By David Cho
Washington Post Staff Writer
Tuesday, April 3, 2007
New Century Financial, a lender that came to symbolize the fast-and-loose mortgage practices of recent years, filed for bankruptcy protection yesterday and said it would lay off 3,200 employees, more than half its workforce.
The filing by the Irvine, Calif., company was widely expected, but it is nonetheless a milestone in the mortgage industry's ongoing contraction. While nearly 50 lenders have filed for bankruptcy protection or shut their doors since the end of last year, none was as large or as respected by Wall Street as New Century.
These companies specialized in "subprime" loans, generally offered to people with blemished credit or insufficient cash for a down payment. Subprime mortgages, which accounted for $600 billion, or about 20 percent, of all new home loans last year, were the main reason millions of working-class Americans were able to buy homes they otherwise could not afford.
Many of these mortgages did not require down payments or had low teaser interest rates that leaped after the first two or three years. Delinquency rates on these mortgages have soared in recent months, prompting Wall Street to cut off funds for companies like New Century.
Analysts worry that the woes in the lending industry will spill over to the broader economy and dampen demand for homes. House prices are flat or declining in much of the country, and some economists fear the situation could get bad enough to tip the economy into recession.
"The fact that New Century is filing for bankruptcy is a real wake-up call," said James Croft, founder of the Mortgage Asset Research Institute in Reston. "It's one thing for smaller lenders to close their doors. But when the company the size of New Century declares bankruptcy, that indicates the level of severity in the current situation."
In months, New Century has gone from Wall Street favorite to financial pariah. Last year, New Century issued $51.6 billion worth of subprime mortgages, second in that market to HSBC Holdings. Its stock has fallen 90 percent since February, after it revealed it had understated the amount of bad loans it had made. The company was delisted from the New York Stock Exchange last month and announced it would stop issuing new loans.
At least eight states have issued cease-and-desist orders forbidding New Century from operating there; the company said it expects more states to follow suit. New Century has said it was cooperating with a criminal investigation by the Justice Department.
In a statement yesterday, chief executive Brad A. Morrice said the bankruptcy filing was "a very hard step for me personally and clearly not the outcome I would have preferred. . . . I particularly regret the impact that the bankruptcy filing will have on our dedicated associates."
New Century said that current mortgage holders would be unaffected but that it would seek to spin off all of its loans to other lenders in coming months. The company announced yesterday that it had sold some mortgages, as well as an administrative division, for $189 million. It also received a $150 million loan from the CIT Group and Greenwich Capital Financial Products, pending court approval, to keep operating while it seeks to reorganize under Chapter 11 of the U.S. Bankruptcy Code.
The company faces massive liabilities. Its creditors, which include Goldman Sachs, Morgan Stanley and Credit Suisse, provided billions of dollars in short-term funding that enabled New Century to make loans to home buyers.
In the past, New Century had been able to package its home loans into massive bonds, known as mortgage-backed securities, and sell them to investors, including some of the big investment banks. Such bonds were popular because they offered relatively high returns in an economic climate in which interest rates are low by historical standards.
Analysts say Wall Street's hunger for these securities drove New Century and other companies to push a high volume of risky loans with insufficient regard for people's ability to repay them.
Lenders like New Century "are selling what is ordered up by Wall Street," said Irv Ackelsberg, a Philadelphia lawyer who assists homeowners facing foreclosure and who testified on the issue to the Senate Banking Committee last month. "The real market demand is for these bond securities."
As the subprime mortgage market unraveled, however, the appetite for such bonds faded. New Century was left with no way to pay its creditors, who cut off funding last month.
While New Century's survival is in doubt, some of its creditors contend they would not take big hits from the bankruptcy filing. Morgan Stanley, for example, has said it would auction $2.5 billion worth of mortgages that it holds as collateral for short-term loans it made to New Century. The bank predicted the auction would cover most of the losses from its New Century deals.
The fall of New Century and other mortgage companies sparked a broad reassessment of lending practices. Many lenders have been tightening standards, requiring home buyers to provide more documentation of their income. Mortgage with no down payments are disappearing.
"It's clear that people at the margin of creditworthiness will have significantly more difficulty obtaining mortgage loans," said Croft of the Mortgage Asset Research Institute. "I think the industry has to take a lot of responsibility for the problems it is experiencing today."
Staff researcher Richard Drezen contributed to this report.