans to an SPE trust created for the purpose of securitization.
The trust then sold securities based on

17. the loan pools to investors. New Century provided credit
enhancement (CE) by providing additional
collateral above the aggregate principal value of the
securitization (called “overcollateralization” or
OC), in case the loans in the securitization pool failed to
generate the expected cash flows. Therefore,
the lowest tranches in the securitization pool and the first risk
of loss belonged to New Century. New
Century was eligible to receive payments from the OC loans
after payment of principal, interest,
servicing fees, and other trust expenses. The expected cash flow
and net interest receivable on these
OC loans constituted New Century’s “residual interest” in the
securitization. New Century
sometimes securitized and sold the expected cash flows from
the OC loans as Net Interest Margin
Securities (NIMS) but would retain a residual interest in the
NIMS pool; this formed part of the
residual interest asset on its balance sheet.
Accounting rules required that when sold, the securitized loans
were removed and residual
interests recorded on the balance sheet and the securitization
sale proceeds reported as sales revenue
on the income statement. According to U.S. GAAP (FAS 140),
residual interests were to be valued at
f For example, New Century charged a 1.59% premium, on
average, during the first nine months of 2006. That is, for a
mortgage with a principal of $100,000, the company charged the
investment banks $101,590 for the loan.
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109-034 New Century Financial Corporation
6
their fair value, i.e., the value at which the asset could be
bought or sold in a current transaction
between willing parties. Since there was no market price for the
residual interests, New Century
valued them based on the present value of their estimated future
cash flows. This required making
estimates for many variables: risk-adjusted discount rates,
prepayment rates and expected losses on
the loans held in the securitization pools, dates when the
securitization trusts would be terminated,
and the value of the loans in the CE pool at the time of
termination.19
Securitizations structured as financing With securitizations
structured as financings, New
Century retained the securities backed by the securitized loans
labeled “mortgage loans held for
investment” (LFHI) as assets on its balance sheet and the bonds
used to finance them as liabilities.
The company received interest from the mortgagor (recorded as
interest income) and paid out
interest to the bondholders (recorded) as interest expense. It
created an Allowance for Loan Losses
(ALL)—a reserve to provide for losses on loans held for
investment. New Century estimated ALL
monthly by calculating the potential for losses in the LHFI

19. account over the next 18 months, based on
projected loss rates, prepayment rates, and interest rates.
Provisions for losses were expensed, and
actual losses were charged to the allowance account.
Lower of cost or market (LCM) valuation of loans held for sale
All loans that New
Century did not classify as “mortgage loans held for
investments,” including repurchased loans that
it intended to sell, were classified as “loans held for sale.”
Accounting rules required that loans held
for sale were reported at the LCM (lower of cost or fair market
value) as of the balance sheet date.
The amount by which the original cost exceeded the fair value
was to be recorded as a valuation
allowance on the balance sheet. Changes in the valuation
allowance were to be included as part of net
income of the period in which the change occurred (Statement
of Financial Accounting Standards No.
65).
Board of Directors
In March 2007, the New Century board included the company’s
three founders and eight other
independent directors including a lead independent director.
(See Exhibit 11 for information on the
independent board members.) The board averaged 2.5 meetings
per month from 2005 to early 2007
and had seven committees: audit; compensation; executive;
finance; governance and nominating;
public and community affairs; and stock option.20
New Century’s audit committee consisted of four members—
Marilyn Alexander, a certified
public accountant (CPA) and an MBA from Wharton; Donald

20. Lange, president and CEO of Pacific
Financial Services, a mortgage banking company and a former
president of the Mortgage Bankers
Association of America; Richard Zona, former vice chairman
and CFO of U.S. Bancorp and former
partner of Ernst and Young; and Michael Sachs, chair of the
audit committee, who was a CPA and an
attorney. All four members of the audit committee satisfied SEC
requirements for being considered
financial experts. The committee met 21 times between May
2005 and December 2006. The internal
audit function reported to the audit committee, and the external
auditors were invited to (and
attended) all audit committee meetings.21
The compensation committee of the board consisted of five
independent directors and was
responsible for executive compensation at New Century. The
compensation plan for senior
management included an annual salary, a performance-based
annual bonus plan and a long-term
incentive plan that consisted of restricted stock, stock options,
and dividend equivalent rights (DER),
which was an annual cash payout linked to dividend payouts. In
2005 Cole, Morrice and Gotschall
each earned identical amounts —a salary of $569,250, bonus of
$1,070,235, and DER payout of
$230,113. In addition, each of them received restricted stock
grants of 15,628 shares and stock option
grants of 39,568 shares with a five-year vesting period.
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21. 2020.
New Century Financial Corporation 109-034
7
Independent Auditor
New Century retained KPMG as the company’s outside auditors
from its inception in 1995 until
April 2007, when KPMG resigned. KPMG did not complete the
2006 fiscal year-end audit and
consequently, no audit report was filed. The last set of financial
statements for which KPMG filed its
audit report was for fiscal year 2005. KPMG had several
different engagement partners with varying
degrees of experience in the mortgage industry heading the New
Century account over the years. In
2005, John Donovan became the new engagement partner with a
largely new team of auditors.
Donovan, new to KPMG—previously he was a partner at Arthur
Andersen until the firm folded—did
not have substantial experience auditing mortgage companies.22
In addition to the engagement team,
specialists within KPMG, such as those from the Structured
Finance Group, sometimes provided help
and expert advice during quarterly reviews and annual audits of
New Century’s accounting
practices.
New Century Announces Restatement23
In late January 2007, management informed the audit committee
and the board of directors that

