Special to American Banker

ALBANY, N.Y. - State regulators are investigating the collapse of a subprime mortgage lender based near here after an allegation that it defrauded its principal warehouse lender of more than $5 million.

National Finance Corp., which telemarketed refinancing and debt consolidation loans nationwide from its Halfmoon, N.Y., headquarters, closed its doors Dec. 21, throwing about 500 people out of work. Bear, Stearns & Co. issued a statement the next day, saying it was told in November by National Finance executives that $5 million to $6 million had been "diverted" and that the company had "falsified reports to us to hide its actions."

The subprime lender had pledged mortgages to the Wall Street company, which supplied warehouse financing, until the loans could be sold, at which point National Finance was supposed to pay down its line of credit. At some point, however, the lender apparently sold mortgages and did not use the proceeds to repay Bear Stearns.

The former president of National Finance, David Silipigno, said the diversion of funds was unintentional.

The state Banking Department got a temporary restraining order in state court in Manhattan to bar the company from making any disbursement without the department's approval and to require management not to remove any asset from the company's offices. The department said in court papers that the company has a negative net worth exceeding $8 million and that "management will not seek protection of bankruptcy court and has essentially abandoned their responsibilities to consumers and their regulator."

Banking Department officials would not comment on either their findings or the nature of their investigation. Bear Stearns also declined to comment beyond its prepared statement.

Mr. Silipigno, who founded the company in 1989 at age 19, acknowledged some of Bear Stearns' account but gave it a different interpretation.

"Bear Stearns was informed that [the money] was inadvertently utilized," Mr. Silipigno said in a brief telephone interview. "They didn't find out. They were told by us."

A report in the Albany Times Union said he elaborated by citing unspecified mistakes in his accounting department and saying that growing too fast had caused cash-flow problems. He said the company's overhead was too high but did not explain how millions of dollars committed to repaying warehouse loans could have been inadvertently used for other purposes.

Though a more complete explanation of the missing millions is unlikely before Banking Department auditors complete their work, National Finance may have been buffeted by the same forces plaguing other independent subprime lenders.

The cost of generating a steady volume of business rose as even borrowers with poor credit histories found it easier to obtain funds from conventional lenders, said Tony Fisher, formerly in-house counsel for the company and now president in charge of winding down its affairs.

Others cited a loss of liquidity in the secondary market for loans that don't meet the packaging standards of Fannie Mae and Freddie Mac, the federally chartered companies that buy most home loans, and a resulting plunge in prices paid by investors.

National Finance had been selling loans for 106% to 107% of their face value before prices plummeted to 103% in October 1998, said Chris Coulthrust, senior vice president and chief information officer for the company.

"That was industrywide," Mr. Coulthrust said. "The people who survived had forward commitments from investors. We had month-to-month commitments."

In addition, he said, National Finance was not especially aggressive in cutting costs, declining for example, to close branches in California, Indiana, Colorado, Illinois, and Florida, though most of these offices' functions could have been performed from the main office. The company did close offices in New York City and New Jersey after trouble developed, he said.

National Finance had originated $40 million to $50 million of loans per month in recent years, Mr. Coulthrust said. The average size of a loan dropped from $55,000 to $47,000 over the course of 1999, he said. Also, at the beginning of that year, 60% of loans were originated by the company's own sales force and 40% by brokers, but by the end of the year the ratio was reversed.

Though managers at Mr. Coulthrust's level knew little of the company's financial difficulties, he said that in hindsight plenty of trouble signs were visible. For example, the company dropped preparations for an initial public offering in late 1998. It subsequently hired Westwood Capital LLC, an investment banking company in New York, to seek a possible buyer. The reason given for the sale "depended on what day of the week it was," Mr. Coulthrust said.

In November, Mr. Silipigno resigned as president, saying publicly that he didn't want his presence to make finding a buyer more difficult. He did not, however, explain why his continued leadership would impede efforts to sell the company.

In its Dec. 22 statement, Bear Stearns said it continued to fund National Finance for a month in hopes that a buyer would be found and that the company's assets would fetch a price sufficient to repay the warehouse loan.

"When it became clear this week that no viable acquisition proposal was available, the remaining senior management and the regulators determined that NFC could not remain in business" Bear Stearns said.

A Bear Stearns spokesman said the investment bank had not found whether it had any recourse to recover the missing money.

Mr. Stoneman is a freelance writer in Albany.

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