Discrepancy in residual valuation struck the subprime mortgage industry again last week, this time spotlighting the accountant firm's role in the debacle.
According to an insider at Superior Bank, the $238 million incongruity is associated with an overcollateralization account that the bank was counting as core capital while drawing upon it to pay down the lower interest mortgages.
"Ernst & Young had taken the position that we could count that as an asset on the books of the bank even though we had been using it to pay down loans," the company source said. Ernst & Young declined to comment when contacted.
Last fall, the bank's residuals were valued at approximately $1.1 billion, then discounted to $939 million, according to the company source. The said O/C account effected a $117.8 million write-down. That, combined with insufficient residual discounting (according to the Office of Thrift Supervision), caused the $238 write-down, which left the bank significantly undercapitalized.
It's unclear exactly how the OTS's analysis on residuals discounting differed from Ernst & Young's.
"The regulators rely very heavily on cash collections, which can be a lot different than future estimates," said one source close to the regulators. "The regulator's analysis focuses on what you've actually collected, and extrapolating that out to indicate what the collection rate is likely to be going forward. It's often much more conservative the methods the accountants use."
The story made mainstream headlines last week as co-owners Alvin Dworman and the Pritzker family injected a combined $350 million into the bank and its holding company, Coast to Coast Financial Corp. The Pritzker family will now own 100% of the company.
Superior Bank is only the latest of several banks who have had residual descrepancies with the regulators. Last year, Advanta Corp. suffered a $214 million write-down after the Office of the Comptrollor of the Currency (OCC) told the bank to raise its residual discount rate to 18% from 15%.
In the Superior example, what is most significant, sources said, is that accounting firm Ernst & Young apparently changed its opinion on the value of Superior Bank's residuals, something that didn't come to light in the previous regulatory encounters.
"The accountants are an issue in this case and apparently haven't been in the other cases, but I would actually be surprised if they haven't been," said David Fanger, a financial institutions analyst at Moody's Investors Service. "In each case, these were residuals that had some accountant's blessing, and yet the regulators still required the residuals to be written down. I'm not sure that this is really as unique as it appears to be."
"The accountants are scared of the regulators these days on valuing residuals. And they ought to be," said a consultant specializing in regulatory issues. "Historically, they've given the client what the client wanted. Now the regulators are coming in with a much more critical eye, and doing the evaluations based on more conservative figures."
Meanwhile, on the news of the capital restructuring, Standard & Poor's will likely reaffirm Superior's subprime loan servicer rating, which the rating agency placed on watch in March, following the OTS enforcement order.