June 24 (Bloomberg) -- Citigroup Inc. suspended loan applications at a unit that produced half of its $115 billion in mortgages last year after a review found that some property appraisals and income-verification documents were missing.

The correspondent division, which buys loans from banks and independent mortgage firms, stopped accepting new loans at 5 p.m. yesterday and will restart July 6, Citigroup said in a June 22 letter to clients. The New York-based company said it will use the time to change procedures and fix the omissions.

“There remain key areas that fall short of our quality- control process,” according to the letter, signed by Brad Brunts, a managing director at the bank’s CitiMortgage division. “We ask you to review your processes and join us in this effort to collectively address these areas of concern.”

Citigroup has been overhauling its mortgage business since January, when Chief Executive Officer Vikram Pandit shifted it into a “non-core” group called Citi Holdings along with other businesses tagged for sale, wind-down or restructuring. The bank lost a record $28 billion in 2008, much of it tied to mortgage- bond writedowns and costs to cover soured home loans amid the global credit crunch.

The bank accepted $45 billion of bailout funds from the U.S. Treasury and has increased employees’ pay to keep them from leaving. Citigroup will raise base salaries by as much as 50 percent to help compensate for a reduction in annual bonuses, a person familiar with the plan said yesterday.

Home Sales

The bank climbed 1.7 percent to $3.06 as of 10:32 a.m. in New York Stock Exchange composite trading today; the shares have tumbled more than 90 percent since the end of 2006. New-home purchases dropped 0.6 percent in May and the median sales price declined 3.4 percent, the Commerce Department said today.

The new procedures in the correspondent unit follow a series of steps Citigroup’s mortgage business took over the past two years to address lapses in documentation or underwriting standards. The business is run by Sanjiv Das, who reports to Citi Holdings CEO Mike Corbat.

In October, Citigroup cut off all but 1,000 of the 9,500 mortgage brokers in its network for selling the bank loans of poor quality, or in insufficient volume to be profitable. The company also stopped making second-lien mortgages through third parties. Regulators blamed practices at independent lenders last year for driving mortgage default rates to record highs.

Quality Control

Mark Rodgers, a spokesman for the bank, confirmed the suspension, adding that quality-control practices at the correspondent unit are reviewed on an “ongoing basis, and we have identified areas of improvement.” He declined to comment on the timing or specifics of the review, or to say how many loans had missing documentation. As of Dec. 31, the bank had $73 billion of mortgages on its books that had been originated through the correspondent channel.

Loan purchases already in the works will continue, according to the letter to clients.

According to the June 22 letter, the review identified “valuation concerns” where “appraisal documentation is missing or incomplete,” or where property-assessment methods were “insufficient/lacking.”

Other missing information included employment confirmations, phone numbers, credit reports and rent verification, the letter said. The review also found “income calculation errors.”

No Tolerance

The suspension of correspondent lending is “a bold step” that may frustrate Citigroup’s mortgage-banking partners and put them on notice that the company will no longer tolerate incomplete loan submissions, said David Lykken, managing partner at consultant Mortgage Banking Solutions in Austin, Texas.

“You need to have a hard stop,” Lykken said. “It is better to pull people off the line, and have a thorough re- education of what goes into a loan, so they can come back and do this the right way.”

Independent mortgage bankers trying to unload their loans during the suspension will have to turn to Citigroup’s competitors, Lykken said.

The correspondent unit was Citigroup’s biggest producer of mortgages last year with $58.5 billion of originations, according to industry publication Inside Mortgage Finance. Other channels include retail -- where the bank deals directly with borrowers through branches or call centers -- and the network of mortgage brokers.

Bank Rankings

JPMorgan Chase & Co. was the biggest correspondent lender last year with $98.7 billion of originations, followed by Wells Fargo & Co. with $80.5 billion and Countrywide Financial Corp. with $59 billion, according to Inside Mortgage Finance. Bank of America Corp., which bought Countrywide last year, ranked fifth with $40.6 billion.

Even before Pandit moved the mortgage business into Citi Holdings, Citigroup had determined that loans coming from the correspondent channel had higher delinquency rates than those from retail, according to the bank’s 2008 annual report, filed in February. The bank later terminated “an undisclosed number of correspondent mortgage banks,” the annual report said.

The letter said the bank remains “committed” to the correspondent business and wants to “continue to be a long-term recognized industry investor.”

The latter statement may address industry speculation that Citigroup will exit the mortgage business, which was kindled by Pandit’s decision to shift it to Citi Holdings, Lykken said.

“This is a positive sign of Citi’s commitment to correspondent channel,” Lykken said. “They want to improve their process, so they can remain an active player.”

Curbing Buybacks

The documentation improvements may reduce the number of bad mortgages Citigroup forces its customers to buy back, said Scott Stern, CEO of mortgage-banking cooperative Lenders One in St. Louis. Most mortgages are sold with warranties guaranteeing their performance.

“If the end result of these actions is a faster loan- acquisition process and fewer loan repurchases for mortgage companies, it will definitely have been a good decision,” Stern said.

To contact the reporters on this story: Josh Fineman in New York at jfineman@bloomberg.netBradley Keoun in New York at bkeoun@bloomberg.net.

Last Updated: June 24, 2009 10:52 EDT