22. the company had been incorrectly calculating its loan
repurchase reserves since Q2 2006, when it had
changed its methodology. On February 7, 2007, New Century
announced that it would restate its Q1–
Q3 2006 financial statements to correct errors related to its
accounting of allowances for loan
repurchase losses. In addition, the company announced that the
restatement would reduce earnings
and that it expected to record a loss for Q4 2006. On February
8, 2007, New Century’s stock price
closed at $19.24—a drop of 36% from the prior day’s close. On
March 2, 2007, the company
announced it would not file its 2006 10-K on time, and it had
asked its warehouse lenders to waive or
amend some loan covenants. On March 5, the first day of
trading after the announcement, New
Century’s stock price closed at $4.56.
As a result of these accounting problems, the company faced a
liquidity crisis. On March 8, 2007,
the company stopped accepting new loan applications and
disclosed that it had been unable to satisfy
$70 million of the $150 million in margin calls from its
warehouse lenders. NYSE delisted the
company’s securities on March 13, 2007. On April 2, 2007, New
Century filed Chapter 11. KPMG
resigned as independent auditor on April 27, 2007. Then, on
May 24, 2007, New Century announced
that its 2005 financial results were also inaccurate.
Bankruptcy Examiner’s Investigation24
On June 1, 2007, subsequent to the company’s Chapter 11
filing, the U.S. Bankruptcy Court for the
District of Delaware ordered the appointment of a bankruptcy
examiner to investigate “accounting

23. and financial statement irregularities, errors or misstatements”
at New Century. On February 29, 2008,
the examiner filed his final report which focused on the period
from 2004 to 2007. The examiner’s
report concluded that there were serious problems with New
Century’s monitoring of loan quality as
well as its key accounting estimates.
Monitoring of Loan Quality
Although senior management had identified loan quality as an
issue as early as 2004, the
examiner concluded that the company did not devote sufficient
attention to loan quality until Q4
2006. New Century was not worried about loan quality as long
as it was successful in selling loans to
investors (even as prices investors paid for the loans declined in
2004 and 2005). New Century’s
quality assurance (QA) department had found that “severe”
errors had occurred in 12%–25% of
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Advanced Auditing Theory and Application-7-1-19-1 taught by
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2020.
109-034 New Century Financial Corporation
8
originations between June 2003 and December 2003. The
internal audit department audited loans

24. originated in late 2004 and found “high risk” problems that
could affect sales of the loans.25 In April
2004, the chief credit officer reported that kick-outs were
increasing and that quality assurance results
pertaining to loan originations were at “unacceptable levels.”
While loan quality was frequently
discussed among senior management and in the audit
committee, no meaningful action was taken to
rectify the problems.
A plan by the credit department in 2005 to monitor and identify
underwriters who approved
defective loans was not approved by senior management. The
chief credit officer speculated to the
examiner that a possible reason was resistance from the
production department. According to the
examiner’s report, Patrick Flanagan, head of the Wholesale
Division (who was in charge of the
company’s loan origination and production at the time), had
“unmistakable” disdain for internal
audit and emphasized loan production even when field audits
revealed there were loan quality
issues.26 The examiner wrote: “Senior Management may have
abdicated its responsibility to manage
the day-to-day affairs” particularly with respect to its failure to
address kick-outs. . . . As a result,
New Century lost millions, possibly hundreds of millions, of
dollars in revenues.27
Accounting Practices
The examiner identified seven types of improper accounting
practices not in conformity with
GAAP. Of these, mistakes in calculating repurchase reserve,
LCM valuation of loans held for sale,
and residual interest valuation led to material misstatements in

25. the financial statements for 2005 and
first three quarters of 2006. Overall, the examiner estimated that
the misstatement of the allowance for
loan repurchases, the LCM valuation allowance, and the value
of the residual interest resulted in an
overstatement of earnings before income taxes of $263 million
over the seven quarters from Q1 2005
to Q3 2006 (see Exhibit 12). Of this, the amount pertaining to
fiscal year 2005, the last audited
financial statement, was $63.6 million, compared with total
reported earnings before income taxes of
$443.4 million for that year.
Repurchase reserve The examiner determined that New Century
calculated the repurchase
reserve incorrectly. The company calculated its repurchase rate
using historical repurchase data. For
example, in the fourth quarter of 2005, this rate was based on
historic averages from 2001 resulting in
a rate of 0.659%. This rate was applied to the quantum of loans
it sold in the prior three months
because management assumed that repurchases would be made
within three months. In the fourth
quarter of 2005, whole loan sales amounted to $10.7 billion,
resulting in a repurchase estimate of $70.6
million and a repurchase allowance of $7.0 million as of
December 31, 2005, which was included as
part of accounts payable and accrued liabilities in the
company’s fiscal-year 2005 consolidated
balance sheet. However, New Century did not have reliable data
on the quantity of repurchase claims
received. Repurchase claims were handled by different
departments within New Century depending
on the issue involved in the claim (e.g., fraud issues were
handled by the legal department,
underwriting issues by the loan production department, etc.).

26. Over time, the decentralization created
a backlog of repurchase claims that were unresolved beyond
three month; this totaled about $188
million by the end of 2005. Significantly, the internal audit
department never audited the processing
of repurchase claims and New Century did not possess adequate
control systems to log, process, and
track repurchase requests. The backlog increased quickly and
reached $421 million by October 31,
2006. In the second quarter of 2006, the historical look-back for
the repurchase calculation was
changed from 2001 to the beginning of 2004, resulting in an
estimated repurchase rate of 1.0% for the
second quarter of 2006, and was further increased to 1.75% in
the third quarter of 2006 to better reflect
the current market environment.28
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2020.
New Century Financial Corporation 109-034
9
Between 2004 and 2007, New Century included “premium
recapture” but never included “interest
recapture,” and beginning in Q3 2006 it dropped “future loss
severity” from the repurchase reserve
calculations. (Exhibit 13 shows New Century’s calculation
methodology. Exhibit 14 highlights the

27. company’s calculation in fiscal year 2005 through the third
quarter of fiscal year 2006.) The company
wrongly included “inventory severity” (the adjustment in the
value of repurchased loans on the
company’s balance sheet) as part of its repurchase reserve
calculation, although it was to be a
valuation-allowance account related to loans held for sale. New
Century stopped including inventory
severity in the repurchase reserve in Q2 of 2006.
Residual interest in off-balance-sheet securitizations The
examiner found that New
Century used “flawed and antiquated internally developed
Excel-based valuation models to value
residual interests.”29 There was a serious lack of documentation
about the working of residual
interest valuation models or how the models assumptions were
established or approved by senior
management.
New Century’s management and independent directors
“repeatedly resisted warnings from
specialists at KPMG, who warned that the discount rates New
Century was using to compute
residual interests were below those used by most of its
peers.”30 In 2005, New Century used a
discount rate of between 12% and 14%, while its competitors
used discount rates of 15% to 21%. By
using a lower discount rate than its competitors, the company
had reported higher estimates of the
value of its residual interests. However, as required by SFAS
140, New Century disclosed, in the
footnotes to its 2005 10-K, the sensitivity of residual interest
fair values to its discount rate
assumptions. It provided the percentage change in residual
interest fair values for a 10% and 20%

