Dec. 2 (Bloomberg) -- The more we learn about the mortgage industry’s documentation snafus, the more troubling hints we get that the financial statements of some of our biggest banks may be less reliable than anyone imagined.
Here’s the latest: Thanks to a Nov. 16 court ruling in Camden, New Jersey, we now know that a Bank of America Corp. employee, Linda DeMartini, testified last year that the lender routinely retained possession of mortgage promissory notes and related documents, even after loans were packaged into bonds that were sold to investors. If we’re to believe what she said, it raises the prospect that some of those loans still should be on Bank of America’s balance sheet today.
Contracts for such securitizations usually require the documents to be transferred to the trustee for mortgage bondholders, as Bloomberg News noted in a Nov. 30 article on DeMartini’s testimony. If the papers weren’t delivered properly, that tees up the question of whether any loan transfers were improperly treated as sales for accounting purposes, and whether the bank’s assets and liabilities may be understated.
DeMartini’s statements also place Bank of America’s outside auditor, PricewaterhouseCoopers LLP, in a tough spot. The firm has no choice now under U.S. auditing standards but to find out definitively if what DeMartini said is correct, and whether the answer would affect any of its prior audit conclusions. PwC billed Bank of America $128 million for its audit and other services last year. The mortgage at issue in the court ruling was originated in 2006 by Countrywide Financial, which Bank of America bought in 2008.
Bank of America is disavowing DeMartini’s testimony, which isn’t surprising considering the stakes. The bank’s P.R. office says DeMartini, a team leader in the lender’s mortgage-litigation management department, had no idea what she was talking about and wasn’t in the right job to know the correct facts, even though the company flew her in from California to testify as its witness. The company also says its local New Jersey attorneys botched the court case.
“The testimony is just wrong,” said Laurence Platt, an attorney at K&L Gates LLP in Washington, whom the bank designated to field questions about the case. “Countrywide’s policy and practice has been and remains to fully comply with the pooling and servicing agreements, including forwarding any necessary documents to the trustee.”
A Bank of America spokesman, Jerry Dubrowski, declined to answer questions about PwC, but said it was premature to speculate on the need for any accounting reviews. A PwC spokesman, Steven Silber, declined to comment. Countrywide’s financial filings show the company sold more than $1 trillion of loans from 2005 to 2007, primarily in the form of securities.
The last thing investors need now, of course, is a new reason to worry about a too-big-to-fail bank’s accounting. The company’s regulators would have every incentive to keep any serious problems from coming to public light, for fear of destabilizing the financial markets. PwC and the other major accounting firms haven’t exactly covered themselves in glory, either, since the financial crisis began in 2007.
What Bank of America can’t do is take back DeMartini’s words. During an August 2009 hearing, U.S. Bankruptcy Judge Judith Wizmur asked DeMartini whether the mortgage notes were “ever moved to follow the transfer of ownership,” according to a transcript released last week. Wizmur was presiding over a suit filed against Countrywide in 2008 by a debtor, John T. Kemp, as part of his Chapter 13 bankruptcy proceedings.
DeMartini replied: “I can’t say that they’re never moved because, I mean, with this many millions of loans as we have I wouldn’t presume to say that, but it is not customary for them to move.” Bank of America’s attorney at the hearing backed up her account, saying the notes weren’t moved in part because of the risk of losing them.
At one point DeMartini told Wizmur she wouldn’t be comfortable testifying about the extent to which notes were moved. She didn’t back off her statement about what was customary, though. DeMartini, who remains an employee, declined to comment.
The possibility that mortgage irregularities might point to accounting errors has received little public attention, compared with the robo-signer foreclosure scandal and mortgage-bond investors’ refund demands.
Generally speaking, for the transfer of a financial asset to qualify as a sale for accounting purposes, there must be a true sale at law. Otherwise, the transaction may have to be treated as a secured borrowing. One condition for sale treatment is that the party receiving the asset must have the right to pledge or exchange it. If the purchaser never received all the necessary paperwork, it might not have gained those rights or the ability to control the asset.
As for the New Jersey case, Judge Wizmur rejected a claim on Kemp’s home, ruling that Countrywide, which serviced his mortgage, failed to transfer the note to the trustee, as required by the Countrywide securitization contract covering his loan. DeMartini, who joined Countrywide about 10 years ago, testified that Kemp’s note never left the company’s possession.
If all this really was some kind of a mistake, it’s a doozy. This much is clear: The judge believed her.
(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)
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