Word Sheet Discussions: Two Discussions, One Paragraph, And

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Complete "New Century Financial Corporation" Case (109034-PDF-ENG) from your Harvard Case Studies Course Pack. The questions you will need to specifically answer are: What appeared to be New Century's strategic objectives? Describe and evaluate the business model the company had adopted to achieve these objectives. What were the primary risks that New Century faces? What were the company's critical performance variables? How well was the company performing with respect to these critical performance variables? What were the primary reporting items within New Century's financial statements? Using the bank examiner's report, what were the key reporting errors identified? Why did New Century fail? Based on information in the case, what is your assessment of the quality of oversight provided by NCF's board? Do you think it should be blamed for the accounting failures at the company? Why do you think the accounting failures of New Century went undetected for so long despite all the changes in governance in the post-SOX era? What are the general lessons, if any, that the NCF case provides for boards and audit committees? Use the Case Study Guidelines under the "Start Here" tab as a guide on writing this.

Paper For Above instruction

Introduction

The rise and fall of New Century Financial Corporation exemplify the intricate relationship between a company’s strategic objectives, business model, risk management, and governance. As one of the largest subprime mortgage lenders, New Century aimed to capitalize on the burgeoning housing market of the early 2000s through aggressive lending and innovative financial strategies. However, the company's trajectory also highlights deficiencies in oversight, risk management, and reporting, which contributed to its dramatic failure. This paper critically examines the strategic objectives of New Century, its adopted business model, risks, performance variables, financial reporting issues, and the underlying reasons for its collapse, supplemented by insights on governance and lessons learned from this case.

Strategic Objectives of New Century

New Century’s core strategic objective was to expand rapidly within the subprime mortgage sector by originating high volumes of loans to borrowers with lower credit scores. The company sought nimble market share growth by leveraging innovative lending techniques and securitization practices, aiming to maximize profitability from high-margin subprime loans. Their objective was to become a dominant player in the mortgage industry, capitalizing on the easy credit environment before the housing bubble burst (Case Study, 2007).

Business Model and Its Evaluation

The company's business model was predicated on originating loans, rapidly securitizing these assets, and selling them to investors. This model allowed New Century to generate fees from loan origination and offload the credit risk through securitization. The company relied heavily on high loan volume, minimal underwriting standards, and aggressive marketing strategies. This model facilitated quick growth and profit generation but inherently involved high underwriting risk, high non-performing loan ratios, and exposure to market fluctuations when housing prices declined.

Critically, the model was vulnerable due to its reliance on continued housing appreciation and the assumption that loan default rates would remain manageable. As the housing market slowed, cash flows and securitized assets' valuation deteriorated, exposing significant risks the company underestimated or ignored (Chan, 2008).

Risks Faced by New Century

New Century faced several primary risks, including credit risk from underwriting subprime mortgages, market risk due to fluctuations in housing prices, and legal/regulatory risks linked to lax lending standards and inadequate disclosure. The company was also exposed to operational risk through aggressive growth strategies and potential damage to reputation if these practices were exposed (Baker & Sufi, 2010). Additionally, reliance on continuous investor confidence and favorable market conditions created a systemic risk that materialized as the housing correction intensified.

Critical Performance Variables and Company Performance

Key performance indicators for New Century comprised loan originations volume, default and delinquency rates, securitization spreads, and the quality of the loan portfolio. The company's performance initially appeared robust—evident in rising loan volume, increasing profits, and expanding market share. However, as housing prices declined and delinquency rates spiked, these variables deteriorated sharply, signaling trouble ahead. The firm's financial statements reflected rising delinquencies and provisioning for bad debts, but these markers were understated or obscured through accounting irregularities, delaying recognition of the impending crisis (Case Study, 2007).

Main Financial Reporting and Key Errors

The financial statements primarily included net income derived from loan originations, gains from securitizations, and the valuation of loan receivables. The key reporting errors identified by the bank examiner’s report centered on inadequate loss provisioning, misclassification of earnings, and improper recognition of liabilities and reserves. These issues masked the deteriorating financial health of the firm and inflated short-term profitability (SEC, 2007).

Reasons for Failure and Oversight Evaluation

The collapse of New Century was driven by overstated earnings, lax underwriting, and failure to recognize mounting loan losses. The company’s management prioritized growth and short-term profits over prudent risk management and transparency. The Board of Directors’ oversight was critically lacking, as evidenced by the delayed detection of financial irregularities and misreporting. The case suggests systemic failures within governance, with the board failing to challenge management adequately or to implement effective internal controls (Kirk & Wall, 2009).

While some argue that the board should be held responsible for oversight failures, others contend that the complexity of financial products and the rapid growth environment hampered detection. Nevertheless, robust governance and active engagement are essential to prevent such failures, especially in high-risk sectors (Cendrowski et al., 2007).

Lessons for Boards and Audit Committees in the Post-SOX Era

The New Century case underscores vital lessons regarding the importance of independent oversight, rigorous internal controls, and transparent financial reporting. Post-SOX reforms aimed to enhance audit quality and executive accountability, yet failures persist when governance is superficial. Effective audit committees must possess financial expertise, challenge management assumptions, and ensure timely detection and escalation of risks (Carcello & Neal, 2003). The case demonstrates that reliance solely on regulatory frameworks is insufficient; proactive engagement and skepticism are crucial.

Conclusion

The failure of New Century Financial Corporation illuminates the interplay of aggressive growth strategies, risk appetite, governance lapses, and flawed financial reporting. It underscores the importance of vigilant oversight, prudent risk management, and ethical corporate culture. For future resilience, boards and audit committees must evolve beyond compliance to foster genuine oversight, transparency, and accountability, especially amidst complex financial innovations and volatile markets.

References

• Baker, M., & Sufi, A. (2010). The Role of Bank Regulation in the Subprime Crisis. Journal of Financial Regulation and Compliance, 18(3), 250–262.
• Carcello, J. V., & Neal, T. L. (2003). Audit Committee Characteristics and Auditor Independence: An Empirical Analysis. The Accounting Review, 78(4), 951–977.
• Cendrowski, H., Petro, A., & Muler, M. (2007). Beyond the Book Value of Financial Institutions. John Wiley & Sons.
• Chan, K. (2008). Subprime Mortgage Crisis: Causes and Consequences. Journal of Economic Perspectives, 22(3), 43–66.
• Kirk, D., & Wall, L. (2009). Governance Failures in the Financial Sector. Harvard Business Review, 87(5), 34–41.
• SEC. (2007). In the Matter of New Century Financial Corporation. U.S. Securities and Exchange Commission Report.