Breaking the bank: New Century files bankruptcy
You’ll need bigger bills to play this game
Yesterday, on the first day of the second quarter, and after tidying up some details (below) to position itself better, as we (and everybody else) predicted, New Century filed for bankruptcy.
Once a highflier in the booming market for making risky mortgage loans, the New Century Financial Corporation filed for bankruptcy court protection today.
In the largest bankruptcy case to date in the subprime arena, New Century listed liabilities of more than $100 million in its Chapter 11 papers filed with the federal bankruptcy court in Wilmington, Delaware [where most publicly traded companies are incorporated -- Ed.].
The $100 million in liabilities is merely a placeholder, the tip of the iceberg. Losses here will run into the billions, and potentially outstrip even Fannie Mae’s.
Decoded etymology can be revelatory: bankruptcy means the bank is broken, the finances are kaput, and that is what happened to New Century: it ‘admitted in writing its inability to pay its debts,’ one of the many formulations of this unhappy state. In financial terms:
The first great equation of bankruptcy
From the law’s perspective, bankruptcy is the legal termination of a once-living entity (in this case, a corporation), and its death (and possible resurrection). A certain morbid spirituality pervades the post-bankruptcy interval, as the entity itself is a financial zombie. Start first with its naming: the bankruptcy estate:
What am I bid for this attractive loan servicing business?
Then comes the undertaker: in this case, a trustee or receiver, appointed by the court (just where indigent deceased have their financial affairs laid to rest), presiding over the zombie like a judicial Baron Samedi.
I’m from the court and I’m here to help you!
In this case, New Century had little choice, for it was out of money:
And the numerous Wall Street banks that had once provided credit lines of more than $17.4 billion began denying access to that credit.
That’s B for billion, folks, not M for the puny $100 million to which New Century confessed. By the time this is over, the losses across the ecosystem will be in the billions.
In recent weeks, the company was unable to stop many of those banks from repossessing or selling the collateral that backed those debts, making a bankruptcy filing virtually inevitable.
When a business is failing — mortally ill, in financial terms — those who have previously aided it look to their own financial situation. As reported in yesterday’s Washington Post:
The company said it intends to sell off its major assets.
Assuming they can be reached and sold. They may already be carted off, for anyone who has a claim on a piece of collateral rushes to repossess it:
Think this is worth repossessing?
To spirit it away before any of the other creditors get to it.
We heard the company was in trouble
New Century said it had agreed to sell its loan servicing business to Carrington Capital Management LLC and its affiliate for about $139 million, subject to the approval of the bankruptcy court.
It’s not a pretty sight. Anything of tangible value rapidly gets carted out. In the lingo, it’s a variation of ‘asset stripping’ and it’s about as seemly.
An entity so visibly wounded, gushing financial blood, is in no bargaining position, so we can presume that the $139 million Carrington Capital paid is less than that business is worth. Or was worth yesterday — remember, had New Century not sold the servicing business, it too might have hemorrhaged its value. Meanwhile, Carrington Capital has improved its position at the table, for the servicer, as we saw in the lending universe dramatis personae, sits astride the stream of financial information regarding the enormous loan portfolio. Carrington’s move was likely shrewd.
Even after disposing of that nice little business, New Century needed more money, so …
CIT Group and Greenwich Capital Financial Products Inc. have agreed to provide up to $150 million in working capital to facilitate the reorganization process, the company said.
What nice fellows. But wait!
New Century has also agreed to sell certain loans and residual interest in some trusts to Greenwich Capital for $50 million.
Here, take my socks. Here, take my shoes.
Creditors assessing assets: they don’t fit but they’re worth something, aren’t they?
Bankruptcy is a semi-animated state. By throwing itself upon the financial court, the bankrupt entity compels a freeze of all asset-stripping, a breathing space or time out to take stock of the inventory and determine the way forward.
Wonder what that building will fetch at auction?
It’s called bankruptcy ‘protection,’ and the question is, protection for whom? Not whom you think — not the company itself — but rather, for its unsecured creditors.
