As Vikram Pandit celebrates his first full-year profit as head of Citigroup Inc., an old nemesis clouds the bank’s future: defective mortgages.
Three years after bad home loans helped trigger the recession and six weeks after the government cashed in the last of its $45 billion Citigroup investment, the New York-based bank is still selling mortgages that violate quality standards, according to an internal Freddie Mac review obtained by Bloomberg.
Fifteen percent of the performing loans Citigroup sold to the government-owned mortgage-finance company in the second half of 2009 and the first half of 2010 had such flaws as missing appraisals or insurance documents or income miscalculations, according to the review of 375 mortgages. The target for defects should be about 5 percent, said Tim Rood, a former executive with Freddie’s sister agency, Fannie Mae, and now managing director at Washington-based advisory firm Collingwood Group LLC.
Pandit, Citigroup’s chief executive officer since December 2007, faces $100 million in payouts on the loans if customers demand refunds for mortgages that stop paying, according to Paul J. Miller of FBR Capital Markets in Arlington, Virginia. Miller based his estimate on the numbers in the Freddie Mac memo. Underwriting gaps that led to failed mortgages contributed to $83.7 billion in credit losses since 2007 for Citigroup and to the government takeover of the mortgage-finance business.
“What you hear from the banks is it’s overwhelmingly mortgages that were originated in ‘05, ‘06, ‘07 and a bit into ’08 that are getting put back to the banks,” said Chris Kotowski, an analyst for New York-based Oppenheimer & Co. “In 2010, if Freddie still finds 15 percent of performing mortgages had flaws, that’s a surprising statistic. I assume thoughtful investors will be surprised.”
Payouts totaling $100 million would represent about a third of a cent per share for the bank. Freddie Mac’s findings suggest “that Citigroup is having significant problems with internal systems and controls” in its mortgage pipeline, said Christopher Whalen of Torrance, California-based Institutional Risk Analytics.
Sanjiv Das, New York-based chief executive officer of CitiMortgage Inc., the Citigroup unit that originates loans and buys them from smaller lenders, declined to comment on the Freddie Mac findings. He said the bank’s own quality control reviews show an improvement in underwriting that “is one of the most outstanding stories in our business.” Freddie Mac has no published standard for defect levels.
“My own information based on our defect rates tells me we are doing a fantastic job,” Das said.
Pandit did not return a telephone call to his office requesting comment for this story.
Citigroup’s net income in the fourth quarter was $1.31 billion, or 4 cents a share, compared with a $7.58 billion loss, or 33 cents, in the same period in 2009, the bank said today. Eight analysts had predicted in a Bloomberg survey that Citigroup would report 7 cents profit per share. It marks the first full-year profit for the bank since 2006. Shares have risen 46 percent in the last year through Jan. 14.
In Freddie Mac’s review of Citigroup’s performing loans -- those on which borrowers were still paying -- the portion rated as “Not Acceptable Quality” fell to 9 percent in the third quarter’s sample from 32 percent in the fourth quarter of 2009, according to the Freddie Mac memo. The average defect rate in the 12 months through Sept. 30 was 15 percent.
“The percentage of acceptable quality loans should be in the high 90s,” said D. Keith Johnson, former president of Shelton, Connecticut-based Clayton Holdings LLC, which evaluates mortgage quality. “There’s a strategic process flaw. How can a report that shows exception rates this high not cause concerns?”
Mortgages reviewed in the third quarter were underwritten between February and May of 2010, according to the memo. Among the defects listed for them: a missing appraisal, missing documentation to verify payment on deferred student loans and missing proof of flood insurance. Two loans were deficient because of their “eligibility,” according to the memo: One where the “maximum loan amount was exceeded,” and another that was underwritten as a regular refinancing when in fact it was a “construction to permanent financing loan.”
Mortgage buyers such as McLean, Virginia-based Freddie Mac, which packages the loans into securities for sale to investors, can ask for their money back if they find that Citigroup or other originators sold them mortgages that failed to meet underwriting standards.
