Paper Economy: New Day for New Century

Friday, February 09, 2007

New Day for New Century

For those of you who may have missed yesterday’s grotesque flogging of sub-prime lender New Century Financial (NYSE:NEW), here’s a wrap-up.

On Wednesday, NEW announced that it would need to restate earnings for the first three quarters of 2006 in order to “correct errors the company discovered in its application of generally accepted accounting principles”.

Apparently, they wrongly calculated the impact of their repurchased loans (loans that immediately go bad at the first payment and get repurchased by the lender) in the following ways:

They did not include the expected “discount upon disposition” of the repurchased loans when estimating their allowance for repurchased loans. In this way it appears that they may have exceeded their reserve for expenses related to bad loans.
They incorrectly estimated the volume of repurchase claims for the first three quarters of 2006. Again, it appears that they significantly underestimated the number of bad loans they would be repurchasing thus exceeding their reserve for expenses related to bad loans.

Properly accounting for these errors will reduce all three previously stated quarters of 2006 as well as postpone the Q4 results which the company has preliminarily stated will show a net loss.

The following is a chart showing NEW stock price over the last 12 months (click for larger version) note yesterdays precipitous drop-off… its current price is that little blue nub way down there at the right under $20!!!

I was shorting this stock (along with CFC, KBH, TOL, LEND etc.) for all of 2006 but I had decided to take a breather on the ‘puts’ as I was getting a little crazy with some of my ‘bets’ so you can imagine my dismay when I saw the pounding this stock got yesterday.

In my opinion, the sub-prime lenders (all home/home-equity lenders for that matter) are all essentially in the same position. They were an enabler for an industry that went absolutely wild during this historic housing run-up and now the chickens have come home to roost.

Home lenders, especially the sub-prime lenders, will spend 2007 and beyond digging out of this horrendous ditch, some will survive but many will not.

The result for the housing market will be a further decrease in sales activity as tightening of lending practices removes a significant percentage of buyers from the marketplace that would have otherwise been qualified during the run-up era.

For a daily view of sub-prime lender news and failures see Mortgage Lender Implode-O-Meter.