28. adverse change in the discount rates it had used in the 2005
financial statements. New Century
estimated prepayment rates and loss rates based on the average
historical performance of its
collateral from 1997 to 2002, not taking into account changing
market conditions. The company also
assumed that the value of all loans remaining in the CE loan
pools could be sold at par regardless of
their delinquency status or market conditions. These
assumptions were modified only in February
2007 to reflect more recent data. The examiner wrote:
Everyone at New Century who was familiar with the Company’s
models for valuing its
residual interests—including members of the board, the highest
levels of senior management,
the Company’s chief financial and accounting officers, and the
people within New Century’s
Secondary Marketing Department who built and operated the
residual interest models—
understood that the accuracy of results produced by those
models depended heavily upon key
assumptions. Yet many of those assumptions were flawed in
ways that tended to result in
inflated valuations.31
Loans held for sale (LHFS) According to the examiner, New
Century failed to apply LCM
valuation on loans held for sale, which would have been
consistent not only with industry practice
but even with its own LCM policy. In order to conduct LCM
analysis, industry accounting practices
required that firms grouped loans by categories (e.g.,
performing versus nonperforming loans) and
conduct LCM analysis separately on the various groups (e.g.,
FAS 65 required firms to group

29. residential and commercial loans separately). For loan types
where market value was below cost, a
valuation allowance was used to write the value down to market
value. While New Century
disaggregated loans to conduct the LCM analysis, it then
regrouped the loans into one single
category for valuation, thereby offsetting losses in certain loan
groups (e.g., scratch-and-dent loans)
using gains in better-performing loan pools. As a result, the
appropriate valuation allowance was not
applied to reduce net income, New Century’s LHFS portfolio
was overvalued, and the values of
scratch-and-dent and other nonperforming loan pools were not
written down on a timely basis.32
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2020.
109-034 New Century Financial Corporation
10
Allowance for loan losses (ALL) As New Century grew its
portfolio of loans held on the
balance sheet, ALL became a critical accounting estimate for
the company. The examiner identified
several inadequacies relating to improper documentation of
calculation methodology and lack of
regular updating to reflect actual loan loss performance. The
company believed that ALL was over-

30. reserved since losses in the past had been lower than expected.
But it expected loan losses to increase
in the future, and therefore did not adjust the allowance
downward. The examiner found that New
Century was aware that its ALL calculation models were poor
predictors of actual losses but made no
changes to modify its practices. The examiner, however, did not
consider the ALL misstatement to be
a material error.
Role of the Board and Audit Committee
The examiner found that while the audit committee had
“expressed concerns” about loan quality,
the committee did not consider it a priority during 2004 and
2005 and its attempts to address loan
quality issues were not effective.33 For example, in August
2004 the audit committee was informed
that bonuses of region managers would be based partly on loan
quality (the compensation system
had historically been tied to loan origination volume). However,
the bonus compensation system in
2005 and 2006 made no reference to loan quality. While the
board reviewed QA reports and asked
for periodic loan quality updates from management in 2004, the
examiner found no evidence that
troubling trends in EPD and kick-out rates were discussed at
board meetings.
Even as loan quality problems continued, the examiner found no
discussion of loan quality issues
in seven audit committee meetings in 2005 until a “reasonably
robust” discussion of loan quality in
October 2005 between senior management and several directors,
in which it was acknowledged that
the company had a problem.34 Even this, the examiner

31. concluded, led to no “meaningful action”
since no one was made responsible for addressing the problems
and reporting back to the audit
committee.35 The audit committee made loan quality a priority
and instructed management to put an
improvement plan in place, but not until January 2006; even
then, the committee “failed to follow up
to ensure that the effort was a top priority.”36 The examiner
wrote:
[T]he Board could have paid closer attention to loan quality
issues during much of 2004 and
through 2007. However, the Examiner recognizes that the Board
is entitled to rely on Senior
Management to run the day-to-day affairs of the Company.
Further, the Board, through the
Audit Committee, periodically did give some attention to loan
quality issues. . . . In 2006, the
Audit Committee gave rather extensive attention to loan quality
issues. . . . In such instances,
particularly in 2006, Senior Management repeatedly assured the
Board that New Century’s
loan quality problems were being addressed.
Richard Zona, an independent director since 2000, had
considered resigning from the board on
two occasions in late 2005. In drafts of letters of resignation,
Zona outlined that he was concerned that
the management team was dysfunctional, Gotschall did not
respect outside directors, Cole was not
fully engaged, and Zona suspected that “management
constructed barriers to implementing board
decisions instead of determining the best way to implement
them.” In addition, Zona argued that
accounting for loan losses was improper and expressed concern
that the management had proposed

32. reversing the ALL by 26 cents per share to meet analysts’
consensus forecast in the third quarter of
2005. The “bleeding down” of the reserve was dropped
following Zona’s opposition. Zona remained
on the board after being persuaded by other independent
directors.37
With respect to accounting estimates, the board and the audit
committee had relied on the
auditors for assurances that accounting estimates were
appropriate and that accounting rules were
followed. The examiner determined that the audit committee
asked the auditors each quarter if the
repurchase reserves were adequate, and the auditors had told the
committee that they were. The
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BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
New Century Financial Corporation 109-034
11
audit committee had not been informed of the change in the
repurchase reserve methodology that
eventually triggered the initial restatement announcement. At
the January 2007 meeting, Zona asked
why the audit committee had not been informed of the change
sooner, to which the company’s
controller explained that it was an inadvertent oversight and

