Identifying Potential Financial Issues of a Purchase Target
A large financial organization seeking to diversify operations
A privately held mortgage origination and servicing company was targeted as a prime investment. The company was one of the largest residential mortgage originators and servicers in the USA. The company was privately held and there were concerns about related party transactions, and risks in the mortgages held for sale, and risks in the servicing portfolio.
Perform a detailed analysis of the target company’s assets, including pipeline of mortgages (from application to in process to closed/held for sale), and servicing portfolio. Interview key managers at the target company, including director of servicing, chief financial officer, and members of the board of directors. In addition, we met with the outside auditors and the principal shareholder.
Significant risks were identified: Cash had not been reconciled for six months. There were financially material, unreconciled transactions between the mortgage company and another company owned by the shareholder. The servicing portfolio had significant risk related to losses on government insured mortgages; a third party expert stated that the risk was material, but could not quantify the maximum risk. We concluded and reported to our client that the financial statements could not be relied upon, and that management could not be relied upon.
Notwithstanding the report of material risks, unreliable financial statements, and poor management, the client acquired the company. Six months after acquisition, it was found that the company had used escrow accounts to fund operations and the company was eventually liquidated at a significant loss to the client.