Easy mortgages put Irvine lender in a house of straw
As mortgage lender New Century Financial Corp. collapsed last week, some of the Irvine company’s top salespeople relaxed at scenic Dromoland Castle in Ireland, which boasts that it pampers guests like they were “landed gentry.”
The trip to Dromoland and other Irish haunts was booked in better days for winners of the firm’s President’s Club awards. New Century’s money troubles led it to rescind sponsorship, but some workers apparently decided that if their employer was dying, an Irish wake was in order.
“Some people had already made personal plans and decided to go ahead on their own,” company spokeswoman Laura Oberhelman said.
Sales incentives such as trips to Ireland were long a part of the culture at New Century and other lenders that specialize in making sub-prime mortgages to people with spotty credit, irregular income or other issues that stopped them from getting lower-cost prime loans.
The business boomed as housing prices soared. Orange County, one of the world’s hottest real estate markets, was a center of the action. New Century and other lenders, including Ameriquest Mortgage Co. in Orange and Irvine-based Option One Mortgage Corp., recruited huge sales forces to hustle business.
“The culture around all of these sub-prime lenders has been ‘Hey, bring it to us. We’ll make it happen,’ ” said Philip X. Tirone, a Los Angeles mortgage broker and author. “ ‘If you have a client with a [low] credit score who only wants to put 5% down and had a bankruptcy not too long ago, that’s OK. Bring us that loan.’ ”
Then it all came crashing down, and few fell harder than New Century.
In little over a decade, New Century had become the nation’s largest independent sub-prime lender. It wrote nearly $52 billion in loans last year and employed 7,500 people. It’s top executives became rich, then richer, as its stock price soared to more than $65 a share.
But last week, the company stood on the verge of extinction. New Century was forced to stop making loans because the Wall Street firms that provided its funding cut off the flow of fresh money. Federal investigators were conducting a criminal probe into its accounting, and the New York Stock Exchange delisted the company after its shares fell below $1.
What went wrong? The company’s rise and fall is in many ways the story of the rise and fall of the sub-prime lending industry.
While housing prices were going up, these lenders flourished. They specialized in serving borrowers with marginal credit -- charging them more for the privilege -- but the robust real estate market took out much of the lenders’ risk. If the payments got too hard to handle, the borrowers could simply refinance into new loans with low initial “teaser” rates, or perhaps even sell their properties for a profit.
But when home prices leveled off or declined, this escape route was blocked. Making matters worse, many companies loosened their lending standards in the last year in an attempt to keep loan volumes up, industry experts say.
The result has been a rising tide of defaults and a decision by Wall Street banks such as Merrill Lynch & Co. to cut off funds to sub-prime specialists.
“I am a little bit shocked that this meltdown didn’t happen sooner,” said Jeff Lazerson, president of Mortgage Grader, a Web-based brokerage in Laguna Niguel. “In the past, we used to say that if you could fog a mirror you could get a loan. For the last five years, you could be dead and get a loan. That’s why we’re in this mess today.”
New Century was founded in 1995 by a trio of mortgage industry veterans -- Robert K. Cole, Brad A. Morrice and Edward F. Gotschall -- who had worked together at Plaza Home Mortgage Corp. in Santa Ana and later helped launch Option One.
They took New Century public in 1997, just as housing prices began picking up after a long slump. Fueled by the housing boom and low interest rates, New Century expanded to 216 sales offices in 35 states -- commanding its empire from an 11-story office tower in Irvine, next to a building once occupied by Charles H. Keating’s Lincoln Savings & Loan, an infamous player in the savings and loan crisis of the 1980s.
Cole, Morrice and Gotschall grew wealthy as the stock price rose, and have been hammered -- on paper, anyhow -- by its sharp decline, each having lost well over $50 million on their holdings since May, when the stock hit a recent high, according to regulatory filings.
Yet they already have realized huge actual profits from the company. In 2003 through 2005, each took home nearly $8.4 million in salary and bonuses. And they earned even more from stock sales: In 2005, for example, Cole cashed in stock options for $12.7 million, Morrice for $13.3 million and Gotschall for $13.9 million, filings with the Securities and Exchange Commission show.