Citigroup sold $15.5 billion in mortgages to Freddie Mac and $31 billion to Fannie Mae last year, according to Inside Mortgage Finance, an industry newsletter based in Bethesda, Maryland.
Brad German, a Freddie Mac spokesman, declined to comment on how many of the defects cited in the review might lead to repurchase requests or how Citigroup’s results compared with other lenders.
“I would expect Citi as far as performance would be in the middle of the pack,” said Chris Gamaitoni, vice president of Compass Point Research & Trading LLC in Washington, who has tracked buyback claims. “I wouldn’t see them as being unusual.”
On Jan. 3, Bank of America Corp., the biggest U.S. lender, announced it paid $1.28 billion to Freddie Mac to extinguish $1 billion of repurchase requests. The agreement also covered all outstanding and potential buyback claims on $127 billion in loans sold by Countrywide Financial Corp., now owned by Bank of America, the Charlotte, North Carolina-based lender said in a presentation on its website.
The bank said it also paid $1.52 billion to Fannie Mae to settle disputes on $3.1 billion in loans, or about 49 cents on the dollar.
In a Jan. 7 letter, four Democratic members of Congress asked the Federal Housing Finance Agency, the agency that oversees Freddie Mac, for “detailed information” on how the settlement with Bank of America “represented the best possible recovery of funds available to taxpayers.”
“We should be paying attention to how FHFA treats claims Fannie and Freddie have that reduce taxpayer liability and are pursuing claims as aggressively as they can to limit taxpayer exposure,” Representative Brad Miller of North Carolina, who signed the letter, said in a phone interview.
Citigroup should expect to reimburse buyers between $2.2 billion and $4.3 billion for defective mortgages originated from 2005 to 2008, according to an Oct. 26 report by Credit Suisse Group AG analysts Moshe Orenbuch and Jill Glaser. Up to $1.9 billion of that will be for loans bought by government-sponsored enterprises such as Freddie Mac and Fannie Mae, they said.
Banks also face putback claims from insurers and investors.
Citigroup was the fourth-largest U.S. lender in 2006 to subprime borrowers, according to Inside Mortgage Finance. After housing prices quit rising that year, delinquencies among such borrowers, who have bad or incomplete credit histories, more than doubled by 2009, according to the Washington-based Mortgage Bankers Association.
Citigroup received $45 billion in investments from the U.S. government in 2008 and $301 billion in asset guarantees, making the bank the biggest recipient of U.S. taxpayer bailout support. The investment has been paid back and the guarantees canceled. Last week, the government, which still owns warrants to buy 465 million of the bank’s shares, announced a plan to auction them off before the end of March.
Plans for Freddie Mac
Freddie Mac, created by Congress to boost U.S. homeownership by buying mortgages, was seized in September 2008 because of increasing loan-related losses. The U.S. government retains a 79.9 percent share of the company. The Treasury Department will announce plans for the mortgage finance company this month.
Freddie Mac has posted five straight quarterly losses and has received $63 billion in aid from the U.S. since September 2008. Freddie and Fannie Mae, which the government also seized, have gotten more than $148 billion in taxpayer aid and returned $14.6 billion in dividends.
“Freddie seems like they’re being more vigilant about nipping problems in the bud with recent vintage loans,” said Robert M. Siegel, a partner with Miami-based Bilzin Sumberg Baena Price & Axelrod LLP who represents smaller lenders in buyback litigation.
Citigroup said it set aside $952 million as of Sept. 30 to cover buybacks, up from $295 million a year earlier, according to the bank’s regulatory filings.
Repurchase requests from Citigroup mortgage buyers increased to 2,054 in the third quarter from 1,779 claims in the third quarter of 2009, Citigroup filings show.
Citigroup was the sixth-largest seller of home loans to Freddie Mac in 2010, behind San Francisco-based Wells Fargo & Co., Bank of America, New York-based JPMorgan Chase & Co., Minneapolis-based US Bancorp and Ally Financial Inc., based in Detroit, according to Inside Mortgage Finance.