# Detecting Accounting Fraud

## Quiz 9 :Mortgage Mayhem

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CASE STUDY TierOne Bank • Read extracts from the SEC Complaint filed on September 25, 2012, against TierOne Bank. • Examine extracts from TierOne?s Financial Statements (10-Ks) for 2005-2008. According to the December 31, 2007, 10-K, "TierOne Corporation ('Company') is a Wisconsin corporation headquartered in Lincoln, Nebraska. TierOne Corporation is the holding company for TierOne Bank ('Bank')" (p. 5). • Respond to the following Case Study Questions. Required a. Underestimation of allowance for loan losses: In the text, Signal #2 is "Allowance for Loan Losses Not Growing in Proportion to the Increase in Troubled Loans." Read the extracts from TierOne's financial statements and notes to its financial statements for the years 2005-2008. Explain whether you can identify the signal that TierOne's allowance for loan losses may allegedly have been understated. Show supporting calculations for your answer. b. Underestimation of allowance for loan losses: In the text, Signal #3 is "Allowance for Loan Losses Not Increasing Significantly as House Prices Fall." Reread the discussion of Signal #3 in the text, as well as extracts from the SEC Complaint against TierOne. Search online for articles published in late 2008 about falling house prices. Explain how Signal #3 could have alerted users of TierOne?s financial statements that its allowance for loan losses at December 2008 may allegedly have been understated. Extracts from Complaint against TierOne Bank* Civil Action No. 12-cv-00343 Filed September 25, 2012 10 IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEBRASKA Omaha Division SECURITIES AND EXCHANGE COMMISSION PARAGRAPHS 3 and 7: 3. TierOne was a century-old thrift bank that had historically focused on residential and agricultural loans in the Nebraska/Iowa/Kansas region. Beginning in about 2004, TierOne expanded into riskier types of lending in high-growth geographic regions such as Las Vegas, Florida, and Arizona. By the second half of 2008, as a result of the financial crisis and accompanying crash in real estate markets, TierOne was experiencing a significant rise in high-risk problem loans. 7. The full extent of TierOne's loan-related losses did not become publicly known until late 2009, after OTS required TierOne to obtain new appraisals for its impaired loans. TierOne ultimately disclosed over $130 million of additional loan losses. Had TierOne recorded these additional loss provisions in the proper quarters, it would have missed the OTS-required capital ratios as of the end of December 31, 2008, and for each quarter thereafter. Following the announcements of the additional loss provisions, TierOne's stock price dropped more than 70 percent. TierOne eventually filed for bankruptcy shortly after the bank was shut down by OTS in June 2010. PARAGRAPHS 24?29 24. Generally Accepted Accounting Principles, or "GAAP," provides that a loan becomes "impaired" when it is probable that the bank will be unable to collect all amounts due under the original loan agreement. In addition, TierOne?s written lending policy stated that a loan greater than 90 days past due should be considered impaired. 25. Under GAAP, TierOne was required to assess probable losses associated with its impaired loans and record those losses in its allowance for loan and lease losses ("ALLL"). GAAP permits the impairment to be measured using the fair value of the underlying collateral if the loan is collateral dependent, which is the method that was typically utilized by TierOne. 26. Any increase in ALLL (a balance sheet item) must be accompanied by the recording of a provision for loan losses (an income statement item), thereby increasing reported loss and further eroding the bank?s capital, which, in turn, negatively impacted the bank's ability to meet the OTS-required elevated capital ratios. 27. Some of TierOne's real estate loans were eventually foreclosed upon and the underlying collateral became the property of the bank, or OREO. GAAP required TierOne to carry OREO on its books at the lower of the property?s book value or fair value, less costs to sell the property. 28. Thus, a key consideration under GAAP regarding the existence and magnitude of losses for impaired loans or OREO is the fair value of the collateral or OREO property. A recent appraisal performed by an independent and certified real estate appraiser is normally the best evidence of a property?s fair value. In the absence of a current appraisal, all relevant and current information known at the time must be used. This information includes: the most recent evidence of market declines, broker price opinions ("BPO"), recent comparable sales, internal determinations of value, current project status and offers to purchase or sell. 29. In this case, TierOne intentionally delayed the process of obtaining current appraisals for properties that had declined in value, relying instead on inaccurate data and assumptions. PARAGRAPHS 60?62 60. In August 2009, OTS directed TierOne to obtain updated appraisals. The new appraisals revealed the actual values of TierOne's collateral for impaired loans and OREO. On October 14, 2009, TierOne filed a Form 8-K reporting an additional$13.9 million in loan loss provisions for the second quarter of 2009. TierOne also announced that it intended to restate its second quarter 2009 financial statements, and that the bank?s capital ratios would fall below the levels required by OTS. In the days following this news, TierOne's stock price fell over 17 percent, from approximately $3.27 per share to$2.69 per share. 61. The situation worsened as more OTS-mandated appraisals came in. On November 10, 2009, TierOne filed another Form 8-K reporting an additional loan loss provision of $120.2 million for the third quarter of 2009. TierOne?s stock price dropped a further 54 percent over the next three trading days, from approximately$1.71 per share to \$0.78 per share. 62. TierOne was shut down by OTS on June 4, 2010, and filed for bankruptcy later that month.