All three landed in homes in the pricey Orange County neighborhoods seen in reality television shows: Gotschall in a sprawling Coto de Caza estate, and Cole and Morrice high in the hills above Laguna Beach.
The growing company sought to burnish its reputation through philanthropy and community involvement, touting affiliations with Habitat for Humanity, public television station KOCE and the Volunteer Center Orange County.
In April 2005, Gotschall and his wife, Susan, gave $3 million to Mission Hospital in Mission Viejo to expand the trauma center. Hospital administrators who trumpeted the donation, then Mission’s second-largest, said they would name the trauma center in the Gotschalls’ honor.
Last May, shortly after he left New Century, former Executive Vice President Patrick Flanagan gave $500,000 to Saint Mary and All Angels in Aliso Viejo, a private school attended by four of his five children. The school head said the money would be spent on a new “crown jewel” of the campus, the Flanagan Family Performing Arts Center.
Flanagan also oversaw New Century’s NASCAR racing team, which in 2005 pledged to give $168 to the Autism Society of America for every lap led by driver Jamie McMurray. Flanagan earned more than $8.4 million in salary and bonuses in the three years from 2003 to 2005, and exercised stock options for a gain of $2.6 million in 2005.
Key employees shared the fruits of success. Top producers in the sales force were treated to vacations in Europe and the Caribbean. Independent mortgage brokers were also given incentives to deal with New Century, said Edward Arce, an Orange County mortgage broker.
“If you were an account executive at New Century, you would go out to brokers like myself and incentivize them by saying, ‘If you do business with us, we will pay you more than our competition is paying,’ ” Arce said.
Account executives offered brokers bonuses of 1% of each loan, Arce said, so that a $500,000 loan would generate a $5,000 premium on top of other commissions, which vary depending on a loan’s terms. (Oberhelman, the company spokeswoman, said New Century had stopped the use of such bonuses in recent years.)
Arce sued New Century and one of its employees in 2003, alleging that the employee’s boyfriend -- who was not a licensed broker -- was impersonating Arce and using his company’s name to sell loans. Arce said the pair wrote about 35 loans in this way. Most of them were “stated income” loans, in which borrowers aren’t required to document their earnings or financial qualifications.
Industry critics have assailed the sub-prime lending industry in general for loose standards. Because loan agents and mortgage brokers work on commission, these critics say, they had little incentive to reject questionable loan applications.
Independent mortgage companies generally sell their loans to Wall Street firms, which bundle them into securities. But these buyers can force the companies to buy back loans that turn out to have involved fraud.
Loan buyers also can force the companies to repurchase mortgages if the borrowers miss initial payments. It was a flood of these early payment defaults that triggered the meltdown in sub-prime, analysts say.
In Arce’s case, the Orange County jury that heard the civil case rendered a split decision: It ruled that the couple had defrauded Arce, but cleared New Century of liability. But Arce said the experience left him with a bitter image of “the whole sub-prime world,” which he now avoids. “The whole industry is in trouble,” he said.
Few disagree with that assessment. Sub-prime loans made in 2006 are going into early default at the fastest pace in years. About three dozen large lenders have closed operations, drastically cut back, filed for bankruptcy protection or been sold to healthier companies.
At New Century, funding problems were exacerbated by a criminal investigation disclosed earlier this month. The U.S. attorney’s office is examining how executives accounted for losses when the company was forced to buy back soured loans last year, and whether its executives profited by selling stock while misleading other investors about the company’s financial situation, according to a regulatory filing. The company has said it is cooperating with federal investigators.
New Century stopped making new loans March 7 and was delisted from the New York Stock Exchange last week amid concerns over its viability.
Shares now trade in the over-the-counter market, closing Friday at $2.34. That’s more than double their value earlier in the week. But less than a year ago, they were worth more than $50.
scott.reckard@latimes.com