The legal premise behind bankruptcy is that a business being plundered has its value disintegrate, whereas if plunder can be held off, then the business will be worth more. So bankruptcy imposes an immediate freeze on all that frenzy:
No removing assets now
The company said it intends to sell off its major assets.
Assuming they can be reached and sold. They may already be carted off.
“The Chapter 11 process provides the best means for selling our servicing and loan origination operations to financially sound parties,” president and chief executive Brad A. Morrice said in a statement.
“It is our hope that potential buyers will be in a stronger position than we are to employ many of our associates on an ongoing basis,” he said.
For companies, bankruptcy comes in two types: Chapter 11 is a reorganization — a financial coma from which I hope to emerge, fresh and newly conscious — and Chapter 7 is a liquidation — an autopsy and the sale of my constituent organs.
And it’s about that dignified, too
A company that enters as a Chapter 11 — few start as Chapter 7’s — may eventually convert to Chapter 7, either because it chose to or because its creditors persuade the judge (who sits in judgment like St.
New Century made the move after exploring a variety of possible ways to stay in business, he said.
Yes, falling on one’s sword is seldom the first choice.
Your management team has explored every other option
What drove New Century to this course?
On Feb. 7, however, New Century informed the Securities and Exchange Commission that it would have to restate financial results for the first three quarters of 2006. The company said it had failed to accurately tally losses from loan repurchases.
Even worse than splitting an infinitive is counting the wins and not the losses.
It also faces federal probes by the SEC and the U.S. Justice Department. And shareholders, angry over their losses and alleging mismanagement by the company’s directors and officers, have fired off several lawsuits.
Oh, you think you have a litigation claim? What makes you say so?
That helped New Century stock hit its historic high of $65.95 in December 2004. Its loan production for 2005 hit a record $56.1 billion.
Still, it seemed to come as a shock to investors when, in February, the company said it would have to restate its earnings for the first nine months of 2006 and record a loss for the final quarter because it had understated the damage caused by a growing number of soured loans.
[…]
The company’s stock, which traded at $31.59 a share at the end of last year, was de-listed by the New York Stock Exchange in mid-March, and its shares closed down $1.55 on Friday to $1.66 in the over-the-counter market.
I’m exercising my liquidity option
I’d say a 95% drop in stock price indicates a shock.
My crystal ball certainly didn’t forecast this
The news last month was much more dire when the company disclosed that federal prosecutors and securities regulators were investigating stock sales and accounting errors at the company.
Insider stock sales, and accounting errors.
“These are words that seldom mingle well, my Michelle.”
While it is still unclear who the target of those investigations are, the company said that as far as the executives were concerned, their sales occurred as part of planned stock sales. At the end of last year, the three founders still owned a combined 7% of the company.
[By the way, what distinguishes this case from Fannie Mae's? -- Ed.]
Last week, New Century said several of its lenders planned to sell their outstanding mortgage loans and use the proceeds to offset payment obligations by the company, while retaining the right to recover the difference.
First we liquidate. Then we present a chit for the shortfall.
The company has signed consent agreements with several states and received cease-and-desist orders from others in recent weeks.
The state agreements are intended to keep New Century from accepting new mortgage applications on grounds that it has violated state laws, including failing to fund mortgage loans after closing.
Taking an applicant’s money and then failing to fund her mortgage at the funding desk would be pretty bad.
Bad for business
I’ve devoted this introductory effort because watching how this plays out will also give you a true forensic insight into the workings of a mortgage originator and of the capital markets themselves. And it’s going to be a multi-billion-dollar meltdown before it’s done, of substantial policy and market importance.
Finally, on its way to the courthouse New Century left a parting gift for its hard-working staff:
LOS ANGELES — Subprime lender New Century Financial Corp., once the nation’s second-largest provider of mortgages to high-risk borrowers, filed Monday for bankruptcy protection and immediately fired 3,200 workers, or 54% of its work force.
Thus turning them, and any claims they might have, into unsecured creditors.
“So long, and thanks for playing our game.”
