Risk Management

New Century Double Trouble: Bad KPMG, No CFO

Bankruptcy examiner says KPMG "acquiesced" to mortgage lender's deficient accounting, but that the lack of a finance chief didn't help.
Roy HarrisMarch 27, 2008

Allegations of KPMG’s complicity in deficient accounting may lie at the center of the bankruptcy-court-commissioned report on the failure of New Century Financial. But the situation was made much worse by a void in the CFO position during the subprime market’s unraveling in 2006.

Further, it was a vigilant new CFO — Taj S. Bindra — who blew the whistle on the Irvine, Calif.-based mortgage lending giant, bankruptcy court examiner Michael Missal tells CFO.com in a telephone interview.

“Taj kind of looked at things and asked, ‘Why is the repurchase reserve number so low?’ It just didn’t look right to him,” says Missal. The alarm sounded by Bindra, who had come to the company from Washington Mutual in November 2006, “got them to look deeper into the methodology that they had been using.”

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Missal’s sharply worded 570-page report, commissioned by the U.S. bankruptcy court in Wilmington, Del., paints the picture of a company infected with a corporate culture much like that of other subprime lenders — a culture that “encouraged production, sales, and growth,” except that it further emphasized beating the competition for business. “New Century had a brazen obsession with increasing loan originations, without due regard to the risks associated with that business strategy,” the report said, noting that originations soared from $14 billion to $60 billion between 2002 and 2006.

The report analyzes numerous cases of how it “made frequent exceptions to its underwriting guidelines for borrowers,” lighting the fuse for the “ticking time bomb that detonated in 2007.” Early that year, New Century collapsed into one of the nation’s largest finance-company bankruptcies. And in that sense the report offers a vivid case study illustrating elements of the whole industry’s plunge.

But it was the underpinning in its poor accounting decisions — and KPMG’s failure to challenge them — that provide the primary colors on the canvas. According to the report, lower-level KPMG employees were frequently reversed by higher-ups, apparently fearful of losing the account.

“KPMG obviously acquiesced to a lot of what New Century wanted to do,” says Missal. “The engagement team was very accommodating, and overruled the specialists on a number of issues.” One problem was “the discount rate being used to compute the residual interest valuation,” because for securitized mortgages, New Century would still get some of the residuals. “The discount rate was very low, and didn’t seem realistic. The company wanted it as low as possible,” so that the valuations could be as high as possible. “And the engagement team at KPMG didn’t push back.”

In fact, the report concluded, if the company “had used a more appropriate discount rate to compute the present value of future cash flows, the residual interest valuations would have been reduced by at least $14.8 million as of Dec. 31, 2005.” The discount rate was the second major accounting concern of the investors, who identified “at least seven wide-ranging improper accounting practices.” The first issue was the level of repurchase reserves.

For years, according to the report, top managers “turned a blind eye to the increasing risks of New Century’s loan originations and did not take appropriate steps to manage those risks.” But people interviewed by the investigators during the five-month probe “claimed that KPMG actually recommended the improper changes to the repurchase reserve calculation that were made in the second and third quarters of 2006.”

In a statement to CFO.com from KPMG spokesman Dan Ginsburg, the accountancy said: “We strongly disagree with the report’s allegations concerning KPMG. We believe that an objective review of the facts and circumstances will affirm our position.”

Unsecured creditors of New Century, however, had been pushing since the middle of last year to include KPMG’s role in the collapse of the mortgage lender.

The abuses and the accounting flaws at New Century worsened during 2006, according to Missal’s report. And while the situation spiraled out of control that year — both internally at New Century, and externally in the subprime market — for several months there was no one actively filling the company’s CFO post.

Officially, the finance chief was Patti Dodge, a long-time executive there. “But the board members just didn’t like her,” Missal tells CFO.com. In March 2006, his investigation showed, “they decided to replace her, and she moved over to investor relations.” But since Taj Bindra didn’t come on board until November, “there was a real void there. And the markets were going haywire.”

Bindra was brought on as executive vice president effective Nov. 6, and CFO effective Nov. 15. He became a member of the executive management committee, reporting to president and CEO Brad Morrice. In its announcement of Bindra’s naming, New Century pointed out that he had 18 years of senior-management experience in financial services, having worked at JPMorgan Chase before moving to Washington Mutual.

While Bindra provided bankruptcy court investigators with good information, Missal told CFO.com, “he wasn’t there for much of the time, and there wasn’t a lot for him to say,” beyond describing the problems that he discovered.

Missal adds the New Century investigation to an impressive and eclectic list of credentials, which include serving as lead counsel to the examiner in the WorldCom bankruptcy proceeding, and being lead counsel for CBS’s independent review panel investigating Dan Rather’s September 2004 report on “60 Minutes Wednesday,” which reported on the status of President Bush’s Texas Air National Guard Service.

Of these varied assignments, the practice area leader for the law firm of Kirkpatrick & Lockhart Preston Gates Ellis says: “They’re all a little different. This one was difficult to do given the time involved, and some of the cooperation issues.”

At one point, KPMG refused to provide documents to Missal, according to the report, and objected to the subpoena that eventually was issued, before reaching a settlement and providing documents late last August. That was “long after most of the KPMG interviews had been completed.”

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