33. that the auditors had been informed of
the change.
According to the examiner, residual interest valuation was a
topic at every board meeting and was
discussed in-depth between the audit committee and the
auditors. Zona was known to direct pointed
questions to the CEO, controller, and the auditors about several
facets of the residual interest
calculation methodology, including the discount rate. According
to one director, the board relied on
the auditors to provide assurances that residual interests were
adequately stated, which the auditors
did at audit committee meetings. The auditors also assured the
audit committee that ALL was
reasonably stated.
Role of the Auditor
The examiner blamed New Century’s auditors for failing to
question important assumptions and
departures from prescribed accounting methods.
The examiner claimed that the auditors were aware of the
repurchase claims backlog as of
December 31, 2005, but did not question the repurchase reserve
calculations made by the company.
He also reported that the auditors knew of the improper changes
to the repurchase reserve
calculation methodology made in the third quarter of 2006.
Further, New Century’s controller
informed the examiner that the auditors approved of the
aggregation of loan categories while
undertaking LCM valuation of loans held for sale. On the issue
of ALL, the examiner determined that
“KPMG allowed New Century to utilize poor documentation

34. policies and improper modeling
methodology without testing the significance of the
variances.”38 The examiner claimed that the
auditors signed off on the financial statements even though the
auditors’ internal experts expressed
concerns with the flaws in the models and assumptions used by
New Century’s management in
valuing residual interests.
The examiner wrote:
[H]ad KPMG conducted its audits and reviews prudently and in
accordance with
professional standards, the misstatements included in New
Century’s financial statements
would have been detected long before February 2007.39 The
2005 [KPMG] engagement team,
in particular, was not staffed with auditors with sufficient
experience in the client’s industry
and/or relating to the particular tasks to which they were
assigned. . . . The team also consisted
of auditors who were relatively inexperienced in the mortgage
banking industry.40 The
engagement team’s lack of experience was compounded by the
fact that New Century’s
accounting function was weak and was led by a domineering
and difficult controller.41
Some accounting experts disagreed with the examiner’s
assessment. Roman Weil, an accounting
professor at the University of Chicago, said: “The business
model of New Century depended on real
estate values that would continue to go up and certainly not go
down. The economic model here is
what is at fault. It’s the cause of what happened, not anything
KPMG did.”42 Others questioned the

35. using of hindsight by the examiner to blame auditors for hard-
to-make judgments.
A spokesperson for KPMG pointed out that the bankruptcy
examiner might be motivated to
maximize the estate for the creditors and was perhaps not
unbiased, stating: “The examiner was
appointed by the court to identify potential lawsuits in a
bankruptcy case. Consistent with that
charge, he has prepared an advocacy piece, which has many
one-sided statements and significant
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2020.
109-034 New Century Financial Corporation
12
omissions. In the end, the examiner concluded that the
bankruptcy estate may be able to file a lawsuit
against KPMG for negligence—a claim we strongly dispute—
and a claim even the examiner notes in
his report for which KPMG has strong defenses.”43 Another
spokesperson added, “We strongly
disagree with the report’s allegations concerning KPMG and we
believe that an objective review of
the facts and circumstances will affirm our position.”44
Conclusion

36. According to the examiner, the corporate culture at New
Century was focused on and encouraged
loan production, sales, and growth. He blamed senior
management for ignoring warning signs of
deteriorating loan quality and not investing in necessary
technologies and personnel to meet its
growing needs. He did not, however, find any evidence of intent
by the company to manipulate the
numbers. He asserted that a lack of internal controls,
particularly the absence of written accounting
policies with regard to financial reporting, “substantially”
contributed to the company’s problems.45
In the examiner’s view, New Century’s audit committee did not
address key operational risks,
inadequately supervised the company’s internal audit
department, and failed to pay sustained
attention to loan quality until 2006. And while the internal audit
department did identify issues about
loan quality, servicing, and appraisals, it did not, in the
examiner’s estimation, address internal
controls over financial reporting. Given that New Century was
in an industry that faced high risks,
the examiner found it unfortunate that New Century did not
have effective internal control systems
and a strong internal audit department.
Upon revelation of the failures at New Century, observers were
left wondering why these
problems had occurred despite the enhanced governance and
disclosure requirements imposed by
the Sarbanes-Oxley Act on management, boards, audit
committees, and auditors. Regardless of
where the blame lay, the damage had been done. The bank
examiner wrote: “The demise of New
Century was an early contributor to the subprime market

37. meltdown. The fallout from this market
catastrophe has been massive and unprecedented. Global equity
markets were rocked, credit markets
tightened, recession fears spread and losses are in the hundreds
of billions of dollars and growing.”46
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This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
New Century Financial Corporation 109-034
13
Exhibit 1 Growth in U.S. Subprime Mortgages (2001 to 2006)
Source: Adapted from “The Subprime Lending Crisis,” Report
and Recommendations by the Majority Staff of the
Joint Economic Committee, Senator Charles E. Schumer,
Chairman, Rep. Carolyn B. Maloney, Vice Chair,
October 2007, p. 18. (Source: Inside Mortgage Finance, The
2007 Mortgage Market Statistical Annual, Top
Subprime Mortgage Market Players & Key Data (2006).)
Exhibit 2 Growth in U.S. Subprime Mortgage-Backed
Securitizations (2001 to 2006)

38. 2001 2002 2003 2004 2005 2006
Subprime mortgage-backed
securities (billions) $95 $121 $202 $401 $507 $483
Percent of subprime
mortgages securitized 50.4% 52.7% 60.5% 74.3% 81.2% 80.5%
Source: Casewriter. Data from “The Subprime Lending Crisis,”
Report and Recommendation by the
Majority Staff of the Joint Economic Committee, October 2007,
via http://www.senate.gov/general/
search/search_cfm.cfm?q=subprime&site=default_collection&n
um=10&filter=0, accessed May
30, 2008.
For the exclusive use of A. Caceres, 2020.
This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
109-034 New Century Financial Corporation
14
Exhibit 3 Illustration of How the Subprime Market Works
Source: The Washington Post at

39. http://www.washingtonpost.com/wp-
dyn/content/graphic/2007/03/14/GR2007031400174.
html, accessed June 4, 2008.
For the exclusive use of A. Caceres, 2020.
This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
New Century Financial Corporation 109-034
15
Exhibit 4 New Century Loan Originations and Purchases (2001
to 2005)
Source: Casewriter. Data from New Century 2005 10-K Report,
p. 54, via http://www.sec.gov/
Archives/edgar/data, accessed May 6, 2008.
Exhibit 5 New Century Loan Originations and Purchases (2004,
2005, Q1 to Q3 2006)
2004 2005 2006 (Q1 to Q3)
Loan Type Total $M % Total $M % Total $M %
Fixed Rate
15- to 30-Year $11,086.4 26.3% $13,845.6 24.6% $10,453.8
23.0%