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Fill in the blank with information and concepts from this chapter. The process in which many loans are pooled together and interests in these pooled loans are sold to investors is known as ___________.
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Mortgage
Mortgage is a debt for the company which is secured by fixed assets. The company has to pay the mortgage with interest.
Securitization refers to the process in which loans are accelerated and pooled together in large quantities and sell the interests on these loans to investors in the form of securities.
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Fill in the blank with information and concepts from this chapter. The housing boom, like most booms, was fueled by easy ___________.
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Easy Credit
The housing boom was stimulated by easy credit option, similar to reason for occurrence of most booms in past. To help the individuals in buying an affordable home for living, the Federal National Mortgage Association and Federal Home Mortgage Corporation was started by the Congress of Country U.
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Answer the following question with T for true or F for false for more practice with key terms and concepts from this chapter. As a result of the process of tranching, a ratings agency could give a higher credit rating to a class of securities carved from a pool of loans than would be given to other classes of securities carved from the same pool of loans.
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Answer the following question with T for true or F for false for more practice with key terms and concepts from this chapter. Leveraged transactions are frequent catalysts in boom-bust cycles.
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Fill in the blank with information and concepts from this chapter. An MBS is a financial ___________ that gives the owner a partial interest in a pool of mortgage loans.
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Answer the following question with T for true or F for false for more practice with key terms and concepts from this chapter. Fannie Mae and Freddie Mac were established to accelerate the funding and issue of mortgage loans.
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Answer the following question with T for true or F for false for more practice with key terms and concepts from this chapter. The term underwriting standards refers to the credit risk standards that lenders require to be met before they will grant a loan to a borrower.
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Answer the following question with T for true or F for false for more practice with key terms and concepts from this chapter. A credit-default swap is a derivative financial instrument that gives only the original lender of the underlying loan the right to payment if the borrower defaults on repayments.
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Answer the following question with T for true or F for false for more practice with key terms and concepts from this chapter. Although the SEC Complaint (June 4, 2009) alleged that Countrywide's description of prime nonconforming and nonprime loans in its 10-K filings was misleading, Countrywide's 10-K filings did reveal that its delinquencies on its pay-option ARM loans were increasing much more rapidly than its allowance for loan losses on all of its loans held for investment.
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Fill in the blank with information and concepts from this chapter. A bubble refers to an inflated price for an asset that is not supported by the ___________ of the asset.
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Fill in the blank with information and concepts from this chapter. Loans that adhered to strict underwriting criteria that were required for the loans to be sold to the GSEs were known as "GSE ___________ loans."
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Answer the following question with T for true or F for false for more practice with key terms and concepts from this chapter. The housing boom was caused by mortgage lenders demanding large down payments from home buyers.
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Fill in the blank with information and concepts from this chapter. Tranching is a process of carving up or separating a pool of mortgages into different classes of securities that absorb different ___________ losses.
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Fill in the blank with information and concepts from this chapter. The Glass-Steagall Act of 1933 ___________ commercial banking from investment banking to prevent consumers' deposits from being used in risky investment banking activities such as trading in securities.
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Fill in the blank with information and concepts from this chapter. Before the passage of the Secondary Mortgage Market Enhancement Act of 1984, there were regulations that prohibited ___________ investors from investing in mortgage-backed securities that were not backed by GSEs.
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Answer the following question with T for true or F for false for more practice with key terms and concepts from this chapter. Pooling a number of loans and selling interests in those loans to investors as securities is known as tranching.
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Answer the following question with T for true or F for false for more practice with key terms and concepts from this chapter. The 80/20 loan is a mortgage loan whereby the borrower takes out a loan for 80 percent of the purchase price and a second loan for 20 percent of the purchase price, leaving the borrower with no equity in the house at the time of the loan.
True False