Primer on Subprime Mortgage Accounting Allegations
NERA Economic Consulting has followed up its widely read primer on “The Subprime Meltdown” with a paper focusing on mortgage originators and the accounting-related allegations made against them in recent subprime lawsuits.
Many of those allegations center on whether originators and other players have valued their mortgage-related securities at fair prices or have failed to make adequate and timely provisions for loan losses.
Sample allegations include:
- The Company lacked sufficient internal controls to determine loan loss provisions
- The Company mischaracterized its Low Documentation Loans as prime loans, and as a result of the deteriorating market conditions, it needed to take on more risky loans in order to maintain its growth.
- The Company lacked requisite internal controls, and as a result, the Company’s projections and reported results issued during the Class Period were based upon defective assumptions and/or manipulated facts;
- The Company’s financial statements were materially misstated due to its failure to properly account for its allowance for loan repurchase losses;
- The Company’s financial statements were materially misstated due to its failure to properly account for its residual interests in securitizations by failing to timely write down the impaired assets
The paper provides helpful answers to the following questions:
- What is a “loan loss provision?”
- What is an “allowance for loan repurchase losses?”
- What is a “residual interest in securitization?”
- How does one know if a residual interest in securitization is impaired or not?
- What are the financial reporting implications of weathering “the full weight of the risk of default?”
It outlines the many factors that can go into calculating fair value of derivative securities and loan loss provisions, and demonstrates the complexity in determining whether companies have behaved responsibly and lawfully.
The manner in which loan loss reserves are estimated is bound to be a key element in subprime lawsuits.
There is no accounting standard that provides guidance about how to estimate loan loss reserves, NERA says. “In attacking or defending a particular company’s method of estimating reserves, it will be necessary to understand completely how the mortgage originator determined the amount of the loan loss reserve and be ready to analyze all assumptions, estimations, and methodologies used to calculate the amount of the reserve.”
The Subprime Meltdown:Understanding Accounting-Related Allegations, can be downloaded at no charge from NERA Economic Consulting website.
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December 14th, 2007 at 11:18 am
[...] was a good week for NERA Economic Consulting, whose Primer on Subprime Mortgage Accounting Allegations led the pack and its Subprime Mortgage Lending Primer from June came in at number [...]