40. Interest Only 0.0 0.0 671.8 1.2 1,097.0 2.4
40-Year 0.0 0.0 489.7 0.9 2,403.6 5.3
HELOC
a
0.0 0.0 0.0 0.0 0.2 0.0
Subtotal 11,086.4 26.3 15,007.1 26.7 13,945.6 30.7
Adjustable Rate (ARM)
15- to 30-Year 22,969.2 54.4 21,194.1 37.8 9,161.1 20.2
Interest Only 8,144.0 19.3 16,580.5 29.6 6,621.0 14.6
40-Year 0.0 0.0 3,298.9 5.9 15,653.4 34.4
HELOC 0.0 0.0 27.6 0.0 53.1 0.1
Subtotal 31,113.2 73.7 41,101.1 73.3 31,488.7 69.3
Total $42,199.6 100.0% $56,108.2 100.0% $45,443.3 100.0%
Weighted Average FICO
score of loans 627 634 634
Source: Bankruptcy Examiner’s Final Report, p. 57.
a Home equity line-of-credit loans.
For the exclusive use of A. Caceres, 2020.
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Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.

41. 109-034 New Century Financial Corporation
16
Exhibit 6 New Century Historical Stock Price (June 1997 to
December 2007)
$63.91
$0.09
$0.00
$10.00
$20.00
$30.00
$40.00
$50.00
$60.00
$70.00
Ju
n
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c-

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46. Price
Source: Thomson One Banker, accessed June 27, 2008.
Exhibit 7 New Century Annual Sales and Earnings per Share
(1997 to 2005)
$0.93
$1.35 $1.33
-$1.17
$1.52
$4.62
$6.56
$8.29
$7.17
-$2.00
$0.00
$2.00
$4.00
$6.00
$8.00

47. $10.00
0
500
1,000
1,500
2,000
2,500
3,000
1997 1998 1999 2000 2001 2002 2003 2004 2005
EPSSales ($mil)
EPS (right axis) Sales (left axis)
Source: Thomson One Banker, accessed June 27, 2008.
Note: The company misstated its 2005 results.
For the exclusive use of A. Caceres, 2020.
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2020.

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This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
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139. te
s.
For the exclusive use of A. Caceres, 2020.
This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
New Century Financial Corporation 109-034
19
Exhibit 9 New Century Activity in the Secondary Market (2003
to Q3 2006)
84%
94%
81% 75%
67%
92%
16%
6%

140. 0% 0%
12%
0%0% 0%
19%
25%
21%
8%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%

141. 2001 2002 2003 2004 2005 2006 (Q1-Q3)
Percent of Total
Whole Loan Sales Securitizations as Sales Securitzations as
Financings
Activity ($ millions) 2001 2002 2003 2004 2005
2006
(Q1–Q3)
Whole loan sales $4,723 $12,420 $20,835 $30,329 $35,315
$41,143
Securitizations structured as sales 898 846 0 0 6,442 0
Securitizations structured as financings 0 0
4,947 10,111 10,962 3,394
Total secondary market activity $5,626 $13,265 $25,782
$40,440 $52,719 $44,538
Source: Casewriter. Data from New Century 2005 10-K Report,
p. 61, via http://www.sec.gov/Archives/edgar/data,
accessed May 6, 2008; New Century TRS Holdings, Inc., Final
Report of Michael J. Missal, Bankruptcy Court
Examiner, United States Bankruptcy Court for the District of
Delaware, Case No. 07-10416 (KJC), February 29, 2008,
pp. 67 and 68.
For the exclusive use of A. Caceres, 2020.

142. This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
109-034 New Century Financial Corporation
20
Exhibit 10 Loan Quality Indicators
Exhibit 10a Early Payment Defaults, Loan Sale Premiums,
Kickouts, and Loans Sold at Discount
(2003 to 2006)
2003 2004 2005 2006
Early Payment Defaults (EPD) 4.38% 7.24% 8.30% 11.96%
Loan Sale Premiums 4.18% 3.58% 2.06% 1.59%
Kickouts ($ billions) n.a. $1.5 $2.3 $5.1
Loans Sold at a Discount
$ millions $247.2 $148.1 $246.5 $916.3a
Percent of Total Secondary Market Activity 1.0% 0.4% 0.5%
2.1%a
Source: Bankruptcy Examiner’s Final Report, pp. 67–68, 111,
119, 137, 143 and 162; 10-K Reports 2004 and 2005.

143. Note: EPD for 2006 is the monthly average for the year.
a For the first nine months of the year.
Exhibit 10b First Payment Defaults and Early Payment Defaults
(January 2004 to February 2007)
2004 2005 2006 2007
FDP EPD FDP EPD FDP EPD FDP EPD
January 1.02% 6.40% 8.05% 1.07% 1.18% 8.37% 2.20% 13.09%
February 0.71% 6.32% __ __ 1.67% 8.83% 1.99% 13.14%
March 0.53% 4.23% 4.47% 0.64% 1.57% 7.76%
April 0.62% 4.53% 0.97% 6.58% 2.00% 12.30%
May 0.86% 8.20% 0.80% 6.66% 1.67% 10.58%
June 0.92% 7.62% 1.06% 7.00% 1.98% 11.19%
July 1.13% 7.91% 1.20% 7.76% 1.94% 12.85%
August 0.94% 7.06% 1.02% 7.28% 2.08% 13.42%
September 1.20% 8.76% 1.37% 8.70% 2.05% 14.88%
October 1.39% 9.70% 1.15% 8.81% 2.29% 12.94%
November 1.35% 10.02% 0.95% 8.72% 2.26% 14.16%

144. December 1.31% 8.72% 1.42% 9.24% 2.58% 16.92%
Source: Bankruptcy Examiner’s Final Report, pp. 141, 148–149,
159.
For the exclusive use of A. Caceres, 2020.
This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
New Century Financial Corporation 109-034
21
Exhibit 10c Kick-out Rates (January 2004 to January 2007)
2004 2005 2006 2007
% of
Whole
Loan
Sales $M
% of
Whole
Loan
Sales $M

