Moody's "underestimated liquidity pressure

Moody's "underestimated liquidity pressure


Why Wasn't NCFE's Collapse Predicted Sooner?
Seth Lubove, 11.21.02, 12:30 PM ET

The implosion and bankruptcy of National Century Financial Enterprises has unleashed the predictable media constabulary and FBI raid typical of the post-Enron reaction to business failures. "Health care scandal intensifies," wailed USA Today. "Ohio Firm's Woes Ripple Across Health Care Business," intoned The New York Times.

But the real story is why anyone is so surprised at the failure of Dublin, Ohio-based NCFE, which purchased health care receivables and packaged them into asset-backed securities for investors. As we discovered when we broke the story in October about NCFE's curious business dealings, the company's legal entanglements and ownership stakes in its clients were easy to find in SEC filings, lawsuits and other public documents (see "Risky Business"). After that story ran, the fallout has been swift, including a downgrading of ratings on NCFE's outstanding bonds (see "Heal Thyself").

The firm's shaky finances were an open secret in the small community of health care receivables specialists, several of whom were eager to talk--on background, of course--about their fears that NCFE was a train wreck waiting to happen. Yet it wasn't until Moody's Investor Service issued a sweeping downgrade of NCFE's paper on Oct. 25 that the business collapsed, leaving bondholders stuck with $3.4 billion in paper that is likely to be worth far less than they paid for it. New York-based financial services firm Ambac Financial Group (nyse: ABK - news - people ) has already announced a $79.4 million hit from the fiasco, while several of NCFE's clients have filed for bankruptcy protection.

Consider it the price of ignorance. For instance, much has been made of the revelation that NCFE's owners owned stakes in the company's clients, a potential conflict of interest if NCFE was propping up favored companies at the expense of others. Although no one has yet proved there was anything illegal about the less-than-arm's-length relationships, you can't accuse NCFE of trying to cover it up, at least so far as the stakes in public companies were concerned.

The most recent proxy statement from NCFE borrower Med Diversified (otc: MDDV - news - people ), for example, clearly lists the shares owned by NCFE co-founder Lance Poulsen, his wife and various other NCFE executives, as well as NCFE itself. Med Diversified, an Andover, Mass., home health care provider, has since turned around and launched a $1 billion lawsuit against NCFE, along with bond trustees J.P. Morgan Chase (nyse: JPM - news - people ) and Bank One (nyse: ONE - news - people ).

The latest 10-K for Rx Medical Services, another NCFE client, notes that because NCFE executives own stakes in it, Rx categorizes NCFE "as a related party" due to its "stock ownership in and its ability to exercise control over the operations of the Company."

Some help. Rx, a Fort Lauderdale, Fla., hospital management outfit, recently announced that "more likely than not" it will end up filing for Chapter 11 due to NCFE's troubles.

NCFE's legal problems were also easy to find with a simple search on the Internet, where a nasty shareholder lawsuit involving NCFE and Dr. Steven Scott of PhyAmerica Physician Group, a Durham, N.C., medical staffing firm, could be downloaded for $34.95 from LegalCaseDocs.com. In the lawsuit, which was settled last year for $4.7 million paid to the shareholders, NCFE was accused of "skimming substantial amounts of money" from PhyAmerica, among other mischief.

In addition, the U.S. attorney's office for the District of Maryland helpfully posts an announcement from last March of a temporary restraining order slapped against subsidiaries of NCFE that prevents the firm from taking over the receivables of a bankrupt nursing home.

And yet until its Oct. 25 bombshell, Moody's gave NCFE a clean bill of health, even offering up an affirmation of its ratings in August in response to "inquiries from investors who have expressed concern about the performance of the receivables." Perhaps those investors were sweating after an earlier ratings downgrade in July from Fitch Ratings, which noted "marked increases in the level of defaulted and rejected receivables."

By the time Moody's finally laid into NCFE with "concerns about NCFE's financial stability," it was too late for any of the bondholders, much less the NCFE customers that have tumbled into bankruptcy themselves.

"Hindsight is 20/20," says Jay Eisbruck, a Moody's senior vice president who evaluates NCFE's paper. He says the firm had signed off on NCFE's existing ratings during the summer after meeting with the company, and saw "little change" in "the performance data that the company had provided to us all along."

But it turns out that the numbers Moody's was looking at may have been questionable in the first place. "I guess there are investigations going on now to see what really is the true nature of the receivables," says Eisbruck, who acknowledged in an Oct. 30 conference call that Moody's "underestimated liquidity pressure NCFE faced."

Small comfort for investors.


More From Forbes
Heal Thyself 12.09.02
Since last month's Forbes story on National Century Financial Enterprises, Moody's and Fitch have slashed their ratings on its outstanding bonds and its chairman has resigned.

Health Care Financier's Bitter Pill 10.30.02
Ratings are cut on National Century's asset-backed securities following a Forbes story.

Risky Business 10.28.02
As a financier of last resort to the health care industry, National Century Financial Enterprises has made its owners rich, but not without controversy.