Nara shares fall as auditor opts out.

Earlier this month, when Nara Bancorp Inc. announced the resignation of its auditor, Deloitte & Touche LLP, investors panicked.

Nara's share price fell by 6 percent on Sept. 17. One Wall Street analyst downgraded the company's stock, and more than 6 million Nara shares traded hands over a five-day period, as much as 10 times the stock's average volume.

"I was shocked," said Benjamin Hong, Nara Bancorp's president and chief executive. "There was a panic because the markets thought there must be something wrong."

It turned out to be a false alarm. Nara was simply a victim of the latest accounting issue: workloads.

The problem is caused by Section 404 of the 2002 Sarbanes-Oxley Act, which requires auditors to conduct a review of a company's internal controls before signing off on its books.

For most public companies, the requirement will come into effect at the end of this year, and it's causing consternation among auditors.

The problem is Section 404 review is time-consuming, not to mention expensive. Big 4 auditing firms are beginning to drop clients rather than absorb the expense.

"The larger firms, the Big 4, are facing some resource allocation issues because of Section 404, and they are signaling that their larger clients are more strategically important," said Kevin McGrath, managing executive of the financial institutions practice at Indianapolis-based Crowe Chizek & Co., the nation's eighth-largest auditing firm.

Sell first, ask later

When an auditor resigns from an account, investors tend to sell first and ask questions later.

So as shares of Nara continued their freefall last week, Hong took action. He wrote a letter to shareholders and customers explaining that the resignation of Deloitte had "nothing to do with the integrity of Nara Bancorp's financial statements or any disagreement with Deloitte."

Hong said Deloitte and other Big 4 accounting firms are dropping many of their small, less profitable clients as a result of Section 404.

He cited testimony given to a Senate banking committee on Sept. 9 by James Turley, chief executive of Ernst & Young LLP.

"In addition to the impact of tougher client acceptance and retention practices, all the larger firms are resigning from significant amounts of work in order to make available resources to do the necessary audit work in a quality manner," Turley said. "Even with that, the demands on our people are intense."

Nara quickly hired Crowe Chizek, which has a niche serving financial institutions. The move restored confidence in the bank, but it took a few days for the market to absorb the information.

Nara shares have since recovered, to $18.96 as of Sept. 22, after falling as low as $16.34 on Sept. 17. Two analysts have upgraded the stock, citing its lower price.

"Nara is a high-growth, high valuation company, and an auditor resignation was unanticipated by the market," said Brett Rabatin, an analyst at FTN Midwest Research, a unit of First Horizon Corp. "It surprised everyone."

One indicator of the changed environment is that Crowe Chizek conducted an initial examination of Nara Bank before signing on as a new client. Like other publicly traded firms whose fiscal year ends Dec. 31, Nara must meet the Section 404 deadline in its audited annual results to be reported early next year.

"The next three months marks the period of adjustment and auditors have to provide an opinion on that," said Hong. "If they were not confident of that time line, they would not have taken us on."

Nara has been a strong-performing local bank with a broad strategy to expand its presence to Korean-American communities throughout the United States. It has added branches in Northern California and New York, and is also benefiting from increases in small business lending.

Rabatin believes Nara's earnings "will be impressive" over the next year. He expects loan growth of 16 percent to 20 percent.

Though its stock is not cheap, Nara and other Korean-American banks in Los Angeles have traditionally traded at a high premium. Like ethnic Chinese banks, they are efficiently run and locked into a growing, entrepreneurial demographic that institutional investors have "discovered" over the past several years.

If Nara is any example, Wall Street should be bracing for even more shocks, not just in the form of accounting firm resignations.

Auditors estimate that 15 percent to 20 percent of public companies may be forced to admit deficiencies in their internal controls, as defined by Section 404 of Sarbanes-Oxley.

The regulations, which were passed by Congress in the wake of the Enron scandal, require that public companies set up their own internal controls over financial reporting. Those systems must then be tested and documented by an outside auditor.

Wall Street may be unprepared for the number of companies that may fail the Section 404 test, according to Turley's testimony.

"It appears there is the potential for many more material weaknesses to be reported and adverse opinions issued than perhaps anyone imagined," Turley said. "For most companies, this will be the first time that internal controls have been scrutinized to the degree that 404 and the resulting SEC rules and PCAOB standards require."

The Public Company Accounting Oversight Board is a private, non-profit group created by Sarbanes-Oxley legislation to oversee the auditors of public companies and protect the public interest.

Nara Bancorp Inc.

YEAR (Dec. 31)                     2003     2002

Revenue (millions)                $61.4    $48.6
Loan Loss Provision (millions)      5.4      2.7
Operating Income (millions)        40.1     32.4
Net Income (millions)              14.3     15.5
Earnings Per Share                $0.62    $0.67

SUMMARY

Business: Commercial banking
Headquarters: Los Angeles
CEO: Benjamin Hong
Market Cap: $440 million Dividend Yield: 0.6%
Total Assets: $1.4 billion P/E Ratio: 27.8