145. % of
Whole
Loan
Sales $M
% of
Whole
Loan
Sales $M
January 6.35% $172.6 5.64% $147.3 6.92% $239.2 11.75% __
February 5.45% 164.2 5.92% 40.8 6.38% 246.0
March 6.92% 132.7 4.98% 180.6 5.67% 330.5
April __ __ 5.59% 48.0 8.27% 131.0
May 5.22% __ 6.03% 202.5 7.54% 319.6
June __ __ 5.59% 136.1 6.61% 477.1
July 7.17% 250.6 5.92% 169.2 9.90% 340.3
August 5.56% 211.4 4.57% 129.9 9.62% 316.8
September 5.65% 94.9 5.62% 283.4 11.48% 979.0
October 5.55% 185.8 8.11% 285.7 11.89% 612.3
November 5.15% 120.6 6.59% 171.8 12.12% 312.9
December 5.35% 172.6 8.77% 486.9 14.95% 804.6
TOTAL $1,505.6 $2,281.7 $5,109.5

146. Source: Bankruptcy Examiner’s Final Report, pp. 143, 150–152,
161–162.
Exhibit 10d Stated Income and 80/20 Loans (2002 to 2006)
As a Percent of Total Loans Originated
As of December Stated Income Loans 80/20 Loansa
2002 34.1% 7.9%
2003 42.5% 9.1%
2004 43.5% 23.5%
2005 45.5% 35.2%
2006 47.2% 29.2%
Source: Bankruptcy Examiner’s Final Report, pp. 127–128.
a 80/20 loans involved two separate loans for the same
transaction resulting in 100%
financing of the property: a first lien mortgage with an 80%
loan-to-value ratio and a
second lien with a 20% loan-to-value ratio. The value of the
80/20 loan for 2002 is as of
3/03.
For the exclusive use of A. Caceres, 2020.
This document is authorized for use only by Ana Caceres in

147. Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
109-034 New Century Financial Corporation
22
Exhibit 11 The Eight Independent Directors on New Century’s
Board (May 2006)
NAME—DIRECTOR SINCE—COMMITTEES
Marilyn A. Alexander—2005—Audit, Finance (Chair),
Governance and Nominating, Public and Community Affairs
Alexander, a certified public accountant, was a strategy,
diagnostics, and process design consultant to corporations and
nonprofits. Previously she held senior marketing and financial
positions at Walt Disney and Marriott Corporation and was on
several boards. She had a bachelor’s degree from Georgetown
Univ. and an MBA from the Wharton Graduate School of
the Univ. of Pennsylvania.
Harold A. Black—2004—Compensation, Public and Community
Affairs (Chair)
Black, a professor of finance at the Univ. of Tennessee,
Knoxville, was previously on the faculties of several U.S.
universities. He had held several government positions,
including deputy director, Department of Economic Research
and
Analysis/Office of the Comptroller of the Currency, and
director/chair of the Nashville Branch of the Federal Reserve

148. Bank
of Atlanta. Black received his undergraduate degree from the
Univ. of Georgia and his MA and Ph.D. from Ohio State Univ.
David Einhorn—2006
Einhorn was co-founder, president and a director of Greenlight
Capital, Inc., which provided investment advice or
management services to three companies (Greenlight Capital
Offshore, Ltd., Greenlight Capital, L.P., and Greenlight
Capital Qualified, L.P. ) that invested in and held securities of
various types. Previously, Einhorn worked as an investment
analyst at an investment firm and in the Investment Banking
Group of Donaldson, Lufkin & Jenrette. He received his B.A. in
Government from Cornell Univ.
Frederic J. Forster—2002—Compensation, Executive,
Governance and Nominating
Forster was a private investor and consultant. Previously, he
was a director of and consultant to LoanTrader, a private
company that developed a website which serviced mortgage
brokers and lenders, a principal of Financial Institutional
Investors, and president and chief operating officer of H.S.
Ahmanson and Company, and its subsidiary, Home Savings of
America. Forster received a B.S. in physics from Princeton
Univ. and an MBA from Harvard Business School.
Donald E. Lange—2002—Audit, Compensation (Chair),
Governance and Nominating
Lange was the president and CEO of Pacific Financial Services,
a mortgage banking and specialty finance company.
Previously, he was president and CEO of OptiFI, a private
company specializing in prepayment analytics and of several
specialty finance subsidiaries of Weyerhaeuser Company. In

149. addition, Lange had been a director of Mortgage Electronic
Registration System, Pacific Gulf Properties, and Pedestal, and
was the president of the Mortgage Bankers Association of
America. He received a bachelor’s degree in Business and
Agriculture from the Univ. of Wisconsin.
William J. Popejoy—2002—Compensation, Governance and
Nominating (Chair), Public and Community Affairs
Popejoy was the managing member of Pacific Capital Investors,
an investment partnership, and was a member of the board
of trustees of PIMCO Funds and PIMCO Commercial Mortgage
Securities, Inc. Previously, he was the CEO and a director
of the California State Lottery; CEO of the County of Orange
CA; chairman and CEO of Financial Corporation of America;
president and CEO of Financial Federation, Inc.; president of
Far West Savings, First Charter Financial and its subsidiary,
American Savings & Loan Assoc.; and president and CEO of
Freddie Mac. He had a bachelors and masters degree from
Sacramento State Univ.
Michael M. Sachs—1995— Audit (Chair), Compensation,
Executive, Finance
Sachs, a certified public accountant and attorney, had been
chairman and CEO of Westrec Financial, an operator of
marinas and related businesses, and of Pinpoint Integrated
Systems, a manufacturer of high tech systems primarily for the
government. Sachs had a B.S. in accounting from the Univ. of
Illinois and J.D. from Stanford Univ.
Richard A. Zona—2000— Audit, Executive, Finance
Zona was chairman and CEO of Zona Financial, a private
financial advisory firm. In addition he was on the boards of
Piper

150. Jaffray Companies (a public securities firm) and Polaris
Industries (a manufacturer of snowmobiles and all-terrain
vehicles).
Previously, he was vice chairman and chief financial officer of
U.S. Bancorp and a director of ING Direct Bank, Shopko
Stores, and a partner at Ernst & Young.
Source: New Century Financial Corporation, Form DEF 14A,
filed April 4, 2006 (period: May 10, 2006).
Note: The Finance Committee was formed in early 2006.
For the exclusive use of A. Caceres, 2020.
This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
New Century Financial Corporation 109-034
23
Exhibit 12 Estimated Impact of Misstatements on Earnings ($
millions, except for EPS)
2006 7-Qtr
FY 2005 Q1 Q2 Q3 Total
Reported earnings before income taxes $443.4 $115.7 $134.8
$90.2 $784.1
Adjusted for misstatements:

151. Allowance for repurchase losses (11.5) (12.9) 3.0 (83.4) (104.8)
LCM valuation allowance (9.8) (8.6) (63.4) (3.9) (85.7)
Valuation of residual interest (42.3) 14.1 (15.2) (29.1)
(72.5)
Total identified misstatements (63.6) (7.4) (75.6) (116.4)
(263.0)
Revised earnings before income taxes 379.8 108.3 59.2 (26.2)
521.1
Reported net earnings $411.1 $101.2 $103.0 $63.5 $678.8
Revised net earnings $372.9 $96.8 $7.6 ($6.3) $471.0
Reported diluted earnings per share (EPS) $7.17 $1.79 $1.81
$1.12
Revised diluted earnings per share (EPS) $6.51 $1.71 $1.01
($0.11)
Percent overstatement 9% 4% 44% 110%
Analysts’ estimates $6.73 to
$8.88
$1.78 to
$1.79
$1.85 to
$1.89
$1.65 to
$1.98

152. Source: Bankruptcy Examiner’s Final Report, pp. 383 and 386.
For the exclusive use of A. Caceres, 2020.
This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
109-034 New Century Financial Corporation
24
Exhibit 13 New Century’s Repurchase Reserve Calculation
Methodology
Premium Recapture
Prior three months loan sales $1,000,000
Estimated repurchase percentage rate 1%
Average premium received from loan purchaser 2%
Estimated premium recapture ($1 million * 1% * 2%) $200
Interest Recapture
Prior three months loan sales $1,000,000
Estimated repurchase percentage rate 1%
Average coupon interest rate 10%

153. Assumed annualized missing interesta $1,000
Estimated interest recapture ($1 million /12) *3 $250
a Typically assumed that the borrower missed three month of
payments.
Future Loss Severity
Prior three months loan sales $1,000,000
Estimated repurchase percentage rate 1%
Historical % of repurchased loans repurchased at a loss 50%
Historical loss rate on repurchase loans 20%
Estimated interest recapture ($1 million * 1%* 50% * 20%)
$1,000
Source: Bankruptcy Examiner’s Final Report, p. 184.
Exhibit 14 Components of New Century’s Loan Repurchase
Reserve (FY 2005 to Q3 FY 2006)
FY 2006
Description FY 2005 Q1 Q2 Q3
Allowance for loan repurchase losses
Interest Recapture Excluded Excluded Excluded Included
Premium Recapture Included Included Included Included

154. Future Loss Severity Included Included Included Excluded
Backlog Claims a Excluded Excluded Excluded Excluded
Inventory Severity Included Included Excluded Excluded
Source: Bankruptcy Examiner’s Final Report, p. 213.
Note: New Century had included Inventory Severity in its
repurchase reserve through Q1 2006, although it was not
by accounting standards a component of a repurchase reserve.
a Backlog claims represented repurchase requests later than 90
days after the loans were sold.
For the exclusive use of A. Caceres, 2020.
This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
New Century Financial Corporation 109-034
25
Appendix A
New Century’s Loan Origination Process
Step Description
1. Independent brokers or New Century brokers identified

155. potential borrowers, completed loan
applications, which they submitted to New Century account
executives or through its web-based
loan underwriting process called FastQual. The company had
established relationships with nearly
50,000 independent brokers and had about 1,000 account
executives.
2. Account executives submitted loan applications to New
Century account managers, who
reviewed the applications to ensure all documentation was in
place. The company had three levels
of income documentation: full, limited, and stated. With full,
the applicant was required to submit two
written forms of income verification showing stable income for
at least 12 months. With limited, the
applicant was generally required to submit six months of bank
statements. With stated, the company
did not require verification of the amount of monthly income
the applicant stated on the loan
application. In all cases, the applicant’s employment status, if a
salaried employee, was verified by
telephone. Within the industry, stated income mortgages were
called “liar loans.”
3. If applications and documentation were in place, account
managers sent loans to New Century
underwriters. Loans the company purchased from other
mortgage bankers and financial
institutions also went through the underwriting process, called
re-underwriting.
Underwriters reviewed loans for compliance to New Century’s
underwriting standards and decided
whether to approve or deny the loans. Underwriters set the
interest rate and the terms of the loan.

156. The company’s underwriting guidelines required a credit report
on all applicants from a credit
reporting company. The company also reviewed all of the
applicant’s prior mortgage payment
histories.
During the underwriting process, the collateral (i.e., home) was
appraised. According to New
Century’s 2005 10-K report: “A qualified independent appraiser
inspected each mortgage property
and gave an opinion of value and condition. Following each
appraisal, the appraiser prepared a
report that included a market value analysis based on recent
sales of comparable homes in the
area.... All appraisals must conform to the Uniform Standards of
Professional Appraisal Practice
adopted by the Appraisal Foundation’s Appraisal Standards
Board and are generally on forms
acceptable by Fannie Mae and Freddie Mac....Our underwriting
guidelines then require our
underwriters be satisfied that the value of the property being
financed, as indicated by the appraisal,
would support the requested loan amount.”
4. If approved, underwriters sent loans to closing agents for
execution.
5. After loan documents were executed, closing agents sent the
documents to New Century funding
officers, who would contact accounting department and request
a wire to the funding officers.
Source: Casewriter. Bankruptcy Examiner’s Final Report, pp.
58–59; New Century Financial 10-K Report (2005), pp. 5–7, via
http://www.sec.gov/Archives/edgar/data, accessed May 6, 2008.

157. Note: Fannie Mae and Freddie Mac were stockholder companies
chartered by the U.S. government to help provide
liquidity to the mortgage industry by participating in the
secondary market. Both companies primarily purchased
mortgages from lenders and resold them with guarantees as
mortgage-backed securities.
For the exclusive use of A. Caceres, 2020.
This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
109-034 New Century Financial Corporation
26
Endnotes
1 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal, Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.
07-10416 (KJC), February 29, 2008, pp. 1 and 40.
2 “The Subprime Lending Industry: A Look At The
Restructuring of a Market in Turmoil,” prepared for the
American Bar Association Annual Meeting Section of Business
Law, Sponsored by the Business Bankruptcy
Committee, at American Bar Association website,
http://www.abanet.org/buslaw/newsletter/0063/materials/

158. pp1a.pdf, accessed May 7, 2008, p. 1.
3 Sumit Agarwal and Calvin T. Ho, “Comparing the Prime and
Subprime Mortgage Markets,” The Federal
Reserve Bank of Chicago, Chicago Fed Letter, August 2007,
Number 214, via http://www.chicagofed.org/
publications/fedletter/cflaugust2007_241.pdf, accessed May 22,
2008.
4 Information for this paragraph obtained from Stephen G.
Ryan, “Accounting in and for Subprime Crisis,”
March 2008,” New York University, SRRN Working Paper
Series, at http://papers.ssrn.com/sol3/papers.cfm?
abstract_id=1115323, accessed September 25, 2008.
5 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal, Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.
07-10416 (KJC), February 29, 2008, p. 10.
6 Ibid., p. 40.
7 Ibid., p. 41.
8 Ibid., pp. 126–128.
9 Jill Riepenhoff and Doug Haddix, “Risky refinancings deepen
financial hole,” Columbus Dispatch, June 2,
2008, p. 1A, via Factiva, accessed September 18, 2008.
10 Unless cited otherwise, information in this paragraph from
New Century TRS Holdings, Inc., Final Report
of Michael J. Missal, Bankruptcy Court Examiner, United States
Bankruptcy Court for the District of Delaware,
Case No. 07-10416 (KJC), February 29, 2008, pp. 55–56, and
116.

159. 11 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal, Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.
07-10416 (KJC), February 29, 2008, p. 84.
12 Zach Gast, “New Century: Presentation of Loan Loss
Allowance in Earnings Release Obfuscates 8.7%
Decline in Allowance and Understates Charge-Offs by 50+%,”
RiskMetrics Group Center for Financial Research
and Analysis, November 6, 2006, p. 1.
13 Unless cited otherwise information in this paragraph from
New Century TRS Holdings, Inc., Final Report
of Michael J. Missal, Bankruptcy Court Examiner, United States
Bankruptcy Court for the District of Delaware,
Case No. 07-10416 (KJC), February 29, 2008, pp. 84 and 87.
14 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal, Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.
07-10416 (KJC), February 29, 2008, p. 62.
15 New Century NT-10K 2007.
16 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.
07-10416 (KJC), February 29, 2008, p. 64.
17 Ibid., p. 66.
18 Ibid., p. 71 and 121.
For the exclusive use of A. Caceres, 2020.

160. This document is authorized for use only by Ana Caceres in
Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
New Century Financial Corporation 109-034
27
19 Unless otherwise cited information for this section from New
Century TRS Holdings, Inc., Final Report of
Michael J. Missal, Bankruptcy Court Examiner, United States
Bankruptcy Court for the District of Delaware,
Case No. 07-10416 (KJC), February 29, 2008, pp. 230–240.
20 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.
07-10416 (KJC), February 29, 2008, pp. 75–76.
21 Ibid., p. 75.
22 Ibid., p. 456.
23 Unless otherwise cited, information for this section from
New Century TRS Holdings, Inc., Final Report of
Michael J. Missal, Bankruptcy Court Examiner, United States
Bankruptcy Court for the District of Delaware,
Case No. 07-10416 (KJC), February 29, 2008, pp. 101, 102,
104, 105.
24 Ibid., pp. 10, 49, 89, 113, 114, 146, 147, 154–156, 165, 180,
205, 222, 229, 230-240, 256–258, 277–278, 297, 336,

161. 389, 429, 443, 457–458, 471, 473.
25 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal, Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.
07-10416 (KJC), February 29, 2008, p. 152.
26 Ibid., p. 89 and 165.
27 Ibid., pp. 175–176.
28 Unless otherwise cited, information for this paragraph from
New Century TRS Holdings, Inc., Final Report
of Michael J. Missal, Bankruptcy Court Examiner, United States
Bankruptcy Court for the District of Delaware,
Case No. 07-10416 (KJC), February 29, 2008, pp. 70, 193, 201,
221.
29 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal, Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.
07-10416 (KJC), February 29, 2008, p. 229.
30 Ibid., p. 230.
31 Ibid., p. 229.
32 Unless otherwise cited, information for this paragraph from
New Century TRS Holdings, Inc., Final Report
of Michael J. Missal, Bankruptcy Court Examiner, United States
Bankruptcy Court for the District of Delaware,
Case No. 07-10416 (KJC), February 29, 2008, pp. 223–225.
33 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal, Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.

162. 07-10416 (KJC), February 29, 2008, p. 140.
34 Ibid., p. 154.
35 Ibid., p. 156.
36 Ibid., p. 146.
37 Ibid., pp. 90–91 and 339.
38 Ibid., p. 342.
39 Ibid., p. 458.
40 Ibid., p. 471.
41 Ibid., p. 473.
For the exclusive use of A. Caceres, 2020.
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2020.
109-034 New Century Financial Corporation
28
42 Vikas Bajaj and Julie Creswell, “A Lender Failed. Did Its
Auditor?” The New York Times, April 13, 2008.
43 Ibid.

163. 44 Jessica C. Lee, “New Century Report Likely Read for
Prosecutors,” Orange County Business Journal, Volume
31; Issue 14; ISSN: 10517480, April 7, 2008, p. 3, via Factiva,
accessed June 10, 2008.
45 New Century TRS Holdings, Inc., Final Report of Michael J.
Missal, Bankruptcy Court Examiner, United
States Bankruptcy Court for the District of Delaware, Case No.
07-10416 (KJC), February 29, 2008, p. 389.
46 Ibid., p. 10.
For the exclusive use of A. Caceres, 2020.
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Advanced Auditing Theory and Application-7-1-19-1 taught by
BUNNEY SCHMIDT, Keiser University from Jan 2020 to Jul
2020.
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/WP-Phonetic
/WPTypographicSymbols
]
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173. ]
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>>
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>>
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>>
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>>
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